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1

On December 31, 2005, Grey, Inc. owned 90% of Winn Corp., a consolidated subsidiary, and 20% of Carr Corp., an investee in which Grey cannot exercise significant influence. On the same date, Grey had receivables of $300,000 from Winn and $200,000 from Carr.
In its December 31, 2005, consolidated balance sheet, Grey should report accounts receivable from affiliates of:

A. $500,000
B. $340,000
C. $230,000
D. $200,000

D. $200,000

A 90% owned subsidiary will be consolidated, and any intercompany receivables such as these are eliminated from both parties' books in the consolidating process.

Therefore, the $300,000 receivable from Winn will not appear on the consolidated balance sheet at all. The $200,000 from Carr is a receivable from an affiliate (20% owned) and will need to be reported as such.

2

Which of the following kinds of transactions should be eliminated in the consolidating process?

Parent to Subsidiary Subsidiary to Parent Subsidiary 1 Subsidiary 2
Yes Yes Yes
Yes Yes No
Yes No No
No Yes Yes

Parent to Subsidiary Subsidiary to Parent Subsidiary 1 Subsidiary 2
Yes Yes Yes

3

Which one of the following is not a characteristic associated with intercompany transactions?
A. Intercompany transactions must be eliminated in the consolidating process.
B. Gains and losses must be eliminated in the consolidating process.
C. Transactions that originate with a subsidiary must be eliminated in the consolidating process.
D. Transactions between two subsidiaries to be consolidated with the same parent do not need to be eliminated.

D. Transactions between two subsidiaries to be consolidated with the same parent do not need to be eliminated.

Intercompany transactions (i.e., transactions between affiliated firms) must be eliminated regardless of whether the transactions are between the parent and its subsidiaries or between two subsidiaries of the same parent.

4

Bell, Inc. owns 60% of Dart Corporation's common stock. On December 31, 20X6, Dart is indebted to Bell for a $200,000 cash advance. In preparing the consolidated balance sheet on that date, what amount of the advance should be eliminated?
A. $-0-
B. $80,000
C. $120,000
D. $200,000

D. $200,000
The amount to be eliminated is $200,000, which is the full amount of the intercompany receivable-payable resulting from the cash advance.

5

Which one of the following will occur on consolidated financial statements if an intercompany inventory transaction is not eliminated?
A. An understatement of sales.
B. An overstatement of sales.
C. An understatement of purchases.
D. An overstatement of accounts receivable.

B. An overstatement of sales.

6

Which of the following can be overstated on consolidated financial statements if intercompany inventory balances on-hand at the end of a period are not eliminated?

Consolidated Income Consolidated Loss
Yes Yes
Yes No
No Yes
No No

Consolidated Income Consolidated Loss
Yes Yes

7

Assume that on January 2, Company P recognized a $3,000 gain on the sale of a depreciable fixed asset to its subsidiary, Company S. Company S will depreciate the asset using straight-line depreciation over the remaining three-year life of the asset. What amount of intercompany gain will be eliminated from P's retained earnings at the end of the year following the year of the intercompany fixed asset transactions?
A. $- 0 -
B. $1,000
C. $2,000
D. $3,000

C. $2,000
The amount of intercompany gain to be eliminated at the end of the year following the year of the intercompany fixed asset sale is $2,000. At the end of the year of the intercompany sale, depreciation taken by the buying affiliate on the $3,000 inter-company gain will be $1,000 ($3,000/3 years). As a consequence, $1,000 of the $3,000 intercompany gain will have been properly recognized, leaving only $2,000 to eliminate at the end of the second year. Depreciation expense taken on the intercompany gain for the second year will confirm another $1,000 of the intercompany gain, and depreciation expense taken on the intercompany gain for the third year will confirm the last $1,000 of the intercompany gain.

8

Scroll, Inc., a wholly owned subsidiary of Pirn, Inc., began operations on January 1, 2005. The following information is from the condensed 2005 income statements of Pirn and Scroll:
Pirn Scroll
Sale to Scroll $100,000 $-
Sales to others 400,000 300,000
500,000 300,000
Cost of goods sold:
Acquired from Pirn - 80,000
Acquired from others 350,000 190,000
Gross profit 150,000 30,000
Depreciation 40,000 10,000
Other expenses 60,000 15,000
Income from operations 50,000 5,000
Gain on sale of equipment to Scroll 12,000 -
Income before income taxes $38,000 $5,000
Additional information:
Sales by Pirn to Scroll are made on the same terms as those made to third parties.
Equipment purchased by Scroll from Pirn for $36,000 on January 1, 2005, is depreciated using the straight-line method over four years.
What amount should be reported as depreciation expense in Pirn's 2005 consolidated income statement?

A. $50,000
B. $47,000
C. $44,000
D. $41,000

B. $47,000
The gain on the equipment sold to Scroll must be eliminated, since it was not sold outside the consolidated entity. With the elimination of the gain, one must also eliminate the depreciation of the gain that Scroll would have been booking (based on their higher purchase price). This excess depreciation is $3,000 a year ($12,000 gain/4 years).
This would reduce the total consolidated depreciation from $50,000 ($40,000+$10,000) to $47,000.

9

Water Co. owns 80% of the outstanding common stock of Fire Co. On December 31, 2005, Fire sold equipment to Water at a price in excess of Fire's carrying amount but less than its original cost. On a consolidated balance sheet on December 31, 2005, the carrying amount of the equipment should be reported at:
A. Water's original cost.
B. Fire's original cost.
C. Water's original cost less Fire's recorded gain.
D. Water's original cost less 80% of Fire's recorded gain.

C. Water's original cost less Fire's recorded gain.

10

For consolidated purposes, what effect will the intercompany sale of a fixed asset at a profit or at a loss have on depreciation expense recognized by the buying affiliate?
At a Profit At a Loss
Overstate Overstate
Overstate Understate
Understate Overstate
Understate Understate

Understate Overstate
An intercompany sale of a fixed asset at a profit will result in the buying affiliate overstating, not understating, depreciation expense by the amount of depreciation taken on the intercompany profit, and an intercompany sale at a loss will result in an understatement of depreciation expense taken by the buying affiliate, not an overstatement of depreciation expense. When an intercompany sale of a fixed asset results in a loss, the carrying value of the asset will be understated by the amount of the loss. As a result, depreciation expense taken by the buying affiliate will be understated by the amount of depreciation that would have been taken on the intercompany loss.

11

Zest Co. owns 100% of Cinn, Inc. On January 2, 1999, Zest sold equipment with an original cost of $80,000 and a carrying amount of $48,000 to Cinn for $72,000. Zest had been depreciating the equipment over a five-year period using straight-line depreciation with no residual value. Cinn is using straight-line depreciation over three years with no residual value. In Zest's December 31, 1999, consolidating worksheet, by what amount should depreciation expense be decreased?
A. $0
B. $8,000
C. $16,000

B. $8,000
There are two ways to approach this solution. First, take the difference in carrying values 72,000-48,000 = 24,000. The 24,000 is the incremental amount Cinn carries the equipment over the carrying amount of Zest. The 24,000/3 = 8,000
OR, compute the depreciation for each company:
Cinn is 72,000/3 = 24,000
Zest is 80,000/5 = 16,000

Since Cinn is 100% owned by Zest, the equipment cannot be depreciated by a greater amount through an intracompany sale. The difference is 24,000 - 16,000 = 8,000.

12

On December 31, 2008, Pico acquired $250,000 par value of the outstanding $1,000,000 bonds of its subsidiary, Sico, in the market for $200,000. At that date, Sico had a $100,000 premium on its total bond liability.

Assume each company maintains its premium or discount in a separate account. Which one of the following will be the intercompany bond elimination entry made on the December 31, 2008 consolidating worksheet?

A.
DR: Bonds Payable
Discount on Bond Investment
Loss on Constructive Retirement
CR: Investment in Bonds
Premium on Bonds Payable
B.
DR: Bonds Payable
Premium on Bonds Payable
CR: Investment in Bonds
Discount on Bond Investment
Gain on Constructive Retirement
C.
DR: Bonds Payable
Premium on Bonds Payable
Discount on Bond Investment
CR: Investment in Bonds
Gain on Constructive Retirement
D.
DR: Investment in Bonds
Gain on Constructive Retirement
CR: Bonds Payable
Premium on Bonds Payable
Discount on Bond Investment

C.
DR: Bonds Payable
Premium on Bonds Payable
Discount on Bond Investment
CR: Investment in Bonds
Gain on Constructive Retirement

the Premium on Bonds Payable $25,000 (a credit balance, so it will be debited) will be eliminated resulting in a Gain on Constructive Retirement of $75,000, a credit balance.

Therefore, the correct entry would be:
DR: Bonds Payable
Premium on Bonds Payable
Discount on Bond Investment
CR: Investment in Bonds
Gain on Constructive Retirement

13

On December 31, 2008, Pico acquired $250,000 par value of the outstanding $1,000,000 bonds of its subsidiary, Sico, in the market for $200,000. On that date, Sico had a $100,000 premium on its total bond liability.

Which one of the following is the net carrying value of Sico's total bond liability?

A. $900,000
B. $1,000,000
C. $1,050,000
D. $1,100,000

D. $1,100,000

14

On December 31, 2008, Pico acquired $250,000 par value of the outstanding $1,000,000 bonds of its subsidiary, Sico, in the market for $200,000. On that date, Sico had a $100,000 premium on its total bond liability.

Which one of the following is the net amount of gain or loss that will be recognized by Pico in its December 31, 2008, consolidated financial statements as a result of its intercompany bonds?

A. $25,000
B. $50,000
C. $75,000
D. $150,000

C. $75,000
In the elimination of intercompany bonds, the intercompany bond liability at par will be eliminated against the intercompany bond investment at par. Therefore, the gain or loss recognized as a result of constructive retirement of intercompany bonds is the net of the premium or discount on the bond liability and the premium or discount on the bond investment. In this case, there is a total $100,000 premium on the bond liability, but because only one-fourth ($250,000/$1,000,000 = 1/4) of the bonds are intercompany, only one fourth of the premium is eliminated. Thus, $25,000 of premium on the bond liability (a credit) will be eliminated against the $50,000 discount on the bond investment (also a credit). As a result of eliminating the two credits ($25,000 + $50,000 = $75,000), a $75,000 gain on constructive retirement will be recognized.

15

In which of the following cases will the elimination of intercompany bonds always result in a gain on constructive retirement?
Issuing Affiliate Has Buying Affiliate Has
Premium Premium
Premium Discount
Discount Premium
Discount Discount

Issuing Affiliate Has Premium

Buying Affiliate Has Discount

When the issuing affiliate has a premium on the bond liability and the buying affiliate has a discount on the bond investment, the elimination of the bond liability against the bond investment will result in a gain on constructive retirement. If the bonds are issued at a premium, the issuing firm received a greater amount for the bonds than face value. In addition, if the buying affiliate acquired the bonds at a discount, it paid less than face value for the bonds. Therefore, the elimination of the payable against the investment in the consolidating process must result in a gain on constructive retirement.

16

Assume Instco acquires an option to buy (a call option) 100 shares of Opco for $50 per share when the market price of Opco is $45 per share and that Instco paid a premium of $1.00 per share to acquire the options. Which one of the following is the underlying related to Instco's options?

A. 100 shares.
B. $1.00 per option.
C. $45.00 per option.
D. $50.00 per option.

D. $50.00 per option.

Underlying = strike price, or the price Instco will buy the stock at.

17

Smythe Co. invested $200 in a call option for 100 shares of Gin Co. $.50 par common stock, when the market price was $10 per share. The option expired in three months and had an exercise price of $9 per share. What was the intrinsic value of the call option at the time of initial investment?
A. $50
B. $100
C. $200
D. $900

B. $100
intrinsic value of a call option = (exercise (strike) price - market price) * # of shares (or notional amount).

18

Which one of the following is an item for which risk associated with the item cannot be hedged for accounting purposes?
A. Foreign currency risk of a net investment in a foreign operation.
B. Fair value of an investment accounted for using the equity method of accounting.
C. Credit risk of investments classified as held for trading.
D. Overall change in the fair value of a non-financial asset

A. Foreign currency risk of a net investment in a foreign operation.

The foreign currency risk associated with a net investment in a foreign operation (e.g., an investment in a foreign subsidiary) can be hedged for accounting purposes.

The fair value of an investment accounted for using the equity method of accounting cannot be hedged for accounting purposes.

19

Hedges of foreign currency risks can be the hedge of:

Fair Value Cash Flows
Yes Yes
Yes No
No Yes
No No

Fair Value Cash Flows
Yes Yes

20

Which one of the following is least likely to be a characteristic of a firm commitment?

A. It is evidenced by a contractual obligation.
B. It can be the hedged item in a fair value hedge.
C. It has been recorded as an asset or liability.
D. It is subject to the risk of change in fair value.

C. It has been recorded as an asset or liability.

A firm commitment has not been recorded (yet) as an asset or liability. A firm commitment occurs when an entity has a contractual obligation or contractual right, but no transaction has been recorded (and no asset or liability recognized) because GAAP requirements for recognition have not yet been met. Nevertheless, the subject matter of the firm commitment is at risk of change in fair value and can be hedged.

21

A derivative cannot be used as a fair value hedge for:

A. A recognized asset.
B. A recognized liability.
C. An unrecognized forecasted transaction.
D. An unrecognized firm commitment.

C. An unrecognized forecasted transaction.

For GAAP purposes, a derivative cannot be used to hedge the risk associated with an unrecognized forecasted transaction, primarily because, since the transaction is only "forecasted," there is no established fair value to hedge. A derivative can be used to hedge the risk associated with a recognized asset, recognized liability, or unrecognized firm commitment, but not an unrecognized forecasted transaction.

22

On October 1, 2008, Buyco entered into a legally enforceable contract to acquire raw material inventory in 180 days for $20,000. In order to mitigate the risk of a change in the value of the raw materials, Buyco also entered into a qualified 180-day forward contract to hedge the fair value of the raw materials. At December 31, 2008, the value of the raw materials had decreased by $500, and the fair value of the futures contract had increased by $480. On March 29, 2009, the date the raw materials were delivered to Buyco, they had a fair value of $19,300, and the forward contract had a fair value of $700. Which one of the following is the net gain or loss that would be recognized on the raw material and related forward contract by Buyco over the life of the contract?

A. $ -0-
B. $20
C. $220
D. $700

A. $ -0-
Because Buyco entered into the forward contract (hedging instrument) to hedge the risk of change in the fair value of the raw materials (hedged item), the change in the fair value of the forward contract over the life of the contract offsets the change in the fair value of the raw materials. Specifically, the decrease in the value of the raw materials, $700 ($20,000 - $19,300 = $700), was offset by the increase in the value of the forward contract of $700 (given), so the net gain recognized over the life of the contract was $700 - $700 = $-0-, which is the correct answer.

23

Which of the following statements concerning derivatives used as foreign currency hedges is/are correct?
I. Can be used to hedge the risk of exchange rate changes on planned transactions.

II. Can be used to hedge the risk of exchange rate changes on available-for-sale investments.

III. Can be used to hedge the risk of exchange rate changes on accounts receivable and accounts payable.

A. I only.
B. I and II only.
C. II and III only.
D. I, II, and III.

D. I, II, and III.

24

Which of the following, if any, can be the risk being hedged in a foreign currency hedge?
Fair Value Cash Flow
Yes Yes
Yes No
No Yes
No No

Fair Value Cash Flow
Yes Yes
Foreign currency hedges may be either fair value or cash flow hedges.

FV hedges:
unrecognized firm commitments, inv. in AFS securities, net inv. in foreign ops.

CF hedges:
foreign currency hedges of forecasted transactions are cash flow hedges.

Additionally, foreign currency hedges of recognized assets or liabilities may be treated either as FV or CF hedges.

25

Which of the following statements concerning disclosure requirements for derivatives used as cash flow hedges is/are correct?
I. The net gain or loss recognized in earnings during the period must be disclosed.

II. The amount of gain or loss deferred in other comprehensive income must be disclosed.

III. A listing of derivatives used for cash flow hedges and the amount of each must be disclosed.

A. I only.
B. I and II only.
C. I and III only.
D. I, II, and III.

B. I and II only.
Both the net gain or loss recognized in earnings during the period (Statement I) and the amount of gain or loss deferred in other comprehensive income (Statement II) must be disclosed. Statement III is not a required disclosure.

26

Which one of the following is not a required disclosure for derivatives used as fair value hedges?
A. The amount of net gain or loss recognized in earnings during the period.
B. The location in the financial statements where any gain or loss is reported.
When derivatives are used as fair value hedges, the location in the financial statements where any gain or loss is reported must be disclosed.
C. The net gain or loss in earnings from firm commitment hedges that no longer qualify for hedge treatment.
D. The amount of gain or loss arising during the period that was deferred.

D. The amount of gain or loss arising during the period that was deferred.
When derivatives are used for fair value hedges, the amount of gain or loss arising during the period that was deferred is not a required (or relevant) disclosure. When fair value hedges are used, any resulting gain or loss is recognized in current income, not deferred. CF hedge G/L is deferred in OCI.

27

Bigco, Inc. transferred long-term receivables with a carrying value of $500,000 and a fair value of $450,000 to Banco for $425,000 cash. Of the $450,000 fair value, $45,000 is attributable to collection of future fees and penalties, which Bigco will retain. The surrender of control requirements have been met, therefore the transfer qualifies as a sale. What amount of loss should Bigco recognize at the time of the transfer?
A. $ -0-
B. $25,000
C. $50,000
D. $75,000

B. $25,000
Bigco's loss is the difference between the carrying value of the portion of the asset transferred and the cash received for the transferred portion. In this case, the total carrying value of $500,000 must be allocated between the portion of the asset surrendered and the portion retained, based on relative fair values. The relative fair values are:
Amount Percent
Asset retained $ 45,000 10%
Asset transferred 405,000 __90_
Total fair value $450,000 100%
Therefore, the carrying value of the asset transferred is .90 x $500,000 = $450,000. The resulting loss is carrying value transferred $450,000 - cash received $425,000 = $25,000 loss.

28

Which one of the following is not associated with accounting for a transfer of a financial asset treated as a sale by the transferor?
A. Derecognizing the asset(s) sold.
B. Recognizing asset(s) obtained or liability(ies) incurred.
C. Measuring assets and liabilities at fair value.
D. Deferring any gain or loss in other comprehensive income.

D. Deferring any gain or loss in other comprehensive income.
Any gain or loss resulting from the transfer of financial assets would not be deferred in other comprehensive income (outside net income) by the transferor, but rather would be recognized in current income.

29

Which of the following statements concerning the transfer of financial assets that qualifies as a sale is/are correct?
I. The transferor may retain an interest in the asset transferred.

II. The transferor may recognize a gain or a loss on the transfer.

III. The transferor's proceeds are decreased by any liability it incurs in the transfer.

A. I only.
B. II only.
C. I and II only.
D. I, II, and III.

D. I, II, and III.
All three statements are correct. The transferor may retain an interest in the asset transferred (Statement I), the transferor may recognize a gain or loss on the transfer (Statement II), and the transferor's proceeds from the transfer are decreased by any liability incurred in the transfer (Statement III).

30

If the transfer of a financial asset does not meet the requirements of surrender of control by the transferor, how will it be treated by the transferor and by the transferee?
Transferor Transferee
Sale Purchase
Sale Secured Lending
Borrowing with Collateral Secured Lending
Borrowing with Collateral Purchase

Transferor Transferee
Sale Secured Lending
Borrowing with Collateral Secured Lending
If the transfer of the financial asset does not meet the requirements of surrender of control by the transferor, the transfer is a borrowing with collateral by the transferor and a secured lending by the transferee (not a sale and purchase, respectively).

31

Will a transferor have to allocate the carrying value of a financial asset when the transferor retains an interest in the transferred asset or when the transferor does not retain an interest in the transferred asset?
Allocate Carrying Value When:

Interest Retained No Interest Retained
Yes Yes
Yes No
No Yes
No No

Interest Retained No Interest Retained
Yes No
The transferor will have to allocate the carrying value of a financial asset when it is transferred and the transferor retains an interest in the asset, but allocation of the carrying value is not necessary when the transferor does not retain an interest in the asset. When no interest is retained, the full carrying value of the asset will be written off by the transferor.

32

A financial asset is transferred with one component of the asset appropriately treated as sold and another component appropriately treated as retained. How will the amount to be written off as sold be determined?
A. Write off the fair value of the component sold.
B. Write off a portion of the asset carrying value based on the relative fair values of the components.
C. Write off the portion of the asset carrying value left after deducting the fair value of the retained interest.
D. Write off the present value of the cash flows of the component sold.

B. Write off a portion of the asset carrying value based on the relative fair values of the components.

The carrying amount of the asset before the transfer will be allocated to the component sold and the component retained based on the relative fair values of the components at the date of the transfer. The portion of the carrying value allocated to the component sold will be written off.

33

Which of the following is not a characteristic associated with the servicing of financial assets?
A. The servicing function is inherent in all financial assets.
B. The right to service financial assets can result in either a separate asset or a separate liability.
C. If a servicing asset is retained as a component in a sale of a financial asset, the servicing asset is measured as a portion of the carrying value of the transferred asset.
D. If a servicing asset is acquired in the market, the servicing asset is measured at fair value.

C. If a servicing asset is retained as a component in a sale of a financial asset, the servicing asset is measured as a portion of the carrying value of the transferred asset.

When a servicing asset is retained as a component in a sale of a financial asset, the servicing asset is not measured as a portion of the carrying value of the transferred asset, but rather at fair value at the date of transfer of the financial asset.

34

Recognized servicing assets should be assessed for impairment and servicing liabilities should be assessed for understatement. In which of the following cases will an impairment loss be recognized?
A. Servicing asset with carrying value less than fair value.
When an asset has a carrying value less than fair value, there is no unrealized loss. If GAAP calls for the asset to be adjusted to fair value (e.g., investment held-for-trading), a gain would be recognized, not a loss.
B. Servicing asset with fair value greater than carrying value.
C. Servicing liability with carrying value less than fair value.
D. Servicing liability with fair value less than carrying value.

C. Servicing liability with carrying value less than fair value.

When a liability has a carrying value less than fair value, an unrealized loss exists. Adjusting the carrying value of the liability to the higher fair value will result in a loss; DR: Impairment Loss (+), CR: Liability (+).

35

On January 2, 20X8, Fiserveco acquired a five-year right to service mortgage contracts for which it paid $120,000. Fiserveco estimated that servicing and other fees would generate $400,000 over the five-year period. During 20X8 the contract generated $100,000 in revenues. Which one of the following is the amount of expense, if any, that Fiseerveco should recognize in 20X8 as amortization of its servicing asset?
A. $ -0-
B. $ 24,000
C. $ 30,000
D. $ 100,000

C. $ 30,000
Since Fiserveco acquired the servicing rights asset in the market, it should recognize a servicing asset at its fair value, which is the cost to Fiserveco in the market. Therefore, it should recognize an asset of $120,000 on January 2, 20X8. That servicing asset should be amortized each period over the life of the contract in the same proportion that period revenues have to expected total revenues. During 20X8, $100,000 of an expected $400,000 total revenues was earned. Therefore, $100,000/$400,000, or ¼ of the servicing asset should be amortized. One-fourth of $120,000 = $30,000, the correct answer.

36

Servco, a loan servicing agency, paid $60,000 to acquire a three-year right to service $1,000,000 of Banco's loans. Servco will be entitled to a servicing fee of 1% of the interest and fees collected during the three-year period. Servco expects its servicing fees to be:
Year 20X1 $40,000
Year 20X2 30,000
Year 20X3 10,000
Which one of the following is the amount of the $60,000 acquisition fee that Servco should amortize during year 1?
A. $ -0-
B. $20,000
C. $30,000
D. $40,000

C. $30,000
Servco would record the $60,000 as a servicing asset and would amortize it in proportion to and over the period of the estimated income. In this case, during year 20X1, $40,000 of the total $80,000 estimated income would be earned. Therefore, 50% of the servicing asset would be amortized in year 20X1. Thus, $60,000 x .50 = $30,000 amortization in year 20X1.

37

Assume a creditor releases a debtor from being primarily responsible for a liability because an unrelated third-party legally assumes the liability, with the original debtor becoming secondarily liable for the obligation. Which of the following statements is correct?
I. The original debtor's liability has been extinguished.

II. The original debtor became a guarantor of the liability.

III. The original debtor may recognize a gain or loss on its release from the obligation.

A. II only.
B. I and II only.
C. I and III only.
D. I, II, and III.

D. I, II, and III.
The original debtor's liability has been extinguished, the debtor has become a guarantor of the liability now held by a third-party, and the original debtor may recognize a gain or loss on its release from the obligation.

38

Sloco has a debt with a carrying value of $500,000 due to Topco. Because Topco is concerned about Sloco's on-going ability to meet its debt obligation, it has agreed to Sloco's proposal that Trico, an unrelated third-party, assume the debt, with Sloco becoming secondarily liable. Sloco will transfer to Trico equipment with a current fair value of $400,000 in exchange for Trico's assumption of its debt to Topco. Based on its objective assessment as to Trico's likelihood of satisfying the debt obligation, Sloco estimates the possibility of its secondary obligation for the debt has a fair value of $70,000.

What amount of gain or loss, if any, should Sloco recognize as a consequence of carrying out its arrangement with Topco and Trico?

A. $ -0-
B. $30,000
C. $100,000
D. $170,000

B. $30,000
Sloco would recognize a gain or loss as the difference between the carrying value of its debt and the fair value of consideration given to extinguish the debt, less any obligation incurred in the arrangement. Therefore, Sloco would write off the carrying value of its debt ($500,000) and the fair value of the equipment conveyed to Trico ($400,000) for a gross gain of $100,000. That gross gain would be reduced by the guarantor obligation it would recognize of $70,000. Thus, Sloco would recognize a net gain of $100,000 - $70,000 = $30,000.

39

Choose the correct statement regarding international accounting standards and U.S. standards as they relate to contingent liabilities and similar items.
A. All provisions under international accounting standards are contingent liabilities under U.S. standards.
B. Both sets of standards require discounting of estimated liabilities.
C. A possible obligation that requires a future event for confirmation is treated as a contingent liability under both sets of standards.
D. Both sets of standards are essentially the same with regard to recognition of contingent assets.

C. A possible obligation that requires a future event for confirmation is treated as a contingent liability under both sets of standards.

This is the one situation where both sets of standards agree with respect to classifying contingent liabilities. For international accounting standards, there are other situations calling for the reporting of a contingent liability.

40

Choose the correct statement about international accounting standards as they relate to contingent liabilities and similar items.
A. A provision that has a reasonably possible chance of requiring the outflow of benefits is treated as a contingent liability.
B. Provisions are recognized only when there is greater than a 90% probability of an outflow of benefits occurring.
C. A recognized provision is a contingent liability.
D. A provision for which it is probable that an outflow of benefits will be required is recognized, even if it is not of estimable amount.

A. A provision that has a reasonably possible chance of requiring the outflow of benefits is treated as a contingent liability.

A provision is a present obligation. This is one of the ways a liability can be treated as a contingent liability under international standards. If the provision involved a probable outflow, then it would be recognized, but would not be a contingent liability.

41

Which of the following is not a contingent liability under international accounting standards?
A. A provision with a 60% chance of requiring an outflow of benefits, amount is estimable.
B. A provision with a 40% chance of requiring an outflow of benefits, amount is estimable.
C. A provision with a 90% chance of requiring an outflow of benefits, amount not estimable.
D. A possible obligation.

A. A provision with a 60% chance of requiring an outflow of benefits, amount is estimable.

A probable (

42

Which of the following is a recognized liability for both international accounting standards and U.S. standards?
A. Regular warranty liability, 60% probability of occurring.
B. Obligation to provide rebates to customers, 90% probability of occurring.
C. Possible loss due to lawsuit, 60% probability of occurring.
D. Possible loss due to lawsuit, 40% probability of occurring.

B. Obligation to provide rebates to customers, 90% probability of occurring.

For international accounting standards, this is a recognized provision. For U.S. standards, it is a recognized contingent liability.

43

A firm considers its regular warranty liability to be an existing liability of uncertain amount. At year-end, the firm estimates that the amount required to extinguish its warranty liability in the future is in the range of $20 to $60 million, with no amount more likely than any other. Under the two sets of standards, what amount will be recognized?

International U.S.
40 40
40 20
20 20
0 40

International U.S.
40 20
International accounting standards recognize the midpoint, whereas U.S. standards recognize the low point.

44

Ian Co. is calculating earnings per share amounts for inclusion in the Ian's annual report to shareholders. Ian has obtained the following information from the controller's office as well as shareholder services:

Net income from January 1 to December 31 $125,000
Number of outstanding shares:
January 1 to March 31 15,000
April 1 to May 31 12,500
June 1 to December 31 17,000
In addition, Ian has issued 10,000 incentive stock options with an exercise price of $30 to its employees and a year-end market price of $25 per share. What amount is Ian's diluted earnings per share for the year ended December 31?

A. $4.63
B. $4.85
C. $7.35
D. $7.94

D. $7.94
Weighted average shares outstanding for basic EPS = 15,000(3/12) + 12,500(2/12) + 17,000(7/12) = 15,750. Basic EPS = $125,000/15,750 = $7.94. The stock options are antidilutive because the exercise price exceeds the average market price of the stock. Such options would not be assumed exercised. Under the treasury stock method, assuming exercise would result in more shares being purchased for the treasury than issued upon assumed exercised. The result is a decrease in the denominator of diluted EPS causing diluted EPS to exceed basic EPS. Therefore, in this case, diluted and basic EPS are equal.

45

A company decided to sell an unprofitable division of its business. The company can sell the entire operation for $800,000, and the buyer will assume all assets and liabilities of the operations. The tax rate is 30%. The assets and liabilities of the discontinued operation are as follows:
Buildings $5,000,000
Accumulated depreciation 3,000,000
Mortgage on buildings 1,100,000
Inventory 500,000
Accounts payable 600,000
Accounts receivable 200,000
What is the after-tax net loss on the disposal of the division?

A. $140,000
B. $200,000
C. $1,540,000
D. $2,200,000

A. $140,000
The after tax net loss on the disposal of the division is the net asset value, ($2,700,000 of assets - $1,700,000 of liabilities) $1,000,000, less the selling price of $800,000. The result is a net loss of $200,000 before tax. After 30% taxes, the net loss is $140,000.

46

On April 30, 2005, Carty Corp. approved a plan to dispose of a segment of its business. The disposal loss is $480,000, including severance pay of $55,000 and employee relocation costs of $25,000, both of which are directly associated with the decision to dispose of the segment. The firm is a calendar-fiscal year firm, and the segment's operating loss for the entire year (2005) through the date of disposal was $120,000.
Before income taxes, what amount should be reported in Carty's income statement for the year ended December 31, 2005, as the total income effect (loss) from discontinued operations?

A. $600,000
B. $480,000
C. $120,000
D. $360,000

A. $600,000
The $600,000 total loss from discontinued operations is the sum of the operating loss ($120,000) and the loss on disposal ($480,000). The two amounts, $120,000 and $480,000, are disclosed separately but together comprise the total loss on the discontinued operation.

47

A firm with a net income of $30,000 and weighted average actual shares outstanding of 15,000 for the year also had the following two securities outstanding the entire year: (1) 2,000 options to purchase one share of stock for $12 per share. The average share price during the year was $20, (2) cumulative convertible preferred stock with an annual dividend commitment of $4,500. Total common shares issued on conversion are 2,900. Compute diluted EPS for this firm.

A. $1.70
B. $1.60
C. $1.55
D. $1.61

B. $1.60
The options and convertible preferred stock are potential common stock (PCS). First compute basic EPS as the basis for diluted EPS, and also as a benchmark for determining whether the two potential common stock securities are dilutive. Basic EPS = ($30,000 - $4,500)/15,000 = $1.70. The preferred dividend is subtracted from income because the preferred is cumulative. Then determine the numerator and denominator effects of the PCS to enter them into diluted EPS in the order of lowest ratio of numerator to denominator effect (n/d) first. The option?s numerator effect is zero; the denominator effect = 2,000 - (2,000)$12/$20 = 800. 2,000 shares would be issued upon exercise but under the treasury stock method the firm is assumed to apply the proceeds from exercise (2,000 x $12) and purchase shares of the firm?s stock for $20 each. Thus, the n/d for options = 0/800 = 0. The n/d for the convertible preferred stock is the ratio of dividends that would not have been declared if the stock converted, to the common shares asson. n/d = $4,500/2,900 = $1.55. Enter the options into diluted EPS first, because the options have the lower n/d. DEPS tentative = ($30,000 - $4,500)/(15,000 + 800) = $1.61. The convertible preferred is dilutive because its n/d ratio of $1.55 is less than $1.61, the tentative or first-pass amount for diluted EPS. DEPS final = ($30,000 - $4,500 + $4,500)/(15,000 + 800 + 2,900) = $1.60.

48

On November 1, 2004, Beni Corp. was awarded a judgment of $1,500,000 in connection with a lawsuit. The decision is being appealed by the defendant, and it is expected that the appeal process will be completed by the end of 2005.
Beni's attorney feels that it is highly probable that an award will be upheld on appeal, but that the judgment may be reduced by an estimated 40%.
In addition to footnote disclosure, what amount should be reported as a receivable in Beni's balance sheet at December 31, 2004?

A. $1,500,000
B. $900,000
C. $600,000
D. $ -0-

D. $ -0-
This is a contingent asset or gain. Contingent assets are not recognized in the accounts.
This is a classic case of conservatism. If all the data were the same except that a loss was expected, a loss would be accrued in the accounts.

49

Chape Co. had the following information related to common and preferred shares during the year:
Common shares outstanding, 1/1 700,000
Common shares repurchased, 3/31 20,000
Conversion of preferred shares, 6/30 40,000
Common shares repurchased, 12/1 36,000
Chape reported net income of $2,000,000 at December 31. What amount of shares should Chape use as the denominator in the computation of basic earnings per share?

A. 684,000
B. 700,000
C. 702,000
D. 740,000

C. 702,000
Weighted average shares outstanding are weighted by the number of months the shares were outstanding during the year. The easiest way to do this is to take each change in common stock and multiply by the number of months remaining - add the shares that increased shares outstanding and subtract shares that reduced shares outstanding.
Shares Months Wtd avg
700,000 12/12 700,000
- 20,000 9/12 - 15,000
+40,000 6/12 +20,000
-36,000 1/12 - 3,000
702,000

50

Jen Co. had 200,000 shares of common stock and 20,000 shares of 10%, $100 par value cumulative preferred stock. No dividends on common stock were declared during the year. Net income was $2,000,000. What was Jen's basic earnings per share?
A. $9.00
B. $9.09
C. $10.00
D. $11.11

A. $9.00
Earnings per share is: (net income - preferred dividends)/common shares outstanding. Preferred stock dividends are $100 X 10% X 20,000 shares = $200,000. Earnings per share is (2,000,000-200,000)/200,000=$9 per share.

51

AB Company reported earnings per share of $10.50 on income before discontinued operations, ($2.00) on income (loss) attributed to discontinued operations, and $8.50 on net income. Which EPS figure is more relevant to a potential investor?
A. ($2.00)
B. $7.50
C. $8.50
D. $10.50

D. $10.50
Potential investors and current investors are interested in the future earnings potential of the entity. Thus, they are interested in the earnings per share on continuing income, which would be the $10.50 per share. The EPS attributed to discontinued operations cannot be used in predicting future earnings, as they are one-time events.

52

A company had the following outstanding shares as of January 1, year 2:
Preferred stock, $60 par, 4%, cumulative 10,000 shares
Common stock, $3 par 50,000 shares
On April 1, year 2, the company sold 8,000 shares of previously unissued common stock. No dividends were in arrears on January 1, year 2, and no dividends were declared or paid during year 2. Net income for year 2 totaled $236,000. What amount is basic earnings per share for the year ended December 31, year 2?

A. $3.66
B. $3.79
C. $4.07
D. $4.21

B. $3.79
Basic EPS = Net Income - Preferred Dividends / Weighted shares outstanding. The numerator is $236,000 - preferred dividends [($60 x 10,000) x .04 = 24,000] = $212,000. The denominator is 50,000 (12/12) + 8,000 (9/12) = 56,000 shares. $212,000 / 56,000 = $3.786 or $3.79.

53

Balm Co. had 100,000 shares of common stock outstanding as of January 1. The following events occurred during the year:
4/1 Issued 30,000 shares of common stock.
6/1 Issued 36,000 shares of common stock.
7/1 Declared a 5% stock dividend.
9/1 Purchased as treasury stock 35,000 shares of its common stock. Balm used the cost method to account for the treasury stock.
What is Balm's weighted average of common stock outstanding at December 31?

A. 131,000
B. 139,008
C. 150,675
D. 162,342

B. 139,008
More than one approach is available to compute WA (each yields the same answer) but perhaps the easiest is to weight each item separately going forward to the end of the year. This approach yields 139,008 = [100,000(12/12) + 30,000(9/12) + 36,000(7/12)](1.05) - 35,000(4/12). The beginning shares are outstanding the entire year (12/12). The next two items are weighted for the fraction of the year they are outstanding. Stock dividends and splits are retroactively applied to all items before their issuance - hence the multiplication by 1.05. The treasury shares are removed from the average for 4/12 of the year - these shares already reflect the stock dividend.

54

The following information pertains to Jet Corp. outstanding stock for 2004:

Common stock, $5 par value
Shares outstanding, 1/1/04
20,000
2-for-1 stock split, 4/1/04
20,000
Shares issued, 7/1/04
10,000
Preferred stock, $10 par value, 5% cumulative
Shares outstanding, 1/1/04
4,000
What are the number of shares Jet should use to calculate 2004 earnings per share?

A. 40,000
B. 45,000
C. 50,000
D. 54,000

B. 45,000
The effect of the stock split is applied retroactively to all changes in the number of shares of common stock outstanding before the split.
The weighted average shares outstanding for this firm for 2004 is: 45,000 = [20,000(2) + 10,000(1/2)]. The split affects only the shares issued before date of the split. The July 1 issuance is weighted only by 1/2 a year because the shares were outstanding only 1/2 a year. EPS is computed only on common stock outstanding. The preferred shares have no effect on the computation.

55

On January 31, 2004, Pack, Inc. split its common stock 2 for 1, and Young, Inc. issued a 5% stock dividend. Both companies issued their December 31, 2003, financial statements on March 1, 2004.
Should Pack's 2003 earnings per share (EPS) take into consideration the stock split, and should Young's 2003 EPS take into consideration the stock dividend?

Pack's 2003 EPS Young's 2003 EPS
Yes No
No No
Yes Yes
No Yes

Yes Yes
EPS is used primarily as an input to predictions of future earnings. The stock split and dividend cause the number of shares outstanding to increase, and thus affect the future earnings prospects on a per share basis. These events should be included in the computation of EPS even though they did not occur as of the balance sheet date. Financial statement users view the information as if it were current as of the date of publication.

56

Strauch Co. has one class of common stock outstanding and no other securities that are potentially convertible into common stock. During 2005, 100,000 shares of common stock were outstanding. In 2006, two distributions of additional common shares occurred:
On April 1, 20,000 shares of treasury stock were sold, and on July 1, a 2-for-1 stock split was issued.
Net income was $410,000 in 2006 and $350,000 in 2005.

What amounts should Strauch report as earnings per share in its 2006 and 2005 comparative income statements?

2006 2005
$1.78 $3.50
$1.78 $1.75
$2.34 $1.75
$2.34 $3.50

$1.78 $1.75
For EPS purposes, stock dividends and splits are retroactively applied to all periods presented, and to all share changes within the year of the split or dividend. This procedure ensures comparability.

The 2-for-1 split in 2006 does not substantively change the value of any shares outstanding. Without retroactive application, EPS would be cut roughly in half in 2006 compared to 2005. Yet there was little substantive change in the performance of the firm. For reporting in 2006:

Weighted average shares, 2005 = 100,000(2) = 200,000.
EPS, 2005 = $350,000/200,000 = $1.75.

Weighted average shares, 2006 = [100,000 + 20,000(9/12)]2 = 230,000
EPS, 2006 = $410,000/230,000 = $1.78.

Had the 2005 shares not been adjusted for the split, 2005 EPS would be $3.50 = $350,000/100,000, or roughly double the EPS of 2006. Without retroactive application, it would appear that the firm had a drastic reduction in EPS in 2006. The retroactive application of the split ensures that the base on which EPS is computed uses the same measuring unit.

57

Balm Co. had 100,000 shares of common stock outstanding as of January 1. The following events occurred during the year:
4/1 Issued 30,000 shares of common stock.
6/1 Issued 36,000 shares of common stock.
7/1 Declared a 5% stock dividend.
9/1 Purchased as treasury stock 35,000 shares of its common stock. Balm used the cost method to account for the treasury stock.
What is Balm's weighted average of common stock outstanding at December 31?

A. 131,000
B. 139,008
C. 150,675
D. 162,342

B. 139,008
More than one approach is available to compute WA (each yields the same answer) but perhaps the easiest is to weight each item separately going forward to the end of the year. This approach yields 139,008 = [100,000(12/12) + 30,000(9/12) + 36,000(7/12)](1.05) - 35,000(4/12). The beginning shares are outstanding the entire year (12/12). The next two items are weighted for the fraction of the year they are outstanding. Stock dividends and splits are retroactively applied to all items before their issuance - hence the multiplication by 1.05. The treasury shares are removed from the average for 4/12 of the year - these shares already reflect the stock dividend.

58

The following information pertains to Jet Corp. outstanding stock for 2004:

Common stock, $5 par value
Shares outstanding, 1/1/04
20,000
2-for-1 stock split, 4/1/04
20,000
Shares issued, 7/1/04
10,000
Preferred stock, $10 par value, 5% cumulative
Shares outstanding, 1/1/04
4,000
What are the number of shares Jet should use to calculate 2004 earnings per share?

A. 40,000
B. 45,000
C. 50,000
D. 54,000

B. 45,000
The effect of the stock split is applied retroactively to all changes in the number of shares of common stock outstanding before the split.
The weighted average shares outstanding for this firm for 2004 is: 45,000 = [20,000(2) + 10,000(1/2)]. The split affects only the shares issued before date of the split. The July 1 issuance is weighted only by 1/2 a year because the shares were outstanding only 1/2 a year. EPS is computed only on common stock outstanding. The preferred shares have no effect on the computation.

59

On January 31, 2004, Pack, Inc. split its common stock 2 for 1, and Young, Inc. issued a 5% stock dividend. Both companies issued their December 31, 2003, financial statements on March 1, 2004.
Should Pack's 2003 earnings per share (EPS) take into consideration the stock split, and should Young's 2003 EPS take into consideration the stock dividend?

Pack's 2003 EPS Young's 2003 EPS
Yes No
No No
Yes Yes
No Yes

Yes Yes
EPS is used primarily as an input to predictions of future earnings. The stock split and dividend cause the number of shares outstanding to increase, and thus affect the future earnings prospects on a per share basis. These events should be included in the computation of EPS even though they did not occur as of the balance sheet date. Financial statement users view the information as if it were current as of the date of publication.

60

Strauch Co. has one class of common stock outstanding and no other securities that are potentially convertible into common stock. During 2005, 100,000 shares of common stock were outstanding. In 2006, two distributions of additional common shares occurred:
On April 1, 20,000 shares of treasury stock were sold, and on July 1, a 2-for-1 stock split was issued.
Net income was $410,000 in 2006 and $350,000 in 2005.

What amounts should Strauch report as earnings per share in its 2006 and 2005 comparative income statements?

2006 2005
$1.78 $3.50
$1.78 $1.75
$2.34 $1.75
$2.34 $3.50

$1.78 $1.75
For EPS purposes, stock dividends and splits are retroactively applied to all periods presented, and to all share changes within the year of the split or dividend. This procedure ensures comparability.

The 2-for-1 split in 2006 does not substantively change the value of any shares outstanding. Without retroactive application, EPS would be cut roughly in half in 2006 compared to 2005. Yet there was little substantive change in the performance of the firm. For reporting in 2006:

Weighted average shares, 2005 = 100,000(2) = 200,000.
EPS, 2005 = $350,000/200,000 = $1.75.

Weighted average shares, 2006 = [100,000 + 20,000(9/12)]2 = 230,000
EPS, 2006 = $410,000/230,000 = $1.78.

Had the 2005 shares not been adjusted for the split, 2005 EPS would be $3.50 = $350,000/100,000, or roughly double the EPS of 2006. Without retroactive application, it would appear that the firm had a drastic reduction in EPS in 2006. The retroactive application of the split ensures that the base on which EPS is computed uses the same measuring unit.

61

The following information pertains to Ceil Co., a company whose common stock trades in a public market:
Shares outstanding at 1/1 100,000
Stock dividend at 3/31 24,000
Stock issuance at 6/30 5,000
What is the weighted average number of shares Ceil should use to calculate its basic earnings per share for the year ended December 31?

A. 120,500
B. 123,000
C. 126,500
D. 129,000

C. 126,500
The stock dividend is considered to be outstanding since the beginning of the year. The weighted average is therefore:
100,000+24,000+ (5,000X6/12) = 126,500.

62

The treasury stock method of entering stock options into the calculation of diluted EPS:

A. Is used only for dilutive treasury stock.
B. Computes the increase in common shares outstanding from assumed exercise of options to be the number of shares under option.
C. Is called the treasury stock method because the proceeds from assumed exercise are assumed to be used to purchase treasury stock.
D. Assumes the treasury shares are purchased at year-end.

C. Is called the treasury stock method because the proceeds from assumed exercise are assumed to be used to purchase treasury stock.

63

A firm has basic earnings per share of $1.29. If the tax rate is 30%, which of the following securities would be dilutive?
A. Cumulative 8%, $50 par preferred stock.
B. Ten percent convertible bonds, issued at par, with each $1,000 bond convertible into 20 shares of common stock.
C. Seven percent convertible bonds, issued at par, with each $1,000 bond convertible into 40 shares of common stock.
D. Six percent, $100 par cumulative convertible preferred stock, issued at par, with each preferred share convertible into four shares of common stock.

C. Seven percent convertible bonds, issued at par, with each $1,000 bond convertible into 40 shares of common stock.

This security is dilutive. The numerator effect is $49 saving in interest ($1,000 x .07 x (1-.3)), and the denominator effect is 40 more shares outstanding. 49 / 40 = $1.225, which is less than the BEPS of $1.29, so the security is dilutive.

64

In 20x5, a firm decided to discontinue a segment with a book value of $200 million and a fair value of $250 million. The cost to dispose of the segment in 20x6 is estimated to be $10 million. In the 20x5 income statement, what amount of disposal gain or loss will be reported in the discontinued operations section?
A. $ -0-
B. $50 million loss.
C. $50 million gain.
D. $40 million gain.

A. $ -0-
The estimated disposal gain is $240 [($250 - $10) proceeds] - $200 book value, or $40. Estimated disposal gains are not recognized, only estimated losses. Next year, the actual disposal gain will be recognized. Nonfinancial assets are not written up in value.

65

On May 15, 2003, Munn, Inc. approved a plan to dispose of a segment of its business. It is expected that the sale will occur on February 1, 2004, at a selling price of $500,000. The segment reported $195,000 in operating losses for 2003. The segment is expected to lose $30,000 from operations in 2004. The carrying amount of the segment at the date of sale was expected to be $850,000. Before income taxes, what amount should Munn report as a loss from discontinued operations in its 2003 income statement?
A. $575,000
B. $225,000
C. $195,000
D. $545,000

D. $545,000
There are two components for discontinued operations: (1) the operating income or loss for the period in which the decision is made to dispose, and (2) the disposal loss. Only actual operating income (or loss) is recognized, but estimated as well as actual disposal losses are recognized. The $350,000 estimated disposal loss is the difference between the $850,000 carrying value of the segment, and its $500,000 estimated selling price. The operating loss for the period ($195,000) plus the estimated disposal loss ($350,000) equals the $545,000 total loss to be recognized for discontinued operations for 2003.

66

During 20x8, a firm discontinued a component qualifying for separate disclosure within the income statement. The disposal was completed before the end of 20x8 and resulted in a $300 disposal gain. The component earned $400 in 20x7 but lost $100 (negative income) in 20x8. The 20x7 income statement reported income from continuing operations (IFCO) of $6,000. The 20x8 income statement reported $7,000 of net income. Determine the following two amounts:
IFCO for 20x7 as it is reported comparatively in the 20x8 statements IFCO for 20x8
$6,000 $7,000
$6,000 $6,800
$5,600 $6,800
$5,600 $7,200

$5,600 $6,800
Remove income/gains and add losses.

The discontinued operations section of the income statement for prior periods shown comparatively separates the operating income of discontinued components from IFCO even though the decision had not yet been made in those earlier periods. This reporting results in improved comparability because each year reports IFCO on the same basis. (1) IFCO for 20x7, as it is reported comparatively in the 20x8 statements, reflects the removal of the $400 operating income for the segment and thus equals $6,000 - $400, or $5,600. (2) IFCO for 20x8 is computed by removing the effect of the disposal gain and operating loss from income. IFCO for 20x8 equals $7,000 net income - $300 disposal gain + $100 operating loss, or $6,800.

67

Hudson Corp. operates several factories that manufacture medical equipment. The factories have a historical cost of $200 million. Near the end of the company's fiscal year, a change in business climate related to a competitor's innovative products indicated to Hudson's management that the $170 million carrying amount of the assets of one of Hudson's factories may not be recoverable. Management identified cash flows from this factory and estimated that the undiscounted future cash flows over the remaining useful life of the factory would be $150 million. The fair value of the factory's assets is reliably estimated to be $135 million. The change in business climate requires investigation of possible impairment. Which of the following amounts is the impairment loss?
A. $15 million
B. $20 million
C. $35 million
D. $65 million

C. $35 million
Under U.S. GAAP, impairment testing is a two step process. The first step compares the assets' carry value (CV) to its undiscounted cash flows (UCF). In this problem the CV > UCF; therefore the asset is potentially impaired and we must go to the second step. The second step compares the assets CV to its fair value (FV). In this problem the FV

68

During 2004, Gum Co. introduced a new product carrying a two-year warranty against defects. The estimated warranty costs related to dollar sales are 2% within 12 months following the sale and 4% in the second 12 months following the sale.
Sales and actual warranty expenditures for the years ended December 31, 2004 and 2005 are as follows:

Sales Actual warranty expenditures
2004 $150,000 $2,250
2005 250,000 7,500
$400,000 $9,750
========= =========
What amount should Gum report as estimated warranty liability in its December 31, 2005, balance sheet?

A. $2,500
B. $4,250
C. $11,250
D. $14,250

D. $14,250
At Dec. 31, 2005, the total warranty liability accrued for the two years is 6% of sales (2% + 4%). This total is $24,000 (.06 x $400,000). Subtracting $9,750 of actual warranty expenditures to the end of 2005 yields the $14,250 ending warranty liability.

69

Vadis Co. sells appliances that include a three-year warranty. Service calls under the warranty are performed by an independent mechanic under a contract with Vadis. Based on experience, warranty costs are estimated at $30 for each machine sold.
When should Vadis recognize these warranty costs?

A. Evenly over the life of the warranty.
B. When the service calls are performed.
C. When payments are made to the mechanic.
D. When the machines are sold.

D. When the machines are sold.

70

At December 31, 2004, Date Co. awaits judgment on a lawsuit for a competitor's infringement of Date's patent. Legal counsel believes it is probable that Date will win the suit and indicated the most likely award together with a range of possible awards.
How should the lawsuit be reported in Date's 2004 financial statements?

A. In note disclosure only.
B. By accrual for the most likely award.
C. By accrual for the lowest amount of the range of possible awards.
D. Neither in note disclosure nor by accrual.

A. In note disclosure only.
This is a gain contingency.

Gain contingencies are footnoted at most, not accrued. To recognize gain contingencies in the accounts would violate the conservatism constraint.

71

During 2003, Manfred Corp. guaranteed a supplier's $500,000 loan from a bank.
On October 1, 2004, Manfred was notified that the supplier had defaulted on the loan and filed for bankruptcy protection. Counsel believes Manfred will probably have to pay between $250,000 and $450,000 under its guarantee.
As a result of the supplier's bankruptcy, Manfred entered into a contract in December 2004 to retool its machines so that Manfred could accept parts from other suppliers. Retooling costs are estimated to be $300,000.

What amount should Manfred report as a liability in its December 31, 2004, balance sheet?

A. $250,000
B. $450,000
C. $550,000
D. $750,000

A. $250,000
The retooling costs are not part of the liability, but are rather a response to changing business conditions. They most likely would be capitalized and amortized over their useful life. The liability is a contingent liability.
The amount depends on the outcome of the bankruptcy proceedings. When a range of values is estimated with no one value being more probable than the others, the lowest amount is accrued. Thus, $250,000 is accrued as of the end of 2004.

72

Baker Co. sells consumer products that are packaged in boxes. Baker offered an unbreakable glass in exchange for two box tops and $1 as a promotion during the current year. The cost of the glass was $2.00. Baker estimated at the end of the year that it would be probable that 50% of the box tops will be redeemed. Baker sold 100,000 boxes of the product during the current year, and 40,000 box tops were redeemed during the year for the glasses. What amount should Baker accrue as an estimated liability at the end of the current year, related to the redemption of box tops?
A. $ -0-
B. $5,000
C. $20,000
D. $25,000

B. $5,000
This is a contingency that meets the criteria for a liability. The total estimated number of box tops redeemed is 100,000 x 50% = 50,000.
Of these 50,000, 40,000 have been redeemed, leaving 10,000 box tops estimated to be redeemed. It takes two box tops per glass, or 10,000/2 = 5,000 glasses.
At a cost of $1 per glass, the total cost is 5,000 X $1 = 5,000 as a liability.

73

Case Cereal Co. frequently distributes coupons to promote new products. On October 1, 2004, Case mailed 1,000,000 coupons for $.45 off each box of cereal purchased. Case expects 120,000 of these coupons to be redeemed before the December 31, 2004, expiration date. It takes 30 days from the redemption date for Case to receive the coupons from the retailers. Case reimburses the retailers an additional $.05 for each coupon redeemed. As of December 31, 2004, Case had paid retailers $25,000 related to these coupons and had 50,000 coupons on hand that had not been processed for payment. What amount should Case report as a liability for coupons in its December 31, 2004, balance sheets?
A. $35,000
B. $29,000
C. $25,000
D. $22,500

A. $35,000

120,000 coupons expected to be redeemed x ($.45 + $.05)
$60,000
Less amount already paid
(25,000)
Liability at 12/31/91
$35,000

74

Dunn Trading Stamp Co. records stamp service revenue and provides for the cost of redemptions in the year stamps are sold to licensees. Dunn's past experience indicates that only 80% of the stamps sold to licensees will be redeemed. Dunn's liability for stamp redemptions was $6,000,000 at December 31, 2005. Additional information for 2006 is as follows:
Stamp service revenue from stamps sold to licensees $4,000,000
Cost of redemptions (stamps sold prior to 1/1/06) 2,750,000
If all the stamps sold in 2006 were presented for redemption in 2007, the redemption cost would be $2,250,000. What amount should Dunn report as a liability for stamp redemptions at December 31, 2006?

A. $7,250,000
B. $5,500,000
C. $5,050,000
D. $3,250,000

C. $5,050,000
Beginning liability balance $6,000,000
Plus estimated redemptions for 2006: .80($2,250,000) 1,800,000
Less actual redemptions in 2006 (2,750,000)
Equals ending liability balance $5,050,000
The firm estimates the redemption cost in the year of sale, much like a warranty liability. For 2006, this increases the redemption liability by $1,800,000. When actual redemptions occur, the liability is extinguished at the cost of the redemptions ($2,750,000).

75

Eagle Co. has cosigned the mortgage note on the home of its president, guaranteeing the indebtedness in the event that the president should default. Eagle considers the likelihood of default to be remote.
How should the guarantee be treated in Eagle's financial statements?

A. Disclosed only.
B. Accrued only.
C. Accrued and disclosed.
D. Neither accrued nor disclosed.

A. Disclosed only.
In the interest of conservatism and disclosure, the guarantee should be disclosed. It is not required to be accrued because the probability is remote that the firm will have to pay the note.

76

What kind of hedge can be used to hedge a foreign currency firm commitment?

Cash Flow Fair Value
Yes Yes
Yes No
No Yes
No No

Cash Flow Fair Value
Yes Yes
A forward contract used to hedge a foreign currency firm commitment can be either a cash flow hedge (as permitted by the FASB's Derivatives Implementation Group) or a fair value hedge (as permitted by FASB #133).

77

On September 1, 2004, Brady Corp. entered into a foreign exchange contract for speculative purposes by purchasing 50,000 Euros for delivery in 60 days. The rates to exchange $1 for 1 Euro follow:

9/1/04 9/30/04
Spot rate .75 .70
30-day forward rate .73 .72
60-day forward rate .74 .73
In its September 30, 2004, income statement, what amount should Brady report as foreign exchange loss?

A. $2,500
B. $1,500
C. $1,000
D. $500

C. $1,000
The correct answer is the difference between the 60-day forward rate on September 1 of $0.74 and the 30-day forward rate on September 30 of $0.72, or $0.02 x 50,000 Euros = $1,000, the correct amount of the loss.

78

On October 1, 2008, RWB Co., a U.S. entity, signed a contract to provide equipment to Pronto, a Spanish entity, for 300,000 Euros. The terms of the sale provided for the equipment to be delivered FOB-Destination on December 1, 2008, with payment by Pronto on January 30, 2009. The following dollar cost per Euro exchange rate information was available:
Spot FR 12/1 FR 12/31 FR 1/30
October 1 $1.30 $1.29 $1.28 $1.27
December 1 $1.29 - $1.28 $1.27
December 31 $1.28 - - $1.27
January 30 $1.27 - - -
Which of the following is the amount (rounded) of the exchange gain or loss that RWB Co. should recognize in 2008 as a result of its sale to and receivable from Pronto?

A. $1,817
B. $3,000
C. $6,000
D. $9,00

B. $3,000
The correct exchange gain or loss would be calculated by multiplying the 300,000 Euros to be received by the spot exchange rates on December 1, the date of the sale, and December 31, the end of 2008, and getting the difference. That calculation would be (300,000E x $1.29 = $387,000) - (300,000E x $1.28 = $384,000) = $3,000, the correct answer.

79

Pinco, a U.S. entity, has a 100% owned subsidiary, Sinco, located in a foreign country. In order to hedge its investment in the foreign operation, Pinco has a long-term borrowing in the same foreign currency in an amount approximating its net equity in the subsidiary. For 2008, the translated value of Sinco's balance sheet decreased by $40,000, and the converted value of Pinco's long-term debt decreased by $42,000. Which one of the following is the net amount that Pinco should recognize in other comprehensive income for 2008?

A. $-0-
B. $2,000
C. $40,000
D. $42,000

A. $-0-

Translation adjustment decrease decreases OCI.
The converted value decrease offsets trans. adjustment.
Remainder is reported in current income.

Since Pinco designated the long-term borrowing to hedge its investment in its foreign operation, the amount of the change in the borrowing equal to the amount of the change in the translated value of the investment should be reported as a translation adjustment (along with the change in the translated value of the investment) in other comprehensive income, and the balance should be reported in current income. Therefore, Pinco would report a $40,000 decrease and a $40,000 increase as translation adjustments, offsetting each other. The remaining $2,000 would be reported in current income.

80

Which one of the following is most likely a foreign currency import transaction by a U.S. company?

A. Sale of goods to be collected in dollars.
B. Purchase of goods to be paid in dollars.
C. Sale of goods to be collected in a foreign currency.
D. Purchase of goods to be paid in a foreign currency.

D. Purchase of goods to be paid in a foreign currency.

81

On September 1, 2005, Cano & Co., a U.S. corporation, sold merchandise to a foreign firm for 250,000 francs. Terms of the sale require payment in francs on February 1, 2006. On September 1, 2005, the spot exchange rate was $.20 per franc. At December 31, 2005, Cano's year end, the spot rate was $.19, but the rate increased to $.22 by February 1, 2006, when payment was received.
How much should Cano report as a foreign exchange gain or loss in its 2006 income statement?

A. $0
B. $2,500 loss
C. $5,000 gain
D. $7,500 gain

D. $7,500 gain
A foreign exchange gain or loss is recognized for any change in value of a monetary debt denominated in a foreign currency. This is true at balance sheet time as well as when it is realized.
Thus, a $2,500 loss would have been recognized at December 31, 2005 (250,000 francs * [.20 - .19]). Then, in 2006, the full difference between the $.19 and $.22 (250,000 francs * .03) would be realized for a total gain of $7,500.

82

Which of the following statements concerning foreign currency hedging is/are correct?

I. The item being hedged is denominated in a foreign currency.

II. The item being hedged must be recorded on the entity’s books in order to be hedged.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

A. I only.

83

When used for speculative purposes, which of the following contracts is likely to result in a foreign currency loss to the contract holder who initiated the contract?

Foreign Currency Forward Exchange Contract Foreign Currency Option Contract
Yes Yes
Yes No
No Yes
No No

Yes No
Forex contract would result in a loss b/c it must be undertaken even w/a loss. The option will not likely be exercised if a loss would occur.

84

On October 1, 2004, Mild Co., a U.S. company, purchased machinery from Grund, a German company, with payment due on April 1, 2005. If Mild's 2004 operating income included no foreign exchange transaction gain or loss, then the transaction could have:
A. Resulted in an extraordinary gain.
B. Been denominated in U.S. dollars.
C. Caused a foreign currency gain to be reported as a contra account against machinery.
D. Caused a foreign currency translation gain to be reported as a separate component of stockholders' equity.

B. Been denominated in U.S. dollars.


All foreign exchange gains and losses on foreign currency transactions are counted as ordinary income from continuing operations. While foreign sub translation gains and losses are reported as a separate component of stockholders' equity, gains and losses on foreign currency transactions cannot be so reported. They must be counted as ordinary gains or losses from continuing operations.

85

In preparing consolidated financial statements of a U.S. parent company with a foreign subsidiary, the foreign subsidiary's functional currency is the currency:
A. In which the subsidiary maintains its accounting records.
A is not correct. Any of those currencies could be the functional currency of the foreign subsidiary, depending on the circumstances. Since no specific circumstances were given in this question, there is no basis for selecting any of these answers. Only D, the definition of functional currency, can be correct.
B. Of the country in which the subsidiary is located.
C. Of the country in which the parent is located.
D. Of the environment in which the subsidiary primarily generates and expends cash.

D. Of the environment in which the subsidiary primarily generates and expends cash.

86

Shore Co. records its transactions in U.S. dollars. A sale of goods resulted in a receivable denominated in Japanese Yen, and a purchase of goods resulted in a payable denominated in Swiss francs.
Shore recorded a foreign exchange gain on collection of the receivable and an exchange loss on settlement of the payable. The exchange rates are expressed as so many units of foreign currency to one dollar.

Did the number of foreign currency units exchangeable for a dollar increase or decrease between the contract and settlement dates?

Yen exchangeable for $1 Francs exchangeable for $1
Increase Increase
Decrease Decrease
Decrease Increase
Increase Decrease

Decrease = gain on receivable.
Decrease = loss on payable.

87

Which one of the following is a direct quotation for a U.S. entity when buying Japanese Yen (JPY)?
I. 0.89 JPY per $1.00.

II. $.011 per 1.00 JPY.

A. I only.
B. II only.
C. Both I or II.
D. Neither I nor II.

B. II only.

88

On December 31, 2008, the end of its fiscal year, Domco had a foreign currency account payable with a settlement amount greater than its previously recorded carrying amount. Which one of the following would Domco recognize for 2008?
A. No exchange gain or loss.
B. Exchange gain.
C. Exchange loss.
D. Deferred gain.

C. Exchange loss.
Since the foreign currency account payable had a settlement amount greater than its previously recorded carrying amount, Domco would have to recognize the change in settlement amounts in the period in which the settlement amount changed - 2008. Specifically, since the amount to settle the account payable increased during 2008, Domco would have to recognize an exchange loss - it will take more dollars to acquire the foreign currency needed to settle the account.

89

Which of the following is the kind of entry Domestico should make on December 31, the end of its fiscal year, in connection with the purchase and obligation due?

A.
DR: Exchange Loss
CR: Inventory
B.
DR: Inventory
CR: Exchange Gain
C.
DR: Exchange Loss
CR: Accounts Payable
D.
DR: Accounts Payable
CR: Exchange Gain

D.
DR: Accounts Payable
CR: Exchange Gain

90

RWB Co., a U.S. entity, purchased goods for resale from a Thai manufacturer. The purchase agreement provided that the U.S. entity would pay the Thai entity 500,000 baht, the Thai currency. The goods were delivered on July 1, 2008, with payment due August 29, 2008. The following exchange rates were determined for the number of baht to the dollar (i.e., B/$):
Spot Rate 60-day Forward Rate
July 1, 2008 35.0B/$ 36.5B/$
August 29, 2008 37.0B/$ 38.0B/$
At which one of the following amounts (rounded) would RWB Co. record the goods purchased from the Thai manufacturer?

A. $13,158
B. $13,514
C. $13,699
D. $14,286

D. $14,286
The goods should be measured and recorded in dollars based on the exchange rate in effect (spot rate) at the date of the purchase, July 1. Thus, the correct amount would be 500,000B/35.0B per $ = $14,286.

91

RWB Co., a U.S. entity, purchased goods for resale from a Thai manufacturer. The purchase agreement provided that the U.S. entity would pay the Thai entity 500,000 baht, the Thai currency. The goods were delivered on July 1, 2008, with payment due August 29, 2008. The following exchange rates were determined for the number of baht to the dollar (i.e., B/$):
Spot Rate 60-day Forward Rate
July 1, 2008 35.0B/$ 36.5B/$
August 29, 2008 37.0B/$ 38.0B/$
Which one of the following is the amount (rounded) of exchange gain or loss, if any, that RWB Co. would recognize on the purchase of goods from the Thai manufacturer?

A. $-0-
B. $185
C. $541
D. $772

D. $772
Since the exchange rate changed between the date the obligation was incurred (July 1) and the date it was settled (August 29), the effects of the exchange rate change must be recognized as an exchange gain or loss. The correct answer would be the difference between the spot rate on July 1 and the spot rate on August 29, or (500,000B/35.0B per $ = $14,286) - (500,000B/37.0B per $ = $13,514) = $772.

92

On September 22, 2005, Yumi Corp. purchased merchandise from an unaffiliated foreign company for 10,000 units of the foreign company's local currency. On that date, the spot rate was $.55. Yumi paid the bill in full on March 20, 2006, when the spot rate was $.65. The spot rate was $.70 on December 31, 2005.
What amount should Yumi report as a foreign currency transaction loss in its income statement for the year ended December 31, 2005?

A. $0
B. $500
C. $1,000
D. $1,500

D. $1,500
When a monetary obligation in a foreign currency exists, all gains and losses reflective of changes in exchange rates are recognized in current income.
The loss would be based on the rate at initiation and the rate at year end. (The recovery in the next period would be treated as a gain in that period.) The loss is $1,500 [($.55 - $.70)10,000], making this response correct.

93

Which of the following exchange rates may be used in accounting for a forward contract hedging instrument?

Spot Rate Forward Rate
Yes Yes
Yes No
No Yes
No No

Spot Rate Forward Rate
Yes Yes

94

Restoration of the carrying value of a long-lived asset is permitted under IFRS if the asset's fair value increases subsequent to recording an impairment loss for which of the following?

Held for use Held for disposal
Yes Yes
Yes No
No Yes
No No

Held for use Held for disposal
Yes Yes
Under IFRS the impairment loss can be recovered if the asset is held for use or disposal.

95

Four years ago on January 2, Randall Co. purchased a long-lived asset. The purchase price of the asset was $250,000, with no salvage value. The estimated useful life of the asset was 10 years. Randall used the straight-line method to calculate depreciation expense. An impairment loss on the asset of $30,000 was recognized on December 31 of the current year. The estimated useful life of the asset at December 31 of the current year did not change. What amount should Randall report as depreciation expense in its income statement for the next year?
A. $20,000.
B. $22,000.
C. $25,000.
D. $30,000.

A. $20,000.
The net book value of the asset at the time of impairment was $150,000: $250,000 cost less $100,000 accumulated depreciation (4 years of depreciation at $25,000 a year). After the impairment of $30,000, the net book value is $120,000 ($150,000 - 30,000). The remaining life is 6 years and annual depreciation is $20,000.

96

A company has a long-lived asset with a carrying value of $120,000, expected future cash flows of $130,000, present value of expected future cash flows of $100,000, and a market value of $105,000. What amount of impairment loss should be reported?

A. $0
B. $5,000
C. $15,000
D. $20,000

A. $0
The recoverable cost (expected future cash flows) of $130,000 exceeds the $120,000 book value. Therefore, the asset is not impaired, and no loss is recorded. Although both the market value and present value of the future cash flows are less than book value, as long as the nominal sum of future cash flows ($130,000) exceeds book value, no impairment is recorded. The firm is expected to recover its book value.

97

On December 31, 2004, a building owned by Pine Corp. was totally destroyed by fire. The building had fire insurance coverage up to $500,000.
Other pertinent information as of December 31, 2004, follows:
Building, carrying amount $520,000
Building, fair market value 550,000
Removal and cleanup cost 10,000
During January 2005, before the 2004 financial statements were issued, Pine received insurance proceeds of $500,000. On what amount should Pine base the determination of its loss on involuntary conversion?

A. $520,000
B. $530,000
C. $550,000
D. $560,000

B. $530,000
The sum of the carrying value ($520,000) and removal/cleanup cost ($10,000) is the amount to compare to the insurance proceeds when computing the loss. The fire caused the latter costs to be incurred; therefore, the cleanup costs should be included in the loss.
The fair value of the property would not figure into the recorded loss because the building account does not reflect this amount.

98

Which one of the following sets shows the correct reporting of an adjustment (gain or loss) that results from translation and one that results from remeasurement of financial statements from a foreign currency to a reporting currency?

Translation Adjustment Remeasurement Adjustment
Net Income Net Income
Net Income Other comprehensive income
Other comprehensive income Net Income
Other comprehensive income Other comprehensive income

Translation = OCI
Remeasurement = NI

99

If the functional currency of a foreign subsidiary is a foreign currency other than the subsidiary's recording currency, which one of the following will be used to convert the subsidiary's financial statements to the final reporting currency?
A. Translation.
B. Remeasurement.
C. Translation and then remeasurement.
D. Remeasurement and then translation.

D. Remeasurement and then translation.
Remeasurement and then translation would be used to convert to the reporting currency when a foreign currency other than the foreign subsidiary's recording currency is the functional currency. Specifically, the financial statements would be remeasured from the recording currency to the other foreign functional currency, and the remeasured financial statements would then be translated to the reporting currency.

100

Gordon Ltd., a 100% owned British subsidiary of a U.S. parent company, reports its financial statement in local currency, the British pound. A local newspaper published the following U.S. exchange rates to the British pound at year end:
Current rate $1.50
Historical rate (acquisition) 1.70
Average rate 1.55
Inventory (FIFO) 1.60
Which currency rate should Gordon use to convert its income statement to U.S. dollars at year end?
A. $1.50
B. $1.55
C. $1.60
D. $1.70

B. $1.55

Since Gordon prepares its financial statements in its local currency, the British pound, and since the British economy has not been in hyperinflation, Gordon's functional currency would be the British pound, and its financial statements would be converted to U.S. dollars using translation, not remeasurement. Under the translation method of converting, income statement items are converted using the average exchange rate for the period.

101

On October 1, 2008, RWB Co., a U.S. entity, signed a contract to provide equipment to Pronto, a Spanish entity, for 300,000 Euros. The terms of the sale provided for the equipment to be delivered FOB-Destination on December 1, 2008, with payment by Pronto on January 30, 2009. The following dollar cost per Euro exchange rate information was available:
Spot Rate Forward Rate for December 1 Forward Rate for December 31 Forward Rate for January 30
October 1 $1.30 $1.29 $1.28 $1.27
December 1 $1.29 - $1.28 $1.27
December 31 $1.28 - - $1.27
January 30 $1.27 - - -
Which of the following is the amount (rounded) at which RWB Co. should recognize sales as a result of its sale to Pronto?

A. $232,558
B. $381,000
C. $387,000
D. $390,000

C. $387,000

Use forward rate for value of receivables.

The correct answer is derived by multiplying the number of Euros to be received (300,000) by the dollar cost (value) per Euro at the date of the sale ($1.29), or 300,000E x $1.29 = $387,000. The amount of the sale would not be adjusted for subsequent changes in exchange rates.

102

Which one of the following sets correctly identifies the relationship between a recorded amount and a related settlement amount that will result in an exchange gain on an import transaction and an exchange loss on an export transaction?
Gain on Import Transaction Loss on Export Transaction
Settlement > Recorded Settlement > Recorded
Settlement > Recorded Recorded > Settlement
Recorded > Settlement Settlement > Recorded
Recorded > Settlement Recorded > Settlement

Gain on Import Transaction (payable): Recorded > Settlement
Loss on Export Transaction (receivable): Recorded > Settlement

103

A sale of goods, denominated in a currency other than the entity's functional currency, resulted in a receivable that was fixed in terms of the amount of foreign currency that would be received. Exchange rates between the functional currency and the currency in which the transaction was denominated changed. The resulting gain should be included as a:

A. Translation gain reported as a component of comprehensive income.
B. Translation gain reported as a component of income from continuing operations.
C. Transaction gain reported as a component of comprehensive income.
D. Transaction gain reported as a component of income from continuing operations.

D. Transaction gain reported as a component of income from continuing operations.

104

Which of the following is a foreign currency export transaction for a U.S. entity?

A. Sale of goods to be collected in dollars.
B. Purchase of goods to be paid in dollars.
C. Sale of goods to be collected in a foreign currency.
D. Purchase of goods to be paid in a foreign currency.

C. Sale of goods to be collected in a foreign currency.

105

On June 19, Don Co., a U.S. company, sold and delivered merchandise on a 30-day account to Cologne GmbH, a German corporation, for 200,000 euros. On July 19, Cologne paid Don in full. Relevant currency exchange rates were:
June 19 July 19
Spot rate $ .988 $ .995
30-day forward rate .990 1.000
What amount should Don record on June 19 as an account receivable for its sale to Cologne?

A. $197,600
B. $198,000
C. $199,000
D. $200,000

A. $197,600
At the date Don Co. entered into the transaction, June 19, and agreed to accept euros in satisfaction of its account receivable, it should record the transaction (sale and account receivable) at the (then exiting or current) spot exchange rate of .988. Thus, the dollar amount of the account receivable (and sale) would be computed as 200,000 E x .988 = $197,600, which also is the dollar value that would be received if the transaction were settled at that date.

106

On November 15, 2005, Celt Inc., a U.S. company, ordered merchandise FOB shipping point from an East German company for 200,000 marks. The merchandise was shipped and invoiced to Celt on December 10, 2005. Celt paid the invoice on January 10, 2006.
The spot rates for marks on the respective dates are as follows:
November 15, 2005 $.4955
December 10, 2005 .4875
December 31, 2005 .4675
January 10, 2006 .4475
In Celt's December 31, 2005, income statement, the foreign exchange gain is:

A. $9,600
B. $8,000
C. $4,000
D. $1,600

C. $4,000
SFAS #52: Recognition is based on the change in the spot rate between the recording of the transaction (when goods arrive and, more importantly, debt is officially incurred due to /FOB destination) and the F/S date.


107

Papco, a U.S. entity, has a subsidiary, Sapco, located in a foreign country. Sapco is essentially a sales unit for Papco. Sapco prepared the following shortened financial statements in its local currency, the FCU, for the fiscal year ended December 31, 2008:

Statement of Net Income and FCUs
Comprehensive Income (2008) (in 000)
Sales 12,000
COGS (4,000)
Depreciation Expense (1,000)
Other Expenses (3,000)
Net Income 4,000
Other Comprehensive Income 0
Comprehensive Income 4,000
Retained Earnings (2008)
Beginning Retained Earnings (end 2007) 6,000
Add: Net Income (2008) 4,000
Deduct: Dividends (2008) (1,000)
Ending Retained Earnings 9,000
Balance Sheet (12/31/2008)
Cash and Account Receivable 2,000
Inventory at cost, acquired evenly in 2008 6,000
Fixed Assets 10,000
Total Assets 18,000
Liabilities 2,000
Common Stock 7,000
Retained Earnings 9,000
Subtotal 18,000
Accumulated Other Comprehensive Income 0
Total Liabilities + Equity 18,000
The following exchange rates were available:

Historic exchange rate when Sanco was established by Panco: 1 FCU = $1.200
Historic exchange rate when Sanco's fixed assets were acquired: 1 FCU = $1.250
Weighted average exchange rate for 2008: 1 FCU = $1.300
Spot exchange rate at date dividend declared: 1 FCU = $1.290
Spot exchange rate at December 31, 2008: 1 FCU = $1.310
Which one of the following is the amount (in 000) of Sapco's inventory in U.S. dollars?

A. $6,000
B. $7,200
C. $7,800
D. $7,860

C. $7,800

Use weighted avg exchange rate for inventory and sales.

Since remeasurement should be used to convert Sapco's financial statements expressed in FCUs to U.S. dollars, inventory should be converted using the historic exchange rate in effect when the inventory was acquired. In this case, the inventory was acquired evenly during 2008 and the weighted average exchange rate for the year was $1.300. Therefore, the correct dollar amount of Sapco's inventory would be 6,000 FCUs x $1.300 = $7,800.

108

Certain balance sheet accounts of a foreign subsidiary of Post Inc., at December 31, 2008, have been translated into U.S. dollars as follows:

Translated at
Current Rate Historical Rate
Accounts Receivable, long-term $120,000 $100,000
Prepaid Insurance 55,000 50,000
Copyright 75,000 85,000
$250,000 $235,000
The subsidiary's functional currency is the currency of the country in which it is located. What total amount should be included in Post's December 31, 2008, consolidated balance sheet for the above accounts?

A. $225,000
B. $235,000
C. $240,000
D. $250,000

D. $250,000

Translate at current rate. Remeasure at weighted average rate.

109

Which of the following statements concerning the objectives of foreign currency translation is/are correct?

I. To reflect financial statements in conformity with U.S. GAAP.

II. To provide information that generally is compatible with expected effects of exchange rate changes on an entity's cash flows and equity.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

C. Both I and II.

110

A foreign subsidiary's functional currency is its local currency, which has not experienced significant inflation. The weighted average exchange rate for the current year would be the appropriate exchange rate for translating:

Salaries expense Sales to external customers
Yes Yes
Yes No
No Yes
No No

Salaries expense Sales to external customers
Yes Yes
When the local currency is the functional currency, and it is not experiencing hyperinflation, financial statements prepared in the foreign currency will be converted to the reporting currency using translation, not remeasurement. Under the translation method of converting from a foreign currency to a reporting currency, revenues, expenses, gains, and losses are converted using the exchange rate in effect when an item was earned or incurred; however, a weighted average exchange rate for the period can be used. Therefore, both salaries expense and sales to external customers can be translated using the weighted average exchange rate for the period.

111

Which one of the following sets correctly identifies the characteristics of foreign currency transactions for a U.S. entity?
Transaction Denominated In Transaction Measured In
Dollars Dollars
Dollars Non-Dollars
Non-Dollars Dollars
Non-Dollars Non-Dollars

Transaction Denominated In Non-Dollars
Transaction Measured In Dollars

112

Which of the following general types of transactions could be a foreign currency transaction?
Operating Transactions Forward Exchange Contract Transactions
Yes Yes
Yes No
No Yes
No No

Operating Transactions Forward Exchange Contract Transactions
Yes Yes

113

Forward exchange contracts may be used to:

Hedge Risk Speculate
No No
No Yes
Yes No
Yes Yes

Hedge Risk Speculate
Yes Yes

114

Which of the following statements concerning foreign exchange forward contracts is/are correct?
I. A foreign currency forward exchange contract will result in the exchange of currencies.

II. All forward contracts require the exchange of currencies.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

A. I only.

115

Which one of the following is not associated with forward contracts?

A. The contract may require a future purchase or sale.
B. The contract provides for using the market price at the date the contract is fulfilled.
C. The contract may permit a future purchase or sale.
D. The contract specifies the subject matter of the exchange.

B. The contract provides for using the market price at the date the contract is fulfilled.

Forward contracts establish the price at the time the contract is executed, not at the time the contract is fulfilled.

116

In which of the following hedges using a forward contract will at least a portion of any currency exchange gain or loss on the hedging instrument be reported as a translation adjustment in other comprehensive income?

A. Forecasted transaction hedge.
B. Firm commitment hedge.
C. Investment in available-for-sale securities hedge.
D. Net investment in foreign operations hedge.

D. Net investment in foreign operations hedge.

117

On November 2, 2005, Platt Co. entered into a 90 day futures contract to purchase 50,000 Swiss francs when the contract quote was $.70. The purchase was for speculation in price movement. The following exchange rates existed during the contract period:
30 day futures Spot rate
November 2, 2005 $.62 $.63
December 31, 2005 .65 .64
January 30, 2006 .65 .68
What amount should Platt report as foreign currency exchange loss in its income statement for the year ended December 31, 2005?
A. $2,500
B. $3,000
C. $3,500
D. $4,000

A. $2,500
A futures contract entered into for speculative purposes (not to hedge) is valued using futures rates, and any gain or loss as a result of changes in futures rates is recognized in net income in the period during which the rate changed. At initiation of Platt's contract, the 90-day futures rate was $.70, as quoted in the contract. On December 31, 2005, 30 days before Platt's contract was to be settled, the 30-day futures rate was $.65. Platt's loss would be computed as follows:
November 2, 2005, 50,000 Swiss francs x $.70 = $35,000

December 31, 2005, 50,000 Swiss francs x $.65 = $32,500
Loss in dollar value of futures contract = $2,500

118

On December 12, 2004, Imp Co. entered into three forward exchange contracts, each to purchase 100,000 francs in 90 days. The relevant exchange rates are as follows:

Spot rate Forward rate (for March 12, 2005)
December 12, 2004 $.88 $.90
December 31, 2004 .98 .93
Imp entered into the third forward contract for speculation. At December 31, 2004, what amount of foreign currency gain should Imp include in income from this forward contract?

A. $0
B. $3,000
C. $5,000
D. $10,000

B. $3,000
All gains and losses in a speculative forward foreign exchange contract are included in income of the period in which the forward exchange rate changes. Gains and losses are measured based on the purchase price of the contract and its current settlement value using forward rates.
In this case, those rates are the $.90 purchase price (forward rate December 12) and the $.93 settlement price (forward rate December 31). Thus, this $3,000 amount is correct [($.93-$.90)100,000].

119

On December 1 of the current year, Bann Co. entered into an option contract to purchase 2,000 shares of Norta Co. stock for $40 per share (the same as the current market price) by the end of the next two months. The time value of the option contract is $600. At the end of December, Norta's stock was selling for $43, and the time value of the option was now $400. If Bann does not exercise its option until January of the subsequent year, which of the following changes would reflect the proper accounting treatment for this transaction on Bann's December 31, year-end financial statements?

A. The option value will be disclosed in footnotes only.
B. Other comprehensive income will increase by $6,000.
C. Net income will increase by $5,800.
D. Current assets will decrease by $200.

C. Net income will increase by $5,800.
An option is a financial derivative and must be reported as either an asset or liability at fair value, with any change in fair value recognized in income of the period that the fair value changes (unless the option is used as a hedge). At the date the option contract was initiated, it had no intrinsic value (the strike price was the same as the current price), but had a time value of $600 (given). At December 31, the time value had decreased to $400, a decline of $200, but the intrinsic value had increased by $6,000, computed as the change in the market price from $40 per share to $43 per share, an increase of $3 x 2,000 shares (the option quantity) = $6,000. Thus, the net change in fair value, and the amount of gain that would be recognized in December 31 financial statements, is + $6,000 - $200 = $5,800, the correct answer.

120

Which one of the following hedges using a forward contract will require the recognition of a new asset or liability if a gain or loss occurs on the hedging instrument?

A. Forecasted transaction hedge.
B. Firm commitment hedge.
C. Recognized asset or liability hedge.
D. Net investment in foreign operations hedge.

B. Firm commitment hedge.

121

Which one of the following is not a characteristic associated with hedging foreign currency firm commitments?

A. The hedged item is for purchase or sale to be recorded in the future.
B. The hedged item is for an already booked asset or liability.
C. The hedged item is evidenced by a contract or similar legal commitment.
D. The risk being hedged exists prior to an asset or liability being recognized.

B. The hedged item is for an already booked asset or liability.

122

Which one of the following is not a criterion that must be met in order to use a forward contract to hedge a forecasted transaction?

A. A specific forecasted transaction (or group of similar transactions) must be identified.
B. The forecasted transaction must be at risk from foreign currency price changes.
C. The forecasted transaction must be expected to be initiated by the entity hedging the forecasted transaction.
D. The hedge must be highly effective in offsetting the effects of exchange rate changes.


C. The forecasted transaction must be expected to be initiated by the entity hedging the forecasted transaction.

123

Based on preliminary discussions with a foreign customer, Alcoco, a U.S. entity, budgeted a significant sale to the foreign entity denominated in its foreign currency expected in June 2009. To hedge the risk of an adverse exchange rate change on the dollar value of the expected sale, on January 2, 2009, Alcoco entered into a forward exchange contract to sell an amount of the foreign currency equal to the expected sale. On March 31, 2009, the value of the expected sale amount in dollars had decreased by $3,800. The fair value of the forward contract at that date had increased by $4,000. Which one of the following is the amount that should be recognized in other comprehensive income for the forward contract only (the hedging instrument) in Alcoco's quarterly financial statements as of March 31?

A. $200
B. $3,800
C. $4,000
D. $7,800

B. $3,800
The effective portion of the hedge ($3,800) should be reported in other comprehensive income, and the ineffective portion ($200) should be reported in current income. The effective portion of the hedge is the amount of change in the forward contract (hedging instrument) equal to the change in the fair value of the expected sale amount (the hedged item) ($3,800); the ineffective portion is the difference ($200).

124

Which of the following statements concerning the hedging of the fair value of a foreign currency commitment is/are correct?

I. The change in fair value of a forward contract used to hedge a foreign currency firm commitment will be recognized as a gain or loss in current income.

II. The change in fair value of a hedged foreign currency firm commitment will be recognized as a gain or loss in current income.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

C. Both I and II.

125

A planned volume variance in the first quarter, which is expected to be absorbed by the end of the fiscal period, ordinarily should be deferred at the end of the first quarter if it is:
Favorable Unfavorable
Yes No
No Yes
No No
Yes Yes

Favorable Yes Unfavorable Yes

126

Kell Corp. reported $111,000 of net income for the quarter ended September 30, 2005. Additional information for the quarter:

A $60,000 gain from discontinued operation, realized on April 30, 2005, was allocated equally to the second, third, and fourth quarters of 2005.
A $16,000 cumulative-effect adjustment (dr.) resulting from a change in inventory valuation method was recognized on August 2, 2005. The new method was used for the quarter ended September 30. The $111,000 earnings amount does not reflect the cumulative effect.
In addition, Kell paid $48,000 on February 1, 2005, for 2005 calendar-year property taxes. Of this amount, $12,000 was allocated to the third quarter of 2005.

For the quarter ended September 30, 2005, Kell should report net income of:

A. $91,000
B. $75,000
C. $111,000
D. $95,000

A. $91,000
The gain from discontinued operations should be recognized entirely in the second quarter. There is no meaningful basis on which to allocate the gain. It is a one-time occurrence. The cumulative effect is not recognized in income. The firm's treatment of the property tax cost is correct. The cost relates to the entire year. Therefore, each quarter should bear 1/4 of the cost.
Third quarter net income = $91,000 = $111,000 - $60,000/3.

127

A corporation issues quarterly interim financial statements and uses the lower cost or market method to value its inventory in its annual financial statements. Which of the following statements is correct regarding how the corporation should value its inventory in its interim financial statements?

A. Inventory losses generally should be recognized in the interim statements.
B. Temporary market declines should be recognized in the interim statements.
C. Only the cost method of valuation should be used.
D. Gains from valuations in previous interim periods should be fully recognized.

A. Inventory losses generally should be recognized in the interim statements.

128

A corporation issues quarterly interim financial statements and uses the lower cost or market method to value its inventory in its annual financial statements. Which of the following statements is correct regarding how the corporation should value its inventory in its interim financial statements?

A. Inventory losses generally should be recognized in the interim statements.
B. Temporary market declines should be recognized in the interim statements.
C. Only the cost method of valuation should be used.
D. Gains from valuations in previous interim periods should be fully recognized.

A. Inventory losses generally should be recognized in the interim statements.

129

For interim financial reporting, a company's income tax provision for the second quarter of 2004 should be determined using the:
A. Effective tax rate expected to be applicable for the full year of 2004 as estimated at the end of the first quarter of 2004.
B. Effective tax rate expected to be applicable for the full year of 2004 as estimated at the end of the second quarter of 2004.
C. Effective tax rate expected to be applicable for the second quarter of 2004.
D. Statutory tax rate for 2004.

B. Effective tax rate expected to be applicable for the full year of 2004 as estimated at the end of the second quarter of 2004.

130

Due to a decline in market price in the second quarter, Petal Co. incurred an inventory loss. The market price is expected to return to previous levels by the end of the year. At the end of the year, the decline had not reversed. When should the loss be reported in Petal's interim income statements?
A. Ratably over the second, third, and fourth quarters.
B. Ratably over the third and fourth quarters.
C. In the second quarter only.
D. In the fourth quarter only.

D. In the fourth quarter only.

131

An inventory loss from a market price decline occurred in the first quarter, and the decline was not expected to reverse during the fiscal year.
However, in the third quarter, the inventory's market price recovery exceeded the market decline that occurred in the first quarter.
For interim financial reporting, the dollar amount of net inventory should:

A. Decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the decrease in the first quarter.
B. Decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the market price recovery.
C. Decrease in the first quarter by the amount of the market price decline and not be affected in the third quarter.
D. Not be affected in either the first quarter or the third quarter.

A. Decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the decrease in the first quarter.
When interim period inventory market value declines are not considered temporary (not expected to reverse), they are recognized in the quarter in which the decline occurs. Later recoveries are recognized as gains to the extent of previous losses only. The inventory may not be marked up above cost.

132

On June 30, 2005, Mill Corp. incurred a $100,000 net loss from disposal of a business segment. Also, on June 30, 2005, Mill paid $40,000 for property taxes assessed for the calendar year 2005.
What amount of the foregoing items should be included in the determination of Mill's net income or loss for the six-month interim period ended June 30, 2005?

A. $140,000
B. $120,000
C. $90,000
D. $70,000

B. $120,000
The disposal loss cannot be allocated to interim periods. It does not relate to any interim period other than the one in which it occurred. Thus, it is recognized completely in the earnings for the six month period ended June 30.
The property tax is allocated to interim periods based on time expired. The $40,000 tax relates to the entire year of 2005. With half of the year elapsed at June 30, half of the tax should be recognized in expense. The sum of the amounts to be recognized at June 30 is $120,000 ($100,000 + $20,000).

133

Bard Co., a calendar-year corporation, reported income before income tax expense of $10,000 and income tax expense of $1,500 in its interim income statement for the first quarter of the year. Bard had income before income tax expense of $20,000 for the second quarter and an estimated effective annual rate of 25%. What amount should Bard report as income tax expense in its interim income statement for the second quarter?
A. $3,500
B. $5,000
C. $6,000
D. $7,500

C. $6,000
Interim income tax expense equals the difference between (1) the total income tax through the end of the interim period at the estimated annual tax rate, and (2) the income tax expense recognized in previous interim periods of the same year. For the second quarter, income tax expense therefore is computed as ($10,000 + $20,000)(.25) - $1,500 = $6,000.

134

Which of the following investments denominated in a foreign currency and classified as available-for-sale, if any, can be hedged?

Investments in Equity Securities Investments in Debt Securities
No No
Yes No
No Yes
Yes Yes

Investments in Equity Securities Yes Investments in Debt Securities Yes

135

What general kind of hedge, if any, is the hedge of an available-for-sale investment denominated in a foreign currency?

I. Fair value.

II. Cash flow.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

A. I only.
The hedge of an available-for-sale investment denominated in a foreign currency is a fair value hedge. The risk hedged is the effect of exchange rate changes on the fair value in dollars of the investment.

136

Which of the following statements concerning the use of a forward contract to hedge a foreign currency investment held available-for-sale is/are correct?

I. The investment security must not be traded in the investor's functional currency.

II. The forward contract used as the hedging instrument must be highly effective in hedging the investment.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

C. Both I and II.

137

Tramco has an investment classified as available-for-sale, which is denominated in 80,000 units of a foreign currency. In order to hedge its investment, Tramco acquired a forward exchange contract for 100,000 units of the foreign currency in which its investment is denominated. During the year, the value of the investment decreased $9,000, and the value of the forward contract increased by $10,000. For the year, how will Tramco recognize in its financial statements the decrease in the value of the investment and the increase in the value of the forward contract that occurred during the year?

Investment Decrease Forward Contract Increase
Other Comprehensive Income Other Comprehensive Income
Other Comprehensive Income Net Income
Net Income Net Income
Net Income Other Comprehensive Income

Net Income Net Income
The hedge of a foreign currency available-for-sale investment is a fair value hedge. Therefore, the change in values of both the investment (hedged item) and the forward contract (hedging instrument) will be reported in current net income. Only 80% of the change in the value of the forward contract will be reported in net income as offsetting the change in value of the investment, but the other 20% also will be reported in net income as a speculative gain.

138

Which of the following statements concerning the hedging of an investment in a foreign operation is/are correct?

I. The hedged item is the result of translating the foreign operation's financial statements.

II. Only forward contracts can be used to hedge an investment in a foreign operation.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

A. I only.

139

Pinco, a U.S. entity, has a 100% owned subsidiary, Sinco, located in a foreign country. In order to hedge its investment in the foreign operation, Pinco has a long-term borrowing in the same foreign currency in an amount approximating its net equity in the subsidiary. For 2008, the translated value of Sinco's balance sheet decreased by $40,000, and the converted value of Pinco's long-term debt decreased by $42,000. Which one of the following is the amount that Pinco should recognize in current income for 2008?

A. $-0-
B. $2,000
C. $40,000
D. $42,000

B. $2,000
Since Pinco designated the long-term borrowing to hedge its investment in its foreign operation, the amount of the change in the borrowing equal to the amount of the change in the translated value of the investment should be reported as a translation adjustment (along with the change in the translated value of the investment), and the balance should be reported in current income. Therefore, Pinco should report $42,000 - $40,000 = $2,000 in current income.

140

Which of the following statements concerning the hedging of recognized foreign currency assets or liabilities is/are correct?

I. The hedged asset or liability already has been booked by the hedging entity.

II. The hedged asset or liability must be denominated in a foreign currency.

III. The hedge can be treated only as a fair value hedge.

A. I only.
B. I and II, only.
C. I and III, only.
D. I, II, and III.

B. I and II, only.
Both Statements I and II are correct; Statement III is not correct. It is correct that in hedging a recognized foreign currency asset or liability the hedged item (asset or liability) has been booked by the hedging entity (Statement I) and that the hedged asset or liability must be denominated in a foreign currency (Statement II). Statement III is not correct; the hedge of a recognized foreign currency asset or liability generally can be treated either as a cash flow hedge or as a fair value hedge, generally, at management’s discretion.

141

On December 12, 2008, Averseco entered into a forward exchange contract to purchase 100,000 units of a foreign currency in 90 days. The contract was designated as and qualified as a fair value hedge of a purchase of inventory made that day and payable in March 2009. The relevant direct exchange rates between the foreign currency and the dollar are as follows:
Spot Rate Forward Rate
(for March 12, 2009)
December 12, 2008 $0.88 $0.90
December 31, 2008 0.98 0.93
At December 31, 2008, what amount of foreign currency transaction net gain or loss should Averseco recognize in income as a result of its foreign currency obligation and related hedge contract? (Ignore premium/discount and present value considerations.)

A. $-0-
B. $3,000
C. $7,000
D. $10,000

C. $7,000
The net loss will be $7,000. The gain or loss on the payable will be measured as the number of foreign currency units multiplied by the change in the spot rate between the date the liability arose, December 12, and the end of the year, December 31. Thus, the loss on the payable will be 100,000 foreign currency units x ($0.98 - $0.88 = $0.10) = $10,000. The gain or loss on the forward contract (disregarding any premium/discount at initiation of the contract and without using a present value factor) will be measured as the number of foreign currency units multiplied by the change in the forward rate between the date the contract was executed, December 12, and the end of the year, December 31. Thus, the gain on the forward contract will be 100,000 foreign currency units x ($0.93 - $0.90 = .03) = $3,000. The net will be $10,000 - $3,000 = $7,000, the correct answer.

142

Tramco has an investment classified as available-for-sale which is denominated in 80,000 units of a foreign currency. In order to hedge its investment, Tramco acquired a forward exchange contract for 100,000 units of the foreign currency in which its investment is denominated. During the year, the value of the investment decreased $9,000 and the value of the forward contract increased by $10,000. For the year, which one of the following amounts should Tramco recognize from the forward contract as hedging (offsetting) the decrease in value of the investment?

A. $-0-
B. $8,000
C. $9,000
D. $10,000

B. $8,000
Because the forward contract was designated as hedging the investment, a change in the value of the investment would be offset by a change in the value of the forward contract. However, because the amount of the forward contract (100,000 foreign currency units) exceeded the amount of the investment being hedged (80,000 foreign currency units - FCU), only 80,000 FCU/100,000 FCU = .80 of the change in the forward contract can be used to offset a change in the investment. The other .20 change in the forward contract must be treated as speculative. Therefore, .80 of the $10,000 change in the value of the contract, or $8,000, can be used to offset the $9,000 change in the value of the investment. The other $2,000 must be treated as a speculative gain.

143

A balance arising from the translation or remeasurement of a subsidiary's foreign currency financial statements is reported in the consolidated income statement when the subsidiary's functional currency is the:
Foreign currency U.S. dollar
No No
No Yes
Yes No
Yes Yes

No Yes
Two different methods can be used for converting the financial statements of a foreign subsidiary, either translation or remeasurement. Which method is used depends on the functional currency of the foreign subsidiary. If the local foreign currency is the functional currency, the statements are translated. If the U.S. dollar is the functional currency, the statements are remeasured. Remeasurement gains and losses affect the income statement, while translation gains or losses are carried directly to an equity account, bypassing the income statement entirely.
This response is correct because a balance arising from remeasurement is reported in the income statement whenever the U.S. dollar is the functional currency (which requires that the financial statements be remeasured).

144

Eagle, Inc. is a manufacturer and distributor of consumer products in the U.S. It has a wholly owned foreign subsidiary, El Rio, which sells Eagle products in Mexico. El Rio receives all of its products from Eagle, sells those products, and remits the proceeds to Eagle. El Rio maintains its books and prepares its financial statements in the Mexican peso. Which one of the following methods will Eagle most likely use to convert El Rio's financial statements to dollar-based statements?

A. Translation.
B. Remeasurement.
C. Translation and then remeasurement.
D. Remeasurement and then translation.

B. Remeasurement. Because El Rio's operations are a direct extension of Eagle, the peso is not El Rio's functional currency.

145

Remeasurement, based on the temporal method of conversion, converts foreign currency amounts to reporting currency amounts using different exchange rates for different accounts based on which of the following distinctions?

A. Current and non-current.
B. Monetary and non-monetary.
C. Asset and liability.
D. Income statement and balance sheet.

B. Monetary and non-monetary.

146

Which one of the following would not be remeasured using a historic exchange rate?

A. Cash.
B. Inventories carried at cost.
C. Property, plant, and equipment.
D. Common stock.

A. Cash.
Under the remeasurement method of converting financial statements from a foreign currency to a reporting currency, monetary assets and liabilities are converted using the current exchange rate, not a historic exchange rate. Therefore, cash (the most monetary of assets) would be converted using the current exchange rate, not a historic exchange rate.

147

Papco, a U.S. entity, has a subsidiary, Sapco, located in a foreign country. Sapco is essentially a sales unit for Papco. After remeasuring Sapco's financial statements from the foreign currency to Papco's reporting currency, Papco determined that it had a loss on the remeasurement. How should Papco report the loss in its consolidated financial statements?

A. As an extraordinary loss.
B. As income from continuing operations.
C. As an item of other comprehensive income.
D. As a deferred item until the subsidiary is sold.

B. As income from continuing operations.
Under the remeasurement method of converting from a foreign currency to a reporting currency, any resulting loss (or gain) is reported as an item of income from continuing operations in current income.

148

Panco, a U.S. entity, has a subsidiary, Sanco, located in a foreign country. Sanco's operations are concentrated in the country in which it is located and are essentially independent of Panco. The economy of the foreign country is not highly inflationary. Sanco prepared the following shortened financial statements in its local currency, the FCU, for the fiscal year ended December 31, 2008:

Statement of Net Income and FCUs
Comprehensive Income (2008) (in 000)
Sales 12,000
COGS (4,000)
Depreciation Expense (1,000)
Other Expenses (3,000)
Net Income 4,000
Other Comprehensive Income 0
Comprehensive Income 4,000
Retained Earnings (2008)
Beginning Retained Earnings (end 2007) 6,000
Add: Net Income (2008) 4,000
Deduct: Dividends (2008) (1,000)
Ending Retained Earnings 9,000
Balance Sheet (12/31/2008)
Cash and Account Receivable 2,000
Inventory 6,000
Fixed Assets 10,000
Total Assets 18,000
Liabilities 2,000
Common Stock 7,000
Retained Earnings 9,000
Subtotal 18,000
Accumulated Other Comprehensive Income 0
Total Liabilities + Equity 18,000
The following exchange rates were available:

Historic exchange rate when Sanco was established by Panco: 1 FCU = $1.200
Weighted average exchange rate for 2008: 1 FCU = $1.300
Spot exchange rate at date dividend declared: 1 FCU = $1.290
Spot exchange rate at December 31, 2008: 1 FCU = $1.310
Which one of the following is the amount (in 000) of Sanco's dividends declared and paid in 2008 in U.S. dollars?

A. $1,000
B. $1,290
C. $1,300
D. $1,310

B. $1,290
Since translation should be used to convert Sanco's financial statements expressed in FCUs to U.S. dollars, dividends declared should be translated at the exchange rate in effect when the dividends were declared (the same would be true for remeasurement). In this case, the exchange rate is given as 1 FCU = $1.290. Therefore, the correct dollar amount of Sanco's dividends declared would be 1,000 FCUs x $1.290 = $1,290.

149

Which of the following statements concerning the determination of a functional currency is/are correct?

I. The functional currency can be selected at management's discretion.

II. The functional currency could be the recording currency of the foreign entity.

III. The functional currency could be the reporting currency of a parent.

A. I only.
B. I and II, only.
C. II and III, only.
D. I, II, and III.

C. II and III, only.

150

The financial statements expressed in a foreign currency that need to be converted to a domestic currency could be the financial statements of a/an:

Equity Investee Subsidiary to be Consolidated
Yes Yes
Yes No
No Yes
No No


Equity Investee Subsidiary to be Consolidated
Yes Yes

151

Which of the following could be the functional currency of a foreign subsidiary?

I. The recording currency of the foreign subsidiary.

II. The reporting currency of the subsidiary's parent.

III. A currency other than either the recording currency of the foreign subsidiary or the reporting currency of the subsidiary's parent.

A. I only.
B. II only.
C. I and II, only.
D. I, II, and III.

D. I, II, and III.

152

Operating transactions denominated in a foreign currency are converted to the functional currency using the:
A. Historic exchange rate.
B. Current exchange rate.
C. Average exchange rate.
D. Forward exchange rate.

B. Current exchange rate.

153

Determining a foreign subsidiary's functional currency will take into account which of the following?

I. The extent to which the subsidiary operates, and generates and expends cash in the local foreign economy in which it is located.

II. The cumulative inflation rate in the local foreign economy in which it is located.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

C. Both I and II.

154

Douglas Co. leased machinery with an economic useful life of 6 years. For tax purposes, the depreciable life is 7 years. The lease is for 5 years, and Douglas can purchase the machinery at fair market value at the end of the lease.
What is the depreciable life of the leased machinery for financial reporting?

A. Zero
B. 5 years
C. 6 years
D. 7 years

B. Because Douglas neither obtains ownership of the machinery at the end of the lease nor has a written option to purchase the machinery at a bargain price, the equipment will be depreciated over the life of the lease, which is 5 years.5 years

155

On January 2, 2004, Cole Co. signed an 8-year noncancelable lease for a new machine, requiring $15,000 annual payments at the beginning of each year.
The machine has a useful life of 12 years, with no salvage value. Title passes to Cole at the lease expiration date. Cole uses straight-line depreciation for all of its plant assets. Aggregate lease payments have a present value on January 2, 2004 of $108,000, based on an appropriate rate of interest.

For 2004, Cole should record depreciation (amortization) expense for the leased machine at

A. $0.
B. $9,000.
C. $13,500.
D. $15,000.

B. $9,000.
Title to the asset passes to the lessee. Therefore, the lessee depreciates the leased asset over its entire useful life of 12 years. Depreciation expense is $9,000 ($108,000/12).

156

On June 30, 2004, Lang Co. sold equipment with an estimated useful life of 11 years and immediately leased it back for 10 years. The equipment's carrying amount was $450,000; the sales price was $430,000; and the present value of the lease payments, which is equal to the fair value of the equipment, was $465,000. In its June 30, 2004 balance sheet, what amount should Lang report as deferred loss?
A. $35,000
B. $20,000
C. $15,000
D. $0

Deferred loss = CV - sales price

B. $20,000
The loss on the sale is $20,000 ($450,000 carrying value - $430,000 sales price). But the fair value of the asset exceeds carrying value.
Thus, the firm has only an "artificial" loss. This loss will most likely be made up by lowering the lease payments on the leaseback. The entire loss is deferred. Whenever the market value exceeds carrying value, a "true" loss has not occurred on the sale and the loss is deferred.

157

Early in 20x3, Shifter, Inc. wrote put options for 1,000 shares of its common stock. Purchasers of the options can sell Shifter stock back to Shifter for $20 per share on 12/31/x3. The estimated fair value of each option is $2 at the time of sale. At 12/31/x3, the share price is $15 and the options are exercised. As a result, Shifter
A. Recognizes a $3,000 loss.
Shifter paid $5,000 more for the treasury stock than its fair value: 1,000 shares x ($20 - $15). The $2,000 fee (1,000 x $2) offsets that loss yielding a net loss of $3,000.
B. Recognizes a $5,000 loss.
The $2,000 fee received offsets the loss by that amount. If there were no fee, this response would be correct.
C. Increases the treasury stock account $20,000 upon purchase.
D. Decreases contributed capital $3,000.

A. Recognizes a $3,000 loss.
Shifter paid $5,000 more for the treasury stock than its fair value: 1,000 shares x ($20 - $15). The $2,000 fee (1,000 x $2) offsets that loss yielding a net loss of $3,000.

158

Winn Co. manufactures equipment that is sold or leased. On December 31, 2005, Winn leased equipment to Bart for a 5-year period ending December 31, 2010, at which date ownership of the leased asset transferred to Bart.
Equal payments under the lease were $22,000 (including $2,000 executory costs) and were due on December 31 of each year.
The first payment was made on December 31, 2005. Collectability of the remaining lease payments was reasonably assured, and Winn had no material cost uncertainties. The normal sales price of the equipment was $77,000, and cost was $60,000.
For the year ending December 31, 2005, what amount of income should Winn realize from the lease transaction?

A. $17,000
B. $22,000
C. $23,000
D. $33,000

A. $17,000
This is a capital lease to the lessor because ownership is transferred to the lessee. There is no interest revenue in 2005 because the lease inception and the balance sheet date are the same. The first payment, thus, includes no interest.
The lease is a sales-type lease to the lessor because the normal selling price of $77,000 exceeds the cost of $60,000. The difference of $17,000 is the dealer profit to be recognized in 2005. There is no other income to be recognized in 2005.

159

At the inception of a capital lease, the guaranteed residual value should be
A. Included as part of minimum lease payments at present value.
B. Included as part of minimum lease payments at future value.
C. Included as part of minimum lease payments only to the extent that guaranteed residual value is expected to exceed estimated residual value.
D. Excluded from minimum lease payments.

A. Included as part of minimum lease payments at present value.

160

Allam, Inc. contracted for services to be provided over a period of time with full payment in Allam's $2 par common stock when the service is completed. At the time of the agreement, Allam stock was trading at $20 per share. The agreed-upon total value of the contract is $20,000. When the service was completed, Allam's stock price was $25 per share. Therefore, Allam
A. Recognizes $25,000 of expense.
B. Increases the common stock account $1,600.
C. Increases contributed capital in excess of par $23,000.
D. Debits a liability for $25,000.

B. Increases the common stock account $1,600.
The value of the stock to be issued is $20,000. At time of issuance, the stock price is $25. Therefore, 800 shares are issued ($20,000/$25). The par value of the stock is $2, requiring a credit of $1,600.

161

An asset with a market value of $100,000 is leased on 1/1/x1. The lease is a capital lease for both parties. Five annual lease payments are due each December 31 beginning 12/31/x1. The unguaranteed residual value on 12/31/x5, the last day of the lease term, is estimated at $40,000. The lessor's implicit interest rate is 8%. Compute the lessor's net lease receivable immediately after the first lease payment is received. Present value factors for 5 years at 8% are: 3.99271 and 0.68058.

A. $112,908
B. $57,073
C. $89,773
D. $92,000

C. $89,773
The lease payment (LP) is computed as: $100,000 = LP(3.99271) + $40,000(0.68058). Solving, LP = $18,227. The initial gross lease receivable balance is 5($18,227) $40,000 or $131,135. Unearned interest is recorded for $31,135 ($131,135 - $100,000) at inception. Interest revenue for the first year is $8,000 (= $100,000 x .08). The journal entry for the first lease payment is: dr. Cash $18,227, dr. unearned interest $8,000, cr. interest revenue $8,000, cr. lease receivable $18,227. The decrease in net lease receivable is $18,227 - $8,000 or $10,227. The ending net lease receivable at year end is $100,000 - $10,227 = $89,773.

162

An inventory loss from a market price decline occurred in the first quarter, and the decline was not expected to reverse during the fiscal year.
However, in the third quarter, the inventory's market price recovery exceeded the market decline that occurred in the first quarter.
For interim financial reporting, the dollar amount of net inventory should:

A. Decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the decrease in the first quarter.
B. Decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the market price recovery.
C. Decrease in the first quarter by the amount of the market price decline and not be affected in the third quarter.
D. Not be affected in either the first quarter or the third quarter.

A. Decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the decrease in the first quarter.
When interim period inventory market value declines are not considered temporary (not expected to reverse), they are recognized in the quarter in which the decline occurs. Later recoveries are recognized as gains to the extent of previous losses only. The inventory may not be marked up above cost.

163

On April 1, year 1, Hall Fitness Center leased its gym to Dunn Fitness Center under a four-year operating lease. Hall normally charges $6,000 per month to lease its gym, but as an incentive, Hall gave Dunn half off the first year's rent, and one-quarter off the second year's rent. Dunn's rental payments were as follows:
Year 1 12 x $3,000 = $36,000
Year 2 12 x $4,500 = $54,000
Year 3 12 x $6,000 = $72,000
Year 4 12 x $6,000 = $72,000
Dunn's rent payments were due on the first day of the month, beginning on April 1, year 1. What amount should Dunn report as rent expense in its monthly income statement for April, year 3?

A. $3,000
B. $4,500
C. $4,875
D. $6,000

C. $4,875
In the absence of information to the contrary, the lessee is assumed to receive the same benefit from the asset each period. Therefore, rent expense for an operating lease is recognized evenly over the lease term, regardless of the pattern of payments. The sum of the lease payments is $234,000 (= $36,000 + $54,000 + $72,000 + $72,000). With four years or 48 months in the term, rent expense for each month in the term is $4,875 (= $234,000/48).

164

Jay's lease payments are made at the end of each period. Jay's liability for a capital lease would be reduced periodically by the
A. Minimum lease payment less the portion of the minimum lease payment allocable to interest.
B. Minimum lease payment plus the amortization of the related asset.
C. Minimum lease payment less the amortization of the related asset.
D. Minimum lease payment.

A. Minimum lease payment less the portion of the minimum lease payment allocable to interest.

165

Kell Corp. reported $111,000 of net income for the quarter ended September 30, 2005. Additional information for the quarter:

A $60,000 gain from discontinued operation, realized on April 30, 2005, was allocated equally to the second, third, and fourth quarters of 2005.
A $16,000 cumulative-effect adjustment (dr.) resulting from a change in inventory valuation method was recognized on August 2, 2005. The new method was used for the quarter ended September 30. The $111,000 earnings amount does not reflect the cumulative effect.
In addition, Kell paid $48,000 on February 1, 2005, for 2005 calendar-year property taxes. Of this amount, $12,000 was allocated to the third quarter of 2005.

For the quarter ended September 30, 2005, Kell should report net income of:

A. $91,000
B. $75,000
C. $111,000
D. $95,000

A. $91,000
The gain from discontinued operations should be recognized entirely in the second quarter. There is no meaningful basis on which to allocate the gain. It is a one-time occurrence. The cumulative effect is not recognized in income. The firm's treatment of the property tax cost is correct. The cost relates to the entire year. Therefore, each quarter should bear 1/4 of the cost.
Third quarter net income = $91,000 = $111,000 - $60,000/3.

166

On July 1, 2004, Gee, Inc. leased a delivery truck from Marr Corp. under a 3-year operating lease. Total rent for the term of the lease was $36,000, payable as follows:

12 months at $500 = $6,000
12 months at $750 = 9,000
12 months at $1,750 = 21,000
All payments were made when due. In Marr's June 30, 2006 balance sheet, the accrued rent receivable should be reported as

A. $0.
B. $9,000.
C. $12,000.
D. $21,000.

B. $9,000.

The amount of rent revenue (expense) to be recognized each year is $12,000 ($36,000/3) - this is the straight-line basis.
As of 6/30/06, 2 years or two-thirds of the lease term has elapsed. Therefore, $24,000 of rent revenue has been recognized, but only $15,000 cash has been received to that point.

Therefore, the lessor has $9,000 in rent receivable for the revenue recognized but not yet received in cash.

167

Glade Co. leases computer equipment to customers under direct-financing leases.
The equipment has no residual value at the end of the lease, and the leases do not contain bargain purchase options. Glade wishes to earn 8% interest on a 5-year lease of equipment with a fair value of $323,400. The present value of an annuity due of $1 at 8% for 5 years is 4.312.

What is the total amount of interest revenue that Glade will earn over the life of the lease?

A. $51,600
B. $75,000
C. $129,360
D. $139,450

A. $51,600
Total interest over the term equals the difference between total lease payments and the fair value of the property at inception. The lease payment is $75,000 ($323,400/4.312). Thus, total interest is 5($75,000) - $323,400 = $51,600.

168

A 6-year capital lease entered into on December 31, 2005 specified equal minimum annual lease payments due on December 31 of each year. The first minimum annual lease payment, paid on December 31, 2005, consists of which of the following?
Interest expense Lease liability
Yes Yes
Yes No
No Yes
No No

No Yes
The first payment, which is made at inception, is completely a principal payment because no time has elapsed in the lease term. Thus, the entire payment is applied to principal and reduces the lease liability by the amount of the payment.

169

On December 31, 2005, Roe Co. leased a machine from Colt for a 5-year period. Equal annual payments under the lease were $105,000 (including $5,000 annual executory costs) and were due on December 31 of each year.
The first payment was made on December 31, 2005, and the second payment was made on December 31, 2006.
The five lease payments were discounted at 10% over the lease term. The present value of minimum lease payments at the inception of the lease and before the first annual payment was $417,000. The lease was appropriately accounted for as a capital lease by Roe.

In its December 31, 2006 balance sheet, Roe should report a lease liability of

A. $317,000.
B. $315,000.
C. $285,300.
D. $248,700.

C. $285,300.
This answer fails to reduce the initial lease liability by $100,000 before computing the reduction in the lease liability for 2006.
The portion of each lease payment that is applied to interest and principal (reduction of the lease liability) is $100,000 ($105,000 - $5,000). The executory costs are applied to maintenance, property taxes, and insurance.
The lease liability after the first payment (at inception, December 31, 2005) is $317,000 ($417,000 - $100,000).

Entry at December 31, 2006
Interest expense ($317,000 x .10) 31,700
Lease liability 68,300
Cash 100,000
The ending lease liability at December 31, 2006 is $248,700 = $317,000 - $68,300.

170

What information about estimates is not required to be disclosed?
A. That estimates involve assumptions about future events
B. Possible material financial statement effects of estimate changes
C. That estimates are required in preparing financial statements
Firms are required to communicate the use of estimates in the preparation of financial statements.
D. The old and new estimate in quantitative terms

D. The old and new estimate in quantitative terms

171

In 2005, Ball Labs incurred the following costs:

Direct costs of doing contract research and development work for the government to be reimbursed by governmental unit $400,000
Research and development costs not included above were:
Depreciation $300,000
Salaries 700,000
Indirect costs appropriately allocated 200,000
Materials 180,000
What was Ball's total research and development expense in 2005?

A. $1,080,000
B. $1,380,000
C. $1,580,000
D. $1,780,000

B. $1,380,000
The sum of $1,380,000 is the firm's research and development expense for 2005 ($300,000 + $700,000 + $200,000 + $180,000).

Depr. + Salaries + Indirect costs + Materials

Not direct costs, because they reduce net contract revenue.

172

Which of the following is not a source of risk and uncertainty for which disclosures are required by GAAP?
A. Nature of a firm's operations
B. Effect of changes in government regulations
C. Use of estimates in financial statements
The use of estimates in financial statements is one of the four sources noted in the applicable standard.
D. Vulnerability to significant concentrations

B. Effect of changes in government regulations

173

Campbell Corp. exchanged delivery trucks with Highway, Inc. Campbell's truck originally cost $23,000, its accumulated depreciation was $20,000, and its fair value was $5,000. Highway's truck originally cost $23,500, its accumulated depreciation was $19,900, and its fair value was $5,700. Campbell also paid Highway $700 in cash as part of the transaction. The transaction lacks commercial substance. What amount is the new book value for the truck Campbell received?

A. $5,700
B. $5,000
C. $3,700
D. $3,000

C. $3,700
When a transaction lacks commercial substance and cash is paid, the new asset is recorded at the book value of the old asset plus any cash given. Campbell has the same economic position as before the exchange - a different truck used in the same manner and $700 less cash. The new truck is the BV of the old asset ($3,000) plus the cash paid ($700) or $3,700.

174

Yellow Co. spent $12,000,000 during the current year developing its new software package. Of this amount, $4,000,000 was spent before it was at the application development stage and the package was only to be used internally. The package was completed during the year and is expected to have a 4-year useful life.
Yellow has a policy of taking a full-year's amortization in the first year. After the development stage, $50,000 was spent on training employees to use the program.

What amount should Yellow report as an expense for the current year?

A. $1,600,000
B. $2,000,000
C. $6,012,500
D. $6,050,000

D. $6,050,000
There are three expenses to be recognized:
(1) software development costs incurred before the application development stage was reached, $4,000,000;
(2) amortization of capitalized software development costs incurred after the application development stage was reached, $8,000,000/4 = $2,000,000;
(3) $50,000 training costs.
The sum of these is $6,050,000.

175

In a barter transaction where advertising services provided are exchanged for advertising services received, under which of the following situations can the advertising provider recognize revenue for the services performed? Assume the accounting is under IFRS guidelines.
A. When the advertising services in the exchange are similar
B. When the fair value of the advertising services received can be reliably measured
C. When there is a nonbarter transaction for similar advertising services that can be reliably measured with the same counterparty
D. When there is a nonbarter transaction for similar advertising services that can be reliably measured with a different counterparty

D. When there is a nonbarter transaction for similar advertising services that can be reliably measured with a different counterparty

176

Vik Auto and King Clothier exchanged goods, held for resale, with equal fair values. Each will use the other's goods to promote their own products. The retail price of the car that Vik gave up is less than the retail price of the clothes received.
There is commercial substance to the exchange.
What profit should Vik recognize for the nonmonetary exchange?

A. A profit is not recognized.
B. A profit equal to the difference between the retail prices of the clothes received and the car.
C. A profit equal to the difference between the retail price and the cost of the car.
D. A profit equal to the difference between the fair value and the cost of the car.

D. A profit equal to the difference between the fair value and the cost of the car.

177

On December 31, 2004, Byte Co. had capitalized software costs of $600,000 with an economic life of 4 years. Sales for 2005 were 10% of expected total sales of the software.
At December 31, 2005, the software had a net realizable value of $480,000.
In its December 31, 2005 balance sheet, what amount should Byte report as net capitalized cost of computer software?

A. $432,000.
B. $450,000
C. $480,000
D. $540,000

B. $450,000

Costs incurred (after technological feasibility has been established) in developing software for sale, lease, or licensing are capitalized and subsequently amortized. Annual amortization is the greater of:
1. The percentage of expected total revenues earned during the period multiplied by total capitalized amount, OR
2. Straight-line amortization based on expected life.
$600,000 costs * 10% = $60,000 amortization.
$600,000 costs/4 years = $150,000 amortization.

$150,000 is greater.

$600,000 - $150,000 = $450,000.

178

Which of the following qualifies as a reportable operating segment?
A. Corporate headquarters, which oversees $1 billion in sales for the entire company
B. North American segment, whose assets are 12% of the company's assets of all segments, and management reports to the chief operating officer
C. South American segment, whose results of operations are reported directly to the chief operating officer, and has 5% of the company's assets, 9% of revenues, and 8% of the profits
D. Eastern Europe segment, which reports its results directly to the manager of the European division, and has 20% of the company's assets, 12% of revenues, and 11% of profits

B. North American segment, whose assets are 12% of the company's assets of all segments, and management reports to the chief operating officer
Only the North American segment meets at least one of the three quantitative criteria at the 10% level (revenue, income, assets) AND reports to the chief operating decision maker of the firm as a whole. For all three criteria, the segment must account for 10% or more of the combined amount for all operating segments. Reporting to the company-wide chief operating decision maker is also a requirement of an operating segment.

179

A company exchanged land with an appraised value of $50,000 and an original cost of $20,000 for machinery with a fair value of $55,000. Assuming that the transaction has commercial substance, what is the gain on the exchange?
A. $0
B. $5,000
C. $30,000
D. $35,000

000 = $30,000.
C. $30,000
The gain on an exchange of nonmonetary assets is based on the fair value and book value of the asset exchanged. The land with a fair value of $50,000 is given for machinery. The company is using the land as legal tender. The gain will be the difference between the book value and the fair value of the asset given or $50,000 - $20,000 = $30,000.

180

Slate Co. and Talse Co. exchanged similar plots of land with fair values in excess of carrying amounts. In addition, Slate received cash from Talse to compensate for the difference in land values.
The exchange lacks commercial substance.
As a result of the exchange, Slate should recognize

A. A gain equal to the difference between the fair value and the carrying amount of the land given up.
B. A gain in an amount determined by the ratio of cash received to total consideration.
C. A loss in an amount determined by the ratio of cash received to total consideration.
D. Neither a gain nor a loss.

B. A gain in an amount determined by the ratio of cash received to total consideration.
When commercial substance is lacking, gains are recognized in proportion to the amount of cash received.

181

Solen Co. and Nolse Co. exchanged trucks with fair values in excess of carrying amounts. In addition, Solen paid Nolse to compensate for the difference in truck values.
The exchange lacks commercial substance.
As a consequence of the exchange, Solen recognizes

A. A gain equal to the difference between the fair value and carrying amount of the truck given up.
Solen does have an unrecognized holding gain in this amount, but it is not recognized on the exchange because it lacks commercial substance.
A gain is recognized on the exchange of nonmonetary assets only to the extent of cash received when there is no commercial substance. Solen paid cash on the exchange and therefore recognizes no gain.

The rationale is that Solen is in the same economic position after the exchange as before.

A. A gain equal to the difference between the fair value and carrying amount of the truck given up.
B. A gain determined by the proportion of cash paid to the total consideration.
C. A loss determined by the proportion of cash paid to the total consideration.
D. Neither a gain nor a loss.

D. Neither a gain nor a loss.
Solen has an implied gain given that the fair value of its asset exceeds its book value. But when there is no commercial substance, such gains are recognized only when cash is received. Solen paid cash on the exchange.

182

Amble, Inc. exchanged a truck with a carrying amount of $12,000 and a fair value of $20,000 for a truck and $5,000 cash. The fair value of the truck received was $15,000.
At what amount should Amble record the truck received in the exchange assuming the exchange lacks commercial substance?

A. $7,000
B. $9,000
C. $12,000
D. $15,000

D. $15,000
There is an implied gain of $8,000, the difference between the $20,000 fair value of the old asset and its $12,000 book value. Because the proportion of cash received is 25% ($5,000/$20,000), the entire gain is recognized and the acquired asset is recognized at fair value ($15,000).
Note that the answer would be the same had there been commercial substance.

183

On June 30, 2005, Finn, Inc. exchanged 2,000 shares of Edlow Corp. $30 par value common stock for a patent owned by Bisk Co. The Edlow stock was acquired in 2003 at a cost of $50,000.
At the exchange date, Edlow common stock had a fair value of $40 per share, and the patent had a net carrying amount of $100,000 on Bisk's books.
Finn should record the patent at

A. $50,000.
B. $60,000.
C. $80,000.
D. $100,000.

C. $80,000.
The patent is valued at the market value of the stock exchanged, which is $80,000 ($40 x 2,000 shares).

184

Which of the following statements describes the proper accounting for losses when nonmonetary assets are exchanged for other nonmonetary assets?

A. A loss is recognized immediately, because assets received should not be valued at more than their cash-equivalent price.
B. A loss is deferred so that the asset received in the exchange is properly valued.
C. A loss, if any, which is unrelated to the determination of the amount of the asset received should be recorded.
D. A loss can occur only when assets are sold or disposed of in a monetary transaction.

A. A loss is recognized immediately, because assets received should not be valued at more than their cash-equivalent price.

185

Yola Co. and Zaro Co. are fuel oil distributors. To facilitate the delivery of oil to their customers, Yola and Zaro exchanged ownership of 1,200 barrels of oil without physically moving the oil. Yola paid Zaro $30,000 to compensate for a difference in the grade of oil.
On the date of the exchange, cost and market values of the oil were as follows:
Yola Co. Zaro Co.
Cost $100,000 $126,000
Market values 120,000 150,000
In Zaro's income statement, what amount of gain should be reported from the exchange of the oil?

A. $0
B. $4,800
C. $24,000
D. $30,000

A. $0
This exchange was made to facilitate a sale of inventory to customers.
Under FAS 153, this is one of the exceptions to measuring exchanges of nonmonetary assets at market value. In this case, the exchange is measured at book value; no gain or loss is recognized. The oil received by Zaro would be measured (debited) at book value ($126,000) less cash received ($30,000), or $96,000. Cash would be debited for $30,000. The oil exchanged would be credited for $126,000.
No gain or loss is recognized.

186

On December 31, 2004, Dirk Corp. sold Smith Co. two airplanes and simultaneously leased them back. Additional information pertaining to the sale-leasebacks follows:

Plane #1 Plane #2
Sales price $600,000 $1,000,000
Carrying amount, 12/31/04 $100,000 $550,000
Remaining useful life, 12/31/04 10 years 35 years
Lease term 8 years 3 years
Annual lease payments $100,000 $200,000
In its December 31, 2004 balance sheet, what amount should Dirk report as deferred gain on these transactions?

A. $950,000
B. $500,000
C. $450,000
D. $0

B. $500,000
Only the $500,000 gain ($600,000 - $100,000) on the sale-leaseback of plane #1 is deferred.
For both capital and operating leases, most gains and losses on the sale in a sale-leaseback are deferred. The gain or loss is an integral part of the transaction and should be recognized over the term of the lease. The exception is when the leaseback part of the transaction is minor. If the present value of the lease payments is 10% or less of the fair value of the property sold, then the leaseback part of the transaction is considered minor and the gain need not be deferred but rather is recognized immediately.

Given that the lease term is less than 10% of the useful life, in all probability the leaseback for plane #2 is a minor one.

187

Able sold its headquarters building at a gain and simultaneously leased back the building. The lease was reported as a capital lease.
At the time of sale, the gain should be reported as

A. Operating income.
B. A gain, net of income tax.
C. A separate component of stockholders' equity.
D. An asset valuation allowance.

D. An asset valuation allowance.
When an asset is sold and then leased back, the lessee defers the gain (subject to certain exceptions, which do not apply in this question). The deferred gain is recorded as a contra account to the leased asset in a capital lease.

188

On December 31, 2005, Bain Corp. sold a machine to Ryan and simultaneously leased it back for 1 year. Pertinent information at this date follows:
Sales price $360,000
Carrying amount 330,000
Present value of reasonable lease rentals ($3,000 for 12 months @ 12%) 34,100
Estimated remaining useful life 12 years

In Bain's December 31, 2005 balance sheet, the deferred revenue from the sale of this machine should be
A. $34,100.
B. $30,000.
C. $4,100.
D. $0.

D. $0.
This is a minor leaseback because the present value of the rentals is less than 10% of the fair value of the property; therefore, none of the gain is deferred. The conceptual basis for immediate recognition of the gain is that the sale is the dominant part of the transaction. The leaseback is a very minor part.

189

On June 1 of the current year, a company entered into a real estate lease agreement for a new building. The lease is an operating lease and is fully executed on that day. According to the terms of the lease, payments of $28,900 per month are scheduled to begin on October 1 of the current year and to continue each month thereafter for 56 months. The lease term spans five years. The company has a calendar year end. What amount is the company's lease expense for the current calendar year?
A. $86,700
B. $161,838
C. $188,813
D. $202,300

C. $188,813
The first four months of the lease term require no lease payments. However, each month bears the same lease expense under the matching principle because the firm will receive the same benefit from the lease each month. The monthly lease expense is the ratio of total lease payments to the length of the lease term in months. Lease payments total $1,618,400 ($28,900 x 56). The number of months in the lease term is 60 (5 x 12). Therefore the monthly lease expense is $1,618,400/60 = $26,973.33. The firm occupied the property for 7 months during the current calendar year (June - December inclusive). Therefore the lease expense for the current calendar year is $188,813 ($26,973.33 x 7). The fact that the first four months require no lease payment does not mean the firm has no lease expense during those months.

190

As an inducement to enter a lease, Graf Co., a lessor, granted Zep, Inc., a lessee, 12 months of free rent under a 5-year operating lease. The lease was effective on January 1, 2005, and provided for monthly rental payments to begin January 1, 2006. Zep made the first rental payment on December 30, 2005.
In its 2005 income statement, Graf should report rental revenue in an amount equal to

A. Zero.
B. Cash received during 2005.
C. One-fourth of the total cash to be received over the life of the lease.
D. One-fifth of the total cash to be received over the life of the lease.

D. One-fifth of the total cash to be received over the life of the lease.

191

On June 1, 2005, Oren Co. entered into a 5-year nonrenewable lease, commencing on that date, for office space and made the following payments to Cant Properties:

Bonus to obtain lease $30,000
First month's rent $10,000
Last month's rent $10,000
In its income statement for the year ending June 30, 2005, what amount should Oren report as rent expense?

A. $10,000
B. $10,500
C. $40,000
D. $50,000

B. $10,500
Rent expense is based on the straight-line method because it is assumed that the tenant will receive equal benefits each period. Therefore, the bonus is amortized into rent expense on the SL basis each year, resulting in a monthly rent expense of $10,500: $10,000 + $30,000/(60 months). The last month's rent is treated as prepaid rent until the last month of the contract, at which time it is expensed.
The income statement is dated 1 month after the rental contract commenced. Only 1 month's rent expense would be reported ($10,500).

192

A company enters into a three-year operating lease agreement effective January 1, year 1. The amounts due on the first day of each year are $25,000 in year 1, $30,000 in year 2, and $35,000 in year 3. What amount, if any, is the related liability on the first day of year 2?
A. $0
B. $5,000
C. $60,000
D. $65,000

B. $5,000
For operating leases, rent expense is recognized on a straight-line basis unless the lessee is receiving benefits from the leased asset in some other manner. This is true even if the payment schedule is uneven, as is the case here. Annual rent expense, therefore, is $30,000 [= ($25,000 + $30,000 + $35,000)/3]. As of 1/1/2, the lessee has recognized $30,000 of expense but paid only $25,000. Therefore, a liability of $5,000 is reported. The lessee owes $5,000 on this date because it has obtained $30,000 worth of use of the asset but paid only $25,000. This answer is correct assuming that the question is asking for the liability amount before the payment due 1/1/2 is made.

193

Wall Co. leased office premises to Fox, Inc. for a 5-year term beginning January 2, 2005.
Under the terms of the operating lease, rent for the first year was $8,000 and rent for years 2 through 5 was $12,500 per annum. However, as an inducement to enter the lease, Wall granted Fox the first 6 months of the lease rent free.

In its December 31, 2005 income statement, what amount should Wall report as rental income?

A. $12,000
B. $11,600
C. $10,800
D. $8,000

C. $10,800
Rental income is recognized on the straight-line basis for operating leases. The schedule of rental receipts does not affect how annual rental income is recognized. Thus, annual rental income to be recognized is $10,800 = [($4000) + 4($12,500)]/5. The trick here is to remember to use only one-half the first year's rent because that is all that will be received the first year.

194

On December 1, 2004, Clark Co. leased office space for 5 years at a monthly rate of $60,000. On the same date, Clark paid the lessor the following amounts:

First month's rent $60,000
Last month's rent $60,000
Security deposit (refundable at lease expiration) $80,000
Installation of new walls and offices $360,000
What should be Clark's 2004 expense relating to utilization of the office space?

A. $60,000
B. $66,000
C. $120,000
D. $140,000

B. $66,000
Rent expense + amortization of leasehold improvements = total expense related to utilizing the office space. Rent expense ($60,000) + Amortization ($360,000/60) = $66,000.

Although the last month's rent was paid in 2004, that amount is a prepayment of rent to be recognized as rent expense in the last month of the lease.

195

Green Co. incurred leasehold improvement costs for its leased property. The estimated useful life of the improvements was 15 years. The remaining term of the nonrenewable lease was 20 years. These costs should be
A. Expensed as incurred.
B. Capitalized and depreciated over 20 years.
C. Capitalized and expensed in the year in which the lease expires.
D. Capitalized and depreciated over 15 years.

D. Capitalized and depreciated over 15 years.

196

On January 1, 2005, Wren Co. leased a building to Brill under an operating lease for 10 years at $50,000 per year, payable the first day of each lease year.
Wren paid $15,000 to a real estate broker as a finder's fee. The building is depreciating $12,000 per year.
For 2005, Wren incurred insurance and property tax expenses totaling $9,000. Wren's net rental income for 2005 should be

A. $27,500.
B. $29,000.
C. $35,000.
D. $36,500.

A. $27,500.
Net rental income = rent revenue - expenses associated with the property
= 50,000 - ($15,000/10 + $12,000 + $9,000) = $27,500
The finder's fee benefits the entire lease term and therefore is allocated evenly over the 10-year lease term.

197

On January 1, 2005, Glen Co. leased a building to Dix Corp. for a 10-year term at an annual rental of $50,000. At the inception of the lease, Glen received $200,000 covering the first 2 years' rent of $100,000 and a security deposit of $100,000.
This deposit will not be returned to Dix upon expiration of the lease but will be applied to payment of rent for the last 2 years of the lease.
What portions of the $200,000 should be shown as a current and long-term liability, respectively, in Glen's December 31, 2005 balance sheet?

Current liability Long-term liability
$0 $200,000
$50,000 $100,000
$100,000 $100,000
$100,000 $50,000

$50,000 $100,000
The ending total liability at 12/31/05 = $150,000
= $200,000 - $50,000 rent revenue earned in 2005
also:

= $50,000 for 2006 rent + $100,000 for last 2 years of rent in term
= current liability + noncurrent liability

The $50,000 liability for 2006 rent will be earned by the end of 2006 and thus is current as of 12/31/05. The $100,000 liability will not be earned for many years and thus is noncurrent as of 12/31/05.

198

On January 1, 2005, Park Co. signed a 10-year operating lease for office space at $96,000 per year.
The lease included a provision for additional rent of 5% of annual company sales in excess of $500,000. Park's sales for the year ending December 31, 2005 were $600,000.
Upon execution of the lease, Park paid $24,000 as a bonus for the lease.
Park's rent expense for the year ending December 31, 2005 was

A. $98,400.
B. $101,000.
C. $103,400.
D. $125,000.

C. $103,400.
Rent expense on an operating lease is recognized on a straight-line basis unless another basis is more appropriate based on the benefits to the lessee.
In this case, the $96,000 annual amount is recognized each year, on the assumption of equal benefits of the basic lease provisions each year. The same holds for the bonus because this amount was paid to secure the lease.

$2,400 is included in the rent expense each year ($24,000 total bonus/10-year term). However, the portion of the rent based on annual sales is recognized based on sales figures for each year. For 2005, this amount is .05($600,000 - $500,000) or $5,000. Adding the three amounts yields rent expense for 2005: $96,000 + $2,400 + $5,000 = $103,400.

199

On January 1, 2003, JCK Co. signed a contract for an 8-year lease of its equipment with a 10-year life.
The present value of the 16 equal semiannual payments in advance equaled 85% of the equipment's fair value. The contract had no provision for JCK, the lessor, to give up legal ownership of the equipment.
Should JCK recognize rent or interest revenue in 2005, and should the revenue recognized in 2005 be the same as or smaller than the revenue recognized in 2004?

2005 revenues recognized 2005 amount recognized compared to 2004
Rent The same
Rent Smaller
Interest The same
Interest Smaller

Interest Smaller

200

During January 2005, Vail Co. made long-term improvements to a recently leased building.
The lease agreement provides for neither a transfer of title to Vail nor a bargain purchase option. The present value of the minimum lease payments equals 85% of the building's market value, and the lease term equals 70% of the building's economic life.

Should assets be recognized for the building and the leasehold improvements?

Building Leasehold improvements
Yes Yes
No Yes
The lease is not a capital lease because title does not transfer to the lessee, there is no bargain purchase option, the lease term is not at least 75% of the useful life of the building, and the present value of the lease payments is not at least 90% of the fair value of the building. These are the four criteria for capitalizing a lease for the lessee and none are met.
The lease, therefore, is an operating lease. The improvements, therefore, are not capitalized to the building because there is no capitalized lease asset. The improvements are debited to leasehold improvements, an asset, and amortized over the remaining lease term or separate useful life, whichever is shorter.

Yes No
No No

Building No
Leasehold improvements
Yes

201

Main, a pharmaceutical company, leased office space from Ash. Main took possession and began to use the building on July 1, 2000. Rent was due the first day of each month. Monthly lease payments escalated over the 5-year period of the lease as follows:
Period Lease Payment
July 1, 2000 - September 30, 2000 $0 - rent abatement during move-in, construction
October 1, 2000 - June 30, 2001 17,500
July, 1, 2001 - June 30, 2002 19,000
July 1, 2002 - June 30, 2003 20,500
July 1, 2003 - June 30, 2004 23,000
July 1, 2004 - June 30, 2005 24,500
What amount would Main show as deferred rent expense at December 31, 2003?
A. $50,658
B. $52,580
C. $68,575
D. $71,550

D. $71,550
This is an operating lease. Thus, the rent expense should be recognized on a straight-line basis. Monthly rent expense would be
(12-3) x $17,500 = $157,500
12 x $19,000 = $228,000
12 x $20,500 = $246,000
12 x $23,000 = $276,000
12 x $24,500 = $294,000
Total = $1,201,500
1,201,500/60 months = $20,025 rent expense each month. The deferred rent expense at 12/31/2003 would be the difference between the monthly rent payment and the rent expense recognized each month multiplied by the number of months left on the lease. This would be
($23,000-$20,025) x 6 months = $17,850
($24,500-$20,025) x 12 months = $53,700

$17,850 + $53,700 = $71,550.

202

Oak Co. leased equipment for its entire 9-year useful life, agreeing to pay $50,000 at the start of the lease term on December 31, 2004 and $50,000 annually on each December 31 for the next 8 years. The present value on December 31, 2004 of the nine lease payments over the lease term, using the rate implicit in the lease, which Oak knows to be 10%, was $316,500. The December 31, 2004 present value of the lease payments using Oak's incremental borrowing rate of 12% was $298,500. Oak made a timely second lease payment. What amount should Oak report as capital lease liability in its December 31, 2005 balance sheet?
A. $350,000
B. $243,150
C. $228,320
D. $0

B. $243,150
The lessee uses 10% because it is the lower of the two rates and is known to the lessee. The lease liability balance immediately after the first payment (at inception) is $266,500 ($316,500 - $50,000). The first payment includes no interest because it is made immediately. The entry for the 12/31/05 payment is:
Lease liability 23,350
Interest expense .10($266,500) 26,650
Cash 50,000
The ending lease liability balance is $266,500 - $23,350 = $243,150.

203

On January 1, 2004, Harrow Co. as lessee signed a 5-year noncancelable equipment lease with annual payments of $100,000 beginning December 31, 2004.
Harrow treated this transaction as a capital lease. The five lease payments have a present value of $379,000 at January 1, 2004 based on interest of 10%.
What amount should Harrow report as interest expense for the year ending December 31, 2004?

A. $37,900
B. $27,900
C. $24,200
D. $0

A. $37,900
The beginning lease liability balance at 1/1/04 is $379,000. That balance is unchanged the entire year because the first lease payment is made 1 year later. Therefore, the interest expense for the first year is $37,900 (.10 x $379,000).

204

What are the components of the lease receivable for a lessor involved in a direct-financing lease?

A. The minimum lease payments plus any executory costs
B. The minimum lease payments plus residual value
C. The minimum lease payments less residual value
D. The minimum lease payments less initial direct costs

B. The minimum lease payments plus residual value

205

On December 31, 2005, Neal, Inc. leased machinery with a fair value of $105,000 from Frey Rentals Co. The agreement is a 6-year noncancelable lease requiring annual payments of $20,000 beginning December 31, 2005.
The lease is appropriately accounted for by Neal as a capital lease.
Neal's incremental borrowing rate is 11%. Neal knows the interest rate implicit in the lease payments is 10%.

The present value of an annuity due of $1 for 6 years at 10% is 4.7908.
The present value of an annuity due of $1 for 6 years at 11% is 4.6959.
In its December 31, 2005 balance sheet, Neal should report a lease liability of

A. $75,816.
B. $85,000.
C. $93,918.
D. $95,816.

A. $75,816.
The $75,816 lease liability at December 31, 2005 is the initial liability at inception less the first payment, which is completely a principal payment. The first payment occurs at inception and therefore could have no interest component. The initial liability at inception is the present value of an annuity due of six periods.

Ending 2005 lease liability = liability at inception - $20,000 first payment
= $20,000(4.7908) - $20,000
= $75,816
The lessee must use the lower of its incremental borrowing rate (11%) and the rate implicit in the lease (10%), hence the use of the 4.7908 present value factor.

206

A firm selling put options to sell the firm's stock
A. Increases owners' equity for the fair value of the options.
B. Does not recognize any change in its financial position at sale of the options.
C. Increases a liability for the fair value of the options.
D. Records an expense equal to the fair value of the options.

C. Increases a liability for the fair value of the options.

207

Choose the correct statement concerning transactions involving the issuance of shares in payment of obligations for goods and services.
A. When the value of shares to be issued is fixed, the number of shares to be issued is variable.
B. When the value of shares to be issued is fixed, the number of shares to be issued is fixed.
C. When the number of shares to be issued is fixed, the expense to be recorded is variable.
D. When the number of

A. When the value of shares to be issued is fixed, the number of shares to be issued is variable.

208

Renwood, Inc. contracted for services to be provided over a period of time in return for 2,000 shares of Renwood's $5 par common stock when the service is completed. At the time, Renwood stock was selling for $10 per share. When the service was completed, Renwood's stock price was $12 per share. Therefore, Renwood
A. Recognizes $24,000 of expense.
B. Increases the common stock account $12,000.
C. Increases contributed capital in excess of par $10,000.
D. Credits a liability for $20,000.

C. Increases contributed capital in eThe total owners' equity increase of $20,000 (2,000 shares x $10) is recorded at signing. Of that amount, the common stock account will receive $10,000 (2,000 shares x $5 par). Therefore, the remainder ($10,000) is allocated to contributed capital in excess of par. Subsequent changes in stock price do not change the total amount of OE recorded in excess of par $10,000.

209

Adel Inc. uses the allowance method of accounting for bad debts.
During 20x5, the financial condition of Botel Co., one of Adel's major customers, deteriorated rapidly due to accounting and other scandals. In February 20x6 it has become clear that Botel will go out of business, although the firm has not declared or been forced into formal bankruptcy proceedings. Adel's receivable from Botel, 9 months old as of the issuance of Adel's 20x5 financial statements, is 20 times the amount of bad debt expense otherwise reported by Adel.

How should the Botel situation be reflected in Adel's 20x5 financial statements?
A. No recognition other than that implied by the bad debt expense already recorded by Adel is necessary.
B. The footnotes should describe the potential loss, but no separate loss or expense for the Botel receivable should be recognized.
Footnote disclosure is appropriate, but a loss is probable and estimable and should also be recognized. The bad debt expense recognized for the period is inadequate.
C. A loss in the amount of the Botel receivable should be recognized along with appropriate footnote disclosure.
D. Increase bad debt expense by a percentage of the Botel receivable amount because bankruptcy has not been declared as of the issuance of the financial statements.

C. A loss in the amount of the Botel receivable should be recognized along with appropriate footnote disclosure.

210

A large manufacturing firm made two significant acquisitions around the close of 20x6 (assume a calendar fiscal year).

The first was to purchase all the outstanding voting stock of Pernod, Inc. in December 20x6. The second was to purchase 40% of the outstanding voting stock of Weynod, Inc. in January 20x7. The manufacturing firm's 20x6 financial statements were issued in February 20x7.

Choose the correct statement regarding the accounting for these acquisitions in the 20x6 financial statements of the manufacturing firm.

Pernod Weynod
consolidated described in the footnotes only
described in the footnotes only described in the footnotes only
consolidated apply equity method
apply equity method apply equity method

Pernod Weynod
consolidated described in the footnotes only

211

On March 21, year 2, a company with a calendar year end issued its year 1 financial statements. On February 28, year 2, the company's only manufacturing plant was severely damaged by a storm and had to be shut down. Total property losses were $10 million and determined to be material. The amount of business disruption losses is unknown. How should the impact of the storm be reflected in the company's year 1 financial statements?
A. Provide NO information related to the storm losses in the financial statements until losses and expenses become fully known.
B. Accrue and disclose the property loss with NO accrual or disclosure of the business disruption loss.
C. Do NOT accrue the property loss or the business disruption loss, but disclose them in the notes to the financial statements.
D. Accrue and disclose the property loss and additional business disruption losses in the financial statements.

C. Do NOT accrue the property loss or the business disruption loss, but disclose them in the notes to the financial statements.
This is a subsequent event that did not exist at the balance sheet date but occurred before the financial statements were issued. The company is required to make a footnote disclosure describing the nature of the event and an estimate of the financial effect, or a statement that an estimate cannot be made. Recognition is inappropriate because the condition existed after the balance sheet date.

212

Wizard Co. purchased two machines for $250,000 each on January 2, 2005.
The machines were put into use immediately. Machine A has a useful life of 5 years and can only be used in one research project. Machine B will be used for 2 years on a research and development project and then used by the production division for an additional 8 years. Wizard uses the straight-line method of depreciation.

What amount should Wizard include in 2005 research and development expense?

A. $75,000
B. $275,000
C. $375,000
D. $500,000

B. $275,000

Machine A (cost)
$250,000
Machine B ($250,000/10 years)
(amortization)25,000
Total R & D Expense (2005)
$275,000

213

What information should a public company present about revenues from foreign operations?
A. Disclose separately the amount of sales to unaffiliated customers and the amount of intracompany sales between geographical areas.
B. Disclose as a combined amount sales to unaffiliated customers and intracompany sales between geographical areas.
C. Disclose separately the amount of sales to unaffiliated customers but not the amount of intracompany sales between geographical areas.
D. No disclosure of revenues from foreign operations needs to be reported.

A. Disclose separately the amount of sales to unaffiliated customers and the amount of intracompany sales between geographical areas.

214

Cott Co.'s four business segments have revenues and identifiable assets expressed as percentages of Cott's total revenues and total assets as follows:
Revenues Assets
Ebon
64%
66%
Fair
14%
18%
Gel
14%
4%
Hak
__8%_
_12%_
100%
100%
======
======
Which of these business segments are deemed to be reportable segments?

A. Ebon only
B. Ebon and Fair only
C. Ebon, Fair, and Gel only
D. Ebon, Fair, Gel, and Hak

D. Ebon, Fair, Gel, and Hak
All four are reportable because each meets at least one of the criteria for a reportable segment. These criteria are based on 10% of revenues, profits, and assets. Even Gel and Hak, which are the smallest of the four, meet one of the criteria. Only one of the three criteria needs to be met in order for a segment to be a reportable segment.

215

In financial reporting of segment data, which of the following must be considered in determining if an industry segment is a reportable segment?
Sales to
unaffiliated
customers Intersegment
sales
Yes Yes
Yes No
No Yes
No No

Sales to
unaffiliated
customers Intersegment
sales
Yes Yes

216

Which of the following is an indication that a cloud computing arrangement includes a software license?
I. The customer has contractual right to take possession of the software at any time during the hosting period without significant penalty.
II. The cloud computing arrangement has an indefinite life because the contract is renewable indefinitely.
III. It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.
A. I., II., and III.
B. I. and II.
C. I. and III.
D. II. and III.

C. I. anOption II. is not a criterion for the cloud computing arrangement to contain a software license.d III.

217

Standard Co. spent $10,000,000 on its new software package that is to be used only for internal use. The amount spent is for costs after the application development stage. The economic life of the product is expected to be three years. The equipment on which the package is to be used is being depreciated over five years.
What amount of expense should Standard report on its income statement for the first full year?

A. $0
B. $2,000,000
C. $3,333,333
D. $10,000,000

C. $3,333,333
The useful life of the product is used rather than the useful life of the equipment because new software can be developed after three years for use on that equipment.

218

During 2004, Pitt Corp. incurred costs to develop and produce a routine, low-risk computer software product as follows:

Completion of detailed program design $13,000
Costs incurred for coding and testing to establish technological feasibility 10,000
Other coding costs after establishment of technological feasibility 24,000
Other testing costs after establishment of technological feasibility 20,000
Costs of producing product masters for training materials 15,000
Duplication of computer software and training materials from product masters (1,000 units) 25,000
Packaging product (500 units) 9,000
In Pitt's December 31, 2004 balance sheet, what amount should be reported in inventory?

A. $25,000
B. $34,000
C. $40,000
D. $49,000

B. $34,000
Only the last two costs in the list are inventoried. The software development is complete when the product masters are produced.

219

Oz, a nongovernmental not-for-profit organization, received $50,000 from Ame Company to sponsor a play given by Oz at the local theater. Oz gave Ame 25 tickets, which generally cost $100 each.
Ame received no other benefits.
What amount of ticket sales revenue should Oz record?

A. $0
B. $2,500
C. $47,500
D. $50,000

B. $2,500
Because Ame received tickets in connection with its contribution to Oz , the transaction must be treated partly as an exchange transaction and partly as a contribution. Oz must recognize Revenue equivalent to the value of the goods or services provided to Ame (25 tickets x $100 = $2,500).
Oz and Ame must each deduct the value of the goods or services exchanged from the total amount received/contributed to arrive at the amount to be recognized as a charitable contribution ($50,000 - $2,500 = $47,500).
Journal Entry:
Cash 50,000
Ticket Sales Revenue 2,500
Contributions Revenue 47,500

220

Other not-for-profit organizations include

A. Hospitals.
B. Colleges and universities.
C. Religious organizations.
D. Voluntary health and welfare organizations.

C. Religious organizations.
There are four broad categories of not-for-profit entities: (1) hospitals and other healthcare entities, (2) colleges and universities, (3) voluntary health and welfare organizations, and (4) other not-for-profit organizations. Other not-for-profit organizations include religious organizations.

221

Metro General is a municipally-owned and operated hospital and a component unit of Metro City. In 2007, the hospital received $7,000 in unrestricted gifts and $4,000 in unrestricted bequests. The hospital has $800,000 in long-term debt and $1,200,000 in fixed assets.
The hospital has transferred certain resources to a hospital guild. Substantially, all of the guild's resources are held for the benefit of the hospital. The hospital controls the guild through contracts that provide it with the authority to direct the guild's activities, management, and policies.
The hospital has also assigned certain functions to a hospital auxiliary, which operates primarily for the benefit of the hospital. The hospital does not have control over the auxiliary.
The financial statements of the guild and the auxiliary are not consolidated with the hospital's financial statements. The guild and the auxiliary have total assets of $20,000 and $30,000, respectively.

Before the hospital's financial statements were combined with those of the city, the city's statements included data on one Special Revenue Fund and one Enterprise Fund.
The city's statements showed $100,000 in Enterprise Fund Long-Term Debt, $500,000 in Enterprise Fund Fixed Assets, $1,000,000 in General Long-Term Debt, and $6,000,000 in General Fixed Assets.

What account or accounts should be credited for the $7,000 in unrestricted gifts and the $4,000 in unrestricted bequests?

A. Operating Revenue $11,000
B. Nonoperating Revenue $11,000
C. Operating Revenue $ 7,000
Nonoperating Revenue $4,000
D. Nonoperating Revenue $ 7,000
Operating Revenue $4,000

B. Nonoperating Revenue $11,000
Both the $7,000 of unrestricted gifts and the $4,000 of unrestricted bequests should be credited to Nonoperating Revenue.

222

Dee City's community hospital, which uses Enterprise Fund reporting, normally includes proceeds from the sale of cafeteria meals in:
A. Patient Service Revenues.
B. Other Revenues.
C. Ancillary Service Revenues.
D. Deductions from Dietary Service Expenses.

B. Other Revenues.
Hospital revenues are classified broadly into three major categories:
Patient Service Revenues,
Premium Fees, and
Other Revenues.
Other Revenues are revenues that are earned from ongoing activities of the hospital other than patient services and Premium Fees. Included in this class of revenues are proceeds from the sale of cafeteria meals.

223

Community Enhancers, a nongovernmental not-for-profit organization, received the following pledges:
Unrestricted $400,000
Restricted for capital additions 300,000
All pledges are legally enforceable. However, Community's experience indicates that 5% of all pledges prove to be uncollectible.

What amount should Community report as pledges receivable, net of any required allowance account?

A. $700,000
B. $665,000
C. $380,000
D. $285,000

B. $665,000
Pledges receivable of $700,000 must be reported net of the allowance for uncollectible pledges (5% x $700,000 = $35,000).
Journal Entry:
Pledges Receivable 700,000
Allowance for Uncollectible Pledges 5%x700,000= 35,000
Contributions Revenue (plug) 665,000
In the Statement of Net Assets:

Assets
Pledges Receivable 700,000
- Allowance for Uncollectible Pledges 35,000
Net Collectible Pledges 665,000

224

The primary standards-setting body for a public museum that receives the majority of its funding from local property taxes is the

A. American Institute of CPAs (AICPA).
B. Financial Accounting Standards Board (FASB).
C. Government Accountability Office (GAO).
D. Governmental Accounting Standards Board (GASB).

D. Governmental Accounting Standards Board (GASB).
A museum that receives the majority of its funding from property taxes is most likely a part of a city government and will be subject to accounting and reporting standards established by the Governmental Accounting Standards Board (GASB).

225

Fenn Museum, a nongovernmental not-for-profit organization, had the following balances in its Statement of Functional Expenses:
Education $300,000
Fund-raising 250,000
Management and general 200,000
Research 50,000
What amount should Fenn report as expenses for support services?

A. $350,000
B. $450,000
C. $500,000
D. $800,000

B. $450,000
Support services for not-for-profit organizations include the following: management, general administration, fund-raising, and membership development. In this case, support services total $450,000.

226

A voluntary health and welfare organization received a $700,000 permanent endowment during the year. The donor stipulated that the income and investment appreciation be used to maintain its senior center. The endowment fund reported a net investment appreciation of $80,000 and investment income of $50,000. The organization spent $60,000 to maintain its senior center during the year.
What amount of change in temporarily restricted net assets should the organization report?

A. $50,000
B. $70,000
C. $130,000
D. $770,000

B. $70,000
Because of the donor stipulation, both the investment income and appreciation can be expended. Recognition of these resources increases temporarily restricted net assets by $130,000. The expenditure of $60,000 to maintain the senior center effectively reduces temporarily restricted net assets. The expenses themselves are paid out of unrestricted net assets; however, $60,000 of temporarily restricted net assets are released from restriction because of the payment, thus increasing unrestricted net assets and decreasing temporarily restricted net assets.

227

An unrestricted cash contribution should be reported in a nongovernmental not-for-profit organization's Statement of Cash Flows as an inflow from
A. Operating Activities.
B. Investing Activities.
C. Financing Activities.
D. Capital and Related Financing Activities.

A. Operating Activities.
Unrestricted cash contributions should be included in the Operating Activities section of the Statement of Cash Flows, along with unrestricted investment earnings, revenue restricted for operating purposes (Program Restrictions), revenue from exchange transactions, and operating expenditures (salaries, supplies, interest expense), including grants to other organizations

228

Birdlovers, a community foundation, incurred $5,000 in management and general expenses during 2005.
In Birdlovers' Statement of Activities for the year ending December 31, 2005, the $5,000 should be reported as

A. A contra account offsetting revenue and support.
B. Part of program services.
C. Part of supporting services.
D. A direct reduction of fund balance.

C. Part of supporting services.
Expenses for not-for-profit organizations fall into two broad categories:
(1) program services and
(2) supporting services. Expenses for program services are incurred because of the stated mission of the not-for-profit. All other expenses fall under the supporting services classification. The $5,000 in management and general expenses should be reported as part of supporting services.

229

Which of the following financial categories are used in a nongovernmental not-for-profit organization's statement of financial position?
A. Net assets, income, and expenses.
B. Income, expenses, and unrestricted net assets.
C. Assets, liabilities, and net assets.
D. Changes in unrestricted, temporarily restricted, and permanently restricted net assets.

C. Assets, liabilities, and net assets.

230

Which of the following not-for-profit entities is required to prepare a Statement of Functional Expenses?
A. An art museum
B. A shelter for the homeless
C. A private foundation
D. A public golf course

B. A shelter for the homeless
According to SFAS No. 117 para. 26, voluntary health and welfare organizations (VHWO) must prepare a Statement of Functional Expenses along with their other financial statements. VHWO are human service organizations that receive contributions from the public and provide health and welfare services for little or no fee to the recipients of the services. A homeless shelter is an example of a VHWO; therefore, it must prepare a Statement of Functional Expenses. The Statement of Functional Expenses is encouraged, but not required, for other types of not-for-profit. Therefore, the private foundation and the art museum (assuming it is a not-for-profit organization) have the option of presenting a Statement of Functional Expenses but are not required to do so. A public golf course is part of a governmental entity and is subject to GASB rather than FASB standards and will not present a Statement of Functional Expenses.

231

Arkin Corp. is a nongovernmental not-for-profit organization involved in research. Arkin's Statement of Functional Expenses should classify which of the following as support services?
A. Salaries of staff researchers involved in research
B. Salaries of fund-raisers for funds used in research
C. Cost of equipment involved in research
D. Cost of laboratory supplies used in research

B. Salaries of fund-raisers for funds used in research

232

Which of the following resources increases the temporarily restricted net assets of a nongovernmental, not-for-profit voluntary health and welfare organization?
A. Refundable advances for purchasing playground equipment.
B. Donor contributions to fund a resident camp program.
C. Membership fees to fund general operations.
D. Participants' deposits for an entity-sponsored trip.

B. Donor contributions to fund a resident camp program.

233

Securities donated to an NPO should be recorded at the

A. Donor's recorded amount.
B. Fair market value at the date of the gift or the donor's recorded amount, whichever is higher.
C. Fair market value at the date of the gift or the donor's recorded amount, whichever is lower.
D. Fair market value at the date of the gift.

D. Fair market value at the date of the gift.

234

At which of the following amounts should a nongovernmental not-for-profit organization report investments in debt securities?
A. Potential proceeds from liquidation sale.
B. Discounted expected future cash flows.
C. Quoted market prices.
D. Historical cost.

C. Quoted market prices.
Unlike for-profit entities, not-for-profit entities do not break debt securities into trading, available-for-sale, and held-to-maturity categories. Following FASB Statement No. 124, not-for-profits value debt securities at fair value (quoted market price).

235

How should a nongovernmental not-for-profit organization classify gains and losses on investments purchased with permanently restricted assets?
A. Gains may not be netted against losses in the statement of activities.
B. Gains and losses can only be reported net of expenses in the statement of activities.
C. Unless explicitly restricted by donor or law, gains and losses should be reported in the statement of activities as increases or decreases in unrestricted net assets.
D. Unless explicitly restricted by donor or law, gains and losses should be reported in the statement of activities as increases or decreases in permanently restricted net assets.

C. Unless explicitly restricted by donor or law, gains and losses should be reported in the statement of activities as increases or decreases in unrestricted net assets.

If the donor placed restrictions on the use of gains (purpose or time restrictions), the gains are temporarily restricted until the restriction is met. If there are no restrictions, the gains and losses are unrestricted. Revenues and expenses must be reported should be reported separately but gains and losses may be reported net.

236

Tuition scholarships for which there is no intention of collection from the student should be classified by a private university as:

A. Revenues and expenditures.
B. A reduction of gross revenue to arrive at net revenue.
C. Revenues and expenses.
D. None of the above.

B. A reduction of gross revenue to arrive at net revenue.

Tuition revenue is reported as Net of Scholarship Allowances and Uncollectible Amounts. Scholarship allowances include scholarships awarded from the general resources of the college or university, scholarships from gifts provided to the university to finance scholarships awarded to students selected by the university, and tuition and fee payments made from resources such as Pell Grants.

237

How should state appropriations to a state university choosing to report as engaged only in business-type activities be reported in its Statement of Revenues, Expenses, and Changes in Net Position?
A. Operating Revenues.
B. Nonoperating Revenues.
C. Capital Contributions.
D. Other Financing Sources.

B. Nonoperating Revenues.

A state university is an example of a special purpose government. Since it is engaged only in business-type activities, it should report the financial statements required for Enterprise Funds. In that case, state appropriations to the university are Nonoperating Revenues.

238

Which of the following should normally be considered ongoing or central transactions for a not-for-profit hospital?
I. Room and board fees from patients.

II. Recovery room fees.

A. Neither I nor II.
B. Both I and II.
C. II only.
D. I only.

B. Both I and II.
Both room and board fees from patients and recovery room fees are normal, ongoing activities of a not-for-profit hospital.

239

In April 2005, Delta Hospital purchased medicines from Field Pharmaceutical Co. at a cost of $5,000. However, Field notified Delta that the invoice was being canceled and that the medicines were being donated to Delta.
Delta should record this donation of medicines as

A. A memorandum entry only.
B. A $5,000 credit to nonoperating expenses.
C. A $5,000 credit to operating expenses.
D. Other operating revenue of $5,000.

D. Other operating revenue of $5,000.
Medicine is considered essential to the major ongoing operation of the hospital, therefore the donation of medicine is recorded as other operating revenue at its fair market value.
dr. Inventory of Medicine

cr. Donated Revenues

SFAS 116

240

Which of the following normally would be included in Other Operating Revenues of a hospital?
Revenues from educational programs Unrestricted gifts
No No
No Yes
Yes No
Government hospitals classify revenues into three broad categories: Patient Service Revenues, Premium Fees, and Other Revenues. The Other Revenues category includes revenues generated by ongoing activities of the hospital other than patient care. Revenues from educational programs are included in this category.
Government hospitals record unrestricted gifts as Nonoperating Gains in the General Fund.

If we assume that the hospital is not a government entity, then it must conform with FASB Statement No. 116. The revenues from educational programs would still be classified as Other Operating Revenues. The unrestricted gifts would be classified as Revenues from Contributions.

Yes Yes

Revenues from educational programs Yes
Unrestricted gifts No

Revenues from secondary activities are Other Revenues, while unrestricted gifts are contribution revenues for NPOs or nonoperating gains for govt. hospitals.

241

Super Seniors is a not-for-profit organization that provides services to senior citizens.
Super employs a full-time staff of 10 people at an annual cost of $150,000. In addition, two volunteers work as part-time secretaries replacing last year's full-time secretary who earned $10,000. Services performed by other volunteers for special events had an estimated value of $15,000.
These volunteers were employees of local businesses and received small-value items for their participation.

What amount should Super report for salary and wage expenses related to the above items?

A. $150,000
B. $160,000
C. $165,000
D. $175,000

B. $160,000
The $150,000 that is paid to the full-time staff should be included in salary and wage expenses. The two volunteers who are replacing a full-time secretary are providing specialized secretarial skills that would have been purchased if not donated; therefore, the criteria for recognizing donated services set by FASB Statement No. 116 are met.
The $10,000 should be included in salary and wage expenses. The entry to record these donated services would be the following:

Expenses - salary and wages 10,000
Revenues - contributions 10,000
The $15,000 of services provided by the other volunteers does not meet the criteria for revenue recognition under FASB Statement No. 116. This amount should not be included in salary and wage expenses. The total amount that should be reported as wage and salary expenses is $150,000 + $10,000 = $160,000.

242

Whitestone, a nongovernmental not-for-profit organization, received a contribution in December year 1. The donor restricted use of the contribution until March year 2. How should Whitestone record the contribution?
A. Footnote the contribution in year 1 and record as income when it becomes available in year 2.
B. No entry is required in year 1 and record as income in year 2 when it becomes available.
C. Report as income in year 1.
D. Report as deferred income in year 1.

C. Report as income in year 1.

243

Janna Association, a nongovernmental not-for-profit organization, received a cash gift with the stipulation that the principal be held for at least 20 years.
How should the cash gift be recorded?

A. A temporarily restricted asset
B. A permanently restricted asset
C. An unrestricted asset
D. A temporary liability

A. A temporarily restricted asset

244

During the current year, the local humane society, a nongovernmental not-for-profit organization, received a $100,000 permanent endowment from Cobb. Cobb stipulated that the income must be used to care for older horses that can no longer race. The endowment reported income of $8,000 in the current year. What amount of unrestricted contribution revenue should the humane society report for the current year?
A. $108,000
B. $100,000
C. $8,000
D. $0

C. $8,000
The $100,000 endowed is recognized as contribution revenue in the permanently restricted net asset category. The $8,000 current year earnings on the endowment are recognized in the temporarily restricted net asset category because there is a purpose (use) restriction. As expenses related to the care for older horses occur, an amount equal to those expenses will be reclassified (i.e., "released") from temporarily restricted net assets to unrestricted net assets to offset the expenses.

245

On January 1, Read, a nongovernmental not-for-profit organization, received $20,000 and an unconditional pledge of $20,000 for each of the next four calendar years to be paid on the first day of each year. The present value of an ordinary annuity for four years at a constant interest rate of 8% is 3.312. What amount of restricted net assets is reported in the year the pledge was received?
A. $ 66,240
B. $ 80,000
C. $ 86,240
D. $100,000

A. $ 66,240
$86,240 is not correct because it includes the $20,000 contribution received, which is unrestricted rather than restricted.

246

Pica, a nongovernmental not-for-profit organization, received unconditional promises of $100,000 expected to be collected within 1 year. Pica received $10,000 prior to year end.
Pica anticipates collecting 90% of the contributions and has a June 30 fiscal year end.
What amount should Pica record as contribution revenue as of June 30?

A. $10,000
B. $80,000
C. $90,000
D. $100,000

C. $90,000
FASB Statement No. 116 requires that unconditional promises to give ("pledges") be recognized on the accrual basis net of the estimate of uncollectible pledges.
As long as the contributions have been pledged for the current period, the receipt of cash does not impact revenue recognition.
In this instance, the $100,000 in pledges is reduced by the estimated uncollectible pledges of $10,000 (10% x $100,000), or $90,000.

247

During the current fiscal year, Foxx, a nongovernmental not-for-profit organization, received unrestricted pledges of $300,000. Of the pledged amount, $200,000 was designated by donors for use during the current year, and $100,000 was designated for next year. Five percent of the pledges are expected to be uncollectible. What amount should Foxx report as restricted support (contributions) in the Statement of Activities for the current year?
A. $200,000
B. $190,000
C. $100,000
D. $95,000

D. $95,000

The $200,000 designated for the current year is recognized as unrestricted support.

The $100,000 designated for next year is recognized as temporarily restricted net assets in the current year.

248

Which of the following contributions would not have to be reported as an asset on the Statement of Financial Position of a not-for-profit organization?

A. Land was donated to the Friends of the Forest Society for conversion into a nature trail.
B. The original courthouse was donated to the Historical Preservation Society, which is converting the courthouse to a museum.
C. An art collector donated a famous oil painting to a local nongovernmental art museum for display in its exhibit hall.
D. None of the above donated assets would have to be reported on the statement of financial position of the not-for-profit organization.

C. An art collector donated a famous oil painting to a local nongovernmental art museum for display in its exhibit hall.

Collections (i.e., inexhaustible fixed assets) donated to a not-for-profit organization do not need to be capitalized. Three conditions must be met:
(1) the asset is held for public exhibition, education, or research rather than financial gain;
(2) the asset must be protected, unencumbered, cared for, and preserved; and
(3) the asset is subject to a policy that requires proceeds from sales of collection items to be used to acquire other items for the collection.

249

Lea Meditators is a not-for-profit religious organization. A storm broke glass windows in Lea's building. A member of Lea's congregation, a professional glazier, replaced the windows at no charge.
In Lea's Statement of Activities, the breakage and replacement of the windows should

A. Not be reported.
B. Be reported by note disclosure only.
C. Be reported as an increase in both expenses and contributions.
D. Be reported as an increase in both net assets and contributions.

C. Be reported as an increase in both expenses and contributions.

250

According to GASB 34, Basic Financial Statements-and Management's Discussion and Analysis-for State and Local Governments, certain budgetary schedules require supplementary information.
What is the minimum budgetary information required to be reported in those schedules?

A. A schedule of unfavorable variances at the functional level.
B. A schedule showing the final appropriations budget and actual expenditures on a budgetary basis.
C. A schedule showing the original budget, the final appropriations budget, and actual inflows, outflows, and balances on a budgetary basis.
D. A schedule showing the proposed budget, the approved budget, the final amended budget, actual inflows and outflows on a budgetary basis, and variances between budget and actual.

C. A schedule showing the original budget, the final appropriations budget, and actual inflows, outflows, and balances on a budgetary basis.

251

Excel City's Water Utility Enterprise Fund issues $10,000,000 in 20-year serial revenue bonds to finance a major expansion of one of its water treatment plants. $500,000 in bonds mature each year. As a result of this transaction, the year-end long-term liability in the governmental activities section of the government-wide financial statements accounts will reflect:
A. $0
B. An increase of $9,500,000.
C. An increase of $10,000,000.
D. A decrease of $500,000.

A. $0
The Water Utility Enterprise Fund uses full accrual accounting and will account for and report on the bonds in the Enterprise Fund. Therefore, this liability appears in the business-type activity section of the government-wide financial statements and not in the governmental activity section.

252

Nox City reported a $25,000 net increase in the fund balances for total Governmental Funds. Nox also reported an increase in Net Position for the following funds:
Motor pool Internal Service Fund $ 9,000
Water Enterprise Fund 12,000
Employee pension fund 7,000
The motor pool Internal Service Fund provides service to the General Fund departments. What amount should Nox report as the Change in Net Position for governmental activities?

A. $25,000
B. $34,000
C. $41,000
D. $46,000

B. $34,000
GASB Stmt. #34 requires that Internal Service Funds be included in the Governmental Activities totals on the Government-Wide Statements since Internal Service Funds supply goods or services only to the government entity.

253

Grove Township issued $50,000 of bond anticipation notes at face amount in 2005 and placed the proceeds into its Capital Projects Fund.
All legal steps were taken to refinance the notes, but Grove was unable to consummate refinancing.
In the Capital Projects Fund, what account should be credited to record the $50,000 proceeds?

A. Other Financing Sources Control.
B. Revenues Control.
C. Deferred Inflow of Resources.
D. Bond Anticipation Notes Payable.

D. Bond Anticipation Notes Payable.
If all legal steps have been taken to refinance the bond anticipation notes and the ability to consummate refinancing criteria (FASB Statement No. 6) have not been met, then the bond anticipation notes should be reported as a Fund Liability in the fund receiving the proceeds. The Capital Projects Fund should credit Bond Anticipation Notes Payable for $50,000.

254

A government has the following debt:
Capital lease liabilities that mature in more than one year (General Fund department leases)-$2,000,000.
Net pension liability associated with general government employees-$4,000,000.
General government bonds that mature in the next fiscal year-$14,000,000.
What amount of debt should be reported in the long-term liabilities in the government-wide financial positions?

A. $2,000,000
B. $6,000,000
C. $18,000,000
D. $20,000,000

D. $20,000,000
All of the items listed are Unmatured Long-Term Liabilities of the general government that will not be recorded in any of the Governmental Funds but will appear as liabilities in the Government-Wide Statement of Net Position.

255

On March 2, 2005, Finch City issued 10-year general obligation bonds at face amount, with interest payable March 1 and September 1.
The proceeds were to be used to finance the construction of a civic center over the period April 1, 2005, to March 31, 2006.
During the fiscal year ended June 30, 2005, no resources had been provided to the Debt Service Fund for the payment of principal and interest.
The liability for the general obligation bonds should be recorded in the:

A. General Fund.
B. Capital Projects Fund.
C. Government-wide financial statements.
D. Debt Service Fund.

C. Government-wide financial statements.
The government-wide financial statements are used to account for all unmatured long-term indebtedness of the government, except for that debt belonging to Proprietary and similar Trust Funds. The liability for the general obligation bonds should be recorded in this account group.

256

Elm City contributes to and administers a single-employer defined benefit pension plan on behalf of its covered employees.
The plan is accounted for in a Pension Trust Fund.
Actuarially determined employer contribution requirements and contributions actually made for the past three years, along with the percentage of annual covered payroll, were as follows:
Contribution made
Actuarial requirement
Amount
Percent
Amount
Percent
2005
$11,000
26
$11,000
26
2004
5,000
12
10,000
24
2003
None
None
8,000
20
What account should be credited in the Pension Trust Fund to record the 2005 employer contribution of $11,000?
A. Revenues Additions.
B. Other Financing Sources Control.
C. Due from Special Revenue Fund.
D. Pension Benefit Obligation.

A. Revenues Additions.
Annual contributions made by employers are viewed as Additions by the Pension Trust Fund.
The following entry should be made when the Pension Trust Fund recognizes the $11,000 as Additions.
Due from Governmental Fund 11,000
Revenues-employer contributions 11,000

257

In which fund would "Salaries Expense" appear?

A. Water Utility Fund.
B. General Fund.
C. Pension Trust Fund.
D. Capital Projects Fund.

A. Water Utility Fund.
"Expense" is a term reserved for funds that use full accrual accounting. A Water Utility Fund is an Enterprise Fund type using full accrual accounting. The General Fund is a Governmental Fund type that uses modified accrual and the term "expenditures."

258

Todd City formally integrates budgetary accounts into its General Fund. Todd uses an Internal Service Fund to account for the operations of its data processing center, which provides services to Todd's other governmental units.
During the year ended December 31, 2005, Todd received a state grant to buy a bus and an additional grant for bus operation in 2005. In 2005, only 90% of the capital grant was used for the bus purchase, but 100% of the operating grant was disbursed.
Todd has incurred the following long-term obligations:
General obligation bonds issued for the Water and Sewer Fund, which will service the debt.
Revenue bonds to be repaid from admission fees collected from users of the municipal recreation center.

These bonds are expected to be paid from Enterprise Funds, and secured by Todd's full faith, credit, and taxing power as further assurance that the obligations will be paid.
Todd's 2005 expenditures from the General Fund include payments for structural alterations to a firehouse and furniture for the mayor's office.
Which of Todd's long-term obligations should be accounted for in the general fund?
General obligation bonds Revenue bonds
Yes Yes
Yes No
No Yes
No No

General obligation bonds Revenue bonds
No No
Neither of the long-term obligations should be accounted for in Todd City's general fund. Bonds directly related to and expected to be paid from Proprietary Funds (Water and Sewer Fund and Municipal Recreation Fund) should be included in the accounts of such funds. These are specific fund liabilities, even though the full faith and credit of Todd City has been pledged as further assurance that the obligations will be paid.

259

Chase City imposes a 2% tax on hotel charges. Revenues from this tax will be used to promote tourism in the city.
Chase should record this tax as what type of NonExchange Transaction?

A. Derived Tax Revenue.
B. Imposed Nonexchange Revenue.
C. Government-Mandated Transaction.
D. Voluntary NonExchange Transaction.

A. Derived Tax Revenue.
GASB Stmt. #33 defines derived tax revenues as Nonexchange Revenues that are based on (or derived from) Exchange Transactions. Other examples of derived non-Exchange Transactions include sales taxes and income taxes.

260

Which of the following fund types used by a government would most likely have a Nonspendable Fund Balance for its Inventory of Supplies?
A. General.
B. Internal service.
C. Nonexpendable Trust.
D. Capital Projects.

A. General.
This answer is correct because the General Fund normally records the purchase of supplies. The supplies must be reported on the General Fund's balance sheet, even though they do not represent current financial resources. In addition, at year end, a portion of the fund balance must be classified as nonspendable for the inventory amount because that amount of resources is not appropriable for future expenditures.

261

Small County's tax assessment department identified the need for new property tax assessment and billing software. A project task force composed of county staff was assembled to address this need. The following outlays were incurred related to the project in 2015:
Task force interviews with operators of the software and users of the information to determine the needs of the users, evaluation of system hardware requirements, assessment of current in-house information technology resources and evaluation of commercially available software packages, and issuing requests for proposals from vendors. Outlays: $1.5 million.
The county awards a contract in the amount of $14.5 million to a vendor to acquire a perpetual license to use its property tax software as modified to meet the County's needs. The vendor is responsible for the installation and modification of the software, while four county employees are dedicated to the project full time until its completion at an additional cost of $0.5 million.
Outlays for data entry and for training software users and operators is $0.6 million.
How much should Small County capitalize related to the outlays associated to the project?

A. $15.6 million
B. $14.5 million
C. $15 million
D. $16.5 million

C. $15 million
Anything in the application stage (licensing and completion of project) is capitalized. R&D and training are expensed.

262

Through an Internal Service Fund, New County operates a centralized data processing center to provide services to New's other governmental units. In 2005, this Internal Service Fund billed New's Parks and Recreation Fund $150,000 for data processing services.
What account should New's Internal Service Fund credit to record this $150,000 billing to the Parks and Recreation Fund?

A. Data Processing Department Expenses.
B. Intergovernmental Transfers.
C. Interfund Exchanges.
D. Operating Revenues Control.

D. Operating Revenues Control.

263

A Capital Projects Fund has outstanding encumbrances of $250,000 as of the end of the fiscal year. Assume that all resources in the Capital Projects Fund are considered to be committed due to the constraints established by the enabling legislation of the governing body of the government. How should the encumbrances be reported in the year-end external financial statements?
A. As a specific identifiable component of the restricted fund balance.
B. As a specific identifiable component of the committed fund balance.
C. As a specific identifiable component of the Assigned Fund balance.
D. The encumbrances would only be reported in the note disclosures.

D. The encumbrances would only be reported in the note disclosures.
GASB Statement No. 54

264

Which of the following fund balance classifications is used for budgetary accounting but not for GAAP financial statement reporting?
A. Nonspendable Fund Balance.
B. Unreserved Fund Balance.
C. Committed Fund Balance.
D. Unassigned Fund Balance.

B. Unreserved Fund Balance.
GASB Statement No. 54 eliminated the use of "reserve" and "unreserved" fund balances. The appropriate fund balance classifications are Nonspendable, Restricted, Committed, Assigned, and Unassigned.

265

Which of the following local government funds uses the accrual basis of accounting?
A. Enterprise.
B. Debt service.
C. Capital projects.
D. Special revenue.

A. Enterprise.
Recall the acronym "DRIP-CEG-PIPPA" where the vowels in "DRIP-CEG" represent fund types that use accrual accounting and the consonants use modified accrual accounting. The "I" stands for Internal Service Fund and "E" for Enterprise Funds. This answer is correct.

266

Encumbrances would not appear in which fund?
A. Capital Projects.
B. Special Revenue.
C. General.
Encumbrance
D. Enterprise.

D. Enterprise.
Encumbrance accounting is used for budgetary control and, therefore, is commonly used in Governmental Fund types, including the General, Special Revenue, and Capital Projects Funds. It is usually not used by Debt Service Funds since the terms of the debt control spending. It is rarely used by Proprietary Funds so the Enterprise Fund (answer D) is the best choice for this question.

267

Harbor City's Appropriations Control Account at December 31, 2005 had a balance of $7,000,000.
When the budgetary accounts were closed at year-end, this $7,000,000 Appropriations Control balance should have:

A. Been debited.
B. Been credited.
C. Remained open.
D. Appeared as a contra account.

A. Been debited.
The Appropriations Control account should have been credited for $7,000,000 when the budget was adopted, and it should have been debited for $7,000,000 when the budgetary accounts were closed at the end of the year.

268

King City Council will be establishing a library fund. Library fees are expected to cover 55% of the library's annual resource requirements. King has decided that an annual determination of net income is desirable in order to maintain management control and accountability over the library. What type of fund should King establish in order to meet their measurement objectives?
A. Special revenue fund
B. General fund
C. Internal service fund
D. Enterprise fund

D. Enterprise fund
An enterprise fund is used when services are provided primarily to the public for a charge. Since enterprise funds use accrual accounting, it will provide the determination of net income and other control and accountability that management desires.

269

Which event(s) is(are) supportive of interperiod equity as a financial reporting objective of a governmental unit?
I. A balanced budget is adopted.

II. Residual equity transfers out equal residual equity transfers in.

A. I only
B. II only
C. Both I and II
D. Neither I nor II

A. I only
The adoption of a balanced budget supports interperiod equity because it is an attempt to ensure that the current generation of citizens does not shift the burden of paying for current-year services to future-years' taxpayers (GASB Concepts Statement 1).
Residual equity transfers are nonrecurring or nonroutine transfers of equity between funds (GASB Codification 1800.102). These transfers occur within one accounting period and do not support interperiod equity as an objective of financial reporting.

270

Which of the following is the paramount objective of financial reporting by state and local governments?
A. Reliability.
B. Consistency.
C. Comparability.
D. Accountability.

D. Accountability.

271

The City of Palo Alto's Service Efforts and Accomplishments Report for Fiscal Year 2010 reported that the average response to fire calls within 8 minutes occurred on 90% of the fire calls in 2010. This rate met the benchmark target goal of 90%. According to GASB's conceptual framework, this information is classified as a measure of

A. Effort.
B. Output.
C. Outcome.
D. Efficiency.

C. Outcome.
The example in the question is an outcome measure. Outcome measures indicate the accomplishments or results that occur because of the services provided.

272

According to GASB's conceptual framework, the primary users of the general purpose external financial report do not include

A. Taxpayers.
B. Bond insurers.
GASB Concepts
C. School boards.
D. Internal managers.

D. Internal managers.
GASB Concepts Statement No. 1 defines the primary users of the general purpose external financial report as the citizenry (e.g., taxpayers), legislative and oversight bodies (e.g., school boards), and investors and creditors (e.g., bond insurers). Typically, internal managers who have access to information through internal reporting are not considered primary users.

273

According to GASB's conceptual framework, which of the following is not an element of the Statement of Financial Position?

A. Net position
B. Net assets
C. Assets
D. Liabilities

B. Net assets

274

When Rolan County adopted its budget for the year ending June 30, 2005, $20,000,000 was recorded for Estimated Revenues Control. Actual Revenues for the year ended June 30, 2005 amounted to $17,000,000.
In closing the budgetary accounts at June 30, 2005,

A. Revenues Control should be debited for $3,000,000.
B. Estimated Revenues Control should be debited for $3,000,000.
C. Revenues Control should be credited for $20,000,000.
D. Estimated Revenues Control should be credited for $20,000,000.

D. Estimated Revenues Control should be credited for $20,000,000.

When the budgetary accounts are closed at the end of the fiscal year, the estimated revenues control account will be credited for the amount for which it was debited when the budget was recorded, $20,000,000.

275

Todd City formally integrates budgetary accounts into its general fund. Todd uses an internal service fund to account for the operations of its data processing center, which provides services to Todd's other governmental units.
During the year ended December 31, 2005, Todd received a state grant to buy a bus, and an additional grant for bus operation in 2005. In 2005, only 90% of the capital grant was used for the bus purchase, but 100% of the operating grant was disbursed.

Todd has incurred the following long-term obligations:

General obligation bonds issued for the water and sewer fund which will service the debt.
Revenue bonds to be repaid from admission fees collected from users of the municipal recreation center.
These bonds are expected to be paid from enterprise funds, and secured by Todd's full faith, credit, and taxing power as further assurance that the obligations will be paid.

Todd's 2005 expenditures from the general fund include payments for structural alterations to a firehouse and furniture for the mayor's office.

When Todd records its annual budget, which of the following control accounts indicates the amount of the authorized spending limitation for the year ending December 31, 2005?

A. Reserved for appropriations.
B. Appropriations.
C. Reserved for encumbrances.
D. Encumbrances.

B. Appropriations.
The Appropriations Control account, a budgetary account, would be credited for the amount of the authorized spending limit.

276

On January 1, Fonk City approved the following general fund resources for the new fiscal period:
Property taxes $5,000,000
Licenses and permits 400,000
Intergovernmental revenues 150,000
Transfers in from other funds 350,000
What amount should Fonk record as estimated revenues for the new fiscal year?

A. $5,400,000
B. $5,550,000
C. $5,750,000
D. $5,900,000

B. $5,550,000

Transfers in from other funds are other financing sources.
Intergovernmental revenues are estimated revenues.

277

Kenn City obtained a municipal landfill and passed a local ordinance that required the city to operate the landfill so that the costs of operating the landfill, as well as the capital costs, are to be recovered with charges to customers. Which of the following funds should Kenn City use to report the activities of the landfill?
A. Enterprise.
B. Permanent.
C. Special revenue.
D. Internal service.

A. Enterprise.
An Enterprise Fund is commonly used in situations where user fees are the primarily source of revenue and the fee charged is based on an amount sufficient to cover the costs of operations and to provide for capital maintenance, which is the case here. Note that the fee for a service provided and that most of the users are external to the government.

278

Which of the following funds would be reported as a fiduciary fund in Pine City's financial statements?
A. Special revenue.
B. Permanent.
C. Private-purpose trust.
D. Internal service.

C. Private-purpose trust.
Recall the acronym "PIPPA" for fiduciary funds.
Fiduciary funds include the following 4 types of funds:
P ension trust funds,
I nvestment trust funds,
P rivate- P urpose trust funds,
and A gency funds.

279

Which of the following funds is not a fiduciary fund type?

A. Police and fire pension trust fund
B. Motor pool fund
C. Historical society private-purpose trust fund
D. County and city tax collection fund

B. Motor pool fund
A motor pool fund is a type of internal service fund that charges other parts of the government for services provided on a cost-reimbursement basis. An internal service fund is one of the two types of proprietary service funds. Recall the mnemonic "PIPPA" for fiduciary funds - pension trust funds, investment trust funds, private-purpose trust funds, and agency funds.

280

Which of the following is not a characteristic of a fund?

A. Fiscal entity
B. Accounting entity
C. Separate legal entity
D. All of the above are characteristics of a fund.

C. Separate legal entity
A fund is both a fiscal and an accounting entity. A fund is "fiscal" because it has assets, liabilities, revenue, expenditure or expense, and fund balance or other equity accounts. A fund is "accounting" because it has its own ledgers and contains a self-balancing set of accounts. A fund is not a separate legal entity.

281

Dayne County's general fund had the following disbursements during the year:
Payment of principal on long-term debt $100,000
Payments to vendors 500,000
Purchase of a computer 300,000
What amount should Dayne County report as expenditures in its governmental funds Statement of Revenues, Expenditures, and Changes in Fund Balances?

A. $300,000
B. $500,000
C. $800,000
D. $900,000

D. $900,000
On the Statement of Revenues, Expenditures, and Changes in Fund Balances, which reports transactions using the modified accrual basis of accounting, repayment of principal on long-term debt, payments to vendors, and purchases of fixed assets are all reported as expenditures.

282

Todd City formally integrates budgetary accounts into its general fund. Todd uses an internal service fund to account for the operations of its data processing center, which provides services to Todd's other governmental units.
During the year ending December 31, 2005, Todd's special revenue fund received a state grant to buy a bus and an additional grant for bus operation in 2005. In 2005, only 90% of the capital grant was used for the bus purchase, but 100% of the operating grant was disbursed.
Todd has incurred the following long-term obligations:
General obligation bonds issued for the water and sewer fund, which will service the debt.
Revenue bonds to be repaid from admission fees collected from users of the municipal recreation center.

These bonds are expected to be paid from enterprise funds and secured by Todd's full faith, credit, and taxing power as further assurance that the obligations will be paid.
Todd's 2005 expenditures from the general fund include payments for structural alterations to a firehouse and furniture for the mayor's office.
In reporting the state grants for the bus purchase and operation, what should Todd include as grant revenues for the year ending December 31, 2005?
90% of the capital grant 100% of the capital grant Operating grant
Yes No No
No Yes No
No Yes Yes
Yes No Yes

90% of the capital grant 100% of the capital grant Operating grant
Yes No Yes

283

Which of the following funds of a governmental unit uses the modified accrual basis of accounting?
A. Internal service funds
B. Enterprise funds
C. Special revenue funds
D. Nonexpendable trust funds

C. Special revenue funds
All governmental funds, including special revenue funds, use the modified accrual basis of accounting.

284

Which of the following funds of a governmental unit recognizes revenues in the accounting period in which they become available and measurable?
General fund Enterprise fund
Yes No
No Yes
Yes Yes
No No

General fund Enterprise fund
Yes No
The general fund uses the modified accrual basis of accounting. Under this basis, revenues are recognized in the accounting period when they become available and measurable.
An enterprise fund uses the accrual basis of accounting. Under this basis, revenues are recognized in the period in which they are earned and measurable.

285

The orientation of accounting and reporting for all proprietary funds of governmental units is
A. Income determination.
B. Project.
C. Flow of funds.
D. Program.

A. Income determination.
Proprietary funds account for activities of the governmental unit that are similar to activities conducted by commercial enterprises. The orientation of accounting and reporting for proprietary funds is similar to that used in private businesses. The accrual basis of accounting is used, and the measurement focus is on income determination, financial position, and cash flow (GASB Codification 1300.102).

286

Encumbrances outstanding at year's end in a state's general fund may be reported as a
A. Liability in the general fund.
B. Fund balance assigned in the general fund.
C. Liability in the general long-term debt account group.
D. Fund balance designation in the general fund.

B. Fund balance assigned in the general fund.

287

Excel City issued $40,000 of purchase orders. Assume that when all the orders were received, the actual cost was $39,100. How much would be recorded as expenditures when the purchase orders were issued?

A. $39,100
B. $40,000
C. $900
D. $0

D. $0
No expenditures are recorded at the time purchase orders were issued. Encumbrances represent a commitment made to the vendor in the form of a purchase order prior to incurring actual expenditures. At the time a purchase order is issued, the encumbrance account is increased by the amount of the purchase orders - in this case, $40,000. Expenditures of $39,100 will be recorded when goods are received along with the invoices, and at that time the $40,000 encumbered will be also be reversed out.

288

Park City uses encumbrance accounting and formally integrates its budget into the general fund's accounting records. For the year ending July 31, 2005, the following budget was adopted:

Estimated revenues
$30,000,000
Appropriations
27,000,000
Estimated transfer to debt service fund
900,000
When Park's budget is adopted and recorded, Park's budgetary fund balance would be a

A. $3,000,000 credit balance.
B. $3,000,000 debit balance.
C. $2,100,000 credit balance.
D. $2,100,000 debit balance.

C. $2,100,000 credit balance.

Park would credit the budgetary fund balance for $2,100,000 when it makes the following entry to record the budget.

Estimated revenues
$30,000,000
Appropriations
$27,000,000
Estimated transfers to debt service fund
$900,000
Budgetary fund balance
$2,100,000

289

As of the end of the fiscal year, a Capital Projects Fund has material balances of supplies inventory. Which fund balance classification would reflect the inventory of supplies?
A. Nonspendable.
B. Restricted.
C. Committed.
D. Assigned.

A. Nonspendable.
According to GASB Statement No. 54, a Nonspendable Fund Balance classification pertains to amounts that cannot be spent either because they are not in a spendable form (e.g., inventory) or are legally or contractually required to be maintained intact.

290

A Special Revenue Fund may report a positive amount in each of the following fund balance classifications except:
A. Restricted.
B. Committed.
C. Assigned.
D. Unassigned.

D. Unassigned.
Only the General Fund can report a positive amount in Unassigned Fund Balance.

291

The County Commissioner Board took formal action to dedicate resources to expand the regional fairgrounds (a particular project) in the Capital Projects Fund. Those resources cannot be redirected for another use unless an equivalent formal action is taken. As of the end of the fiscal year, a portion of these resources remain in the fund balance. The proper fund balance classification for these resources would be:
A. Restricted.
B. Committed.
C. Assigned.
D. Designated.

B. Committed.
According to GASB Statement No. 54, amounts that can only be used for a specific purpose, because of constraints imposed by formal action of the government's highest level of decision making authority, should be reported as Committed Fund Balance.

292

In preparing Chase City's reconciliation of the Statement of Revenues, Expenditures, and Changes in fund balances to the Government-Wide Statement of Activities, which of the following items should be subtracted from the changes in fund balances?
A. Capital Assets Purchases.
B. Payment of long-term debt principal.
C. Internal Service Fund increase in Net Position.
D. Book value of capital assets sold during the year.

D. Book value of capital assets sold during the year.

293

The Statement of Activities of the Government-Wide Financial Statements is designed primarily to provide information to assess which of the following?
A. Operational accountability.
B. Financial accountability.
C. Fiscal accountability.
D. Functional accountability.

A. Operational accountability.

294

Which of the following is a section of a comprehensive annual financial report?

A. Introductory.
B. Financial.
C. Statistical.
D. All of the above.

D. All of the above.

295

Which of the following is true?

A. A government can issue its CAFR without its basic financial statements, management's discussion and analysis, and other required supplementary information.
B. A government can issue its basic financial statements, management's discussion and analysis, and other required supplementary information without its CAFR.
C. Both A and B are possible.
D. Neither A nor B is permitted.

B. A government can issue its basic financial statements, management's discussion and analysis, and other required supplementary information without its CAFR.

The minimum reporting requirement for a government is a General Purpose Financial Statement, which has three main components: (1) management's discussion and analysis, (2) basic financial statements, and (3) required supplementary information.

296

The introductory section of a CAFR typically includes all of the following except:

A. The letter of transmittal.
B. An organizational chart.
C. The independent auditor's opinion.
D. The table of contents.

C. The independent auditor's opinion.
The auditor's report is not part of the introductory section of the CAFR. It is part of the financial section of the CAFR.

297

Which of the following statements are required to be presented for special-purpose governments engaged only in business-type activities (such as utilities)?
A. Statement of Net Position only.
B. Management's Discussion and Analysis (MD&A) and Required Supplementary Information (RSI) only.
C. The financial statements required for Governmental Funds, including MD&A.
D. The financial statements required for Enterprise Funds, including MD&A and RSI.

D. The financial statements required for Enterprise Funds, including MD&A and RSI.

298

The Excel City School District has a separate elected governing body that administers the public school system. The district's budget must be approved by the city council of Excel City. The school district's financial activity should be reported in the City's financial statements by:

A. Discrete presentation.
B. Blending.
C. Footnote.
D. Not at all.

A. Discrete presentation.
The school district is financially accountable to the city and, therefore, is a component of the city. Component units should be discretely presented in the city's financial statements unless its governing body is substantially the same as the governing body of the primary government, if the component unit provides services almost entirely to the primary government. Since neither exception is met in this case, the school should be discretely presented.

299

For general purpose external financial reporting, discrete component unit information:

A. Is not presented.
B. Is included in the government-wide statements only.
C. Is included in the fund financial statements only.
D. Is included in both the government-wide and the fund financial statements.

B. Is included in the government-wide statements only.
Discretely presented component units are presented in the Government-Wide Financial Statements only and not in the fund-level statements.

300

Tree City reported a $1,500 net increase in the fund balance for Governmental Funds. During the year, Tree purchased general capital assets totaling $9,000 and recorded a depreciation expense of $3,000.
What amount should Tree report as the Change in Net Position for governmental activities in Tree's Statement of Activities?

A. ($4,500)
B. $ 1,500
C. $ 7,500
D. $10,500

C. $ 7,500
The increase in the fund balance for Governmental Funds is measured on the modified accrual basis, while the Change in Net Position for governmental activities is measure on the full accrual basis. To convert the increase in fund balance to full accrual:
+ $1,500
+ 9,000
- 3,000
= $7,500

301

Big City recently lost a lawsuit relating to an incident involving one of their police officers. A judgment was rendered against the city, and, immediately prior to the current fiscal year end, the city was ordered to pay a total of $500,000. $100,000 is due immediately and the remaining is to be paid in installments of $100,000 per year for an additional four years. How will the external financial statements of the city be affected in the year the court case was settled?
A. The General Fund statements should report both expenditures and a claims and judgments liability of $500,000.
B. The General Long-Term Liabilities accounts should report a $500,000 liability.
C. The General Fund statements should report expenditures and a current liability of $100,000, and the Agency Fund should report a liability of $400,000.
D. The General Fund statements should report expenditures and a current liability of $100,000, and the government-wide statements should report a long-term liability of the present value of the $400,000.

D. The General Fund statements should report expenditures and a current liability of $100,000, and the government-wide statements should report a long-term liability of the present value of the $400,000.

The $100,000 portion of the judgment due in the current year is reported in the General Fund and will appear as expenditures in the fund-level statements. The unmatured $400,000 portion is reported in the Government-Wide Statements as a liability at present value. The long-term portion of the liability is RECORDED in the Schedule of General Long-term Debt.