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1

How to do royalty expense questions:

Royalty expense for the year equals x% of sales for the year year, regardless of when the royalties are paid.

The $40,000 paid on September 30, 2006 applies to the sales in the first half of 2006 (January - June). Sales for the second half of 2006 were $300,000. The royalty expense associated with these sales is .15($300,000) = $45,000. Therefore, total royalty expense for the year 2006 is $40,000 + $45,000 = $85,000.

2

total revenue on single-step income statement

Just sales, not purchase discounts or recovery of accounts written off.

3

Ande Co. estimates uncollectible accounts expense using the ratio of past actual losses from uncollectible accounts to past net credit sales, adjusted for anticipated conditions. The practice follows the accounting concept of:

matching.

The matching principle requires that we recognize and match expenses with the revenues generated. For all sales in a given period, some will be uncollectible. The cost of those uncollectible accounts is matched in the period that the revenue is recognized.

4

Which of the following accounting bases may be used to prepare financial statements in conformity with a comprehensive basis of accounting other than Generally Accepted Accounting Principles?
I. Basis of accounting used by an entity to file its income tax return;

II. Cash receipts and disbursements basis of accounting.

Both I and II.

This question is not asking whether other comprehensive bases of accounting are acceptable under GAAP. Rather, it is simply asking which statements describe a comprehensive basis other than GAAP. Both I and II are found in various situations of accounting practice.

5

According to the conceptual framework, is neutrality is an ingredient of faithful representation, relevance, or both?

Neutrality is one of the ingredients of faithful representation, along with completeness and free from material error. Neutrality means lack of bias-that financial reporting does not have a preconceived objective or agenda.

6

An analysis of Thrift Corp.'s unadjusted prepaid expense account at December 31, 2004, revealed the following:

Thrift had an opening balance of $1,500 for its comprehensive insurance policy. Thrift had paid an annual premium of $3,000 on July 1, 2003.

A $3,200 annual insurance premium payment made July 1, 2004 was unadjusted.

A $2,000 advance rental payment for a warehouse Thrift leased for one year beginning January 1, 2005 was included.

In its December 31, 2004, Balance Sheet, what amount should Thrift report as prepaid expenses?

$3,600.

Opening balance $1,500
less the amortization of remaining balance. The $3,000 payment on July 1, 2003 covers the period July 1, 2003 - June 30, 2004. Thus by the end of 2004, the prepayment has expired.
(1,500)
Plus the annual payment made July 1, 2004
3,200
Less 1/2 year's amortization to December 31, 2004
(1,600)
Plus warehouse prepayment (no amortization is required for this payment because the lease term begins Jan. 1, 2005)
2,000
Equals ending 2004 prepaid expenses (prepaid asset)
3,600

7

Which of the following characteristics relates to both accounting relevance and faithful representation?

Comparability.


Comparability is the quality of information that enables users to identify similarities and differences between sets of information. For information to be comparable, it must be both relevant (make a difference to a user) and reliable (be accurate and trustworthy).

8

Young & Jamison's modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses?

Cash-based operating expenses $150,000
Add the beginning of the year prepaid expenses, 10,000.
Subtract the end of the year prepaid expenses, (15,000).
Subtract the beg. year accrued expenses, (5,000).
Add the end of the year accrued expenses, 25,000.
Accrual-based operating expenses, $165,000

9

cost-benefit constraint

When the cost of information exceeds its benefit, it should not be reported, even if it might be useful.

10

Which of the following would be reported as an investing activity in a company's statement of cash flows?
A. Collection of proceeds from a note payable.
Proceeds from a note payable is a financing activity.
B. Collection of a note receivable from a related party.
C. Collection of an overdue account receivable from a customer.
D. Collection of a tax refund from the government.

B. Collection of a note receivable from a related party.

Collection on a note receivable from a related party is an investing activity. The company is lending money to the related party and lending is not a primary business activity – the fact that the loan is in the form of a note implies that it is interest bearing.

11

Which of the following characteristics of accounting information primarily allows users of financial statements to generate predictions about an organization?
A. Reliability.
B. Timeliness.
C. Neutrality.
D. Relevance.

The question is asking which of the following terms captures predictive value. The term reliability is no longer part of the conceptual framework. Faithful representation is now used to capture completeness, neutrality, and free from material error. Predictive value is a component of relevance.

12

Which of the following assumptions means that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis?
A. Going concern.
B. Periodicity.
C. Monetary unit.
D. Economic entity.

The monetary unit assumption provides the basis for using the home-country currency as the reporting basis in the financial statements and also tends to imply that the unit of currency is stable (little or no inflation or deflation).

13

In reference to proposed accounting standards, the term "negative economic consequences" includes:
A. The cost of complying with GAAP.
B. The inability to raise capital.
C. The cost of government intervention when not in compliance with GAAP.
D. The failure of internal control systems.

B. The inability to raise capital

Although lower compliance costs are preferred, "negative economic consequences" refers to the potentially negative effects of proposed standards, including a reduced ability to raise capital, and higher capital costs.

14

determining commission expense

Commission expense is 3% of sales or $450,000 (.03 x $15,000,000). The information about advances is irrelevant because it pertains to how commissions are paid, not recognized.

15

On January 1, 2001, Sip Co. signed a five-year contract enabling it to use a patented manufacturing process beginning in 2001.
A royalty is payable for each product produced, subject to a minimum annual fee. Any royalties in excess of the minimum will be paid annually. On the contract date, Sip prepaid a sum equal to two years' minimum annual fees. In 2001, only the minimum fees were incurred.

The royalty prepayment should be reported in Sip's December 31, 2001, financial statements as:
A. An expense only.
B. A current asset and an expense.
C. A current asset and noncurrent asset.
D. A noncurrent asset.

B. A current asset and an expense.

At the end of 2001, 1/2 of the prepayment is recognized as an expense. The minimum fee was incurred in 2001 equaling 1/2 of the prepayment amount. Sip has received the benefit of 1/2 of prepayment amount. The other 1/2 is applied to 2002 and allows Sip to use the patent in that year. This amount had future value as of 12/31/01. That future value is expected to expire at the end of 2002 and, thus, is classified as a current asset at the end of 2001. Additional use in 2002 beyond the minimum will be paid in that year.

16

Prepaid expenses Accrued liabilities
Beginning balance $ 5,000 $ 8,000
Ending balance 10,000 20,000

Debits to operating expenses totaled $100,000. What amount did Ina pay for operating expenses during the current year?

An increase in prepaid expenses indicates that more cash was paid than expensed (5,000). An increase in accrued liabilities indicates that more expense was accrued than paid (12,000). The reconciliation of operating expense to cash paid is: 100,000 + 5,000 - 12,000 = 93,000.

17

Pak Co.'s professional fees expense account had a balance of $82,000 on December 31, 2001, before considering year-end adjustments relating to the following:
Consultants were hired for a special project at a total fee not to exceed $65,000. Pak has recorded $55,000 of this fee based on billings for work performed in 2001.
The attorney's letter requested by the auditors dated January 28, 2002, indicated that legal fees of $6,000 were billed on January 15, 2002, for work performed in November 2001, and unbilled fees for December 2001 were $7000.
What amount should Pak report for professional fees expense for the year ended December 31, 2001?

The two amounts listed in the attorney's letter should be added to the preadjusted amount of expense, but the appropriate amount of the consultant expense has been included in the preadjusted amount. The ending expense balance therefore is $95,000 ($82,000 + $6,000 + $7,000).
The expense amount already includes the $55,000 amount for the work performed in 2001. The $10,000 extra is irrelevant.

18

On November 1, 2005, Key Co. paid $3,600 to renew its insurance policy for three years. At December 31, 2005, Key's unadjusted trial balance showed a balance of $90 for prepaid insurance and $4,410 for insurance expense.
What amounts should be reported for prepaid insurance and insurance expense in Key's December 31, 2005, financial statements?

Prepaid insurance at year end is $3,400, which is the portion of the prepayment on November 1 that continues to the next three years. Of the 36 months of coverage purchased, 34 months remain at December 31: $3,400 = (34/36)($3,600). Insurance expense includes three items: (1) the $90 of prepaid insurance remaining in the trial balance that has expired, (2) the $200 of insurance expense related to the November 1 purchase above ($3,600-$3,400 remaining prepaid), and (3) the expense portion of the $4,410 insurance expense amount in the unadjusted trial balance ($4,410-$3,600) = $810. This firm must have expensed the entire $3,600 November 1 purchase because it was not reflected in prepaid insurance. The difference of $810 reflects actual expense. Therefore, total insurance expense equals $1,100 = $90 + $200 + $810.

19

Based on 2000 sales of compact discs recorded by an artist under a contract with Bain Co., the artist earned $100,000 after an adjustment of $8,000 for anticipated returns.
In addition, Bain paid the artist $75,000 in 2000 as a reasonable estimate of the amount recoverable from future royalties to be earned by the artist.
What amount should Bain report in its 2000 Income Statement for royalty expense?

$100,000. The net amount earned by the artist is also the royalty expense to the firm.

20

calculating total insurance premiums paid

Beg. prep. bal.
+ Premiums paid
- Expense charges
= End. prep. bal.

21

Compared to the accrual basis of accounting, the cash basis of accounting overstates income by the net increase during the accounting period of the...

accrued expenses payable.

22

In financial statements prepared on the income-tax basis, how should the nondeductible portion of expenses, such as meals and entertainment, be reported?
A. Included in the expense category in the determination of income.
B. Included in a separate category in the determination of income.
C. Excluded from the determination of income but included in the determination of retained earnings.
D. Excluded from the financial statements.

A. Included in the expense category in the determination of income.

Despite the fact that these expenses are not deductible for tax purposes, they are still business expenses and need to be included in the determination of income on the financial statements. In addition, the income tax return requires information on the total meals and entertainment expense in order to calculate the deductible amount.

23

Compared to its 2004 cash-basis net income, Potoma Co.'s 2004 accrual-basis net income increased when it:
A. Declared a cash dividend in 2003 that it paid in 2004.
B. Wrote off more accounts receivable balances than it reported as uncollectible accounts expense in 2004.
C. Had lower accrued expenses on December 31, 2004, than on January 1, 2004.
D. Sold used equipment for cash at a gain in 2004.

C. Had lower accrued expenses on December 31, 2004, than on January 1, 2004.

If the accrued expenses account (a current liability, often called accrued expenses payable) decreased during 2004, then a greater amount of cash was paid for those expenses in 2004 than were accrued in 2004. This would cause cash-basis net income to be less than accrual-basis net income. Cash-basis net income reflects expenses paid; accrual-basis net income reflects expenses recognized (accrued).

24

Sanni Co. had $150,000 in cash-basis pretax income for the year. At the current year end, accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from their previous year-end balances. Compared to the accrual-basis method of accounting, Sanni's cash-basis pretax income is:

A. Higher by $4,000.
B. Lower by $4,000.
C. Higher by $36,000.
D. Lower by $36,000

C. Higher by $36,000.
The $20,000 AR decrease implies that cash received on account was $20,000 greater than accrual sales. Cash-basis income is, therefore, $20,000 greater than accrual income for this difference. The $16,000 accounts payable increase implies that more inventory was purchased and included in accrual cost of goods sold than was paid. Cash-basis income is, therefore, $16,000 more than accrual income for this difference. In total, cash-basis income is $36,000 greater than accrual income.

25

Hahn Co. prepared financial statements on the cash basis of accounting. The cash basis was modified so that an accrual of income taxes was reported.
Are these financial statements in accordance with the modified cash basis of accounting?
A. Yes.
B. No, because the modifications are illogical.
C. No, because there is no substantial support for recording income taxes.
D. No, because the modifications result in financial statements equivalent to those prepared under the accrual basis of accounting.

Under a strict cash basis of accounting, revenues and expenses are recorded only when cash is received or paid. Under a modified cash basis of accounting, certain accruals and/or deferrals are recorded for financial-statement purposes.
The most common modifications are the capitalization and amortization of long-lived assets and the accrual for income taxes (recognition of income tax expense and related liability).

26

Before 2001, Droit Co. used the cash basis of accounting. As of December 31, 2001, Droit changed to the accrual basis. Droit cannot determine the beginning balance of supplies inventory.
What is the effect of Droit's inability to determine beginning supplies inventory on its 2001 accrual basis net income and December 31, 2001, accrual basis owners' equity?

Net income is overstated, but owner's equity is not affected.

Supplies expense for 2001 under the accrual method is: supplies expense = beginning supplies + purchases - ending supplies. If beginning supplies cannot be determined, then it is assumed to be zero and supplies expense is understated, causing 2001 income to be overstated. However, total supplies expense for the entire life of the business is unaffected by the inability to determine beginning supplies for 2001. Total supplies expense for the life of the business is total purchases less ending inventory in 2001. These two amounts are determinable, and thus, owners' equity at the end of 2001 can be determined.

27

Cash collected on accounts receivable =

Beg. A/R bal.
+ Sales
- Collections (or beg A/R - end A/R)
- Write-offs
= End. A/R bal.

28

definition of current asset

The definition of a current asset uses the period "operating cycle or one year, whichever is longer."

29

Do prepaid taxes leave the balance sheet once the current tax bill is calculated?

Yes.

30

In analyzing a company's financial statements, which financial statement would a potential investor use primarily to assess the company's liquidity and financial flexibility?

Balance sheet.

31

Converting from cash to accrual

Add the beginning liability balances and subtract the ending liability balances; also, subtract beginning asset balances and add ending asset balances.

32

Converting from accrual to cash

Add the ending liability balances and subtract the beginning liability balances; also, subtract ending asset balances and add beginning asset balances.

33

How is notes. rec. adjusted for interest rec. accrual?

It isn't. Int. rec. is recorded in a separate account.

34

How is equipment adjusted for depr. cost.

It isn't. Acc. depr. is recorded in a separate account.

35

salaries payable =

given balance + accrued salaries.

36

acc. depr. =

given balance + depr. for current year

37

How are warranty obligations measured?

At NRV or settlement rate.

38

How are long-term bonds payable measured?

At PV of FCFs.

39

The process of converting noncash resources and rights into cash or claims to cash.

realization

40

The process of formally recording an item in the financial statements of an entity after it has met existing criteria and been subject to cost-benefit constraints and materiality thresholds.

recognition

41

Inflows or other enhancements of assets of an entity or settlements of its liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing operations.

revenues

42

A performance measure concerned primarily with cash-to-cash cycles.

earnings

43

During the period when an enterprise is under the direction of a particular management, its financial statements will directly provide information about:
A. Both enterprise performance and management performance.
Financial statements only provide direct information about enterprise performance. There are too many factors affecting the performance of the enterprise to isolate the contribution of management.
B. Management performance but does not directly provide information about enterprise performance.
C. Enterprise performance but not directly provide information about management performance.
D. Neither enterprise performance nor management performance.

C. Enterprise performance but not directly provide information about management performance.

The financial statements provide a wealth of information about the performance and financial position of the enterprise, but they do not directly allow an evaluation of management. There are too many factors that affect the firm's performance to be able to single out management's contribution (or lack of it). Many factors interact to determine the performance of the enterprise, one of them being management's performance. Also, for example, current enterprise performance is affected by the past actions of managers that may no longer be with the enterprise.

44

What is the conceptual framework intended to establish?
A. Generally Accepted Accounting Principles in financial reporting by business enterprises.
B. The meaning of "present fairly in accordance with Generally Accepted Accounting Principles."
C. The objectives and concepts for use in developing standards of financial accounting and reporting.
D. The hierarchy of sources of Generally Accepted Accounting Principles.

C. The objectives and concepts for use in developing standards of financial accounting and reporting.
The concepts statements, also collectively called The Conceptual Framework, provide the general underpinnings for specific GAAP. In a way, it is a "constitution" for developing specific accounting principles. The concepts statements are not GAAP, however.

45

Conceptually, interim financial statements can be described as emphasizing:
A. Timeliness over faithful representation.
B. Faithful representation over relevance.
C. Relevance over comparability.
D. Comparability over neutrality.

A. Timeliness over faithful representation.
Interim reporting emphasizes timeliness over faithful representation. Interim reports are generally more aggregate and reflect estimates that are of a more approximate nature than those found in annual reports. The objective is to provide reasonable information in a timely fashion, rather than exact information. The cost to provide the latter would often be prohibitive on a quarterly basis.

46

Which of the following characteristics of accounting information primarily allows users of financial statements to generate predictions about an organization?
A. Reliability.
B. Timeliness.
C. Neutrality.
D. Relevance.

D. Relevance.
The question is asking which of the following terms captures predictive value. Predictive value along with confirmatory value is a component of relevance.

47

According to the conceptual framework, the process of reporting an item in the financial statements of an entity is:
A. Recognition.
B. Realization.
C. Allocation.
D. Matching.

A. Recognition.
Recognition is the process of formally recording and reporting an item as one of the elements of financial statements. It is the "strongest" application an item can receive.
Footnote disclosure may report an item, but it does not include the item in an account balance. When an item is recognized, it affects an account balance reported in the financial statements. The item may not be separately listed, but it will be reflected in one of the accounts in the statements.

48

According to the FASB conceptual framework, certain assets are reported in financial statements at the amount of cash or its equivalent that would have to be paid if the same or equivalent assets were acquired currently. What is the name of the reporting concept?

A. Replacement cost.
B. Current market value.
C. Historical cost.
D. Net realizable value.

A. Replacement cost.

Replacement cost is the amount to be paid for an item at the current time. This concept is used in the lower-of-cost-or-market inventory valuation procedure. Replacement cost is an example of an entry price-the amount required to be paid currently to obtain an asset already held.

49

General Motors rounds its balance sheet amounts to the nearest million dollars. This is an example of materiality.
True
False

True

50

Papa Company acquired land with an office building on it from its subsidiary, Sonny Company, for $110,000. Prior to the sale, Sonny's carrying value of the land was $60,000 and its net carrying value of the building was $50,000. At the time of the transaction, Papa appropriately determined that the land had a fair value of $75,000 and the building had a fair value of $35,000. At what amount should the land and building be reported on Papa's consolidated statements prepared immediately after the transaction?

Land $60,000. Building $50,000.

Even though there was no profit or loss on the intercompany transaction, it resulted in amounts being redistributed between the depreciable asset office building and the non-amortizable asset land, which would result in different amounts of depreciation expense than if the transaction had not occurred. Therefore, the intercompany transaction must be "eliminated" so that the consolidated statements would show land at $60,000 and buildings at $50,000. (Sonny also would need to assess the building for possible impairment.)

51

Which of the following is not a required component of the 10-K filing?
A. Product market share.
B. Description of the business.
C. Market price of common stock.
The market price of the common stock is a required disclosure in Part I, 5.
D. Executive compensation.

A. Product market share.
The market share of the company's product is not a required disclosure. The company may chose to voluntarily present this information, but it is not a required disclosure.

52

Alphaco has two subsidiaries, Betaco and Charlieco, both of which are consolidated by Alphaco. Alphaco and Betaco have elected to measure their respective investments held-to-maturity at fair value. Charlieco measures its investments held-to-maturity using amortized cost. In its consolidated financial statements, for which companies, if any, may Alphaco elect to report investment held-to-maturity at fair value?
A. Alphaco only.
B. Alphaco and Betaco only.
C. Alphaco, Betaco, and Charlieco.
D. None of the companies; all investments held-to-maturity must be measured and reported at amortized cost.

C. Alphaco, Betaco, and Charlieco.
As the parent, Alphaco may elect to report all of the investments held-to-maturity at fair value in its consolidated statements (only), whether or not the fair value option was elected by its subsidiaries for their separate books and any separate reporting purposes.

53

I. The determination of fair value is based on a hypothetical transaction.
II. The determination of fair value is based on an exit price.
III. The determination of fair value of a nonfinancial asset should be based on the intended use of the asset by the reporting entity.
A. I only.
B. II only.
C. I and II only.
D. II and III only.

C. I and II only.
Both Statements I and II are correct. The determination of fair value is based on a hypothetical transaction and on the use of a (hypothetical) exit price. Statement III is not correct. The determination of fair value of a nonfinancial asset should be based on the highest and best use of the asset by market participants, not based on the intended use by the reporting entity.

54

Which of the following statements concerning the fair value hierarchy used in ascertaining fair value is/are correct?

I. Quoted market prices should be adjusted for a "blockage factor" when a firm holds a sizable portion of the asset being valued.

II. Quoted market prices in markets that are not active because there are few relevant transactions cannot be used.

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

D. Neither I nor II.
Neither Statement I nor Statement II is correct. Quoted market prices should not be adjusted for a "blockage factor" when a firm holds a sizable portion of the asset being valued (Statement I). A "blockage factor" occurs when an entity holds a sizable portion of an asset (or liability) relative to the trading volume of the asset or liability in the market. Using a "blockage factor" would adjust the market value for the impact of such a large block of securities being sold, but is not permitted in determining fair value. Additionally, quoted market prices in markets that are not active because there are few relevant transactions can be used in determining fair value (Statement II). Such prices would be considered level 2 factors, observable inputs but not in active markets.

55

Which of the following statements concerning disclosures when fair value measurement is used is/are correct?

I. Disclosures must be provided that show information for each major category of assets and/or liabilities.

II. Most disclosures must be in both interim and annual financial statements.

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

C. Both I and II.
Both Statement I and Statement II are correct. Disclosures must be provided that show information for each major category of assets and/or liabilities (e.g., investments held-for-trading, investments available-for-sale, derivatives, etc.) (Statement I), and most disclosures must be in both interim and annual financial statements (Statement II).

56

Even though the SEC delegates the creation of accounting standards to the private sector, the SEC frequently comments on accounting and auditing issues. The main pronouncements published by the SEC are:
A. Federal Reporting Updates (FRU).
B. Financial Reporting Releases (FRR).
C. Staff Auditing Bulletins (SAB).
D. Accounting Principles Opinions (APO).

B. Financial Reporting Releases (FRR).

The main pronouncements published by the SEC are the Financial Reporting Releases (FRR) and the Staff Accounting Bulletins (SAB).

57

The SEC enforces the corporate registration requirements of the Securities Act of 1933 as one of its principal objectives. These requirements are intended to provide information that enables the SEC to:
A. Evaluate the financial merits of the corporation offering the securities to the public.
B. Ensure that investors are provided with adequate information on which to base investment decisions.
C. Guarantee that the facts contained in the registration statement are accurate.
D. Assure investors of the accuracy of the financial statements.

B. Ensure that investors are provided with adequate information on which to base investment decisions.

The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. In order to carry out the mandates in the Securities Act of 1933, the SEC is ensuring that investors are provided with adequate information on which to base investment decisions. www.SEC.gov, What We Do.

58

The SEC defines a foreign private issuer as any issuer other than a foreign government, except an issuer that where more than 50% of the outstanding voting securities are directly or indirectly owned by residents of the U.S. and what other condition?
A. The business of the issuer is administered principally in the foreign country.
B. More than 50% of the assets of the issuer are located in the foreign country.
C. The majority of its executive officers or directors are U.S. citizens or residents.
D. All of the above.

C. The majority of its executive officers or directors are U.S. citizens or residents.

A foreign private issuer is any foreign issuer other than a foreign government, except an issuer that meets the following conditions:
A. More than 50% of the outstanding voting securities are directly or indirectly owned by residents of the U.S., and
B. Any of the following:
The business of the issuer is administered principally in the U.S.
More than 50% of the assets of the issuer are located in the U.S.
The majority of its executive officers or directors are U.S. citizens or residents.
Rule 205, Securities Act 1933

59

A company that is a large accelerated filer must file its Form 10-Q with the United States Securities and Exchange Commission within how many days after the end of the period?
A. 30 days.
B. 40 days.
C. 45 days.
D. 60 days.

B. 40 days.
A large accelerated filer is a company with worldwide market value of outstanding voting and nonvoting common equity held by nonaffiliates of $700 million or more. A large accelerated filer must file its 10Q within 40 days after quarter end. A non-accelerated filer has 45 days to file its 10Q.

60

For a firm that elects to use fair value to measure eligible financial assets and financial liabilities, specific disclosures are required for which of the following financial statements?

Statement of Financial Position (Balance Sheet) Income Statement
Yes Yes
Firms which elect to measure financial assets and financial liabilities at fair value are required to make significant additional disclosures for both the statement of financial position (balance sheet) and for the income statement.
Yes No
No Yes
No No

Yes Yes
Firms which elect to measure financial assets and financial liabilities at fair value are required to make significant additional disclosures for both the statement of financial position (balance sheet) and for the income statement.

61

Marco has an investment that is traded in two different markets, Front market and Side market. Marco has equal access to each market. In order to determine the fair value of its investment, Marco has obtained the following per share information for the securities as of the close of business December 31, the end of its fiscal year:

Front Market Side Market
Selling Price $52/sh $50/sh
Transaction Cost $ 6/sh $ 1/sh
If neither Front market nor Side market is a principal market for the security for Marco, using the market approach which one of the following would be the per share amount used for measuring the investment at fair value?

A. $52/sh
B. $50/sh
C. $49/sh
D. $46/sh

B. $50/sh
Since neither market is the principal market for the security, Marco must determine the most advantageous market, which is the market in which the asset could be sold at a price that maximizes the amount that would be received. Marco would receive $52/sh - $6/sh = $46/sh in Front market and would receive $50/sh - $1/sh = $49/sh in Side market. Therefore, Side market is its most advantageous market, and fair value would be determined in that market as the price at which the security could be sold, or $50/sh. The market selling price would not be adjusted for the related direct transaction cost, even though it enters into determining the most advantageous market.

62

The use of fair value measurement is required for some items in financial statements and optional for other items. Is the framework for determining fair value measurement, as set forth in ASC 820, "Fair Value Measurement," generally required to be followed in circumstances where fair value measurement is required and/or in circumstances where fair value measurement is elected by a firm?
Fair Value Required Fair Value Elected
Yes Yes
Yes No
No Yes
No No

Yes Yes
The framework for determining (measuring) fair value provided in ASC 820, "Fair Value Measurement," must be followed (with very limited exceptions) whenever fair value measurement is used, either as required by GAAP or permitted by GAAP as an alternative that is elected by an entity.

63

Giaconda, Inc. acquires an asset for which it will measure the fair value by discounting future cash flows of the asset. Which of the following terms best describes this fair value measurement approach?
A. Market.
B. Income.
C. Cost.
D. Observable inputs.

B. Income.
The income approach to fair value measurement of an asset measures fair value by converting future amounts to a single present amount. Discounting future cash flows would be an income approach to determining fair value.

64

A company is required to file quarterly financial statements with the United States Securities and Exchange Commission on Form 10-Q. The company operates in an industry that is not subject to seasonal fluctuations, which could have a significant impact on its financial condition. In addition to the most recent quarter end, for which of the following periods is the company required to present Balance Sheets on Form 10-Q?
A. The end of the corresponding fiscal quarter of the preceding fiscal year.
B. The end of the preceding fiscal year and the end of the corresponding fiscal quarter of the preceding fiscal year.
C. The end of preceding fiscal year.
D. The end of the preceding fiscal year and the end of the prior two fiscal years.

C. The end of preceding fiscal year.
The Balance Sheet for the end of the preceding fiscal year would have been the last audited Balance Sheet. This Balance Sheet is presented along with the current fiscal quarter.

65

Which one of the following financial items may not be measured and reported at fair value at the election of an entity?

A. Accounts receivable.
B. Investment in debt securities to be held to maturity.
C. Investment in a subsidiary that is to be consolidated.
D. Accounts payable.

C. Investment in a subsidiary that is to be consolidated.
A firm may not use fair value to measure and report an investment in a subsidiary that is to be consolidated. The financial asset "Investment in subsidiary" will be eliminated in the consolidating process and be replaced by the subsidiary's assets and liabilities (and possibly goodwill) on the consolidated balance sheet.

66

Under U.S. GAAP the disclosure requirements when fair value measurement is used are differentiated by which of the following classifications?

A. Between assets measured at fair value and liabilities measured at fair value.
B. Between fair value measurements that result in gains and fair value measurements that result in losses.
C. Between items measured at fair value on a recurring basis and items measured at fair value on a non-recurring basis.
D. Between items for which fair value measurement is required and items for which fair value measurement is elected.

C. Between items measured at fair value on a recurring basis and items measured at fair value on a non-recurring basis.
Disclosure requirements when fair value measurement is used are differentiated between items measured at fair value on a recurring basis and items measured at fair value on a non-recurring basis. Items measured at fair value on a recurring basis are adjusted to (measured at) fair value period after period; an example would be investments held-for-trading. Items measured at fair value on a non-recurring basis are adjusted to (measured at) fair value only when certain conditions are met; an example would be the impairment of an asset.

67

For which of the following circumstances is the guidance for determining fair value as provided in the fair value framework presented in ASC 820, "Fair Value Measurement," least likely to apply?

A. Determination of the fair value to be assigned to land acquired in a business combination.
B. Determination of the fair value of a bond liability for applying the fair value option.
C. Determination of the fair value of legal services received in exchange for an entity's common stock.
D. Determination of the fair value of a production facility when assessing whether or not an impairment loss has occurred.

The guidance for determining fair value provided in the fair value framework is not appropriate for determining the fair value of legal services received in exchange for an entity's common stock. ASC 820 specifically exempts share-based payment transactions (and inventory valuing and other minor items) from the purview of the fair value framework.

68

A company is an accelerated filer that is required to file Form 10-K with the United States Securities and Exchange Commission (SEC). What is the maximum number of days after the company's fiscal year end that the company has to file Form 10-K with the SEC?
A. 60 days.
B. 75 days.
C. 90 days.
D. 120 days.

B. 75 days.
An accelerated filer has an aggregate worldwide market value of the voting and nonvoting common stock held by nonaffiliates of $75 million or more, but less than $700 million on the last business day of the issuer's most recently completed second fiscal quarter. A large accelerated filer has market capitalization (as described) of $700 million or more. Beginning in 2006 the SEC changed the 10-K filing deadline for large accelerated filers to be 60 days from the fiscal year end. Accelerated filers still have 75 days to file their 10-K.

69

For which one of the following described assets does the guidance for determining fair value as provided in ASC 820, "Fair Value Measurement," not apply?

A. Accounts receivable.
B. Investments in debt securities to be held-to-maturity.
C. Investments in equity securities held for trading.
D. Inventory reported at lower of cost or market.

D. Inventory reported at lower of cost or market.

Inventory valuation under lower of cost or market is specifically exempt from the fair value measurement guidance provided by ASC 820, "Fair Value Measurement." The use of lower of cost or market valuation places upper ("ceiling") and lower ("floor") limits on the measurement of "market" that may not result in a true fair value measurement. Thus, the measurement of inventory at "market" is one of the few exceptions to the use of ASC 820 guidance for fair value measurement.

70

In determining the fair value of an asset or liability, would the fair value of the asset or the fair value of the liability be determined using an entry price or an exit price?

Asset Fair Value Liability Fair Value
Entry price Entry price
Entry price Exit price
Exit price Entry price
Exit price Exit price

Exit price Exit price
The appropriate basis for determining the fair value of an asset or a liability is an exit price.

71

Which one of the following is not a required disclosure in annual financial reports for an entity that uses fair value measurement?

A. The level of the fair value hierarchy within which fair value measurements fall.
B. The valuation techniques used to measure fair value.
C. Combined disclosures about fair value measurements required by all pronouncements.
D. A discussion of any change from the prior period in valuation techniques used to measure fair value.

C. Combined disclosures about fair value measurements required by all pronouncements.

Combined disclosures about fair value measurements required by all pronouncements are not required, but are encouraged.

72

Since 2008, the SEC has permitted foreign private issuers to file their financial statements using:
A. U.S. GAAP.
B. FASB Standards.
C. IFRS as adopted by the European Union.
D. IFRS as issued by the IASB.

D. IFRS as issued by the IASB.
Foreign private issuers in the U.S. markets can file their financial statements using IFRS issued by the IASB since 2008.

73

Which one of the following is not a purpose of the fair value framework as set forth in ASC 820, "Fair Value Measurement"?

A. Provide a uniform definition of "fair value" for GAAP purposes.
B. Provide a framework for determining fair value for GAAP purposes.
C. Establish new measurement requirements for financial instruments.
D. Establish expanded disclosures about fair value when it is used.

C. Establish new measurement requirements for financial instruments.

Establishing new measurement requirements for financial instruments, or for any other asset or liability, is not one of the purposes of the fair value framework. Measurement requirements or elections are determined by other pronouncements; the "Fair Value Measurement" pronouncement establishes standards to be followed in determining (measuring) fair value when it is used.

74

In determining the fair value of an asset in the most advantageous market, the market based exit price should be adjusted for

Transaction Cost Transportation Cost
Yes Yes
Yes No
No Yes
No No

No Yes
In determining the fair value of an asset in the most advantageous market, the market based exit price would not be adjusted for transaction cost associated with executing the (hypothetical) transaction, but would be adjusted for transportation cost to get the asset to the principal or most advantageous market.

75

On January 1, year 1, Peabody Co. purchased an investment for $400,000 that represented 30% of Newman Corp.'s outstanding voting stock. For year 1, Newman reported net income of $60,000 and paid dividends of $20,000. At year end, the fair value of Peabody's investment in Newman was $410,000. Peabody elected the fair value option for this investment. What amount should Peabody recognize in net income for year 1 attributable to the investment?
A. $ 6,000
B. $10,000
C. $16,000
D. $18,000

C. $16,000

Since Peabody has elected to report the investment in Newman using the fair value option, it should recognize its share of cash dividends received during the period (.30 x $20,000 = $6,000) and the increase in the fair value of the investment ($400,000 > $410,000 = $10,000), or $6,000 + $10,000 = $16,000.

76

Papa Company acquired land with an office building on it from its subsidiary, Sonny Company, for $110,000. Prior to the sale, Sonny's carrying value of the land was $60,000 and its net carrying value of the building was $50,000. At the time of the transaction, Papa appropriately determined that the land had a fair value of $75,000 and the building had a fair value of $35,000. At what amount should Papa record the land and building on its books at the date of the transaction?

Land Building
$75,000 $35,000
$55,000 $55,000
$60,000 $50,000
$50,000 $60,000

$75,000 $35,000
Papa should record the land and building on its books at the appropriately determined fair value at the date of the transaction. The prior carrying values on Sonny's books are not relevant to the amounts at which Papa should record the assets on its books, but are relevant to the amounts that should be reported in the consolidated financial statements.

FV on its own books, but carrying value on consolidated F/S.

77

Which of the following valuation methods may be used to measure investments classified as held-to-maturity?

Amortized Cost Fair Value
No No
No Yes
Yes No
Yes Yes

Yes Yes
Both amortized cost and fair value may be used to measure and report investments classified as held-to-maturity. Amortized cost is the traditional measurement method for investments held-to-maturity and would be used unless an entity elects to use fair value, which is permitted by the fair value option.

78

Multico is a securities dealer whose principal market is with other securities dealers. To take advantage of a perceived opportunity, on December 31, the end of its fiscal year, Multico acquired a financial asset in a market other than its principal market for $50,000. At that date, the identical instrument could be sold in Multico's principal market for $50,100 with a $200 transaction cost. Which of the following amounts would constitute fair value to Multico for the financial asset at December 31?

A. $49,800
B. $49,900
C. $50,000
D. $50,100

D. $50,100
Since fair value is based on an exit price, the amount at which Multico could have sold the asset in its principal market is its fair value to Multico. Since the asset could have been sold by Multico in its principal market for $50,100, that is its fair value to Multico. The transaction cost to execute the sale should not be deducted from the market price to get fair value.

79

The SEC is comprised of five commissioners, appointed by the President of the United States, and four divisions. Which of the following divisions is responsible for overseeing compliance with the securities acts?
A. Division of Corporate Finance.
B. Division of Enforcement.
C. Division of Trading and Markets.
D. Division of investment management.

A. Division of Corporate Finance.
The Division of Corporate Finance oversees the compliance with the securities acts and examines all filings made by publicly held companies.

80

Which of the following best describes the term "public accountability" according to IFRSs and IFRS for SME?
I. Entity files, or is in the process of filing, its financial statements with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market.

II. Entity holds assets in a fiduciary capacity for a broad group of outsiders, such as a bank, insurance entity, securities broker/dealer, pension fund, mutual fund, or investment banking entity.

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

C. Both I and II.
Both statements are included in the definition of the term "public accountability." The entity files, or is in the process of filing, its financial statements with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market, and the entity holds assets in a fiduciary capacity for a broad group of outsiders, such as a bank, insurance entity, securities broker/dealer, pension fund, mutual fund, or investment-banking entity. IFRS for SMEs, para. 1.3.

81

IAS 8, Accounting Policies, Changes in Accounting Estimates, and Errors includes the IFRS hierarchy. What is the second-level, or the level after the initial level, addressing the requirements and guidance in IFRS?
A. The definitions, recognition criteria, and measurement concepts for assets, liabilities, comprehensive income, revenue, expenses, and gains and losses in the Framework.
B. The definitions, recognition criteria, and measurement concepts for assets, liabilities, revenue, and expenses in the Framework.
C. Pronouncements of other standard-setting bodies, other accounting literature, and accepted industry practices.
D. Pronouncements of other standard setting bodies using a similar conceptual framework, other accounting literature, and accepted industry practices.

B. The definitions, recognition criteria, and measurement concepts for assets, liabilities, revenue, and expenses in the Framework.
The IFRS hierarchy, as presented in IAS 8, includes first, the requirements in IFRS dealings with similar or related issues; second, the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework; and lastly, the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature, and accepted industry practices, to the extent that these do not conflict with IFRS or the Framework. IAS 8, para. 12.

82

Which of the following statements, if any, concerning IFRS for SMEs is/are correct?
I. IFRS for SMEs is based on accrual basis accounting.

II. Generally, IFRS for SMEs may be used as an alternative to using OCBOA.

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

C. Both I and II.
Both statements are correct. IFRS for SMEs is based on accrual basis accounting (Statement I) and, generally, IFRS for SMEs may be used as an alternative to using OCBOA (Statement II).

83

The IFRS Foundation serves as the administrative umbrella for a group of bodies. Which of the following bodies are NOT included under the IFRS Foundation umbrella?
A. International Federation of Accountants (IFAC).
B. International Accounting Standards Board.
C. IFRS Interpretations Committee.
D. IFRS Advisory Council.

A. IFAC.
The International Federation of Accountants (IFAC) is a global organization for the accounting profession. Its members are accounting and auditing organizations throughout the world. It is an independent organization not under the IFRS Foundation umbrella, but it does support the activities of the IFRS Foundation by encouraging high-quality practices by the world's accountants and auditors.

84

Which of the following is not a role of the trustees of the IFRS Foundation?
A. Appoint the members of the IASB and establish their contracts of service and performance criteria.
B. Appoint the members of the IFRS Interpretations Committee and the IFRS Advisory Council.
C. Approve the annual budget of the IFRS Foundation and determine the basis for funding.
D. Annually review the strategy of the IFRS Foundation and the IASB and its effectiveness, including the determination of the IASB's agenda.

D. Annually review the strategy of the IFRS Foundation and the IASB and its effectiveness, including the determination of the IASB's agenda.
The Trustees do not determine the agenda of the IASB. Rather, the Trustees annually review the strategy of the IFRS Foundation and the IASB and its effectiveness, including the consideration, but not the determination, of the IASB's agenda.

85

Which one of the following is a characteristic of accounting under IFRS for SMEs?
A. Interest incurred during construction must be capitalized.
B. Earnings per share must be provided in the financial statements.
C. Goodwill must be amortized.
D. The LIFO cost flow assumption can be used in valuing inventories.

C. Goodwill must be amortized.

Under IFRS for SMEs, goodwill is assumed to have a limited life and is amortized over that life, or a period not to exceed 10 years if the life cannot be reasonably estimated. Under U.S. GAAP, goodwill is assumed to have an unlimited life and is not amortized.

86

IFRS requires a classified Statement of Financial Position. What are the required classifications?
A. Cash; trade receivables and payables; property, plant and equipment; long-term assets and liabilities; and other assets and liabilities.
B. Cash; trade receivables and payables; property, plant and equipment; and other assets and liabilities.
C. Current, long-term, and other assets and liabilities.
D. Current and non-current assets and liabilities.

D. Current and non-current assets and liabilities.

Under IFRS, the classified Statement of Financial Position has just two classifications: Current and Non-current. Both assets and liabilities are divided into these two classifications, with Non-current being the default category.

87

A. To enforce the use and rigorous application of those standards.
B. To take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings.
C. To develop, in the public interest, a single set of high-quality, understandable, enforceable, and globally accepted financial-reporting standards (IFRSs) through its member associations.
D. To require adoption of international financial reporting standards (IFRSs) globally.

B. or C.

B. To take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings.

The objective of the IFRS Foundation is to take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings.
C. To develop, in the public interest, a single set of high-quality, understandable, enforceable, and globally accepted financial-reporting standards (IFRSs) through its member associations.

The objective of the IFRS Foundation is to develop, in the public interest, a single set of high-quality, understandable, enforceable, and globally accepted financial reporting standards based upon clearly articulated principles. These standards should require high-quality, transparent, and comparable information in financial statements and other financial reporting to help investors, other participants in the world's capital markets, and other users of financial information make economic decisions. There are no member associations of the IASB. Rather, representatives of many associations do partake in an advisory capacity, through the IFRS Advisory Council.

88

The purpose of IASB's Framework for the preparation and presentation of financial statements includes all of the following except:
A. Assist users of financial statements in interpreting the information contained in financial statements that are prepared in conformity with IFRSs.
B. Assist national standard-setting bodies in developing national standards.
C. Assist the IASB in the development of future IFRSs and in its review of existing IFRSs.
D. Assist the IASB in enforcing regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative treatments permitted by IFRSs.

D. Assist the IASB in enforcing regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative treatments permitted by IFRSs.

Remember that the IASB has no enforcement authority. The enforcement is carried out by regulators, such as the SEC in the U.S., Central Banks, and governmental authorities. As such, the purpose of the IASB's Framework is not to assist in enforcing regulations, accounting standards, and procedures but, rather, to assist in promoting the harmonization of regulations, accounting standards, and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative treatments permitted by IFRSs. IASB Framework, para. 1.

89

ccording to the IASB Framework, which of the following is an essential characteristic of an asset?
A. The claims to an asset's benefits are legally enforceable.
B. An asset is tangible.
C. An asset is obtained at a cost.
D. An asset provides future benefits.

D. An asset provides future benefits.
According to the IASB's Framework, an asset is defined as "a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity." IASB Framework, para. 49.

90

The Statement of Changes in Equity shows an increase in the common stock account of $2,000 and an increase in the additional paid-in capital account of $10,000. If the common stock has a par value of $2, and the only transactions affecting these accounts were these issues of common stock, what was the average issue price of the common stock during the year?

A. $2
B. $5
C. $10
D. $12

D. $12
If the par value of the stock is $2, and the increase in the common stock account is $2,000, then $2,000/$2 = 1,000 shares issued. The average issue price is the sum of the par value ($2) and the additional paid-in capital ($10,000/1,000 shares, or $10), which totals $12.

91

Which of the following statements is false?

A. A Statement of Cash Flows categorizes cash inflows and outflows into operating, investing, and financing activities.
B. A Statement of Owner's Equity summarizes the changes in owner's equity for a specific period of time.
C. An Income Statement summarizes the revenues, expenses, changes in owner's equity, and the resulting net income/loss for a specific period of time.
D. A Balance Sheet reports the assets, liabilities, and owner's equity at a specific date.

C. An Income Statement summarizes the revenues, expenses, changes in owner's equity, and the resulting net income/loss for a specific period of time.
The following statement is false: An Income Statement summarizes the revenues, expenses, changes in owner's equity, and resulting net income/loss for a specific period of time. Changes in owner's equity are reported in a separate statement and is not included in the Income Statement.

92

Which of the following accounts is a contra account?
A. Accumulated depreciation, equipment.
B. Depreciation expense, office equipment.
C. Dividends.
D. Unearned revenue.

A. Accumulated depreciation, equipment.
Accumulated depreciation is a contra account. The asset account Equipment is reported on the Balance Sheet as the net of accumulated depreciation. As such, the accumulated depreciation account has a credit balance, reducing the Equipment account from its historical cost balance to its carrying or book value.

93

In a Statement of Cash Flows, which of the following items is reported as a cash outflow from financing activities?
I. Payments to retire mortgage notes;
II. Interest payments on mortgage notes;
or III. Dividend payments.

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

D. I and III.
Both I and III are financing cash outflows. Principal payments on loans from financial institutions are financing because they are a return of a source of long-term financing.
The dividends are a return to shareholders who have provided a considerable portion of total firm financing.

94

Reporting accounts receivable at net realizable value is a departure from the accounting principle of:
A. Conservatism.
B. Fair value.
C. Market value.
D. Historical cost.

D. Historical cost.
Reporting accounts receivable at net realizable value is a departure from the principle of historical cost. Accounts receivable is usually aged by some method and reported at net realizable value.

95

Which type of material related-party transactions require disclosure?
A. Only those not reported in the body of the financial statements.
B. Only those that receive accounting recognition.
C. Those that contain possible illegal acts.
D. All those other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business.

D. All those other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business.
Material related party transactions must be disclosed unless they are ordinary business transactions, such as payment of employees and other routine transactions.

96

Brad Corp. has unconditional purchase obligations associated with product financing arrangements. These obligations are reported as liabilities on Brad's balance sheet, with the related assets also recognized.
In the notes to Brad's financial statements, the aggregate amount of payments for these obligations should be disclosed for each of how many years following the date of the latest balance sheet?

A. 0
B. 1
C. 5
D. 10

C. 5
The payments for the five years following the balance sheet date must be disclosed.
This question requires memorization of a relatively obscure piece of information. However, there are other cases for which data must be disclosed for the five years following the balance sheet date. Few, if any disclosures are required for a full ten years after the balance sheet date.

97

The following items were among those reported on Lee Co.'s Income Statement for the year ended December 31, 2005:
Legal and audit fees $170,000
Rent for office space 240,000
Interest on inventory floor plan 210,000
Loss on abandoned data processing equipment used in operations 35,000
The office space is used equally by Lee's sales and accounting departments. What amount of the above-listed items should be classified as general and administrative expenses in Lee's multiple-step Income Statement?
A. $290,000
B. $325,000
C. $410,000
D. $500,000

A. $290,000
General and administrative expenses include expenses that are not related to significant specifically identifiable activities. G & A costs benefit the entire firm rather than one specific function.
The $170,000 of legal and audit fees are included in G & A expenses and are 1/2 of the rent for the office space ($120,000 = .5 x $240,000). The portion of rent related to accounting is G & A. The other half of the rent is a selling expense, a significant separate activity. The interest and loss are also separately reported. Thus total G & A expense is $290,000 ($170,000 + $120,000).

98

Tam Co. reported the following items in its year-end financial statements:

Capital expenditures $1,000,000
Capital lease payments 125,000
Income taxes paid 325,000
Dividends paid 200,000
Net interest payments 220,000
What amount should Tam report as supplemental disclosures in its Statement of Cash Flows prepared using the indirect method?

A. $545,000
B. $745,000
C. $1,125,000
D. $1,870,000

A. $545,000
Although the indirect method does not report operating cash flows in the body of the statement, income taxes paid and interest payments must be disclosed in the notes or supplementary schedule. The total of these amounts is $545,000 ($325,000 + $220,000).

99

In preparing its cash flow statement for the year ended December 31, 20x4, Reve Co. collected the following data:
Gain on the sale of equipment $ (6,000)
Proceeds from the sale of equipment 10,000
Purchase of A.S., Inc. bonds (par value $200,000) (180,000)
Amortization of bond discounts 2,000
Dividends declared (45,000)
Dividends paid (38,000)
Proceeds from the sale of treasury stock (carrying amount $65,000) 75,000
In its December 31, 20x4, Statement of Cash Flows, what amount should Reve report as net cash used in investing activities?
A. $170,000
B. $176,000
C. $188,000
D. $194,000

A. $170,000

Proceeds from sale of equipment $10,000
Less purchase of A.S. bonds (180,000)
Equals net cash outflow from investing activities $(170,000)

100

Which of the following should be included in general and administrative expenses?
Interest Advertising
Yes Yes
Yes No
No Yes
No No

Neither expense is normally included in general and administrative expenses because interest and advertising are expenses that result from very specific activities and are frequently material in amount. They should be separately identified.

101

In Yew Co.'s 2004 annual report, Yew described its social awareness expenditures during the year as follows:

"The Company contributed $250,000 in cash to youth and educational programs. The Company also gave $140,000 to health and human service organizations, of which $80,000 was contributed by employees through payroll deductions. In addition, consistent with the Company's commitment to the environment, the Company spent $100,000 to redesign product packaging."
What amount of the above should be included in Yew's Income Statement as charitable contributions expense?

A. $310,000
B. $390,000
C. $410,000
D. $490,000

A. $310,000
The charitable contributions are limited to the $250,000 contribution and the portion of the $140,000 contribution paid for by the firm (which amounted to $60,000 or $140,000 - $80,000 paid by the employees). Thus total charitable contributions are $310,000.
The product packaging cost is a promotional cost.

102

A multi-step Income Statement is prepared:
A. By all corporations.
B. By a company whose main activity is sales.
C. Because it is required by FASB.
D. Because it is more meaningful presentation of revenue and expenses.

D. Because it is more meaningful presentation of revenue and expenses.
A multi-step Income Statement is not required but is prepared because it is a more meaningful presentation of revenue and expenses. In a multi-step Income Statement, gross profit (margin), operating profit (margin), and pretax income from continuing operations are determined. The focus is on the determination of operating profit rather than simply income from continuing operations.

103

The following costs were incurred by Griff Co., a manufacturer, during 2004:

Accounting and legal fees $ 25,000
Freight-in 175,000
Freight-out 160,000
Officers' salaries 150,000
Insurance 85,000
Sales reps' salaries 215,000
What amount of these costs should be reported as general and administrative expenses for 2004?

A. $260,000
B. $550,000
C. $635,000
D. $810,000

The only costs included in general and administrative costs are:

Accounting and legal
$ 25,000
Officers' salaries
150,000
Insurance
85,000
Total G&A cost
$ 260,000
The remaining costs are classified (in order of appearance) as product cost, distribution cost, and sales/promotional costs.

104

In a multi-step Income Statement:
A. Total expenses are subtracted from total revenues.
B. Gross profit (margin) is shown as a separate item.
C. Cost of sales and operating expense are subtracted from total revenues.
D. Other income is added to revenue from sales.

B. Gross profit (margin) is shown as a separate item.
In a multi-step Income Statement, gross profit (margin), operating profit (margin), and pretax income from continuing operations are determined. The focus is on the determination of operating profit rather than simply income from continuing operations. Gross profit (margin) is shown as a separate item.

105

A company's activities for year two included the following:
Gross sales $3,600,000
Cost of goods sold 1,200,000
Selling and administrative expense 500,000
Adjustment for a prior-year understatement of amortization expense 59,000
Sales returns 34,000
Gain on sale of AFS 8,000
Gain on disposal of a disc. bus. segment 4,000
Unrealized gain on AFS 2,000
The company has a 30% effective income tax rate. What is the company's net income for year two?

A. $1,267,700
B. $1,273,300
C. $1,314,600
D. $1,316,000

C. $1,314,600
All items are included in net income except the prior year adjustment to amortization expense and the unrealized gain on the AFS securities. The pre-tax income is $1,878,000 and after 30% taxes the net income is $1,314,600.

106

COGM

Cost of goods manufactured ?
Plus finished goods beginning inventory $400,000
Less finished goods ending inventory (360,000)
Equals cost of sales $240,000

107

In Baer Food Co.'s 2005 single-step Income Statement, the section titled "Revenues" consisted of the following:
Net sales revenue $187,000
Results from discontinued operations:
Loss from operations of the segment (net of $1,200 tax effect) $(2,400)
Gain on the disposal of segment (net of $7,200 tax effect) 14,400 12,000
Interest revenue 10,200
Gain on the sale of equipment 4,700
Total revenues $213,900
In the revenues section of the 2005 Income Statement, Baer Food should have reported total revenues of:
A. $216,300
B. $215,400
C. $203,700
D. $201,900

D. $201,900
Net sales $187,000
Interest revenue 10,200
Gain on equipment 4,700
Total revenues $201,900

This answer includes the gain on the sale of equipment. It is the best answer from among the four because this answer less the gain is not represented. However, many would argue that the gain is not a revenue. Discontinued operations is not a revenue; rather, it is a special item of disclosure found below income from continuing operations in the Income Statement.

108

In LM's single-step income statement, the section titled Revenues consisted of the following:
Net sales revenue $187,000
Results from discontinued operations:
Loss from operations of segment, net of $1,200 tax effect $ 2,400
Gain on disposal of segment, net of $7,200 tax effect 14,400 12,000
Interest revenue 10,200
Gain on sale of equipment 4,700
Cumulative change in previous year's income due to change
In depreciation method, net of $750 tax effect 1,500
Total revenues $215,400
In the revenues section of the income statement, LM should have reported total revenues of

A. $217,800
B. $215,400
C. $203,400
D. $201,900

D. $201,900
In a single step income statement, total revenue is the sum of all revenues, including Net Sales Revenue ($187,000) plus Interest Revenue ($10,200) plus Gain on sale of equipment ($4,700), or $201,900. Results from discontinued operations are reported at the end of the income statement. The cumulative change item is not reported in current year's income statement, as it was a one-time adjustment for the prior reporting period.

109

1. Products are sold with the following warranty: the product may be returned for service free of cost to the customer any time during the year of sale and for the succeeding three calendar years. Thus if a product is sold in 20x3, the warranty covers the product through the end of 20x6. The cost to service warranty claims is estimated to be 1% of sales in the year of sale, 2% in the year following sale, 3% in the second year after sale, and 4% in the third year after sale. During 20x3, sales under warranty totaled $600,000. Assume that warranty expense is recorded as an adjusting entry at year-end. Record that entry for 20x3.

1. $600,000(1% + 2% + 3% + 4%) = $60,000. The entire amount of warranty expense and liability is recognized in the year of sale. When the claims are serviced, the warranty liability is reduced; no additional expense is recognized.

The entry would be:

Warranty expense 60,000
Warranty Liability 60,000

110

2. The count of inventory at year-end for a firm using the periodic inventory system revealed that inventory had increased $40,000 compared with the beginning inventory. Gross purchases for the year totaled $670,000; purchases discounts taken were $12,000; purchases returns and allowances were $82,000; transportation in amounted to $33,000; and transportation out was $9,000. Provide the adjusting entry that establishes cost of goods sold for the period, updates the inventory account, and closes the other accounts related to inventory (only).

2. Transportation out is not a product cost it is a selling cost and; it will be closed along with other expenses and revenues. The other inventory related accounts (purchases, purchase discounts, purchase R&A, and transportation in) are closed to calculate CGS. Even though we do not know the value of beginning inventory - we know that ending inventory is 40,000 higher than beginning inventory. You can assume a beginning inventory value of zero and proceed with the calculation.

Beg. Inv. 0
Purchases 670,000
Less:
Purch. disc. (12,000)
Purchase R&A (82,000) (94,000)
Net Purch. 576,000
Plus trans in 33,000
Less End Inv (40,000)
Cost of Goods Sold 569,000

111

3. The CEO's compensation contract includes a provision for a bonus of 15% of income before the bonus but after income taxes (30% rate). Income before bonus and income tax is $1.2 million for the current year. The bonus is computed and paid at year-end to obtain the tax deduction for the bonus in the current year. Prepare the journal entry to record the bonus only.

3. Let B = bonus and T = income tax

B = .15(1.2 million - T)
T = .30(1.2 million - B)
B = .15(1.2 million - [.30(1.2 million - B)])
B = .15(1.2 million - [.30(1.2 million) - .30B])
B = .15(1.2 million - .36 million + .30B)
B = .15(.84 million + .30B)
B = .126 million + .045B
.955B = .126 million
B = .126 million/.955 = 131,937

Since the bonus is paid before year end, the entry would be:
Salary expense 131,937
Cash 131,937

112

4. Inventory with a recorded cost of $550,000 was completely destroyed in an uninsured casualty. The relevant tax rate is 35%. Record journal entry for the loss.

4. The loss on the destruction of inventory is reported as a component of income from continuing operations. Inventory is reduced for the amount of the loss ($550,000). If the loss is material, the amount of the loss should be disclosed in the financial statements or footnotes.

113

Palmyra Co. has net income of $11,000, a positive $1,000 net cumulative effect of a change in accounting principle, a $3,000 unrealized loss on available-for-sale securities, a positive $2,000 foreign currency translation adjustment, and a $6,000 increase in its common stock. What amount is Palmyra's comprehensive income?
A. $4,000
B. $10,000
C. $11,000
D. $17,000

B. $10,000
The components of comprehensive income are: Net Income, Unrealized gain/loss on AFS securities, foreign currency translation adjustment, unrecognized gain/loss on pension benefits, and deferred gain/loss on certain hedging transactions. Therefore, the Comprehensive income of Palmyra Co is $11,000 - 3,000 + 2,000 = $10,000.

114

The accumulated other comprehensive income (AOCI) beginning balance for the current year was $6,000 dr. Net income for the period is $21,000. During the year the following two other comprehensive income items were recognized:
foreign currency translation loss, $2,000
and unrealized gain on AFS securities, $9,000.
What amount is reported for comprehensive income (CI) for the year, and what is the ending AOCI balance?

CI AOCI
$7,000 $1,000 cr.
$28,000 $1,000 cr.
$21,000 $7,000 cr.
$28,000 $6,000 dr.

$28,000 $1,000 cr.
CI ($28,000) is the sum of income ($21,000) and other comprehensive income (-$2,000 + $9,000 = $7,000). AOCI is the running OE account, which is increased or decreased by other comprehensive income for the period. Ending AOCI = $6,000 dr. - $7,000 other comprehensive income (positive) = $1,000 cr. AOCI began the year with a new loss of $6,000 (debit balance), but the $7,000 positive other comprehensive income for the year turned the beginning dr. balance of AOCI into a net credit of $1,000.

115

Rock Co.'s financial statements had the following balances at December 31:
Extraordinary gain $ 50,000
Foreign currency translation gain 100,000
Net income 400,000
Unrealized gain on AFS 20,000
What amount should Rock report as comprehensive income for the year ended December 31?
A. $400,000
B. $420,000
C. $520,000
D. $570,000

C. $520,000

The extraordinary gain ($50,000) is already included in net income ($400,000) and would be included in comprehensive income as part of net income.

116

The Statement of Changes in Equity:
A. Is one of the required financial statements under U.S. GAAP
B. Includes accounts such as the retained earnings and common share accounts but not other comprehensive income items.
C. Is used only if a corporation frequently issues common shares
D. Reconciles all of the beginning and ending balances in the equity accounts.

D. Reconciles all of the beginning and ending balances in the equity accounts.

The Statement of Changes in Equity reconciles all of the beginning and ending balances in the equity accounts. The statement shows the opening balance then details all changes in the accounts, ending with the closing balance.

117

Which of the following information should be disclosed as supplemental information in the Statement of Cash Flows?
Cash flow per share Conversion of debt to equity
Yes Yes
Yes No
No Yes
No No

Cash flow per share Conversion of debt to equity
No Yes
Cash flow per share is specifically prohibited from being disclosed unless it is based on contractual amounts.
The conversion of debt to equity is an example of a transaction that would appear in the supplemental noncash disclosure schedule.

118

Which of the following is not disclosed on the Statement of Cash Flows, either on the face of the statement or in a separate schedule, when prepared under the direct method?
A. The major classes of gross cash receipts and gross cash payments.
B. The amount of income taxes paid.
C. A reconciliation of net income to net cash flow from operations.
D. A reconciliation of ending retained earnings to net cash flow from operations.

D. A reconciliation of ending retained earnings to net cash flow from operations.

119

Which of the following sets of financial statements generally cannot be prepared directly from the adjusted trial balance?
A. Income Statement, Balance Sheet, Statement of Cash Flows.
B. Income Statement, Statement of Cash Flows.
C. Statement of Cash Flows.
D. Balance Sheet and Statement of Cash Flows.

C. Statement of Cash Flows.

120

Paper Co. had net income of $70,000 during the year. The dividend payment was $10,000. The following information is available:
Mortgage repayment $20,000
Available-for-sale securities purchased 10,000 increase
Bonds payable-issued 50,000 increase
Inventory 40,000 increase
Accounts payable 30,000 decrease

What amount should Paper report as net cash provided by operating activities in its Statement of Cash Flows for the year?
A. $0
B. $10,000
C. $20,000
D. $30,000

A. $0

Operating Activities come from adjustments to reconcile net income to net cash flows and through analyzing the change in current asset and liability accounts. Net income - increase in inventory - decrease in accounts payable $70.000 - $40 000 - $30 000 = $0

121

Mend Co. purchased a three-month U.S. Treasury bill. Mend's policy is to treat all highly liquid investments with an original maturity of three months or less when purchased as cash equivalents . How should this purchase be reported in Mend's Statement of Cash Flows?
A. As an outflow from operating activities.
B. As an outflow from investing activities.
C. As an outflow from financing activities.
D. Not reported.

D. Not reported.

The three-month bill meets the definition of a cash equivalent. Three months is the maximum original maturity under the definition. Cash and cash equivalents are the reporting basis of the Statement of Cash Flows. Cash decreased but cash equivalents increased the same amount as a result of this purchase. Thus, there is no net effect on cash and cash equivalents. Therefore, there is nothing to report in the Statement of Cash Flows.

122

Which of the following items is included in the Financing Activities section of the Statement of Cash Flows?
A. Cash effects of transactions involving making and collecting loans.
B. Cash effects of acquiring and disposing of investments and property, plant, and equipment.
C. Cash effects of transactions obtaining resources from owners and providing them with a return on their investment.
D. Cash effects of transactions that enter into the determination of net income.

C. Cash effects of transactions obtaining resources from owners and providing them with a return on their investment.

Financing cash flows are those between the firm and the parties providing it with debt and equity financing. Financing cash flows are the major sources of nonoperating cash inflows and repayments of those amounts to the providers. For example, borrowings and proceeds from stock issuance, retirements of debt, treasury stock purchases, and dividends paid are all financing cash flows. Interest paid, however, is an operating cash flow.

123

Abbott Co. is preparing its Statement of Cash Flows for the year. Abbott's cash disbursements during the year included the following:
Payment of interest on bonds payable $500,000
Payment of dividends to stockholders 300,000
Payment to acquire 1,000 shares of Marks Co. common stock 100,000
What should Abbott report as total cash outflows for financing activities in its Statement of Cash Flows?

A. $0
B. $300,000
C. $800,000
D. $900,000

B. $300,000
Dividends paid to shareholders are a financing activity. The payment of interest on bonds is an operating activity, and payments to acquire shares of Marks Co. stock are investing activities.

124

A company acquired a building, paying a portion of the purchase price in cash and issuing a mortgage note payable to the seller for the balance.
In a Statement of Cash Flows for the purchasing company, what amount is included in financing activities for the above transaction?

A. Cash payment.
B. Acquisition price.
C. Zero.
D. Mortgage amount.

C. Zero.
The cash payment is an investing cash outflow, not a financing cash flow. The transaction would show no entry in the financing section of the Statement of Cash Flows.
The payment amount (only) would be reported in the investing activity section of the Statement of Cash Flows as an outflow.

125

Polk Co. acquires a forklift from Quest Co. for $30,000. The terms require Polk to pay $3,000 down and finance the remaining $27,000. On March 1, year 1, Polk pays the $3,000 down and accepted delivery of the forklift. Polk signed a note that requires Polk to pay principal payments of $1,000 per month for 27 months beginning July 1, year 1. What amount should Polk report as an investing activity in the statement of cash flows for the year ended December 31, year 1?
A. $3,000
B. $9,000
C. $12,000
D. $30,000

A. $3,000
Only actual cash inflows and outflows are presented on the statement of cash flows. In this case, Polk paid $3,000 in cash as a down payment for the forklift and financed the remainder of the purchase price. Therefore, the only cash outlay as an investing activity on the statement of cash flows is $3,000. The cash outflows associated with the payment on the note would be classified as a financing activity.

126

Which of the following transactions is included in the operating activities section of a cash flow statement prepared using the indirect method?
A. Gain on sale of plant asset.
B. Sale of property, plant and equipment.
C. Payment of cash dividend to the shareholders.
D. Issuance of common stock to the shareholders.

A. Gain on sale of plant asset.
The gain on the sale of a plant asset is a noncash item that is used to reconcile net income to cash flows from operations.

127

In a Statement of Cash Flows, which of the following items is reported as a cash outflow from financing activities?

I. Payments to retire mortgage notes;
II. Interest payments on mortgage notes;
or III. Dividend payments.

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

D. I and III.
Both I and III are financing cash outflows. Principal payments on loans from financial institutions are financing because they are a return of a source of long-term financing.
The dividends are a return to shareholders who have provided a considerable portion of total firm financing.

128

Karr, Inc. reported net income of $300,000 for 2004. Changes occurred in several Balance Sheet accounts as follows:
Equipment $25,000 increase
Accumulated depreciation 40,000 increase
Note payable 30,000 increase
Additional information:

During 2004, Karr sold equipment costing $25,000, with accumulated depreciation of $12,000, for a gain of $5,000.
In December 2004, Karr purchased equipment costing $50,000 with $20,000 cash and a 12% note payable of $30,000.
Depreciation expense for the year was $52,000.
In Karr's 2004 Statement of Cash Flows, net cash provided by operating activities should be:

A. $340,000
B. $347,000
C. $352,000
D. $357,000

B. $347,000

Only an indirect calculation is possible from the data. The reconciliation of net income and net cash flow from operating activities shows the calculation.
Net income $300,000
Plus depreciation expense 52,000
Less gain on sale of equipment (5,000)
Equals net cash provided by operations $347,000
C. $352,000
D. $357,000

129

In its cash flow statement for the current year, Ness Co. reported cash paid for interest of $70,000. Ness did not capitalize any interest during the current year. Changes occurred in several balance sheet accounts as follows:
Accrued interest payable $17,000 decrease
Prepaid interest 23,000 decrease
What amount of interest expense for the current year will Ness report in its income statement?
A. $ 30,000
B. $ 64,000
C. $ 76,000
D. $110,000

A summary journal entry is helpful to sort out what happened with interest during the period:
DR: Int exp 76,000
DR: Accrued interest payable 17,000
CR: Prepaid interest 23,000
CR: Cash 70,000

The interest expense amount for the year is the derived amount in the entry. Also, a more verbal approach works:
(1) accrued interest payable decreased implying that $17,000 more cash was paid in interest than was recognized in expense, and
(2) prepaid interest decreased implying that $23,000 less cash was paid in interest than was recognized in expense.
The net of these two yields $6,000 less cash paid in interest than was recognized in expense. With $70,000 cash paid for interest, $76,000 must have been expensed. Interest expense of $76,000 = cash interest paid of $70,000 - accrued payable decrease of $17,000 + prepaid interest decrease $23,000.

130

Should the following be added back to net income when reporting operating activities' cash flows by the indirect method?
Excess of treasury stock acquisition cost over sales proceeds (cost method) Bond discount amortization
Yes Yes
No No
No Yes
Yes No

No Yes
Treasury stock transactions are not operating and never affect net income. Thus, they would never be shown in the reconciliation of net income and net operating cash flows.

The amortization of the bond discount increases interest expense but does not require the outflow of cash. Therefore, it is added in the reconciliation.

131

The differences in Beal Inc.'s Balance Sheet accounts at December 31, 20x4 and 20x3, are presented below:
Assets Increase (Decrease)
Cash and cash equivalents $ 120,000
Short-term investments 300,000
Account receivable, net -
Inventory 80,000
Long-term investments (100,000)
Plant assets 700,000
Accumulated depreciation -
$1,100,000
Liabilities and Stockholders' Equity
Accounts payable and accrued liabilities $ (5,000)
Dividends payable 160,000
Short-term bank debt 325,000
Long-term debt 110,000
Common Stock, $10 par 100,000
Additional paid-in capital 120,000
Retained Earnings 290,000
$1,100,000
The following additional information relates to 20x4:

net income was $790,000;
cash dividends of $500,000 were declared;
building costing $600,000, with a carrying amount of $350,000 was sold for $350,000;
equipment costing $110,000 was acquired through issuance of long-term debt; and
a long-term investment was sold for $135,000. There were no other transactions affecting long-term investments. These investments are categorized as available for sale.
10,000 shares of common stock were issued for $22 a share.
The short-term investments are classified as trading securities.

In Beal's 20x4 Statement of Cash Flows, net cash provided by operating activities was:
A. $1,160,000
B. $1,040,000
C. $620,000
D. $705,000

C. $620,000

Net income $ 790,000
Increase in inventory (80,000)
Decrease in AP/accrued liabilities ( 5,000)
Gain on sale of long-term investments ($135,000 - $100,000) (35,000)
Increase in short-term investments (from purchase) (300,000)
Depreciation expense 250,000
Equals net operating cash inflow $ 620,000

The accumulated depreciation account did not change during the year. Therefore, depreciation expense equals $250,000, which offsets the decrease in the account due to the sale of the equipment.

132

Metro, Inc. reported net income of $150,000 for 2005. Changes occurred in several Balance Sheet accounts during 2005 as follows:
Investment in Videogold, Inc. stock, carried on the equity basis $5,500 increase
Accumulated depreciation, caused by major repair to projection equipment 2,100 decrease
Premium on bonds payable 1,400 decrease
Deferred income tax liability (long-term) 1,800 increase
In Metro's 2005 cash flow statement, the reported net cash provided by operating activities should be:
A. $150,400
B. $148,300
C. $144,900
D. $142,800

C. $144,900

Net income $150,000
Less increase in equity investment (5,500)
Less amortization of bond premium (1,400)
Plus increase in deferred income tax liability 1,800
Net cash flow from operating activities $144,900

Second, this answer subtracts the accumulated depreciation change caused by the equipment repair. Accumulated depreciation is sometimes debited (decreased) when a major repair is made. This is not an operating cash outflow but rather an investing cash outflow. The repair cost was capitalized-net plant assets were increased by the repair. This $2,100 decrease in accumulated depreciation should not be subtracted from earnings in the operating section of the Statement of Cash Flows.
The amortization of bond premiums reduces interest expense relative to cash interest paid.

133

How should the (increased) amortization of a bond discount on long-term debt be reported in a Statement of Cash Flows prepared using the indirect method?

A. As a financing activities inflow.
B. As a financing activities outflow.
C. In operating activities as a deduction from income.
D. In operating activities as an addition to income.

D. In operating activities as an addition to income.

134

Baker Co. began its operations during the current year. The following is Baker's Balance Sheet at December 31:

Baker Co.
Balance Sheet
Assets
Cash $192,000
Accounts receivable 82,000
Total Assets $274,000
Liabilities and stockholders' equity
Accounts payable $ 24,000
Common stock 200,000
Retained earnings 50,000
Total liabilities and stockholders' equity $274,000
Baker's net income for the current year was $78,000, and dividends of $28,000 were declared and paid. Common stock was issued for $200,000. What amount should Baker report as cash provided by operating activities in its Statement of Cash Flows for the current year?

A. $20,000
B. $50,000
C. $192,000
D. $250,000

A. $20,000

Cash provided from operating activities is derived as follows: $78,000 net income - $82,000 accounts receivable increase + $24,000 accounts payable increase = $20,000.

135

In a Statement of Cash Flows, if used equipment is sold at a gain, the amount shown as a cash inflow from investing activities equals the carrying amount of the equipment:
A. Plus the gain.
B. Plus the gain and less the amount of tax attributable to the gain.
C. Plus both the gain and the amount of tax attributable to the gain.
D. With no addition or subtraction.

A. Plus the gain.
The carrying amount plus the gain equals the cash proceeds received. The proper disclosure is something along the lines of the following journal entry:
Proceeds from sale of equipment $xxxxxx.
Gain xxxxx
Equipment (book value) xxxxx

136

On September 1, 20x2, Canary Co. sold used equipment for a cash amount equaling its carrying amount for both book and tax purposes. On September 15, 20x2, Canary replaced the equipment by paying cash and signing a note payable for new equipment. The cash paid for the new equipment exceeded the cash received for the old equipment. How should these equipment transactions be reported in Canary's 20x2 Statement of Cash Flows?
A. Cash outflow equals the cash paid less the cash received.
B. Cash outflow equal to the cash paid and note payable less the cash received.
C. Cash inflow equal to the cash received and a cash outflow equal to the cash paid and noted payable.
D. Cash inflow equal to the cash received and a cash outflow equal to the cash paid.

D. Cash inflow equal to the cash received and a cash outflow equal to the cash paid.

137

The differences in Beal Inc.'s Balance Sheet accounts at December 31, 20x4 and 20x3, are presented below:
Assets Increase (Decrease)
Cash and cash equivalents $ 120,000
Short-term investments 300,000
Accounts receivable, net -
Inventory 80,000
Long-term investments (100,000)
Plant assets 700,000
Accumulated depreciation -
$1,100,000
Liabilities and Stockholders' Equity
Accounts payable and accrued liabilities $ (5,000)
Dividends payable 160,000
Short-term bank debt 325,000
Long-term debt 110,000
Common Stock, $10 par 100,000
Additional paid-in capital 120,000
Retained Earnings 290,000
$1,100,000
The following additional information relates to 20x4: net income was $790,000; cash dividends of $500,000 were declared; building costing $600,000, with a carrying amount of $350,000, was sold for $350,000; equipment costing $110,000 was acquired through the issuance of long-term debt; and a long-term investment was sold for $135,000. There were no other transactions affecting long-term investments. 10,000 shares of common stock were issued for $22 a share. In Beal's 20x4 Statement of Cash Flows, Net cash provided by financing activities was:
A. $20,000
B. $45,000
C. $150,000
D. $205,000

D. $205,000
Dividends paid ($500,000 declared less $160,000 increase in dividends payable) $(340,000)
Issuance of stock 10,000($22) $220,000
Increase in short-term bank debt $325,000
Net cash provided by financing activities 205,000
The increase in long-term debt is not included because the entire increase is represented by the issuance of long-term debt for equipment. This is a non-cash transaction.

138

The differences in some of Beal Inc.'s Balance Sheet accounts at December 31, 20x4 and 20x3, are presented below:
Assets Increase (Decrease)
Cash and cash equivalents $ 120,000
Investments in trading securities 300,000
Accounts receivable, net -
Inventory 80,000
Long-term investments (100,000)
Plant assets (gross) 700,000
Liabilities and stockholders' equity
Accounts payable and accrued liabilities $ (5,000)
Dividends payable 160,000
Short-term bank debt 325,000
Long-term debt 110,000
Common Stock, $10 par 100,000
Additional paid-in capital 120,000
Retained Earnings 290,000
The following additional information relates to 20x4: net income was $790,000; cash dividends of $500,000 were declared; building costing $600,000, with a carrying amount of $350,000, was sold for $350,000; equipment costing $110,000 was acquired through the issuance of long-term debt; and a long-term investment was sold for $135,000. There were no other transactions affecting long-term investments. 10,000 shares of common stock were issued for $22 a share. In Beal's 20x4 Statement of Cash Flows, Net cash used in investing activities was:
A. $705,000
B. $1,190,000
C. $1,005,000
D. $165,000

A. $705,000
Proceeds from sale of securities $ 135,000
Proceeds from sale of building 350,000
Purchase of other plant assets (1,190,000)
Net cash used in investing activities $( 705,000)
The plant assets (gross) account increased $700,000. $700,000 increase = -$600,000 (sale of building) + $110,000 (equipment purchase) + X. X = additional purchases of plant assets. X = $1,190,000. The available long-term investments were sold at a gain. That is why the change in the account ($100,000) does not equal the cash inflow from the sale. The equipment purchased with long-term debt is not listed in the investing section because no cash was used on the purchase (it is disclosed in the supplemental information). The purchase of trading securities is an operating cash flow.

139

Lance Corp.'s Statement of Cash Flows for the year ended September 30, 2004, was prepared using the indirect method and included the following:

Net income $60,000
Non-cash adjustments:
Depreciation expense 9,000
Increase in accounts receivable 5,000
Decrease in inventory 40,000
Decrease in accounts payable (12,000)
Net cash flows from operating activities $92,000
=========
Lance reported revenues from customers of $75,000 in its 2004 Income Statement. What amount of cash did Lance receive from its customers during the year ended September 30, 2004?

A. $80,000
B. $70,000
C. $65,000
D. $55,000

B. $70,000
Accounts receivable increased during the year. Therefore, more sales were recognized than cash was collected.
The amount of cash collected from customers is $70,000 = $75,000 sales - $5,000 increase in accounts receivable. The increase in accounts receivable is that portion of sales that was not collected.

140

Flax Corp. uses the direct method to prepare its Statement of Cash Flows. Flax's trial balances at December 31, 2004 and 2003, are as follows:
December 31
2004 2003
Debits:
Cash $ 35,000 $ 32,000
Accounts Receivable 33,000 30,000
Inventory 31,000 47,000
Property, plant & equipment 100,000 95,000
Unamortized bond discount 4,500 5,000
Cost of goods sold 250,000 380,000
Selling expenses 141,500 172,000
General and administrative expenses 137,000 151,300
Interest expense 4,300 2,600
Income tax expense 20,400 61,200
$756,700 $976,100
======== ========
Credits:
Allowance for uncollectible accounts $ 1,300 $ 1,100
Accumulated depreciation 16,500 15,000
Trade accounts payable 25,000 17,500
Income taxes payable 21,000 27,100
Deferred income taxes 5,300 4,600
8% callable bonds payable 45,000 20,000
Common stock 50,000 40,000
Additional paid-in capital 9,100 7,500
Retained earnings 44,700 64,600
Sales 538,800 778,700
$756,700 $976,100
========= =========
Flax purchased $5,000 in equipment during 2004.

Flax allocated one-third of its depreciation expense to selling expenses and the remainder to general and administrative expenses.

What amounts should Flax report in its Statement of Cash Flows for the year ended December 31, 2004, for the following:

Cash paid for selling expenses?

A. $142,000
B. $141,500
C. $141,000
D. $140,000

C. $141,000
There is no related payable account to selling expenses. Thus, the amount of selling expense recognized is the same as the cash paid for selling expenses except for the amount of depreciation allocated to selling expenses.
There was no equipment sold during the period. Therefore, depreciation expense equals the change in accumulated depreciation for the year, or $1,500. One-third of this amount, or $500, is allocated to selling expenses. Depreciation is not a cash outflow. Therefore, the amount paid for selling expenses is $141,000 ($141,500 - $500).

141

The following balances were reported by Mall Co. at December 31, 2005 and 2004:

12/31/05 12/31/04
Inventory $260,000 $290,000
Accounts payable 75,000 50,000
Mall paid suppliers $490,000 during the year ended December 31, 2005. What amount should Mall report for cost of goods sold in 2005?
A. $545,000
B. $495,000
C. $485,000
D. $435,000

A. $545,000
Amount paid to suppliers = Cost of goods sold - Inventory decrease - AP increase.
$490,000 = Cost of goods sold - $30,000 - $25,000
$545,000 = Cost of goods sold
The inventory decrease is subtracted from cost of goods sold because it is an inventory reduction included in cost of goods sold that was not paid for in the current period. The accounts payable increase is also subtracted because it represents an increase in inventory and, therefore, cost of goods sold that was not paid for in the current period.

142

Dee's inventory and accounts payable balances at December 31, 2005, increased over their December 31, 2004, balances.
Should these increases be added to or deducted from cash payments to suppliers to arrive at 2005 cost of goods sold?

Increase in inventory Increase in accounts payable
Added to Added to
Deducted from Deducted from
Deducted from Added to

Deducted from Added to

Since it is asking how to adjust the cash payments to get to CoGS, not adjusting CoGS, it is the opposite of what you are thinking.

143

Which of the following facts concerning fixed assets should be included in the summary of significant accounting policies?
Depreciation method Composition
No Yes
Yes Yes
Yes No
No No

Yes No
The summary of significant accounting policies requires that the methods of depreciation used by a firm be disclosed.
The composition of plant assets must also be disclosed, but not in the summary of significant accounting policies. The composition information typically is disclosed in another footnote.

144

Neely Co. disclosed in the notes to its financial statements that a significant number of its unsecured trade account receivables are with companies that operate in the same industry. This disclosure is required to inform financial statement users of the existence of
A. Concentration of credit risk.
B. Concentration of market risk.
C. Risk of measurement uncertainty.
D. Off-balance sheet risk of accounting loss.

A. Concentration of credit risk.
This disclosure will give the financial statement reader information about concentration of credit risk related to the receivables that are all in the same industry.

145

Jen has been employed by Komp, Inc. since February 1, 2009. Jen is covered by Komp's Section 401(k) deferred compensation plan. Jen's contributions have been 10% of salaries. Komp has made matching contributions of 5%. Jen's salaries were $21,000 in 2009, $23,000 in 2010, and $26,000 in 2011. Employer contributions vest after an employee completes three years of continuous employment. The balance in Jen's 401(k) account was $11,900 on December 31, 2011, which included earnings of $1,200 on Jen's contributions. What amount should be reported for Jen's vested interest in the 401(k) plan in Jen's December 31, 2011, personal statement of financial condition?
A. $11,900
B. $8,200
C. $7,000
D. $1,200

B. $8,200
Jen's personal statement of financial condition should report only the contributions and earnings to which Jen has a claim (i.e., that have vested). Thus, the correct answer is Jen's salaries of $21,000 + $23,000 + $26,000 = $70,000 x Jen's contribution rate of 10% = $7,000, plus the earnings on those contributions of $1,200 (given) = $8,200, the correct answer. Since Jen was employed on February 1, 2009, as of December 31, 2011, the employer's (Komp's) contributions have not vested and, therefore, do not "belong" to Jen and should not be included in Jen's personal statement of financial condition.

146

Which of the following are not measured at the expected cash to be paid or received?
A. Notes payable.
B. Equipment in use.
C. Unrecorded patent.
D. Equipment held for sale.

A. Notes payable.
Liabilities are to be measured using existing GAAP and not written down based on "expectations" unless legally forgiven.

147

Alco, Inc., a small manufacturing company, prepares its financial statements using its income tax basis of accounting. In December, 2012, it determined that an error had been made in the amount of rent expense reported in its 2011 tax return. How should Alco account for the amount of the rental expense error in its 2012 financial statements?
A. As an adjustment to 2012 rental income.
B. As an income tax expense in 2012.
C. As a prior period adjustment.
D. No reporting in 2012 required.

C. As a prior period adjustment.
The amount of the rental expense error made in the tax return (and financial statements) of the prior period would be reported as a prior period adjustment in Alco's 2012 financial statements.

148

Which of the following is the purpose of the liquidation basis accounting?
A. To report the amount of net cash flows expected to be received in the process of bankruptcy.
B. To distinguish which assets the entity will sell and which assets will be kept.
C. To inform the financial statement users that liquidation is imminent.
D. To help management decide which assets are valuable.

Liquidation basis of accounting is focused on informing the financial statement users that liquidation is imminent.

149

Which of the following does not have an alternative accounting for private companies?
A. Interest rate swaps—variable rates to fixed rates.
B. VIE criteria to common controlled leasing arrangements.
C. Accounting for certain intangibles in business combination.
D. Recognition of contingent consideration in a business combination.

D. Recognition of contingent consideration in a business combination.

150

Stent Co. had total assets of $760,000, capital stock of $150,000, and retained earnings of $215,000. What was Stent's debt-to-equity ratio?
A. 2.63
B. 1.08
C. 0.52
D. 0.48

B. 1.08
First, we must compute the amount of debt. Since Assets = Liabilities + Stockholders' Equity, we have 760,000 = ? + (150,000 + 215,000). Thus, debt = $395,000. Debt to Equity is 395,000/(150,000 + 215,000) = 1.08

151

The Private Company Council has issued modified accounting for private companies for what aspect of Goodwill?
A. Goodwill impairment testing.
B. Goodwill amortization.
C. Goodwill measurement.
D. Goodwill reporting.

B. Goodwill amortization.
The PCC allows private companies to amortize goodwill over a period to not exceed 10 years.

152

Selected data pertaining to Lore Co. for the calendar year 2005 is as follows:
Net cash sales
$ 3,000
Cost of goods sold
18,000
Inventory at the beginning of the year
6,000
Purchases
24,000
Accounts receivable at the beginning of the year
20,000
Accounts receivable at the end of the year
22,000
Lore would use which of the following to determine the average days' sales in inventory?

Numerator Denominator
365 Average inventory
365 Inventory turnover
Average inventory Sales divided by 365
Sales divided by 365 Inventory turnover

365 Inventory turnover

153

Successful use of leverage is evidenced by a
A. Rate of return on investment greater than the rate of return on stockholders' equity.
B. Rate of return on investment greater than the cost of debt.
C. Rate of return on sales greater than the rate of return on stockholders' equity.
D. Rate of return on sales greater than the cost of debt.

B. Rate of return on investment greater than the cost of debt.
Successful leverage is practiced by a company when it can borrow at a particular rate of interest, and then use the proceeds to earn a higher rate of return on stockholder's equity (contributed capital investment). As long as business opportunities present themselves under these conditions, prudent borrowing is recommended.

154

The following data pertain to Ruhl Corp.'s operations for the year ended December 31, 2005:
Operating income $800,000
Interest expense 100,000
Income before income tax 700,000
Income tax expense 210,000
Net income $490,000
The times interest earned ratio is
A. 8.0 to 1.
B. 7.0 to 1.
C. 5.6 to 1.
D. 4.9 to 1.

A. 8.0 to 1.
The times interest earned ratio is: (income before interest expense and income tax/interest expense).
For Ruhl, this ratio is: $800,000/$100,000 = 8. This means that the firm has earnings that would support interest eight times the current level. In other words, the firm could pay its current level of interest eight times.
If interest expense were $800,000, net income would be zero and no tax would be due. $800,000 of interest could be paid from resources earned in the current period.

155

The controller of Peabody, Inc. has been asked to present an analysis of accounts receivable collections at the upcoming staff meeting. The following information is used:
12/31, Year 2 12/31, Year 1
Accounts receivable $100,000 $130,000
Allowance, doubtful accounts (20,000) (40,000)
Sales 400,000 200,000
Cost of goods sold 350,000 170,000
What is the receivables turnover ratio as of December 31, Year 2?
A. 5.0
B. 4.7
C. 3.5
D. 0.6

B. 4.7
The receivables turnover ratio = net sales/average net accounts receivables. This would be: 400,000/85,000. The denominator is calculated as: (100,000 - 20,000 + 130,000 - 40,000)/2

156

Assuming constant inventory quantities, which of the following inventory-costing methods will produce a lower inventory turnover ratio in an inflationary economy?

A. FIFO (first in, first out).
B. LIFO (last in, first out).
C. Moving average.
D. Weighted average.

A. FIFO (first in, first out).
Inventory turnover ratio is Cost of Goods Sold/Average Inventory. Therefore, to produce the lowest inventory turnover ratio, we need the highest value of ending inventory. The method that produces the highest value of ending inventory in an inflationary economy (prices are rising) is FIFO.

157

On December 31, 2004, Curry Co. had the following balances in selected asset accounts:

2004 Increase over 2003
Cash $300 $100
Accounts receivable, net 1,200 400
Inventory 500 200
Prepaid expenses 100 40
Other assets 400 150
Total assets $2,500 $890
====== ======
Curry had current liabilities of $1,000 on December 31, 2004 and net credit sales of $7,200 for the year ended.

What was the average number of days to collect Curry's accounts receivable during 2004?

A. 30.4
B. 40.6
C. 50.7
D. 60.8

C. 50.7
Average days to collect accounts receivable = 365/AR turnover. AR turnover = credit sales/average accounts receivable = $7,200/[.5($800 + $1,200)] = 7.2
(Beginning 2004 AR is $800 because ending AR of $1,200 is $400 higher than beginning AR.)
Average days to collect accounts receivable = 365/7.2 = 50.7

158

On December 30, 2005, Vida Co. had cash of $200,000, a current ratio of 1.5:1 and a quick ratio of .5:1. On December 31, 2005, all cash was used to reduce accounts payable.
How did these cash payments affect the ratios?

Current ratio Quick ratio
Increased Decreased
Increased No effect
Decreased Increased
Decreased No effect

Increased Decreased
The numerator and denominator of both ratios are reduced by $200,000 as a result of the transaction. Cash is included in both current and quick assets (current assets that are highly liquid), the numerators of the two ratios. Accounts payable is a part of current liabilities, which is the denominator of both ratios.
The current ratio exceeds 1.00 before the transaction. Reducing the numerator and denominator the same amount causes the denominator to fall a greater percentage than the numerator. Thus, the ratio increases. Example: if the ratio were $900,000/$600,000 before the transaction; after the transaction, the ratio is $700,000/$400,000, a higher ratio. The quick ratio is less than 1.00 before the transaction. Thus, the ratio decreases. Example: if the ratio were $300,000/$600,000 before the transaction, after the transaction the ratio is $100,000/$400,000, a lower ratio.

159

The following information was taken from Baxter Department Store's financial statements:
Inventory on January 1 $ 100,000
Inventory on December 31 300,000
Net sales 2,000,000
Net purchases 700,000
What was Baxter's inventory turnover for the year ending December 31?

A. 2.5
B. 3.5
C. 5
D. 10

A. 2.5
Inventory turnover is the ratio of cost of goods (CGS) sold to average inventory. First, calculate CGS = beginning inventory $100,000 + purchases $700,000 - ending inventory $300,000 = $500,000. Then, average inventory = (beginning inventory + ending inventory)/2 = ($100,000 + $300,000)/2 = $200,000. Turnover = $500,000/$200,000 = 2.5.

160

The following computations were made from Clay Co.'s 2005 books:

Number of days' sales in inventory 61
Number of days' sales in trade accounts receivable 33
What was the number of days in Clay's 2005 operating cycle?

A. 33
B. 47
C. 61
D. 94

D. 94
The operating cycle is the total period of time from the purchase of inventory, to sale, and then finally to the collection of cash from receivables.
The operating cycle thus can be approximated by the sum of the number of days' sales in inventory, which is the average number of days before an item of inventory is sold, plus the number of days' sales in receivables, which is the average number of days to collect a receivable. This sum is 94 (61 + 33) days.

161

Times interest earned ratio =



Return on total assets = (net income + after-tax interest expense)/average total assets = [420 + .70(100)]/.5(2,400 + 2,800) = .19 The tax rate is .30 = (income tax expense)/(income before tax)= 180/600.

Return on equity = net income/average OE = 420/.5(100 + 200 + 300 + 810 - 100 + 100 + 250 + 350 + 1080 - 120) = 420/1,485 = .28

Dividend payout ratio = common dividends/net income = 150/420 = .36. Retained earnings increased 270 (1,080 - 810). 270 = 420 net income - dividends declared. Therefore dividends declared are 150.

(net income + interest expense + income tax expense)/interest expense

162

Profit margin on sales =

net income/sales

163

Return on total assets =

(net income + after-tax interest expense)/average total assets

164

Return on equity =

net income/average OE

165

Dividend payout ratio =

common dividends/net income

166

The following is the stockholders' equity section of Harbor Co.'s balance sheet on December 31:
Common stock $10 par, 100,000 shares authorized, 50,000 shares issued of which 5,000 have been reacquired, and are held in treasury $ 450,000
Additional paid-in capital common stock 1,100,000
Retained earnings 800,000
Subtotal $2,350,000
Less treasury stock (150,000)
Total stockholders' equity $2,200,000
Harbor has insignificant amounts of convertible securities, stock warrants, and stock options. What is the book value per share of Harbor's common stock?

A. $31
B. $44
C. $46
D. $49

D. $49
Book value per share, for this basic situation, is total owners' equity divided by the number of shares outstanding: $2,200,000/45,000 = $49 rounded to the nearest dollar. The number of shares outstanding equals the number of shares issued (50,000) less the number in the treasury (5,000).

167

The following data pertain to Cowl, Inc., for the year ended December 31, 2004:
Net sales
$ 600,000
Net income
150,000
Total assets, January 1, 2004
2,000,000
Total assets, December 31, 2004
3,000,000
What was Cowl's rate of return on assets for 2004?

A. 5%
B. 6%
C. 20%
D. 24%

B. 6%

Rate of return on assets is the ratio of net income for a period to average total assets for the same period.
$150,000/[($2,000,000 + $3,000,000)/2] = 6%.

After-tax interest expense is also added to the numerator but this information was not provided in the problem.

168

The following financial ratios and calculations were based on information from Kohl Co.'s financial statements for the current year.
Accounts receivable turnover
Ten times during the year

Total assets turnover
Two times during the year

Average receivables during the year
$200,000

What were Kohl's average total assets for the year?
A. $2,000,000
B. $1,000,000
C. $400,000
D. $200,000

B. $1,000,000

Correct! From the given information, (asset turnover) = 2 = sales/(average total assets). (AR turnover) = 10 = sales/(average AR). Therefore, (average total assets) are 5 times (average AR). (average total assets) = 5(average AR) = 5($200,000) = $1,000,000.

169

Are the following ratios useful in assessing the liquidity position of a company?
Defensive-interval ratio Return on stockholders' equity
Yes Yes
Yes No
No Yes
No No

Yes No
The defensive interval ratio is the ratio of quick assets to daily operating expenditures. Quick assets are current assets that are very readily converted to cash. They include cash, accounts receivable, and certain investments. The ratio indicates the length of time in days that the firm can operate with its present liquid resources. Thus, the measure is a liquidity measure.
The return on stockholders' equity is the ratio of income to average owners' equity. This ratio is a profitability ratio, not a liquidity ratio. A firm could have a strong return on equity ratio and not be particularly liquid.

170

When a set of financial statements is prepared using the cash basis or the modified cash basis of accounting, which one of the following is least likely to be an appropriate financial statement title?
A. Statement of Cash Receipts and Cash Disbursements.
B. Balance Sheet.
C. Income Statement.
D. Statement of Financial Position.

C. Income Statement.
When the cash basis or the modified cash basis of accounting is used, the title Income Statement, which is appropriate when the accrual basis of accounting is used, should be replaced by the title Statement of Cash Receipts and Cash Disbursements. This helps distinguish that the statement is not based on full accrual accounting consistent with U.S. GAAP.

171

Which of the following items would be recognized in financial statements prepared using an income tax basis of accounting relating to permanent differences?
Nontaxable Income Nondeductible Expenses
Yes Yes
Yes No
No Yes
No No

Nontaxable Income Nondeductible Expenses
Yes Yes
Both nontaxable income items (e.g., life insurance proceeds from the death of an officer) and nondeductible expenses (e.g., premium cost of life insurance on an officer) would be recognized in financial statements prepared using an income tax basis of accounting.

172

For the purpose of estimating income taxes to be reported in personal financial statements, assets and liabilities measured at their tax bases should be compared to assets and liabilities measured at their
Assets Liabilities
Estimated current value Estimated current amount
Historical cost Historical cost
Estimated current value Historical cost
Historical cost Estimated current amount

Estimated current value Estimated current amount
To estimate the tax liability to be reported in personal financial statements (i.e., personal statement of financial condition) the tax basis of assets and liabilities should be compared with the fair value (estimated current value) of assets and the fair value (estimated current amount) of liabilities. Any excess of the fair value of the net assets (assets minus liabilities) over the tax basis of the net assets generally is a taxable gain subject to an income tax liability.

173

The personal statement of financial condition for Allen Harvey reported a net worth of $825,000 on December 31, 20X0. During the calendar year 20X1, Harvey had earned income of $68,000. For 20X1, his broker's reports showed that his investments had increased by $23,000. In addition, for the year, his credit card debt increased $6,000 and his home mortgage principal balance decreased by $24,000. There were no other changes in Harvey's financial condition during 20X1. Which one of the following is Harvey's net worth as of December 31, 20X1?
A. $934,000
B. $878,000
C. $866,000
D. $830,000

C. $866,000
The correct answer ($866,000) is computed as beginning balance $825,000 + increase in investments $23,000 - increase in credit card debt $6,000 + increase resulting from decrease in mortgage $24,000 = $866,000, the correct answer.

174

Which of the following statements normally would be included in a set of personal financial statements?
Income Statement Statement of Cash Flows
Yes Yes
Yes No
No Yes
No No

No Yes
Neither an Income Statement nor a Statement of Cash Flows is normally included in a set of personal financial statements. A Statement of Financial Condition (Balance Sheet) is always included in a set of personal financial statements, and a Statement of Changes in Net Worth may be included, but is not required.

175

In personal financial statements, how should estimated income taxes on the excess of the estimated current values of assets over their tax bases be reported in the statement of financial condition?
A. As liabilities.
B. As deductions from the related assets.
C. Between liabilities and net worth.
D. In a footnote disclosure only.

C. Between liabilities and net worth.
Estimated income taxes (i.e., provision for income taxes) on the excess of the estimated current values of assets over their tax bases should be reported as a separate line item between liabilities and net worth sections of the personal financial statement.

176

Clint owns 50% of Vohl Corp.'s common stock. Clint paid $20,000 for this stock in 2006. As of December 31, 2011, Clint's 50% stock ownership in Vohl had a fair value of $180,000. Vohl's cumulative net income and cash dividends declared for the five years ended December 31, 2011, were $300,000 and $40,000, respectively. In Clint's personal statement of financial condition on December 31, 2011, what amount should be shown as the investment in Vohl?
A. $20,000
B. $150,000
C. $170,000
D. $180,000

D. $180,000
Assets should be reported in a personal statement of financial condition at estimated current value (fair value), which for the Vohl stock is $180,000 on December 31, 1991.

177

The following information pertains to an insurance policy that Barton owns on his life:
Face amount $100,000
Accumulated premiums paid up to December 31, 2011 8,000
Cash value at December 31, 2011 12,000
Policy loan 3,000
In Barton's personal statement of financial condition at December 31, 2011, what amount should be reported for the investment in life insurance?

A. $97,000
B. $12,000
C. $9,000
D. $8,000

C. $9,000
Assets should be reported at estimated current value (fair value), which for a life insurance policy is the current cash value, less the settlement amount of any loans against the life insurance policy. Thus, the correct answer is cash value of $12,000 less the loan against the policy of $3,000, which results in a reportable fair value of $9,000.

178

Quinn is preparing a personal statement of financial condition as of April 30, 20X5. Included in Quinn's assets are the following:
50% of the voting stock of Ink Corp. A stockholders' agreement restricts the sale of the stock and, under certain circumstances, requires Ink to repurchase the stock. Quinn's tax basis for the stock is $430,000, and on April 30, 20X5, the buyout value is $675,000.
Jewelry with a fair value aggregating $70,000 based on an independent appraisal on April 30, 20X5, for insurance purposes. This jewelry was acquired by purchase and gift over a 10-year period and has a total tax basis of $40,000.
What is the total amount at which the Ink stock and jewelry should be reported in Quinn's April 30, 20X5 personal statement of financial condition?

A. $470,000
B. $500,000
C. $715,000
D. $745,000

D. $745,000
Both the Ink stock and the jewelry should be measured at fair value. Thus, the correct answer is $745,000, which is the sum of the buyout value (fair value) of the stock ($675,000) and the fair value of the jewelry ($70,000).

179

On January 15, 2011, three brothers formed an S Corporation for the purpose of investing in an income producing property. The investment was to be funded with $200,000 cash from each of the brothers and a $1,000,000 loan from a commercial bank. Which one of the following would the bank most likely require in connection with considering the loan application from the S Corporation?
A. Personal income statements from each of the brothers for the year ended December 31, 2010.
B. Personal statements of financial condition from each of the brothers as of December 31, 2010.
C. Projected income statements for the S Corporation for the three years including 2010 through 2012.
D. Projected statements of cash flows for the S Corporation for the three years 2010 through 2012.

B. Personal statements of financial condition from each of the brothers as of December 31, 2010.

180

The estimated values of Lane's personal assets on December 31, 20X0, totaled $1,000,000 with tax bases aggregating $600,000. Included in those assets was a vested interest in a deferred profit-sharing plan with a current value of $80,000 and a tax basis of $70,000. The estimated current amounts of Lane's personal liabilities equaled their tax bases on December 31, 20X0. Lane's 20X0 effective income tax rate was 30%. In Lane's personal statement of financial condition on December 31, 20X0, what amount should be provided for estimated income taxes relating to the excess of current values over tax bases?
A. $120,000
B. $117,000
C. $3,000
D. $0

A. $120,000
The estimated income taxes on the excess of current values over tax bases should be determined as the effective tax rate applied to the difference between the current values of net assets (assets "liabilities") and the tax bases of the net assets. Since, in this question, there is no difference between the estimated current amount of liabilities and their tax bases, the estimated tax would be based solely on the excess current values of assets over the tax bases of those assets. The current estimated values of personal assets is $1,000,000 and the tax bases is $600,000, resulting in an excess (taxable amount) of $400,000 multiplied by the effective tax rate of 30% for an estimated tax liability of $400,000 x .30 = $120,000, the correct answer. The difference between the current value of the deferred profit-sharing plan ($80,000) and its tax bases ($70,000) is included in the total excess of current values over tax bases and does not have to be treated separately.

181

Shea, a calendar-year taxpayer, is preparing a personal statement of financial condition as of April 30, 20X2. Shea's 20X1 income tax liability was paid in full on April 15, 20X2. Shea's tax on income earned from January through April 20X2 is estimated at $30,000. In addition, $25,000 is estimated for income tax on the differences between the estimated current values of Shea's assets, the current amount of liabilities, and their tax bases on April 30, 20X2. No withholdings or payments have been made toward the 20X2 income tax liability. In Shea's statement of financial condition on April 30, 20X2, what is the total of the amount or amounts that should be reported for income taxes?
A. $0
B. $25,000
C. $30,000
D. $55,000

D. $55,000
Since no taxes have been withheld and no estimated payments made during 20X2, Shea will have an obligation on April 30 both for the income earned from January through April 20X2 (estimated amount = $30,000) and for the excess of current values of net assets (assets - liabilities) over the tax bases of those net assets (estimated amount = $25,000). Thus, Shea should report an income tax liability of $55,000 in a personal statement of financial condition as of April 30, 20X2.

182

Which of the following is the tradeoff for setting GAAP by the Private Company Council?
A. Relevance versus cost-benefit.
B. Reliability versus cost-benefit.
C. Relevance versus materiality.
D. Reliability versus materiality.

A. Relevance versus cost-benefit.
The PCC sets standards for private companies by weighing the relevance of the information versus the cost benefit.

183

Which of the following is the purpose of the Private Company Council?
A. To certify whether a company meets the definition of a public business entity.
B. To set auditing standards for private company audits.
C. To assist the FASB in identifying whether and when a private company accounting standard should be developed.
D. To provide input to the Emerging Issues Task Force regarding accounting issues faced by private companies.

C. To assist the FASB in identifying whether and when a private company accounting standard should be developed.
The PCC works with the FASB to set private company accounting standards.

184

Under IFRS for SMEs, which of the following methods, if any, can be used by an investor to account for an investment in another entity (an associate) over which the investor has significant influence?
Cost Method Equity Method
Yes Yes
Yes No
No Yes
No No

Cost Method Equity Method
Yes Yes
Under IFRS for SMEs, either the cost method or equity method may be used by an investor to account for an investment in another entity (called an "associate" in IFRS for SMEs) over which the investor has significant influence. Under U.S. GAAP, only the equity method may be used.

185

Which one of the following is not an other comprehensive basis of accounting (OCBOA)?
A. Cash basis.
B. Modified cash basis.
C. Income tax basis.
D. IFRS for SMEs.

D. IFRS for SMEs.
IFRS for SMEs is not an other comprehensive basis of accounting, but rather is one form of generally accepted accounting principles (GAAP). The cash basis of accounting, the modified cash basis, and the income tax basis are all regarded as an other comprehensive basis of accounting (OCBOA) systems.

186

Under IFRS for SMEs, which of the following, if any, must be disclosed in financial statements?
Earnings per Share (EPS) Information by Segment
Yes Yes
Yes No
No Yes
No No

No No
Under IFRS for SMEs, neither earnings per share (EPS), nor information by segment is required in financial statements. Since financial statements prepared under IFRS for SMEs are those of entities not traded on exchanges or otherwise required to file with regulatory agencies, earnings per share and segment reporting are not considered important information for users. These are two of the simplifications in IFRS for SMEs that make the standards less burdensome than either U.S. GAAP or full IFRS.

187

During the year, Hauser Co. wrote off a customer's account receivable. Hauser used the allowance method for uncollectable accounts. What impact would the write-off have on net income and total assets?

Net income Total assets
Decrease Decrease
Decrease No effect
No effect Decrease
No effect No effect
Under the allowance method for uncollectible accounts there is no impact on the balance sheet or net income when the receivable is written off. The estimated uncollectible is recognized at the time of the sale; therefore, when the account is written, off the allowance and the accounts receivable are both reduced resulting in no effect on the income statement or balance sheet.

No effect No effect
Under the allowance method for uncollectible accounts there is no impact on the balance sheet or net income when the receivable is written off. The estimated uncollectible is recognized at the time of the sale; therefore, when the account is written, off the allowance and the accounts receivable are both reduced resulting in no effect on the income statement or balance sheet.

188

Tinsel Co.'s balances in allowance for uncollectible accounts were $70,000 at the beginning of the current year and $55,000 at year end. During the year, receivables of $35,000 were written off as uncollectible. What amount should Tinsel report as uncollectible accounts expense at year end?
A. $15,000
B. $20,000
C. $35,000
D. $50,000

B. $20,000
To determine the amount of uncollectible expense (bad debt expense) use T accounts. Solve for ???? = 20,000
Allowance for uncollectible
70,000 Beg balance
Write-offs 35,000 ???? Bad debt expense
55,000 End balance

189

On Merf's April 30, 2004, balance sheet, a note receivable was reported as a noncurrent asset and its accrued interest for eight months was reported as a current asset. Which of the following terms would fit Merf's note receivable?
A. Both principal and interest amounts are payable on August 31, 2004 and August 31, 2005.
B. Principal and interest are due December 31, 2004.
C. Both the principal and the interest amounts are payable on December 31, 2004 and December 31, 2005.
D. Principal is due August 31, 2005. Interest is due August 31, 2004 and August 31, 2005.

D. Principal is due August 31, 2005. Interest is due August 31, 2004 and August 31, 2005.

190

Poe, Inc. had the following bank reconciliation at March 31, 2005:
Balance per bank statement, 3/31/05 $46,500
Add deposit in transit 10,300
56,800
Less outstanding checks (12,600)
Balance per books, 3/31/05 $44,200
Data per bank for the month of April 2005 follow:
Deposits $58,400
Disbursements 49,700

All reconciling items at March 31, 2005 cleared the bank in April. Outstanding checks at April 30, 2005 totaled $7,000. There were no deposits in transit at April 30, 2005. What is the cash balance per books at April 30, 2005?
A. $48,200
B. $52,900
C. $55,200
D. $45,900

A. $48,200
Balance per books, 3/31 $44,200
Deposits per bank, April $58,400
Less deposit in transit, 3/31 (10,300)
Equals deposits made by firm in April 48,100
Checks clearing bank in April $49,700
Less outstanding checks, 3/31 (12,600)
Plus outstanding checks, 4/30 7,000
Equals checks written by firm in April (44,100)
Balance per books, 4/30 $48,200

191

On June 30, Almond Co.'s cash balance was $10,012 before adjustments, while its ending bank statement balance was $10,772. Check number 101 was issued June 2 in the amount of $95, but was erroneously recorded in Almond's general ledger balance as $59. The check was correctly listed in the bank statement at $95.
The bank statement also included a credit memo for interest earned in the amount of $35, and a debit memo for monthly service charges in the amount of $50.

What was Almond's adjusted cash balance on June 30?

A. $9,598
B. $9,961
C. $10,048
D. $10,462

B. $9,961
The adjusted cash balance is computed as $10,012 - corrected #101 amount ($95 - $59) + $35 interest - $50 service charge = $9.96. Check #101 was recorded for $59 but should have been recorded for $95.

192

After being held for 40 days, a 120-day, 12% interest-bearing note receivable was discounted at a bank at 15%. The proceeds received from the bank equal
A. Maturity value less the discount at 12%.
B. Maturity value less the discount at 15%.
C. Face value less the discount at 12%.
D. Face value less the discount at 15%.

B. Maturity value less the discount at 15%.
The bank charges its discount (its fee) on the maturity value, which is the face value of the note plus 12% interest for 120 days. The bank charges 15% on this amount for the 80 remaining days in the note term. Thus, the proceeds equal the maturity value less its fee.

193

On July 1, 2005, Lee Co. sold goods in exchange for a $200,000, 8-month, noninterest-bearing note receivable. At the time of the sale, the note's market rate of interest was 12%.
What amount did Lee receive when it discounted the note at 10% on September 1, 2005?

A. $194,000
B. $193,800
C. $190,000
D. $188,000

Six months remain in the note term at the date of discounting.

Maturity value of note:
$200,000
Less discount: $200,000(.10)(6/12)
(10,000)
Equals proceeds on note
$190,000

194

Under IFRS, a cash generating unit (CGU) is:
A. The smallest business segment.
B. Any grouping of assets that generates cash flows.
C. Any group of assets that are reported separately to management.
D. The smallest group of assets that generates independent cash flows from continuing use.

D. The smallest group of assets that generates independent cash flows from continuing use.

195

On April 1, Aloe, Inc. factored $80,000 of its accounts receivable without recourse. The factor retained 10% of the accounts receivable as an allowance for sales returns and charged a 5% commission on the gross amount of the factored receivables. What amount of cash did Aloe receive from the factored receivables?
A. $68,000
B. $68,400
C. $72,000
D. $76,000

A. $68,000
The net cash received when the receivables were factored was $80,000 x .85 (100% - 10% - 5%) = $68,000.

196

Delta, Inc. sells to wholesalers on terms of 2/15, net 30. Delta has no cash sales but 50% of Delta's customers take advantage of the discount. Delta uses the gross method of recording sales and trade receivables. An analysis of Delta's trade receivables balances on December 31, 2004, revealed the following:

Age Amount Collectible
0 - 15 days $100,000 100%
16 - 30 days 60,000 95%
31 - 60 days 5,000 90%
Over 60 days 2,500 $500
$167,500
=========
In its December 31, 2004 balance sheet, what amount should Delta report for allowance for discounts?

A. $1,000
B. $1,620
C. $1,675
D. $2,000

A. $1,000
Only the accounts in the 0 - 15 day age category can take the discount, because the discount period ends 15 days after the sale (2/15, n30).
The discount percentage is 2% (2/15, n30). One-half of the customers take the discount. Therefore, the expected discounts to be taken after December 31, 2004 are: (.5)($100,000)(.02) = $1,000. This expected discount amount reduces net sales and net accounts receivable for 2004 because it is based on sales in 2004.

197

On June 1, 2005, Pitt Corp. sold merchandise with a list price of $5,000 to Burr on account. Pitt allowed trade discounts of 30% and 20%.
Credit terms were 2/15, n/40 and the sale was made FOB shipping point. Pitt prepaid $200 of delivery costs for Burr as an accommodation.
On June 12, 2005, Pitt received from Burr a remittance in full payment amounting to

A. $2,744
B. $2,940
C. $2,944
D. $3,140

C. $2,944
$5,000(1 - .30)(1 - .20)(.98) + $200 = $2,944.
The chain trade discounts are applied to each successive net amount as shown in the calculation, and the cash discount of 2% is then applied to the final invoice amount.

The cash discount applies because the payment was made within 15 days of purchase. The goods were shipped FOB shipping point. Therefore, title transferred to Burr at the shipping point, meaning Burr bears the shipping charges. Because Pitt prepaid them as an accommodation, Burr must reimburse Pitt for the $200, the last term in the calculation leading to $2,944.

198

Jole Co. lent $10,000 to a major supplier in exchange for a noninterest-bearing note due in three years and a contract to purchase a fixed amount of merchandise from the supplier at a 10% discount from prevailing market prices over the next three years.
The market rate for a note of this type is 10%. On issuing the note, Jole should record

Discount on note receivable Deferred charge
Yes Yes
Yes No
No Yes
No No

Discount on note receivable Deferred charge
Yes Yes

199

Cook Co. had the following balances on December 31, 2004:

Cash in checking account
$350,000
Cash in money market account
250,000
U.S. Treasury bill, purchased 12/1/04, maturing 2/28/05
800,000
U.S. Treasury bond, purchased 3/1/04, maturing 2/28/05
500,000
Cook's policy is to treat as cash equivalents all highly liquid investments with a maturity of three months or less when purchased. What amount should Cook report as cash and cash equivalents in its December 31, 2004, balance sheet?

A. $600,000
B. $1,150,000
C. $1,400,000
D. $1,900,000

C. $1,400,000

200

Ward Co. estimates its uncollectible accounts expense to be 2% of credit sales. Ward's credit sales for 2004 were $1,000,000. During 2004, Ward wrote off $18,000 of uncollectible accounts. Ward's allowance for uncollectible accounts had a $15,000 balance on January 1, 2004. In its December 31, 2004 income statement, what amount should Ward report as uncollectible accounts expense?
A. $23,000
B. $20,000
C. $18,000
D. $17,000

B. $20,000
The credit sales method does not adjust the allowance balance to a required ending amount, but rather simply places the appropriate percent of sales into uncollectible accounts expense and the allowance account. 2% x $1,000,000 = $20,000.

201

On October 31, 2005, Dingo, Inc. had cash accounts at three different banks. One account balance is segregated solely for a November 15, 2005, payment into a bond sinking fund. A second account, used for branch operations, is overdrawn. The third account, used for regular corporate operations, has a positive balance.
How should these accounts be reported in Dingo's October 31, 2005, classified balance sheet?

A. The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability.
B. The segregated and regular accounts should be reported as current assets, and the overdraft should be reported as a current liability.
C. The segregated account should be reported as a noncurrent asset, and the regular account should be reported as a current asset net of the overdraft.
D. The segregated and regular accounts should be reported as current assets net of the overdraft.

A. The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability.

The accounts are with different banks. Thus, the accounts cannot be offset against one another.
The overdraft is a liability because the bank honored a check or withdrawal causing the account to be negative. The firm owes the bank this amount.

202

When a note receivable is determined to be impaired,
A. The note is written-off.
B. No recognition of the impairment is required until a formal troubled-debt restructuring takes place.
C. The note is written down to the nominal sum of future cash flows expected to be collected, including interest.
A note impairment requires a write-down of the note but the new carrying value is the present value of future cash flows. Use of the present value increases the loss relative to the loss computed on nominal value.
D. A loss or expense is recognized as equal to the difference between the note carrying value and the present value of the cash flows expected to be received.

D. A loss or expense is recognized as equal to the difference between the note carrying value and the present value of the cash flows expected to be received.

203

The following are held by Smite Co.:
Cash in checking account $20,000
Cash in bond sinking fund account 30,000
Post-dated check from customer dated one month from balance sheet date 250
Petty cash 200
Commercial paper (matures in two months) 7,000
Certificate of deposit (matures in six months) 5,000
What amount should be reported as cash and cash equivalents on Smite's balance sheet?

A. $57,200
B. $32,200
C. $27,450
D. $27,200

D. $27,200
The cash balance is $20,200: the sum of the checking account balance and the petty cash. Because it has a maturity of less than three months, the only cash equivalent is the $7,000 of commercial paper. The final sum of these two accounts is $27,200.

The post-dated check is neither cash nor cash equivalent. The item should be treated as a receivable. It is not cash until the date written on the check.

204

The following is Gold Corp.'s June 30, 2004, trial balance:

Cash overdraft
$ 10,000
Accounts receivable, net
$ 35,000
Inventory
58,000
Prepaid expenses
12,000
Land held for resale
100,000
Property, plant, and equipment, net.
95,000
Accounts payable and accrued expenses
32,000
Common stock
25,000
Additional paid-in capital
150,000
Retained earnings
83,000
_________
_________
$300,000
$300,000
========
========
Additional information:

Checks amounting to $30,000 were written to vendors and recorded on June 29, 2004, resulting in a cash overdraft of $10,000. The checks were mailed on July 9, 2004.
Land held for resale was sold for cash on July 15, 2004.
Gold issued its financial statements on July 31, 2004.
In its June 30, 2004, balance sheet, what amount should Gold report as current assets?

A. $225,000
B. $205,000
C. $195,000
D. $125,000

Current assets are those assets expected to be consumed or realized in cash within one year of the balance sheet date. There is no overdraft because the checks were not sent as of the balance sheet date. Thus, the balance sheet should disclose $20,000 in cash ($30,000 - $10,000).

The land held for resale is a current asset because it is expected to be sold in the next year (and the corroboration of this expectation was known before the issuance of the financial statements).

Cash
$ 20,000
Net accounts receivable
35,000
Inventory
58,000
Prepaid expenses
12,000
Land held for resale
100,000
Total current assets
$225,000

205

The following information pertains to Grey Co. on December 31, 2003:
Checkbook balance
$12,000
Bank statement balance
16,000
Check drawn on Grey's account, payable to a vendor, dated and recorded 12/31/03 but not mailed until 1/10/04
1,800
On Grey's December 31, 2003 balance sheet, what amount should be reported as cash?

A. $12,000
B. $13,800
C. $14,200
D. $16,000

B. $13,800
The correct cash balance is the balance per the checkbook ($12,000) plus the $1,800 check written to the vendor, for a total of $13,800.

This check reduced the balance in the checkbook but was not mailed. Thus, the amount remains in Grey's cash balance at the end of the year. The bank statement balance is not the correct balance because information about transactions affecting cash near the end of the month, recorded by Grey, did not reach the bank by the cutoff date.

206

In preparing its August 31, 1990 bank reconciliation, Apex Corp. has the following information available:
Balance per bank statement, 8/31/90 $18,050
Deposit in transit, 8/31/90 3,250
Return of customer's check for insufficient funds, 8/31/90 600
Outstanding checks, 8/31/90 2,750
Bank service charges for August 100
On August 31, 1990, Apex's correct cash balance is
A. $18,550
B. $17,950
C. $17,850
D. $17,550

A. $18,550
Balance per bank statement $18,050
Plus deposit in transit 3,250
Less outstanding checks (2,750)
Equals ending cash balance $18,550

The effects of the bank service charges and the insufficient funds check are already reflected in the balance per bank statement. The bank was the source of that information.

207

Hilltop Co.'s monthly bank statement shows a balance of $54,200. Reconciliation of the statement with company books reveals the following information:
Bank service charge $ 10
Insufficient funds check 650
Checks outstanding 1,500
Deposits in transit 350
Check deposited by Hilltop and cleared by the bank for $125,
but improperly recorded by Hilltop as $152
What is the net cash balance after the reconciliation?

A. $52,363.
B. $53,023.
C. $53,050.
D. $53,077.

C. $53,050.
The reconciling items that need to be adjusted to the bank balance are: checks outstanding (-1,500) and deposit in transit (+350). The net cash after the reconciliation is: Bank balance $54,200 - 1,500 + 350 = $53,050. The bank service charge and insufficient funds are already reflected in the bank balance. The error is on Hilltop's books, not on the bank statement and therefore does not need to be included in the reconciliation.

208

A bank reconciliation with the headings "Balance per Books" and "Balance per Bank" lists three adjustments under the former and four adjustments under the latter. The company makes separate adjusting entries for each item in the reconciliation that requires an adjustment. How many adjusting entries are recorded?

A. 3
B. 4
C. 7
D. 0

A. 3
Only amounts adjusting the balance per books require an adjusting entry because only those amounts explain why the firm's recorded cash balance is not the same as the true cash balance. Common adjustments of this type include bank service charges, notes collected, and interest. The firm cannot alter the bank balance.

209

When the allowance method of recognizing bad debt expense is used, the allowance would decrease when a(an)
A. The account previously written off is collected.
B. Account previously written off becomes collectible.
C. Specific uncollectible account is written off.
D. Provision for uncollectible accounts is recorded.

C. Specific uncollectible account is written off.
The allowance account is increased when estimated uncollectible accounts expense is recognized. The allowance records the expected reduction in net accounts receivable until accounts are written off.
Then, when accounts actually become uncollectible and are written off, the allowance is decreased because it is no longer needed. The identity of the specific uncollectible account is known and that account is also decreased.

This transaction reinstates (increases) the allowance that was removed when the account was originally written off. The entries are:
AR
Allowance
Cash
AR

210

Gibbs Co. uses the allowance method for recognizing uncollectible accounts. Ignoring deferred taxes, the entry to record the write-off of a specific uncollectible account
A. Affects neither net income nor working capital.
B. Affects neither net income nor accounts receivable.
C. Decreases both net income and accounts receivable.
D. Decreases both net income and working capital.

A. Affects neither net income nor working capital.
The entry is:
Allowance for uncollectible accounts
Accounts receivable

211

Bee Co. uses the direct write-off method to account for uncollectible accounts receivable.
During an accounting period, Bee's cash collections from customers equal sales adjusted for the addition or deduction of the following amounts:
Accounts written off Increase in accounts receivable balance
Deduction Deduction
Addition Deduction
Deduction Addition
Addition Addition

Deduction Deduction
Under the direct write-off method, write-offs are credited directly to accounts receivable (AR). No allowance account is used. Under the terms of the question, accounts receivable increased during the year.

Increase in AR = sales - cash collections - write-offs
cash collections = sales - increase in AR - write-offs.

212

Adam Co. reported sales revenue of $2,300,000 in its income statement for the year ended December 31, 2005. Additional information was as follows:
12/31/04 12/31/05
Accounts receivable $500,000 $650,000
Allowance for uncollectible accounts (30,000) (55,000)

Uncollectible accounts totaling $10,000 were written off during 2005. Under the cash basis of accounting, Adam would have reported 2005 sales of
A. $2,140,000
B. $2,150,000
C. $2,175,000
D. $2,450,000

A. $2,140,000

You were right, except you forgot to deduct the $10,000 in accounts written off.

213

In its December 31 balance sheet, Butler Co. reported trade accounts receivable of $250,000 and related allowance for uncollectible accounts of $20,000.
What is the total amount of risk of accounting loss related to Butler's trade accounts receivable, and what amount of that risk is off-balance sheet risk?

Risk of accounting loss Off-balance sheet risk
$0 $0
$230,000 $0
$230,000 $20,000
$250,000 $20,000

$230,000 $0

214

Marr Corp. reported rental revenue of $2,210,000 in its cash basis federal income tax return for the year ended November 30, 2004. Additional information is as follows:
Rents receivable - November 30, 2004
$1,060,000
Rents receivable - November 30, 2003
800,000
Uncollectible rents written off during the fiscal year
30,000
Under the accrual basis, Marr should report rental revenue of

A. $1,920,000
B. $1,980,000
C. $2,440,000
D. $2,500,000

D. $2,500,000
The cash basis revenue in the tax return is the amount of rent collected for tax purposes.

beg. rent receivable + accrual revenue - collections - write-offs = end. rent receivable
$800,000 + accrual revenue - $2,210,000 - $30,000 =
$1,060,000

215

Mare Co.'s December 31, 2005, balance sheet reported the following current assets:

Cash
$ 70,000
Accounts receivable
120,000
Inventories
60,000
Total
$250,000
========
An analysis of the accounts disclosed that accounts receivable consisted of the following:

Trade accounts
$ 96,000
Allowance for uncollectible accounts
(2,000)
Selling price of Mare's unsold goods out on consignment, at 130% of cost, not included in Mare's ending inventory
26,000
_________
Total
$120,000
========
On December 31, 2005, the total of Mare's current assets is

A. $224,000
B. $230,000
C. $244,000
D. $270,000

C. $244,000
Corrected total current assets is computed as follows:
$250,000 - $26,000 + $26,000/1.30 = $244,000.

The only adjustment needed is to remove the unrecognized gross margin on the unsold inventory out on consignment.

Although the cost of the inventory of $20,000 ($26,000/1.30) is incorrectly classified in accounts receivable, that misclassification does not affect the total for current assets because accounts receivable is part of current assets. Subtracting the $26,000 removes the inventory at selling price. Adding the $26,000/1.30 term adds the cost of the inventory back to current assets. Inventory is reported at cost, not selling price, because the items are unsold. Including them at selling price would imply profit recognition before sale.

216

On the December 31, 2005 balance sheet of Mann Co., the current receivables consisted of the following:
Trade accounts receivable $ 93,000
Allowance for uncollectible accounts (2,000)
Claim against shipper for goods lost in transit (Nov. 2005) 3,000
Selling price of unsold goods sent by Mann on consignment at 130% of cost (not included in Mann's ending inventory) 26,000
Security deposit on lease of warehouse used for storing some inventories 30,000
Total $150,000
========

On December 31, 2005, the correct total of Mann's current net receivables was
A. $94,000
B. $120,000
C. $124,000
D. $150,000

A. $94,000
Only the first three items are included in net receivables:
Trade accounts receivable $93,000
Allowance for uncollectible accounts (2,000)
Claim against shipper for goods lost in transit (Nov. 2005) 3,000
Net receivables $94,000

The claim for lost goods is a definite receivable. The firm has a current claim on another entity. The goods on consignment should be included in Mann's inventory at cost, not in accounts receivable at sales value. They have not been sold. The security deposit is not included in current receivables because the firm will likely not receive this deposit back during the next fiscal year.

217

The following information relates to Jay Co.'s accounts receivable for 2004:

Accounts receivable, 1/1/04
$ 650,000
Credit sales for 2004
2,700,000
Sales returns for 2004
75,000
Accounts written off during 2004
40,000
Collections from customers during 2004
2,150,000
Estimated future sales returns at 12/31/04
50,000
Estimated uncollectible accounts at 12/31/04
110,000
What amount should Jay report for accounts receivable, before allowances for sales returns and uncollectible accounts, on December 31, 2004?

A. $1,200,000
B. $1,125,000
C. $1,085,000
D. $925,000

C. $1,085,000
The question is asking for the gross accounts receivable balance, before allowances for future sales returns, allowances, and uncollectible accounts:
AR 1/1 + Credit sales - Sales returns - Write-offs - Collections = AR 12/31
$650,000 + $2,700,000 - $75,000 - $40,000 - $2,150,000 = $1,085,000

218

Marr Co. had the following sales and accounts receivable balances, prior to any adjustments at year end:
Credit sales $10,000,000
Accounts receivable 3,000,000
Allowance for uncollectible accounts (debit balance) 50,000
Marr uses 3% of accounts receivable to determine its allowance for uncollectible accounts at year end. By what amount should Marr adjust its allowance for uncollectible accounts at year end?

A. $0
B. $40,000
C. $90,000
D. $140,000

D. $140,000
The amount of the adjustment to get the $50,000 debit balance to a $90,000 (3% x $3,000,000) credit balance is $140,000.

219

On March 31, 2005, Vale Co. had an unadjusted credit balance of $1,000 in its allowance for uncollectible accounts. An analysis of Vale's trade accounts receivable on that date revealed the following:

Age
Amount
Estimated uncollectible
0 - 30 days
$60,000
5%
31 - 60 days
4,000
10%
Over 60 days
2,000
$1,400
What amount should Vale report as allowance for uncollectible accounts in its March 31, 2005, balance sheet?

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

A. $4,800
The sum of the products of the AR amounts and uncollectible percentages yield the required ending allowance balance (the third AR category's estimated uncollectible has already been computed): $60,000(5%) + $4,000(10%) + $1,400 = $4,800.

220

Pie Co. uses the installment sales method to recognize revenue. Customers pay the installment notes in 24 equal monthly amounts, which include 12% interest.
What is an installment note's receivable balance six months after the sale?

A. 75% of the original sales price.
B. Less than 75% of the original sales price.
C. The present value of the remaining monthly payments discounted at 12%.
D. Less than the present value of the remaining monthly payments discounted at 12%.

C. The present value of the remaining monthly payments discounted at 12%.

221

Each of Potter Pie Co.'s 21 new franchisees contracted to pay an initial franchise fee of $30,000.
By December 31, 2005, each franchisee had paid a nonrefundable $10,000 fee and signed a note to pay $10,000 principal plus the market rate of interest on December 31, 2006 and December 31, 2007.
Experience indicates that one franchise will default on the additional payments. Services for the initial fee will be performed in 2006.
What amount of net unearned franchise fees would Potter report on December 31, 2005?

A. $400,000
B. $600,000
C. $610,000
D. $630,000

C. $610,000

The $610,000 net unearned fee revenue = (21)($30,000) - $20,000. This amount includes the notes received, but does not include the one expected uncollectible note.

This amount includes only the notes receivable. No services have been performed as of the end of 2005. Therefore, the cash collected also represents unearned revenue.

222

On December 30, 2005, Chang Co. sold a machine to Door Co. in exchange for a noninterest-bearing note requiring ten annual payments of $10,000. Door made the first payment on December 30, 2005. The market interest rate for similar notes at the date of issuance was 8%. Information on present value factors is as follows:
Period
Present value of $1 at 8%
Present value of ordinary annuity of $1 at 8%
9
0.50
6.25
10
0.46
6.71
In its December 31, 2005, balance sheet, what amount should Chang report as note receivable?

A. $45,000
B. $46,000
C. $62,500
D. $67,100

C. $62,500
The note receivable should be reported at the present value of the nine remaining payments. The first payment was made at the date of the sale. The remaining nine payments comprise an ordinary annuity as of December 31, 2005 because the next payment is due one year from that date.
Therefore, the present value and reported note value on that date is 6.25($10,000) = $62,500.

223

Leaf Co. purchased from Oak Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments of $5,009. The note was discounted to yield a 9% rate to Leaf. At the date of purchase, Leaf recorded the note at its present value of $19,485.
What should be the total interest revenue earned by Leaf over the life of this note?

A. $5,045
B. $5,560
C. $8,000
D. $9,000

B. $5,560
Total interest revenue is the amount received over the term of the note less the present value of the note: 5($5,009) - $19,485 = $5,560.
Leaf paid $19,485 for the note, and will receive 5($5,009) over the note term. The difference is interest revenue.

224

Frame Co. has an 8% note receivable, in the original amount of $150,000, dated June 30, 2003. Payments of $50,000 in principal plus accrued interest are due annually on July 1, 2004, 2005, and 2006.
In its June 30, 2005, balance sheet, what amount should Frame report as a current asset for interest on the note receivable?

A. $0
B. $4,000
C. $8,000
D. $12,000

C. $8,000
As of June 30, 2005, only one payment has been received (July 1, 2004). Thus, $100,000 of principal balance has been outstanding for an entire year as of the balance sheet date. Interest receivable on June 30, 2005 is thus $8,000 (.08 x $100,000).

225

Frame Co. has an 8% note receivable, in the original amount of $150,000, dated June 30, 2003. Payments of $50,000 in principal plus accrued interest are due annually on July 1, 2004, 2005, and 2006.
In its June 30, 2005, balance sheet, what amount should Frame report as a current asset for interest on the note receivable?

A. $0
B. $4,000
C. $8,000
D. $12,000

C. $8,000
As of June 30, 2005, only one payment has been received (July 1, 2004). Thus, $100,000 of principal balance has been outstanding for an entire year as of the balance sheet date. Interest receivable on June 30, 2005 is thus $8,000 (.08 x $100,000).

226

On August 15, 2005, Benet Co. sold goods for which it received a note bearing the market rate of interest on that date. The four-month note was dated July 15, 2005.
Note that the principal, together with all interest, is due November 15, 2005.
When the note was recorded on August 15, which of the following accounts increased?

A. Unearned discount.
B. Interest receivable.
C. Prepaid interest.
D. Interest revenue.

B. Interest receivable.
The note was received one month into its term. Like a bond issued between interest dates and which collects accrued interest from the bondholder since the most recent interest payment date, this note is recorded with interest receivable for one month.
Benet earns only three months of interest revenue because that is the length of time it will hold the note.

227

On December 1, 2005, Tigg Mortgage Co. gave Pod Corp. a $200,000, 12% loan.
Pod received proceeds of $194,000 after the deduction of a $6,000 nonrefundable loan origination fee. Principal and interest are due in 60 monthly installments of $4,450, beginning January 1, 2006. The repayments yield an effective interest rate of 12% at a present value of $200,000 and 13.4% at a present value of $194,000.

What amount of accrued interest receivable should Tigg include in its December 31, 2005 balance sheet?

A. $4,450
B. $2,166
C. $2,000
D. $0

C. $2,000
The term "accrued interest receivable" refers to the cash amount of interest due. The cash amount of interest due is based on the contractual interest rate and face value. The loan origination fee is a way of increasing the effective interest but it does not affect the cash interest component. The $2,000 accrued interest = (.12)(1/12)($200,000).

228

On December 31, 2005, Jet Co. received two $10,000 notes receivable from customers in exchange for services rendered. On both notes, interest is calculated on the outstanding principal balance at the annual rate of 3% and payable at maturity.
The note from Hart Corp., made under customary trade terms, is due in nine months and the note from Maxx, Inc. is due in five years. The market interest rate for similar notes on December 31, 2005 was 8%. The compound interest factors to convert future values into present values at 8% follow:
Present value of $1 due in nine months: .944
Present value of $1 due in five years: .680

At what amounts should these two notes receivable be reported in Jet's December 31, 2005, balance sheet?

Hart Maxx
$9,440 $6,800
$9,652 $7,820
$10,000 $6,800
$10,000 $7,820

$10,000 $7,820
The 9-month note is reported at face value ($10,000) because current notes need not be measured at present value. The 5-year note is reported at $7,820, the present value of the future cash flows. The five years of interest is payable at maturity.
$7,820 = [$10,000 + $10,000(.03)(5 years)](.680)], which is the present value of the note plus the present value of the 3% interest.

229

On December 31, 1999, Key Co. received two $10,000 noninterest-bearing notes from customers in exchange for services rendered. The note from Alpha Co., which is due in nine months, was made under customary trade terms, but the note from Omega Co., which is due in two years, was not. The market interest rate for both notes at the date of issuance is 8%. The present value of $1 due in nine months at 8% is .944. The present value of $1 due in two years at 8% is .857. At what amounts should these two notes receivable be reported in Key's December 31, 1999, balance sheet?
Alpha Omega
$ 9,440 $ 8,570
$10,000 $ 8,570
The note from Alpha Co. is a short-term liability. It is reported at the face value of $10,000. The note from Omega is discounted as a single sum for two time periods at 8% to be reported at $10,000X.857=$8,750.
$ 9,440 $10,000
$10,000 $10,000

$10,000 $ 8,570
The note from Alpha Co. is a short-term liability. It is reported at the face value of $10,000. The note from Omega is discounted as a single sum for two time periods at 8% to be reported at $10,000X.857=$8,750.

230

On January 2, 2004, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a $600,000 noninterest-bearing note due January 2, 2007. There was no established exchange price for the equipment. The prevailing rate of interest for a note of this type on January 2, 2004, was 10%. The present value of $1 at 10% for three periods is 0.75.
In Emme's 2004 income statement, what amount should be reported as interest income?

A. $9,000
B. $45,000
C. $50,000
D. $60,000

B. $45,000
The initial recorded value of the note is $450,000 (.75 x $600,000). Thus, interest income for the first year is $45,000 ($450,000 x .10). The note is not recorded at $600,000 because this amount includes interest to be recognized in the future.

231

Ace Co. sold King Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments. This note was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of $1 for five periods are as follows:

8% 3.992
9% 3.890
What should be the total interest revenue earned by King on this note?

A. $9,000
B. $8,000
C. $5,560
D. $5,050

C. $5,560
Total interest over the life of the note equals the total amount paid by Ace over the life of the note less the proceeds to Ace. The proceeds equal the present value of the payments at the 9% yield rate. The annual payment is found using the 8% rate because that rate is contractually set and determines the annual payment.
The annual payment P is found as: $20,000 = P(3.992). P = $5,010

Total interest revenue = total payments by Ace - proceeds to Ace
= 5($5,010) - $5,010(3.89) = $5,560.

232

Garr Co. received a $60,000, 6-month, 10% interest-bearing note from a customer. After holding the note for two months, Garr was in need of cash and discounted the note at the United Local Bank at 12%.
The amount of cash Garr received from the bank was
A. $60,480
B. $60,630
C. $61,740
D. $62,520

A. $60,480
The calculation leading to the correct answer is:
Maturity value of the note: $60,000 + $60,000(.10)(6/12) =
$63,000
Less discount to bank: $63,000(.12)(4/12) =
2,520
Equals proceeds to Garr
$60,480
The bank charges its discount on the maturity value of the note, for the period of time it will hold the note.

233

Roth, Inc. received from a customer a one-year, $500,000 note bearing annual interest of 8%. After holding the note for six months, Roth discounted the note at Regional Bank at an effective interest rate of 10%. What amount of cash did Roth receive from the bank?
A. $540,000
B. $523,810
C. $513,000
D. $495,238

C. $513,000
Maturity value of the note: $500,000(1.08)
$540,000
Less discount to the bank: $540,000(.10)(6/12)
(27,000)
Equals proceeds to Roth
$513,000
The bank charges its discount on the maturity amount, for the period it holds the note. In effect, it is charging interest on interest yet to accrue (for the last six months). This procedure is followed because the maturity value is the amount at risk.

234

On November 1, 2004, Davis Co. discounted with recourse at 10%, a one-year, noninterest-bearing, $20,500 note receivable maturing on January 31, 2005.
What amount of contingent liability for this note must Davis disclose in its financial statements for the year ended December 31, 2004?

A. $0
B. $20,000
C. $20,333
D. $20,500
The firm is contingent for the maturity amount, which for a noninterest-bearing note is the face value. If the maker of the note fails to pay the bank or financial institution with whom Davis discounted the note, Davis would be called on to pay the entire maturity amount.

D. $20,500
The firm is contingent for the maturity amount, which for a noninterest-bearing note is the face value. If the maker of the note fails to pay the bank or financial institution with whom Davis discounted the note, Davis would be called on to pay the entire maturity amount.

235

Choose the correct accounting by the creditor for a loan impairment. Column (1): recognize a loss or expense upon recognizing the impairment. Column (2): rate of interest to use in computing the revised book value of the receivable after the impairment.
1 2
Yes Original effective rate
Yes New implied effective rate
No Original effective rate
No New implied effective rate

Yes Original effective rate
A loan impairment is recorded by reducing the net book value of the receivable to the present value of probable future cash inflows, discounted at the original rate in the receivable. The original rate is used because the loan continues to exist. The loss to the firm is measured at the rate existing when the original loan was created. The difference between the book value and present value, at the date of recognizing the impairment, is recorded as an expense or loss. There is no reason to report overstated assets.

236

A creditor's note receivable has a carrying value of $60,000 at the end of Year 1. Based on information about the debtor, the creditor believes the note is impaired and establishes the new carrying value of the note to be $25,000 at the end of Year 1. During Years 2 and 3, the debtor pays $14,000 on the note each year (total payments, $28,000). For Year 3, under which method of the two indicated is interest revenue recognized?
Interest Method Cost Recovery Method
Yes Yes
No No
Yes No
No Yes

Interest Method Cost Recovery Method
Yes Yes
The interest method recognizes interest revenue each year until the note is collected because the note was written down to present value when the impairment was recorded. The estimated future cash flows to be received include interest, which is recognized over the remaining term of the note.

The cost recovery method recognizes interest revenue only after cash equal to the new carrying value is collected. During Year 3, total collections surpassed the $25,000 new carrying value.

237

Ashe Co. recorded the following data pertaining to raw material X during January 2005:
Units
Date Received Cost Issued On Hand
1/1/05 Inventory $8.00 3,200
1/11/05 Issue 1,600 1,600
1/22/05 Purchase 4,800 $9.60 6,400
The moving-average unit cost of X inventory on January 31, 2005 is

A. $8.80
B. $8.96
C. $9.20
D. $9.60

C. $9.20
Units beginning inventory remaining at year-end (3,200 - 1,600)$8 = $12,800
Plus 1/22 purchase: 4,800($9.60) = 46,080
Ending inventory $58,880
Ending unit cost: $58,880/6,400 = $9.20
The moving average method costs issues at the unit cost of goods on hand at that point. Thus, the issue was costed at $8.00 per unit. The cost per unit changes with each purchase.

238

Brock Co. adopted the dollar-value LIFO inventory method as of January 1, 2003. A single inventory pool and an internally computed price index are used to compute Brock's LIFO inventory layers. Information about Brock's dollar-value inventory follows:

Inventory
_________________________________
Date at base-year cost at current-year cost at dollar-value LIFO
1/1/03 $40,000 $40,000 $40,000
2003 layer 5,000 14,000 6,000
__________ __________ __________ __________
12/31/03 45,000 54,000 46,000
2004 layer 15,000 26,000 ?
__________ __________ __________ __________
12/31/04 $60,000 $80,000 ?
========= ========== ==========
What was Brock's dollar-value LIFO inventory on December 31, 2004?

A. $80,000
B. $74,000
C. $66,000
D. $60,000

C. $66,000
The ending inventory is used to construct the internal price index. At the end of 2004, the ratio of current cost to base-year cost for ending inventory is $80,000/$60,000 = 1 1/3 or 4/3. This ratio is applied to the 2004 layer at base-year cost, yielding $20,000 ($15,000 x 4/3). This amount is the increase to DV LIFO. Therefore, ending 2004 DV LIFO is $66,000 ($46,000 + $20,000).

239

Seafood Trading Co. commenced operations during the year as a large importer and exporter of seafood. The imports were all from one country overseas. The export sales were conducted as drop shipments and were merely transshipped at Seattle. Seafood Trading reported the following data:
Purchases during the year $12.0 million
Shipping costs from overseas 1.5 million
Shipping costs to export customers 1.0 million
Inventory at year end 3.0 million
What amount of shipping costs should be included in Seafood Trading's year-end inventory valuation?

A. $0
B. $250,000
C. $375,000
D. $625,000

C. $375,000
Only transportation-in is treated as a product cost and included in inventory. This cost is considered a cost necessary to bring the inventory to a salable condition. $1.5 million was incurred for this cost - the cost to import. Inventory represents $3/$12 or 25% of total purchases. Therefore, 25% of $1.5 million, or $375,000, of transportation-in is included in inventory. Shipping costs to customers are treated as a period cost.

240

Generally, which inventory costing method approximates most closely the current cost for each of the following?
Cost of goods sold Ending inventory
LIFO FIFO
LIFO LIFO
FIFO FIFO
FIFO LIFO

LIFO FIFO
LIFO assumes the sale of the most recent purchases first and thus results in cost of goods sold that is the most current value. FIFO assumes the sale of the earliest purchases first (and beginning inventory before any purchases) and thus results in ending inventory that is the most current value. FIFO is sometimes called LISH: last in still here.

241

The following information pertained to Azur Co. for the year:
Purchases $102,800
Purchase discounts 10,280
Freight-in 15,420
Freight-out 5,140
Beginning inventory 30,840
Ending inventory 20,560
What amount should Azur report as cost of goods sold for the year?

A. $102,800
B. $118,220
C. $123,360
D. $128,500

B. $118,220
Cost of goods sold is determined (in a periodic inventory system) as:


Beginning Inventory
+ Net Purchases
= Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold

Beginning Inventory $ 30,840
+ Purchases $102,800
- Purchases Discounts (10,280)
+ Freight-in 15,420
+ Net Purchases 107,940
= Goods Available for Sale $138,780
- Ending Inventory 20,560
= Cost of Goods Sold $118,220

242

The following information was taken from Cody Co.'s accounting records for the year ended December 31, 2005:
Decrease in raw materials inventory $ 15,000
Increase in finished goods inventory 35,000
Raw materials purchased 430,000
Direct labor payroll 200,000
Factory overhead 300,000
Freight-out 45,000

There was no work-in-process inventory at the beginning or end of the year. Cody's 2005 cost of goods sold is
A. $895,000
B. $910,000
C. $950,000
D. $955,000

B. $910,000

Raw materials purchased $430,000
Plus decrease in raw materials 15,000*
Direct labor 200,000
Factory overhead 300,000
Less finished goods increase (35,000) **
Cost of goods sold $910,000

243

In January, Stitch, Inc. adopted the dollar-value LIFO method of inventory valuation. At adoption, inventory was valued at $50,000. During the year, inventory increased $30,000 using base-year prices, and prices increased 10%. The designated market value of Stitch's inventory exceeded its cost at year-end. What amount of inventory should Stitch report in its year-end balance sheet?

A. $80,000
B. $83,000
C. $85,000
D. $88,000

B. $83,000
Beginning inventory of $50,000 is at base-year dollars and the current year increase of $30,000 is also at base-year dollars. The current year layer must be converted to current year costs ($30,000 x 1.10) = $33,000. Ending dollar value LIFO is the beginning dollar value LIFO (in this case it was adopted in January so the beginning inventory must be $50,000) plus the current year layer of $33,000 or $83,000.

Note that the sentence "The designated market value of Stitch's inventory exceeded its cost at year end" is a distracter. It is simply stating that there is not an issue with the lower of cost or market since cost is lower.

244

On October 20, 2005, Grimm Co. consigned 40 freezers to Holden Co. for sale at $1,000 each and paid $800 in transportation costs.
On December 30, 2005, Holden reported the sale of 10 freezers and remitted $8,500. The remittance was net of the agreed 15% commission.
What amount should Grimm recognize as consignment sales revenue for 2005?

A. $7,700
B. $8,500
C. $9,800
D. $10,000

D. $10,000
Consignment sales revenue is the revenue recognized on consignment sales.
In this case, total consignment revenue is 10 x $1,000 = $10,000. The commission and transportation costs are expenses that reduce earnings on consignment revenues, but they do not affect total revenues to be recognized.

245

During 2005, Kam Co. began offering its goods to selected retailers on a consignment basis. The following information was derived from Kam's 2005 accounting records:
Beginning inventory
$122,000
Purchases
540,000
Freight-in
10,000
Transportation to consignees
5,000
Freight-out
35,000
Ending inventory - held by Kam
145,000
- held by consignees
20,000
In its 2005 income statement, what amount should Kam report as the cost of goods sold?

A. $507,000
B. $512,000
C. $527,000
D. $547,000

B. $512,000

Beg. inventory + Net purchases - End. inventory = Cost of goods sold
$122,000 + ($540,000 + $10,000 + $5,000) - ($145,000 + $20,000) = $512,000

246

On December 1, 2004, Alt Department Store received 505 sweaters on consignment from Todd. Todd's cost for the sweaters was $80 each, and they were priced to sell at $100. Alt's commission on consigned goods is 10%. December 31, 2004, five sweaters remained.
In its December 31, 2004, balance sheet, what amount should Alt report as payable for consigned goods?

A. $49,000
B. $45,400
C. $45,000
D. $40,400

C. $45,000

A total of 500 sweaters have been sold.
Alt earns 10% of the sales price ($10) as commission, and thus must pay Todd $90 for each sweater sold. Thus, the ending payable balance to Todd is $45,000 ($90 x 500). There is no liability for the sweaters remaining as these assets belong to Todd and are not reflected on Alt's balance sheet.

This is the cost of the 505 sweaters to Todd.
Alt's liability is not based on cost, but rather on the sales value of the sweaters sold less commission. Also, Alt has no liability for the sweaters remaining as these assets belong to Todd. These assets are not reflected on Alt's balance sheet.

247

Jel Co., a consignee, paid the freight costs for goods shipped from Dale Co., a consignor. These freight costs are to be deducted from Jel's payment to Dale when the consignment goods are sold. Until Jel sells the goods, the freight costs should be included in Jel's

A. Cost of goods sold.
B. Freight-out costs.
C. Selling expenses.
D. Accounts receivable.

D. Accounts receivable.

The freight costs are actually a cost of Dale, not Jel. Jel paid the costs for convenience and will be reimbursed later by submitting an amount from the sale of the goods minus the freight costs.

248

Stone Co. had the following consignment transactions during December 2005:
Inventory shipped on consignment to Beta Co.
$18,000
Freight paid by Stone
900
Inventory received on consignment from Alpha Co.
12,000
Freight paid by Alpha
500
No sales of consigned goods were made through December 31, 2005. Stone's December 31, 2005, balance sheet should include consigned inventory at
A. $12,000
B. $12,500
C. $18,000
D. $18,900

D. $18,900
The $18,900 amount to be included in consigned inventory (this would be included in Stone's ending inventory) = $18,000 + $900 freight.
This inventory is owned by Stone. The freight is included because it is a cost necessary to bring the inventory into salable condition and location. The inventory Stone received on consignment is not an asset of Stone's and is not included in Stone's inventory. Stone is helping to sell Alpha's inventory, just as Beta is helping to sell Stone's inventory.

249

How should the following costs affect a retailer's inventory?
Freight-in Interest on inventory loan
Increase No effect
All costs necessary to prepare inventory for sale are capitalized to inventory. Freight-in is such a cost. The goods must be shipped to the seller's location before they can be sold. Interest on inventory loans is a financing cost. It does not contribute to the process of making the inventory ready for sale.
Increase Increase
No effect Increase
No effect No effect

Freight-in Interest on inventory loan
Increase No effect
All costs necessary to prepare inventory for sale are capitalized to inventory. Freight-in is such a cost. The goods must be shipped to the seller's location before they can be sold. Interest on inventory loans is a financing cost. It does not contribute to the process of making the inventory ready for sale.

250

The following information pertains to Deal Corp.'s 2004 cost of goods sold:
Inventory, 12/31/03
$ 90,000
2004 purchases
124,000
2004 write-off of obsolete inventory
34,000
Inventory, 12/31/04
30,000
The inventory written off became obsolete due to an unexpected and unusual technological advance by a competitor. In its 2004 income statement, what amount should Deal report as cost of goods sold?

A. $218,000
B. $184,000
C. $150,000
D. $124,000

C. $150,000
The write-off cannot be counted in cost of goods sold because it is a decrease in inventory not associated with sales.

251

Nest uses the LIFO method to cost inventory. What amount should Nest report as inventory on January 31 under each of the following methods of recording inventory?
Perpetual Periodic
A. $2,600 $5,400
B. $5,400 $2,600
C. $2,600 $2,600
D. $5,400 $5,400
A. A
B. B
C. C
D. D

B. B

(Note: Figure out perpetual and then perpetual and periodic cannot be the same for LIFO).

Under the LIFO (last-in, first-out) inventory method, goods sold are assumed to be the most recently acquired goods (at their related costs). Therefore, goods remaining (ending inventory) are assumed to be the earliest acquired goods (at their related costs). If the perpetual LIFO inventory method is used, when goods are sold, they are assumed to be the goods acquired just prior to the sale.
Thus, Nest's sale of 1,800 units on 1/23 would have consisted of the 1,200 units acquired 1/8 and 600 units (of the 2,000) in beginning inventory. Ending inventory on January 31 would be:

1,400 units of beginning inventory @ $1 each = $1,400
800 units purchased 1/28 @ $5 each = 4,000
2,200 units in ending inventory reported @ = $5,400

If the periodic LIFO inventory method is used, ending inventory (and cost of goods sold) are determined only at the end of the period. Therefore, Nest's sale of 1,800 units on 1/23 would have consisted of (by assumption at the end of the period) 800 units acquired on 1/28 and 1,000 units (of the 1,200) acquired on 1/8. Ending inventory on January 31 would be:

200 units of the 1,200 purchased 1/8 @ $3 = $ 600
2,000 units (all) of beginning inventory @ $1 = 2,000
2,200 units in ending inventory reported @ = $2,600

252

Drew Co. uses the average cost inventory method for internal reporting purposes and LIFO for financial statement and income tax reporting.
On December 31, 2005, the inventory was $375,000 using average cost and $320,000 using LIFO. The unadjusted credit balance in the LIFO Reserve account on December 31, 2005 was $35,000.

What adjusting entry should Drew record to adjust from average cost to LIFO on December 31, 2005?

Debit Credit
Cost of goods sold $55,000 Inventory $55,000
Cost of goods sold $55,000 LIFO reserve $55,000
Cost of goods sold $20,000 Inventory $20,000
Cost of goods sold $20,000 LIFO reserve $20,000

Cost of goods sold $20,000 LIFO reserve $20,000
The ending difference between average cost and LIFO is $55,000 ($375,000 - $320,000). This is the required LIFO reserve account.
The balance before adjustment is $35,000. Thus, $20,000 must be added to the account. The conversion to LIFO, for reporting purposes, increases cost of goods sold because, under LIFO, ending inventory is lower. The entry in this answer alternative increases the cost of goods sold. The inventory account itself is not credited. Rather, the LIFO reserve account acts as a valuation account to reduce inventory to LIFO for balance sheet purposes.

253

In 2005, Cobb adopted the dollar-value LIFO inventory method.
At that time, Cobb's ending inventory had a base-year cost and an end-of-year cost of $300,000. In 2006, the ending inventory had a $400,000 base-year cost and a $440,000 end-of-year cost.

What dollar-value LIFO inventory cost would be reported in Cobb's December 31, 2006, balance sheet?

A. $440,000
This answer is the ending current cost of the inventory.
For each period, DV LIFO first computes the increase in the inventory in terms of base-year dollars, converts that increase to current prices, and adds that increase to the beginning inventory DV LIFO. The result is a set of layers, one for each year, which reflect the prices in those years. The ending DV LIFO inventory is not the ending current cost for the year.

B. $430,000
C. $410,000
D. $400,000

C. $410,000
The price level index for 2006 is 1.1 ($440,000/$400,000). Ending 2006 DV LIFO inventory equals the beginning inventory DV LIFO plus the increase in inventory at base-year dollars converted to 2006 prices:
Ending DV LIFO = Beginning DV LIFO + (increase at base-year dollars)(1.1)
= $300,000 + ($400,000 - $300,000)(1.1) = $410,000.

254

Bach Co. adopted the dollar-value LIFO inventory method as of January 1, 2006.
A single inventory pool and an internally computed price index are used to compute Bach's LIFO inventory layers. Information about Bach's dollar-value inventory follows:
Inventory
Date at base-year cost at current-year cost
1/1/06 $90,000 $90,000
2006 layer 20,000 30,000
2007 layer 40,000 80,000

What was the price index used to compute Bach's 2007 dollar-value LIFO inventory layer?
A. 1.09
B. 1.25
C. 1.33
D. 2.00

C. 1.33
The question provides the ending inventory for 2007 at current cost by layer. The sum of the current cost column ($200,000) is the current cost of the entire inventory at the end of 2007. The sum of the base-year cost for the three years is $150,000. Hence, under this assumption, the ratio of current cost for the total inventory at the end of 2007 to the base-year cost is 1.33 ($200,000/$150,000). This index is then multiplied by the 2007 layer in base-year dollars to derive the increment to DV LIFO ending inventory.

255

Walt Co. adopted the dollar-value LIFO inventory method as of January 1, 2005, when its inventory was valued at $500,000.
Walt's entire inventory constitutes a single pool. Using a relevant price index of 1.10, Walt determined that its December 31, 2005, inventory was $577,500 at current-year cost, and $525,000 at base-year cost.

What was Walt's dollar-value LIFO inventory on December 31, 2005?

A. $525,000
B. $527,500
C. $552,500
D. $577,500

B. $527,500
Ending inventory at current cost
$577,500
Ending inventory in base-year dollars $577,500/1.10
$525,000
Less beginning inventory in base-year dollars
500,000
Equals increase in inventory in base-year dollars
25,000
Times current price level index
x 1.10
Equals increase in inventory at current prices
27,500
Plus beginning inventory, DV LIFO
500,000
Equals ending inventory, DV LIFO
$527,500
In the year of adoption only, the beginning inventory under DV LIFO is the same as beginning inventory in base-year dollars. DV LIFO ending inventory is the sum of the base-year inventory plus layers measured in the prices of the year added.

256

I. The original cost is less than replacement cost.

II. The net realizable value is greater than replacement cost.

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

B. II only.
When a company reports its inventory at replacement cost (market value), original cost must exceed replacement cost. Lower of cost or market means the inventory is reported at replacement cost when replacement cost is less than original cost. Thus, statement I is not correct.
When determining market value, net realizable value is the ceiling or maximum amount. If replacement cost is less than net realizable value, then replacement cost is used as market (as long as replacement cost exceeds net realizable value less a normal profit margin - the floor or minimum value for market).

The firm in the question is reporting the inventory at replacement cost. Therefore, replacement cost must be less than net realizable value.

257

The lower of cost or market rule for inventories may be applied to total inventory, to groups of similar items, or to each item.
Which application generally results in the lowest inventory amount?
A. All applications result in the same amount.
B. Total inventory.
C. Groups of similar items.
D. Separately to each item.

D. Separately to each item.

Total inventory results in highest valuation for each item.

258

Based on a physical inventory taken on December 31, 2004, Chewy Co. determined its chocolate inventory on a FIFO basis at $26,000 with a replacement cost of $20,000.
Chewy estimated that, after further processing costs of $12,000, the chocolate could be sold as finished candy bars for $40,000. Chewy's normal profit margin is 10% of sales.

Under the lower of cost or market rule, what amount should Chewy report as chocolate inventory in its December 31, 2004, balance sheet?

A. $28,000
B. $26,000
C. $24,000
D. $20,000

B. $26,000
This amount is the cost of the inventory. In applying LCM to this data, market value is less than cost. Therefore, the inventory is reported at market value.
Market is the middle figure of replacement cost - $20,000, net realizable value - $28,000 ($40,000 - $12,000 processing cost), and net realizable value less normal profit margin - $24,000 ($28,000 - .10 x $40,000). Therefore, market is $24,000.

The lower of cost ($26,000) or market ($24,000) is market ($24,000), and market is the reported amount for the inventory.

259

The original cost of an inventory item is below both replacement cost and net realizable value. The net realizable value less normal profit margin is below the original cost.
Under the lower of cost or market method, the inventory item should be valued at

A. Replacement cost.
B. Net realizable value.
C. Net realizable value less normal profit margin.
D. Original cost.

D. Original cost.

If both the original and replacement costs are between NRV and NRV - profit margin, then use the lower of the two.

260

Kahn Co., in applying the lower of cost or market method, reports its inventory at replacement cost. Which of the following statements are correct?
The original cost is greater
than replacement cost The net realizable value, less a
normal profit margin, is greater
than replacement cost
Yes Yes
Yes No
No Yes
No No

The original cost is greater
than replacement cost The net realizable value, less a
normal profit margin, is greater
than replacement cost
Yes Yes

261

Thread Co. is selecting its inventory system in preparation for its first year of operations.
Thread intends to use either the periodic weighted average method or the perpetual moving average method, and to apply the lower of cost or market rule either to individual items or to the total inventory. Although a few individual prices will decrease, inventory prices are expected to generally increase throughout 2005.

What inventory system should Thread select if it wants to maximize the inventory carrying amount for December 31, 2005?

Inventory method Cost or market application
Perpetual Total inventory
Perpetual Individual item
Periodic Total inventory
Periodic Individual item


Inventory method Cost or market application
Perpetual Total inventory

262

The replacement cost of an inventory item is below the net realizable value and above the net realizable value less the normal profit margin. The original cost of the inventory item is below the net realizable value less the normal profit margin.
Under the lower of cost or market method, the inventory item should be valued at

A. Net realizable value.
B. Net realizable value less the normal profit margin.
C. Original cost.
D. Replacement cost.

C. Original cost.
In LCM, market value is replacement cost if replacement cost is between the ceiling value (net realizable value) and the floor value (net realizable value less normal profit margin).
This is the situation in this question. The original cost is below the floor value. Thus, market exceeds cost and the item is recorded at cost (lower of cost or market).

263

How LCM Works

Under LCM, the market value of inventory is the middle of three figures (in amount):
RC, NRV, NRV - PM

If the middle figure (market) is less than cost, then the inventory is reported at market. The inventory in this question is reported at replacement cost, which means that replacement cost is market value and replacement cost is less than cost. Also, replacement cost is the middle of the three figures (or tied with one of the other two).

Net realizable value less normal profit margin could not exceed replacement cost because that would imply that replacement cost is the lowest of the three figures, which contradicts the fact that replacement cost is market value.

Therefore, in terms of the question,
(1) original cost is greater than replacement cost, and
(2) net realizable value less normal profit margin is not greater than replacement cost.

264

A flash flood swept through Hat, Inc.'s warehouse on May 1. After the flood, Hat's accounting records showed the following:
Inventory, January 1 $ 35,000
Purchases, January 1 through May 1 200,000
Sales, January 1 through May 1 250,000
Inventory not damaged by flood 30,000
Gross profit percentage on sales 40%
What amount of inventory was lost in the flood?

A. $55,000
B. $85,000
C. $120,000
D. $150,000

A. $55,000
The gross margin method of estimating inventory is used to solve this problem. The cost of inventory lost cannot be identified by count but it can be estimated.
First, an estimate of cost of goods sold is subtracted from the cost of goods available on the date of the flood yielding the total amount of inventory that would have been present on May 1.

Second, the amount of inventory not lost is subtracted from the May 1 estimated total inventory. The result is an estimate of the amount lost.

With gross profit being 40% of sales, cost of goods sold must be 60% of sales, on average. Therefore, the estimate of cost of goods sold is $150,000 (.60 x $250,000).

Beginning inventory ($35,000)
+ Purchases ($200,000)
= Goods available = $235,000.
- End. Inv. $85,000
=CoGS $150,000

With $30,000 of inventory still accounted for, the amount of lost inventory at cost is $55,000 ($85,000 - $30,000).

265

When marking up a specific line of household items for resale, a retailer computes its markup as 40% of cost. For purposes of estimating ending inventory using the gross margin method, what percentage is applied to sales when estimating cost of goods sold?
A. 40
B. 71
C. 60
D. 29

B. 71
The gross margin method applies the cost to sales ratio to sales in order to derive an estimate of cost of goods sold. Subtracting the resulting estimate of cost of goods sold from the cost of goods available for sale yields an estimate of ending inventory without counting the items. This firm determines the selling price to be 140% of cost because the markup is 40% of cost. Cost plus markup yields selling price. Therefore, the cost to sales ratio is 1.00/1.40 or .71.

266

The following two inventory items were purchased as a group in a liquidation sale for $1,000.
Replacement Carrying Value
Item Cost On Seller's Books
A $400 $390
B 700 755
The firm purchasing the inventory records item A at what amount?

A. $341
B. $390
C. $364
D. $500

C. $364
When items are purchased as a group, the total cost of the group is allocated to the individual items based on fair value. Replacement cost is the appropriate value to use in this case. The total replacement cost of the items is $1,100 ($400 + $700). Therefore, Item A is allocated 4/11 of the purchase cost, or $364 = ($400/$1,100)$1,000.

267

How does the retail inventory method establish the lower-of-cost-or-market valuation for ending inventory?
A. The procedure is applied on a cost basis at the unit level.
B. By excluding net markups from the cost-to-retail ratio.
C. By excluding beginning inventory from the cost-to-retail ratio.
D. By excluding net markdowns from the cost-to-retail ratio.

D. By excluding net markdowns from the cost-to-retail ratio.

268

The retail inventory method includes which of the following in the calculation of both cost and retail amounts of goods available for sale?
A. Purchase returns.
B. Sales returns.
C. Net markups.
D. Freight in.

A. Purchase returns.

269

Union Corp. uses the first-in, first-out retail method of inventory valuation. The following information is available:
Cost Retail
Beginning inventory $12,000 $ 30,000
Purchases 60,000 110,000
Net additional markups 10,000
Net markdowns 20,000
Sales revenue 90,000
If the lower of cost or market rule is disregarded, what would be the estimated cost of the ending inventory?

A. $24,000
B. $20,800
C. $20,000
D. $19,200

A. $24,000

The cost to retail ratio under FIFO is: [$60,000/($110,000 + $10,000 - $20,000)] = .60.
Ending inventory at retail is $30,000 + $110,000 + $10,000 - $20,000 - $90,000 = $40,000.
Ending inventory at cost, therefore, is .60($40,000) = $24,000.
B. $20,800
C. $20,000
The $20,000 incorrect answer is derived by excluding net markdowns from the cost to retail computation. Such a procedure results in LCM, which violates the conditions of the problem.
The correct answer is $24,000:
The cost to retail ratio under FIFO is: [$60,000/($110,000 + $10,000 - $20,000)] = .60.
Ending inventory at retail is $30,000 + $110,000 + $10,000 - $20,000 - $90,000 = $40,000.
Ending inventory at cost, therefore, is .60($40,000) = $24,000.

270

Choose the correct inclusions to the cost-to-retail ratio computation under the dollar-value LIFO retail method.
Beginning Inventory Net Markdowns
Yes Yes
The LIFO retail method uses the FIFO cost-to-retail ratio because layers added under LIFO must reflect only the purchases during the period. The beginning inventory reflects costs and prices not relevant to the current period.
Yes No
No Yes
No No

Beginning Inventory Net Markdowns
No Yes
DV LIFO retail uses the FIFO (not LCM) cost-to-retail ratio. Under LIFO, a layer added during a period should reflect only the cost and retail amounts pertaining to that period. Thus, beginning inventory amounts are not used in calculating the ratio. Also, because LIFO may contain inventory layers for several preceding periods, excluding net markdowns is not an effective way to accomplish the LCM valuation objective. Thus, net markdowns are included in the cost to retail computation.

271

nformation for a firm using the dollar value (DV) LIFO retail method follows. The cost to retail (C/R) is provided along with price level indices. The data reflects the use of the method through year one.
Retail Retail DV LIFO
Layer Base Index Current C/R Cost
Base $200 1.00 $200 .40 $80
year one 80 1.10 $88 .34 $30
For year two, ending inventory at retail (by count) totaled $310. The ending price-level index for the year was 1.15. The cost-to-retail ratio was .42. What is the ending inventory for financial reporting purposes for this firm?

A. $121
B. $108
C. $106
D. $130

C. $106
When ending retail inventory at base is less than the beginning-of-the-year amount, a layer has been reduced or liquidated. The most recent layer added is used first. The reduction in retail at base is converted to the retail amount at the prices in effect when that layer was added. The reduction in retail at that historical price level index is converted to cost using the cost-to-retail ratio in effect when that layer was added. The result is the reduction in DV LIFO retail, at cost. The computations are:
Ending inventory, retail, at base = $310(1.00/1.15) = $270

Decrease in retail, at base = ($200 + $80)-$270 = $10

Reduction in year one layer at retail = $10(1.10/1.00) = $11

Decrease in cost = $11(.34) = $4

Ending inventory at cost = ($80 + $30)-$4 = $106

272

Information for a firm using the dollar value (DV) LIFO retail method follows. The cost to retail (C/R) is provided along with price level indices. The data reflects the use of the method through year one.
Retail Retail DV LIFO
Layer Base Index Current C/R Cost
Base $200 1.00 $200 .40 $80
year one 80 1.10 88 .34 $30
For year two, ending inventory at retail (by count) totaled $450. The ending price-level index for the year was 1.15. The cost-to-retail ratio was .42. What is the ending inventory for financial reporting purposes for this firm?

A. $164
B. $54
C. $189
D. $177

A. $164
The DV LIFO retail process applies the DV LIFO method to retail dollars, and then deflates the retail layer added, now reflecting current prices, to cost, using the cost-to-retail ratio. The calculations are:
Ending inventory, retail, at base = $450(1.00/1.15) = $391
Increase in retail, current = $111(1.15/1.00) = $128
Increase in cost = $128(.42) = $54
Ending inventory at cost = ($80 + $30) + $54 = $164

Use ending price index for increase in retail, but use index given in retail base table (beginning price index) for decrease in retail.

273

A firm uses the dollar value LIFO retail method and has $2,000 in beginning inventory at retail at the beginning of the current year. The base year equivalent of this amount is $1,600. The base year index is 1.00. The beginning inventory reported in the Balance Sheet is $800. During the current year, the firm purchased $12,000 of inventory at cost and marked that up to $40,000. Sales for the year were $28,000. The relevant ending price index is 1.60. What amount does this firm report as inventory in its Balance Sheet at the end of the current year?
A. $4,286
B. $13,440
C. $4,232
D. $4,200

This is a two-step process. First, DV LIFO is applied to retail dollars to determine the layer added in current-year retail dollars. Then, the FIFO cost-to-retail ratio (C/R) is applied to convert that layer to cost. Finally, this layer is added to beginning inventory at cost to yield ending inventory at cost. The calculation is:
EI retail, current index = $2,000 + $40,000-$28,000 = $14,000

EI retail, base = $14,000/1.6 = $8,750
Increase in EI retail, base = $8,750-$1,600 = $7,150

Increase in EI retail, current = $7,150(1.6) = $11,440
C/R (use FIFO, not LCM) = $12,000/$40,000 = .30

Increase in EI, cost = .30($11,440) = $3,432
EI, cost = $800 + $3,432= $4,232

274

When an inventory overstatement in year one counterbalances in year two, this means:

A. There are no reporting errors, even if the overstatement is never discovered.
B. A prior period adjustment is recorded if the error is discovered in year three.
C. The year one Balance Sheet does not need to be restated if the error is discovered in year three.
D. A prior period adjustment is recorded if the error is discovered in year two.

D. A prior period adjustment is recorded if the error is discovered in year two.

275

If ending inventory for 20x5 is understated because certain items were missed in the count, then:

A. Net income for 20x5 will be overstated.
B. CGS for 20x5 will be understated.
C. Net income for 20x5 will be understated, but net income for 20x6 will be unaffected.
D. Net income for 20x5 will be understated and CGS for 20x6 will be understated.

D. Net income for 20x5 will be understated and CGS for 20x6 will be understated.

276

A retailer failed to record a purchase of inventory on credit near the end of the current year. The goods did arrive and were included in the inventory count. The purchase will be recorded next year, when the goods are paid for. As a result,

A. Cost of goods sold is understated for the current year.
B. Net income for next year is overstated.
C. Income tax expense for the next year is overstated.
D. By the end of next year, all of the effects of the error will be automatically eliminated.

A. Cost of goods sold is understated for the current year.
The error affects purchases but not ending inventory. Therefore, cost of goods sold for the current period is understated because goods available is understated. When ending inventory (which is not in error) is subtracted from goods available, cost of goods sold is understated by the amount of the understatement in purchases.

When purchases are understated, CoGS is understated.

277

On January 2 of the current year, LTTI Co. entered into a three-year, non-cancelable contract to buy up to 1 million units of a product each year at $.10 per unit with a minimum annual guarantee purchase of 200,000 units. At year end, LTTI had only purchased 80,000 units and decided to cancel sales of the product. What amount should LTTI report as a loss related to the purchase commitment as of December 31 of the current year?
A. $0
B. $ 8,000
C. $12,000
D. $52,000

D. $52,000
This amount represents the amount of the minimum guaranteed amount ($60,000 {200,000 units a year x 3 years x $.10}) less what was already purchased ($8,000 {80,000 units x $.10}) = $52,000.

278

At the end of 20x4, a firm recognized a loss on a contractual commitment to purchase inventory for $60,000. The value of the inventory at the end of 20x4 is $52,000. When the inventory was actually purchased in 20x5, its value had risen to $62,000. Choose the correct statement concerning reporting in 20x5.

A. A $10,000 gain is recognized.
B. The inventory is recorded at $60,000.
C. The inventory is recorded at $52,000.
D. There is no additional loss or gain recognized.

B. The inventory is recorded at $60,000.
The maximum recorded value of the inventory is $60,000, which is the contractual amount and, also, the cost. If the firm can sell the inventory for more than $60,000, then gross margin will be recognized. The value of the inventory more than fully recovered, but gains are limited to the amount of previously recognized losses, which in this case, is $8,000.

279

In October of year one, a firm committed to a purchase of inventory at a total cost of $26,000. The contract is irrevocable and specifies a delivery date in March of year two. At the end of year one, the market value of the inventory under contract is worth $23,000 at current cost. Choose the correct reporting for the year one financial statements:

A. A liability of $3,000 is reported in the Balance Sheet.
B. An extraordinary loss of $3,000 is reported in the Income Statement.
C. The potential loss on contract is reported in the footnotes, but there is no recognition in the financial statements.
D. No reporting is required.

A. A liability of $3,000 is reported in the Balance Sheet.

280

A company determined the following values for its inventory as of the end of its fiscal year:
Historical cost $100,000
Current replacement cost 70,000
Net realizable value 90,000
Net realizable value less normal profit margin 85,000
Fair value 95,000
Under IFRS, what amount should the company report as inventory on its Balance Sheet?

A. $70,000
B. $85,000
C. $90,000
D. $95,000

C. $90,000
Since historical cost is greater than any of the other values, the question is to what value should the inventory be marked down? This answer is correct because it is the net realizable value and the IFRS requires the lower of cost or net realizable value.

GAAP: lower of cost and market (middle of RC, NRV and NRV - NP)
IFRS: lover of cost and NRV

281

A company manufactures and distributes replacement parts for various industries. As of December 31, year 1, the following amounts pertain to the company's inventory:
Item Cost Net
replacement
cost Sale price Cost to
sell or
dispose Normal
profit
margin
Blades $41,000 $ 38,000 $ 50,000 $ 2,000 $15,000
Towers 52,000 40,000 54,000 4,000 14,000
Generators 20,000 24,000 30,000 2,000 6,000
Gearboxes 80,000 105,000 120,000 12,000 8,000
What is the total carrying value of the company's inventory as of December 31, year 1, under IFRS?

A. $178,000
B. $191,000
Inventory under IFRS is reported at the lower of cost or net realizable value (NRV) where NRV is the selling price less the cost to complete or dispose. The table below calculates the NRV for each inventory item.
NRV Cost Lower of Cost
or NRV
Blades 50,000 - 2,000 = 48,000 41,000 41,000
Towers 54,000 - 4,000 = 50,000 52,000 50,000
Generators 30,000 - 2,000 = 28,000 20,000 20,000
Gearboxes 120,000 - 12,000 = 108,000 80,000 80,000
Total 191,000
C. $193,000
D. $207,000

B. $191,000
Inventory under IFRS is reported at the lower of cost or net realizable value (NRV) where NRV is the selling price less the cost to complete or dispose. The table below calculates the NRV for each inventory item.
NRV Cost LCNRV
Blades 50,000 - 2,000 = 48,000 41,000 41,000
Towers 54,000 - 4,000 = 50,000 52,000 50,000
Generators 30,000 - 2,000 = 28,000 20,000 20,000
Gearboxes 120,000 - 12,000 = 108,000 80,000 80,000
Total 191,000

282

Under IFRS the test for asset impairment is to compare the carrying value of the asset to its recoverable amount. Which of the following is the recoverable amount according to IFRS?
A. The greater of future undiscounted cash flows or future discounted cash flows.
B. The greater of future discounted cash flows or fair value.
C. The greater of fair value less cost to sell or value in use.
D. The greater of fair value or value in use.

C. The greater of fair value less cost to sell or value in use.

283

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. Under IFRS what amount of impairment loss should be reported?

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

C. $15,000
This response is the difference between carrying value and recoverable amount. According to IFRS the recoverable amount is the greater of fair value less cost to sell ($105,000) or value in use ($100,000). Value in use is the discounted cash flows. Therefore, this asset is has an impairment of $15,000 because the recoverable amount is $105,000 and the carrying value is $120,000.

284

A manufacturing firm purchased used equipment for $135,000. The original owners estimated that the residual value of the equipment was $10,000. The carrying amount of the equipment was $120,000 when ownership transferred. The new owners estimate that the expected remaining useful life of the equipment was 10 years, with a salvage value of $15,000. What amount represents the depreciable base used by the new owners?

A. $105,000
B. $110,000
C. $120,000
D. $125,000

C. $120,000
The purchase price of the asset acquired less its salvage value is the asset's depreciable cost. In this case, total depreciation on the asset is limited to $120,000 ($135,000 purchase price-$15,000 salvage value). The cost to the seller and the previous salvage value are not relevant to the new owner.

Depreciable base for new owner is purchase price - current salvage value.

285

Restorations of carrying value for long-lived assets are permitted if an 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
No Yes
If an asset is held for disposal, previous losses can be recovered. The logic is that the recovery will be realized in the near future if the asset is in the process of being disposed. In contrast, an asset held for use CANNOT recover previous impairment because there is no certainty regarding the ultimate realization of those losses.

286

A state government condemned Cory Co.'s parcel of real estate. Cory will receive $750,000 for this property, which has a carrying amount of $575,000. Cory incurred the following costs as a result of the condemnation:

Appraisal fees to support a $750,000 value $2,500
Attorney fees for the closing with the state 3,500
Attorney fees to review contract to acquire replacement property 3,000
Title insurance on replacement property 4,000
What amount of cost should Cory use to determine the gain on the condemnation?

A. $581,000
B. $582,000
C. $584,000
D. $588,000

A. $581,000
The total value to be compared to the amount received from the government in computing the gain:

Carrying amount $575,000
Plus appraisal fees to support a $750,000 value 2,500
Plus attorney fees for the closing with the state 3,500
Equals total cost to compare to $750,000 received from state $581,000
The second and third items in the above list essentially reduce the net proceeds from the state and thus decrease the gain. The $3,000 and $4,000 amounts pertaining to the replacement property are not associated with the existing property and do not affect the gain on its condemnation.

287

A firm began a mineral exploitation venture during the current year by spending (1) $40 million for the mineral rights; (2) $100 million exploring for the minerals, one-fourth of which were successful; and (3) $60 million to develop the site. Management estimated that 20 million tons of ore would ultimately be removed from the property. Wages and other extraction costs for the current year amounted to $10 million. In total, 2 million tons of ore were removed from the deposit in the current year. The entire production for the period was sold. Compute cost of goods sold under the successful efforts method.

A. $30 million
B. $12.5 million
C. $10 million
D. $22.5 million

D. $22.5 million
The depletion rate = [$40 + (.25)($100) + $60]/20 = $6.25/ton. Depletion = 2,000,000($6.25/ton) = $12,500,000. Because all the ore removed was sold, cost of goods sold includes the entire amount of depletion and the extraction costs. Cost of goods sold = $12,500,000 +$10,000,000 = $22,500,000. Note, that extraction costs is included in inventory (and therefore, cost of goods sold), but not in the deposit (and therefore, not in depletion).

288

A company has a parcel of land to be used for a future production facility. The company applies the revaluation model under IFRS to this class of assets. In year 1, the company acquired the land for $100,000. At the end of year 1, the carrying amount was reduced to $90,000, which represented the fair value at that date. At the end of year 2, the land was revalued, and the fair value increased to $105,000. How should the company account for the year 2 change in fair value?
A. By recognizing $10,000 in other comprehensive income.
B. By recognizing $15,000 in other comprehensive income.
C. By recognizing $15,000 in profit or loss.
D. By recognizing $10,000 in profit or loss and $5,000 in other comprehensive income.

D. By recognizing $10,000 in profit or loss and $5,000 in other comprehensive income.
Under IFRS an increase in an assets fair value above original cost are recorded in a revaluation surplus account and any decreases in an assets fair value below the original cost are recorded as losses to the income statement. Therefore, the 10,000 decrease in year 1 would have been recorded as a loss to the income statement and the 15,000 increase in year 2 would be recorded as a 10,000 gain to the income statement and 5,000 gain in revaluation surplus (OCI).

289

On April 1, 2004, Kew Co. purchased new machinery for $300,000. The machinery has an estimated useful life of five years, and depreciation is computed by the sum-of-the-years'-digits method.
The accumulated depreciation on this machinery at March 31, 2006 should be:

A. $192,000
B. $180,000
C. $120,000
D. $100,000

B. $180,000
$180,000, the correct answer, equals $300,000[(5 + 4)/(5 + 4 + 3 + 2 + 1)].

290

Two approaches are available for applying interest rates to average accumulated expenditures for the purpose of capitalizing interest. These approaches are called the specific method and the weighted average method. In some cases, these approaches yield the same results. Two situations may be encountered in practice for a specific period:
(1) average accumulated expenditures exceed total interest bearing debt (principal) and

(2) the interest rates on all interest bearing debt instruments are the same.

Which situation yields the same results for the two approaches?

A. only (1).
B. only (2).
C. both (1) and (2).
D. neither (1) nor (2).

C. both (1) and (2).
When average accumulated expenditures exceeds interest bearing debt, all interest for the period is capitalized because all debt could have been avoided if the construction had not taken place. Also, if the interest rates on all debt are the same, then the two approaches yield the same results because, ultimately, only one interest rate is applied to average accumulated expenditures for computing capitalized interest.

291

On June 18, 2005, Dell Printing Co. incurred the following costs for one of its printing presses:
Purchase of collating and stapling attachment $84,000
Installation of attachment 36,000
Replacement parts for overhaul of press 26,000
Labor and overhead in connection with overhaul 14,000

The overhaul resulted in a significant increase in production. Neither the attachment nor the overhaul increased the estimated useful life of the press. What amount of the above costs should be capitalized?

A. $0
B. $84,000
C. $120,000
D. $160,000

D. $160,000
All four costs should be capitalized because they result in an increase in the productivity of the asset. Costs that increase EITHER the life OR productivity are capitalized. Either type of increase results in enhanced asset values. $160,000 is the sum of the four costs listed.

292

A firm began the construction of its new manufacturing facility in January of 20x2. The following expenditures were made on construction in that year:
Jan. 1 $40,000
Mar. 1 120,000
Oct. 31 96,000
Debt outstanding the entire year:

6%, $60,000 construction loan
4%, $90,000 note payable not related to construction
6%, $90,000 note payable not related to construction
Compute interest to be capitalized using the specific method (use the construction loan first).

A. $7,000
B. $12,600
C. $8,400
D. $8,190

C. $8,400
Average accumulated expenditures is $156,000 = $40,000 + $120,000(10/12) + $96,000(2/12). This method uses the specific construction loan first, and then the remaining debt is applied. The nonspecific loans have the same principal balance. Therefore, the weighted average interest rate on those two loans is 5% (the midpoint between 4% and 6%).

Capitalized interest = .06($60,000) + .05($156,000-$60,000) = $3,600 + $4,800 = $8,400.

The weighted average rate on the two nonspecific loans can also be computed as: [.04($90,000) + .06($90,000)]/($90,000 + $90,000)] = 5%.

293

Plant assets are occasionally acquired by means other than by paying cash. Choose the correct statement about such acquisitions.
A. If equipment is acquired with 100% debt financing, the equipment is capitalized at the sum of all interest and principal payments on the debt.
When debt is incurred to purchase a plant asset, only the principal value of the debt (its present value) is capitalized. The interest subsequently paid is not considered part of the cost of the equipment because it does not contribute to the asset's value in use.
B. If a building is acquired by issuing an amount of stock that is significant in relation to the amount of stock outstanding before the exchange, the fair value of the building should be used to initially debit the building account.
C. If land is received by a firm as a donation, no amount should be recorded for the land because there is no cost to the firm.
D. If land is acquired as one component of a group of plant assets for a discounted aggregate price, the amount capitalized for the land is its market value.

B. If a building is acquired by issuing an amount of stock that is significant in relation to the amount of stock outstanding before the exchange, the fair value of the building should be used to initially debit the building account.
The more objective or readily determinable value is used for recording the building. If the number of shares is significant in relation to the total shares outstanding, the stock price will be affected by the increase in the shares outstanding resulting from the purchase. The more objective value is the appraised value of the building.

294

Which of the following is a required footnote disclosure on property, plant, and equipment?
A. Range of useful lives of plant assets.
B. Depreciation methods of plant assets.
The depreciation methods used for plant assets are a required disclosure. However, the other responses are also correct. Therefore, you must keep reading the responses to determine the best answer to the question. Read through select disclosures of the financial statements of real companies-this will help reinforce the disclosure requirements and jog your memory because you will remember reading about the disclosure.
C. Accumulated depreciation related to plant assets.
D. All of the above.

D. All of the above.
All items listed are required disclosures: useful life, depreciation methods, and the accumulated depreciation of plant asset. Read through select disclosures of the financial statements of real companies-this will help reinforce the disclosure requirements and jog your memory because you will remember reading about the disclosure.

295

During 2004, Burr Co. had the following transactions pertaining to its new office building:
Purchase price of land $ 60,000
Legal fees for contracts to purchase land 2,000
Architects' fees 8,000
Demolition of old building on site 5,000
Sale of scrap from old building 3,000
Construction cost of new building (fully completed) 350,000
In Burr's December 31, 2004 Balance Sheet, what amounts should be reported as the cost of land and cost of building?

Land Building
$60,000 $360,000
$62,000 $360,000
$64,000 $358,000
$65,000 $362,000

$64,000 $358,000
Land Building
Purchase price of land $ 60,000
Legal fees for contracts to purchase land 2,000
Architects' fees 8,000
Demolition of old building on site 5,000
Sale of scrap from old building (3,000)
Construction cost of new building (fully completed) 350,000
Total cost reported $ 64,000 $358,000