Midterm Practice Problems

Question 1

For companies that use FIFO, average cost, or any other method other an LIFO or retain inventory method, inventory is valued at:

a. replacement cost
b. net realizable value
c. cost
d. the lower of cost or net realizable value

Answer 1

d. the lower of cost or net realizable value

Question 2

For purposes of accounting for inventory, net realizable value is defined as:

a. estimated selling price less expected returns by customers.
b. estimated selling price less any costs of completion, disposal and transportation.
c. estimated selling price.
d. estimated cost to replace the inventory.

Answer 2

b. estimated selling price less any costs of completion, disposal and transportation.

Question 3

The following information pertains to one item of inventory of the Simon Company:

(Per Unit)
Cost:
180
Replacement cost:
150
Selling price:
195
Costs to sell:
35

Applying the lower of cost or net realizable value rule, this item should be valued at:

a. 150
b. 180
c. 160
d. 195

Answer 3

c. 160

NRV of $160 ($195 − 35) is lower than cost of $180.

Question 4

Consider the following information pertaining to a company’s inventory:

Product Quantity Cost NRV
Rev 16 120 150
Spurs 23 27 22
Hats 12 56 40

Applying the lower of cost or net realizable value rule to individual inventory items, at what amount should the company report its inventory?

a. 3,213
b. 3,386
c. 2,996
d. 2,906

Answer 4

d. 2,906

(16 × $120) + (23 × $22) + (12 × $40) = $2,906.

Question 5

A company has four types of products in its inventory. The company applies the rules under lower of cost and net realizable value to its inventory at the end of the year as shown below:

Product Quantity Cost NRV
A 15 7 8
B 10 15 14
C 20 8 6
D 15 11 10

The year end adjustment based upon the information above would include a:

a. debit to COGS $65
b. credit to inventory $50
c. debit to inventory $65
d. debit to COGS $50

Answer 5

a. debit to COGS $65

Product B = ($15 − $14) × 10 = $10.
Product C = ($8 − $6) × 20 = $40.
Product D = ($11 − $10) ×15 = $15.
Total adjustment to cost of goods sold = $10 + $40 + $15 = $65.

Question 6

At the end of a reporting period, a company determines that its ending inventory has a net realizable value below cost. What would be the effect(s) of the adjusting entry to record inventory at net realizable value?

a. decrease total assets
b. increase total expenses
c. decrease retained earnings
d. all the other answers are correct

Answer 6

d. all the other answers are correct

The entry to write down inventory to net realizable value includes a debit to cost of goods sold and a credit to inventory. The debit to cost of goods sold increases total expenses and therefore decreases retained earnings. The credit to inventory decreases total assets.

Question 7

The following information pertains to one item of inventory of the Simon Company:

(Per Unit)
Cost
180
Replacement cost
150
Selling price
195
Costs to sell
35

What should be the book value of Simon’s inventory if the company prepares its financial statements according to International Financial Reporting Standards?

a. 150
b. 180
c. 160
d. 195

Answer 7

c. 160

Under IFRS, inventory is reported using the lower of cost or net realizable value. NRV of $160 ($195 − $35) is lower than cost of $180.

Question 8

When reporting inventory using the lower of cost or market method, market should not be less than:

a. replacement cost
b. net realizable value
c. selling price
d. net realizable value less a normal profit margin

Answer 8

d. net realizable value less a normal profit margin

Market is the inventory’s current replacement cost (by purchase or reproduction) except that market should not be less than net realizable value reduced by an allowance for an approximately normal profit margin (this forms a “floor” on market).

Question 9

When reporting inventory using the lower of cost or market method, market should not be more than:

a. replacement cost
b. net realizable value
c. selling price
d. net realizable value less a normal profit margin

Answer 9

b. net realizable value

Market is the inventory’s current replacement cost (by purchase or reproduction) except that market should not be more than net realizable value (this forms a “ceiling” on market).

Question 10

The following information pertains to one item of inventory of the Simon Company:

(Per Unit)
Cost
200
Replacement cost
170
Selling price
190
Disposal costs
10
Normal profit margin
30

Using the lower of cost or market method, this item should be valued at:

a. 150
b. 200
c. 170
d. 190

Answer 10

c. 170

Market = replacement cost ($170), which is below the ceiling ($190 − $10 = $180) and above the floor ($190 − $10 − $30 = $150).

Question 11

Fickle Company purchased a machine at a total cost of $220,000 (no residual value) at the beginning of 2018. The machine was being depreciated over a 10 year life using the sum of the years digits method. At the beginning of 2021, it was decided to change to straight line. Ignoring taxes, the 2021 adjusting entry will include a debit to depreciation expense of:

a. 11,000
b. 16,000
c. 22,000
d. 38,000

Answer 11

b. 16,000

Sum-of the years’ digits depreciation was $108,000 {$220,000 × [(10 + 9 + 8) / 55]}. Thus, the undepreciated value at the beginning of 2021 is $112,000 ($220,000 − $108,000), which will be depreciated over seven years.

Question 12

Which of the following is not usually accounted for retrospectively?

a. change in the composition of firms reporting on a consolidated basis.
b. change from LIFO to FIFO.
c. change from expensing extraordinary repairs to capitalizing the expenditures.
d. change from FIFO to LIFO.

Answer 12

d. change from FIFO to LIFO.

With a change to LIFO, companies may not have the necessary information related to the cost of inventory to retrospectively adjust retained earnings.

Question 13

Which of the following is accounted for prospectively?

a. changes from average to FIFO
b. change in reporting entity
c. correction of an error
d. change in the percentage used to determine warranty expense

Answer 13

d. change in the percentage used to determine warranty expense

The new warranty percentage is applied to the current year reported amount and future years. The new percentage is not applied to previous years.

Question 14

Early in 2021, Brandon Transport discovered that five year insurance premium payment of $250,000, at the beginning of 2018 was debited to insurance expense. The correcting entry would include:

a. a debit to prepaid insurance of $250,000
b. a debit to insurance expense of $100,000
c. a debit to prepaid insurance of $150,000
d. a credit to retained earnings of $100,000

Answer 14

d. a credit to retained earnings of $100,000

The correcting entry would debit prepaid insurance for $100,000 and a credit to retained earnings for $100,000 since there are two years remaining on the insurance policy.

Question 15

Which of the following is not a change in accounting principle usually accounted for by retrospectively revising prior financial statements?

a. change from SYD and DDB
b. change from FIFO to the average method
c. change from the average method to FIFO
d. change from LIFO to FIFO

Answer 15

a. change from SYD and DDB

changes in depreciation methods are treated as changes in estimates and accounted for prospectively.

Question 16

The prospective approach usually is required for:

a. a change in estimate
b. a change in reporting entity
c. a change in accounting principle
d. a correction of an error

Answer 16

a. a change in estimate

With a change in estimate, the current amounts are used to apply the new estimate this year and future years. The new estimate is not applied to previous periods.

Question 17

Lamont Company has amortized a patent on a straight line basis since it was acquired in 2018 at a cost of $50 million. During 2021 management decided that the benefits from the patent would be received over a total period of 8 years rather than the 20 year legal life being used to amortize the cost. Lamont’s 2021 financial statements should include:

a. a patent balance of $50 million
b. patent amortization expense of $2.5 million
c. patent amortization expense of $5 million
d. a patent balance of $34 million

Answer 17

d. a patent balance of $34 million

Accumulated amortization at the end of 2018 is $16 million, comprised of 3 year’s amortization at $2.5 million per year ($50 / 20 years) plus one year’s amortization at $8.5 million [($50 − $7.5) / (8 − 3) years].

Question 18

Which of the following is not true regarding the correction of an error?

a. A journal entry is made to correct any account balances that are incorrect as a result of the error.
b. the correction is reported prospectively, previous financial statements are not revised.
c. prior years financial statements are restated to reflect the correction of the error (if the error affected those statements).
d. a disclosure note should describe the nature of the error and the impact of its correction on net income, income before extraordinary items, and earnings per share.

Answer 18

b. the correction is reported prospectively, previous financial statements are not revised.

The effect of the error is reported as an adjustment to beginning-of-period retained earnings and prior years’ financial statements are restated.

Question 19

In 2021, it was discovered that Brandon Irons Metal works had debited expense for the full cost of an Asset purchased on January 1, 2018. The cost was $12 million with no expected residual value. Its useful life was 5 years and straight line depreciation is used by the company. The correcting entry assuming the error was discovered in 2021 before the adjusting entries and closing entries includes:

a. a credit to accumulated depreciation of $7.2 million
b. a debit to accumulated depreciation of $4.8 million
c. a credit to an asset of $12 million
d. a debit to retained earnings of $4.8 million

Answer 19

a. a credit to accumulated depreciation of $7.2 million

Accumulated depreciation would be credited for three year’s depreciation (2012 to 2014) at $2.4 million per year. Depreciation for 2018 will be accounted for normally. In addition, an asset account would be debited for $12 million and retained earnings would be credited for $4.8 million.

Question 20

The price of a corporate bond is the present value of its face amount at the market or effective rate of interest:

a. plus the present value of all future interest payments at the market or effective rate of interest. a
b. plus the present value of all future interest payments at the stated rate of interest.
c. reduced by the present value of all future interest payments at the market or effective rate of interest.
d. reduced by the present value of all future interest payments at the stated rate of interest.

Answer 20

a. plus the present value of all future interest payments at the market or effective rate of interest.

The price of a bond is equal to the present value of all future cash outflows, principal and interest, using the market or effective rate.

Question 21

On June 30, 2021 Marby Corporation issued $5 million of its 8% bonds for $4.6 million. The bonds were priced to yield 10%. The bonds are dated June 30, 2021. Interest is payable semiannually on December 31 and July 1. If the effective interest method is used, by how much should the bond discount be reduced for the 6 months ended December 31, 2021?

a. $16,000
b. $20,000
c. $23,000
d. $30,000

Answer 21

d. $30,000

$30,000: Under the effective interest method, the interest expense is computed as the beginning book value of the debt times the yield interest rate. The difference between the interest expense and the interest payment represents the amortization of the discount. Here, the interest expense is $230,000 ($4,600,000 × 0.10 × 6/12) and the interest payment is $200,000 ($5,000,000 × 0.08 × 6/12).

Question 22

A discount on bonds payable should be reported in the balance sheet:

a. at the present value of the future addition to the bond interest expense due to the discount
b. as a reduction in bond issue costs
c. as a reduction of the face amount of the bond
d. as a deferred credit

Answer 22

c. as a reduction of the face amount of the bond

A discount on bonds is a contra liability account and therefore deducted from the face amount when presented on the balance sheet.

Question 23

On January 1, 2021, Blair Company sold $800,000 of 10% ten year bonds. Interest is payable semiannually on June 30 and December 31. The bonds were sold for $708,000, priced to yield 12%. Blair records interest at the effective rate. Blair should report interest expense for the six months ended June 30, 2021 in the amount of:

a. $35,400
b. $40,000
c. $42,480
d. $48,000

Answer 23

c. $42,480

Under the effective interest method, the interest expense is computed as the beginning book value of the debt times the yield interest rate. ($708,000 × 0.12 × 6/12).

Question 24

In a bond amortization table for bonds issued at a discount:

a. the effective interest expense is less with each successive interest payment
b. the total effective interest over the term to maturity is equal to the amount of the discount plus the total cash interest paid
c. the outstanding (book value) of the bonds declines eventually to face value.
d. the reduction in the discount is less with each successive interest payment

Answer 24

b. the total effective interest over the term to maturity is equal to the amount of the discount plus the total cash interest paid

Total interest expense for bonds issued at a discount is equal to the total interest payments over the life of the bonds plus the initial discount when the bonds are sold.

Question 25

When bonds are issued at a discount and interest expense is recorded at the effective interest rate, interest expense in the earlier years of the term to maturity will be: a. less than the cash payments made b. less than if the straight line method were used c. greater than if the straight line method were used d. the same as if the straight line method were used

Answer 25

b. less than if the straight line method were used Under the effective interest method, the interest expense is computed by multiplying the market rate times the beginning-of-period book value. As the discount is amortized, the book value increases, causing the interest expense to increase over time. Since the total interest expense is the same regardless of the method used, the interest expense will be less than straight-line in the earlier years (and higher in later years).

Question 26

Douglas Roberts has bonds outstanding during a year in which the market rate of interest has rise. He has elected the fair value option for the bonds. What will the company report for the bonds in its statement of comprehensive income for the year? a. interest expense and a gain b. interest expense and a loss c. no interest expense and a gain d. no interest expense and a loss

Answer 26

a. interest expense and a gain If interest rates increase, the fair value of liabilities decrease creating a gain. Interest expense and a gain. Any portion of the change in fair value attributable to a change in general interest rates is reported in net income; any portion due to a change in credit risk is reports as OCI. Either way, net income or OCI, it increases total comprehensive income.

Question 27

Brubaker Company issued 11% bonds, dated January 1, with a face amount of $400,000 on January 1, 2021. The bonds sold for $369,908 and mature in 2041 (20 years). For bonds of similar risk and maturity the market yield was 12%. Interest is paid semiannually on June 30 and December 31. Brubaker determines interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2021, the fair value of the bonds was $365,000 as determined by their market value on the NYSE. Brubaker’s statement of comprehensive income for the year will include: a. A gain from change in the fair value of debt of $5,309. b. A loss from change in the fair value of debt of $5,309. c. A gain from change in the fair value of debt of $5,102. d. A loss from change in the fair value of debt of $5,102.

Answer 27

a. A gain from change in the fair value of debt of $5,309. This is the difference between the fair value and the book value at Dec. 31, where the book value is the $369,908 increased by the discount amortization on June 30 and Dec. 31. Any portion of the change in fair value attributable to a change in general interest rates is reported in net income; any portion due to a change in credit risk is reports as OCI. Either way, net income or OCI, it increases total comprehensive income.

Question 28

On March 1, 2021, Big Brands Corporation issued $600,000 of 10% bonds at 105. Each $1,000 bond was sold with 50 detachable stock warrants, each permitting the investor to purchase one share of common stock for $35. On that date, the market value of the common stock was $30 per share and the market value of each warrant was $4. Big Brands should record what amount of the proceeds from the bond issue as an increase in liabilities? a. $510,000 b. $600,000 c. $630,000 d. $0

Answer 28

a. $510,000 Big Brands received $630,000 from the issue of the 600 bonds and 30,000 warrants (600 bonds × 50 warrants per bond). The total market value of the warrants is $120,000 (30,000 warrants × $4). Thus the remaining $510,000 of the proceeds is allocated to the bonds.

Question 29

On June 30, 2021, Kerr Industries had outstanding $40 million of 8%, convertible bonds that mature on June 30, 2022. Interest is payable each year on June 30 and December 31. The bonds are convertible into 2 million shares of $10 par common stock. At June 30, 2021, the unamortized balance in the discount on bonds payable account was $2 million. On June 30, 2021, half the bonds were converted when Kerr's common stock had a market price of $25 per share. When recording the conversion using the book value method, Kerr should credit paid-in capital—excess of par: a. $8 million b. $9 million c. $11 million d. $12 million

Answer 29

b. $9 million The book value of the bonds converted is $19 million. This is the book value of the 1 million common shares issued. Par value is $10 million, leaving $9 million for paid-in capital—excess of par.

Question 30

During 2021 Belair Company was encountering financial difficulties and seemed likely to default on a $600,000, 10%, four-year note dated January 1, 2019, payable to Second Bank. Interest was last paid on December 31, 2020. On December 31, 2021, Second Bank accepted $500,000 in settlement of the note. Ignoring income taxes, what amount should Belair report as a gain from the debt restructuring in its 2021 income statement? a. $40,000 b. $100,000 c. $160,000 c. $0

Answer 30

c. $160,000 Belair owed a total of $660,000 ($600,000 principal and $60,000 in accrued, but unpaid interest). This debt was settled for $500,000, yielding a $160,000 gain.

Question 31

On January 1, 2021, Ventrini International issued $10 million of 9%, 10-year convertible bonds at 101. The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into 40 shares of Ventrini’s no par common stock. Bonds that are similar in all respects, except that they are nonconvertible, currently are selling at 99. Ventrini applies International Financial Reporting Standards. Upon issuance, Ventrini should a. credit bonds payable $9,900,000. b. credit premium on bonds payable $100,000. c. credit equity $100,000. d. credit bonds payable $10,100,000.

Answer 31

a. credit bonds payable $9,900,000. $9,900,000 = 99% × $10 million. IFRS requires the proceeds from convertible bonds to be allocated between debit and equity. Using the gross method, rather than the net method, we would credit bonds payable $10,000,000 and debit discount on bonds $100,000.

Question 32

Preston Laird Company issued 5% bonds convertible into shares of the company's common stock. Preston Laird applied IFRS standard. Upon issuance, the company should record: a. the proceeds of the bond issue as part debt and part equity b. the proceeds of the bond issue entirely as debt c. the proceeds of the bond issue entirely as equity d. the proceeds of the bond issue entirely as debt if the bonds are mandatorily redeemable

Answer 32

a. the proceeds of the bond issue as part debt and part equity IFRS requires the proceeds from convertible bonds to be allocated between debit and equity, GAAP requires all proceeds from the sale of convertible bonds be recorded as debt.

Question 33

Which of the following is true about accounting for a troubled debt restructuring? a. if a receivable is expected to be uncollectible, it is remeasured at the discounted present value of the cash flows that were originally expected to be collected, but at a revised discount rate. b. receivables are not remeasured, instead, fair values are obtained from reliable factors. c. if a receivable is continued, but with modified terms, a loss is typically recorded d. receivables are ne3ver settled outright at the time of a restructuring

Answer 33

c. if a receivable is continued, but with modified terms, a loss is typically recorded

Question 34

Brewer Inc. is owed $202,000 by Carol Co. under a 15% note with two years remaining to maturity. Due to financial difficulties Carol Co. did not pay the prior year's interest. Brewer agrees to settle the receivable (and accrued interest) in exchange for a cash payment of $152,000. The journal entry that Brewer would make to record this transaction would include a loss on troubled debt restructuring as bad debt expense in the amount of: a. $0. b. $30,300. c. $50,000. d. $80,300.

Answer 34

d. $80,300. Cash 152,000 bad debt expense 80,300 Interest receivable (202k*.15) 30,300 Notes receivable 202,000

Question 35

Unrealized holding gains and losses are included in an investors earnings for: a. TS - Yes; AFS - No b. TS- Yes; AFS - Yes c. TS - Yes; AFS- Yes d. TS - No; AFS - No a. option a b. option b c. option c d. option d

Answer 35

a. option a Unrealized holding gains and losses are recognized in earnings for trading securities but not for available-for-sale securities.

Question 36

Which of the following statements is untrue regarding investments in equity securities? a. if the investor owns less than 20 percent of outstanding voting common stock, the equity method is usually not used b. if the investor owns more than 50 percent of the outstanding voting common stock the financial statements are consolidated. c. if the investor owns 20-50 percent of the outstanding coting common stock, the equity method is required d. if the investor owns less than 20 percent of outstanding voting common stock, the securities generally are reported at their fair value.

Answer 36

c. if the investor owns 20-50 percent of the outstanding coting common stock, the equity method is required

Question 37

Unrealized holding gains and losses for securities to be held to maturity are: a. reported as a separate component of the shareholders' equity section of the balance sheet b. included in the determination of income from operations in the period of the change c. reported as extraordinary items d. not reported in the income statement nor the balance sheet

Answer 37

d. not reported in the income statement nor the balance sheet Held to maturity securities are recorded at amortized cost.

Question 38

Unrealized holding gains and losses for securities available for sale are: a. reported as a separate component of the shareholders' equity section of the balance sheet b. included in the determination of income from operations in the period of the change c. reported as extraordinary items d. not reported in the income statement nor the balance sheet

Answer 38

a. reported as a separate component of the shareholders' equity section of the balance sheet Unrealized holding gains and losses are included in accumulated other comprehensive income for available-for-sale investments.

Question 39

Unrealized holding gains and losses for trading securities are: a. reported as a separate component of the shareholders' equity section of the balance sheet b. included in the determination of income from operations in the period of the change c. reported as extraordinary items d. not reported in the income statement nor the balance sheet

Answer 39

b. included in the determination of income from operations in the period of the change Unrealized holding gains and losses are included in income for trading securities.

Question 40

On January 12, Henderson Corporation purchased bonds of Honeycutt Corporation for $73 million and classified the securities as available-for-sale. At the close of the same year, the fair value of the securities is $81 million. Henderson Corporation should report: a. A gain of $8 million on the income statement. b. An increase in shareholders' equity of $8 million. c. An investment of $73 million. d. None of the choices are correct.

Answer 40

b. An increase in shareholders' equity of $8 million. Henderson has an unrealized holding gain of $81 million − $73 million = $8 million, which would be included in shareholders’ equity given that the investment is accounted for as an available-for-sale investment.

Question 41

Evans Company owns 450 bonds of Fraizer Company classified as AFS. During 2018, the fair value of those bonds decreased by $9 million. What effect did this increase have on Evans' 2018 financial statements? a. net assets increased b. total assets decreased c. net income increased d. shareholders equity decreased

Answer 41

a. net assets increased The investment would be carried at fair value on the balance sheet, so the asset would increase by $9 million.

Question 42

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Answer 42

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Question 43

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Answer 43

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Question 44

The equity method is used when an investor can’t control, but can exercise significant influence over the operating and financial policies of the investee. We presume, in the absence of evidence to the contrary, that this is so if: a. The investor classifies the investment as available-for-sale. b. The investor classifies the investment as held-to-maturity. c. The investor owns between 51% or more of the investee's voting shares. d. The investor owns between 20% and 50% of the investee's voting shares.

Answer 44

d. The investor owns between 20% and 50% of the investee's voting shares.

Question 45

When applying the equity method, an investor should report dividends from the investee as: a. dividend revenue b. an extraordinary item c. a reduction in the investment account d. an increase in the investment account

Answer 45

c. a reduction in the investment account Receipt of dividends is recorded with a debit to cash and a credit to the investment account.

Question 46

Western Manufacturing Company owns 40% of the outstanding common stock of Eastern Supply Company. During 2018, Western received a $50 million cash dividend from Eastern. What effect did this dividend have on Western’s 2018 financial statements? a. Total liabilities increased. b. Total assets decreased. c. Net income increased. d. Total assets are unchanged.

Answer 46

d. Total assets are unchanged. The dividend increases cash but decreases the investment asset.

Question 47

The accounting for unrealized holding gains and losses will be different if the fair value option is elected for all of the following type of investments except: a. HTM b. TS c. AFS d. Equity method

Answer 47

b. TS Trading securities are already accounted for at fair value.

Question 48

The fair value option a. must be elected when a security is purchased, and is irrevocable. b. can be traded on exchanges, similar to other options. c. for debt that is available only if anticipated to not be held to maturity. d. is not available for equity method investments.

Answer 48

a. must be elected when a security is purchased, and is irrevocable. The fair value option cannot be elected or changed after the security is purchased.

Question 49

On January 1, 2021, SteveCo purchased $100,000 of Clear Company bonds at a premium of $8,000. The Clear bonds pay 8% interest but were purchased when the market interest rate was 7% for bonds of similar risk and maturity. The bonds pay interest semiannually on June 30 and December 31 of each year. SteveCo accounts for the bonds as a held-to-maturity investment, and uses the effective interest method. In SteveCo's December 31, 2021, journal entry to record the second period of interest, SteveCoRupar would record a credit to interest revenue of: a. $3,500. b. $3,772. c. $3,780. d. $4,000.

Answer 49

b. $3,772 1/1/21 Investment in bonds 100K Prem on bond inv 8k Cash 108k 6/30/21 Cash (.08/2)(100k) 4k Prem on bond INV 4k 12/31/24 Cash (.08/2)(100k) 4,000 Prem on bond INV 228 INT Rev (.07/2)(100k+8k-220) 3,772

Question 50

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Answer 50

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