Financial Accounting for Decision Makers 3rd Edition By Mark DeFond

Chapter 1 Accounting Environment and the Conceptual Framework Learning Objectives – Coverage by question Multiple Choice

LO 1-1 – Describe the objective of general purpose reporting.

1-4

LO 1-2 – Identify key organizations that determine GAAP, how GAAP is used for accounting research, and the factors that drive high- quality reporting

5-8

LO 1-3 –Describe the qualitative characteristics of, and the constraint on, useful financial information.

9-13

LO 1-4 – Explain financial statement elements in the FASB conceptual framework.

14-18

LO 1-5 – Describe the four key accounting assumptions.

19-24

LO 1-6 – Describe the four key accounting principles.

25-30

Intermediate Accounting, 3rd Edition

Chapter 1: Accounting Environment and the Conceptual Framework Multiple Choice Topic: Describe the objective of general purpose financial reporting LO: 1 1. General purpose financial reports A) Are designed to show the value of the reporting entity to investors and creditors. B) Are designed for use by a variety of users, both internal and external to the reporting entity. C) Reflect financial information of the reporting entity and its owners. D) Both A and C are true. E) None of these are true. Answer: E Rationale: General purpose financial reports are specifically not designed to show the value of the reporting entity, nor are they designed with internal users of financial information in mind. Also, they only supply financial information about the reporting entity separate and apart from the owners. Hence, the correct answer is E.

Topic: Describe the objective of general purpose financial reporting LO: 1 2. General purpose financial statements A) Are used only by external users who are not investors or creditors of the reporting entity. B) Serve the needs of investors, creditors, and other external decision makers other than investors and creditors of the reporting entity. C) Are used by creditors mainly to assess the growth of the earnings of the reporting entity. D) Both A and B are true. E) Both B and C are true. Answer: B Rationale: General purpose financial statements are designed to help investors and creditors make decisions about capital allocation and are used to creditors mainly to assess the capacity of the company to repay debt and interest, not to assess earnings growth. However, B is correct: because there are many economic decision makers beyond investors and creditors, the needs of these other users are taken into account in the reporting in general purpose financial statements.

Test Bank, Chapter 1

Topic: Describe the objective of general purpose financial reporting LO: 1 3. General purpose financial reporting A) Benefits society by helping decision makers make better resource allocation decisions, thus improving the overall economy. B) Is unique because only accrual-based financial information is used, therefore maximizing the reporting on the economic status of the company. C) Include the issuance of four main financial statements and notes that provide additional information to financial statement users. D) Both A and B are true. E) Both A and C are true. Answer: E Rationale: B is incorrect because general purpose financial reporting provides both accrual and cashbased financial information for use by external users. A is correct because improved resource allocation (which should result from informed decision-makers) is, in fact, the invisible hand in our capitalistic economy. C is correct as well; financial statements are not considered complete without accompanying notes.

Topic: Describe the objective of general purpose financial reporting LO: 1 4. Management accounting A) Is governed by generally accepted accounting principles as well as accrual accounting. B) Provides internal management reports, available to investors and creditors. C) Serves the information needs of internal management of a company to help them make decisions and assess results. D) Both A and C are true. E) Bothe A and B are true. Answer: C Rationale: A is incorrect because managerial accounting is not bound by GAAP nor accrual accounting (exclusively). B is incorrect because most internal management reports are not available to investors and creditors. C is correct; the form and use of management accounting is determined by the information needs of internal management.

Topic: Identify key organizations that determine GAAP and the factors that drive high-quality reporting. LO: 2 5. Generally accepted accounting principles A) Were exclusively established by a designated rule-making body, such as the Financial Accounting Standards Board. B) Have mostly been developed in the private sector through the efforts of the American Institute of Certified Public Accounts and the Financial Accounting Standards Board. C) Is not a concern of the Securities and Exchange Commission. D) Both A and B are true. E) Both B and C are true. Answer: B Rationale: A is incorrect; some GAAP has achieved general acceptance through practice. C is incorrect; the SEC has both regulatory and enforcement powers over financial accounting (i.e. GAAP). B is correct, the SEC, although having regulatory and enforcement powers over standards setting, largely allows the FASB to set GAAP.

Intermediate Accounting, 3rd Edition

Topic: Identify key organizations that determine GAAP and the factors that drive high-quality reporting. LO: 2 6. Some terms used as section names in the Accounting Standards Codification (ASC) designate very basic activities in the accounting process. Which of the following is true about these terms. A) To assign a numerical amount to a financial item is to measure. B) To recognize is to record a particular item in financial statements. C) To include information about a financial item in the notes of a financial statement is an example of recognition. D) A, B, and C are true. E) Both A and B are true. Answer: E Rationale: A and B are true by definition. C is incorrect; disclosure (including information about a financial item in the notes of a financial statement) is not recognition.

Topic: Identify key organizations that determine GAAP and the factors that drive high-quality reporting. LO: 2 7. Which of the following organizations is tasked with considering accounting issues of limited importance and scope, requiring technical guidance, which could be resolved quickly? A) Financial Accounting Standards Board (FASB). B) Financial Accounting Standards Advisory Council (FASAC). C) Emerging Issues Task Force (EITF). D) Both A and C are correct E) Securities and Exchange Commission (SEC). Answer: C Rationale: The description in the stem of this question describes the essential mission of the EITF.

Topic: Identify key organizations that determine GAAP and the factors that drive high-quality reporting. LO: 2 8. The due process for developing new financial accounting standards A) Is directly and actively controlled by the Securities and Exchange Commission. B) Is open to industry and professional groups but is closed to the public. C) Must take into account the general interest, the technical and conceptual characteristics of an issue, and the specific interests of preparers, auditors, and users. D) Both A and B are true. E) Both A and C are true. Answer: C Rationale: The SEC does not actively control the FASB’s standard setting process, nor is the FASB’s due process closed to the public. C is correct, the due process of standard setting includes the political process to reconcile the conceptual and technical aspects of an issue with the public interest and the specific interests of the main users of accounting standards.

Test Bank, Chapter 1

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Topic: Describe the qualitative characteristics of, and the constraint on, useful financial information. LO: 3 9. Which of these statements about the conceptual framework is false? A) The conceptual framework is considered as GAAP and can be cited as an authoritative source for financial accounting decisions. B) The overall theme of the conceptual framework is the objective of financial reporting. C) The conceptual framework was developed as a theoretical framework to support standard setters in resolving accounting and reporting problems. D) The overall theme of the conceptual framework is the qualitative characteristics of accounting information. E) Both B and C are false. F) Both A and D are false Answer: F Rationale: A is false; the conceptual framework is not considered to be GAAP. D is also false; the overall theme of the conceptual framework is the objective of financial reporting. Both B and C are true.

Topic: Describe the qualitative characteristics of, and the constraint on, useful financial information. LO: 3 10. AGNO Corp., a multimillion dollar company, disclosed in a footnote that its CEO was charged by the SEC for paying a $25,000 bribe to a government official in another country. No other details were given because this allegation was made just prior to AGNO’s year end. This allegation, if true, is a clear violation of the Foreign Corrupt Practices Act and a serious federal crime. In addition, it could tarnish AGNO’s much publicized plans for expanding internationally. Which of the following fundamental qualitative characteristics of accounting information is (are) best represented in this example? A) Confirmatory value. B) Materiality. C) Free from error. D) Neutrality. E) Both B and D are best represented. Answer: E Rationale: A is incorrect; there was no prior information that this item confirms. C is also incorrect; there is no mention of how the fine was determined nor any other qualitative or quantitative information that would allow users to judge if the disclosure was free from error. The characteristics best represented are materiality and neutrality. Although the magnitude of the fine is low, the nature of the fine is serious. Omitting this information from the notes could influence decisions made by investors. Hence, the item is material. In addition, it is presented neutrally – there is no slant or bias in the reporting and no attempt to shape or omit the disclosure to affect the decisions of users.

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Topic: Describe the qualitative characteristics of, and the constraint on, useful financial information. LO: 3 11. Metro Loft Apartments Inc. does the following: 1. The company makes a concise listing of long-term debt in the footnotes of its financial statements, clearly showing the lender, interest rate, due date, and principal amount for each note. 2. The company keeps invoices for all fixed assets purchased as support for the assets’ recorded costs. 3. The company has used the same method to calculate bad debt expense of its accounts receivable for the past 15 years. Which enhancing qualitative characteristics are exemplified by these practices?

A) B) C) D) E)

Practice 1 Verifiability Understandability Comparability Verifiability Understandability

Practice 2 Understandability Verifiability Understandability Comparability Comparability

Practice 3 Comparability Comparability Verifiability Understandability Verifiability

Answer: B Rationale: Practice 1 is an example of understandability – relevant information is presented clearly and concisely. Practice 2 is an example of verifiability; any auditor would be able to come up with the same or similar cost for the assets. Practice 3 is comparability, in this case comparability within the company.

Topic: Describe the qualitative characteristics of, and the constraint on, useful financial information. LO: 3 12. Kinderhook Awnings Corp. discovered that there was a reporting error in the shop supplies account totaling between $5,000 and $13,500. They see they have two options: spend about $35,000 to perform the detailed analysis to come up with the exact amount of the error or record an adjustment of $13,500 to correct the error. What should Kinderhook do? A) Find the correct amount so that the balance is free from error. B) Find the correct amount because the amount is material. C) Record the adjustment because the amount will be presented in a timely manner. D) Record the adjustment because the cost to determine the correct amount outweighs the benefit. E) Find the correct amount to increase the understandability of the financial statements. Answer: D Rationale: Kinderhook should record the adjustment because the benefit of knowing the exact amount (which will, at most, differ from the maximum error of $13,500 by only $8,800) is far less than the $35,000 cost necessary to produce that benefit.

Test Bank, Chapter 1

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Topic: Describe the qualitative characteristics of, and the constraint on, useful financial information—CHALLENGING LO: 3 13. Which of these enhancing qualitative characteristics is most closely related to faithful representation? A) Comparability B) Timeliness C) Verifiability D) Both A and B. E) Both B and C. Answer: C Rationale: Verifiability is defined in the conceptual framework as that enhancing qualitative characteristic that helps assure users of the representational faithfulness of the financial item in question. Timeliness and comparability relate to relevance, the capacity of the information to influence decision makers.

Topic: Explain financial statement elements in the FASB conceptual framework. LO: 4 14 Which statement(s) below is (are) true? A) Point in time elements are those elements shown on the income statement that affect accounts on the balance sheet. B) Period of time elements present the results of events and circumstances. C) The balance sheet is comprised of the cumulative ending balances of period of time elements. D) Both A and B are true. E) Both A and C are true. Answer: B Rationale: As the book describes, period of time elements “describe the effects of transactions and other events that affect an entity during intervals of time.” A is incorrect; actually it is certain period of time elements that are shown on the income statement and affect accounts on the balance sheet. C is also incorrect; the balance sheet is comprised of the cumulative ending balances of point in time elements.

Topic: Explain financial statement elements in the FASB conceptual framework. LO: 4 15. How do gains differ from revenues? A) Revenues stem from delivering or producing goods or rendering services while gains stem from events other than those resulting from revenues or investments by owners. B) Gains stem from an increase in equity of a firm while revenues stem only from an increase in assets. C) Gains and revenues are both period of time elements. D) Both A and B are true. E) Both A and C are true. Answer: E Rationale: Revenues stem from delivering or producing goods or rendering services while gains stem from events other than those resulting from revenues or investments by owners. Both are period of time elements. B is incorrect; both gains and revenues stem from an increase in equity of a firm. Revenues increase equity by either an increase in assets, a decrease in liabilities, or a combination of both, not just from an increase in assets.

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Topic: Explain financial statement elements in the FASB conceptual framework. LO: 4 16. Which of the following accounts are a liability? A) Prepaid insurance. B) Deferred revenue. C) Interest payable D) Both A and C. E) Both B and C. Answer: E Rationale: Prepaid insurance is an asset. Both deferred revenue and interest payable are liabilities.

Topic: Explain financial statement elements in the FASB conceptual framework. LO: 4 17. Which of the following statements are true? A) Dividends payable is a liability and is shown on the balance sheet. B) Dividends payable is an equity account and is shown on the balance sheet. C) Dividends payable is an equity account and is shown in the stockholders’ equity statement. D) Dividends payable is an expense account and is shown on the income statement. E) Both B and C are true. Answer: A Rationale: Dividends payable is a liability created on the date of declaration of a dividend and is shown on the balance sheet only.

Topic: Explain financial statement elements in the FASB conceptual framework. LO: 4 18. Which of the following statements are true? A) Loss on impairment of intangible asset is an asset and is shown on the balance sheet. B) Loss on impairment of intangible asset is a loss and is shown on the balance sheet. C) Loss on impairment of intangible asset is an equity element and is shown on the stockholders’ equity statement. D) Loss on impairment of intangible asset is a loss and is shown on the income statement. E) Loss on impairment of intangible asset is a point in time element shown on the income statement. F) Both D and E are correct. Answer: D Rationale: All losses are shown on the income statement and are considered to be a period of time element.

Test Bank, Chapter 1

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Topic: Describe the four key accounting assumptions. LO: 5 19. Which of the following are examples of the correct application/interpretation of the monetary unit assumption, assuming a stable period of inflation or deflation? A) Domain Corp. shows land for its offices acquired in 1995 at its original cost in the balance sheet. B) Domain Corp. shows land for its office acquired in 1995 at an inflation-adjusted cost in the balance sheet. C) Domain Corp. routinely adjusts the cost of productive assets to reflect changes in the purchasing power of the dollar. D) Domain Corp. records and reports its sales in Europe in euros and its sales in America in dollars. E) Both A and D are correct examples. Answer: A Rationale: A is correct; the cost of acquiring an asset in the past is not adjusted for the changes in purchasing power of the dollar in subsequent years. For that reason, B and C are incorrect. D is incorrect because the results of a company’s economic activities are reported in US dollars.

Topic: Describe the four key accounting assumptions. LO: 5 20. Which of the following are examples of the correct application/interpretation of the economic entity assumption? A) Jay Parker, the majority shareholder in Rosanio Air Hose Corp, lists the machinery owned by Rosanio in his own personal balance sheet that he submits to his bank for a loan. B) Taylor Coupling Inc. (parent company) owns 100% of the stock of Neuf Air Systems (subsidiary company). However, because each company is legally separate, they must create separate financial statements. C) Jay Parker, the majority shareholder in Rosanio Air Hose Corp., pays the utility bills for his home with Rosanio’s checks and recording the expenditures as Rosanio’s expense. D) Kraft-Heinz produces financial statements in which the financial position and results of operations of the parent company’s many subsidiaries are consolidated. E) Both A and D are correct examples. Answer: D Rationale: Although each subsidiary and the parent company are all separate legal entities, they operate as one economic entity. That is not the case with Jay Parker’s treatment of Rosanio’s resources; he and the company are not one economic entity.

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Topic: Describe the four key accounting assumptions. LO: 5 21. Which of the following are examples of the correct application/interpretation of the going concern assumption? A) The sole shareholder of Montgomery Bay Awnings, Inc. plans to liquidate the business in 15 to 20 years, but still continues to record acquired assets at historical cost. B) 4M, a stable company, reports the historical cost of its fixed assets in its balance sheet. C) Trexler, a company filing for liquidation, has restated its balance sheet to show the estimated net realizable value of its assets. D) Both B and C are correct examples. E) All the above are correct examples. Answer: E Rationale: The going concern assumption is the bedrock of the historical cost principle, so B is correct, as is C. If a company expects to be liquidated in the near future, the accounting should be based on estimated net realizable value of assets, not their historical cost. Although the company in A is expected to be liquidated in 15 to 20 years, that period of time is “sufficient to carry out contemplated operations, contracts, and commitments,” and thus still permits the use of historical cost.

Topic: Describe the four key accounting assumptions. LO: 5 22. In GAAP, fixed assets are recorded at their historical cost and reported on the balance sheet at their book value (historical cost minus accumulated depreciation). Which of the following accounting assumptions support this treatment? A) Economic entity and going concern assumptions. B) Monetary unit and going concern assumptions. C) Periodicity and monetary unit assumptions. D) Going concern and periodicity assumptions. E) Economic entity, going concern, and monetary unit assumptions. Answer: B Rationale: Historical cost recording is only appropriate if the company is a going concern, which is assumed, if there is no information to the contrary. The practice of continuing to report the fixed assets’ historical cost, unadjusted for price-level changes, over subsequent years is an application of the monetary unit assumption. Periodicity and economic entity assumptions don’t apply here, except peripherally (annual reporting of historical cost and increases in accumulated depreciation each succeeding year).

Test Bank, Chapter 1

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Topic: Describe the four key accounting assumptions. LO: 5 23. Big Bang Galore Explosives Company recorded depreciation expense for its fixed assets (calculated on historical costs) for the year ending March 31, 2019, its fiscal year. Which of the following accounting assumptions support this treatment? A) Economic entity and going concern assumptions. B) Monetary unit and going concern assumptions. C) Periodicity and monetary unit assumptions. D) Economic entity and monetary unit assumptions E) Monetary unit, going concern, and periodicity assumptions. Answer: E Rationale: Historical cost recording is only appropriate if the company is a going concern, which is assumed, if there is no information to the contrary. The practice of continuing to report the fixed assets’ historical cost, unadjusted for price-level changes, over subsequent years is an application of the monetary unit assumption. The periodicity assumption is at play because depreciation expense is recorded for the company’s fiscal year.

Topic: Describe the four key accounting assumptions. LO: 5 24. Paul LeGuard, majority stockholder of Total Fitness Corp., has been applying for personal credit cards by listing the fixed assets of Total Fitness at their cost in today’s dollars (that is, adjusting for changes in purchasing power) as his personal assets. Which of the following accounting assumptions have been violated here? A) Economic entity and going concern assumptions. B) Periodicity and monetary unit assumptions. C) Monetary unit and going concern assumptions. D) Monetary unit and economic entity assumptions. E) Monetary unit, periodicity, and economic entity assumptions. Answer: D Rationale: The monetary unit assumption is violated because the cost of the assets are adjusted for price level changes. The economic entity assumption is violated because although LeGuard is a majority stockholder of Total Fitness, they are not part of the same economic entity – the assets of Total Fitness belong to Total Fitness, not the owners.

Intermediate Accounting, 3rd Edition

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Topic: Describe the four key accounting principles. LO: 6 25. Carpenter Inc. signs a contract with Delicious Pig Catering Corp. on June 1 in which Delicious Pig agrees to cater a summer office party on July 1 for Carpenter for a total of $25,000. Carpenter is to make an advance payment of $5,000 and will be billed for the balance on July 1, with 30 days to pay. Assuming both parties follow the terms of the contract and Carpenter pays $20,000 on July 15, when and how much revenue can Delicious Pig recognize from this project? June 1 July 1 July 15 A) $5,000 $20,000 B) $5,000 $20,000 C) $25,000 D) $25,000 E) Revenue is recognized evenly through this period. Answer: C Rationale: Per the revenue recognition principle, revenue can be recognized when the seller satisfies its performance obligation, that is, delivers the catered event. In this case, the earliest date on which Delicious Pig can record revenue is on July 1, after the catered event is complete.

Topic: Describe the four key accounting principles. LO: 6 26. One GAAP approved measurement model is to require the entity to measure the value of an asset or liability (belonging to certain asset or liability classes) at its fair value. However, fair value of an asset or liability can be estimated using various means. Which of the following statement(s) is true? A) One requirement of the use of fair value measurement is that preparers must disclose the level of the reliability of the estimate. B) Disclosure of the estimated reliability of fair value measurement estimates consists only of indicating which level of the fair value hierarchy the measurement falls. C) Disclosure related to a Level 1 asset is more extensive than disclosure of a Level 3 asset. D) A, B, and C are true. E) Both A and C are true. Answer: A Rationale: The preparers are required to disclose the level of the estimate’s fair value by not only indicating the estimate’s level on the FASB’s fair value hierarchy, but also by providing additional information, the amount of which should increase with the level of the estimate.

Test Bank, Chapter 1

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Topic: Describe the four key accounting principles. LO: 6 27. Carpenter Inc. signs a contract with Delicious Pig Catering Corp. on June 1 in which Delicious Pig agrees to cater a summer office party on July 1 for Carpenter for a total of $25,000. Carpenter is to make an advance payment of $5,000 on June 1st to be used to buy food and supplies to be consumed at the catered event, and will be billed for the balance on July 1, with 30 days to pay. Assuming both parties follow the terms of the contract and Carpenter pays the $20,000 balance on July 15th, when should Delicious Pig charge the food and supplies to expense? A) The costs should be charged to expense during June as the expenses are incurred. A) The costs should be charged to expense on July 1st. B) The costs should be charged to expense on July 15th. C) The costs should be charged to expense on June 1st D) The costs should be allocated to expense over the period from June 1 st to July 1st. Answer: B Rationale: The cost of the food and consumable supplies should be charged to cost of goods sold on the day that revenue is recognized, July 1st, because the expense is directly related to the revenue.

Topic: Describe the four key accounting principles. LO: 6 28. Which of the following statements about the full disclosure principle is (are) true? A) Notes to financial statements, supplementary schedules, and modifying comments on the face of the financial statements are all required parts of issued financial statements. B) The FASB is engaged in developing a disclosure framework to make disclosure more effective. C) The purpose of full disclosure is to provide additional relevant information bearing on the economic affairs of the company to external users. D) A, B, and C are correct. E) Both B and C are correct. Answer: E Rationale: A is false because supplementary schedules are not required to be provided by preparers. B and C are true, per the text.

Topic: Describe the four key accounting principles. LO: 6 29. The FASB has identified the fundamental recognition criteria that should be met before an item is recognized in financial reporting. Which of the following are part of the fundamental recognition requirements? A) An item must meet the definition of an element of financial statements. B) Information about an item is representationally faithful, verifiable, and neutral. C) Materiality of an item is only considered after an item meets the fundamental recognition criteria. D) A, B, and C are true. E) Both A and B are true. Answer: D Rationale: All three assertions are true, per the text.

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Topic: Describe the four key accounting principles -- CHALLENGING LO: 6 30. The revenue recognition process, as described in the ASC, is fairly easily used in the case of a retailer selling a customer a pair of pants for cash. The performance obligation of the retailer is met when the pants are transferred to the customer, so at that point, the retailer can recognize revenue. In more complex transactions, the new revenue recognition rules require additional steps and sellers must deal with more complex problems... A) In the case of a contract in which there is more than one performance obligation, none of the total transaction price is recognized until the final performance obligation is completed. B) One step is to determine the performance obligation(s) in the contract. C) One difficulty in some complex transactions is the lack of a distinctive transaction price. D) A, B, and C are true. E) B and C are true. Answer: E Rationale: Both B and C are true, per the text. A is incorrect; in the case of more than one performance obligation, the seller must allocate the transaction price among the different performance obligations. Then the allocated transaction price for a specific performance obligation will be recognized when that particular performance obligation is competed.

Test Bank, Chapter 1

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Chapter 2 Accounting Information Systems Learning Objectives – Coverage by question Multiple Choice LO 2-1 – Analyze the effects of economic transactions using the accounting equation

1-2

LO 2-2 – Identify, record, and post transactions

3-7

LO 2-3 – Prepare an unadjusted trial balance

8-10

LO 2-4 – Identify, record, and post adjusting journal entries

11-16

LO 2-5 – Prepare an adjusted trial balance

17-18

LO 2-6 – Prepare financial statements from an adjusted trial balance

19-23

LO 2-7 – Prepare and post closing entries and prepare a post-closing trial balance

24-27

LO 2-8 – Appendix 2A – Describe the use of special purpose frameworks and the conversion from cash basis income to accrual basis income

28-29

LO 2-9 – Appendix 2B – Prepare reversing entries

30-31

LO 2-10 – Appendix 2C – Utilize an accounting worksheet

Intermediate Accounting, 3rd Edition

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Chapter 2: Accounting Information Systems Multiple Choice Topic: The effect of economic transactions on the accounting equation LO 1 1. Which of the following statements is true? A) Retained earnings, as a category, represents the resources available to a business. B) Liabilities show the amount of assets claimed by creditors. C) The accounting equation shows that the total resources of a business is equal to the total amount of financing of those resources. D) Both A and B are true. E) Both B and C are true. Answer: E Rationale: The answer A is incorrect; retained earnings shows the residual interest of the owners in the business. However, both B and C are true, hence E is the correct answer. Liabilities show the amount of financing of assets provided (and claimed) by creditors. The accounting equation shows the equality of assets (resources) and the sourcing of those assets (financing).

Topic: The effect of economic transactions on the accounting equation LO 1 2. If Alexis Corp. paid $3,500 to a marketing firm for help with an advertising campaign, how would this transaction affect Alexis’s accounting equation? Assets A)

Advertising +$3,500

Cash -$3,500

Cash +$3,500

Advertising +$3,500

Liabilities

Stockholders’ Equity

Accounts Payable +$3,500 Consulting Expense -$3,500 Accounts Payable +$3,500 Consulting Expense -$3,500

Answer: B Rationale: Cash paid represents a decrease in assets and a decrease (via an expense) of shareholders’ equity.

Test Bank, Chapter 2

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Topic: Identify, record, and post transactions LO 2 3. Cal-Ex Corp. received $32,000 cash from Slender Fastly, Inc. as a prepayment on a consulting engagement. Cal-Ex will provide the consulting service to Slender Fastly starting next month. On Cal-Ex’ books, the journal entry recorded for this transaction will include A) A credit to Deferred Revenue. B) A credit to Cash. C) A debit to Prepaid Consulting. D) A credit to Consulting Revenue. E) A credit to Accounts Payable. Answer: A Rationale: The journal entry will consist of a debit to Cash for the increase in cash and a credit to Deferred Revenue to record the obligation to provide service in the future.

Topic: Identify, record, and post transactions LO 2 4. Which of the following accounts have a debit normal balance? A) Dividends Payable B) Salaries Expense C) Deferred Revenue D) Both A and B have debit normal balances. E) Both A and C have debit normal balances. Answer: B Rationale: The accounts listed in A and C are liabilities, so they have a credit normal balances. Salaries Expense is an expense account so it has a debit normal balance.

Topic: Identify, record, and post transactions LO 2 5. If the Accounts Payable account starts with a normal balance of $34,500, and the firm purchases $4,300 worth of inventory on account, and later pays $12,700 on the accounts payable amount due, what is the ending balance of Accounts Payable? A) A debit balance of $26,100. B) A credit balance of $21,800. C) A credit balance of $26,100. D) A debit balance of $21,800. E) The correct ending balance is not displayed as a choice. Answer: C Rationale:

Accounts Payable 12,700

34,500 4,300 26,100

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Topic: Identify, record, and post transactions LO 2 6. Cal-Ex Corp. sold products from inventory for $23,500 cash. The inventory sold had a cost of $11,300. Which statement below is true about the journal entries recorded for the sale of the inventory? A) The account Retained Earnings is credited for $23,500. B) The account Cost of Goods Sold is credited for $11,300. C) The account Sales Revenue is credited for $12,200. D) The account Inventory is credited for $11,300. E) Both B and C are true. Answer: D Rationale: The journal entries for the transaction are as follows: XXX

Cash

23,500 Sales Revenue

XXX

Cost of Goods Sold Inventory

23,500 11,300 11,300

Topic: Identify, record, and post transactions LO 2 7. Which of the following will be recorded as a debit in a journal entry? A) An increase in Dividends Payable... B) An increase in Salaries Expense. C) An increase in Salaries Payable. D) A decrease in Accounts Receivable. E) A decrease in Prepaid Insurance Answer: B Rationale: An increase in Dividends Payable and Salaries Payable are shown with a credit (they are liabilities and increasing), and a decrease in Accounts Receivable and Prepaid Insurance will also be shown with a credit (they are assets and decreasing). Salaries Expense is an expense account and increasing; hence it is debited.

Topic: Prepare an unadjusted trial balance LO 3 8. Management uses an unadjusted trial balance to A) Make sure the accounts are totally error free. B) Check if a transaction has not been recorded. C) Make sure the sum of debit balances and the sum of credit balances are equal. D) Catch all erroneous entries. E) Make sure all accounts are correctly classified. Answer: C Rationale: A and D are incorrect because there is no way to assure that there are no errors at all, nor any check offered by the unadjusted trial balance that would catch all erroneous entries. E is incorrect because there is nothing in the structure that guarantees all accounts are correctly classified. B is incorrect because the structure of the unadjusted trial balance is such that there is no way to know if a particular transaction was recorded or not. C is correct, because the structure of the unadjusted trial balance demonstrates whether the sum of the debit and credit balances are equal.

Test Bank, Chapter 2

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Topic: Prepare an unadjusted trial balance LO 3 9. Jim Dandy Inc. shows the following normal balances in its general ledger at the end of year. Cash Accounts Receivable Allowance for Doubtful Accounts Equipment Accumulated Depreciation - Equipment Accounts Payable Dividends Payable Notes Payable Deferred Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Depreciation Expense Lease Expense

$33,800 78,600 11,000 134,700 12,600 29,400 5,000 30,000 26,700 20,000 81,700 9,000 158,400 85,100 12,600 21,000

When they create their adjusted trial balance for the year, the total amount in the debit column should be: A) $374,800 B) $342,200 C) $354,800 D) $365,800 E) $379,800 Answer: A Rationale: Cash A/R Allowance for D/A Equipment A/D - Equipment A/P Dividends Payable Notes Payable Deferred Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Depreciation Expense Lease Expense

Debits $33,800 78,600

Credits

$11,000 134,700 12,600 29,400 5,000 30,000 26,700 20,000 81,700 9,000 158,400 85,100 12,600 21,000 $374,800

$374,800

Intermediate Accounting, 3rd Edition

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Topic: Prepare an unadjusted trial balance LO 3 10. Jim Dandy Inc. shows the following normal balances in its general ledger at the end of year. Cash Accounts Receivable Allowance for Doubtful Accounts Equipment Accumulated Depreciation - Equipment Accounts Payable Dividends Payable Notes Payable Deferred Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Depreciation Expense Lease Expense

$33,800 78,600 11,000 134,700 12,600 29,400 5,000 30,000 26,700 20,000 81,700 9,000 158,400 85,100 12,600 21,000

Before they started to create their unadjusted trial balance for the year, a bookkeeper discovered an error in the accounts - a cash collection of $1,600 on accounts receivable was debited to Cash and credited to Deferred Revenue. After the error is corrected, the total amount in the debit column of the unadjusted trial balance should be: A) $376,400 B) $373,200 C) $356,400 D) $378,200 E) Some other number Answer: B Rationale: Cash A/R Allowance for D/A Equipment A/D - Equipment A/P Dividends Payable Notes Payable Deferred Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Depreciation Expense Lease Expense

Debits 33,800 77,000

Credits

11,000

134,700 12,600 29,400 5,000 30,000 25,100 20,000 81,700 9,000 158,400 85,100 12,600 21,000 $ 373,200

$ 373,200

Test Bank, Chapter 2

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Intermediate Accounting, 3rd Edition

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Topic: Identify, record, and post adjusting journal entries LO 4 11. Arpeni Corp. (whose fiscal year is a calendar year) purchased a vinyl press on July 1, 2019, for $59,000. Management estimates that the press has a salvage value of $3,000 and will be used for the next 7 years. After the end of the year adjusting journal entries are made on December 31, 2019, Arpeni will have recorded ____________ of depreciation expense for the year for that machine. A) $4,215 B) $8,000 C) $8,429 D) $4,000 E) Some other number. Answer: D Rationale: The correct depreciation expense for the vinyl press for the 6 months of 2019 will be (59,000 – 3,000)/7 x 6/12 = $4,000.

Topic: Identify, record, and post adjusting journal entries LO 4 12. Dynasty Pianos Inc. is making an adjusting journal entry on December 31, 2019 for depreciation expense of $4,250 on a specialized warehouse forklift. The forklift cost is in the Warehouse Equipment account and the asset’s book value after the adjusting entry will be $53,200. The proper form of the adjusting journal entry for the forklift is: A) 12/31 Accumulated Depreciation – Warehouse Equipment Warehouse Equipment B) 12/31 Depreciation Expense Warehouse Equipment C) 12/31 Depreciation Expense Accumulated Depreciation – Warehouse Equipment D) 12/31 Warehouse Equipment Depreciation Expense E) 12/31 Depreciation Expense Warehouse Equipment Accumulated Depreciation – Warehouse Equipment Cash

4,250 4,250 4,250 4,250 4,250 4,250 4,250 4,250 4,250 53,400 4,250 53,400

Answer: C Rationale: The correct form for a deferred expense journal entry for depreciation is to debit an expense (depreciation expense) and credit the contra asset account for the asset (accumulated depreciation). There is no expense listed in A; in B, the asset is credited, not the contra asset account; in D, the expense is credited; and in E, the entry shows a cash outflow for the remaining book value.

Test Bank, Chapter 2

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Topic: Identify, record, and post adjusting journal entries LO 4 13. Pinkerton HR Consultants borrowed $100,000 from National Bank on October 1, 2019, with a 9 month 6% note payable. The principal and interest on the note are due to be paid back on July 1, 2020. Pinkerton should record the following amount of interest expense in an adjusting journal entry on December 31, 2019: A) $-0B) $ 4,500 C) $ 6,000 D) $ 1,500 E) $ 2,000 Answer: D Rationale: The calculation of interest expense for the three months the note was held in 2019 is $100,000 x 6% x 3/12 = $1,500.

Topic: Identify, record, and post adjusting journal entries LO 4 14. Pinkerton HR Consultants borrowed $100,000 from National Bank on October 1, 2019, with a 9 month 6% note payable. The principal and interest on the note are due to be paid back on July 1, 2020. Pinkerton should record an adjusting journal entry for this note on December 31, 2019, with the following accounts debited and credited: A) Debit Interest Expense; Credit Interest Revenue. B) Debit Interest Expense; Credit Note Payable. C) Debit Interest Expense; Credit Cash. D) Debit Interest Expense; Credit Interest Payable E) Debit Interest Expense; Credit Prepaid Interest Answer: D Rationale: The proper form for an adjusting entry recording an accrued expense is to debit an expense and credit the related payable. In this case, the related payable is Interest Payable.

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Topic: Identify, record, and post adjusting journal entries LO 4 15. At December, 31, 2019, Pixel Film Corp. estimates that it would need an increase to its Allowance for Doubtful Accounts of $14,600 so that its $187,400 of accounts receivables would be shown at net realizable value. The adjusting journal entry that Pixel would make at December 31, 2019, would be: A) 12/31 Allowance for Doubtful Accounts 14,600 Accounts Receivable 14,600 B) 12/31 Bad Debt Expense 14,600 Allowance for Doubtful Accounts 14,600 C) 12/31 Bad Debt Expense 14,600 Accounts Receivable 14,600 D) 12/31 Allowance for Doubtful Accounts 14,600 Bad Debt Expense 14,600 E) 12/31 Accounts Receivable 14,600 Allowance for Doubtful Accounts 14,600 Answer: B Rationale: The proper form for this type of accrued expense is to debit an expense (Bad Debt Expense, in this case) and credit the contra asset (Allowance for Doubtful Accounts). Although there is no increase in a liability, as in most accrued expense adjusting entries, the asset is indirectly reduced by the increase in the contra asset account.

Topic: Identify, record, and post adjusting journal entries LO 4 16. At the beginning of 2019, Pixel Film Corp. had a balance of $23,000 in its Deferred Demolition Revenue account. During 2019, Pixel Film Corp. received additional cash prepayments totaling $156,800 by customers for demolition jobs to be completed later. The cash prepayments were correctly accounted for with an increase in Deferred Demolition Revenue. As of the company’s year end of December 31, 2019, Pixel had completed $143,500 of the prepaid contracts. Pixel should record the following journal entry on December 31, 2019: A) 12/31 Deferred Demolition Revenue 143,500 Demolition Revenue B) 12/31 Deferred Demolition Revenue 36,300 Demolition Revenue C) 12/31 Demolition Revenue 36,300 Deferred Demolition Revenue D) 12/31 Demolition Revenue 23,000 Cash 120,500 Deferred Demolition Revenue E) 12/31 Deferred Demolition Revenue 143,500 Accounts Receivable Demolition Revenue

143,500 36,300 36,300

143,500 23,000 120,500

Answer: A Rationale: The proper form for a deferred revenue adjusting entry for a contract liability is a debit to the deferred revenue account (here, Deferred Demolition Revenue) and a credit to the related revenue account (here, Demolition Revenue) for the amount of the contract liability for which the company has satisfied its performance obligation.

Test Bank, Chapter 2

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Topic: Prepare an adjusted trial balance LO 5 17. What statements below are true about an adjusted trial balance? A) The sum of debit balances should equal the sum of credit balances. B) The retained earnings account should be updated for current year income and dividends. C) There should be fewer accounts listed than on the unadjusted trial balance. D) Both A and B are true. E) Both A and C are true. Answer: A Rationale: B is incorrect because the balance in retained earnings will be updated only after the closing entries for the year are made. C is incorrect; there should be at least as many accounts in the adjusted trial balance as there are in the unadjusted trial balance, if not more. Many adjusting journal entries draw on accounts not used during the year, so there is the possibility that there may be more accounts on the adjusted trial balance. A is correct, as it is the goal of any trial balance, if the books are in balance. Topic: Prepare an adjusted trial balance LO 5 18. The adjusted trial balance and not the unadjusted trial balance is used to prepare financial statements, because the adjusted trial balance include the effect of adjusting entries. Please indicate which one of the following effects of adjusting entries is NOT true. A) One type of adjusting entry corrects an overstatement of an asset and the understatement of an expense. B) One type of adjusting entry corrects an understatement of an asset and an understatement of a liability. C) One type of adjusting entry corrects an understatement of an asset and an understatement of a revenue. D) One type of adjusting entry corrects an understatement of a liability and an understatement of an expense. E) One type of adjusting entry corrects an overstatement of a liability and an understatement of a revenue. Answer: B Rationale: A describes the effect of a deferred expense adjusting entry, C the effect of an accrued revenue, D the effect of an accrued expense, and E the effect of a deferred revenue. B does not represent a typical adjusting entry. Topic: Prepare financial statements from an adjusted trial balance. LO 6 19. In preparing financial statements (except the statement of cash flows) from an adjusted trial balance, which financial statement is prepared first and why? A) The income statement is prepared first because it is the simplest in terms of content. B) The balance sheet is prepared first because it represents a snapshot of the accounting equation at the end of the year. C) The income statement is prepared first because net income must be determined in order to complete the remaining financial statements. D) The statement of stockholders’ equity is prepared first so that shareholders see an overview of what is theirs. E) The retained earnings component of the statement of stockholders’ equity is prepared first so that the balance sheet can be produced. Answer: C Rationale: The creation of the statement of stockholders’ equity, the balance sheet, and the cash flow statement depend on the calculation of net income, so the income statement is created first. © Cambridge Business Publishers, 2023 2-11

Intermediate Accounting, 3rd Edition

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Use the following adjusted trial balance to answer Questions 20 – 23.

Clemsy Tines Corp. Adjusted Trial Balance December 31, 2019 Debits Credits Cash $ 19,600 Accounts Receivable 98,500 Allowance for Doubtful Accounts $ 6,500 Inventory 134,900 Prepaid insurance 11,000 Equipment 178,400 Accumulated Depreciation - Equipment 32,400 Accounts Payable 54,700 Notes Payable 10,000 Interest Payable 500 Salaries Payable 1,300 Deferred Revenue 19,200 Common Stock 120,000 Retained Earnings 214,500 Dividends 6,500 Sales Revenue 823,000 Service Revenue 32,700 Cost of Goods Sold 634,100 Salaries Expense 167,500 Depreciation Expense 12,600 Lease Expense 26,000 Interest Expense 1,500 Bad Debt Expense 3,200 Insurance Expense 21,000 $ 1,314,800 $ 1,314,800

Topic: Prepare financial statements from an adjusted trial balance. LO 6 20. Clemsy Tines Corp. is preparing its financial statements for the year ended December 31, 2019, from the adjusted trial balance above. What are the total revenue and total expenses on Clemsy’s income statement for the year ended December 31, 2019? Total Revenues Total Expenses A) $874,900 $865,900 B) $855,700 $872,400 C) $855,700 $865,900 D) $874,900 $872,400 E) Some other pair of numbers. Answer: C Rationale: Total revenues is the sum of Sales Revenue and Service Revenue (823,000 + 32,700 = 855,700) and total expenses (from Cost of Goods Sold to Insurance Expense) equals $865,900. The distractor expense above comes from adding Dividends as an expense. The distractor revenue comes from adding Deferred Revenue as a revenue amount. © Cambridge Business Publishers, 2023 2-12

Test Bank, Chapter 2

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Topic: Prepare financial statements from an adjusted trial balance. LO 6 21. When Clemsy prepares its Statement of Stockholders’ Equity for the year ended December 31, 2019, the balance of Retained Earnings as of December 31, 2019, should be A) $214,500 B) $197,800 C) $217,000 D) $210,500 E) Some other number. Answer: B Rationale: Beginning balance of R/E January 1, 2019 Revenues: Expenses: Net loss Less dividends Ending balance of R/E December 31, 2019

$214,500 $855,700 865,900 (10,200) (6,500) $197,800

Topic: Prepare financial statements from an adjusted trial balance LO 6 22. On Clemsy’s Balance Sheet dated December 31, 2019, total assets should equal A) $442,400 B) $410,000 C) $435,900 D) $403,500 E) Some other number. Answer: D Rationale: Cash A/R Less Allowance Inventory Prepaid Insurance Equipment Less A/D Total Assets

$19,600 $98,500 6,500

178,400 32,400

92,000 134,900 11,000 146,000 $403,500

Topic: Prepare financial statements from an adjusted trial balance LO 6 23. On Clemsy’s Balance Sheet dated December 31, 2019, total stockholders’ equity should equal: A) $337,000 B) $317,800 C) $334,500 D) $330,500 E) Some other number. Answer: B Rationale: Total stockholders’ equity equals Common Stock plus Retained Earnings equals $317,800 ($120,000 + 197,800).

Intermediate Accounting, 3rd Edition

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Topic: Prepare and post closing entries and prepare a post-closing trial balance. LO 8 24. What statement(s) below is(are) true? A) The total of the debit column in a post-closing trial balance will always equal the total assets on the current balance sheet. B) The post-closing trial balance presents the balances of all the permanent accounts of a company. C) The balance of the retained earnings account is the only permanent account whose balance changes from that in the adjusted trial balance. D) Both B and C. E) A, B, and C. Answer: D Rationale: A is incorrect when there are contra asset accounts (whose balances are credits) and hence left out of the total debit balances. B and C are both true – only permanent accounts (assets, liabilities, and stockholders’ equity accounts) are left with any balances after the closing entries are made, and the one goal of closing entries is to update the balance in Retained Earnings.

Topic: Prepare and post closing entries and prepare a post-closing trial balance. LO 8 25. The purpose(s) of closing entries is(are) to: A) Transfer the balances of temporary accounts to Retained Earnings. B) Set the balances of income statement accounts only to zero at the end of the fiscal year. C) Update the balance of Retained Earnings for the effect of current year net income/(loss) and dividends declared. D) A, B, and C are all true. E) A and C are true. Answer: E Rationale: B is incorrect because if there is a Dividends account, its balance too should be set to zero, but it is not part of the income statement. E is correct – closing entries transfer the balances of all temporary accounts (revenues, expenses, gains, losses, and dividends) to Retained Earnings and another goal of closing entries is to update Retained Earnings for the current year’s net income/(loss) and dividends declared.

Topic: Prepare and post closing entries and prepare a post-closing trial balance. LO 8 26. After the first two closing entries, Culmsy Corp. had the following balances in its general ledger: Dividends 14,000

Income Summary 730,200 745,850

Retained Earnings 144,800

What additional entry will be made as part of the closing process? A) Debit Income Summary and credit Dividends for $14,000 B) Debit Retained Earnings and credit Income Summary for $144,800 C) Debit Retained Earnings and credit Income Summary for $15,650 D) Debit Income Summary and credit Retained Earnings for $15,650

Test Bank, Chapter 2

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Answer: D Rationale: A is incorrect because Dividends is closed to Retained Earnings, not Income Summary. B is incorrect because we do not close out the existing balance in Retained Earnings. C is incorrect because the goal in the next entry is to close out the balance in Income Summary to Retained Earnings. The current balance in Income Summary is a credit balance of $15,650. The entry in C would actually double the existing account balance in Income Summary. D is correct because debiting Income Summary for the existing credit balance will zero out the Income Summary account and correctly update Retained Earnings.

Topic: Prepare and post closing entries and prepare a post-closing trial balance. LO 8 27. What statement(s) is(are) true about the income summary account? A) Dividends get closed to Income Summary. B) Income Summary is a permanent account. C) After closing entries, the balance in Income Summary is zero. D) The beginning balance in Retained Earnings gets closed to Income Summary. E) In the final closing entry involving Income Summary, Income Summary is debited. Answer: C Rationale: A is incorrect – Dividends get closed to Retained Earnings. B is incorrect because Income Summary gets closed out itself in the closing process. The beginning balance in Retained Earnings stays in the account, so D is false. If Income Summary has a net debit balance by the final entry involving Income Summary, then the account will be credited, so E is incorrect. C is correct because Income Summary is a temporary clearing account.

Topic: Convert from cash-basis to accrual-basis net income LO 8 28. Sinker Ball Dynamics, Inc. shows the following information in its records: As of December 31 Accounts receivable Deferred revenue Prepaid operating expenses Accrued liabilities

2018 2019 8,000 $ 6,500 1,500 6,000 9,800 4,000 7,800 5,200

For the year ended 2020 Cash receipts from customers $ 260,000 Cash paid for operating expenses 110,000

What is the accrual-based revenue that Sinker Ball Dynamics earned in the year ended December 31, 2019? A) $257,000 B) $254,000 C) $263,000 D) $266,000 E) Some other number. Answer: B Rationale: Cash receipts Less beg. A/R Plus end A/R Add beg. Def rev Less end def rev

$ 260,000 (8,000) 6,500 1,500 (6,000)

Accrual revenue

$ 254,000

Intermediate Accounting, 3rd Edition

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Topic: Convert from cash-basis to accrual-basis net income LO 8 29. Sinker Ball Dynamics, Inc. shows the following information in its records: As of December 31 Accounts receivable Deferred revenue Prepaid operating expenses Accrued liabilities

2018 2019 $ 8,000 $ 6,500 1,500 6,000 9,800 4,000 7,800 5,200

For the year ended 2020 Cash receipts from customers $ 260,000 Cash paid for operating expenses 110,000

What is the accrual-based operating expenses that Sinker Ball Dynamics incurred in the year ended December 31, 2019? A) $113,200 B) $101,600 C) $106,800 D) $118,400 E) Some other number. Answer: A Rationale: Cash payments Add beg pp exp Less end pp exp Less beg payables Add end payables

$ 110,000 9,800 (4,000) (7,800) 5,200

Accrual expenses

$ 113,200

Topic: Prepare reversing entries LO 9 30. Williamson Artist Supply Co. recorded an adjusting journal entry on December 31, 2019, to accrue $23,500 of Salaries and Wages Expense incurred by the company for work completed in 2019, but payable to the employees in the first payroll checks in January. On January 1, 2020, the company’s bookkeeper reversed the adjusting entry. On January 9, 2020, Williamson paid a total of $54,200 in salaries and wages for the first pay period ending in 2020. What would the balance in Williamson’s Salaries and Wages Expense account be on January 9, 2020, after the payroll entry was posted to the ledger? A) $77,700 B) $54,200 C) $30,700 D) $23,500 E) Some other number. Answer: C Rationale: The reversing entry created a credit balance of $23,500 in the Salaries and Wages Expense account on January 1, 2020. When the first pay of 2020 was recorded and posted as a debit to the Salaries and Wages Expense account, the resulting balance would be $54,200 - $23,500 = $30,700.

Test Bank, Chapter 2

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Topic: Prepare reversing entries LO 9 31. Which of the following adjusting journal entries made on December 31, 2020, are eligible for reversing entries to be made on January 1, 2021? 1. 2. 3. 4. 5. A) B) C) D) E)

Debit Interest Expense and credit Interest Payable Debit Lease Expense and credit Prepaid Lease Debit Depreciation Expense and credit Accumulated Depreciation – Equipment Debit Prepaid Advertising and credit Advertising Expense Debit Deferred Service Revenue and credit Service Revenue

Entries 1, 2, 4, and 5 are eligible. All five of the entries are eligible. Entries 1, 4, and 5 are eligible. Entries 1 and 4 are eligible. Only entry 1 is eligible.

Answer: D Rationale: Reversing entries are only appropriate for adjusting entries that defer the recognition of revenue or expense items recorded initially as revenue or expense in full (Entry 4) or accrue revenue or expense items during the current period (Entry 1). The other entries do not meet either of these requirements.

Intermediate Accounting, 3rd Edition

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Chapter 3 Income Statement and Comprehensive Income Learning Objectives – Coverage by question Multiple Choice

LO 3-1 – Prepare an income statement using single-step and multiplestep formats, focusing on income from continuing operations

1-5

LO 3-2 – Record the impact of unusual and infrequent items

6-10

LO 3-3 – Prepare an income statement to include discontinued operations

11-15

LO 3-4 – Disclose earnings per share on the income statement

16-17

LO 3-5 – Report other comprehensive income

18-21

LO 3-6 – Describe the statement of stockholders’ equity

22-24

LO 3-7 – Report changes in accounting estimate, changes in accounting principle, and error corrections

25-28

LO 3-8 – Appendix 3A Describe interim financial reporting

29-30

Intermediate Accounting, 3rd Edition

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Chapter 3: Income Statement and Comprehensive Income Multiple Choice Topic: Prepare an income statement using multiple-step format LO: 3 1. Lannon Industries is a manufacturer of outdoor furniture. Which of the following expenses incurred during the year would be reported as an operating expense in a multiple-step income statement? A) Cost of factory employee health insurance B) Depreciation of sales office equipment C) Interest on note payable D) A and B E) B and C F) All of the above Answer: D Rationale: Interest is considered a non-operating expense. Depreciation and employee benefits are costs incurred in efforts to generate revenue.

Topic: Prepare an income statement using single-step format LO: 1 2. Which of the following subtotals would not be included on a single-step income statement? A) Gross profit B) Total expenses and losses C) Operating income D) A and B E) B and C F) A and C Answer: F Rationale: Gross profit and income from operations are not subtotals appearing on single-step income statements

Use the following information to answer Questions 3-5. The accounting records of Marlon’s Marvels, a retail store, show the following balances for the fiscal year ending June 30, 2020: Store sales revenue Marketing expense Interest expense Loss on sale of investment Other administrative expenses

$4,420,000 124,900 20,350 12,000 108,000

Salaries expense Depreciation expense Cost of goods sold Rent and utilities expense Dividend income

$800,000 62,500 2,652,000 110,000 2,000

Test Bank, Chapter 3

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Topic: Prepare an income statement using multiple-step format LO: 1 3. In a multiple-step statement, Operating income would total ________________. A) $532,250 B) $542,250 C) $562,600 D) $625,100 Answer: C Rationale: Gross profit 1,768,000 (4,420,000 – 2,652,000) less operating expenses 1,205,400 (800,000+124,900+110,000+62,500+108,000) = $562,600

Topic: Prepare an income statement using single step format LO: 1 4. In a single-step statement, total revenues and gains would total ________________. A) $1,768,000 B) $1,770,000 C) $4,410,000 D) $4,420,000 E) $4,422,000 Answer: E Rationale: Store revenue ($4,420,000) plus Dividend income ($2,000)

Topic: Prepare and income statement using single-step and multiple-step formats LO: 1 5. When the multiple-step and single-step income statements for Mason’s Marvels are compared, net income ________________. A) Would be higher (by $2,000) on the multiple-step statement B) Would be lower by ($12,000) on the multiple-step statement C) Would be lower by ($30,350) on the multi-step statement D) Would be the same (in dollars) on both statements Answer: D Rationale: There is no difference in net income between multi-step and single-step income statements.

Topic: Report the impact of unusual and infrequent items LO: 2 6. Wanton Industries, a company located in San Diego, suffered considerable damage to its warehouse due to a January blizzard. The total cost to repair the damage was $200,000. Income from operations (not including the $200,000 in repair costs) was $335,450. In the income statement for the year ended 12/31, Wanton Industries _______________. A) Could report the $200,000, net of taxes, as a separate line item in the Other expenses and losses section B) Could disclose the cost to repair the damage but not include the amount in the income statement. C) Could either report the $200,000 as a separate line item in the Other expenses and losses section or include the amount with similar costs in that section and disclose the details in a note. D) Could report the $200,000 as part of discontinued operations, net of tax. Answer: C Rationale: 220-20-45-1 allows for two reporting alternatives

Intermediate Accounting, 3rd Edition

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Use the following information to answer Questions 7-10. The accounting records of Slater Corporation, a small manufacturing company, show the following balances for the fiscal year ending December 31, 2019: Sales revenue Research and development Interest income Restructuring costs Interest expense

$3,425,000 96,400 18,400 112,000 32,000

Selling expense Gain on sale of bonds Cost of goods sold General and administrative expense

$782,000 20,300 1,611,000 585,700

The restructuring costs were incurred as a result of one-time changes in raw materials management. Slater prepares multiple-step income statements. Use 25% as the tax rate.

Topic: Report the impact of unusual and infrequent items LO: 2 7. Slater Corporation’s Net income for 2019 equals ______. A) $183,450 B) $244,600 C) $267,450 D) $262,425 E) $334,725 Answer: A Rationale: Gross profit $1,814,000 (3,425,000 – 1,611,000) less operating expenses $1,464,100 (782,000+585,700+96,400) – Other income/expense $(105,300) (18,400+20,300-32,000-112,000) = Income before tax $244,600. Income before tax – Tax $61,150 (244,600 * .25) = $183,450

Topic: Report the impact of unusual and infrequent items LO: 2 8. Operating expenses for Slater Corporation totaled ___________ in 2019. A) $1,367,700 B) $1,399,700 C) $1,464,100 D) $1,496,100 E) $1,608,100 Answer: C Rationale: Selling (782,000) + General and Administrative (585,700) + Research and Development (96,400) = $1,464,100

Test Bank, Chapter 3

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Topic: Report the impact of unusual and infrequent items LO: 2 9. Slater Corporation’s Operating income for 2019 equals __________. A) $1,814,000 B) $349,900 C) $244,600 D) $317,900 E) $336,300 Answer: B Rationale: Gross profit $1,814,000 (3,425,000 – 1,611,000) – Operating expenses $1,464,100 from Question 8 = $349,900

Topic: Report the impact of unusual and infrequent items LO: 2 10. Other expenses and losses on Slater Corporation’s Income statement totaled __________ in 2019. A) $112,000 B) $1,608,100 C) $1,399,700 D) $105,300 E) $144,000 Answer: E Rationale; Interest expense (32,000) + Restructuring costs (112,000) = $144,000

Topic: Prepare an income statement to include discontinued operations LO: 3 11. In June 2019, Fiona Fitness announced that its line of protein shakes (a major line of business which represented 15% of Fiona’s revenue) was being discontinued. The protein shake line was ultimately sold in early 2020. In Fiona’s annual financial statements for 2019, three years of operations were presented in the income statement (2017, 2018, and 2019). Results of operations for the protein shake line would be reported AFTER income from continuing operations in the 2019 statements _________________. A) Only for 2019 results B) For 2017, 2018, and 2019 results C) For none of the years. Gains or losses from the discontinued product line would not be presented until the product line was sold in 2020. D) For 2019 results only if there was a loss from operations for the protein shake line in 2019. E) For 2017, 2018, and 2019 results only if there was an impairment loss on the protein shake line in 2019. Answer: B Rationale: Once the decision to sell or otherwise dispose of a business component is made, results of the to be discontinued operation “are removed from continuing operations for all years presented”. (pg 3-10)

Intermediate Accounting, 3rd Edition

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Topic: Prepare an income statement to include discontinued operations LO: 3 12. Which categories of income from discontinued operations might be presented on the Income statement of a company, assuming the discontinued component was sold after year end? A) Gain from discontinued component, net of tax B) Loss on disposal of discontinued component, net of tax C) Impairment loss on discontinued component, net of tax D) A and B E) A and C F) A, B, and C Answer: E Rationale: B would not be presented since discontinued component had not been sold as of year-end.

Use the following information to answer Questions 13-14. In June 2019, Fiona Fitness announced that its line of protein shakes (a major line of business which represented 15% of Fiona’s revenue) was being discontinued. The line was ultimately sold in early 2020. Additional financial information for the protein shake product line: Operating loss in 2019 Operating loss in 2020 Impairment loss in 2019 Gain on sale of line in 2020 Fiona’s tax rate for both 2019 and 2020 Fiona’s year end

$26,500 $11,000 $12,000 $8,000 25% 12/31

Topic: Prepare an income statement to include discontinued operations LO: 3 13. How much, in total, should be reported in Fiona Fitness’s income statement as Discontinued operations for 2019? A) $(28,875) B) $(19,875) C) $0 D) $(38,500) E) $(31,125) Answer: A Rationale: Operating loss in 2019 (26,500) + Impairment loss in 2019 (12,000) – Taxes ((26,500+12,000) * 0.75) = $(28,875).

Test Bank, Chapter 3

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Topic: Prepare an income statement to included discontinue operations LO: 3 14. How much, in total, should be reported in Fiona Fitness’s income statement as Discontinued operations for 2020? A) $(31,125) B) $(15,000) C) $(2,250) D) $(8,250) E) $0 Answer: C Rationale: Operating loss in 2020 (11,000) + Gain on sale in 2019 (8,000) = loss of $3,000. Net of taxes (3,000*.75) = $(2,250).

Topic: Prepare an income statement to include discontinued operations 15. In June 2019, Fiona Fitness announced that its line of protein shakes (a major line of business which represented 15% of Fiona’s revenue) was being discontinued. The line was ultimately sold in early 2020. In 2019, Jensen Industries reported gross profit of $875,000, Operating expenses of $350,000, Interest expense of $26,500; and loss from discontinued operations of $88,000. The company’s tax rate was 25%. In the Income statement for 2019, what did the company report as Income from continuing operations and net income, respectively? A) $498,500; $432,500 B) $373,875; $307,875 C) $498,500; $410,500 D) $373,875; $285,875 Answer: B Rationale: Income from continuing operations before tax = $498,500 (875,000-350,000-26,500). Income from continuing operations = $373,875 (498,500-(25%*498,500 or 124,625)

Topic: Disclose earnings per share on the income statement LO: 4 16. Which of the following per share amounts would be reported in a company with no preferred stock and no discontinued operations? A) Earnings per share – Gross profit B) Earnings per share – Income from continuing operations C) Earnings per share – Net income D) A and B E) A and C F) B and C G) A, B, and C Answer: C Rationale: 260-10-45-2 Entities with simple capital structures ….. shall present basic per-share amounts for income from continuing operations and for net income. (p.3-15) Since there are no discontinued operations in the problem, there would be no separate amount for income from continuing operations.

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Topic: Disclose earnings per share on the income statement LO: 4 17. Lansing Corporation declared and paid preferred dividends of $50,000 in 2019. There were 100,000 weighted average common shares outstanding. 2019 Net income for the company totaled $1,500,000. The company reported a loss from discontinued component (net of tax) of $50,000 and a loss on sale of discontinued component (net of tax) of $10,000 during the year. What was reported as earnings per share for continuing operations for 2019? A) $15.10 B) $14.50 C) $15.60 D) $15.00 E) $14.40 F) $13.90 Answer: A Rationale: Income from continuing operations equals 1,560,000 (Net income (1,500,000) + losses on discontinued component (60,000). Income from continuing operations (1,560,000) – Preferred dividends (50,000) = 1,510,000 divided by 100,000 shares = $15.10 per share

Topic: Report other comprehensive income LO: 5 18. Which of the following financial statement presentation formats would be acceptable in a company with unrealized holding gains on debt investments (other comprehensive income). A) A single statement of Comprehensive Income B) Two consecutive statements (An Income Statement followed by a Statement of Comprehensive Income) C) A single statement of Net Income with components of comprehensive income disclosed in the footnotes. D) A and B E) A and C F) B and C G) A, B, and C Answer: D Rationale: 220-10-45-1A supports the single statement format (A). 220-10-45-1B supports the two consecutive statement format (B).

Test Bank, Chapter 3

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Use the following information to answer Questions 19-20. Pendergrass Industries had the following account balances at 12/31/20 (the end of its fiscal year): Sales revenue Foreign currency translation adjustment, gain General and administrative expense Gain on sale of investments

$2,800,000 12,500 285,000 21,500

Selling expense Interest expense Cost of goods sold Interest income

$360,000 32,000 1,585,000 16,300

The company’s tax rate was 25%.

Topic: Report other comprehensive income LO: 5 19. Pendergrass Industries reported $_____________ in Other comprehensive income in its Statement of Comprehensive Income in 2020. A) $12,500 B) $34,000 C) $16,125 D) $9,375 E) $25,500 Answer: D Rationale: Foreign currency translation gain (12,500), net of tax at 25% (3,125) = $9,375

Topic: Report other comprehensive income LO: 5 20. Comprehensive income for Pendergrass Industries in 2020 totaled $_____________. A) $570,000 B) $431,850 C) $444,350 D) $441,225 Answer: D Rationale: Income before tax = 575,800 (2,800,000 – 1,585,000 – 360,000 – 32,000 – 285,000 + 16,300 + 21,500). Net income = 431,850 (575,800 – 25% * 575,800). Other comprehensive income, net = 9,375 (12,500 – 25% of 12,500). Comprehensive income = $441,225. (431,850 + 9,375)

Topic: Report other comprehensive income LO: 5 21. Which of the following statements is not true? A) Net income does not need to be separately stated In a single continuous statement of comprehensive income. B) If two consecutive statements are presented, the Statement of Comprehensive Income should follow the Income Statement. C) Other comprehensive income is reported net of tax. D) Foreign currency translation adjustments would be reported in the Other comprehensive income section of the Statement of Comprehensive Income. Answer: A Rationale: 220-10-45-1A specifies that net income should be presented in a separate section of a single continuous statement. © Cambridge Business Publishers, 2023 3-9

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Topic: Describe the statement of stockholders’ equity LO: 6 22. Nigel Imports, Inc. opened on July 1, 2019 with $250,000 from the sale of common stock. The company reported $622,000 in net income for the year ended June 30, 2020 (its first year of operations). On June 1, 2020, a $10,000 dividend was declared. (The dividend was paid on July 1.) Nigel reported a $5,000 foreign currency translation adjustment loss for the year. The company’s tax rate was 25%. What was the balance in Retained Earnings on June 30, 2020? A) $622,000 B) $612,000 C) $608,250 D) $607,000 Answer: B Rationale: Net income (622,000) – Dividends (10,000) = $612,000 Topic: Describe the statement of stockholders’ equity LO: 6 23. Nigel Imports, Inc. opened on July 1, 2019 with $250,000 from the sale of common stock. The company reported $622,000 in net income for the year ended June 30, 2020 (its first year of operations). On June 1, 2020, a $10,000 dividend was declared. (The dividend was paid on July 1.) Nigel reported a $5,000 foreign currency translation adjustment loss for the year. The company’s tax rate was 25%. What was the balance in Accumulated Other Comprehensive Income on June 30, 2020? A) $0 B) $(5,000) C) $(3,750) D) $5,000 E) $3,750 Answer: C Rationale: Foreign currency translation adjustment loss (5,000) net of tax savings at 25% (1,250) = $(3,750) Topic: Describe the statement of stockholders’ equity LO: 6 24. Nigel Imports, Inc. opened on July 1, 2019 with $250,000 from the sale of common stock. The company reported $622,000 in net income for the year ended June 30, 2020 (its first year of operations). On June 1, 2020, a $10,000 dividend was declared. (The dividend was paid on July 1.) Nigel reported a $5,000 foreign currency translation adjustment loss for the year. The company’s tax rate was 25%. Stockholders’ Equity totaled _____________on June 30, 2020. A) $612,000 B) $608,250 C) $858,250 D) $857,000 E) $862,000 Answer: C Rationale: Common stock (250,000) + Retained Earnings from Question 22 (612,000) + Accumulated Other Comprehensive Loss from Question 23 (3,750) = $858,250

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Topic: Report changes in accounting estimate, changes in accounting principle, and error corrections LO: 7 25. Which of the following would be considered a change in accounting principle? A) A change from the LIFO method to the FIFO method of inventory valuation B) A change from the Double-Declining-Balance method to the Straight-line Depreciation method for depreciating factory equipment C) A change in the method used to calculate research and development expense following the adoption of a new accounting standard D) A and B E) A and C F) B and C G) A, B, and C Answer: E Rationale: A change in depreciation method (B) is treated as a change in estimate (250-10-45-18)

Topic: Report changes in accounting estimate, changes in accounting principle, and error corrections LO: 7 26. In 2020, Henderson Fashions, Inc. found and corrected an error in its method of calculating deferred revenue. The error in method originated in 2017, and resulted in material overstatements of revenue in 2017 and in each of the following three years. Which of the following would not need to be disclosed in the financial statements issued for 2020? (Henderson Fashions presents three years of operating results in its financial statements.) A) Statement that previously issued statements have been restated B) Description of the error C) Effect of the correction in 2017 operating results, by line item D) Effect of the correction in 2018 operating results, by line item E) Effect of the correction in 2019 operating results, by line item F) Cumulative effect of the change to Retained Earnings at the beginning of 2018. Answer: C Rationale: 2017 operating results were not presented in the 2020 financial statements. The effect of the 2017 error would be disclosed as cumulative effect of the change to Retained Earnings at the beginning of 2018.

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Topic: Report changes in accounting estimate, changes in accounting principle, and error corrections LO: 7 27. Stetson Industries purchased and placed in service equipment costing $50,000 on January 1, 2016. The equipment was expected to last 8 years and to have no salvage value. The factory manager revised the estimate of the equipment’s useful life on January 1, 2020. The equipment was now expected to last another 8 years (a useful life of 12 years in total). The company used the straight-line method to depreciate factory equipment. What is the new annual depreciation expense amount? A) $2,083 B) $3,125 C) $4,167 D) $6,250 Answer: B Rationale: Accumulated depreciation at 1/1/20 = $25,000 (50,000/8*4 years (Jan. 2016 – Dec. 2019)). Net book value at 1/1/20 is $25,000 (50,000 – 25,000). Remaining life in years is 8 (12-4). New annual depreciation amount is $3,125 (25,000/8.)

Topic: Report changes in accounting estimate, changes in accounting principle, and error corrections LO: 7 28. In 2018 and 2019, Drake Manufacturing reported its gross margin as follows:

Drake Manufacturing Partial Income Statement

Sales Cost of Goods Sold Gross margin

$ $

2018 2019 1,680,000 $ 1,835,000 750,400 884,600 929,600 $ 950,400

In 2020, Drake Manufacturing changed its inventory valuation method. If the new inventory method had been used in 2018 and 2019, cost of goods sold would have been less by $25,000 in 2018 and by $35,000 in 2019. In the 2020 financial statements, what should be reported for the 2019 gross margin? A) $915,400 B) $890,400 C) $950,400. There would be no difference in the amount reported since the inventory valuation method wasn’t changed until 2020. D) $985,400 E) $1,040,400 Answer: D Rationale: Originally reported gross margin of 950,400 would be increased by 35,000 for a total of $985,400. (New cost of goods sold would be 849,600.)

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Topic: Describe interim financial reporting LO: 8 29. Manatee Imports, Inc., a publicly traded company, is preparing its interim report for the quarter ended June 30, 2020. Which of the following costs incurred during the quarter should be reported (expensed) in full in the Income statement? A) Cost of goods sold B) First and last month rent payment for warehouse opened in June C) Loss on sale of sales department computer equipment D) A and B E) A and C F) B and C G) A, B, and C Answer: E Rationale: Cost of goods sold is a cost directly associated with revenue (270-10-45-4); Losses that would not be deferred at year end should not be deferred (or allocated) to later interim periods (27010-45-8). Although the June rent would be recognized in full in the interim statement, the last month’s rent should be recognized in the period the benefit is received.

Topic: Describe interim financial reporting LO: 8 30. Holliday Cameras, Inc., a publicly traded company, is preparing its interim report for the third quarter of the year. (Holliday’s year end is December 31.) Annual insurance premium paid July 1 Depreciation on van purchased at end of second quarter (3 year life, no salvage value, straight-line depreciation method) Bonuses based on third quarter revenues paid to sales staff on 10/15 Bonus based on second quarter earnings paid to general manager on 7/31

$240,000 $36,000 purchase price $75,000 $35,000

Determine the total expense reported for the quarter related to the following costs: A) $138,000 B) $56,000 C) $98,000 D) $275,000 E) $386,000 Answer: A Rationale: Three months insurance $60,000 (240,000/4) + three months depreciation $3,000 (36,000/36*3) + bonuses based on third quarter earnings $75,000 = $138,000. Bonuses based on second quarter earnings would not be recognized in the third quarter interim report.

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Chapter 4 Balance Sheet and Financial Reporting Learning Objectives – Coverage by question Multiple Choice

LO 4-1 – Identify classifications of asset, liability, and equity accounts on the balance sheet

1-7

LO 4-2 – Prepare a classified balance sheet

8-14

LO 4-3 – Explain notes to financial statements

15-20

LO 4-4 – Describe SEC ﬁlings of publicly traded companies in the U.S.

21-26

LO 4-5 – Appendix 4A Identify segment reporting requirements

27-30

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Chapter 4: Balance Sheet and Financial Reporting Multiple Choice Topic: Identify classifications of asset, liability, and equity accounts on the balance sheet LO: 1 1. In what order would the following accounts normally be listed in a classified balance sheet? a. b. c. d. A) B) C) D) E)

Retained earnings Accumulated other comprehensive income Noncontrolling interest Common stock

a, b, c, d a, d, b, c d, a, b, c d, a, c, b d, b, a, c

Answer: C Rationale: Capital stock is normally listed first in the equity section. Then retained earnings and accumulated other comprehensive income. Noncontrolling interests would normally be listed last.

Topic: Identify classifications of asset, liability, and equity accounts on the balance sheet LO: 1 2. We Got This, LLC is an event-planning company. Which of the following would be included in the current asset section of a classified balance sheet dated December 31, 2019? a. b. c. d. e. f. A) B) C) D) E)

15-month certificate of deposit Customer advances on New Year’s parties Last month rent payment (lease expires in 2021) Investment in stocks, to be sold in 2020 Income tax refund receivable Inventory

d, e, and f a, b, c, e, and f b, e, f a, b, c, d, e, and f e and f

Answer: A Rationale: The 15-month certificate of deposit and last month’s rent payment will not be converted to cash or consumed within the next 12 months.

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Topic: Identify classifications of asset, liability, and equity accounts on the balance sheet LO: 1 3. PIA Services (a nonprofit organization) has the following account balances at 6/30/2020. Cash, general checking Savings, money market account Cash, checking account

$15,000 50,000 2,500

Fair value of equity security (to be sold in July) Cash restricted for equipment purchase in August

How much should be reported as Cash and cash equivalents in its classified balance sheet? A) $108,500 B) $73,500 C) $67,500 D) $50,000 E) $17,500 Answer: C Rationale: Restricted cash and marketable securities are not considered cash equivalents

Topic: Identify classifications of asset, liability, and equity accounts on the balance sheet LO: 1 4. Picollo Manufacturing, Inc. has the following liabilities at June 30, 2020. Line of credit, due on demand

$103,500

Deferred revenue

38,000

Accounts payable

$35,000

Federal income tax payable

16,200

Note payable, issued June 30, 2020, due in monthly installments of $5,000 plus interest

250,000

7%, 20-year bonds payable, issued July 1, 2010, interest payable annually on 7/1

150,000

How much should be reported in the Current liabilities and Long term liabilities sections, respectively, of its classified balance sheet? A) $51,200, $541,500 B) $89,200; $503,500 C) $99,700; $503,500 D) $149,200; 443,500 E) $159,700; $443,500 F) $263,200; $340,000 Answer: F Rationale: Current liabilities include Line of credit, Accounts payable, Deferred revenue, Federal income tax payable, $60,000 of the Note payable (5,000 x 12), and interest on the Bond ($150,000 x 7%). The balance in Note payable ($190,000) and the Bond payable would be reported in the longterm liabilities section.

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$ 6,000 35,000

Topic: Identify classifications of asset, liability, and equity accounts on the balance sheet LO: 1 5. Which account types are listed in order of permanence in a classified balance sheet? A) Long term liabilities and Equity B) Equity C) Long term assets and Long term Liabilities D) Long term assets, Long term liabilities, and Equity E) No account types are listed in order of permanence. Answer: B Rationale: “Stockholder’s equity items are classified and presented in order of permanence”. (p. 4-9) Assets are reported in order of liquidity and liabilities are generally reported in order of time to maturity (p. 4-3 and p. 4-7)

Topic: Identify classifications of asset, liability, and equity accounts on the balance sheet LO: 1 6. Which of the following statements are accurate? a. Equity attributable to noncontrolling interests in the net assets of a company's subsidiaries is shown separately on the balance sheet. b. An election to report certain individual asset at fair market value can be revoked at a subsequent balance sheet date. c. Investments in nonconsolidated subsidiaries should be reported as Long-term investments. d. Companies with operating cycles longer than one year should use one-year when classifying assets or liabilities as current. e. The cost of unusable and unsaleable warehouse equipment should be reported as an Other asset until the equipment is fully depreciated. A) B) C) D) E) F)

All of the statements are accurate a, b, c, and e a, c, and e d and e a and c b, c, and e

Answer: E Rationale: Statement b is not accurate (“The fair value option …. is generally not revocable” p. 4-4). Statement d is not accurate (210-10-45-3 states “if the period of the operating cycle is more than 12 months ……. the longer period shall be used.) Statement e is not accurate since the equipment is not an asset – is not a right to an economic benefit (SFAC No. 8 E17)

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Topic: Identify classifications of asset, liability, and equity accounts on the balance sheet LO: 1 7. Perrin’s Bank, a commercial bank, has the following account balances (partial list) at December 31, 2019: Interest bearing deposits with the Federal Reserve Goodwill Consumer residential loans ($600,000 due in 2020) Allowance for losses on consumer residential loans

$785,000 432,000 $8,665,000 102,000

The total reported as Current assets from the above list would be ________________. A) $9,984,000 B) $9,780,000 C) $9,348,000 D) $1,283,000 E) $498,000 F) $0 Answer: F Rationale: “Financial institutions do not use a current asset designation…” p. 4-11 Challenge question

Use the following information to answer Questions 8-10. Rizzo Corporation had the following balances at December 31, 2020: Property, plant, and equipment Interest payable

$1,255,000

Goodwill

$212,000

6,000

Common stock

5,000

Line of credit, due on demand

120,000

Prepaid insurance

24,000

Customer list

35,000

Accounts payable

50,000

Additional paid-in capital

545,000

Retained earnings December 31, 2019

410,000

Salaries payable

12,000

Accumulated depreciation

145,000

Cash and cash equivalents

85,000

Accounts receivable, net

120,000

Pension liability

65,000

Accumulated other comprehensive loss

Inventory

436,000

Note payable, due in annual installments of $25,000 plus interest on December 31

Land held for future expansion

136,000

5,000 675,000

Net income for 2020 totaled $325,000. The company declared dividends of $50,000 on December 15, 2019.

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Topic: Prepare a classified balance sheet LO: 2 8. How much did Rizzo Corporation report as Current liabilities and Long-term liabilities, respectively, in its classified 2020 Balance sheet? A) $68,000; $860,000 B) $213,000; $715,000 C) $188,000; $740,000 D) $253,000; $675,000 E) $278,000; $650,000 Answer: B Rationale: Current liabilities $213,000 (Line of credit + Accounts payable, + Salaries payable, + Interest payable + Current portion of long term debt ($25,000). Long term liabilities $715,000 (Long term debt net of current portion ($650,000) + Pension liability

Topic: Prepare a classified balance sheet LO: 2 9. Rizzo Corporation’s working capital totaled ________________ at the end of 2020. A) $452,000 B) $477,000 C) $733,000 D) $588,000 E) $487,000 Answer: A Rationale: Current assets $665,000 (85,000 + 120,000 + 436,000 + 24,000) – current liabilities $213,000 (from Question 8) = $452,000

Topic: Prepare a classified balance sheet LO: 2 10. How much did Rizzo Corporation report as Stockholders’ equity in the 2020 Balance sheet? A) $960,000 B) $955,000 C) $1,280,000 D) $1,230,000 E) $1,290,000 Answer: D Rationale; Common stock $5,000 + Additional paid-in capital $545,000 + Retained earnings $ 685,000 (Beginning R/E 410,000 + Net income 325,000 – Dividends 50,000) – Accumulated other comprehensive loss $5,000)

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Topic: Prepare a classified balance sheet LO: 2 11. Piccadilly, Inc. has a working capital ratio (Current assets divided by Current liabilities) of 1.5. Accounts payable equals $10,000. If Piccadilly uses $5,000 of its available cash to reduce Accounts payable, the working capital ratio ________. A) will remain the same B) will increase C) will decrease D) might increase or decrease but would need additional information to determine the effect. Answer: B Rationale: Subtracting equal amounts from the numerator and the denominator of a ratio greater than one will increase the ratio.

Topic: Prepare a classified balance sheet LO: 2 12. Piccadilly, Inc. has a working capital ratio (Current assets divided by Current liabilities) of 0.9. Accounts payable equals $10,000. If Piccadilly uses $5,000 of its available cash to reduce Accounts payable, the working capital ratio ________. A) will remain the same B) will increase C) will decrease D) might increase or decrease but would need additional information to determine the effect. Answer: C Rationale: Subtracting equal amounts from the numerator and the denominator of a ratio less than one will decrease the ratio.

Topic: Prepare a classified balance sheet LO: 2 13. Use the following partial list of accounts to determine the amount that should be reported as total current assets on the balance sheet. Accounts receivable Allowance for doubtful accounts Advance deposits from customers Inventory Investment in trading securities A) B) C) D) E)

$15,000 5,000 2,000 11,000 21,000

$54,000 $44,000 $42,000 $31,000 $21,000

Answer: C Rationale: All accounts other than Advance deposits from customer (which would be reported as a current liability). (15,000-5,000+11,000+21,000)

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Topic: Prepare a classified balance sheet LO: 2 14. Use the following information to determine the amount that should be reported as total Stockholders’ equity on the balance sheet dated December 31, 2020. Common stock Accumulated other comprehensive income Operating expenses Retained earnings, Dec. 31, 2019

$100,000

Treasury stock

16,000 800,000 840,000

Revenues Loss from discontinued component Cost of goods sold

$25,000 2,500,000 11,000 1,250,000

Use 25% as the tax rate. A) B) C) D) E)

$1,260,250 $943,000 $1,410,750 $1,047,250 $1,370,000

Answer: A Rationale: Common stock ($100,000) - Treasury stock ($25,000) + Accumulated other comprehensive income ($16,000) + Retained earnings ($1,169,250) = $1,260,250. Retained earnings = Beginning retained earnings $840,000 + Income from continuing operations before tax $450,000 (2,500,000 – 1,250,000 -800,000) – Tax on income from continuing operations $112,500 ($450,000 x 25%) – Loss from discontinued operations, net $8,750 (11,000 – 25%x11,000) = $1,169,250

Topic: Explain notes accompanying financial statements LO: 3 15. Ping Construction builds custom homes. In accordance with the _________________ principle, Ping includes information about the timing of revenue recognition in its notes to the financial statements. A) Investor information B) Revenue recognition C) Full disclosure D) Generally Accepted Accounting Answer: C Rationale: “Notes to financial statements are a way to provide additional information to financial statement users in accordance with the full disclosure principle.” p. 4-15

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Use the following information about Dublin Enterprises in answering Questions 16-19: a. Dublin has three wholly owned subsidiaries. All companies operate in the retail industry. b. Dublin loaned $250,000, a material amount, to its Chief Executive Officer during the year. The loan is payable over 20 years with interest at 5%. c.

Dublin’s current liabilities exceeded its current assets as of the balance sheet date.

d. Dublin records investments in equity securities at fair market value. All investments are in shares of publicly traded companies. e. Dublin uses FIFO to value its inventory. f.

Dublin has issued 200,000 shares of Common stock, par value $1

g. Dublin terminated one of its Regional Sales Managers subsequent to year end. (The Manager was terminated for poor performance.) h. Dublin uses estimates in determining the useful lives of factory equipment.

Topic: Explain notes accompanying financial statements LO: 3 16. Which of the items above would be reported on the face of Dublin Enterprises’s classified balance sheet? A) d and f B) a, d, and f C) c and f D) f E) All of the items would be disclosed in the classified balance sheet. Answer: C Rationale: Item c: Total amounts of current assets and current liabilities would be listed separately in a classified balance sheet. Item f: Number of shares issued is required to be included on the face of the balance sheet (210-10-S99-1-29)

Topic: Explain notes accompanying financial statements LO: 3 17. Which of the above items would normally be disclosed in the Summary of significant accounting policies note of Dublin Enterprises? A) a, e, and h B) a, d, e, and h C) d and e D) a, e, and h E) a, b, d, e, f, and h Answer: D Rationale: Item a: Basis of consolidation would be described in the Summary note (235-10-50-4); Nature of the business would also be described in the Summary note (235-10-05-5). Item e: Inventory pricing methods would be described in the Summary note (235-10-50-4). Item h: Use of estimates in determining financial statement amounts is required to be disclosed in 275-10-05-6. Items b and d would be disclosed in separate notes. Items c and f are reported on the face of the balance sheet. Item g would not need to be disclosed.

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Topic: Explain notes accompanying financial statements LO: 3 18. Which of the following statements about Dublin Enterprises’s Investment in equity securities is not correct? A) The fair value measurement of the investments would be classified as Level 1. B) Since Dublin Enterprises intends to hold the investments for over a year, the investments would be considered non-recurring items. C) Information about the inputs used in the valuation of the investments would be included in the financial statement note. D) Disclosure information about the investments would be reported in a separate note on fair value. E) All of the statements are correct. F) B and C G) A, B, and C Answer: F Rationale: B: Investments in stocks of publicly traded companies would be a recurring item (evaluated period after period). C: Information about inputs is only required in Level 2 and Level 3 measurements. (ASC 820-10-50-2). Measurements of investments in shares of publicly traded would be classified as Level 1.

Topic: Explain notes accompanying financial statements LO: 3 19. Which of the above items above would not need to be disclosed or reported in Dublin Enterprises’s financial statements? A) a, b, g, and h B) a, g, and h. C) b and h D) b and g E) g Answer: E Rationale: The termination of the Regional Sales Manager subsequent to year end would not be a material event requiring disclosure.

Topic: Explain notes accompanying financial statements LO: 3 20. Which of the following would not need to be disclosed in a related party transaction note? (Assume all related dollar amounts are material.) A) Corporate guarantee of CEO’s home mortgage B) Lease of factory equipment from subsidiary C) Sale of land to parent entity D) All of the above would need to be disclosed. E) None of the above would need to be disclosed. Answer: D Rationale: All of the items would meet the criterion for disclosure in 850-10-05-4.

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Topic: Identify and describe sections of Form 10-K LO: 4 21. Which of the following components of Form 10-K is not directly covered by the Accounting Standards Codification? A) Management’s discussion and analysis B) Segment information C) Notes to the financial statements D) Supplementary information Answer: A Rationale: MD&A requirements are set by the SEC in Regulation S-K. p. 4-24

Topic: Identify and describe sections of Form 10-K LO: 4 22. Management is required to provide information about ________________ in the Management’s Discussion and Analysis of Financial Operations section of Form 10-K. A) the company’s internal controls over financial reporting B) the Auditor’s report C) the company’s liquidity D) fluctuations in the company’s stock price during the year E) all of the above F) none of the above Answer: C Rationale: Liquidity is a required component of the MD&A. p 4-24

Topic: Identify and describe sections of Form 10-K LO: 4 23. Gianni Industries is considering doubling the size of the company’s plant, hopefully using funds borrowed from its bank. What type of financial statement would the company be most likely to prepare for the bank? A) Pro forma statement B) Financial forecast C) Financial projection D) Comparative statement E) Year-end statement Answer: C Rationale: Financial projections show expected results of operations, financial position, and cash flows based on hypothetical assumptions (the plant size was doubled and bank debt was incurred).

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Topic: Identify and describe sections of Form 10-K LO: 4 24. During the audit of Jasper Corporation, the auditors discovered that a material lease obligation that they believed met the criterion for capitalization, had not been capitalized. Jasper Corporation’s management was unwilling to adjust the statements. No other material misstatements were noted. The auditor’s report would likely include a(n) _______________. A) unqualified opinion B) adverse opinion C) unqualified opinion with a special note describing the lease in question D) qualified opinion E) disclaimer of opinion Answer: D Rationale: Since the exception was limited to a single lease obligation, the auditor would likely give a qualified opinion.

Topic: Identify and describe sections of Form 10-K LO: 4 25. Johansen Industries, a public company, is required to file Form 10-K with the SEC. Which of the following statements about the form is(are) accurate? (Johansen Industries is not a large accelerated registrant.) A) Management’s Report on Internal Control over Financial Reporting must be signed by the chief executive officer and chief financial officer of Johansen Industries and by the auditor. B) Cash dividends declared per common share during the last three years must be included in the Selected Financial Data section. C) Johansen Industries must file Form 10-K within 75 days of year-end. D) Comparative financial statements (two years of data for each required statement) must be presented in Form 10-K E) All of the statements are accurate Answer: C Rationale: A: The auditor does not sign management’s report. B: Selected Financial Data is no longer required. D: Three years of data are required for all statements other than the Balance Sheet.

Topic: Identify and describe sections of Form 10-K LO: 4 26. A company’s external auditors are responsible for which of the following? A) The accuracy of the financial statements and accompanying notes included in Form 10-K B) The accuracy of the required supplementary information included in Form 10-K C) All of the opinions expressed in auditor reports included in Form 10-K D) A, B, and C E) A and B F) A and C G) B and C Answer: C Rationale: Auditors are solely responsible for the opinions included in their audit reports. Management is responsible for the accuracy of the financial information presented.

Test Bank, Chapter 4

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Use the following information to answer Questions 27 and 28 Stetson Industries is a manufacturer of affordable menswear. The company manages its business primarily on a geographic basis. There are differences in the methods used to distribute products between the segments. Selected information about Stetson’s segments is included below:

Operating segment Pacific Coast Atlantic Coast Southwest Midwest Southeast Northeast Totals

Revenues $200,000 36,000 95,000 52,000 180,000 25,000 $588,000

Pretax operating profit (loss) $18,000 4,000 12,000 3,000 12,000 (8,000) $41,000

Identifiable assets $1,800,000 550,000 1,425,000 400,000 1,750,000 250,000 $6,175,000

Topic: Describe requirements of segment reporting LO: 5 27. Which of Stetson Industries’ segments would be considered a reportable segment (i.e. meets a quantitative threshold). (Assume that all of the segments meet the definition of an operating segment.) A) All segments other than Northeast B) All segments other than Atlantic Coast, Midwest, and Northeast C) All segments other than Atlantic Coast and Midwest D) All segments other than Northeast and Atlantic Coast E) Only Pacific Coast and Southeast would be considered reportable segments Answer: C Rationale: Pacific Coast, Southwest, and Southeast exceed the revenue, operating profit, and identifiable assets thresholds. Northeast exceeds the pretax operating profit threshold. Atlantic Coast and Midwest do not meet any of the thresholds.

Topic: Describe requirements of segment reporting LO: 5 28. What is the combined total of reportable operating segment revenue in Stetson Industries’ Form 10-K? A) $563,000 B) $500,000 C) $475,000 D) $527,000 E) $380,000 Answer: B Rationale: Reportable segment total revenue = $500,000 (Pacific Coast (200,000), Southwest (95,000), Southeast (180,000), and Northeast (25,000)

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Topic: Describe requirements of segment reporting LO: 5 29. Which of the following types of quantitative information are required to be disclosed in Form 10-K for each reportable segment? A) Profit or loss amounts B) Total asset amounts C) The amount of revenue from a single customer representing 10% or more of any reportable segment’s total revenue. D) A and B E) B and C F) A and C G) A, B, and C Answer: D Rationale: C is incorrect. Revenues from a single customer must equal or exceed 10% of the company’s total revenues before any disclosure is required. If that threshold is met, total revenue from the customer and the identity of the segment or segments reporting revenues from the customer would be disclosed.

Topic: Describe requirements of segment reporting LO: 5 30. In addition to profit or loss and total asset amounts, certain revenue and expense amounts must be disclosed for each reportable segment if ________________. A) those items are reported as separate line items on the segment report regularly reviewed by the company’s chief operating decision maker. B) the amount of the revenue or expense item equals or exceeds 10% of the total revenue or expense item for the company as a whole C) those revenue or expense items are reported as separate line items on the Statement of Comprehensive Income D) the auditor determines that the amounts are material E) No specific revenue or expense amounts must be disclosed. Answer: A Rationale: “…items that are included in the measure of segment profit or loss that is reviewed by the chief operating decision maker must ….be reported.” p 4-33. B, C, and D are incorrect. A is the only test for determining whether additional revenue and expense amounts are disclosed. E is incorrect. Certain revenue and expense amounts must be disclosed if those items are included in segment reports reviews by the chief operating decision maker.

Test Bank, Chapter 4

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Chapter 5 Statement of Cash Flows and Financial Analysis Learning Objectives – Coverage by question Multiple Choice LO 5-1 – Identify operating, investing, and financing activities

1-6

LO 5-2 – Prepare a statement of cash flows using the indirect method to present cash flows from operating activities

7-11

LO 5-3 – Describe the interrelations of financial statements

12-15

LO 5-4 – Perform an investment analysis using the DuPont Framework

16-19

LO 5-5 – Perform a credit analysis using key ratios

20-23

LO 5-6 – Perform horizontal and vertical analyses

24-25

LO 5-7 – Recognize non-GAAP financial measures

26-27

LO 5-8 – Appendix 5A Prepare the operating activities section of the statement of cash flows using the direct method

28-30

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Chapter 5: Statement of Cash Flows and Financial Analysis Multiple Choice Topic: Identify operating, investing, and financing activities LO: 1 1. Which of the following activities would be included in the Investing section of the Statement of Cash Flows? a. b. c. d. A) B) C) D) E) F)

Nontrade loan to another entity Purchase of the net assets of another company in exchange for company stock Cash dividends received on investment in stocks Sale of equipment used in operations, for cash

a and d a, b, and d a and c b and c All of the activities would be included in the investing section None of the activities would be included in the Investing section

Answer: A Rationale: Items a and d are correct; loans (nontrade) and sale of equipment for cash are both investing activities. Item b is incorrect; this is a non-cash activity. Item c is incorrect; receipt of cash dividends on investments is an operating activity.

Test Bank, Chapter 5

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Use the following information to answer Questions 2 and 3. Below is select information from 2020 for Neverland, Inc. Neverland, Inc. – 2020 Selected Information Net income Purchase of treasury stock Proceeds from sale of sales manager’s vehicle Increase in Accounts Payable Increase in Accounts Receivable

$85,000 $12,500 $12,000 $1,200 $1,400

Depreciation expense Increase in Inventory Gain on sale of sale of sales manager’s vehicle Decrease in Prepaid Expenses Bank borrowing proceeds

$5,000 $2,500 $500 $200 $10,000

Neverland, Inc. prepares its statement of cash flows using the indirect method.

Topic: Identify operating, investing, and financing activities LO: 1 2. In Neverland’s statement of cash flows, what were the totals of the amounts that increased and decreased, respectively, net cash from operations? A) $86,400; $9,400 B) $98,400; $3,900 C) $23,400; 3,900 D) $93,900; $1,900 E) $91,400; $4,400 Answer: E Rationale: $91,400 inflow (Net income + depreciation expense + increase in accounts payable and a decrease in prepaid expenses). $4,400 outflow (Increase in inventory + gain on sale of vehicle + increase in accounts receivable)

Topic: Identify operating, investing, and financing activities LO: 1 3. In Neverland’s statement of cash flows, what was the total reported in the investing activities section? A) $2,500 used in investing activities B) $12,000 provided by investing activities C) $11,500 provided by investing activities D) $9,500 provided by investing activities E) $0. There were no investing activities listed. Answer: B Rationale: Proceeds from the sale of the sales manager’s vehicle is the only investing activity listed

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Topic: Identify operating, investing, and financing activities LO: 1 4. Renoir Industries declared cash dividends totaling $26,000 in 2020. Dividends payable at December 31, 2019, and December 31, 2020, totaled $5,000 and $8,000, respectively. In the statement of cash flow for 2020, dividends would be reported as a ________________. A) $45,000 investing cash inflow B) $30,000 operating cash outflow C) $23,000 financing cash outflow D) $29,000 financing cash inflow E) $42,500 investing cash outflow Answer: C Rationale: Dividends declared $26,000 + Beginning dividends payable $5,000 - Ending dividends payable $8,000 = $23,000. Payment of dividends is a financing activity

Topic: Identify operating, investing, and financing activities LO: 1 5. Which of the following statements is(are) true? 1. The statement of cash flows is required if a company provides a set of statements that includes a balance sheet and statement of operations. 2. If an equipment purchase is financed 100% through the manufacturer, the total cost should be reported in both the investing and financing sections of the cash flow statement. 3. Payments of dividends and interest are classified as operating activities.

A) B) C) D) E) F)

Statement 1 Statement 2 Statement 3 Statements 1 & 2 Statements 1 & 3 Statements 2 & 3

Answer: A Rationale: Statement 1 is correct; the statement of cash flows is a required statement (230-10-15-3). Statement 2 is incorrect; 100% financed equipment would be disclosed as a non-cash activity. Statement 3 is partially incorrect; payments of dividends is classified as a financing activity.

Test Bank, Chapter 5

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Topic: Identify operating, investing, and financing activities LO: 1 6. Which of the following combinations of events would be most likely to trigger a cash flow problem for a company? A) Increase in slow moving inventory, increase in receivables turnover, and easing of credit by suppliers B) Decrease in receivables turnover, increase in long term debt, and easing of credit by suppliers C) Increase in inventory turnover, increase in receivables turnover, and tightening of credit by suppliers D) Increase in slow moving inventory, decrease in receivables turnover, and tightening of credit by suppliers Answer: D Rationale: Option D is the only option without any events providing additional cash flow. In option A, increases of receivables turnover and easing of credit of supplies would help offset increase in slow moving inventory. In option B, borrowing and easing of credit by suppliers would help offset decrease in receivables turnover. In Option C, faster moving inventory and faster collection of receivables would help offset tightening of credit

Topic: Prepare a statement of cash flows using the indirect method to present cash flows from operating activities LO: 2 7. Holy Cow, Inc.’s trial balances at December 31, 2018, and December 31, 2019, (after temporary accounts were closed) are shown below. All accounts have normal balances.

Cash Accounts receivable Inventory Prepaid expenses Equipment Accumulated depreciation Accounts payable Salaries payable Dividends payable Sales taxes payable Long-term debt Capital stock Retained earnings

Dec. 31, 2018 $22,000 43,000 89,000 4,000 385,000 175,000 51,000 6,500 0 5,500 250,000 25,000 30,000

Dec. 31, 2019 $35,000 48,000 85,000 6,000 416,500 205,000 42,000 4,500 2,000 6,000 250,000 25,000 56,000

You have the following additional information: • Net income was $28,000 for the year. • No equipment was sold. Cash was used for equipment purchases. • There were no new borrowings. • Holy Cow used the indirect method to present cash flows. The total reported for net cash from operating activities was ______________. A) $44,500 B) $46,500 C) $69,500 D) $41,500 E) $71,500

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Answer: A Rationale: Net income (28,000) + Depreciation (30,000) – Changes in A/R, Prepaids, A/P, and Salaries payable (18,000 (5,000+2,000+9,000+2,000)) + Changes in Inventory and Sales taxes payable (4,500 (4,000+500)) = $44,500

Topic: Prepare a statement of cash flows using the indirect method to present cash flows from operating activities LO: 2 8. On September 30, 2020, Priscilla Enterprises sold a large piece of equipment to Caliope Company for $100,000. Caliope paid $10,000 as a down payment and agreed to make annual payments of $10,000 plus interest starting in 2021. The equipment was originally purchased by Priscilla on October 1 of 2014 for $500,000. It was expected to have a useful life of 8 years. Priscilla uses the straight line method of depreciation. How would the equipment sale be reported in Priscilla’s Statement of cash flows for 2020? A) $25,000 subtracted from net income in operating activities section; $100,000 reported as a cash inflow in investing activities section; $90,000 reported as cash outflow in financing activities section. B) $25,000 subtracted from net income in operating activities section; $10,000 reported as a cash inflow in investing activities section; $90,000 reported as cash outflow in financing activities section. C) $10,000 positive impact on investing activities total; $90,000 disclosed as a nonoperating investing activity. D) $25,000 added to net income in operating activities section; $10,000 reported as a cash inflow in investing activities section; $90,000 disclosed as a nonoperating investing activity. E) $25,000 added to net income in operating activities section; $100,000 reported as a cash inflow in investing activities section; $90,000 reported as cash outflow in financing activities section. Answer: D Rationale: Operating activities section: $25,000 Loss on sale (100,000 – 125,000 (500,000 – (500,000/8*6))) added back to net income; Investing activities section: $10,000 cash down payment reported. Noncash investing activity (financing $90,000 balance due on equipment sale) would be disclosed.

Topic: Prepare a statement of cash flows using the indirect method to present cash flows from operating activities LO: 2 9. Which of the following activities would be considered a noncash operating activity? A) Depreciation expense B) Increase in customer advances C) Loss on sale of equipment D) a and b E) a and c F) b and c G) a, b, and c Answer: E Rationale: Both depreciation and loss on sale of equipment are noncash operating activities. An increase in customer advances (a liability account) would be an operating cash inflow

Test Bank, Chapter 5

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Use the following information to answer Questions 10 and 11. iWork Manufacturing’s trial balances at December 31, 2019, and December 31, 2020, (after temporary accounts were closed) are shown below. All accounts have normal balances.

Cash Accounts receivable, net Inventory Prepaid expenses Equipment Accumulated depreciation Accounts payable Salaries payable Current portion of long-term debt Long-term debt Capital stock Retained earnings

Dec. 31, 2019 $15,400 70,900 126,000 1,200 545,000 216,000 125,000 12,500 20,000 250,000 50,000 85,000

Dec. 31, 2020 $35,000 83,100 149,000 4,500 595,000 236,000 86,000 15,600 32,000 283,000 75,000 139,000

You have the following additional information: • Equipment with a net book value of $10,000 was sold for $12,000, cash during the year. The equipment originally cost $50,000. • During 2020, Inches paid $5,000 down on an equipment purchase and financed the balance. That was the only purchase of equipment made during the year. • The company issued common stock during the year, for cash. • No dividends were declared during the year. • Inches used the indirect method in its Statement of cash flows.

Topic: Prepare a statement of cash flows using the indirect method to present cash flows from operating activities LO: 2 10. What the total net adjustment for noncash revenues and expenses included in the operating activities section of Inches’ statement of cash flows A) $18,000 B) $58,000 C) $60,000 D) $(2,000) E) $22,000 Answer: B Rationale: Depreciation expense of 60,000 (236,000-216,000+40,000 accumulated depreciation on equipment sold) – Gain on sale of equipment of 2,000 = $58,000 Challenge question

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Topic: Prepare a statement of cash flows using the indirect method to present cash flows from operating activities LO: 2 11. What was reported as net cash from operating activities in iWork’s Statement of cash flows for 2020? A) $(23,200) B) $(22,400) C) $ (2,400) D) $ 37,600 Answer: D Rationale: Net income of 54,000 + net noncash adjustments from question 10 of 58,000 – increases in current assets of 38,500 (12,200 + 23,000 + 3,300) – decrease in A/P of 39,000 + increase in Salaries payable of 3,100 = $37,600 Challenge question

Topic: Describe the interrelations of financial statements LO: 3 12. Which of the following amounts appear as separate line items on multiple financial statements? A) Dividends declared B) Net income C) Retained earnings D) A and B E) B and C F) A and C G) A, B, and C Answer: E Rationale: B and C are correct. Net income would appear on the Statement of operations or the Statement of Comprehensive Income, on the Statement of Stockholders’ Equity and on the Statement of Cash Flows (if the indirect method was used). Retained earnings would appear on the Balance Sheet and the Statement of Stockholders’ Equity. A is incorrect. Dividends declared would only appear as a separate line item on the Statement of Stockholders’ Equity.

Topic: Describe the interrelations of financial statements LO: 3 13. The balance in Retained earnings on December 31, 2019, was $85,000 (credit). The following activity took place during 2020. Foreign currency translation gain Dividends declared Dividends paid Purchase of treasury stock

$15,000 20,000 8,000 18,000

The balance is Retained earnings on December 31, 2020, was $140,000 (credit). What was net income for the year ended December 31, 2020? A) $48,000 B) $60,000 C) $75,000 D) $63,000 E) $57,000 Answer: C Rationale: Net income = Ending retained earnings – Beginning retained earnings + Dividends declared = $75,000 (140,000 – 85,000 + 20,000) © Cambridge Business Publishers, 2023 5-8

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Topic: Describe the interrelations of financial statements LO: 3 14. Mallory Enterprises reported the following on its Statement of Cash Flows for 2019. Net cash used by operating activities Net cash provided by investing activities Net cash used in financing activities

$42,000 30,000 25,000

Cash totaled $180,000 at the end of the year. What was the cash balance at the beginning of the year? A) $193,000 B) $83,000 C) $217,000 D) $277,000 E) $143,000 Answer: C Rationale: Decrease in cash for the year = 37,000 (-42,000+30,000-25,000). Cash ending + net decrease = $217,000 (180,000 + 37,000).

Topic: Describe the interrelations of financial statements LO: 3 15. Which of the following activities would not be recognized in comprehensive income for the year? a. Principal payment on long-term debt b. Declaration of dividends c. Foreign currency translation adjustment, loss A) a B) b C) c D) a and b E) b and c F) a and c G) a, b, and c Answer: D Rationale: Principal payment on long-term debt does not result in a change in net assets and would therefore not be included in comprehensive income for the year. Dividend declaration results in a change in equity from a transaction with an owner; thus, does not affect comprehensive income.

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Topic: Perform an investment analysis using the DuPont Framework LO: 4 16. Bailey Industries reported the following information for the year ending June 30, 2019: Net income Net sales Return on equity Return on assets

$125,000 $1,340,000 10% 5%

What was the financial leverage ratio? A) 0.93 B) 5.0 C) 1.07 D) 2.0 E) Need more information to answer this question Answer: D Rationale: Average total assets = 2,500,000 (125,000/.05). Average stockholders’ equity = 1,250,000 (125,000/.10). Financial leverage ratio = 2 (2,500,000/1,250,000) Challenge question

Use the following information to answer Questions 17 and 18. Selected Information for Mackinac Industries — 2020 Average Accounts Receivable Average Inventory Average Accounts Payable Net Sales Cost of Goods sold

$20,000 $12,900 $6,000 $200,000 $120,000

Topic: Perform an investment analysis using the DuPont Framework LO: 4 17. Based on the data provided, how would an investor most likely rank the effectiveness of Mackinac’s management of receivables, inventory, and payables? (Rank in order of best to worst.) A) Receivables; Inventory; Payables B) Inventory; Payables, Receivables C) Payables, Receivables; Inventory D) Inventory; Receivables; Payables E) Receivables; Payables; Inventory F) Payables; Inventory; Receivables Answer: A Rationale: Receivables turnover is 10 (200,000/20,000); Inventory turnover is 9.3 (120,000/12,900); Payables turnover is 20 (120,000/6,000). Receivables has a better turnover rate than inventory. From an investor’s point of view, the payables turnover rate is too high (would likely be considered an inefficient use of cash).

Test Bank, Chapter 5

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Topic: Perform an investment analysis using the DuPont Framework LO: 4 18. What was Mackinac’s cash conversion cycle in 2020? If the company decreased the accounts payable turnover rate, would the conversion cycle be shorter or longer? A) 57; longer B) 94; shorter C) 57; shorter D) 94; longer Answer: C Rationale: Days in receivable 36.5 (365/10 from question 17) + Days in inventory 39.24 (365/9.3 from question 17) – Days in payables 18.25 (365/20 from question 17). A payables turnover would increase the Days in payables which would shorten the cash conversion cycle.

Topic: Perform an investment analysis using the DuPont Framework LO: 4 19. Which of the following events would not improve (increase) a company’s return on equity? (Assume all else remains the same.) a. Retirement of long-term debt with cash b. Sale of common stock for cash c. Reduction in operating expenses A) a B) b C) c D) a and b E) a and c F) b and c G) None of the events would improve a company’s return on equity. Answer: B Rationale: Event b would not improve ROE (Stockholders’ equity would increase; Return on equity would decrease). Event a would increase Return on assets but would decrease Leverage. (A subsequent drop ininterest expense would improve ROE by increasing net income). Event c would improve ROE (net income would increase).

Topic: Perform a credit analysis using key ratios LO: 5 20. A lender would most likely focus most on ________________ ratios when evaluating a company’s loan application. A) profitability and solvency B) activity and profitability C) liquidity and profitability D) liquidity and solvency E) solvency and activity Answer: D Rationale: For creditors “…more attention is focused on liquidity and solvency measures”. P. 5-24

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Use the following information to answer Questions 21 and 22. Ratios Quick ratio Cash debt coverage Current cash debt coverage Current ratio Financial leverage Total-liabilities-to-equity Profit margin Return on assets Return on equity

Tito 0.32 0.56 0.56 0.41 1.79 79% 14.67% 16.60% 29.65%

Eddie 0.78 0.53 1.38 1.03 2.07 107% 18.27% 25.00% 51.80%

Topic: Perform a credit analysis using key ratios LO: 5 21. Based on the ratios, which of the companies (Tito or Eddie) is most liquid, most solvent? A) Tito is most liquid; Eddie is most solvent B) Tito is most liquid and most solvent C) Eddie is most liquid and most solvent D) Eddie is most liquid; Tito is most solvent Answer: D Rationale: Eddie has stronger liquidity ratios (higher current and quick ratios and a higher current cash debt coverage ratio). Tito appears more solvent (lower total-liabilities-to-equity and financial leverage ratios, similar cash debt coverage ratios).

Topic: Perform a credit analysis using key ratios LO: 5 22. Eddie clearly has better profitability ratios. What could Tito do in the next six months to improve its profitability ratios? A) Buy back more of its own stock. B) Increase the allowance for doubtful accounts for accounts past due 120 days. C) Start purchasing inventory from a local supplier, eliminating shipping costs. D) A and B E) B and C F) A and C G) A, B, and C Answer: F Rationale: Option A would improve the Return on equity ratio by reducing stockholders’ equity. Option C would improve the profit margin ratio by reducing expenses. Option B would not improve return on equity (increase in expense and a decrease in assets).

Test Bank, Chapter 5

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Topic: Perform a credit analysis using key ratios LO: 5 23. Penn, Inc. has applied for an expansion loan from its bank. The loan officer has asked for the following historical data:

Inventory turnover Profit margin Current ratio Quick Ratio Total liabilities-to-equity

2016 10 11.5% 1.1 .8 .5

2017 9 12.1% 1.2 .7 .75

2018 8.5 12.3% 1.0 .7 1.2

2019 6 12.6 1.1 .5 1.1

What tentative conclusions might a competent loan officer come to after reviewing the data? A) The profit margins are increasing but the steep decline in the quick ratio compared to the consistency of the current ratio is concerning. This may indicate inflated inventory values. B) The profit margin and total liabilities-to-equity ratios are improving. Solvency, in particular, improved substantially in 2018. C) Although the quick ratio is decreasing, that may simply be the result of decreasing inventory levels as seen by decreasing inventory turnover ratios. D) It appears that Penn might have acquired a significant amount of debt in 2018. E) A and B F) A and D G) B and C Answer: F Rationale: A and D are supported by the data. B is incorrect. Higher total liabilities-to-equity ratios would not indicate an improvement in solvency. C is incorrect. Inventory changes would not impact the quick ratio.

Topic: Perform horizontal and vertical analyses LO: 6 24. Which of the following statements is(are) true? A) Horizontal analysis is often referred to as trend analysis. B) A vertical analysis is most commonly used to evaluate operations over time. C) Significant categories of costs are highlighted in common size analysis. D) A and B E) B and C F) A and C G) A, B, and C Answer: F Rationale: B is not true. (Horizontal analysis is most often used to evaluation operations over time.)

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Topic: Perform horizontal and vertical analyses LO: 6 25. Sales at Jacksonville Tech Productions totaled $100,000, $112,000, and $126,000 in 2018, 2019, and 2020, respectively. What were the percentage changes in sales in 2019 and 2020 using prior period revenue as the base amount? A) 12%; 12.5% B) 112%; 112.5% C) 12%; 26% D) 112%; 126% Answer: A Rationale: 2019 = 12% ((112,000-100,000)/100,000); 2020 = 12.5% ((126,000-112,000)/112,000)

Topic: Recognize non-GAAP financial measures LO: 7 26. A company elects to provide a pro forma income statement in the MD&A section of its annual report. In the statement, losses related to significant disposals of obsolete equipment are omitted. Which of the following statements are correct? a. The external auditor must express an opinion on the presentation of the pro forma information. b. The company must provide a reconciliation of the difference(s) between net income in the pro forma statement and GAAP net income in the Statement of Operations in a note to the financial statements. c. The company must follow the “alternative financial measures” standards issued by the FASB in determining the pro forma net income amount. A) a B) b C) c D) a and b E) b and c F) a and c G) All of the listed statements are accurate. H) None of the listed statements are accurate.

Answer: H Rationale: Statement a is incorrect. Auditors do not provide opinions on non-GAAP financial measures. Statement b is partially incorrect. The reconciliation is required but would not be included in the notes to the financial statements. Statement c is incorrect. There are no “alternative financial measures” standards.

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Topic: Recognize non-GAAP financial measures LO: 7 27. Which of the following would likely be perceived, by users, as a benefit of non-GAAP financial measures included in a company’s annual report? a. Non-GAAP financial measures provide additional information that could be used to evaluate the financial health of the company. b. Non-GAAP financial measures are more flexible and do not have to be calculated in a way comparable to other companies in the same industry using similar measures. c. Non-GAAP financial measures are regulated by the Securities Exchange Commission (SEC). A) a B) b C) c D) a and b E) b and c F) a and c G) All of the listed statements are accurate. H) None of the listed statements are accurate Answer: A Rationale: Statement a is accurate. Non-GAAP financial measures do provide additional information which may be valuable to some users. Statement b is not accurate. A lack of consistency and comparability would not likely be perceived as a benefit. Statement c is not accurate. Disclosures related to non-GAAP financial measures are required by the SEC. The measures themselves are not regulated.

Use the following information to answer Questions 28 and 29. Baltic Backpack Company, a distributor, purchases all its backback inventory from PacTrax Limited. Selected account balances are included in the following table:

Cash Accounts receivable Allowance for doubtful accounts Shoe inventory Accounts payable, Styles Limited

Dec. 31, 2019 $15,400 85,000 7,100 100,000 50,000

Sales revenue Cost of Goods Sold Operating expenses

Dec. 31, 2020 $35,000 92,000 9,900 75,000 45,000 1,000,000 600,000 282,000

Baltic Backpack Company uses the direct method to report operating activities in its Statement of Cash Flows

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Topic: Prepare the operating activities section of the statement of cash flows using the direct method LO: 8 28. How much will Baltic report as cash paid to suppliers in its 2020 Statement of Cash Flows? A) $605,000 B) $575,000 C) $625,000 D) $600,000 E) $580,000 Answer: E Rationale: Purchases = COGS + Ending inventory – Beginning inventory = $575,000 (600,000 + 75,000 – 100,000). Cash paid to suppliers = Purchases + Beginning A/P – Ending A/P = $580,000 (575,000 + 50,000 – 45,000)

Topic: Prepare the operating activities section of the statement of cash flows using the direct method LO: 8 29. How much will Baltic report as cash collected from customers in its 2020 Statement of Cash Flows? A) $823,000 B) $993,000 C) $908,000 D) $1,007,000 E) $1,000,000 Answer: B Rationale: Cash collected = A/R beginning + Sales – A/R ending = $993,000 (85,000+1,000,000-92,000)

Topic: Prepare the operating activities section of the statement of cash flows using the direct method LO: 8 30. Which of the following statements is(are) true? A) If a company elects to use the direct method in its statement of cash flows, a reconciliation of net income to cash from operations must be included in a supplementary schedule. B) In a statement of cash flows prepared using the direct method, items in the operating section are listed in order of magnitude. C) Net cash from operating activities reported using the direct method would never differ from net cash from operating activities reported using the indirect method. D) A and B E) B and C F) A and C G) A, B, and C Answer: F Rationale: A and C are correct. B is incorrect. Cash inflow items are listed first; cash outflow items are listed next.

Test Bank, Chapter 5

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Chapter 6 Time Value of Money Learning Objectives – Coverage by question Multiple Choice LO 6-1 -- Explain the calculation of compound interest.

1-4

LO 6-2 –Apply future value concepts to a single amount.

5-8

LO 6-3 – Apply present value concepts to a single amount.

9-13

LO 6-4 – Apply future value concepts to an ordinary annuity and an annuity due.

14-17

LO 6-5 – Apply present value concepts to an ordinary annuity and an annuity due.

18-21

LO 6-6 – Apply time value of money concept to common accounting scenarios.

22-26

LO 6-7 – Appendix 6A Apply time value of money concept to bond discount amortization.

27-28

LO 6-8 – Appendix 6B Apply time value of money concept using a financial calculator and compound interest tables.

29-30

Intermediate Accounting, 3rd Edition

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Chapter 6: Time Value of Money Multiple Choice Topic: Compound interest—Time value concept LO: 1 1. Five thousand dollars today is worth more than five thousand dollars four years from now under the time value of money concept A) Only if the purchasing power of the dollar in the future is about the same as it is now B) Except when investment markets are in decline C) Because the concept refers to the growth of dollars from investment D) B and C E) As long as inflation is low Answer: C Rationale: The basic assumption behind the time value concept is that the time value of money is focused in growth from investment only.

Topic: Compound interest—Effect of compounding periods LO: 1 2. Which of the following compounding options will return the least amount of interest revenue in a year? A) Daily B) Quarterly C) Semiannual D) Annual E) Bi-weekly Answer: D Rationale: The amount of interest revenue increases as the number of compounding periods in a year increases. Hence, the least amount of interest revenue will be returned with annual compounding.

Topic: Compound interest—Computation of interest revenue LO: 1 3. Sally invested $5,000 in a three-year 3% CD with interest compounded monthly. What are the values for the following?

A) B) C) D) E)

Interest Rate per Compounding Period 3% 0.25% 1% 0.25% 1%

Total Number of Compounding Periods 12 36 12 12 36

Answer: B Rationale: The interest rate per compounding period is the quoted rate divided by the number of compounding periods in a year (3%/12 = 0.25%), while the total number of compounding periods for the security is the number of compounding periods per year times the number of years (12 x 3 = 36)

Test Bank, Chapter 6

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Topic: Compound interest—Relationship of stated and rate per compounding period LO: 1 4. Which of one of the statements below is true? A) The annual rate of interest is larger than the interest rate per compounding period whenever there is compounding. B) The interest rate per compounding period increases as the number of years an investment is held increases. C) The interest rate per compounding period decreases as the number of compounding periods per year increases. D) Under annual compounding, the interest rate per compounding period is equal to the annual interest rate. E) Both C and D are correct. Answer: E Rationale: A is incorrect; the annual rate is equal to the rate per compounding period for annual compounding. B is incorrect because the number of years an investment is held is not a factor in calculating the rate per compounding period. E is correct because both C and D are correct. The rate per compounding period is a function of the number of compounding periods in a year— the interest rate per compounding period decreases as the number of compounding periods in a year increases. Also, when an account is compounded annually, both rates are the same.

Topic: Future value of a single amount—Evaluation of alternatives LO: 2 5. Alberta Corp. is looking to invest $8,000 in an account with an annual rate of 5.6%, compounded annually over 6 years. However, the CFO wants to consider other investment options. Which of the following investments will return the most for Alberta? A) Investing $8,000 in an account with an annual rate of 5.6% compounded annually over 6 years. B) The same as A but with an annual interest rate of 6%. C) The same as A but compounded semiannually. D) The same as A but investing $8,200 initially. E) The same as A but investing $8,100 and compounding quarterly Answer: D Rationale: Future value of a single sum =FV(RATE,NPER,PMT, PV)

A B C D E

RATE 0.056 0.060 0.028 0.056 0.014

NPER 6 6 12 6 24

PMT 0 0 0 0 0

PV -8000 -8000 -8000 -8200 -8100

FV $11,093.63 $11,348.15 $11,143.13 $11,370.97 $11,308.26

Intermediate Accounting, 3rd Edition

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Topic: Future value of a single amount—Excel calculation LO: 2 6. Which of the following arguments for the Excel FV function will return the future value of an investment of $16,000 in an account with an annual 3.6% rate, held for 4 years compounded monthly? A) =FV(0.036,4,0,-16000) B) =FV(0.003,48,0,-16000) C) =FV(0.009,16,0,-16000) D) =FV(0.036,48,0,-16000) E) None of these are a correct set of arguments for the investment given. Answer: B Rationale: The RATE argument is the stated rate divided by the number of compounding periods in a year (3.6%/12 = 0.3%). The NPER argument is the total number of compounding periods (4 years x 12 periods per year =48).

Topic: Future value of a single amount—Evaluation of alternatives LO: 2 7. Which of the following investments of $10,000 will return the most to an investor? A) An investment of $10,000 at an annual rate of 4%, compounded quarterly for 6 years. B) An investment of $10,000 at an annual rate of 4.2%, compounded semiannually for 5 years. C) An investment of $10,000 at an annual rate of 4.8%, compounded monthly for 5 years. D) An investment of $10,000 at an annual rate of 3.6%, compounded annually for 7 years E) An investment of $10,000 at an annual rate of 5%, compounded annually for 4 years. Answer: D Rationale: Future value of a single sum =FV(RATE,NPER,PMT, PV) A B C D E

RATE 0.010 0.021 0.004 0.036 0.050

NPER 24 10 60 7 4

PMT 0 0 0 0 0

PV -10000 -10000 -10000 -10000 -10000

FV $12,697.35 $12,309.98 $12,706.41 $12,809.09 $12,155.06

Topic: Future value of a single amount—Evaluation of alternatives LO: 2 8. Which of the following investments will return the most to an investor? A) $12,000 invested at an annual rate of 5%, compounded semiannually for 8 years. B) $12,000 invested at an annual rate of 6%, compounded annually for 6 years. C) $10,000 invested at an annual rate of 6%, compounded quarterly for 8 years. D) $8,000 invested at an annual rate of 6%, compounded monthly for 9 years. E) $8,000 invested at an annual rate of 8%, compounded annually for 10 years. Answer: A Rationale: Future value of a single sum =FV(RATE,NPER,PMT, PV) Future value of a single sum =FV(RATE,NPER,PMT, PV) Ans RATE NPER PMT PV FV A 0.025 16 0 -12000 $17,814.07 B 0.060 6 -12000 $17,022.23 C 0.015 32 -10000 $16,103.24 D 0.005 108 -8000 $13,709.60 E 0.080 10 -8000 $17,271.40

Test Bank, Chapter 6

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Topic: Present value of a single amount—Disclosure LO: 3 9. If a company estimates their warranty liability by discounting expected future cash flows, what are some of the disclosure requirements? A) The company should note that the liability represents a Level 3 on the FASB’s fair value hierarchy, because the inputs used to calculate the value is unobservable to the statement user. B) The company should note that the liability represents a Level 2 on the FASB’s fair value hierarchy, because other companies use the same approach with similar liabilities. C) There are no disclosure requirements other than the recording of the amount of liability and notice that the value represents the present value of expected future cash flows. D) The company should provide more disclosure about assumptions, estimates, and methods used in calculating the amount. E) Both A and D are correct. F) Both B and D are correct. Answer: E Rationale: A is correct because a warranty liability calculated using the present value of expected future cash flows stems from inputs that are unobservable to the financial statement user. D is also correct in this case. The company must provide enough documentation about how a Level 3 fair value estimate was made so that financial statement users will trust that due care was taken by management when calculating the amount and can make their own judgment about the soundness of management’s underlying assumptions and methods.

Topic: Present value of a single amount—Evaluation of alternatives LO: 3 10. Nikolai wants to know how much to invest today (rounded to the nearest dollar) in an account earning 6.4% interest compounded quarterly to have $80,000 at the end of 8 years. Which value below is correct? A) $48,703 B) $10,989 C) $48,138 D) $70,460 E) Some other value. Answer: C Rationale: Answer is calculated as follows: PV(.016,32,0,-80000) = $48,138

Intermediate Accounting, 3rd Edition

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Topic: Present value of a single amount—Expected cash flow technique LO: 3 11. FrackStar Corp. is estimating remediation costs related to cleaning up a fracking site in 20 years when the site is estimated to be closed. Due to uncertainties related to the degree of possible site contamination, management estimates the following remediation costs and related probability of occurrence: Remediation Costs $1,000,000 850,000 700,000 500,000

Probability 15% 50% 30% 5%

Using the expected cash flow technique and assuming a risk-free rate of 4%, what value should FrackStar record for the remediation costs (to the nearest dollar) in the current year financial statements?

A) B) C) D)

Expected Cash Flow $762,500 810,000 762,500 810,000

Recorded Value $ 347,995 1,774,810 1,670,731 369,673

Answer: D Rationale: The actual expected cash flow is: (1,000,000*15%)+(850,000*50%)+(700,000*30%)+(500,000*5%) = $810,000. Present value is calculated as follows: =PV(.04,20,0,-810000).

Topic: Present value of a single amount—Calculation of annual interest rate LO: 3 12. Which of the following investments are paying at the same annual interest rate? NOTE: Take your calculation to the nearest fourth decimal point (or two decimal points for a percentage). A) Investing $12,000 today in an account compounding monthly for 3 years and returning $14,105.20. B) Investing $7,000 today in an account compounding quarterly for 6 years and returning $9,657.58. C) Investing $10,000 today in an account compounding semiannually for 4 years and returning $15,230.88. D) A and B. E) A, B and C. Answer: D Rationale: The annual rate for A and B is 5.4%.

Ans A B C

NPER 36 24 8

PMT -

Rate =RATE(NPER,PMT, PV,FV) PV FV RATE -12000 14105.2 0.450% Monthly -7000 9657.58 1.350% Quarterly -10000 15230.88 5.400% Semiannual

Annual Int. Rate 12 0.0540 4 0.0540 2 0.1080

Test Bank, Chapter 6

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Topic: Present value of a single amount—Evaluation of alternatives LO: 3 13. Fiona wants to invest a windfall inheritance of $12,500 for 5 years in an account bearing a 4.2% interest rate. Which compounding approach will give Fiona a return of $15,404.10 at the end of five years? A) Monthly compounding B) Quarterly compounding C) Annual compounding D) Semiannual compounding E) Daily compounding Answer: B Rationale: Answer is calculated as follows: FV(.0105,20,0,-12500) = $15,404.10.

Topic: Apply future value concepts to an ordinary annuity and an annuity due—Calculation LO: 4 14. Javy plans to make the following cash outflows for an investment returning 6.0% (annual compounding) per year: $14,000 today, $8,000 in a year from now, and $2,000 two years from now. He wants to know how much he will have at the end of the third year. Which of the Answers below is correct? A) Add up the following: ($14,000 x 6.0%) + ($8,000 x 6.0%) + ($2,000 x 6.0%). B) Apply the Excel function to calculate the future value of an annuity due, with payment equaling the average of the three payments (($14,000 + $8,000 + $2,000)/3 = $8,000), C) Apply the Excel function to calculate the future value of a single sum to each payment as it were a single sum. Then add the future value of $14,000 in three years, the future value of $8,000 in two years, and the future value of $2,000 in one year together. D) Apply the Excel function to calculate the future value of a single sum with the present value equaling the average of the three payments ($8,000). Answer: C Rationale: Per the text, “In cases where payments are … unequal, each cash amount is considered a lump-sum amount and not an annuity.” In this case, C outlines the correct calculation:

Topic: Apply future value concepts to an ordinary annuity and an annuity due—Calculation and deferral LO: 4 15. Chuck wants to know the future value of two different investing strategies. • In plan 1, Chuck would invest $500 today and at the end of each of the next 36 months, in an account paying a 5.4% annual interest rate compounded monthly. • In plan 2, Chuck would make the same series of payments in the same account, but would start after 2 years. Which of these pairs of results is correct? Round your calculations to the nearest dollar. A) B) C) D)

Plan 1 $19,493 $18,989 $19,580 $19,493

Plan 2 $21,711 $21,655 $19,580 $19,493

Answer: C Rationale: In the case of a deferred future value, the future value of the deferred future value is the same as that of the same future value calculation without deferral. This is because no investment took place in the deferral period. The calculation is as follows: =FV(.0045,36,500,0,1) = $19,580.

Intermediate Accounting, 3rd Edition

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Topic: Apply future value concepts to an ordinary annuity and an annuity due—Evaluation of alternatives LO: 4 16. On January 1, 2020, Megan Is considering starting a monthly investment plan, with equal payments made each of the next X number of months into an account that pays interest compounded monthly. Which of the following alternatives will give Megan the highest future value at the end of the investment period? A) Monthly payments of $105 starting on January 1, 2020, with subsequent payments being made on the 1st of each of the next 119 months (120 months total). The annual interest rate is 5.4%. B) Monthly payments of $105 starting on January 31, 2020, with subsequent payments being made at the end of each of the next 119 months (120 months total). The annual interest rate is 6%. C) Monthly payments of $100 starting on January 1, 2020, with subsequent payments being made on the 1st of each of the next 119 months (120 months total). The annual interest rate is 6%. D) Monthly payments of $105 starting on January 31, 2020, with subsequent payments being made at the end of each of the next 119 months (120 months total). The annual interest rate is 5.4%. E) Monthly payments of $100 starting on January 31, 2020, with subsequent payments being made at the end of each of the next 119 months (120 months total). The annual interest rate is 6%. Answer: B Rationale: Alternative B yields the highest future value of $17,207 as shown in the following analysis.

Ans A B C D E

Future value of an annuity = FV(RATE, NPER,PMT, PV, FV, TYPE) RATE NPER PMT PV Type 0.0045 120 -105 0 1 0.0050 120 -105 0 0 0.0050 120 -100 0 1 0.0045 120 -105 0 0 0.0050 120 -100 0 0

FV $16,733 Annuity due $17,207 Ordinary ann. $16,470 Annuity due $16,658 Ordinary ann. $16,388 Ordinary ann.

Topic: Apply future value concepts to an ordinary annuity and an annuity due LO: 4 17. If Layla wants to make annual payments at the start of each of the next 8 years into a fund paying 5% compounded annually, what should her payment be if she wants to have $60,000 in the fund at the end of the 8th year? A) $40,610 B) $ 5,984 C) $ 7,500 D) $ 7,370 E) $ 5,076 Answer: B Rationale: The calculation is as follows: =PMT(.05,8,0,-60000,1) = $5,984.

Test Bank, Chapter 6

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Topic: Apply present value concepts to an ordinary annuity and an annuity due—Calculation of revenue earned LO: 5 18. An amount of money was invested in an account that earns interest compounded semiannually. From this investment, the investor could withdraw $2,000 at the start of the first 6-month period and at the start of each of the next nine, 6-month periods (a total of ten, 6-month periods), after which time, the account balance is zero. Interest revenue generated from this arrangement equals: A) The present value of the annuity due. B) $20,000 minus the present value of the annuity due. C) The present value of the annuity due minus $20,000. D) The future value of the annuity due. E) The future value of the annuity due minus $20,000. Answer: B Rationale: The amount initially invested equals the present value of the annuity due of the withdrawals. Hence, the interest revenue is calculated by subtracting the initial amount invested (the present value of the annuity of withdrawals) from the total undiscounted withdrawals (10 withdrawals of $2,000 or $20,000.

Topic: Apply present value concepts to an ordinary annuity and an annuity due—Deferred annuity LO: 5 19. Which of the following annuities has the lowest present value? Where applicable, use the same compounding pattern for the deferred years as for the years payments were made. A) A series of 8 annual payments of $4,000 paid on the first day of the year for each of the next 8 years (compounded annually) with an interest rate of 9%. B) A series of payments of $2,250 paid on the last day of each six-month period (compounded semiannually) for 7 years with an interest rate of 9%. C) No payments made for two years and then the same payment pattern as A. D) No payments made for one year and then the same payment pattern as B. E) Both A and C are equal and the lowest. F) Both B and D are equal and the lowest. Answer: C Rationale:

Ans A B

Present value of an annuity = PV(RATE, NPER,PMT, FV, TYPE) RATE NPER PMT FV Type 0.0900 8 -4000 0 1 0.0450 14 -2250 0 0

Ans C D

Present value of a single sum =PV(RATE,NPER,PMT, FV) RATE NPER PMT FV PV 0.090 2 0 ($24,132) $ 20,311 0.045 2 ($23,001) $ 21,063

PV $24,132 Annuity due $23,001 Ordinary ann.

Intermediate Accounting, 3rd Edition

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Topic: Apply present value concepts to an ordinary annuity and an annuity due LO: 5 20. Which of the following statements are true about the present value calculations for ordinary annuities and annuities due? A) All else being equal, the higher the rate of interest, the higher the present value of either type of annuity will be. B) The present value of a deferred annuity will be the same as the present value of the same annuity without the deferral. C) All else being equal, the present value of an ordinary annuity will be higher than the same annuity structured as an annuity due. D) Both B and C are true. E) None of these are true. Answer: E Rationale: A is false; actually a higher interest rate will pull more interest out of the annuity flows, resulting in a lower present value. B is false; that statement is only true for the future value of a deferred annuity. In this case, there is an investment that grows as a single sum for the deferral period before the annuity starts. Hence, one must first take the present value of the annuity and then discount the present value of the annuity as a lump-sum over the deferral period. C is false; the present value of the annuity due will be higher because the payments out of the present value start on day one and end a period earlier than the payments of an ordinary annuity. Hence, more is needed initially to fund the earlier payments of an annuity due as opposed to the later ordinary annuity payments.

Topic: Apply present value concepts to an ordinary annuity and an annuity due LO: 5 21. Assume Rachel plans to invest an amount today in an account with an interest rate of 7.2% (compounded annually) and wait 5 years before withdrawing $4,000 at the start of each of the next 120 months (10 years), at which the account will have a zero balance. What is the initial amount that Rachel should invest today to make that happen? (Round your answer to the nearest dollar. Use the same compounding pattern for the deferred years as for the years payments were made.) A) $239,920 B) $442,175 C) $704,212 D) $491,841 E) $238,489 F) Present value is not shown. Answer: A Rationale: A represents the present value of the annuity due of $343,515 (=PV(.006,120,-4000,0,1)) further discounted to calculate the present value of the annuity’s present value, treated as a lump sum to arrive at $239,920 (=PV(.006,60,0,-343515).

Test Bank, Chapter 6

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Topic: Apply time value of money concept to common accounting scenarios LO: 6 22. On January 1, Aero Corp. issued 200, 10 year, 7%, $1,000 bonds with cash interest payable on July 1 and January 1. The market price for bonds of similar risk is 6%. What is selling price of the bonds? Round your calculation to the nearest dollar. A) $200,000 B) $218,002 C) $185,788 D) $214,877 E) $188,772 F) None of these numbers are correct. Answer: D Rationale: Interest payments are 6/12 * 7% * (200 * 1,000) or $7,000. The discount rate is 6/12 * 6% = 3% and the number of compounding periods is 2 * 10 years = 20. Thus, the present value of the bond is calculated as follows: =PV(.03,20,-7000,-200000) = $214,877.

Topic: Apply time value of money concept to common accounting scenarios LO: 6 23. Simple Leasing Co. leases equipment to Sullivan Dynamics over an 8-year period with payments due annually starting immediately on January 1, 2020. The equipment has a useful life of 8 years and no salvage value. Simple Leasing Co. builds a 13% rate of return into the lease. The annual lease payment on the lease is $13,277.80. What is the fair value of the equipment leased and what is the amount of interest revenue Simple Leasing will earn over the lease term? Round both amounts to the nearest dollar.

A) B) C) D)

Fair Value Equipment $106,222 $ 72,000 $106.222 $ 72,000

Interest Revenue $85,186 $ 9,360 $13,809 $34,222

Answer: D Rationale: Fair value of equipment = PV(.13,8,13277.8,0,1) = $72,000. 8 payments of $13,277.80 = $106,222. Interest revenue = $106,222 - $72,000 = $34,222.

Intermediate Accounting, 3rd Edition

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Topic: Apply time value of money concept to common accounting scenarios—Debt retirement LO: 6 24. BoSox Systems, Inc. borrowed $180,000 on an installment note payable on January 1, 2020. The note bears a 9% interest rate and BoSox must make equal payments at the end of each month, starting January 31, 2020 for the next 10 years. What is the monthly payment required, so that BoSox can pay of the note as planned? Calculate the monthly payment to the nearest dollar. A) $ 1,635 B) $ 2,280 C) $ 930 D) $11,848 E) $18,751 Answer: B Rationale: The payment is calculated as follows: PMT(.0075,120,-180000) = $2,280.

Topic: Apply time value of money concept to common accounting scenarios LO: 6 25. On January 1, 2020, Flannagan Fencing Corp. establishes a debt retirement fund to pay off a $500,000 debt due in 8 years. If the fund earns interest at 6% and payments will be made monthly, starting January 1, 2020, what amount must be deposited each month? Round your answer to the nearest dollar. A) $ 6,571 B) $ 4,050 C) $28,408 D) $ 6,538 E) $ 7,677 Answer: D Rationale: Answer is calculated as follows: =PMT(0.005,96,-500000,0,1) = $6,538.

Topic: Apply time value of money concept to common accounting scenarios LO: 6 26. Tailored Suits, Inc. wants to purchase ten 3-D printers on January 1, 2020, that will “print” clothing to custom sizes. The following are the alternatives available from several printer companies. 1. Purchase 10 printers for $1,100,000 each, payment due immediately. 2. Purchase 10 printers in total with a down payment of $1,700,000 today and $1,300,000 a year, payable starting on December 31, 2020, and on December 31 of the next 11 years (a total of 12 annual payments). 3. Lease the 10 printers as a group for $1,750,000 per year, paid annually on January 1, with the first payment made immediately, for 13 years total. The printers in this arrangement have a unique feature that will allow Tailored Suits to use the printers overnight to print diapers in bulk, an arrangement that Tailored Suits estimates will return an extra net cash inflow of $38,000 per month (collected at the end of each month). This arrangement will not compromise the main use of these printers – that is, to print out tuxedos. 4. Lease the 10 printers as a group for $1,250,000 per year, paid annually on January 1, with the first payment made immediately, for 15 years. continued

Test Bank, Chapter 6

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Assume the following: • The relevant market rate of interest is 9%. Ignore tax considerations. • The printers all have the same useful lives and productivity in suit printing. • Tailored Suits has sufficient resources and is looking solely to determine which of these three assumptions is the least expensive. Which of these alternatives is the least expensive? A) Alternative 1 B) Alternative 2 C) Alternative 3 D) Alternative 4 Answer: C Rationale:

Alternative 1: 10 x $1,100,000 = $11,000,000 Alternative 2: Present value of an annuity = PV(RATE, NPER,PMT, FV, TYPE) Ans RATE NPER PMT FV Type 0.0900 12 -1300000 0 Downpayment PV of ord ann Total cost

PV $9,308,943 Ord. ann.

$ 1,700,000 9,308,943 $ 11,008,943

Alternative 3: Present value of an annuity = PV(RATE, NPER,PMT, FV, TYPE) Ans RATE NPER PMT FV Type 0.0900 13 -1750000 0 1 0.0075 156 38000 0 0 Total cost, net of diaper cash flow Alternative 4: Present value of an annuity = PV(RATE, NPER,PMT, FV, TYPE) Ans RATE NPER PMT FV Type 0.0900 15 -1250000 0 1

PV $14,281,269 Ann. Due ($3,487,261) Ordinary ann. $10,794,008

PV $10,982,688 Ann. Due

Intermediate Accounting, 3rd Edition

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Topic: Apply time value of money concept to bond discount amortization—Conceptual LO: 7 27. Bond interest expense for a year for a bond paying interest annually is equal to A) The market rate of interest times the face value of the bond. B) The stated rate of interest times the face value of the bond. C) The market rate of interest times the carrying value of the bond at the end of the annual interest period. D) The stated rate of interest times the carrying value of the bond at the beginning of the annual interest period. E) None of these Answers are correct. Answer: E Rationale: B and D are incorrect because the stated rate is used only to calculate the cash interest payment required for a bond. A and C are incorrect; bond interest for a year on a bond paying interest annually is equal to the market rate of interest times the carrying value of a bond at the beginning of the annual interest period.

Topic: Apply time value of money concept to bond discount amortization—Calculation LO: 7 28. Assume that, on January 1, 2020, a $100,000, 8%, 5 year bond with semiannual cash interest payments due each July 1 and December 31 is issued. The market rate for bonds with a similar risk profile is 10%. What is the bond interest expense at the end of the 6 th six month interest payment period where the starting carrying value of this bond was $95,671 and the ending carrying value of the bond was $96,454? Round to the nearest dollar. A) $ 5,000 B) $ 3,827 C) $ 4,823 D) $ 784 E) $ 4,784 Answer: E Rationale:

A B C D E

$ 5,000 ($100,000 x 5%) $ 3,827 ($95,671 x 4%) $ 4,823 ($96,454 x 5%) $ 784 ($96,455-$95,671) $ 4,784 ($95,671 x 5%)

Test Bank, Chapter 6

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Topic: Apply time value of money concept using a financial calculator and compound interest tables—Conceptual LO: 8 29. The disadvantage(s) of using compound interest tables to solve time value problems is/(are) A) The tables are more time consuming to use than using a calculator or Excel. B) The calculation of the selling price of a bond requires two separate calculations. C) The tables only apply for interest rates and number of periods published in the tables. D) A, B, and C are correct. E) Both A and C are correct. Answer: D Rationale: A and C are correct, per the text. B is also correct; although Excel calculates the selling price of a bond using one function, table users will need to access two separate tables to calculate the same amount. The present value of the payment of face or maturity value at the end of the bond issue’s term is calculated using the present value of a single amount table, and present value of the ordinary annuity of the cash interest payments is calculated by using the present value of an ordinary annuity table. The two present value calculations then need to be added together.

Topic: Apply time value of money concept using a financial calculator and compound interest tables LO: 8 30. On January 1, 2020, Cahlo Inc. issued 150 6%, 10 year, $1,000 bonds that pay interest on each July 1 and December 31. The market rate of interest for bonds of similar risk is 4%. Using the compound interest tables and rounding calculations to the nearest dollar, the bond selling price equals: A) ($3,000 x 16.35143 [PV of an ordinary annuity, n=20, i=2%] ) + ($150,000 x 0.67297 [ PV of $1, n=20, i=2%]) B) ($3,000 x 14.87747 [PV of an ordinary annuity, n=20, i=3%] ) + ($150,000 x 0.55368 [ PV of $1, n=20, i=3%]) C) ($4,500 x 16.35143 [PV of an ordinary annuity, n=20, i=2%] ) + ($150,000 x 0.67297 [ PV of $1, n=20, i=2%]) D) ($4,500 x 14.87747 [PV of an ordinary annuity, n=20, i=3%] ) + ($150,000 x 0.55368 [ PV of $1, n=20, i=3%]) E) None of these are correct. Answer: C Rationale: The cash interest payment is $150,000 x 6% x 6/12 = $4,500 and the interest rate to use on the tables is 6/12 of the market rate of 4% or 2%.

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Chapter 7 Revenue Recognition Learning Objectives – Coverage by question Multiple Choice LO 7-1 – Apply the five-step revenue recognition process

1-3

LO 7-2 – Identify the contract with the customer—Step 1

4-6

LO 7-3 – Identify performance obligations in the contract—Step 2

7-9

LO 7-4 –Determine the transaction price—Step 3

10-12

LO 7-5 – Allocate the transaction price to performance obligations in the contract—Step 4

13-15

LO 7-6 – Recognize revenue when (or as) the seller satisfies a performance obligation—Step 5

16-20

LO 7-7 – Recognize revenue after a contract modification

21-22

LO 7-8 – Recognize revenue in more complex revenue arrangements

23-25

LO 7-9 – Describe accounting for contract costs and disclosure requirements for revenue recognition.

26-27

LO 7-10 – Appendix 7A Apply the revenue recognition process to long-term contracts expected to be profitable

28-29

LO 7-11 – Appendix 7B Apply the revenue recognition process to long-term contracts expected to be unprofitable

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Chapter 7: Revenue Recognition Multiple Choice Topic: Applying the five-step revenue recognition process LO: 1 1. Which of the following statements is true? A) In order to recognize revenue, a company must fulfill all five steps in revenue recognition. B) The five steps of the revenue recognition process may occur consecutively, but not simultaneously. C) Step five of the revenue recognition process is evaluated based upon the perspective of the seller. D) In order to recognize revenue, all five indicators that control has transferred from a seller to a customer must be present. E) Both A and D are true. F) Both A and C are true. Answer: A Rationale: Answer A is correct because completion of all five steps is required before revenue may be recognized. Answer B is incorrect: the steps may be fulfilled simultaneously. Answer C is incorrect: Step five is evaluated based upon the perspective of the customer. Answer D is incorrect because indicators are factors to consider but they do not all need to be met in order to recognize revenue. Topic: Applying the five-step revenue recognition process LO: 1 2. The following revenue recognition steps, listed in no particular order, provided below relate to a merchandiser (Elgin Co.) and a customer (James). 1. The transaction price of a smartwatch manufactured by Elgin Co. is determined to be $200. 2. A performance obligation is identified as the providing of one fully functioning smartwatch to James. 3. James takes possession of the smartwatch after providing his credit card as a means of payment of $200. At this point, Elgin Co. recognizes revenue. 4. A contract is established through common business practices where Elgin Co. provides a fully functioning smartwatch to James for the listed retail price of $200. 5. The $200 retail price of the smartwatch is fully allocated to the obligation of Elgin Co. to provide a fully functioning smartwatch to James. Continued

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Arrange the five items provided above in the order of the five steps of the revenue recognition process described in ASC 606. A) B) C) D) E)

1, 2, 3, 4, 5 2, 4, 5, 1, 3 4, 2, 1, 5, 3 1, 4, 2, 5, 3 4, 1, 2, 3, 5

Answer: C Rationale: Answer C follows the five steps of the revenue recognition process: 1. Identify contract with customer; 2. Identify performance obligation in the contract; 3. Determine transaction price; 4. Allocate transaction price to performance obligation; 5. Recognize revenue when (or as) each performance obligation is satisfied through a transfer of control.

Topic: Applying the five-step revenue recognition process LO: 1 3. ASC 606 includes a list of indicators in determining whether control has transferred from a seller to a customer. Which of the following is not included as an indicator to a transfer of control. A) Customer has accepted the asset. B) Customer takes physical possession of the asset. C) Customer has legal title to the asset. D) Seller has communicated the transaction price to the customer. E) Customer has significant risks and rewards of ownership of the asset. Answer: D Rationale: A, B, C, and E are all indicators of control as included in Exhibit 7-1. The final indicator is that the seller has a right to payment, which is not the same as simply communicating the transaction price to the customer.

Topic: Step One—Identify the contract with the customer LO: 2 4. Which of the following is not a condition of a valid contract? A) Full collection on the contract is probable. B) Payment terms are identified. C) Contract has been approved. D) Rights and obligations are identified. E) Contract has commercial substance. Answer: A Rationale: Answer A is incorrect because the probability of the collection of substantially all of the consideration is required but not 100%. The other items listed are part of a valid contract as described in ASC 606-10-25-1.

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Topic: Step One—Identify the contract with the customer LO: 2 5. Which of the following circumstances most likely indicates that a contract between a seller and a customer is not valid. A) While the contract does not include a stated price, there is sufficient information provided to allow for an estimate of the transaction price. B) The customer, but not the seller, may cancel the contract at any time without a reimbursement of costs. C) The customer has the intent and ability to pay substantially all (but not all) of payments that come due. D) The contract between the seller and the customer is completed orally, and the parties have no plans to follow up with a written contract. Answer: B Rationale: Answer A does not imply an invalid contract because there is information to estimate a price and a fixed price is not a requirement of a valid contract. Answer C does not imply that a contract is invalid because a probability of substantially all (but not 100%) is required for a valid contract. Answer D does not present a problem necessarily as contracts may be initiated in writing, orally, or through normal business practices. Answer B is the correct answer because either party may not have the right to unilaterally cancel a contract without reimbursing the other party, hence, a right to cancel a contract by a customer means the contract is likely invalid.

Topic: Step One—Identify the contract with the customer LO: 2 6. In the event that a contract does not meet all five conditions of a valid contract outlined in ASC 606, A) The contract is still valid because validity does not require all five conditions to be met as long as indicators of validity are present. B) The seller recognizes revenue on a straight-line basis over the contract term. C) The contract is automatically considered terminated. D) The seller generally records a liability for any consideration received. E) The seller may recognize revenue as long as the consideration received from the customer is nonrefundable. Answer: D Rationale: Answer A is not correct because all five conditions must be met for a valid contract. Answer B is not correct because revenue may not be recognized until the conditions outlined in 60610-25-7 are met. Answer C is not correct because a contract is not automatically considered terminated—this would require actions by the parties to the contract. Answer E is not correct because other conditions are required under 606-10-25-7 besides the nonrefundability of payment such as contract termination. Answer D is correct because a seller must record a liability when consideration is received in advance of a contract being considered valid (unless the conditions of ASC 606-10-25-7 are met).

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Topic: Step Two–Identify performance obligations in the contract LO: 3 7. In order for a performance obligation to be considered a separate performance obligation under the revenue recognition standard, the obligation must be A) Economically beneficial to the customer. B) Identifiable from other promises within the contract. C) Material considering the seller’s total assets. D) A and B E) A, B, and C F) A or B Answer: D Rationale: Performance obligations are identified separately if they are capable of being distinct or distinct within the context of a contract; hence D is correct which encompasses A and B. C is not correct because a performance obligation does not require (but does not exclude) a seller from identifying obligations separately that are not material to the context of the contract, not total assets.

Topic: Step Two–Identify performance obligations in the contract LO: 3 8. An indication that a promise in a contract should be considered a separate performance obligation is A) That the seller regularly sells the good separately through online sales. B) That the additional promise is in the form of a volume discount that adjusts prices of past purchases when a specified volume is met. C) That the additional promise is in the form of a customer option that is available to other interested parties without entering into the contract. D) That it does not require the use of other readily available resources that the customer currently does not own. Answer: A Rationale: A is correct because this indicates that the customer can benefit from the good. B is incorrect because retroactive volume discounts affect the transaction price and are not considered separate performance obligations. C is incorrect because customer options that are available to the public without entering into the contract are not considered separate performance obligations. D is incorrect because a customer may benefit from a good or service in combination with other readily available resources that are sold separately or have already been obtained. Thus, it is not required that the customer already have the readily available resources on hand.

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Topic: Step Two–Identify performance obligations in the contract LO: 3 9. A seller offers a promotion to customers which provides one free box of golf balls (valued at $20) if the customer purchases three boxes of golf balls at the regular price of $20 each. In order to receive the free box of golf balls, the customer must fill out a request form and mail it to the seller within three weeks of the date of purchase of the golf balls. The seller estimates that approximately 45% of customers will complete the request form necessary to take advantage of the promotion. In addition, the seller provides three free golf tees (valued at $0.15) with every purchase. The seller A) Considers: the sale of golf balls, the free golf tees, and the right to the fourth box of golf balls as three separate performance obligations. B) Considers the sale of golf balls, the free golf tees, and the right to the fourth box of golf balls as one performance obligation because the goods are interrelated. C) Considers the sale of golf balls and the right to the fourth box of golf balls as two separate performance obligations. D) Considers the sale of golf balls, the free golf tees, and the right to the fourth box of golf balls as one performance obligation because the likelihood of redemption on the promotion is low. Answer: C Rationale: A is incorrect because the golf tees of $0.15 would be considered immaterial to the context of the contract ($80). B is incorrect because the items are not interrelated. D is incorrect because even considering the redemption rate, the promotion would be considered material to the context of the contract. C is correct because the material customer right is accounted for as a separate performance obligation from the original sale of golf balls.

Topic: Step Three—Determine the transaction price LO: 4 10. Three Amigos, Inc. sells merchandise with a cost of $25,000 during the year to customer for $55,000. It is Three Amigos’ policy to accept returns up to 60 days after the date of purchase. Three Amigos estimates that there is a 60% probability that returns will be 3% of sales and a 40% probability that returns will be 2.5% of sales. What is Three Amigos’ transaction price? A) $55,000 B) $53,460 C) $48,625 D) $53,350 E) $25,000

Answer: B Rationale: ($55,000 x 0.97 x 0.6) + ($55,000 x 0.975 x 0.4) = $53,460

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Topic: Step Three—Determine the transaction price LO: 4 11. Platinum Inc. sells merchandise with a cost of $80,000 to Free Trade Inc. for $180,000 during the month. As part of the contract, Platinum pays Free Trade $5,000 in slotting fees for premium shelf position in the retail stores and $4,000 for advertising Platinum’s product in Free Trade’s weekly flier that is emailed to Free Trade’s customer list. What is Platinum’s transaction price? A) $171,000 B) $180,000 C) $176,000 D) $175,000 E) $185,000 Answer: D Rationale: Correct answer is $175,000 or $180,000 minus the slotting fees of $5,000. Because Platinum paid for a distinct service (advertising), the amount paid is recorded as a selling expense and does not affect the transaction price.

Topic: Step Three—Determine the transaction price LO: 4 12. McElroy Inc., a marketing consulting firm, entered into the following three revenue contracts in the current month. 1. The contract with Customer A requires that McElroy Inc. provides 10 hours of consulting services at $300 per hour for the month. 2. The contract with Customer B requires that McElroy Inc. develops an electronic promotion of the customer’s new product line. Payment for the services are equal to $6,000 plus 2% of the customer’s sales over the one-month promotion period. McElroy Inc. estimates that there is a 30% chance of sales totaling $100,000, a 50% chance of sales totaling $150,000, and a 20% chance of sales totaling $200,000. 3. The contract with Customer C requires McElroy Inc. to create a promotional mailing for its product in exchange for consideration of $8,000. McElroy Inc. will receive a $500 bonus if the project is completed within 5 business days and $250 if the project is completed within 6 business days. Based on McElroy Inc.’s estimate of time to complete the project and status of other projects, McElroy estimates that the most likely amount of the bonus is $500. Determine the total transaction price of the three revenue contracts and whether the transaction price is fixed, variable, or some combination of both.

A) B) C) D) E)

Transaction Price $20,400 $20,400 $19,500 $20,000 $19,500

Fixed Consideration $11,000 $17,000 $17,000 $17,500 $17,000

Variable Consideration $9,400 $3,400 $2,500 $2,500 $2,500

Answer: B Rationale: Correct answer is fixed consideration of $3,000 + $6,000 + $8,000 = $17,000. Variable consideration is $2,900 for Customer B ((2% x 30% x $100,000) + (2% x 50% x $150,000) + (2% x 20% x $200,000) and for Customer C is $500 for a total of $3,400.

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Topic: Step Four— Allocation of the transaction price to performance obligations LO: 5 13. Lawnclippers Inc. is offering a fall promotion to new customers signing a contract within the next two weeks. For a bundled price of $99, Lawnclippers will provide fall aeration, lawn overseeding and tree fertilization. The standalone selling price of each service sold separately is fall aeration $69, lawn overseeding, $20, and tree fertilization $29. Allocate the transaction price to the three separate performance obligations, rounding your final answers to the nearest whole dollar. Allocated transaction prices are as follows:

A) B) C) D) E)

Fall Aeration $69 $33 $82 $55 $58

Lawn Overseeding $20 $33 $24 $18 $17

Tree Fertilization $29 $33 $35 $26 $24

Answer: E Rationale: Correct answer is fall aeration of $58 ($69/$118 x $99); lawn overseeding of $17 ($20/$118 x $99) and tree fertilization of $24 ($29/$118 x $99).

Topic: Step Four— Allocation of the transaction price to performance obligations LO: 5 14. Stalwart Inc., a merchandiser, is running a promotion where a customer receives Product B for free with the purchase of Product A for $150. The standalone selling price of Product A is $150. The standalone selling price of Product B must be estimated because Stalwart has never sold this product in the past because it’s based on new technology. Stalwart Inc. is aware of a competitor selling a product similar to Product B in the market for $30. Allocate the transaction price to Product A and Product B, rounding your final answers to the nearest whole dollar. Allocated transaction prices are as follows:

A) B) C) D) E)

Product A $150 $ 0 $125 $120 $100

Product B $ 0 $150 $ 25 $ 30 $ 50

Answer: C Rationale: Correct answer is Product A of $125 ($150/$180 x $150) and Product B of $25 ($30/$180 x $150)).

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Topic: Step Four— Allocation of the transaction price to performance obligations LO: 5 15. Which of the following statements is not true regarding the standalone selling price of a performance obligation in a revenue contract. A) May be measured through estimation or through direct observation in the market. B) Is always equal to the stated price of the good or service. C) May be estimated through the adjusted market assessment approach, the expected cost plus a margin approach, or the residual approach. D) Is measured using all information that is reasonably available. E) is preferable to be supported by direct observation over estimation. Answer: B Rationale: While the standalone selling price may be equal to the stated or list price, this may not always be the case. For example, a product may be given away for free with the purchase of another. The stated price is free, but the standalone selling price would need to be determined through observation or estimation.

Topic: Step Five— Recognition of Revenue LO: 6 16. A seller offers a promotion to customers which provides one free box of golf balls (valued at $20) if the customer purchases three boxes of golf balls at the regular price of $20 each. In order to receive the free box of golf balls, the customer must fill out a request form and mail it to the seller within three weeks of the date of purchase of the golf balls. The seller estimates that approximately 45% of customers will complete the request form necessary to take advantage of the promotion. In addition, the seller provides three free golf tees (valued at $.15) with every purchase. What amount of revenue would the seller record upon a cash sale of three boxes of golf balls (plus the three free golf tees) to a customer? A) $45 B) $52.17 C) $50.70 D) $52.19 Answer: B Rationale: The standalone selling price of the three boxes of golf balls is $60 (3 x $20) and the standalone expected selling price of the free box of golf balls is $9 ($20 x 45%). The amount of revenue to recognize is equal to $60/$69 x $60 = $52.17. Note that answer D is not correct because revenue would not be allocated to the golf tees due to immateriality.

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Topic: Step Five— Recognition of Revenue LO: 6 17. Jamestown Inc. enters into a $300,000 contract for the purchase of customized equipment with Bennington Inc. The construction of the equipment is expected to take two years. Jamestown Inc. owns the work in process during the two-year period but will not take possession of the equipment until completed. The contractor will bill Jamestown monthly for performance completed to date. After yearone, Bennington Inc. incurred costs of $120,000 and expects remaining costs to be $108,000. Bennington Inc. has billed Jamestown $150,000 in total for the year. Jamestown has paid $135,000 to Bennington Inc. Determine the amount of revenue and expenses that Bennington Inc. should recognize in the first year of the contract.

A) B) C) D) E)

Revenue $ 78,947 $150,000 $157,895 $150,000 $0

Expenses $120,000 $120,000 $120,000 $114,000 $0

Answer: C Rationale: The correct revenue amount is equal to $120,000/$228,000 x $300,000. Total expenses incurred to date equal $120,000.

Topic: Step Five— Recognition of Revenue LO: 6 18. Jamestown Inc. enters into a $300,000 contract for the purchase of standard equipment with Bennington Inc. The construction of the equipment is expected to take two years. Jamestown will take control of the equipment upon completion. After year-one, Bennington Inc. incurred costs of $120,000 and expects remaining costs to be $108,000. Bennington Inc. will collect 50% of the contract price upon completion of the equipment. The remaining 50% will be billed evenly over the contract period. Any amounts paid are nonrefundable. Determine the amount of revenue and expenses that Bennington Inc. should recognize in the first year of the contract.

A) B) C) D) E)

Revenue $157,895 $ 75,000 $ 75,000 $157,895 $0

Expenses $120,000 $120,000 $114,000 $114,000 $0

Answer: E Rationale: The contract does not meet the revenue recognition criteria described in Exhibit 7-3. Jamestown Inc. does not own the work in process (takes control at contract completion), the equipment is not customized, and payments are not based upon performance completed to date. Thus, revenue and expenses are recognized at a point in time (upon completion); thus, there is no recognition of revenue or expenses in year one.

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Topic: Step Five— Recognition of Revenue LO: 6 19. A customer enters into a contract with MyTablet Inc. to purchase an electronic tablet plus a one-year internet data plan for the tablet for a combined price of $700. The standalone selling price of the electronic tablet is $500 and the standalone selling price of the one-year internet data plan is $25 a month. MyTablet Inc. collects $400 upfront and bills the remaining balance evenly over the contract period of one year. Choose the correct answer regarding the accounting for the sale of a tablet plus the data plan by MyTablet Inc. (Assume all amounts below are rounded to the nearest whole dollar.) A) MyTablet Inc. would record sales revenue of $438 when the customer takes control of the tablet. B) MyTablet Inc. would defer revenue of $300 upon sale of the electronic tablet. C) MyTablet Inc. would increase its contract asset by $3 each month. D) MyTablet Inc. would record a contract liability of $38 when the customer takes control of the tablet. E) Both A and C. F) Both A and D. Answer: A Rationale: The entry upon initiation of the contract is as follows: Cash 400 Contract Asset ($438 - $400) 38 Sales Revenue ($500/$800 x $700)

438

Each month, MyTablet Inc. records the following entry: Cash ($700 - $400)/12 Contract Asset (38/12) Service Revenue

3 22

Thus, answer A is correct. Answer B is not correct because $262 (or $700 - $438) of revenue is deferred. Answer C is not correct a contract asset is reduced each month by $3. Answer D is not correct because a contract asset, not a contract liability is recognized.

Topic: Step Five— Recognition of Revenue LO: 6 20. Subs-R-Us Inc. grants franchisees the right to operate a restaurant using the company’s name, menu, and operational procedures. On March 1, a franchisee enters into a 4-year contract with Subs-R-Us Inc. and pays a $150,000 initial franchise fee. The franchisee also pays $10,000 for equipment for the restaurant with a delivery date scheduled in 10 days. Per the contract, the franchisee will also pay a royalty equal to 3% of the franchisee sales over the contract life. The commission for the month of March is estimated to be $3,000 based upon Subs-R-Us Inc. extensive experience with new franchises. What amount of revenue will Subs-R-Us Inc. record on March 1? A) $0 B) $3,125 C) $6,125 D) $16,126 E) $150,000 F) $163,000 Answer: A Rationale: Correct answer is A: at the inception of the contract, no revenue is recognized. The franchise fee will be recognized over time, revenue related to the equipment will be recognized when control of the equipment passes to the franchisee, and the royalty revenue will be recognized when sales occur.

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Topic: Recognition of Revenue After a Contract Modification LO: 7 21. Darling Inc. enters into a contract with a customer to sell 100 distinct items of merchandise for $10,000 ($100 per item) over a 12-month period. Six months later, the parties to the contract agree to a contract modification to add an additional 50 items for $105 each within the original contract period. The $105 per unit price for the additional items represents the standalone selling price of these items on the date of the modification. If 75 items had already been delivered under the original contract, how would revenue be allocated to the remaining 25 items under the original contract and the 50 items per the contract modification?

A) B) C) D)

Revenue for 25 Items Under Original Contract $2,500 $2,542 $2,583 $2,625

Revenue for 50 Items in Contract Modification $5,250 $5,083 $5,167 $5,250

Answer: A Rationale: The modification is treated as a new and separate contract with no change to the original contract because the change involves distinct goods at standalone prices. Thus, the company recognizes $2,500 (or 25 units x $100) for the 25 items remaining in the original contract and $5,250 (or 50 units x $105) for the 50 units in the new contract.

Topic: Recognition of Revenue After a Contract Modification LO: 7 22. Darling Inc. enters into a contract with a customer to sell 100 distinct items of merchandise for $10,000 ($100 per item) over a 12-month period. Six months later, the parties to the contract agree to a contract modification to add an additional 50 items for $105 each within the original contract period. The $105 per unit price for the additional items does not represent the standalone selling price of these items on the date of the modification. If 75 items had already been delivered under the original contract, how would revenue be allocated to the remaining 25 items under the original contract and the 50 items per the contract modification?

A) B) C) D)

Revenue for 25 Items Under Original Contract $2,500 $2,542 $2,583 $2,625

Revenue for 50 Items in Contract Modification $5,250 $5,083 $5,167 $5,250

Answer: C Rationale: The modification results in a new combined contract with a termination of the original contract because the change involves distinct goods not at standalone prices. Thus, the company determines a blended price equal to $103.333 or ((25 units x $100) + (50 units x $105))/75 units). Thus, revenue recognized is equal to $2,583 for the original 25 units (25 units x $103.333) and $5,167 for the 50 units in the modification (50 units x $103.333).

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Topic: Recognition of Revenue in More Complex Arrangements LO: 8 23. A supply company enters into a contract to supply 1,000 pet crates to a national retailer at $40 per unit. The contract specifies that the pet crates will be delivered to a specific distribution center with date(s) of delivery to be supplied by the retailer. The retailer expects to have sufficient shelf space at the time of delivery. As of year-end, the supply company has inventory of 3,000 pet crates, including the 1,000 pet crates relating to the contract with the retailer. The 1,000 pet crates are stored with its other 2,000 pet crates, which are all interchangeable products. However, the supply company put controls in place to assure that they will not deplete total inventory below 1,000 units. At the inception of the contract, how much revenue should the supply company recognize? A) $40,000 B) $20,000 C) $13,333 D) $0 Answer: D Rationale: Although the retailer has a substantive reason for the deferred shipping arrangement (lack of shelf space) the supply company has not stored these units separately. Therefore, revenue is not recognized until control of the units has passed to the customer.

Topic: Recognition of Revenue in More Complex Arrangements LO: 8 24. Mitchners Inc. provided 80 items of product to Weller Inc. for sale to its customers. Mitchners Inc. retains title to the products until they are scanned at the register of Weller Inc. upon sale to its customer. At that time, Weller Inc. is obligated to pay Mitchners Inc. for the cost of the product ($5 per unit). Any unsold products may be returned to Mitchners Inc. In addition, Mitchners Inc. may call back or transfer unsold products to another Weller. Assume that 80 units of product were transferred on March 1 to Weller Inc.; 10 units of product were sold for $9 each to Weller Inc.’s customers on March 3; and 8 units of product were sold to Weller Inc.’s customers for $9 each on March 4. On March 5, Weller Inc. electronically transferred payment to Mitchners Inc. for sales to date. What dollar amount of revenue would Mitchners Inc. and Weller Inc. recognize on the following dates? March 1

March 3

March 4

March 5

Mitchners Inc. Weller Inc.

$0 $0

$0 $90

$0 $72

$90 $72

Mitchners Inc. Weller Inc.

$0 $0

$0 $90

$0 $72

$90 $0

Mitchners Inc. Weller Inc.

$0 $0

$50 $90

$40 $72

$0 $0

Mitchners Inc. Weller Inc.

$400 $0

$0 $90

$0 $72

$0 $0

Answer: C Rationale: The goods are held on consignment at Weller Inc. as supported by the indicators in ASC 606-10-55-80. Thus, Mitchners and Weller would both recognize revenue when control of the product has passed to the final customers on March 3 and March 4.

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Topic: Recognition of Revenue in More Complex Arrangements LO: 8 25. On January 1, 2020, Orbit Inc. sells equipment to Aldren Inc. for $5,000. The contract includes a repurchase option effective one year from the contract’s inception. Choose one statement from the following statements relating to this equipment sale on January 1 that is not true.

A) If Orbit Inc. is required to repurchase the equipment, and the repurchase price is $4,800, Orbit Inc. would record the transaction as a lease.

B) If Orbit Inc. has the right to repurchase the equipment, and the repurchase price is $5,000, Orbit Inc. would record the transaction as a financing agreement.

C) If Aldren Inc. has the right to require Orbit Inc. to repurchase the equipment, the expected market value is $5,200, and the repurchase price is $5,100, Orbit Inc. would recognize a sale with a right of return. D) If Aldren Inc. has the right to require Orbit Inc. to repurchase the equipment, the expected market value is $4,800, and the repurchase price is $5,100, Orbit Inc. would record the transaction as a lease. Answer: D Rationale: D is incorrect because according to ASC 606-10-55-72 to 76, under a put option where the repurchase price is greater than the expected market value and greater than the original price, the transaction is recorded as a financing agreement.

Topic: Contract Costs LO: 9 26. On December 31, 2020, Westin Co. enters into a two-year contract with a customer. An allocation of the cost of salaries of sales and administrative staff is estimated to be $4,800. Salaries are paid in January of 2021. Westin Co. expects to recover the allocated salary costs from the amounts billed on the contract. The contract does not have a renewal option. How would Westin account for the contract cost in its year-end financial statements dated December 31, 2020? A) Westin Co. would recognize an asset (Contract Cost) of $4,600 and a liability (Salaries Payable) of $4,800, on December 31, 2020, and expense (Contract Cost Expense) of $200 for the year 2020. B) Westin Co. would recognize an asset (Contract Cost) of $4,400 and a liability (Salaries Payable) of $4,800, on December 31, 2020, and expense (Contract Cost Expense) of $400 for the year 2020. C) Westin Co. would recognize a liability (Salaries Payable) of $4,800, on December 31, 2020, and expense (Salaries Expense) of $4,800 for the year 2020. D) Westin Co. would recognize an asset (Contract Cost) of $4,800 and a liability (Salaries Payable) of $4,800, on December 31, 2020. Answer: C Rationale: C is correct because salaries should be expensed as incurred as these are not incremental costs associated with the contract as required in ASC 340-40-25-1. These are simply allocated costs that would have been incurred even if the contract has not taken place. Thus, the full amount should be expensed as incurred.

Test Bank, Chapter 7

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Topic: Contract Costs LO: 9 27. On December 1, 2020, Westin Co. enters into a two-year contract with a customer where outside attorney costs of $4,800 to establish the contract were incurred. The amount is due in 60 days. Westin Co. expects to recover the legal fees from the amounts billed on the contract. The contract does not have a renewal option. How would Westin account for the contract cost in its year-end financial statements dated December 31, 2020, assuming that payment was not made to the attorneys by this date? A) Westin Co. would recognize an asset (Contract Cost) of $4,600 and a liability (Accrued Legal Expense) of $4,800, on December 31, 2020, and expense (Contract Cost Expense) of $200 for the year 2020. B) Westin Co. would recognize an asset (Contract Cost) of $4,400 and a liability (Accrued Legal Expense) of $4,800, on December 31, 2020, and expense (Contract Cost Expense) of $400 for the year 2020. C) Westin Co. would recognize an asset (Contract Cost) of $4,800 and a liability (Accrued Legal Expense) of $4,800, on December 31, 2020. D) Westin Co. would recognize a liability (Accrued Legal Expense) of $4,800, on December 31, 2020, and expense (Contract Cost Expense) of $4,800 for the year 2020. Answer: A Rationale: A is correct because the legal fees are capitalized (costs are incremental and recoverable), and amortized over the contract period ($4,800 ÷ 24 months = $200 amortization per month). The net contract asset balance on December 31, 2020, is $4,600 which is $4,800 - $200.

Topic: Profitable Long-Term Contracts LO: 10 28. Regan Builders Co. entered into a long-term contract to build a facility for $900,000. Regan Builders began on January 1, 2020 and was completed at the end of 2021. Regan uses the cost-to-cost method to measure the completion of its long-term performance obligations when revenue is recognized over time. Data related to the contract is as follows.

Costs incurred during year Estimated total costs Billings during the year Cash collections during the year

2020 $522,000 747,000 486,000 450,000

2021 $216,000 * 414,000 450,000

*Project completed at year-end; thus all costs are actual.

What amount of revenue will Regan Builders Co. recognize in 2020 and 2021 related to the long-term contract, assuming that revenue is recognized over time?

A) B) C) D) E)

2020 $638,920 $433,260 $486,000 $0 $628,916

2021 $261,080 $466,740 $414,000 $900,000 $271,084

Answer: E Rationale: Revenue in 2020 is equal to $628,916 calculated as $522,000/$747,000 x $900,000. Revenue in 2021 is equal to $271,084 calculated as $900,000 - $628,916.

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Topic: Profitable Long-Term Contracts LO: 10 29. Regan Builders Co. entered into a long-term contract to build a facility for $900,000. Regan Builders began on January 1, 2020 and was completed at the end of 2021. Regan Builders uses the cost-tocost method to measure the completion of its long-term performance obligations when revenue is recognized over time. Data related to the contract is as follows.

Costs incurred during year Estimated total costs Billings during the year Cash collections during the year

2020 $522,000 747,000 486,000 450,000

2021 $216,000 * 414,000 450,000

*Project completed at year-end; thus all costs are actual.

What amount of revenue will Regan Builders Co. recognize in 2020 and 2021 related to the long-term contract, assuming that revenue is recognized at a point in time?

A) B) C) D) E)

2020 $638,920 $433,260 $486,000 $0 $628,916

2021 $261,080 $466,740 $414,000 $900,000 $271,084

Answer: D Rationale: Revenue in 2020 is equal to $0 because revenue is not recognized until the end of construction. Thus, all revenue is recognized in 2021.

Test Bank, Chapter 7

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Topic: Unprofitable Long-Term Contracts LO: 11 30. Regan Builders Co. entered into a long-term contract to build a facility for $900,000. Regan Builders began on January 1, 2020 and was completed at the end of 2021. Regan Builders uses the cost-tocost method to measure the completion of its long-term performance obligations when revenue is recognized over time. Data related to the contract are as follows.

Costs incurred during year Estimated total costs Billings during the year Cash collections during the year

2020 $522,000 905,000 486,000 450,000

2021 $385,000 * 414,000 450,000

*Project completed at year-end; thus all costs are actual.

What amount of (1) revenue or gain and (2) expense or loss will Regan Builders Co. recognize in 2020 related to the long-term contract, assuming that revenue is recognized over time?

A) B) C) D) E)

Revenue/Gain $524,900 $519,116 $486,000 $0 $521,150

Expense/Loss $527,000 $524,116 $522,000 $5,000 $378,850

Answer: B Rationale: Revenue in 2020 is equal to $519,116, calculated as $522,000/$905,000 x $900,000. Expenses are equal to revenues of $519,116 plus the loss of $5,000 calculated as $900,000 minus $905,000.

Intermediate Accounting, 3rd Edition

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Chapter 8 Cash and Receivables Learning Objectives – Coverage by question Multiple Choice LO 8-1 – Classify cash, cash equivalents, restricted cash, and compensating balances

1-3

LO 8-2 – Account for sales and collections on account including the impact of cash discounts

4-6

LO 8-3 – Account for the impact of sales returns and allowances

7-9

LO 8-4 – Measure and record accounts receivable at net amount expected to be collected

10-14

LO 8-5 – Measure and record notes receivable

15-19

LO 8-6 – Account for the sale of receivables and use as collateral for borrowing

20-24

LO 8-7 – Describe receivables disclosures and ratio analyses

25-27

LO 8-8 – Appendix 8A Apply cash controls

LO 8-9 – Appendix 8B Account for impairment of noncurrent receivables

29-30

Intermediate Accounting, 3rd Edition

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Chapter 8: Cash and Receivables Multiple Choice Topic: Classifying cash, cash equivalents, restricted cash, and compensating balances LO: 1 1. Zinnea Corp. had the following amounts at December 31, 2020. Description

Amount

Amount on deposit in a checking account Certificate of deposit, 4-month term Legally restricted compensating balance on deposit Checks received from customer; not deposited Receivable from employee for travel advance

$10,000 2,500 5,000 4,500 1,000

What amount would be classified as cash and cash equivalents on December 31, 2020? A) $10,000 B) $14,500 C) $17,000 D) $16,500 E) $17,500 Answer: B Rationale: The amount of cash and cash equivalents includes the amount on deposit ($10,000) and checks received but not cashed ($4,500). Note that the CD is not included as its maturity is greater than the typical maturity of 3-months or less for a cash equivalent.

Topic: Classifying cash, cash equivalents, restricted cash, and compensating balances LO: 1 2. Which of the following items would most likely not be classified as a cash equivalent by Comet Company? A) A 12-month U.S. Treasury bill purchased three months from maturity B) Commercial paper of Utility Company with a 30-day maturity. Utility Company has a strong credit rating. C) Money market fund with an original maturity of four months. D) Certificate of deposit with a one-month maturity. Answer: C Rationale: A maturity of four months is greater than the recommended maturity of 3-months or less for a cash equivalent; thus, Answer C is the correct answer. Note that Answer A is not correct because the one-year note was purchased with 3 months until maturity. The original maturity date to the buyer is relevant rather than the original maturity date of the investment.

Test Bank, Chapter 8

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Topic: Classifying cash, cash equivalents, restricted cash, and compensating balances LO: 1 3. What is the effective rate of borrowing $100,000 through a 5% note when 3% of the proceeds are required to be maintained on deposit through the term of the note? A) 5.00% B) 4.85% C) 2.86% D) 5.15% E) 4.76% Answer: D Rationale: The effective rate of 5.15% is equal to annual interest of $5,000 (computed at $100,000 x 5%) divided by available cash proceeds of $97,000 (computed as $100,000 - $3,000). Challenge: Information included in the Expanding Your Knowledge section.

Topic: Accounting for sales and collections on account including the impact of cash discounts LO: 2 4. Which of the following statements is not true regarding the accounting for cash discounts? A) A cash discount is considered variable consideration because of the uncertainty as to when a customer will make a payment. B) At any point in time, total revenue recognized in the financial statements will be the same whether the gross or net method is used to account for sales discounts. C) Under the gross method, the account Sales Discount is debited when a customer pays within the discount period. D) Under the net method, the account Sales Discount Forfeited is credited when a customer pays after the discount period. Answer: B Rationale: The gross and net method will only produce the same accounting results after the receivable is collected. Before the receivable is collected, revenue may be overstated under the gross method and understated under the net method.

Topic: Accounting for sales and collections on account including the impact of cash discounts LO: 2 5. On June 30, 2020, Chelsea Inc. sold merchandise for $1,500 on credit terms 2/10, n/30. Chelsea accounts for sales discounts using the gross method. If the customer pays the balance in full on July 8, 2020, Chelsea’s entry would include a A) Debit to Sales Discount for $30. B) Credit to Accounts Receivable for $1,470. C) Debit to Cash for $1,500. D) Debit to Accounts Receivable for $30. E) None of the above. Answer: A Rationale: The entry on July 8, 2020, which falls within the discount period includes a debit to Cash for $1,470, a debit to Sales Discount for $30, and a credit to Accounts Receivable for $1,500. Thus, answer A is correct.

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Topic: Accounting for sales and collections on account including the impact of cash discounts LO: 2 6. On June 30, 2020, Chelsea Inc. sold merchandise for $1,500 on credit terms 2/10, n/30. Chelsea accounts for sales discounts using the net method. The customer paid the balance in full on July 28, 2020. Choose the correct statement which describes Chelsea’s accounting for this transaction. A) On June 30, Chelsea would debit Accounts Receivable for $1,500. B) On July 28, Chelsea would credit sales for $30. C) On July 28, the net impact of the journal entry would be to increase assets by $30 and increase equity by $30. D) After all of the entries, net sales would be recognized for $1,500. E) None of the above. Answer: C Rationale: A is incorrect because Chelsea would debit Accounts Receivable for $1,470. B is incorrect because Chelsea would credit Sales Discount Forfeited for $30, a revenue account. D is incorrect because net sales would be $1,470. The credit to Sales Discount Forfeited would be included in other revenue on the income statement. Answer C is correct because Cash is increased by $1,500 and Accounts Receivable is decreased by $1,470, causing a net increase in assets of $30. The increase in Sales Discount Forfeited causes an increase in equity of $30.

Topic: Accounting for the impact of sales returns and allowances LO: 3 7. Five Hands Inc. sells merchandise for $50,000 for the month of June. The company estimates returns to be equal to 2.5% of sales. Actual returns for the month for items sold in June totaled $500. What is the correct balance in Refund Liability on June 30 based on these transactions? A) $-0B) $1,250 C) $750 D) $500 Answer: C Rationale: The answer of $750 is calculated as ($50,000 x 2.5%) - $500.

Test Bank, Chapter 8

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Topic: Accounting for the impact of sales returns and allowances LO: 3 8. Six Sisters Inc. sells merchandise for $480,000 with a cost of $216,000 in the month of June. The company estimates returns to be equal to 3% of sales. Actual returns for the month for items sold in June totaled $10,000. The unadjusted credit balance in Refund Liability on June 30 is $2,400 and the unadjusted debit balance in Inventory—Estimated Returns is $1,080. What is included as part of the entries to estimate returns at month-end? A) A debit to Sales Returns for $4,400. B) A debit to Inventory—Estimated Returns for $1,980. C) A debit to Cost of Goods Sold for $900. D) A credit to Refund Liability for $2,000. Answer: D Rationale: The entries to estimate returns at the end of the period are as follows. Sales Returns ((($480,000 x 3%) - $10,000) - $2,400)) Refund Liability Inventory—Estimated Returns ($2,000 x 45%) Cost of Goods Sold

2,000 2,000 900 900

Note: Because $1,080/$2,400 is equal to 45% (same as the cost percentage on sales which is $216,000/$480,000), we can simply use the cost percentage to adjust Inventory-Estimated Returns.

Topic: Accounting for the impact of sales returns and allowances LO: 3 9. Which of the following statements does not illustrate the accounting for sales returns and allowances? A) Sales returns and allowances are considered forms of variable consideration. B) A refund liability is recognized for consideration received from a customer that is expected to be refunded in part or total. C) Estimating sales returns involves a review of historical information and consideration of changes expected in the future. D) A difference between actual and expected sales returns and allowances is treated as a change in accounting principle. Answer: D Rationale: Discrepancies are treated as a change in accounting estimate (not a change in accounting principle), which requires prospective accounting treatment.

Intermediate Accounting, 3rd Edition

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Topic: Measuring and recording accounts receivable at net amount expected to be collected using the allowance method LO: 4 10. When the allowance method of recognizing doubtful accounts is used, the entries to record collection of a small account previously written off would A) Increase the allowance for doubtful accounts. B) Increase net income. C) Decrease the allowance for doubtful accounts. D) Have no effect on the allowance for doubtful accounts. Answer: A Rationale: The entries for a collection of amounts previously written off include an entry to reinstate the receivable (Dr. Accounts Receivable and Cr. Allowance for Doubtful Accounts) and the typical entry to record cash collections (Dr. Cash and Cr. Accounts Receivable). Answer A is correct because the Allowance for Doubtful Accounts, which carries a normal credit balance, increases. Hence, answer C and D are incorrect. Since all accounts are balance sheet accounts, answer B is incorrect. Topic: Measuring and recording accounts receivable at net amount expected to be collected using the allowance method LO: 4 11. On December 31, 2020, Traxx Inc. establishes an allowance for doubtful accounts of 3% of its accounts receivable balance of $180,000. Traxx Inc. decides on March 15, 2021, not to pursue collection of Jones’s $1,000 account. The likelihood of collection does not support further collection efforts. What is the net value of accounts receivable before and after the write-off of the Jones account?

A) B) C) D)

Accounts Receivable, Net Accounts Receivable, Net Before Write-Off After Write-Off $174,600 $174,600 $174,600 $175,600 $174,600 $173,600 $180,000 $179,000

Answer: A Rationale: The correct answer is A. Before the write-off, net accounts receivable is equal to $180,000 - $5,400 which is $174,600. After the write-off, net accounts receivable is equal to $179,000 - $4,400 which is also $174,600. The entry to write off the account includes a debit to the Allowance for Doubtful Accounts for $1,000 and a credit to Accounts Receivable for $1,000.

Test Bank, Chapter 8

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Topic: Measuring and recording accounts receivable at the net amount expected to be collected using the allowance method LO: 4 12. Which of the following statements best illustrates the process of estimating credit losses when adjusting the allowance for doubtful accounts under the CECL (Current Expected Credit Loss) model? A) The allowance for doubtful accounts primarily reflects credit losses expected over the next year because accounts receivable is a current asset account. B) It is not necessary to consider credit losses that are considered remote when adjusting the allowance for doubtful accounts. C) Accounts receivable of similar risks may be pooled together when estimating credit losses to adjust the allowance for doubtful accounts. D) An entity may rely only on historical information in estimating credit losses such as trends of collections. Answer: C Rationale: Answer A is incorrect because expected credit losses must be considered over the entire term of the contract (ASC 326-20-30-6). Answer B is incorrect because even remote losses must be considered in estimating credit losses per ASC 326-20-30-10. Answer D is incorrect because a company must also consider current conditions and supportable forecasts per ASC 326-20-30-9. Answer C is correct because receivables of similar risk may be pooled under ASC 326-20-30-2.

Topic: Measuring and recording accounts receivable at the net amount expected to be collected using the allowance method LO: 4 13. The aging schedule at December 31, 2020, for Gidget Inc. shows the following breakdown of total accounts receivable. Status Not past due Past due 1-30 days Past due 31-60 days Past due over 60 days Total

Amount $455,000 108,000 55,000 14,000 $632,000

Intermediate Accounting, 3rd Edition

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Answer: B Rationale: Accounts Receivable Credit Loss Rate Credit Loss $ 455,000 0.5% $ 2,275 108,000 1.0% 1,080 55,000 2.0% 1,100 14,000 8.0% 1,120 $

632,000

5,575

Unadjusted balance in AFDA Adjustment required to AFDA

3,300 $

2,275

Topic: Measuring and recording accounts receivable at the net amount expected to be collected using the allowance method LO: 4 14. The aging schedule at December 31, 2020, for Gidget Inc. shows the following breakdown of total accounts receivable. Status Not past due Past due 1-30 days Past due 31-60 days Past due over 60 days Total

Amount $455,000 108,000 55,000 14,000 $632,000

The company considers the risk of credit losses to be similar within the aging pools and estimates the following credit loss rates by pool: not past due, 0.5%; past due 1-30 days, 1%; past due 31-60 days, 2%; and past due over 60 days, 8%. The Allowance for Doubtful Accounts has an $1,800 debit balance before adjustment. What is included in the entry to adjust the Allowance for Doubtful Accounts on December 31, 2020 to its desired ending balance? A) A debit to Bad Debt Expense for $5,575. B) A debit to Bad Debt Expense for $4,775. C) A debit to Bad Debt Expense for $7,375. D) A debit to Bad Debt Expense for $3,775. Answer: C Rationale: Accounts Receivable Credit Loss Rate Credit Loss $ 455,000 0.5% $ 2,275 108,000 1.0% 1,080 55,000 2.0% 1,100 14,000 8.0% 1,120 $

632,000

5,575

Unadjusted balance in AFDA Adjustment required to AFDA

1,800 $

7,375

Test Bank, Chapter 8

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Topic: Measuring and recording notes receivable LO: 5 15. On December 31, 2020, Caprio Consulting Inc., received two notes from customers in exchange for services rendered. First, the note from Talen Corp. is a two-year, $8,000 note with a 4% stated rate. Cash interest is due each December 31 beginning December 31, 2021, and the entire principal is due December 31, 2022. The second note is a two-year, noninterest-bearing note with a stated value of $5,000 from Blanton Inc. The market rate for similar notes from both customers is 8% on December 31, 2020. At what amounts should the two notes be reported on Caprio Consulting Inc.'s December 31, 2020, balance sheet?

A) B) C) D) E)

Talen Note $7,429 $8,000 $8,604 $8,888 $8,000

Blanton Note $4,287 $4,287 $5,000 $3,969 $5,000

Answer: A Rationale: Correct answer is A. For the first note, the present value calculation is as follows: PV(0.08,2,320,8000). For the second note, the present value calculation is as follows: PV(0.08,2,0,5000).

Topic: Measuring and recording notes receivable LO: 5 16. On September 1, 2020, Zulu Co. loaned $5,000 cash to Zilch Inc. and received a two-year, 8% note. Cash interest is due each August 31, and the principal is due at the end of the second year. The stated rate and market rate are equal. Zulu Co. has a December 31 year-end. Assuming the proper amount of interest was accrued on December 31, 2020, what account shows a decrease in its balance on August 31, 2021? A) Cash B) Interest Revenue C) Interest Receivable D) Interest Expense E) Note Receivable Answer: C Rationale: The entry on August 31, 2020, would include an increase to cash, a decrease to interest receivable and an increase to interest revenue. Thus, the correct answer is C.

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Topic: Measuring and recording notes receivable LO: 5 17. On January 1, 2020, Mumford Inc. sells equipment financed through a $50,000, two-year, 5% note, issued by its customer. The company uses the effective interest method to amortize any discounts or premiums. Assuming a market rate of 8%, what is the balance of Note Receivable, Net on January 1, 2020, and what is interest revenue recognized for 2020?

A) B) C) D) E)

Note Receivable, Net Jan. 1, 2020 $47,325 $50,000 $52,789 $47,325 $52,789

Interest Revenue 2020 $3,786 $2,500 $2,639 $2,366 $4,223

Answer: A Rationale: Correct answer is A. The Note Receivable, Net balance is calculated as PV(.08,2,-2500,50000) and interest revenue is calculated as $47,325 x 8%.

Topic: Measuring and recording notes receivable LO: 5 18. On January 1, 2020, Mumford Inc. sells equipment financed through a $50,000, two-year, zero-interest bearing note, issued by its customer. The company uses the effective interest method to amortize any discounts or premiums. Assuming a market rate of 8%, what is balance of Note Receivable, Net on January 1, 2020, and what is interest revenue recognized for 2021?

A) B) C) D) E)

Note Receivable, Net Jan. 1, 2020 $50,000 $50,000 $46,296 $44,855 $42,867

Interest Revenue 2021 $4,000 $3,429 $4,000 $3,429 $3,704

Answer: E Rationale: The Note Receivable, Net balance is calculated as PV(.08,2,0,-50000) and interest revenue is calculated as 8% x ($42,867 + ($42,867 x .08)).

Test Bank, Chapter 8

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Topic: Measuring and recording notes receivable LO: 5 19. Which of the following relations described below is true? A) If the market rate is less than the stated rate, a note receivable is issued at a discount. B) If a note is received and recorded at a discount, interest revenue decreases over the term of the note. C) If a note is issued in exchange for services, the note is initially measured at the fair value of the services or the amortized value of the note, whichever is more clearly determinable. D) Interest revenue for a period is calculated by taking the note’s carrying value at the beginning of the period multiplied by the market rate. Answer: D Rationale: Answer A is incorrect because the note would be issued at a premium. Answer B is incorrect because interest revenue increases as the principal of the note moves toward the stated value. Answer C is incorrect because the measurement is the fair value of the services or the fair value of the note, whichever is more clearly determinable. Answer D is correct.

Topic: Accounting for the sale of receivables and use as collateral for borrowing LO: 6 20. On July 1, 2020, Leland Corp. sold goods in exchange for a $100,000, 5%, one-year note, with interest due at maturity. Leland Corp. discounted the note on September 1 to a bank. Assume that the discounting qualifies as a sale and that the bank charges an 8% fee on the maturity value of the note. What amount did Lee receive when it discounted the note? A) $99,360 B) $92,000 C) $93,333 D) $98,000 Answer: D Rationale: The correct answer is D calculated as follows: ($100,000 x 1.05) – ($105,000 x 8% x 10/12) = $98,000.

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Topic: Accounting for the sale of receivables and use as collateral for borrowing LO: 6 21. Caprese Inc. factors without recourse $450,000 of accounts receivable with a finance company. The factor charges a 10% finance fee and retains an amount equal to 15% of the accounts receivable for sales adjustments. What is the amount of the loss on sale of receivables that Caprese would recognize upon sale of its receivables to a factor. A) $45,000 B) $67,500 C) $112,500 D) $-0Answer: A Rationale: The following entry is made upon sale of receivables: Cash Receivables from Factor Loss on Sale of Receivables Accounts Receivable

337,500 67,500 45,000 450,000

Thus, the answer is A.

Topic: Accounting for the sale of receivables and use as collateral for borrowing LO: 6 22. Caprese Inc. factors with recourse $450,000 of accounts receivable with a finance company. The factor charges a 5% finance fee and retains an amount equal to 15% of the accounts receivable for sales adjustments. Caprese estimates its recourse liability for bad debts to be $6,000. What is the amount of the loss on sale of receivables that Caprese would recognize upon sale of its receivables to a factor? A) $67,500 B) $28,500 C) $22,500 D) $6,000 E) $-0Answer: B Rationale: The following entry is made upon sale of receivables: Cash Receivables from Factor Loss on Sale of Receivables Accounts Receivable Recourse Liability

360,000 67,500 28,500 450,000 6,000

Thus, the answer is B.

Test Bank, Chapter 8

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Topic: Accounting for the sale of receivables and use as collateral for borrowing LO: 6 23. Caprese Inc. factors with recourse $450,000 of accounts receivable with a finance company. The factor charges a 5% finance fee and retains an amount equal to 15% of the accounts receivable for sales adjustments. Caprese estimates its recourse liability for bad debts to be $6,000. What is the amount of financing revenue that the factor would recognize upon the purchase of receivables from Caprese Inc? A) $67,500 B) $28,500 C) $22,500 D) $6,000 E) $-0Answer: C Rationale: The following entry is made upon purchase of receivables: Accounts Receivable Payable to Caprio Financing Revenue Cash

450,000 67,500 22,500 360,000

Thus the answer is C.

Topic: Accounting for the sale of receivables and use as collateral for borrowing LO: 6 24. How does a sale of accounts receivable differ from the use of accounts receivable as collateral for a loan? A) With a sale of receivables, the operating cycle is shortened, but with a collateralized loan, the operating cycle is extended. B) With a collateralized loan, the borrower records a note payable, but in a sale, the seller records a note receivable. C) With a collateralized loan, the borrower recognizes potential credit losses, but in a sale with recourse, the seller does not recognize potential credit losses. D) With a collateralized loan, the receivables remain under the control of the borrower but in a sale, the seller no longer has title to the receivables. Answer: D Rationale: A is not true because the operating cycle is shortened in both cases. B is not true, because in a sale, cash is received (plus amounts due to factor in some cases) and not a note receivable. C is not true because in a sale with recourse, the seller is responsible for credit losses on the receivable and recognizes this through a recourse liability.

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Topic: Describing receivables disclosures and ratio analyses LO: 7 25. Leland Inc. recognized net sales of $800,000 for the year ended December 31, 2020. The accounts receivable balance at December 31, 2019, was $65,000. If Leland computed a receivable turnover ratio of 12.50, what is the accounts receivable balance on December 31, 2020? A) $58,000 B) $60,000 C) $63,000 D) $66,000 Answer: C Rationale: Average accounts receivable is equal to $800,000 ÷ 12.5 which is equal to $64,000. Next, solve for accounts receivable ending balance. ($65,000 + x )/2 = $64,000 x = $63,000

Topic: Describing receivables disclosures and ratio analyses LO: 7 26. Why is it required that companies disclose a significant concentration of credit risk in the notes accompanying the financial statements? A) The disclosure provides an estimate of net receivables. B) The company could incur a significant loss if the customers that make up the concentration do not perform. C) A risk of loss should be disclosed in the financial statements, even if the risk of loss is remote. D) The activity in the allowance for doubtful accounts must be disclosed for each period. Answer: B Rationale: Answer A is not correct because net receivables is reported through the allowance for doubtful accounts. Answer C is not correct because this statement applies to credit losses and not to disclosures regarding concentration of credit losses. Answer D, although a true statement, is separate from the requirements of concentration of credit risk disclosures.

Test Bank, Chapter 8

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Topic: Describing receivables disclosures and ratio analyses LO: 7 27. The following information relates to a retailer of yard maintenance goods. Item Accounts receivable, Dec. 31, 2019 Accounts receivable, Dec. 31, 2020 Net sales, 2019 Net sales, 2020

Amount $22,000 $25,000 $880,000 $875,000

What is the accounts receivable turnover and the average days to collect receivables for 2020?

A) B) C) D) E)

Accounts Receivable Turnover 35.00 37.34 35.10 40.00 37.23

Average Days to Collect Receivables 10.43 9.77 10.40 9.13 9.80

Answer: E Rationale: Accounts receivable turnover ratio is calculated as $875,000 divided by ($22,000 +$25,000)/2 = $37.23. The average days to collect receivables is calculated as 365 ÷ 37.23 = 9.80.

Topic: Applying cash controls LO: 8 28. The following unadjusted balances pertain to Pierre Deux Corp. at December 31, 2020. Bank statement balance, Dec. 31, 2020 Book balance, Dec. 31, 2020

$10,000 13,610

The following additional information pertains to Pierre Deux Corp.: Deposits in transit Outstanding checks Bank monthly service fee* Electronic payment to a supplier made by bank at the direction of Pier10* Electronic deposit from a customer made directly to Pier10’s account*

$5,000 1,000 10 900 1,300

*Amounts authorized by Pier10 but not yet recorded in Pier10’s financial records.

What is Pierre Deux’s correct ending cash balance on December 31, 2020? A) $14,000 B) $13,200 C) $16,000 D) $13,220 Answer: A Rationale: Correct answer is $14,000 = $13,610 – 10 – 900 + 1,300.

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Topic: Accounting for impairment of noncurrent receivables LO: 9 29. Latham has a 5%, $40,000 note receivable from the sale of merchandise on January 1, 2020. The note was issued when the market rate was 5%. The note is due December 31, 2024. Annual interest is due each December 31. On December 31, 2020, Latham reviews the collectibility of its note and determines that only $15,000 is likely to be received on the due date from this note. Although Latham received the 2020 interest payment, the company does not expect to receive further interest payments. What is included as part of the adjusting entry that Latham records on December 31, 2020? A) Debit to Bad Debt Expense of $27,659. B) Credit to Accounts Receivable for $12,341. C) Debit to Bad Debt Expense of $19,432. D) Credit to the Allowance for Doubtful Accounts for $25,000. Answer: A Rationale: Correct answer A is calculated as $40,000 minus $12,341 calculated as PV(.05,4,0,-15000).

Topic: Accounting for impairment of noncurrent receivables LO: 9 30. Latham has a 5%, $40,000 note receivable from the sale of merchandise on January 1, 2020. The note was issued when the market rate was 5%. The note is due December 31, 2024. Annual interest is due each December 31. On December 31, 2020, Latham reviews the collectibility of its note and determines that there is a 30% probability of collecting $15,000 on the due date (and no further interest), and a 70% probability of collecting no further payments. What is included as part of the adjusting entry that Latham records on December 31, 2020? A) Debit to Bad Debt Expense of $31,702. B) Credit to Accounts Receivable for $25,798. C) Debit to Bad Debt Expense of $36,298. D) Credit to the Allowance for Doubtful Accounts for $35,500. Answer: C Rationale: Correct answer C. The write-off (debit to Bad Debt Expense) is calculated as $40,000 minus ($12,341 x 30%), where $12,341 is calculated as PV(.05,4,0,-15000).

Test Bank, Chapter 8

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Chapter 9 Inventory: Measurement Learning Objectives – Coverage by question Multiple Choice LO 9-1 – Determine the initial recognition and measurement of inventory

1-4

LO 9-2 – Demonstrate accounting in a periodic inventory system

5-8

LO 9-3 – Demonstrate specific identification, average cost, FIFO, and LIFO in a periodic inventory system

9-12

LO 9-4 – Demonstrate accounting in a perpetual inventory system

13-16

LO 9-5 – Demonstrate moving average, FIFO, and LIFO in a perpetual inventory system

17-20

LO 9-6 – Explain and compute a LIFO reserve

21-22

LO 9-7 – Describe and compute the effect of LIFO liquidation

23-24

LO 9-8 – Apply the dollar-value LIFO method

25-28

LO 9-9 – Perform inventory ratio analysis and interpretation

29-30

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Chapter 9: Inventory: Measurement Multiple Choice Topic: Determination of the initial measurement of inventory LO: 1 1. Which of the following items should be included in determining unit cost for inventory purposes? A) B) C) D) E)

Abnormal shipping costs Freight-in Freight-out Selling expenses Both B and C

Answer: B Rationale: Freight-in is included as part of inventory costs. The remaining costs listed are period costs which are expensed in the period incurred.

Topic: Determination of the initial recognition and measurement of inventory LO: 1 2. Kalen Co. had the following consignment transactions during March 2020. Transaction Inventory on consignment to Rad Co. Freight paid by Kalen Co. Inventory held on consignment from Star Co. Freight paid by Star Co.

Amount $18,000 900 12,000 500

No sales of consigned goods were made through March 2020. Kalen’s March 31, 2020, balance sheet should include consigned inventory for the following amount. A) B) C) D)

$18,900 $18,000 $12,500 $12,000

Answer: A Rationale: Answer A is calculated as $18,000 + $900 = $18,900.

Test Bank, Chapter 9

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Topic: Determination of the initial recognition and measurement of inventory LO: 1 3. The records of Colatta Inc. at the end of the year included the following. Item

Amount

Merchandise sold, in transit, shipped f.o.b. destination Merchandise sold, in transit, shipped f.o.b. shipping point Merchandise purchased, in transit, shipped f.o.b. destination Merchandise purchased, in transit, shipped f.o.b. shipping point

$320,000 240,000 190,000 100,000

What amount would Colatta Inc. include on its year-end balance sheet for inventory? A) B) C) D)

$340,000 $510,000 $430,000 $420,000

Answer: D Rationale: Answer D is calculated as $320,000 + $100,000.

Topic: Determination of the initial recognition and measurement of inventory LO: 1 4. Which of the following items would not be included as part of the inventory balance of Clarinet Inc. on December 31, 2020? A) Clarinet sold goods to a customer for $5,000, but the contract obligates Clarinet to buy back the inventory in 90 days. B) Clarinet shipped $16,000 of goods to a customer; however, Clarinet retains legal title of the goods until the goods are sold to the final customer. The customer may return the goods at any time. C) Clarinet shipped $2,000 of goods to a customer, terms f.o.b. shipping point, that are still in transit. D) Clarinet purchases $4,000 of goods from a vendor, terms f.o.b. shipping point, that are still in transit. Answer: C Rationale: Answer A is incorrect because control of the goods have not passed to the customer; therefore, Clarinet still owns the inventory. Answer B is incorrect because Clarinet is the consignor and retains control of the inventory. Answer D is incorrect because the items are in control of Clarinet at the point the goods were with the shipper. Answer C is correct because these items are not in control of Clarinet—at the point that the goods were with the shipper, they were under the control of the customer.

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Use the following information to complete Questions 5 and 6. Madison Corp. has the following information for 2020: Item Sales Beginning inventory Freight-out Purchases

Amount $180,000 64,800 16,200 77,400

Sales commissions Purchase discount Purchase returns Freight-in Cost of goods sold

9,000 8,000 5,400 7,200 108,000

Topic: Demonstration of the accounting in a periodic inventory system LO: 2 5. What is Madison’s December 31, 2020, ending inventory balance under a periodic inventory system? A) B) C) D) E)

$28,000 $44,200 $54,800 $37,000 $20,800

Answer: A Rationale: Ending inventory is equal to $64,800 + $77,400 + $7,200 - $8,000 - $5,400 - $108,000.

Topic: Demonstration of the accounting in a periodic inventory system LO: 2 6. What is Madison’s gross margin for 2020 under a periodic inventory system? A) B) C) D) E)

$63,000 $46,800 $55,800 $72,000 $39,600

Answer: D Rationale: The gross margin is equal to $180,000 - $108,000.

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Topic: Demonstration of the accounting in a periodic inventory system LO: 2 7. On June 30, 2020, Chesterton Inc. purchased merchandise for $2,500 on credit terms 2/10, n/30. Chesterton accounts for purchase discounts using the gross method and follows a periodic inventory system. If Chesterton paid the balance in full on July 8, 2020, Chesterton’s entry would include a: A) B) C) D) E)

Debit to Purchase Discount for $50. Debit to Accounts Payable for $2,450. Credit to Cash for $2,450. Credit to Inventory for $50. None of the above.

Answer: C Rationale: The cash payment would be made net of the 2% discount which is equal to $2,500 x 98%.

Topic: Demonstration of the accounting in a periodic inventory system LO: 2 8. On June 30, 2020, Chesterton Inc. purchased merchandise for $2,500 on credit terms 2/10, n/30. Chesterton accounts for purchase discounts using the net method and follows a periodic inventory system. If Chesterton paid the balance in full on July 25, 2020, Chesterton’s entry would include a A) B) C) D) E)

Debit to Purchases for $50. Debit to Interest Expense for $50. Credit to Inventory for $50. Debit to Accounts Payable for 2,500. None of the above.

Answer: B Rationale: The lost discount is equal to $2,500 x 2% or $50.

Use the following information to complete Questions 9 through 12. The following information is available for Garrett Inc. Date Oct. 1 Oct. 5 Oct. 15 Oct. 25

Item Beg. Bal. Purchase Purchase Purchase

Units 40 60 100 50

Unit Cost $5.00 5.20 5.40 5.50

A physical inventory count shows 80 units in stock on October 31. Garrett maintains a periodic inventory system.

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Topic: Demonstration of specific identification inventory method in a periodic inventory system LO: 3 9. Garrett Inc. uses the specific identification inventory method to value month-end inventory. Garrett determines that the ending inventory units consist of 5 units from beginning inventory, 10 units from the October 5th purchase, 30 units from the October 15th purchase, and 35 units from the October 25th purchase. What is Garrett’s cost of goods sold recognized for the month of October? A) B) C) D) E)

$695.50 $895.50 $905.00 $431.50 $422.00

Answer: B Rationale: Answer B is calculated as follows. First, ending inventory is calculated as (5 x $5) + (10 x $5.20) + (30 x $5.40) + (35 x $5.50) = $431.50. Next, cost of goods sold is equal to $1,327 (cost of goods available for sale) minus $431.50 (ending inventory) = $895.50 (cost of goods sold).

Topic: Demonstration of the FIFO inventory method in a periodic inventory system LO: 3 10. Garrett Inc. uses the FIFO inventory method to value month-end inventory and applies a periodic inventory system. What is Garrett’s cost of goods sold recognized for the month of October? A) B) C) D) E)

$437 $408 $902 $919 $890

Answer: E Rationale: Answer E is calculated as follows: $1,327 (cost of goods available for sale) minus $437 = (50 x $5.50 + 30 x $5.40) (ending inventory) = $890 (cost of goods sold). (Alternatively, COGS may be calculated directly: (40 x $5.00) + (60 x $5.20) + (70 x $5.40) = $890.)

Topic: Demonstration of the LIFO inventory method in a periodic inventory system LO: 3 11. Garrett Inc. uses the LIFO inventory method to value month-end inventory and applies a periodic inventory system. What is Garrett’s ending inventory recognized on October 31? A) B) C) D) E)

$437 $408 $902 $919 $890

Answer: B Rationale: Answer B is calculated as follows: (40 x $5.00) + (40 x $5.20) = $408

Test Bank, Chapter 9

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Topic: Demonstration of the average cost inventory method in a periodic inventory system LO: 3 12. Garrett Inc. uses the average cost method to value month-end inventory and applies a periodic inventory system. What is Garrett’s ending inventory recognized on October 31? A) B) C) D)

$902.36 $905.00 $424.64 $422.00

Answer: C Rationale: Answer C is calculated as follows: $1,327 ÷ 250 units x 80 units = $424.64.

Use the following information to complete Questions 13 and 14. Madison Corp. begins the month with an inventory balance of $1,500 and completed the following transactions for the month, listed in chronological order. Madison uses the gross method to record purchase discounts. Transaction Purchased inventory from vendor, terms 2/10, n30 Paid for shipping on the inventory purchase Returned inventory to vendor Paid an account balance within discount period Sold inventory collecting $580 in cash Paid for shipping on inventory sold

Cost Amount $1,200 60 150 1,029 400 20

Topic: Demonstration of accounting in a perpetual inventory system LO: 4 13. What is Madison’s month-end inventory balance under a perpetual inventory system? A) B) C) D) E)

$2,209 $2,039 $2,129 $2,189 $1,979

Answer: D Rationale: Ending inventory is equal to $1,500 + $1,200 + $60 - $150 - $21 - $400 = $2,189, where $21 = ($1,029/.98) - $1,029.

Topic: Demonstration of accounting in a perpetual inventory system LO: 4 14. What is Madison’s gross margin for the month under a perpetual inventory system? A) B) C) D) E)

$180 $160 $420 $69 $400

Answer: A Rationale: Gross margin is calculated as follows: $580 - $400 = $180. © Cambridge Business Publishers, 2023 9-7

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Topic: Demonstration of accounting in a perpetual inventory system LO: 4 15. On June 30, 2020, Chesterton Inc. purchased merchandise for $3,500 on credit terms 1/10, n/30. Chesterton accounts for purchase discounts using the gross method and follows a perpetual inventory system. If Chesterton paid the balance in full on July 8, 2020, Chesterton’s entry would include a: A) B) C) D) E)

Credit to Purchase Discount for $35. Debit to Accounts Payable for $3,465. Credit to Cash for $3,500. Credit to Inventory for $35. None of the above.

Answer: D Rationale: Inventory would be reduced by the discount of 1% x $3,500 = $35. The entry would be as follows: Accounts Payable Inventory Cash

3,500 35 3,465

Topic: Demonstration of accounting in a perpetual inventory system LO: 4 16. On June 30, 2020, Chesterton Inc. purchased merchandise for $3,500 on credit terms 1/10, n/30. Chesterton accounts for purchase discounts using the net method and follows a perpetual inventory system. If Chesterton paid the balance in full on July 25, 2020, Chesterton’s entry would include a A) B) C) D) E)

Debit to Inventory for $35. Debit to Interest Expense for $50. Credit to Cash for $3,465. Debit to Accounts Payable for 3,465. None of the above.

Answer: D Rationale: Accounts payable is reduced by the net amount of $3,465, which is the amount that it was originally credited. The entry would be as follows: Accounts Payable Interest Expense Cash

3,465 35 3,500

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Use the following information to complete Questions 17 and 18. Witt Hardware had an inventory of 1,500 hammers valued at $5.00 each to begin the month. Witt sold 800 hammers on the 15th of the month and purchased 2,800 hammers on the last day of the month at $5.80 each.

Topic: Demonstration of accounting in a moving average perpetual inventory system LO: 5 17. The moving average cost per unit at the beginning of the next month is _______. A) B) C) D)

$5.40 $5.52 $5.62 $5.64

Answer: D Rationale: Answer D of $5.64 is computed as follows: [(700 units x $5.00) + (2,800 units x $5.80)] ÷ 3,500 units.

Topic: Demonstration of accounting in a FIFO perpetual inventory system LO: 5 18. Witt's inventory on a FIFO basis as of the beginning of the next month is _________. A) B) C) D)

$19,100 under the periodic system only. $19,740 under either inventory system. $19,740 under the perpetual system only. $19,740 under the periodic system only.

Answer: B Rationale: Answer B is calculated as follows: (2,800 units x $5.80) + (700 units x $5.00) = $19,740. This amount is the same whether the calculations are made at the end of the period (periodic system) or continually (perpetual system). Challenge: Also encompasses LO: 3

Topic: Demonstration of accounting in a LIFO perpetual inventory system LO: 5 19. Witt's inventory on a LIFO basis as of the beginning of the next month is __________. A) B) C) D)

$19,100 under the perpetual system only. $19,740 under the periodic system only. $19,740 under the perpetual system only. $19,100 under both inventory systems.

Answer: C Rationale: Answer C is calculated as follows: (700 units x $5.00) + (2,800 units x $5.80) = $19,740. Because the latest purchase is relative to the time that it is calculated, results differ under the periodic and perpetual inventory methods. Under the periodic system only, ending inventory is calculated as (1,500 units x $5.00) + (2,000 units x $5.80) = $19,100. Thus, Answers A, B, and D are incorrect. Challenge: Also encompasses LO: 3

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Topic: Demonstration of accounting in a moving average, FIFO, and LIFO in a perpetual inventory system LO: 5 20. Which of the following statements regarding inventory valuation is correct? A) The LIFO inventory method produces the same results whether a periodic system or a perpetual system is used. B) LIFO and moving average, but not FIFO method, apply assumed inventory flows that don’t necessarily match the physical flow. C) In periods of rising prices, LIFO produces a lower cost of goods sold amount than under FIFO. D) Under the moving average inventory system, a new unit cost is calculated after each inventory purchase but not after an inventory sale. Answer: D Rationale: Answer A is not correct because LIFO produces different results under periodic and perpetual because the latest purchase is a relative value. Answer B is incorrect because all three methods listed apply an assumed cost flow assumption. Answer C is incorrect because LIFO produces a higher cost of goods sold than FIFO in periods of rising prices. Answer D is correct because a new unit cost is determined under the moving average method after each purchase; however, the most recent inventory cost is applied at the time of a sale.

Topic: Explanation and computation of a LIFO reserve LO: 6 21. Which of the following statements describes a LIFO inventory reserve? A) Identifies the difference between inventory valued under FIFO (or another method) for internal purposes and under LIFO for external reporting. B) Is always recorded using an inventory allowance account. C) Is seldom used because a company would normally use LIFO for internal accounting and reporting purposes. D) Is adjusted continually throughout the accounting period. Answer: A Rationale: Answer A is correct because the LIFO reserve is only necessary when the inventory methods differ between internal and external reporting. Answer B is not correct because the allowance account is not used when the conversion to LIFO takes place outside of the accounts. Answer C is not correct because companies would likely not use LIFO for internal reporting and control purposes. Answer D is not correct because the LIFO reserve is calculated at reporting dates.

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Topic: Explanation and computation of a LIFO reserve LO: 6 22. SeaGull Inc. uses FIFO for internal purposes and LIFO for income tax and external reporting purposes. At the end of the year, the inventory records of SeaGull Inc. include the following items.

Ending inventory at FIFO

2020 $120,000

2021 $160,000

Ending inventory at LIFO

$75,000

$100,000

The entry to adjust the inventory allowance to reduce FIFO inventory to LIFO inventory at the end of 2021 would include what amount? A) B) C) D)

A debit to cost of goods sold for $60,000. A credit to cost of goods sold for $60,000. A debit to cost of goods sold for $15,000. A credit to cost of goods sold for $15,000.

Answer: C Rationale: Answer C is correct, calculated as follows: Year one allowance balance is $45,000, equal to $120,000 - $75,000. Year two allowance balance is $60,000, equal to $160,000 - $100,000. The increase to the allowance and cost of goods sold is $15,000, equal to $60,000 (desired balance) less $45,000 (prior balance).

Topic: Description and computation of the effect of LIFO liquidation LO: 7 23. Oates Inc. has beginning inventory of 100,000 units (cost of $15 per unit) accounted for using the LIFO inventory method. During the year, the company sold more items than purchased, causing the ending inventory balance to drop to 65,000 units. Assuming a tax rate of 25%, and a current replacement cost of inventory of $28 per unit, what is the LIFO liquidation effect on after-tax income? A) B) C) D)

$341,250 $113,750 $455,000 $633,750

Answer: A Rationale: Answer A is correct, calculated as follows: (100,000 – 65,000) x ($28 - $15) x 75% = $341,250.

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Topic: Description and computation of the effect of LIFO liquidation LO: 7 24. What is (are) possible reason(s) for a liquidation of an old layer of inventory at year-end when following the LIFO inventory method in a periodic inventory system? A) Management voluntarily decides to reduce inventory due to a decline in customer demand for the product. B) Due to a strike, inventory is not being manufactured, thus inventory levels are depleted in order to fill current customer orders. C) Although inventory is up from the prior year, the first quarter showed a liquidation of inventory. D) Both A and B. E) A, B, and C. Answer: D Rationale: Answer D is correct—LIFO liquidation can take place due to voluntary or involuntary reasons. Answer C is not correct because a company will typically replace inventory liquidations before year-end if possible.

Topic: Application of the dollar-value LIFO method LO: 8 25. Which of the following best illustrates the dollar-value LIFO method? A) B) C) D) E)

Companies use this method for both internal reporting and external reporting purposes. This method pools inventory which decreases the chance of liquidation of LIFO layers. Pools consist of inventory dollars rather than of separate inventory units. Both A and B. Both B and C.

Answer: E Rationale: Answer A is incorrect because dollar-value LIFO is used for reporting purposes only. The company would continue to use FIFO (or another method other than LIFO) for internal reporting purposes.

Topic: Application of the dollar-value LIFO method LO: 8 26. The following steps in the computation of dollar-value LIFO are listed below in no particular order. a. b. c. d.

Step__ Restate Layers of Inventory into Current Year Dollars Step__ Arrange Restated Inventory Balance into Layers Step__ Restate Ending Inventory at Base Year Dollars Step__ Match Layers to the Appropriate Price Indices

Arrange the steps in the proper order. A) B) C) D)

a, b, c, d a, b, d, c c, b, d, a a, c, b, d

Answer: C Rationale: The four steps as included in LO: 8 are listed in the proper sequence.

Test Bank, Chapter 9

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Topic: Application of the dollar-value LIFO method LO: 8 27.Wilderness Inc. accounts for inventory using the dollar-value LIFO method. The following information is available for the years 2020 through 2022. Year 2020 2021

Ending Inventory at FIFO $10,000 16,000

Price Index 1.00 1.12

2022

22,000

1.15

What is ending inventory for year 2022 using the dollar-value LIFO method? A) B) C) D)

$18,039 $19,130 $20,371 $17,940

Answer: C Rationale: 2021 $16,000/1.12

$14,286

$10,000 x 1.00 4,286 x 1.12

2022

$19,130

$10,000 x 1.00 4,286 x 1.12 4,844 x 1.15

$22,000/1.15

$10,000 4,800 5,571 $20,371

Topic: Application of the dollar-value LIFO method LO: 8 28. Northwest Inc. accounts for inventory using the dollar-value LIFO method. The following information is available for the years 2020 through 2022. Year 2020 2021 2022

Ending Inventory at FIFO $10,000 20,000 14,000

Price Index 1.00 1.15 1.20

What is ending inventory for year 2022 using the dollar-value LIFO method? A) B) C) D)

$11,917 $12,000 $13,417 $11,667

Answer: A Rationale: 2021 $20,000/1.15

$17,391

$10,000 x 1.00 7,391 x 1.15

2022

$11,667

$10,000 x 1.00 1,667 x 1.15

$14,000/1.20

$10,000 1,917 $11,917

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Topic: Inventory ratio analysis LO: 9 29. Luciano Inc. reported the following information. Item

Amount

Inventory, Dec. 31, 2019 Inventory, Dec. 31, 2020 Cost of goods sold, 2019 Cost of goods sold, 2020 Sales, 2019 Sales, 2020

$ 81,000 84,000 480,000 500,000 900,000 950,000

Compute the inventory turnover ratio and the average days in inventory for 2020.

A) B) C) D)

Inventory Turnover Ratio 5.95 6.06 11.52 5.45

Average Days in Inventory 61.32 60.23 31.70 66.92

Answer: B Rationale: Inventory turnover ratio is equal to $500,000 ÷ ($81,000 + $84,000)/2) = 6.06. Average days in inventory is equal to 365 days ÷ 6.06 = 60.23.

Topic: Inventory ratio analysis and interpretation LO: 9 30. Which of the following statements regarding inventory ratio analysis is not true? A) If inventory turnover is significantly lower than the industry average, a company may be holding excess inventory. B) If average days in inventory is greater than the industry average, a company may not have sufficient inventory to support its operations. C) In periods of rising prices, inventory turnover is generally higher under LIFO than under FIFO. D) The inventory method applied in a company will impact the calculation of its inventory turnover ratio. Answer: B Rationale: If average days in inventory is greater than the industry average, a company may be holding excess inventory (not lacking inventory); hence, Answer B is not true.

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Chapter 10 Inventory: Additional Issues Learning Objectives – Coverage by question Multiple Choice LO 10-1 – Apply lower-of-cost-or-net realizable value rule to inventory

1-4

LO 10-2 – Apply lower-of-cost-or-market rule to inventory

5-8

LO 10-3 – Demonstrate the relative sales value method to allocate costs to inventory

9-11

LO 10-4 – Demonstrate the gross profit method to estimate inventory

12-14

LO 10-5 – Demonstrate the accounting for purchase commitments

15-17

LO 10-6 – Describe the accounting treatment for changes in inventory methods

18-21

LO 10-7 – Explain the accounting treatment of inventory errors

22-24

LO 10-8 – Estimate inventory using the average cost and conventional retail methods

25-28

LO 10-9 – Appendix 10A Estimate inventory using LIFO retail and dollar-value LIFO retail methods

29-30

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Chapter 10: Inventory: Additional Issues Multiple Choice Topic: Application of the lower-of-cost-or-net realizable value rule to inventory LO: 1 1. Waltham Distribution Company has measured its December 31, 2020, inventory on a FIFO basis at $200,000. Information pertaining to that inventory follows. Item Estimated selling price Estimated cost of disposal Normal profit margin Current replacement cost

Amount $208,000 10,000 30,000 190,000

At December 31, 2020, what is the loss that Waltham should recognize? Assume no previously recorded inventory losses. A) $ 8,000 B) $10,000 C) $ 2,000 D) $-0Answer: C Rationale: Because the company uses the FIFO inventory method, the lower-of-cost-or-net realizable value rule applies. Answer C is correct because the net realizable value of $198,000 ($208,000 $10,000) is less than the cost of $200,000 by $2,000.

Use the following information to complete Questions 2 and 3. Information pertaining to the inventory of Paddington Company follows. FIFO Cost Category: Supreme Item A Item B Item C Category: Classic Item X Item Y Item Z

Net Realizable Value

$3,500 4,500 11,000

$3,000 4,800 10,500

18,000 22,000 35,000

19,000 26,000 33,000

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Topic: Application of the lower-of-cost-or-net realizable value rule to inventory LO: 1 2. What is the lower-of-cost-or-net realizable value of Paddington’s December 31, 2020, inventory applying the rule to each individual item? A) $91,000 B) $92,500 C) $94,000 D) $96,300 E) $93,300 Answer: A Rationale: The lower-of-cost-or net realizable value rule applied to each individual inventory items produces the following result by item: Item A, $3,000; Item B, $4,500; Item C, $10,500; Item X, $18,000; Item Y, $22,000; Item Z, $33,000. This totals $91,000 which is less than the total cost of these items of $94,000. Topic: Application of the lower-of-cost-or-net realizable value rule to inventory LO: 1 3. What is the loss (if any) that Paddington would record on December 31, 2020, applying the lower-ofcost-or net realizable value rule to (a) each inventory category and (b) to total inventory?

A) B) C) D)

Inventory Category $0 $3,000 $ 700 $ 700

Total Inventory $0 $0 $2,300 $0

Answer: D Rationale: Considering categories, net realizable value of category A is $18,300 which is less than the cost of $19,000. The net realizable value of category B is $78,000, which is greater than the cost of $75,000. Thus, inventory would be valued at $93,300 ($18,300 + $75,000). This amount is less than cost by $700. Considering inventory in total, the cost is $94,000 which is less than net realizable value in total of $96,300. Hence, no loss is recorded.

Topic: Application of the lower-of-cost-or-net realizable value rule to inventory LO: 1 4. Which of the following statements regarding a valuation loss determined through the application of the lower-of-cost-or-net realizable value rule is true? A) A significant valuation loss considered unusual or infrequent would be reported either as cost of goods sold or as part of other expenses and losses. B) A valuation loss may not be recorded when cost exceeds net realizable value under certain cases such as when there is an effective government-controlled market. C) On the balance sheet, the valuation loss is reflected either as a reduction to inventory directly or in a contra asset account. D) A and C E) B and C F) A and B Answer: E Rationale: A valuation loss that is considered both significant and unusual or infrequent should be shown in the other expenses and loss section of the income statement; hence, answer A is not true. Both B and C are both true so the correct answer is E. *Challenge question as it uses “Expanding Your Knowledge” information.

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Topic: Application of the lower-of-cost-or-market rule to inventory LO: 2 5. Waltham Distribution Company has determined its December 31, 2020, inventory on a LIFO basis at $200,000. Information pertaining to that inventory follows. Item Estimated selling price Estimated cost of disposal Normal profit margin Current replacement cost

Amount $208,000 10,000 30,000 190,000

At December 31, 2020, what is the loss that Waltham should recognize? Assume no previously recorded inventory holding loss. A) $32,000 B) $10,000 C) $2,000 D) $-0Answer: B Rationale: Because the company uses the LIFO inventory method, the lower-of-cost-or market rule applies. Answer B is calculated as follows: Market price is equal to $190,000 (replacement cost) because it falls between the ceiling of $198,000 ($208,000 - $10,000) and the floor of $168,000 ($198,000 - $30,000). Because market is less than the cost of $200,000, a loss is recorded ($190,000 - $200,000).

Topic: Application of the lower-of-cost-or-market rule to inventory LO: 2 6. Under the lower-of-cost-or-market method, the replacement cost of an inventory item would be used as the designated market value A) When it is below the net realizable value less the normal profit margin. B) When it is at or below the net realizable value and at or above the net realizable value less the normal profit margin. C) When it is above the net realizable value. D) Regardless of net realizable value. Answer: B Rationale: The replacement cost is used when it falls between the ceiling (net realizable value) and the floor (net realizable value less the normal profit margin).

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Topic: Application of the lower-of-cost-or-market rule to inventory LO: 2 7. The original cost of an inventory item is above the replacement cost and above the net realizable value. The replacement cost is below the net realizable value less the normal profit margin. Under the lowerof-cost-or-market method the inventory item should be priced at its A) Original cost. B) Replacement cost. C) Net realizable value. D) Net realizable value less the normal profit margin. Answer: D Rationale: The requirement is to determine the price at which the inventory should be stated under the lower of cost or market valuation method. Inventory is priced at market when market value is less than cost. In this situation, replacement cost (market) lies below the floor limitation of NRV less normal profit margin. Therefore, NRV less a normal profit margin will be used as market, and answer D is correct.

Topic: Application of the lower-of-cost-or-market rule to inventory LO: 2 8. Information pertaining to the inventory of Paddington Company follows.

Category: Supreme .Item A .Item B .Item C Category: Classic .Item X .Item Y .Item Z

LIFO Cost

Selling Price

Replacement Cost

$3,500 4,500 11,000

$4,000 4,500 11,000

$3,000 4,800 10,500

18,000 22,000 35,000

18,000 26,500 30,000

19,000 26,000 33,000

The company has a normal profit margin of 20% of selling price and has no additional costs to complete or sell the items. What is the lower-of-cost-or-market value of Paddington’s December 31, 2020, inventory applying the rule to (a) each individual item and (b) to each inventory category?

A) B) C) D)

Inventory Item $88,200 $89,700 $92,000 $94,000

lnventory Category $92,200 $94,000 $92,000 $94,000

Answer: A Rationale: The lower-of-cost-or-market value rule applied to each individual inventory items produces the following result by item: Item A, $3,200; Item B, $4,500; Item C, $10,500; Item X, $18,000; Item Y, $22,000; Item Z, $30,000. This totals $88,200 which is less than the total cost of these items of $94,000. Considering categories, market value of category A is $18,200 which is less than the cost of $19,000. The market value of category B is $74,000, which is less than the cost of $75,000. Thus, inventory would be valued at $92,200 ($18,200 + $74,000).

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Use the following information to complete Questions 9 and 10. Ragherty Inc. purchased land for development for $2,500,000. The land will be parceled into lots and sold for vacation homes as follows: 10 lots (Type A) to sell for $100,000 each; 15 lots (Type B) to sell for $70,000 each; and 20 lots (Type C) to sell for $50,000 each. Topic: Demonstration of the relative sales value method to allocate costs to inventory LO: 3 9. How much of the purchase price of $2,500,000 would be allocated to the Type B lots? A) $ 860,656 B) $ 833,333 C) $1,250,000 D) $ 795,455 Answer: A Rationale: The allocated price is equal to $1,050,000 (15 lots x $70,000 per lot) ÷ $3,050,000 (total selling price of lots) x $2,500,000 = $860,656.

Topic: Demonstration of the relative sales value method to allocate costs to inventory LO: 3 10. What is the gross profit for the sale of six Type A lots? A) $ 75,000 B) $193,333 C) $108,197 D) $266,667 Answer: C Rationale: The gross profit is computed as sales of $600,000 (6 lots x $100,000) minus cost of goods sold of $491,803 ($1,000,000/$3,050,000 x $2,500,000 ÷ 10 x 6) = $108,197.

Topic: Demonstration of the relative sales value method to allocate costs to inventory LO: 3 11. When is the relative sales value method used to allocate costs to inventory? A) When the relative sales value method is more economical than determining the cost of each inventory item. B) When the sales value of the inventory is a good indicator of the economic utility of the inventory item. C) When at least two different types of inventory items are purchased for one lump sum price. D) Both A and B E) Both B and C F) Both A and C Answer: E Rationale: Answer A is not correct because the relative sales value method is not justifiable because it is less expensive to apply. However, both answers B and C are correct; hence, answer E is correct.

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Topic: Demonstration of the gross profit method to estimate inventory LO: 4 12. Jeptha Co.’s accounting records include the following information. Item Inventory, January 1, 2020 Purchases during 2020 Sales during 2020

Amount $1,000,000 5,000,000 6,400,000

A physical inventory taken on December 31, 2020, resulted in an ending inventory of $1,150,000. Jeptha's gross margin on sales has remained constant at 25% in recent years. Jeptha suspects that an unusual amount of inventory may have been damaged and disposed of without appropriate tracking. At December 31, 2020, what is the estimated cost of missing inventory? A) $ 50,000 B) $200,000 C) $350,000 D) $450,000 Answer: A Rationale: First, ending inventory is estimated using the gross profit method. Beginning inventory of $1,000,000 plus purchases of $5,000,000, minus estimated cost of goods sold of $4,800,000 ($6,400,000 x 75%) = $1,200,000. The difference between the estimated inventory of $1,200,000 and the physical inventory of $1,150,000 is $50,000.

Topic: Demonstration of the gross profit method to estimate inventory LO: 4 13. Jeptha Co.’s accounting records include the following information. Item Inventory, January 1, 2020 Purchases during 2020 Sales during 2020

Amount $1,000,000 5,000,000 6,400,000

A physical inventory taken on December 31, 2020, resulted in an ending inventory of $1,050,000. Jeptha's markup on cost has remained constant at 32% in recent years. Jeptha suspects that an unusual amount of inventory may have been damaged and disposed of without appropriate tracking. At December 31, 2020, what is the estimated cost of missing inventory? A) $151,515 B) $336,000 C) $598,000 D) $101,514 Answer: D Rationale: First, ending inventory is estimated using the gross profit method. Gross profit as a percent of sales = 0.32/1.32 = 24.2424%. Beginning inventory of $1,000,000 plus purchases of $5,000,000, minus estimated cost of goods sold of $4,848,486 ($6,400,000 x 75.7576%) = $1,151,514. The difference between the estimated inventory of $1,151,514 and the physical inventory of $1,050,000 is $101,514.

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Topic: Demonstration of the gross profit method to estimate inventory LO: 4 14. Which of the following items would not affect the accuracy of an estimated inventory value measured through the use of the gross profit method? A) The company’s gross margin rate varies widely from period to period. B) Different categories of inventory have different gross margin rates that change at different rates. C) Future sales revenue is difficult to forecast but the gross margin rate remains stable. D) The company expects a change in sales mix of inventory categories that have different gross margin rates. Answer: C Rationale: The correct answer is C because the calculation uses actual, not estimated sales. The other answer options all have an impact on the gross margin rate which impacts the estimated inventory value.

Topic: Demonstration of the accounting for purchase commitments LO: 5 15. On June 1, 2020, Mackenzie Inc. entered into a noncancelable contract to purchase 100,000 units of raw materials inventory at $60 per unit, which is the current market price of the inventory at that date. The contract period extends for one year from the date of its inception. Mackenzie’s accounting period ends December 31. On December 31, 2020, raw materials were being sold for $58 per unit. What loss, if any, should Mackenzie recognize on December 31, 2020? A) $200,000 B) $100,000 C) $116,667 D) $-0Answer: A Rationale: The difference between $60 and $58 per unit multiplied by 100,000 units is recognized as a loss on December 31. Such a loss is recognized before the actual purchase of inventory as required in ASC 330-10-35-17.

Topic: Demonstration of the accounting for purchase commitments LO: 5 16. On June 1, 2020, Mackenzie Inc. entered into a noncancelable contract to purchase 100,000 units of raw materials inventory at $60 per unit, which is the current market price of the inventory at that date. The contract period extends for one year from the date of its inception. Mackenzie’s accounting period ends December 31. On December 31, 2020, raw materials were being sold for $62 per unit. What gain, if any, should Mackenzie recognize on December 31, 2020? A) $200,000 B) $100,000 C) $116,667 D) $-0Answer: D Rationale: Only losses, not gains, are recognized for the difference between the net realizable value and the contract price per ASC 330-10-35-17.

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Topic: Demonstration of the accounting for purchase commitments LO: 5 17. On December 1, 2020, Mackenzie Inc. entered into a noncancelable contract to purchase 100,000 units of raw materials inventory at $60 per unit, which is the current market price of the inventory at that date. On December 31, 2020, the company’s year-end, the company recognized a loss of $100,000 because the net realizable value of the inventory under contract dropped below the contract price. In 2021, if the net realizable value increases beyond the previously recorded loss, Mackenzie Inc.: A) Would reverse the loss, recognizing the full gain as income in 2021 B) Would reverse the loss and recognize income, but only up to the point of the prior loss C) Would reverse the loss, recognizing the full gain as income if sustained for 6 months D) Would not reverse the loss Answer: D Rationale: The company is prohibited from recognizing a recovery of estimated losses.

Topic: Description of the accounting treatment for changes in inventory methods LO: 6 18. A company may change from one inventory method to another inventory method during an accounting period. How would the following changes typically be treated for accounting purposes?

A) B) C) D)

Voluntary Change from FIFO to Average Cost Retrospective Treatment Retrospective Treatment Prospective Treatment Retrospective Treatment

Voluntary Change from FIFO to LIFO Retrospective Treatment Prospective Treatment Retrospective Treatment Modified Retrospective Treatment

Answer: B Rationale: ASC 250-10-45-5 indicates that a change in accounting principle is treated retrospectively unless the it impracticable to do so. In such a case, ASC 250-10-45-7 indicates that prospective treatment is appropriate.

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Use the following information to complete Questions 19 and 20. Fascinator Corporation changed from FIFO to average cost on January 1, 2021, for reporting inventory. Inventory balances under both methods follow. Fastener Corporation has a December 31 year-end. Inventory Balance at Dec. 31 Ending inventory, average cost Ending inventory, FIFO

2021 $165,000 n/a

2020 $150,000 90,000

2019 $110,000 75,000

Topic: Description of the accounting treatment for changes in inventory methods LO: 6 19. Ignoring taxes, the journal entry on January 1, 2021, to account for the change in inventory method would include the following A) A debit to Retained Earnings for $60,000. B) A credit to Retained Earnings for $60,000. C) A debit to Retained Earnings for $35,000. D) A credit to Retained Earnings for $35,000. Answer: B Rationale: The company would record an entry to debit Inventory and credit Retained Earnings for $60,000 ($150,000 - $90,000).

Topic: Description of the accounting treatment for changes in inventory methods LO: 6 20. Fascinator Company prepared its year-end financial statements dated December 31, 2021. What amounts would appear on its comparative balance sheets for the years ended December 31, 2021, and December 31, 2020, related to inventory?

A) B) C) D)

Dec. 31, 2021 $165,000 $165,000 $150,000 $150,000

Dec. 31, 2020 $150,000 $ 90,000 $110,000 $ 75,000

Answer: A Rationale: Under retrospective accounting treatment, both years would reflect the accounting under the new accounting method which is the average cost method. Hence, answer A is correct.

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Topic: Description of the accounting treatment for changes in inventory methods LO: 6 21. Annually, Wahlberg Company pays a bonus on pretax income of 5% that is paid out to employees. In 2020, a change in method to account for inventory results in a retrospective increase of $340,000 in pretax income of the prior year (2019). The entry to record the additional bonus payable would include the following: A) An increase to liabilities and an increase to assets in the amount of $17,000. B) An increase to assets and a decrease to equity in the amount of $17,000. C) An increase to liabilities and a decrease to equity in the amount of $17,000. D) A decrease to liabilities and an increase to equity in the amount of $17,000. Answer: C Rationale: The required entry includes a debit to Compensation Expense and a credit to Bonus Payable for $17,000. Per ASC 250-10-45-8, indirect effects of a change in accounting principle are recognized in the period in which the accounting change is made.

Topic: Explanation of the accounting treatment of inventory errors LO: 7 22. In 2021, Alpha Jax Inc. discovered errors in previously reported financial statements that understated ending inventory on December 31, 2020, by $5,000 and on December 31, 2019, by $11,000. Ignoring income taxes and assuming an operating cycle of less than one year, what is included in the correcting journal entry on January 1, 2021? A) A debit to inventory for $11,000. B) A debit to inventory for $6,000. C) A debit to Retained Earnings for $6,000 D) A credit to Retained Earnings for $5,000.

Answer: D Rationale: The correcting entry includes a debit to Inventory and a credit to Retained Earnings for $5,000. Note that the understatement of inventory on Dec. 31, 2019 is self-correcting; thus, no entry is required.

Topic: Explanation of the accounting treatment of inventory errors LO: 7 23. What is the effect on costs of goods sold (COGS) and pretax income of an error resulting in an understatement of beginning inventory? COGS A) Understated B) Understated C) Overstated D) Overstated

Pretax Income Overstated Understated Overstated Understated

Answer: A Rationale: An understatement of beginning inventory causes cost of goods available for sale to be understated. This causes COGS to be understated. It follows that if costs are understated, pretax income would be overstated for the period.

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Topic: Explanation of the accounting treatment of inventory errors LO: 7 24. What is the effect on costs of goods sold (COGS) and pretax income of an error resulting in an understatement of ending inventory? COGS A) Understated B) Understated C) Overstated D) Overstated

Pretax Income Overstated Understated Overstated Understated

Answer: D Rationale: An understatement of ending inventory causes COGS to be overstated. It follows that if costs are overstated, pretax income would be understated for the period.

Use the following information to complete Questions 25 and 26. Data relating to the computation of the inventory at June 30, 2020, for Daphne Inc. follow. Item Beginning inventory, July 1, 2019 Purchases Markups, net Sales Markdowns, net

Cost $ 252,000 1,428,000

Retail $ 350,000 2,362,500 245,000 2,415,000 175,000

Topic: Using the average cost and conventional retail methods LO: 8 25. What is ending inventory at cost on June 30, 2020, using the average cost retail method? A) $221,887 B) $367,500 C) $208,757 D) $184,450 Answer: A Rationale: The cost ratio of .60378 is calculated as $1,680,000 ($252,000 + $1,428,000) ÷ $2,782,500 ($350,000 + $2,362,500 + $245,000 - $175,000). Ending inventory at cost is equal to $367,500 ($350,000 + $2,362,500 + $245,000 - $175,000 - $2,415,000) x .60378 = $221,887. Note that the cost ratio takes into account both markups and markdowns.

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Topic: Using the average cost and conventional retail methods LO: 8 26. What is ending inventory at retail and at cost on June 30, 2020, using the conventional retail inventory method?

A) B) C) D)

Ending Inventory at Retail $220,500 $367,500 $367,500 $297,500

Ending Inventory at Cost $367,500 $220,500 $208,757 $184,450

Answer: C Rationale: Inventory at retail is equal to ($350,000 + $2,362,500 + $245,000 - $175,000 - $2,415,000) = $367,500. Inventory at cost is equal to the cost ratio of .568047 ($1,680,000 ($252,000 + $1,428,000)) ÷ $2,957,500 (($350,000 + $2,362,500 + $245,000) x $367,500 = $208,757. Note that the cost ratio takes into account markups but not markdowns.

Use the following information to complete Questions 27 and 28. Belfast Company reports inventory at cost of $63,000 and retail of $143,000 on January 1, 2020. Purchases in 2020 are $42,000 at cost and $63,000 at retail. It made additional markups of $16,800 (with cancellations of $6,300) and markdowns of $2,100. Belfast uses the conventional retail inventory method and estimates the cost of ending inventory at $21,000.

Topic: Using the average cost and conventional retail methods LO: 8 27. What is the cost ratio for Belfast Company for 2020? A) 0.489 B) 0.510 C) 0.485 D) 0.490 Answer: C Rationale: The cost ratio is equal to $105,000 ($63,000 + $42,000) ÷ $216,500 ($143,000 + $63,000 + $10,500) = 0.485. Topic: Using the average cost and conventional retail methods LO: 8 28. What are net sales for Belfast Company for 2020? A) $171,100 B) $204,215 C) $175,300 D) $193,400 Answer: A Rationale: First, ending inventory at retail is calculated by taking ending inventory at cost of $21,000 and dividing by the cost ratio of 0.48499 to equal $43,300. $216,500 – net sales - $2,100 = $43,300; net sales = $171,100.

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Topic: Estimating inventory using LIFO retail and dollar-value LIFO retail methods LO: 9 29. On December 31, 2019, Jacklin Company adopted the dollar-value LIFO retail inventory method. The increase in price level for 2020 is 10% and the cost to retail ratio for 2020 is 0.70. Inventory data for 2020 follow.

Inventory, Dec. 31, 2019 Inventory, Dec. 31, 2020

Cost $648,000 ?

Retail $ 900,000 1,320,000

Using the dollar value LIFO retail method, what is Jacklin's inventory at cost at December 31, 2020? A) $971,400 B) $858,000 C) $943,800 D) $879,000 Answer: D Rationale: Ending inventory at base-year retail prices is equal to $1,200,000 ($1,320,000 ÷ 1.1). This is composed of two layers: the first layer of $900,000 and the second layer of $300,000. The first layer is at a cost of $648,000. The second layer is at a cost of $231,000 ($300,000 x 1.10 x .70). The sum of the cost of these two layers is $879,000.

Topic: Estimating inventory using LIFO retail and dollar-value LIFO retail methods LO: 9 30. The LIFO retail method is applied to retail inventory A) Using the average cost method. B) Using the conventional method. C) Assuming net markups and net markdowns relate entirely to purchases rather than to beginning inventory. D) A and B E) B and C F) A and C Answer: F Rationale: The LIFO retail method is applied to retail inventory using the average cost method rather than the conventional method.

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Chapter 11 Property, Plant, and Equipment: Acquisition and Disposition Learning Objectives – Coverage by question Multiple Choice LO 11-1 – Determine cost to capitalize for land, land improvements, equipment, buildings, and construction in process

1-5

LO 11-2 – Determine costs to capitalize for lump-sum purchases of property, plant, and equipment

6-8

LO 11-3 – Account for acquisition of property, plant, and equipment through debt and equity issuances

9-11

LO 11-4 – Account for contributed property, plant, and equipment

12-13

LO 11-5 – Calculate capitalized interest

14-17

LO 11-6 – Account for asset retirement obligations

18-20

LO 11-7 – Account for property, plant, and equipment related costs after acquisition

21-23

LO 11-8 – Account for disposal of property, plant, and equipment

24-26

LO 11-9 – Account for exchange of property, plant, and equipment

27-30

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Chapter 11: Property, Plant, and Equipment: Acquisition and Disposition Multiple Choice Topic: Determine cost to capitalize for land, land improvements, equipment, buildings, and construction in process LO: 1 1. Which of the following costs should not be capitalized as an acquisition cost? A) Cost to update wiring to accommodate new factory equipment B) Cost to ship newly purchased computer equipment to factory C) Cost to calibrate measuring equipment before initial use D) Cost to train employees to use new factory equipment. E) All of the costs should be capitalized as acquisition costs F) None of the cost should be capitalized as acquisition costs Answer: D Rationale: Training costs do not enhance the value of the asset; thus are expensed as incurred. The other items are all capitalizable as acquisition costs under 360-10-30-1.

Use the following information to answer Questions 2 and 3. Privett, Inc. purchased land in 2019. An existing structure was demolished, and a new warehouse was constructed on the property in September of 2019. Privett hired construction workers at a rate of $25 per hour to do the work (1,680 hours in total). Privett’s operations manager spent 25% of his time in September supervising the construction. Warehouse Construction Cost Data Purchase price – Land Operation manager’s monthly salary Paving of parking lot Foundation work Parking lot lighting Electrical/Plumbing contractors Hourly wage rate – Workers

$125,000 5,000 10,000 15,000 10,000 25,000 25

Cost to remove structure on land Proceeds from sale of metal from demolished structure Landscaping costs Direct materials – Warehouse Closing costs on land purchase Payroll tax rate (all employees)

$10,000 3,000 12,000 105,000 5,000 10%

Privett had an appraisal done in October 2019. The land and land improvements were appraised for $150,000 and $50,000, respectively; the building was appraised for $175,000.

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Topic: Determine cost to capitalize for land, land improvements, equipment, buildings, and construction in process LO: 1 2. What is the amount in the Land account related to this construction project? A) $122,000 B) $127,000 C) $130,000 D) $125,000 E) $137,000 Answer: E Rationale: Total cost capitalized as land includes $125,000 for the purchase of land, $5,000 for closing costs, $10,000 for the removal of the existing structure, minus the sale of the existing structure for $3,000.

Topic: Determine cost to capitalize for land, land improvements, equipment, buildings, and construction in process LO: 1 3. What is the depreciable cost of the warehouse project? A) $220,250 B) $228,700 C) $207,000 D) $192,575 E) $196,700 Answer: C Rationale: Fair value of the building $175,000 + Cost of land improvements $32,000 ($10,000, paving + $12,000, landscaping, + $10,000, lighting) = $207,000. Note that the total cost of the building of $192,575 ($15,000, foundation +$105,000, direct materials + $42,000, (1,680 hours x $25) + $1,250, (25% x $5,000 manager salary) + $4,325 (($1,250 + $42,000) x 10% payroll tax rate) + $25,000, electrical and plumbing) exceeded the fair value of the building. Thus, the appraised value is capitalized while the excess of actual costs is expensed.

Topic: Determine cost to capitalize for land, land improvements, equipment, buildings, and construction in process LO: 1 4. A company purchased a piece of equipment in 2009. The equipment was expected to have a useful life of 10 years with no salvage value. The company failed to properly capitalize the cost of the equipment. Which of the following statements is(are) inaccurate? (Assume the equipment is still in use at the end of the identified reporting period.) A) Retained earnings at December 31, 2020, is understated. B) Total assets at December 31, 2015, are understated. C) Net income in 2009 is understated. D) A and B E) B and C F) A and C G) A, B, and C

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Answer: A Rationale: Option A is inaccurate: Equipment would be fully depreciated at December 31, 2020 so retained earnings would not be impacted. Option B is accurate. Equipment would not be fully depreciated at December 31, 2015, so total assets would be too low by the net book value of equipment. Option C is accurate. Expensing the cost of the equipment would understate net income in the year of purchase.

Topic: Determine cost to capitalize for land, land improvements, equipment, buildings, and construction in process LO: 1 5. Tomisito Enterprises made an online purchase of furniture for the office of its new sales manager in September. It arrived on September 30. The furniture cost $3,100. Sales tax was assessed at 10%. Tomlin paid $500 to have the furniture assembled. Installation was completed on October 15. The furniture is expected to last for five years with a salvage value of $300. The new sales manager started working on December 1. What was accumulated depreciation on the furniture (rounded to the nearest whole dollar) as of December 31? (Tomisito uses the straight-line method of depreciation.) A) $ 60 B) $150 C) $ 52 D) $130 E) $181 Answer: A Rationale: Depreciable cost: $3,610 (($3,100 x 1.1) + $500 - $300). Monthly depreciation: $60 ($3,610 / 60). Accumulated depreciation: $60 (depreciation for December (month placed in service).

Topic: Determine costs to capitalize for lump-sum purchases of property, plant, and equipment LO: 2 6. Drysdale, Inc. recently purchased a small factory in San Francisco (land, building, and equipment) for one lump sum price. The factory had been owned by the seller since 1975. Which of the following might be used effectively to determine the relative fair value of the components of the purchase? A) Independent appraisal B) Building cost records provided by seller C) Insurance valuations D) A and B E) B and C F) A and C G) A, B, and C Answer: F Rationale: B would not be a good indicator of fair value given significant changes in cost of land relative to costs of equipment in San Francisco since 1975.

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Topic: Determine costs to capitalize for lump-sum purchases of property, plant, and equipment LO: 2 7. Metropolis Products purchased property (land and building) for $1,000,000. The building will be used in operations. The most recent property tax assessment values the land at $600,000 and the building at $200,000. The journal entry to record the purchase includes a debit of $__________ to Land. A) $600,000 B) $500,000 C) $750,000 D) $700,000 Answer: C Rationale: Relative FV of Land 75% ($600,000/$800,000). Amount allocated to Land $750,000 ($1,000,000 x .75)

Topic: Determine costs to capitalize for lump-sum purchases of property, plant, and equipment LO: 2 8. Middletown Urgent Care purchased medical equipment, furniture, and artwork for $150,000 in a lumpsum purchase. An independent appraiser provided them with the following estimates of fair value: Medical equipment Office furniture Art works

$150,000 30,000 45,000

The appraiser did explain that she had minimal experience valuing artwork, so Middletown got a second opinion. The second appraiser agreed with the valuation of the medical equipment and the office furniture but assigned $0 as the fair value of the artwork. How much would Middletown Urgent Care allocate to Medical equipment using the first or second appraisal, respectively? A) $100,000; $125,000 B) $100,000; $100,000 C) $125,000; $100,000 D) $ 50,000; $ 75,000 Answer: A Rationale: Proportional: Total appraised value $225,000. Equipment share 66.67% ($150,000/$225,000). Allocated cost $100,000 ($150,000 x 75%). Incremental: Total appraised value $180,000. Equipment share 83.33% ($150,000/$180,000). Allocated cost $125,000 ($150,000 x 83.33%)

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Topic: Account for acquisition of property, plant, and equipment through debt and equity issuances LO: 3 9. Premier Products purchased raw land in an area expected to be heavily developed in the next five years. Because of the uncertainty of the extent and timing of development and lack of similar sales nearby, the fair value of the land is unknown. Premier purchased the land with a noninterest-bearing bearing note payable for $250,000. Note payments of $50,000 are to be made at the end of each year for five years. The company paid $3,000 for a title search, $15,000 for past due property taxes, and $2,000 in debt issuance fees, with cash. The borrowing rates for loans with similar terms is 5%. What is the capitalized cost of the land and the Discount on Note payable, respectively? A) $234,474; $15,526 B) $219,474: $30,526 C) $270,000; $20,000 D) $234,474; $33,526 E) $268,000; $33,526 Answer: D Rationale: Land: PV of payments $216,474 (PV(.08,5,50000) + Other capitalizable costs $18,000 ($3,000 + $15,000) = $234,474. Loan costs are not capitalizable as Land. Discount: $250,000 - PV of loan $216,474 = $33,526.

Topic: Account for acquisition of property, plant, and equipment through debt and equity issuances LO: 3 10. Premier Products purchased raw land in an area expected to be heavily developed in the next five years. The fair value of the land was $200,000. Premier purchased the land with a noninterestbearing note payable for $250,000. Note payments of $50,000 are to be made at the end of each year for five years. The company paid $3,000 for a title search, $15,000 for past due property taxes, and $2,000 in debt issuance fees, with cash. Because of the riskiness of the loan due to uncertainty of future values of the property, the borrowing rate was imputed. What was the imputed interest rate? (Rounded to two decimals.) What was the capitalized value of the land? A) 7.93%; $218,000 B) 4.75%: $236,000 C) 4.42%; $240,000 D) 7.93%; $268,000 E) 2.51%; $270,000 Answer: A Rationale: Imputed rate: 7.93% =RATE(5,-50000,200000) Land: FV $200,000 + Other capitalizable costs $18,000 ($3,000 + $15,000) = $218,000. Loan costs are not capitalizable as Land.

Test Bank, Chapter 11

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Topic: Account for acquisition of property, plant, and equipment through debt and equity issuances LO: 3 11. The fair value of a 50-year old building to be purchased by a public company cannot be reliably determined. Which of the following statements is(are) true about the purchase? A) If the building is purchased with company stock, the building should be recorded at the fair value of the stock. B) If the building is being purchased with company debt (five-year noninterest-bearing loan), and the prevailing interest rate is known, the building should be recorded at the present value of the payments required under the loan agreement. C) If the building is being purchased with company debt (five-year noninterest-bearing loan), and the prevailing interest rate is not known, the building should be recorded using the seller’s original cost. D) A and B E) B and C F) A and C G) A, B, and C Answer: D Rationale: C is not correct. If neither the fair value of the property or the prevailing rate is known, the company would need to determine a best estimate of one or the other. The seller’s original cost would not be used.

Topic: Account for acquisition of property, plant, and equipment through donation LO: 4 12. Physicians Ltd. received a highly specialized piece of medical equipment from a nearby hospital, without offering anything of value in exchange. If the equipment was purchased new, it would cost $500,000. Similar equipment, slightly used, can be purchased for $425,000. Physicians Ltd. paid to move the equipment ($10,000) and to install the equipment ($4,000). In addition, the manager of Physicians Ltd. decided to paint and retile the room where the equipment was installed at a cost of $1,000. What is the capitalized cost of the equipment and the amount of the contribution revenue, respectively? A) $500,000; $500,000 B) $425,000; $425,000 C) $439,000; $425,000 D) $439,000; $500,000 E) $440,000; $425,000 Answer: C Rationale: Cost: Fair value of equipment $425,000 + Other capitalizable costs $14,000 ($10,000 + $4,000) = $439,000 Contribution revenue: Fair value of equipment $425,000.

Intermediate Accounting, 3rd Edition

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Topic: Account for acquisition of property, plant, and equipment through donation LO: 4 13. A local hospital donated a highly specialized piece of medical equipment to a medical clinic, without receiving anything of value in exchange. The equipment had a net book value of $260,000 (Cost of $400,000). The equipment has a fair value of $325,000. Which of the following statements is true? A) The hospital should report a Loss on equipment disposal of $65,000 and Contribution expense of $260,000. B) The hospital should report a Loss on equipment disposal of $140,000 and Contribution expense of $400,000 C) The hospital should report a Gain on equipment disposal of $65,000 and Contribution expense of $325,000. D) The hospital should report a Loss on equipment disposal of $75,000 and Contribution expense of $325,000 E) The hospital should report Contribution expense of $260,000. No gain or loss should be recognized. Answer: C Rationale: Gain: Fair value of $325,000 – NBV at time of donation $260,000 = Gain of $65,000. Contribution expense: Fair value of equipment ($325,000)

Topic: Calculate capitalized interest LO: 5 14. Annapolis Corporation borrowed $600,000 on December 1, 2018, to finance construction of a new office building. The interest rate on the loan was 8%. Construction began on January 1, 2019, and the building was completed in March 2020. The following payments were made in 2019 related to the building project: Jan. 1 Mar. 1 Aug. 1 Dec. 1

Purchased the land Made progress payment to contractor Made progress payment to contractor Made progress payment to contractor

$120,000 150,000 180,000 90,000

How much of the interest should be capitalized? A) $16,600 B) $26,200 C) $43,200 D) $24,000 Answer: B Rationale: Interest Incurred: $600,000 x .08 = $48,000: Avoidable: [$120,000 + ($150,000 x 10/12) + ($180,000 x 5/12) + ($90,000 x 1/12)] x 8% = $26,200

Test Bank, Chapter 11

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Use the following information to answer Questions 15 and 16. Venetian, Inc. decided to open a new retail outlet in a neighboring town. On January 1, 2019, Venetian took out a $400,000 construction loan and purchased the land on January 15, 2019. Construction for the new store began on March 1, 2019. The company expected to complete construction in early 2020. Information about 2019 construction expenditures and details about Venetian’s debt structure are included below. Venetian Construction Expenditures—2019 Land purchase Payment for excavation and foundation work Payment for framing, electrical, plumbing, etc. Payment for drywall, fixtures, etc.

Jan. 15, 2019 Mar. 31, 2019 June 30, 2019 Dec. 31, 2019

$200,000 50,000 350,000 150,000

Venetian Debt Structure—2019 Construction loan for retail building project Note payable Bond payable

Jan. 1, 2019 Mar. 31, 2018 Oct. 31, 2018

$400,000 350,000 250,000

6% 8% 10%

Topic: Calculate capitalized interest LO: 5 15. What was the total weighted average accumulated expenditure for the Venetian project? What was the weighted average interest rate on general debt (non-project specific)? A) $379,167; 8.83% B) $404,167; 9.00% C) $379,167: 7.70% D) $550,000: 8.83% E) $404,167; 7.70% Answer: A Rationale: Weighted average accumulated expenditures: $166,667 ($200,000 x 10/12) + $37,500 ($50,000 x 9/12) + $175,000 ($350,000 x 6/12) = $379,167. Weighted average interest rate: $53,000 ($350,000 x 8% + $250,000 x 10%) / $600,000 ($350,000 + $250,000) = 8.83%. Challenge question: Note that interest is not capitalizable until the project is active so expenditures are not weighted until March 1.

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Topic: Calculate capitalized interest LO: 5 16. Venetian incurred $_________ in total interest costs in 2019; $____________ was capitalized to Construction in Process; $______________ was capitalized to Land. A) $77,000; $16,683; $6,067 B) $57,750; $24,000; $0 C) $80,000; $20,000; $0 D) $57,750; $16,683; $20,000 E) $77,000; $22,750; $0 Answer: E Rationale: Total interest: ($400,000 x 6%) + ($350,000 x 8%) + ($250,000 x 10%) = $77,000. Capitalized interest: $379,167 (see question #15) x 0.06 = $22,750. No interest would be allocated to land since the project was for the retail outlet (835-20-15-8). Challenge question

Topic: Calculate capitalized interest LO: 5 17. Which of the following statements about interest disclosures is correct? A) If a company has incurred interest costs during the period, but none of that interest has been capitalized, no disclosure is necessary. B) If a company has incurred interest costs during the period and some of the interest has been capitalized, the amount of interest expensed during the period, the amount of interest capitalized during the period, and the cumulative amount of interest capitalized by the company must be disclosed. C) If a company has incurred interest costs during the period and some of the interest has been capitalized, only the amount of interest capitalized during the period must be disclosed. D) If a company has incurred interest costs during the period and some of the interest has been capitalized, the amount of interest expensed during the period and the amount of interest capitalized during the period must be disclosed. Answer: D Rationale: Based on 835-20-50-1: A is incorrect because the amount of interest cost incurred and charged to expense must be disclosed even if no interest is capitalized. B is incorrect because only interest incurred in the current period must be disclosed (amount and treatment). C is incorrect because both interest costs charged to expense and interest costs capitalized must be disclosed. D is correct.

Test Bank, Chapter 11

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Use the following information to answer Questions 18-20. Pump-N-Go Gasoline installed three new underground storage tanks at one of its gas stations on January 1, 2020. The cost of the tanks was $150,000. The expected life of the tank is 10 years. Under new state laws, the tanks must be removed after 10 years. Cost to remove the three tanks is expected to be $20,000. Pump-N-Go’s borrowing rate is 6%.

Topic: Account for asset retirement obligations LO: 6 18. What was the reported cost of the three storage tanks installed at Pump-N-Go Gasoline’s gas station? (Round your answer to the nearest whole number.) A) $150,000 B) $161,168 C) $170,000 D) $ 94,927 Answer: B Rationale: Tank cost $150,000 + ARO $11,167.90 (PV(.06,10,0,-20000) = $161,168 (rounded)

Topic: Account for asset retirement obligations LO: 6 19. What was Pump-N-Go Gasoline’s depreciation expense and accretion expense, respectively, in 2021? (Round your answer to the nearest whole number.) A) $15,000; $670 B) $16,117; $710 C) $17,000; $670 D) $16,117; $670 Answer: B Rationale: Depreciation: Cost from question 18, $161,168 divided by 10 = $16,117. Accretion expense: ($11,168 + $670) x 6% = $710 (rounded).

Topic: Account for asset retirement obligations LO: 6 20. Assume that on December 31, 2024, Pump-N-Go Gasoline removed the three tanks before putting the gas station lot up for sale. The cost of the removal was $18,000. Which of the following statements is true? A) Pump-N-Go debited Asset Retirement Obligation for $11,168. B) Pump-N-Go recognized a loss on settlement of the asset retirement obligation of $3,055. C) Pump-N-Go recognized a gain on settlement of the asset retirement obligation of $2,000. D) Pump-N-Go debited Asset Retirement Obligation for $18,000 Answer: B Rationale: Balance in asset retirement obligation at December 31, 2024, would be $14,945. The difference between the settlement amount ($18,000) and the ARO balance ($14,945) is $3,055 (loss). Interest Beg. Balance Year 1 accretion - 2020 Year 2 accretion - 2021 Year 3 accretion - 2022 Year 4 accretion - 2023 Year 5 accretion - 2024

$670 710 753 798 846

ARO Balance $11,168 11,838 12,548 13,301 14,099 14,945

Intermediate Accounting, 3rd Edition

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Topic: Account for property, plant, and equipment related costs after acquisition LO: 7 21. Pepperoni’s Pizza incurred the following costs during 2019: Purchase of warming units for delivery vehicles Cost to install warming units Replacement parts for refurbishment of pizza ovens Labor related to refurbishment of ovens

$25,000 2,000 6,000 2,000

The refurbishment improved the efficiency of the ovens by 20% but did not extend the oven’s useful life. This is the first time Pepperoni’s had installed warming units in its vehicles. Of the above costs, $___________ should be capitalized. A) $ 8,000 B) $27,000 C) $31,000 D) $25,000 E) $35,000 F) $0 Answer: E Rationale: Both the warming units and the refurbishment increase the productivity of the assets.

Topic: Account for property, plant, and equipment related costs after acquisition LO: 7 22. In 2018, Ellis Limited purchased a highly specialized piece of manufacturing equipment for $50,000. The estimated service life was 5 years. In 2020, the company paid $5,000 to update the control panel. The updated panel is expected to extend the service life of the equipment another 2 years. The cost was material to Ellis. The company should _____________. A) Debit Repairs and Maintenance Expense for $5,000 B) Debit the Equipment account for $5,000. (The $5,000 should then be depreciated over the remaining 3-year life of the equipment.) C) Debit the Accumulated Depreciation account related to the equipment for $5,000. D) Debit the Equipment account for $5,000. (The $5,000 should be depreciated over a 2-year period.) E) Give the Operations Manager the responsibility of selecting the accounting treatment. Answer: C Rationale: Debiting Accumulated Depreciation is the accounting treatment used when an improvement extends the life but not the functionality of the equipment. Option A is incorrect because the change extends the life of the equipment. Option B is incorrect. The life of the equipment has been extended. Option D is incorrect. The new life is 7 years. The panel would be depreciated over the remaining 5 years.

Test Bank, Chapter 11

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Topic: Account for property, plant, and equipment related costs after acquisition LO: 7 23. Allegiance, Inc. has a large factory operating in western Washington. In 2020, extensive mold was discovered in the factory. The mold, located in the air duct system, was caused by several roof leaks that had been there for several years. The cost to remove the mold was $200,000. The cost was material to the company. Which of the following statements is accurate? A) The cost to remove the mold should be expensed in 2020. B) The cost to remove the mold should be capitalized and depreciated over the remaining useful life of the factory building. C) The cost to remove the mold should be capitalized and the service life of the building should be extended. D) The cost to remove the mold should be capitalized and the service life of the building should be reduced. Answer: A Rationale: The mold was caused by neglect (failure to maintain the roof). Mold removal would not extend (or reduce) the life or functionality of the building.

Topic: Account for disposal of property, plant, and equipment LO: 8 24. Account balances in Yellowstone, LLC’s fixed asset accounts at the beginning and end of the year are as follows:

Property, plant, and equipment Accumulated depreciation

Beginning of year

End of year

$200,000 85,000

$160,000 90,000

The company sold some equipment at a loss of $10,000. The company also purchased equipment during the year for $50,000. Depreciation expense was $20,000. What were the proceeds on the sale of the equipment? A) $80,000 B) $ 5,000 C) $95,000 D) $65,000 Answer: D Rationale: Net book value of sold equipment: Cost $90,000 (BOY $200,000 + Purchased $50,000 - EOY $160,000) – A/D $15,000 (BOY $85,000 + Depreciation expense $20,000 – EOY $90,000) = $75,000. NBV $75,000 – Loss on sale $10,000 = $65,000

Intermediate Accounting, 3rd Edition

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Topic: Account for disposal of property, plant, and equipment LO: 8 25. Delany’s Deconstruction purchased a truck on June 15, 2015, for $35,000. A 6% sales tax was added to the cost. In addition, Delany’s paid $2,500 to ship the truck to its main office. The truck arrived on July 1, just in time to start work on a major customer project. The truck was estimated to have a 10-year service life. On January 1, 2018, Delany’s purchased and installed a truck-mounted generator for $8,000 (sales tax included). With the generator, Delany’s was able to increase the number of services provided to its customers. On July 1, 2019, Delany’s replaced two of the tires on the truck for $1,000. On December 31, 2020, Delany’s sold the truck for $22,000. Delany’s Deconstruction recognized a ______ of $_______ on the sale. (Delany’s uses the straightline method of depreciation.) A) Gain; $1,450 B) Gain: $650 C) Loss; $1,389 D) Loss; $422 E) Loss; $620 Answer: E Rationale: Net book value of truck: Cost $47,600 ($35,000 + ($35,000 x .06) + $2,500 + $8,000) – Acc depn $24,980 (($35,000 + ($35,000 x .06) + $2,500) ÷ 10 x 5.5) + ($8,000 ÷ 7.5 x 3)) = $22,620. Loss on sale: Proceeds $22,000 - $22,620 (net book value) = $(620).

Topic: Account for disposal of property, plant, and equipment LO: 8 26. Which of the following statements is(are) inaccurate? A) Gains or losses on equipment disposals are reported as part of income from continuing operations in the income statement. B) The net book value of uninsured equipment destroyed in a flood would be reported net of the tax benefit, in the income statement. C) If the net book value of an abandoned plant asset is zero at the time of disposal, no journal entry is required. D) A and B E) B and C F) A, B, and C Answer: E Rationale: Option B is inaccurate. Gains/losses on disposals are not reported net of taxes. Option C is inaccurate. A journal entry to remove the asset and its accumulated depreciation would be required.

Test Bank, Chapter 11

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Topic: Account for exchange of property, plant, and equipment LO: 9 27. A company exchanged a warehouse for another similar warehouse. The fair value of the warehouse received exceeded the net book value of the warehouse given up in the exchange by $5,000. The entry to record the transaction would not include any debits or credits to income statement accounts in which of the following situations? A) The exchange lacked commercial substance and no cash was paid or received. B) The exchange lacked commercial substance and $3,000 in cash was paid. C) The exchange lacked commercial substance and $3,000 in cash was received. D) A and B E) B and C F) A and C G) A, B, and C Answer: D Rationale: A and B are correct. Gains are fully deferred in exchanges where cash is paid and in exchanges where no cash changes hands. C is not correct because a journal entry for the situation described in C could include the recognition of a partial gain.

Topic: Account for exchange of property, plant, and equipment LO: 9 28. Bling Containers exchanged equipment with a fair value of $65,000 plus a cash payment of $10,000 for equipment with a fair value of $75,000 owned by Brighton in 2020. Bling anticipated an increase in cash flow as a result of the exchange. Bling’s equipment originally cost $200,000. It had been depreciated down to its expected residual value of $35,000. Brighton’s equipment had a net book value of $90,000 (original cost of $250,000.) How much of a gain or loss did Bling Containers report in its income statement for 2020? A) $0 B) $25,000 loss C) $30,000 gain D) $ 3,529 gain Answer: C Rationale: Gain is computed as follows: FV of equipment received ($75,000) – Cash payment ($10,000) – Net book value of old equipment ($35,000) = $30,000.

Intermediate Accounting, 3rd Edition

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Topic: Account for exchange of property, plant, and equipment LO: 9 29. Compass, Inc. exchanged a heavy-duty dump truck for a similar truck owned by Northwest, Inc. Compass’s truck had a net book value of $50,000 (original cost $130,000) and a fair value of $45,000. Northwest’s truck had a net book value of $40,000 (original cost $100,000) with a fair value of $50,000. Compass agreed to pay Northwest $5,000 as part of the exchange. The exchange had no effect on either company’s cash flows. What was the amount of gain or loss recognized by Compass and Northwest, respectively, in the year of the exchange? A) $0; $0 B) $5,000 loss; $1,000 gain C) $5,000 gain; $5,000 loss D) $5,000 loss; $10,000 gain E) $5,000 loss; $0 Answer: B Rationale: Compass: FV of asset received ($50,000) – Cash paid ($5,000) – NBV of truck ($50,000) = $(5,000). Losses on exchanges are recognized in full in any type of exchange. Northwest: FV of asset received ($45,000) + Cash received ($5,000) – NBV of truck ($40,000) = $10,000 gain. Partial gain is recognized on exchange with no commercial substance when cash is received. Partial gain recognized Cash ($5,000) ÷ [Cash + Fair value of assets received ($5,000 + $45,000)] x Total gain ($10,000) = $1,000 recognized gain.

Topic: Account for exchange of property, plant, and equipment LO: 9 30. Chastain Manufacturing exchanged a tract of land costing $150,000 for a tract of land with a fair value of $225,000. Chastain received $80,000 in cash as part of the exchange agreement. There was no commercial substance to the transaction. How much gain or loss would Chastain report on the exchange? A) $155,000 B) $ 40,656 C) $0 D) $ 75,000 E) $ 80,000 Answer: A Rationale: Full gain is recognized since cash received was greater than 25% of the total proceeds ($80,000 ÷ ($80,000 + $225,000) = 26%). Gain is $155,000 ($225,000 + $80,000 - $150,000).

Test Bank, Chapter 11

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Chapter 12 Depreciation, Impairments, and Depletion Learning Objectives – Coverage by question Multiple Choice LO 12-1 – Calculate depreciation using straight-line, sum-of-the-years’digits, declining-balance, and units-of-production methods

1-3

LO 12-2 – Account for depreciation in partial periods

4-6

LO 12-3 – Calculate depreciation using group and composite methods

7-9

LO 12-4 – Account for changes in estimate as they relate to depreciation

10-12

LO 12-5 – Account for changes in depreciation methods

13-15

LO 12-6 – Account for errors in reporting property, plant, and equipment

16-18

LO 12-7 – Account for impairments of property, plant, and equipment

19-21

LO 12-8 – Account for assets held for sale

22-24

LO 12-9 – Describe property, plant, and equipment disclosures and ratio analyses

25-26

LO 12-10 – Record acquisition and depletion of natural resources

27-29

LO 12-11 – Appendix 12A – Calculate MACRS (tax) depreciation

Intermediate Accounting, 3rd Edition

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Chapter 12: Depreciation, Impairments, and Depletion Multiple Choice Topic: Calculate depreciation using straight-line, sum-of-the-years’-digits, declining-balance, and units-of-production methods LO: 1 1. On January 1, 2016, Flannery’s, Inc. purchased equipment having an estimated useful life of 10 years. Resale value at the end of its service was estimated at 20% of original cost. On December 31, 2020, the equipment was sold for 50% of its original cost. Flannery’s recognized a loss on the sale. Which of the following depreciation methods had Flannery’s been using? A) Straight-line B) Sum-of-the-years’-digits C) Double-declining balance D) Either A or B E) Either B or C F) Either A, B, or C Answer: A Rationale: Straight-line would have resulted in a book value of greater than 50% of the original cost at the end of year 5, the date of sale. (Accumulated depreciation at December 31, 2020, would be 5(X20%X)/10 or 40%X. As a result, book value would be 60%X; greater than the 50% sales price.) Both of the accelerated depreciated methods would have resulted in a book value less than 50% at the time of sale.

Use the following information to answer Questions 2 and 3. Deacon Industries purchased a delivery vehicle on January 1, 2019, for $30,000. They paid sales taxes of $2,000 and one year’s insurance premium of $2,000 on the same day. The company estimated a residual value of $3,000 at the end of the 5-year expected service life. Expected usage (in miles) of the new delivery vehicle 2019 2020 2021 2022 2023

16,000 22,000 25,000 21,000 16,000

Mileage estimates were based on expected increases in customers and the addition of a second delivery vehicle in 2022.

Test Bank, Chapter 12

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Topic: Calculate depreciation using straight-line, sum-of-the-years’-digits, declining-balance, and units-of-production methods LO: 1 2. What was the book value of the vehicle at December 31, 2021, under the straight-line and units-ofproduction depreciation methods, respectively? A) $12,800; $11,840 B) $13,600; $12,580 C) $15,400: $14,470 D) $13,800; $12,990 E) $14,600; $13,730 Answer: E Rationale: Straight-line: Cost ($32,000) – Acc Depn at 12/31/21 ($17,400) (Depreciable cost ($29,000) / Life (5) * Years to date (3)) = $14,600; Units-of-production: Cost ($32,000) – Acc Depn at 12/31/21 $18,270 (Rate $.29/mile (20,000/100,000) * Miles 63,000 (16,000+22,000+25,000) = $13,730

Topic: Calculate depreciation using straight-line, sum-of-the-years’-digits, declining-balance, and units-of-production methods LO: 1 3. What was depreciation expense of the vehicle in 2021 under the sum-of-the-years’-digits and doubledeclining balance depreciation methods, respectively? A) $6,800; $4,896 B) $5,800: $4,608 C) $6,200; $4,896 D) $6,400; $4,176 E) $6,400; $4,176 Answer: B Rationale: Sum-of-the-years’-digits: $29,000*3/15=$5,800 Double-declining balance: $32,000-$20,480 (accumulated depreciation at 12/31/20) * 40% = $4,608.

Topic: Account for depreciation in partial periods LO: 2 4. Clapton Industries purchased a vehicle for $23,000 on April 1, 2019. The service life was estimated at 5 years with no resale value. In 2019, the company recognized $3,833 in depreciation expense related to the vehicle. What depreciation and proration methods, respectively, did the company use to determine that amount? A) Sum-of-the-years’-digits method; Half-year convention B) Straight-line method; Full-month convention C) Double-declining method; Full-year convention (End of period) D) Straight-line method; Full-year convention (End of period) E) Sum-of-the-years’-digits method; Full-month convention Answer: A Rationale: $23,000 * 5/15 = $7,667 for 6 months = $3,833

Intermediate Accounting, 3rd Edition

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Topic: Account for depreciation in partial periods LO: 2 5. Shay Enterprises purchased equipment on March 18, 2018, at a cost of $40,000. The equipment was expected to have a 10-year service life, $4,000 in residual value. Sanchez uses the declining balance (150%) method to calculate depreciation. On November 21, 2020, the equipment was sold for $30,000. Assuming Shay used the full-month, half-year and full-year (beginning of period) conventions, respectively, what amount of gain or loss would be recognized on the sale date? A) $7,778; $4,080; $4,400 B) $2,572; $(182); $(10) C) $3,969; $909; $1,100 D) $6,572; $3,818; $3,990 E) $3,597; $(1,450); $1,100 Answer: C Rationale:

Topic: Account for depreciation in partial periods LO: 2 6. Which depreciation method would result in the same depreciation expense amount regardless of the partial period convention used by the company? A) Straight-line B) Sum-of-the-years’-digits C) Declining-balance D) Units-of-production Answer: D Rationale: Units-of-production method is not based on time. Partial period conventions wouldn’t apply.

Topic: Calculate depreciation using group and composite methods LO: 3 7. The straight-line depreciation method is used by which of the following depreciation methods: • • A) B) C) D)

Group Composite

Group Composite both Group and Composite neither Group nor Composite

Answer: C Rationale: Both methods use the straight-line method in calculating depreciation expense. © Cambridge Business Publishers, 2023 12-4

Test Bank, Chapter 12

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Topic: Calculate depreciation using group and composite methods LO: 3 8. Chocomelts, Inc. uses a composite depreciation system for its factory equipment. The following equipment was purchased in January 2020:

Mixing equipment Forming equipment Testing equipment Packaging equipment

Quantity 3 4 10 2

Unit Cost $50,000 40,000 2,000 60,000

Unit Residual Value 0 4,000 0 9,000

Life 5 3 5 6

In January 2021, one of the testing units was sold for $500. What is the balance in accumulated depreciation at the end of 2021, assuming no other changes? A) $196,000 B) $196,060 C) $196,500 D) $197,560 E) $198,000 Answer: B Rationale:

Intermediate Accounting, 3rd Edition

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Topic: Calculate depreciation using group and composite methods LO: 3 9. Which of the following statements about group and composite depreciation is(are) accurate? A) The depreciation rate of a composite group would change if there were a material change in the makeup of the assets included in the group. B) In a composite depreciation system, gains and losses on asset disposals are not recognized. C) In a composite depreciation system, it is possible to fully depreciate an asset before the end of its useful life. D) A and B E) B and C F) A and C G) A, B, and C Answer: G Rationale: All statements are accurate.

Topic: Account for changes in estimate as they relate to depreciation LO: 4 10. On July 8, 2017, Lucky’s, Inc. purchased a service vehicle for $53,000. The estimated useful life was estimated at 5 years; $20,000 residual value. The company uses the straight-line method of depreciation; full month convention. On January 21, 2019, Lucky’s had storage and shelving units permanently installed in the vehicle, increasing the type of jobs that Lucky’s personnel could handle at remote job sites. The cost of the upgrade was $15,015. The upgrade was not expected to extend the life of the vehicle. In December 2020, the service manager revised the estimate of the life and residual value of the vehicle to 7 years; $10,000, respectively. How much depreciation expense should Lucky’s recognize on the vehicle in 2021? A) $7,524 B) $3,762 C) $10,381 D) $8,260 Answer: A Rationale:

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Topic: Account for changes in estimate as they relate to depreciation LO: 4 11. On July 8, 2017, Lucky’s, Inc. purchased a service vehicle for $53,000. The estimated useful life was 5 years; $20,000 residual value. The company uses the straight-line method of depreciation; full month convention. On January 21, 2019, Lucky’s had storage and shelving units permanently installed in the vehicle, increasing the type of jobs that Lucky’s personnel could handle at remote job sites. The cost of the upgrade was $15,015. The upgrade was not expected to extend the life of the vehicle. In December 2020, the service manager revised the estimate of the life and residual value of the vehicle to 7 years; $10,000, respectively. Which of the following is(are) true about Lucky’s financial statement disclosure requirements for 2021? A) No special disclosures are required. This is a change in estimate made in the ordinary course of business. B) Lucky’s would need to disclose the new depreciation amount for the asset and the reason for the change in estimated life and residual value. C) Lucky’s would need to disclose the effect of the change in life and residual value on depreciation expense in 2021, if the amount is material. D) Lucky’s would need to disclose the effect of the change in life and residual value on related pershare amounts, if material. E) B and D F) C and D G) B and C Answer: F Rationale: The dollar impact of changes in estimates affecting multiple future periods on the income statement and related per-share amounts is required under 250-10-50-4, if material.

Topic: Account for changes in estimate as they relate to depreciation LO: 4 12. Ontario Products revised estimates on two of its plant assets on December 31, 2022, as follows:

Purchase date Equipment cost Original estimates: Life in years Residual value New estimates: Life in years Residual value 2023 Income before depreciation # of common shares outstanding

Asset #1

Asset #2

Jan. 1, 2018 $45,000

June 30, 2019 $75,000

6 $4,000

6 $10,000

10 $4,000

6 $0 $85,075 10,000

Ontario uses the straight-line method of depreciation, full month convention. Continued

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What amounts would be disclosed related to the change in the above estimates in the 2023 financial statements? (Ignore income taxes.) A) $1,467 decrease in net income; $0.15 decrease in earnings per share B) $1,698 increase in net income: $0.17 increase in earnings per share C) $1,067 increase in net income; $0.11 increase in earnings per share D) $1,467 increase in net income; $0.15 increase in earnings per share E) $1,698 decrease in net income: $0.17 decrease in earnings per share F) $1,067 decrease in net income; $0.11 decrease in earnings per share Answer: D Rationale:

Topic: Account for changes in depreciation methods LO: 5 13. Platinum Manufacturing paid $75,000 (no residual value) for equipment with a useful life of 5 years on January 1. Platinum uses the double-declining-balance method of depreciation. However, after two years, Platinum changes to the straight-line method for depreciation purposes. What is depreciation expense in year 3? A) $ 5,400 B) $13,500 C) $16,000 D) $ 9,000 E) $15,000 Answer: D Rationale: Depreciation under the straight-line method is $9,000 in year 3 ($75,000 - $30,000 $18,000) / 3 = $9,000.

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Topic: Account for changes in depreciation methods LO: 5 14. Which of the following statements about changes in depreciation methods is(are) correct? A) A change in depreciation method is treated as a change in accounting principle and is accounted for prospectively. B) A company must disclose the reason for changes in depreciation methods in the notes to the financial statements, if the effect of the change in depreciation method is material. C) Although changes in depreciation methods are accounted for prospectively, disclosure of the balance in accumulated depreciation prior to the change in method is required. D) A and B E) B and C F) A and C G) A, B, and C Answer: B Rationale: B is correct. Reasons for changes in estimates are disclosed along with impacts on net income and earnings per share. Statement A is partially incorrect. A change in depreciation method is treated as a change in estimate, not a change in accounting principle. Statement C is incorrect. There is no required disclosure of accumulated depreciation prior to a change in method.

Topic: Account for changes in depreciation methods LO: 5 15. In early July 2019, Matterhorn Enterprises purchased its first service vehicle for $46,000. The company adopted units-of-production (mileage) as the depreciation method. It was estimated that the vehicle would have a service life of 6 years and that mileage would total 120,000. Residual value was estimated at $10,000. After the first six months, the company concluded that vehicle usage was tied more to the type of service call than mileage. It was expected that service vehicles would be used more heavily in the first half of the service life. The company decided to change the depreciation method to doubledeclining-balance on January 1, 2020. Mileage in the first six months of operations totaled 12,000. What was depreciation expense in 2020? A) $14,132 B) $10,799 C) $12,954 D) $13,799 E) $10,466 Answer: A Rationale: Accumulated depreciation at 12/31/19: $3,600 (46,000-10,000)/120,000*12,000) Net book value at 12/31/19: $42,400 (46,000-3,600). DDB 2020: $14,132 (42,400*.33333)

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Use the following information to answer Questions 16 and 17. Snapbacks Inc., a custom sports hat manufacturer, started operations in 2018 with a capital contribution of $100,000. The company leases its facilities under a five-year lease agreement (January 2018December 2022). Snapbacks declared and paid dividends of $50,000 in 2019 and $100,000 in 2020. The company has been very successful in its first three years and is hoping to expand operations. Snapbacks’ bank has requested comparative financial statements (three years) as part of Snapbacks’ loan application. Operating information to date follows.

Net income Total assets Total liabilities

2018 $ 135,000 1,785,000 1,550,000

2019 $ 165,000 1,844,000 1,494,000

2020 $ 180,000 2,066,000 1,636,000

The accountant preparing the statements discovers that $50,000 in leasehold improvements (installed in January 2018) was expensed in error.

Topic: Account for errors in reporting property, plant, and equipment LO: 6 16. In the 2020 comparative financial statements, what would Snapbacks report for December 31, 2018, total assets and 2018 net income, respectively, after the accountant makes the corrections? (Ignore income taxes. Assume all other amounts are fairly stated.) A) $1,775,000; $185,000 B) $1,775,000; $125,000 C) $1,825,000; $175,000 D) $1,745,000; $95,000 Answer: C Rationale:

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Topic: Account for errors in reporting property, plant, and equipment LO: 6 17. In the 2020 comparative financial statements, what would Snapbacks report for December 31, 2020, Total Equity and Retained earnings, respectively, after the accountant makes the corrections? (Ignore income taxes. Assume all other amounts are fairly stated.) A) $480,000; $380,000. B) $400,000; $300,000 C) $370,000: $270,000 D) $450,000; $350,000 E) $520,000; $420,000 Answer: D Rationale: See answer/rationale for Question 16. Challenge question

Topic: Account for errors in reporting property, plant, and equipment LO: 6 18. Flagler Industries was audited for the first time in 2021. The auditors found a number of errors in 2020 activity related to plant assets: •

$5,110 of depreciation on the company’s sales office was recorded twice.

•

$10,000 in residual value on a new dump truck was not factored into the calculation of depreciation. (The truck was purchased on December 1 for $52,500. Service life was estimated at 7 years.)

•

Truck maintenance costs of $15,000 in May 2020 were capitalized and depreciated. The service life was set at 2 years.

Flagler uses the straight-line method of depreciation, half-year convention on all plant assets. After Flagler recorded the corrections, by how much did Retained earnings increase/decrease at December 31, 2020? A) Decreased by $5,426 B) Decreased by $6,021 C) Decreased by $7,583 D) Increased by $5,426 E) Increased by $11,959 F) Increased by $15,646 Answer: A Rationale:

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Topic: Account for impairments of property, plant, and equipment LO: 7 19. On January 1, 2016, Griffin Company purchased a piece of manufacturing equipment for $200,000. The estimated useful life of the equipment was 10 years, with no salvage value. The company uses the straight-line method to depreciate equipment (full-month convention). On December 31, 2019, the company recognized a $30,000 impairment loss on the equipment. What amount should Griffin report as depreciation expense in 2020? A) $15,714 B) $20,000 C) $15,000 D) $23,000 E) $25,000 Answer: C Rationale: Carrying value at 12/31/19: $200,000 – 110,000 (200,000/10*4+30,000) = $90,000 Depreciation: $90,000 / 6 remaining years = $15,000

Topic: Account for impairments of property, plant, and equipment LO: 7 20. Lilliput Boutique owns a small retail outlet in a California coastal town. In the last few years, a significant percentage of the residents have moved further inland after a number of landslides destroyed area homes. The building was purchased on January 1, 1990, at a cost $1,200,000. The building has been depreciated assuming a service life of 40 years, $300,000 salvage value. The company’s chief financial officer is concerned about impairment. A conservative estimate of future annual net cash flows is $60,000. Lilliput Boutique uses 6% as a discount rate. An independent appraiser estimates the fair value of the property at $450,000. What is the recoverable cost of the property as of December 31, 2019? What should Lilliput Boutique report as the impairment loss, if any in the 2020 financial statements? A) $600,000; $0. B) $441,605; $75,000 C) $600,000; $75,000 D) $60,000; $75,000 E) $441,605; $0 F) $60,000; $0 Answer: A Rationale: Recoverable cost: $60,000 X remaining 10 years = $600,000. Since recoverable cost exceeds carrying value of $525,000, no impairment loss would be recognized. (Carrying value = $1,200,000-$675,000 (($1,200,000-$300,000)/40*30) = $525,000.)

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Topic: Account for impairments of property, plant, and equipment LO: 7 21. Which of the following statements would accurately complete the sentence: “An impairment loss on assets expected to be used in operations _________________.”? A) is recognized whenever the carrying value of the asset exceeds the fair value of the asset. B) can be reversed in a future period if the circumstances causing the recognition of the impairment loss improve C) wouldn’t be recognized if the undiscounted recoverable cost exceeds the carrying value of the asset. D) A and B E) B and C F) A and C G) A, B, and C Answer: C Rationale: A is incorrect. If the undiscounted recoverable cost exceeded the carrying cost, the impairment test would not be performed. B is incorrect. Impairment losses on assets used in a business cannot be recovered (360-10-35-20). C is correct. The impairment test is not performed if the recoverable cost exceeds the carrying value.

Use the following information to answer Questions 22 and 23. Lilliput Boutique owns a small retail outlet in a California coastal town. In the last few years, a significant percentage of the residents have moved further inland after a number of landslides destroyed area homes. The building was purchased on January 1, 1990, at a cost $1,200,000. The building has been depreciated assuming a service life of 40 years, $300,000 salvage value. Annual net cash inflows have averaged $60,000 over the last few years. An independent appraiser estimates the fair value of the property at $450,000. After reviewing the situation, the owners of Lilliput Boutique decided to close the store in January 2020 and sell the property.

Topic: Account for assets held for sale LO: 8 22. The property was listed at $475,000 through a local real estate broker on January 2, 2020. The sales agent feels the list price is too high but is willing to make best efforts to negotiate with prospective buyers. Management is prepared to accept a lower offer, if necessary, to complete the sale before Spring 2021. Commissions and other selling costs are expected to be $45,000. The company should _____________. A) not record an impairment loss. The recoverable costs exceed the carrying value. B) record an impairment loss of $50,000 C) record an impairment loss of $75,000 D) record an impairment loss of $95,000 E) record an impairment loss of $120,000 F) record an impairment loss of $225,000 Answer: E Rationale: Carrying value = $1,200,000-$675,000 (($1,200,000-$300,000)/40*30) = $525,000 Fair value less selling costs = $405,000 ($450,000 from independent appraiser – $45,000) Impairment loss = $120,000 ($405,000 – $525,000) © Cambridge Business Publishers, 2023 12-13

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Topic: Account for assets held for sale LO: 8 23. If Lilliput Boutique records an impairment loss, which of the following statements is(are) true about the accounting and reporting related to the loss in the 2020 financials assuming the property is unsold as of December 31, 2020? A) The company should continue to depreciate the building. B) The company should continue to classify the building as property, plant, and equipment until the building is sold. C) The company should report the impairment loss and operating costs related to the closed store as discontinued operations in the income statement, net of taxes. D) A and B E) B and C F) A and C G) A, B, and C Answer: C Rationale: C is correct. The impairment loss and closed store operating costs would be considered discontinued operations and should be reported net of tax, below operating income on the income statement. A is incorrect: The store would meet all criteria for held-for-sale treatment when it was “available for immediate sale in its present condition” (360-10-45-9). At that point, depreciation would not be recorded. B is incorrect. Held-for-sale property should be reclassified and reported as Other Assets on the balance sheet.

Topic: Account for assets held for sale LO: 8 24. Philly Enterprises upgraded its manufacturing operations in June 2019. Given the significant changes in technology related to the upgrade, several pieces of equipment purchased July 1, 2012, could no longer be used. The equipment had a book value of $65,000 (original cost of $200,000) on December 31, 2019, and was being depreciated (straight-line) over 10 years, assuming a zero residual value. The company put the equipment up for sale on July 1 at a fair value price of $25,000. Costs to sell the equipment were estimated at $5,000. The equipment met all the criteria for treatment as an asset held for sale as of July 1, 2020. On October 31, 2020, one of the production managers located a potential market for the equipment in a nearby state. The going price for equipment similar to the equipment owned by Philly was $80,000. Additional transportation costs would increase the cost to sell the equipment to $10,000 total. What was the carrying value of the equipment on July 31, 2020, and December 31, 2020, respectively? A) $25,000; $80,000 B) $20,000; $70,000 C) $25,000; $65,000 D) $20,000; $55,000 E) $55,000; $70,000 Answer: D Rationale: Carrying value on 7/31 is equal to $20,000(=$25,000 fair value - $5,000 selling costs) which is less than the net book value of $55,000 (=$65,000 - $10,000 (=$200,000 / 10 for half year). On December 31, the company can write the asset up to its original net book value of $55,000 at the time of sale. (Fair value at that time is $70,000 which is equal to $80,000 - $10,000.) © Cambridge Business Publishers, 2023 12-14

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Topic: Describe property, plant, and equipment disclosures and ratio analyses LO: 9 25. Which of the following are not required disclosures related to property, plant, and equipment? A) Description of depreciation methods used B) Amount of accumulated depreciation as of the balance sheet date C) Total depreciation expense included in the income statement for each year presented D) Total cost of property, plant, and equipment purchases for each year presented E) Breakdown of property, plant, and equipment balances as of the balance sheet date, by type Answer: D Rationale: Purchase totals are not required disclosures under 360-10-50-1

Topic: Describe property, plant, and equipment disclosures and ratio analyses LO: 9 26. Financial information from two companies is presented below: Trinity Industries Net sales Net income Average PP&E Average Assets

2020 $125,900 39,200 33,000 272,700

2019 $110,400 17,600 26,600 254,600

Sausalito Products 2020 $265,600 59,500 37,550 370,500

2019 $229,200 48,400 30,400 348,500

In which ratio, did the two companies show the most improvement from 2019 to 2020 (asset turnover, return on assets, or fixed asset turnover)? Which company showed the most improvement in that ratio? A) Fixed asset turnover; Sausalito B) Asset turnover; Sausalito C) Fixed asset turnover; Trinity D) Return on assets; Sausalito E) Return on assets; Trinity Answer: E Rationale: Both companies showed the strongest gains in return on assets. Trinity showed a 108% increase. Sausalito showed a 16% increase.

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Use the following information to answer Questions 27 & 28. Forestry Products purchased 400 acres of timberland for $2,070 per acre in January 2019. They paid $12,000 to get the land ready for logging (roads, etc.) and $85,000 for the equipment necessary to cut and remove the logs. The equipment could be used on other projects. The service life of the equipment is estimated at 5 years; $15,000 in residual value. Forestry intends to log (remove) the mature trees and then sell the land to a land management company. The land is estimated to have a value of $500 per acre without the mature timber. Total board feet to be harvested is estimated at 4,000 board feet per acre.

Topic: Record acquisition and depletion of natural resources LO: 10 27. What is Forestry Product’s depletion rate? A) $0.52 per board foot B) $0.40 per board foot C) $0.57 per board foot D) $0.44 per board foot E) $0.56 per board foot Answer: B Rationale: Cost after residual value: $640,000 ($2,070*400+$12,000) – ($500*400). Board feet total: 1,600,000 (400*4000). Rate: $.40 (=$640,000/1,600,000)

Topic: Record acquisition and depletion of natural resources LO: 10 28. During 2019, Forestry Products logged 4,250 trees (1,062,500 board feet). The company sold 985,000 board feet. At December 31, 2019, what was reported on the balance sheet for Timberlands and for Lumber inventory, respectively? A) $316,672; $43,497 B) $278,156; $40,106 C) $415,000; $31,000 D) $306,711; $44,223 E) $453,516; $34,931 Answer: C Rationale: Depletion total: $425,000 (1,062,500*.40) Sold: $394,000 (985,000*.40) Total – sold = Lumber inventory $31,000 ($425,000-$394,000) Timberland: Cost $840,000 (2,070*400+12,000) – Depletion total $425,000 = Timberland balance $415,000

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Topic: Record acquisition and depletion of natural resources LO: 10 29. In 2019, Aikman, Inc. incurred costs of $15 million drilling for oil in 10 different wells. As of December 31, 2019, the company had completed exploration in 6 of the 10 wells at a cost of $12 million ($2 million per well). 3 of the 6 wells were successful. An estimated 6 million barrels of oil are recoverable in the 6 wells. Aikman is still exploring the other 4 wells. The current market price of oil is $40 per barrel. Aikman has elected the successful-efforts method of accounting for the costs of exploration costs. During the year ending December 31, 2019, which of the following statements is(are) true? A) Aikman should capitalize the $15 million. The amount is less than the value of the oil discovered in the 3 successful wells. B) Aikman should capitalize $6 million of the costs as Oil reserves and expense $6 million of the costs as Exploration expense. C) Aikman should capitalize $9 million of the costs as Oil reserves and expense $3 million of the costs as Exploration expense. D) Aikman should capitalize $6 million of the costs as Oil reserves and $3 million as Exploration-inprogress costs. $3 million should be expensed as Exploration expense. Answer: C Rationale: Only the cost of exploring the 3 successful wells should be capitalized as Oil reserves. The cost of the 4 in-progress wells should be capitalized separately (932-360-25-3). The cost of the 3 unsuccessful wells should be expensed in the current year.

Topic: Calculate MACRS (tax) depreciation LO: 11 30. Which of the following statements is(are) accurate? A) Under MACRS, assets are depreciated beyond residual value. B) The full-month convention is built into MACRS rates. C) MACRS rates are based on a combination of double-declining balance and straight-line methods. D) A and B E) B and C F) A and C G) A, B, and C Answer: F Rationale: B is incorrect. The half-year convention is built into MACRS.TS63290

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Chapter 13 Intangible Assets and Goodwill Learning Objectives – Coverage by question Multiple Choice LO 13-1 – Identify and classify intangible items

1-5

LO 13-2 – Determine the initial and subsequent measurements of finite life intangible assets

6, 8-10

LO 13-3 – Account for impairment and derecognition of ﬁnite life intangible assets

16-18, 20

LO 13-4 – Account for changes in estimates for ﬁnite life intangible assets

22-25

LO 13-5 – Determine the initial measurement of indeﬁnite life intangible assets and goodwill

7, 10-15

LO 13-6 – Account for impairment of indeﬁnite life intangible assets and goodwill

19, 21

LO 13-7 – Account for research and development costs

26-30

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Chapter 13: Intangible Assets and Goodwill Multiple Choice Topic: Identify and classify intangible items LO: 1 1. Santa Ana Enterprises incurred the following costs designing and building a specialized medical tool: Engineering department costs (salaries and supplies) to design the tool Cost to purchase the patent on a component used in the equipment Fees paid to Landslide Legal to register the patent Production department costs to build a prototype of the tool

$12,000 15,000 5,000 22,000

How much of the above costs, in total, should be capitalized? A) $54,000 B) $42,000 C) $39,000 D) $20,000 E) $0 Answer: D Rationale: External costs should be capitalized: $20,000 ($15,000 + $5,000). Cost of developing the tool should be expensed: $34,000 ($12,000 + $22,000).

Topic: Identify and classify intangible items LO: 1 2. Costs to purchase a copyright should __________________. A) be amortized over the remaining legal life B) be amortized over the remaining useful life C) be amortized over the greater of the remining legal life or the remaining useful life D) be amortized over the lesser of the remaining legal life or the remaining useful life E) Not be amortized Answer: D Rationale: Costs to purchase copyrights are capitalizable; the lesser of the legal or useful life should be used as the amortization period. (350-30-35-3)

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Topic: Identify and classify intangible items LO: 1 3. Cecilia Beaux entered into a franchise agreement with Old Towne Market. The franchise agreement has an initial term of 10 years although Cecilia has the option to renew the agreement for an unspecified period of time. She incurred the following costs in setting up her new business: Purchase of patent on a unique foot measuring tool, legal life 15 years, indeterminate service life Excess of purchase price over fair value in acquisition of net assets of former building owner Initial franchise fee Cost of customer list purchased from nearby retail clothing store to be used during first 2 years of operations Cost of city-wide grand opening advertising campaign

$45,000 35,000 25,000 10,000 8,000

Cecilia opened the store on November 1, 2019. On October 31,2019, how much of the above costs would be reported as Intangible assets (indefinite life) on the balance sheet? How much would be reported as Intangible assets (finite life) on the balance sheet? A) $35,000; $88,000 B) $60,000: $55,000 C) $80,000; $35,000 D) $60,000; $63,000 E) $35,000; $80,000 Answer: B Rationale: Indefinite life: $60,000 ($25,000 + $35,000). Finite life: $55,000 ($10,000+ $45,000). Advertising would be reported as a Prepaid expense.

Topic: Identify and classify intangible items LO: 1 4. Cecilia Beaux entered into a franchise agreement with Old Towne Market. The franchise agreement has an initial term of 10 years although Cecilia has the option to renew the agreement for an unspecified period of time. She incurred the following costs in setting up her new business between January 1 and October 31, 2019: Purchase of patent on a unique foot measuring tool, legal life 15 years, indeterminate service life Excess of purchase price over fair value in acquisition of net assets of former building owner Initial franchise fee Cost of customer list purchased from nearby retail clothing store to be used during first 2 years of operations Cost of city-wide grand opening advertising campaign

$45,000 35,000 25,000 10,000 8,000

continued

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Cecilia opened the store on November 1, 2019. For the year ended December 31, 2019, how much in expenses would be recognized related to the above costs? (Assume Old Towne Market uses the straight-line method of depreciation.) A) $1,333 B) $9,750 C) $3,083 D) $1,750 E) $9,333 Answer: E Rationale: Advertising expense ($8,000) + Amortization expense - Patent ($500 ($45,000/15/12 x 2)) + Amortization expense – Customer list ($833 ($10,000/24 x 2)) = $9,333.

Topic: Identify and classify intangible items LO: 1 5. Which of the following statements are incorrect under generally accepted accounting principles? A) Intangible assets can have finite or infinite lives. B) A patent should always be amortized over the remaining legal life of the patent. C) An asset that can be sold or transferred by a company is considered an identifiable asset. D) A and B E) B and C F) A and C G) All of the statements are incorrect. H) None of the statements are incorrect. Answer: D Rationale: Statement A is incorrect because intangible assets finite or indefinite (not infinite) lives. (35035-35-4); Statement B is incorrect because a patent should be amortized over the lesser of the remaining useful life or legal life of the patent.

Topic: Determine the initial and subsequent measurements of finite life intangible assets LO: 2 6. Danika Manufacturing purchased a patent from Clayton Industries on January 1, 2015, by paying $10,500 in cash and issuing a $35,000 noninterest-bearing note payable. The note called for six annual payments of $5,000 starting on December 31, 2015. The patent had a remaining legal life of 14 years. Danika expected that the patent would have a useful life of 15 years. Danika’ borrowing rate was 6%. Danika uses the straight-line method to amortize intangibles. In 2019, Danika unsuccessfully sued a competitor for patent infringement. The company paid legal fees of $5,000 on June 30, 2019. What was the carrying value of the Patent at December 31, 2019? Assume no impairment adjustment is required. A) $22,556 B) $29,250 C) $28,987 D) $22,293 E) $29,513 Answer: A Rationale: Cost: $10,500 + $24,587 (PV(.06,6,-5000)) = $35,087. Accumulated amortization at December 31, 2019: $12,531 ($35,087/14 x 5). Carrying value = $22,556 ($35,087 - $12,531).

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Topic: Determine the initial and subsequent measurements of indefinite life intangible assets LO: 5 7. Flounder, Inc. paid a graphic design firm $35,000 on June 30, 2005, to design its trademark. Flounder’s in-house attorney registered the trademark on July 1, 2005. Labor costs related to the registration process amounted to $1,200. Registration fees total $500. The company intended to renew the trademark indefinitely. The company’s attorney renewed the trademark for another 10 years on July 1, 2015. Registration fees were $500. Labor costs related to the registration renewal totaled $800. The straight-line method is used by Flounder to amortize intangibles. On December 31, 2019, the company decided a more updated trademark was needed. Flounder intends to go back to the graphic design firm in 2020 and expects to roll out the new trademark beginning July 1, 2022. What is the carrying cost of the trademark as of December 31, 2019? What will amortization expense be in 2020? A) $275; $50 B) $8,213; $1,825 C) $36,000; $14,400 D) $38,000; $15,200 E) $715; $130 F) $36,000; $0 Answer: C Rationale: Carrying value at December 31, 2019: $36,000 ($35,000 + $500 + $500). Indefinite life, no amortization. Amortization for 2020: $14,400 ($36,000/2.5 years (to July 1, 2022))

Topic: Determine the initial and subsequent measurements of finite life intangible assets LO: 2 8. Khalil Products, Inc. is a medical device manufacturer. The company owns the following two patents: Device

Acquired

Date

Cost

Original service life

Original legal life

Hearing evaluation equipment

Internally developed

March 31, 2007

$200,000

Body fat measurement device

Purchased

Sept 30, 2015

$150,000

Khalil paid $10,000 in professional fees to register the patent on the hearing evaluation equipment on March 31, 2007. In 2017, the company successfully defended the body fat measurement device patent in a lawsuit filed by a competitor. Khalil paid a legal firm $50,000 related to the lawsuit on March 31, 2017. On December 31, 2019, the company adjusted the expected service life of the body fat measurement device from 30 to 15 years. What was the total carrying value of the Hearing evaluation equipment patent and the body fat measurement device patent at December 31, 2019? A) $172,847 B) $164,318 C) $236,818 D) $245,347 E) $121,750

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Answer: B Rationale: Hearing evaluation equipment: $10,000 – ($10,000/20 x 12.75) = $3,625 Note: Internal costs of $200,000 are expensed as incurred. Body fat measurement device: Sept. 30, 2015 to March 31, 2017: $150,000 – ($150,000/20 x 1.5) = $138,750 April 1, 2017 to Dec. 31, 2019: ($150,000 - $11,250 + $50,000) – (($150,000 - $11,250 + $50,000)/18.5 x 2.75) = $160,693 Total = $164,318 ($3,625 + $160,693)

Topic: Determine the initial and subsequent measurements of finite life intangible assets LO: 2 9. Khalil Products, Inc. is a medical device manufacturer. The company owns the following two patents: Device

Acquired

Date

Cost

Original service life

Original legal life

Hearing evaluation equipment

Internally developed

March 31, 2007

$200,000

Body fat measurement device

Purchased

Sept 30, 2015

$150,000

Khalil paid $10,000 in professional fees to register the patent on the hearing evaluation equipment on March 31, 2007. In 2017, the company successfully defended the body fat measurement device patent in a lawsuit filed by a competitor. Khalil paid a legal firm $50,000 related to the lawsuit on March 31, 2017. On December 31, 2019, the company adjusted the expected service life of the body fat measurement device from 30 to 15 years. What was amortization expense in 2020? A) $25,448 B) $26,625 C) $16,625 D) $11,488 E) $15,448 Answer: E Rationale: Hearing evaluation equipment: $10,000/20 = $500 Body fat measurement device: Carrying value of $160,693 (see problem #8) ÷ 10.75 (remaining life of 15 years – 4.25 years) = $14,948. Total amortization = $15,448 ($500 + $14,948).

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Topic: Determine the initial and subsequent measurements of intangible assets LO: 2, 5 10. Which of the following is not accurately stated as a disclosure requirement for intangible assets reported in the financial statements? A) Amortization expense for the period(s) reported B) Amount of goodwill recognized during the period C) Estimated amortization expense for each of the five succeeding years D) Accumulated amortization, in total, but not by major finite intangible asset class. Answer: D Rationale: D is inaccurate—disclosure is required by major finite intangible asset class.

Use the following information to answer Questions 11 and 12. Volunteer Manufacturing was considering bankruptcy. Although they had a popular product line, an unfavorable judgment in a recent lawsuit had negatively affected the company’s financial position. Trajectory Manufacturing was interested in expanding its product line to include Volunteer’s most popular product. Volunteer provided Trajectory with the following information: Volunteer Manufacturing—Partial balance sheet Dec. 1, 2019 Cash $50,000 Accounts receivable, net 75,000 Inventory 40,000 Property, plant, and equipment, net 300,000

Independent appraiser valuations $50,000 70,000 40,000 200,000 10 year life, $50,000 residual value

Accounts payable Accrued liabilities Long-term debt

85,000 20,000 500,000

As part of the purchase, Trajectory would also obtain the following:

Customer list Equipment patent Tradename

Fair Value

Life

$50,000 125,000 150,000

5 years 10 years (legal and useful) 5 years, renewable (legal)

After reviewing the data, Trajectory made an offer of $280,000 to purchase the assets of Volunteer other than cash and assume all recorded liabilities. Volunteer accepted the offer and the purchase was completed on December 31, 2020. Trajectory uses the straight-line method to amortize intangibles and the double-declining balance method to depreciate property, plant, and equipment. Trajectory intends to renew the tradename indefinitely.

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Topic: Record goodwill resulting from an acquisition LO: 5 11. How much should Trajectory record as goodwill in its 2019 financial statements? A) $330,000 B) $62,500 C) $140,000 D) $250,000 E) $145,000 Answer: D Rationale: Purchase price $280,000 – Net assets $30,000 = Goodwill $250,000. Net assets: Total assets $635,000 (70,000+40,000+200,000+50,000+125,000+150,000) – Total liabilities $605,000 (85,000+20,000+500,000) = $30,000

Topic: Record goodwill resulting from an acquisition LO: 5 12. What amount of expense will Trajectory recognize in 2021 related to the long-term assets purchased from Volunteer? (Assume no assets were considered impaired during the year.) A) $52,500 B) $62,500 C) $92,500 D) $82,500 Answer: B Rationale: Depreciation: $40,000 ($200,000 x 20%) + Amortization: $22,500 ($50,000/5 + $125,000/10) = $62,500

Topic: Record goodwill resulting from an acquisition LO: 5 13. Hillsdale Industries acquired the net assets of a competitor, Ingles, for cash. Amounts recorded by Hilsdale related to the acquisition included current assets of $80,000, intangibles of $125,000, goodwill of $75,000, and current liabilities of $150,000. How much did Hillsdale pay Ingles? A) $55,000 B) $70,000 C) $75,000 D) $130,000 E) $200,000 Answer: D Rationale: Assets: $280,000 (80,000+125,000+75,000) – Liabilities: $150,000 = $130,000 (purchase price.)

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Topic: Record goodwill resulting from an acquisition LO: 5 14. On July 1, 2010, Jablonski Products purchased the net assets of Duquesne Industries for $285,000 (cash of $85,000 and a short-term note payable of $200,000). The assets included current assets of $125,000, property, plant, and equipment with a fair value of $250,000 (book value of $300,000), and a trademark valued at $150,000. Jablonski assumed liabilities totaling $200,000. The entry to record the purchase would include: A) A debit to Goodwill of $40,000 B) A credit to Gain on Purchase of $90,000 C) A credit to Goodwill of $40,000 D) A debit to Goodwill of $90,000 E) A credit to Gain on Purchase of $40,000 Answer: E Rationale: Net assets: $325,000 (125,000+250,000+150,000-200,000) – Purchase price $285,000 = Gain on purchase $40,000

Topic: Record goodwill resulting from an acquisition LO: 5 15. Which of the following are required disclosures when the amount paid for the net assets of a company is less than the fair value of the net assets acquired? A) Amount of the gain reported in the income statement B) The amount of goodwill reported in the balance sheet C) Description of the reasons for the gain D) A and B E) B and C F) A and C G) A, B, and C Answer: F Rationale: A and C are required under 805-30-50-1f. Option B is incorrect. There would be no goodwill recorded in a bargain purchase.

Topic: Account for impairment and derecognition of intangibles LO: 3 16. The recoverability test is required in an impairment analysis of: A) Finite life intangible assets B) Indefinite life intangible assets C) Goodwill D) A and B E) B and C F) A and C G) A, B, and C Answer: A Rationale: Recoverability tests are only required for finite life intangible assets.

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Use the following information to answer Questions 17 and 18. Orlando Packaging Company purchased a patent on a box-folding machine for $160,000 on July 1, 2012. The useful life was estimated at 20 years. There were 19 years remaining on the patent when it was purchased. In 2019, the CEO of Orlando Packaging noted a decrease, industry-wide, in the demand for folded boxes. As a result, an impairment analysis was done as of June 30, 2019. The CEO estimated that the patent had a remaining useful life of 5 years. Expected annual cash flows over the next 5 years were estimated at $20,000. The discount rate used by Orlando Packaging is 5%.

Topic: Account for impairment and derecognition of intangibles LO: 3 17. Was the Orlando Packaging Company patent impaired at June 30, 2019? If so, what was the amount of the impairment loss? A) No; $0 B) Yes; $14,463 C) Yes; $17,410 D) Yes; $4,000 E) Yes; $1,053 Answer: B Rationale: Carrying value of patent at June 30: ($160,000/19 x 7) = $101,053.

Cost: $160,000 – Accumulated amortization: $ 58,947

Undiscounted cash flows $100,000 ($20,000 x 5). Asset is impaired. Loss on impairment: Carrying value of patent: $101,053 – Fair value: $86,590 (PV(.05,5,20,000) = $14,463 Loss on impairment

Topic: Account for impairment and derecognition of intangibles LO: 3 18. How much amortization expense was recognized by Orlando Packaging Company in 2019? A) $7,818 B) $4,211 C) $12,659 D) $7,330 E) $12,870 Answer: E Rationale: First half of the year: $4,211 ($160,000/19 x .5). Second half of the year: $86,590 (See question #17)/5 x .5 = $8,659 Total: $12,870

Test Bank, Chapter 13

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Topic: Account for impairment and derecognition of intangibles LO: 6 19. ____________ and ___________ are compared when determining the amount of a possible impairment loss on an indefinite life intangible asset. A) Fair value of asset, present value of future cash flows B) Future value of asset, carrying value of asset C) Carrying value of asset, book value of asset D) Fair value of asset, carrying value of asset E) Future value of asset, present value of future cash flows Answer: D Rationale: The fair value of an indefinite intangible asset is compared to its carrying value.

Topic: Account for impairment and derecognition of intangibles LO: 3 20. On June 30, 2019, Liam sold its patent with a carrying value of $79,884 to Tierney Enterprises for $5,000 cash and a note specifying ten annual payments of $10,000. The first payment was due June 30, 2020. Liam uses 8% as its discount rate. Which of the following would not be included in the journal entry to record the sale of the patent on June 30, 2019? A) CR Discount on Note Receivable $32,899 B) CR Gain on Sale of Patent $7,783 C) CR Patent $79,884 D) DR Cash $5,000 E) All of the above would be included in the journal entry. Answer: B Rationale: There was a loss of $7,783 on the sale of the patent equal to proceeds of $5,000 cash plus the present value of the note of $67,101 (PV(.08,10,-10000) less carrying value of $79,884.

Topic: Account for impairment and derecognition of intangibles LO: 6 21. Which of the following statements about goodwill impairment testing is inaccurate? A) The qualitative goodwill impairment test identifies the existence of goodwill impairment; the quantitative goodwill impairment test identifies the amount of any impairment loss. B) When multiple assets are tested for impairment, goodwill must be tested last. C) Annual goodwill impairment tests can be performed at any time during the year, as long the test is performed at the same time each year. D) Consistent decreases in the trading price of company stock may indicate impairment. Answer: A Rationale: A is incorrect. The quantitative goodwill impairment test is used to both identify the existence of impairment and to measure the amount of the impairment loss.

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Topic: Account for changes in estimates with intangible assets LO: 4 22. Wine & Dine purchased a customer list from a nearby gourmet grocery for $20,000 on January 1, 2017. The expected service life was 10 years with an expected residual value of $2,000. Since the list would be most valuable (most current) in the first few years, the company elected to use double-declining balance method of amortizing the cost. By December 31, 2019, it was clear that the customers on the list were more transient than Wine & Dine expected. The owners believed that the list would continue to have value through December 31, 2021, but that there would be no residual value. The amortization method was switched to straight-line. What was the carrying value of customer list on December 31, 2019? What was amortization expense for 2020? A) $9,760; $4,880 B) $10,240; $5,120 C) $10,496; $5,248 D) $9,200; $4,600 Answer: B Rationale: Amortization for 2017: $4,000 ($20,000 x .20) Amortization for 2018: $3,200 ($16,000 x .20) Amortization for 2019: $2,560 ($12,800 x .20) Net book value on Dec. 31, 2019: $20,000 - $4,000 - $3,200 - $2,560 = $10,240 2020 Amortization expense = $10,240 ÷ 2 = $5,120.

Topic: Account for changes in estimates with intangible assets LO: 4 23. Wine & Dine its purchased a customer list from a nearby gourmet grocery for $20,000 on January 1, 2017. The expected service life was 5 years with an expected residual value of $2,000. Since the list would be most valuable (most current) in the first few years, the company elected to use doubledeclining balance method of amortizing the cost. By December 31, 2019, it was clear that the customers on the list were more stable than Wine & Dine expected. The owners believed that the customer list would have a total useful life of 10 years with no residual value. The amortization method was switched to straight-line. What was amortization expense for 2020? A) $617 B) $841 C) $432 D) $695 E) $2,000 Answer: A Rationale: Amortization for 2017: $20,000 x .40 = $8,000 Amortization for 2018: $12,000 x .40 = $4,800 Amortization for 2019: $7,200 x .40 = $2,880 Net book value on Dec. 31, 2019: $20,000 - $8,000 - $4,800 - $2,880 = $4,320. Amortization expense for 2020: $4,320 ÷ 7 (10 year – 3 years) = $617

Test Bank, Chapter 13

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Topic: Account for changes in estimates with intangible assets LO: 4 24. Which of the following statements is(are) accurate? A) A change in net income resulting from a change in the estimated residual value of an indefinite life intangible asset should be accounted for prospectively. B) Changes in the estimates of the useful life of a finite life intangible asset would not affect prior period operating results. C) A change in the expected life of a finite life intangible asset would affect income from operations. D) A and B E) B and C F) A and C G) A, B, and C Answer: D Rationale: A is not accurate. Indefinite life intangible assets are not amortized.

Topic: Account for changes in estimates with intangible assets LO: 4 25. Regal Properties was amortizing a finite life intangible asset over 15 years. In the 12th year, the company revised the service life to 18 years. Regal should account for the change by ___________________. A) crediting beginning Retained Earnings and debiting Accumulated Amortization B) reducing the amount of amortization expense in the next three years C) increasing the amount of amortization expense in the next six years D) reducing the amount of amortization expense in the next six years E) debiting Intangible Asset and crediting Amortization Expense to correct the carrying value of the intangible asset Answer: D Rationale: Amortization expense would need to be reduced to reflect the increase in the useful life. Options A and E are incorrect because revisions of lives of intangible assets are not accounted for by making retrospective adjustments (A) or by restating the carrying value of the asset (E) 250-10-45-17. B is incorrect because the remaining life is six years, not three. C is incorrect because extension of the life reduces the periodic expense.

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Topic: Account for research and development costs LO: 7 26. Greenbelt Tech Products completed a working model of a new computer software program at a cost of $50,000 in the first half of 2019. The company registered for copyright protection on July 1, 2019. The software was available for sale on September 1, 2019. The company expects to sell the products for a minimum of 5 years; a maximum of 10 years. Copyright protection lasts for 95 years. What would amortization expense be through December 31, 2019 (amortized using the straight-line method)? A) $263 B) $1,667 C) $2,222 D) $3,333 E) $0 Answer: E Rationale: Initial costs of developing computer software for sale are expensed. (ASC 985-20-25)

Topic: Account for research and development costs LO: 7 27. Which of the following statements is not accurate? A) Research and development costs, in total, must be disclosed for every period presented in the financial statements. B) Depreciation on equipment used for research activities would be recognized as operating expense. C) Cost of significant modifications to product designs are expensed as research and development expenses. D) The cost of a patent purchased for multiple research products is capitalized as an intangible asset. E) The cost of a license purchased for use in one research product is expensed as a research and development cost. Answer: B Rationale: Depreciation expense related to assets used for R&D purposes is classified as research and development expense.

Test Bank, Chapter 13

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Topic: Account for research and development costs LO: 7 28. Watt Pharmaceuticals manufactures several drugs used to treat bacterial infections. The company is currently working on a drug to treat malaria. Which of the following costs should be expensed as Research and development expense? Which of the following costs should be capitalized as an intangible asset? Salaries of biochemists working on the new malaria drug Administrative costs allocated to R&D department Salaries of physicians working on final stage clinical trials for malaria drug Salaries for production staff working on improving general manufacturing processes Depreciation of equipment used in multiple drug trials Purchase of patent for process used exclusively in development of malaria drug A) B) C) D) E)

$125,000 95,000 85,000 80,000 25,000 20,000

$350,000; $0 $305,000; $20,000 $245,000; $105,000 $310,000; $0 $220,000; $105,000

Answer: A Rationale: Research & Development: $350,000 (125,000+95,000+85,000+25,000+20,000). There are no intangible assets in list.

Topic: Account for research and development costs LO: 7 29. Xavier Software develops and sells accounting software. The company has four departments:

Function

Share of Administrative Costs

Software development team

Design and program new products

25%

Software product launch team

Test and debug working models of new software products

Software product maintenance team

Update existing software products and provide technical support to customers

30%

Administrative team

Sales, accounting, human resources, operations, executive

40%

Department

The company incurred the following costs during the first nine months of 2020: Administrative costs Cost to develop working models for new products Cost to design new products Cost of final coding and debugging new software products Cost of minor updates to existing software products

$500,000 225,000 80,000 75,000 30,000

continued

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How much of Xavier’s costs through September 30, 2020, were charged to Research & Development Expense and Software Intangible Asset, respectively? A) $305,000; $75,000 B) $380,000; $30,000 C) $430,000; $250,000 D) $430,000; $100,000 E) $505,000; $175,000 Answer: D Rationale:

Topic: Account for research and development costs LO: 7 30. Xavier Software develops and sells accounting software. $200,000 of research and development costs (incurred after the point of technological feasibility) through September 30, 2020, were related to QRey’s new software product ‘Balanced’. Xavier’s management estimated that the product would have a service life of 5 years and would generate revenues of $3 million. The product was released and available for sale on October 1, 2020. Sales of Balanced from October 1 to December 31 totaled $500,000. What was the amortization expense for Balanced in 2020 under the straight-line and revenue methods, respectively? A) $40,000; $33,333 B) $10,000; $8,333 C) $10,000; $33,333 D) $9,523; $8,333 E) $8,750; $29,167 Answer: C Rationale: Straight-line amortization expense: $200,000/5 x .25 = $10,000. Amortization expense under the Revenue method: $500,000/$3,000,000 x $200,000 = $33,333.

Test Bank, Chapter 13

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Chapter 14 Investments in Debt and Equity Securities Learning Objectives – Coverage by question Multiple Choice LO 14-1 – Account for debt securities measured at amortized cost

1-4

LO 14-2 – Account for debt securities measured at FV-NI

5-8

LO 14-3 – Account for debt securities measured at FV-OCI

9-12

LO 14-4 – Account for equity securities measured at FV-NI

13-15

LO 14-5 – Account for equity securities following the equity method

16-18

LO 14-6 – Adjust debt and equity securities for impairment

19-21

LO 14-7 – Explain the accounting for transfers of investments

22-24

LO 14-8 – Describe accounting for special-purpose funds and investments in life insurance policies

25-26

LO 14-9 – Describe and account for derivatives

27-30

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Chapter 14: Investments in Debt and Equity Securities Multiple Choice Topic: Account for debt securities measured at amortized cost LO: 1 1. Tennison Products purchased a 5-year, $50,000 bond at face value on July 1, 2017. The bond’s stated interest rate is 5%, paid annually on June 30. Tennison has the intent and the ability to hold the bond for the full five years. As a result of changes in the overall economy, the bond had a fair value of $51,000 on July 1, 2018, and $52,000 on July 1, 2019. What is the carrying value of the debt security on July 1, 2018, and 2019, respectively? A) $50,000; $50,000 B) $51,000; $52,000 C) $50,000; $55,000 D) $52,500; $55,000 E) $50,000; $52,500 Answer: A Rationale: HTM bonds purchased at face value are carried at cost, regardless of fair value.

Topic: Account for debt securities measured at amortized cost LO: 1 2. Calliope Enterprises purchased a $100,000 bond on January 1, 2019. The bond matures on December 31, 2023, and pays interest annually (on December 31), at 6%. Calliope purchased the bond at a price to yield an 8% return and properly recorded the bond as a held-to-maturity security. Calliope uses the effective interest method to determine interest revenue. What was the carrying value of the investment at December 31, 2019? How much interest revenue was reported in 2021?

A) B) C) D) E)

Investment Carrying Value $93,376 $100,000 $92,015 $94,846 $108,425

Interest Revenue $7,588 $8,160 $7,470 $7,715 $9,119

Answer: A Rationale:

Jan. 1, 2019 Dec. 31, 2019 Dec. 31, 2020 Dec. 31, 2021

Cash Interest

Interest Revenue

Amortization

$6,000 6,000 6,000

$7,361 7,470 7,588

$1,361 1,470 1,588

Carrying Value $92,015 93,376 94,846 96,434

Test Bank, Chapter 14

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Topic: Account for debt securities measured at amortized cost LO: 1 3. Calliope Enterprises purchased $100,000 bond on January 1, 2019. The bond matures on December 31, 2023, and pays interest annually (on December 31), at 6%. Calliope purchased the bond at a price to yield a 5% return and properly recorded the bond as a held-to-maturity security. Calliope uses the straight-line method to determine interest revenue. What was the carrying value of the investment at December 31, 2019? How much total interest revenue did Calliope report over the 5-year bond term? Investment Carrying Value A) $103,463 B) $100,000 C) $104,329 D) $102,837 E) $103,546

Interest Revenue $25,671 $30,000 $30,000 $26,454 $80,000

Answer: A Rationale:

Jan. 1, 2019 Dec. 31, 2019

Cash Interest

Interest Revenue

$6,000

$5,134

Amortization $(866)

Carrying Value $104,329 $103,463

Total interest revenue is equal to $30,000 ($6,000 x 5) - $4,329 ($104,329 - $100,000) = $25,671.

Topic: Account for debt securities measured at amortized cost LO: 1 4. Which of the following statements about held-to-maturity (HTM) debt securities is(are) accurate? A) Amortized cost method can be used in accounting for all debt securities that the entity has the intent and ability to hold to maturity. B) All remaining HTM securities must be reclassified to either trading or available-for-sale securities if an entity sells any of its HTM securities before maturity. C) Fair values and unrecognized holding gains or losses on HTM securities must be disclosed in the financial statements. D) A and B E) A and C Answer: E Rationale: A is accurate because an entity must have the intent and ability to hold the debt security to maturity before the amortized cost method can be used (320-10-25-3). B is not accurate because a “pattern of sales or transfers” must exist before reclassification of other debt securities is required (320-10-25-3). C is accurate. “The aggregate fair value of an HTM investment and any unrecognized holding gain (loss) are disclosed……”. (p. 14-5)

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Topic: Account for debt securities measured at FV-NI LO: 2 5. Wyatt, Inc. purchased a $75,000 bond, at par, from Arrow, Inc. on November 30, 2019. The bond’s stated interest rate is 6% with interest paid semiannually (June 30 and December 31). The bond’s maturity date is December 31, 2023. Wyatt anticipated a decrease in interest rates over the next year and intended to sell the bond at that time. As of December 31, 2019, however, the fair value of the bond was $74,500. Wyatt classifies the bond as a trading security. How much did Wyatt pay for the bond on November 30, 2019? How much interest did Arrow pay Wyatt in 2019? What was the carrying value of the bond at December 31, 2019?

A) B) C) D) E)

Bond Purchase Price $75,375 $75,000 $77,250 $76,875 $76,875

Interest Paid $375 $1,875 $2,250 $4,500 $2,250

Bond Carrying Value $73,125 $75,000 $75,000 $74,500 $74,500

Answer: E Rationale: The amount paid for the bond includes the face value of $75,000 plus accrued interest of $1,875 ($75,000 x 3% ÷ 6 x 5) for a total of $76,875. The amount of interest paid to Arrow equals the 6-month interest payment of $2,250 ($75,000 x 3%). The carrying value of the bond at year-end is the fair value of $74,500.

Use the following information to answer Questions 6 and 7. On July 1, 2019, Daphne’s Delights Inc. purchased a 3-year, $75,000 face value bond with a June 30, 2022, maturity date. The bond’s stated rate of interest was 5%, paid semiannually (June 30 and December 31). The bond was properly reported as a trading security.

Topic: Account for debt securities measured at FV-NI LO: 2 6. The fair value of the bond purchased by Daphne’s was $73,500 on December 31, 2019. What was the balance in the Fair Value Adjustment account at December 31, 2019? What was the net dollar impact of any and all bond related entries on 2019 income before income taxes?

A) B) C) D) E)

FVA Account Bal. $1,500 Cr. $1,500 Cr. $1,500 Dr. $1,500 Dr. $1,500 Cr.

Effect on Net Income $ 375 increase $3,375 increase $2,250 increase $ 375 increase $2,250 increase

Answer: A Rationale: The fair value adjustment account has a $1,500 credit balance on December 31, 2019, ($73,500 - $75,000). The net effect on net income is an increase of $375: Interest revenue of $1,875 ($75,000 x .05 ÷ 2) less an unrealized loss of $1,500 to equal a net increase of $375.

Test Bank, Chapter 14

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Topic: Account for debt securities measured at FV-NI LO: 2 7. Daphne’s Delights sold the bond to Wilson Products, Inc. on March 31, 2020, for $77,500 (the fair value). How much did Wilson Products pay Daphne’s Delights? What was the net dollar impact of any and all bond related entries on 2020 income before income taxes? Assume that the investment was adjusted to its fair value of $73,500 on December 31, 2019.

A) B) C) D) E)

Amount Paid $77,500 $78,438 $79,375 $78,438 $79,375

Effect on Net Income $4,000 $4,938 $5,875 $3,438 $2,125

Answer: B Rationale: The amount Wilson paid is equal to the selling price of $77,500 plus the interest accrued to date of $938 ($75,000 x .025 ÷ 2) which is equal to $78,438. The effect on net income is equal to interest revenue of $938 plus the increase in fair value of $4,000 ($77,500 - $73,500).

Topic: Account for debt securities measured at FV-NI LO: 2 8. Medina Company purchases a $50,000 bond, at face value, on October 1, 2019. The company intends and has the ability to hold the bond to maturity. Medina could: A) Account for the investment using the amortized cost method. B) Elect on October 1 to report the investment at fair value (under the fair value option) and recognize current and future unrealized gains or losses in the income statement. C) Elect on October 1 to report the investment at cost, and then at year-end elect to apply the fair value option to the security. D) A or B E) A or C F) A, B, or C Answer: D Rationale: A is possible because Medina has the intent and ability to hold the security to maturity. B is possible since Medina elected the fair value option on the purchase date. C is not possible. The fair value option must be elected on the purchase date. (825-10-50-28)

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Topic: Account for debt securities measured at FV-OCI LO: 3 9. Which of the following statements about accounting for available-for-sale (AFS) securities is inaccurate? A) AFS securities are reported at fair value. B) Unrealized gains or losses on AFS securities are recognized in other comprehensive income. C) Net income is not impacted by AFS securities activity until the security is sold. D) Companies are required to disclose the amount of unrealized gains or losses for AFS securities included in accumulated other comprehensive income during the year(s) being reported and the amount of gains or losses that were reported in the income statement. E) AFS securities can be classified as current assets. Answer: C Rationale: C is inaccurate. Interest revenue is recognized during the period the security is held.

Use the following information to answer Questions 10 and 11. Vopelak Laboratories purchased four $20,000 bonds on July 1, 2018, to yield 6%. The stated interest rate on the bonds is 7%. Interest is paid quarterly on March 31, June 30, September 30, and December 31. The bonds mature on June 30, 2023. The bonds are classified as available-for-sale securities. The fair value of the bonds on December 31, 2018, is $82,500.

Topic: Account for debt securities measured at FV-OCI LO: 3 10. What is the purchase price of the bonds on April 1, 2018? What is the amortized cost of the bonds on December 31, 2018? What is the amount of the investment recognized on Vopelak’s balance sheet on December 31, 2018?

A) B) C) D) E)

Bond Purchase Price $83,434 $76,649 $83,412 $83,434 $83,412

Amortized Cost $83,135 $76,935 $83,114 $83,285 $83,114

Investment on Balance Sheet $82,500 $82,500 $83,114 $83,285 $82,500

Answer: A Rationale: The purchase price of the bonds is $83,434 (=PV(.015,20,-1400,-80000). The amortized cost on December 31, 2018, is equal to $83,135 shown as follows:

Ju;y 1, 2018 Sept 30, 2018 Dec. 31, 2018

Cash Interest

Interest Revenue

Amortization

$1,400 1,400

$1,252 1,249

$148 151

Carrying Value $83,434 83,285 83,135

The amount recognized on December 31, 2018, is equal to the fair value (amount provided of $82,500).

Test Bank, Chapter 14

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Topic: Account for debt securities measured at FV-OCI LO: 3 11. On January 1, 2019, Vopelak sold two of the bonds for a total of $41,250. What was the net dollar impact on the income statement in 2019 related to the two bonds sold? A) $ 393 loss B) $2,783 gain C) $ 307 loss D) $ 318 loss E) No impact Answer: D Rationale: The loss is equal to the selling price of $41,250 less the carrying value of $41,568 ($83,135/2). Note that the difference between the amortized cost and selling price is recognized in the year of the disposal while the prior year adjustment to fair value did not impact net income, but instead, OCI.

Topic: Account for debt securities measured at FV-OCI LO: 3 12. On January 1, 2019, McCord Products paid $20,000 (face value) for a 5-year bond with a stated interest rate of 5%. The bonds had a fair value of $16,000 on December 31, 2019, and a fair value of $22,000 on December 31, 2020. McCord sold the bond on December 31, 2020, for fair value. The bond was classified as an available-for-sale security. What was the gain on sale recognized in income by McCord in the year ended December 31, 2020? A) $3,000 B) $2,000 C) $6,000 D) $8,000 E) $4,000 Answer: B Rationale: Selling price $22,000 – Amortized cost $20,000 = $2,000.

Topic: Account for equity securities measured at FV-NI LO: 4 13. The most important factor to consider when determining the accounting treatment for equity investments is: A) Ownership percent B) Intent C) Ability to hold D) Influence E) Time expected to be held Answer: D Rationale: Although percentage of ownership (A) can indicate probable level of influence, actual level of influence (D) should be the deciding factor. B and C are factors used in determining accounting treatment of debt securities. E is only used in determining classification on the balance sheet.

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Use the following information for Questions 14 and 15. On November 1, 2020, Fashion Supplies, Inc. purchased 2,000 shares of Everyday Couture, Inc. for $30,000. Everyday Couture shares are actively traded. The per share stock prices were: Share Price November 1, 2020 December 15, 2020 December 31, 2020

$15.00 14.50 16.00

Fashion Supplies’ shares represent a 1% interest in Everyday Couture. Fashion Supplies does not have significant influence over Everyday Couture.

Topic: Account for equity securities measured at FV-NI Accounting Treatment No. 2 LO: 4 14. On December 15, 2020, Fashion Supplies sold 500 shares of Everyday Couture at the trading price. Fashion Supplies made a fair value adjustment to the investment in the 500 shares before recording the sale of the securities. In the entry to record the sale on December 15, 2020, what was the amount posted to the Fair Value Adjustment account? A) $0 B) $250 Debit C) $500 Debit D) $250 Credit Answer: B Rationale: The entry upon sale would include a debit to Cash for $7,250, a debit to the Fair Value Adjustment account for $250 and a credit to Investments for $7,500.

Topic: Account for equity securities measured at FV-NI Accounting Treatment No. 1 LO: 4 15. On December 15, 2020, Fashion sold 500 shares of Everyday Couture at the trading price. Fashion Supplies adjusts the Fair Value Adjustment Account at year-end only. What is the net impact on the income statement for the year ended December 31, 2020, related to all of the Fashion Supplies’ investment activities? A) $1,250 gain B) $ 250 loss C) $1,000 gain D) $1,250 loss Answer: A Rationale: The gain of $1,250 is made up of the realized loss on sale of $250 ($0.50 x 500 shares) plus the increase in fair value of the remaining 1,500 shares (2,000 – 500) of $1,500 equal to 1,500 shares x $1.00 ($16 - $15).

Test Bank, Chapter 14

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Topic: Account for equity securities following the equity method LO: 5 16. Manning Manufacturing, Inc. purchased a 30% interest in Lowlands Manufacturing, Inc. for $200,000 on July 1, 2021, halfway through the reporting year. Manning reports the investment using the equity method. At the date of acquisition, the book value of Lowlands’ assets approximated fair value, except for plant and equipment with a fair value $50,000 higher than book value and no residual value. The plant and equipment’s remaining life at July 1, 2021, was 5 years, and straight-line depreciation is appropriate. Both companies have reporting years ending December 31. Lowlands reported net income of $100,000 for the year ending December 31, 2021, and declared and paid total cash dividends of $8,000 on December 31, 2021. What amount should Manning report as investment income for 2021? What is the investment balance on December 31, 2021? A) $13,500; $213,500 B) $15,000; $207,000 C) $27,000; $219,000 D) $13,500; $211,100 E) $30,000; $227,400 Answer: D Rationale: ($100,000 x 1/2 x 30%) – ($50,000/5 x 1/2 x 30%) = $13,500 investment income $200,000 + $13,500 – ($8,000 x 30%) = $211,100 investment ending balance

Topic: Account for equity securities following the equity method LO: 5 17. Annika Industries purchased 1,250 of Leander Manufacturing’s 5,000 shares of common stock for $50,000 on January 1, 2020. Leander’s balance sheet at date of purchase:

Assets

Total Assets

Leander’s Condensed Balance Sheet, January 1, 2020 $1,500,000 Liabilities Common stock ($1 par value, 5,000 shares outstanding) Retained Earnings $1,500,000 Total Liabilities & Equity

$1,250,000 140,000 110,000 $1,500,000

Fair values were the same as book values on January 1, 2020. • • •

In 2020, Leander reported net income of $71,000. No dividends were declared or paid that year. In 2021, Leander reported net income of $91,000. Common stock dividends of $10,000 were declared. In 2022, a Leander competitor released a cheaper, more advanced product. Leander’s sales decreased dramatically, and the company reported a loss ($200,000). No dividends were declared in 2022.

Annika Industries accounts for the investment in Leander under the equity method. What was the balance in the investment account at the end of 2020, 2021, and 2022, respectively? A) $68,750; $90,000; $40,000 B) $69,750; $97,000; $47,000 C) $67,750: $88,000; $38,000 D) $68,750; $90,000; $90,000 E) $67,750; $88,000; $88,000 © Cambridge Business Publishers, 2023 14-9

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Answer: C Rationale: Year one Investment balance: $50,000 + $71,000 x .25 (1,250 shares ÷ 5,000 total shares) = $67,750. Year two Investment balance: $67,750 + $22,750 ($91,000 x .25) - $2,500 ($10,000 x .25) = $88,000. Year three Investment balance: $88,000 - $50,000 ($200,000 x .25) = $38,000.

Topic: Account for equity securities following the equity method LO: 5 18. Which of the following are acceptable under generally accepted accounting principles? A) Accounting for an investment under the equity method when an investor holds 15% of the common shares of the investee and has a significant influence over the investee. B) Accounting for an investment at fair value with adjustments affecting net income when an investor holds 30% of the common shares of the investee without holding a significant influence over the investee. C) Accounting for an investment at fair value with adjustments affecting net income when an investor holds 30% of the common shares of the investee, has a significant influence over the investee, and elects to account for the investment under the fair value option at the date of purchase. D) A and B E) B and C F) A and C G) A, B, and C Answer: G Rationale: All are answers are correct. In the first two cases, whether or not an investor has significant influence over an investee determines the accounting of the investment. In C, the investor elected to account for the investment under the fair value option allowing for fair value treatment over the equity method treatment.

Topic: Adjust debt and equity securities for impairment LO: 6 19. Archer Enterprises reports the following investments: Investment in: Corporate bond, classified as a held-to-maturity investment Corporate bond, classified as a trading security Corporate bond, classified as available-for-sale Corporate stock, 2% interest Corporate stock, 49% interest

Carrying Value $50,000 75,000 100,000 150,000 95,000

Investments with a total carrying value of $__________ would need to be tested for impairment. A) $470,000 B) $245,000 C) $150,000 D) $300,000 E) $225,000 Answer: B Rationale: $50,000+$100,000+$95,000 = $245,000

Test Bank, Chapter 14

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Topic: Adjust debt and equity securities for impairment LO: 6 20. Trenholm Enterprises paid $250,000 (face value) for a 5-year bond on July 1, 2018. The bond, issued by Heredity Products, was classified as a held-to-maturity investment by Trenholm. On November 1, 2021, Heredity announced the loss of contracts representing 60% of its annual revenue due to the bankruptcies of two of its customers. Based on this information, Trenholm determined that it was probable that the present value of the amount to be collected was $200,000. In early 2022, Heredity announced a new product. The new product represented a significant advancement in technology. Sales for Heredity in the third and fourth quarters substantially exceeded estimates. As of December 31, the bond had a fair value of $270,000. How was the $50,000 impairment recorded in 2021? What was the carrying value of the Investment at December 31, 2022? A) $50,000 impairment loss in income; $270,000 B) $50,000 debit to other comprehensive income; $270,000 C) $50,000 impairment loss in income; $210,000 D) $50,000 debit to other comprehensive income; $210,000 E) $50,000 impairment loss in income; $250,000 F) $50,000 debit to other comprehensive income; $250,000 Answer: E Rationale: “Impairment losses are reported as a charge against income.” (p. 14-34). “..favorable reversals may not exceed the initial credit loss…” (p. 14-34)

Topic: Adjust debt and equity securities for impairment LO: 6 21. On June 30, 2018, Interlochen, Inc. purchased a 5-year bond (6%, $100,000 face value) from Mile High Enterprises for $96,000. The investment was classified as an available-for-sale investment. Mile High filed for bankruptcy under Chapter 11 in June 2021. Fair value of the bond at December 31, 2021, was $55,000. On Interlochen’s books, amortized cost at December 31, 2021, was $98,600. The Fair Value Adjustment account had a credit balance of $43,600. Interlochen’s management intends to sell the bond in January 2022. $40,000 of the loss is due to credit factors. Which of the following entries, if any, should be made by Interlochen on December 31, 2021? A) Loss on Impairment Investment in Mile High Bond Fair Value Adjustment Unrealized Loss – Other Comprehensive Income B) Loss on Impairment Allowance for Credit Losses Fair Value Adjustment Unrealized Loss – Other Comprehensive Income C) Loss on Impairment Investment in Mile High Bond D) Loss on Impairment Allowance for Credit Losses E) No entry is necessary. Investment is already reported at fair value.

43,600 43,600 43,600 43,600 40,000 40,000 40,000 40,000 43,600 43,600 40,000 40,000

Answer: A Rationale: Interlochen intends to sell the bond. The entire impairment loss should be recognized in the income statement and the investment account should be adjusted to fair value. © Cambridge Business Publishers, 2023 14-11

Intermediate Accounting, 3rd Edition

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Topic: Explain the accounting for transfers of investments LO: 7 22. VisionClear, Inc. purchased a 25% share of Specs, Inc. (2,000 shares) in 2019. The investment was properly reported under the equity method. In 2022, one of the investors in Specs acquired a 60% interest in the company through a large stock purchase. As a result, VisionClear now has minimal influence over the operating and financial decisions of Specs, Inc. VisionClear elects to change the investment classification and report the investment at fair value and recognize unrealized gains and losses in net income. As of the transfer date, the balance in the Investment account was $120,000; the fair value of Specs’ stock was $70 per share. VisionClear should reclassify the Investment account, A) adjust the account balance to $140,000 as of the date of the transfer, and record the $20,000 unrealized gain as other comprehensive income. B) and leave the account balance at $120,000 as of the date of the transfer. Any gain or loss on the investment would be recognized when the stock is sold. C) leave the account balance at $120,000 as of the date of the transfer, and derecognize any balance in the Fair Value Adjustment account. D) and leave the account balance at $120,000 as of the date of the transfer. The account balance should be adjusted to fair value at the next reporting date. E) and adjust the account balance to $140,000 as of the date of the transfer. The $20,000 difference should be credited to retained earnings. Answer: D Rationale: The balance in the investment account at the date of transfer becomes the new cost basis. (323-10-35-36).

Topic: Explain the accounting for transfers of investments LO: 7 23. Which of the following security classification transfers might impact net income on the transfer date? In all cases, assume investments are adjusted as required at a reporting date before considering the transfer. A) Transfer of an AFS debt security to an HTM debt security. B) Transfer of an AFS security to a TS. C) Transfer of an equity security reported under FV-NI rules to an equity security reported under the equity method D) A and B E) B and C F) A and C Answer: B Rationale: A is incorrect. Any unrealized gain or loss is amortized in future income as a yield adjustment (320-10-35-10d). B is correct. Any unrecognized holding gain or loss is recognized in net income (320-10-35-10b). C is incorrect. In this case, any unrealized gain or loss would already be recognized in net income through the reporting process before considering the transfer.

Test Bank, Chapter 14

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Topic: Explain the accounting for transfers of investments LO: 7 24. Keto Snacks, Inc. reported an investment in a bond issued by Paleo Production, Inc. as an availablefor-sale security in 2020. The Investment had an amortized cost of $45,000 at December 31, 2020. Keto properly adjusted the books to reflect the $47,000 fair value of the bond at year-end. On January 1, 2021, the company decided to change the classification of the investment to a trading security. Which of the following would be included in the entry to record the transfer? A) Debit to Unrealized gain on investment (OCI) - $2,000 B) Credit to Fair Value Adjustment - $2,000 C) Debit to Investment in TS – Paleo Bond - $45,000 D) A and B E) B and C F) A and C Answer: D Rationale: C is not accurate. The entry would be: Investment in TS – Paleo Bond Investment in AFS – Paleo Bond Fair Value Adjustment – AFS

47,000

Unrealized Gain – OCI Unrealized Gain – NI

2,000

45,000 2,000

2,000

Topic: Describe accounting for special-purpose funds and investments in life insurance policies LO: 8 25. Which of the following statements about special-purpose funds and investments in life insurance policies is(are) inaccurate? A) Special-purpose funds are classified as held-to-maturity securities B) The cash surrender value of a life insurance policy is the amount that is paid out to the beneficiary in the event of the insured’s death. C) The excess of the increase in cash surrender value over premiums paid during the period should be expensed. D) A and B E) B and C F) A and C G) All of the statements are inaccurate. H) None of the statements are inaccurate. Answer: G Rationale: A is inaccurate. “A special-purpose fund does not meet the definition of a security.” (p.14-10) B is inaccurate. The CSV is the amount that would be refunded in the event the policy is terminated by the insured. C is inaccurate. The excess of premiums paid over the increase in the CSV is the amount that should be expensed.

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Topic: Describe accounting for special-purpose funds and investments in life insurance policies LO: 8 26. Wallaby Industries plans to build a second factory in 5 years. The estimated cost of the factory is $1.5 million. A special-purpose fund with an agreed upon annual interest rate of 6% has been set up at the company’s bank. Wallaby decided to fund the construction by making 10 equal semiannual cash deposits to the special purpose fund. What is the amount of each deposit? A) $130,846 B) $266,095 C) $127,035 D) $251,033 E) $113,802 Answer: C Rationale: PMT(.06/2,10,0,-1500000,1) = $127,035

Topic: Describe and account for derivatives LO: 9 27. Which of the following does not meet the definition of an underlying? A) Bond price B) Credit rating C) 200 shares of stock D) Percent change in interest rate E) Price of gold Answer: C Rationale: C does not meet the definition of an underlying because it’s not variable.

Test Bank, Chapter 14

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Topic: Describe and account for derivatives LO: 9 28. Angus Products, Inc. sells feed and other supplies to Texas ranchers. The company intends to purchase 400 bushels of corn on March 31, 2020. Corn prices have been fluctuating recently so, to hedge the risk of rapidly increasing prices, Angus Products entered into a no-cost futures contract with Ranchers, Inc. on September 30, 2019, for delivery of 400 bushels at $4.50 per bushel. The hedge is considered highly effective. On December 31, corn was selling for $5.00 per bushel. On March 31, 2020, corn was selling for $4.80 per bushel. Angus Products purchased the 400 bushels of corn on March 31 at the market price. All 400 bushels were sold in 2020 to Angus Products’ customers at $6 per bushel. What was the Futures Contract balance at December 31, 2019? What was the net dollar impact of any and all corn futures contract related entries on 2019 income before income taxes? What was reported as gross profit on the sale of the 400 bushels of corn in the 2020 income statements?

A) B) C) D) E)

Futures Contract Bal. $200 $200 $200 $0 $0

Net Effect on Net Income $200 $0 $0 $0 $0

Gross Profit $480 $480 $600 $480 $600

Answer: C Rationale: Futures contract balance: $200 ((5.00-4.50)*400). Impact on 2019 profit: $0. Amount is reported in OCI. Gross profit in 2020: Revenue: $2,400 (6*400) – COGS $1,800 (400*4.80 – 400 *(4.80-4.50)) = $600

Topic: Describe and account for derivatives LO: 9 29. Which of the following best describes a contract with a put option, held as a hedging derivative? A) Company enters into an agreement which gives them the right to sell a $100,000 bond at a fixed price during a period of time. B) Company enters into an agreement to swap interest payments on a specified amount of long- term debt. C) Company enters into an agreement which gives them the right to purchase 50 shares of stock at a specified price during a period of time. D) Company enters into an agreement to purchase 10,000 gallons of oil at a particular price per gallon at a specified future date. E) Company purchases five $10,000 bonds at par value. Answer: A Rationale: B describes an interest rate swap. C and D describe call options. E is not a derivative.

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Topic: Describe and account for derivatives LO: 9 30. FlexWorks Manufacturing borrows $100,000 on a 2-year note from the bank at a fixed rate of 6% on June 30, 2019, with interest payable annually on June 30. FlexWorks anticipates decreases in borrowing rates over the next year so the company enters into an interest rate swap agreement with Jefferson Financial Group on July 1, 2019. Under the agreement, FlexWorks agrees to pay interest at LIBOR + 2% during the two year term of the note. Jefferson agrees to pay the fixed 6% rate. The first cash settlement of the swap occurs on June 30, 2020. At that date, LIBOR was 3½ %. The estimated fair value of the swap is $1,000. What was the net dollar impact of any and all debt interest related entries on income before income taxes for the year ended June 30, 2020? What was the Interest Rate Swap Contract balance at June 30, 2020? What was the note payable balance at June 30, 2020? (No principal payments were made on the loan during the year.)

A) B) C) D) E)

Net Effect on Net Income $(6,000) $6,000 $(5,500) $(3,500) $5,500

Interest Rate Swap Bal. $0 $1,000 $1,000 $1,000 $1,000

Note Payable Bal. $100,000 $100,000 $101,000 $100,000 $99,000

Answer: C Rationale: Note payable Fixed rate

100,000 6.00%

LIBOR at 6/30/20 Interest paid to bank through 6/30 Interest at LIBOR +2% Interest on 100,000 at LIBOR Interest expense through 6/30

3.5% $

6,000

(500) Difference between fixed and LIBOR (6,000-5,500) 5,500

Fair value of interest swap contract

1,000

Note payable, adjusted to fair value

5.50% 5,500

101,000 100,000+1,000

Test Bank, Chapter 14

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Chapter 15 Current Liabilities and Contingencies Learning Objectives – Coverage by question Multiple Choice LO 15-1 – Record accounts payable and sales taxes payable

1-4

LO 15-2 – Record customer deposits and advances

5-8

LO 15-3 – Record accruals for payroll, compensated absences, bonuses, and defined contribution plans

9-14

LO 15-4 – Account for short-term debt and classify debt on the balance sheet

15-20

LO 15-5 – Describe accounting for subsequent events and contingencies including litigation, warranties, and other contingencies

21-28

LO 15-6 – Explain liability and contingency disclosures and analyses using liquidity ratios

29-31

Intermediate Accounting, 3rd Edition

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Chapter 15: Current Liabilities and Contingencies Multiple Choice Topic: Recognizing a liability LO: 1 1. Indicate which of the following are necessary characteristics for an item to be considered a liability. A) The transfer of an asset or the obligation to provide a service is assured. B) The magnitude of the obligation must be material relative to the company's assets. C) The obligation to transfer assets or provide services must be unavoidable if the existence of the obligation is at least probable. D) The obligation arises from a past event. E) An explicit interest rate must be stated. F) A, C, and D G) C and D H) All of the above Answer: G Rationale: Only answers C and D are necessary characteristics. For Answer A, the sacrifice only needs to be probable, not assured. For answer B, an obligation (liability) exists regardless of the amount. If the amount is sufficiently small, a liability may not be recognized but that does not mean there is no liability. This is the materiality issue. For Answer E, an interest rate may be implicit. An obligation discharged at a later time without an explicit interest rate should be discounted.

Topic: Record accounts payable LO: 1 2. On May 1, 2020, Radler Inc. purchased merchandise for resale for $130,000 on credit terms 2/10, n/30 from a supplier. Radler Inc. incurred a shipping charge from a freight provider of $8,000 on the purchase, which was immediately paid. The company uses the gross method to record purchases. If Radler Inc. paid for half of its purchase on May 9, 2020, the entry to record the payment would include the following: A) Credit to cash for $65,000 B) Credit to inventory for $1,300 C) Credit to inventory for $1,380 D) Debit to Accounts Payable for $63,700 Answer: B Rationale: The payment entry is as follows: Accounts Payable

65,000 Inventory Cash

1,300 63,700

Note that the shipping charge increased the inventory account, but does not affect the payment entry to the supplier.

Test Bank, Chapter 15

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Topic: Record sales taxes payable LO: 1 3. A state requires quarterly sales tax returns to be filed with the sales tax bureau by the 20th day following the end of the calendar quarter. However, the state further requires that sales taxes collected be remitted to the sales tax bureau by the 20th day of the month following any month such collections exceed $1,000. These payments can be taken as credits on the quarterly sales tax return. Tactic Corporation operates a retail hardware store. All items are sold subject to a 6% state sales tax, which Tactic collects and records as sales revenue. The sales taxes paid by Tactic are charged against sales revenue. Tactic pays the sales taxes when they are due. Following is a monthly summary appearing in Tactic's first-quarter 2020 sales revenue account: Debit $ — 1,200 — $1,200

January February March

Credit $21,200 14,840 19,080 $55,120

In its financial statements for the quarter ended March 31, 2020, Tactic’s sales revenue and sales taxes payable would be:

A) B) C) D)

Sales Revenue $55,120 $53,920 $52,000 $52,000

Sales Taxes Payable $3,120 $1,200 $3,120 $1,920

Answer: D Rationale: Sales revenue = $55,120/1.06 = $52,000 Sales taxes payable = ($55,120 - $52,000) - $1,200 = $1,920

Topic: Record sales taxes payable LO: 1 4. Chelsea Inc. sells merchandise to its customers in the first quarter of 2020 and collects $410,750. The amount collected includes sales tax of 6%. The sales tax amount will be submitted to taxing authorities on a quarterly basis with the next payment due April 5, 2020. Assuming no other transactions affecting sales tax, what is the balance in Sales Taxes Payable on March 31, 2020? A) $-0B) $24,645 C) $23,250 D) $ 7,750 E) $69,750 Answer: C Rationale: The amount of sales for the first quarter is equal to $410,750 ÷ 1.06 = $387,500. Sales taxes payable is equal to $23,250 or $410,750 minus $387,500.

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Topic: Record customer advances LO: 2 5. Mears Company requires advance payments with special orders from customers for machinery constructed to its specifications. Information for 2020 is summarized as follows: Customer advances—balance Dec. 31, 2019 Advances received with orders in 2020 Advances applied to orders shipped in 2020 Advances applicable to orders canceled in 2020

$590,000 920,000 820,000 250,000

At December 31, 2020, what amount should Mears report as a current liability for customer advances? A) $-0B) $440,000 C) $690,000 D) $740,000 Answer: B Rationale: To determine the December 31, 2020, balance of the liability for customer advances, the solutions approach is to set up a T-account for the liability. Customer Advances 2020 advances applied 2020 advances canceled

820,000 250,000

590,000 920,000 440,000

Dec. 31, 2019 balance 2020 advances received Dec. 31, 2020 balance

When advances are received ($920,000), cash is debited and the liability account is credited. When advances are applied to orders shipped ($820,000), the liability account is debited and sales is credited. When an order is canceled ($250,000), the liability account is debited and either cash or a revenue account is credited, depending on whether or not the deposit is returned to the customer.

Topic: Record customer advances LO: 2 6. Gerughty operates as a retailer of pools and spas. Some customers pick out hot tubs and place deposits with Gerughty to set the hot tubs aside for future delivery. The balance is due upon delivery of the hot tub, at which time, Gerughty satisfied its performance obligation and revenue is recognized. The average gross margin on the hot tubs is 75% of sales. The following pertinent data were taken from Gerughty's December 31, 2020, unadjusted trial balance: Regular sales Prepayments received from customers

$5,000,000 $2,000,000

An analysis of the customer prepayments revealed that $1,200,000 was received for hot tubs delivered to customers during 2020. In Gerughty's December 31, 2020, balance sheet, deferred revenue would be A) $2,000,000 B) $1,500,000 C) $1,200,000 D) $ 800,000

Test Bank, Chapter 15

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Answer: D Rationale: Of the $2,000,000 balance in the prepayments account, only $1,200,000 represents sales where Gerughty’s performance obligation was satisfied. The remaining $800,000 represents collections from customers where revenue has not been recognized and thus would be recognized as a liability (credit balance), deferred revenue.

Topic: Record customer deposits LO: 2 7. On October 1, 2020, Vijay Storage received $4,000 as a deposit from a customer for some special containers that are to be returned by April 1, 2021. Vijay Storage agreed to "give the customer credit at an annual rate of 6% interest on the deposit," to be paid to the customer when the containers are returned. The containers were returned to Vijay Storage on April 1, 2021. In Vijay Storage’s annual financial statements on December 31, 2020, the company would report the following amounts:

A) B) C) D) E)

Interest Expense 2020 $60 $60 $240 $0 $0

Liability—Returnable Deposit December 31, 2020 $4,060 $4,000 $4,240 $4,060 $4,000

Answer: A Rationale: The deposit (liability) increases by the interest the customer earned (recognized by Vijay Storage as interest expense) over 3 months (October through December) equal to $4,000 x 6% x 3/12 = $60. Thus, the liability is $4,060 on December 31, 2020, or $4,000 plus $60.

Topic: Record customer advances LO: 2 8. Especial Inc. gathered the following information related to its gift card sales for 2020, its first year of selling gift cards: Sales of nonrefundable gift cards, 2020 Gift card redemptions, 2020

$25,500 $18,360

Especial Inc. estimates that 90% of the value of gift cards sold in 2020 will be redeemed while 10% will remain unclaimed. Under the proportional method, what would Especial Inc. recognize for gift card breakage revenue in 2020? A) $-0B) $825 C) $1,725 D) $2,550 E) $2,040 Answer: E Rationale: The rate of gift card redemption is equal to 80% or $18,360/$22,950 ($22,950 is the expected redemptions calculated as $25,500 x 90%). $2,040 of expected gift card breakage revenue is recognized which is equal to 80% x ($25,500 x 10%).

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Topic: Measure and record employee payroll LO: 3 9. Which of the following is classified as an accrued liability by an employer?

A) B) C) D)

Liability for Federal Unemployment Taxes Yes Yes No No

Liability for Employer’s Share of FICA Tax Yes No No Yes

Answer: A Rationale: Accrued liabilities include expenses which have been incurred but not yet paid. Both federal unemployment tax and the employer's share of FICA taxes represent the employer's payroll tax expense which is incurred as employees earn wages, but which is only paid periodically. Therefore, both types of expense represent accrued liabilities.

Topic: Measure and record compensated absences LO: 3 10. An employer's obligation relating to employees' rights to receive compensation for future absences is attributable to employees' services already rendered. If the payment of compensation is probable, and the amount of compensation can be reasonably estimated, compensation should be: A) Accrued if the obligation relates to rights that vest or accumulate. B) Accrued if the obligation relates to rights that do not vest or accumulate. C) Expensed when paid. D) Disclosed but not accrued if the obligation relates to rights that vest or accumulate. Answer: A Rationale: ASC 710-10-25-1 requires employers to accrue a liability for future absences when all of the following are met: 1) 2) 3) 4)

The employees' service have already been rendered, The obligation relates to rights which vest or accumulate, Payment is probable, and The amount can be easily estimated.

Conditions 1, 3, and 4 are met by the information. Condition 2 is met by answer A.

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Topic: Measure and record compensated absences LO: 3 11. Raleigh Company grants all employees two weeks' paid vacation for each full year of employment, up to six weeks. Unused vacation time can be accumulated and carried forward to succeeding years and will be accrued and paid at the salaries in effect when vacations are taken or when employment is terminated. There was no employee turnover in 2020. Additional information relating to the year ended December 31, 2020, is: Liability for accumulated vacations on January 1, 2020

$50,000

Pre-2020 accrued vacations taken from January 1, 2020 to September 30, 2020 (the authorized period for vacations)

30,000

Vacations earned for work in 2020 (adjusted to current rates)

40,000

Raleigh granted a 10% salary increase to all employees on October 1, 2020, its annual salary-increase date. For the year ended December 31, 2020, Raleigh should report vacation pay expense of: A) $42,000 B) $45,000 C) $60,000 D) $70,000 Answer: A Rationale: Per ASC 710-10-25-1, an employer is required to accrue a liability for employees' rights to receive compensation for future absences, such as vacations, when certain conditions are met. The standard does not, however, specify how such liabilities are to be measured. Since Raleigh adjusts its vacation liability and expense to current salary levels, Raleigh's 2020 vacation pay expense consists of vacations earned for work in 2020 (adjusted to current rates) of $40,000 plus the amount necessary to adjust its pre-2020 vacation liability for the 10% salary increase. The amount of this adjustment is equal to 10% of the pre-existing liability balance at December 31, 2020 [($50,000 – $30,000) × .10 = $2,000]. Therefore, total vacation pay expense for the period is equal to $42,000 ($40,000 + $2,000).

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Use the following information to answer Questions 12 and 13. Payroll records for Quittin’ Time Inc. included the following amounts: Weekly payroll, March 1 to March 7, 2020 Withholdings taxes payable (federal and state) Federal unemployment taxes payable State unemployment taxes payable FICA taxes payable (employer share) FICA taxes payable (employee share) Health care premiums payable Union dues payable

$150,000 33,000 900 8,100 11,475 11,475 10,000 5,000

Employees are paid weekly, one week after the week worked.

Topic: Measure and record employee payroll LO: 3 12. What amount would Quittin’ Time Inc. recognize as salaries payable on March 7, 2020, based on the payroll information provided above? A) $108,000 B) $150,000 C) $ 90,525 D) $ 81,525 Answer: C Rationale: Salaries payable on March 7, 2020, would be equal to salaries of $150,000 minus $33,000 (withholdings), minus $11,475 (employee’s share of FICA), minus $10,000 (health care premiums payable), minus $5,000 (union dues payable) = $90,525.

Topic: Measure and record employee payroll LO: 3 13. What amount would Quittin’ Time Inc. recognize as payroll tax expense for the first week of March, based on the payroll information provided above? A) $12,375 B) $44,475 C) $53,475 D) $20,475 Answer: D Rationale: Payroll tax expense is equal to $20,475 calculated as $900 (FUTA) plus $8,100 (SUTA) plus $11,475 (FICA).

Topic: Describe defined contribution plans LO: 3 14. Clapboard Company contributes 3% of full-time employees’ salaries to a traditional 401(k) plan. The company made the complete contractual cash payment of $10,000 to the plan in 2020. The company expects to make contributions of $10,000 in 2021 and to make additional contributions to the plan totaling $100,000 over the next 8 years according to current employee contracts. The present value of © Cambridge Business Publishers, 2023 15-8

Test Bank, Chapter 15

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the total payments is equal to $96,500.

What is the amount of the liability recognized on the company’s year-end balance sheet dated December 31, 2020? A) $-0B) $10,000 C) $95,500 D) $100,000

Answer: A Rationale: Answer A is correct: this plan is a defined contribution plan. Because the company contributed amounts related to employee service in 2020, there is no reported liability under the plan.

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Topic: Account for short-term debt LO: 4 15. On September 1, 2020, Live Oak Company borrows $400,000 cash by issuing a one-year note payable to Suburban Bank in the amount of $400,000, bearing interest at 8%, with interest payable at the maturity date. On December 31, 2020, Live Oak Company’s annual report date, what amount should Live Oak Company report as note payable and as interest payable?

A) B) C) D) E)

Note Payable $400,000 $400,000 $400,000 $432,000 $410,667

Interest Payable $10,667 $ 8,000 $32,000 $ 0 $21,333

Answer: A Rationale: The note payable was issued at its face value, thus the note payable is recognized for $400,000. Interest payable is equal to interest prorated for 4 months which is equal to $10,667 = $400,000 x 0.08 x 4/12.

Topic: Account for short-term debt LO: 4 16. On September 1, 2020, Live Oak Company borrows cash by issuing a one-year noninterest-bearing note payable to Suburban Bank in the amount of $61,480. The market rate of the note is 6%. The company amortizes any discount on the note using the straight-line method. On December 31, 2020, Live Oak Company’s annual report date, what amount should Live Oak Company report as the Discount on Note Payable? A) $1,230 B) $2,320 C) $2,030 D) $1,480 Answer: B Rationale: The note payable was issued for cash in the amount of $58,000 calculated as PV(.06,1,0,61480). Thus, the original discount on the note was $3,480 calculated as $61,480 minus $58,000. The discount would be amortized for 4 months on December 31, 2020, so the net unamortized discount would be equal to $2,320 calculated as $3,480 x 8/12.

Test Bank, Chapter 15

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Topic: Account for short-term debt LO: 4 17. On September 1, 2020, Live Oak Company borrows cash by issuing a one-year noninterest-bearing note payable to Suburban Bank in the amount of $61,480. The market rate of the note is 6%. The company amortizes any discount on the note using the straight-line method and the adjusting entry on December 31, 2020, the company’s year-end, was appropriately recorded. Upon maturity of the note payable on August 31, 2021, Live Oak Company would record the following: A) A credit to Cash for $58,000 B) A debit to Interest Expense for $3,480 C) A debit to Interest Expense for $1,160 D) A credit to Discount on Note Payable for $2,320 E) A credit to Discount on Note Payable for $1,160 Answer: D Rationale: The original discount on the note is $3,480 calculated as $61,480 minus $58,000 (=PV(0.06,1,0,-61480). The entry upon maturity would be recorded as follows: Note Payable Interest Expense ($3,480 x 8/12) Cash Discount on Note Payable

61,480 2,320 61,480 2,320

Thus, the correct answer is E.

Topic: Account for short-term debt LO: 4 18. Indicate which of the following statements is not true. A) If the stated rate of a note is less than the market rate, the note will be issued at a discount. B) At the time of borrowing, a note appears on the balance sheet at the present value of the cash expected to be paid, discounted at the market rate. C) A noninterest-bearing note has a stated rate of zero; thus the recognition of interest expense is deferred until the note’s maturity date. D) A bond premium is amortized over a note’s term, resulting in a decrease to interest expense each period. Answer: C Rationale: While a noninterest-bearing note does have a zero stated rate, there is interest expense recognized over the term of the note based upon the market rate.

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Topic: Account for short-term debt LO: 4 19. Siasconset Inc. borrowed $1,000,000 through a 8%, 10-year note payable dated December 31, 2020. Interest is due annually on December 31, and the principal is due annually in $100,000 installment payments, beginning on December 31, 2021. How would the debt be recognized on Siasconset’s December 31, 2020, balance sheet?

A) B) C) D) E)

Current $-0$100,000 $200,000 $1,000,000 $900,000

Noncurrent $1,000,000 $900,000 $800,000 $-0$100,000

Answer: B Rationale: The installment payment due within the next year would be recognized as current, while the remaining balance on the note ($1,000,000 - $100,000) would be considered noncurrent.

Topic: Account for short-term debt LO: 4 20. Payables Inc. had the following debt outstanding on December 31, 2020: •

$30,000, 5-year note payable, due upon maturity, December 15, 2021

•

$50,000, 15-year bond payable, due upon maturity, December 15, 2024

•

$100,000, 10-year note payable, due upon maturity, January 15, 2021, retired with proceeds from the issuance of common stock (where proceeds from the issuance exceed note payable amount)

•

$80,000, 5-year note payable, due upon maturity, December 15, 2024; note is considered callable because Debtor Inc. is currently in violation of a debt covenant

On December 31, 2020, Payables Inc. would report the following as a current liability and a noncurrent liability on its balance sheet:

A) B) C) D)

Current Liability $110,000 $130,000 $180,000 $180,000

Noncurrent Liability $150,000 $130,000 $80,000 $80,000

Answer: A Rationale: The current liability amount consists of $30,000 + $80,000 (callable thus due immediately). The noncurrent liability amount consists of $50,000 + $100,000 (retired with equity, thus classified as noncurrent).

Test Bank, Chapter 15

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Topic: Describe accounting for contingencies LO: 5 21. Kahlo Co. includes coupons in direct mailings that may be presented at retail stores to obtain discounts on other Kahlo products. The coupons are not offered as part of a revenue contract. Retailers are reimbursed for the face amount of coupons redeemed plus 10% of that amount for handling costs. Kahlo honors requests for coupon redemption by retailers up to three months after the consumer expiration date. Kahlo estimates that that it is probable that 25% of all coupons issued will ultimately be redeemed. Information relating to coupons issued by Kahlo during 2020 is as follows: consumer expiration date, December 31, 2020; total face amount of coupons issued, $300,000; and total payments to retailers as of December 31, 2020, $40,000. What amount should Kahlo report as a liability for unredeemed coupons at December 31, 2020? A) $-0B) $35,000 C) $42,500 D) $72,500 Answer: C Rationale: At December 31, 2020, Kahlo should report a liability even though the coupons expired because retailers may submit coupons to Kahlo for three months after the expiration date. Thus, Kahlo will still have to redeem coupons until March 31. Total expected redemptions are $75,000 (0.25 × $300,000), and on those redemptions Kahlo expects to pay out $82,500 ($75,000 plus 10% of $75,000 for handling). As of December 31, total payments to retailers have been $40,000, which means a liability of $42,500 should be reported ($82,500 - $40,000).

Topic: Describe accounting for contingencies LO: 5 22. Kob Company sells appliance service contracts to repair appliances for a two-year period. Kob's past experience is that, of the total amount spent for repairs on service contracts, 40% is incurred evenly during the first contract year and 60% is incurred evenly during the second contract year. Receipts from service contract sales for the two years ended December 31, 2020, are $250,000 in 2019 and $300,000 in 2020. Receipts from contracts are credited to Deferred Warranty Revenue. Assume that all contract sales are made evenly during the year. What amount should Kob report as Deferred Warranty Revenue at December 31, 2020? A) $180,000 B) $235,000 C) $240,000 D) $315,000 Answer: D Rationale: All contract sales are made evenly during the year. Therefore, the 2019 contracts range from 1 year expired (if sold on December 31, 2019) to two years expired (if sold on January 1, 2019), for an average of 1 ½ years expired [(2+1)/2]. Similarly, the 2020 contracts range from 0 years expired to 1 year expired, for an average of ½ year expired [(0+1)/2]. The average unearned portion of the 2019 contracts is ½ year (2 years - 1 ½ years), the last half of the second contract year. The amount of deferred revenue related to 2019 contracts is computed as: $250,000 × 60% × 1/2 = $75,000. The average deferred portion of the 2020 contracts is 1 ½ years (2 years - ½ year), the last half of the first contract year and all of the second contract year. The amount of deferred revenue related to the 2020 contracts is computed as follows: 2020:

$300,000 × .40 × ½ = $300,000 × .60=

60,000 180,000 $ 240,000

Therefore, the total deferred warranty revenue is $315,000: ($75,000 + $240,000). © Cambridge Business Publishers, 2023 15-13

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Topic: Describe accounting for contingencies LO: 5 23. Queen City Inc. sells merchandise of $800,000 in 2020 that includes a two-year limited warranty against manufacturing defects as part of the selling price. Warranty costs are estimated to be 1% of sales. If the company incurred $2,200 of actual costs in responding to warranty claims in 2020 (related to 2020 sales), how much should Queen City record in warranty expense for 2020? A) $8,000 B) $5,800 C) $2,200 D) $-0Answer: A Rationale: While the warranty accrual on December 31, 2020, would be $5,800 [($800,000 x 1%) – $2,200], expense for the year would be equal to the full estimate of warranty costs of $800,000 x 1%.

Topic: Describe accounting for contingencies LO: 5 24. A manufacturer of consumer batteries has a contingency due to a potential product recall based on the discovery of a possible defect in one of its product lines. The occurrence of the loss is reasonably possible, and the costs can be reasonably estimated. This possible loss should be:

A) B) C) D)

Accrued No No Yes Yes

Disclosed in Notes No Yes Yes No

Answer: B Rationale: A loss contingency will be accrued only if its occurrence is probable and the amount can be reasonably estimated. In this case the loss is not considered probable and, therefore, should not be accrued. Although a contingent loss is not accrued if it is only reasonably possible (not probable), it will be disclosed in the notes to the financial statements. Therefore, the correct answer is (B). The reasonably possible loss will not be accrued, but it will be disclosed. Such disclosures should indicate the nature of the contingency and should give an estimate of the possible loss or range of loss or state that such an estimate cannot be made.

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Topic: Describe accounting for contingencies LO: 5 25. The following information pertains to a fire insurance policy in effect at December 31, 2020, covering Aspen Company's inventory: Face amount of policy Deductible per claim Amount of annual premium

$400,000 25,000 2,000

Aspen's inventory averages $500,000 uniformly throughout the year. Aspen's income tax rate is 25%. How much of a contingent liability should Aspen accrue at December 31, 2020, to cover possible future fire losses? A) $-0B) $18,750 C) $23,000 D) $75,000 Answer: A Rationale: A The requirement is to determine the amount Aspen should accrue as a contingent liability at December 31, 2020, to cover possible future fire losses. Answer A is correct because, per ASC 450-20-25-2, a contingent liability shall only be accrued if the likelihood of occurrence is probable and the amount of the loss can be reasonably estimated. An event such as possible future fire loss is not considered probable at December 31, 2020, based on the information given nor can an amount of the loss from such an event be reasonably estimated. Thus, an accrual at December 31, 2020, is not required.

Topic: Describe accounting for contingencies LO: 5 26. Indicate which of the following item(s) is/are true. A) A loss contingency is never accrued when the possibility of a loss is remote. B) A loss contingency is never disclosed when the possibility of a loss is remote. C) A loss contingency may be disclosed when the possibility of a loss is remote regarding a guarantee of indebtedness of another entity. D) None of the above. Answer: A Rationale: The general rule is that a loss contingency is not accrued when the possibility of a loss is remote. Answer B is not correct because under ASC 460-10-50-2, certain loss contingencies must be disclosed even if the possibility is remote. Answer C is not correct because the contingency must be disclosed, not may be disclosed.

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Topic: Describe accounting for subsequent events LO: 5 27. The following events all took place after the balance sheet date of December 31, 2020, but before the issuance of the financial statements on March 1, 2021, of Tannenbaum Inc. The amounts indicated for each event are considered material to the company’s financial statements. 1. A customer reported a bankruptcy providing evidence that the December 31, 2020, accounts receivable balance of $22,000 will not be collectible. 2. The company issued 1,000 shares of common stock for $40,000. 3. An inventory loss due to a flood damage in 2021 was estimated to be $14,000. 4. Tannenbaum Inc. settled a legal dispute for $250,000 related to an employee accident that took place in 2018. Which of the preceding items (if any) should be considered for recognition on the 2020 financial statements? A) Item 1 only. B) Items 1 and 4 only. C) Items 1, 3, and 4 only. D) All of the items should be recognized in the 2020 financial statements. E) None of the items should be recognized in the 2020 financial statements, but they should all be disclosed in the notes accompanying the financial statements. Answer: B Rationale: Items 1 and 4 are recognized subsequent events as they provide additional evidence about conditions that existed at the balance sheet date. Thus, these items must be recognized in the financial statements. The other items are nonrecognized subsequent events and would be considered for disclosure if they are required to keep the financial statements from being misleading.

Topic: Explain liability and contingency disclosures LO: 5 28. The disclosure of a contingency includes: A) The nature of the contingency. B) An estimate of the possible loss or a range of loss. C) An estimate of the possible loss, a range of loss, or a statement that an estimate cannot be made. D) A and B E) A and C Answer: E Rationale: Per ASC 450-20-54-4, both A and C must be disclosed.

Test Bank, Chapter 15

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Topic: Analyze liquidity ratios LO: 6 29. Which of the following statements is incorrect? A) The quick ratio is a more rigorous test of liquidity than the current ratio. B) The quick ratio considers only the most liquid assets including cash, short-term investments and accounts receivable. C) A large current ratio is always desirable because it indicates that assets are used effectively to pay off debts. D) The current ratio is not used to assess a company’s profitability. Answer: C Rationale: A higher ratio indicates a stronger level of liquidity. However, a large ratio, such as a ratio of 3, may indicate that the company has idle assets that should be invested or returned to the shareholders.

Use the following information to answer Questions 29 and 30. Bryce Inc. reported the following information on its most recent balance sheet. Description Cash

Debit $

Credit

9,800

Accounts receivable

49,600

Inventory

75,000

Prepaid insurance

2,250

Short-term investments

3,000

Building

150,000

Equipment

80,000

Accumulated depreciation

3,250

Accounts payable

48,000

Deferred service revenue

8,000

Interest payable

10,000

Note payable, long-term

125,000

Common stock

110,000

Retained earnings

________

65,400

$369,650

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Topic: Analyze liquidity ratios LO: 5 30. The current ratio for Bryce is equal to: A) 2.12 B) 1.90 C) 2.02 D) 0.70 Answer: A Rationale: The current ratio is equal to 2.12 calculated as Current assets of $139,650 ($9,800 + $49,600 + $75,000 + $2,250 + $3,000) / Current liabilities of $66,000 ($48,000 + $8,000 + $10,000).

Topic: Analyze liquidity ratios LO: 5 31. The quick ratio for Bryce is equal to: A) 2.12 B) 2.08 C) 0.90 D) 0.95 E) 1.33 Answer: D Rationale: The quick ratio is equal to 0.95 calculated as $62,400 ($9,800 + $49,600 + $3,000) / current liabilities of $66,000 ($48,000 + $8,000 + $10,000).

Test Bank, Chapter 15

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Chapter 16 Long-Term Liabilities Learning Objectives – Coverage by question Multiple Choice LO 16-1 – Identify types and features of bonds

1-2

LO 16-2 – Measure and record bonds at issuance

3-5

LO 16-3 – Account for bonds issued at face value

LO 16-4 – Account for bonds issued at a discount

7-9

LO 16-5 – Account for bonds issued at a premium

10-12

LO 16-6 – Measure and record notes at issuance and after issuance

13-15

LO 16-7 – Account for extinguishment of debt

16-18

LO 16-8 – Account for conversion of debt into equity

19-21

LO 16-9 – Account for bonds with stock warrants

22-24

LO 16-10 – Apply the fair value option for liabilities

LO 16-11 – Describe financing disclosures and analyses using leverage ratios

26-27

LO 16-12 – Appendix 16A Account for debt restructuring

28-30

Test Bank, Chapter 16

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Chapter 16: Long-Term Liabilities Multiple Choice Topic: Identify types and features of bonds LO: 1 1. Old Style Inc. authorized and issued $100,000, 10-year, 5% bonds on January 1, 2020. Interest is paid annually on December 31, and the principal is due upon maturity. The bonds are redeemable at the option of Old Style Inc. prior to October 1, 2028, at a specified rate. The bonds are backed by specific assets of the company. The bonds issued by Old Style Inc. are best described as: A) Corporate, Debenture, Serial, Callable B) Municipal, Secured, Term, Convertible C) Corporate, Secured, Term, Callable D) Municipal, Secured, Serial, Callable E) Corporate, Debenture, Term, Callable F) Corporate, Secured, Serial, Callable Answer: C Rationale: The bonds are corporate (Old Style Inc., not a municipality), secured (backed by the company’s assets), term (mature on a single date), and callable (redeemable).

Topic: Identify features of bonds LO: 1 2. Gilligan Inc. authorized and issued 10-year, $75,000 bonds on January 1, 2020, at 102, bearing interest at 6%, payable semiannually on July 1 and January 1. For this bond issuance, what is the face value, selling price, and stated rate per payment period?

A) B) C) D) E) F)

Face Value $75,000 $75,000 $76,500 $76,500 $75,000 $75,000

Selling Price $76,500 $76,500 $75,000 $75,000 $73,529 $73,529

Stated Rate per Payment Period 3% 6% 3% 6% 3% 6%

Answer: A Rationale: The bonds have a stated or face value of $75,000 and sell at 102% of $75,000 which is $76,500. The stated rate per payment period is equal to the annual rate of 6% divided by 2 which is 3% per semiannual interest payment period.

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Topic: Measure and record bonds at issuance LO: 2 3. The selling price of an interest-bearing bond is equal to the present value of the principal of the bond A) And the present value of the cash interest payments discounted at the stated rate. B) And the present value of the cash interest payments discounted at the market rate. C) Discounted at the stated rate. D) Discounted at the market rate. Answer: B Rationale: The selling price of the bond is equal to the present value of the face value and the cash interest payments, discounted at the market rate of interest.

Topic: Measure and record bonds at issuance LO: 2 4. On March 1, Year 1, Six Sisters Corp. issued $50,000, 6%, 10-year bonds payable at 98 plus accrued interest. The bonds are dated February 1, Year 1, and mature on February 1, Year 11. The bonds pay cash interest semiannually on February 1 and August 1. Calculate the selling price of the bonds (including interest). A) $49,000 B) $50,250 C) $50,500 D) $49,250 Answer: D Rationale: The selling price of the bonds of $49,250 is equal to the discounted bond price of $49,000 ($50,000 x 0.98) plus accrued interest for one month from February 1 to March 1 of $250 equal to $50,000 x 6% x 1/12.

Topic: Measure and record bonds at issuance LO: 2 5. On January 1, Year 1, Aikman Co. authorizes and issues $300,000, 5% interest-bearing bonds. The bonds mature December 31, Year 5, and pay interest semiannually on June 30 and December 31. Compute the selling price of the bonds under three different market rate assumptions.

A) B) C) D)

5% $300,000 $300,000 $300,000 $300,000

Market Rate 6% $287,205 $277,920 $222,719 $351,181

4% $313,474 $324,333 $263,501 $380,843

Answer: A Rationale: The selling prices are calculated as follows: 5% market rate: =PV(0.025,10,-7500,-300000) 6% market rate: =PV(0.03,10,-7500,-300000) 4% market rate: =PV(0.02,10,-7500,-300000)

Test Bank, Chapter 16

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Topic: Account for bonds issued at face value LO: 3 6. Westerfield Corp. issued $400,000, 8%, 20-year bonds on February 1, 2020, at face value. The bonds are dated January 1, 2020. Cash interest is paid semiannually on July 1 and January 1. What will Westerfield Corp. report as interest payable on its September 30, 2020, balance sheet? A) $16,000 B) $24,000 C) $ 8,000 D) $ 5,333 Answer: C Rationale: The amount of interest payable is equal to the face value of $400,000 x 8% (stated rate) x 3/12 (months July through September) = $8,000.

Topic: Account for bonds issued at a discount LO: 4 7. The following information pertains to Summit Tours, Inc., issuance of bonds on July 1, 2020: Face amount Term Stated interest rate Interest payment dates Yield (market rate)

$400,000 10 years 6% Annually on July 1 9%

What is the issue price for each $1,000 bond? A) $1,000 B) $ 864 C) $ 807 D) $ 700 Answer: C Rationale: Total issuance price is equal to $807 calculated as the issue price of the bonds of $322,988 (PV(0.09,10,-24000,-400000)) multiplied by $1,000/$400,000.

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Topic: Accounting for debt issuance costs LO: 4 8. Delilah Company incurred costs of $6,600 when it issued, on January 1, 2020, $100,000, 5%, five-year debenture bonds. The bonds pay interest annually on December 31 and the company applies the effective interest method to amortize any bond discount or premium. The bonds were sold at a market rate of 6%. What amount of bond interest expense should Delilah report in its income statement for the year ended December 31, 2020? A) $6,855 B) $5,747 C) $5,351 D) $4,563 E) $5,000 Answer: A Rationale: The bond carrying value at the date of issuance is equal to $89,188 calculated as the present value of the bond payments of $95,788 (=PV(0.06,5,-5000,-100000)) minus bond issue costs of $6,600. The rate for the effective interest method is equal to 7.686% (RATE=(5,5000,-89188,100000). Thus, interest expense for the first year is equal to 7.686% x $89,188 = $6,855.

Topic: Account for bonds issued at a discount LO: 4 9. On July 1, 2020, Midland Company issued for $414,205, 8%, 20-year bonds with a face value of $500,000. Interest is paid semiannually on December 31 and June 30. The bonds were issued to yield 10%. Midland uses the effective interest method to amortize any bond discount or premium. What is the carrying amount of the bonds in Midland’s December 31, 2021, balance sheet? A) $414,915 B) $416,245 C) $415,661 D) $414,205 E) $416,444 Answer: E Rationale: The bond carrying value on December 31, 2021, is $416,444 as shown in the following schedule.

July 1, 2020 Dec. 31, 2020 July 1, 2021 Dec. 31, 2021

Cash Interest

Interest Expense

Discount Amortization

$20,000 20,000 20,000

$20,710 20,746 20,783

$710 746 783

Bonds Payable, Net $414,205 414,915 415,661 416,444

Test Bank, Chapter 16

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Use the following information to answer Questions 10 and 11. On July 1, 2020, Midland Company issued for $598,964, 10%, 20-year bonds with a face value of $500,000. Interest is paid semiannually on December 31 and June 30. The bonds were issued to yield 8%. Midland uses the effective interest method to amortize any bond discount or premium.

Topic: Account for bonds issued at a premium LO: 5 10. What is the carrying amount of the bonds on Midland's December 31, 2021, balance sheet? A) $597,922 B) $596,839 C) $591,542 D) $595,713 E) $594,802 Answer: D Rationale: The bond carrying value on December 31, 2021, is $595,713 as shown in the following schedule.

July 1, 2020 Dec. 31, 2020 July 1, 2021 Dec. 31, 2021

Cash Interest

Interest Expense

Premium Amortization

$25,000 25,000 25,000

$23,959 23,917 23,874

$1,041 1,083 1,126

Bonds Payable, Net $598,964 597,922 596,839 595,713

Topic: Account for bonds issued at a premium LO: 5 11. What is the amount of interest expense that Midland will report for the year ended December 31, 2021? A) $47,791 B) $47,875 C) $47,917 D) $59,896 Answer: A Rationale: Interest expense reported for the year ended December 31, 2021, is $47,791 ($23,917 + $23,874) as shown in the following schedule.

July 1, 2020 Dec. 31, 2020 July 1, 2021 Dec. 31, 2021

Cash Interest

Interest Expense

Premium Amortization

$25,000 25,000 25,000

$23,959 23,917 23,874

$1,041 1,083 1,126

Bonds Payable, Net $598,964 597,922 596,839 595,713

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Topic: Account for bonds issued at a premium LO: 5 12. On July 1, 2020, Midland Company issued for $598,964, 10%, 20-year bonds with a face value of $500,000. Interest is paid semiannually on December 31 and June 30. The bonds were issued to yield 8%. Midland uses the straight-line method to recognize interest expense. What is the carrying amount of the bonds in Midland's December 31, 2021, balance sheet? A) $596,490 B) $598,964 C) $591,542 D) $594,016 E) $589,067 Answer: C Rationale: The bond carrying value on December 31, 2021, is $591,542 as shown in the following schedule.

July 1, 2020 Dec. 31, 2020 July 1, 2021 Dec. 31, 2021

Cash Interest

Interest Expense

Premium Amortization

$25,000 25,000 25,000

$22,526 22,526 22,526

$2,474 2,474 2,474

Bonds Payable, Net $598,964 596,490 594,016 591,542

Topic: Measure and record notes at issuance and after issuance LO: 6 13. On January 1, 2020, a borrower signed a long-term note, face amount, $250,000; time to maturity, three years; stated interest rate, 8% paid annually on December 31; and cash proceeds from the loan, $243,672. Using the effective interest method, what is the amount of interest expense recognized for the year ended December 31, 2021? A) $22,104 B) $20,000 C) $19,494 D) $21,930 Answer: A Rationale: The market rate on this note is equal to 9% calculated as RATE(3,20000,-243672,250000). The market rate determines interest expense in the following schedule:

Jan. 1, 2020 Dec. 31, 2020 Dec. 31, 2021

Cash Interest

Interest Expense

Discount Amortization

$20,000 20,000

$21,930 22,104

$1,930 2,104

Note Payable, Net $243,672 245,602 247,706

Test Bank, Chapter 16

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Topic: Measure notes at issuance LO: 6 14. Brosnan Inc. purchased land on January 1, 2020, by issuing a two-year, $185,000 note, structured as a zero-interest-bearing note. The entire principal is payable December 31, 2021. The market rate of 8% is implicit in this agreement. What is the implied fair value of the land and how would your answer change if instead, the stated rate of interest was 6%, due annually on December 31, and the market rate was 8%?

A) B) C) D)

Zero-interest-bearing $185,000 $158,608 $171,296 $158,608

Stated interest of 6% $178,402 $178,402 $181,574 $185,000

Answer: B Rationale: The fair value of the land is equal to the present value of the notes, calculated as follows: Zero-interest-bearing note: PV(0.08,2,0,-185000) = $158,608 Interest-bearing note: PV(0.08,2,-11100,-185000) = $178,402

Topic: Measure notes at issuance LO: 6 15. When goods or services are exchanged for a note, the stated rate is not used to measure the fair value of the note when: A) An interest rate is not stated. B) The stated interest rate is unreasonable. C) The stated value of the note is materially different from the fair value of the note. D) A and B E) A and C F) B and C G) A, B, and C Answer: G Rationale: Per ASC 835-30-05-2, all 3 items indicate that the stated rate does not represent fair and adequate compensation to the supplier of the note funds.

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Topic: Account for extinguishment of debt LO: 7 16. A bond issuer extinguishes its bonds, originally issued at a discount, on a date other than an interest payment date. If the bond issuer does not first record an entry to update bond discount amortization before recording the entry for the debt extinguishment: A) The amount of net income will be inaccurate. B) The related balance sheet amounts will be inaccurate. C) The allocation between interest expense and any gain or loss will be inaccurate. D) A and B E) A and C F) A, B, and C Answer: C Rationale: While the net effect on net income and the elimination of the net bond payable will be accurate, the amount allocated to any gain or loss will include amortization expense from the last report date. Thus, any loss would be overstated and any gain would be understated.

Use the following information to answer Questions 17 and 18. On January 1, 2020, Venice Co. issued $280,000 of 10-year bonds at 96. The bonds pay 6% cash interest annually on December 31. The company retired 30% of the bonds on June 1, 2020, when the bonds were selling at 90 plus accrued interest. Assume the straight-line interest method is used to amortize the bond discount.

Topic: Account for extinguishment of debt LO: 7 17. What is the carrying value of the bonds to be redeemed just prior to the bond redemption? A) $84,000 B) $80,780 C) $80,640 D) $80,808 Answer: B Rationale: The discount on the bond issuance date is equal to $11,200 calculated as $280,000 x 4%. The discount is amortized on a straight-line basis which equates to $1,120 per year over the 10-year bond term. We prorate the annual amortization for 5 months (January 1 to June 1) and for the 30% redemption. Thus, we would amortize $140 or $1,120 x 5/12 x 30%. Thus, the unamortized discount would be $3,220 calculated as ($11,200 x 30%) - $140. The carrying value would be $84,000 ($280,000 x 30%) - $3,220 or $80,780.

Test Bank, Chapter 16

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Topic: Account for extinguishment of debt LO: 7 18. What is the gain recognized on the redemption of the bonds? A) $5,040 gain B) $5,180 gain C) $8,400 gain D) $5,208 gain Answer: B Rationale: There is a gain recognized on the bond redemption equal to the carrying value of the bonds of $80,780 (See question #17) minus the cash paid of $75,600 ($84,000 x 90%) equals $5,180.

Topic: Account for conversion of debt into equity LO: 8 19. Which of the following statements is true? A) Cash paid to bondholders as an incentive to convert the debt to equity reduces paid-in capital in excess of par. B) Convertible bonds are often issued with a higher stated rate than an equivalent bond without the conversion feature. C) The issuance of convertible debt does not typically include a credit to a paid-in capital account. D) Under the book value method, a gain or loss on conversion would typically be recognized. Answer: C Rationale: Per ASC 470-20-25-12, no portion of the proceeds from the issuance of convertible debt is attributed to the conversion feature. Answer A is not correct because bond inducements are expensed. Answer B is not correct because the conversion feature typically has a value to shareholders that results in a lower stated rate on the debt. Answer D is incorrect because this describes the fair value method.

Use the following information to answer Questions 20 and 21. McGowan Corp. issued $100,000 of 8%, 10-year convertible bonds. Each $1,000 bond is convertible into 2 shares of common stock ($1 par value per share) of McGowan Corp. The bonds were sold at 97 on January 1, 2020.

Topic: Account for convertible debt LO: 8 20. Upon issuance of the convertible bonds, McGowan Corp. would credit to Paid-in Capital—Common Stock for the following amount. A) $-0B) $1,500 C) $2,000 D) $3,000 Answer: A Rationale: Per ASC 470-20-25-12, no portion of the proceeds from the issuance of convertible debt is attributed to the conversion feature.

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Topic: Account for conversion of debt into equity LO: 8 21. Assume that the conversion feature for 75% of the bonds is exercised on December 31, 2020, after McGowan Corp. made payments of $10,000 to shareholders to induce conversion. Assume that any discount or premium has been amortized through the date of conversion using the straight-line interest method. The common stock is selling at $80 per share on December 31, 2020. Upon conversion of 75% of the convertible bonds, McGowan Corp. would credit to Paid-in Capital— Common Stock for the following amount: A) $72,600 B) $97,150 C) $72,825 D) $82,825 Answer: C Rationale: McGowan Corp. would record the following entry upon conversion of the debt to equity: Bonds Payable Conversion expense Discount on Bonds Payable Common Stock Paid-in Capital in Excess of Par Cash

75,000 10,000 2,025* 150 72,825 10,000

*$2,025 = ((3% x $100,000)/10) x 75%

Topic: Account for bonds with stock warrants LO: 9 22. If a bond is issued with detachable stock warrants: A) The entire bond price is allocated to the debt. B) A portion of the bond price is allocated to equity but only when the fair value of either the bonds or the stock warrants is known. C) A portion of the bond price is allocated to equity but only when the fair value of both the bonds and stock warrants is known. D) A portion of the bond price is allocated to equity. Answer: D Rationale: Per ASC 470-20-25-2, a portion of the proceeds upon issuance of bonds with detachable warrants is allocated to paid-in capital. Thus, D is correct.

Test Bank, Chapter 16

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Topic: Account for bonds with stock warrants LO: 9 23. Linus Corp. issues $500,000 of 6%, 5-year bonds with nondetachable stock warrants on January 1, 2020. Each $1,000 bond carries 5 warrants. Each warrant entitles the holder to purchase one share of $1 par common stock for $12. Assume the bond issue sells for 102. Management estimates that the bonds would sell for $500,000 if the warrants were not attached. Upon issuance, Linus Corp. would record a credit to Paid-in Capital—Stock Warrants for the following amount: A) $-0B) $2,000 C) $5,000 D) $10,000 Answer: A Rationale: Per ASC 470-20-25-2, a portion of the proceeds upon issuance of bonds with detachable warrants is allocated to paid-in capital. Because the warrants are nondetachable, no amount is allocated to equity for the warrants; thus, A is correct.

Topic: Account for bonds with stock warrants LO: 9 24. Linus Corp. issues $500,000 of 6%, 5-year bonds with detachable stock warrants on January 1, 2020. Each $1,000 bond carries 5 warrants. Each warrant entitles the holder to purchase one share of $1 par common stock for $12. Assume the bond issue sells for 102. Shortly after issuance, the warrants trade for $8 each and the bonds were quoted at 100 without warrants attached. Upon issuance of the bonds, the company would record: A) A debit to Discount on Bonds Payable for $9,820 B) A debit to Discount on Bonds Payable for $19,231 C) A debit to Discount on Bonds Payable for $9,615 D) A credit to Premium on Bonds Payable for $10,000 Answer: C Rationale: The company would allocate a portion of the proceeds from the bond issuance of $510,000 ($500,000 x 1.02) to the bonds. The portion allocated to the bonds of $490,385 is equal to $510,000 x ($500,000 ÷ $520,000). The $520,000 is equal to the fair value of the bonds of $500,000 plus the fair value of the warrants of $20,000 equal to $500,000/$1,000 x 5 x $8. The discount is equal to $500,000 - $490,385 = $9,615.

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Topic: Apply the fair value option for liabilities LO: 10 25. Bell Tower Inc. adjusts the balance in its bonds payable account to fair value at a reporting date under the fair value option election. Where in the financial statements would the portion of any unrealized gain or loss be recognized for a change due to general risk and for a change due to the company’s own credit risk?

A) B) C) D)

General risk Net income Other comprehensive income Net income Other comprehensive income

Company’s own risk Other comprehensive income Net income Net income Other comprehensive income

Answer: A Rationale: Per ASC 825-10-45-5, any change in the fair value of the liability due to general risk is recognized in net income and any change due to company specific risk is recognized in other comprehensive income.

Topic: Describe financing disclosures LO: 11 26. In the notes accompanying the financial statements, the company will disclose: A) The aggregate amount of maturities of all long-term debt borrowings for each of the five years following the latest balance sheet date. B) The sinking fund requirements of all long-term debt borrowings for each of the five years following the latest balance sheet date. C) The aggregate amount of maturities of all long-term debt borrowings for each of the ten years following the latest balance sheet date. D) The sinking fund requirements of all long-term debt borrowings for each of the ten years following the latest balance sheet date. E) A and B F) C and D Answer: E Rationale: Per ASC 470-10-50-1, “The combined aggregate amount of maturities and sinking fund requirements for all long-term borrowings shall be disclosed for each of the five years following the date of the latest balance sheet presented.”

Topic: Analyze leverage ratios LO: 11 27. AmeriCo. reported total assets of $550,000 and total liabilities of $250,000 on December 31, 2020. AmeriCo’s loan agreement with First National Bank requires AmeriCo to maintain a debt-to-equity ratio of no more than 0.90. What is AmeriCo’s debt-to-equity ratio at year-end and is AmeriCo in compliance with its loan agreement? A) AmeriCo’s debt-to-equity ratio is 0.45 and AmeriCo is in compliance with the loan agreement. B) AmeriCo’s debt-to-equity ratio is 0.83 and AmeriCo is in compliance with the loan agreement. C) AmeriCo’s debt-to-equity ratio is 1.0 and AmeriCo is in compliance with the loan agreement. D) AmeriCo’s debt-to-equity ratio is 1.2 and AmeriCo is not in compliance with the loan agreement. Answer: B Rationale: AmeriCo’s debt-to-equity ratio is 0.83 calculated as $250,000/($550,000-$250,000); and thus, AmeriCo is in compliance with the debt covenant. © Cambridge Business Publishers, 2023 16-13

Test Bank, Chapter 16

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Topic: Account for debt restructuring LO: 12 28. Rolling Hills Corporation agreed to give Lenders Company land in full settlement of a note payable to Lenders. The land’s original cost was $70,000. The note’s face amount was $55,000. On the date of the agreement, the note’s carrying amount was $50,500, and its present value at the current market rate was $45,000. In addition, the land’s fair value was $52,000. What total amount of loss should Lenders recognize in its income statement? A) Loss of $1,500 B) Loss of $15,000 C) Loss of $18,000 D) Loss of $19,500 E) Loss of $25,000 Answer: D Rationale: The loss is equal to $19,500 which is equal to the loss on disposal on land of $18,000 ($52,000 - $70,000) plus the loss on the debt settlement of $1,500 ($50,500 minus $52,000). Per ASC 470-60-35-3, a gain or loss on settlement of debt through the transfer of assets is recognized in net income.

Topic: Account for debt restructuring LO: 12 29. Wilhem Company granted an equity interest to a creditor in full settlement of a $92,000 debt owed to the creditor. At the date of this transaction, the equity interest in common stock had a fair value of $88,000. What should Wilhem recognize in its financial statements? A) $4,000 gain on debt restructuring in the income statement B) $4,000 loss on debt restructuring in the income statement C) $4,000 increase in other comprehensive income in the comprehensive income statement D) $4,000 net increase to paid-in capital on the statement of stockholders’ equity E) $-0- gain or loss in its income statement Answer: A Rationale: The gain of $4,000 is equal to $92,000 minus $88,000. Per ASC 470-60-35-4, the difference between the fair value of the equity interest and the carrying amount of the debt is recognized as a gain on restructuring.

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Topic: Account for debt restructuring LO: 12 30. During 2020, Gustavo’s Company experienced financial difficulties and was likely to default on a $50,000, 15%, three-year note dated January 1, 2020, payable to Urban Bank. On January 15, 2021, the bank agreed to restructure the note and unpaid 2020 interest of $7,500 for $31,000 cash, payable on January 31, 2021. What should Gustavo’s recognize in its financial statements on January 31, 2021? A) Increase in other comprehensive income of $26,500 in its statement of comprehensive income. B) $-0- gain or loss in its income statement. C) Gain of $26,500 in its income statement. D) Loss of $26,500 in its income statement. E) Loss of $75,000 in its income statement. Answer: C Rationale: A gain of $26,500 Is recognized in its income statement, calculated as $50,000 + $7,500 – $31,000 = $26,500. Per ASC 470-60-35-6, the gain resulting from a restructuring of the debt terms is recognized in net income.

Test Bank, Chapter 16

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Chapter 17 Accounting for Leases Learning Objectives – Coverage by question Multiple Choice LO 17-1 – Identify a lease, determine lease types for lessee, and classify leases using lease criteria

1, 3, 4

LO 17-2 – Account for a basic finance lease for a lessee

5, 6, 8

LO 17-3 – Account for a basic operating lease for a lessee

13, 14

LO 17-4 – Account for complex ﬁnance leases for a lessee

2, 4, 7

LO 17-5 – Account for complex operating leases for a lessee

15, 16

LO 17-6 – Determine lease types and account for a basic sales-type lease for a lessor

1, 3, 9, 10

LO 17-7 – Account for an operating lease for a lessor

17, 18, 19

LO 17-8 – Account for complex sales-type leases for a lessor

11, 12, 26, 27

LO 17-9 – Explain the accounting policy election for short- term leases and other lease disclosures

23, 24, 28-30

LO 17-10 – Appendix 17A – Account for direct financing leases by the lessor

LO 17-11 – Appendix 17B – Explain lease modiﬁcations and lease remeasurements

20-22

LO 17-12 – Appendix 17C – Describe the difference in accounting for a sale-leaseback versus a failed sale

Test Bank, Chapter 17

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Chapter 17: Accounting for Leases Multiple Choice Topic: Determine lease types for lessees and lessors and classify leases using lease criteria LO: 1, 6 1. Fieldman Company purchased a machine for leasing purposes on January 1, 2020, for $1,000,000. The machine has a 10-year life, has no residual value, and will be depreciated on a straight-line basis. On January 2, 2020, Fieldman leased the machine to Dahlia Company for $130,000 a year for a fiveyear period ending December 31, 2024, at which time, the machine reverts to Fieldman. Dahlia does not guarantee a residual value of the machine at lease-end, although Fieldman does plan to lease the equipment to Dahlia (or another company) for an additional 5 years. Dahlia paid $130,000 to Fieldman on January 2, 2020, the first annual payment date. How would Fieldman Company and Dahlia Company classify the lease, considering a 5% implicit interest rate for both parties?

A) B) C) D)

Fieldman Company Operating Lease Finance Lease Finance Lease Operating Lease

Dahlia Company Finance Lease Operating Lease Finance Lease Operating Lease

Answer: D Rationale: The lease is classified as an operating lease for both the lessee and lessor because none of the five lease classification criteria are met as shown below: 1. Ownership transfer: Machine reverts to lessor at lease-end. 2. Purchase option: Lease does not contain a purchase option. 3. Lease term length: Lease term is only 50% of the asset life. 4. PV of lease payments: PV of the lease payments is $590,974 (=PV(0.05,5,-130000,0,1) which is considerably less than the fair value of the machine. 5. Alternative use: There are alternative uses for the equipment at lease-end.

Topic: Accounting for a complex finance lease for a lessee LO: 4 2. According to ASC 842, which of the following items are classified as a lease payment. A) Variable payment where variability is based on the CPI index. B) Variable payment based upon a lessee’s annual revenue. C) Unguaranteed residual value D) A and C E) B and C F) A and B Answer: A Rationale: Per ASC 842-10-30-5, lease payment includes only variable lease payments that depend on an index or rate; thus, Answer B is not a lease payment. Per ASC 842-10-30-5, amounts probable of being owed by the lessee under residual value guarantees are included; thus, Answer C is not a lease payment.

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Topic: Determine lease types for lessees and lessors and classify leases using lease criteria LO: 1, 6 3. Lease Y does not contain a purchase option that the lessee is reasonably expected to exercise, but the lease term is equal to 80% of the estimated economic life of the leased property. Lease Z does not transfer ownership of the property to the lessee by the end of the lease term, but the present value of the lease payments is equal to 80% of the fair value of the leased property. How should the lessee classify these leases based only on the information provided above?

A) B) C) D)

Lease Y Finance lease Finance lease Operating lease Operating lease

Lease Z Operating lease Finance lease Finance lease Operating lease

Answer: A Rationale: Per ASC 842-10-25-2, one of the lease criterion is met in order to consider a lease a finance lease if the lease term is a major part of the remaining economic life of the underlying asset. ASC 84210-55-2 identifies 75% or more as a “major part.” Thus, Lease Y is a finance lease. Per ASC 842-10-25-2, one of the lease criterion is met in order to consider a lease a finance lease if the present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset. ASC 842-10-55-2 identifies 90% or more as “substantially all.” Thus, Lease Z is an operating lease.

Topic: Determine lease types for lessees and classify leases using lease criteria LO: 1, 4 4. Liesel Inc. is considering the following two separate leases. Each lease pertains to the lease of equipment with a fair value of $100,000.

Ownership of equipment transfers to lessee at lease-end Lease includes a purchase option Length of lease term Economic life of the equipment Alternative use of the equipment at lease-end Annual lease payment, first payment due at end of each period. Guaranteed residual value

Lease One No No 5 8 Yes $21,500 $20,000

Lease Two No Yes 7 8 Yes $18,000 $0

Liesel Inc.’s incremental borrowing rate is 7% and Lessee Inc. is not aware of the implicit rate of either lease. For Lease One, the lessee estimates an expected fair value of only $12,000 of the equipment at lease-end based on its expected usage. For Lease Two, although the fair value of the equipment is expected to be greater than the purchase option, Liesel Inc. is not reasonably assured that it will take advantage of the option based on its forecast of available cash at that time. continued

Test Bank, Chapter 17

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How would Liesel Inc. classify Lease One and Lease Two?

A) B) C) D)

Lease One Finance lease Finance lease Operating lease Operating lease

Lease Two Operating lease Finance lease Finance lease Operating lease

Answer: B Rationale: Liesel Inc. would classify each lease as a finance lease. Lease One does not transfer ownership, does not include a purchase option reasonably expected to be exercised, and does not have a lease term considered to be a major part of the asset’s life (5/8 = 63%). However, the present value of the lease payments of $93,858 (=PV(0.07,5,-21500,-8000) is substantially all of the fair value of the asset of $100,000 at 94%. Lease Two does not transfer ownership, does not include a purchase option reasonably expected to be exercised, but does have a lease term considered to be a major part of the asset’s life (7/8 = 88%). Also, the present value of the lease payments of $97,007 (=PV(0.07,7,18000) is substantially all of the fair value of the asset of $100,000 at 97%.

Topic: Account for a basic finance lease for a lessee LO: 2 5. On January 2, 2020, Ashevilleville Company entered into a 10-year noncancelable lease requiring yearend payments of $100,000. Asheville's incremental borrowing rate is 9%, and the lessor's implicit interest rate, known to Asheville, is 10%. Ownership of the property remains with the lessor at expiration of the lease. There is no purchase option associated with the lease. The leased property has an estimated economic life of 12 years. What amount (rounded) should Asheville capitalize for this leased property on January 2, 2020? A) $1,000,000 B) $614,500 C) $565,000 D) $675,900 E) $0 Answer: B Rationale: This is a finance lease for the lessee because the lease term (10 years) is a major part of the economic life of the leased asset (83%). With a finance lease, the lessee records a lease liability and a right-of-use asset at the present value of lease payments, discounted using the implicit rate (if known); otherwise the incremental borrowing rate. In this case, the lessee knows the implicit rate is 10%, thus, at lease commencement, the PV amount recorded as an asset and liability is $614,500 (=PV(0.1,10,100000,0,0).

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Topic: Account for a basic finance lease for a lessee LO: 2 6. On December 30, 2019, Trace Company leased equipment under a finance lease for a period of 10 years. Trace contracted to pay $90,000 annual rent on December 31, 2019, and on December 31 of each of the next nine years. The finance lease liability was appropriately recorded at $608,312 on December 30, 2019, before the first payment. The leased equipment has a useful life of 12 years, and the interest rate implicit in the lease is 10%, known by Trace. Trace uses the straight-line method for depreciating all equipment. In recording the December 31, 2021, payment, Trace should reduce its lease liability by: A) $41,986 B) $32,086 C) $29,169 D) $38,169 Answer: A Rationale: The lease liability is reduced by $41,986 in the year 2021, as shown below.

Date Dec. 30, 2019 Dec. 30, 2019 Dec. 31, 2020 Dec. 31, 2021

Lease Payment

Interest on Liability

$ 90,000 90,000 90,000

$― 51,831 48,014

Lease Liability Reduction $90,000 38,169 41,986

Net Lease Liability $608,312 518,312 480,143 438,158

Topic: Account for a complex finance lease for a lessee LO: 4 7. On January 2, 2018, Uhrhan, Inc., signed an eight-year lease for office space. Uhrhan classified the lease as a finance lease. Uhrhan has the option to renew the lease for an additional four-year period on or before January 2, 2022. During early January 2020, two years after occupying the leased premises, Uhrhan made general improvements to the premises costing $360,000 and having an estimated useful life of 10 years. At December 31, 2020, Uhrhan's intentions as to the exercise of the renewal option are uncertain because they depend upon future office space requirements. Uhrhan should record amortization of leasehold improvements for 2020 at: A) B) C) D)

$30,000 $36,000 $45,000 $60,000

Answer: D Rationale: The cost of leasehold ($360,000) should be amortized over the remaining life of the lease, or the useful life of the improvements, whichever is shorter. When the lease contains a renewal option, the life of the lease does not include the renewal period unless it is probable that the option will be exercised. Therefore, in this case, the remaining life of the lease is six years (8-year lease term less the two years gone by). The renewal period of four years is not considered since exercise of the option is uncertain. The useful life of the improvements is ten years, so the improvements are amortized over the remaining lease life of six years. This results in 2020 amortization of $60,000 ($360,000/6 years).

Test Bank, Chapter 17

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Topic: Account for a basic finance lease for a lessee LO: 2 8. On January 1, 2020, Warrior Company signed a 10-year noncancelable lease for new equipment, requiring $20,000 annual payments at the beginning of each year. The equipment has a useful life of 15 years, with no salvage value. Title passes to Warrior at the lease expiration date. At the lease commencement, Warrior records a right-of-use asset and a lease liability of $126,000, based on an appropriate rate of interest. For 2020, Warrior should record amortization on its right-of-use asset of: A) $20,000 B) $12,600 C) $8,400 D) $0 Answer: C Rationale: Since title passes to the lessee at the end of the lease, this is a finance lease for the lessee. The right-of-use asset is amortized on a straight-line basis over its useful life of 15 years, resulting in a yearly depreciation charge of $8,400 ($126,000/15). The right-of-use asset is amortized over its useful life rather than over the lease term because title transfers to the lessee, allowing the lessee to use the asset for 15 years.

Topic: Account for a basic sales-type lease for a lessor LO: 6 9. In a lease that is recorded as a sales-type lease by the lessor, interest revenue A) Does not arise B) Should be recognized over the life of the lease by the effective interest method C) Should be recognized over the life of the lease by the straight-line method D) Should be recognized in full as revenue at the lease's inception Answer: B Rationale: Interest revenue is recognized for a sales-type lease over the lease term so as to produce a constant rate of return on the lease receivable. This requires the use of the effective interest method. Therefore, Answer B is correct and Answer C is incorrect. Answer A is incorrect because, interest revenue does arise in a sales-type lease. Answer D is incorrect because the interest is to be earned over the life of the lease, not in full at the lease's inception.

Topic: Account for a basic sales-type lease for a lessor LO: 6 10. On January 1, 2020, Nugget Inc. leased new equipment to Warrior Company under a 10-year noncancelable lease, requiring $20,000 annual payments at the beginning of each year. The new equipment cost Nugget Inc. $144,938 and has a useful life of 12 years, with no salvage value. Title passes to Warrior at the lease expiration date. What is the rate implicit in the lease agreement? A) 7.5% B) 10.9% C) 6.3% D) 8.0% Answer: D Rationale: The implicit rate is equal to 8% (=RATE(10,-20000,144938,0,1). © Cambridge Business Publishers, 2023 17-6

Intermediate Accounting, 3rd Edition

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The following information is used for Questions 11 and 12. On January 1, 2020, Commonwealth Inc. leases equipment to Tap Inc. The equipment has a fair value of $100,000, a carrying value of $80,000, an economic life of four years, and a lease term of three years. Commonwealth's incremental borrowing rate is 10% and there is a purchase option at the end of the lease of $10,000 that is reasonably expected to be executed by Tap at that time. The annual lease payment is $33,809.39, with the first payment due immediately on January 1, 2020.

Topic: Account for a complex sales-type lease for a lessor LO: 8 11. What is the gross profit (if any) recognized on January 1, 2020 by Commonwealth Inc.? A) $0 B) $20,000 C) $12,487 D) $35,237 Answer: B Rationale: The lease is recognized as a sales-type lease because the lease term is a major part of the estimated life of the equipment (3/4 = 75%). For a sale-type lease, gross profit recognized is equal to sales revenue of $100,000, rounded (=PV(0.1,3,-33809.39,-10000,1) minus cost of goods sold of $80,000 or $20,000.

Topic: Account for a complex sales-type lease for a lessor LO: 8 12. What is the amount of interest revenue recognized in 2020 by Commonwealth Inc.? A) $0 B) $6,619 C) $10,000 D) $4,619 E) $7,619 Answer: B Rationale: Interest revenue is equal to $66,191.60 (calculated as $100,000 - $33,809.39) x 10% to equal $6,619 (rounded).

Test Bank, Chapter 17

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Use the following information to answer Questions 13 and 14. Fieldman Company purchased a machine for leasing purposes on January 1, 2020, for $1,000,000. On March 1, 2020, Fieldman leased the machine to Dahlia Company for $130,000 a year for a five-year period ending December 31, 2024, at which time, the machine reverts to Fieldman. Dahlia Company estimates the machine’s useful life to be 10 years. Dahlia does not guarantee a residual value of the machine at leaseend. Dahlia paid $130,000 to Fieldman on January 2, 2020, the first annual lease payment. Dahlia is not aware of the implicit rate of the lease, but Dahlia’s incremental borrowing rate is 5%.

Topic: Account for a basic operating lease for a lessee LO: 3 13. What was the lease expense recognized by Dahlia Company for the year ended December 31, 2020? A) $130,000 B) $106,951 C) $118,195 D) $100,000 Answer: A Rationale: The lease is classified as an operating lease by the lessee because none of the five lease classification criteria are met as shown below: 1. Ownership transfer: Machine reverts to lessor at lease-end. 2. Purchase option: Lease does not contain a purchase option. 3. Lease term length: Lease term is only 50% of the asset life. 4. PV of lease payments: PV of the lease payments is $590,974 (=PV(0.05,5,-130000,0,1) which is considerably less than the fair value of the machine. 5. Alternative use: There are alternative uses for the equipment at lease-end. The amount recorded for lease expense is equal to the straight-line expense of $130,000 per year (same amount each year over the lease term).

Topic: Account for a basic operating lease for a lessee LO: 3 14. What was the deduction to the Right-of-Use Asset account in 2020 for Dahlia Company? A) $118,195 B) $106,951 C) $100,451 D) $130,000 Answer: B Rationale: The amount of reduction in the right-of-use asset account for 2020 was $106,951, calculated as follows: Lease Payment

Interest on Liability

$130,000 130,000

$ ― 23,049

Lease Expense

Interest on Liability

$130,000

$23,049

Lease Expense Lease Liability Right-of-Use Asset

Lease Liability Reduction $130,000 106,951 Right-of-Use Asset Amortization $106,951

Net Lease Liability $590,974 460,974 354,022 Net Right-of-Use Asset $590,974 484,022

130,000 23,049 106,951

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Topic: Account for a complex operating lease for a lessee LO: 5 15. To calculate the initial right-of-use asset for a lessee in accounting for an operating lease, A) Start with the initial measurement of a lease liability at the date the lease is signed. B) Add lease incentive received. C) Add initial direct costs incurred. D) Add any maintenance costs incurred before the lease period begins. Answer: C Rationale: Answer A is incorrect: we start with the lease liability at the lease commencement date. Answer B is incorrect: we subtract lease incentives received. Answer D is incorrect: maintenance costs are not considered a lease payment. Answer C is correct as initial direct costs incurred are added.

Topic: Account for a complex operating lease for a lessee LO: 5 16. Laurel Inc. entered into a 4-year lease agreement of equipment requiring $8,000 annual payments, with the first payment due immediately. The lease does not contain a renewal or purchase option, and the asset reverts to the lessor at the end of the four-year period. The lessee’s incremental borrowing rate is 7% and the implicit rate of the lease is 8%, known by the lessee. Just prior to the lease commencement, the lessee (a) incurred legal fees to execute the lease of $800, (b) received $2,500 from the lessor as a lease incentive to sign the new lease, and (c) made the first annual payment of $8,000. What is the amount of the lease liability recognized by Laurel Inc. at the commencement of the lease? A) $28,566 B) $33,566 C) $28,764 D) $26,917 Answer: D Rationale: The lease liability is equal to the initial measurement of the lease liability of $20,617 (=PV(0.08,3,-8000) + $800 of initial direct costs - $2,500 of lease incentives received + $8,000 of prepaid lease payments equals $26,917.

Test Bank, Chapter 17

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Topic: Account for an operating lease for a lessor LO: 7 17. Fieldman Company purchased a machine for leasing purposes on January 1, 2020, for $1,000,000. The machine has a 10-year life, has no residual value, and will be depreciated on a straight-line basis. On March 1, 2020, Fieldman leased the machine to Dahlia Company for $130,000 a year for a fiveyear period ending December 31, 2024, at which time, the machine reverts to Fieldman. Dahlia does not guarantee a residual value of the machine at lease-end, although Fieldman does plan to lease the equipment to Dahlia (or another company) for an additional 5 years. Dahlia paid $130,000 to Fieldman on January 2, 2020, the first annual lease payment. During the year ended December 31, 2020, Fieldman incurred normal maintenance and other related expenses of $1,000 under the provisions of this lease. What was the income before income taxes derived by Fieldman from this lease for the year ended December 31, 2020? A) $29,000 B) $24,000 C) $21,500 D) $25,000 Answer: B Rationale: The lease is classified as an operating lease by the lessor because none of the five lease classification criteria are met as shown below: 1. Ownership transfer: Machine reverts to lessor at lease-end. 2. Purchase option: Lease does not contain a purchase option. 3. Lease term length: Lease term is only 50% of the asset life. 4. PV of lease payments: PV of the lease payments is $590,974 (=PV(0.05,5,-130000,0,1) which is considerably less than the fair value of the machine. 5. Alternative use: There are alternative uses for the equipment at lease-end. For an operating lease, a lessor recognizes rents as revenue and recognizes depreciation and maintenance as expense. For 2020, 10/12 of the $130,000 annual payment is recognized; that is, $108,333. Maintenance of $1,000 and depreciation for 10 months out of 120 months (the lease term) are also recognized. 10 month’s rent Maintenance Depreciation ($1,000,000 x 10/120)

$108,333 ( 1,000) (83,333) $ 24,000

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Topic: Account for an operating lease for a lessor LO: 7 18. On January 1, 2020, Miller Corporation leased a machine to Otterbein Corporation for a five-year term at an annual rental of $50,000. On this date, Miller Corporation incurred legal fees of $1,000 related to the execution of the lease. The lease is appropriately classified as an operating lease by Miller Corporation. At the inception of the lease, Miller received $100,000, covering the first year's rent of $50,000 and a security deposit of $50,000. This deposit will not be returned to Otterbein upon expiration of the lease but will instead be applied to payment of rent for the last year of the lease. Miller Corporation calculated annual depreciation expense on the machine of $35,000, using the straight-line method. What is the net profit (ignoring taxes) that Miller Corporation recognized on its 2020 income statement? A) $24,000 B) $24,800 C) $14,800 D) $14,000 Answer: C Rationale: Prepayments received for leasing services to be provided in the future should be recorded as deferred lease revenue (a liability) until the leasing services are provided. Thus, net profits for the year 2020 of $14,800 is equal to rent revenue for 2020 of $50,000, minus $35,000 (depreciation expense), minus $200 (amortization of the initial direct costs of one year equal to $1,000 / 5 = $200).

Topic: Account for an operating lease for a lessor LO: 7 19. Sorenstam Inc. (lessor) entered in a lease agreement of equipment for a 5-year period with Lemor Inc. (lessee). The lease is properly classified as an operating lease by Sorenstam Inc. Lease payments were structured as follows: Year One: Year Two: Year Three: Year Four: Year Five:

$5,000 $8,000 $10,000 $10,000 $2,500

What is the amount of lease revenue recognized in Year One and Year Two by Sorenstam Inc.?

A) B) C) D)

Year One $5,000 $7,100 $6,500 $2,500

Year Two $8,000 $7,100 $6,500 $10,000

Answer: B Rationale: Per 842-30-25-11, lease income is recognized on a straight-line basis (or another systematic method) over the lease term. Thus, revenue is recognized for $7,100 per year calculated as ($5,000 + $8,000 + $10,000 + $10,000 + $2,500)/5)

Test Bank, Chapter 17

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Topic: Explain lease modifications LO: 11 20. If a lease is modified to extend the lease for an additional year, A) and the lease payments for the extension are at current market prices, the contract for the lease extension is considered to be a separate lease. B) and the lease payments for the extension are below current market prices, the original lease plus the new lease extension is considered to be a combined new lease. C) and the lease payments for the extension are above current market prices, the contract for the lease extension is considered to be a separate lease. D) Both A and B E) Both A and C F) All of the above Answer: D Rationale: Per ASC 842-10-25-8, a separate lease results with a modification of additional rights at standalone prices (thus, Answer A is correct). Otherwise, the lease is treated as a single, modified lease. Answer B is an example of a modification not at standalone prices, treated as a single, modified lease. Answer C is incorrect because a modification not at standalone prices is treated as a single, modified lease.

Topic: Explain lease remeasurements LO: 11 21. Which of the following items would not result in a lease remeasurement: A) A change in standalone prices for the services under lease. B) A change in a lease term C) A change in the probable amount owed for a guaranteed residual value. D) A change in a lessee’s assessment of whether or not they will exercise a purchase option Answer: A Rationale: Per ASC 842-10-35-4, answers B through D, but not A, require lease remeasurement.

Topic: Explain lease modifications and lease remeasurements LO: 11 22. HI-FIVE Corp. entered into a 5-year lease agreement on January 1, 2020, for $10,000 annually, with payments beginning immediately. The lease included a guaranteed residual value of $5,000, but HIFIVE determined that the probable amount owed was zero. However, on December 31, 2021, HIFIVE Corp. now believes that $5,000 is the probable amount owed for the guaranteed residual value. HI-FIVE Corp’s incremental borrowing rate changed from 5% at the lease commencement to 7% currently. What is the lease liability on January 1, 2020, and on December 31, 2021, considering all information provided.

A) B) C) D)

January 1, 2020 $45,460 $45,460 $41,542 $41,542

December 31, 2021 $32,913 $32,162 $32,162 $32,913

Answer: A Rationale: On January 1, 2020, the lease liability is measured at $45,460 (=PV(.05,5,-10000,0,1)) and on December 31, 2021, the lease liability is measured at $32,913 (=PV(.05,3,-10000,-5000,1)). Note that per ASC 842-20-35-5, upon remeasurement of a lease liability, the interest rate is not updated for a change in the probable amount owed for a guaranteed residual value. © Cambridge Business Publishers, 2023 17-12

Intermediate Accounting, 3rd Edition

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Topic: Explain the accounting policy election for short-term leases LO: 9 23. In order for a lease to qualify for the short-term lease election, the lease: A) Must be of a duration of 12 months or less and include no purchase option of the leased asset and no renewal option beyond one year. B) Must be of a duration of 12 months or less and include no purchase option. C) Must be of a duration of 12 months or less and may include a purchase or renewal option beyond a year, but the lessee is not reasonably expected to exercise either option. D) Must be of a duration of 12 months or less and may include a purchase option but may not include a renewal option extending beyond one year. Answer: C Rationale: According to the ASC glossary definition of a short-term lease, the lease term is 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise. According to the example in ASC 842-10-65-1, a renewal option is not considered part of the lease term if the lessee is not reasonably certain to exercise the option.

Topic: Explain the accounting policy election for short-term leases LO: 9 24. On July 1, 2020, a lessee enters into an agreement to lease equipment for a 12-month period ending June 30, 2021. The present value of the 12 lease payments is $50,000. If the lessee elects to account for the lease under the short-term lease election, what amount would the lessee recognize as the rightof-use asset on December 31, 2020, its annual reporting period? A) $0 B) $50,000 C) $25,000 D) More information is required. Answer: A Rationale: Under the short-term lease election, the company would not record a right-of-use asset for the lease. Instead, the lessee would simply expense the $50,000 lease payment each month.

Topic: Account for direct financing leases LO: 10 25. In order for a lease to be classified as a direct financing lease, the lease must meet the following criteria: A) Ownership of the leased asset transfers to the lessee at the end of the lease term. B) It is reasonably certain that the lessee will exercise a purchase option. C) The lease term is a major part of the estimated life of the leased asset. D) The present value of the lease payments plus the residual guaranteed by a third party equals or exceeds substantially all of the fair value of the leased asset. E) The leased asset has no alternative use at the conclusion of the lease. F) All of the above. G) None of the above. Answer: D Rationale: ASC 842-10-25-3b indicates that a lease which would otherwise be classified as an operating lease, but where the present value of the sum of the lease payments plus any guaranteed residual equals or exceeds substantially all of the fair value of the underlying asset would be classified as a direct financing lease. Answers A, B, and C indicate that the lease is a sales-type lease, not an operating lease.

Test Bank, Chapter 17

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Use the following information to answer Questions 26 and 27. Laurel Inc. leased equipment with a fair value of $45,000 and a carrying value of $37,000, under the following terms: Lease Terms Ownership of equipment transfers to lessee at lease-end Lease includes a purchase option Length of lease term in years Economic life of the equipment in years Alternative use of the equipment at lease-end Annual lease payment, first payment due at the end of the year Guaranteed residual value by an insurance company Laurel Inc.’s implicit interest rate

No No 6 10 Yes $8,750 $9,000 8.7412%

Topic: Account for direct financing leases LO: 8 26. How would Laurel Inc. classify the lease? Assume that the company considers 90% of fair value to be substantially all of fair value. A) Direct financing lease B) Finance lease C) Operating lease D) Sales-type lease Answer: A Rationale: The lease does not transfer ownership, does not include a purchase option reasonably expected to be exercised, and does not have a lease term considered to be a major part of the asset’s life (6/10 = 60%). The present value of the lease payments of $39,557 (=PV(0.087412,6,-8750) is not substantially all of the fair value of the asset of $45,000 at 88%. However, considering the guaranteed residual value by the insurance company, the present value of the lease payments of $45,000 (=PV(0.087412,6,-8750,-9000) is substantially all of the fair value of the asset of $45,000 at 100%. Thus, the lease qualifies as a direct financing lease.

Topic: Account for direct financing leases LO: 8 27. What is interest revenue recognized for the first year of the lease? A) $3,934 B) $3,198 C) $3,234 D) $5,552 E) $0 Answer: D Rationale: The lease is classified as a direct financing lease (see question #26). The net lease receivable is equal to $37,000 ($45,000 lease receivable minus $8,000 deferred gross profit). [Note: The lease receivable of $45,000 is calculated as PV(.0874,6,-8750,-9000) and the deferred gross profit of $8,000 is calculated as $45,000 minus $37,000.] The rate of 15.0047% used in the effective interest table below is calculated as RATE(6,8750,-37000,9000). Lease Payment

Interest on Receivable

Lease Receivable Deduction

$8,750

$5,551.75

$3,198.25

Net Lease Receivable $37,000.00 33,801.75

Intermediate Accounting, 3rd Edition

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Topic: Describe the difference in accounting for a sale-leaseback versus a failed sale LO: 9 28. In a sale-leaseback transaction the seller-lessee has retained the property. The gain on the sale should be recognized at the time of the sale-leaseback if the lease is classified as which of the following?

A) B) C) D)

Finance Lease Yes No No Yes

Operating Lease Yes No Yes No

Answer: C Rationale: If a seller-lessee classifies a leaseback as an operating lease, a sale has occurred, any gain or loss would be recognized, and the transaction is appropriately recorded as a lease. However, if a seller-lessee classifies a leaseback as a finance lease, no sale has occurred and this would be considered a failed sale. This is because a finance lease is an effective purchase of the asset. Thus, a gain would be recorded for a sale (operating lease), but not under a failed sale (finance lease).

Topic: Describe the difference in accounting for a sale-leaseback versus a failed sale LO: 9 29. The following information pertains to equipment sold by Bardstown Company to Kerry Company on December 31, 2020: Sales price Book value Estimated remaining economic life

$300,000 $100,000 20 years

Simultaneously with the sale, Bardstown leased back the equipment for a period of 16 years. How much of the gain on the sale should Bardstown recognize on December 31, 2020? A) $200,000 B) $12,500 C) $10,000 D) $0 Answer: D Rationale: In this case, the lease qualifies as a finance lease because the lease term is a major part of the remaining economic life of the leased property (80%). Therefore, at December 31, 2020, none of the $200,000 ($300,000 - $100,000) gain would be recognized by Bardstown Company and the transaction would be instead recorded as a note payable.

Test Bank, Chapter 17

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Topic: Describe the difference in accounting for a sale-leaseback versus a failed sale LO: 9 30. On December 31, 2020, Tulane, Inc., sold equipment to Noelle and simultaneously leased it back for 9 years. Pertinent information at this date is as follows: Sales price Cost of equipment Accumulated depreciation on equipment Estimated remaining economic life

$480,000 $400,000 $40,000 15 years

At December 31, 2020, how much should Tulane report as a gain from the sale of the equipment? A) $0 B) $110,000 C) $112,000 D) $120,000 Answer: D Rationale: If a seller-lessee classifies a leaseback as an operating lease, a sale has occurred, any gain or loss would be recognized, and the transaction is appropriately recorded as an operating lease. Based on the information above, the lease is classified as an operating lease because the lease term is not a major part of the asset’s useful life (9/15 = 60%). Thus, the gain of $120,000 ($480,000 – ($400,000 - $40,000)) would be recognized.

Intermediate Accounting, 3rd Edition

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Chapter 18 Income Taxes Learning Objectives – Coverage by question Multiple Choice LO 18-1 – Describe taxable temporary differences that lead to deferred tax liabilities and related income tax expense

1-4

LO 18-2 – Describe deductible temporary differences that lead to deferred tax assets and related income tax expense

5-8

LO 18-3 – Explain how to record and report a valuation allowance for deferred tax assets

9-11

LO 18-4 – Describe permanent differences and other items that impact the reported effective tax rate

12-14

LO 18-5 – Explain how a change in tax rates impacts deferred taxes

15-17

LO 18-6 – Describe accounting for net operating loss carryforwards and loss carryback/carryforwards

18-21

LO 18-7 – Explain and demonstrate accounting for uncertainty in income tax decisions

22-25

LO 18-8 – Describe financial statement disclosure for deferred taxes and income tax expense

26-27

LO 18-9 – Appendix 18A – Apply intraperiod tax allocation

LO 18-10 – Appendix 18B – Apply tax effects to changes in accounting principle and error corrections

29-30

Test Bank, Chapter 18

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Chapter 18: Income Taxes Multiple Choice Topic: Describe taxable temporary differences that lead to deferred tax liabilities and related income tax expense LO: 1 1. A future taxable amount results when: A) The GAAP basis of an asset is greater than its tax basis. B) The GAAP basis of an asset is less than its tax basis. C) The GAAP basis of a liability is greater than its tax basis. D) The GAAP basis of a liability is less than its tax basis. E) A and C F) A and D G) B and C Answer: F Rationale: A future taxable amount which results in a deferred tax liability results when the GAAP basis of an asset is greater than its tax basis or when the GAAP basis of a liability is less than its GAAP basis.

Topic: Describe taxable temporary differences that lead to deferred tax liabilities and related income tax expense LO: 1 2. The following schedule reconciles Zorro Co.’s pretax GAAP income to its taxable income for the current year: Pretax GAAP income Interest revenue on municipal bonds GAAP installment sales in excess of taxable amounts GAAP warranty expense in excess of deductible amounts Taxable income

$90,000 (1,200) (30,000) 3,000 $61,800

Assuming a tax rate of 25%, what would the company calculate as a deferred tax liability (ignoring any deferred tax assets or permanent differences)? A) $7,500 B) $6,750 C) $7,800 D) $ 750 Answer: A Rationale: The deferred tax liability is equal to the future taxable amount of $30,000 multiplied by the tax rate of 25% which equals $7,500.

Intermediate Accounting, 3rd Edition

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Topic: Describe taxable temporary differences that lead to deferred tax liabilities and related income tax expense LO: 1 3. Which of the following items would not result in a deferred tax liability for financial reporting purposes? A) Installment sales, accrued for GAAP purposes, but taxable when payments are collected. B) Rental receipts received in advance of services provided are deferred for GAAP purposes, but are taxable as collected for tax purposes. C) Six-month prepaid insurance amount, recognized as prepaid expense for GAAP purposes, but deductible when paid for tax purposes. D) Depreciation of equipment in its first year of purchase, calculated under the straight-line method for GAAP purposes, but under MACRS for tax purposes. Answer: B Rationale: Rental receipts received in advance of services provided create a future deductible amount which results in a deferred tax asset.

Topic: Describe taxable temporary differences that lead to deferred tax liabilities and related income tax expense LO: 1 4. On January 1, Year 1, Santana Corp. purchased equipment for $75,000 with a five-year useful life. Santana depreciates the equipment for reporting purposes using the straight-line method. Pretax GAAP income for Year 1 is $148,000. For tax purposes, the company depreciates 100% of the equipment balance in Year 1. The company’s tax rate is 25%. What is income tax expense for Year 1 and what is the balance of the deferred tax liability on December 31 of Year 1?

A) B) C) D) E)

Income tax expense $67,000 $ 7,000 $37,000 $82,000 $37,000

Deferred tax liability $15,000 $ 0 $15,000 $60,000 $52,000

Answer: C Rationale: The deferred tax liability balance is equal to $15,000 calculated as $60,000 ($75,000 $75,000/5) multiplied by the 25% tax rate. Income tax expense is equal to $22,000 (($148,000 $60,000) x 0.25) plus $15,000 which equals $37,000.

Test Bank, Chapter 18

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Topic: Describe deductible temporary differences that lead to deferred tax assets and related income tax expense LO: 2 5. Which of the following items would not result in a deferred tax asset for financial reporting purposes? A) Six-month payment for a prepaid internet plan, recognized as a prepaid expense for GAAP purposes, but deductible when paid for tax purposes. B) Advances from customers received for services to be performed in the future are deferred for GAAP, but are taxable when collected. C) Bad debts are estimated and expensed at the time of sale for GAAP purposes, but are deducted when the account is formally written off for tax purposes. D) Costs related to a potential product recall are accrued for GAAP purposes, but are not deductible for tax purposes unless costs are actually incurred and paid. Answer: A Rationale: The prepaid expense creates a future taxable amount which results in a deferred tax liability.

Topic: Describe deductible temporary differences that lead to deferred tax assets and related income tax expense LO: 2 6. The following schedule reconciles Celebrity Co.’s pretax GAAP income to its taxable income for the current year: Pretax GAAP income Nondeductible expense for fines Tax deductible depreciation in excess of GAAP depreciation expense Taxable rental receipts in excess of GAAP rental revenue

$104,000 3,100 (18,000) 13,000

Taxable income

$102,100

Assuming a tax rate of 25%, what would the company calculate as a deferred tax asset (ignoring any deferred tax liabilities or permanent differences)? A) $ 0B) $4,025 C) $4,500 D) $3,250 Answer: D Rationale: The deferred tax asset is equal to the future deductible amount of $13,000 multiplied by the tax rate of 25% which equals $3,250.

Intermediate Accounting, 3rd Edition

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Topic: Describe deductible temporary differences that lead to deferred tax assets and related income tax expense LO: 2 7. Naperville Inc. had current tax expense of $44,000 for the year ended December 31. The ending deferred tax asset balance was $36,000, which was an $8,000 decrease from January 1. The tax rate is 25%. What was total income tax expense for the current year? A) $52,000 B) $44,000 C) $36,000 D) $46,000 Answer: A Rationale: Income tax expense is equal to current tax expense of $44,000 plus the decrease to the deferred tax asset of $8,000 which equals $52,000.

Topic: Describe deductible temporary differences that lead to deferred tax assets and related income tax expense LO: 2 8. Nutritarian Corp. had pretax GAAP income of $192,000 in the current year. The January 1 balance in the Deferred Tax Asset account was $12,000. At the end of the year, the GAAP basis of deferred rent revenue is $60,200 more than the tax basis of deferred rent revenue. The company’s tax rate is 25%. What is total income tax expense for the current year? A) $66,100 B) $60,000 C) $44,950 D) $48,000 Answer: B Rationale: Income tax expense is shown in the following entry: Income Tax Expense ($63,050 - $3,050) Deferred Tax Asset (($60,200 x 25%) - $12,000) Income Tax Payable (($192,000 + $60,200) x 25%)

60,000 3,050 63,050

Topic: Explain how to record and report a valuation allowance for deferred tax assets LO: 3 9. A valuation allowance for deferred tax assets A) Is required when future deductible amounts are expected to be applied against future taxable income. B) Requires evidence that it is more likely than not that none of the deferred tax asset will be realized. C) Is a contra asset account shown on the tax return. D) Is likely to be recognized if a company expects losses in early future years. Answer: D Rationale: Per ASC 740-10-30-21, negative evidence that supports a valuation allowance is future losses expected in early years. Answer A is incorrect because the opposite is true: realization of a deferred tax asset is supported by the deductibility of amounts in the future. Answer B is incorrect because an allowance is necessary if even part of an asset is more likely than not to be realized. Answer C is incorrect because an allowance account is reported on the balance sheet.

Test Bank, Chapter 18

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Topic: Explain how to record and report a valuation allowance for deferred tax assets LO: 3 10. K. Wood, Inc. had the following balances:

Deferred tax asset, Dec. 31, 2020 Valuation allowance for deferred tax asset, unadjusted

Dec. 31, 2020 $80,000 Dr. 10,000 Cr.

Management reviewed all available positive and negative evidence to estimate that it was more likely than not that 45% of the deferred tax asset would not be realized. The entry to adjust the valuation allowance to the desired ending balance would include: A) A debit to Income Tax Expense for $36,000 B) A debit to Valuation Allowance for Deferred Tax Asset for $36,000 C) A credit to Deferred Tax Asset for $26,000 D) A credit to Valuation Allowance for Deferred Tax Asset for $26,000 Answer: D Rationale: The valuation allowance needs to have an ending balance of $36,000 ($80,000 x 45%). Thus, with an unadjusted credit balance of $10,000, the entry would include a credit to the valuation allowance for deferred tax asset.

Topic: Explain how to record and report a valuation allowance for deferred tax assets LO: 3 11. K. Wood, Inc. had the following balances:

Deferred tax asset, Dec. 31, 2020 Valuation allowance for deferred tax asset, unadjusted

Dec. 31, 2020 $60,000 Dr. 5,000 Dr.

Management reviewed all available positive and negative evidence to estimate that it was more likely than not that 90% of the deferred tax asset would not be realized. The entry to adjust the valuation allowance to the desired ending balance would include: A) A debit to Income Tax Expense for $59,000 B) A debit to Valuation Allowance for Deferred Tax Asset for $59,000 C) A credit to Deferred Tax Asset for $49,000 D) A credit to Valuation Allowance for Deferred Tax Asset for $49,000 Answer: A Rationale: The valuation allowance needs to have an ending balance of $54,000 ($60,000 x 90%). Thus, with an unadjusted debit balance of $5,000, the entry would include a debit to income tax expense and a credit to the valuation allowance for $59,000 ($54,000 + $5,000).

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Topic: Describe permanent differences and other items that impact the reported effective tax rate LO: 4 12. The following schedule reconciles Zorro Co.’s pretax GAAP income to its taxable income for the current year: Pretax GAAP income Interest revenue on municipal bonds Installment sales in excess of taxable amounts Warranty expense in excess of deductible amounts Taxable income

$90,000 (1,200) (30,000) 3,000 $61,800

Assuming a tax rate of 25%, what would the company report as income tax expense in the current year? A) $ 8,700 B) $22,500 C) $23,700 D) $22,200 E) $15,450 Answer: D Rationale: Income tax expense is $22,200 as shown in the following entry: Income Tax Expense Deferred Tax Asset ($3,000 x .25) Deferred Tax Liability ($30,000 x .25) Income Tax Payable ($61,800 x .25)

22,200 750 7,500 15,450

Topic: Describe permanent differences and other items that impact the reported effective tax rate LO: 4 13. The following schedule reconciles Celebrity Co.’s pretax GAAP income to its taxable income for the current year: Pretax GAAP income Nondeductible expense for fines Tax deductible depreciation in excess of GAAP depreciation expense Taxable rental receipts in excess of GAAP rental revenue Taxable income

$104,000 3,100 (18,000) 13,000 $102,100

Assuming a tax rate of 25%, what would the company report as income tax expense in the current year? A) $25,525 B) $26,775 C) $24,275 D) $26,000 Answer: B Rationale: Income tax expense is $26,775 as shown in the following entry: Income Tax Expense Deferred Tax Asset ($13,000 x .25) Deferred Tax Liability ($18,000 x .25) Income Tax Payable ($102,100 x .25)

26,775 3,250 4,500 25,525

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Topic: Describe permanent differences and other items that impact the reported effective tax rate LO: 4 14. Which of the following statements regarding permanent differences is not true. A) A permanent difference never reverses. B) Considering only permanent differences, income tax expense on the income statement would equal income taxes on the tax return. C) Corporate bond interest revenue is an example of a permanent difference. D) The effective tax rate often differs from the statutory tax rate due to permanent differences. Answer: C Rationale: Only interest revenue on municipal bonds is generally not taxable.

Topic: Explain how a change in tax rates impacts deferred taxes LO: 5 15. Due to a decrease in the enacted tax rate effective for the following year, a company with a net deferred tax asset balance will recognize A) A decrease in income tax expense in the current year. B) An increase in income tax expense in the current year. C) No change to income tax expense in the current year. D) A decrease in income tax expense in the following year. E) An increase in income tax expense in the following year. Answer: B Rationale: Per ASC 740-10-25-47, a change in a tax rate is recognized at the date of the enactment. This means that even if the change takes place the following year, the effect would be reflected in the current year. Also, when a tax rate is reduced, the value of the deferred tax asset is also reduced causing an increase to income tax expense.

Topic: Explain how a change in tax rates impacts deferred taxes LO: 5 16. On January 1, Year 1, Santana Corp. purchased equipment for $75,000 with a five-year useful life. Santana depreciates the equipment for reporting purposes using the straight-line method. Taxable income for Year 1 is $148,000. For tax purposes, the company depreciates 100% of the equipment balance in Year 1. The company’s current tax rate is 25%. However, in Year 1, the enacted tax rate increased to 35% beginning in Year 3 and beyond. What is income tax expense for Year 1 and what is the balance of the deferred tax liability on December 31 of Year 1?

A) B) C) D)

Income tax expense $63,250 $60,250 $58,000 $56,500

Deferred tax liability $26,250 $23,250 $21,000 $19,500

Answer: D Rationale: The deferred tax liability balance is equal to $19,500 calculated as ($15,000 x 25%) + ($15,000 x 35%) + ($15,000 x 35%) + ($15,000 x 35%). Income tax expense is equal to $37,000 (($148,000 x .25) plus $19,500 which equals $56,500.

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Topic: Explain how a change in tax rates impacts deferred taxes LO: 5 17. At the end of Year 1, Pueblo Inc. has one temporary difference of $125,000 due to a GAAP accrual for a warranty contingency with a tax basis of zero. Any resulting deferred tax amounts are based on a current tax rate of 35%. However, on December 30, Year 1, a new tax rate of 20% was enacted into law, effective for the following year and beyond. After taking into account the change in the enacted tax rate: A) Income tax expense will increase by $18,750 in Year 1. B) Income tax expense will increase by $18,750 on January 1, Year 2. C) Income tax expense will decrease by $18,750 in Year 1. D) Income tax expense will decrease by $18,750 on January 1, Year 2. Answer: A Rationale: The deductible temporary difference results in a deferred tax asset of $43,750 ($125,000 x 35%) that decreases to $25,000 ($125,000 x 20%) based upon the change in the enacted tax rate. This results in a net decrease of $18,750. The change takes place in the year that the tax rate was enacted which means that the increase in income tax expense (required to decrease the deferred tax asset) will take place in Year 1.

Topic: Describe accounting for net operating loss carryforwards LO: 6 18. After several years of recognizing profits, Eastern Inc. experiences a net operating loss in 2020 of $25,000. The company applied the net operating loss carryfoward method. In 2021, Eastern Inc. rebounds with earnings before taxes of $40,000. Eastern’s tax rate for all years is 25% and the company determines that no valuation allowance for any deferred tax assets is required. Assuming no deferred income taxes before 2020, what amount should Eastern Inc. recognize as income tax expense in 2021? A) $ 3,750 B) $10,000 C) $ 6,250 D) $ 6,000 Answer: B Rationale: Income tax expense of $10,000 is equal to the current income tax payable amount of $3,750 (($40,000 - $25,000) x 25%) plus $6,250 due to the reversal of the deferred tax asset calculated as $25,000 x 25%. Note that the 80% limit does not affect the reversal of the asset because 80% of the profit of $40,000 equal to $32,000 exceeds the reversal of a $25,000 loss. In other words, a maximum of 80% of profits in 2021 can be reversed which is equal to $32,000.

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Use the following information to answer Questions 19 and 20. After several years of recognizing profits, Eastern Inc. experiences a net operating loss in 2020 of $25,000. The company applied the net operating loss carryfoward method. In 2021, Eastern Inc. rebounds with earnings before taxes of $10,000. Eastern’s tax rate for all years is 25% and the company determines that no valuation allowance for any deferred tax assets is required. Assume no deferred income taxes before 2020.

Topic: Describe accounting for net operating loss carryforwards LO: 6 19. What amount should Eastern Inc. recognize as the increase in income tax payable in 2021? A) $6,250 B) $-0C) $2,500 D) $ 500 Answer: D Rationale: The increase in income tax payable is equal to 20% x $10,000 profit x 25% tax rate. Note that a maximum of 80% of the 2021 profit may be reversed which is equal to $8,000. Thus, the company owes taxes on the difference or $10,000 x 20% in 2021.

Topic: Describe accounting for net operating loss carryforwards LO: 6 20. What amount should Eastern Inc. recognize as its net deferred tax asset balance at the end of 2021 if the company determines it is more likely than not that 60% of the deferred tax asset will not be realized? A) $2,550 B) $1,500 C) $2,500 D) $1,700 Answer: D Rationale: The original deferred tax asset of $6,250 ($25,000 x .25) was reduced by $2,000 in 2021 due to the reversal ($10,000 x 80% x 25%) for a balance of $4,250. This balance is reduced by the allowance of 60% for a net deferred tax asset balance of $1,700 (equal to $4,250 x 40%).

Topic: Describe accounting for net operating loss carryforwards LO: 6 21. If a company has a net operating loss in the current period and follows the net operating loss carryforward method, A) 80% of the loss can be carried forward to offset future taxable income indefinitely. B) The loss may offset a maximum of 80% of taxable income in each future year, indefinitely. C) 80% of any resulting deferred tax asset may be used to offset any future year with taxable income. D) The loss may be carried back one year only while the rest may be carried forward to offset a maximum of 80% of taxable income in each future year, indefinitely. Answer: B Rationale: Per current federal tax laws a company may carry federal income tax losses forward indefinitely. However, net operating loss carryforwards can only offset a maximum of 80% of taxable income in each of the future years. Thus, answers A, C, and D are incorrect.

Intermediate Accounting, 3rd Edition

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Topic: Explain and demonstrate accounting for uncertainty in income tax decisions LO: 7 22. The accounting treatment of uncertain tax positions is determined through the application of a two-step process. Which of the following statements is not true regarding this process? A) To meet the recognition threshold, it must be more likely than not that the taxpayer will maintain its tax position in a dispute with taxing authorities. B) A tax benefit related to an uncertain tax position is measured as the largest amount of tax benefit that is greater than 50% likely of being realized. C) A tax benefit related to an uncertain tax position will only be recognized if it is more likely than not to meet the recognition threshold. D) In determining whether the recognition threshold is met, the company must assume that audit by the taxing authority will take place. Answer: C Rationale: ASC 740-10-25-6 and 740-10-55-5 describes the two-step process in recognizing a tax benefit of holding an uncertain tax position. Answer C is not correct because a tax benefit is measured when the recognition threshold is met, not when it is more likely than not that the recognition threshold is met.

Topic: Explain and demonstrate accounting for uncertainty in income tax decisions LO: 7 23. Lasso Inc. considered the probability of its recent tax position taken related to the deductibility of certain expenses of $100,000. Lasso Inc. is less than 50% certain that its tax position supporting the deductibility of the $100,000 will hold if the company is audited by the taxing authorities. Lasso Inc. paid taxes based upon its tax position taken. Lasso’s income tax payable is $280,000, after considering the $100,000 deductible amount. Lasso’s tax rate is 25%. When recording the entry to recognize income tax expense, liabilities will increase by: A) $305,000 B) $280,000 C) $286,250 D) $355,000 Answer: A Rationale: Because Lasso Inc. is less than 50% certain that its tax position will be maintained, the company has not reached the recognition threshold, thus none of the benefit may be recognized. Thus, liabilities will increase by $280,000 plus $25,000 ($100,000 x 25%) which equals $305,000.

Test Bank, Chapter 18

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Topic: Explain and demonstrate accounting for uncertainty in income tax decisions LO: 7 24. Lasso Inc. considered the probability of its recent tax position taken related to the deductibility of certain expenses of $100,000. Lasso Inc. is more than 50% certain that its tax position supporting the deductibility of the $100,000 will hold if the company is audited by the taxing authorities. However, based upon the information available, the company believes that it will have to settle with the taxing authorities for less than 100% of the $100,000 of tax deductions taken. Using available information, Lasso Inc. created the following summary of the amounts and probabilities of estimated outcomes if Lasso Inc. settled with taxing authorities: Amount of Allowable Tax Deductions $100,000 75,000 50,000 25,000

Individual Probability of Occurring 25% 30% 20% 25%

Lasso Inc. paid taxes based upon its tax position taken: Lasso’s income tax payable is $280,000, after considering the $100,000 deductible amount. Lasso’s tax rate is 25%. When recording the entry to recognize income tax expense, income tax expense will increase by A) $305,000 B) $280,000 C) $286,250 D) $298,750 Answer: C Rationale: Because Lasso Inc. is more than 50% certain that its tax position will be maintained, the company has reached the recognition threshold, thus we move to the measurement step. At a cumulative probability of 55% (> 50%), the company estimates that $75,000 in tax deductions will be allowed. Thus, liabilities will increase by $280,000 plus the tax effect of the amount assumed to be denied of $6,250 ($25,000 x 25%) which equals $286,250.

Topic: Explain and demonstrate accounting for uncertainty in income tax decisions LO: 7 25. O’Reilly Inc. considered the probability of its recent tax position taken related to the deductibility of certain expenses of $100,000. O’Reilly Inc. is more than 50% certain that its tax position supporting the deductibility of the $100,000 will hold if the company is audited by the taxing authorities. Based upon the information available, the company believes that it will have to settle with the taxing authorities for less than 100% of the $100,000 of tax deductions taken. As a result, O’Reilly Inc. recorded a liability of $10,000 in addition to income taxes payable of $280,000, which factored in $100,000 of deductions. O’Reilly Inc.’s tax rate is 25%. In the following year, O’Reilly Inc. was audited by the taxing authorities and based upon the settlement, O’Reilly recorded income tax expense of $7,500. What was the dollar amount of allowable deductions based upon the settlement? A) $60,000 B) $70,000 C) $30,000 D) $40,000 E) $90,000

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Answer: C Rationale: Income tax payable upon settlement would be equal to $17,500 ($10,000 liability reversal plus the additional expense of $7,500). Thus, the amount of denied deductions would be equal to $17,500 / 25% or $70,000. Therefore, $100,000 less $70,000 = $30,000 of allowable deductions.

Topic: Describe financial statement disclosure for deferred taxes and income tax expense LO: 8 26. Eclectic Inc. summarized the following balances related to its December 31 year-end: Account Deferred tax asset Deferred tax liability Valuation allowance for deferred tax asset

December 31 $50,000 $42,000 $32,000

On the company’s balance sheet on December 31, the company would report A) Noncurrent deferred tax liability of $24,000. B) Noncurrent deferred tax liability of $42,000 and a noncurrent deferred tax asset of $18,000. C) Noncurrent deferred tax asset of $50,000 and a noncurrent deferred tax liability of $82,000. D) Unknown because additional information is required to determine the current asset and liability amounts. Answer: A Rationale: The company would record a net deferred tax liability of $24,000 which is equal to $42,000 minus $18,000 ($50,000 - $32,000).

Topic: Describe financial statement disclosure for deferred taxes and income tax expense LO: 8 27. The following items create deferred tax assets and deferred tax liabilities at December 31. Assume no beginning balances in deferred tax accounts. 1. Excess tax depreciation over GAAP depreciation is $40,000. 2. Rental receipts collected in advance and considered taxable of $220,000 are accrued under GAAP. 3. Warranty expense amount of $25,000 is tax deductible when actual costs are incurred. 4. Nontaxable interest received on municipal bonds, $5,000. 5. Valuation allowance for deferred tax asset is estimated to be 30% of the deferred tax asset balance. 6. Taxable income for year is $100,000. 7. The tax rate is 25%. On the company’s balance sheet on December 31, the company would report the following deferred tax amount(s): A) Noncurrent deferred tax asset of $31,625. B) Noncurrent deferred tax asset of $26,625. C) Noncurrent deferred tax asset of $32,875. D) Noncurrent deferred tax asset of $131,500. Answer: C Rationale: Deferred tax asset balance is $42,875 or 70% of the deferred tax asset balance of $61,250 calculated as 25% of ($220,000 + $25,000). The deferred tax liability is $10,000 calculated as 25% of $40,000. Therefore, there is a net noncurrent deferred tax asset balance of $32,875 ($42,875 minus $10,000). © Cambridge Business Publishers, 2023 18-13

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Topic: Describe financial statement disclosure for deferred taxes and income tax expense LO: 9 28. Intraperiod tax allocation is not required for the following financial statement line item: A) Other comprehensive income B) Income (loss) from continuing operations C) Income (loss) from discontinued operations D) Comprehensive income Answer: D Rationale: Intraperiod tax allocation is the allocation of tax expense to different income statement segments. Income tax is allocated separately to the net income components of continuing and discontinued operations and to other comprehensive income—not in totality to comprehensive income.

Topic: Apply tax effects to changes in accounting principle and error corrections LO: 10 29. The effect of a change in accounting principle, specifically a change from the weighted-average inventory method to the FIFO inventory method, will be reported: A) Cumulatively, net of tax, as an adjustment to beginning retained earnings of the earliest reporting year presented. B) Cumulatively, as an adjustment to beginning retained earnings of the earliest reporting year presented. C) Net of tax, as an adjustment to retained earnings in each reporting year presented. D) Net of tax, as an adjustment to net income in each reporting year presented. Answer: A Rationale: A change in accounting principle is reflected retrospectively which means that all periods will reflect the application of the new accounting principle while the cumulative effect of the change in prior periods (net of tax) will be reported as an adjustment to beginning retained earnings of the earliest reporting year presented.

Topic: Apply tax effects to changes in accounting principle and error corrections LO: 10 30. During 2021, Daisy Company discovers that amortization expense of a patent for 2019 and 2020 was erroneously unrecorded for each year by $12,000 for both accounting and income tax purposes. The company's tax rate is 25%. The company records an entry dated January 1, 2021, to correct the error resulting in: A) A net decrease to assets of $24,000, a net decrease to liabilities of $6,000, and a net decrease to stockholders’ equity of $18,000. B) A net decrease to assets of $18,000 and a net decrease to stockholders’ equity of $18,000. C) A net decrease to assets of $24,000 and a net decrease to stockholders’ equity of $24,000. D) A net increase to assets of $18,000 and a net increase to stockholders’ equity of $18,000. Answer: B Rationale: The entry would include a debit to Retained Earnings for $18,000 ($24,000 x 70%); a debit to Income Tax Receivable for $6,000 ($24,000 x 30%); and a credit to Patent for $24,000 ($12,000 + $12,000). Thus, assets decrease by $18,000 ($24,000 minus $6,000) and stockholders’ equity decreases by $18,000.

Intermediate Accounting, 3rd Edition

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Chapter 19 Pensions and Postretirement Benefits Learning Objectives – Coverage by question Multiple Choice LO 19-1 – Describe defined benefit plans and the measurement of related pension obligations

1-4

LO 19-2 – Determine the five components of change in projected benefit obligation

5-7

LO 19-3 – Reconcile pension plan assets and determine funded status

8-10

LO 19-4 – Determine the five components of pension expense

11-15

LO 19-5 – Record prior service cost amendment, pension expense, gains and losses, funding, and benefits paid

16-20

LO 19-6 – Describe the reporting of pensions in financial statements

21-22

LO 19-7 – Use a pension worksheet to record pension journal entries

23-24

LO 19-8 – Appendix 19A – Explain postretirement benefit plans and differences from pension plans

25-26

LO 19-9 – Appendix 19B – Record postretirement benefit expense, gains and losses, funding, and benefits paid

27-28

LO 19-10 – Appendix 19C – Allocate prior service cost using the service method

29-30

Test Bank, Chapter 19

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Chapter 19: Pensions and Postretirement Benefits Multiple Choice Topic: Describe defined contribution plans and defined benefit plans and the measurement of related pension obligations LO: 1 1. Defined contribution plans and defined benefit plans are two common types of pension plans. Choose the correct statement regarding these plans. A) The required annual contribution to the plan is determined by formula or contract in a defined contribution plan. B) Both plans provide the same amount of retirement benefits. C) The retirement benefit is usually determinable well before retirement in a defined contribution plan. D) In both types of plans, pension expense is generally the amount funded during the year. Answer: A Rationale: Answer A is correct: the contribution to a defined benefit plan is contractual. Answer B and Answer C are incorrect: benefits are contractual under the defined benefit plan and benefits are not under the defined contribution plan. Answer D is incorrect: pension expense for defined benefit plans is affected by many factors including service cost, interest cost, and expected return on plan assets.

Use the following information to answer Questions 2 and 3. Astrid Inc. sponsors a defined benefit plan where employees vest 25% after 2 years, 50% after 4 years, and 100% after 8 years. One of Astrid 's employees currently has a salary of $50,000, has just met the 50% threshold on December 31, 2020, and is expected to retire in 15 years with a salary at that time of $80,000. The annual benefit formula is equal to 3% x Number of years of service x Final salary.

Topic: Describe defined benefit plans and the measurement of related pension obligations LO: 1 2. What is the present value at the employee’s projected retirement date, assuming a 10-year retirement and a discount rate of 6%, under a (1) VBO, (2) ABO, and (3) PBO pension liability measurement?

A) B) C) D)

VBO $35,328 $39,542 $27,600 $22,080

ABO $70,657 $79,085 $55,201 $44,161

PBO $ 88,321 $126,536 $ 88,321 $ 70,657

Answer: D Rationale: Answer D is correct, calculated as follows: VBO: ABO: PBO:

3% x 4 years x $50,000 x 50% = $3,000; PV(0.06,10,-3000) = $22,080 3% x 4 years x $50,000 = $6,000; PV(0.06,10,-6000) = $44,161 3% x 4 years x $80,000 = $9,600; PV(0.06,10,-9600) = $70,657

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Topic: Describe defined benefit plans and the measurement of related pension obligations LO: 1 3. What is the present value on December 31, 2020, of an assumed 10-year retirement cash flow stream under a (1) VBO, (2) ABO, and (3) PBO pension liability measurement? Assume a discount rate of 6%.

A) B) C) D)

VBO $11,517 $9,213 $16,500 $14,741

ABO $23,033 $18,427 $32,999 $29,483

PBO $36,853 $29,483 $52,799 $36,853

Answer: B Rationale: Answer B is correct, calculated as follows, using amounts from the solution for Question 2: VBO: ABO: PBO:

=PV(0.06,15,0,-22080) = $9,213 =PV(0.06,15,0,-44161) = $18,427 =PV(0.06,15,0,-70657) = $29,483

Topic: Describe defined benefit plans and the measurement of related pension obligations LO: 1 4. Which statement best describes the projected benefit obligation measurement? A) Actuarial present value of the benefits attributed to employee service rendered to date, as measured by the benefit formula using current salary levels. B) Actuarial present value of the benefits attributed to employee service rendered to date, as measured by the benefit formula using estimated future salary levels. C) Actuarial present value of the benefits attributed to employee service rendered to date, as measured by the benefit formula using current salary levels, limited to vested benefits. D) Actuarial present value of the benefits attributed to employee service rendered to date, as measured by the benefit formula using future salary levels, limited to vested benefits. Answer: B Rationale: Answer B is correct. PBO is equal to the actuarial present value of the benefits attributed to employee service rendered to date, as measured by the benefit formula using estimated future salary levels.

Test Bank, Chapter 19

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Topic: Determine the five components of change in projected benefit obligation LO: 2 5. Interest cost included in the change in projected benefit obligation recognized by an employer sponsoring a defined benefit pension plan represents: A) The amortization of the discount on unrecognized prior service cost. B) The increase in the fair value of plan assets due to the passage of time. C) The increase in the projected benefit obligation due to the passage of time. D) The shortage between the expected and actual returns on plan assets. Answer: C Rationale: Answer C is correct: per the ASC glossary, interest cost is the amount recognized in a period determined as the increase in the projected benefit obligation due to the passage of time.

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Topic: Determine the five components of change in projected benefit obligation LO: 2 6. Welldone Inc. sponsors a defined benefit plan covering all employees. Benefits are based on years of service and compensation levels at the time of retirement. Welldone Inc. determined that as of December 31, 2020, its plan assets had a $390,000 fair value and the projected benefit obligation had a balance of $380,120. If the company identified service cost of $38,000, interest cost of $16,520, benefit payments of $4,800, and made contributions to the plan for $28,000 in 2020, what was the January 1, 2020, balance of the PBO? A) $320,800 B) $292,800 C) $380,120 D) $330,400 Answer: D Rationale: Answer D is correct, calculated as $380,120 + 4,800 – $16,520 – $38,000 = $330,400

Topic: Determine the five components of change in projected benefit obligation LO: 2 7. The following information pertains to a defined benefit pension plan that Borealis Inc. sponsors in 2020. PBO balance, January 1, 2020 Service cost Interest cost Prior service cost adjustment based on past service, January 1, 2020 Amortization of prior service cost Actuarial gain on PBO Benefits paid to retirees Contributions to plan

$160,000 19,000 11,200 30,000 3,000 6,000 2,500 18,000

What is the PBO balance on December 31, 2020? A) $228,700 B) $216,700 C) $211,700 D) $193,700 Answer: C Rationale: Answer C is the correct answer, calculated as follows: $160,000 + $19,000 + $11,200 + $30,000 – $6,000 – $2,500 = $211,700.

Test Bank, Chapter 19

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Topic: Reconcile pension plan assets and determine funded status LO: 3 8. The following information pertains to Austin’s defined pension plan. Plan assets, December 31, 2020 Plan assets, January 1, 2020 Pension expense, 2020 Employer plan contributions, 2020 Benefits paid to retirees, 2020

$466,000 400,000 68,000 64,000 14,000

If the expected return on plan assets was $15,000, what was the unexpected gain or loss (if any) on plan assets for the year? A) $-0B) $1,000 unexpected gain C) $1,000 unexpected loss D) $3,000 unexpected loss E) $3,000 unexpected gain Answer: B Rationale: The actual return on plan assets is equal to: $16,000 ($466,000 + $14,000 - $64,000 – $400,000). With an expected return of $15,000, there would be an unexpected gain on plan assets of $1,000 ($16,000 – $15,000).

Topic: Reconcile pension plan assets and determine funded status LO: 3 9. The following information pertains to Evergreen Inc.’s defined benefit plan. Description Projected benefit obligation Plan assets at fair value Accumulated OCI—Pension Gain/Loss Accumulated OCI—Prior Service Cost Accumulated benefit obligation

Dec. 31 Balance $145,000 Cr. 132,000 Dr. 18,000 Dr. 88,000 Cr. 128,000 Cr.

On Evergreen Inc’s December 31 balance sheet, what amounts would the company report for assets, liabilities and stockholders’ equity? Assets A) $0 B) $132,000 C) $0 D) $132,000 E) $132,000

Liabilities $13,000 $145,000 $13,000 $145,000 $128,000

Stockholders’ Equity $70,000 $70,000 $0 $0 $70,000

Answer: A Rationale: The unfunded balance for this plan of $13,000 ($145,000 – $132,000) would be recognized as a liability on the balance sheet while the balance in the accumulated OCI accounts of $70,000 ($88,000 – $18,000) would be recognized as a component of stockholders’ equity.

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Topic: Reconcile pension plan assets and determine funded status LO: 3 10. Palace Inc. sponsors a defined benefit plan covering all employees. Palace has not made contributions to the plan for the current year. The following data relates to the plan for the current year. Projected benefit obligation, Dec. 31, estimated Accumulated benefit obligation, Dec. 31, estimated Plan assets at fair value, Dec. 31, estimated Pension expense, annual Employer’s contribution, annual

$187,500 130,000 168,850 22,500 ?

What amount should Palace contribute to the plan by Dec. 31 in order to report a Net Pension Asset/Liability of $3,750 Cr. on its December 31 balance sheet? A) $37,400 B) $22,400 C) $14,900 D) $18,650 Answer: C Rationale: Before taking into account contributions, the PBO of $187,500 exceeds plan assets of $168,850 by $18,650. Contributions to the plan decreases the company’s cash and increases plan assets. Thus, contributions of $14,900 are necessary to decrease the difference to $3,750 ($18,650 – $3,750).

Topic: Determine the five components of pension expense LO: 4 11. On January 1, 2020, Alpha Inc. reported a $10,000 debit balance in Accumulated OCI—Pension Gain/Loss related to its defined pension plan. The company had a PBO balance on January 1, 2020, of $75,000 and on December 31, 2020, of $100,000. The company had a plan asset balance on January 1, 2020, of $66,000 and on December 31, 2020, of $91,000. Alpha Inc. amortized unrecognized gains and losses using the corridor approach over the average remaining service life of employees (10 years). What amount (if any) of the pension gain/loss is amortized in 2020? A) $250 increase to pension expense B) $250 decrease to pension expense C) $340 increase to pension expense D) $340 decrease to pension expense E) $-0Answer: A Rationale: The corridor of $7,500 is equal to 10% of $75,000 (greater of beginning of year PBO or plan assets). The unrealized loss of $10,000 exceeds the corridor by $2,500. Thus, $250 is recognized as pension expense equal to $2,500 / service average service life of 10 years.

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Topic: Determine the five components of pension expense LO: 4 12. Choose the correct statement concerning the amortization of Accumulated OCI—Pension Gain/Loss assuming that the company follows the Corridor Approach: A) Some amortization must be recognized in a year that begins with a non-zero unrecognized gain or loss. B) The corridor is the maximum amortization allowed. C) The corridor amount for the current year is 10% of the greater of these two December 31, yearend values: PBO and plan assets at fair value. D) The amortization of an unrecognized gain yields a reduction in pension expense and a reduction in accumulated OCI. Answer: D Rationale: Answer A is incorrect because under the corridor approach, a gain may not meet the threshold for amortization. Answer B is incorrect because ASC 715-30-35-24 does not indicate a maximum amortization amount. Answer C is incorrect because the values that are relevant are beginning of year values (not end of year). Answer D is correct because the entry to amortize a gain is a debit to OCI-Pension Gain/Loss and credit to Pension Expense.

Topic: Determine the five components of pension expense LO: 4 13. Which of the following is not a component of pension expense? A) Service cost B) Amortization of pension gain/loss C) Contribution to plan for the period D) Amortization of prior service cost E) Growth (interest cost) in PBO since the beginning of the period Answer: C Rationale: Answer C is incorrect: contributions to the plan do not adjust pension expense.

Topic: Determine the five components of pension expense LO: 4 14. On July 31, 2020, Tassels Company amended its defined benefit pension plan by granting increased benefits for services provided prior to 2020. This prior service cost will be reflected in its December 31 year-end financial statement (s) for: A) Years before 2020 only B) 2020 only C) 2020 and years before and after 2020 D) 2020 and the following years only Answer: D Rationale: Answer D is correct: per ASC 715-30-35-11, prior service cost is amortized to each future period of service of employees expected to receive benefits under the plan.

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Topic: Determine the five components of pension expense LO: 4 15. The following information pertains to Dockside Corporation’s defined benefit pension plan for 2020. Assume no beginning balance in Accumulated OCI—Pension Gain/Loss. Service cost Actual and expected gain on plan assets Actuarial loss on PBO incurred during 2020 Amortization of unrecognized prior service cost Annual interest on pension obligation Employer contribution to plan

$80,000 15,000 18,000 4,000 25,000 40,000

What amount should Dockside report as pension expense in its 2020 income statement? A) $94,000 B) $112,000 C) $124,000 D) $142,000 Answer: A Rationale: Answer A is correct; pension expense is equal to $94,000 calculated as $80,000 – $15,000 + $4,000 + $25,000.

Topic: Record prior service cost amendment, pension expense, gains and losses, funding, and benefits paid LO: 5 16. In order to record a benefit payment of $40,000 to retirees under a defined benefit plan, the sponsoring company of the plan would: A) Debit Pension Expense for $40,000 and credit Plan Assets for $40,000 B) Debit Pension Expense for $40,000 and credit Cash for $40,000 C) Debit Projected Benefit Obligation for $40,000 and credit Plan Assets for $40,000 D) Debit Projected Benefit Obligation for $40,000 and credit Cash for $40,000 Answer: C Rationale: The benefit payment reduces the plan assets (not cash as cash decreases with plan contributions) and reduces the PBO.

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Topic: Record prior service cost amendment, pension expense, gains and losses, funding, and benefits paid LO: 5 17. A company that sponsors a defined benefit plan records an entry to debit OCI—Pension Gain/Loss for $5,000 and credit Plan Assets. The company uses the corridor approach to amortize Accumulated OCI—Pension Gain/Loss. This entry indicates that: A) The expected return on plan assets exceeded actual return on plan assets. B) The actual return on plan assets exceeded the expected return on plan assets. C) The beginning balance in Accumulated OCI—Pension Gain/Loss exceeded the corridor. D) The beginning balance in Accumulated OCI—Pension Gain/Loss did not exceed the corridor. E) A and C F) B and D Answer: A Rationale: The expected returned was greater than the actual return resulting in an unexpected loss on plan assets. (Thus Answer A is correct and Answer B is incorrect.) The loss is not included directly in expense. Instead, the loss is included in accumulated OCI. Answers C and D are incorrect because there is no indication that the loss was amortized because no entry with debit to pension expense was provided.

Topic: Record prior service cost amendment, pension expense, gains and losses, funding, and benefits paid LO: 5 18. Which of the following items do not result in a debit (increase) to pension expense? A) Interest cost B) Amortization of prior service cost C) Amortization of pension gain D) Service cost Answer: C Rationale: The amortization of a gain would decrease pension expense; thus answer C is the correct answer.

Topic: Record prior service cost amendment, pension expense, gains and losses, funding, and benefits paid LO: 5 19. Which of the following statements is incorrect regarding the recording of entries for a defined benefit plan? A) To record an employer contribution to a defined pension plan, debit Plan Assets and credit Cash. B) To record benefits paid to retirees, debit PBO and credit Plan Assets. C) To defer an actuarial loss on the PBO, debit OCI—Pension Gain/Loss and credit PBO. D) To record a prior service cost amendment, debit OCI—Prior Service Cost and credit PBO. E) To record interest cost on the PBO, debit Interest Expense and credit PBO. Answer: E Rationale: Interest cost on the PBO increases pension expense (debit); thus, Answer E is the incorrect entry. The remaining entries are accurate.

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Topic: Record prior service cost amendment, pension expense, gains and losses, funding, and benefits paid LO: 5 20. A company sponsoring a defined benefit plan grants credit for prior service. In accounting for this service credit, the company will: A) Initially increase the PBO for the full cost and subsequently decrease the PBO over the period of the benefit. B) Initially defer the cost in accumulated OCI and subsequently reverse the cost to expense over the period of benefit. C) Initially defer the cost in accumulated OCI and subsequently reverse the cost to expense over the period of benefit for any amount over the corridor. D) Initially increase the PBO for the full cost and subsequently decrease (debit) OCI—Pension Gain/Loss over the period of the benefit. Answer: B Rationale: Upon granting the credit, the company defers the full cost by debiting OCI—Pension Gain/Loss and crediting PBO. Then, over the period of benefit, the company will debit Pension Expense and credit OCI—Pension Gain/Loss. Thus, answer B is correct. Amortization is computed using the straight-line method or the service method.

Topic: Describe the reporting of pensions in financial statements LO: 6 21. Which of the following defined benefit pension plan disclosures should be made in a company's financial statements? 1. A reconciliation of beginning and ending balance of both the PBO and plan assets. 2. The amount of net periodic pension cost for the period. 3. The fair value of each class of plan assets. A) B) C) D)

1 and 2 1, 2, and 3 1 and 3 1 only.

Answer: B Rationale: Per ASC 715-20-50-1, all items 1 through 3 are required disclosures.

Topic: Describe the reporting of pensions in financial statements LO: 6 22. Pension expense is classified in a multiple-step income statement as follows: A) Pension expense is classified as operating expenses. B) Pension expense is classified as other expenses. C) The portion of pension expense related to service cost is included in operating expenses and the remainder is included in other expenses. D) The portion of pension expense related to service cost is included in other expenses and the remainder is included in operating expenses. Answer: C Rationale: Per ASC 715-20-45-3A, the components of pension expense other than service cost are included outside of income from operations. Thus, Answer C is correct.

Test Bank, Chapter 19

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Use the following information to answer Questions 23 and 24. Lighthouse Co. sponsored a defined benefit plan, which included January 1, 2020, balances of $15,000 and $14,800 in Plan Assets and Projected Benefit Obligation, respectively. During 2020, the company incurred $11,000 in service cost, made plan contributions of $3,310, and paid benefits to retirees for $1,900. The discount rate is 5% and the expected and actual rate of return on plan assets is 6%.

Topic: Use a pension worksheet to record pension journal entries LO: 7 23. Given the information provided for the defined benefit plan, what amounts are presented as the December 31, 2020, balances for plan assets and PBO from a completed pension worksheet?

A) B) C) D)

Plan Assets $17,160 $15,510 $17,310 $21,110

PBO $(24,788) $(24,640) $(24,640) $(28,440)

Answer: C Rationale: See worksheet below.

Pension Worksheet

Reported Net in Financial Statements

Balance Sheet Net Pension Asset/Liabilit y

Income Statemen t Cash Outflo w

Plan Assets

PBO

$15,000

$(14,800)

$200

Service cost

(11,000)

$11,000

Interest cost

(740)

740

900

(900)

Contributions to fund

3,310

Benefit payments

(1,900)

1,900

—

$17,310

$(24,640)

$ (7,330)

$10,840

Balance, January 1, 2020

Expected return

Balance, December 31, 2020

Pension Expense

$(3,310)

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Topic: Use a pension worksheet to record pension journal entries LO: 7 24. Given the information provided for the defined benefit plan, Net Pension Asset/Liability decreased by what amount as shown on a completed pension worksheet? A) $7,530 B) $7,330 C) $9,330 D) $7,828 E) $7,130 Answer: A Rationale: As shown in the pension worksheet below, Net Pension Asset/Liability decreased from an asset of $200 to a liability of $7,330, representing a $7,530 decrease ($200 + $7,330).

Pension Worksheet

Reported Net in Financial Statements

Balance Sheet Net Pension Asset/Liabilit y

Income Statemen t Cash Outflo w

Plan Assets

PBO

$15,000

$(14,800)

$200

Service cost

(11,000)

$11,000

Interest cost

(740)

740

900

(900)

Balance, January 1, 2020

Expected return

900

Contributions to fund

3,310

Benefit payments

(1,900)

1,900

—

$17,310

$(24,640)

$ (7,330)

$10,840

Balance, December 31, 2020

3,310

Pension Expense

$(3,310)

Topic: Explain postretirement benefit plans and differences from pension plans LO: 8 25. Which of the following statements correctly describes the relationship between expected postretirement benefit obligation (EPBO) and accumulated postretirement benefit obligation (APBO)? A) EPBO can be less than or equal to APBO but never more. B) EPBO and APBO are never equal. C) EPBO and APBO are always equal. D) APBO can be less than or equal to EPBO but never more. Answer: D Rationale: The EPBO is the present value of the expected postretirement benefits to be paid to retirees. The APBO is the present value of the expected benefits attributed to employee services rendered to date. It follows that the APBO is a portion of the EPBO, thus Answer D is correct: the APBO can be less than or equal to EPBO but never more.

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Topic: Explain postretirement benefit plans and differences from pension plans LO: 8 26. A postretirement plan promises health care coverage for all employees who retire after age 62 and complete service of 15 years. As of January 1, 2020, one 50-year old participant has rendered services for 8 years, and is expected to retire at age 65. The following amounts pertain to the participant’s benefits. Present value of postretirement benefit cash flow stream at the date of retirement

$30,000

Present value of postretirement cash flow stream on Jan. 1, 2020

$4,000

What is the value of the accumulated postretirement benefit obligation (APBO) on January 1, 2020? A) $2,133 B) $1,391 C) $1,600 D) $12,000 Answer: C Rationale: The APBO is equal to the expected postretirement benefit obligation (EPBO) of $4,000 multiplied by 8 years of service divided by 20 years in full attribution period to equal $1,600. The full attribution period of 20 years is equal to the prior years of service of 8 years plus 12 years until the participant reaches 62 years old (62 – 50).

Topic: Record postretirement benefit expense, gains and losses, funding, and benefits paid LO: 9 27. A company reports an underfunded accumulated postretirement benefit obligation in its report of funded status. This amount generally equals the A) Amount by which cumulative postretirement benefit expense exceeds cumulative funding since transition. B) Amount by which the present value of benefit payments expected to be made exceeds the plan assets at fair value. C) Net postretirement asset balance less amounts funded to date. D) Amount by which the present value of benefit payments earned to date exceeds the plan assets at fair value. Answer: D Rationale: If a plan is underfunded, than the APBO (present value of postretirement benefits) is greater than plan assets at fair value. Thus, Answer D is correct. Funding is not a factor, thus Answers A and C are incorrect. Answer B describes the EPBO not the APBO, thus is incorrect.

Topic: Record postretirement benefit expense, gains and losses, funding, and benefits paid LO: 9 28. Which of the following items will increase postretirement benefit expense? A) Amortization of prior service cost B) Contributions to benefit plan C) Expected return on plan assets D) Actual return on plan assets Answer: A Rationale: Pension expense is debited for the amortization of prior service cost (credited to OCI—Prior Service Cost). The other items will not impact postretirement benefit expense.

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Topic: Allocate prior service cost using the service method LO: 10 29. On January 1, 2020, Trend Inc. amended its defined benefit pension plan by retroactively granting benefits for services previously performed. The present value the benefits is measured at $50,000 on January 1, 2020. Three employees are impacted by the amendment.

Employee Employee 1 Employee 2 Employee 3

Remaining Years of Service 2 5 8

The amount of amortization of the prior service cost in 2020 calculated using the service method is: A) $6,250 B) $10,000 C) $3,333 D) $6,667 Answer: B Rationale: Total years of service is equal to 15 years (3 + 3 + 2 + 2 + 2 + 1 + 1 + 1). In 2020, amortization is equal to $10,000 or $50,000 x 3/15.

Topic: Allocate prior service cost using the service method LO: 10 30. Prior service cost is initially deferred and subsequently recognized over time. If prior service cost is amortized under the service method: A) An equal amount of prior service cost is allocated to each service year. B) More expense is allocated to each earlier year of service than each later year of service. C) More expense is allocated to each later year of service than each earlier year of service. D) An equal amount is amortized over the employees’ average service period. Answer: A Rationale: Under the service method, an equal amount of prior service cost is allocated to each service year; thus Answer A is correct and Answers B and C are incorrect. Answer D describes the straightline method.

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Chapter 20 Stockholders’ Equity Learning Objectives – Coverage by question Multiple Choice LO 20-1 – Describe and report key components of stockholders’ equity

1-4

LO 20-2 – Account for common stock issuance including par and nopar, cash and noncash, and issue costs

5-8

LO 20-3 – Account for reacquisition of common stock

9-12

LO 20-4 – Describe and account for preferred stock

13-16

LO 20-5 – Record dividend distributions, including cash, property, and liquidating

17-20

LO 20-6 – Account for stock dividends and stock splits

21-24

LO 20-7 – Describe comprehensive income, its components, and how it is reported

25-27

LO 20-8 – Explain stockholders’ equity disclosures and key ratios

28-30

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Chapter 20: Stockholders’ Equity Multiple Choice Topic: Describe and report stockholders’ equity key components LO: 1 1. An owner of common stock is typically entitled to a proportionate share in: A) Dividends in arrears of preferred stock. B) Purchase of new shares of common stock (limited to the number of current shares) if new shares are issued for sale. C) The vote in stockholder meetings. D) Assets upon liquidation prior to creditor claims. Answer: C Rationale: Ownership of common stock will typically entitle the holder to a proportionate share in voting, declared dividends, distribution of assets upon liquidation, and preemptive rights related to new share issuances. Thus Answer C is correct. Answer A is incorrect because common shareholders do not have a right to preferred dividends. Answer B is incorrect because a preemptive right allows holders to purchase enough shares to maintain their current ownership percentage. Answer D is incorrect because equity holders receive assets after creditors. Topic: Describe and report stockholders’ equity key components LO: 1 2. Which of the following statements is not true regarding one of the components of stockholders’ equity. A) Contributed capital includes capital stock and additional paid-in capital. B) Retained earnings includes an accumulation of a company’s net income (loss) from inception and a deduction for accumulated dividends. C) Treasury stock consists of either preferred or common stock that has been reacquired from shareholders but not formally retired or resold. D) Noncontrolling interest is equity owned by noncontrolling shareholders and is deducted to arrive at total stockholders’ equity. Answer: D Rationale: While noncontrolling interest does represent the amount of the company’s equity owned by outside investors in one of a company’s subsidiaries that are not part of the controlling stockholders’ interest, it is added to arrive at total stockholders’ equity.

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Topic: Describe and report stockholders’ equity key components LO: 1 3. Halas Co. reported the following stockholders’ equity section in its balance sheet dated December 31, 2020. Common stock, par $2, 50,000 shares authorized Paid-in capital in excess of par Retained earnings Treasury stock, 500 shares Total stockholder’s equity

8,000 52,000 220,000 (6,000) $424,000

Based on the information provided, what are the number of shares issued, unissued, and outstanding?

A) B) C) D)

Shares issued 4,000 8,000 4,000 8,000

Shares unissued 46,000 42,000 46,000 42,000

Shares outstanding 3,500 7,500 4,500 8,500

Answer: A Rationale: 4,000 shares are issued ($8,000/$2); 46,000 are unissued (50,000 – 4,000); 3,500 shares are outstanding (4,000 – 500). Thus, Answer A is correct. Topic: Describe and report stockholders’ equity key components LO: 1 4. Creighton Co. summarized select account balances on December 31, 2020, and activity for 2020 in the following table. Retained earnings, beginning balance Common stock, $1 par, 100,000 shares authorized, 50,000 shares issued Treasury stock, 1,000 shares Paid-in capital in excess of par Accumulated other comprehensive income Investment in stock Bonds payable Net income for 2020 (not included in retained earnings above) Dividends declared and paid during 2020 (not included in retained earnings above) Noncontrolling interests

$60,000 40,000 10,500 440,000 25,000 100,000 50,000 12,000 5,000 2,500

Based on the information provided, what is total stockholders’ equity on December 31, 2020? A) $559,000 B) $585,000 C) $564,000 D) $574,000 Answer: C Rationale: Total stockholders’ equity is equal to $564,000 calculated as $60,000 + $40,000 – $10,500 + $440,000 + $25,000 + $12,000 – $5,000 + $2,500.

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Topic: Account for par value common stock issuance including issue costs LO: 2 5. Julep Inc. issued 50,000 shares of common stock, $1 par, for cash of $18 per share on January 1, 2020. Julep Inc. also incurred $10,000 in stock issue costs, paid in cash. The entry to record the issuance would include: A) A credit to Paid-in Capital in Excess of Par—Common Stock for $850,000. B) A credit to Paid-in Capital in Excess of Par—Common Stock for $840,000. C) A debit to Stock Issuance Costs for $10,000. D) A debit to Stock Issuance Expense for $10,000. Answer: B Rationale: Stock issuance costs decrease cash and decrease paid-in capital. Thus, the entry is recorded as follows which supports Answer B as the correct Answer: Cash (($18 x 50,000) - $10,000) Common Stock ($1 x 50,000) Paid-in Capital in Excess of Par—Common Stock (($18 - $1) x 50,000) - $10,000)

890,000 50,000 840,000

Topic: Account for par value common stock issuance in a lump sum issuance LO: 2 6. On January 1, 2020, Burke Inc. issued in one combined offering, 5,000 shares of common stock, $1 par, and 1,000 shares of preferred stock, $15 par. The total combined selling price was $100,000. Separately however, the common stock is selling at $20 per share, and the preferred stock at $25 per share. Of the total cash received of $100,000, how much will be allocated to Paid-In Capital in Excess of Par— Common Stock and to Paid-in Capital in Excess of Par—Preferred Stock?

A) B) C) D)

Paid-in Capital—Common Stock $80,000 $75,000 $60,000 $90,000

Paid-in Capital—Preferred Stock $20,000 $ 5,000 $20,000 $10,000

Answer: B Rationale: The stock was sold in a lump sum issuance. The lump sum price is allocated to each stock through the proportional method. Common stock:

((5,000 x $20)/$125,000 x $100,000) – ($1 x 5,000) = $75,000

Preferred stock:

((1,000 x $25)/$125,000 x $100,000) – ($15 x 1,000) = $5,000

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Topic: Account for noncash common stock issuance LO: 2 7. On January 1, 2020, Philbin Corp. issued 4,500 of its 400,000, $1 par, common shares in exchange for land. Philbin’s common stock shares are frequently and widely traded on a public exchange. On January 1, the common shares were trading for $35 per share. However, a recent appraisal indicates that the land is valued at $155,000. Upon issuance of the common stock, Philbin would record a credit to Paid-in Capital in Excess of Par— Common Stock for: A) $155,000 B) $157,500 C) $153,000 D) $150,500 Answer: C Rationale: The fair value of the stock issued or the noncash consideration received, whichever is the most reliably determinable, is used to measure the transaction. Fair value of stock widely traded on an exchange is more reliable than a land appraisal (stock trades at market while an appraisal is based on one source). Thus, the land is valued at 4,500 shares x $35 per share which equals $157,500. The amount allocated to paid-in capital of $153,000 equals $157,500 minus the par value of common stock of $4,500.

Topic: Account for no-par common stock issued LO: 2 8. If a company issues no-par stock: A) The full proceeds from the sale of no-par stock is always considered total legal capital. B) The entry upon issuance of no-par stock will never include the account, Paid-in Capital in Excess of Par—Common Stock. C) If no-par stock is assigned a stated value by state law, the excess of the proceeds over stated value is equal to legal capital. D) A stated value assigned to no-par stock is accounted for in the same way as par value assigned to stock. Answer: D Rationale: No-par stock with a stated value is accounted for in the same way as par value stock. Thus, the stated value is considered legal capital just as par value would be. Thus, Answer D is correct and Answers A and C are incorrect. Answer B is incorrect because the Paid-in Capital account is used to account for the excess over stated value if a stated value is assigned to the no-par stock.

Topic: Account for reacquisition of common stock LO: 3 9. When accounting for treasury stock under the cost method, which of the following statements is inaccurate? A) Treasury stock is deducted in the stockholders’ equity section of the balance sheet. B) A cost flow assumption is applied when a company has multiple purchases of treasury stock. C) When treasury stock is sold for more than its acquisition cost, the difference is credited to either Retained Earnings or Paid-in Capital —Treasury Stock. D) When treasury stock is sold for less than its acquisition cost, the difference is credited to either Retained Earnings or Paid-in Capital —Treasury Stock. Answer: C Rationale: Per 505-30-30-10, if treasury stock is sold for more than its acquisition costs, the gain on sale of treasury stock not previously accounted for as constructively retired is credited to additional paid-in capital. Thus, Answer C is inaccurate because Retained Earnings would not be credited. © Cambridge Business Publishers, 2023 20-5

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Topic: Account for reacquisition of common stock LO: 3 10. On January 1, 2020, Twyla Corp. sold 10,000 shares of common stock, par $2, at $18 per share. September 30, 2020, Twyla Corp. acquired 500 shares of its common stock at $15 per share.

What amount is debited to Common Stock (a) under the treasury stock method and (b) under a direct stock retirement?

A) B) C) D)

Treasury Stock Method $1,000 $0 $0 $1,000

Direct Retirement $1,000 $1,000 $9,000 $0

Answer: B Rationale: When stock is reacquired under the treasury stock method, treasury stock (not common stock) is debited for the purchase price, in this case, $7,500 (500 x $15). Under a direct retirement, common stock is debited at par, and in this case, par is equal to $2 x 500 shares or $1,000. Thus, Answer B is correct.

Use the following information to answer Questions 11 and 12. On January 1, 2020, Meyer Inc. issued 10,000 shares of $1 par common stock for $10 per share. On June 30, 2020, Meyer Inc. reacquired 1,000 shares of common stock at $8 per share. On December 15, 2020, Meyer Inc. reissued 500 shares of common stock at $12 per share.

Topic: Account for reacquisition of common stock LO: 3 11. Assume that Meyer accounts for repurchases of its common stock under the treasury stock method. The entry on December 15, 2020, to account for the reissuance of stock would include: A) A debit to Paid-in Capital—Treasury Stock for $2,000. B) A credit to Paid-in Capital—Treasury Stock for $2,000. C) A credit to Paid-in Capital—Treasury Stock for $4,000. D) A credit to Retained Earnings for $2,000. Answer: B Rationale: When the treasury shares are reissued, the company would debit cash for $6,000 (500 x $12), credit Treasury Stock for $4,000 (500 x $8) and credit the difference to Paid-in Capital—Treasury Stock for $2,000. Thus Answer B is correct.

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Topic: Account for reacquisition of common stock LO: 3 12. Assume that Meyer accounts for repurchases of its common stock as direct stock retirements. The entry on June 30, 2020, to account for the direct stock retirement would include: A) A debit to Retained Earnings for $9,000. B) A credit to Paid-in Capital in Excess of Par—Common Stock for $2,000. C) A debit to Paid-in Capital in Excess of Par—Common Stock for $9,000. D) A credit to Retained Earnings for $2,000. Answer: C Rationale: The entry upon retirement of the 1,000 shares is as follows. Common Stock (1,000 x $1) Paid-in Capital in Excess of Par—Common Stock (1,000 x $9) Paid-in Capital—Retired Stock (to balance) Cash (1,000 x $8)

1,000 9,000 2,000 8,000

Thus, Answer C is correct.

Topic: Describe and account for preferred stock LO: 4 13. What characteristics of preferred stock require its classification as a liability on the balance sheet? A) Must include an unconditional obligation for the issuer to reacquire the shares at a specific date. B) Allows the stockholders to return the stock for payment at a specified price. C) Must include an unconditional obligation for the issuer to reacquire the shares at a specified or determinable date and at a specified price. D) Includes an unconditional obligation for the issuer to reacquire the shares at a specified or determinable date. Answer: D Rationale: Per ASC 480-10-25-4, mandatorily redeemable financial instruments are classified as a liability. Per the ASC glossary, a mandatorily redeemable financial instrument includes an unconditional obligation requiring the issuer to redeem the instrument by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur. Therefore, Answer D is correct. Answer A is incorrect, because the redemption date could be determinable, not specified. Answer B is incorrect as a redemption is not required in the description. Answer C is incorrect because a specified price is not required.

Test Bank, Chapter 20

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Topic: Describe and account for preferred stock LO: 4 14. On January 1, 2020, Castaway Corp. issued 5,000 shares of preferred stock ($15 par value) at $45 per share. Each share of preferred stock is convertible into 2 shares of common stock ($1 par value) at the option of the holder. On September 1, 2020, preferred shareholders holding 2,000 shares of preferred stock converted the stock to common shares when the common stock was trading at $20 per share. The entry recorded by Castaway Corp. on September 1, 2020, would include the following: A) A credit to Paid-in Capital in Excess of Par—Common Stock for $86,000. B) A credit to Paid-in Capital in Excess of Par—Common Stock for $60,000. C) A debit to Retained Earnings for $10,000. D) A debit to Loss on Conversion for $10,000. Answer: A Rationale: Upon conversion, Castaway Corp. would record the following entry: Preferred Stock (2,000 x $15) Paid-in Capital in Excess of Par—Preferred Stock (2,000 x $30) Common Stock (2,000 x 2 x $1) Paid-in Capital in Excess of Par—Common Stock (to balance)

30,000 60,000 4,000 86,000

Thus, Answer A is correct.

Use the following information to answer Questions 15 and 16. On January 1, 2020, Castaway Corp. issued 5,000 shares of preferred stock ($15 par value) at $45 per share. Each share of preferred stock is redeemable at the option of the stockholder at $45 per share. On September 1, 2020, preferred shareholders holding 1,000 shares of preferred stock redeemed their stock.

Topic: Describe and account for preferred stock LO: 4 15. The entry recorded by Castaway Corp. on January 1, 2020, would not include the following: A) Credit to preferred stock at par value. B) Credit to additional paid-in capital for the excess of the issuance price over the par value. C) Debit to cash for the issuance price. D) Credit to a liability for the redemption feature. Answer: D Rationale: Only preferred stock that his mandatorily redeemable would be classified as a liability. Because the stock is not mandatorily redeemable at a set or determinable date, the issuance is recorded as a straight equity issuance.

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Topic: Describe and account for preferred stock LO: 4 16. The entry recorded by Castaway Corp. on September 1, 2020, would include the following: A) No net change to stockholders’ equity. B) A decrease to retained earnings for $5,000. C) A decrease to assets for $45,000. D) No net change to preferred stock outstanding. Answer: C Rationale: Upon redemption, the company would debit preferred stock at par for $15,000 (1,000 x $15); debit paid-in capital for $30,000 (1,000 x $30); and credit cash for $45,000 (1,000 x $45). Thus Answer C is correct (cash is an asset and it decreases by $45,000). Answer A is incorrect because there is a decrease in equity for $45,000. Answer B is incorrect because there is no impact on retained earnings. Answer D is incorrect because the number of preferred stock shares outstanding decreases after redemption.

Topic: Record cash dividend distributions LO: 5 17. Cavern Corp. declared a $50,000 cash dividend on July 1, 2020, with the following related information: Ex-Dividend Date: Date of Record: Date of Payment:

July 14, 2020 July 15, 2020 July 31, 2020

For this transaction, would Cavern Corp.’s liabilities increase, decrease, or remain unchanged on each listed date?

A) B) C) D)

July 1 No change Increase Decrease No change

July 14 No change No change No change No change

July 15 Increase No change No change Decrease

July 31 Decrease Decrease Increase Increase

Answer: B Rationale: Liabilities would increase at the declaration date on July 1 when the dividends become an enforceable obligation (Dr. Retained Earnings and Cr. Dividends Payable) and decrease when the liabilities are paid (Dr. Dividends Payable and Cr. Cash). Thus, Answer B is correct.

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Topic: Record liquidating dividend distributions LO: 5 18. Madaket Corporation declared a common stock dividend of $80,000 on April 1, 2020, payable to shareholders on April 15, 2020. Madaket Corporation announced to shareholders that 80% of the dividend amount was a return of capital. Upon recording the required entry on April 1, 2020, Madaket Corporation would record: A) An increase in liabilities for $64,000. B) A decrease to retained earnings of $64,000. C) A decrease in assets of $80,000. D) A decrease in stockholders’ equity of $80,000. Answer: D Rationale: Upon declaration of the liquidating dividend, the company would record the following entry: Retained Earnings ($80,000 x 0.20) Paid-in Capital in Excess of Par—Common Stock ($80,000 x 0.80) Dividends Payable

16,000 64,000 80,000

Thus, Answer D is correct because equity decreases by $80,000.

Topic: Record property dividend distributions LO: 5 19. On January 31, 2020, Astrid Corp. purchased 5,000 shares of Smart Co. common stock for $15 a share. Astrid accounts for the investment at fair value with adjustments to fair value recorded in net income. On March 15, 2020, Astrid Corp. declared a property dividend of 3,000 shares of Sienna Co. common stock, to be distributed on March 31, 2020. The shares of Sienna Co. were selling at $18 per share on March 15, 2020. The investment has not been adjusted to fair value since its purchase date. On the date of declaration of the property dividend, the Astrid Corp. would: A) Recognize a liability account of $45,000. B) Recognize a decrease in assets of $45,000. C) Recognize an increase in net income of $9,000. D) Recognize a liability account of $9,000. Answer: C Rationale: Upon declaration of the property dividend on March 15, the company would first adjust the investment to fair value resulting in a gain on the income statement of $9,000 (3,000 x ($18 - $15)). Thus, Answer C is correct. The company would also decrease retained earnings for $54,000 (fair value of the investment) and increase property dividends payable for $54,000. Thus, Answers A and D are incorrect. Answer B is incorrect because the asset account is not decreased until the dividend is distributed on March 31.

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Topic: Record cash dividend distributions LO: 5 20. Norris Company has the following capital structure. • •

Preferred stock, 6%, $15 par, 20,000 shares issued and outstanding Common stock, $1 par, 100,000 shares issued and outstanding

If the preferred stock is cumulative and 3 years of dividends are in arrears, how much would the common shareholders receive under two different scenarios? Scenario One: Scenario Two:

A) B) C) D)

Scenario One $0 $12,000 $6,000 $0

The company declares $60,000 in dividends The company declares $100,000 in dividends Scenario Two $28,000 $28,000 $46,000 $46,000

Answer: A Rationale: Under Scenario One, the company would pay no dividends to common shareholders because the total dividend would be due to preferred shareholders. Amount owed to preferred shareholders = $72,000 calculated as 4 years of dividends (3 years in arrears plus the current year) x 6% x $15 x 20,000. Thus, the declared amount of $60,000 is less than $72,000 which means the entire amount of $60,000 would be paid to preferred shareholders and none to common shareholders. Under Scenario Two, after the preferred shareholders are paid $72,000, the common shareholders are paid the remainder: $28,000 (calculated as $100,000 - $72,000).

Topic: Account for stock dividends LO: 6 21. Norris Company has the following capital structure: Common stock, $1 par, 100,000 shares issued and outstanding. On October 1, 2020, the company declared a 5% common stock dividend when the market price of the common stock was $15 per share. The stock dividend will be distributed on October 15, 2020, to stockholders on record on October 10, 2020. Upon declaration of the stock dividend, Norris Company would record: A) A debit to Retained Earnings for $5,000 B) A credit to Dividends Payable for $70,000 C) A credit to Paid-in Capital in Excess of Par—Common Stock for $70,000 D) A credit to Retained Earnings for $75,000 Answer: C Rationale: Upon declaration of the stock dividend, the company would record the following: Retained Earnings (100,000 x 5% x $15) 75,000 Common Stock (100,000 x 5% x $1) Paid-in Capital in Excess of Par—Common Stock ($75,000 - $5,000)

5,000 70,000

Thus, Answer C is correct.

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Topic: Account for stock dividends LO: 6 22. Norris Company has the following capital structure: Common stock, $2 par, 200,000 shares issued and outstanding On October 1, 2020, the company declared a 50% common stock dividend when the market price of the common stock was $10 per share. The stock dividend will be distributed on October 15, 2020, to stockholders on record on October 10, 2020. Upon declaration of the stock dividend, Norris Company would record: A) A debit to Retained Earnings for $200,000 B) A credit to Dividends Payable for $200,000 C) A credit to Paid-in Capital in Excess of Par—Common Stock for $800,000 D) A credit to Retained Earnings for $1,000,000 Answer: A Rationale: Upon declaration of the stock dividend, the company would record the following: Retained Earnings (200,000 x 50% x $2) Common Stock Dividends Distributable (200,000 x 50% x $2)

200,000 200,000

Thus, Answer A is correct.

Topic: Account for stock dividends and stock splits LO: 6 23. A company is considering the effect on its financial statements for the distribution of stock dividends and stock splits. Which of the following statements is inaccurate? A) The declaration of a 5% stock dividend will result in an increase to paid-in capital and a decrease to retained earnings B) The declaration of a 50% stock dividend will result in an increase to capital stock and a decrease to retained earnings C) A stock split results in a decrease to par value per share and an increase in capital stock. D) A 1-for-3 reverse stock split does not impact total stockholders’ equity. Answer: C Rationale: All answers are accurate except for Answer C. A stock split decreases par value per share and increases total shares resulting in no change to capital stock.

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Topic: Account for stock dividends LO: 6 24. Norris Company has the following capital structure: Common stock, $1 par, 100,000 shares issued and outstanding On October 1, 2020, the company declared a 5% common stock dividend when the market price of the common stock was $15 per share. Of the 5,000 stock dividend shares, 4,800 were whole shares and 200 were fractional shares. The company’s policy is to pay cash to shareholders for fractional shares. The stock dividend will be distributed on October 15, 2020, to stockholders on record on October 10, 2020. Upon declaration of the stock dividend, Norris Company would record A) A debit to Retained Earnings for $67,200 B) A credit to Dividends Payable for $3,000 C) A credit to Paid-in Capital in Excess of Par—Common Stock for $70,000 D) A credit to Common Stock for $4,800 Answer: B Rationale: Upon declaration of the stock dividend, the company would record the following: Retained Earnings (5,000 x $15) Dividends Payable (200 x $15) Common Stock Dividends Distributable (4,800 x $1) Paid-in Capital in Excess of Par—Common Stock (4,800 x $14)

75,000 3,000 4,800 67,200

Thus, Answer B is correct.

Topic: Describe comprehensive income and its components LO: 7 25. Which of the following items is not classified as other comprehensive income. A) Gain from a foreign currency translation adjustment. B) Loss from a fair value adjustment of a cash flow hedge. C) Unrealized holding gain on an available-for-sale debt security. D) Unrealized holding loss on a trading security. Answer: D Rationale: Unrealized holding gains or losses on available-for-sale debt securities are recognized as OCI while unrealized gains and losses on trading securities are recognized in net income. Thus, the answer is D.

Topic: Describe the reporting of comprehensive income LO: 7 26. The reporting of comprehensive income A) Must take place in either a single continuous statement or as two separate statements of income and comprehensive income. B) Must be shown in a single continuous statement, as two separate statements of income and comprehensive income, or as a separate segment in the statement of stockholders’ equity. C) Must be shown in a single continuous statement. D) Must be shown as two separate statements of income and comprehensive income. Answer: A Rationale: GAAP requires the reporting of comprehensive income in the financial statements either as a single continuous statement of comprehensive income or as two separate statements of income and comprehensive income. Thus, Answer A is correct. © Cambridge Business Publishers, 2023 20-13

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Topic: Describe comprehensive income, its components, and how it is reported LO: 7 27. Kensington Corp. reports net income of $280,000 for the year ended December 31, 2020. The company recorded an unrealized loss on available-for-sale debt securities of $15,000 (pre-tax) for the year ended December 31, 2020. The company declared dividends of $40,000 for the year and its tax rate is 25%. The December 31, 2019, balance in accumulated other comprehensive income is $18,000 (debit balance) and the balance in retained earnings is $100,000 (credit balance). What is the ending balance in accumulated other comprehensive income and retained earnings on December 31, 2020?

A) B) C) D)

Accumulated OCI $6,750 debit $29,250 debit $29,250 debit $33,000 debit

Retained Earnings $380,000 credit $350,000 credit $340,000 credit $340,000 credit

Answer: C Rationale: Accumulated OCI ending balance of $29,250 is equal to $18,000 + $11,250 ($15,000 x 0.75). Ending retained earnings is equal to $340,000 calculated as $100,000 + $280,000 - $40,000.

Use the following information to answer Questions 28 through 30. The following information is provided for Indy Inc. Total common stockholders’ equity on Dec. 31, 2020 Total common stockholders’ equity on Dec. 31, 2019 Sales, 2020 Total assets Common shares outstanding, 2020 Dividends declared and paid, 2020 Market price per share, Dec. 31, 2020

$302,000 $288,000 $165,000 $605,000 50,000 $6,000 $21

Topic: Compute stockholders’ equity key ratios LO: 8 28. What is the company’s book value per share on December 31, 2020? A) $5.90 B) $6.04 C) $12.10 D) $6.06 Answer: B Rationale: Book value per share of $6.04 is equal to total common stockholders’ equity of $302,000 divided by shares of 50,000.

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Topic: Compute stockholders’ equity key ratios LO: 8 29. If the payout ratio is 0.20, what is the return on equity? A) 0.10 B) 0.09 C) 0.08 D) 0.07 Answer: A Rationale: With a payout ratio of 0.20, net income is calculated as $6,000 / 0.20 = $30,000. Return on equity is equal to $30,000 / [($302,000 + $288,000)/2] = 0.10. Topic: Compute stockholders’ equity key ratios LO: 8 30. What is the company’s price-to-earnings ratio? A) 21 B) 30 C) 32 D) 35 Answer: D Rationale: $21/($30,000/50,000) = 35

Test Bank, Chapter 20

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Chapter 21 Share-Based Compensation and Earnings per Share Learning Objectives – Coverage by question Multiple Choice LO 21-1 – Account for restricted stock plans

1-3

LO 21-2 – Account for stock options

4-6

LO 21-3 – Account for employee share purchase plans

LO 21-4 – Compute earnings per share (EPS) with a simple capital structure

8-9

LO 21-5 – Compute EPS given share issuances, buybacks, dividends, and splits

10-14

LO 21-6 – Compute EPS using if-converted method for convertible securities

15-21

LO 21-7 – Compute EPS using treasury stock method for options, warrants, and restricted stock

22-25

LO 21-8 – Compute EPS given contingently issuable shares

26-28

LO 21-9 – Compute EPS given multiple securities and describe EPS financial statement presentation

29-31

LO 21-10 – Appendix 21A – Describe accounting for stock appreciation rights

32-33

Test Bank, Chapter 21

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Chapter 21: Share-Based Compensation and Earnings per Share Multiple Choice Use the following information to answer Questions 1 and 2. On September 30 of Year One, Gracious Inc. issued a total of 2,000 shares of $1 par, restricted common stock to five executives. The fair value of the shares of stock on September 30 is $200,000. The restricted shares require a vesting period of 2 years, which is the requisite service period, and no forfeitures are anticipated.

Topic: Account for restricted stock plans LO: 1 1. What is the amount of compensation expense recognized in Year One? A) $100,000 B) $200,000 C) $-0D) $25,000 Answer: D Rationale: Per ASC 718-10-35-2, compensation cost is recognized over the requisite service period. Thus, the fair value of the award of $200,000 would be recognized at $100,000 per each 12-month period. For Year One, the expense recognized would equal $100,000 x 3/12 months equal to $25,000.

Topic: Account for restricted stock plans LO: 1 2. On December 31, Year 2, half of the restricted shares were forfeited due to executive resignations. Assume that forfeitures are recognized as incurred. What is the amount of compensation expense recognized in Year Two? A) $37,500 B) $62,500 C) $25,000 D) $75,000 Answer: A Rationale: While an additional $100,000 of compensation would be recognized in Year 2 ($200,000 / 2 service years), a portion of this would be reversed. Half of the compensation expense recognized to date would be reversed which is 50% x ($25,000 + $100,000) equal to $62,500. Thus, net expense for Year 2 is $37,500 equal to $100,000 minus $62,500.

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Topic: Account for restricted stock plans LO: 1 3. On September 30 of Year One, Gracious Inc. issued a total of 2,000 stock units to its executives. Each stock unit may be exchanged for one share of $1 par common stock. The fair value of the shares on September 30 is $45 per share. The units require a vesting period of 3 years, which is the requisite service period, and no forfeitures are anticipated. On December 31, Year Two, management now estimates that 400 stock units will be forfeited due to an executive resignation. Assume that the company’s policy is to estimate forfeitures. What is the amount of expense recognized in Year One and Year Two?

A) B) C) D)

Year One $7,500 $7,500 $6,000 $6,000

Year Two $30,000 $22,500 $24,000 $28,500

Answer: B Rationale: In Year One, compensation expense is equal to (2,000 x $45)/3 x 3/12 months = $7,500. At the end of Year Two, total compensation costs to date are now estimated to be (1,600 x $45)/3 x 1.25 = $30,000. This means that an additional $22,500 ($30,000 - $7,500) will be expensed in Year Two.

Topic: Account for stock option plans LO: 2 4. Maebe Inc. awards stock options to key executives as part of their compensation package. Which of the following statements is inaccurate regarding the accounting for the stock option plan? A) The total cost of the compensation is measured at the date of grant. B) An option-pricing model used to measure the fair value of stock options, takes into account prospective information. C) If a stock option award is based on a company’s target stock price, compensation is recognized when it is probable that the condition will be met. D) If a stock option award is based on a company’s sales target, compensation is recognized when it is probable that the condition will be met. Answer: C Rationale: Answer A is correct: per ASC718-10-30-6, awards are measured at the grant date. Answer B is correct because option models take into account prospective information such as the expected volatility of stock price and the expected dividend yield of the stock. Per ASC 718-10-25-20, compensation expense is recognized when the probable outcome of a performance condition has been met; thus, Answer D is correct. However, per ASC 718-10-30-14, the effect of a market condition (such as the fluctuation in stock price) is already reflected in the fair value of the award. Thus, Answer C is incorrect.

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Use the following information to answer Questions 5 and 6. Laurels Co. sponsors a stock option incentive plan to purchase common stock for key employees. The plan allows the purchase of one share of $1 par value common stock at an option price of $30 per share. Using an option-pricing model, at the grant date the fair value of the options granted was $155,000. The options are exercisable starting two years from the date of grant which is the requisite service period. On July 1, Year One, 1,500 options were granted to employees when the market price was $30 per share. Employees exercised 1,000 options, when the market price of the stock was $45 per share on July 1, Year Three.

Topic: Account for stock option plans LO: 2 5. What amount of compensation expense is recognized in Year One, Year Two, and Year Three?

A) B) C) D)

Year One Year Two $38,750 $77,500 $155,000 $-0$51,667 $51,667 $22,500 $45,000

Year Three $38,750 $-0$51,666 $22,500

Answer: A Rationale: The fair value of the stock option grant is measured at the date of grant for $155,000. cost is amortized over the 2-year service period beginning on July 1, Year One.

The

Year One expense is equal to $155,000 / 2 x ½ year = $38,750. Year Two expense is equal to $155,000 / 2 = $77,500. Year Three expense is also equal to $38,750.

Topic: Account for stock option plans LO: 2 6. What was the net change in net stockholders’ equity in Year Three based upon all entries related to the stock options? A) Net decrease of $38,750 B) Net increase of $30,000 C) Net increase of $132,333 D) Net increase of $103,333 Answer: B Rationale: The amortization of expense results in a debit to compensation expense for $38,750 and a credit to Paid-in Capital—Stock Options for $38,750. This results in no net change to stockholders’ equity. Upon exercise of the stock options, the company records the following entry: Cash (1,000 x $30) Paid-in Capital—Stock Options ($155,000 x 1,000/1,500) Common Stock (1,000 x $1) Paid-in Capital in Excess of Par—Common Stock

30,000 103,333 1,000 132,333

Based on this entry, the net change to stockholders’ equity is $30,000 equal to $1,000 + $132,333 – $103,333.

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Topic: Account for employee share purchase plans LO: 3 7. Holland Inc. has an employee stock purchase plan for all eligible employees. Under the plan, shares of the company’s $1 par value common stock may be purchased at a discounted amount of the fair value of the stock on the last day of each quarterly period. Holland records compensation expense for the discount granted on the employee stock purchases if: A) Substantially all (but not 100%) employees of the company may participate in the plan. B) The discount is greater than 5%. C) Employees are able to cancel participation in the plan before the purchase date of the stock. D) Employees may enroll in the plan up to 31 days after each quarter-end. Answer: B Rationale: Per ASC 718-50-25-1, if the discount is greater than 5%, the plan is considered compensatory. The remaining items are identified in the standard as not giving rise to compensation expense.

Topic: Compute earnings per share (EPS) with a simple capital structure LO: 4 8. The financial presentation of basic earnings per share requires: A) Presentation on the face of the income statement. B) Presentation on the face of the income statement or in the notes accompanying the financial statements. C) Presentation in the notes accompanying the financial statements. D) Presentation on the face of the income statement only if the amount changed from the previous period presented. Answer: A Rationale: Per ASC 260-10-45-2, for a simple capital structure, a single EPS presentation showing basic earnings per share is appropriate on the face of the income statement. Thus, Answer A is correct.

Topic: Compute earnings per share (EPS) with a simple capital structure LO: 4 9. At December 31, 2019, and 2020, Lydon Corp. had 150,000 shares of common stock issued and outstanding, with a total par value of $75,000. Dividends declared and paid on the common stock on June 30, 2020, were $35,000. Net income for 2020 was $280,000. Compute basic earnings per common share for 2020. A) $1.63 B) $1.75 C) $1.87 D) $3.73 Answer: C Rationale: Earnings per share is equal to $280,000 divided by 150,000 = $1.87.

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Topic: Compute EPS given share issuances, buybacks, and splits LO: 5 10. The following information pertains to Testa Inc. for 2020. Jan. 1 March 1 July 31 Nov. 30 Dec. 31

Number of common shares issued and outstanding, 100,000 Number of common shares purchased for the treasury, 13,000 Number of common shares purchased for the treasury, 5,000 Reverse two-for-one stock split Reported net income of $88,000

What is the company’s earnings per share reported in its financial statements for the year ended December 31, 2020? A) $2.00 B) $1.05 C) $1.56 D) $2.02 Answer: D Rationale: Earnings per share is equal to $88,000 / 43,542 (see schedule below) = $2.02 Outstanding Shares 100,000 87,000 82,000 41,000

Months Outstanding 2 5 4 1

Restatement 0.5 0.5 0.5 1.0

WA Shares Outstanding 8,333 18,125 13,667 3,417 43,542

Topic: Compute EPS given preferred dividends LO: 5 11. Norris has the following capital structure: • •

Preferred stock, 6%, $15 par, 20,000 shares issued and outstanding for the year Common stock, $1 par, 100,000 shares issued and outstanding for the year

Net income for the current year is $168,000. If the preferred stock is cumulative and 2 years of dividends are in arrears, what is the company’s earnings per share reported in its financial statements for the current year? A) $1.68 B) $1.14 C) $1.50 D) $1.32 Answer: C Rationale: Earnings per share is equal to net income of $168,000 minus preferred dividends of $18,000 (calculated as 6% x $15 x 20,000) / 100,000 = $1.50. Because the preferred dividends are cumulative, annual dividends are subtracted each year.

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Topic: Compute EPS given preferred dividends LO: 5 12. Norris has the following capital structure: • •

Preferred stock, 6%, $15 par, 20,000 shares issued and outstanding for the year Common stock, $1 par, 100,000 shares issued and outstanding for the year

Net income for the current year is $168,000. Preferred dividends were declared and paid in the last three years. If the preferred stock is noncumulative and no dividends were declared in the current year, what is the company’s earnings per share reported in its financial statements for the current year? A) $1.68 B) $1.14 C) $1.50 D) $1.32 Answer: A Rationale: Earnings per share is equal to net income of $168,000 / 100,000 = $1.68. Because the preferred dividends are noncumulative, dividends are subtracted only if declared and paid in the current year.

Topic: Compute EPS given share issuances, stock dividends LO: 5 13. The following information pertains to Ricochet Inc. for 2020. Jan. 1 Feb. 1 July 31 Dec. 31

Number of common shares issued and outstanding, 200,000 Number of new common shares issued, 8,000 100% common stock dividend Reported net income of $560,000

What is the company’s earnings per share reported in its financial statements for the year ended December 31, 2020? A) $1.35 B) $1.90 C) $1.45 D) $1.03 Answer: A Rationale: Earnings per share is equal to $560,000 / 414,667 (see schedule below) = $1.35. Outstanding Shares 200,000 208,000 416,000

Months Outstanding 1 6 5

Restatement 2.0 2.0 1.0

WA Shares Outstanding 33,333 208,000 173,333 414,666

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Topic: Compute EPS given share issuances, stock dividends LO: 5 14. The following information pertains to Ricochet Inc. for 2020. Jan. 1 Feb. 1 Dec. 31

Number of common shares issued and outstanding, 200,000 Number of new common shares issued, 8,000 Reported net income of $560,000

A 200% stock dividend was declared on February 1, 2021, prior to the release of the 2020 financial statements. What is the company’s earnings per share reported in its financial statements for the year ended December 31, 2020? A) $2.70 B) $1.35 C) $1.41 D) $1.45 Answer: B Rationale: Earnings per share is equal to $560,000 / 414,667 (see schedule below) = $1.35. Note that per ASC 260-10-55-12, shares are adjusted for stock dividends, even if they take place after year-end. Outstanding Shares

Months Outstanding

Restatement

200,000 208,000

1 11

2.0 2.0

WA Shares Outstanding 33,333 381,333 414,666

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Use the following information to answer Questions 15 and 16. The following information pertains to Petit Four Inc. Net income 5% Convertible bonds issued at par Weighted-average shares outstanding Tax rate

$548,000 $225,000 188,000 25%

Each $1,000 bond is convertible into 20 shares of common stock at the option of the bondholder. The bonds were outstanding all year. The company computes diluted EPS using the if-converted method.

Topic: Compute EPS using if-converted method for convertible securities LO: 6 15. Calculate basic and diluted EPS for the year.

A) B) C) D)

Basic EPS $2.91 $2.19 $2.91 $2.91

Diluted EPS $2.80 $2.19 $2.91 $2.89

Answer: D Rationale: Basic earnings per share equals $548,000 / 188,000 shares = $2.91. Diluted EPS: Numerator of $556,438 equals $548,000 + interest net of tax ($225,000 x 5% x 0.75). Denominator of 192,500 equals 188,000 + 4,500 new shares upon an assumed conversion calculated as (20 shares x $225,000/$1,000). Thus, diluted EPS equals $556,438 / 192,500 = $2.89.

Topic: Compute EPS using if-converted method for convertible securities LO: 6 16. Calculate basic and diluted EPS for the year assuming that the convertible bonds were issued on November 1.

A) B) C) D)

Basic EPS $2.91 $2.19 $2.91 $2.91

Diluted EPS $2.80 $2.19 $2.91 $2.89

Answer: C Rationale: Basic earnings per share equals $548,000 / 188,000 shares = $2.91. Diluted EPS: Numerator of $549,406 equals $548,000 + interest net of tax ($225,000 x 5% x 0.75 x 2/12). Denominator of 188,750 equals 188,000 + 750 new shares upon an assumed conversion calculated as (20 shares x $225,000/$1,000*2/12). Thus, diluted EPS equals $549,406 / 188,750 = $2.91. © Cambridge Business Publishers, 2023 21-9

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Topic: Compute EPS using if-converted method for convertible securities LO: 6 17. The following information pertains to Beignet Inc. Net loss 8% Convertible bonds issued at par Weighted-average common shares outstanding Tax rate,

$(30,000) $225,000 200,000 25%

Each $1,000 bond is convertible into 10 shares of common stock at the option of the bondholder. The bonds were outstanding all year. The company computes diluted EPS using the if-converted method. Calculate basic and diluted EPS for the year.

A) B) C) D)

Basic EPS $(0.15) $(0.15) $(0.11) $(0.11)

Diluted EPS $(0.15) $(0.08) $(0.11) $(0.04)

Answer: A Rationale: Basic earnings per share equals $(30,000) / 200,000 shares = $(0.15). Per ASC 260-10-45-19, in the case of a net loss from continuing operations, no potentially dilutive securities are considered; thus, basic EPS and diluted EPS will be reported as the same amount.

Topic: Compute EPS using if-converted method for convertible securities LO: 6 18. Monsieur Company had 80,000 shares of common stock outstanding during 2020 and 2,000 shares of cumulative 6%, $100 par preferred stock, each convertible into 5 shares of common stock with $1 par value per share. The company’s tax rate is 25%. During 2020, Monsieur Company declared and paid $5,000 in preferred dividends and no common stock dividends. Monsieur Company reported net income of $318,000 in 2020. Compute basic and diluted EPS for 2020.

A) B) C) D)

Basic EPS $3.83 $3.91 $3.83 $3.91

Diluted EPS $3.40 $3.53 $3.53 $3.48

Answer: C Rationale: Basic earnings per share equals ($318,000 – (2,000 x 6% x 100)) / 80,000 shares = $3.83. Diluted EPS: Numerator of $318,000. Denominator of 90,000 equals 80,000 + (2,000 x 5). Thus, diluted EPS equals $318,000 / 90,000 = $3.53.

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Topic: Compute EPS using if-converted method for convertible securities LO: 6 19. The if-converted method of computing earnings per share data assumes conversion of convertible securities as of: A) The beginning of the earliest period reported (or at the time of issuance, if later) B) The beginning of the earliest period reported (regardless of time of issuance) C) The middle of the earliest period reported (regardless of time of issuance) D) The ending of the earliest period reported (regardless of time of issuance) Answer: A Rationale: Per the ASC Glossary definition of the if-converted method, conversion is assumed to be at the beginning of the reporting period (or at time of issuance, if later). Thus, Answer A is correct.

Topic: Compute EPS using if-converted method for convertible securities LO: 6 20. Suppose a company’s convertible debt is dilutive in determining earnings per share. What would be the effect of considering the convertible debt in calculating the following?

A) B) C) D)

Basic EPS Decrease Increase No effect Decrease

Diluted EPS Decrease No effect Decrease Increase

Answer: C Rationale: Dilution affects the diluted EPS only and reduces the EPS amount. Thus, Answer C is correct.

Topic: Compute EPS using if-converted method for convertible securities LO: 6 21. In determining diluted earnings per share, undeclared annual dividends on convertible cumulative preferred stock should: A) Result in no net effect on the numerator. B) Be added back to net income in the numerator whether declared or not. C) Be deducted from net income in the numerator only if declared. D) Be deducted from net income in the numerator whether declared or not. Answer: D Rationale: Per ASC 260-10-45-16, preferred dividends on convertible securities are added back (after being deducted for basic EPS), thus there is no net adjustment in the numerator; thus, Answer D is correct.

Test Bank, Chapter 21

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Topic: Compute EPS using treasury stock method for stock options LO: 7 22. Norris has the following capital structure: Common stock, $1 par, 50,000 shares issued and outstanding for the year Net income for the current year is $144,000. At the beginning of the year, the company had granted 800 options to key executives to purchase its common stock at $15 per share. The average market price of common stock was $18 per share for the year and the stock price on the last day of the year was $20 per share. What is the company’s diluted earnings per share reported in its financial statements for the current year? A) $2.88 B) $2.87 C) $2.83 D) $2.84 Answer: B Rationale: Basic earnings per share equals $144,000 / 50,000 shares = $2.88. Diluted EPS: Numerator of $144,000. Denominator of 50,133 equals 50,000 + 133 (calculated as 800 – ((800 x $15)/$18). Thus, diluted EPS equals $144,000 / 50,133 = $2.87.

Topic: Compute EPS using treasury stock method for stock options LO: 7 23. Norris has the following capital structure: Common stock, $1 par, 50,000 shares issued and outstanding for the year Net income for the current year is $144,000. At the beginning of the year, the company had granted 800 options to key executives to purchase its common stock at $15 per shares. The average market price of common stock was $12 for the year and the stock price on the last day of the year was $10. What is the company’s diluted earnings per share reported in its financial statements for the current year? A) $2.88 B) $2.89 C) $2.87 D) $2.84 Answer: A Rationale: Basic earnings per share equals $144,000 / 50,000 shares = $2.88. Diluted EPS: Antidilutive because the market price is less than the exercise price. Thus, Basic EPS = Diluted EPS.

Intermediate Accounting, 3rd Edition

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Topic: Compute EPS using treasury stock method for restricted stock LO: 7 24. Norris has the following capital structure: Common stock, $1 par, 150,000 shares issued and outstanding for the year Net income for the current year is $308,000. At the beginning of the year, the company had granted 8,000 restricted common stock shares to key executives that will vest after three years of service. At the date of grant, the market price of the common stock was $12 per share and the average market price of common stock was $12 per share for the year. The tax rate is 25%. What is the company’s diluted earnings per share reported in its financial statements for the current year? A) $2.02 B) $1.51 C) $1.95 D) $2.09 Answer: A Basic earnings per share equals $308,000 / 150,000 shares = $2.05. Diluted EPS: Numerator of $308,000. Denominator of 152,667 equals 150,000 + 2,667 (calculated as 8,000 – [(8,000 x $12) x 2/3) / $12]. Thus, diluted EPS equals $308,000 / 152,667 = $2.02.

Topic: Compute EPS using treasury stock method for options, warrants, and restricted stock LO: 7 25. Which of the following statements is accurate regarding the process of applying the treasury stock method in computing diluted EPS? A) Cash received upon an assumed exercise of stock options is used to purchase stock for the treasury at the end of year market price. B) Incremental shares (assumed issued shares over purchased shares) are subtracted from the denominator of the diluted EPS calculation. C) Stock options are not assumed to be exercised when the average market price is less than or equal to the exercise price. D) If restricted stock is issued, the amount of unearned compensation on a reporting date is added to the numerator of the diluted EPS calculation. Answer: C Rationale: Answer A is inaccurate: Per ASC 260-10-45-23, Stock purchased for the treasury is assumed purchased at the average market price. Answer B is inaccurate: Per ASC 260-10-45-23, incremental shares are added to the denominator in the diluted EPS calculation. Answer D is inaccurate: the amount of unearned compensation at a reporting date is used to calculate an assumed purchase of shares for the treasury at an average market price. This only affects the denominator. Answer C is accurate. In this case, options would not be exercised by the investor because it would be less expensive to purchase shares directly on the market.

Test Bank, Chapter 21

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Topic: Compute EPS given contingently issuable shares LO: 8 26. When computing diluted EPS, if a company has shares of common stock that will be issued only if certain conditions are satisfied: A) The shares are always included in the denominator of the calculation. B) Weight the shares as outstanding for the period that the conditions have been satisfied. C) If the conditions have not been satisfied, do not add the shares to the denominator of the calculation. D) There is no impact on the numerator of the calculation. Answer: D Rationale: Answer A is inaccurate: there are instances where shares are not added. Answer B is inaccurate: shares are considered outstanding as of the beginning of the period in which the conditions were satisfied. Answer C is inaccurate: include the shares as if the end of the reporting period were the end of the contingency period and if the result is dilutive. Answer D is accurate: there is no effect on the numerator.

Use the following information to answer Questions 27 and 28. In 2020, McGowen Inc. committed to shareholders of a company it recently acquired, that if McGowen’s 2021 net income exceeded $100,000, an additional 50,000 shares of McGowen Inc. stock would be issued to the shareholders in 2022.

Topic: Compute EPS given contingently issuable shares LO: 8 27. Net income in 2020 was reported on a quarterly basis: first quarter, $10,000; second quarter, $20,000; third quarter, $30,000; fourth quarter, $50,000. In computing diluted earnings per share in 2020, McGowen Inc. would: A) Include 50,000 contingent shares in the denominator. B) Include none of the contingent shares in the denominator. C) Include 12,500 contingent shares in the denominator. D) Not be required to calculate diluted earnings per share. Answer: A Rationale: Per ASC 260-10-45-48, if all necessary conditions have not been satisfied by the end of the period, we include the number of contingently issuable shares based on the number of shares that would be issuable if the end of the reporting period (Dec. 31, 2020) were the end of the contingency period (Dec. 31, 2021). Thus, because net income in 2020 exceeded $100,000, the shares would be added to the denominator (shares included as of the beginning of the period that the condition was met). Thus Answer A is correct and Answers B, C, and D are incorrect.

Intermediate Accounting, 3rd Edition

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Topic: Compute EPS given contingently issuable shares LO: 8 28. Net income in 2020 was reported on a quarterly basis: first quarter, $10,000; second quarter, $20,000; third quarter, $25,000; fourth quarter, $30,000. In computing diluted earnings per share in 2020, McGowen Inc. would: A) Include 50,000 contingent shares in the denominator. B) Include none of the contingent shares in the denominator. C) Include 12,500 contingent shares in the denominator. D) Not be required to calculate diluted earnings per share. Answer: B Rationale: Per ASC 260-10-45-48, if all necessary conditions have not been satisfied by the end of the period, we include the number of contingently issuable shares based on the number of shares that would be issuable if the end of the reporting period (Dec. 31, 2020) were the end of the contingency period (Dec. 31, 2021). Thus, because net income in 2020 did not exceed $100,000, the shares would not be added to the denominator. Thus Answer B is correct and Answers A, C, and D are incorrect.

Topic: Describe EPS financial statement presentation LO: 9 29. Basic earnings per share must be disclosed on the face of the income statement, net of tax for: A) Income (loss) from continuing operations B) Income (loss) from discontinued operations C) Net income (loss) D) All of the above E) A and C Answer: E Rationale: Per ASC 260-10-45-2, basic per-share amounts for income from continuing operations and for net income are shown on the face of the income statement. Thus, Answer E is correct.

Test Bank, Chapter 21

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Use the following information to answer Questions 30 and 31. The following information relates to Smith Corporation on December 31, 2020. Common stock, $1 par, 300,000 issued and outstanding shares Cumulative, convertible, 6%, $50 par preferred stock, 10,000 issued and outstanding shares 5% Convertible bonds

$300,000 $500,000 $200,000

During 2020, no dividends were declared on its preferred stock. The preferred shares are convertible into 50,000 shares of common stock. The 5% bonds are convertible into 60,000 shares of common stock. Net income for 2020 is $610,000. Assume that the income tax rate is 25% and that the common stock, preferred stock, and the bonds were outstanding all year.

Topic: Compute EPS given multiple securities LO: 9 30. Compute basic EPS for 2020. A) $1.93 B) $2.03 C) $1.87 D) $1.97 Answer: A Rationale: Basic earnings per share equals ($610,000 – ($500,000 x 6%)) / 300,000 shares = $1.93

Topic: Compute EPS given multiple securities LO: 9 31. Compute diluted EPS for 2020. A) $1.93 B) $1.58 C) $1.59 D) $1.51 Answer: D Rationale: First the securities are ranked from most to least dilutive. Then, each security is considered for its dilutive effect on EPS as shown below. Ranking of Securities 5% Convertible bonds Convertible preferred

Basic EPS 5% Convertible bonds Add back interest, net of tax Add new common shares Tentative diluted EPS Convertible preferred Add back preferred dividends Additional common shares Tentative diluted EPS

Increase in Income $ 7,500 30,000

Increase in Number of Common Shares 60,000 50,000

Earnings per Incremental Share $0.13 0.60

Net Income Available to Common Stockholders $580,000

Weighted Average Common Shares Outstanding 300,000

Per Share $1.93

$ 7,500 587,500

60,000 360,000

1.63

50,000 410,000

$1.51

30,000 $617,500

Intermediate Accounting, 3rd Edition

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Topic: Describe accounting for stock appreciation rights LO: 10 32. A company's restricted stock compensation plan was structured as follows: • • • •

Each restricted stock unit is equivalent to one share of $1 par value, common stock Restricted stock units vest two years after the date of grant. Shares are distributed after the vesting period if the employee is still employed by the company. Employees have the right to settle the SARs agreement in cash.

On January 1, 2020, 10,000 restricted stock units were granted to key employees under this plan. The fair value of the SARS is $15, $18, and $20 per unit on January 1, 2020, December 31, 2020, and December 31, 2021, respectively. What would the company recognize as compensation expense in 2020 and 2021?

A) B) C) D)

2020 $ 75,000 $ 90,000 $ 75,000 $100,000

2021 $125,000 $110,000 $ 75,000 $100,000

Answer: B Rationale: Per ASC 718-10-25-11, if the agreement may be settled in cash, the plan is recognized as a liability (as is the case here). The liability is adjusted each period as shown in the following schedule.

Year-end 2020 2021

Year-end Fair Value $18.00 20.00

Aggregate Compensation $180,000 200,000

% of Service Period Accrued 50.00% 100.00%

Total SARs Liability Accrued $ 90,000 200,000

Annual Expense $ 90,000 110,000

Topic: Describe accounting for stock appreciation rights LO: 10 33. Which of the following statements is inaccurate regarding a compensation plan where an employee is granted the right to appreciation in the market price of a company’s stock? A) When the employer has a right to settle the compensation agreement in stock instead of cash, compensation expense is recognized on a straight-line basis over the service period. B) When the employer has a right to settle the compensation agreement in stock instead of cash, total compensation is measured at the date of grant. C) When the employee has the right to settle the compensation agreement in cash, compensation expense is recognized as a liability, adjusted to align with the expected cash payment. D) When the employee has the right to settle the compensation agreement in cash, total compensation is measured at the date of grant. Answer: D Rationale: Answer D is inaccurate because compensation expense is adjusted continually to align the liability with the expected cash payment. Thus, the cost of the compensation plan is not determinable on the grant date.

Test Bank, Chapter 21

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Chapter 22 Statement of Cash Flows Revisited Learning Objectives – Coverage by question Multiple Choice LO 22-1 – Identify operating, investing, and financing activities, and the statement of cash flows format

1-4

LO 22-2 – Prepare the operating activities section of the statement of cash flows using the indirect method

5-9, 12

LO 22-3 – Prepare the investing activities section of the statement of cash flows

10-14, 22

LO 22-4 – Prepare the financing activities section of the statement of cash flows

15-19

LO 22-5 – Describe required disclosures including that for noncash transactions

20-23

LO 22-6 – Utilize a worksheet to prepare the statement of cash flows

24-25

LO 22-7 – Prepare the operating cash flow section of the statement of cash flows using the direct method

20, 26-29

LO 22-8 – Appendix 21A – Prepare a statement of cash flows using the cash T-account approach

Test Bank, Chapter 22

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Chapter 22: Statement of Cash Flows Revisited Multiple Choice Topic: Identify the statement of cash flows format LO: 1 1. Oahu Manufacturing Company purchased a three-month U.S. Treasury bill, to be classified as a cash equivalent. In the preparation of Oahu 's statement of cash flows, this purchase would: A) Not be reported separately as a cash outflow, but the amount would be included in the cash balance at the end of the period B) Be treated as an outflow from financing activities C) Be treated as an outflow from operating activities D) Be treated as an outflow from investing activities. Answer: A Rationale: Per ASC 230-10-45-24, the statement of cash flows reports the net effect of cash flows on cash, cash equivalents, and restricted cash. Thus, the purchase is not shown separately, but the ending balance in cash equivalents is shown in the cash balance on the statement of cash flows.

Topic: Identify operating, investing, and financing activities, and the statement of cash flows format LO: 1 2. Which of the following items would be classified as an investing activity on the statement of cash flows? A) Declaration and payment of a preferred stock dividend B) Proceeds from the issuance of bonds issued at a discount C) Cash purchase of a competitor’s business D) Cash paid for a legal settlement related to an environmental assessment Answer: C Rationale: The purchase of another business (productive assets) results in an outflow classified as an investing activity. Answers A and B would be classified as financing activities and Answer D would be classified as an operating activity.

Topic: Identify operating, investing, and financing activities, and the statement of cash flows format LO: 1 3. Red Oak Inc. determined its net cash flows from operating activities to be an inflow of $35,000 and its ending cash balance to be $26,000. Net cash flows from investing activities is an outflow of $23,000 while net cash flows from financing activities is an inflow of $5,000. A purchase of equipment for the same period resulted in a cash outflow of $20,000 and an increase in notes payable of $40,000. What is the cash balance at the beginning of the period? A) $29,000 B) $ 9,000 C) $ 5,000 D) $25,000 Answer: B Rationale: Cash at the beginning of the period equals $26,000 – ($35,000 - $23,000 + $5,000) = $9,000. Note that the cash outflow for equipment would already be included in the net cash flows from investing. Also, the equipment exchanged for a note is a noncash item which does not affect the change in cash.

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Topic: Identify operating, investing, and financing activities, and the statement of cash flows format LO: 1 4. Which of the following items is not classified as a cash flow from operating activities: A) Proceeds from the sale of an equity investment held in a trading account. B) Principal payment on a note payable issued to acquire inventory. C) Proceeds from collection on a note receivable originating from a sale of inventory. D) Cash outflow for a loan to another entity. Answer: D Rationale: Answers A, B, and C are considered operating activities per ASC 230-10-45-19, 230-10-4516a and 230-10-45-17a. Note that receivables or payables related to amounts with customers or suppliers are considered operating activities. Answer D is an example of an item that would be shown in the investing section. ASC Glossary definition of investing activities directly supports this answer.

Topic: Prepare the operating activities section of the statement of cash flows using the indirect method LO: 2 5. How should a gain from the sale of used equipment for cash be reported in a statement of cash flows using the indirect method? A) In investment activities as a reduction of the cash inflow from the sale. B) In investment activities as a cash outflow. C) In operating activities as a deduction from income. D) In operating activities as an addition to income. Answer: C Rationale: A gain on sale increases net income but does not result in a cash inflow. Thus, the gain is backed out of net income through a deduction. Instead, the entire amount of proceeds from the sale is included in the investing section.

Topic: Prepare the operating activities section of the statement of cash flows using the indirect method LO: 2 6. Would the following be added back to net income in the reconciliation of net income and cash flows from operating activities?

A) B) C) D)

Excess of Treasury Stock Acquisition Cost over Sales Proceeds Yes No No Yes

Bond Discount Amortization Yes No Yes No

Answer: C Rationale: The excess of the treasury stock cost over the sales proceeds of that treasury stock would be debited directly to either additional paid-in capital or retained earnings. Thus, it doesn’t impact net income and is therefore not a reconciling item in the operating activities section. The bond discount amortization is a noncash item that increased interest expense but didn’t result in a cash outflow. Thus, the amount needs to be added back to net income in the operating activities section of the statement of cash flows.

Test Bank, Chapter 22

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Topic: Prepare the operating activities section of the statement of cash flows using the indirect method LO: 2 7. Napoli Inc. summarized the following information for 2020: Net increase in cash Net decrease in deferred tax liability, noncurrent Loss on sale of fixed assets Increase in accounts receivable, net Decrease in inventory Increase in accounts payable Increase in nontrade note payable Depreciation expense Net income

$15,000 5,000 2,000 8,000 6,000 10,000 6,000 11,000 180,000

Based on the information provided, what is net cash flows from operating activities for 2020? A) $196,000 B) $217,000 C) $202,000 D) $223,000 Answer: A Rationale: Net cash flows from operating activities is equal to $180,000 + $11,000 + $10,000 + $6,000 -$8,000 + $2,000 - $5,000 = $196,000.

Topic: Prepare the operating activities section of the statement of cash flows using the indirect method LO: 2 8. Which of the following items is not a correct description of an adjustment to net income in the operating activities section of the statement of cash flows? A) Add compensation expense related to a stock option compensation plan. B) Subtract an unrealized gain on debt securities classified as available-for-sale. C) Add an unrealized loss on equity securities accounted for at fair value. D) Add the excess of pension expense over cash contributions to a defined benefit pension plan. Answer: B Rationale: An unrealized gain on debt securities classified as available-for-sale affects OCI; thus, there is no adjustment needed to net income in the operating activities section.

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Topic: Prepare the operating activities section of the statement of cash flows using the indirect method LO: 2 9. Eggsie’s Inc. reported net cash from operating activities of $29,150 for the year. The company showed a net increase over the year in accounts receivable and accounts payable of $1,200 and $500, respectively. The company showed a net decrease over the year in inventory and equipment of $1,150 and $8,000, respectively. The sale of equipment resulted in a gain of $2,000. The company also incurred depreciation expense of $4,500, amortization expense on a patent of $1,000, and amortization of a discount on bonds payable of $200. What was net income for the year? A) $25,200 B) $33,000 C) $25,000 D) $33,300 Answer: C Rationale: Net income is calculated as follows: $29,150 - $500 - $1,150 + $1,200 + $2,000 - $200 $1,000 - $4,500 = $25,000.

Topic: Prepare the investing activities section of the statement of cash flows LO: 3 10. Catalina Company sold used equipment for a cash amount equaling its carrying amount for both book and tax purposes. A few days later, Catalina replaced the equipment by paying a cash down payment and signing a note payable for new equipment. The cash down payment exceeded the cash received for the old equipment. How should these equipment transactions be reported in the investing activities section of Catalina 's statement of cash flows? A) Cash outflow equal to the down payment less the cash received. B) Cash outflow equal to the down payment and note payable less the cash received. C) Cash inflow equal to the cash received and a cash outflow equal to the down payment and note payable. D) Cash inflow equal to the cash received and a cash outflow equal to the down payment. Answer: D Rationale: The cash inflow from the sale of equipment and the cash outflow from the purchase of equipment would be shown in the investing section. Gross proceeds and payments are shown separately on the statement of cash flows.

Test Bank, Chapter 22

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Use the following information to answer Questions 11 and 12. Lorelai Inc. reported Equipment on January 1 of $430,000 and on December 31 of $392,000. The company also reported Accumulated Depreciation on January 1 of $280,000 and December 31 of $313,000. During the year, the company sold equipment with an original cost of $80,000 and a carrying value of $60,000, resulting in a loss of $5,000.

Topic: Prepare the investing activities section of the statement of cash flows LO: 3 11. What would be shown in the investing activities section for the year based upon this information? A) Cash inflow for the sale of equipment of $65,000 and a cash outflow for equipment purchases of $42,000. B) Cash inflow for the sale of equipment of $55,000 and a cash outflow for equipment purchases of $42,000. C) Cash inflow for the sale of equipment of $55,000, a cash outflow for equipment purchases of $42,000, and add back the loss of $5,000. D) Cash inflow for the sale of equipment of $55,000 and a cash outflow for equipment purchases of $22,000. Answer: B Rationale: The sale of equipment (cash inflow) is equal to the carrying value of $60,000 minus the loss of $5,000 which equals $55,000. The purchase of equipment (cash outflow) is equal to $392,000 + $80,000 - $430,000 = $42,000.

Topic: Use investing activities information to derive amounts in the statement of cash flows LO: 2, 3 12. What amounts would be included in the operating activities section of the statement of cash flows? A) Add depreciation expense of $93,000 and subtract loss on sale of equipment of $5,000 from net income. B) Add depreciation expense of $53,000 and subtract loss on sale of equipment of $5,000 from net income. C) Add depreciation expense of $93,000 and add loss on sale of equipment of $5,000 to net income. D) Add depreciation expense of $53,000 and add loss on sale of equipment of $5,000 to net income. Answer: D Rationale: Depreciation expense is equal to $313,000 + $20,000 (calculated as $80,000 - $60,000) $280,000 = $53,000. The loss (given) and depreciation expense are both noncash items added back to net income in the operating activities section.

Intermediate Accounting, 3rd Edition

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Topic: Prepare the investing activities section of the statement of cash flows LO: 3 13. In the statement of cash flows, which of the following would increase reported cash flows from investing activities? A) Increase in intangible assets due to an acquisition for cash. B) Increase in mortgage payable due to the purchase of land. C) Proceeds from the sale of equity investments accounted for at fair value. D) Loss on an insurance settlement for equipment damaged by fire. Answer: C Rationale: The sale of the equity investments would increase cash flows from investing activities. Thus, Answer C is correct. Answer A is incorrect because an increase in intangibles would result in a decrease to investing activities. Answer B is incorrect because it describes a noncash transaction. Answer D is incorrect because losses are added back to net income in the operating activities section.

Topic: Prepare the investing activities section of the statement of cash flows LO: 3 14. Winnetka Inc. reported the following transactions in the current year. Purchased an investment in debt securities (long-term) for cash Sold equipment for cash, previously used in operations Paid cash for dividends Issued common stock for cash Retired a 10-year bond payable through the issuance of common stock Sold investment in equity securities accounted for at fair value Borrowed cash by signing a six-month note payable Paid interest on note payable

$ 50,000 125,000 45,000 128,000 125,000 23,000 35,000 1,000

What is the net amount of cash flows that the company would report in the investing activities section of the statement of cash flows? A) Net cash inflow of $98,000 B) Net cash inflow of $148,000 C) Net cash inflow of $133,000 D) Net cash outflow of $53,000 Answer: A Rationale: The net cash inflow of $98,000 is equal to $(50,000) + $125,000 + $23,000.

Test Bank, Chapter 22

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Topic: Prepare the financing activities section of the statement of cash flows LO: 4 15. Steinbeck Corporation issued a $80,000, 15-year bond dated January 1, 2020, at 7% with 5% interest payable annually on December 31. The principal amount is due upon maturity. Assume that the company uses the effective interest method to amortize any discounts or premiums. How would the bond transactions affect the financing activities section of the statement of cash flows for 2020, assuming that the company uses the indirect method in reporting cash flows from operating activities? A) Cash inflow for $96,607 and a cash outflow for $830. B) Cash inflow for $80,000 and a cash outflow for $4,000. C) Cash inflow for $65,427 and a cash outflow for $580. D) Cash inflow for $65,427. Answer: D Rationale: The proceeds from the bonds equal $65,427 calculated as PV=(0.07,15,-4000,-80000). The interest payment is shown in the operating activities section of the statement of cash flows.

Topic: Prepare the financing activities section of the statement of cash flows LO: 4 16. In the statement of cash flows, which of the following would decrease reported cash flows from financing activities? A) Issuance of common stock previously purchased for the treasury. B) Increase in dividends payable. C) Principal payments on installment note. D) Interest payment on bonds issued at par value. Answer: C Rationale: The principal payments on installment notes would be deducted in the financing activities section. Answer A is incorrect because the issuance of stock increases financing activities. Answer B is incorrect because an increase in dividends payable is a noncash item. Answer D is incorrect because interest is shown in the operating activities section of the statement of cash flows.

Topic: Prepare the financing activities section of the statement of cash flows LO: 4 17. Jennings Inc. recognized the following balances in its financial records: Account Dividends payable Retained earnings

Dec. 31, 2019 $ 40,000 200,000

Dec 31, 2020 $ 10,000 275,000

Jennings Inc. reported net income of $155,000 in 2020. Based on this information, what is the effect on the financing activities section of the statement of cash flows? A) Cash outflow of $80,000 B) Cash outflow of $110,000 C) Cash outflow of $50,000 D) Cash outflow of $30,000 Answer: B Rationale: Dividends for the period are calculated as $200,000 + $155,000 - $275,000 = $80,000. Cash dividends paid equal $80,000 plus the decrease in dividends payable of $30,000 ($40,000 - $10,000) = $110,000. © Cambridge Business Publishers, 2023 22-8

Intermediate Accounting, 3rd Edition

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Topic: Prepare the financing activities section of the statement of cash flows LO: 4 18. Winnetka Inc. reported the following transactions in the current year. Purchased an investment in debt securities (long-term) for cash Sold equipment for cash, previously used in operations Paid cash for dividends Issued common stock for cash Retired a 10-year bond payable through the issuance of common stock Sold investment in equity securities (held for 9 months) Borrowed cash by signing a six-month note payable Paid interest on note payable

$ 50,000 125,000 45,000 128,000 125,000 23,000 35,000 1,000

What is the net amount of cash flows that the company would report in the financing activities section of the statement of cash flows? A) Net cash outflow of $7,000 B) Net cash inflow of $118,000 C) Net cash inflow of $117,000 D) Net cash outflow of $138,000 Answer: B Rationale: The net cash inflow of $118,000 is equal to $(45,000) + $128,000 + $35,000.

Topic: Prepare the financing activities section of the statement of cash flows LO: 4 19. On January 1, 2020, Rickshaw Inc. issued a 5% note payable to First Bank for $80,000 with 10 equal annual payments (principal plus interest) with the first payment due December 31, 2020. Indicate the net impact on the financing activities section of the statement of cash flows for 2020. A) Net cash inflow of $73,640 B) Net cash outflow of $10,360 C) Net cash inflow of $69,640 D) Net cash inflow of $76,000 Answer: A Rationale: The net impact on the financing activities section of $73,640 is equal to the proceeds on the note of $80,000 minus $6,360, the amount allocated to principal for the first installment payment. The payment is equal to $10,360 (PMT(0.05,10,-80000,0)). Interest on the first payment is equal to $80,000 x 5% = $4,000. Thus, the reduction of principal based on the first payment is $10,360 - $4,000 = $6,360.

Topic: Describe required disclosures LO: 5, 7 20. Under the indirect method, the reconciliation of net income to operating cash flows A) Is required on the face of the statement of cash flows. B) Is required as a separate schedule. C) Is not required, but is highly encouraged for inclusion on the face of the statement of cash flows. D) Is required on the face of the statement of cash flows or as a separate schedule. Answer: D Rationale: Per ASC 230-10-45-31, when the indirect method is used to reconcile net income to operating cash flows, the reconciliation may be included on the face of the statement of cash flows or in a separate schedule.

Test Bank, Chapter 22

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Topic: Describe required disclosures including that for noncash transactions LO: 5 21. Which of the following items must be disclosed when the indirect method of reconciling net income to operating cash flows is used in the operating activities section of a statement of cash flows? A) Cash paid for income taxes B) Cash paid for interest C) Cash paid for research and development costs D) All of the above E) A and B F) A and C G) B and C Answer: E Rationale: Per ASC 230-10-50-2, cash paid for income taxes and interest must be disclosed.

Topic: Describe required disclosures including that for noncash transactions LO: 3, 5 22. Baltic Co. issued 1,000 shares of privately held common stock, $1 par and paid cash of $50,000 to purchase land with a fair value of $200,000. The fair value of the common stock is not readily determinable. What is the impact on the statement of cash flows including any required disclosures? A) Investing cash outflow of $200,000; Financing cash inflow of $150,000; Noncash disclosure of a $200,000 exchange of common stock for land. B) Investing cash outflow of $200,000; Financing cash inflow of $150,000; Noncash disclosure of a $150,000 exchange of common stock for land. C) Noncash disclosure of a $150,000 exchange of common stock for land. D) Investing cash outflow of $50,000; Noncash disclosure of a $150,000 exchange of common stock for land. Answer: D Rationale: The cash outflow for the land is $50,000 classified as an investing activity. The issuance of stock was entirely for an exchange of land; thus, there is no cash impact on the financing activity section. The noncash disclosure would describe the exchange of stock for land ($200,000 - $50,000).

Topic: Describe required disclosures including that for noncash transactions LO: 5 23. Which of the following items would not be considered a noncash exchange? A) Refinancing of a $200,000 long-term note payable by extending the terms 5 additional years. B) Obtaining a building with a fair value of $1,000,000 through a donation. C) Purchasing leased equipment at the end of the lease term by paying the contractual amount of $10,000. The right-of-use asset was reclassified to equipment. D) A convertible bond issuance of $10,000 was converted to common stock by the shareholders. Answer: C Rationale: All of the transactions as described do not require a cash outflow except for Answer C. A $10,000 cash payment was required to secure the leased asset at the end of the lease term.

Intermediate Accounting, 3rd Edition

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Topic: Utilize a worksheet to prepare the statement of cash flows LO: 6 24. The process of creating a cash flow worksheet as an aid in preparing the statement of cash flows: A) Is a required step in creating a statement of cash flows that is accurately presented. B) Provides the required information for recording transaction entries in the general journal. C) Identifies the income statement changes that impact the statement of cash flows. D) Requires the reconciliation of all balance sheet account changes. Answer: D Rationale: The work sheet is an optional tool to assist in the preparation of the statement of cash flows (thus answer A is incorrect.). It recreates transaction entries (thus Answer B is incorrect) that explain the changes in balance sheet accounts (thus Answer C is incorrect and Answer D is correct) and classifies the changes that affect operating, investing, and financing cash flows.

Topic: Utilize a worksheet to prepare the statement of cash flows LO: 6 25. The following excerpt is from an accounting worksheet of Alpha Omega Company, used to prepare a statement of cash flows using the indirect method to present net cash flows from operating activities.

Net income Depreciation expense Decrease in accounts receivable Increase in inventory Decrease in accounts payable Decrease in salaries payable Purchase of equipment Proceeds from sale of plant assets Dividends paid Issuance of bonds Issuance of stock

Dr. $515 400 100

Cr.

$200 35 25 1,200 500 190 200 100

Based on the partial worksheet, what is net change in cash for the period? A) Increase in cash of $165 B) Decrease in cash of $165 C) Increase in cash of $330 D) Decrease in cash of $330 Answer: A Rationale: Cash increased by $165 calculated as $515 + $400 + $100 - $200 - $35 - $25 - $1,200 + $500 - $190 + $200 + $100.

Test Bank, Chapter 22

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Topic: Prepare the operating cash flow section of the statement of cash flows using the direct method LO: 7 26. In the statement of cash flows, which of the following would be reported as an increase in cash flows from operating activities under the direct method? Ignore tax considerations. A) Dividends received from investments. B) Gain on sale of equipment. C) Loss on early retirement of bonds. D) Change from straight-line to accelerated depreciation method. Answer: A Rationale: Dividends received would be reported as a cash inflow. Noncash items such as gains and losses are not cash flows; thus, are not included in the operating activities section. Answer D also references depreciation expense which is a noncash item that does not impact the operating activities section using the direct method.

Use the following information to answer Questions 27 through 29. Thirty Rock Inc. reported the following balance sheet and income statement at its annual year-end of December 31. Balance Sheets As of December 31: Assets Cash Investments, short-term Accounts receivable (net) Inventory Investments, long-term Equipment, net Patent Other assets Total assets

2019

2020

$ 30,000 — 34,000 20,000 — 120,000 6,000 14,000 $224,000

$ 43,000 6,000 40,000 30,000 20,000 118,000 5,500 14,000 $276,500

Liabilities and Stockholders' Equity Accounts payable Accrued expenses payable Notes payable Common stock Retained earnings Total liabilities and stockholders' equity

$ 24,000 — 80,000 70,000 50,000 $224,000

$ 44,000 17,400 40,000 89,000 86,100 $276,500

Income Statement For Year Ended December 31, 2020 Sales revenue Cost of goods sold Depreciation expense Patent amortization Other operating expenses Net income

$200,000 (110,000) (16,000) (500) (35,400) $ 38,100

Intermediate Accounting, 3rd Edition

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Topic: Prepare the operating cash flow section of the statement of cash flows using the direct method LO: 7 27. What is amount of cash collections from customers reported in the operating activities section of the statement of cash flows under the direct method assuming an allowance for doubtful accounts of $2,000 in 2020 and $1,800 in 2019? A) $194,000 B) $206,000 C) $193,800 D) $194,200 Answer: A Rationale: Cash collections is equal to sales revenue of $200,000 minus the increase in accounts receivable of $6,000 ($40,000 - $34,000) = $194,000.

Topic: Prepare the operating cash flow section of the statement of cash flows using the direct method LO: 7 28. What is amount of cash paid to suppliers reported in the operating activities section of the statement of cash flows under the direct method? A) $140,000 B) $120,000 C) $100,000 D) $80,000 Answer: C Rationale: Cash paid to suppliers is equal to cost of goods sold of $110,000 plus increase in inventory of $10,000 ($30,000 - $20,000) minus an increase in accounts payable of $20,000 ($44,000 - $24,000) = $100,000.

Topic: Prepare the operating cash flow section of the statement of cash flows using the direct method LO: 7 29. What is amount of cash paid for operating expenses reported in the operating activities section of the statement of cash flows under the direct method? A) $52,800 B) $18,000 C) $36,800 D) $34,500 Answer: B Rationale: The cash paid for operating expenses is equal to other operating expenses of $35,400 minus the increase in accrued expenses payable of $17,400 ($17,400 - $0) = $18,000.

Test Bank, Chapter 22

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Topic: Prepare a statement of cash flows using the cash T-account approach LO: 8 30. In preparing a statement of cash flows using the Cash T-Account method: A) A cash T-account is reconstructed to show the cash flow effects of operating, investing, and financing activities. B) Entries are recorded resulting in a decrease or increase to the cash account. C) The change in cash in the cash T-account is equal to the change in total liabilities, plus the change in total equity, minus the change in total assets. D) Entries are recreated only from changes in balances in the balance sheet and income statement. Answer: A Rationale: Answer A is true: the cash T-account method is an optional tool that reconstructs entries to show the effect on operating, investing, and financing activities. Answer B is inaccurate because entries are recreated but not actually recorded. Answer C is incorrect because the change in cash is equal to the change in liabilities, plus the change in equity, minus the change in non-cash assets. Answer D is inaccurate because additional information outside the financial statements is required.

Intermediate Accounting, 3rd Edition

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