TEST BANK for Intermediate Accounting 3rd Edition. by Gordon, Raedy, Sannella by digitaldownload87

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 1 The Financial Reporting Environment 1.1

Overview of Financial Reporting

1) The financial reporting process generates three basic financial statements. Answer: FALSE Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The demand for financial information is based on market participant demand. Answer: TRUE Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Managers of economic entities are best considered to be users of financial information. Answer: FALSE Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Managers of economic entities are best considered to be preparers of financial information. Answer: TRUE Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The Securities and Exchange Commission (SEC) regulates financial reporting for publicly traded companies. Answer: TRUE Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) The FASB gives the SEC authority to regulate accounting for publicly traded companies. Answer: FALSE Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) The Public Company Accounting Oversight Board (PCAOB) sets financial accounting standards and oversees the audits of public companies in the United States. Answer: FALSE Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Financial accounting standards influence the behavior of managers and other internal users. Answer: TRUE Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Theories and procedures that evolve as a result of lobbying from various groups are examples of proactive factors within the legal, economic, political, and social environment. Answer: FALSE Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Financial information includes information that is not governed by rules set forth by the accounting standard-setting bodies. Answer: TRUE Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) What is the term that describes the process of identifying, measuring, and communicating financial information about an economic entity to various user groups? A) financial reporting B) accounting standard setting C) financial statement D) financial accounting Answer: D Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Which element of financial accounting involves identifying the individuals who demand financial information? A) financial information B) economic entity C) user groups D) legal, economic, political, and social environment Answer: C Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Which of the following is not one of the four basic financial statements? A) balance sheet B) trial balance C) cash flows statement D) statement of comprehensive income Answer: B Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Which organization is responsible for promulgating U.S. GAAP? A) Financial Accounting Standards Board B) Public Company Accounting Oversight Board C) International Accounting Standards Board D) Securities and Exchange Commission Answer: A Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Which organization is responsible for setting auditing standards and overseeing the audits of public companies in the United States? A) Financial Accounting Standards Board B) Public Company Accounting Oversight Board C) American Institute of Certified Public Accountants D) Securities and Exchange Commission Answer: B Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Which organization prepares and grades the Uniform CPA Examination? A) Financial Accounting Standards Board B) Public Company Accounting Oversight Board C) American Institute of Certified Public Accountants D) International Accounting Standards Board Answer: C Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Which of the following user groups consists of individuals that provide guidance to others in making investment and credit decisions? A) financial analysts B) equity investors C) creditors D) suppliers Answer: A Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Which of the following user groups consists of individuals who expect to receive a return on their investment? A) employees B) equity investors C) creditors D) suppliers and customers Answer: B Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Which of the following user groups consist of companies that analyze financial information to identify the reporting entity's objectives, assumptions, overall business strategy, and capabilities? A) competitors B) creditors and other debt investors C) employees and labor unions D) suppliers and customers Answer: A Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Which party involved in the financial reporting process provides assurance that the financial statements prepared by management fairly present the financial position and performance of the company? A) standard setters B) regulators C) internal auditors D) external auditors Answer: D Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Which regulatory body sets auditing standards and oversees the audits of public companies in the United States? A) Public Company Accounting Oversight Board (PCAOB) B) Financial Accounting Standards Board (FASB) C) American Institute of Certified Public Accountants (AICPA) D) Securities and Exchange Commission (SEC) Answer: A Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Which of the following types of information would be categorized as financial information? A) asset values governed by accounting standards B) footnote disclosures in annual reports C) auditor's report D) all of the above Answer: D Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) Equity investors include all but which of the following? A) partners B) shareholders C) bondholders D) sole proprietor Answer: C Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) What group or organization both protects investors and oversees the accounting standard-setting process in the United States? A) public accounting firms B) American Institute of Public Accountants C) United States Securities and Exchange Commission D) Financial Accounting Standards Board Answer: C Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) ________ is the process of analyzing large data sets in order to draw useful conclusions. A) Technology Innovation B) Financial Reporting C) Data Analytics D) Data Capture Answer: C Diff: 1 Objective: 1.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) How does accounting help in the capital allocation process? Answer: Financial accounting provides information that enables users to evaluate economic entities and make efficient resource allocation decisions based on the risks and returns of a particular investment. This process directs capital flows to their most productive uses. The notion of "efficient and effective" allocation of capital helps drive capitalist economies and societies to greater standards of living. To provide unreliable and irrelevant information leads to poor capital allocation which adversely affects the securities market. An inefficient and wasteful allocation would reward poorly run entities until they ultimately flounder or go bust. Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

27) In what ways does accounting information proactively interact with its environment? Answer: Financial accounting is proactive in that it can change or influence its environment by providing feedback information that is used by organizations and individuals to reshape the economy. Accounting information is used to efficiently allocate capital resources throughout the economy. Accounting standards can also influence managerial behavior. Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

28) What is meant by general-purpose financial statements? Answer: Published financial statements are called general-purpose financial statements because they provide information to a wide spectrum of user groups: investors, creditors, financial analysts, customers, employees, competitors, suppliers, unions, and government agencies. Although considered general purpose, most financial information is provided to satisfy users with limited ability or authority to obtain additional information, which includes investors and creditors. Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

29) Define data analytics and explain how it can be used in financial reporting. Answer: Data analytics is the process of analyzing large data sets to draw useful conclusions. It involves converting raw data into useful knowledge. Data analytics is playing an increasingly important role in the accounting profession. In financial reporting, we can use data analytics to improve the quality of our estimates and valuations. Auditors are using it to increase the quality and accuracy of the audit. Diff: 2 Objective: 1.1 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

1.2

Role of Standard Setters

1) IFRS refers to generally accepted accounting standards that apply globally. Answer: TRUE Diff: 1 Objective: 1.2 IFRS/GAAP: IFRS AACSB: Application of knowledge

2) Standard setters develop accounting standards based on natural economic laws. Answer: FALSE Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The FASB and the IFRS have been working together to converge U.S. and international standards to and have eliminated most differences. Answer: FALSE Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The FASB promulgates accounting standards in the U.S. and the International Accounting Standards Board (IASB) issues international accounting standards. Answer: TRUE Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Accountants in the United States do not need to learn international accounting standards. Answer: FALSE Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The SEC permits the use of IFRS-based financial statements by international companies with shares trading on U.S. stock exchanges. Answer: TRUE Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) When accountants work on the financial statements of U.S. companies with foreign subsidiaries prepared under IFRS in the home countries, the accountants do not convert the subsidiaries' financial statements to U.S. GAAP. Answer: FALSE Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) The American Institute of Certified Public Accountants tests IFRS on the uniform CPA exam. Answer: TRUE Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following statements correctly identifies accounting standard setters? A) The AICPA promulgates accounting standards in the U.S. and the IFRS issues international accounting standards. B) The AICPA promulgates accounting standards in the U.S. and the IASB issues international accounting standards. C) The FASB promulgates accounting standards in the U.S. and the IFRS issues international accounting standards. D) The FASB promulgates accounting standards in the U.S. and the IASB issues international accounting standards. Answer: D Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Which of the following statements is false? A) The SEC permits the use of IFRS-based financial statements by international companies with shares trading on U.S. stock exchanges. B) Non-U.S. companies operate in the United States but prepare their financial statements using IFRS. C) Accountants must convert to U.S. GAAP the IFRS financial statements of foreign subsidiaries that belong to U.S. companies. D) The accounting profession has determined that a working knowledge of IFRS is not important for accountants working in the United States. Answer: D Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Which of the following is not a reason why an accountant in the United States should learn international accounting standards? A) The United States has plans to fully adopt IFRS in the near future. B) The SEC permits the use of IFRS-based financial statements by international companies with shares trading on the U.S. stock exchanges. C) An accountant may work for, or assist, a foreign company that operates in the U.S. and uses IFRS for financial reporting. D) U.S. companies operate subsidiaries outside of the United States which report under IFRS in their home countries. Answer: A Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Accounting standards setters do which of the following? A) protect investors and creditors B) develop concepts, rules, and guidelines for financial reporting C) assure transparent and truthful reporting and guarantee the efficient functioning of the capital markets D) prosecute violators of their rules and guidelines so as to maintain the public trust and to ensure the efficient functioning of capital markets Answer: B Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) List four reasons why it is important for an accountant in the United States to learn international accounting standards. Answer: • U.S. companies operate subsidiaries outside of the United States. • Non-U.S. companies operate in the United States and prepare their financial statements using IFRS. • The SEC permits the use of IFRS-based financial statements by international companies with shares trading on U.S. stock exchanges. • U.S. accountants and auditors need a working knowledge of IFRS to implement global standards in companies and perform audits. • Many U.S. accountants now spend time working outside of the United States. • The accounting profession has determined that a working knowledge of IFRS is important for today's accountant. Diff: 1 Objective: 1.2 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

1.3

The Standard-Setting Process

1) The U.S. Congress has given the Securities and Exchange Commission the power to promulgate accounting standards for all publicly traded firms. Answer: TRUE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Accounting standard setting began in the United States with the 1934 Securities Exchange Act. Answer: TRUE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The Securities and Exchange Commission currently delegates its standard-setting power to the AICPA, a private sector organization. Answer: FALSE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Official U.S. GAAP consist of the bulletins, opinions, and statements issued by the CAP, the APB, and the FASB. Answer: FALSE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The FASB Accounting Standards Codification is the single source of GAAP in the United States. Answer: TRUE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Both financial and governmental accounting standards are under the auspices of the Financial Accounting Foundation. Answer: TRUE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) The FASB is a subcommittee of the AICPA. Answer: FALSE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) The FAF is financed primarily by funds from the Public Company Accounting Oversight Board which assesses fees against companies that issue equity securities. Answer: TRUE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) The Private Company Council has authority to make the final decision about changing U.S. GAAP for private companies. Answer: FALSE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Both FASB and IASB, through their standard-setting process, require a post-implementation review of each new standard. Answer: FALSE Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Which of the following is not true of FASB? A) The FASB is a full-time board of seven members. B) Board members must sever all relationships with outside entities. C) Board members must be CPAs. D) The FASB is not a subcommittee of the AICPA. Answer: C Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Currently, what is the single source of generally accepted accounting principles in the United States? A) Financial Accounting Statements B) APB Opinions C) Accounting Standards Codification D) Accounting Research Bulletins Answer: C Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) The ________ obtains funds primarily through the Public Company Accounting Oversight Board (PCAOB), which assesses charges known as accounting support fees against issuers of equity securities based on their market capitalization. A) American Institute of Certified Public Accountants (AICPA) B) Financial Accounting Foundation (FAF) C) Securities and Exchange Commission (SEC) D) Financial Accounting Standards Advisory Council (FASAC) Answer: B Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Which of the following organizations is responsible for setting accounting standards for state and local governments? A) Government Issues Task Force (GITF) B) Government Accounting Standards Board (GASB) C) Securities and Exchange Commission (SEC) D) Government Accounting Standards Advisory Council (GASAC) Answer: B Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) During the standard-setting process, an ________ is issued by the FASB to solicit input from financial statement preparers, auditors, and other users of financial statements. A) exposure draft B) accounting standards update C) accounting research bulletin D) accounting comment letter Answer: A Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Which of the following statements about the global standard-setting structure is false? A) The IFRS Interpretations Committee is similar to the EITF in the U.S. B) The Monitoring Board was formed to enhance public accountability of the IFRS Foundation. C) The IASB oversees the IFRS Advisory Council which advises the Monitoring Board. D) The IFRS Foundation oversees the IASB and finances IASB operations. Answer: C Diff: 1 Objective: 1.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

17) In addition to the comments obtained from responses to the exposure drafts and public round tables, the U.S. standard setting process relies on the information gathered and opinions from all of the following except ________. A) the Monitoring Board B) users C) managers D) auditors Answer: A Diff: 2 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) The ________ is responsible for oversight, administration, and finances of the Financial Accounting Standards Board (FASB). A) General Accounting Standards Board (GASB) B) Financial Accounting Foundation (FAF) C) Public Company Accounting Oversight Board (PCAOB) D) Financial Accounting Standards Advisory Council (FASAC) Answer: B Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Which organization exists to advise the Financial Accounting Standards Board (FASB) on technical issues? A) General Accounting Standards Board (GASB) B) Financial Accounting Foundation (FAF) C) Emerging Issues Task Force (EITF) D) Financial Accounting Standards Advisory Council (FASAC) Answer: D Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) The Governmental accounting Standards Advisory Council (GASAC) serves as an advisory board to the ________. A) General Accounting Standards Board (GASB) B) Financial Accounting Foundation (FAF) C) Emerging Issues Task Force (EITF) D) Financial Accounting Standards Advisory Council (FASAC) Answer: A Diff: 1 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) List the seven steps of the FASB standard-setting process. Answer: Step 1: Identification of an issue. Step 2: Decision to pursue. Step 3: Public meetings. Step 4: Exposure Draft. Step 5: Public roundtables. Step 6: Redeliberation. Step 7: Publication of the final standard. Diff: 2 Objective: 1.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

1.4

Trends in Standard Setting

1) In recent years, the FASB standards that have been set indicate that the income statement is more important than the balance sheet. Answer: FALSE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Principles-based standards are deemed to be more optimal than rules-based standards and objectives-based standards. Answer: FALSE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Objectives-based standards are deemed to be more optimal than rules-based standards and principles-based standards. Answer: TRUE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Rules-based standards rely on theories and concepts that are linked to a well-developed theoretical framework. Answer: FALSE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Principles-based standards involve few, if any, exceptions. Answer: TRUE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Principles-based standards typically provide sufficient guidance to implement a standard. Answer: FALSE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Rules-based standards require a significant amount of professional judgment. Answer: FALSE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Rules-based standards result in inconsistencies between standards. Answer: TRUE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) U.S. GAAP contains more rules-based standards than IFRS. Answer: TRUE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Principles-based standards are more consistent with the asset/liability approach and rules-based standards are more consistent with the income statement approach. Answer: FALSE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Fair value of an asset is the amount at which the asset could be bought in a current transaction between willing parties. Answer: TRUE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Fair value measurements have a long-standing tradition in U.S. GAAP. Answer: FALSE Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which of the following is not a current trend in accounting-standards setting? A) increase in political involvement B) move toward principles-based system C) focus on asset/liability approach D) emphasis on measuring fair value Answer: A Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Which type of standard relies on theories and concepts that are linked to a well-developed theoretical framework? A) objectives-based standard B) principles-based standard C) theories-based standard D) rules-based standard Answer: B Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Which of the following is a characteristic of rules-based standards? A) involve few, if any, exceptions B) result in inconsistencies between standards C) contain no bright-line tests D) provide insufficient guidance Answer: B Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Which of the following is a characteristic of objectives-based standards? A) do not rely on professional judgment B) increase bright-line tests C) somewhere between principles-based and rules-based D) no exceptions Answer: C Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Which financial statement is implicitly considered dominant as standard setting shifts toward the asset/liability approach? A) statement of financial position B) statement of cash flows C) statement of shareholders' equity D) statement of comprehensive income Answer: A Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) ________ is the amount at which a liability could be incurred or settled in a current transaction between willing parties. A) Income value B) Settlement value C) Current value D) Fair value Answer: D Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Which of the following is a bright-line test? A) An item is deemed material if it is large enough to influence the CEO's decision making. B) An item is deemed material if it exceeds 10% of net income. C) An item is deemed material if it is large in size. D) An item is deemed material if it is large enough to influence an investor's decision making. Answer: B Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Which of the following best defines fair value? A) The amount at which an asset could be bought or sold in a current transaction between willing parties. B) The market value of an asset determined by a transaction between related parties. C) The amount at which an asset could be sold in a transaction occurring within the last year. D) The amount at which an asset could be bought or sold in a current transaction between any two parties. Answer: A Diff: 1 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Contrast the differences between rules-based standards and principles-based standards. Answer: Principles-based Rules-based Few exceptions Many exceptions No bright-line tests Many bright-line tests Provide less guidance Provide more guidance Involve much interpretation Involve little interpretation Few inconsistencies between Many inconsistencies between standards standards Diff: 2 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Give two examples of assets that may be valued at fair value as opposed to historical cost. Answer: Firms must report some investments in equity securities that have a readily determinable fair value and some investments in debt at fair value, as opposed to historical cost. Diff: 2 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

23) Describe rules-based vs. principles-based standards. Answer: A principles-based standard relies on theories, concepts, and principles of accounting that are linked to a well-developed theoretical framework. A rules-based standard contains specific, prescriptive procedures rather than relying on a consistent theoretical framework. Diff: 2 Objective: 1.4 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 2 Financial Reporting Theory 2.1

Overview of the Conceptual Framework

1) U.S. GAAP and IFRS set forth the same objective of financial reporting and the same qualitative characteristics in their respective conceptual frameworks. Answer: TRUE Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The purpose of the conceptual framework is to assist standard setters in developing and revising accounting standards. Answer: TRUE Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Under U.S. GAAP, the conceptual framework overrides accounting standards. Answer: FALSE Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) At the present time, the FASB and IASB are working together on the conceptual framework. Answer: FALSE Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The FASB is currently working on the objectives of financial reporting and presentation. Answer: FALSE Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Before issuing a new standard, the standard setters weigh constraints, which may deter requiring the new standard. Answer: TRUE Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Based on the information in the textbook at the time of printing, the FASB has completed the conceptual framework chapters on the objective of financial reporting, qualitative characteristics, and notes to the financial statements. Answer: TRUE Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) What is the primary purpose of the conceptual framework? A) to override accounting standards B) to assist standard setters in developing and revising accounting standards C) to revise the objective of financial reporting D) All of the above Answer: B Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) The conceptual framework assists with ________. A) the development of a set of standards which provide absolute answers for accounting questions B) the development of a set of standards for auditors to use when looking for material misstatements or fraud C) the development of a set of standards which ensure that accounting standards are coherent and uniform D) All of the above Answer: C Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Which of the following is not a purpose of FASB's conceptual framework? A) aid in development of new standards B) support understanding of accounting standards C) assist with revision of accounting standards D) override existing accounting standards Answer: D Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) ________ are identical under U.S. GAAP and IFRS. A) Elements and Recognition B) Presentation and Disclosure C) Objective and Qualitative Characteristics D) Subjective and Quantitative Characteristics Answer: C Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) When developing new standards, the standard setters must first determine ________. A) which elements of the financial statements are affected by the proposed standard B) if the proposed standard possesses the qualitative characteristics that make accounting information useful C) if the proposed standard meets the objective of financial reporting D) which recognition and measurement concepts are used to support the proposed standard Answer: C Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) When developing a new proposed accounting standard, after FASB has determined that the proposed standard meets the objective of financial reporting, the next step in the development process is to ________. A) determine which elements of the financial statements are affected by the proposed standard B) consider whether the proposed standard possesses the qualitative characteristics that make accounting information useful C) weigh constraints on issuing the new standard, which may deter requiring the new standards D) identify recognition and measurement concepts used to support the proposed standard Answer: B Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Which of the following best characterizes the current situation concerning revisions to the conceptual framework? A) The FASB is considering revisions to their conceptual framework but IASB is not. B) The IASB is considering revisions to the conceptual framework but FASB is not. C) The FASB and the IASB are working independently on their conceptual frameworks. D) The FASB and the IASB are working cooperatively on a single conceptual framework. Answer: C Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) All of the following are components of the conceptual framework for financial reporting except ________. A) qualitative characteristics B) standards C) principles of recognition and measurement D) elements of the financial reporting system Answer: B Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) The IASB and FASB share the goal that standards will be based on an agreed set of fundamental ________. A) practices B) constraints C) standards D) concepts Answer: D Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) When comparing FASB's Conceptual Framework to the IASB's Conceptual Framework, ________. A) the objective and qualitative characteristics are closely related B) FASB includes an additional chapter on Financial Statements and the Reporting Entity C) FASB includes an additional chapter on Concepts of Capital and Capital Maintenance D) All of the above Answer: A Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) The purpose of the conceptual framework is to provide guidance to ________. A) preparers of financial statements B) auditors C) standard setters D) CEOs Answer: C Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) List the active phases in the FASB conceptual framework project. Answer: Three active phases in the FASB conceptual framework project are: - Elements - Measurement - Presentation Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) List the completed phases in the FASB conceptual framework project. Answer: Three completed phases in the FASB conceptual framework project are: - Objective - Qualitative Characteristics - Notes to the Financial Statements Diff: 1 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Discuss how standard setters use the conceptual framework in developing new standards. Answer: Standard setters will: - Determine if the proposed standard meets the objective of financial reporting. - Establish that the information provided by the new standard possesses qualitative characteristics that make accounting information useful. - Consider the elements of the financial statements affected and the recognition and measurement concepts used to support the new standard. - Weigh constraints such as the cost and benefit of issuing the new standard, which may deter requiring the new standard. Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) List the three primary components of the conceptual framework for financial reporting and the two subcomponents of each component. Answer: The primary components of the conceptual framework for financial reporting and related subcomponents are: • Qualitative characteristics - Fundamental characteristics - Enhancing characteristics • Elements - Point-in-time elements - Period-of-time elements • Principles - Recognition - Measurement Diff: 2 Objective: 2.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2.2

The Objective of Financial Reporting

1) The conceptual framework defines the objective of financial reporting as providing financial information that is useful to existing and potential investors, lenders, and other creditors in making decisions. Answer: TRUE Diff: 1 Objective: 2.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The conceptual framework indicates that the primary users of financial information are investors, lenders, and other creditors who cannot demand information from the entity. Answer: TRUE Diff: 1 Objective: 2.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Which of the following is not considered to be a primary user of financial information for which financial reporting standards are designed? A) creditors that are suppliers B) investors such as stockholders and bondholders C) regulators D) lenders such as banks Answer: C Diff: 2 Objective: 2.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Which of the following types of information is not a focus of the primary objective of financial reporting? A) information that helps a banker decide to provide a loan B) information that helps a manager assess the efficiency and effectiveness of operations C) information that helps a creditor evaluate the amount and timing of cash flows of its customers D) information that helps an investor form an opinion about a company's future cash flows Answer: B Diff: 2 Objective: 2.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) ________ is the careful and responsible management of something entrusted in one's care. A) Regulation B) Stewardship C) Financial planning D) Financial reporting Answer: B Diff: 1 Objective: 2.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Who are the primary users of financial information? Discuss how FASB and IASB take them into account. Answer: Primary users are investors, lenders, and other creditors that cannot demand information from the entity. Whereas a large creditor such as Bank of America may be able to demand certain information that meets their needs, many investors and creditors may not have that same ability. As a result, when making decisions regarding the conceptual frameworks, the boards consider the needs of these groups. Diff: 2 Objective: 2.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

7) What is the purpose of the conceptual framework? Answer: The purpose of the conceptual framework is to establish objectives and fundamental concepts that are the basis for developing and revising financial accounting and reporting standards. Diff: 1 Objective: 2.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Frank Smith is a student getting his degree in business administration. He does not like his accounting class very much, and doesn't understand why he needs to study accounting — stating "I'm never going to be an accountant — why do I need to know this?" Explain to Frank why it is important for business students to learn about accounting and give examples. Answer: Answers will vary — should include discussion on accountability and transparency. Other points could be the need to talk intelligently with their accountant, to know which gauges to watch (and be able to understand their meaning and consequence), and be able to identify economic events that could impact the company. (If open book exam, they could reference the interview with Paul Pacter from Section 2.2.) Diff: 2 Objective: 2.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

2.3

The Qualitative Characteristics of Financial Information

1) The two types of qualitative characteristics are fundamental characteristics and elective characteristics. Answer: FALSE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The role of qualitative characteristics in the conceptual framework is to increase the decision usefulness of financial information. Answer: TRUE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Information exhibits the characteristic of faithful representation if it is complete, neutral, and free from error. Answer: TRUE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Information is relevant if it reliably depicts the substance of an economic event. Answer: FALSE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Information has predictive value if it provides feedback about prior evaluations. Answer: FALSE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Information that is not material is never relevant. Answer: TRUE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Verifiability is a characteristic of faithful representation. Answer: FALSE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Relevance is an enhancing characteristic of financial information. Answer: FALSE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Information that is not accurate can be considered faithfully representative. Answer: FALSE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Materiality cannot always be expressed quantitatively and sometimes requires professional judgment. Answer: TRUE Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) In the conceptual framework, what are the two types of qualitative characteristics of financial information? A) fundamental and enhancing B) point-in-time and period-of-time C) recognition and measurement D) elements and principles Answer: A Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) The two fundamental characteristics of financial information are ________. A) comparability and understandability B) relevance and timeliness C) reliability and faithful representation D) faithful representation and relevance Answer: D Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Information that is reported free from error ________. A) contains no mistakes or omissions in the description of an event or in the process used to produce financial information B) is accurate in all respects C) does not include estimates D) All of the above Answer: A Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) ________ characteristics distinguish useful financial information from information that is not useful. A) Representative B) Relevant C) Fundamental D) Quantitative Answer: C Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) What are the attributes of relevant information? A) predictive value, timeliness, free from error B) materiality, predictive value, and confirmatory value C) comparability, verifiability, and predictive value D) complete, neutral, free from error Answer: B Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Which of the following is not a characteristic of relevance? A) confirmatory value B) materiality C) free from error D) predictive value Answer: C Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) ________ indicates whether financial information depicts an economic event in a way that is complete, neutral, and free from error. A) Relevance B) Faithful representation C) Verifiability D) Truthfulness Answer: B Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Which of the following is a characteristic of faithful representation? A) timely B) comparable C) material D) complete Answer: D Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) The attribute ________ relates to information that is relevant. A) comparative value B) predictive value C) neutrality D) verifiability Answer: B Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) All of the following are enhancing characteristics except ________. A) understandability B) verifiability C) consistency D) comparability Answer: C Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) ________ means that a group of reasonably informed financial statement users are able to reach a consensus decision that reported information is a faithful representation of an underlying economic event. A) Comparability B) Verifiability C) Understandability D) Freedom from error Answer: B Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Financial statements should provide all financial information that is relevant and faithfully representative within the limitations of the ________ constraint. A) benefit B) materiality C) usefulness D) cost Answer: D Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) Baxter Company issues its annual financial reports within one month of the end of the year. This is an example of which enhancing quality of accounting information? A) confirmatory value B) relevance C) verifiability D) timeliness Answer: D Diff: 1 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

24) Southcoast Warehousing Inc. reported earnings per share of $3.41. This surpassed the average analyst forecast of $2.90. This information has ________ to users of financial information. A) confirmatory value B) comparable value C) consistent value D) both A & C Answer: A Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

25) Coffee Mugs Inc. is aware that a large portion of its receivables may become uncollectible because the customer is in talks for bankruptcy. By choosing not to disclose this information, the information provided in the statements ________. A) is not verifiable B) does not faithfully represent the firm's financial position C) both A & B D) neither A nor B Answer: B Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

26) Which of the following characteristics is fulfilled by separating current and noncurrent assets on the balance sheets? A) relevance B) faithful representation C) comparability D) understandability Answer: D Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) Do you agree or disagree with the following statement: "Financial statements that are free from error are accurate." Explain your answer. Answer: A financial statement that is free from error is not the same thing as an accurate statement. The nature of accrual accounting is one that relies on estimates; therefore, when saying information reported is free from error, it is really referring to the process used to generate the financial statements being error-free. The amounts reported may be different than the actual amounts because they rely on estimates. Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

28) What is the cost constraint and how does it affect financial reporting? Answer: The conceptual framework stipulates that standard setters should compare the cost of requiring information to the benefits derived from presenting this information when developing accounting standards. The FASB and the IASB must determine that the costs of implementing a standard will not exceed the benefits that might be derived from it. Standard setters consider costs for both financial statement reporters and users. To be reported, accounting information not only must be relevant and faithfully represented but it also must pass an economic test by satisfying the cost constraint. Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

29) Caesar & Company is planning a major expansion, and is in negotiations with their bank for a loan. The bank requested that Caesar & Co provide them with financial statements as soon as possible after the end of the year. Caesar & Co has several suppliers that are slow to submit invoices, so they are considering making estimates for the amounts associated with those liabilities in order to expedite the preparation of the financial statements for the bank. Discuss the qualitative characteristics that they need to consider. Answer: This will be a trade-off between faithful representation and timeliness. By estimating the amounts for the liabilities, the statements will be less faithfully representative — because the associated invoices will not be available. To be faithfully representative, information must be complete, neutral and free from error. Estimates of the liabilities may not be free of error. However, this will allow them to prepare the statements quickly — and timeliness stipulates that financial information is available to users early enough to assist with decision making. Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

30) Complete the following table — identify which fundamental characteristic and which attribute are indicated in each independent scenario.

Scenario Moss Inc.'s accountant has verified that all equipment has been depreciated according to the company's depreciation schedule. Cross & Grant Company includes in a note all relevant details relating to the company's equipment — including depreciation method, estimated useful life, historical cost, and accumulated depreciation. Excellent Foundation discloses plans to dispose of a major operating segment. TLR Studios discloses information relating to a pending lawsuit that is likely to have an unfavorable outcome.

Fundamental Characteristics

Attribute

Answer: Fundamental Scenario Characteristics Attribute Moss Inc.'s accountant has verified that all Faithful equipment has been depreciated according Free from error Representation to the company's depreciation schedule. Cross & Grant Company includes in a note all relevant details relating to the company's equipment — including depreciation Faithful Representation Complete method, estimated useful life, historical cost, and accumulated depreciation. Excellent Foundation discloses plans to Relevance Materiality dispose of a major operating segment. TLR Studios discloses information relating to a pending lawsuit that is likely to have an Faithful Representation Neutral unfavorable outcome. Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

31) Complete the following table — identify which enhancing characteristic is indicated in each independent scenario and whether it was satisfied or violated.

Scenario Search Engine Corporation reports the historical cost of its archery park on the balance sheet. Creighton's Fine Products produces very basic financial statements, without classification or notes. They do have complicated lease and borrowing agreements, and have changed depreciation estimates. Realistic Ventures Company switched to fair value accounting for standing timber, which is the method used by most companies in the industry. Roy & Quinn's Lakeside Properties provides financial statement information every other year.

Enhancing Characteristics

Satisfied or Violated

Answer: Enhancing Characteristics

Scenario Search Engine Corporation reports the historical cost of its archery park on the Verifiability balance sheet. Creighton's Fine Products produces very basic financial statements, without classification or notes. They do have Understandability complicated lease and borrowing agreements, and have changed depreciation estimates. Realistic Ventures Company switched to fair value accounting for standing timber, which Comparability is the method used by most companies in the industry. Roy & Quinn's Lakeside Properties provides financial statement information every other Timeliness year.

Satisfied or Violated Satisfied

Violated

Satisfied

Violated

Diff: 2 Objective: 2.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

2.4

Elements of Financial Reporting

1) U.S. GAAP and IFRS identify the same seven period-of-time elements. Answer: FALSE Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) U.S. GAAP and IFRS identify the same three point-in-time elements. Answer: TRUE Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) According to U.S. GAAP, elements are categorized by whether they are relevant or faithfully representative. Answer: FALSE Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) According to IFRS, point-in-time elements include assets, liabilities, and equity. Answer: TRUE Diff: 1 Objective: 2.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

5) According to IFRS, period-of-time elements include income, expenses, performance, and transactions with owners. Answer: FALSE Diff: 1 Objective: 2.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) Comprehensive income is the residual interest in the assets of an entity that remains after deducting its liabilities. Answer: FALSE Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) According to U.S. GAAP, period-of-time elements include performance, income, expenses, and capital maintenance adjustments. Answer: FALSE Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) IFRS does not treat transactions with owners as separate elements. Answer: TRUE Diff: 1 Objective: 2.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

9) The IFRS element Income is identical to the GAAP element comprehensive income. Answer: FALSE Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) According to IFRS, two type of income would be revenues and gains. Answer: TRUE Diff: 2 Objective: 2.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

11) In the conceptual framework, what are the two types of elements of financial reporting? A) fundamental and enhancing B) point-in-time and period-of-time C) recognition and measurement D) elements and principles Answer: B Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Under U.S. GAAP, comprehensive income includes which of the following? A) Investments by Owners No

Operating Income Yes

B) Investments by Owners Yes

Operating Income No

C) Investments by Owners No

Operating Income No

D) Investments by Owners Yes

Operating Income Yes

Answer: A

Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) According to the FASB's conceptual framework, gains include increases in equity from which of the following activities? A) Investments by Owners Peripheral Transactions Yes No B) Investments by Owners Peripheral Transactions Yes Yes C) Investments by Owners Peripheral Transactions No No D) Investments by Owners Peripheral Transactions No Yes Answer: D

Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Which term is described as the building blocks of the financial statements? A) fundamental characteristics B) enhancing characteristics C) elements D) assets Answer: C Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

15) ________ elements appear on the balance sheet. A) Period-of-time B) Point-in-time C) Piece-of-time D) Phase-in-time Answer: B Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Under U.S. GAAP, ________ is an example of a period-of-time element and appears on the ________. A) accounts receivable; balance sheet B) depreciation expense; statement of shareholders' equity C) salary payable; balance sheet D) sales revenue; income statement Answer: D Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) IFRS and U.S. GAAP both identify assets as ________ elements. A) phase-in-time B) period-of-time C) point-in-time D) piece-of-time Answer: C Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) U.S. GAAP identifies ________ point-in-time elements. A) two B) three C) four D) five Answer: B Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) U.S. GAAP identifies ________ period-in-time elements. A) four B) five C) six D) seven Answer: D Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) IFRS identifies ________ point-in-time elements. A) one B) three C) five D) seven Answer: B Diff: 1 Objective: 2.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

21) IFRS identifies ________ period-in-time elements. A) two B) four C) five D) seven Answer: A Diff: 1 Objective: 2.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

22) According to U.S. GAAP, changes in equity that result from the company's central business operations are ________. A) revenues and gains B) gains and losses C) revenues and expenses D) losses and expenses Answer: C Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Which of the following terms describe probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events? A) performance B) income C) equity D) asset Answer: D Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) ________ include(s) all changes in equity during a period except those resulting from transactions with owners. A) Performance B) Revenues C) Comprehensive income D) Period-of-time elements Answer: C Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Which element of the financial statements results from peripheral or incidental transactions? A) gains B) revenues C) equity D) liabilities Answer: A Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Which of the following statements is not true about distributions to owners? A) Distributions to owners represent a decrease in equity. B) Distributions to owners result from incurring liabilities by the enterprise to owners. C) Distributions to owners are included in other comprehensive income. D) Distributions to owners result from rendering services by the enterprise to owners. Answer: C Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) The primary distinction between expenses and losses is ________. A) the verifiability of the transactions B) the nature of the activities that bring about the transactions C) the timing of the transactions D) the amount and materiality of the transactions Answer: B Diff: 1 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) IFRS identifies two period-of-time elements as ________. A) Assets and Liabilities B) Assets and Equity C) Income and Expenses D) Revenues and Gains Answer: C Diff: 1 Objective: 2.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

29) The IFRS element income relates to which U.S. GAAP element(s)? A) comprehensive income B) cash flows and gains C) revenues and expenses D) revenues and gains Answer: D Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

30) The IFRS element expenses encompasses which U.S. GAAP elements? A) revenues and expenses B) losses and expenses C) gains and expenses D) expenses only Answer: B Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

31) A period-of-time element under GAAP that increases equity in a business by transferring something of value from other entities is ________. A) Distribution to owners B) Investments by owners C) Gains D) Revenues Answer: B Diff: 2 Objective: 2.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

32) Which of the following is a point-in-time element? A) Income B) Liabilities C) Expenses D) Distributions to owners Answer: B Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

33) Which of the following is a period-of-time element? A) Liabilities B) Equity C) Assets D) Gains Answer: D Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

34) Which of the following is a point-in-time element? A) Fees Earned B) Notes Payable C) Cost of Goods Sold D) Dividends Answer: B Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

35) Which of the following is a period-of-time element? A) Unearned Revenue B) Common Stock C) Accounts Receivable D) Gain on the Disposal of Equipment Answer: D Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

36) What is the relationship between the point-in-time elements and the period-of-time elements? Answer: The period-of-time elements provide a way to describe how the point-in-time elements change during the accounting period. Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

37) What is equity and how does it change during a period of time? Answer: Equity is the residual interest in the assets of an entity that remains after deducting its liabilities. It changes when there are investments by the owners, distributions to the owners, and increases or decreases in comprehensive income. Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

38) Explain comprehensive income in terms of other elements of the financial statements. Answer: Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. That is, comprehensive income includes revenues, expenses, gains, and losses, and all other changes to equity not resulting from transactions with the owners. Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Reflective thinking

39) Identify the element, and whether it is point-in-time or period-of-time.

Definition Element Increases in equity (net assets) from peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity with the exception of revenues or investments by owners. Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Increases in equity resulting from transfers to it from other entities of something valuable to obtain or increase ownership interests (or equity) in it. Outflows or other consumption of assets, incurrence of liabilities, or both — from delivering or producing goods, rendering services, or carrying out other activities that constitute the company's ongoing major or central operations.

Point-in-time or Period-of-time

Answer: Definition Element Increases in equity (net assets) from peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity with the exception of revenues or investments by owners. Gains Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Assets Increases in equity resulting from transfers to it from other entities of something valuable to obtain Investments by or increase ownership interests (or equity) in it. Owners Outflows or other consumption of assets, incurrence of liabilities, or both — from delivering or producing goods, rendering services, or carrying out other activities that constitute the company's ongoing major or central operations. Expenses Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

Point-in-time or Period-of-time

Period-of-time

Point-in-time

Period-of-time

40) Identify the element, and whether it is point-in-time or period-of-time. Point-in-time or Period-of-time

Definition Element Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. The change in equity of a business during a period from transactions and other events and circumstances from nonowner sources. The net assets or residual interest in the assets of an entity that remains after deducting its liabilities. Answer:

Point-in-time or Period-of-time

Definition Element Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. Liabilities Point-in-time The change in equity of a business during a period from transactions and other events and circumstances from nonowner sources. Comprehensive income Period-of-time The net assets or residual interest in the assets of an entity that remains after deducting its liabilities. Equity Point-in-time Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

41) Identify the element, and whether it is point-in-time or period-of-time. Point-in-time or Period-of-time

Definition Element Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Decreases in equity resulting from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. Decreases in equity (net assets) from peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity except those that result from expenses or distributions to owners. Inflows or other enhancements of an entity's assets, settlements of liabilities, or both, from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations. Answer:

Point-in-time or Period-of-time

Definition Element Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Assets Point-in-time Decreases in equity resulting from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. Distribution to Owners Period-of-time Decreases in equity (net assets) from peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity except those that result from expenses or distributions to owners. Losses Period-of-time Inflows or other enhancements of an entity's assets, settlements of liabilities, or both, from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations. Revenues Period-of-time Diff: 2 Objective: 2.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2.5

Principles of Recognition and Measurement

1) The FASB and IASB are converged in general recognition principles. Answer: FALSE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Recognition is the process of reporting an economic event in the financial statements. Answer: TRUE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The cost constraint means that an item is not recognized in the financial statements unless its omission would significantly influence the judgment of an informed user. Answer: FALSE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The major difference between cash and accrual accounting is the timing of revenue and expense recognition. Answer: TRUE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Under the principles of accrual accounting, revenues are considered earned when a company exchanges a good or service for cash or claims for cash. Answer: FALSE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) According to the expense recognition principle in U.S. GAAP, firms recognize expenses when only one requirement is met: an asset has a reduced future benefit or when a liability is incurred or increased without an associated economic benefit. Answer: FALSE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Current cost is the amount of cash received in exchange for an asset less the direct costs of disposal. Answer: FALSE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) U.S. GAAP does not allow companies to prepare financial statements using a cash-basis system. Answer: TRUE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Quoted prices in active markets are the measure of fair value that is neither the most observable nor the least observable. Answer: FALSE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Revenue and expense recognition under the current IFRS conceptual framework is the same as under the U.S. GAAP conceptual framework. Answer: FALSE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Unobservable values cannot be used to report the fair value of assets and liabilities in the financial statements. Answer: FALSE Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Which of the following is not an underlying principle of accrual accounting? A) bases of measurement B) monetary unit assumption C) revenue and expense recognition D) general recognition Answer: B Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) The process of reporting an economic event in the financial statements is known as ________. A) recording B) writing C) recognition D) transcribing Answer: C Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Which of the following is not one of the four general recognition criteria under U.S. GAAP? A) relevant B) measurable C) reliable D) material Answer: D Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) Under IFRS, which of the following is not a criterion for recognizing items in the financial statements? A) The item is measurable with a high degree of certainty. B) The item is relevant. C) The item meets the definition of an element. D) Economic benefits from the item are probable. Answer: D Diff: 1 Objective: 2.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

16) A Fortune-500 company purchases a new clock for $35. The clock is expected to last for five years. According to the materiality threshold, this would be treated as an ________ in the accounting records. A) asset B) expense C) equipment D) none of the above Answer: B Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Under IFRS, which of the following is considered to be a measure of current cost? A) systematic value B) direct cost C) present value of future cash flows D) historical cost Answer: C Diff: 1 Objective: 2.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

18) Under U.S. GAAP, what is a condition for revenue to be realized or realizable? A) Cash or fixed claims to cash are received. B) Contracts are written as per negotiations. C) The company exchanges a good or service. D) Both A & C Answer: D Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Under U.S. GAAP, revenues are considered ________ when the seller has accomplished what it must do to be entitled to the revenues. A) recognized B) earned C) realized D) entitled Answer: B Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) IFRS includes ________ as bases of measurement. A) present value of future cash flows and historical cost B) historical cost and net realizable value C) historical cost and current value D) net realizable value and current value Answer: C Diff: 1 Objective: 2.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

21) Under IFRS, revenue is recognized simultaneously with ________. A) increases in assets or increases in liabilities B) decreases in assets or increases in liabilities C) increases in assets or decreases in liabilities D) decreases in assets or decreases in liabilities Answer: C Diff: 2 Objective: 2.5 IFRS/GAAP: IFRS AACSB: Analytical thinking

22) Under the U.S. GAAP, which of the following is not an approach used to determine when to report an expense? A) systematic allocation B) when incurred C) match with revenues D) net realizable value Answer: D Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) U.S. GAAP identifies ________ measurement bases used in financial reporting and IFRS identifies ________. A) three; four B) four; two C) five; two D) four; three Answer: C Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) The ________ cost is the amount of cash (or equivalent) that a firm paid to acquire an asset, whereas ________ is the amount the firm would pay if the asset were purchased today. A) historical; current cost B) present value; current market value C) historical; current market value D) realized; present value Answer: A Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) ________ is the amount of cash that the firm actually paid to acquire an asset. A) Current market value B) Current cost C) Historical cost D) Net realizable value Answer: C Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

26) When the buyer and seller are unrelated and independent, the transaction is considered to be ________. A) a bad deal B) an arms-length transaction C) an independent contract D) a bribe Answer: B Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Are the identified measurement bases consistent with fair value reporting? A) Current market value Yes

Net realizable value No

B) Current market value No

Net realizable value No

C) Current market value Yes

Net realizable value Yes

D) Current market value No

Net realizable value Yes

Answer: C

Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) When deciding how to measure the fair value of an asset or liability, there is sometimes a trade-off between ________. A) understandability and comparability B) faithful representation and neutrality C) verifiability and neutrality D) relevance and faithful representation Answer: D Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

29) ________ accounting measures cash receipts and disbursements, leaving out economic activity. A) Accrual B) Cash-basis C) Cloud D) Historic Answer: B Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

30) ________ accounting measures noncash transactions. A) Accrual B) Cash-basis C) Cloud D) Historic Answer: A Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) Purrfect Pets, Inc. provides animal daycare for $29 per day. Customers buy three month packages, which provide 15 days of care per month. In January they received cash payments from 10 customers. For the month of January, they will recognize ________ of revenue under the cash basis, and ________ of revenue under the accrual basis. A) $435; $1305 B) $13,050; $13,050 C) $13,050; $4350 D) $4350; $4350 Answer: C Explanation: Cash basis they recognize the cash received ($29 × 45 days × 10 customers = $13,050); accrual basis they recognize the revenue of the 15 days of care provided that month ($29 × 15 days × 10 customers = $4350). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

32) Purrfect Pets, Inc. provides animal daycare for $31 per day. Customers buy three month packages, which provide 15 days of care per month. In January, they received cash payments from 13 customers. For the month of February, they will recognize ________ of revenue under the cash basis, and ________ of revenue under the accrual basis. A) $0; $403 B) $6045; $6045 C) $403; $403 D) $0; $6045 Answer: D Explanation: Cash basis is zero, because no cash was collected during February. Accrual basis they recognize the revenue for the 15 days of care provided that month ($31 × 15 days × 13 customers = $6045). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

33) Shadow's Cleaning Service provides weekly cleaning services for $41 per week. In January, they collected payments from 60 customers for 3 months (12 weeks) of service each. For the month of January, they will recognize ________ of revenue under the cash basis, and ________ under the accrual basis. A) $2460; $720 B) $3180; $0 C) $9840; $29,520 D) $29,520; $9840 Answer: D Explanation: Using cash basis they recognize what is collected in January ($41 × 12 weeks × 60 customers = $29,520). Using the accrual basis they recognize what was earned in January ($41 × 4 weeks × 60 customers = $9840). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

34) Shadow's Cleaning Service provides weekly cleaning services for $48 per week. In January, they collected payments from 57 customers for 3 months (12 weeks) of service each. For the month of February, they will recognize ________ of revenue under the cash basis, and ________ under the accrual basis. A) $0; $10,944 B) $10,944; $10,944 C) $10,944; $32,832 D) $32,832; $10,944 Answer: A Explanation: Using cash basis they recognize what is collected in February — which was zero. Using the accrual basis they recognize what was earned in February ($48 × 4 weeks × 57 customers = $10,944). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

35) Southeast Industries Inc. charges $185 per month for a storage unit. In the first quarter of the year, they collected $9065. Ten customers pre-paid for three months' rental in January, seven customers prepaid for two months rental in February, and five customers paid for one month rental in March. Using the cash basis of accounting, Southeast will recognize ________ in revenue for January and ________ using the accrual basis. A) $9065; $5550 B) $5550; $9065 C) $1850; $5550 D) $5550; $1850 Answer: D Explanation: Cash basis recognizes the cash collected in January ($185 × 3 months × 10 people = $5550). Accrual recognizes the amount earned in January ($185 for January × 10 people = $1850). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

36) Southern Light Container Corp. charges $105 per month for a storage unit. In the first quarter of the year, they collected $5145. Ten customers pre-paid for three months' rental in January, seven customers pre-paid for two months rental in February, and five customers paid for one month rental in March. Using the cash basis of accounting, Southern will recognize ________ in revenue for February and ________ using the accrual basis. A) $0; $735 B) $735; $1470 C) $1470; $1785 D) $1785; $2520 Answer: C Explanation: Cash basis recognizes cash collected in February ($105 × 2 months × 7 people = $1470). Accrual recognizes the amount earned in February ($105 for February × 17 people = $1785). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

37) Southern Light Containers charges $125 per month for a storage unit. In the first quarter of the year, they collected $6125. Ten customers pre-paid for three months' rental in January, seven customers prepaid for two months rental in February, and five customers paid for one month rental in March. Using the cash basis of accounting, Southern will recognize ________ in revenue for March and ________ using the accrual basis. A) $0; $3375 B) $625; $0 C) $1250; $2500 D) $625; $2750 Answer: D Explanation: Cash basis recognizes cash collected in March ($125 × 1 month × 5 people = $625). Accrual recognizes the amount earned in March ($125 for March × 22 people = $2750). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

38) Angelo's charges $280 per month for catering services. In the first quarter of the year, they collected $19,600. Fifteen customers pre-paid for three months of catering beginning in January, ten customers pre-paid for two months of catering beginning in February, and five customers paid for one month of catering in March. Using the cash basis of accounting, Angelo's will recognize ________ in revenue for January and ________ using the accrual basis. A) $4200; $0 B) $7000; $4200 C) $12,600; $4200 D) $0; $12,600 Answer: C Explanation: Cash basis recognizes cash collected in January ($280 × 3 months × 15 customers = $12,600). Accrual basis recognizes the amount earned in January ($280 for January × 15 customers = $4200). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

39) Angelo's charges $240 per month for catering services. In the first quarter of the year, they collected $16,800. Fifteen customers pre-paid for three months of catering beginning in January, ten customers pre-paid for two months of catering beginning in February, and five customers paid for one month of catering in March. Using the cash basis of accounting, Angelo's will recognize ________ in revenue for February and ________ using the accrual basis. A) $0; $3600 B) $4800; $6000 C) $3600; $7200 D) $4800; $0 Answer: B Explanation: Cash basis recognizes cash collected in February ($240 × 2 months × 10 customers = $4800). Accrual basis recognizes the amount earned in February ($240 for February × 25 customers = $6000). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

40) Angelo's charges $280 per month for catering services. In the first quarter of the year they collected $19,600. Fifteen customers pre-paid for three months of catering beginning in January, ten customers pre-paid for two months of catering beginning in February, and five customers paid for one month of catering in March. Using the cash basis of accounting, Angelo's will recognize ________ in revenue for March and ________ using the accrual basis. A) $0; $1400 B) $8400; $1400 C) $1400; $0 D) $1400; $8400 Answer: D Explanation: Cash basis recognizes cash collected in March ($280 × 1 month × 5 customers = $1400). Accrual basis recognizes the amount earned in March ($280 for March × 30 customers = $8400). Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

41) Sydney & Caesar Law Firm uses the accrual basis to keep their accounting records. During 2022, they collected $460,000 from clients. On December 31, 2021 they had accounts receivable of $50,000. On December 31, 2022 they had accounts receivable of $70,000 and unearned revenue of $27,000. Using the accrual basis, how much is Sydney & Caesar Law Firm's service revenue for 2022? A) $410,000 B) $467,000 C) $453,000 D) $480,000 Answer: C Explanation: $460,000 cash collected - $50,000 A/R earned in 2021 + $70,000 A/R earned in 2022 - $27,000 unearned = $453,000 Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

42) TLR Consulting keep their accounting records using the accrual basis. During 2022, they collected $425,000 from clients. On December 31, 2021 they had accounts receivable of $61,000 and on December 31, 2022 they had accounts receivable of $46,000. Additionally, they had unearned revenues of $7000. Using the accrual basis of accounting, what did TLR Consulting earn in service fees for 2022? A) $403,000 B) $417,000 C) $433,000 D) $447,000 Answer: A Explanation: $425,000 cash collected - $61,000 A/R earned in 2021 + $46,000 A/R earned in 2022 - $7000 unearned = $403,000 Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

43) Hanker LLC uses the accrual basis to keep his accounting records. During 2022, he collected $374,000 from clients. At December 31, 2021 he had accounts receivable of $139,000. At December 31, 2022 he had accounts receivable of $164,000 and unearned revenue of $41,000. What did Hanker LLC earn in service revenue for 2022 using the accrual basis of accounting? A) $194,000 B) $308,000 C) $349,000 D) $358,000 Answer: D Explanation: $374,000 cash collected - $139,000 A/R earned in 2021 + $164,000 A/R earned in 2022 $41,000 unearned = $358,000 Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

44) On May 2, Johnson's Landscaping LLC paid $4700 for repairs made to equipment during April. During May fuel costs for its machinery were $5800 to be paid in June. Johnson's lawn mowers were depreciated for May by an amount of $1000 using the straight-line method. What would be the company's equipment-related expenses for May under cash accounting and what would the expenses be under the accrual basis for May? A) $10,500 under both cash and accrual basis B) $4700 under cash basis; $5800 under accrual basis C) $4700 under the cash basis; $6800 under the accrual basis D) $4700 under the cash basis; $10,500 under accrual basis Answer: C Explanation: The only cash outlay for expenses in May is $4700. Under accrual basis, expenses are recognized when incurred — regardless of when the cash is paid. Therefore, the expenses for May are $6800 ($5800 for fuel and $1000 for depreciation.) Depreciation is a noncash expense. Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

45) On April 2, the salaried employees of LaSalle Company receive their paychecks representing 8 workdays in March and 2 days in April for a total gross pay of $15,000. Other expenditures paid in April include advertising from March of $500 and property taxes for the first quarter of the year of $5700. Property taxes for the second quarter are also expected to be $5700. The company's vehicle was repaired on April 1 for an amount of $460 to be paid May 1. What are the expenses for April under the cash accounting method and what would they be under accrual basis accounting? A) $21,200 under both cash and accrual basis B) $21,200 under cash basis and $5360 under accrual basis accounting C) $15,000 under the cash basis; $6660 under the accrual basis D) $12,000 under the cash basis; $12,460 under accrual basis Answer: B Explanation: The cash outlays for expenses in April total $21,200 ($15,000 salaries + $500 advertising + $5700 property taxes). Under accrual basis, expenses are recognized when incurred – regardless of when the cash is paid. Therefore, the expenses for April are $5360 ($15,000 × 2/10 = $3000 of salary for April + $460 of vehicle repairs + $1900 property taxes ($5700/3)). Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

46) Axe Furniture and Accessories Inc. sold an oak custom-designed harvest table for $4,000 on July 31, 2022. The wood, labor, and overhead costs of $1,200 were incurred during the three months leading up to the sale (May, June, and July). Under the expense recognition principle, which of the following statements would be true? A) The costs of $1,200 should be expensed as cost of goods sold in the month of July under the concept of matching costs with related revenue in the period the revenue occurred. B) The costs of $1,200 should be systematically recognized by spreading the costs as cost of goods sold over the three months that the production of the table took place. C) The cost of the table should not be recognized as an expense as it is an asset called merchandise inventory and therefore it is a point-in-time element. D) The cost of the table should be recognized as cost of goods sold in the earliest period in which the company knew that the table would eventually be sold and, in this case, that would be in May. Answer: A Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

47) Materially (significantly) large amounts of supplies should be recognized as an expense under which of the following approaches? A) when purchased B) upon use in operations C) strictly as a function of time D) in a systematic allocation as services of laborers are performed Answer: B Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

48) Depreciation expense is recognized over time and systematically allocated over the periods of use of the related asset. When depreciation expense is recognized, what related balance sheet line item is also impacted? A) Equipment B) Machinery C) Accumulated Depreciation D) Supplies Answer: C Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

49) Yellow Pencil Company pays Helen, a staff accountant, a $10,000 a month salary. How should the salary be recognized as an expense? A) matched with revenue earned by the Yellow Pencil Company B) systematically allocated with the use of the pencil making machinery of the Yellow Pencil Company factory C) upon the sale of pencils and in proportion to those sales D) recorded as a measure of the effort expended by the staff accountant in the periods in which she works Answer: D Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

50) In using fair value as a measurement for assets, a company ________. A) would always use level 1 inputs B) ideally would use level 1 inputs but if that is not possible would use the highest level of reliability possible C) would calculate the present value of the expected future cash flows of the asset and use that as a measure regardless of what other inputs are available D) would only value an asset with input levels 1 or 2 if the asset is impaired Answer: B Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

51) Identify the three main approaches to expense recognition under U.S. GAAP and provide examples of each. How does IFRS expense recognition principles differ? Answer: Under U.S. GAAP, the three main approaches are to match the expense with the related revenue, to expense it in the period incurred, or to systematically allocate the expense over periods of use. An example of matching the expense to the revenue would be matching the cost of goods sold expense to the related revenue recognized when the inventory is sold. Expensing in the period incurred would be recording supplies expense during the period that they were consumed. Depreciating a piece of equipment over its useful life is an example of systematic allocation. Under current IFRS conceptual framework, firms recognized expenses in the income statement at the same time as the initial recognition or increase of a liability or the derecognition or decrease in an asset. IFRS does not use the matching approach for expense recognition. Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

52) Under the new revenue standard, what drives the measurement and timing of revenue recognition? Answer: Companies should recognize revenue when there is a transfer of control of goods or services. This occurs when a company satisfies its performance obligations specified in the contract with a customer. Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Reflective thinking

53) Identify the measurement base described in each definition, then indicate whether it applies to U.S. GAAP, IFRS, or both. U.S. GAAP or IFRS or both

Definition Measurement Base The amount of cash (or equivalent) to be received in exchange for an asset, less the direct costs of disposal. In the case of a liability, it is the amount of cash (or equivalent) expected to be paid to liquidate the obligation, including any direct costs of liquidation. The amount of cash (or equivalent) that the firm would receive by selling the asset in an orderly liquidation. The amount of cash (or equivalent) that the firm paid to acquire the asset. In the case of a liability, this is the amount that the firm received when it incurred the obligation. The amount of cash (or equivalent) that would be required if the firm acquired the asset currently. Answer: Definition Measurement Base The amount of cash (or equivalent) to be received in exchange for an asset, less the direct costs of disposal. In the case of a liability, it is the amount of cash (or Net realizable value equivalent) expected to be paid to liquidate the obligation, including any direct costs of liquidation. The amount of cash (or equivalent) that the firm would receive by selling the asset in an Current market value orderly liquidation. The amount of cash (or equivalent) that the firm paid to acquire the asset. In the case of a Historical cost liability, this is the amount that the firm received when it incurred the obligation. The amount of cash (or equivalent) that would be required if the firm acquired the Current cost asset currently.

U.S. GAAP or IFRS or both

U.S. GAAP

Both

U.S. GAAP

Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

54) Freddie's Fish Store maintains saltwater aquariums for office buildings in Anchorage. The following events occurred during the first two months of 2022. For each event, determine the revenue or expense under the cash and accrual bases of accounting. a. In January, Freddie's purchased a new industrial vacuum for cleaning tanks - it is expected to last 5 years, and cost $5,000. b. In January, Freddie's collected $30,000 prepayment for cleaning services to be completed during January and February. c. In February, Freddie's signed a new client, collecting $6,000 for six months of services. d. In February, Freddie's paid its bimonthly utility bill of $500 for two months of utilities. The bill covers the current and prior months. They are always billed this amount and are paid at the end of every two months. Answer: a. Cash basis recognize $5,000 expense in January; accrual basis will allocate this over 5 years through depreciation expense. The annual depreciation expense is $1,000 ($5,000/5 = $1,000). The monthly depreciation expense is $83.33 ($1,000/12 = $83.33). b. Cash basis recognizes $30,000 revenue in January; accrual basis recognizes $15,000 revenue in January and February. c. Cash basis recognizes $6,000 revenue in February; accrual basis recognizes $1,000 revenue for February - July. d. Cash basis recognizes $500 expense in February; accrual basis recognizes $250 expense in January and February. Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

55) Freddie's Fish Store maintains saltwater aquariums for office buildings in Anchorage. The following events occurred during the first two months of 2022. Determine the net income for each month using both the cash and accrual bases. For depreciable items use straight line depreciation with no salvage value. a. In January, Freddie's purchased a new industrial vacuum for cleaning tanks - it is expected to last 5 years, and cost $5,000. b. In January, Freddie's collected $30,000 prepayment for cleaning services to be completed during January and February. c. In February, Freddie's signed a new client, collecting $6,000 for six months of services. d. In February, Freddie's paid its bimonthly utility bill of $500 for two months of utilities. The bill covers the current and prior months. They are always billed this amount and are paid at the end of every two months. Answer: January Cash basis: revenue $30,000 - expense $5,000 = $25,000 Accrual basis: revenue $15,000 - expense ($83.33 depreciation + $250 utility bill) = $14,666.67 February Cash basis: revenue $6,000 - expense $500 = $5,500 Accrual basis: revenue $16,000 - expense ($83.33 depreciation + $250 utility bill) = $15,666.67 Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

56) Krump's Pie Company reported revenue of $500,000 in its accrual basis income statement for the year ended December 31, 2022. Additional information from the books: Accounts receivable December 31, 2021 Accounts receivable December 31, 2022 Uncollectible accounts written off during 2022

$150,000 310,000 20,000

What would Krump's revenue be under the cash basis of accounting? Answer: $500,000 + $150,000 - $310,000 - $20,000 = $320,000 Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

57) Jimmy's Jelly Company reported revenue of $250,000 in its accrual based income statement for the year ended December 31, 2022. Additional information from the books: Accounts receivable December 31, 2021 Accounts receivable December 31, 2022 Uncollectible accounts written off during 2022

$75,000 80,000 3,000

What would Jimmy's Jelly Company's revenue be under the cash basis of accounting? Answer: $250,000 + $75,000 - $80,000 - $3,000 = $242,000 Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

58) Afternoon Dessert's Inc. reported revenue of $200,000 in its cash basis income statement for the year ended December 31, 2022. Additional information from the books: Accounts receivable December 31, 2021 Accounts receivable December 31, 2022 Prepaid subscription in 2022

$10,000 5,000 1,000

What would Afternoon Dessert's revenue be under the accrual basis of accounting? Answer: $200,000 - $10,000 + $5,000 - $1,000 = $194,000 Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

59) John's Shoe Store reported revenue of $375,000 in its cash basis income statement for the year ended December 31, 2022. Additional information from the books: Accounts receivable December 31, 2021 Accounts receivable December 31, 2022 Deposits on custom orders in 2022

$50,000 75,000 10,000

What would John's Shoe Store's revenue be under the accrual basis of accounting? Answer: $375,000 - $50,000 + $75,000 - $10,000 = $390,000 Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

60) Grinnell and Griffin (G&G) Company services fire protection systems at a fee of $200 per month. Clients pay in advance every quarter - and the company currently services 100 buildings. During the first quarter of the year, G&G collected all service fees on January 1; they also incurred the following expenses: $9,000 in January, $14,000 in February, and $8,000 in March. They paid half of the expense total in February and the rest in March, they did not pay expenses in January. Determine G&G's net income for each month, as well as the quarterly total, under both the cash and accrual bases. Is the quarterly total the same? If it is different, what would account for this? Answer: The quarterly total is the same.

Revenue Month January February March Total

Recognition

Expense

Recognition

Net Income

Cash Basis Accrual Basis Cash Basis Accrual Basis Cash Basis Accrual Basis 60,000 20,000 9,000 60,000 11,000 20,000 15,500 14,000 (15,500) 6,000 20,000 15,500 8,000 (15,500) 12,000 60,000 60,000 31,000 31,000 29,000 29,000

Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

61) Brendan's Alarm Company sells subscriptions to its monitoring service at a fee of $75 per month. Clients pay bimonthly, every two months. As of January 1, Brendan currently has 50 clients paying on an even month rotation (February, April, etc.) and 30 clients paying on an odd month rotation (January, March, etc.). Brendan incurs expenses each month for $100 in electric bills and pays the bill every other month. The next payment for utilities is due in February. Determine Brendan's Alarm Company's net income for each month for the first quarter of the year, as well as the quarterly total, under both the cash and accrual bases. Is the quarterly total the same? If it is different, what would account for this? Answer: The quarterly total is different – due to bimonthly collections and payments – the cash basis recognizes less revenue and expense during the quarter. Revenue Recognition Expense Recognition Net Cash Accrual Accrual Month Basis* Basis** Cash Basis Basis Cash Basis January 4,500 6,000 0 100 4,500 February 7,500 6,000 200 100 7,300 March 4,500 6,000 0 100 4,500 Total 16,500 18,000 200 300 16,300 *30 × $75 × 2 = $4,500; 50 × $75 × 2 = $7,500 **80 × $75 = $6,000 Diff: 1 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

Income Accrual Basis 5,900 5,900 5,900 17,700

62) The following events took place at Forrest's Tree Service during the first quarter of the year. Determine Forrest's net income for each month, including a quarterly total, under both the cash and accrual bases of accounting. a. Performed tree services in January - billed clients for $5,000. b. Monthly saw sharpening — January, February, March - paid $500 per month. c. Collected $2,500 from January clients on February 10th. d. Performed tree services in February — billed clients for $8,000. e. Employees are paid every other month; salary expense is $5,000 per month — paid on February 28. f. Performed tree services in March — billed clients for $10,000 - also collected remaining January balance and $5,000 due from February. Answer: Revenue Month January February March Total

Recognition

Expense

Recognition

Net

Cash Basis Accrual Basis Cash Basis Accrual Basis Cash Basis 0 5,000 500 5,500 (500) 2,500 8,000 10,500 5,500 (8,000) 7,500 10,000 500 5,500 7,000 10,000 23,000 11,500 16,500 (1,500)

Income Accrual Basis (500) 2,500 4,500 6,500

Diff: 3 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

63) Perfect Tournaments Inc. (PTI), a sports venue in Atlanta, Georgia that has gross sales of over $30 million a year, has added a check box to the registration form that allows it to retain sports statistics from all the games and as a result of the performance of all participants (players) who compete in its amateur tournaments. The rights do not cost the company anything; however, there is some debate as to whether acquiring and retaining this information offers value to PTI. The controller has asked for the advice of experts and believes that the current database of statistics would have a market value of no more than $1,000. There is speculation that at some point in the future, such statistical information may have some significant value but that is not currently the case. As a result, the controller has decided not to disclose the value of the information rights on the balance sheet or in the notes to the financial statements. Explain what may have guided his decision. Answer: Even those a case might be made that the information rights are something of value, the value is difficult to measure, it is not significant and its omission would most likely have no influence on the decision made by users of the financial statements. Diff: 2 Objective: 2.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

2.6

Disclosure in the Notes to the Financial Statements

1) The primary purpose of the notes to the financial statements is to further explain the information that is recognized on the face of the financial statements. Answer: TRUE Diff: 1 Objective: 2.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) If the nature of the entity's primary activities isn't well known or if the activities are complex, then they do not need to be disclosed as a note on the financial statements. Answer: FALSE Diff: 1 Objective: 2.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Entities should also disclose in the notes to the financial statement's information about the disaggregation of consolidated entities or other units that are managed separately. Answer: TRUE Diff: 1 Objective: 2.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Under IFRS, aggregation is useful to summarize a large amount of detail. Answer: TRUE Diff: 1 Objective: 2.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The ________ on the financial statements is a unit of information, a heading or a category presented on its own line on the face of the financial statements. A) line item B) line disclosure C) line note D) line presentation Answer: A Diff: 1 Objective: 2.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which is not an example of a type of event that is not currently recognized in the financial statements but could impact future cash flows? A) litigations against the company B) a contract to deliver goods C) services that were billed to a customer on account but payment has not been received D) existing contract to preform services Answer: C Diff: 1 Objective: 2.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Under IFRS, ________ includes sorting assets, liabilities, equity income, or expenses based on shared characteristics such as the nature of the item, its role in business activities, or how it is measured. A) disclosure B) classification C) aggregation D) conceptual framework Answer: B Diff: 1 Objective: 2.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) Under IFRS, ________ is the adding together of assets, liabilities, equity, income, or expenses that have shared characteristics and are included in the same classification. A) disclosure B) classification C) aggregation D) conceptual framework Answer: C Diff: 1 Objective: 2.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

9) What three items should be contained in a note to the financial statements? Answer: 1. The line items on the financial statements to which the note refers, 2. The reporting entity, or 3. Past events and current conditions that have not yet been recognized in the financial statements but that might affect the entity's cash flows. Diff: 2 Objective: 2.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) Under IFRS, effective communication in the financial statements requires: 1. 2. 3. Answer: 1. Focusing on objectives and principles as opposed to focusing on rules. 2. Classifying information in a way that groups similar items. 3. Aggregating information in a way that does not provide excessive detail but is segregated. Diff: 2 Objective: 2.6 IFRS/GAAP: IFRS AACSB: Analytical thinking

2.7

Additional Conceptual Framework Topics: IFRS

1) IASB includes three chapters in its conceptual framework that FASB does not include. Answer: FALSE Diff: 1 Objective: 2.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The IFRS Conceptual Framework provides a distinction between the objective of financial reporting and the objective of the financial statements. Answer: TRUE Diff: 1 Objective: 2.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

3) In the IFRS Conceptual Framework, the objective of financial statements is to provide information about the entity's assets, liabilities, equity, income, and expenses that is useful both for assessing future net cash inflows and for assessing the stewardship of economic resources by the entity's management. Answer: TRUE Diff: 1 Objective: 2.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

4) Chapters that the IASB includes in its conceptual framework but the FASB does not are ________. A) "Financial Reporting Records" and "Capital Concepts" B) "Financial Reporting Records" and "Capital Maintenance" C) "Financial Statements and the Reporting Entity" and "Conceptual Framework" D) "Financial Statements and the Reporting Entity" and "Concepts of Capital and Capital Maintenance" Answer: D Diff: 2 Objective: 2.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Financial reporting is broader and can include financial information outside of the financial statements. For example, other forms of financial reporting include all of the following except ________. A) physical capital maintenance B) management commentaries C) interim financial reports D) press releases Answer: A Diff: 2 Objective: 2.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) Under the concept of ________, capital is regarded in terms of the productive capacity of a company. A) physical capital maintenance B) fiscal capital maintenance C) financial capital maintenance D) profit capital maintenance Answer: A Diff: 2 Objective: 2.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

7) Financial capital maintenance refers to the concept that capital is viewed in terms of ________. A) the comprehensive income B) the changes in equity for the period C) the monetary investment in the company D) the closing cash account Answer: C Diff: 2 Objective: 2.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) Under the concept of ________, capital is viewed as the financial amount, or money amount, invested in a company. A) physical capital maintenance B) fiscal capital maintenance C) financial capital maintenance D) profit capital maintenance Answer: B Diff: 2 Objective: 2.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

9) Describe what is meant by capital maintenance adjustments. Answer: IFRS defines capital maintenance adjustments as restatements or revaluations of reported amounts of assets and liabilities that companies do not report in net income. Diff: 2 Objective: 2.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

10) What are the two concepts of capital maintenance? Answer: 1. Financial capital maintenance 2. Physical capital maintenance Diff: 2 Objective: 2.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

2.8

Assumptions in Financial Reporting

1) IFRS explicitly addresses the going concern concept. Answer: TRUE Diff: 1 Objective: 2.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

2) Following U.S. GAAP, the going concern concept justifies accounting practices such as depreciation. Answer: TRUE Diff: 1 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The going concern concept is explicitly stated in the IFRS conceptual framework but is only implicit in the U.S. GAAP conceptual framework. Answer: TRUE Diff: 1 Objective: 2.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The periodicity assumption stipulates that the entity will continue to operate for an indefinite period of time. Answer: FALSE Diff: 1 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The economic entity concept stipulates that an entity will measure and report economic activities in monetary units. Answer: FALSE Diff: 1 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following is not an underlying assumption in U.S. GAAP financial reporting? A) economic entity concept B) monetary unit assumption C) reliability concept D) periodicity assumption Answer: C Diff: 1 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) A company reports financial results each year with the issuance of its income statement and balance sheet. Which underlying assumption is illustrated by this example? A) economic entity concept B) going concern concept C) monetary unit assumption D) periodicity assumption Answer: D Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

8) The ________ justifies the use of depreciation on buildings. A) economic entity concept B) monetary unit assumption C) going concern concept D) historical cost assumption Answer: C Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) The ________ ignores inflation. A) economic entity concept B) monetary unit assumption C) historical cost assumption D) business entity concept Answer: B Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) If a company is facing a bankruptcy from which it is quite doubtful that the firm may ever recover, which underlying assumption would not be valid? A) periodicity assumption B) economic entity concept C) monetary unit assumption D) going concern concept Answer: D Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) Classification of assets on the company's balance sheet into current and long-term illustrates which assumption? A) going concern concept B) economic entity concept C) monetary unit assumption D) historical cost assumption Answer: A Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) The ________ justifies the use of accrual accounting. A) historical cost concept B) going concern concept C) monetary unit assumption D) business entity concept Answer: B Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which underlying assumption presumes that the owner's personal residence should not be included as an asset on the company balance sheet? A) monetary unit assumption B) periodicity assumption C) economic entity concept D) common sense assumption Answer: C Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) The ________ stipulates that an entity measure and report its economic activities in dollars (or some other monetary unit). A) monetary unit assumption B) business entity concept C) U.S. banking assumption D) going concern concept Answer: A Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Which attribute of a fundamental characteristic makes explicit the assumption of the full disclosure principle? A) relevance B) materiality C) verifiability D) completeness Answer: D Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Recording online sales transactions in bitcoin currency is a violation of ________. A) the business entity concept B) common sense C) the monetary unit assumption D) the going concern concept Answer: C Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) The economic entity concept ________. A) stipulates all transactions are stated in economic units B) is applicable to all forms of business organizations C) requires periodic income measurement D) recognizes the legal aspects of business organizations Answer: B Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Preparation of consolidated financial statements when a parent-subsidiary relationship exists is an example of the ________. A) monetary unit assumption B) periodicity assumption C) economic entity concept D) common sense assumption Answer: C Diff: 2 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Identify the assumption represented in each scenario, and then decide if it is satisfied or violated. Scenario Assumption Extensive Products Corporation is a publicly traded company. They only issue financial statements to external users every other year. Creative Merchandise Inc. adds the cost of land purchased in 2014 to the balance of land purchased in 2000. Gary Corp pays the CEO's mortgage and records it as miscellaneous expense. Jackson & Company depreciates property, plant, and equipment over their useful lives.

Satisfied or violated?

Answer: Scenario Assumption Extensive Products Corporation is a publicly traded company. They only issue financial statements to external users every other year. Periodicity Creative Merchandise Inc. adds the cost of land purchased in 2014 to the balance of land purchased in 2000. Monetary Unit Gary Corp pays the CEO's mortgage and records it as miscellaneous expense. Economic Entity Jackson & Company depreciates property, plant, and equipment over their useful lives. Going Concern

Satisfied or violated?

Violated

Satisfied

Violated

Satisfied

Diff: 3 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

20) Identify the assumption represented in each scenario, and then decide if it is satisfied or violated. Scenario Assumption Harold Inc. adjusted the valuation of balance sheet items to keep up with changes in inflation. Campers Inc. is facing bankruptcy — they choose not to list assets and liabilities at liquidation values on the balance sheet. Template Co. issues quarterly and annual financial statements to external users. Texas Studio's president only uses the company limo for business purposes.

Satisfied or violated?

Answer: Scenario Assumption Harold Inc. adjusted the valuation of balance sheet items to keep up with changes in inflation. Monetary Unit Campers Inc. is facing bankruptcy — they choose not to list assets and liabilities at liquidation values on the balance sheet. Going concern Template Co. issues quarterly and annual financial statements to external users. Periodicity Texas Studio's president only uses the company limo for business purposes. Economic Entity

Satisfied or violated?

Violated

Satisfied

Diff: 3 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

21) Identify the assumption represented in each scenario, and then decide if it is satisfied or violated. Scenario Assumption Danios Inc. distributes an annual report to shareholders. Illeo Industries does not regularly prepare financial statements. Maynard Inc.'s president purchases a car to be used solely for personal purposes with company funds. Archer Corporation, a publicly traded U.S. company measures financial elements using the dollar.

Satisfied or violated?

Answer: Scenario Assumption Danios Inc. distributes an annual report to shareholders. Periodicity Illeo Industries does not regularly prepare financial statements. Periodicity Maynard Inc.'s president purchases a car to be used solely for personal purposes with company funds. Economic Entity Archer Corporation, a publicly traded U.S. company measures financial elements using the dollar. Monetary Unit

Satisfied or violated?

Satisfied

Violated

Satisfied

Diff: 3 Objective: 2.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 3 Judgment and Applied Financial Accounting Research 3.1

The Importance and Prevalence of Judgment in Financial Reporting

1) Accountants must often use judgment when deciding when to recognize revenue. Answer: TRUE Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Accounting judgment occurs when managers manipulate financial information and misrepresent the firm's financial position. Answer: FALSE Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Earnings management occurs when managers manipulate financial information and misrepresent the firm's financial position. Answer: TRUE Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When accountants use judgment to interpret standards, it often detracts from the usefulness of the financial statements. Answer: FALSE Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Accounting standards allow financial statement preparers to use judgment to report the substance of a transaction in the financial statements, within certain boundaries, in the manner that best reflects economic reality. Answer: TRUE Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) In practice, accountants frequently use ________ to prepare and audit financial statements. A) clear-cut methods B) judgment C) strict rules D) imagination Answer: B Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) The process by which an accountant reaches a decision in situations with multiple alternatives is referred to as ________. A) earnings management B) GAAP C) judgment D) financial reporting Answer: C Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) An example of a judgment in accounting for Accounts Receivable is ________. A) the percentage of credit sales that may be uncollectible B) the amount a customer paid during the previous month C) the decision whether to extend credit to a new customer D) the percentage that may be deducted to calculate a sales discount Answer: A Diff: 2 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) An example of a judgment in accounting for product warranties is ________. A) the items sold that are subject to warranty coverage B) whether a product warranty should be for one year or two years C) the cost of a specific replacement part D) the amount of warranty expense to be accrued as a percent of sales Answer: D Diff: 2 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) ________ occurs when managers manipulate financial information and misrepresent the firm's financial position and performance. A) Earnings management B) GAAP C) Judgment D) Decision-making Answer: A Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Accountants use judgment when ________. A) researching and interpreting standards B) recognizing and contemplating standards C) estimating and recording economic events D) All of the above Answer: D Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Accounting standards allow financial statement preparers to use judgement in a manner that best represents ________. A) earnings management B) estimated reality C) a firm's financial position D) economic reality Answer: D Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which of the following is true with regards to judgement and flexibility in selecting accounting methods and applying accounting standards? A) Flexibility makes it difficult if not impossible to prepare financial statements that allow users to compare the results of operations of similar companies in the same industry. B) Accounting standards allow very little flexibility in the choice of methods as accounting rules tend to be strict and clear minimizing the opportunity for management judgement. C) Flexibility in the selection of methods and application of accounting standards allows management to best reflect the economic realities of a company. D) Financial statement information is not enhanced by allowing flexibility in the choice of accounting methods used. Answer: C Diff: 1 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Management is afforded a certain amount of latitude and must exercise judgment when selecting accounting methods. Discuss why this could be problematic for users of financial statements. Provide examples. Answer: It can make comparisons between companies in the same industry problematic when the companies use different methods or estimation techniques. Examples will vary. The comparison of companies using different inventory valuation methods is given in the text. Diff: 2 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Your classmate, Marla Smith, tells you that she likes accounting because it provides a clear-cut set of methods and rules to follow. As a result, it should be an easy job to get the hang of. Explain to her why accountants frequently need to use their judgment. Give specific examples. Answer: Answers will vary. Some examples students might reference are revenue recognition, investments, and inventory. Diff: 2 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Explain why allowing management and their accountants to choose between various accounting methods when applying accounting standards is a good thing as opposed to requiring strict compliance with the application of specific methods. Answer: The flexibility afforded in the selection and application of accounting standards permits managers and accountants to choose those methods and assumptions that best reflect the economic reality of their transactions. Therefore, the financial information provided and user decisions based on that information may be enhanced by not requiring all companies to use certain accounting methods that may not be appropriate based on the unique circumstances of the situation and the entity. Diff: 2 Objective: 3.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3.2

The Role of Assumptions and Estimates

1) Very few amounts reported on the financial statements are based upon assumptions. Answer: FALSE Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The footnote outlining the portfolio of accounting choices is one of the first footnotes in the financial statements. Answer: TRUE Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When compared to U.S. GAAP, IFRS requires that companies disclose additional information about assumptions and estimates made at the end of the reporting period. Answer: TRUE Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) IFRS and U.S. GAAP have the same disclosure requirements regarding the estimates made at the end of the accounting period. Answer: FALSE Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Financial statement users rely on the accounting policies footnote information to compare a company to other firms in the same industry. Answer: TRUE Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following is most likely based on an assumption? A) how to record petty cash transactions B) decision about which method of depreciation to use C) the balance in the cash account D) the value of the accounts payable account Answer: B Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

7) Which of the following is most likely based on an assumption? A) accounting for an investment based on how long management intends to hold it B) accounting for sales tax charged a customer C) accounting for land owned by the business D) both A & C Answer: A Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

8) Which of the following balances is most likely based on an estimate? A) Net accounts receivable B) Net accounts payable C) Notes payable D) Stockholders' equity Answer: A Diff: 2 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Which of the following is most likely based on assumptions? A) Revenue B) Depreciation expense C) Rent expense D) Dividends declared Answer: B Diff: 2 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) Which part of an asset is based on an estimate? A) cost of getting the asset ready for use B) cost of the asset C) pattern of use D) Both A & B Answer: C Diff: 2 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) Depreciation expense is based on estimates of ________. A) the value of the asset B) the use and purpose of the asset C) the life and pattern of the asset's use D) the warranty that comes with the asset Answer: C Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Is it possible to know where management applied judgment in the financial statements? A) No, this information is only available to company accountants. B) Yes, upon written request to the company. C) No, although auditors are provided with a supplement explaining accounting policies. D) Yes, the accounting policies footnote in the disclosures will provide some of this information. Answer: D Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) The accounting policies footnote is ________. A) optional B) required by U.S. GAAP C) required by auditors D) an internal management document Answer: B Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) The ________ is generally one of the first notes to the financial statements. A) accounting policies footnote B) contingencies footnote C) employee benefits footnote D) intangibles explanation footnote Answer: A Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) The accounting policies footnote would be a good place to look if you want to know ________. A) the inventory costing method used by a company B) the depreciation method used by a company C) the lives a company uses to depreciate plant assets D) how the bad debt expense is estimated E) All of the above Answer: E Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) Financial statement users can look to the ________ to determine whether a company uses incomeincreasing or income-reducing accounting policies. A) revenue policies footnote B) contingencies footnote C) accounting policies footnote D) intangibles explanation footnote Answer: C Diff: 2 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) In addition to disclosing judgments involving estimates and assumptions, ________ requires that companies disclose judgments made when determining appropriate accounting treatments for amounts reported on the financial statements. A) U.S. GAAP B) IFRS C) Both A & B D) Neither A nor B Answer: B Diff: 2 Objective: 3.2 IFRS/GAAP: IFRS AACSB: Application of knowledge

18) Based on an analysis of annual reports from 175 companies, the asset or liability with the most companies using estimates is for ________. A) environmental liabilities B) taxation C) impairment of property, plant, and equipment D) impairment of goodwill and other intangible assets Answer: D Diff: 2 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) A statement that a company reported inventory at the lower-of-cost-or-market and valued inventory using the first-in, first-out method would be found ________. A) within the balance sheet in the 10K B) within the income statement in the annual report C) within the auditor's report as part of an annual report D) within the description of the portfolio of accounting policies in a footnote Answer: D Diff: 2 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) After deciding to record a business event, accountants use assumptions and estimates for what purpose? Answer: To answer the questions related to when to recognize the transactions, what accounting method to use, and what amount to record. Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

21) Explain how an accountant would use assumptions and estimates when accounting for property, plant, and equipment. Answer: Accountants use assumptions about the pattern of use of PP&E when determining what depreciation method to use. Will the asset be used uniformly over time, or will it be used more heavily in the beginning? In addition, they must make estimates about the useful life of the asset and residual value. As a result, the net amount reported for PP&E is based on the estimated amount of depreciation. Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

22) List five issues that are typically addressed in a company's accounting policy footnote. Answer: Correct answers include: Revenue recognition Financial instruments Receivables Inventory valuation Deferred taxes Intangible assets and goodwill Warranty provisions Contingent liabilities Foreign exchange risks Financial instruments Long-term assets Product liability Property, plant, and equipment and depreciation Business combinations Share-based compensation Research and development Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Briefly explain how IFRS disclosures about accounting-related issues differ from U.S. GAAP disclosures. Answer: IFRS further requires that companies disclose additional information about the assumptions and estimates it made at the end of the reporting period. IFRS also requires that companies disclose the judgments (apart from those involving estimates and assumptions) that management has made in determining appropriate accounting treatments for amounts reported on the financial statements. For example, companies will make judgments as to whether potential obligations are probable and thus should be reported as liabilities. IFRS requires information disclosed about the judgments made in this situation. Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) Give two examples of when accountants use estimates to derive the reported values of assets and briefly explain how those estimates are derived. Answer: There can be several correct answers. Here are two such answers. The value reported for property, plant, and equipment is net of accumulated depreciation. Depreciation is based upon estimates of the life and pattern of use of the depreciable assets. Accountants estimate the residual value, and useful life and choose one of several acceptable methods to derive annual depreciation. The net book value of the reported PPE is its cost less accumulated depreciation. The actual residual value and useful life might actually be different from the initial estimates. Accounts receivable are reported on the balance sheet net of an allowance for those receivables that are not likely to be collected. The doubtful (uncollectible) accounts amount — in other words, the allowance amount is an estimate based on a number of assumptions. Diff: 1 Objective: 3.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3.3

Judgment Obstacles in Preparing Financial Information

1) Cognitive biases can impede an accountant's use of good judgment. Answer: TRUE Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Documenting the rationale for decisions made can help mitigate cognitive biases. Answer: TRUE Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The tendency to agree to an answer or choice based on an attempt to avoid conflict represents the overconfidence bias. Answer: FALSE Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The confirmatory bias is the tendency to use the data that is most readily available or most easily recalled to make a decision. Answer: FALSE Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Cognitive bias is an attitude that includes a questioning mind and critical assessment of evidence. Answer: FALSE Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following situations might influence management to intentionally bias estimates for the financial statements and impede the use of good judgment? A) Earnings are on track to surpass analysts' forecasts. B) Management's bonuses are tied to net income. C) Employees work for commission. D) All of the above Answer: B Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

7) Auditors should exercise ________ to minimize management bias. A) common sense B) ratio analysis C) professional skepticism D) interrogation techniques Answer: C Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) An attitude that includes a questioning mind and a critical assessment of audit evidence is known as ________. A) anchoring bias B) groupthink C) unprofessional behavior D) professional skepticism Answer: D Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) ________ are systematic deviations from rationality which can impact judgments on a daily basis. A) Cognitive biases B) Relational biases C) Emotional biases D) Subjective biases Answer: A Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Failing to consider all relevant data, and just using the information most readily available or easily recalled is known as ________. A) the groupthink bias B) the anchoring bias C) the availability bias D) the confirmatory bias Answer: C Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Weighting one piece of information more heavily than others is an example of ________. A) the overconfidence bias B) the anchoring bias C) the availability bias D) the groupthink bias Answer: B Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Failing to adequately weigh information which is inconsistent with an individual's initial beliefs is known as ________. A) the anchoring bias B) the overconfidence bias C) the groupthink bias D) the confirmatory bias Answer: D Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Being more confident than your abilities or experience level warrant is an example of ________. A) the overconfidence bias B) the availability bias C) the confirmatory bias D) the anchoring bias Answer: A Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Failure to consider all reasonable alternatives when reaching a group consensus, in an attempt to avoid conflict is an example of ________. A) the availability bias B) the overconfidence bias C) the groupthink bias D) the confirmatory bias Answer: C Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) To mitigate cognitive biases, accountants must be as ________ as possible. A) intelligent B) clever C) objective D) subjective Answer: C Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Joe Woods is a first-year accountant. When asked to provide data regarding where to purchase new computers for the office, without doing any research, he suggests buying the computers at a store where his friend works. His friend tells him the computers will do what the company needs. In addition, his friend will get a good commission if Joe diverts the purchase in his direction. What type of bias is represented in the above scenario? A) overconfidence bias B) confirmatory bias C) groupthink bias D) availability bias Answer: D Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Ann Byer is a first-year accountant who always did well academically. She is asked by her employer to estimate the amount of the accounts receivable balance that might not be paid by the customers. Although she remembers discussing the concept, she cannot quite remember how to go about estimating the amount. She does what she thinks is correct without double-checking. After all, she always received "A"s in class so she must be correct. What type of bias is represented in the above scenario? A) availability bias B) overconfidence bias C) confirmatory bias D) groupthink bias Answer: B Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Emily Bradly is part of a team at work that has been charged with the responsibility of researching differences between IFRS and U.S. GAAP. The team reaches a consensus on a given topic that Emily does not agree with. Not wanting to enter into a conflict, Emily agrees with the group. What type of bias is represented in the in the above scenario? A) availability bias B) overconfidence bias C) confirmatory bias D) groupthink bias Answer: D Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Caesar Company needs to purchase a new delivery truck. Rather than taking the time to research which truck would best fit the company's needs, the manager calls his friend to ask which truck he would recommend. The manager is exhibiting ________. A) bad judgment B) overconfidence bias C) availability bias D) anchoring bias Answer: C Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Bill Smith is on assignment for his first audit, when he runs into an accounting practice he's never dealt with before. Rather than asking a more experienced colleague for advice, Bill decides he knows enough to handle it. After all, he passed the CPA exam, didn't he? Bill is exhibiting ________. A) arrogance bias B) overconfidence bias C) anchoring bias D) poor judgment Answer: B Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Riley Watson, lead salesperson for Bowman Industries, begins customer negotiations by proposing an unusually high price. Riley is hoping her customer will exhibit which cognitive bias in the negotiations? A) arrogance bias B) overconfidence bias C) anchoring bias D) confirmatory bias Answer: C Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Terry Fowler is a firm believer in traditional accounting software. Bob Fossey just gave a presentation touting the benefits of cloud accounting software, but Terry wants nothing to do with it. He didn't really listen to the presentation. Terry is exhibiting ________. A) stubborn behavior B) overconfidence bias C) anchoring bias D) confirmatory bias Answer: D Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Robert and Francis Associates, Inc. had a board meeting to discuss future investment opportunities. Edward was a loud proponent of investing in Excel-o-rator Corporation, so much so that nobody else got a word in edgewise. Many board members didn't really think investing in Excel-o-rator was a good idea, but agreed to invest in Excel-o-rator in order to keep Edward happy, and get the meeting over with. The board is exhibiting ________. A) availability bias B) anchoring bias C) groupthink bias D) confirmatory bias Answer: C Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) This technique to mitigate cognitive biases allows you to be more objective in your decision-making process. A) Delay final judgement until you have gathered all the facts and information and have considered the alternatives. B) Speak with as many people as possible to ensure your decision represents a well-rounded opinion. C) Make decisions swiftly, based on gut instinct. D) None of the above Answer: A Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Auditors should exercise professional skepticism, which means that ________. A) auditors should have questioning minds and make a critical assessment of audit evidence B) auditors should assume that management is dishonest until proven otherwise C) auditors should assume that management has incentives to bias information in the financial statements D) auditors should believe that there is biased information in the financial statements and work to extract that type of information Answer: A Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) List the techniques accountants can use to mitigate cognitive biases. Answer: Techniques that can help accountants to be more objective and mitigate cognitive biases include: • being organized and methodical in the decision-making process • generating alternatives — even when they think they already have the correct answer • document the rationale used when selecting alternatives • delay final judgment until all facts and information is gathered and all alternatives have been considered. Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Complete the following table. Identify the bias indicated in the definition. Definition Cognitive Bias In an attempt to avoid conflict, members reach a consensus without considering all alternatives. The tendency to be more confident than your abilities and experience level would warrant. One piece of information is weighted more heavily than other pieces when the decision maker focuses on just that data. The tendency to use the most readily available or easily recalled data to make a decision. The decision maker under-weighs information that is inconsistent with their initial beliefs. Answer: Definition Cognitive Bias In an attempt to avoid conflict, members reach a consensus without considering all alternatives. Groupthink bias The tendency to be more confident than one's abilities and experience level would warrant. Overconfidence bias One piece of information is weighted more heavily than other pieces when the decision maker focuses on just that data. Anchoring bias The tendency to use the most readily available or easily recalled data to make a decision. Availability bias The decision maker under-weighs information that is inconsistent with their initial beliefs. Confirmatory bias Diff: 1 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) Complete the following table. Identify which cognitive bias is represented in each example. Example Cognitive Bias Wolf Co. is looking to purchase a new computer. The manager noticed one model that advertised free maintenance for one year. He appears to be more focused on the free maintenance than the specs of the model. Sydney, Inc. needs new copiers. The manager was asked to research the latest models, but instead purchased the same model as they did last year. S & C Company needs to upgrade the office computers. The salesperson demonstrated how Brand A (which the staff prefer) will run all the required software and provide increased functionality. However, the manager in charge of decision making for the purchase prefers Brand B — and only 'listened' to the presentation to be polite. Answer: Example Cognitive Bias Wolf Co. is looking to purchase a new computer. The manager noticed one model that advertised free maintenance for one year. He appears to be more focused on the free maintenance than the specs of the model. Anchoring bias Sydney, Inc. needs new copiers. The manager was asked to research the latest models, but instead purchased the same model as they did last year. Availability bias S & C Company needs to upgrade the office computers. The salesperson demonstrated how Brand A (which the staff prefers) will run all the required software and provide increased functionality. However, the manager in charge of decision making for the purchase prefers Brand B — and only 'listened' to the presentation to be polite. Confirmatory bias Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) Complete the following table. Identify which cognitive bias is represented in each example. Example The new manager at Danio Fisheries makes several investments on the company's behalf. Even though he has no experience related to investments, he is sure that he has made a smart move for the company. The audit team Bob, Chris, and Belle, are deciding which sampling methods to use on their current audit. Belle is bossy, and Bob and Chris defer to her choice without fully exploring the options. The manager at Betta Co. needs to determine the useful life for the new equipment used to filter water for the fish tanks. The owner has asked that he research the topic, but he decides to just use the useful life based on the claims made by the salesperson.

Cognitive Bias

Answer: Example Cognitive Bias The new manager at Danio Fisheries makes several investments on the company's behalf. Even though he has no experience related to investments, he is sure that he has made a smart move for the company. Overconfidence bias The audit team Bob, Chris, and Belle, are deciding which sampling methods to use on their current audit. Belle is bossy, and Bob and Chris defer to her choice without fully exploring the options. Groupthink bias The manager at Betta Co. needs to determine the useful life for the new equipment used to filter water for the fish tanks. The owner has asked that he research the topic, but he decides to just use the useful life based on the claims made by the salesperson. Availability bias Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

30) Complete the following table. Give a definition and example of each of the cognitive biases listed (be original). Cognitive Bias anchoring bias overconfidence bias confirmatory bias availability bias groupthink bias

Definition and Example

Answer: Answers will vary for examples — definitions will generally follow text definitions (below). Cognitive Bias

Definition and Example The decision maker focuses on one piece of information, anchoring bias weighting it more heavily than other pieces of information. The tendency to be more confident than your abilities and overconfidence bias experience level would objectively warrant. A decision maker under-weights information that is not confirmatory bias consistent with her initial beliefs. The tendency to use the data that is most readily available or most easily recalled to make a decision, as opposed to availability bias considering all relevant data. A phenomenon that occurs in situations where members of a group, in an attempt to avoid conflict, reach a consensus groupthink bias decision without considering all of the reasonable alternatives. Diff: 2 Objective: 3.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3.4

Authoritative Literature Used in Applied Financial Accounting Research

1) The Codification subtopics are generally distinguished by accounting area or scope. Answer: TRUE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The Basis for Conclusions found in accounting pronouncements is found in the Codification for U.S. GAAP. Answer: FALSE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The highest level of authoritative guidance for U.S. GAAP is the Accounting Standards Codification. Answer: TRUE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Numerical references to the Accounting Standards Codification are structured as Section-ParagraphTopic-Subtopic. Answer: FALSE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Numerical references to the Accounting Standards Codification are structured as Topic-SubtopicSection-Paragraph. Answer: TRUE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) In the Accounting Standards Codification, the section numbers under each subtopic are uniform throughout the Codification. Answer: TRUE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) In the Accounting Standards Codification, the subtopic numbers under each topic are uniform throughout the Codification. Answer: FALSE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Unlike U.S. GAAP, the Basis for Conclusions discussion is not included in the IFRS but is published separately. Answer: FALSE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) With regard to U.S. GAAP, basis for Conclusions are considered to be authoritative. Answer: FALSE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) The Basis for Conclusions are found in the Statements of Financial Accounting Standards. Answer: TRUE Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) ________ is the systematic investigation into an issue. A) Interpretation B) Judgment C) Research D) Analysis Answer: C Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Why would an accountant engage in financial accounting research? A) when they need to determine the appropriate reporting treatment for a transaction B) when a given transaction requires judgment C) Both A & B D) Neither A nor B Answer: C Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) U.S. GAAP includes all of the following except ________. A) Statements of Financial Accounting Standards B) Accounting Research Bulletins C) Accounting Principles Board Opinions D) All of the above are authoritative literature on U.S. GAAP Answer: D Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) What prompted the development of the Accounting Standards Codification? A) The decision to merge with IFRS made it necessary to redesign the Codification. B) The large volume of diverse and complex standards was difficult to use. C) Businesses are more complex now and need better guidance. D) Overuse of judgment led to financial frauds. Answer: B Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) When the FASB issues a new pronouncement, it is referred to as an ________. A) Accounting Standards Update B) Accounting Codification Update C) Accounting Topic Update D) Accounting Reporting Update Answer: A Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) The Codification is divided into ________. A) chapters, topics, sections, and paragraphs B) topics, subtopics, sections, and paragraphs C) chapters, sections, subsections, and paragraphs D) topics, sections, subsections, and paragraphs Answer: B Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) The ________ are uniform throughout the Codification. A) topics B) subtopics C) sections D) subsections Answer: C Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) In ASC 450-20-35-2, 450 represents the ________. A) chapter B) topic C) section D) paragraph Answer: B Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) In ASC 450-20-35-2, 20 represents the ________. A) topic B) section C) subtopic D) subsection Answer: C Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) In ASC 450-20-35-2, 35 represents the ________. A) chapter B) topic C) subtopic D) section Answer: D Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) In ASC 450-20-35-2, 2 represents the ________. A) topic B) paragraph C) section D) subsection Answer: B Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Regina Woods, CPA is unsure about the presentation of one of the financial statements. In which topic grouping should she begin her research? A) 1XX B) 2XX C) 3XX D) 4XX Answer: B Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Larry Smith, CPA does not know how to account for a deferred revenue transaction. In which topic grouping should he begin his research? A) 2XX B) 3XX C) 4XX D) 5XX Answer: C Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Ron Fowler, CPA isn't quite sure how to handle a deferred cost transaction. In which topic grouping should he begin his research? A) 2XX B) 3XX C) 4XX D) 5XX Answer: B Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Kramerica Corporation is in the research and development stage with a new product. Their accountant is unsure how to account for these costs. In which topic grouping would he find more information about R&D? A) 6XX B) 7XX C) 8XX D) 9XX Answer: B Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Psychics R' Us has a new and unique revenue stream, but they are unsure when to recognize the revenue. Their accountant is unsure as well. In which topic grouping would she find more information about revenue recognition? A) 6XX B) 7XX C) 8XX D) 9XX Answer: A Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Costanos Casino has an industry-specific question. In which topic grouping would the accountant begin his/her research? A) 3XX B) 5XX C) 7XX D) 9XX Answer: D Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) You've been assigned to write a research paper for your Intermediate Accounting class. You have been assigned "fair value measurements" and are supposed to begin your research in the Codification. In which topic grouping would you begin? A) 2XX B) 4XX C) 6XX D) 8XX Answer: D Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) Which topic grouping of Codification establishes the Codification as the authoritative source for U.S. GAAP? A) 1XX B) 2XX C) 6XX D) 8XX Answer: A Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

30) If you are researching the accounting treatment for equity, in which topic grouping of the Codification would you begin your review? A) 1XX B) 2XX C) 5XX D) 8XX Answer: C Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) Airlines Insider is a well-respected publication for the airline industry. The publication prescribes a certain accounting treatment which differs from what is indicated in the Codification. How should this be handled? A) Follow the treatment discussed in Airlines Insider. B) Follow the treatment discussed in the Codification. C) Choose whichever treatment is most conservative. D) Create a blend of the two treatments. Answer: B Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

32) The GAAP Hierarchy has ________ levels and the IFRS Hierarchy has ________ levels. A) two; three B) three; three C) three; four D) three; two Answer: C Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

33) IFRS standards include all of the following except ________. A) Standing Interpretations Committee Interpretations B) IFRS Interpretations Committee Interpretations C) Standing Accounting Standards D) International Accounting Standards Answer: C Diff: 1 Objective: 3.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

34) The ________ is used to rank the authoritative literature for its various accounting standards. A) IFRS hierarchy B) GAAP hierarchy C) Both A & B D) Neither A nor B Answer: C Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

35) Which of the following is not a required attribute for information to be considered reliable under IFRS? A) complete in all material respects B) prudent C) neutral D) faithful to past standards Answer: D Diff: 1 Objective: 3.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

36) The Basis for Conclusions for pronouncements under U.S. GAAP are ________. A) authoritative in nature B) not included in the Codification C) Both A & B D) Neither A nor B Answer: B Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

37) Which of the following would not be considered a user of the Codification? A) SEC staff B) accounting students C) investors D) All of the above would be considered users. Answer: D Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

38) Which of the following is not a U.S. GAAP Hierarchy level? A) The Codification and all SEC rules and interpretive releases. B) The Conceptual Framework definitions, recognitions, criteria, and measurement concepts for assets, liabilities, income and expenses. C) Authoritative rules and principles from U.S. GAAP for similar transactions. D) Non-authoritative material such as the FASB Concepts Statements, IFRS, AICPA Issues Papers, Technical Information Services Inquiries and Replies included in AICPA Technical Practice Aids, pronouncements of professional associations or regulatory agencies, industry practice, and textbooks. Answer: B Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

39) Accountants undertake financial accounting research when a standard is unclear. Discuss why the standards may be unclear. Give at least one example. Answer: Accounting standards may be unclear when judgment is involved — so there is no single correct answer. They may be unclear when there is a single correct answer, but the issue is complex and requires research to determine the answer. Finally, it may be unclear when the standards have no direct guidance that relate to the issue. For example, there may be no standards relating to a new financial instrument. Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

40) Complete the following table. Provide a brief description of the literature included for each level of the U.S. GAAP Literature Hierarchy. Level Level 1 Level 2 Level 3 Answer: Level Level 1 Level 2 Level 3

Brief description

Brief description The Codification and all SEC rules and interpretive releases. Authoritative rules and principles from U.S. GAAP for similar transactions. Non-authoritative material.

Diff: 1 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

41) Complete the following table. Provide a brief description of the literature included for each level of the IFRS Literature Hierarchy. Level Level 1 Level 2 Level 3 Level 4 Answer: Level Level 1 Level 2

Level 3

Level 4

Brief description

Brief description IFRS standards and interpretations that specifically apply to a transaction, event, or condition. Authoritative rules from IFRS for similar and related transactions. The Conceptual Framework definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses. Recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature, and accepted industry practices, to the extent that these do not conflict with the other sources in Levels 1 and 2.

Diff: 1 Objective: 3.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

42) Identify the level of the U.S. GAAP Literature Hierarchy that each item belongs to. Authoritative Literature Textbooks SEC rules and interpretive releases Authoritative rules and principles from U.S. GAAP for similar transactions Answer: Authoritative Literature Textbooks SEC rules and interpretive releases Authoritative rules and principles from U.S. GAAP for similar transactions Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

Level

Level Level 3 Level 1 Level 2

43) Identify the level of the U.S. GAAP Literature Hierarchy that each item belongs to. Authoritative Literature The Codification Industry practice AICPA Issue Papers

Level

Answer: Authoritative Literature The Codification Industry practice AICPA Issue Papers

Level Level 1 Level 3 Level 3

Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

44) Identify the level of the U.S. GAAP Literature Hierarchy that each item belongs to. Authoritative Literature Authoritative rules and principles from U.S. GAAP for similar transactions FASB Concept Statements International Financial Reporting Standards Answer: Authoritative Literature Authoritative rules and principles from U.S. GAAP for similar transactions FASB Concept Statements International Financial Reporting Standards Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

Level

Level Level 2 Level 3 Level 3

45) Identify the level of the IFRS Literature Hierarchy that each item belongs to. Authoritative Literature Industry practice The Conceptual Framework recognition criteria related to income Authoritative rules from IFRS for similar and related transactions Answer: Authoritative Literature Industry practice The Conceptual Framework recognition criteria related to income Authoritative rules from IFRS for similar and related transactions

Level

Level Level 4 Level 3 Level 2

Diff: 2 Objective: 3.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

46) Tracy Smith is researching a financial reporting issue. She did not find guidance for the specific transaction in the Accounting Standards Codification. Briefly explain how she should proceed in resolving her accounting research question. Answer: She must look elsewhere in the authoritative literature. If she does not find guidance in the Codification, she should refer to SEC rules and interpretive releases, then to other authoritative rules and principles from U.S. GAAP for similar transactions, and then to non-authoritative materials such as the FASB Concepts Statements, IFRS, AICPA Issues Papers, Technical Information Services Inquiries and Replies included in AICPA Technical Practice Aids, pronouncements of professional associations or regulatory agencies, industry practice, and textbooks. Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

47) Frank Reynolds is a controller researching an accounting issue and finds relevant information in an industry publication that prescribes a particular accounting treatment. Frank's research also reveals that the Codification indicates that a different approach is more appropriate. Which guidance should Frank follow and why? Answer: In this case, Frank (and the entity) would be required to follow the Codification, because the Codification is the higher level of authority. Diff: 2 Objective: 3.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3.5

Steps in the Applied Financial Accounting Research Process

1) The first step in the accounting research process is to identify the issue. Answer: FALSE Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The first step in the accounting research process is to establish and understand the facts. Answer: TRUE Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The final step in the accounting research process is to communicate the results. Answer: TRUE Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The final step in the accounting research process is to develop conclusions. Answer: FALSE Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Best practice suggests that accountants should commit the accounting standards to memory. Answer: FALSE Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) An accountant may find that there is no single correct answer to his or her research question in the accounting literature. Answer: TRUE Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) The third step in the accounting research process it to search the authoritative literature, which can take a considerable amount of time. Answer: TRUE Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) In the fifth step of the accounting research process, accountant never use judgement to work down the levels of hierarchy as an answer should exist in the literature. Answer: FALSE Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) What is the first step in the financial accounting research process? A) identify the issue B) search the authoritative literature C) establish and understand the facts D) review the transaction reports Answer: C Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) The second step in the applied financial accounting research process is to ________. A) identify the issue B) search the authoritative literature C) establish the research question D) both A & C Answer: D Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Step 3 in the financial accounting research process involves ________. A) searching the authoritative literature B) establishing the fact pattern associated with the transaction C) reading the authoritative literature D) deciding the best financial reporting treatment for the transaction Answer: A Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) The fourth step in the financial accounting research process may require you to ________. A) cross reference information in the Codification B) change or refine your research question C) work down the levels of the hierarchy to identify a similar transaction D) draft a memo Answer: B Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) In step five of the financial accounting research process, the accountant will ________. A) communicate the results of their research B) document their conclusions C) decide on the best financial reporting treatment D) obtain additional facts as needed Answer: C Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Step 6 of the financial accounting research process involves ________. A) documenting the research process B) communicating the results of the research process C) comparing alternative treatments D) Both A & B Answer: D Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) It is important to understand the facts of a transaction prior to conducting research because ________. A) it is necessary for documentation B) misunderstood facts can lead to incorrect conclusions C) it provides direction when searching the Codification D) it is useful when comparing similar transactions Answer: B Diff: 2 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) During the research process, if you are unsure whether or not you've found all the relevant literature, what should you do? A) Call your manager to verify that you've found it all. B) Complain that it's too much work and call it a day. C) Google it to see if there is anything else you've missed. D) Use the search engine included in the Codification. Answer: D Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) Acquiring research skills ________. A) is something that comes naturally to most accountants B) takes a great deal of practice C) is not necessary because the business environment is constantly changing D) None of the above Answer: B Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Typically, ________ use the applied financial accounting research process. A) auditors B) investors C) financial statement preparers D) Both A & C Answer: D Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Questions such as "Which parties are involved?" and "What is the timing of the transaction?" would first be addressed in which step of the financial accounting research process? A) Step 1 B) Step 2 C) Step 3 D) Step 4 Answer: A Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

20) Posing the question "Which method of depreciation should TNT Company use for their new equipment?" would most likely occur in which step of the financial accounting research process? A) Step 1 B) Step 2 C) Step 3 D) Step 4 Answer: B Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

21) Why is it important for accountants to build good research skills? A) There are too many standards for accountants to commit to memory. B) If their assistant is busy, they'll need to find information on their own. C) Research skills look good on a resume. D) None of the above Answer: A Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) When evaluating research, you find that you need additional facts related to the business transaction. What should you do? A) Make a note of your questions, but continue on through the steps. B) Return to step 2. C) Return to step 1. D) Ask for help; you clearly didn't pose the right question to begin with. Answer: C Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Which of the following presents the steps for the applied accounting research process in the correct order? A) Identify the issue, understand the facts, search the authoritative literature. B) Search the authoritative literature, evaluate the results, develop conclusions. C) Establish the facts, search the authoritative literature, identify the issue. D) Evaluate the results, write a recommendation, develop conclusions. Answer: B Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) What are the first three steps, in correct sequence, of the accounting research process? A) Identify the issue, establish the facts, search the authoritative literature. B) Search the authoritative literature, identify the issue, establish the facts. C) Establish the facts, identify the issue, search the authoritative literature. D) Search the authoritative literature, establish the facts, evaluate the results. Answer: C Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) The first three steps of the accounting research process are establishing the facts, identify the issue and search the authoritative literature. What are the last 3 steps, in correct sequence, of the accounting research process? A) Evaluate the results of the search, develop conclusions, communicate the results. B) Communicate the results of the search, develop conclusions, communicate the results of the research. C) Evaluate the results, communicate the results of the research, develop conclusions. D) Develop conclusions, evaluate the results, communicate the results of the research. Answer: A Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Why is it important for accountants to understand the structure of the Codification? Answer: Conducting financial accounting research can be very time consuming, and there is a lot of information to sort through. Understanding the structure of the Codification can streamline the search process, because accountants can begin by searching for a topic and narrowing the search from there, or easily finding cross-referenced material. Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Complete the table. Identify the steps in the applied financial accounting research process. Step in research process Description Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 Answer: Step in research process Step 1 Step 2 Step 3 Step 4 Step 5 Step 6

Description Establish and understand the facts. Identify the issue. Search the authoritative literature. Evaluate results of the search. Develop conclusions. Communicate the results of the research.

Diff: 1 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

28) You are the new accountant for Apple of my Eye Computer store. The company sells computers and computer-related accessories. Additionally, the company sells extended warranties for the computers. Because the extended warranties are a significant profit center for the company, salespeople are encouraged to promote the extended warranties. In return they receive a 35% commission on all warranties that they sell. You have never encountered commission sales before, so you will need to research this topic. Complete the first two steps of the research process based on the information provided in this problem. Answer: Step 1 - Establish and Understand the Facts: Warranties are sold separately from the computers, and commissions are based on extended warranty sales. Step 2 - Identify the Issue: What is the research question? The issue is how to account for the commission expense. Should the expense be recognized in the period the commission is paid, or earned, or should it be deferred and recognized over the length of the warranty agreement? Diff: 2 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) You just got hired to do accounting for Starlight Espresso, which is a boutique coffee production company. The owner approaches you and says that he's concerned about the crops this year, because he heard that many of them could be ruined because of a disease affecting the shrubs this year. If the supply is limited, he fears prices will go up; however, he said his friend told him he should look into futures contracts. He would like you to find out if this can help save the company money, and also explain to him what a futures contract is. Eager to impress the owner, you decide to put your accounting research skills to use. How would you approach the first two steps of the research process given the information in this problem? Answer: Step 1 - Establish and Understand the Facts: The cost of beans may rise sharply, but it is unknown for sure what will happen to the price at this point. Step 2 - Identify the Issue: What is the research question? The issue is what is a futures contract and does it have the possibility to protect against rising costs? Diff: 2 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

30) You just landed your dream job — doing accounting for a small, organic farm! Due to high demand for the popular Honeycrisp apples, the owner is looking to expand. She has asked you to prepare a set of financial statements for the bank to review with her loan application. The apples have been picked and boxed up, but have not been sold or shipped yet. You are unsure how to report the apples on the balance sheet. You have never dealt with inventory valuation for agricultural products. Complete the first two steps of the research process based on the information provided in this problem. Answer: Establish and Understand the Facts: The product is ready for sale, but it hasn't sold yet. This is agriculture-related inventory. Identify the Issue: What is the research question? The issue is how to account for agricultural inventory. What amount should be reported for the apples on the balance sheet? Is there anything notable about this type of inventory? Diff: 2 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) Your accounting client operates a website through which it sells products offered by other companies. You have gathered facts that indicate your client is an order-taker who receives payments from customer-buyers through its website, and then sends the order to the other company so they can ship their product to the customer. You have identified an accounting issue that suggests your client is acting as an agent for the other company which brings into question the way they recognize revenue from the transaction. Briefly describe how you should proceed in resolving this accounting research question. Answer: Having gathered the facts and identified the accounting issue, the next step is to search the Accounting Standards Codification for guidance beginning with topic 6XX related to Revenue to identify the specific topic, subtopic, and section under which you may find specific authoritative guidance for this issue. The next steps are to evaluate what you find and develop conclusions, if possible. If it is not possible to develop conclusions, you should repeat the process iteratively until the issue is resolved, so you can then communicate the results of your research to your client. Diff: 2 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Written and oral communication

32) What are the Codification topic number and the International Accounting Standards number in which you would begin your research into a question about revenue recognition? Answer: Codification Topic 605—Revenue Recognition; IFRS 15–Revenue from Contracts with Customers Diff: 2 Objective: 3.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

33) When establishing and understanding the facts of an accounting research project, what questions should the researcher initially ask? Answer: The first step in the research process is to understand the facts involved in the business transaction. The researcher should ask the following questions: What exactly does the business transaction look like? Which parties are involved and how? What are the stipulations specified in any relevant contract? What is the timing of the transaction(s)? Diff: 2 Objective: 3.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 4 Review of the Accounting Cycle 4.1

The Accounting Cycle

1) The first step in the accounting cycle is recording transactions in the general journal. Answer: FALSE Diff: 1 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The final step in the accounting cycle is the preparation of a post-closing trial balance. Answer: TRUE Diff: 1 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Financial statements are prepared after the temporary accounts are closed. Answer: FALSE Diff: 1 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The accounting cycle describes a process that includes all of the following except ________. A) recording business transactions B) aggregating business transactions into the financial statements C) creating a road map of events D) summarizing business transactions into the financial statements Answer: C Diff: 1 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) After transactions are recorded in the general journal, the next step in the accounting cycle is to ________. A) prepare adjusting journal entries B) prepare an adjusted trial balance C) prepare financial statements D) post journal entries to the general ledger Answer: D Diff: 1 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The first step in the accounting cycle is to ________. A) journalize transactions B) analyze transactions C) post journal entries to the general ledger D) prepare a worksheet Answer: B Diff: 1 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The final step in the accounting cycle is to ________. A) prepare an adjusted trial balance B) close temporary accounts C) prepare a post-closing trial balance D) prepare financial statements Answer: C Diff: 1 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) The first four steps in the accounting cycle, in proper sequence, are ________. A) journalize, analyze the transactions, post to the general ledger, prepare an unadjusted trial balance B) analyze the transactions, journalize, post to the general ledger, prepare an unadjusted trial balance C) analyze the transactions, prepare an unadjusted trial balance, post to the general ledger, prepare an adjusted trial balance D) prepare an unadjusted trial balance, journalize, post to the general ledger, prepare an adjusted trial balance Answer: B Diff: 1 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Once the adjusting entries have been prepared (journalized and posted), which of the following steps of the accounting cycle are carried out in proper sequence? A) Prepare an adjusted trial balance, prepare financial statements, close temporary accounts, prepare a post-closing trial balance. B) Prepare an unadjusted trial balance, prepare financial statements, close temporary accounts, prepare a post-closing trial balance. C) Prepare closing entries, prepare financial statements, prepare an adjusted trial balance, prepare a postclosing trial balance. D) Prepare financial statements, prepare an adjusted trial balance, prepare closing entries, prepare a postclosing trial balance. Answer: A Diff: 2 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) List the steps in the accounting cycle in the correct order. Answer: 1. Analyze the transactions. 2. Journalize the transactions. 3. Post journal entries to the general ledger. 4. Prepare an unadjusted trial balance. 5. Prepare adjusting journal entries. 6. Prepare an adjusted trial balance. 7. Prepare financial statements. 8. Close temporary accounts. 9. Prepare a post-closing trial balance. Diff: 1 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4.2

Analyze the Transaction

1) Liabilities represent claims of third parties against the assets of a business. Answer: TRUE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) To be recorded in the general journal, a transaction must be an economic event. Answer: TRUE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Accumulated other comprehensive income is included in retained earnings. Answer: FALSE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Gains and losses result from peripheral transactions of a company. Answer: TRUE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Rent expense is normally considered a peripheral transaction of a company. Answer: FALSE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The accounting equation may be stated as Assets = Liabilities + Shareholders' Equity. Answer: TRUE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Revenues and gains will increase retained earnings. Answer: TRUE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

8) Expenses and losses will decrease liabilities. Answer: FALSE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

9) The accounting equation is Assets + Liabilities = Stockholders' Equity. Answer: FALSE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) The fact that all transactions affect at least two accounts and that the accounting equation will always balance is referred to as the double-entry system. Answer: TRUE Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) The accounting equation is correctly stated as ________. A) Assets = Liabilities + Equity B) Assets + Liabilities = Equity C) Assets = Liabilities - Equity D) Assets = Liabilities = Equity Answer: A Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Decreases in equity that result from peripheral transactions of an entity are referred to as ________. A) liabilities B) expenses C) losses D) dividends Answer: C Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Jenner Corporation paid its annual dividend. This transaction represents a(n) ________. A) liability B) distribution to shareholders C) loss D) expense Answer: B Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Arnold Company provided services to its customers on credit for $25,000. This transaction ________. A) increased assets B) increased liabilities C) increased expenses D) decreased shareholders' equity Answer: A Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Douglas Corporation paid $6,000 for monthly rental on its warehouse. This transaction ________. A) decreased liability B) increased shareholders' equity C) increased assets D) increased expenses Answer: D Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

16) Bradley Company paid $25,000 in dividends to its shareholders. This transaction ________. A) increased expenses B) decreased revenues C) increased liabilities D) decreased shareholders' equity Answer: D Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

17) Abacus Corporation purchased equipment costing $56,000. It paid $12,000 in cash and signed a note payable for $44,000. This transaction ________. A) increased assets by $56,000, liabilities by $44,000 and shareholders' equity by $12,000 B) increased assets by $56,000 and liabilities by $44,000 C) increased assets and liabilities each by $44,000 D) increased assets and shareholders' equity each by $56,000 Answer: C Explanation: Assets would increase by $56,000 with the acquisition of the equipment but decrease by $12,000 with the payment of cash for a net change of $44,000. By signing a note payable for $44,000, liabilities increase by $44,000. Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

18) Atlas Corporation sold a used machine for less than its carrying value. This transaction results in a(n) ________. A) revenue B) expense C) gain D) loss Answer: D Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Jackson Company sold land that had been held for future plant expansion for more than its carrying value. This transaction results in a(n) ________. A) revenue B) expense C) gain D) loss Answer: C Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Helmsley Corporation received one year's rent in advance on a warehouse. This transaction results in a(n) ________. A) expense B) liability C) asset D) revenue Answer: B Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Nature's Way used and paid for the services of its employees. As a result, it will ________. A) decrease assets and decrease stockholders' equity B) decrease assets and increase stockholders' equity C) increase assets and increase stockholders' equity D) increase assets and decrease stockholders' equity Answer: A Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

22) The Dark Chocolate Shoppe collected cash for amounts owed to the company. As a result, it will ________. A) increase revenue and increase cash B) increase revenue and decrease accounts receivable C) increase accounts receivable and decrease revenue D) increase cash and decrease accounts receivable Answer: D Diff: 1 Objective: 4.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

23) List and define the elements of the accounting equation. Element Assets Liabilities Shareholders' Equity Revenues Expenses Gains Losses Distributions to Owners Investments by Owners

Definition

Answer: Element

Definition Probable future economic benefits obtained or controlled by an entity Assets as a result of past economic events Probable future sacrifices of economic benefits arising from present Liabilities obligations of a particular entity Shareholders' Net assets or residual interest in the assets of an entity that remains after Equity deducting the liabilities Inflows or other enhancements of an entity's assets or settlement of its Revenues liabilities from delivering or producing goods and/or services to external parties Outflows of assets and/or incurrence of liabilities resulting from an Expenses entity delivering or producing goods and/or services to external parties Increases in an entity's net assets resulting from peripheral transactions Gains with external parties Decreases in an entity's net assets resulting from peripheral transactions Losses with third parties Distributions to Decreases in an entity's net assets resulting from rendering services, Owners incurring liabilities, or transferring assets to owners of the entity Increases in equity of a particular business enterprise resulting from Investments by transfers to it from other entities of something valuable to obtain or Owners increase ownership interests (or equity) in it

Diff: 2 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Murphy Corporation engaged in the following transactions during the month of January. Please analyze these transactions and indicate whether they cause an increase (+) or decrease (-) in the balance sheet and income statement accounts. Transaction

Asset

Liability

SH Equity

Revenue Expense

a. Issued 50,000 shares of nopar common stock for $50,000. b. Signed an agreement with Computer Experts to purchase three new computers costing a total of $2,000 in 10 days. c. Purchased supplies on account for $10,000 from Birmingham Company. d. Purchased a two-year insurance policy for $3,600. This policy will become effective February 1. e. Paid $2,500 in office rent for the month of January. f. Accepted delivery of the new computers and paid cash. g. Paid wages of $5,000 to employees. h. Sold a parcel of land for $50,000. Murphy Company had purchased the land originally for $45,000. i. Paid $30,000 to Jackson Company on account. j. Received $45,000 from customers for services rendered.

Gain

Loss

Answer: Transaction a. Issued 50,000 shares of no-par common stock for $50,000. b. Signed an agreement with Computer Experts to purchase three new computers costing a total of $2,000 in 10 days. c. Purchased supplies on account for $10,000 from Birmingham Company. d. Purchased a two-year insurance policy for $3,600. This policy will become effective February 1. e. Paid $2,500 in office rent for the month of January. f. Accepted delivery of the new computers and paid cash. g. Paid wages of $5,000 to employees. h. Sold a parcel of land for $50,000. Murphy Company had purchased the land originally for $45,000. i. Paid $30,000 to Jackson Company on account. j. Received $45,000 from customers for services rendered.

Asset

Liability

SH Equity

Revenue Expense

Gain

No entry

+/-

Diff: 2 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

Loss

25) Murphy Corporation engaged in the following transactions during the month of February. Please analyze these transactions and indicate whether they cause an increase (+) or decrease (-) in the balance sheet and income statement accounts. Transaction

Asset

Liability

SH Equity

Revenue

a. Issued 10,000 shares of no-par common stock for $250,000. b. Signed an agreement with CompuSource to purchase three new computers costing a total of $6,000 in 10 days. c. Purchased supplies on account for $60,000 from Birmingham Company. d. Purchased a two-year insurance policy for $3,600. This policy will become effective February 1. e. Paid $1,500 in office rent for the month of February. f. Provided $10,000 of services to a customer for cash. g. Paid wages of $5,000 to employees. h. Provided $12,000 of services to a customer on account. i. Incurred legal fees of $1,200 to be paid in March. j. Received $45,000 cash from customers for services rendered in January and initially on account.

Expense

Answer: Transaction

Asset

a. Issued 10,000 shares of no-par common stock for + $250,000. b. Signed an agreement with CompuSource to purchase three new computers No entry costing a total of $6,000 in 10 days. c. Purchased supplies on + account for $60,000 from d. Purchased a two-year insurance policy for $3,600. +/This policy will become effective February 1. e. Paid $1,500 in office rent for the month of February. f. Provided $10,000 of + services to a customer for cash. g. Paid wages of $5,000 to employees. h. Provided $12,000 of services to a customer on + account. i. Incurred legal fees of $1,200 to be paid in March. j. Received $45,000 cash from customers for services +/rendered in January and initially on account.

Liability

SH Equity

Revenue

Expense

+ + +

Diff: 2 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

26) Jones Company engaged in the following transactions during the month of February. Please analyze these transactions and indicate the amount of increase or decrease in the balance sheet and income statement accounts. Transaction

Asset

Liability

SH Equity

Revenue

a. Issued 10,000 shares of nopar common stock for $20,000 cash. b. Purchased supplies on account for $6,000 from Brooks Company. c. Purchased a two-year insurance policy for $3,000. This policy will become effective February 1. d. Paid $1,500 in office rent for the month of February. e. Provided $10,000 of services to a customer for cash. f. Paid wages of $5,000 to employees. g. Provided $12,000 of services to a customer on account. h. Paid salaries for the month in cash $2,000. i. Received $45,000 cash from customers for services rendered in January and initially on account.

Expense

Answer: Transaction a. Issued 10,000 shares of nopar common stock for $20,000 cash. b. Purchased supplies on account for $6,000 from Brooks Company. c. Purchased a two-year insurance policy for $3,000. This policy will become effective February 1. d. Paid $1,500 in office rent for the month of February. e. Provided $10,000 of services to a customer for cash. f. Paid wages of $5,000 to employees. g. Provided $12,000 of services to a customer on account. h. Paid salaries for the month in cash $2,000. i. Received $45,000 cash from customers for services rendered in January and initially on account.

Asset

Liability

20,000

6,000

SH Equity

Revenue Expense

20,000

6,000

3,000 -3,000 -1,500

-1,500

10,000

-5,000

12,000

-2,000

45,000 -45,000

Diff: 2 Objective: 4.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

4.3

Journalize the Transactions

1) The normal balance of an account is the side on which an increase in the account balance is recorded. Answer: TRUE Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The normal balance of a liability account is a debit. Answer: FALSE Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A revenue account has a normal debit balance. Answer: FALSE Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The balance in the common stock account is increased by a credit. Answer: TRUE Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Which of the following accounts has a normal debit balance? A) Accounts Payable B) Advertising Expense C) Gain on Sale of Assets D) Retained Earnings Answer: B Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Each of the following accounts has a normal credit balance except ________. A) Sales Revenue B) Accumulated Depreciation C) Investments D) Accounts Payable Answer: C Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following accounts has a normal credit balance? A) Accounts Receivable B) Taxes Payable C) Patents D) Equipment Answer: B Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) All of the following accounts have a normal debit balance except ________. A) Dividends B) Loss on Sale of Land C) Additional Paid in Capital D) Land Answer: C Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following accounts has a normal credit balance? A) Interest Expense B) Deferred Revenue C) Investments D) Loss on Sale of Equipment Answer: B Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Cameron Diaz Corporation purchased a computer system for $15,000. The company paid $2000 cash and issued a $13,000 note payable for the entire balance. The journal entry to record this transaction includes a ________. A) debit to Equipment for $15,000 B) credit to Accounts Payable for $13,000 C) debit to Expense for $15,000 D) credit to Cash for $15,000 Answer: A Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Bay City Corporation received $29,000 for 12 months rent in advance. What entry is used to record this transaction? A) Cash

29,000 Prepaid Rent

B) Rent Expense Cash C) Cash

29,000

29,000 29,000

29,000 Deferred Rent Revenue

D) Deferred Rent Revenue Rent Revenue

29,000

29,000 29,000

Answer: C

Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

12) Smith Corporation purchased $68,000 of merchandise on credit. The company uses the perpetual method of recording inventory purchases. What would be the correct journal entry to record the purchase? A) Merchandise Inventory Accounts Payable

68,000

B) Purchases Accounts Payable

68,000

C) Merchandise Inventory Cash

68,000

D) Purchases Interest Payable

68,000

Answer: A

Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

13) Jones Company sold merchandise on account for $80,000. This merchandise cost $55,000. The company uses the perpetual method of accounting for inventory. What would be the correct journal entry or entries to record the transaction? A) Accounts Receivable Sales Revenue B) Accounts Receivable Sales Revenue Cost of Goods Sold Merchandise Inventory C) Accounts Receivable Merchandise Inventory Gain on Sale D) Accounts Receivable Cost of Goods Sold Sales Revenue

80,000 80,000

80,000 80,000 55,000 55,000

80,000 55,000 25,000

25,000 55,000 80,000

Answer: B

Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

14) The issuance of common stock for cash would be recorded by a ________. A) credit to Retained Earnings B) credit to Common Stock C) debit to Investments D) credit to Revenues Answer: B Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) ABC Corporation issued no-par common stock to its investors for $125,000. The journal entry to record this transaction includes a ________. A) debit to Investments B) credit to Revenue C) credit to Common Stock D) debit to Expense Answer: C Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

16) When a company receives a utility bill for electricity used this past month and payable next month, the entry includes a ________. A) debit to a liability B) credit to an asset C) debit to an expense D) debit to an asset Answer: C Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) Realistic Rentals collected $10,000 in payment of advance rent for 6 months. This an example of ________. A) an accrued receivable B) a prepaid expense C) a deferred revenue D) an accrued liability Answer: C Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

18) Formally recording the transaction in the accounting system is an example of ________. A) posting B) journalizing C) preparing D) closing Answer: B Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) A numerical listing of account names and numbers is called the ________. A) chart of accounts B) general journal C) general ledger D) chart of journals Answer: A Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) The general journal presents transactions ________. A) by account B) chronologically C) by normal balance D) None of the above Answer: B Diff: 1 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Mobile Corporation had the following transactions for the month of January. Record these transactions along with explanations. If no entry is required, state "No Entry." a. Issued 10,000 shares of no-par common stock for $250,000. b. Signed an agreement with CompuSource to purchase three new computers costing a total of $6,000 in 10 days. Computers will be used by employees of Mobile. c. Purchased office furniture for $70,000 on account from Birmingham Company. d. Purchased a two-year insurance policy for $3,600. Paid cash. This policy will become effective February 1. e. Paid $1,500 in office rent for the month of January. f. Accepted delivery of the new computers and paid cash. g. Paid wages of $5,000 to employees. h. Provided services on account for $80,000. i. Paid $50,000 to Birmingham Company on account. j. Received payment in full from customers in part (h). k. Paid an electricity bill for $325.

Answer: a. Cash

250,000

Common Stock To record issuance of common stock

250,000

b. No entry needed c. Furniture

70,000

Accounts Payable To record purchase of furniture

70,000

d. Prepaid Insurance Cash To record purchase of insurance policy

3,600

e. Rent Expense

1,500

3,600

Cash To record rent expense

1,500

f. Computers

6,000

Cash To record purchase of computers

6,000

g. Wages Expense Cash To record wages expense

5,000

h. Accounts Receivable Service Revenue To record service revenue

80,000

i. Accounts Payable Cash To record payment to vendor

50,000

j. Cash

80,000

5,000

80,000

50,000

Accounts Receivable To record payments from customers k. Utilities Expense Cash To record payment for utilities

80,000

325 325

Diff: 2 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

22) Orlando Company began operations on December 1. The company had the following transactions during December. Record these transactions in proper form, including explanations. If an entry is not required, please write "No Entry." a. Issued 50,000 shares of no par common stock and received $350,000 cash. b. Extended an offer of employment to a sales manager who will begin work on January 1. c. Purchased machinery on account for $450,000 from Tampa Company. d. Purchased a two-year insurance policy for $4,800. Paid cash. This policy will become effective on January 1. e. Paid $2,500 in office rent for the month of January. f. Purchased office furniture for $50,000 with a 10% down payment and a six month note payable for the balance. g. Paid wages of $15,000 to employees. h. Provided services to customers on account for $85,000. i. Paid $200,000 to Tampa Company on account. j. Received payment in full for services rendered in part (h). k. Paid a telephone bill for $525.

Answer: a. Cash

350,000

Common Stock To record issuance of common stock

350,000

b. No entry needed c. Machinery

450,000

Accounts Payable To record purchase of machinery

450,000

d. Prepaid Insurance Cash To record purchase of insurance policy

4,800

e. Prepaid Rent Cash To record rent expense

2,500

f. Furniture

50,000

4,800

2,500

Cash Notes Payable To record purchase of office furniture

5,000 45,000

g. Wages Expense Cash To record wages expense

15,000

h. Accounts Receivable Service Revenue To record service revenue

85,000

i. Accounts Payable Cash To record payment to vendor

200,000

j. Cash

85,000

15,000

85,000

200,000

Accounts Receivable To record payments from customers k. Utilities Expense Cash To record payment for telephone

85,000

525 525

Diff: 2 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

23) Significant Technologies Corporation had the following transactions in the month of August. Record these transactions in proper form, including explanations. If an entry is not required, please write "No Entry." a. Significant Technologies received $100,000 cash in exchange for shares of Significant Technologies' common stock. b. Purchased store equipment for $11,000 cash. c. Provided services for cash of $9,000. d. Provided services on credit for $20,000. e. Received bill and paid utilities of $5,000. f. Paid sales salaries of $8,000. Ignore withholding and related payroll taxes. g. Incurred legal fees of $6,000 to be paid later. h. Declared and paid dividends to stockholders of $2,000. i. Collected $15,000 for services to be provided over the coming year but has not yet provided those services. j. Paid $12,000 for a three-year insurance policy with coverage starting on September 1. k. Paid $1,000 for rental of some servers which will be returned to the leasing company on August 30th. l. Collected $10,000 from the transaction described in part d. m. Paid $6,000 of the amount owed for legal fees incurred in the transaction described in part g.

Answer: a. Cash

100,000

Common Stock To record the issuance of common stock b.

100,000

Store Equipment Cash To record the purchase of store equipment

11,000

Cash

9,000

11,000

Service Revenue To record services rendered d.

9,000

Accounts Receivable Service Revenue To record services rendered on account

20,000

Utilities Expense Cash Paid utility bill

5,000

Sales Salaries Expense Cash To record payroll

8,000

Legal Expenses Accounts Payable To record legal fees incurred

6,000

Dividends Cash To record dividends declared and paid

2,000

20,000

5,000

8,000

6,000

2,000

Cash Deferred Service Revenue To record cash received in advance of providing services

15,000

Prepaid Insurance Cash Record insurance premium paid that covers a three year period

12,000

1,000

Rent Expense Cash To record lease payments for servers

15,000

12,000

1,000

Cash Accounts Receivable To record collections from customers

10,000

Accounts Payable Cash To record the payment of legal fees

6,000

10,000

6,000

Diff: 2 Objective: 4.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4.4

Post to the General Ledger

1) Accounts are presented in the general ledger in the same order as they are presented in the balance sheet. Answer: TRUE Diff: 1 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The posting reference in the general ledger is the general journal page number. Answer: TRUE Diff: 1 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Posting is the process of transferring information contained in journal entries to the individual ledger accounts. Answer: TRUE Diff: 1 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) An account will have a debit balance if the credits exceed the debits. Answer: FALSE Diff: 1 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The process of transferring information into individual ledger accounts is called ________. A) ledgering B) transferring C) journalizing D) posting Answer: D Diff: 1 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) A simplified version of a ledger account is known as a ________. A) t-account B) debit account C) credit account D) GL account Answer: A Diff: 1 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) In transferring information to the general ledger, the reference column in the ledger contains the ________. A) chronological order of the entry B) general journal page number C) account abbreviation D) general ledger page number Answer: B Diff: 1 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Amazing Grapes wine store paid utilities and recorded the economic event in the general journal. When posting the related journal entries to the ledger, an impacted account or accounts would include ________. A) Retained Earnings B) Accounts Payable C) Utilities Expense D) Both B & C Answer: C Diff: 1 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) The account number associated with an account in the general ledger refers to ________. A) Chart of Account numerical listing B) chronological order of the entry C) general journal page number D) general ledger page number Answer: A Diff: 1 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Write the journal entries for the following transactions and post to the ledgers. Jan. 2 - Our company issued $30,000 in common stock. Jan. 3 - Our company received $10,000 cash for services completed from a customer. Jan. 4 – Our company invoiced a customer, Joe Brown, for $12,000 for services completed on account. Jan. 5 -Our company received $3,000 cash from customer Joe Brown as payment towards his account. Jan. 6 – Our company purchased $100 of supplies on account. Jan. 7 - Our company paid dividends of $1,000 cash.

Answer: Cash Date Item Jan. 2 3 5 7

11 Post Ref. J1 J1 J1 J1

Debit 30,000 10,000 3,000

Credit

1,000

Accounts Receivable Date Item Jan. 4 5

Post Ref. J1 J1

12 Debit 12,000

Credit 3,000

Supplies Date Item Jan. 6

Post Ref. J1

Debit

Balance Debit Credit 100

Credit 100

22 Post Ref. J1

Debit

Credit 100

Common Stock Date Item Jan. 2

Post Ref. J1

Debit

Credit 30,000

Balance Debit Credit 30,000 32

Post Ref. J1

Debit

Credit 1,000

Service Revenue Date Item Jan. 3 4

Balance Debit Credit 100 31

Dividends Date Item Jan. 7

Balance Debit Credit 12,000 9,000 14

Accounts Payable Date Item Jan. 6

Balance Debit Credit 30,000 40,000 43,000 42,000

Balance Debit Credit 1,000 41

Post Ref. J1 J1

Debit

Credit 10,000 12,000

Balance Debit Credit 10,000 22,000

Diff: 3 Objective: 4.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4.5

Prepare the Unadjusted Trial Balance

1) Balance sheet accounts are the first accounts to be listed on the unadjusted trial balance. Answer: TRUE Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The amounts on a company's unadjusted trial balance are taken from the general ledger. Answer: TRUE Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Financial statements are prepared using data from the unadjusted trial balance. Answer: FALSE Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) If the total of all debit entries equals the total of all credit entries on the unadjusted trial balance, all transactions have been correctly recorded. Answer: FALSE Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) If a journal entry has not been posted to the general ledger, the unadjusted trial balance will still balance. Answer: TRUE Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

6) If a debit to Repairs Expense is inadvertently posted to Rent Expense, the unadjusted trial balance will still balance. Answer: TRUE Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

7) The unadjusted trial balance reflects all of a company's events and transactions. Answer: FALSE Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) An entry to record depreciation in the current period will be recorded after the unadjusted trial balance is prepared. Answer: TRUE Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following recording errors will be revealed by the unadjusted trial balance? A) incorrectly posting a debit for Supplies Expense to Salaries Expense B) inadvertently omitting from posting an entry recording the purchase of small tools on account C) posting a journal entry to record rent expense and the credit to cash twice D) posting a $50,000 entry to Accounts Receivable as $5,000 while correctly recording the corresponding revenue correctly Answer: D Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Which of the following errors will not be revealed by the unadjusted trial balance? A) incorrectly posting a debit for Salaries Expense to Supplies Expense B) failing to post one side of a journal entry C) posting a $50,000 debit to Accounts Receivable as $5,000 while recording the credit to revenue as $50,000 D) posting a credit to cash for $5,400 as $4,500 while posting the debit to expense as $5,400 Answer: A Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) What are the common errors that a trial balance will not reveal? Answer: 1. A transaction that is not journalized. 2. A correct journal entry that is not posted. 3. An entry that is posted twice. 4. The debiting or crediting of incorrect accounts. 5. Debiting and crediting incorrect dollar amounts. Diff: 1 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Given the follow unadjusted amounts, prepare the unadjusted trial balance. Cash Accounts Receivable Supplies Equipment Accounts Payable Common Stock Retained Earnings Dividends Service Revenue Rent Expense Salary Expense Rent Expense Answer: Cash Accounts Receivable Supplies Equipment Accounts Payable Common Stock Retained Earnings Dividends Service Revenue Rent Expense Salary Expense Rental Expense Total

37,000 10,000 5,000 8,000 15,000 26,000 5,000 2,000 21,000 1,000 3,500 500

37,000 10,000 5,000 8,000 15,000 26,000 5,000 2,000 21,000 1,000 3,500 500 $67,000

$67,000

Diff: 2 Objective: 4.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4.6

4Prepare Adjusting Journal Entries

1) Every adjusting journal entry will affect one balance sheet account and one income statement account. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Adjusting journal entries are normally not necessary when cash-basis accounting is used. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Adjusting journal entries are made to ensure that all revenues and/or expenses are recognized in the period in which they are incurred. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Accruals occur when a company receives or pays cash before recognizing the revenue or expense in the financial statements. Answer: FALSE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Deferrals occur when a company receives or pays cash before recognizing the revenue or expense in the financial statements. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) If a company initially records a prepaid expense as an asset, an adjusting entry must be made at the end of the period to increase the expense account. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Recording depreciation expense is necessary to allocate the cost of an asset over its expected useful life. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) If a company does not adjust a prepaid expense initially recorded as an asset, assets will be understated. Answer: FALSE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) If a company does not adjust a prepaid expense initially recorded as an asset, expenses will be overstated. Answer: FALSE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Deferred expenses may be initially recorded as assets or expenses. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Deferred expenses may be initially recorded as assets or revenues. Answer: FALSE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) If a company initially records a deferred revenue as a liability, an adjusting entry must be made at the end of the period to increase the liability account. Answer: FALSE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) If a company initially records a deferred revenue as a liability, an adjusting entry must be made at the end of the period to increase the revenue account. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) If a company fails to adjust a deferred revenue recorded as a liability, revenues will be overstated on the income statement. Answer: FALSE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) If a company fails to adjust a deferred revenue recorded as a liability, liabilities will be overstated on the income statement. Answer: FALSE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) If a company earns interest in June but does not receive it until December, this is referred to as an accrued revenue on June 30. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Accrued revenues are earned before they are received. Answer: TRUE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Accrued expenses are paid before they are incurred. Answer: FALSE Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Which of the following is an adjusting entry? A) Allowance for Uncollectible Accounts Accounts Receivable B) Amortization Expense Intangible Asset C) Cash Deferred Revenue D) Interest Expense Cash Answer: B

Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Which of the following is not an adjusting entry? A) Depreciation Expense Accumulated Depreciation B) Deferred Service Revenue Service Revenue C) Cash Deferred Rent Revenue D) Insurance Expense Prepaid Insurance Answer: C

Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) When a prepaid expense initially recorded as an asset is incurred, the adjusting entry includes ________. A) a debit to an asset B) a credit to a liability C) a credit to an expense D) a debit to an expense Answer: D Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) When a deferred revenue is initially recorded as a liability, the adjusting entry includes ________. A) a credit to a liability B) a credit to a revenue C) a debit to a revenue D) a debit to an expense Answer: B Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) The White Boar Pub purchased a two year insurance policy for $24,000 on February 1 and recorded it as an asset. On June 30, the adjusting entry that should be made is ________. A) Prepaid Insurance Insurance Expense

19,000

B) Insurance Expense Prepaid Insurance

5000

C) Prepaid Insurance Insurance Expense

5000

D) Insurance Expense Prepaid Insurance

19,000

5000

19,000

Answer: B Explanation: Five months would have expired by June 30. $24,000/24 months × 5 months = $5000 of insurance expense. Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

24) Edmond Office Equipment borrowed $80,000 at a 10% annual interest rate on July 1. Principal and interest are due on December 31. The company's fiscal year ends on October 31. What adjusting entry should be made on that date? (Do not round intermediary calculations. Only round your final answer to the nearest dollar.) A) No entry B) Interest Expense Interest Payable

4000

C) Interest Expense Interest Payable

2667

D) Prepaid Interest Interest Payable

2667

4000

2667

Answer: C Explanation: $80,000 × 10% × 4/12 = $2667. Four (4) months have transpired since the loan was made and, therefore, 4 months of accrued interest needs to be recognized as interest expense. Since the interest has not yet been paid, interest payable also needs to be recorded. Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

25) The employees of Lucid Laboratories are paid every two weeks on Friday for a Monday though Friday work week. Total payroll is $20,000 and covers 10 workdays. The end of the current month falls on the second Tuesday of the pay period. What is the adjusting journal entry to accrue payroll at the end of the month? A) Salaries Expense Salaries Payable

6000

B) Prepaid Salaries Salaries Payable

6000

C) Salaries Expense Prepaid Salaries Salaries Payable

14,000 6000

D) Salaries Expense Salaries Payable

14,000

20,000

14,000

Answer: D Explanation: $20,000 × 7/10 = $14,000 of accrued salaries which is both an expense and a payable. Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

26) On January 1, the Thunderball Hockey Association sold 800 season passes for $190 each. The season lasts from February through May. If the amount received was credited to deferred ticket revenue, what adjusting entry will be made on February 28? A) Prepaid Ticket Revenue Ticket Revenue

38,000

B) Ticket Revenue Ticket Payable

76,000

C) Deferred Ticket Revenue Ticket Revenue

38,000

D) Deferred Ticket Revenue Ticket Revenue

76,000

38,000

76,000

38,000

76,000

Answer: C Explanation: 800 × $190 = $152,000 of deferred revenue (a liability account). When February concludes, 1/4 (1 month divided by the 4 months of the season) has transpired and therefore 1/4 of the deferred revenue has been earned ($152,000 × 1/4 = $38,000). The debit to Deferred Ticket Revenue lowers the liability and the credit to Ticket Revenue recognizes the earned revenue (because 1/4 of the games have been played.) Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

27) On November 1, Fisher and Sons Music Center loaned a customer $12,000 at a 8% annual interest rate for six months. What is the interest receivable on the note at December 31? (Do not round intermediary calculations. Only round your final answer to the nearest dollar.) A) $80 B) $160 C) $320 D) $960 Answer: B Explanation: $12,000 × 8% × 2/12 = $160 Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

28) St. Augustine Properties collected advance rentals of $330,000 from its customers during the year. The balance in the deferred rent revenue account increased from $13,000 on January 1 to $39,000 on December 31. Rents earned during the year totaled ________. A) $343,000 B) $356,000 C) $304,000 D) $369,000 Answer: C Explanation: $13,000 + $330,000 - $39,000 = $304,000 Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

29) Wesley Foundation had $22,000 in supplies inventory at the beginning of the year. The company purchased $60,000 in supplies throughout the year and used $80,000. What is the ending balance in the supplies inventory? A) $42,000 B) $20,000 C) $58,000 D) $2000 Answer: D Explanation: $22,000 + $60,000 - $80,000 = $2000 Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

30) Heartland Corporation records all insurance premiums as prepaid insurance. Additional information for the current year is presented below: Prepaid Insurance, January 1 Insurance expense for year Prepaid Insurance, December 31

$62,000 $160,000 $72,000

What were the total amount of insurance premiums paid during the year? A) $232,000 B) $170,000 C) $134,000 D) $160,000 Answer: B Explanation: $160,000 - $62,000 + $72,000 = $170,000 Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

31) Thunderball Sports Club collected $328,000 deferred revenue from its clients during the year. If deferred revenue at the beginning of the year was $61,000 and revenue earned during the year was $350,000, what was deferred revenue at the end of the year? A) $22,000 B) $39,000 C) $83,000 D) $289,000 Answer: B Explanation: $61,000 + $328,000 - $350,000 = $39,000 Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

32) Bay Meadows Real Estate collected rentals of $600,000 during the year. The beginning balance in its rent receivable account was $50,000 and its ending balance was $40,000. What was total rent revenue for the year? A) $589,000 B) $590,000 C) $610,000 D) $622,000 Answer: B Explanation: $600,000 - $50,000 + $40,000 = $590,000 Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

33) Olympic Equipment borrowed $800,000 on November 1. The note matures in one year and the interest rate is 8%. What amount of interest expense will be accrued on December 31? (Do not round intermediary calculations. Only round your final answer to the nearest dollar.) A) $32,000 B) $128,000 C) $10,667 D) $64,000 Answer: C Explanation: $800,000 × 8% × 2/12 = $10,667 Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

34) Jackson Company records all insurance premiums as prepaid insurance. Additional information for the current year is presented below: Prepaid Insurance, January 1 Insurance premiums paid Prepaid Insurance, December 31

$50,000 $250,000 $85,000

What was the total amount of insurance expense incurred during the year? A) $335,000 B) $215,000 C) $285,000 D) $300,000 Answer: B Explanation: $50,000 + $250,000 - $85,000 = $215,000 Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

35) Johnson Company neglected to accrue interest expense of $2,000 on its year-end trial balance. This results in an ________. A) overstatement of net income B) overstatement of assets C) overstatement of liabilities D) understatement of shareholders' equity Answer: A Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

36) Mattox Corporation had an unadjusted balance of $7000 in Supplies. The actual balance was $100. The accountant failed to make the adjusting entry. What is the effect on the current year financial statements? A) Net income is understated by $6900. B) Current assets are overstated by $6900. C) Current assets are understated by $7000. D) Retained Earnings is overstated by $7000. Answer: B Explanation: $7000 - $100 = $6900 Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

37) True North Real Estate Management failed to adjust its Deferred Rent Revenue account for the $15,000 that had been earned during the current year. What effect does this omission have on the current year financial statements? A) Assets are understated by $15,000. B) Revenues are overstated by $15,000. C) Expenses are understated by $15,000. D) Liabilities are overstated by $15,000. Answer: D Explanation: Since Deferred Rent Revenue is a liability, liabilities would be overstated by $15,000. Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

38) Which of the following is not a reason for why adjusting journal entries are necessary? A) to ensure all revenues are recognized in the period earned B) to ensure all expenses are recognized in the period incurred C) because U.S. GAAP requires that financial information be reported using the accrual basis of accounting D) because U.S. GAAP requires that financial information be reported on the cash basis of accounting and adjusting entries adjust accounts from the accrual to the cash basis Answer: D Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

39) To ensure that all economic events are properly reflected in the financial statements ________. A) companies record adjusting entries B) companies only record deferrals C) companies only record accruals D) companies use the cash basis of accounting Answer: A Diff: 1 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

40) Selected transactions for Rosewood Industries are presented below. The fiscal year end for the company is April 30. Net income prior to these adjustments is $43,670. a. The company had purchased a 2-year insurance policy for $2,400 on January 1 and debited the prepaid insurance account. Insurance coverage begins on January 1. b. Depreciation on equipment for the month was $600. Equipment was purchased on January 1 of the current year. c. The company borrowed $15,000 on February 1 at 12% interest. Principal and interest are due on February 1 of the following year. d. The unadjusted trial balance showed a balance in Supplies of $2,650. A month-end inventory showed $900 on hand. e. The company loaned $8,000 to a customer on April 1. The note has an annual interest rate of 12% and is due along with accrued interest on March 31 of the following year. f. Employees had earned $5,600 in salaries as of April 30. These salaries will be paid on May 3. g. The unadjusted trial balance showed deferred revenues of $7,200. During April, $1,200 of these revenues were earned. Required: 1. Prepare the necessary adjusting entries for Rosewood Industries as of April 30. Please include explanations. 2. Compute net income after these adjustments have been made.

Answer: Insurance Expense Prepaid Insurance To adjust prepaid insurance($2,400/24 × 4)

400 400

Depreciation Expense-Equipment Accumulated DepreciationEquipment To record depreciation expense on equipment ($600 × 4 = $2,400)

2400

Interest Expense Interest Payable To record interest expense ($15,000 × 12% × 3/12)

450

Supplies Expense Supplies To record supplies expense ($2,650 - $900)

1,750

Interest Receivable Interest Revenue To record interest revenue ($8,000 × 12% × 1/12)

2400

450

1,750

Salaries Expense Salaries Payable To record salaries expense

5,600

Deferred Revenues Revenues To record revenues earned

1,200

5,600

1,200

Unadjusted Net Income Add: Deferred Revenues Interest Revenue

$43,670 $1,200 80

Deduct: Insurance Expense Depreciation Expense Interest Expense Supplies Expense Salaries Expense Adjusted Net Income

400 2,400 450 1,750 5,600

1,280

(10,600) $34,350

Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

41) Lucid Solutions Inc. has the following selected account balances from its unadjusted trial balance as of December 31, 2022, the company's year-end: • • • • • • • • •

Prepaid Insurance: $75,000 Prepaid Rent: $50,000 Buildings: $3,600,000 Wages Payable: $420,000 Note Payable: $360,000 Wage Expense: $1,120,000 Insurance Expense: $120,000 Interest Expense: $234,000 Rent Expense: $260,000

At year-end, Lucid makes the necessary adjusting journal entries to properly record revenues and expenses for the year. The following information applies to the adjusting journal entries: a. The prepaid insurance balance relates to a two-year insurance policy purchased on June 1 that covers the period of 7/1/18–6/30/20. b. The prepaid rent balance relates to rent that was paid in January 2022 to cover the company's facilities for the year 2022. c. Wages for the last week of 2022 amount to $33,000 and will be paid after year-end and have not yet been recorded. d. Lucid purchased the buildings on January 1, 2022 and depreciates them on a yearly basis. It must record a full year of depreciation at the end of 2022. The buildings have no residual value, a 30-year estimated useful life, and will be depreciated on a straight-line basis. e. Lucid has not yet recorded accrued interest expense for 2022 on the note payable in the amount of $16,000. It will not be paid until 2023.

Answer: a. Insurance Expense Prepaid Insurance To record insurance that has expired ($75,000/24 × 6 months expired) b. Rent Expense Prepaid Rent To record expired rent

$18,750 $18,750

$50,000 $50,000

c. Wages Expense Wages Payable To record wages earned but not yet paid

$33,000

d. Depreciation Expense - Buildings Accumulated Depreciation Buildings To record annual depreciation on buildings ($3,600,000/30 = $120,000) e. Interest Expense Interest Payable To record accrued interest on note payable

$120,000

$33,000

$120,000

$16,000 $16,000

Diff: 2 Objective: 4.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

4.7

Prepare the Adjusted Trial Balance

1) The adjusted trial balance is used to prepare the financial statements for an organization. Answer: TRUE Diff: 1 Objective: 4.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The adjusted trial balance proves the accuracy of the financial statements. Answer: FALSE Diff: 1 Objective: 4.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The adjusted trial balance includes only permanent accounts. Answer: FALSE Diff: 1 Objective: 4.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Which of the following errors would cause the adjusted trial balance to not balance? A) failure to post one side of a journal entry B) omitting the adjusting entry for depreciation expense C) posting the debit for accrued interest to insurance expense D) reversing the debits and credits in an adjusting entry Answer: A Diff: 1 Objective: 4.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The unadjusted trial balance in prepaid insurance is $79,000. During the period, $8000 of the prepaid insurance has now expired. The adjusted balance for prepaid insurance is ________. A) $79,000 B) $71,000 C) $8000 D) $87,000 Answer: B Diff: 1 Objective: 4.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The unadjusted trial balance in deferred service revenue is $27,000. During the period, $7800 of the deferred service revenue has been earned. The balance for deferred service revenue is ________. A) $27,000 B) $7800 C) $34,800 D) $19,200 Answer: D Diff: 1 Objective: 4.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4.8

Prepare Financial Statements

1) The first financial statement to be prepared is the statement of net income. Answer: TRUE Diff: 1 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The final financial statement to be prepared is the statement of cash flows. Answer: TRUE Diff: 1 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The statement of cash flows is prepared after all other financial statements have been prepared. Answer: TRUE Diff: 1 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The first financial statement prepared from the adjusted trial balance is the ________. A) balance sheet B) statement of net income C) statement of cash flows D) statement of retained earnings Answer: B Diff: 1 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The final financial statement prepared is the ________. A) balance sheet B) statement of net income C) statement of cash flows D) statement of retained earnings Answer: C Diff: 1 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which of the following choices shows the correct sequence of the order of preparation of the financial statements? A) balance sheet, statement of net income, statement of stockholders' equity, statement of cash flows B) statement of net income, statement of stockholders' equity, balance sheet, statement of cash flows C) statement of net income, balance sheet, statement of stockholders' equity, statement of cash flows D) statement of stockholders' equity, balance sheet, statement of net income, statement of cash flows Answer: B Diff: 1 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) List the sequence in which financial statements are prepared. Answer: Statement of Net Income Statement of Stockholders' Equity Balance Sheet Statement of Cash Flows Diff: 1 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Explain why the financial statements must be prepared in the following order: statement of net income, statement of stockholders' equity, balance sheet, statement of cash flows. Answer: The amount of net income is needed to correctly reflect retained earnings which is reported on the statement of stockholders' equity. Retained earnings is used to derive total stockholders' equity as of the end of the period. The ending balances of the components of stockholders' equity from the statement of stockholders' equity are reported next on the balance sheet. The changes in balance sheet accounts (from period to period), net income, and noncash expenses are all needed to prepare the statement of cash flows. Diff: 1 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Presented is an adjusted trial balance for Steelman Accounting Services, Inc. for December 31 of the current year. Steelman Accounting Services, Inc Adjusted Trial Balance December 31 Adjusted Trial Balance Account Title Accounts Receivable Supplies Prepaid Rent Equipment Accumulated Depreciation—Equipment Accounts Payable Wages Payable Note Payable Common Stock Retained Earnings Service Revenue Wages Expense Depreciation Expense Interest Expense Property Tax Expense Rent Expense Supplies Expense Utility Expense

Debit $89,300 8,000 15,000 250,000

Credit

$75,000 26,100 6,000 30,000 90,000 52,000 405,000 130,000 25,000 1,800 31,500 60,000 19,500 12,000 $684,100

$684,100

a. Prepare a single-step income statement. b. Prepare a statement of stockholders' equity. c. Prepare a classified balance sheet.

Answer: a.

Steelman Accounting Services, Inc. Statement of Net Income For Year Ended December 31

Service Revenue Expenses: Wages Expense Utilities Expense Tax Expense Supplies Expense Rent Expense Interest Expense Depreciation Expense Total Expenses Net Income

$405,000

$130,000 12,000 31,500 19,500 60,000 1,800 25,000 279,800 $125,200

b. Steelman Accounting Services, Inc. Statement of Stockholders' Equity For Year Ended December 31

Balance, January 1 Add: Net Income Balance, December 31

Total Capital Retained Shareholders' Stock Earnings Equity $90,000 $52,000 $142,000 125,200 125,200 $90,000 $177,200 $267,200

Steelman Accounting Services, Inc. Balance Sheet December 31

Assets Current Assets Cash Accounts Receivable Supplies Prepaid Rent Total Current Assets Property and Equipment Equipment Less: Accumulated Depreciation Total Assets

$42,000 89,300 8,000 15,000 154,300 $250,000 75,000

Liabilities and Stockholders' Equity Current liabilities: Accounts Payable Wages Payable Notes Payable Total Current Liabilities Stockholders' Equity Capital Stock Retained Earnings Total Liabilities and Stockholders' Equity

175,000 $329,300

$26,100 6,000 30,000 62,100 $90,000 177,200

267,200 $329,300

Diff: 3 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

10) Presented below is an adjusted trial balance for Jackson Services Inc. for December 31 of the current year: Adjusted Trial Balance Account Title Debit Cash $87,000 Accounts Receivable 170,300 Supplies 15,000 Prepaid Rent 10,000 Equipment 35,000 Accumulated Depreciation—Equipment Accounts Payable Wages Payable Note Payable (due in 6 months) Common Stock Retained Earnings Service Revenue Utilities Expense 12,000 Wages Expense 25,000 Advertising Expense 26,000 Depreciation Expense 1,800 Interest Expense 3,000 Property Tax Expense 15,000 Rent Expense 20,000 Supplies Expense 3,900 $424,000

Credit

$25,000 16,000 6,000 30,000 90,000 52,000 205,000

$424,000

a. Prepare a single-step income statement for the year. b. Prepare a statement of stockholders' equity for the year. There were no new issues or retirements of common stock during the year. c. Prepare a classified balance sheet at year end.

Answer: a.

Jackson Services, Inc. Statement of Net Income For Year Ended December 31

Service Revenue Expenses: Wages Expense Utilities Expense Advertising Expense Supplies Expense Rent Expense Interest Expense Property Tax Expense Depreciation Expense Total Expenses Net Income

$205,000

$25,000 12,000 26,000 3,900 20,000 3,000 15,000 1,800 106,700 $98,300

b. Jackson Services, Inc. Statement of Stockholders' Equity For Year Ended December 31 Total Common Retained Shareholders' Stock Earnings Equity Balance, January 1 $90,000 $52,000 $142,000 Add: Net Income 98,300 98,300 Balance, December 31 $90,000 $150,300 $240,300

Jackson Services, Inc. Balance Sheet As of December 31

Assets Current Assets Cash Accounts Receivable Supplies Prepaid Rent Total Current Assets Noncurrent Assets Equipment Less: Accumulated Depreciation Total Assets

$87,000 170,300 15,000 10,000 $282,300 $35,000 25,000

Liabilities and Stockholders' Equity Current Liabilities: Accounts Payable Wages Payable Notes Payable Total Current Liabilities Stockholders' Equity Common Stock Retained Earnings Total Stockholders' Equity Total Liabilities and Stockholders' Equity

10,000 $292,300

$16,000 6,000 30,000 $52,000 $90,000 150,300 240,300 $292,300

Diff: 3 Objective: 4.8 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

4.9

Close Temporary Accounts

1) Permanent accounts include all balance sheet accounts. Answer: TRUE Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Temporary accounts carry a balance from period to period. Answer: FALSE Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Asset accounts are temporary accounts. Answer: FALSE Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Expense accounts are temporary accounts. Answer: TRUE Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Closing revenue accounts results in a credit to income summary. Answer: TRUE Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Permanent accounts do not include ________. A) Rent Expense B) Taxes Payable C) Prepaid Insurance D) Interest Receivable Answer: A Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following accounts is a permanent account? A) Interest Expense B) Gain on Sale of Equipment C) Patents D) Bad Debt Expense Answer: C Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) All of the following accounts are permanent accounts except ________. A) Accounts Payable B) Goodwill C) Dividends D) Marketable Securities Answer: C Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following accounts is a temporary account? A) Supplies B) Interest Expense C) Patents D) Insurance Answer: B Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) All of the following accounts are temporary accounts except ________. A) Gain on Sale of Equipment B) Sales Revenue C) Dividends Payable D) Interest Expense Answer: C Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) To close out an expense or loss account ________. A) credit the income summary and debit expense and loss accounts B) debit the income summary and credit expense and loss accounts C) debit the income summary and credit revenue and expense accounts D) credit the income summary and debit revenue and expense accounts Answer: B Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

12) To close out the income summary ________. A) debit income summary, credit retained earnings for the amount of net income B) credit income summary and debit retained earnings for the amount of the net loss C) Both A & B D) Neither A nor B Answer: C Diff: 2 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

13) To close out the dividends account ________. A) debit retained earnings and credit the dividends account B) credit retained earnings and debit the dividends account C) debit retained earnings and credit dividends payable D) credit retained earnings and debit dividends payable Answer: A Diff: 2 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

14) If service revenue is $280,000, total expenses are $190,000, additional capital stock issued of $18,000 and dividends declared are $2000, what is the change in retained earnings as a result of the closing process? A) an increase of $280,000 B) an increase of $88,000 C) an increase of $2000 D) an increase of $16,000 Answer: B Explanation: Income summary would be credited by $280,000 for revenue, debited $190,000 for expenses which would result in net income of $90,000, an increase (credit to) in retained earnings. The $2000 of dividends would decrease retained earnings (debit) which would result in a net change (increase) in retained earnings of $88,000. $90,000 - $2000 = $88,000 Diff: 2 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

15) List the steps required to close temporary accounts. Answer: 1. Close out revenue accounts with debits and a corresponding credit to income summary. 2. Close out expense accounts with credits and a corresponding debit to income summary. 3. Close out income summary account. Debit income summary and credit retained earnings for net income; credit income summary and debit retained earnings for net loss. 4. Close out the dividends account by debiting retained earnings and crediting the dividends account. Diff: 1 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Nantucket Corporation has the following income statement accounts for the year ended December 31. Service Revenue Salaries Expense Dividend Revenue Interest Expense Gain on Sale of Equipment

$750,000 425,000 4,500 9,500 6,000

Rent Expense Utilities Expense Depreciation Expense Income Tax Expense Insurance Expense

Required: Prepare the necessary closing entries for December 31. Answer: Dec 31 Service Revenue 750,000 Gain on Sale of Equipment 6,000 Dividend Revenue 4,500 Income Summary 760,500 To close revenue accounts Dec 31

Dec 31

Income Summary Salaries Expense Rent Expense Utilities Expense Depreciation Expense Income Tax Expense Interest Expense Insurance Expense To close expense accounts

628,000

Income Summary Retained Earnings To close income summary account

132,500

425,000 105,000 11,000 16,500 38,000 9,500 23,000

132,500

Diff: 2 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

$105,000 11,000 16,500 38,000 23,000

17) Management InfoSys Incorporated had the following account balances at year end. Service Revenue Salaries Expense Dividend Revenue Interest Expense Gain on Sale of Equipment

$950,000 435,000 5,500 9,500 6,000

Rent Expense Utilities Expense Depreciation Expense Income Tax Expense Insurance Expense

Required: Prepare the closing entries at December 31. Answer: Dec 31 Service Revenue Dividend Revenue Income Summary To close revenue accounts

950,000 5,500

Dec 31 Income Summary Salaries Expense Rent Expense Utilities Expense

665,000

955,500

435,000 115,000 11,000

Depreciation Expense

26,500

Income Tax Expense Interest Expense Insurance Expense Loss on sale of

40,000 9,500 22,000 6,000

equipment To close expense accounts

Dec 31 Income Summary Retained Earnings To close income summary account

290,500 290,500

Diff: 2 Objective: 4.9 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

$115,000 11,000 26,500 40,000 22,000

4.10

Prepare Post-Closing Trial Balance

1) The post-closing trial balance proves the accuracy of the accounts. Answer: FALSE Diff: 1 Objective: 4.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The post-closing trial balance contains only permanent accounts. Answer: TRUE Diff: 1 Objective: 4.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The post-closing trial balance contains both permanent and temporary accounts. Answer: FALSE Diff: 1 Objective: 4.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Which of the following accounts would be shown on the post-closing trial balance? A) Dividends B) Investments C) Bad Debt Expense D) Loss on Sale of equipment Answer: B Diff: 1 Objective: 4.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Which of the following accounts would be shown on the post-closing trial balance? A) Salaries Payable B) Salaries Expense C) Wage Expense D) Depreciation Expense Answer: A Diff: 1 Objective: 4.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which of the following accounts would not be shown on the post-closing trial balance? A) Dividends Payable B) Depletion Expense C) Patent D) Investment in Bonds Answer: B Diff: 1 Objective: 4.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following accounts would not be shown on the post-closing trial balance? A) Rent Expense B) Retained Earnings C) Cash D) Common Stock Answer: A Diff: 1 Objective: 4.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Presented below are the account balances after closing entries for Jackson Services Inc. for December 31 of the current year. Prepare the post-closing trial balance. Post-Closing Trial Balance Cash Accounts Receivable Supplies Prepaid Rent Equipment Accumulated Depreciation–Equipment Accounts Payable Wages Payable Note Payable (due in 6 months) Common Stock Retained Earnings

$87,000 170,300 15,000 10,000 35,000 25,000 16,000 6,000 30,000 90,000 150,300

Answer:

Post-Closing Trial Balance Account Title Debit Cash $87,000 Accounts Receivable 170,300 Supplies 15,000 Prepaid Rent 10,000 Equipment 35,000 Accumulated Depreciation–Equipment Accounts Payable Wages Payable Note Payable (due in 6 months) Common Stock Retained Earnings $317,300

Credit

25,000 16,000 6,000 30,000 90,000 150,300 $317,300

Diff: 2 Objective: 4.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

4.11

Appendix A: Alternative Treatment of Deferred Revenues and Expenses

1) Prepaid expenses may be initially recorded as assets or expenses. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Prepaid expenses may be initially recorded as liabilities or revenues. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) If a prepaid expense is initially recorded as an asset, the end-of-period adjusting entry records the expired portion. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) If a prepaid expense is initially recorded as an asset, the end-of-period adjusting entry records the unexpired portion. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) If a prepaid expense is initially recorded as an expense, the end-of-period adjusting entry records the expired portion. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) If a prepaid expense is initially recorded as an expense, the end-of-period adjusting entry records the unexpired portion. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) If a prepaid expense is recorded as an expense, and the adjusting entry is not made at the end of the period, assets on the balance sheet will be overstated. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) If a prepaid expense is recorded as an expense, and the adjusting entry is not made at the end of the period, expenses on the income statement will be overstated. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Deferred revenues may be initially recorded as liabilities or revenues. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Deferred revenues may be initially recorded as assets or expenses. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) If a deferred revenue is initially recorded as a liability, the end-of-period adjusting entry records the earned portion. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) If a deferred revenue is initially recorded as a liability, the end-of-period adjusting entry records the deferred portion. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) If a deferred revenue is initially recorded as a revenue, the end-of-period adjusting entry records the earned portion. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) If a deferred revenue is initially recorded as a revenue, the end-of-period adjusting entry records the unexpired portion. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Snowden Company purchased a 2 year insurance policy on March 31, 2022 for $4000 and charged the entire amount to Insurance Expense. The adjusting entry on December 31, 2022 will include ________. A) a credit to Insurance Expense for $2500 B) a credit to Prepaid Insurance for $2500 C) a debit to Insurance Expense for $1500 D) a credit to Cash for $1500 Answer: A Explanation: $4000/24 months × 9 months = $1500 expense in 2022. Snowden has Insurance Expense recorded for $4000, so it is too high. We should credit Insurance Expense (to reduce it) for $2500 = $4000 $1500 = $2500. Diff: 2 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

16) On January 1, Mountbatten Corporation paid $16,000 for a year's advance rent on a building and recorded it as Rent Expense. The rental period begins on January 1. When financial statements are prepared on March 31, the adjusting entry should include ________. (Do not round intermediary calculations. Only round your final answer to the nearest dollar.) A) a credit to Cash for $12,000 B) a credit to Rent Expense for $12,000 C) a credit to Prepaid Rent for $4000 D) a debit to Rent Expense for $4000 Answer: B Explanation: $16,000 × 3/12 = $4000 of insurance expense and therefore the insurance expense account would have to be credited by $12,000 ($16,000 - $4000) to bring it to the proper level of expense for the period. Diff: 2 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

17) On March 31, Paris Enterprises received $31,000 in payment for annual advertising contracts and recorded it as advertising revenue. If the revenue is earned equally each month, the adjusting entry on June 30 will include a ________. (Do not round intermediary calculations. Only round your final answer to the nearest dollar.) A) credit to Prepaid Expenses for $23,250 B) credit to Deferred Revenue for $7750 C) debit to Advertising Revenue for $23,250 D) credit to Advertising Revenue for $7750 Answer: C Explanation: $31,000 × 3/12 = $7750 is the amount of revenue earned and therefore the advertising revenue account needs to be adjusted with a $23,250 debit ($31,000 - $7750) to bring it to the proper level of revenue earned for the period. Diff: 2 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

18) On July 1, Madrid Corporation received $9600 from New Iberia Company for six months rent on a factory building and recorded it as revenue. What adjusting entry will Madrid make on August 31? (Do not round intermediary calculations. Only round your final answer to the nearest dollar.) A) Prepaid Rent 6400 Rent Revenue 6400 B) Rent Revenue

6400

Deferred Rent Revenue C) Deferred Rent Revenue Rent Revenue

6400

3200

D) Rent Revenue Deferred Rent Revenue

3200

3200 3200

Answer: B Explanation: $9600/6 months × 2 month = 3200 is the amount that is earned and therefore the revenue must be adjusted down to that figure which would be done with a 6400 debit ($9600 -3200.) Diff: 2 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

19) Boston Corporation purchased two insurance policies during the current year. On February 1, 2022 the company purchased a two-year liability policy for $18,000. On May 1, 2022 it purchased a one year automobile policy for $7,200. These payments were charged to insurance expense. Boston Company has a fiscal year end of June 30. Required: 1. How much insurance expense should be recognized from these policies on June 30, 2022? 2. What adjusting entry will be required on June 30, 2022? Answer: 1. The company should recognize $4,950 in expense in 2022. ($750 × 5) + ($600 × 2) = ($18,000/24 × 5) + ($7,200/12 × 2). The company recorded insurance expense of $25,200, which is too high. So they will credit insurance expense for $20,250 = $25,200 - $4,950. 2. The adjusting entry is as follows: June 30 Prepaid Insurance Insurance Expense

20,250 20,250

Diff: 2 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

20) New York Enterprises provides advertising services to travel agencies. The company bills annually and receives payments in advance. All advertising is earned equally each month. In January, the company received $120,000; in February, it received $144,000. The company recorded Advertising Revenue of $264,000. The fiscal year ends on February 28. Required: 1. How much revenue should be recognized from these contracts on February 28? 2. What adjusting entry will be required on February 28? Answer: 1. The company should recognize $32,000 in revenue. [($120,000 / 12) × 2] + [($144,000 / 12) × 1] 2. The adjusting entry is as follows: Feb 28 Advertising Revenue 232,000 Deferred Revenue 232,000 Recorded deferred revenue ($264,000 - $32,000 = $232,000) Diff: 2 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

21) Selected transactions of Ventura Corporation are presented below: March 1—Received $9,000 in payment for 6 months advance rent from Franken Company and recorded it as rent revenue. May 1—Paid Acme Insurance $6,000 for a 2-year liability policy and recorded it as insurance expense. Policy begins on May 1. June 1—Received $5,400 from Kennedy Corporation as an advance payment for a 6-month advertising contract and recorded it as advertising revenue. Contract begins on June 1. Required: Prepare the adjusting entries that would be required on June 30. Answer: Jun 30 Rent Revenue 3,000 Deferred Rent Revenue 3,000 Jun 30 Prepaid Insurance Insurance Expense

5,500

Jun 30 Advertising Revenue Deferred Advertising Revenue

4,500

5,500

4,500

Diff: 2 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

4.12

Appendix B: Using a Worksheet

1) The first step in preparing a worksheet is to record the adjusting journal entries. Answer: FALSE Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The final step in preparing a worksheet is to compute net income or loss. Answer: TRUE Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A form used to simplify the adjustment process and the preparation of the financial statements is ________. A) a worksheet B) a post-closing trial balance C) an unadjusted trial balance D) Both B & C Answer: A Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The first step in preparing a worksheet is to ________. A) place adjusted trial balance amounts in appropriate income statement and balance sheet columns B) compute the adjusted balance in the adjusted trial balance columns C) enter the adjusting journal entries in the adjustments columns D) prepare an unadjusted trial balance Answer: D Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Step 4 in completing the worksheet is to place the adjusted trial balance amounts in the ________ columns. A) Income statement B) Balance sheet C) Adjustments D) Both A & B Answer: D Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

6) List the steps in preparing a worksheet. Answer: 1. Prepare an unadjusted trial balance directly on the worksheet. 2. Enter the adjusting entries in the adjustments columns and record them in the general journal. 3. Compute the adjusted trial balances in the adjusted trial balance columns. 4. Place adjusted trial balance amounts in appropriate income statement and balance sheet columns. 5. Total the statement columns, compute the net income (loss) and complete the worksheet. Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

4.13

Appendix C: Reversing Entries

1) Reversing entries change the amounts reported in previously issued financial statements. Answer: FALSE Diff: 1 Objective: App C IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Reversing entries are used in connection with accrued revenues and accrued expenses. Answer: TRUE Diff: 1 Objective: App C IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Which of the following transactions would never be reversed in the following period? A) accrual of interest revenue B) accrual of wages expense C) assignment of depreciation expense D) accrual of interest expense Answer: C Diff: 1 Objective: App C IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Powers Company accrued unpaid wages of $3000 on January 31. These wages will be included in paychecks totaling $5000 on February 2. The reversing entry will include a ________. A) credit to Cash for $3000 B) debit to Wages Payable for $5000 C) debit to Wages Expense for $5000 D) credit to Wages Expense for $3000 Answer: D Explanation: The adjusting entry debited Wages Expense for $3000 and credited Wages Payable for $3000. The reversing entry will debit Wages Payable for $3000 and credit Wages Expense for $3000. Diff: 1 Objective: App C IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

5) Carroll Company accrued interest of $800 on a $20,000, 8% note payable at December 31. The annual interest payment will be made on July 1. The reversing entry will include a ________. A) credit to Interest Payable for $800 B) debit to Notes Payable for $20,000 C) credit to Interest Expense of $800 D) debit to Cash for $800 Answer: C Explanation: The adjusting entry debited Interest Expense for $800 and credited Interest Payable for $800. The reversing entry will debit Interest Payable for $800 and credit Interest Expense for $800. Diff: 1 Objective: App C IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

6) On December 31, Griffin Company accrued interest revenue of $60 on a $3000, 8% note. The annual interest payment will be made on October 1. The reversing entry will include a ________. A) credit to Interest Revenue for $180 B) debit to Interest Revenue for $60 C) debit to Interest Receivable for $180 D) debit to Cash for $60 Answer: B Explanation: The adjusting entry debited Interest Receivable for $60 and credited Interest Revenue for $60. The reversing entry will debit Interest Revenue for $60 and credit Interest Receivable for $60. Diff: 1 Objective: App C IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

7) The December 31 financial statements of Jagger Company included the effects of the following transactions recorded on December 31: a. Wages of $6,800 were recorded. These wages will be paid on January 2. b. Interest expense of $750 that will be paid on February 1 was recorded. c. Interest revenue of $300 that will be paid on March 1 was recorded. Required: Prepare the reversing entries for these transactions. Answer: Jan 1 Wages Payable 6800 Wages Expense 6800 Jan 1

Jan 1

Interest Payable Interest Expense

750

Interest Revenue Interest Receivable

300

750

300

Diff: 2 Objective: App C IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 5 Statements of Net Income and Comprehensive Net Income 5.1

Overview of the Income Statements

1) The two parts that compose comprehensive income are operating income and net income. Answer: FALSE Diff: 1 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Comprehensive income is comprised of only elements explicitly excluded from net income. Answer: FALSE Diff: 1 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Other comprehensive income is comprised of elements explicitly excluded from net income. Answer: TRUE Diff: 1 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Comprehensive income may be reported in the financial statements in either of two formats. Answer: TRUE Diff: 1 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Which of the following is considered to be a limitation of income statements? A) Income statements depend on accounting methods selected. B) Income statements evaluate past performance. C) Income statements assess uncertainties of achieving future cash flows. D) Income statements predict future performance. Answer: A Diff: 1 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following is considered to be a characteristic of the usefulness of income statements? A) Income statements require judgment. B) Income statements evaluate past performance. C) Income statements depend on the accounting methods selected. D) Income statements exclude unreliable information. Answer: B Diff: 1 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Morton Company has the following transactions in the current year. Assuming that all of the transactions are material, which of them will most likely have no effect on current year net income? A) advance in technology that renders certain inventory items obsolete B) retirement of callable bonds at a premium C) sale of used equipment that had been fully depreciated in prior years D) increase in the fair value of certain available-for-sale securities held as an investment Answer: D Diff: 1 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Which statement is true about the computation of net income and comprehensive income? A) They are the same under either reporting alternative. B) The one statement format provides a higher net income than the two consecutive statements format. C) The two consecutive statements format provides a higher net income than the one statement format. D) Net income always equals comprehensive income under the one statement format. Answer: A Diff: 2 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) What is a limitation of the income statement? A) It has no predictive value. B) It requires extensive judgement and estimation in order to draw conclusions. C) It does not allow users to judge risk. D) It only reports financial standing as of a point in time. Answer: B Diff: 2 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) In what ways is the income statement useful to users? A) helps users evaluate past performance B) helps users predict future results C) helps users assess the risk of future cash flows D) All of the above Answer: D Diff: 2 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Which of the following would not be included in net income? A) sales from products and services that occurred during the accounting period B) an unrealized gain on an available-for-sale debt investment as of the end of the accounting period C) wages and salaries expense incurred during the accounting period D) a gain from the disposal of equipment that occurred on the last day of the accounting period Answer: B Diff: 2 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Which of the following would be included in net income? A) an unrealized gain on an available-for-sale debt investment as of the end of the accounting period B) a gain from the disposal of equipment that occurred on the last day of the accounting period C) an unrealized gain as a result of a foreign currency translation adjustment D) an unrealized loss on an available-for-sale debt investment as of the end of the accounting period Answer: B Diff: 2 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) In what ways do the accounting standards allow companies to report comprehensive income in the financial statements? Answer: Entities may report comprehensive income in two ways: • In one statement usually called the statement of comprehensive income, or • In two consecutive statements: the statement of net income and the statement of comprehensive income. Diff: 1 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) How does the fact that accounting standards allow managers to exercise their professional judgment when making accounting policy decisions constitute a limitation of the income statement? Answer: In general, allowing managers to use judgment when making accounting policy choices that best reflect the economic reality of a transaction will enhance the usefulness of the financial statements. However, due to significant subjectivity and estimation uncertainties involved in financial reporting, management can bias their judgments to enhance the entity's financial performance by manipulating revenues, gains, expenses, and losses. Even if management is not intentionally biasing reported earnings, different judgments will lead to different income numbers, resulting in reduced comparability. The measurement of income is dependent upon the accounting methods selected. For example, identical companies that purchase the same asset but depreciate that asset using different depreciation methods will report a different net income, resulting in reduced comparability. Diff: 1 Objective: 5.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

5.2

Earnings Quality

1) Most elements of operating income are permanent in nature. Answer: TRUE Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Elements of other comprehensive income are primarily permanent in nature. Answer: FALSE Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The "big bath" earnings management technique involves increasing an expected net loss so as to report an even larger net loss. Answer: TRUE Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The "cookie jar reserves" earnings management technique involves increasing earnings in the current period so as to increase managers' compensation. Answer: FALSE Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Cookie jar reserves are used in future periods to increase earnings as needed, possibly to exceed analysts' forecasts. Answer: TRUE Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following income statement items is considered to be permanent? A) gains on disposal of equipment B) impairment losses C) interest expense D) discontinued operations Answer: C Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following income statement items is considered to be transitory? A) promotional costs for a new product B) sales revenue from the general public C) interest expense on short-term loans D) income from discontinued operations Answer: D Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Which of the following statements about earnings quality is false? A) Earnings quality is enhanced when managers are afforded discretion and judgment in applying accounting standards. B) Permanent earnings result in higher earnings quality, while transitory earnings result in lower earnings quality. C) Earnings quality is of considerable interest not only to investors and creditors but also to auditors, regulators, and academics. D) Earnings quality captures the degree to which reported income provides financial statement users with useful information for predicting future firm performance. Answer: A Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Each of the following is a motivation to engage in earnings management except ________. A) beat benchmarks B) avoid reporting a loss C) separate other comprehensive income from net income D) present a smooth, upwards trend in earnings Answer: C Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Which of the following is an earnings management technique that involves increasing a current loss to show a future increase in net income? A) inversion B) comprehensive counting C) big bath D) cookie jar reserves Answer: C Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) The "cookie jar reserves" earnings management technique involves ________. A) increasing earnings in the current period in anticipation of significant future decreases B) decreasing earnings in the current period in anticipation of significant future increases in earnings C) increasing earnings so as to increase managers' compensation D) increasing losses in the current period to allow the firm to show increased net losses in the future Answer: B Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Which of the following is not usually a motivating factor for management to manage earnings? A) present earnings in a smooth and upward trend B) to meet desired profit goals C) to meet a regulatory requirement to manage earnings D) to avoid reporting a loss for a particular accounting period Answer: C Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which of the following is considered a transitory item when assessing earnings quality? A) gains on disposal of long-lived assets B) cost of goods sold C) selling expenses D) sales Answer: A Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Which of the following is considered a permanent item when assessing earnings quality? A) a gain of the disposal of a truck B) a loss on the sale of a machine which had been used in operations C) general and administrative expenses of the corporate headquarters D) a gain on discontinued operations Answer: C Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) According to a survey of auditors, what is the most common approach to earnings management by management? A) manipulate revenues and gains B) manipulation of expenses and losses C) exploit business combinations D) engage in fraudulent activity Answer: B Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) ________ are(is) used in future periods to increase earnings as needed, possibly to exceed analysts' forecasts. A) Inversion B) Comprehensive counting C) Big bath D) Cookie jar reserves Answer: D Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Identify and describe the two primary factors that impact earnings quality. Answer: The two factors that impact earnings quality are: (1) the nature of earnings and (2) management discretion allowed by the accounting standards. 1. Earnings quality is dependent upon whether the components of earnings presented are permanent or transitory in nature. 2. Management will sometimes engage in earnings management by using the discretion afforded under the accounting standards to manipulate earnings to meet desired goals. Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) What are the most common approaches management uses to manipulate earnings? Answer: A summary of the approaches management uses to manipulate earnings shows that the most common approach is through the manipulation of expenses and losses followed by the manipulation of revenues and by opportunities around business combinations. Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) In what ways is management motivated to engage in earnings management? Answer: Management is motivated to manage earnings to: 1. Beat benchmarks such as prior-quarter earnings or earnings from the same quarter of a prior year. 2. Avoid reporting a loss. 3. Present a firm's earnings as a smooth, upward trend. 4. Increase their own compensation when bonus plans are based on the net income or stock price of the firm. Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Compare and contrast two earnings management techniques. Answer: When low earnings are expected, management may decide that, because everyone is expecting low earnings or perhaps even a loss, they might as well show lower earnings now in the current period. This big bath earnings management technique involves increasing a current period loss to allow the firm to show increased net income in a future period. When earnings are higher than expected in the current period, managers may elect to reduce those earnings to create cookie jar reserves which are then used in future periods to increase earnings as needed so as to exceed analysts' forecasts and market expectations. Diff: 1 Objective: 5.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5.3

Statement of Net Income Elements and Classifications

1) The "nature approach" to classifying expenses refers to classification by source such as salary costs or rent expense. Answer: TRUE Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) U.S. GAAP requires firms to classify revenues and expenses using the functional approach. Answer: FALSE Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The four income statement elements are gains, losses, revenues, and expenses. Answer: TRUE Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Which of the following income statement elements is an economic inflow that occurs from primary operations? A) revenue B) comprehensive income C) gain D) net income Answer: A Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Which of the following income statement elements is an economic outflow that occurs from primary operations? A) loss B) expense C) revenue D) deficit Answer: B Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following transactions will most likely result in a loss reported on the income statement? A) A shoe store acquires a large supply of shoe polish from a supplier going through bankruptcy. B) A manufacturer pays a company a fee to license that company's proprietary technology. C) A bank pays more interest than expected on customers' savings accounts. D) A grocery store sells marketable securities after a decline in value. Answer: D Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following is a classification of expenses using the nature approach? A) cost of goods sold B) payroll costs C) sales expense D) administration expense Answer: B Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Which of the following is a classification of expenses using the functional approach? A) administration expense B) cost of raw materials used C) supplies expense D) salary costs Answer: A Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) A sporting goods retailer sells some of its cash registers. Which of the following would be a false statement? A) If it sells the registers for more than their book value, then this transaction results in a gain. B) If it sells the registers for less than their book value, it would be an expense added to cost of goods sold. C) The inflow from the sale of the cash registers would only be classified as revenue if the retailer were in the business of selling cash registers. D) In no cases would the inflow from the sale of cash registers be classified as a revenue. Answer: B Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) How are revenues similar to gains and how are they different? Answer: Revenues and gains are both inflows or other enhancements of an entity's assets that result in an increase in net income and an increase in stockholders' equity. Revenues arise from an entity's ongoing major or primary operations while gains result from secondary events and circumstances. Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) How are expenses similar to losses and how are they different? Answer: Expenses and losses are both outflows or other consumption of an entity's assets that result in a decrease in net income and a decrease in stockholders' equity. Expenses arise from an entity's ongoing major or primary operations while losses result from secondary events and circumstances. Diff: 1 Objective: 5.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5.4

Statement of Net Income Presentation

1) The single-step income statement format combines all revenues and expenses into a single category and all gains and losses into another single category. Answer: FALSE Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Key performance measures on the statement of net income include gross profit and net assets, among others. Answer: FALSE Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Key performance measures on the statement of net income include operating income and income from continuing operations, among others. Answer: TRUE Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When a large number of line items limits the usefulness of the income statement, companies use a single-step income statement. Answer: FALSE Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) IFRS requires companies to report specific items on the income statement including finance costs. Answer: TRUE Diff: 1 Objective: 5.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) Approximately 15% of reporting entities use a single-step income statement. Answer: TRUE Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) IFRS requires companies to present specific items on the income statement including write-downs of inventories and litigation settlements. Answer: FALSE Diff: 1 Objective: 5.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) IFRS requires companies to disclose write-downs of inventory or of property, plant, and equipment if they are not presented on the income statement. Answer: TRUE Diff: 1 Objective: 5.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

9) Which of the following is not a subtotal on the multi-step income statement? A) interest expense B) gross profit C) operating income D) income from continuing operations before tax Answer: A Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Which section of the multi-step income statement reports revenues and expenses related to secondary operations of the entity? A) discontinued operations section B) secondary section C) non-operating section D) operating section Answer: C Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Which of the following is not a drawback of the single-step income statement? A) It does not separate operating and non-operating items. B) It combines revenues and gains without classification. C) It does not classify expenses by function. D) It misstates net income due to oversimplification. Answer: D Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Which of the following items does IFRS require to be presented on the income statement that U.S. GAAP does not require? A) litigation settlements B) finance costs C) after-tax profit or loss on discontinued operations D) restructuring costs Answer: B Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which of the following items does IFRS require to be disclosed but not necessarily presented on the income statement? A) litigation settlements B) finance costs C) turnover D) income of associates Answer: A Diff: 1 Objective: 5.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

14) Which of the following is the key performance measure reported on the income statement that is typically presented first in sequence? A) sales revenue B) income from continuing operations C) gross profit D) operating income Answer: C Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Which of the following is the key performance measure reported on the income statement that is typically presented last in sequence? A) earnings per share B) income from continuing operations C) net income D) operating income Answer: A Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Companies use ________ income statements when a large number of line items distracts the user from identifying key measures and relationships. A) comprehensive B) condensed C) single-step D) multi-step Answer: B Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Which of the following items would not appear in the operating section of the multiple-step income statement of a manufacturer? A) sales of products B) the cost of goods sold during the period C) depreciation expense of the machinery used on the assembly line D) the gain or loss on the disposal of equipment used on the assembly line Answer: D Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Which of the following items would not appear in the operating section of the multiple-step income statement of a retailer? A) sales of products B) the cost of goods sold during the period C) depreciation expense related to store equipment such as cash registers and store fixtures D) the gain or loss on the disposal of store equipment used in operations Answer: D Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Under U.S. GAAP, identify the six key performance measure subtotals on the statement of net income. Answer: Key performance measures on the statement of net income include: 1. Gross profit 2. Operating income 3. Income before tax (or Income from continuing operations before tax) 4. Income from continuing operations 5. Net income 6. Earnings per share Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Truko, Inc. provided the following partial trial balance for the current year. Prepare a single-step income statement for the year ended December 31. Truko is subject to a 40% income tax rate. Truko Inc. Partial Trial Balance (Selected Accounts) For the Year Ended December 31 Accounts Dividends Sales Dividend Income Interest Income Gain on Disposal of Plant Assets Unrealized Gain on Trading Investments Cost of Goods Sold Office Supplies Expense Sales Salaries Expense Selling Expenses Accounting and Legal Fees—General Expense Advertising Expense Office Salaries Expense Depreciation Expense—General Expense Interest Expense Loss on Asset Impairment

Debit $2,460

Credit $225,400 3,830 1,450 14,810 7,270

90,100 4,500 8,390 11,210 2,400 6,660 21,480 18,600 2,570 1,840

Answer:

Truko, Inc. Statement of Net Income For the year ended December 31

Revenue and Gains Sales Interest Income Dividend Income Gain on Disposal of Plant Assets Unrealized Gain on Trading Investments Total Revenues and Gains Expenses and Losses Cost of Goods Sold Selling Expenses Advertising Expense Sales Salaries Expense Office Salaries Expense Office Supplies Expense Accounting and Legal Fees Depreciation Expense Interest Expense Loss on Asset Impairment Income Tax Expense (252,760 -167,750) × 40% Total Expenses and Losses Net Income

$225,400 1,450 3,830 14,810 7,270

$90,100 11,210 6,660 8,390 21,480 4,500 2,400 18,600 2,570 1,840 34,004

Diff: 2 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

$252,760

201,754 $51,006

21) Truko, Inc. provided the following partial trial balance for the current year. Prepare a multi-step income statement for the year ended December 31. Truko is subject to a 40% income tax rate. Truko Inc. Partial Trial Balance (Selected Accounts) For the Year Ended December 31 Accounts Dividends Sales Dividend Income Interest Income Gain on Disposal of Plant Assets Unrealized Gain on Trading Investments Cost of Goods Sold Office Supplies Expense—General Expense Sales Salaries Expense Selling Expenses Accounting and Legal Fees—General Expense Advertising Expense Office Salaries Expense—Admin. Expense Depreciation Expense—General Expense Interest Expense Loss on Asset Impairment

Debit $2,460

Credit $225,400 3,830 1,450 14,810 7,270

90,100 4,500 8,390 11,210 2,400 6,660 21,480 18,600 2,570 1,840

Answer:

Truko, Inc. Statement of Net Income For the year ended December 31

Sales Cost of Goods Sold Gross Profit

$225,400 (90,100)

Operating Expenses: Selling Expenses: Selling Expenses Advertising Expense Sales Salaries Expense

$11,210 6,660 8,390

General and Administrative Expenses Office Salaries Expense Office Supplies Expense Accounting and Legal Fees Depreciation Expense Total Operating Expenses

$21,480 4,500 2,400 18,600

Operating Income

$135,300

26,260

46,980 (73,240) 62,060

Other Revenues and Gains Interest Income Dividend Income Gain on Disposal of Plant Assets Unrealized Gain on Trading Investments Total Other Revenues and Gains Other Expenses and Losses Interest Expense Loss on Asset Impairment Total Other Expense and Losses

$1,450 3,830 14,810 7,270

(2,570) (1,840)

27,360

(4,410)

Income Before Taxes

85,010

Income Tax Expense (85,010 × 40%)

34,004

Net Income

51,006

Diff: 2 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

22) Why do companies issue condensed income statements? Answer: Companies use condensed income statements when a large number of line items limits the usefulness of the net income statement, because too much detail distracts the user from identifying key measures and relationships on the net income statement. Rather than present a cluttered income statement, many companies will provide a condensed income statement and disclose the details of significant revenues and expenses in the footnotes or supporting schedules. Diff: 1 Objective: 5.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) On the single-step income statement, IFRS requires that companies report which six (6) line items on the income statement? Answer: 1. Revenue (Sales revenues are also called Turnover) 2. Finance costs 3. Share of income/loss of associates 4. Tax expense 5. After-tax profit or loss on discontinued operations 6. Net Income, also called Net Profit or Net Loss Diff: 2 Objective: 5.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

24) IFRS requires companies to disclose what other items if they are not presented on the income statement? Answer: • Write-downs of inventories or of property, plant, and equipment, as well as reversals • Restructuring costs • Disposals of property, plant, and equipment items • Disposals of investments • Discontinued operations • Litigation settlements • Other reversals of provisions Diff: 2 Objective: 5.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

5.5

Income from Continuing Operations

1) Operating income is gross profit less all operating expenses and income taxes. Answer: FALSE Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Sales minus cost of goods sold equals gross profit. Answer: TRUE Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The income tax provision includes all income taxes from every source and every cause such as discontinued operations. Answer: FALSE Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) On the income statement, the line item that comes before income tax expense is called income from continuing operations. Answer: FALSE Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Which of the following is not typically included in the determination of income from continuing operations? A) other comprehensive income B) income tax provision C) non-operating items D) earnings before interest and taxes Answer: A Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following is typically included in the determination of income from continuing operations? A) other comprehensive income B) non-operating gains and losses C) gain on disposal of discontinued segment D) reserved retained earnings Answer: B Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following is typically included in the determination of operating income? A) other comprehensive income B) provision for income tax C) gross profit D) restructuring charges Answer: C Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) On the income statement, ________ is gross profit less all operating expenses. A) retained earnings B) net income C) income from continuing operations D) operating income Answer: D Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Which of the following is typically included in the income tax provision? A) deferred income tax B) state and local income tax C) federal income tax on gain from discontinued operations D) federal, state, and local payroll tax Answer: B Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) The following data include all the elements from Tuche Millinery's income statement: Administrative Expense Cost of Goods Sold Gain on Sale of Securities Income Tax Expense Loss on Discontinued Operations Loss on Disposal of Equipment Revenue Selling Expense

$220 261 43 51 38 86 878 124

What is the amount of gross profit for Tuche Millinery? A) $273 B) $493 C) $617 D) $397 Answer: C Explanation: Revenues of $878 less Cost of Goods Sold of $261 = Gross Profit of $617 Diff: 2 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) The following data include all the elements from Tuche Millinery's income statement: Administrative Expense Cost of Goods Sold Gain on Sale of Securities Income Tax Expense Loss on Discontinued Operations Loss on Disposal of Equipment Revenue Selling Expense

$229 259 46 53 38 86 866 124

What is the amount of operating income for Tuche Millinery? A) $607 B) $378 C) $254 D) $197 Answer: C Explanation: Revenue of $866 less Cost of Goods Sold of $259 less Administrative Expense of $229 less Selling Expense of $124 = Operating Income of $254 Diff: 2 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) The following data include all the elements from Tuche Millinery's income statement: Administrative Expense Cost of Goods Sold Gain on Sale of Securities Income Tax Expense Loss on Discontinued Operations Loss on Disposal of Equipment Revenue Selling Expense

$226 251 47 56 38 86 865 124

What is the amount of income from continuing operations for Tuche Millinery? A) $264 B) $388 C) $490 D) $169 Answer: D Explanation: Revenue $865 less Cost of Goods Sold $251 less Administrative Expenses $226 less Selling Expenses $124 less Income Tax $56 plus Gain on Sale of Securities $47 less Loss on Disposal of Equipment $86 equals Income from Continuing Operations of $169 Diff: 2 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) The following data include all the elements from Cambridge Company's income statement: Administrative Expense Cost of Goods Sold Gain on Sale of Securities Income Tax Expense Loss on Discontinued Operations Loss on Disposal of Equipment Revenue Selling Expense

$872 3604 623 1,234 1,229 237 8741 1,425

What is the amount of gross profit for Cambridge Company? A) $3903 B) $1606 C) $4526 D) $5137 Answer: D Explanation: Revenue $8741 less Cost of Goods Sold $3604 = $5137 Gross Profit Diff: 2 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) The following data include all the elements from Cambridge Company's income statement: Administrative Expense Cost of Goods Sold Gain on Sale of Securities Income Tax Expense Loss on Discontinued Operations Loss on Disposal of Equipment Revenue Selling Expense

$872 3627 623 1,234 1,229 237 8766 1,425

What is the amount of operating income for Cambridge Company? A) $2842 B) $5139 C) $3228 D) $3465 Answer: A Explanation: Revenue of $8766 less Cost of Goods Sold of $3627 less Administrative Expense of $872 less Selling Expense of $1,425 = Operating Income of $2842 Diff: 2 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) The following data include all the elements from Cambridge Company's income statement: Administrative Expense Cost of Goods Sold Gain on Sale of Securities Income Tax Expense Loss on Discontinued Operations Loss on Disposal of Equipment Revenue Selling Expense

$873 3615 623 1,234 1,229 237 8771 1,425

What is the amount of income from continuing operations for Cambridge Company? A) $3244 B) $2621 C) $2010 D) $3481 Answer: C Explanation: Revenue $8771 less Cost of Goods Sold $3615 less Administrative Expenses $873 less Selling Expenses $1,425 less Income Tax $1,234 plus Gain on Sale of Securities $623 less Loss on Disposal of Equipment $237 = Income from Continuing Operations of $2010 Diff: 2 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) What items are included in a company's operating income? Answer: Operating income includes revenues and expenses related to the entity's major or central operations, including sales, cost of goods sold, selling expenses, and general and administrative expenses. Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) What items are included in a company's income from continuing operations and how are these items categorized if the company uses (a) a multi-step format or (b) a single-step format? Answer: Income from continuing operations is income from portions of the business that are expected to continue into the future. In the multi-step format, firms typically calculate income from continuing operations as the sum of three income statement items: 1. Operating income 2. Non-operating revenues/gains and expenses/losses 3. Income tax provision In the single-step format, all revenues and gains are combined and from that total all expenses and losses, including income tax expense, are subtracted to equal income from continuing operations. Diff: 1 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Based on the information below, prepare an income statement for the operating section calculating the operating income. General and Administrative Expenses Cost of Goods Sold Revenue Selling Expense

$2,000 3,000 9,000 1,500

Answer: Revenue Less: Cost of Goods Sold Gross Profit Less: Selling Expense Less: General and Administrative Expenses Operating Income

$9,000 3,000 $6,000 1,500 2,000 $2,500

Diff: 2 Objective: 5.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

5.6

Discontinued Operations

1) A discontinued operation must be a business segment or unit that is a portion of an entity with operations and cash flows. Answer: TRUE Diff: 1 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Gains and losses from discontinued operations are shown on the income statement after the provision for income taxes is presented. Answer: TRUE Diff: 1 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When a significant operation that does meet the definition of a discontinued operation is disposed of, U.S. GAAP requires disclosure of the pre-tax profit (loss) of that operation. Answer: TRUE Diff: 1 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Which of the following is not a characteristic that must be considered when determining that a business activity is a component of an entity for purposes of classifying that activity as a discontinued operation? A) The activity comprises operations and cash flows. B) The activity constitutes a strategic advantage. C) The activity can be clearly distinguished for financial reporting purposes. D) The activity is a portion of the entity. Answer: B Diff: 1 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) After a company has determined that a portion of a business is a component of an entity, evaluating whether the disposal of a component of an entity constitutes a discontinued operation includes ________. A) remeasuring the value of net assets held for disposal B) identifying the cash flows that can be clearly distinguished operationally C) segregating its operating revenues and expenses from those of continuing operations D) assessing whether a strategic shift has occurred Answer: D Diff: 1 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) On May 1, Jonson Industries decided to discontinue its prepackaged business segment. At the end of the year, the company is still holding the business segment for disposal, which is expected early in the following year. On its year-end income statement, Jonson Industries will report as income from discontinued operations the profits generated by the prepackaged business segment ________. A) for the entire year, before taxes B) for the entire year, net of taxes C) since May 1, before taxes D) since May 1, net of taxes Answer: B Diff: 1 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) When a company decides to discontinue an operation, it values the assets and liabilities of that operation at ________ if this amount is lower than the carrying value. A) gross book value (historical cost) B) net book value (historical cost less accumulated depreciation) C) fair value D) fair value less selling costs Answer: D Diff: 1 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) When a company initially remeasures the value of a discontinued operation, an adjustment is made to recognize ________. A) a loss, but not a gain, for the difference between book value of the net assets and their fair value B) a loss, but not a gain, for the difference between book value of the net assets and their fair value net of selling costs C) the gain or loss for the difference between book value of the net assets and their fair value D) the gain or loss for the difference between book value of the net assets and their fair value net of selling costs Answer: B Diff: 1 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) If a company writes down the net assets of a discontinued operation from original carrying value to a remeasurement of fair value in one year, and then in the next year the fair value changes ________. A) the company will recognize any subsequent loss or gain for the difference between new fair value and prior year remeasured fair value B) the company will recognize any subsequent loss but limit gains up to the original carrying value before remeasurement C) the company will recognize any subsequent loss but no gains for the difference between new fair value and prior year remeasured fair value D) the company cannot recognize any subsequent loss or gain Answer: B Diff: 1 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Which of the following criteria for determining a discontinued operation is the same for IFRS as for U.S. GAAP? A) the definition of a discontinued operation B) the definition of a component of an entity C) the need for the discontinued operation to represent a strategic shift D) the requirement for the discontinued operation to be a part of a single coordinated disposal plan Answer: A Diff: 2 Objective: 5.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Which of the following is not part of the U.S. GAAP definition of a component of an entity under discontinued operations? A) a subsidiary acquired exclusively with a view to resale B) comprising operations and cash flows C) a portion of the entity D) clearly distinguished, operationally, and for financial reporting purposes from the rest of the entity Answer: A Diff: 2 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Paxdot Labs provided the following partial trial balance for the current year. Beginning with the line item Operating Income, prepare a statement of net income for the year ended December 31. Paxdot is subject to a 40% income tax rate. Paxdot Labs Partial Trial Balance (Selected Accounts) For the Year Ended December 31 Accounts Operating Income Dividend Income Gain on Sale of Discontinued Operations Unrealized Gain on Trading Investments Gain on Foreign Currency Translation Loss on Asset Impairment Loss from Discontinued Operations Unrealized Loss on Available-for-Sale Investments Answer:

Debit

23,030 15,420 18,340

Paxdot Labs Statement of Net Income For the year ended December 31

Income from Operations

$233,000

Other Revenues and Gains Dividend Income Unrealized Gain on Trading Investments

24,680 37,260

Other Expenses and Losses: Loss on Asset Impairment

(23,030)

Income from Continuing Operations before Taxes

271,910

Provision for Income Taxes (271,990 × 40%)

(108,764)

Income from Continuing Operations

163,146

Discontinued Operations: Gain on Sale of Discontinued Operations (net of taxes $14,804) [(1 - 40%) × 37,010)] Loss from Discontinued Operations (net of taxes $6,168) [(1 - 40%) × 15,420)]

22,206 (9,252)

Net Income

$176,100

Diff: 2 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

Credit $233,000 24,680 37,010 37,260 29,970

13) Baggow Styles provided the following partial trial balance for the current year. Beginning with the line item Income from Operations, prepare a statement of net income for the year ended December 31. Baggow is subject to a 40% income tax rate. Baggow Styles Partial Trial Balance (Selected Accounts) For the Year Ended December 31 Accounts Income from Operations Interest Income Gain from Discontinued Operations Gain on Sale of Land Unrealized Gain on Available-for-Sale Debt Investments Accumulated Depreciation on Assets from Discontinued Operations

Debit

Loss on Pension Adjustment Loss on Disposal of Discontinued Operations Amortization of Intangible Asset Unrealized Loss on Trading Investments

$29,510 13,440 19,280 62,050

Credit $567,000 12,870 44,700 19,560 41,920 23,630

Answer:

Baggow Styles Statement of Net Income For the year ended December 31

Income from Operations

$567,000

Other Revenues and Gains: Dividend Income Gain on Sale of Land

12,870 19,560

Other Expenses and Losses: Unrealized Loss on Trading Investments

(62,050)

Income from Continuing Operations before Taxes

$537,380

Provision for Income Taxes ($537,380 × 40%)

(214,952)

Income from Continuing Operations

$322,428

Discontinued Operations: Gain from Discontinued Operations (net of taxes $17,880) [(1 - 40%) × 44,700)] Loss from Disposal of Discontinued Operations (net of taxes $5,376)[(1 - 40%) × 13,440)]

26,820 (8,064)

Net Income

$341,184

Diff: 2 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) What items are included in a company's results from discontinued operations? For this purpose, how is a component defined? Answer: Companies report three main types of income, gain or loss under discontinued operations on the income statement: 1. Income or loss from operations of discontinued segment, unit or group, net of tax. 2. Gain or loss on remeasurement of net assets held for sale to fair value less disposal costs, net of tax. 3. Gain or loss on disposal of assets or disposal group(s) constituting the discontinued operation, net of tax. A component of an entity has three main characteristics: It is (1) a portion of the entity (2) comprising operations and cash flows (3) that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. A company must be able to separate the discontinued component's operations and cash flows from the continuing operations' earnings and cash flows. It should also be able to separately report discontinued operations in its financial statements. Diff: 2 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Why are the results from discontinued operations separated from the results from continuing operations on an income statement? Answer: A company must be able to separate the discontinued component's operations and cash flows from the continuing operations' earnings and cash flows. It should also be able to separately report discontinued operations in its financial statements. The purpose of the separation is to segregate the continuing predictable cash flows from the transitory cash flows that are not likely to have any impact on the future cash flows of the company. The discontinued operations represent transitory cash flows. Diff: 2 Objective: 5.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

5.7

Net Income, Noncontrolling Interest and Earnings per Share

1) The noncontrolling interest line item on the income statement represents the income attributable to the portion of a subsidiary owned by others. Answer: TRUE Diff: 1 Objective: 5.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) A noncontrolling interest represents the portion of the reporting entity that is owned by others (noncontrolling owners). Answer: TRUE Diff: 1 Objective: 5.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Earnings per share is presented for continuing operations, discontinued operations, and net income. Answer: TRUE Diff: 1 Objective: 5.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Earnings per share is presented for gross profit, continuing operations, discontinued operations, and net income. Answer: FALSE Diff: 1 Objective: 5.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) There is a noncontrolling interest when ________. A) a company uses the equity method to account for ownership of another company B) a company controls another company, but owns less than 100% of voting shares C) a company controls another company but owns less than 100% of that other company D) a company is owned by others outside the company Answer: B Diff: 1 Objective: 5.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) The noncontrolling interest line item on the income statement represents ________. A) the portion of the subsidiary owned by others, which is deducted to determine net income B) the portion of the subsidiary owned by the reporting entity, which is added to determine net income C) the portion of earnings that belongs to others, which is deducted to determine net income attributable to the controlling interest D) the portion of earnings that belongs to others, which is added to determine net income attributable to the controlling interest Answer: C Diff: 1 Objective: 5.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Companies report earnings per share for all of the following except ________. A) operating income B) net income C) income from continuing operations D) discontinued operations Answer: A Diff: 1 Objective: 5.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) What is a noncontrolling interest and what does it represent in the income statement? Answer: There is a noncontrolling interest when one company controls another company (e.g., a subsidiary), but owns less than 100% of its voting shares. The controlling company adds all of the subsidiary's income to its own, because it controls the subsidiary's ability to generate income. However, because it does not own 100% of the subsidiary, the controlling company must identify the amount of the income that is attributable to noncontrolling owners. The noncontrolling interest line item on the income statement represents the income attributable to the portion of a subsidiary owned by others, the noncontrolling owners. The portion of income (loss) attributed to the noncontrolling interest is deducted (added) on the income statement to arrive at income attributed to the controlling interest. Diff: 2 Objective: 5.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) What is earnings per share and how is it reported in the financial statements? Answer: Earnings per share represents the amount of earnings assigned to each outstanding share of the company's common stock. Companies report earnings per share for continuing operations, discontinued operations, and net income in a supplemental section of the income statement, reported directly below net income or loss for the period. Diff: 2 Objective: 5.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

5.8

The Statement of Comprehensive Income

1) Companies presenting comprehensive income in two statements will include the statement of comprehensive income in the notes somewhere after the statement of net income. Answer: FALSE Diff: 1 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Both IFRS and U.S. GAAP permit reporting of comprehensive income in one statement or two statements. Answer: TRUE Diff: 1 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Other comprehensive income includes unrealized gains and losses from all investment securities. Answer: FALSE Diff: 1 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Other comprehensive income includes gains and losses from all foreign currency translations. Answer: TRUE Diff: 1 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) IFRS and U.S. GAAP include the same four items in Other Comprehensive Income. Answer: FALSE Diff: 1 Objective: 5.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) IFRS allows companies to include in Other Comprehensive Income the increase in fair value of longlived assets such as buildings. Answer: TRUE Diff: 1 Objective: 5.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

7) Which of the following transactions is not reported as other comprehensive income according to U.S. GAAP? A) unrealized gains and losses from available-for-sale portfolio of debt investment securities B) unrealized gains on the upward valuation of property, plant, and equipment C) adjustments to unrecognized pension costs (benefits) D) foreign currency translation gains and losses Answer: B Diff: 1 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Which of the following transactions is not reported as other comprehensive income by either U.S. GAAP or IFRS? A) gains and losses from foreign currency translation B) adjustments to unrecognized pension costs (benefits) C) unrealized gains and losses from trading securities D) unrealized gains and losses from derivatives classified as cash flow hedges Answer: C Diff: 1 Objective: 5.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) How is reporting for other comprehensive income (OCI) different between U.S. GAAP and IFRS? A) U.S. GAAP allows either a one-statement approach or a two-statement approach while IFRS requires a two-statement approach using the direct method. B) U.S. GAAP allows either a one-statement approach or a two-statement approach while IFRS requires a two-statement approach and allows more items to be classified as OCI. C) Both U.S. GAAP and IFRS allow either a one-statement approach or a two-statement approach while IFRS requires the direct method. D) Both U.S. GAAP and IFRS allow either a one-statement approach or a two-statement approach while IFRS allows more items to be classified as OCI. Answer: D Diff: 1 Objective: 5.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Which of the following is an advantage of the two-statement approach to reporting other comprehensive income (OCI)? A) Net income retains its emphasis as the primary income measure. B) Other comprehensive income is more heavily emphasized when presented in its own statement. C) Companies apply the tax effects to OCI in total in the one-statement approach but to each individual item in the two-statement approach, thereby enhancing usefulness. D) The two-statement approach is significantly less costly to prepare. Answer: A Diff: 1 Objective: 5.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Bandana Company had the following balances for net income and pretax gains and losses on December 31: Net income Loss on discontinued operations Unrealized gain on trading security Foreign currency translation gain

$ 39,000 (11,000) 20,000 15,000

The company's effective tax rate is 40%. What amount should Bandana Company report as comprehensive income for the year ended December 31? A) $32,400 B) $48,000 C) $44,400 D) $53,400 Answer: B Explanation: The loss on discontinued operations would already be accounted for in the net income as well as the unrealized gain on the trading security. However, the foreign currency translation gain would be included in other comprehensive income, net of income taxes (which would be $15,000 × .4 = $6000). Therefore, comprehensive income would be the net income of $39,000 plus $9000 as the after-tax gain from foreign currency translation ($15,000 - $6000) which equals comprehensive income of $48,000. Diff: 2 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Gerogi Company had the following balances for income from continuing operations and pretax gains and losses on December 31: Income from continuing operations Loss on discontinued operations Unrealized gain on available-for-sale debt security Loss on impairment of Goodwill Foreign currency translation loss

$227,000 (76,000) 28,000 (140,000) (66,000)

The company's effective tax rate is 40%. What amount should Gerogi Company report as comprehensive income for the year ended December 31? A) $181,400 B) $74,600 C) $158,600 D) $198,200 Answer: C Explanation: The loss on discontinued operations is deducted from income from continuing operations, net of tax. The unrealized gain on available-for-sale debt security is other comprehensive income and is reported as part of other comprehensive income, net of tax. The loss on impairment of goodwill is already incorporated into income from continuing operations. The foreign currency translation loss is reported as part of other comprehensive income and is reported net of tax. The comprehensive income is $158,600 calculated as follows: Income from continuing operations Loss on discontinued operations, net of income tax at 40% Net Income Other Comprehensive Income: Unrealized gain on available-for-sale debt security Foreign currency translation loss Comprehensive income

$227,000 (45,600) $181,400 16,800 (39,600) $158,600

Diff: 2 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Gerogi Company had the following balances for income from continuing operations and pretax gains and losses on December 31: Income from continuing operations Unrealized loss on trading security Unrealized gain on available-for-sale debt security Unrealized loss on pension adjustment Gain on disposal of discontinued operations

$540,000 (92,000) 30,000 (110,000) 240,000

The company's effective tax rate is 40%. What amount should Gerogi Company report as comprehensive income for the year ended December 31? A) $580,800 B) $684,000 C) $492,000 D) $636,000 Answer: D Explanation: The unrealized loss on trading security is already included in income from continuing operations. The unrealized gain on available-for-sale debt security is reported as other comprehensive income, net of income tax as is the unrealized loss on pension adjustment. The gain on disposal of discontinued operations is reported net of income tax. The comprehensive income is $636,000 calculated as follows: Income from continuing operations Gain on disposal of discontinued operations Net Income Unrealized gain on available-for-sale debt security Unrealized loss on pension adjustment Comprehensive Income

$540,000 144,000 $684,000 18,000 (66,000) $636,000

Diff: 2 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Golgotha Industries provided the following partial trial balance for the current year. Beginning with the line item Income from Continuing Operations Before Taxes, prepare a statement of comprehensive income for the year ended December 31. Golgotha is subject to a 40% income tax rate. Golgotha Industries Partial Trial Balance (Selected Accounts) For the Year Ended December 31 Accounts Income from Continuing Operations Before Taxes Dividend Income Gain on Sale of Closed Sales Office Unrealized Gain on Trading Investments Gain on Foreign Currency Translation Loss on Pension Adjustment Loss on from Discontinued Operations Loss on Asset Impairment Unrealized Loss on Available-for-Sale Debt Investments Answer: Golgotha Industries Statement of Comprehensive Income For the year ended December 31

Debit

37,260 41,820 23,030 18,340

Income from Continuing Operations before Taxes

$99,000

Provision for Income Taxes (99,000 × 40%)

(39,600)

Income from Continuing Operations

59,400

Discontinued Operations: Loss from Discontinued Operations (net of taxes $16,728) [(1 - 40%) × 41,820)]

(25,092)

Net Income

34,308

Other Comprehensive Income: Gain on Foreign Currency Translation [(1 - 40%)× 29,970)] 17,982 Unrealized Loss on Available-for-Sale Debt Investments [(1 - 40%) × 18,340)] (11,004) Loss on Pension Adjustment [(1 - 40%) × 37,260)] (22,356)

(15,378)

Comprehensive Income

$18,930

Diff: 2 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

Credit $99,000 11,680 15.420 37,260 29,970

15) Bass Steel provided the following partial-trial balance for the current year. Prepare a multi-step statement of comprehensive income for the year ended December 31. Bass Steel is subject to a 30% income tax rate. Bass Steel Partial Trial Balance (Selected Accounts) For the Year Ended December 31 Accounts Sales Dividend Income Interest Income Gain on Disposal of Discontinued Operations Unrealized Gain on Available-for-Sale Debt Investments Loss on Disposal of Equipment Loss on Foreign Currency Translation Loss on Discontinued Operations Loss on Asset Impairment Dividends Cost of Goods Sold Office Supplies Expense—General Expense Sales Salaries Expense Selling Expenses Accounting and Legal Fees—General Expense Advertising Expense Office Salaries Expense—General Expense Depreciation Expense—General Expense Interest Expense Treasury Shares Acquired

Debit

Credit $845,300 19,470 25,420 34,860 17,260

$9,650 33,620 46,730 16,060 110,000 320,900 34,560 68,740 11,210 12,400 32,780 41,390 29,330 7,570 31,330

Answer:

Bass Steel Statement of Comprehensive Income For the year ended December 31

Sales Cost of Goods Sold Gross Profit

$845,300 (320,900)

Operating Expenses: Selling Expenses: Selling Expenses Advertising Expense Sales Salaries Expense

11,210 32,780 68,740

General and Administrative Expenses: Office Salaries Expense Office Supplies Expense Accounting and Legal Fees Depreciation Expense Total Operating Expenses

41,390 34,560 12,400 29,330

Operating Income

$524,400

(112,730)

(117,680) (230,410) 293,990

Other Revenues and Gains: Interest Income Dividend Income

25,420 19,470

44,890

Other Expenses and Losses: Interest Expense Loss on Asset Impairment Loss on Disposal of Equipment

(7,570) (16,060) (9,650)

(33,280)

Income from Continuing Operations before Taxes

$305,600

Provision for Income Taxes (305,600 × 30%)

(91,680)

Income from Continuing Operations

$213,920

Discontinued Operations: Loss from Discontinued Operations (net of taxes $14,019) [(1 - 30%) × 46,730)] Gain on Disposal of Discontinued Operations (net of taxes $10,458) [(1 - 30%) × 34,860)]

(32,711)

Net Income

$205,611

24,402

(8,309)

Other Comprehensive Income: Unrealized Gain on Available-for-Sale Debt Investments [(1 - 30%) × 17,260)] Loss on Foreign Currency Translation [(1 - 30%) × 33,620)]

12,082 (23,534)

Comprehensive Income

(11,452) $194,159

Diff: 2 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) Shawmut Metal Inc. provided the following partial trial balance for the current year. Prepare a multi-step statement of comprehensive income for the year ended December 31. Shawmut is subject to a 40% income tax rate. Shawmut Metal Inc. Partial Trial Balance (Selected Accounts) For the Year Ended December 31 Accounts Sales Dividend Income Interest Income Gain on Disposal of Discontinued Operations Unrealized Gain on Available-for-Sale Debt Investments Loss on Disposal of Equipment Loss on Foreign Currency Translation Loss on Discontinued Operations Loss on Asset Impairment Dividends Cost of Goods Sold Office Supplies Expense—General Expense Sales Salaries Expense Distribution Expenses Accounting and Legal Fees—General Expense Advertising Expense Office Salaries Expense—General Expense Depreciation Expense—General Expense Interest Expense

Debit

Credit $900,000 20,000 1,000 12,000 18,000

$12,000 28,000 47,000 16,000 2000 350,000 28,000 90,000 10,000 9,000 33,000 39,000 31,000 6,000

Answer:

Shawmut Metal Inc. Statement of Comprehensive Income For the year ended December 31

Sales Cost of Goods Sold Gross Profit

$900,000 350,000

Operating Expenses: Selling Expenses: Distribution Expenses Advertising Expense Sales Salaries Expense

10,000 33,000 90,000

General and Administrative Expenses: Office Salaries Expense Office Supplies Expense Accounting and Legal Fees Depreciation Expense Total Operating Expenses

39,000 28,000 9,000 31,000

Operating Income

$550,000

(133,000)

(107,000) (240,000) $310,000

Other Revenues and Gains: Interest Income Dividend Income

1,000 20,000

21,000

Other Expenses and Losses: Interest Expense Loss on Asset Impairment Loss on Disposal of Equipment

(6,000) (16,000) (12,000)

(34,000)

Income from Continuing Operations before Taxes

297,000

Provision for Income Taxes (297,000 × 30%)

118,800

Income from Continuing Operations

178,200

Discontinued Operations: Loss from Discontinued Operations (net of income tax $18,800)

(28,200)

Gain on Disposal of Discontinued Operations (net of income tax $4,800)

7,200

Net Income

(21,000) 157,200

Other Comprehensive Income: Unrealized Gain on Available-for-Sale Debt Investments (net of income tax) Loss on Foreign Currency Translation (net of income tax) Comprehensive Income

10,800 (16,800) $151,200

Diff: 2 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) What two alternatives does a company have for reporting its comprehensive income under U.S. GAAP and IFRS? Answer: Companies may choose to report comprehensive income in one statement (usually called the statement of comprehensive income) or in two consecutive statements (the statement of net income and the statement of comprehensive income). Companies presenting in TWO statements are required to include the statement of comprehensive income immediately after the statement of net income (i.e., on the next page of the financial report). The statement of comprehensive income begins with net income and then presents the components of other comprehensive income, ultimately arriving at a figure for comprehensive income. Firms presenting ONE statement of comprehensive income combine the statement of net income with a presentation of OCI. Diff: 2 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Currently, under U.S. GAAP, what are the three items of other comprehensive income? Why should these items not flow through net income? Answer: The key line items consist of: 1. Unrealized gains and losses from the available-for-sale portfolio of debt investment securities and derivatives classified as cash flow hedges. 2. Foreign currency translation gains and losses. 3. Unrecognized pension costs (benefits) from adjustments needed to bring the accounting pension asset or liability to the funded status of the pension plan. The items reported as other comprehensive income typically have at least one of these three characteristics: 1. There is a low probability of cash realization in the short run. 2. These items are transitory components of income; excluding them from the income statement reduces earnings volatility. 3. The majority of these items are not part of the entity's normal operations. Diff: 2 Objective: 5.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

5.9

The Statement of Stockholders' Equity

1) IFRS requires, but U.S. GAAP does not require, a statement of stockholders' equity. Answer: TRUE Diff: 1 Objective: 5.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) U.S. public companies are required to provide a statement of stockholders' equity. Answer: TRUE Diff: 1 Objective: 5.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Under IFRS, the statement of stockholders' equity summarizes changes of exactly three elements: contributed capital, retained earnings, and other comprehensive income. Answer: FALSE Diff: 1 Objective: 5.9 IFRS/GAAP: IFRS AACSB: Application of knowledge

4) In general, changes in contributed capital accounts are related to additional investments by equity investors and purchases and disposals of treasury stock by the entity. Answer: TRUE Diff: 1 Objective: 5.9 IFRS/GAAP: IFRS AACSB: Application of knowledge

5) Which of the following is not an account type reported in the statement of stockholders' equity? A) accumulated other comprehensive income B) controlling interest C) treasury stock D) contributed capital Answer: B Diff: 1 Objective: 5.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following is not an account type reported in the statement of stockholders' equity? A) comprehensive income B) noncontrolling interest C) treasury stock D) contributed capital Answer: A Diff: 1 Objective: 5.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following is false concerning the statement of stockholders' equity? A) IFRS require a statement of stockholders' equity. B) U.S. GAAP does not require a statement of stockholders' equity. C) Net income and dividends close into Retained Earnings. D) Other comprehensive income and retirement of repurchased shares close into Accumulated Other Comprehensive Income. Answer: D Diff: 1 Objective: 5.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Clowns-R-Us reported the following in the statement of comprehensive income for the year ended December 31: Income from continuing operations before tax Income tax expense Net income Other comprehensive income Comprehensive income

$800,000 (300,000) 500,000 130,000 600,000

During the year, the company paid $103,000 in dividends and purchased treasury stock with a par value of $20,000 at a cost of $95,000. If the balance of Retained Earnings at the beginning of the year was $470,000, what is the balance of Retained Earnings at the end of the year? A) $1,007,000 B) $970,000 C) $867,000 D) $1,110,000 Answer: C Explanation: Beginning retained earnings $470,000 + Net income $500,000 – Dividends $103,000 = $867,000 Diff: 2 Objective: 5.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Biglo Chemical Company reported the following in the statement of comprehensive income for the year ended December 31: Income from continuing operations before tax Income tax expense Net income Other comprehensive income Comprehensive income

$600,000 (140,000) 460,000 110,000 240,000

During the year, the company paid $60,000 in dividends and purchased treasury stock with a par value of $10,000 at a cost of $70,000. If the balance of Retained Earnings at the beginning of the year was $380,000, what is the balance of Retained Earnings at the end of the year? A) $560,000 B) $780,000 C) $840,000 D) $620,000 Answer: B Explanation: Beginning retained earnings $380,000 + Net income $460,000 - dividends $60,000 = $780,000 Diff: 2 Objective: 5.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) The Stockholders' Equity section of the 20X1 balance sheet for Beengo Enterprises is presented below: Beengo Enterprises Stockholders' Equity December 31, 20X1

Common Stock Retained Earnings Accumulated Other Comprehensive Income Total Stockholders' Equity

$12,000 56,800 3,700 $72,500

For the year ended December 31, 20X2, the statement of comprehensive income reported $5,678 net income and $4,987 comprehensive income. During 20X2, Beengo paid $2,200 in dividends, issued $2,000 of no-par common stock, then repurchased $300 of its shares at the end of the reporting period. Prepare the statement of stockholders' equity for 20X2. Answer: Beengo Enterprises Statement of Stockholders' Equity For the Year Ended December 31, 20X2

Balance, 1/1/20X2 Net income Dividends Issue stock Repurchase stock OCI Balance, 12/31/20X2

Common Stock $12,000

2,000

$14,000

Diff: 2 Objective: 5.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

Retained Earnings $56,800 5,678 (2,200)

Accumulated OCI $3,700

Treasury Stock -0-

(300) $60,278

(691) $3,009

($300)

Total $72,500 5,678 (2,200) 2,000 (300) (691) $76,987

11) List the five component accounts included in stockholders' equity. Answer: The statement of stockholders' equity is a financial statement that summarizes the changes in stockholders' equity during a period and includes the following accounts: 1. Contributed capital accounts (e.g., common stock, preferred stock, and additional paid-in capital in excess of par) related to investments by owners 2. Retained earnings, including net income (loss) and distributions to owners 3. Accumulated other comprehensive income, also called reserves under IFRS 4. Treasury stock 5. Noncontrolling interest While the balance sheet reports the final balances in each of these accounts, the statement of stockholders' equity provides an analysis of the changes in these accounts for the year. Diff: 2 Objective: 5.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) The Stockholders' Equity section of the 20X2 balance sheet for Taylor and Company is presented below: Taylor and Company Stockholders' Equity December 31, 20X2 Common Stock Retained Earnings Accumulated Other Comprehensive Income Treasury Stock Total Stockholders' Equity

$15,000 40,000 3,000 (2,000) $56,000

For the year ended December 31, 20X3, the statement of comprehensive income reported $5,000 net income and $4,500 comprehensive income. During 20X3, Taylor and Company paid $2,300 in dividends, issued $2,500 of no-par common stock, then repurchased $300 of its shares at the end of the reporting period. Prepare the statement of stockholders' equity for 20X3. Answer: Taylor and Company Statement of Stockholders' Equity For the Year Ended December 31, 20X3

Balance, 1/1/20X3 Net income Dividends Issue stock Repurchase stock OCI Balance, 12/31/20X3

Common Stock $15,000

Retained Accumulate Earnings d OCI $40,000 $3,000 5,000 (2,300)

Treasury Stock (2,000)

2,500 (300) $17,500

(500) $2,500

$42,700

($2,300)

Diff: 2 Objective: 5.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

Total $56,000 5,000 (2,300) 2,500 (300) (500) $60,400

5.10

Appendix A: Financial Statement Analysis

1) Horizontal analysis examines the percentage change in financial statement items from year to year. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Horizontal analysis expresses financial information in relation to some relevant total or amount within one year. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Common-size financial statements ________. A) measure financial standing or operational performance relative to a base period B) measure balance sheet items relative to income statement items C) measure each financial statement line item relative to some key amount or total D) measure financial performance with financial statement items relative to some key amount or total adjusted for inflation Answer: C Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

4) All of the following are true about the use of common-size financial statements except: ________. A) Financial statement users can use common-size financial statements to compare a company's current financial position to its financial position at some past time B) Financial statement users can use common-size financial statements to compare a company's performance over time C) Financial statement users can use common-size financial statements to compare a company to different firms of varying size D) Financial statement users can use common-size financial statements to analyze financial statements without the distortions of inflation or currency fluctuations Answer: D Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Based on the following income statement, prepare a common-size income statement based on sales. Round to two decimal places. Sales Cost of goods sold Gross profit Selling and administrative expenses Operating income Interest expense Income before tax Income tax expense Net Income Answer: Sales Cost of goods sold Gross profit Selling and administrative expenses Operating income Interest expense Income before tax Income tax expense Net Income Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

$200,000 147,800 52,200 20,480 $31,720 7,320 $24,400 7,320 $17,080 100.00% 73.90% 26.10% 10.24% 15.86% 3.66% 12.20% 3.66% 8.54%

6) Based on the following income statement, prepare a common-size income statement based on sales. Round to two decimal places. Cash Accounts receivable, net of allowance for doubtful accounts Inventory Total current assets Property, plant, and equipment net of depreciation Total assets

$60,000 550,000 650,000 $1,260,000 1,300,000 $2,560,000

Accounts payable Salaries payable Taxes payable Total current liabilities Bonds payable Total liabilities Common stock Retained earnings Total liabilities and stockholders' equity Answer: Cash Accounts receivable, net of allowance for doubtful accounts Inventory Total current assets Property, plant, and equipment net of depreciation Total assets

50.78% 100.00%

Accounts payable Salaries payable Taxes payable Total current liabilities Bonds payable Total liabilities Common stock Retained earnings Total liabilities and stockholders' equity

10.55% 3.13% 2.15% 15.82% 35.16% 50.98% 17.58% 31.45% 100.00%

Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

$270,000 80,000 55,000 405,000 900,000 $1,305,000 450,000 805,000 $2,560,000 2.34% 21.48% 25.39% 49.22%

7) Based on the following income statement information from the past two years, prepare a horizontal analysis. Round to two decimal places.

Sales Cost of goods sold Gross profit Selling and administrative expenses Operating income Interest expense Income before tax Income tax expense Net Income

Year 2 $600,000 420,000 180,000

Year 1 $550,000 380,000 170,000

20,000 160,000 6,500 153,500 61,400 $92,100

21,000 149,000 7,000 142,000 56,800 $85,200

Percentage Change Year 2- change From 1 Year 1

Answer:

Sales Cost of goods sold Gross profit Selling and administrative expenses Operating income Interest expense Income before tax Income tax expense Net Income

Year 2 $600,000 420,000 180,000

Percentage Change Year 2- change From Year 1 1 Year 1 $550,000 50,000 9.09% 380,000 40,000 10.53% 170,000 10,000 5.88%

20,000 160,000 6,500 153,500 61,400 $92,100

21,000 149,000 7,000 142,000 56,800 $85,200

(1,000) 11,000 (500) 11,500 4,600 6,900

Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

-4.76% 7.38% -7.14% 8.10% 8.10% 8.10%

5.11

Appendix B: Profitability Analysis

1) Profitability is a company's ability to generate a return for its shareholders based on the revenues or resources available. Answer: TRUE Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The profit margin indicates the percent of each dollar of sales remaining after paying all liabilities. Answer: FALSE Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The return on assets ratio measures the income generated for shareholders from each dollar of average total assets. Answer: TRUE Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The return on equity ratio measures the return on shareholders' investment in the company. Answer: TRUE Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Profitability analysis is an evaluation of ________. A) a company's financial position relative to past financial position B) how well a company performs relative to its revenue or resources C) how well a company generates revenue from a base of assets D) the growth of assets relative to the growth of liabilities over a particular time frame Answer: B Diff: 2 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following measures profit margin? A) Net income/Sales Revenue B) Net income/Average Assets C) Net income/Average Equity D) Net income/(Assets – Liabilities) Answer: A Diff: 2 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Based on the selected financial information shown below, calculate the profit margin for year 2. Round to two decimal places.

Total assets Total shareholders' equity Sales Net Income

Year 1 $1,200,000 $760,000 $5,000,000 $200,000

Year 2 $1,300,000 $800,000 $5,500,000 $225,000

Answer: 4.09% profit margin: $225,000/$5,500,000 Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Based on the selected financial information shown below, calculate the return on assets for year 2. Round to two decimal places.

Total assets Total shareholders' equity Sales Net Income

Year 1 $1,200,000 $760,000 $5,000,000 $200,000

Year 2 $1,300,000 $800,000 $5,500,000 $225,000

Answer: 18% = $225,000/($1,200,000 + $1,300,000)/2 Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Based on the selected financial information shown below, calculate the return on equity for year 2. Round to two decimal places.

Total assets Total shareholders' equity Sales Net Income

Year 1 $1,200,000 $760,000 $5,000,000 $200,000

Year 2 $1,300,000 $800,000 $5,500,000 $225,000

Answer: 28.85% = $225,000/($760,000 + $800,000)/2 Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 6 Statements of Financial Position and Cash Flows and the Annual Report 6.1

The Statement of Financial Position

1) The balance sheet reflects the financial position of an entity over a period of time. Answer: FALSE Diff: 1 Objective: 6.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Solvency is a measure of a firm's long-term ability to pay its obligations as they mature. Answer: TRUE Diff: 1 Objective: 6.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A firm that responds quickly to unexpected needs and opportunities exhibits a high level of financial flexibility. Answer: TRUE Diff: 1 Objective: 6.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The relevance of the balance sheet is limited because many assets are recorded at historical costs. Answer: TRUE Diff: 1 Objective: 6.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Which of the following is not a cash flow measure? A) profitability B) solvency C) liquidity D) financial flexibility Answer: A Diff: 1 Objective: 6.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) If an entity can borrow funds to meet an unexpected financial crisis, it exhibits high ________. A) liquidity B) solvency C) stability D) financial flexibility Answer: D Diff: 1 Objective: 6.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following is not a limitation of the balance sheet? A) Many balance sheet accounts are reported at historical cost instead of market values or liquidation values. B) A number of assets and liabilities, such as human capital and reputation, are not reported on the balance sheet. C) Many balance sheet accounts are based upon estimates as opposed to determinable amounts. D) Many of the balances are reported at their liquidation values. Answer: D Diff: 1 Objective: 6.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Which of the following best describes the concept of liquidity? A) It is a measure of an asset's ability to be quickly converted to cash without risk of loss. B) It is a measure of a firm's long-term ability to pay its obligations as they mature. C) It indicates an entity's ability to respond to unexpected needs. D) It indicates a firm's ability to take advantage of opportunities by taking actions that alter the amounts and timing of cash flows. Answer: A Diff: 1 Objective: 6.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) List three areas in which the balance sheet provides important information to financial statement users. Answer: 1. The balance sheet summarizes economic resources and obligations that impact the entity's ability to generate future cash flows. 2. The balance sheet is useful in assessing an entity's rate of return on its investments. 3. The balance sheet aids in assessing the risk associated with an entity by providing inputs for cash flow measures. Diff: 1 Objective: 6.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) List and explain three common cash flow measures based upon balance sheet information. Answer: 1. Liquidity is a measure of an asset's ability to be quickly converted to cash without risk of loss. 2. Solvency is a measure of a firm's long-term ability to pay its obligations as they mature. 3. Financial flexibility indicates an entity's ability to respond to unexpected needs and opportunities by taking actions that alter the amounts and timing of cash flows. Diff: 2 Objective: 6.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) What are three limitations associated with the balance sheet? Answer: 1. Many balance sheet accounts are reported at historical cost instead of market values or liquidation values; this limits the relevance of information in the balance sheet. 2. A number of assets and liabilities, such as human capital and reputation, are not reported on the balance sheet. 3. Many balance sheet accounts are based upon estimates as opposed to determinable amounts. Diff: 2 Objective: 6.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6.2

Balance Sheet Classification

1) Current assets are those that a firm expects to convert into cash within one year or its operating cycle, whichever is longer. Answer: TRUE Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Prepaid expenses are normally reported as current assets. Answer: TRUE Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) In order to be a cash equivalent, an investment must have a maturity date of three months or less when purchased. Answer: TRUE Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Land held for resale is classified as property, plant, and equipment. Answer: FALSE Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The portion of long-term debt that matures during the coming year is classified as a current liability. Answer: TRUE Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) IFRS specifies that biological assets should be reported on the balance sheet. Answer: TRUE Diff: 1 Objective: 6.2 IFRS/GAAP: IFRS AACSB: Application of knowledge

7) The IFRS definition of current liabilities differs from the definition of current liabilities under GAAP. Answer: TRUE Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Accumulated other comprehensive income appears on an entity's income statement. Answer: FALSE Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following is a current asset? A) treasury bill acquired with 2 months to maturity B) land held for investment C) equipment D) goodwill Answer: A Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Which of the following is not a cash equivalent? A) commercial paper acquired with 75 days to maturity B) bond sinking fund C) money market funds D) treasury bill acquired with 30 days to maturity Answer: B Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Which of the following is not a current liability? A) income tax payable B) accounts payable C) subscriptions collected one year in advance D) bond sinking fund Answer: D Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Which of the following is not a component of shareholders' equity? A) Retained Earnings B) Paid-in Capital C) Accrued Liabilities D) Accumulated Other Comprehensive Income Answer: C Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Which of the following is a not a component of shareholders' equity? A) Common Stock B) Dividends Payable C) Additional Paid-in Capital D) Treasury Stock Answer: B Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Where does Accumulated Other Comprehensive Income appear? A) on the balance sheet in the shareholders' equity section B) on the balance sheet in the long-term liabilities section C) on the income statement after net income D) on the balance sheet as a long-term asset Answer: A Diff: 1 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Classify the following accounts as assets (A), liabilities (L), or shareholders' equity (SE) and whether they are current (C), non-current (NC), or not applicable (N/A). Account Merchandise Inventory Unearned Rent (one-year lease) Prepaid Insurance Bonds Payable (due in 5 years) Investment in B Company (to be held 5 years) Goodwill Additional Paid-in Capital Accumulated Other Comprehensive Income Equipment Income Tax Payable

A, L, SE

C, NC, N/A

A, L, SE A L A L

C, NC, N/A C C C NC

A SE

NC N/A

N/A

A L

NC C

Answer: Account Merchandise Inventory Unearned Rent (one-year lease) Prepaid Insurance Bonds Payable (due in 5 years) Investment in B Company (to be held 5 years) Goodwill Additional Paid-in Capital Accumulated Other Comprehensive Income Equipment Income Tax Payable Diff: 2 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Classify the following accounts as assets (A), liabilities (L), or shareholders' equity (SE) and whether they are current (C), non-current (NC), or not applicable (N/A). Account Accounts Receivable Accounts Payable Supplies Bonds Payable (due in 10 years) Investment in A Company (to be sold in 6 months) Copyright Additional Paid-in Capital Retained Earnings Land Wages Payable

A, L, SE

C, NC, N/A

A, L, SE A L A L

C, NC, N/A C C C NC

A SE SE A L

NC N/A N/A NC C

Answer: Account Accounts Receivable Accounts Payable Supplies Bonds Payable (due in 10 years) Investment in A Company (to be sold in 6 months) Copyright Additional Paid-in Capital Retained Earnings Land Wages Payable Diff: 2 Objective: 6.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6.3

Balance Sheet Presentation and Format

1) The report format of the balance sheet lists assets on the left side and liabilities and stockholders' equity on the right side of the statement. Answer: FALSE Diff: 1 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The account format of the balance sheet lists assets on the left side and liabilities and stockholders' equity on the right side of the statement. Answer: TRUE Diff: 1 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) When preparing a balance sheet using IFRS, a company may choose to list noncurrent assets first. Answer: TRUE Diff: 1 Objective: 6.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

4) A company reporting under IFRS may list its assets in either increasing or decreasing order of liquidity. Answer: TRUE Diff: 1 Objective: 6.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

5) A company reporting under IFRS must list its liabilities in order of liquidity for each grouping. Answer: FALSE Diff: 1 Objective: 6.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) Which of the following statements regarding balance sheet presentation is true? A) IFRS does not prescribe the ordering of liabilities within current and noncurrent groups. B) The account format lists liabilities and shareholders' equity directly below the assets. C) The report format lists liabilities and shareholders' equity on the right side of the statement. D) U.S. GAAP allows assets to be listed in either increasing or decreasing order of liquidity. Answer: A Diff: 1 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Hendrickson Corporation's trial balance for July 31, the end of its fiscal year, included the following accounts: Accounts Receivable Inventories Copyright Investments Prepaid Insurance Note receivable, due in two years Cash in Bank

$22,000 65,000 20,000 41,000 12,000 77,000 6,500

Investments are treasury bills that were purchased in May and mature on August 15. Prepaid insurance is a three-year policy that was purchased on July 31. The amount that should be classified as current assets in the July 31 balance sheet is ________. A) $146,500 B) $138,500 C) $87,000 D) $215,500 Answer: B Explanation: Cash in Bank $6,500 + Accounts Receivable $22,000 + Inventories $65,000 + Investments $41,000 + Prepaid Insurance $4,000 ($12,000/3 years) = $138,500 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Webb Corporation's trial balance for July 31, the end of its fiscal year, included the following accounts: Accounts Receivable Inventories Franchise Investments Prepaid Insurance Note Receivable Cash in Bank

$30,000 46,000 35,000 48,000 5,000 102,000 8,000

The investments account consists of marketable securities of which management plans to sell half of by December 31. The rest of the securities will be held longer than one year. Prepaid insurance is a twoyear policy that was purchased on July 31. The note receivable is an installment note that will be paid in three equal installments on December 31 of each year. The amount that should be classified as current assets in the July 31 balance sheet is ________. A) $144,500 B) $147,000 C) $182,500 D) $212,500 Answer: A Explanation: Cash in Bank $8,000 + Accounts Receivable $30,000 + Inventories $46,000 + Note Receivable $34,000 ($102,000/3) + Investments $24,000 ($48,000/2) + Prepaid Insurance $2,500 ($5,000/2) = $144,500 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Glover Corporation's trial balance for December 31, the end of its fiscal year, included the following accounts: Accounts Payable Dividends Payable Bond Payable, maturing in 9 years Salaries Payable Note Payable, due in 1 year Note payable, due in 5 years

$30,000 16,000 36,000 8,000 30,000 60,000

The amount that should be classified as current liabilities on Glover's December 31 balance sheet is ________. A) $54,000 B) $68,000 C) $84,000 D) $144,000 Answer: C Explanation: Accounts Payable $30,000 + Dividends Payable $16,000 + Salaries Payable $8,000 + Note Payable $30,000 = $84,000 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Anderson Corporation's trial balance for December 31, the end of its fiscal year, included the following accounts: Accounts Payable Dividends Payable Bond Payable, maturing in 9 years Salaries Payable Note Payable, due in 1 year Note payable, due in 5 years

$40,000 14,000 54,000 10,000 25,000 80,000

The bond payable is a serial bond with equal amounts of principal maturing each year. The note payable due in 5 years has equal principal payments due each year. The amount that should be classified as current liabilities on Anderson's December 31 balance sheet is ________. A) $91,000 B) $105,000 C) $111,000 D) $159,000 Answer: C Explanation: Accounts Payable $40,000 + Dividends Payable $14,000 + Bonds Payable $6,000 ($54,000/9) + Salaries Payable $10,000 + Note Payable, due in one year $25,000 + Current Portion Note Payable, due in 5 years $16,000 ($80,000/5) = $111,000. Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Presented below are selected accounts for San Marcos Corporation for December 31 of the current year. Debit Accounts Receivable—trade Building and Equipment Cash in Bank—operating Interest Receivable— due in 1 month Installment Receivables— due in 6 months Merchandise Inventory Land Notes Receivable—long term Petty Cash Prepaid Expenses—current Supplies Patent Accounts Payable—trade Accumulated Depreciation Additional Paid-in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes Payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Credit $730 1030 49 45 90 45 330 545 28 62 49 80 $625 245 620 75 70 65 105 920 65 105 240 628

200 $3523

$3523

What are current assets for San Marcos Corporation? A) $1023 B) $1098 C) $1070 D) $1523 Answer: A Explanation: Accounts Receivable $730 – Allowance for Uncollectible Accounts $75 + Cash in Bank $49 + Interest Receivable $45 + Installment Receivables $90 + Merchandise Inventory $45 + Petty Cash $28 + Prepaid Expenses – current $62 + Supplies $49 = $1023 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Presented below are selected accounts for San Marcos Corporation for December 31 of the current year.

Accounts Receivable—trade Building and Equipment Cash in bank—operating Interest Receivable Installment Receivables Merchandise Inventory Land Notes Receivable—long term Petty cash Prepaid Expenses—current Supplies Patent Accounts Payable—trade Accumulated Depreciation Additional Paid-in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes Payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Debit $720 1040 59 65 90 25 300 535 8 52 19 90

Credit

$625 255 600 55 60 75 85 900 65 95 250 638 200 $3453

$3453

What are current liabilities for San Marcos Corporation? A) $710 B) $770 C) $805 D) $865 Answer: B Explanation: Accounts Payable $625 + Cash Dividends Payable $60 + Income Tax Payable $85 = $770 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Presented below are selected accounts for San Marcos Corporation for December 31 of the current year.

Accounts Receivable—trade Building and Equipment Cash in Bank—operating Interest Receivable Installment Receivables—due in 6 months Merchandise Inventory Land Notes Receivable—long term Petty Cash Prepaid Expenses—current Supplies Patent Accounts Payable—trade Accumulated Depreciation Additional Paid-in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes Payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Debit $720 1040 69 55 90 45 310 535 38 32 19 80

Credit

$655 245 610 85 70 65 105 910 65 85 260 598 200 $3493

$3493

What is working capital for San Marcos Corporation? A) $115 B) $153 C) $308 D) $658 Answer: B Explanation: Current Assets = Cash in Bank $69 + Accounts Receivable $635 ($720 - $85) + Interest Receivable $55 + Installment Receivables $90 + Merchandise Inventory $45 + Petty Cash $38 + Prepaid Expenses $32 + Supplies $19 = $983; Current liabilities = Accounts Payable $655 + Cash Dividends Payable $70 + Income Tax Payable $105 = $830. Current Assets of $983 – Current Liabilities $830 = $153 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Presented below are selected accounts for San Marcos Corporation for December 31 of the current year.

Accounts Receivable—trade Building and Equipment Cash in Bank—operating Interest Receivable– due in 1 month Installment Receivables– due in 3 months Merchandise Inventory Land Notes Receivable—long term Petty Cash Prepaid Expenses—current Supplies Patent Accounts Payable—trade Accumulated Depreciation Additional Paid-in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes Payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Debit $750 1040 79 65 80 35 310 525 8 42 29 90

Credit

$625 225 620 75 90 55 105 920 65 85 240 628 200 $3493

$3493

What are total assets for San Marcos Corporation? A) $2753 B) $2808 C) $2828 D) $2883 Answer: A Explanation: Accounts Receivable-Trade $750 – Allowance for Uncollectible Accounts $75 + Cash in Bank $79 + Interest Receivable $65 + Installment Receivables $80 + Merchandise Inventory $35 + Petty Cash $8 + Prepaid Expenses $42 + Supplies $29 + Building and Equipment $1040 - Accumulated Depreciation $225 + Land $310 + Notes Receivable – long-term $525 + Patent $90 = $2753 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Presented below are selected accounts for San Marcos Corporation for December 31 of the current year.

Accounts Receivable—trade Building and Equipment Cash in bank—operating Interest Receivable Installment Receivables—due in 6 months Merchandise Inventory Land Notes Receivable—long term Petty Cash Prepaid Expenses—current Supplies Patent Accounts Payable—trade Accumulated Depreciation Additional Paid-in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes Payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Debit $730 1020 69 55 70 35 330 535 18 42 49 60

Credit

$645 235 630 65 90 65 105 900 95 115 260 528 200 $3473

$3473

What are long-term assets for San Marcos Corporation? A) $1175 B) $1650 C) $1710 D) $1945 Answer: C Explanation: Building and Equipment $1020 – Accumulated Depreciation $235 + Land $330 + Notes Receivable – long term $535 + Patent $60 = $1710 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Presented below are selected accounts for San Marcos Corporation for December 31 of the current year.

Accounts Receivable—trade Building and Equipment Cash in Bank—operating Interest Receivable Installment Receivables Merchandise Inventory Land Notes Receivable—long term Petty Cash Prepaid Expenses—current Supplies Patent Accounts Payable—Trade Accumulated Depreciation Additional Paid-in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes Payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Debit $720 1040 49 55 90 55 310 525 18 42 49 90

Credit

$655 255 620 55 90 65 85 920 95 95 250 558 200 $3493

$3493

What are long-term liabilities for San Marcos Corporation? A) $920 B) $1010 C) $1015 D) $1100 Answer: C Explanation: Notes Payable – 2 years $920 + Unearned Revenues – 2 years $95 = $1015 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Presented below are selected accounts for San Marcos Corporation for December 31 of the current year.

Accounts Receivable—trade Building and Equipment Cash in Bank—operating Interest Receivable Installment Receivables Merchandise Inventory Land Notes Receivable—long term Petty Cash Prepaid Expenses—current Supplies Patent Accounts Payable—trade Accumulated Depreciation Additional Paid-in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes Payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Debit $720 1050 49 45 70 55 330 535 28 62 29 60

Credit

$655 235 610 75 90 55 95 910 85 115 270 578 200 $3503

$3503

What are total liabilities for San Marcos Corporation? A) $1775 B) $1865 C) $1880 D) $1940 Answer: B Explanation: Accounts Payable $655 + Cash Dividends Payable $90 + Income Tax Payable $95 + Notes Payable – 2 years $910 + Unearned Revenues – 2 years $115 = $1865 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Presented below are selected accounts for San Marcos Corporation for December 31 of the current year.

Accounts Receivable—trade Building and Equipment Cash in Bank—operating Interest Receivable Installment Receivables Merchandise Inventory Land Notes Receivable—long term Petty Cash Prepaid Expenses—current Supplies Patent Accounts Payable—trade Accumulated Depreciation Additional Paid-in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Debit $730 1050 69 35 70 35 320 535 38 62 19 90

Credit

$655 225 600 75 70 55 95 930 85 115 270 618 200 $3523

$3523

What is total stockholders' equity for San Marcos Corporation? A) $740 B) $888 C) $1343 D) $1428 Answer: B Explanation: Additional Paid-in Capital $600 + Common Stock - $1 par value $55 + Retained Earnings $85 – Cash Dividends Declared $270 + Service Revenue $618 – Operating Expenses $200 = $888 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Presented below are selected accounts for San Marcos Corporation for December 31 of the current year.

Accounts Receivable—trade Building and Equipment Cash in Bank—operating Interest Receivable Installment Receivables Merchandise Inventory Land Notes Receivable—long term Petty Cash Prepaid Expenses—current Supplies Patent Accounts Payable—trade Accumulated Depreciation Additional Paid-in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes Payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Debit $740 1020 69 35 80 55 300 525 28 32 49 80

Credit

$655 245 610 75 90 45 105 910 65 85 240 568 200 $3453

$3453

What is ending retained earnings for San Marcos Corporation? A) $328 B) $193 C) $305 D) $633 Answer: B Explanation: Retained Earnings $65 – Cash Dividends Declared $240 + Service Revenue $568 – Operating Expenses $200 = $193 Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Use the following information for the next 3 questions. San Pedro Industries Presented below are selected accounts from the adjusted trial balance ($ Millions) for San Pedro Industries for June 30 of the current year.

Accounts Receivable—trade Building and Equipment Cash in Bank—operating Interest Receivable Installment Receivables—due in 6 months[ Merchandise Inventory Land Notes Receivable—long term Petty Cash Prepaid Expenses -current Supplies Patent Accounts Payable—Trade Accumulated Depreciation Additional Paid in Capital Allowance for Uncollectible Accounts Cash Dividends Payable Common Stock—$1 par value Income Tax Payable Notes Payable—2 years Retained Earnings Unearned Revenues—2 years Cash Dividends Declared Service Revenue Operating Expenses Totals

Debit $895 1425 76 60 120 100 600 475 12 46 28 85

Credit

710 375 725 95 50 90 105 1000 85 125 200 962 200 $4322

$4322

20) Prepare a classified balance sheet using the account format for San Pedro Industries. Answer: San Pedro Industries Balance Sheet At June 30 Assets Current Assets Cash

Liabilities Current Liabilities: $88 Accounts Payable

$710

Accounts Receivable - net

800 Income Tax Payable

105

Interest Receivable

60 Dividends Payable

Installment Receivable

120 Total Current Liabilities

Merchandise Inventory

100

Supplies

28 Noncurrent Liabilities

Prepaid Expenses

46 Notes Payable

$1,000

$1,242 Unearned Revenues Total Noncurrent Liabilities

125 $1,125

$475 Total Liabilities

$1,990

Total Current Assets

Noncurrent Assets Notes Receivable Property, Plant, and Equipment Land Buildings and Equipment Less: Accumulated Depreciation

$865

600 $1,425

Stockholders' Equity

(375)

1,050 Common Stock at par

Property, Plant, and Equipment-net

$90

Additional Paid-in Capital

725

$1,650 Retained Earnings Total Stockholders' Equity

647 $1,462

Intangible Assets— Patent - net Total Noncurrent Assets

$85 $2,210

Total Assets

Total Liabilities and $3,452 Stockholders' Equity

Diff: 3 Objective: 6.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

$3,452

21) Prepare a classified balance sheet using the report format for San Pedro Industries. Answer: San Pedro Industries Balance Sheet At June 30 Assets Current Assets Cash Accounts Receivable - net Interest Receivable Installment Receivable Merchandise Inventory Supplies Prepaid Expenses Total Current Assets

$88 800 60 120 100 28 46 $1,242

Noncurrent Assets Notes Receivable Property, Plant, and Equipment Land Buildings and Equipment Less: Accumulated Depreciation

$475 600 $1,425 (375)

1,050

Property, Plant, and Equipment - net

$1,650

Intangible Assets —Patent - net Total Noncurrent Assets Total Assets

$85 $2,210 $3,452

Liabilities Current Liabilities: Accounts Payable Income Tax Payable Dividends Payable Total Current Liabilities

$710 105 50 $865

Noncurrent Liabilities Notes Payable Unearned Revenues Total Noncurrent Liabilities

$1,000 125 $1,125

Total Liabilities

$1,990

Stockholders' Equity Common Stock at par

$90

Additional Paid-in Capital Retained Earnings Total Stockholders' Equity Total Liabilities and Stockholders' Equity

725 647 $1,462 $3,452

Diff: 3 Objective: 6.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Prepare a classified balance sheet in IFRS-acceptable format for San Pedro Industries. Answer: San Pedro Industries Balance Sheet At June 30 Assets Noncurrent Assets Intangible Assets--Patent - net Property, Plant, and Equipment Buildings and Equipment Less: Accumulated Depreciation Land Property, Plant, and Equipment—net Notes Receivable Total Noncurrent Assets

$85 $1,425 (375)

1,050 600 $1,650 $475 $2,210

Current Assets Merchandise Inventory Accounts Receivable - net Interest Receivable Installment Receivable Supplies Prepaid Expenses Cash Total Current Assets Total Assets

$100 800 60 120 28 46 $88 $1,242 $3,452

Liabilities Current Liabilities: Accounts Payable Income Tax Payable Dividends Payable Total Current Liabilities

$710 105 50 $865

Noncurrent Liabilities Notes Payable Unearned Revenues Total Noncurrent Liabilities Total Liabilities Net Assets Stockholders, Equity Share Capital Share Premium Retained Profit Total Stockholders' Equity

$1,000 125 $1,125 1,990 $1,462 $90 725 647 $1,462

Total Liabilities and Stockholders' Equity

$3,452

Diff: 3 Objective: 6.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

23) After grouping assets as current and noncurrent what further classifications within those categories are made when compiling a balance sheet? Assume U.S. GAAP. Answer: Companies make further classifications. Specifically, within current and noncurrent assets, companies list each asset in decreasing order of liquidity. Current assets precede noncurrent assets. The most liquid asset is first, followed by less liquid assets. In the current assets section, cash, the most liquid asset, is usually listed first, followed by short-term investments, receivables, merchandise inventories, and then prepaid expenses. In the noncurrent assets, long-term investments are listed, followed by property, plant and equipment, intangible assets and other assets. Within property, plant, and equipment, land is listed first, followed by buildings, equipment, furniture, and fixtures. Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) List and describe the two balance sheet formats. Answer: The two formats are the account and report formats. The account format lists assets on the left side and liabilities and stockholders' equity on the right side of the statement. The report format lists liabilities and stockholders' equity directly below assets on the same page. Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Compare and contrast the presentation of assets under U.S. GAAP versus IFRS reporting. Answer: Under U.S. GAAP, after grouping assets as current and noncurrent, further classifications within those categories are made when compiling a balance sheet. Specifically, within current and noncurrent assets, companies list each asset in decreasing order of liquidity. Current assets precede noncurrent assets. The most liquid asset is first, followed by less liquid assets. Cash, the most liquid asset, is usually listed first, followed by short-term investments, receivables, and then other less liquid assets. With IFRS-reporting, companies can present either current assets or noncurrent assets first. IFRS permits asset presentation in either a decreasing or an increasing order of liquidity. When using an increasing order of liquidity, the least-liquid assets are typically presented first within each balance sheet section. Diff: 2 Objective: 6.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6.4

The Statement of Cash Flows

1) The statement of cash flows summarizes a firm's cash inflows and outflows at a specific point in time. Answer: FALSE Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The statement of cash flows summarizes a firm's cash flows and outflows over a period of time. Answer: TRUE Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Dividend payments to shareholders are classified as operating activities on the statement of cash flows. Answer: FALSE Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Purchases of fixed assets are classified as investing activities on the statement of cash flows. Answer: TRUE Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) In order to sustain operations, a firm must have positive cash flows from operating activities over the long run. Answer: TRUE Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Redemption of bonds payable is classified as a financing activity on the statement of cash flows. Answer: TRUE Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Cash receipts from interest and dividends are classified as operating activities on a U.S. GAAP-based statement of cash flows. Answer: TRUE Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) The statement of cash flows enables financial statement users to do all of the following except ________. A) assess an entity's ability to pay liabilities and dividends B) determine the extent to which an entity will require external financing C) assess the collectability of existing accounts receivable D) reconcile differences between net income and the associated cash receipts and payments Answer: C Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following is classified as an operating activity on a statement of cash flows? A) payment of dividends B) sale of equipment C) issuance of common stock D) purchase of inventory with cash Answer: D Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Which of the following is classified as an investing activity on a statement of cash flows? A) purchase of land B) issuance of serial bonds C) purchase of insurance policy D) purchase of treasury stock Answer: A Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Which of the following is classified as a financing activity on a statement of cash flows? A) purchase of a vendor's common stock B) sale of equipment at a gain C) payment of dividends to shareholders D) redemption of a sinking fund Answer: C Diff: 1 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) All of the following activities are classified as operating activities on a statement of cash flows except ________. A) purchase of inventory with cash B) sale of merchandise for cash C) receipts from customers D) purchase of a certificate of deposit Answer: D Diff: 2 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) All of the following activities are classified as investing activities on a statement of cash flows except ________. A) purchase of land B) sale of long-term investments C) purchase of copyright D) gain on sale of securities Answer: D Diff: 2 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) All of the following activities are classified as financing activities on a statement of cash flows except ________. A) distribution of dividends in the form of stock B) issuance of serial bonds C) payment of mortgage D) sale of treasury stock Answer: A Diff: 2 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Presented below are activities from Prosser Industries, Inc. Activity Purchase of equipment with cash Sale of treasury stock Payments to employees Sale of idle land Purchase of inventory with cash Payment of dividends to shareholders Redemption of bonds payable Sale of long-term investments Payment of interest on bonds payable

O, I, or F

Required: Please indicate whether each of these activities is classified as an (O)perating, (I)nvesting, or (F)inancing Activity on the statement of cash flows. Answer: Activity O, I, or F Purchase of equipment with cash I Sale of treasury stock F Payments to employees O Sale of idle land I Purchase of inventory with cash O Payment of dividends to shareholders F Redemption of bonds payable F Sale of long-term investments I Payment of interest on bonds payable O Diff: 2 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Presented below are activities from Ford Enterprises, Inc. Activity Purchase of buildings with cash Issuance of treasury stock Payments to vendors Sale of old equipment Sales to customers for cash Repayment of notes to bank Issuance of bonds payable Purchase of municipal bonds Receipt of interest on municipal bonds

O, I, or F

Required: Please indicate whether each of these activities is classified as an (O)perating, (I)nvesting, or (F)inancing Activity on the statement of cash flows. Answer: Activity O, I, or F Purchase of buildings with cash I Issuance of treasury stock F Payments to vendors O Sale of old equipment I Sales to customers for cash O Repayment of notes to bank F Issuance of bonds payable F Purchase of municipal bonds I Receipt of interest on municipal bonds O Diff: 2 Objective: 6.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Describe the statement of cash flows and its purpose including what a financial statement user can determine or assess by reviewing a well-prepared statement of cash flows. Answer: The statement of cash flows provides information about a firm's cash receipts and cash payments during a period of time. The statement reconciles the change in the cash balance to the cash flows for the period and summarizes the firm's cash flows by classifying them into operating, investing, and financing activities. The statement of cash flows enables financial statements users to: 1. Assess the entity's ability to meet its obligations and pay dividends. 2. Determine whether the entity will require external financing. 3. Identify the differences between net income and the associated cash receipts and payments. Diff: 2 Objective: 6.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Complete the U.S. GAAP and IFRS columns in the table below by identifying the cash flow activity on the statement of cash flows: Operating, Investing, or Financing. If a standard allows for more than one activity classification be sure to note both. For example, if an activity can be classified as "Operating or Financing," please note both classifications. Activities Cash receipts from interest Cash payments for interest Cash receipts from dividends Cash payments for dividends to owners

Answer: Activities Cash receipts from interest Cash payments for interest Cash receipts from dividends Cash payments for dividends to owners

U.S. GAAP

IFRS

U.S. GAAP Operating Operating Operating

IFRS Operating or Investing Operating or Investing Operating or Investing

Financing

Operating or Investing

Diff: 3 Objective: 6.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6.5

Format for Cash Flows from Operating Activities

1) The only difference between the statement of cash flows under the indirect method and the direct method is in the reporting of cash flows from operating activities. Answer: TRUE Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The FASB prefers the indirect method of preparing the operating activities section of the statement of cash flows. Answer: FALSE Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When preparing the operating activities section of the statement of cash flows under the indirect method, depreciation expense is subtracted from net income. Answer: FALSE Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When preparing the operating activities section of the statement of cash flows under the indirect method, gains on sale of equipment are subtracted from net income. Answer: TRUE Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) When preparing the operating activities section of the statement of cash flows under the direct method, an increase in accounts receivable is subtracted from sales. Answer: TRUE Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) When preparing the operating activities section of the statement of cash flows under the indirect method, losses on sales of equipment are omitted. Answer: FALSE Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) When preparing the operating section of the statement of cash flows using the indirect method, which of the following items are added to net income? A) decrease in accrued expenses B) gain on sale of long-term assets C) bad debt expense D) increase in accounts receivable Answer: C Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) When preparing the operating section of the statement of cash flows using the indirect method, which of the following items are added to net income? A) decrease in accounts payable B) unrealized gains on trading securities C) loss on sale of equipment D) increase in merchandise inventory Answer: C Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) When preparing the operating section of the statement of cash flows using the indirect method, which of the following items are subtracted from net income? A) depreciation expense B) gain on sale of long-term assets C) decrease in prepaid expenses D) increase in income taxes payable Answer: B Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) When preparing the operating section of the statement of cash flows using the direct method, which of the following statements is true? A) An increase in accounts payable is subtracted from cost of goods sold. B) An increase in accounts receivable is added to sales. C) Depreciation expense is added to cash flows. D) Gains on sales of long-term assets are subtracted from cash flows. Answer: A Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) When preparing the operating section of the statement of cash flows using the direct method, which of the following statements is true? A) An increase in accounts payable is added to expenses. B) An increase in accounts receivable is added to sales. C) Depreciation expense is deducted from cash flows. D) Gains on sales of long-term assets are omitted from cash flows. Answer: D Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Which of the following is considered an investing activity when preparing the statement of cash flows? A) a purchase of equipment B) a payment on an equipment note C) sale of common stock D) payment of interest on a bond issue Answer: A Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which of the following is not considered an investing activity when preparing the statement of cash flows? A) a purchase of equipment B) a sale of investments C) payment of dividends D) receipts on notes receivable Answer: C Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Which of the following is considered a financing activity when preparing the statement of cash flows? A) cash payment for the purchase of equipment B) cash payment for extending credit to others C) cash receipt from the sale of common stock D) payment of interest on a bond issue Answer: C Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Which of the following is not considered a financing activity when preparing the statement of cash flows? A) issuance of common stock B) redemption of bonds payable C) payment of dividends D) receipts on notes receivable Answer: D Diff: 1 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Danielsen Inc. had salaries payable of $60,000 as of January 1 and $20,000 as of December 31. During the year, Danielsen showed $750,000 in salaries expense on the income statement. Cash outflows for salaries for the year were ________. A) $710,000 B) $750,000 C) $790,000 D) $810,000 Answer: C Explanation: Salaries Expense $750,000 + Decrease in Salaries Payable $40,000 = $790,000 Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Bookworm Booksellers reported sales revenue of $340,000 for the fiscal year ended July 31. The accounts receivable balance at the beginning of the year was $29,000 and $33,000 at the end of the year. On the statement of cash flows, what amount of cash would be shown as collected from customers? A) $311,000 B) $336,000 C) $340,000 D) $344,000 Answer: B Explanation: Sales Revenues of $340,000 – Increase in Accounts Receivables $4,000 = $336,000 Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Moore Corporation reported net income of $230,000 for the current year ended June 30. Accounts receivable had a beginning balance of $40,000 and an ending balance of $48,000. Accounts payable had a beginning balance of $26,000 and an ending balance of $40,000. Assuming that this is all of the relevant information, Moore's cash flows from operating activities are ________. A) $208,000 B) $236,000 C) $224,000 D) $252,000 Answer: B Explanation: Net Income $230,000 + Beginning Accounts Receivables $40,000 – Ending Accounts Receivables $48,000 + Ending Accounts Payables $40,000 – Beginning Accounts Payables $26,000 = $236,000 Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Hitchcock Enterprises sold a vacant plot of land for $20,000. The company had paid $6,000 for the land ten years ago. On the statement of cash flows, this transaction would be reported as a(n) ________. A) operating cash inflow of $14,000 B) investing cash inflow of $14,000 C) investing cash inflow of $20,000 D) financing cash inflow of $20,000 Answer: C Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Presented here are cash flows (in $ Millions) for Valley Mills Enterprises' most recent fiscal year. Cash received from: Customers Interest on investments Sale of old equipment Sale of company's capital stock Long-term debt proceeds

$2,300 290 240 900 1,600

Cash paid for: Interest on debt Income tax Principal payments on debt Purchase of building Purchase of inventory Dividends on capital stock Operating expenses

$600 130 1,000 6,000 1,400 300 725

Net cash flows provided (used) by operating activities (direct method) are ________. A) ($265) B) ($125) C) ($355) D) $460 Answer: A Explanation: Cash received from customers $2,300 + Interest on investments $290 – Income Tax $130– Interest on debt $600 - Purchase of Inventory $1,400 - Operating expenses $725 = ($265) Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Presented here are cash flows (in $ Millions) for Valley Mills Enterprises' most recent fiscal year. Cash received from: Customers Interest on investments Sale of old equipment Sale of company's capital stock Long-term debt proceeds

$2,200 310 230 700 1,800

Cash paid for: Interest on debt Income tax Principal payments on debt Purchase of building Purchase of inventory Dividends on capital stock Operating expenses

$400 120 700 5,000 1,400 200 525

Net cash flows provided (used) by investing activities are ________. A) ($2,970) B) ($4,460) C) ($4,770) D) ($5,000) Answer: C Explanation: Sale of old equipment $230 – Purchase of Building $5,000 = -$4,770 Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Presented here are cash flows (in $ Millions) for Valley Mills Enterprises' most recent fiscal year. Cash received from: Customers Interest on investments Sale of old equipment Sale of company's capital stock Long-term debt proceeds

$2,700 290 220 800 1,300

Cash paid for: Interest on debt Income tax Principal payments on debt Purchase of building Purchase of inventory Dividends on capital stock Operating expenses

$600 140 1,100 6,000 1,700 300 625

Net cash flows provided (used) by financing activities are ________. A) ($200) B) $960 C) $700 D) $1,390 Answer: C Explanation: Sale of company's capital stock $800 + Long-term debt proceeds $1,300 – Principal payments on debt $1,100 – Dividends on capital stock $300 = $700 Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Presented here are cash flows (in $ Millions) for Baton Rouge Corporation's most recent fiscal year: Cash received from: Customers Interest on investments Sale of investments Sale of company's capital stock Issuance of debt securities

$3,300 1,000 3,900 490 2,400

Cash paid for: Interest on debt Income tax Principal payments on debt Purchase of land Payments to vendors Dividends on capital stock Operating expenses

$365 150 1,200 1,200 1,700 330 710

Net cash flows from operating activities (direct method) are ________. A) $375 B) $1,375 C) $1,525 D) $1,740 Answer: B Explanation: Cash received from customers $3,300 + Cash received from interest on investments $1,000 – Interest on debt $365 – Income tax $150 – Payments to vendors $1,700 - Operating expenses $710 = $1,375 Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Presented here are cash flows (in $ Millions) for Baton Rouge Corporation's most recent fiscal year: Cash received from: Customers Interest on investments Sale of investments Sale of company's capital stock Issuance of debt securities

$3,800 700 4,200 480 2,600

Cash paid for: Interest on debt Income tax Principal payments on debt Purchase of land Payments to vendors Dividends on capital stock Operating expenses

$355 150 1,100 1,100 1,400 330 710

Net cash flows provided (used) by investing activities are ________. A) ($1400) B) $3100 C) $3800 D) $5700 Answer: B Explanation: Cash received from sale of investments $4,200 – Purchase of land $1,100 = $3,100 Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Presented here are cash flows (in $ Millions) for Baton Rouge Corporation's most recent fiscal year: Cash received from: Customers Interest on investments Sale of investments Sale of company's capital stock Issuance of debt securities

$3,600 900 3,800 420 2,800

Cash paid for: Interest on debt Income tax Principal payments on debt Purchase of land Payments to vendors Dividends on capital stock Operating expenses

$405 150 1,100 1,200 1,800 380 780

Net cash flows provided (used) by financing activities are ________. A) ($1,060) B) $1,590 C) $1,740 D) $2,640 Answer: C Explanation: Cash received from sale of company's capital stock $420 + Issuance of debt securities $2,800 – Principal payments on debt $1,100 – Dividends on capital stock $380 = $1,740 Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Presented below are the comparative December 31 financial statements for Martin Industries, Inc. . Prepare a statement of cash flows for December 31, Year 2 using the indirect method. Martin Industries, Inc. Balance Sheets At December 31, Year 2 and Year 1 Cash Accounts Receivable Inventory Prepaid Insurance Long-term Investments

Year 2 $96,719 100,000 206,250 1,875 19,375

Year 1 $28,694 85,313 181,250 2,500 106,250

Land, Buildings, and Equipment Accumulated Depreciation

1,562,500 (762,500)

1,406,250 (715,000)

Total Assets

$1,224,219

$1,095,257

Accounts Payable Salaries Payable Notes Payable (long-term) Bonds Payable Common Stock

$95,425 25,000 31,250 250,000 375,000

$185,838 30,625 93,750 375,000

Retained Earnings

447,544

410,044

$1,224,219

$1,095,257

Total Liabilities and Stockholders' Equity

Additional information for Year 2 (1) Sold available for sale securities costing $86,875 for $92,500. (2) Equipment costing $25,000 with a book value of $6,250 was sold for $7,500 (3) Issued 8% bonds at face value for $250,000. (4) Purchased new equipment for $181,250 and paid cash. (5) Paid cash dividends of $25,000. (6) Net income was $62,500.

Answer:

Martin Industries, Inc. Statement of Cash Flows, Year 2 For the Year Ended December 31

Net income Adjustments to reconcile net income to net cash used by operating activities Depreciation expense Gain on sale of investments Gain on sale of equipment Changes in operating working capital accounts Increase in accounts receivable Increase in inventory Decrease in prepaid insurance Decrease in accounts payable Decrease in salaries payable Net cash used by operating activities

$62,500

66,250 (5,625) (1,250) (14,687) (25,000) 625 (90,413) (5,625) (13,225)

Investing Activities Sale of available for sale securities Sale of equipment Purchase of equipment Net cash used by investing activities

92,500 7,500 (181,250)

Financing Activities Sale of bonds payable Payment of notes payable Payment of cash dividends Net cash provided by financing activities

250,000 (62,500) (25,000)

(81,250)

162,500

Net increase in cash Cash Balance, January 1 Cash Balance, December 31

$68,025 28,694 $96,719

Diff: 3 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Presented below are the December 31 financial statements for Phillips Corporation (in $ Millions).

Assets Cash Accounts Receivable Inventory Long-Term Investments Totals

Phillips Corporation Balance Sheets as of December 31 Year 2 $29,025 263,250 243,000 0 $535,275

Liabilities and Shareholders' Equity Accounts Payable Other Current Liabilities Notes Payable Common Stock Retained Earnings Totals

$101,250 32,400 94,500 168,750 138,375 $535,275

Year 1 $162,000 141,750 303,750 81,000 $688,500

$162,000 20,250 135,000 168,750 202,500 $688,500

Phillips Corporation Income Statement For the Year Ended December 31, Year 2 Sales Cost of Goods Sold Gross Profit Operating expenses Income from operations Loss on Sale of long-term investment Net loss

$756,000 506,250 249,750 243,000 6,750 (10,125) $(3,375)

Cash dividends of $60,750 were paid to shareholders during Year 2. Prepare a statement of cash flows using the direct method.

Answer:

Phillips Corporation Income Statement For the Year Ended December 31, Year 2

Operating Activities Cash collected from customers Cash outflows Cash paid for merchandise Cash paid to other suppliers Net cash used by operating activities Investing Activities Sale of long term investments Net cash provided by investing activities Financing Activities Payment of notes payable Payment of cash dividends Net cash used by financing activities

$634,500 (506,250) (230,850)

70,875

(40,500) (60,750)

Net increase in cash Cash balance, January 1 Cash balance, December 31

$(102,600)

70,875

(101,250) (132,975) 162,000 $29,025

Diff: 3 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) Explain the difference between the direct and indirect methods of preparing the operating section of the statement of cash flows. Which method is preferred by GAAP? Answer: When the indirect method of preparing the operating section of the statement of cash flows is used, net income is the starting point. Non-cash expenses such as depreciation expense and nonoperating items, such as losses on sales of assets are added back to net income, because they do not result in an outflow of cash. Likewise, non-operating revenue items, such as gains on sale of equipment and investments are deducted from net income, because they do not create inflows of cash. After these adjustments are made, then changes in elements of working capital are added or subtracted. Decreases in current assets and increases in current liabilities are added to net income, while increases in current assets and decreases in current liabilities are subtracted from net income. The end result is net cash provided/used by operating activities. The direct method of preparing the operating activities section of the statement of cash flows converts each element of income and expense on the income statement from the accrual basis to the cash basis of accounting. Sales revenue is adjusted by adding the decrease in accounts receivable (or subtracting the increase in accounts receivable) to arrive at cash received from customers. Likewise, cost of goods sold is converted into cash paid for merchandise by adding the increase in inventory (or subtracting the decrease in inventory) and subtracting the increase in accounts payable (or adding the decrease in accounts payable). Other expenses are adjusted in a similar fashion and depreciation and amortization are omitted. Because the direct method of presenting cash flows from operating activities is more easily understandable, GAAP prefers its use on the statement of cash flows. However, most companies choose to use the indirect method. Diff: 2 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) Johnson Company presented its financial statements to a local bank as part of a loan application. The loan officer was concerned because, even though cash flow had increased during the year and net income was positive, net cash flows from operating activities had a significant negative balance. At the same time, the company had sold a large part of its investment portfolio and issued additional stock to its shareholders. Write a memo to Johnson Company and explain the loan officer's concern. Include the relationship between cash flows from the three types of activities. Answer: Memo To: Johnson Company From: Local Bank Re: Your Statement of Cash Flows We are quite concerned about the financial position of your company. While your overall cash flows are positive, the loan committee noticed that there was a large inflow in cash flows from investing activities that came from the sale of investments. Likewise, there were additional positive cash flows from the sale of common stock. Your operating activities, however created a significant outflow of cash. Cash flows from operating activities must be positive over a period of years for a company to be able to sustain itself. Net income can be adjusted through the use of accruals and deferrals of revenues and expenses. But cash flows tell the true picture of a company's liquidity. Your company sustained itself through issuing additional stock and selling investments, but, at the same time it decreased its asset base. Borrowing additional money will further increase the burden on the corporation. You should examine what is causing cash flows from operating activities to be so negative and make the necessary corrections to your operations. Diff: 3 Objective: 6.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6.6

Financial Statement Articulation

1) Accumulated other comprehensive income is reported on the statement of comprehensive income. Answer: FALSE Diff: 1 Objective: 6.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The statement of net income is the first financial statement prepared. Answer: TRUE Diff: 1 Objective: 6.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The relationships among financial statements and financial statement elements, is a critical concept in understanding financial statements. Answer: TRUE Diff: 1 Objective: 6.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Firms use the statement of net income (or the statement of comprehensive income) and the balance sheet to prepare the statement of stockholders' equity. Answer: FALSE Diff: 1 Objective: 6.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Which financial statement is the first to be prepared? A) balance sheet B) statement of comprehensive income C) statement of shareholders' equity D) statement of cash flows Answer: B Diff: 1 Objective: 6.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which financial statement is the last to be prepared? A) statement of comprehensive income B) statement of stockholders' equity C) statement of cash flows D) balance sheet Answer: C Diff: 1 Objective: 6.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following is used to arrive at ending retained earnings? A) current year OCI B) net income C) previous year OCI D) stockholders' equity Answer: B Diff: 2 Objective: 6.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) The relationships among financial statements and financial statement elements is referred to as ________. A) comprehensive income B) financial statement articulation C) financial statement position D) equity position Answer: B Diff: 1 Objective: 6.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) List the four basic financial statements and how they are intrinsically interrelated. Answer: 1. Net income and other comprehensive income (OCI) on the statements of net income and comprehensive income. Revenues and gains increase net income and expenses and losses decrease net income. 2. The statement of stockholders' equity. Net income and dividends are used to arrive at ending retained earnings, and current-year OCI is used to arrive at the ending balance in accumulated OCI. 3. Statement of financial position (balance sheet). Firms report ending retained earnings and ending accumulated OCI in the stockholders' equity section of the statement of financial position. 4. Statement of cash flows. The statement of net income (or comprehensive income) and the balance sheet are used to prepare the statement of cash flows. Diff: 2 Objective: 6.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

6.7

Notes to the Financial Statements

1) The first footnote in a set of financial statements is usually a summary of significant accounting policies. Answer: TRUE Diff: 1 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Details about the composition of intangible assets are located in the summary of significant accounting policies. Answer: FALSE Diff: 1 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A subsequent event is one that takes place after a company's year-end and after the financial statements are issued. Answer: FALSE Diff: 1 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) If a subsequent event relates to a condition that existed at the balance sheet date, then the financial statements should be adjusted. Answer: TRUE Diff: 1 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Disclosure of a related-party transaction must include an evaluation of the fairness of the transaction's terms. Answer: FALSE Diff: 1 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Financial statements issued under IFRS require additional disclosures relating to executive compensation for related-party transactions. Answer: TRUE Diff: 1 Objective: 6.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

7) Which of the following information is found in the summary of significant accounting policies? A) methods of revenue recognition B) composition of cash and cash equivalents C) composition of inventory D) maturity dates of long-term debt Answer: A Diff: 1 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Which of the following events would not be treated as a subsequent event? A) settlement of litigation between the year end and the issuance of the financial statements B) sale of a business segment between the year end and the issuance of financial statements C) recalculation of estimated salvage values for property and equipment at year end D) stock split occurring ten days after the end of the fiscal year Answer: C Diff: 2 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following would be disclosed in the summary of significant accounting policies? A) composition of inventories B) details of a related party transaction C) definition of cash equivalents D) maturity dates of long-term debt Answer: C Diff: 2 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Which of the following is not a disclosure of a related-party transaction? A) the nature of the relationship with the related parties B) the names and birthdates of the related parties C) the amounts of the transaction with the related parties D) any amounts due from or to the related parties Answer: B Diff: 2 Objective: 6.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Which of the following statements is not true regarding related-party transactions and IFRS? A) IFRS includes specific disclosure requirements on executive compensation by type. B) IFRS includes specific disclosure requirements on executive compensation by employee. C) IFRS requires specific disclosure requirements on executive compensation in total. D) The definition and disclosures of related-party transactions are similar to US. GAAP. Answer: B Diff: 2 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Under IFRS, companies are required to disclose information about the assumptions and estimates made ________. A) at the end of the reporting period B) throughout the reporting period C) at the beginning of the reporting period D) Unlike U.S. GAAP, IFRS does not require disclosures of assumptions and estimates. Answer: A Diff: 1 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) If there is substantial doubt as to whether an entity will continue to operate within one year after the financial statements are issued and management has devised plans that will probably alleviate the conditions that raise the going concern doubts, then which of the following must be disclosed? A) The conditions or events that raised substantial doubt about the entity's ability to continue operations. B) Management's plans that alleviate substantial doubt about the entity's continued operations. C) Management's plans that are intended to mitigate the conditions or events that raise substantial doubt. D) A and B Answer: D Diff: 2 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Which of the following would probably not be a related party? A) a major stockholder B) the CEO C) a subsidiary D) a customer Answer: D Diff: 1 Objective: 6.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Explain the importance of the summary of significant accounting policies and list five facts that are generally included in this note. Answer: The Summary of Significant Accounting Policies is the first footnote discusses a company's GAAP-based methods in preparing financial statements. Five facts that are included in this footnote are: 1. Method of revenue recognition 2. Method of valuing inventories 3. Definition of cash and cash equivalents 4. Methods of accounting for income tax 5. Methods of depreciation used for depreciation property, plant, and equipment Diff: 2 Objective: 6.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Explain the additional footnote disclosures to financial statements that are required by IFRS. Answer: While IFRS requires similar information to GAAP with regard to significant accounting policies, subsequent events, and related part transactions, IFRS has additional requirements with regard to subsequent events, related part transactions, and sources of estimation uncertainty for assets and liabilities. • Subsequent events—Under IFRS, if a company's board of directors has authorized the issuance of the financial statements before a subsequent event occurs, it does not have to be reported on the financial statements. • Related party transactions—In addition to the disclosures required under GAAP, IFRS also requires specific disclosures on executive compensation in total and by type. • Sources of estimation uncertainty—Under IFRS, companies are required to disclose information about the assumptions and estimated made at the end of the reporting period and if there will be a significant risk of material adjustment in the subsequent period. Diff: 2 Objective: 6.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

17) Define the term subsequent event, explain the two types of subsequent events and provide an example of each. Answer: A subsequent event is one that occurs in the time frame after the ending date of a company's fiscal year but before the financial statements are issued. There are two types of significant events: 1. Those with circumstances that existed at the date of the balance sheet and 2. Those with circumstances that did not exist at the balance sheet date. An example of the first type of event is a customer whose account was significantly delinquent as of the balance sheet date and who subsequently became insolvent and filed for bankruptcy. Such an event requires both a financial statement adjustment and disclosure. The second type of event is one that did not exist at the balance sheet date. It must be disclosed, but it does not require financial statement adjustment. An example of such an event is a stock split that occurred between the end of the year and the issuance of the financial statements. This will have a significant effect on subsequent financial statements but it does not affect the current one. Diff: 2 Objective: 6.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) The accounting staff of Brooks and Dunn Corporation is preparing the annual report for the current fiscal year. The staff member in charge of developing the footnotes has requested assistance with classifying the following information: 1. The depreciable lives of the company's assets range from 5 to 10 years. 2. The corporation acquired Miley Cyrus Corporation by issuing 100,000 shares of common stock two weeks after the end of the current fiscal year. 3. The total amount, interest rate, and maturity dates of all leases. 4. The company uses FIFO and lower of cost or market to value its inventory. 5. The allowance for uncollectible accounts is $16,000. 6. Structure of the company's pension plan. 7. The company uses the percentage of completion method to account for construction contracts. 8. Accrued liabilities are composed of salaries payable, taxes payable, and interest payable. 9. Cash equivalents are defined as those financial instruments that can be converted into cash in 90 days or less. 10. The corporation leases a building from a majority shareholder at a rate that is comparable to market rates. Required: Indicate whether the above items should be disclosed in (a) the summary of significant accounting policies note, (b) in a separate disclosure note, or (c) on the face of the balance sheet. Answer: 1. a 2. b 3. b 4. a 5. c 6. b 7. a 8. c 9. a 10. b Diff: 2 Objective: 6.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) A subsequent event is a significant event that occurs after the date of the fiscal year-end, but before the financial statements are issued or available to be issued. Explain how these significant events are disclosed. Answer: An entity can recognize material subsequent events either in the financial statements for the preceding year or disclose them in the notes to the financial statements. The recognition versus disclosure decision depends upon whether the event relates to a condition that existed on the balance sheet date (the end of the fiscal year). If the condition existed as of the balance sheet date, the firm should make an adjustment to the financial statements to account for the subsequent event. If the condition did not exist as of the balance sheet date, the entity is only required to disclose the subsequent event, as opposed to adjusting the financial statements. Diff: 2 Objective: 6.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

6.8

The Annual Report

1) Most annual reports begin with the letter to the shareholders. Answer: TRUE Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The Management Discussion and Analysis section of the annual report is a part of the audited financial statements. Answer: FALSE Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) If an auditor's independence is impaired during an audit, an adverse opinion will be issued. Answer: FALSE Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) If an auditor is unable to form an opinion on the fair presentation of the financial statements, a disclaimer of opinion will be issued. Answer: TRUE Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Management is responsible for the fair presentation of a company's financial statements. Answer: TRUE Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following topics is not required by the Securities and Exchange Commission to be included in the Management Discussion and Analysis section? A) liquidity B) adjustments for inflation C) capital resources D) off balance sheet arrangements Answer: B Diff: 2 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) If there is concern that a company might not continue in existence, but the auditor has concluded that the financial statements are fairly presented, the opinion that will be issued is a(n) ________. A) disclaimer of opinion B) unqualified opinion with explanatory paragraph C) adverse opinion D) qualified opinion Answer: B Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) The most common auditor's opinion issued on financial statements is a(n) ________. A) unqualified opinion B) qualified opinion C) adverse opinion D) disclaimer of opinion Answer: A Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) If an auditor is not able to gather enough evidence to form an opinion on financial statements, the auditor issues a(n) ________. A) unqualified opinion B) adverse opinion C) qualified opinion D) disclaimer of opinion Answer: D Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) If a company's financial statements are not fairly presented, which type of opinion will the auditor issue? A) qualified B) unqualified C) adverse D) disclaimer Answer: C Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Which of the following items is not required to be presented in management's report on internal control? A) an assertion of management's responsibility for establishing and maintaining internal control B) management's assertion of the effectiveness of internal control C) the extent to which internal auditors assisted management D) identification of the framework used to assess the effectiveness of internal control Answer: C Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) A body that oversees the activities of the company is known as ________. A) auditors B) the audit committee C) the board of directors D) management Answer: C Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) All of the following are required disclosures of the board members except ________. A) name of each board member B) home address of each board member C) principal occupations of each board member D) principal business activities of entities employing board members Answer: B Diff: 1 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) List the types of opinions that may be issued by an auditor on a company's financial statements and explain the circumstances under which it is issued. Answer: There are five types of opinions that may be issued on a company's financial statements: 1. Unqualified—This is also known as a "clean" opinion. This opinion asserts that the financial statements have been fairly presented in accordance with generally accepted accounting principles. 2. Unqualified Opinion with Explanatory Paragraph—This type opinion is issued with there is a lack of consistency, a going concern issue, or a particular matter that should be emphasized. The statements are fairly presented but an explanatory paragraph is needed to clarify a point. 3. Qualified—The auditor concludes that: (1) the financial statements are fairly presented, but the scope of the audit was subject to significant limitations or (2) the financial statements are not in compliance with GAAP. 4. Adverse—There is a major departure from GAAP, such as expensing all capital expenditures, that causes the financial statements to not be fairly presented in accordance with generally accepted accounting principles. 5. Disclaimer of Opinion—Because the auditor is unable to form an opinion or a lack of independence on the part of the auditor, it is not possible to issue an opinion on the fair presentation of the financial statements. This is not the same thing as withdrawing from the engagement. Diff: 2 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) List and discuss the four financial notes covered in this chapter. Answer: Four financial notes include: 1. Management's discussion and analysis of the financial condition and results of operations (typically referred to as the MD&A) is a required part of the annual report. The MD&A section provides the information necessary to understand the entity's financial condition, changes in financial condition, and results of operations 2. An audit is an examination of the financial statements (including the note disclosures) and the internal controls over the systems that generate the financial statements and notes. Auditors then attest to the fairness of the financial statements. For public companies, the auditors must also test the internal controls and attest to their effectiveness. The SEC requires all public companies to conduct an annual audit of their financial statements and note disclosures. Many private companies also choose to have an annual audit. 3. The management report of a publicly traded entity is required to provide two letters in the annual report: a letter stating its responsibility for the financial statements and a letter providing an assessment of the effectiveness of the internal controls over the financial reporting process. 4. Board of directors list, the body that oversees the activities of the company. Companies are also required to provide the principal occupations of their board members. This disclosure includes the names and the principal business activities of the entities employing the members of the board. Diff: 2 Objective: 6.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

6.9

Appendix A: Overview of the Preparation of the Statement of Cash Flows

1) The indirect method of reporting cash flows from operating activities begins with net income from the income statement. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The direct method of reporting cash flows from operating activities begins with net income from the income statement. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When using the indirect method to report cash flows from operating activities, depreciation expense is subtracted from net income to arrive at net cash provided by operating activities. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When using the direct method, losses on the sale of long-term assets are added to net income in the operating activities section. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

5) When using the direct method of reporting cash flows from operating activities, increases in accounts receivable are subtracted from revenues to arrive at cash receipts from customers. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following adjustments to net income is correct when using the indirect method for computing cash flows from operating activities? A) Subtract losses from sales of securities. B) Add an increase in accounts receivable. C) Subtract gains from sales of equipment. D) Deduct an increase in accounts payable. Answer: C Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following adjustments to net income is incorrect when using the indirect method for computing cash flows from operating activities? A) Deduct depreciation expense from net income. B) Add a decrease in inventory to net income. C) Deduct an increase in prepaid expenses from net income. D) Add an increase in accounts payable to net income. Answer: A Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

8) When using the indirect method of preparing the statement of cash flows, an increase in accounts payable should be treated as ________. A) a cash outflow B) inflow and outflow of cash C) an addition to net income D) a deduction from net income Answer: C Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Hackett, Inc. had property tax payable of $920,000 and $100,000 at the end of 2022 and 2023 respectively. During 2023, Hackett recorded $740,000 in property tax expense on its income statement. Cash outflows for property tax during 2023 were ________. A) $1,560,000 B) $740,000 C) $80,000 D) $640,000 Answer: A Explanation: Property tax expense $740,000 + Beginning property tax payable $920,000 – Ending property tax payable $100,000 = $1,560,000 Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Deluxe Hotels reported revenues of $600,000 for the year ended December 31, 2023. Accounts receivable at December 31, 2022 and 2023 were $65,000 and $49,000. If Deluxe uses the direct method of reporting operating cash flows, the company would report cash collected from customers of ________. A) $600,000 B) $616,000 C) $535,000 D) $584,000 Answer: B Explanation: Revenues $600,000 + Decrease Accounts Receivable $16,000 = $616,000 Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Williams Corporation reported Cost of Goods Sold of $960,000 for December 31, 2023. Accounts payable on the balance sheet were $61,000 for December 31, 2022 and $55,000 for December 31, 2023. Merchandise Inventory was $89,000 for December 31, 2022 and $90,000 for December 31, 2023. Cash paid for merchandise during 2023 was ________. A) $966,000 B) $967,000 C) $953,000 D) $954,000 Answer: B Explanation: Cost of Goods Sold $960,000 + Decrease Accounts Payable $6,000 + Increase Inventory $1,000 = $967,000 Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Hackett Company's prepaid rent was $12,000 at December 31 Year 1 and $15,000 at December 31, Year 2. Hackett reported rent expense of $43,000 on its Year 2 income statement. What would be reported as cash paid for rent on the statement of cash flows? A) $40,000 B) $43,000 C) $46,000 D) $58,000 Answer: C Explanation: Rent expense $43,000 + Increase Prepaid Rent $3,000 = $46,000 Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Under the direct method, calculating cash paid for merchandise includes ________. A) adding an increase in Accounts Payable B) subtracting an increase in Accounts Payable C) adding a decrease in Inventory D) subtracting an increase in Inventory Answer: B Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Presented below are the comparative balance sheets and income statement for Pierce Manufacturing Corporation (in $ millions) for the year ended December 31, Year 2: Pierce Manufacturing Corporation Balance Sheet At December 31, Year 2 Year 2

Year 1

Assets Cash Accounts Receivable Inventory Prepaid Insurance Property Plant and Equipment Less: Accumulated Depreciation Totals

$330 825 704 55 2,310 (924) $3,300

$220 913 660 22 1,980 (660) $3,135

Liabilities and Shareholders' Equity Accounts Payable Other Current Liabilities Income Taxes Payable Notes Payable—long term Common Stock Retained earnings Totals

$330 330 220 880 990 550 $3,300

$396 440 165 660 880 594 $3,135

Pierce Manufacturing Corporation Income Statement For Year Ending December 31, Year 2 Sales Cost of Goods Sold Gross Profit Expenses Administrative Expenses Insurance Expense Depreciation Income before income taxes Income tax expense Net income

$7,700 3,696 $4,004 $1,980 110 264

2,354 $1,650 660 $990

Prepare the operating section of the statement of cash flows using the direct method and a reconciliation using the indirect method.

Answer: Direct Method: Operating Activities Cash collected from customers Cash paid for merchandise Cash paid to other suppliers

$3,806 233

Cash paid for taxes Net cash provided by operating activities

605

Indirect Method: Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities Depreciation Expense Changes in operating working capital accounts Decrease in accounts receivable Increase in inventory Increase in prepaid insurance Decrease in accounts payable Decrease in other current liabilities Increase in income taxes payable Net cash provided by operating activities

6,644 $1,144

$990

$264 88 (44) (33) (66) (110) 55

Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

6.10

$7,788

154 $1,144

Appendix B: Liquidity and Solvency Analysis

1) Solvency measures a company's ability to meet its long-term obligations as they become due. Answer: TRUE Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Liquidity measures a company's ability to meet its long-term obligations as they become due. Answer: FALSE Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) There is an inverse relationship between a company's solvency level and risk of default. Answer: TRUE Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) There is a direct relationship between a company's interest coverage ratio and degree of solvency. Answer: TRUE Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The two components of return on equity are return on assets and financial leverage. Answer: TRUE Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Two components of return on equity are liquidity and solvency. Answer: FALSE Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The formula for the current ratio is ________. A) current assets divided by noncurrent assets B) current assets divided by total assets C) current assets divided by current liabilities D) current assets divided by total liabilities Answer: C Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) The formula for working capital is ________. A) total assets - current liabilities B) current assets - current liabilities C) total assets - total liabilities D) current assets - total liabilities Answer: B Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) The formula for interest coverage ratio includes all of the following except ________. A) interest expense B) income tax expense C) net income D) long-term liabilities Answer: D Diff: 1 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Degree of solvency refers to ________. A) a company's ability to meet long-term obligations as they become due B) a company's ability to refinance long-term debt as it becomes due C) a company's ability to quickly convert current assets into cash D) a company's ability to quickly convert long-term assets into current assets Answer: A Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Presented below is selected financial information for Matthews Corporation for the most recent fiscal year ended December 31 ($ millions) Current assets: Cash and cash equivalents Short-term investment Receivables, net Merchandise inventories Other current assets Total current assets Noncurrent assets Total assets

$2,442 1,436 1,270 5,174 1,357 11,679 3,517 $15,196

Current liabilities: Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $90) Income before income tax Income tax expense Net income

Previous Year's Financial Data Total Assets Shareholders' Equity

$5,050 2,717 7,767 2,459 4,970 $15,196

$40,339 38,889 1,450 (63) 1,387 (141) $1,246

$14,013 $3,989

The current ratio for Matthews Corporation is ________. (Round your answer to two decimal places, X.XX.) A) 0.67 B) 1.50 C) 1.43 D) 4.75 Answer: B Explanation: Current assets $11,679 divided by current liabilities $7,767 = 1.50 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Presented below is selected financial information for Matthews Corporation for the most recent fiscal year ended December 31 ($ millions) Current assets: Cash and cash equivalents Short-term investment Receivables, net Merchandise inventories Other current assets Total current assets Noncurrent assets Total assets

$2,432 1,436 1,310 5,164 1,357 11,699 3,567 $15,266

Current liabilities: Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $90) Income before income tax Income tax expense Net income

Previous Year's Financial Data Total Assets Shareholders' Equity

$40,339 38,889 1,450 (63) 1,387 (141) $1,246

$14,013 3,989

Working capital for Matthews Corporation is ________. A) $2,608 B) $4,980 C) $3,912 D) $7,479 Answer: C Explanation: Total current assets $11,699 – total current liabilities $7,787 = $3,912 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

$5,040 2,747 7,787 2,499 4,980 $15,266

13) Presented below is selected financial information for Matthews Corporation for the most recent fiscal year ended December 31 ($ millions) Current assets: Cash and cash equivalents Short-term investment Receivables, net Merchandise inventories Other current assets Total current assets Noncurrent assets Total assets

Current liabilities: $2,412 Accounts payable 1,426 Other current liabilities 1,250 Total current liabilities 5,204 Noncurrent liabilities 1,367 Shareholders' Equity 11,659 Total liabilities and shareholders' equity 3,567 $15,226

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $90) Income before income tax Income tax expense Net income

Previous Year's Financial Data Total Assets Shareholders' Equity

$5,040 2,727 7,767 2,489 4,970 $15,226

$40,339 38,889 1,450 (63) 1,387 (141) $1,246

$14,013 3,989

The debt to equity ratio for Matthews Corporation is ________. (Round your answer to two decimal places, X.XX.) A) 0.50 B) 1.01 C) 1.56 D) 2.06 Answer: D Explanation: Total liabilities $10,256/$4,970 = 2.06 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Presented below is selected financial information for Matthews Corporation for the most recent fiscal year ended December 31 ($ millions) Current assets: Cash and cash equivalents Short-term investment Receivables, net Merchandise inventories Other current assets Total current assets Noncurrent assets Total assets

$2,452 1,416 1,310 5,194 1,387 11,759 3,547 $15,306

Current liabilities: Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $80) Income before income tax Income tax expense Net income

$40,339 38,889 1,450 (53) 1,397 (141) $1,256

Statement of Cash Flows (excerpt) For the most recent fiscal year ended December 31 Interest paid

Previous Year's Financial Data Total Assets Shareholders' Equity

$5,020 2,737 7,757 2,519 5,030 $15,306

$90

$14,013 3,989

The interest coverage ratio for Matthews Corporation is ________. (Round your answer to two decimal places, X.XX.) A) 10.48 B) 16.41 C) 15.70 D) 17.46 Answer: B Explanation: Operating income $1,450 + other income $27 = EBIT $1,477 divided by $90 of interest paid = 16.41 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Presented below is selected financial information for Matthews Corporation for the most recent fiscal year ended December 31 ($ millions) Current assets: Cash and cash equivalents Short-term investment Receivables, net Merchandise inventories Other current assets Total current assets Noncurrent assets Total assets

$2,442 1,466 1,270 5,154 1,357 11,689 3,557 $15,246

Current liabilities: Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $90) Income before income tax Income tax expense Net income

$5,020 2,737 7,757 2,469 5,020 $15,246

$40,339 38,889 $1,450 (53) $1,397 (161) $1,236

Previous Year's Financial Data Total Assets Shareholders' Equity

$14,013 3,709

The return on equity for Matthews Corporation is ________. (Round your answer to two decimal places, X.XX.) A) 28.32% B) 24.62% C) 37.67% D) 33.32% Answer: A Explanation: 28.32% = Net income of $1,236 divided by average equity of $4,364.50 ($5,020 + $3,709 )/2 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Presented below is selected financial information for Matthews Corporation for the most recent fiscal year ended December 31 ($ millions) Current assets: Cash and cash equivalents Short-term investment Receivables, net Merchandise inventories Other current assets Total current assets Noncurrent assets Total assets

$2,422 1,476 1,250 5,194 1,397 $11,739 3,527 $15,266

Current liabilities: Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $90) Income before income tax Income tax expense Net income

Previous Year's Financial Data Total Assets Shareholders' Equity

$5,020 2,717 7,737 2,509 5,020 $15,266

$40,339 38,889 $1,450 (43) 1,407 (161) $1,246

$14,013 $3,809

The return on assets for Matthews Corporation is ________. (Round your answer to two decimal places, X.XX.) A) 8.89% B) 8.16% C) 8.51% D) 10.61% Answer: C Explanation: 8.51% = Net income of $1,246 divided by average total assets of $14,639.50 ($15,266 + $14,013)/2 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Presented below is selected financial information for Matthews Corporation for the most recent fiscal year ended December 31 ($ millions) Current assets: Cash and cash equivalents Short-term investment Receivables, net Merchandise inventories Other current assets Total current assets Noncurrent assets Total assets

$2,452 1,456 1,280 5,194 1,367 11,749 3,567 $15,316

Current liabilities: Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $90) Income before income tax Income tax expense Net income

$5,010 2,777 7,787 2,519 5,010 $15,316

$40,339 38,889 $1,450 (73) 1,377 (161) $1,216

Previous Year's Financial Data Total Assets Shareholders' Equity

$14,013 $4,009

The financial leverage for Matthews Corporation is ________. (Round your answer to two decimal places, X.XX.) A) 2.93 B) 3.06 C) 3.25 D) 3.50 Answer: C Explanation: Financial leverage is measured using this formula: Average total assets/average stockholders' equity = 3.25 = ($14,013 + $15,316 )/2 divided by ($4,009 + $5,010)/2 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Presented below is selected financial data for Teague Industries for the current year: Current assets: Cash and cash equivalents Short-term investments Receivables, net Merchandise inventories Other current assets Total current assets

$3,573 1,605 1,811 6,265 1,995 15,249

Noncurrent assets Total assets

4,474 $19,723

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $80) Income before income tax Income tax expense Net income

$50,826 45,963 4,863

Current liabilities Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

$5,305 2,942 8,247 5,186 6,290 $19,723

(56) 4,807 (1,439) $3,368

Previous Years' Financial Data Total Assets $17,320 Shareholders' Equity 3,970 The current ratio for Teague Industries is ________. (Round your answer to two decimal places, X.XX.) A) 0.77 B) 1.47 C) 1.85 D) 2.94 Answer: C Explanation: 1.85 = current assets divided by current liabilities = $15,249 /$8,247 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Presented below is selected financial data for Teague Industries for the current year: Current assets: Cash and cash equivalents Short-term investments Receivables, net Merchandise inventories Other current assets Total current assets

$3,553 1,565 1,831 6,185 1,995 15,129

Noncurrent assets Total assets

4,564 $19,693

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $90) Income before income tax Income tax expense Net income

$50,826 45,963 4,863

Current liabilities Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

(66) 4,797 (1,429) $3,368

Previous Years' Financial Data Total Assets $17,020 Shareholders' Equity 3,970 Working capital for Teague Industries is ________. A) $6,220 B) $6,882 C) $1,792 D) $11,446 Answer: B Explanation: Current assets less current liabilities = $15,129 - $8,247 = $6,882 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

$5,345 2,902 8,247 5,226 6,220 $19,693

20) Presented below is selected financial data for Teague Industries for the current year: Current assets: Cash and cash equivalents Short-term investments Receivables, net Merchandise inventories Other current assets Total current assets

$3,553 1,605 1,841 6,225 1,965 15,189

Noncurrent assets Total assets

4,514 $19,703

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $80) Income before income tax Income tax expense Net income

$50,826 45,963 4,863

Current liabilities Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

$5,365 2,892 8,257 5,196 6,250 $19,703

(56) 4,807 (1,449) $3,358

Previous Years' Financial Data Total Assets $17,220 Shareholders' Equity 4,030 The debt to equity ratio for Teague Industries is ________. (Round your answer to two decimal places, X.XX.) A) 1.13 B) 0.83 C) 1.32 D) 2.15 Answer: D Explanation: Total liabilities divided by Shareholders' equity = 2.15 = ($8,257 + $5,196)/$6,250 = 2.15 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Presented below is selected financial data for Teague Industries for the current year: Current assets: Cash and cash equivalents Short-term investments Receivables, net Merchandise inventories Other current assets Total current assets

$3,563 1,575 1,891 6,255 1,995 15,279

Noncurrent assets Total assets

4,364 $19,643

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $60) Income before income tax Income tax expense Net income

$50,826 45,963 4,863

Current liabilities Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

$5,345 2,882 8,227 5,176 6,240 $19,643

(36) 4,827 (1,449) $3,378

Previous Years' Financial Data Total Assets $17,220 Shareholders' Equity 4,030

Statement of Cash Flows (excerpt) For the most recent fiscal year ended December 31 Interest paid

$80

The interest coverage ratio for Teague Industries is ________. (Round your answer to two decimal places, X.XX.) A) 61.09 B) 80.45 C) 56.30 D) 104.60 Answer: A Explanation: (Net income + interest expense + income tax expense)/interest payments = 61.09 = ($3,378 + $60 + $1,449)/$80 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Presented below is selected financial data for Teague Industries for the current year: Current assets: Cash and cash equivalents Short-term investments Receivables, net Merchandise inventories Other current assets Total current assets

$3,523 1,585 1,881 6,245 1,935 15,169

Noncurrent assets Total assets

4,644 $19,813

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $90) Income before income tax Income tax expense Net income

$50,826 45,963 4,863

Current liabilities Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

$5,375 2,952 8,327 5,196 6,290 $19,813

(66) 4,797 (1,439) $3,358

Previous Years' Financial Data Total Assets $17,220 Shareholders' Equity 4,000 The return on equity for Teague Industries is ________. (Round your answer to two decimal places, X.XX.) A) 83.95% B) 53.39% C) 93.24% D) 65.27% Answer: D Explanation: Net income divided by average shareholders' equity = 65.27% = $3,358/($4,000 + $6,290)/2 Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) Presented below is selected financial data for Teague Industries for the current year: Current assets: Cash and cash equivalents Short-term investments Receivables, net Merchandise inventories Other current assets Total current assets

$3,533 1,575 1,891 6,225 1,975 15,199

Noncurrent assets Total assets

4,564 $19,763

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $70) Income before income tax Income tax expense Net income

$50,826 45,963 4,863

Current liabilities Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

$5,365 2,922 8,287 5,216 6,260 $19,763

(46) 4,817 (1,429) $3,388

Previous Years' Financial Data Total Assets $17,320 Shareholders' Equity 4,030 The return on assets for Teague Industries is ________. (Round your answer to two decimal places, X.XX.) A) 17.14% B) 18.27% C) 27.81% D) 19.56% Answer: B Explanation: Net income divided by average total assets = 18.27% = $3,388/($17,320 + $19,763)/2 = 18.27% Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) Presented below is selected financial data for Teague Industries for the current year: Current assets: Cash and cash equivalents Short-term investments Receivables, net Merchandise inventories Other current assets Total current assets

$3,503 1,555 1,811 6,205 1,975 15,049

Noncurrent assets Total assets

4,674 $19,723

Revenues Costs and Expenses Operating Income Other income/expense (including interest expense of $60) Income before income tax Income tax expense Net income

$50,826 45,963 4,863

Current liabilities Accounts payable Other current liabilities Total current liabilities Noncurrent liabilities Shareholders' Equity Total liabilities and shareholders' equity

$5,385 2,892 8,277 5,196 6,250 $19,723

(36) 4,827 (1,449) $3,378

Previous Years' Financial Data Total Assets $17,020 Shareholders' Equity 4,000 The financial leverage for Teague Industries is ________. (Round your answer to two decimal places, X.XX.) A) 2.94 B) 3.16 C) 3.58 D) 3.76 Answer: C Explanation: Average total assets divided by average total stockholders' equity = 3.58 = ( $17,020 + $19,723)/2 divided by ($4,000 + $6,250)/2 Diff: 3 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) Define the Dupont Analysis model and explain the relationship between its components. Answer: Dupont Analysis separates return on equity (ROE) into two components to analyze a company's sources of profitability. Return on equity is defined as (Net Income / Average Stockholders' Equity). ROE can be expanded into two components: Return on Assets (ROA) and Financial Leverage. ROA is defined as (Net Income / Average Total Assets) while financial leverage is defined as (Average Total Assets / Average Stockholders' Equity). The lower the financial leverage ratio, the lower the amount of debt financing that is being used. When ROA is constant, a company can increase its ROE by increasing financial leverage. However, it must balance this with the risk of insolvency from too much debt. Diff: 2 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

26) Presented below are financial statements for Brownsville Industries: Brownsville Industries Balance Sheet At June 30 Cash Short-Term Investments Accounts Receivable (net) Merchandise Inventory Property, Plant, and Equipment, net Intangible Assets Total Assets

$26,000 51,000 125,000 82,400 325,000 19,500 $628,900

Current Liabilities 11% Bonds payable, long-term Common Stock Paid in Capital in excess of par Retained Earnings Total Liabilities and Equity

$97,500 200,000 10,000 40,000 281,400 $628,900

Brownsville Industries Income Statement For the Year Ended June 30 Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Income Interest Expense Income before Income Taxes Income Taxes Net Income Prior year data Total Assets Shareholders' Equity

$750,000 395,000 $355,000 155,400 $199,600 22,000 $177,600 53,280 $124,320

$525,000 220,000

Compute the following ratios a. Current ratio b. Debt to Equity Ratio c. Interest Coverage Ratio (Assume interest expense equals interest paid.) d. Return on Assets e. Financial Leverage f. Return on Equity What do these ratios reveal about the financial condition of Brownsville Industries?

Answer: Ratio Current Debt/Equity Interest Coverage Return on Assets Financial Leverage Return on Equity

Computation $(284,400 / $97,500) ($297,500 / $331,400) ($124,320 + $53,280 + $22,000) / $22,000 $124,320 / (($628,900 + $525,000) / 2) (($628,900 + $525,000)/2)/(($331,400 + $220,000)/ 2) ($124,320 / ($331,400 + $220,000) / 2))

Answer 2.92 0.898 9.07 21.6% 2.09 45.1%

Without prior year comparisons, it is difficult to make any definite assessment of this company's financial condition. However, based on this data, the company has sufficient current assets to cover its current liabilities. It is heavily reliant on debt financing, but has enough income to service its debt. Its ROA and financial leverage result in an outstanding return on equity of 45.1%. Both return on assets and return on equity are outstanding. Diff: 3 Objective: App B IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 7 Accounting and the Time Value of Money 7.1

Time Value of Money Basic Concepts

1) Simple interest is computed on just the accumulated interest left on deposit. Answer: FALSE Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Compound interest is computed on both the principal and on the accumulated interest. Answer: TRUE Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Compound interest includes interest earned on interest. Answer: TRUE Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The effective interest rate is the same as the stated interest rate. Answer: FALSE Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The effective interest rate is calculated as the total interest earned during the year divided by the beginning balance of the investment as the first of the year. Answer: TRUE Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The value of a dollar today is greater than the value of a dollar in the future because a dollar today can be invested to earn interest. Answer: TRUE Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The length of a compounding period is determined by the frequency of interest compounding. Answer: TRUE Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Which of the following items does not use an accounting measure based on present value? A) patents B) leases C) pensions D) bonds Answer: A Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Determining the future value of one or more present day cash flows is known as ________. A) disinvesting B) compounding C) discounting D) annuitizing Answer: B Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Determining the present value of one or more future amounts is known as ________. A) inverting B) compounding C) discounting D) annuitizing Answer: C Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) The method of converting a future dollar amount into its present dollar value by removing the time value of money is called ________. A) devaluing B) amortizing C) compounding D) discounting Answer: D Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Interest calculated on the original principal regardless of the amount of interest that has been paid or accrued in the past is ________. A) principal interest B) original interest C) simple interest D) compound interest Answer: C Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) What is the term that describes the value today of a cash flow or series of cash flows to be received or paid in the future? A) present value B) compound value C) discount value D) temporal value Answer: A Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) When payments take place at the beginning of each period, the series of cash flows is called a(n) ________. A) ordinary annuity B) annuity due C) posterior annuity D) anterior annuity Answer: B Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Simple interest on a $220,000, 8%, 18-month note is ________. A) $35,200 B) $17,600 C) $13,200 D) $26,400 Answer: D Explanation: $26,400 = $220,000 × 8% × 18/12 Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Bob Marby purchased a TV from Tryton Sales and signed a 2-year, 8% promissory note for $1,400. What is the amount required to pay off the note if it accrues simple interest over the term of the loan? A) $1,176 B) $1,512 C) $1,624 D) $1,288 Answer: C Explanation: $1,624 = $1,400 + ($1,400 × 8% × 2) Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) What is the effective interest rate for an investment fund that pays 11% interest compounded monthly? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer two decimal places, X.XX%.) A) 11.92% B) 11.00% C) 11.57% D) 11.30% Answer: C Explanation: If you use the EFFECT function in Excel, the answer is 11.57% which is found using this syntax: EFFECT(0.11, 12) where 0.11 is the rate of 11% and 12 is the number of compounding periods in a year. Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) What is the effective interest rate for an investment fund that pays 6% interest compounded semiannually? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer two decimal places, X.XX%.) A) 6.50% B) 6.09% C) 6.00% D) 6.17% Answer: B Explanation: If you use the EFFECT function in Excel, the answer is 6.09% which is found using the following syntax: EFFECT(0.06, 2) where 0.06 is the rate of 6% and 2 is the number of compounding periods in a year (semi-annual.) Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) What is the time value of money? Answer: The time value of money concept means that a dollar received today is worth more than a dollar received at some time in the future. This statement is true because a dollar received today can be invested to provide a return. Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Why do accountants need to be familiar with present value concepts? Answer: The time value of money concept is critical in several areas of accounting, particularly when valuing many of the assets and liabilities reported in the financial statements. For example, measuring assets and liabilities at fair value may require time value of money computations. Time value of money concepts determine the asset's value today based on the future cash flows it will generate. The same approach applies to determining the fair value of a liability. For example, a pension liability today can be measured using time value of money concepts and the future cash outflows a company promises to make to its employees when they retire. Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) How is the effective interest rate determined? Answer: The effective interest rate is different from the stated interest rate when interest is compounded more frequently than yearly. First, compare the account balance (interest plus investment) at the end of the year with the beginning balance (interest plus investment) to determine the total amount of interest for the year. Then, divide that total amount of interest for the year by the beginning balance of the investment to determine the effective interest rate. Diff: 1 Objective: 7.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7.2

Single-Sum Problems

1) A present value is always less than the corresponding future value. Answer: TRUE Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) A future value is always less than the corresponding present value. Answer: FALSE Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Future value factors are determined by two characteristics: the interest rate per compounding period and the number of compounding periods. Answer: TRUE Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Present value factors are determined by two characteristics: the interest rate and the length of the compounding periods. Answer: FALSE Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) For any specific number of periods, the present value factor for a single sum decreases as the discount rate increases. Answer: TRUE Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The relationship between the future value of a single sum and the corresponding present value of a single sum is determined by two variables. What are those two variables? A) interest rate; length of compounding periods B) interest rate per compounding period; number of compounding periods C) conversion rate; length of compounding periods D) conversion rate; number of compounding periods Answer: B Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The relationship between the future value of a single sum and the corresponding present value of a single sum is determined by the interest rate per compounding period and ________. A) number of compounding periods B) length of compounding periods C) principal balance D) time of year Answer: A Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Which of the following statements is true? A) The process of accumulating interest on interest is referred to as discounting. B) The higher the discount rate, the higher the present value. C) If interest is 13% compounded annually, $1,300 due one year from today is equivalent to $1,000 today. D) If interest is 4% compounded annually, $1,040 due one year from today is equivalent to $1,000 today. Answer: D Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) The PV (present value) function for a single sum in a Microsoft Excel spreadsheet requires inputting all of the following variables except ________. A) length of compounding period B) number of compounding periods C) interest rate per compounding period D) future value of single sum Answer: A Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) You decide to deposit $5,000 at a local bank for two years at a 4% rate of interest compounded annually. What is the future value of your investment? (Do not round any intermediary calculations, and round your final answer to the nearest dollar.) Use the formula approach. A) $5,000 B) $5,200 C) $5,414 D) $5,408 Answer: D Explanation: The future value of the deposit is $5,408 = $5,000 × = $5,000 × (1 + 4%) × (1.04) Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) You decide to deposit $5,000.00 at a local bank for two years at a 7% rate of interest compounded annually. What is the future value of your investment? (Use the future value of $1 factor table provided). Excerpt of Future Value of $1 Table Periods 7% 1 1.0700 2 1.1449 3 1.2250 4 1.3108 5 1.4026 6 1.5007 7 1.6058 8 1.7182 9 1.8385 10 1.9672 11 2.1049 12 2.2522 A) $5,000.00 B) $5,350.00 C) $6,125.00 D) $5,724.50 Answer: D Explanation: The future value of the deposit is $5,724.50 = $5,000.00 × 1.1449 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) You decide to deposit $7,000 at a local bank for three years at a 8% rate of interest compounded semiannually. The future value of your investment is approximately equal to ________. (Use the formula approach and round your final answer to the nearest dollar.) A) $8,818 B) $8,878 C) $8,857 D) $8,680 Answer: C Explanation: The semi-annual rate is equal to 4% (8%/2). The future value of the deposit is $8,857 = $7,000 × (1 + 0.04)6. One plus the interest rate per compounding period (1.04) is raised to the 6th power because there are 6 periods (3 years × 2). Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) You decide to deposit $2,000 at a local bank for three years at a 4% rate of interest compounded quarterly. The future value of your investment is approximately equal to ________. (Use the formula method and round to the nearest dollar.) A) $2,240 B) $2,254 C) $2,252 D) $2,255 Answer: B Explanation: $2,254 = $2,000 × (1 + 0.04/4)12 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Dover Company deposits $70,000 with Second National Bank in an account earning interest at 5% per annum, compounded semi-annually. How much will Dover have in the account after five years if interest is reinvested? Use the formula method.(Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $87,500 B) $78,750 C) $89,743 D) $89,606 Answer: D Explanation: $89,606 = $70,000 × (1 + 5%/2)10 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) $90,000 is put in an investment account today. The investment account compounds interest at a rate of 3% per month. What amount will be available five years from today? Use the formula method. (Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $162,550 B) $252,000 C) $120,952 D) $530,244 Answer: D Explanation: $530,244 = $90,000 × (1 + 3%)60 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) You have discovered an investment opportunity that earns a 6% rate of interest compounded annually. What amount should you deposit today to have $9,000 in two years? Use the formula method. (Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $7,996 B) $8,010 C) $8,036 D) $8,460 Answer: B Explanation: Present value = Future Value/(1 + rate)number of periods = $8,010 = $9,000/(1 + 6%)2= $9,000/1.12360 = $8,010

Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) You have discovered an investment opportunity that earns a 3% rate of interest compounded semiannually. What amount should you deposit today to have $7,000 in three years? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $6,406 B) $6,400 C) $6,402 D) $6,370 Answer: C Explanation: Using Excel, =PV(0.03/2,6,0,7,000) = $6,402 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) You have discovered an investment opportunity that earns a(n) 7% rate of interest compounded quarterly. Which of the following amounts is approximately equal to the amount you should deposit today to have $2,000 in five years? Use the formula method. (Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $1,300 B) $1,426 C) $1,418 D) $1,414 Answer: D Explanation: $1,414 = $2,000/(1 + 0.07/4)20 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) A zero-interest bond pays $900,000 in seven years. What amount would you be willing to pay to acquire the bond today if you want to earn a return of approximately 6%? Use the present value of $1 table shown below. (Do not round any intermediary calculations, and round your final answer to the nearest dollar.) Excerpt of Present Value of $1 Table Periods 6% 1 0.94340 2 0.89000 3 0.83962 4 0.79209 5 0.74726 6 0.70496 7 0.66506 A) $849,060 B) $712,881 C) $598,554 D) $522,000 Answer: C Explanation: $598,554 = $900,000 × 0.66506 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) A zero-interest bond pays $500,000 in 10 years. What amount would you be willing to pay to acquire the bond today if you want to earn a return of approximately 8%? Use the present value table of $1 provided. (Do not round any intermediary calculations, and round your final answer to the nearest dollar.) Excerpt of Present Value of $1 Table Periods 8% 1 0.92593 2 0.85734 3 0.79383 4 0.73503 5 0.68058 6 0.63017 7 0.58349 8 0.54027 9 0.50025 10 0.46319 A) $100,000 B) $340,290 C) $228,193 D) $231,595 Answer: D Explanation: $231,595 = $500,000 × 0.46319 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Como Company borrowed $5,300 from its bank. Como will repay $7,800 in five years. What is the approximate interest rate that Como will incur on this loan, assuming annual compounding? Use the future value of $1 table. Excerpt of Future Value of $1 Table Periods 7% 8% 1 1.07000 1.08000 2 1.14490 1.16640 3 1.22504 1.25971 4 1.31080 1.36049 5 1.40255 1.46933 6 1.50073 1.58687

9% 1.09000 1.18810 1.29503 1.41158 1.53862 1.67710

A) 8% B) 7% C) 9% D) 32% Answer: A Explanation: Future value $7,800 divided by Present value $5,300 = 1.47169811 which is approximately found at the intersection of 8% and 5 periods. Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Punjab Company borrowed $118,000 from its bank. Punjab will repay $140,000 in 7 years. What is the approximate interest rate that Punjab will incur on this loan, assuming annual compounding? Use a financial calculator or a spreadsheet to derive your answer. (Do not round any intermediary calculations, and round your final answer two decimal places, X.XX%.) A) 1.63% B) 2.47% C) 15.71% D) 3.32% Answer: B Explanation: Using the Excel RATE function with the following syntax: ==RATE(7,0,-$118,000,$140,000) the rate is 2.47% Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) Fanagi Corp. borrowed $51,000 from its bank at a 6% annual interest rate and will repay $292,918. Assume annual compounding. In approximately how many years will Fanagi repay the loan? Use the future value of $1 factor table shown below. Excerpt of Future Value of $1 Table Periods 1% 2% 1 1.01000 1.02000 2 1.02010 1.04040 3 1.03030 1.06121 4 1.04060 1.08243 5 1.05101 1.10408 10 1.10462 1.21899 20 1.22019 1.48595 25 1.28243 1.64061 30 1.34785 1.81136 35 1.41660 1.99989 40 1.48886 2.20804

3% 1.03000 1.06090 1.09273 1.12551 1.15927 1.34392 1.80611 2.09378 2.42726 2.81386 3.26204

4% 1.04000 1.08160 1.12486 1.16986 1.21665 1.48024 2.19112 2.66584 3.24340 3.94609 4.80102

5% 1.05000 1.10250 1.15763 1.21551 1.27628 1.62889 2.65330 3.38635 4.32194 5.51602 7.03999

6% 1.06000 1.12360 1.19102 1.26248 1.33823 1.79085 3.20714 4.29187 5.74349 7.68609 10.28572

A) 35 years B) 20 years C) 25 years D) 30 years Answer: D Explanation: $292,918/$51,000 = 5.74349. Using the future value of $1 factor table, search for 5.74349 in the 6% column. You will find the approximate factor on the 30 period (years) line. Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) Wasup Corp. is thinking of borrowing $190,000 from its bank at 8% annual interest rate. The amount that will be repaid is $325,626. Assume annual compounding. In approximately how many years will Wasup Corp. need to repay the loan? Use the future value of $1 factor table shown below. Excerpt of Future Value of $1 Table Periods 7% 8% 1 1.07000 1.08000 2 1.14490 1.16640 3 1.22504 1.25971 4 1.31080 1.36049 5 1.40255 1.46933 6 1.50073 1.58687 7 1.60578 1.71382

9% 1.09000 1.18810 1.29503 1.41158 1.53862 1.67710 1.82804

A) 7 years B) 6 years C) 5 years D) 4 years Answer: A Explanation: $325,626/$190,000 = 1.71382. In searching down the 8% column of the future value of $1 factor table, the factor is found on the 7 periods line (7 years). Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) The parents of a recent high school graduate decide to invest the $16,000 she received for her high school graduation in a fund earning 11% annual interest. At the end of the four-year period, she expects to withdraw the money to pay for accumulated college tuition loans. What is the approximate amount that would be available for withdrawal after four years if interest is compounded monthly? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations and round your final answer to the nearest dollar.) A) $26,961 B) $24,289 C) $7,040 D) $24,794 Answer: D Explanation: If you use Excel, you can utilize the FV function to solve this question. The syntax of the FV function would be as follows: =FV(0.11/12,48,0,16000)= 24,794. Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) A single amount is invested and increases over time as interest is compounded. If the number of periods is known, the interest rate can be approximately determined by ________. A) dividing the present value by the future value and looking for the quotient in the future value of $1 table B) multiplying the present value by the future value and looking for the product in the present value of $1 table C) dividing the future value by the present value and looking for the quotient in the future value of $1 table D) dividing the future value by the present value and looking for the quotient in the present value of $1 table Answer: C Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) List the variables in a single-sum problem. Answer: 1. Present value of single sum 2. Future value of single sum 3. Interest rate per compounding period 4. Time period or number of compounding periods Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

28) You are provided with two tables for the time value of money. One is a present value of $1 table and one is a future value of $1 table. How can you tell which table is which type? Answer: Because the future value of $1 is always greater than the present value of $1, the factors on the future value of $1 table are all greater than one such that the factor for one period is equal to one plus the interest rate and the factors for periods greater than one get progressively larger. Because the present value of $1 is always less than the future value of $1, the factors on the present value of $1 table are all less than one such that the factors for periods greater than one get progressively smaller. Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

29) Maria Gonzales is considering two investment options for a $2,500 gift she received for graduation. Both investments have the same annual interest rates but one offers quarterly compounding while the other compounds on a monthly basis. Which investment should she choose? Why? Answer: She should choose monthly compounding, because the balance in the account on which interest will be earned will be increased more frequently. Thus, more frequent compounding results in more interest earned on the investment. Diff: 1 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

30) Henry Rector deposited $5,000 in a certificate of deposit that provides interest of 10% compounded quarterly if the amount is maintained for 5 years. How much will Henry have at the end of 5 years? Use the formula approach. Answer: Because interest is compounded quarterly, the relevant interest rate is 2.5% and five years represents 20 quarters. Therefore, FV = $5,000 × (1 + .025)20 = $5,000 × 1.63862 = $8,193 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

31) Paula Poser will receive $80,000 on December 31, 2029, from a trust fund established by her mother. Assuming the appropriate interest rate for discounting is 12% (compounded semiannually), what is the present value of this amount as of January 1, 2025 (5 years earlier)? Use the formula approach. Answer: $80,000 × .55839 (present value of 1 at 6% for 10 periods) = $44,671 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

32) You decide to deposit $10,000 at a local bank for four years at a 5% rate of interest compounded annually. What is the future value of your investment? (Use the future value of $1 factor table provided). Excerpt of Future Value of $1 Table Periods 5% 1 1.0500 2 1.1025 3 1.1576 4 1.2155 5 1.2763 6 1.3401 7 1.4071 8 1.4775 9 1.5513 10 1.6289 11 1.7103 12 1.7959 Answer: $12,155 Explanation: The future value of the deposit is $12,155 = $10,000 × 1.2155 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

33) A zero-interest bond pays $100,000 in 6 years. What amount would you be willing to pay to acquire the bond today if you want to earn a return of approximately 4%? Use the present value table of $1 provided. Excerpt of Present Value of $1 Table Periods 4% 1 0.96154 2 0.92456 3 0.88900 4 0.85480 5 0.82193 6 0.79031 7 0.75992 8 0.73069 9 0.70259 10 0.67556 Answer: $79,031 Explanation: $79,031 = $100,000 × 0.79031 Diff: 2 Objective: 7.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7.3

Annuities

1) An ordinary annuity is a series of equal periodic payments made at the beginning of each period. Answer: FALSE Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) An annuity due is a series of equal periodic payments made at the beginning of each period. Answer: TRUE Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) An ordinary annuity is a series of equal periodic payments and an annuity due is a series of unequal periodic payments. Answer: FALSE Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) With an annuity due, a payment is made or received on the date the agreement begins. Answer: TRUE Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) A specific future value of an ordinary annuity factor for a given number of periods and a specific discount rate is equal to the cumulative sum of the future value of single sum factors over the given number of periods for that discount rate. Answer: FALSE Diff: 2 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The future value of an ordinary annuity for any given interest rate and number of periods is always less than the future value of an annuity due for the same interest rate and number of periods. Answer: TRUE Diff: 2 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The present value of an annuity due for any given interest rate and number of periods is always less than the future value of an annuity due for the same interest rate and number of periods. Answer: TRUE Diff: 2 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) A series of equal periodic payments in which the first payment is made one compounding period after the date of the contract is ________. A) an ordinary annuity B) an annuity due C) a deferred annuity D) a compound annuity Answer: A Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) What is the primary difference between an ordinary annuity and an annuity due? A) the interest rate B) annuity due only relates to future values C) ordinary annuity only relates to future values D) the timing of the periodic payment Answer: D Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) All of the following are conditions for an ordinary annuity except ________. A) the future value is equal to the present value B) the time periods between the cash flows are the same length C) periodic cash flows must be equal in amount D) interest is compounded at the end of each time period Answer: A Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) All of the following are conditions for an annuity due except ________. A) the interest rate is constant for each time period B) payments occur at the end of each time period C) the time periods between the cash flows are the same length D) periodic cash flows must be equal in amount Answer: B Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) The future amount of an annuity due is determined ________. A) one period after the last cash payment in the series B) one period before the last cash payment in the series C) at the same time as the first cash payment in the series D) at the same time as the last cash payment in the series Answer: A Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) On January 1, 2024, Denero Company issued 10-year bonds with a face value of $2,000,000 due on December 31, 2034. The company will accumulate a fund to retire these bonds at maturity. It will make ten annual deposits to the fund beginning on December 31, 2024. How much must Denero deposit each year to achieve this investment goal, assuming that it will earn 5% interest compounded annually? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $259,009 B) $151,437 C) $159,009 D) $200,000 Answer: C Explanation: Using the Excel FV function, you can solve for the annuity of $159,009 by dividing face value of $2,000,000 by 12.57789, which is the future value of an ordinary annuity of $1 factor for 10 periods at 5%, = FV(0.05,10,1). Alternatively, using Excel, you can solve for the payment using the payment function, =PMT(5%,10,0,2000000) = $159,009 Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Cline Corporation deposits $75,000 every quarter in a savings account (beginning at the end of the current quarter) for the next six years so that it can purchase a new piece of machinery at the end of six years. The interest rate is 4%. How much money will Cline Corporation have at the end of six years? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $2,931,195 B) $2,023,010 C) $2,043,240 D) $1,126,935 Answer: B Explanation: Using the Excel FV function the answer is $2,023,010 using the following syntax: =FV(0.04/4,6*4,-75000). Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Harlan Corporation deposits $175,000 every June 30th and December 31st in a savings account (beginning in the current year) for the next four years so that it can purchase a new piece of machinery at the end of four years. The interest rate is 4%. How much money will Harlan Corporation have at the end of four years? Use the future value of an ordinary annuity factor table shown below to derive your answer. Periods 1% 2% 3% 4% 1 1 1 1 1 2 2.01000 2.02000 2.03000 2.04000 3 3.03010 3.06040 3.09090 3.12160 4 4.06040 4.12161 4.18363 4.24646 5 5.10101 5.20404 5.30914 5.41632 6 6.15202 6.30812 6.46841 6.63298 7 7.21354 7.43428 7.66246 7.89829 8 8.28567 8.58297 8.89234 9.21423 9 9.36853 9.75463 10.15911 10.58280 10 10.46221 10.94972 11.46388 12.00611 A) $1,502,020 B) $721,282 C) $1,612,490 D) $743,131 Answer: A Explanation: $175,000 × 8.58297 = $1,502,020 Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Leberland Corporation deposits $100,000 every year in a savings account (beginning at the end of the current year) for the next eight years so that it can purchase a new piece of machinery at the end of eight years. The interest rate is 5%. How much money will Leberland Corporation have at the end of eight years? Use the future value of an ordinary annuity factor table shown below to derive your answer. Excerpt from future value of an ordinary annuity factor table Periods 3% 4% 5% 1 1.00000 1.00000 1.00000 2 2.03000 2.04000 2.05000 3 3.09090 3.12160 3.15250 4 4.18363 4.24646 4.31013 5 5.30914 5.41632 5.52563 6 6.46841 6.63298 6.80191 7 7.66246 7.89829 8.14201 8 8.89234 9.21423 9.54911 9 10.15911 10.58280 11.02656 10 11.46338 12.00611 12.57789

6% 1.00000 2.06000 3.18360 4.37462 5.63709 6.97532 8.39384 9.89747 11.49132 13.18079

A) $954,911 B) $431,013 C) $477,456 D) $215,507 Answer: A Explanation: $100,000 × 9.54911 = $954,911 Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) BillyBob Corporation deposits $40,000 at the beginning of every quarter in a savings account for the next five years so that it can purchase a new piece of machinery at the end of five years. The interest rate is 8%. How much money will BillyBob Corporation have at the end of five years? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $971,895 B) $212,325 C) $253,437 D) $991,333 Answer: D Explanation: Solving using the FV function in Excel, $991,333 = FV(0.08/4,20,-40000,0,1) Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Maddie's Place Corporation deposits $100,000 at the beginning of every quarter in a savings account for the next five years so that it can purchase a new piece of machinery at the end of five years. The interest rate is 12%. How much money will Maddie's Place Corporation have at the end of five years? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $2,687,037 B) $2,767,649 C) $711,519 D) $546,841 Answer: B Explanation: Solving this in Excel using the FV function: $2,767,649 = FV(0.12/4,20,-100000,0,1)) Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Aucutt Incorporated deposits $100,000 every January 1st and July 1st in a savings account for the next six years so that it can purchase a new piece of machinery at the end of six years. The interest rate is 12%. How much money will Aucutt Incorporated have at the end of six years? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $1,788,214 B) $1,686,994 C) $908,901 D) $811,519 Answer: A Explanation: Using the Excel FV function: $1,788,214 = FV(0.12/2,6*2,-100000,0,1) Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Bobby's parents loaned him $110,000 to fund his college education. His parents are not charging interest. They desire to be paid one lump sum of $110,000 when Bobby can accumulate that amount. Bobby established a savings plan that earns 4% compounded annually. His new job promises to pay an annual holiday bonus that will enable him to make equal annual, year-end deposits of $6,500 starting next year. Approximately how many years will it take Bobby to accumulate the $110,000? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer two decimal places.) A) 16.92 years B) 15.71 years C) 13.18 years D) 14.72 years Answer: C Explanation: Using the Excel NPER function, 13.18 years = NPER(0.04,-6500,0,110000) Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Anne wants to accumulate $50,000 by December 31, 2023. To accumulate that sum, she will make twelve equal quarterly deposits of $3,942.44 at the end of March, June, September, and December for the next three years, beginning on March 31, 2020, into a fund that earns interest compounded quarterly. What annual rate of interest must the fund provide to yield the desired sum? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest year.) A) 1% B) 2% C) 4% D) 5% Answer: C Explanation: Quarterly rate using the Excel RATE function, 1% = RATE(12,-3942.44,0,50000) Quarterly rate of 1% × 4 periods = 4% Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) List the five primary variables of an annuity problem and explain the difference between an ordinary annuity and an annuity due. Answer: Annuity problems can have five variables: 1. Present value 2. Future value 3. Interest rate per compounding period 4. Number of compounding periods 5. Amount of payments An annuity is a series of equal payments. For an ordinary annuity, those payments occur at the end of each period; for an annuity due, those payments occur at the beginning of each period. Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) You are provided with two-time value of money tables. One table provides factors for the future value of an ordinary annuity and the other provides factors for the future value of an annuity due. How can you tell which table is which type? Answer: An ordinary annuity is an annuity where the cash flows occur at the end of the interest period and an annuity due is an annuity where the cash flows occur at the beginning of the interest period. Therefore, for any given number of periods, and a set interest rate, the future value factor for an ordinary annuity is always smaller than the corresponding factor for an annuity due. For the first period, the future value factor for an annuity due is always 1 plus the interest rate for any interest rate while the future value factor for an ordinary annuity is always 1.0. Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) Each year for the next 10 years, Carmen Lector will deposit $4,000 into an investment fund that pays 10% compounded annually. Use the formula approach . a. How much will Carmen have at the end of 10 years if the first of 10 deposits are made at the end of each year? b. How much will Carmen have at the end of 10 years if the first of 10 deposits are made at the beginning of each year? Answer: a. $4,000 × [(1.10)10 – 1]/0.10 = $4,000 × 15.93742460 (future value of an ordinary annuity at 10% for 10 periods) = $63,750 b. $4,000 × [((1.10)10 – 1)/0.10](1.1) = $4,000 × 17.53116706 (future value of an annuity due at 10% for 10 periods) = $70,125

Diff: 2 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) Each quarter for the next 10 years, Carmen Lector will deposit $1,000 into an investment fund that pays 8% compounded quarterly. Use the formula approach. a. How much will Carmen have at the end of 10 years if the first of 40 quarterly deposits are made at the end of each quarter? b. How much will Carmen have at the end of 10 years if the first of 40 quarterly deposits are made at the beginning of each quarter? Answer: a. $1,000 × [(1.02)40 – 1]/0.02 = $1,000 × 60.40198318 (future value of an ordinary annuity at 2% for 40 periods) = $60,402 b. $1,000 × [((1.02)40 - 1)/0.02](1.02) = $1,000 × 61.61002284 (future value of an annuity due at 2% for 40 periods) = $61,610

Diff: 2 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) Johnson Corporation deposits $100,000 every year in a savings account (beginning at the end of the current year) for the next ten years. The interest rate is 5%. How much money will Johnson Corporation have at the end of ten years? Use the future value of an ordinary annuity factor table shown below to derive your answer. Excerpt from future value of an ordinary annuity factor table Periods 3% 4% 5% 1 1.00000 1.00000 1.00000 2 2.03000 2.04000 2.05000 3 3.09090 3.12160 3.15250 4 4.18363 4.24646 4.31013 5 5.30914 5.41632 5.52563 6 6.46841 6.63298 6.80191 7 7.66246 7.89829 8.14201 8 8.89234 9.21423 9.54911 9 10.15911 10.58280 11.02656 10 11.46338 12.00611 12.57789

6% 1.00000 2.06000 3.18360 4.37462 5.63709 6.97532 8.39384 9.89747 11.49132 13.18079

Answer: $100,000 × 12.57789 = $1,257,789 Diff: 1 Objective: 7.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7.4

Present Value of Ordinary Annuities

1) A specific present value of an ordinary annuity factor for a given number of periods and a specific discount rate is equal to the cumulative sum of the present value of single sum factors over the given number of periods for that discount rate. Answer: TRUE Diff: 2 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) A specific present value of an ordinary annuity factor for a given number of periods and a specific discount rate is equal to the cumulative sum of the present value of a single sum factors over all the discount rates for that specific number of periods. Answer: FALSE Diff: 2 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) For any discount rate and number of periods, the present value of an annuity due factor is always greater than the corresponding present value of an ordinary annuity factor. Answer: TRUE Diff: 2 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Which of the following must be known to compute the interest rate incurred from financing an asset purchased with an annuity? A) fair value of the asset purchased, number and dollar amount of the annuity payments B) present value of the annuity, dollar amount and number of the annuity payments C) fair value of the asset and timing of the annuity payments D) future value of the annuity and number of the annuity payments Answer: B Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Which of the following transactions would best use the present value of an annuity due table? A) Bengatti, Inc. leases a truck for 5 years with annual lease payments of $10,000 to be made at the beginning of each year. B) Turkel Co. leases a warehouse for 7 years with annual lease payments of $150,000 to be made at the end of each year. C) Ponzi, Inc. borrows $50,000 and has agreed to pay back the principal plus interest in three years. D) Skool, Inc. wants to deposit a lump sum to accumulate $100,000 for the construction of a new parking lot in 5 years. Answer: A Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The factor for the present value of an ordinary annuity for 11% and eight periods is less than ________. A) the factor for the present value of an ordinary annuity for 8% and eight periods B) the factor for the present value of an annuity due for 12% and seven periods C) the factor for the present value of an ordinary annuity for 10% and seven periods D) the factor for the present value of an ordinary annuity for 11% and ten periods Answer: A Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) In the present value of an annuity due table, the factors ________. A) increase as the interest rates increase, given a set number of periods B) decrease as the periods increase, given a set interest rate C) increase as the periods decrease, given a set interest rate D) decrease as the interest rates increase, given a set number of periods Answer: D Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Assume that you have the opportunity to receive $1,000 at the end of each of the next four years. Given an interest rate of 7%, how much would you be willing to pay for this investment today? Use the present value of an ordinary annuity interest factor table shown below. Excerpt from present value of an ordinary annuity interest factor table Periods 6% 7% 8% 9% 1 0.94340 0.93458 0.92593 0.91743 2 1.83339 1.80802 1.78326 1.75911 3 2.67301 2.62432 2.57710 2.53129 4 3.46511 3.38721 3.31213 3.23972 5 4.21236 4.10020 3.99271 3.88965 6 4.91732 4.76654 4.62288 4.48592 7 5.58238 5.38929 5.20637 5.03295 A) $2,624 B) $3,312 C) $3,387 D) $4,100 Answer: C Explanation: $1,000 × 3.38721 = $3,387 Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10% 0.90909 1.73554 2.48685 3.16987 3.79079 4.35526 4.86842

9) Assume that you have the opportunity to receive $3,000 at the end of each of the next five years. Given an interest rate of 10%, how much would you be willing to pay for this investment today? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $9,510 B) $11,372 C) $11,088 D) $13,066 Answer: B Explanation: Using the Excel PV function: $11,372 =PV(0.1,5,3000,0,0) Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Jenks Company financed the purchase of a machine by paying $30,000 a year for the next five years, with the first payment due one year from today. The purchase cost of the machine is considered to be the present value of those payments. What was the purchase cost of the machine to Jenks assuming a discount rate of 5%? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $150,000 B) $129,884 C) $136,379 D) $117,529 Answer: B Explanation: Using the Excel PV function: $129,884 =PV(0.05,5,-30000) Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

11) Terry Brown purchased a used car and agreed to pay $800 per month for two-and-a-half years with the first payment due at the end of the first month. What was the purchase price of the car assuming an annual rate of 12%? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $24,000 B) $20,853 C) $20,646 D) $26,880 Answer: C Explanation: Using the Excel PV function: $20,646 = PV(0.12/12,30,800) Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Bangin Inc. financed the purchase of a machine by making ten annual payments of $10,000 with the first payment due today. The purchase cost of the machine is considered to be the present value of those payments. What was the purchase cost of the machine to Bangin assuming a discount rate of 9%? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $42,241 B) $100,000 C) $64,177 D) $69,952 Answer: D Explanation: Using the Excel PV function: $69,952 = PV(0.09,10,-10000,0,1) Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Potash Corporation financed the purchase of a building by making semiannual payments of $39,000 for the next twenty years, with the first payment due six months from today. The purchase cost of the building is considered to be the present value of those payments. What was the purchase cost of the building to Potash assuming an annual interest rate of 10%? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $702,665 B) $669,204 C) $780,000 D) $221,591 Answer: B Explanation: Using the Excel PV function: $669,204 = PV(0.1/2,40,-39000,0,0) Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) You have just won the Multi-State Lottery. You have the option of receiving a check for $45,000,000 every year at the end of the next 24 years. The lottery commission also allows you the option of receiving a one-time payment of $436,797,530 when you turn in the winning ticket. What is the approximate interest rate that the lottery commission is using to determine the one-time payment? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest percent, X%.) A) 9% B) 3% C) 7% D) 8% Answer: A Explanation: Using the Excel RATE function: 0.09 = RATE(24,45000000,-436797530) Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) On January 1, Yumati Electric borrows $500,000 at an interest rate of 6% today and will repay this amount by making 10 semiannual payments beginning May 31. What is the approximate amount of each payments that Yumati will need to make? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $30,000 B) $50,000 C) $58,615 D) $67,934 Answer: C Explanation: Using the Excel PMT function: $58,615 = PMT(0.06/2,10, 500000) Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

16) You are provided with two-time value of money tables. One table provides factors for the present value of an ordinary annuity and the other provides factors for the present value of an annuity due. How can you tell which table is which type? Answer: An ordinary annuity is an annuity where the cash flows occur at the end of the interest period and an annuity due is an annuity where the cash flows occur at the beginning of the interest period. Therefore, for any given number of periods, and a set interest rate, the present value factor for an ordinary annuity is always smaller than the corresponding present value factor for an annuity due. For the first period, the present value factor for an annuity due is always 1.0 for any interest rate while the present value factor for an ordinary annuity is always less than one (one divided by one plus the interest rate). Diff: 1 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Each year for the next 10 years, Carmen Lector will deposit $4,000 into an investment fund that pays 8% compounded annually. Use the following tables: Excerpt from the Present Value of an Ordinary Annuity of $1 Table Periods 8% 9% 10% 1 0.92593 0.91743 0.90909 2 1.78326 1.75911 1.73554 3 2.57710 2.53130 2.48685 4 3.31213 3.23972 3.16986 5 3.99271 3.88965 3.79079 6 4.62288 4.48592 4.35526 7 5.20637 5.03295 4.86842 8 5.74664 5.53482 5.33493 9 6.24689 5.99525 5.75902 10 6.71008 6.41766 6.14457 Excerpt from the Present Value of an Annuity Due of $1 Table Periods 8% 9% 10% 1 1.0 1.0 1.0 2 1.92593 1.91743 1.90909 3 2.78326 2.75911 2.73554 4 3.57710 3.53130 3.48685 5 4.31213 4.23972 4.16986 6 4.99271 4.88965 4.79079 7 5.62288 5.48592 5.35526 8 6.20637 6.03295 5.86842 9 6.74664 6.53482 6.33493 10 7.24689 6.99525 6.75902 a. What is the present value of those investment payments if the first of 10 deposits are made at the end of each year? b. What is the present value of those investment payments if the first of 10 deposits are made at the beginning of each year? Answer: a. $4,000 × 6.71008 (present value of an ordinary annuity at 8% for 10 periods) = $26,840 b. $4,000 × 7.24689 (present value of an annuity due at 8% for 10 periods) = $28,988 Diff: 2 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Each quarter for the next 10 years, Carmen Lector will deposit $1,000 into an investment fund that pays 8% compounded quarterly. Use the following tables: Excerpt from the Present Value of an Ordinary Annuity of $1 Table Periods 2% 4% 6% 8% 10 8.98259 8.1109 7.36009 6.71008 40 27.35548 19.79277 15.04630 11.92461 Excerpt from the Present Value of an Annuity Due of $1 Table Periods 2% 4% 6% 10 9.16224 8.43533 7.80169 40 27.90259 20.58448 15.94907

8% 7.24689 12.87858

a. What is the present value of those investment payments if the first of 40 deposits are made at the end of each quarter? b. What is the present value of those investment payments if the first of 40 deposits are made at the beginning of each quarter? Answer: a. $1,000 × 27.35548 (present value of an ordinary annuity at 2% for 40 periods) = $27,355 b. $1,000 × 27.90259 (present value of an annuity due at 2% for 40 periods) = $27,903 Diff: 2 Objective: 7.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7.5

Deferred Annuities

1) A deferred annuity is an annuity for which payments are delayed until the end of each period. Answer: FALSE Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) A deferred annuity is an annuity for which the first payment is delayed until a future period. Answer: TRUE Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A deferred annuity is an annuity in which interest is not compounded until a future period. Answer: FALSE Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The present value of a four-year ordinary annuity for which the first payment is deferred for five years (not received until year six) is equal to the present value of a nine-year ordinary annuity minus the present value of a five-year ordinary annuity. Answer: TRUE Diff: 2 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) When two or more periods precede the payment of the first cash flow in a series of cash flows, the annuity is ________. A) an ordinary annuity B) a future annuity C) an annuity due D) a deferred annuity Answer: D Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) A series of equal periodic payments that starts more than one period after the agreement begins is called ________. A) an ordinary annuity B) an annuity due C) a deferred annuity D) a delayed annuity Answer: C Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following is false? A) To calculate the present value of a deferred annuity, determine the present value of an ordinary annuity for the entire period and subtract the present value of the payments which were not received during the deferral period. B) The future value of a deferred annuity is equal to the future value of an annuity not deferred. C) If the first payment is received at the end of the fifth period, it means the ordinary annuity is deferred for five periods. D) The present value of a deferred annuity is less than the present value of an annuity not deferred. Answer: C Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Baxter desires to purchase an annuity on January 1, 2023, that yields him five annual cash flows of $11,000 each, with the first cash flow to be received on January 1, 2026. The interest rate is 10% compounded annually. The cost (present value) of the annuity on January 1, 2023, is ________. (Use spreadsheet software or a financial calculator to calculate your answer. Round intermediary calculations two decimal places and round your final answer to the nearest dollar.) A) $28,481 B) $55,000 C) $34,462 D) $45,869 Answer: C Explanation: Using the Excel PV functions first determine the present value of the 5 year annuity due as of 1/1/23: = $45,868.52 = PV(0.10,5,11000,0,1), then determine the present value of that amount assuming 3 years and the 10% discount rate: $34,462 = PV(0.1,3,0,45868.52) Diff: 2 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Annie Laerz wants to invest $10,000 on January 1, 2020, so that she may withdraw 10 annual payments of equal amounts beginning January 1, 2035. If the fund earns 5% annual interest over its life, what will be the amount of each of the withdrawals? (Use spreadsheet software or a financial calculator to calculate your answer. Round intermediary calculations two decimal places and round your final answer to the nearest dollar.) A) $10,000 B) $2,692 C) $2,564 D) $3,386 Answer: C Explanation: Using Excel FV function, grow the investment for 15 years: $20,789.28 = FV(0.05,15,0,10000), then amortize that amount over 10 years using the PMT function = $2,564 = PMT(0.05,10,20789.28,0,1) Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Suppose you borrow money from your parents for college tuition on January 1, 2019. Your parents require four annual payments of $10,000 each, with the first payment due on January 1, 2023. They are charging you 10% annual interest. What is the cost of the college tuition? (Use spreadsheet software or a financial calculator to calculate your answer. Round intermediary calculations two decimal places and round your final answer to the nearest dollar.) A) $40,000 B) $27,619 C) $34,869 D) $23,816 Answer: D Explanation: Using the Excel PV function, first calculate the present value of the loan payments as of January 1, 2023: $34,868.52 = PV(0.1,4,10000,0,1) then find the present value of that amount as of January 1, 2019: $23,816 = PV(0.1,4,0,34868.52) Diff: 2 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) An example of a deferred annuity is payments for ________. A) pension benefits B) loan obligations C) preferred dividends D) insurance premiums Answer: A Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) What is a deferred annuity? Answer: A deferred annuity results from a variety of contracts where payments or receipts are delayed until a future period. For example, a company may receive annual payments of $50,000 for five years, but the payments will not begin until three years from today. Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Explain how to determine the present value for any deferred, ordinary annuity by using only the table for factors of the present value of an ordinary annuity. Answer: Assume the deferred annuity begins after d periods and is paid for n periods. First, determine the present value of an ordinary annuity of n + d periods. From this amount is subtracted the present value of an ordinary annuity of d periods. A mathematically equivalent procedure is to obtain the present value of an ordinary annuity factor for n + d periods and then subtract from that the present value of an ordinary annuity factor for d periods. This difference is multiplied by the value of each cash flow to determine the final present value of the deferred annuity. Diff: 1 Objective: 7.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7.6

Time Value of Money Accounting Applications

1) The expected cash flow approach values an asset or liability using a range of estimated future cash flows times the probability of their occurrence discounted at the market rate of interest. Answer: TRUE Diff: 1 Objective: 7.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The selling price of a bond is equal to the present value of the interest payments plus the present value of the maturity value. Answer: TRUE Diff: 1 Objective: 7.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Which of the following tables would show the smallest value for an interest rate of 8% for ten periods? A) future value of $1 B) present value of $1 C) future value of an ordinary annuity D) present value of an ordinary annuity Answer: B Diff: 1 Objective: 7.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) In order to measure the purchase price of an investment in bonds, which of the following time value of money concepts is used? A) the present value of an ordinary annuity B) the future value of $1 C) the future value of an ordinary annuity D) all of these Answer: A Diff: 1 Objective: 7.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Balance sheet values are calculated using compound interest (present value) calculations for all of the following except ________. A) bonds payable B) long-term notes receivable C) long-term lease liabilities D) deferred income taxes Answer: D Diff: 1 Objective: 7.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) What is the market price of a $800,000, ten-year, 10% bond issue sold to yield an effective rate of 8% if interest is paid semiannually? (Use spreadsheet software or a financial calculator to calculate your answer. Do not round any intermediary calculations, and round your final answer to the nearest dollar.) A) $907,361 B) $908,723 C) $554,217 D) $930,467 Answer: B Explanation: Using the Excel PV function: $908,723 = PV(0.08/2,10*2,(-0.1/2*800,000),-800000) Diff: 1 Objective: 7.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The expected cash flow approach encompasses all of the following features in determining a present value of an asset or liability except ________. A) the market rate of interest B) a range of estimated future cash flows C) the fair value of the asset or liability D) the probabilities of various cash-flow outcomes Answer: C Diff: 1 Objective: 7.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Dana Zorowski has recently started her accounting career and her 25th birthday is coming soon. She has been told that now is the ideal time to begin to prepare for retirement. She has determined that she would like to retire with a pension that will pay $50,000 per year in retirement benefits after she retires with the expectation that the retirement fund should last for 20 years. To meet her pension retirement benefit goals, how much should she deposit annually for the next 40 years in a retirement investment fund that earns 8%? Assume all retirement deposits and benefit payments occur at the end of each year. Use the following tables: Excerpt from Present Value of Ordinary Annuity of $1 Table Periods 8% 10 6.71008 20 9.81815 40 11.92461 60 12.37655 Excerpt from Future Value of Ordinary Annuity of $1 Table Periods 8% 10 14.48656 20 45.76196 40 259.05652 60 1253.21330 Answer: The answer to this question can be determined in at least two ways. (1) The future value when Dana is 65 years old of the 40 annual retirement fund deposits would be equal to the present value (at age 65) of the ensuing 20 years of retirement benefit payments. First, to determine the value at age 65 of the retirement benefit payments: $50,000 × 9.81815 (present value factor at age 65 of an ordinary annuity at 8% for 20 periods) = $490,908 Then, to determine the annual retirement fund deposits: $490,908 (value at age 65) / 259.05652 (future value factor of an ordinary annuity at 8% for 40 periods) = $1,895 (2) The present value (at age 25) of the 40 years of annual deposits would be equal to the present value (at age 25) of the 20 years of retirement benefit payments (from age 65 to 85). First, to determine the value at age 25 of the retirement benefit payments from age 65 to 85 (a deferred annuity): $50,000 × [12.37655 (present value factor of an ordinary annuity at 8% for 60 periods) - 11.92461 (present value factor of an ordinary annuity at 8% for 40 periods) = $50,000 × 0.45194 = $22,597 Then, to determine the annual retirement fund deposits: $22,597 (value at age 25) / 11.92461 (present value factor of an ordinary annuity at 8% for 40 periods) = $1,895 Therefore, to provide for retirement benefits of $50,000 per year from ages 65 to 85 requires annual retirement deposits of $1,895 per year from ages 25 to 65 (assuming an interest rate of 8%). Diff: 3 Objective: 7.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Cocopedia Inc. is planning to issue bonds that will pay 6% semiannual interest and mature in 10 years. a. How much will investors be willing to pay for a $1,000 bond if the prevailing market yield rate is 4%? Use the Excel function. b. How much will investors be willing to pay for a $1,000 bond if the prevailing market interest rate is 8%? Use the Excel function. Answer: The value of a bond is the sum of the present value of the interest payments plus the present value of the maturity value. The bond will provide for 20 semiannual interest payments of $30 ($1,000 × 6% × 0.5). The present values will be evaluated using the prevailing market interest rate as the interest rate. a. =PV(0.02,20,-30,-1000) = $1,163.51 = $1,164 Total bond value @ 4% yield rate = $1,164 b. =PV(.04,20,-30,-1000) = $864.10 = $864 Total bond value @ 8% yield rate = $864 That is, the $30 interest payments plus the $1,000 maturity value will provide an 8% return on investment for investors who pay $864 for the bond or a 4% return on investment for investors who pay $1,164. Diff: 3 Objective: 7.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 8 Revenue Recognition 8.1

Revenue Recognition Overview

1) The first step in the revenue recognition process is to determine the transaction price. Answer: FALSE Diff: 1 Objective: 8.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Revenue recognition deals with the issues of timing and measurement of revenue. Answer: TRUE Diff: 1 Objective: 8.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The final step in the revenue recognition process is the allocation of the transaction price to the performance obligation. Answer: FALSE Diff: 1 Objective: 8.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The timing of revenue recognition is dependent upon the control of the good being in the hands of ________. A) the buyer B) the seller C) management D) any third party Answer: A Diff: 1 Objective: 8.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Recognition of revenue as each performance obligation is satisfied is which step in the recognition process? A) 1st B) 3rd C) 5th D) 4th Answer: C Diff: 1 Objective: 8.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The local Mini Mart makes cash sales of $4,000 on April 5th of the current year. The journal entry to record the sale part of the transaction would be to ________. A) Cash 4,000 Sales Revenue 4,000 B) Sales Revenue Cash

4,000

C) Accounts Receivable Sales Revenue

4,000

D) Cash

4,000

4,000 Accounts Receivable

4,000

Answer: A

Diff: 2 Objective: 8.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Able sells and delivers a piece of equipment to Smythe for $1,800 on August 1 and the equipment cost $1,300. The sale is a credit sale. The journal entry to record the transaction using the perpetual system would be ________. A) Sales Revenue 1,300 Accounts Receivable 1,300 Cost of Goods Sold Inventory B) Accounts Receivable Sales Revenue Cost of Goods Sold Inventory C) Sales Revenue Accounts Receivable Cost of Goods Sold Inventory D) Accounts Receivable Sales Revenue Cost of Goods Sold Inventory

1,800 1,800

1,800 1,800 1,300 1,300

1,300 1,300 1,800 1,800

Answer: B

Diff: 2 Objective: 8.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Jackson sells and delivers a piece of equipment to Abby for $2,300 on August 1 and the equipment cost $1,200. The sale is a credit sale. How is this transaction accounted for under a perpetual system of inventory? A) Sales Revenue 2,300 Accounts Receivable 2,300 Cost of Goods Sold Inventory B) Accounts Receivable Sales Revenue Cost of Goods Sold Inventory C) Sales Revenue Accounts Receivable Inventory Cost of Goods Sold D) Accounts Receivable Sales Revenue Cost of Goods Sold Inventory

1,200 1,200

2,300 2,300 1,200 1,200

Answer: B

Diff: 2 Objective: 8.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) What are the five principal steps in the revenue recognition process? Answer: The five principal steps in the revenue recognition process are: 1. Identify the contract or contracts with the customer. 2. Identify the performance obligations in the contract. 3. Determine the transaction price. 4. Allocate the transaction price to the performance obligations. 5. Recognize revenue when, or as, it satisfies each performance obligation. Diff: 2 Objective: 8.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) John sells and delivers a piece of equipment to Thomas for $2,000 on April 1 and the equipment cost $1,500. The sale is a credit sale. How is this transaction recorded under a perpetual system of inventory? Answer: April 1 Accounts Receivable 2,000 Sales Revenue 2,000 Cost of Goods Sold Inventory

1,500 1,500

Diff: 2 Objective: 8.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8.2

Step 1: Identify the Contract(s) with a Customer

1) Approval of a contract by the parties must be in writing. Answer: FALSE Diff: 1 Objective: 8.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) If a seller receives cash before the appropriate time to recognize revenue, the seller should treat the consideration as a liability. Answer: TRUE Diff: 1 Objective: 8.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) U.S. GAAP sets a higher threshold for the assessment of collectability of consideration from a contract than IFRS. Answer: TRUE Diff: 1 Objective: 8.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) When a contract is expected to affect the risk, timing, or amount of the entity's future cash flows, the contract is said to have ________. A) non-commercial substance B) no substance C) commercial substance D) no profit Answer: C Diff: 1 Objective: 8.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Under U.S. GAAP, when a contract meets the collectability criterion, this means ________. A) the seller believes it is 50% likely to collect the consideration in the contract B) the seller believes it is more likely than not to collect the consideration in the contract C) the seller believes it is likely to collect the consideration in the contract D) the seller believes it is unlikely to collect the consideration in the contract Answer: C Diff: 1 Objective: 8.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) If multiple contracts are negotiated as a package and have a single commercial objective, the contracts should be combined and accounted for as ________. A) multiple contracts B) a single contract C) assets D) liabilities Answer: B Diff: 2 Objective: 8.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) IFRS defines the probable collection from a credit sale as ________. A) likely to be collected B) more likely than not to be collected C) at least a 50% probability of being collected D) at least a 45% probability of being collected Answer: B Diff: 2 Objective: 8.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) What are the five criteria that must be met for a contract with a customer to exist? Answer: 1. All parties agree to the contract and commit to performing under the contract. 2. Each party's rights are identifiable. 3. The payment terms are identifiable. 4. The contract has commercial substance. 5. It is probable that the seller will collect the consideration to which it is entitled. Diff: 2 Objective: 8.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Define the term "commercial substance." Answer: A contract is said to have commercial substance if the risk, timing, or amount of the entity's future cash flows is expected to change as a result of the contract. Diff: 1 Objective: 8.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8.3

Step 2: Identify the Performance Obligations in the Contract

1) A performance obligation is a promise to transfer a good or service that is distinct. Answer: TRUE Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) A good or service must be explicitly identified in a contract in order to identify a performance obligation. Answer: FALSE Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Judgment may be involved in the determination of whether the promise to deliver the good or service is separate from other promises. Answer: TRUE Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) A performance obligation is a promise to transfer a good or service that is ________. A) indistinguishable B) distinct C) available D) nondescript Answer: B Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Able sells a piece of equipment to Smythe for $1,800 on August 1. The equipment cost $1,000. The equipment is picked up by Smythe on August 10. How many performance obligations are included in this transaction? A) 1 B) 2 C) 3 D) 4 Answer: A Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Able sells a piece of equipment to Smythe for $1,800 on August 1. The equipment cost $1,000. The equipment is picked up by Smythe on August 10. The contract also includes a 12-month service plan. How many performance obligations are included in this transaction? A) 1 B) 2 C) 3 D) 4 Answer: B Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) A yacht dealer sells high performance yachts to affluent customers. The sale also includes a 90 day warranty against any defects in workmanship. The number of performance obligations for each yacht is ________. A) 1 B) 2 C) 3 D) 4 Answer: A Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) ABC provides a product and installation to be used in conjunction with the buyer's production system. The buyer's system is unusable without ABC's product. The product and the installation are an example of ________. A) three performance obligations B) no performance obligations C) a single performance obligation D) two performance obligations Answer: C Diff: 2 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) In determining whether the promise to deliver goods and services is separate from other promises the accountant must often rely on ________. A) professional skepticism B) professional judgment C) professional standards D) standards of conduct Answer: B Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) An automotive magazine charges an annual subscription fee of $300, with customers prepaying the fee. Subscribers receive 50 issues for the annual fee. The publisher provides the new subscribers with a discount coupon good for a 30 percent discount on a race car ride at a major track. The list price of the ride along experience is $200. The company estimates that 35% of the coupons will be utilized. What is the number of performance obligations? A) 1 B) 2 C) 3 D) 4 Answer: B Diff: 2 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Able Company enters into a contract with a customer to provide them with an accounts receivable program. Able will also provide installation services as part of the contract. The customer is free to enlist the services of another entity to install the software. What is the number of performance obligations for this contract? A) 0 B) 1 C) 2 D) 3 Answer: C Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Able Company enters into a contract with a customer to provide them with an accounts receivable program. Able will also provide installation services as part of the contract. Able will make sure that this program will be installed so that it will be customized and be able to integrate with the company's other program modules. What is the number of performance obligations for this contract? A) 1 B) 2 C) 3 D) 4 Answer: A Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) What are the requirements for a good or service to be distinct? Answer: A performance obligation is considered distinct if: 1. it benefits the customer on its own or in conjunction with other assets that are readily available to the customer, and 2. it is separately identifiable from other promises in the contract. Diff: 1 Objective: 8.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8.4

Step 3: Determine the Transaction Price

1) The transaction price is the amount of consideration the entity expects to be entitled to as a result of providing goods or services to the customer. Answer: TRUE Diff: 1 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The transaction price is always the price stated in the contract. Answer: FALSE Diff: 1 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The expected-value approach for revenue recognition is appropriate when variable consideration is included in the contract. Answer: TRUE Diff: 1 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The amount of consideration that an entity expects to be entitled to as a result of providing goods or services to a customer is the ________. A) performance obligation B) expected value C) transaction price D) variable consideration Answer: C Diff: 1 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) A financing component is accounted for separately in a sales contract if delivery occurs in advance of payment or payment occurs in advance of delivery by more than ________. A) six months B) one year C) two years D) three years Answer: B Diff: 1 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) If noncash consideration such as stock of a publicly-traded company is given in a revenue contract, then the value to be used for the transaction price should be ________. A) fair value of stock B) book value of stock C) historical cost of stock D) net present value of revenue Answer: A Diff: 1 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Walker Consulting helped McCall Roofers put various cost saving techniques into place. The contract specifies that Walker will receive a flat fee of $70,000 and an additional $11,000 if McCall attains a target amount of cost savings. Walker estimates a 20% chance that McCall will reach the target for cost savings. Assuming that Walker uses the expected-value approach, what is the transaction price for this product? A) $11,000 B) $70,000 C) $72,200 D) $81,000 Answer: C Explanation: $72,200 = $70,000 + ($11,000 × 0.2) Diff: 1 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) ABC Company enters into a contract with Edmond Library to help them streamline their purchasing process. The contract specifies that Edmond Library will pay ABC $100,000 in the form of a fixed fee plus an additional $10,000 if the library achieves $200,000 in cost savings. ABC estimates a 55% chance that the library will achieve a $200,000 savings. Assume ABC estimates that the transaction price is the expectedvalue transaction price. The transaction price is recorded as ________. Ignore any constraints on variable consideration. A) $100,000 B) $105,500 C) $110,000 D) $94,500 Answer: B Explanation: $105,500 = $100,000 + ($10,000 × 0.55) Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) An automotive manufacturer, A-2 Auto, provides maintenance services to Mako. In exchange, A-2 Auto received 580 shares of Mako's no-par common stock. Mako's common stock is currently trading on the open market for $26 per share. The standalone value of the maintenance provided was $19,080. What is the transaction price of this contract? A) $15,080 B) $19,080 C) $18,080 D) Cannot be determined from the information given. Answer: A Explanation: $15,080 = 580 shares × $26 Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Gray Uniforms is a wholesaler who sells school uniforms to retailers. On August 1, Gray contracts with Excel School Uniforms to sell 2,000 uniforms to Excel to be delivered September 1. The contract price is set at $340 each. The contract provides for a 10% volume discount if sales exceed 3,000 uniforms. The probability of sales exceeding 3,000 uniforms is expected to be 61%. Using the most-likely-amount approach, the consideration is estimated to be ________. A) $887,400 B) $622,200 C) $612,000 D) $414,800 Answer: C Explanation: $612,000 = 2,000 × $340 × (1 - .1) Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) White Labs is a wholesaler who sells microscopes for use in high schools to retailers. On August 1 White contracts with the XYZ to sell 1,700 microscopes to XYZ to be delivered September 1. The contract price is set at $310 each, with a 10% volume discount if sales exceed 2,500 microscopes within the year. The probability of sales exceeding 2,500 microscopes is expected to be 55%. Ignore any constraints on variable consideration. Using the most-likely-amount approach, the consideration to be recognized is estimated to be ________. A) $474,300 B) $527,000 C) $289,850 D) $52,700 Answer: A Explanation: $474,300 = 1,700 × $310 × (1 - .1) Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Jones Corporation enters into a contract with Warner Video to add their programs to Jones' network. Warner will pay Jones an upfront fixed fee of $300,000 for 12 months of access, and will also pay a $130,000 bonus if Jones' users access Warner Video for at least 10,000 hours during the 12 month period. Jones estimates that it has a 60% chance of earning the $130,000 bonus. Ignore any constraints on variable consideration. Refer to Jones Corporation. Using the expected-value approach, the transaction price would be ________. A) $170,000 B) $300,000 C) $378,000 D) $430,000 Answer: C Explanation: $378,000 = $300,000 + ($130,000 × 0.6) Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Jones Corporation enters into a contract with Warner Video to add their programs to Jones' network. Warner will pay Jones an upfront fixed fee of $250,000 for 12 months of access, and will also pay a $120,000 bonus if Jones' users access Warner Video for at least 10,000 hours during the 12 month period. Jones estimates that it has a 60% chance of earning the $120,000 bonus. Ignore any constraints on variable consideration. Refer to Jones Corporation. Using the most-likely-amount approach, the transaction price would be ________. A) $120,000 B) $250,000 C) $322,000 D) $370,000 Answer: D Explanation: $370,000 = $250,000 + $120,000 Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Jones Corporation enters into a contract with Warner Video to add their programs to Jones' network. Warner will pay Jones an upfront fixed fee of $290,000 for 12 months of access, and will also pay a $120,000 bonus if Jones' users access Warner Video for at least 10,000 hours during the 12 month period. Jones estimates that it has a 60% chance of earning the $120,000 bonus. Refer to Jones Corporation. Upon collection of the upfront fee, Jones would recognize a/an ________. A) deferred revenue of $290,000 B) deferred revenue of $410,000 C) prepaid revenue of $290,000 D) prepaid revenue of $410,000 Answer: A Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Aztec Company contracted with the Kirk Company to review their revenue recognition policies for recording sales. The contract will pay Aztec $600,000 in the form of a fixed fee. Aztec will also receive $150,000 additionally if Kirk achieves $200,000 in additional revenues. Aztec estimates a 67% chance that Kirk Company will achieve $200,000 in additional revenues. Refer to Aztec Company. Assume that Aztec estimates that the transaction price is the probability weighted amount of expected consideration. The transaction price is ________. A) $700,500 B) $600,000 C) $402,000 D) $198,000 Answer: A Explanation: $700,500 = $600,000 + ($150,000 × 67%) Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Aztec Company contracted with the Kirk Company to review their revenue recognition policies for recording sales. The contract will pay Aztec $600,000 in the form of a fixed fee. Aztec will also receive $150,000 additionally if Kirk achieves $200,000 in additional revenues. Aztec estimates a 67% chance that Kirk Company will achieve $200,000 in additional revenues. Refer to Aztec Company. Assume that Aztec estimates that the transaction price is the most likely value. The transaction price is ________. A) $600,000 B) $700,500 C) $402,000 D) $750,000 Answer: D Explanation: $750,000 = $600,000 + $150,000 Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Greenwell Farm Equipment sells a tractor to Farmer for $90,000 on January 1, 2025. The tractor is delivered that day. Greenwell agrees that the Farmer may delay the payment for 2 years. The market rate of interest is 8%. Refer to Greenwell Farms. How much sales revenue will Greenwell report on January 1, 2025? Use the formula approach. A) $90,000 B) $82,800 C) $97,200 D) $77,160 Answer: D Explanation: $77,160 = $90,000 × 1/(1 + 8%)2 Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Greenwell Farm Equipment sells a tractor to Farmer for $150,000 on January 1, 2025. The tractor is delivered that day. Greenwell agrees that the Farmer may delay the payment for 2 years. The market rate of interest is 8%. Refer to Greenwell Farms. How much interest revenue will Greenwell report on January 1, 2025? A) $162,000 B) $138,000 C) $0.00 D) $12,000 Answer: C Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Greenwell Farm Equipment sells a tractor to Farmer for $120,000 on January 1, 2025. The tractor is delivered that day. Greenwell agrees that the Farmer may delay the payment for 2 years. The market rate of interest is 6%. Refer to Greenwell Farms. How much interest revenue will Greenwell report over the life of this contract? (Do not round intermediary calculations, and round your final answer to the nearest whole number.) Use the formula approach. A) $13,200 B) $7,200 C) $14,400 D) $14,832 Answer: A Explanation: $120,000 × 1/(1 + 6%)2 = $106,800; $120,000 - $106,800 = $13,200 Interest Revenue Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Shady Equipment sells a truck to Fred for $190,000 on January 1, 2022. Payment of $190,000 is received two years later and interest is paid at the end of two years. The truck is delivered two years later. The market rate of interest is 9%. Refer to Shady Equipment. How much sales revenue will Shady report on January 1, 2022? A) $0.00 B) $190,000 C) $172,900 D) $95,000 Answer: A Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Shady Equipment sells a truck to Fred for $110,000 on January 1, 2022. Payment of $110,000 is received is received on January 1, 2022, and interest is incurred over two years. The truck is delivered two years later. The market rate of interest is 10%. Refer to Shady Equipment. How much interest expense will Shady report over the term of the contract? (Do not round intermediary calculations, and round your final answer to the nearest whole number.) A) $23,100 B) $11,000 C) $110,000 D) $36,410 Answer: A Explanation: $23,100 = Year 1 $110,000 × 10% = $11,000 + year 2 ($110,000 + $11,000) × 10% Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) In determining the transaction price, when does a significant financing component exist? Answer: A significant financing component may occur either when: 1. delivery of the goods or services happens far in advance of payment, therefore, the seller is providing financing to the buyer. 2. delivery of the goods or services occurs well after payment; therefore, the buyer is providing financing to the seller. Diff: 1 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) What are the issues to consider when determining the transaction price? Answer: The following are the issues to be considered when determining the transaction price: 1. Variable consideration and constraining estimates of variable consideration 2. Significant financing component in the contract 3. Noncash consideration 4. Consideration payable to a customer Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) If a contract includes noncash consideration, how should the transaction be measured? Answer: Noncash consideration requires the use of fair value of the noncash consideration received by the seller. Diff: 1 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Agee Corporation (use the following information for the next 3 questions) Agee enters into a contract with Pipkin Video to add their programs to Agee's network. Pipkin will pay Agee an upfront fee of $250,000 for 12 months of access, and will also pay a $100,000 bonus if Agee's users access Pipkin Video for at least 10,000 hours during the 12-month period. Agee estimates that it has a 55% chance of earning the $100,000 bonus. 25) Refer to Agee Corporation. Using the expected-value approach, determine the transaction price. Answer: $250,000 × 100% $250,000 $100,000 × 55% 55,000 Transaction Price 305,000 Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) Refer to Agee Corporation. Using the most-likely-amount approach, determine the transaction price. Answer: $250,000; Variable consideration of $100,000 is constrained because the probability is under 70%. To include the bonus, the probability must be at least 70%, so it is excluded. Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

27) Refer to Agee Corporation. Using the most-likely-amount approach, record the receipt of the upfront fee and the first month's revenue. Answer: Cash

250,000 Deferred Revenue

Deferred Revenue (250,000 / 12) Service Revenue

250,000

20,833 20,833

Diff: 2 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

28) Hill and Dale Enterprises offers a promotion that provides a customer signing up for a membership the opportunity to enroll in educational courses. A customer signing up the first time is entitled to a 25% discount off a full year 's worth of courses. A new membership costs $1,600 annually and a year's worth of courses another $1,200. Hill and Dale estimate that approximately 40% of the customers will take advantage of the 25% discount. The company is offering a 10% discount on all courses at this time. Required: a. Identify the separate performance obligations in the new customer deal. b. Allocate the price to the separate performance obligations. Use the most-likely amount approach. c. Record the journal entry to record the sale of a new membership and one year of courses. The customer paid cash. Answer: a. The separate performance obligations include: 1. the membership fee 2. the courses that may be taken b. Performance Obligation Fee Courses Total

Standalone Price $1,600 $1,200 $2,800

Most Likely Amount $1,600 $1,080 $2,680

c. Cash

2,680 Deferred Membership Revenue Deferred Course Revenue

1,600 1,080

Diff: 3 Objective: 8.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8.5

Step 4: Allocate the Transaction Price to the Performance Obligation

1) The residual approach of determining a standalone price for a good or service focuses on internal factors by forecasting costs and adding an appropriate profit margin. Answer: FALSE Diff: 1 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The general rule is that the transaction price should be allocated to the performance obligations based on the relative standalone selling prices. An exception occurs when the contract includes variable consideration. Answer: TRUE Diff: 1 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Which one of the following approaches is not a method for allocating a transaction price to multiple performance obligations? A) adjusted market assessment B) expected-cost-plus-a-margin C) residual D) present cost basis Answer: D Diff: 1 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The general rule is that the transaction price should be allocated to the performance obligations based on the relative standalone selling prices unless a discount is ________. A) not related to all of the contract's performance obligations B) related to all of the contract's performance obligations C) less than the standalone selling price D) not part of the variable consideration Answer: A Diff: 2 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) If the sum of standalone selling prices is greater than the transaction price, then any discount should be allocated to the performance obligations based on the relative ________. A) historical cost B) standalone selling prices C) book values D) net present values Answer: B Diff: 1 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Hopner Products enters into a contract with Tulles to sell three different products. The total transaction price is $310,000. Each of the products is a separate performance obligation. Based on the information presented in the table, what is the allocated transaction price of product Z using the adjusted market assessment approach? (Round intermediary percentages to the nearest hundredth percent, and round your final answer to the nearest whole number.) Product X Y Z

Standalone Price $140,000 $95,000 Not Available

Market Price $120,000 $125,000 $85,000

A) $79,856 B) $90,484 C) $103,333 D) $65,000 Answer: A Explanation: $85,000/$330,000 = 0.2576 × $310,000 = $79,856 Diff: 2 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

7) Hopner Products enters into a contract with Tulles to sell three different products. The total transaction price is $400,000. Each of the products is a separate performance obligation. Based on the information presented in the table, what is the allocated transaction price of product Z using the expected-cost-plus-a-profit margin approach? (Round intermediary percentages to the nearest hundredth percent, and round your final answer to the nearest whole number.) Product X Y Z

Standalone Price $150,000 $90,000 Not Available

Market Price $130,000 $205,000 $80,000

Forecasted Cost $100,000 $65,000 $185,000

A) $211,437 B) $77,120 C) $133,333 D) $235,000 Answer: A Explanation: $211,437 = $185,000 + [($400,000 - $350,000)/$350,000) × $185,000] Diff: 2 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

8) Hopner Products enters into a contract with Tulles to sell three different products. Each of the products is a separate performance obligation. Based on the information presented in the table, what is the standalone price of product Z using the residual approach? Transaction Price Product X Y Z

$415,000 Standalone Price $150,000 $125,000 Not available

A) $290,000 B) $175,000 C) $140,000 D) $315,000 Answer: C Explanation: $140,000 = $415,000 - $150,000 - $125,000 Diff: 2 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) If a seller does not sell the same goods or services separately, the standalone selling prices should be estimated using prices that maximize observable inputs. What are the three suggested approaches to accomplish this? Answer: 1. The adjusted market assessment approach 2. Expected cost plus a margin approach 3. The residual approach Diff: 2 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Kramer Iron Works (use the following information for the next 3 questions) Kramer Iron Works signs a contract to provide three different products to a customer for a total transaction price of $325,000. Each product represents a separate performance obligation. Kramer only sells two of the three products on an individual basis so they must estimate the standalone selling price for the third product. The information about these three products is provided in the following table.

Product A-1 A-2 A-3 Total

Standalone Selling Price $87,500 150,000 Not Available

Market Competition Price $66,500 156,000 100,000 $322,500

Forecasted Cost $60,000 125,000 65,000 $250,000

10) Refer to Kramer Iron Works. Allocate the transaction price using the adjusted market assessment approach. Round percentages to two decimal places. Answer: Market Allocated Competitor Percentage of Transaction Product Price Total Price A-1 $66,500 20.62% $67,015 A-2 156,000 48.37% 157,203 A-3 100,000 31.01% 100,782 Total $322,500 100.00% $325,000 Diff: 3 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Refer to Kramer Iron Works. Allocate the transaction price using expected-cost-plus-a-margin approach. Answer: Product Forecasted Cost Margin = 30%* Allocated Transaction A-1 $60,000 $60,000 × 30% = $18,000 $78,000 125,000 $125,000 × 30% = $37,500 162,500 A-3 65,000 $65,000 × 30% = $19,500 84,500 Total $250,000 $325,000 Diff: 3 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Refer to Kramer Iron Works. Allocate the transaction price using the residual approach. Answer: Standalone Product Product Price Transaction Price $325,000 A-1 (87,500) A-2 (150,000) A-3 $87,500 Diff: 3 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Costanzo Auto Shop (use the following information for the next 3 questions) Costanzo Auto Shop signs a contract to provide three different products to a customer for a total transaction price of $975,000. Each product represents a separate performance obligation. Costanzo only sells two of the three products on an individual basis so they must estimate the standalone selling price for the third product. The information about these three products is provided in the following table.

Product Zoom-1 Zoom-2 Zoom-3 Total

Standalone Selling Price $262,500 450,000 Not Available

Market Competition Forecasted Price Cost $199,500 $180,000 468,000 375,000 300,000 195,000 $967,500 $750,000

13) Refer to Costanzo Auto Shop. Allocate the transaction price using the adjusted market assessment approach. Round percentages to two decimal places. Answer: Market Allocated Competitor Percentage of Transaction Product Price Total Price Zoom-1 $199,500 20.62% $201,045 Zoom-2 468,000 48.37% 471,608 Zoom-3 300,000 31.01% 302,347 Total $967,500 100.00% $975,000 Diff: 3 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Refer to Costanzo Auto Shop. Allocate the transaction price using expected-cost-plus-a-margin approach. Answer: Allocated Transaction Product Forecasted Cost Margin = 30%* Price Zoom-1 $180,000 $180,000 × 30% = $54,000 $234,000 Zoom-2 375,000 $375,000 × 30% = $112,500 487,500 Zoom-3 195,000 $195,000 × 30% = $58,50 253,500 Total $750,000 $975,000 *$975,000/$750,000 – 1 = 30%

Diff: 3 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Refer to Costanzo Auto Shop. Allocate the transaction price using the residual approach. Answer: Standalone Product Product Price Transaction Price $975,000 Zoom-1 (262,500) Zoom-2 (450,000) Zoom-3 $262,500 Diff: 3 Objective: 8.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8.6

Step 5: Recognize Revenue When, or As, Each Performance Obligation is Satisfied

1) Goods and services may be transferred to a customer over time or at a point in time. Answer: TRUE Diff: 1 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Goods and services are transferred over time if the customer controls the asset as the seller creates it or enhances it over time. Answer: TRUE Diff: 1 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) If the seller does not meet the three criteria for revenue recognition, then it assumes that goods or services are transferred over time. Answer: FALSE Diff: 1 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) An example of a good transferred over time is a ________. A) refrigerator B) soft drink C) magazine subscription D) suit Answer: C Diff: 1 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) A good or service transferred at a point in time would include a ________. A) suit B) magazine subscription C) gym membership D) Sam's Club membership Answer: A Diff: 1 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which one of the following is not an indicator of the transfer of control to the buyer? A) Seller has present right to payment for the asset. B) Seller has legal title to the asset. C) Seller has transferred physical possession of property. D) Customer has accepted the asset. Answer: B Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Pemco Enterprises sells annual memberships to its shooting lodge. The memberships cost $300 each. On January 1, Pemco sold 2,000 memberships and received cash. Refer to Pemco Enterprises. How much revenue should Pemco recognize on January 1? A) $0 B) $600,000 C) $300,000 D) $50,000 Answer: A Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Pemco Enterprises sells annual memberships to its shooting lodge. The memberships cost $240 each. On January 1, Pemco sold 4,000 memberships and received cash. Refer to Pemco Enterprises. How much revenue should Pemco recognize each month? (Round your final answer to the nearest whole number.) A) $0 B) $40,000 C) $80,000 D) $96,000 Answer: C Explanation: $240 × 4,000 = $960,000 × 1/12 = $80,000 Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Pemco Enterprises sells annual memberships to its shooting lodge. The memberships cost $230 each. On January 1, Pemco sold 4,000 memberships and received cash. How should Pemco record the receipt of cash on January 1? A) liability of $920,000 B) revenue of $920,000 C) liability of $0 D) revenue of $76,667 Answer: A Explanation: $920,000 = 4,000 × $230 Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Pemco Enterprises sells annual memberships to its shooting lodge. The memberships cost $310 each. On January 1, Pemco sold 2,800 memberships and received cash. What journal entry should Pemco Enterprises make on January 31st if adjusting entries are completed monthly. A) Debit Deferred Revenue; Credit Cash B) Debit Membership Revenue; Credit Deferred Revenue C) Debit Deferred Revenue; Credit Membership Revenue D) Debit Cash; Credit Membership Revenue Answer: C Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Derby Company sells season passes to its entertainment center. The passes sell for $95 each and are good for the year. On January 1, Derby sells 2,000 passes and received cash. The amount of revenue to be recognized on January 1 is ________. A) $0 B) $95,000 C) $190,000 D) $15,833 Answer: A Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Derby Company sells season passes to its entertainment center. The passes sell for $105 each and are good for the year. On January 1, Derby sells 4,200 passes and received cash. The amount of revenue to be recognized each month is ________. A) $44,100 B) $36,750 C) $441,000 D) $49,000 Answer: B Explanation: $36,750 = (4,200 × $105) × 1/12 Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Derby Company sells season passes to its entertainment center. The passes sell for $125 each and are good for one year. On January 1, Derby sells 4,800 passes and received cash. What journal entry should Derby Company make on January 31st assuming adjusting entries are made monthly? A) Debit Deferred Revenue; Credit Ticket Revenue B) Debit Ticket Revenue; Credit Deferred Revenue C) Debit Cash; Credit Deferred Revenue D) Debit Deferred Revenue; Credit Cash Answer: A Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Novella Company sells annual memberships to its auto club. The memberships cost $400 each. On January 1, Novella sold 7,000 memberships and received cash. How should Novella record the receipt of cash on January 1? A) revenue of $233,333 B) liability of $0 C) revenue of $2,800,000 D) liability of $2,800,000 Answer: D Explanation: $2,800,000 = 7,000 × $400 Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Novella Company sells annual memberships to its auto club. The memberships cost $700 each. On January 1, Novella sold 14,000 memberships and received cash. How much revenue should Novella record on January 1? A) $0 B) $700 C) $8,400 D) $9,800,000 Answer: A Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Which of the following is not an indicator to determine when control transfers? A) Seller has present right to payment for the asset B) Customer has significant risk and rewards of ownership of the asset C) Seller has legal title to asset D) Seller has transferred physical possession of the asset Answer: C Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) The first step in revenue recognition is to ________. A) identify contracts with customers B) allocate the transaction price to the performance obligation C) identify the performance obligations D) recognize revenue Answer: A Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) The last step in revenue recognition is to ________. A) identify contracts with customers B) allocate the transaction price to the performance obligation C) identify the performance obligations D) recognize revenue Answer: D Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) IT Technology enters into a contract with the federal government to create a system for the price of $8 million. IT receives $3 million when the contract is signed and the other $5 million upon completion of the project. The government maintains control of the system during the creation process. IT estimates that 15,000 labor hours will be required to complete the product. During the current year 7,000 labor hours are used and during the following year, the remaining 8,000 hours were used. What is the journal entry at inception of the project? A) Debit to Cash; Credit to Sales Revenue B) Debit to Cash; Credit to Deferred Revenue C) Debit to Cash; Government Contracts D) Debit to Cash; Credit to Accounts Receivable Answer: B Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) IT Technology enters into a contract with the federal government to create a system for the price of $14 million. IT receives $5.6 million when the contract is signed and the other $8.4 million upon completion of the project. The government maintains control of the system during the creation process. IT estimates that 33,000 labor hours will be required to complete the product. During the current year 9,900 labor hours are used and during the following year, the remaining 23,100 hours were used. What will be included in the journal entry at the end of the current year? (Round any intermediary calculations to the nearest cent, and round your final answer to the nearest dollar.) A) Debit to Service Revenue for $4,199,976 B) Credit to Deferred Revenue for $8,400,000 C) Credit to Service Revenue for $9,800,024 D) Debit to Deferred Revenue for $4,199,976 Answer: D Explanation: $14,000,000/33,000 hours = $424.24 an hour × 9,900 = $4,199,976 Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) What are the conditions that must be met in order for the seller to recognize revenue? Answer: A good or a service is transferred and revenue is recognized when the customer obtains control of the good or service. A customer has control of the asset if he has the ability to direct the use of the asset and receives all (or substantially all) of the remaining benefits of the asset. Diff: 1 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Fancy Gardens sells an annual magazine subscription for $50. On January 1 of the current year, Fancy Gardens sells 2,000 annual subscriptions to its magazine. The magazine is issued monthly, and begins on January 1. Required: Prepare the journal entry to record the initial sale of the subscriptions and the adjusting entry on January 31. Answer: January 1 Cash ($50 × 2,000) 100,000 Deferred Revenue 100,000 January 31

Deferred Revenue ($100,000 / 12 months) Subscription Revenue

8,333 8,333

Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) Motorcycle Madness sells an annual membership to its club for $300. On July 1, 2022 Motorcycle Madness sells 1,000 of these. The memberships begin immediately. The club prepares financial statements annually on December 31. Required: Prepare the journal entries that Motorcycle Madness would record on July 1, 2022, December 31, 2022, and on June 30, 2023. Answer: July 1 Cash ($300 × 1,000) 300,000 Deferred Revenue 300,000 December 31 Deferred Revenue ($300,000 × 50% earned) Membership Revenue

150,000

June 30

150,000

Deferred Revenue Membership Revenue

150,000

Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) Macro Tech enters a contract on January 1, 2025 to produce software for a customer for $5,000,000. Macro Tech receives $2,000,000 from the customer upon contract signing and the balance at the completion of the contract. According to the contract, the customer controls the system during the creation of the program. Macro Tech estimates that it will take two years to complete the project and uses the number of labor hours to estimate the rate of completion. Macro Tech spends 30,000 hours in the first year of the contract and another 20,000 hours the second year. Required: Prepare the entries recorded by Macro Tech over the life of this contract. Assume that all payments are complete by the end of 2026. Answer: % Labor Revenue (c) = Labor Hours Year Hours to Total Revenue (a) Total (b) × (b) 2025 30,000 60% $3,000,000 2026 20,000 40% 2,000,000 Total 50,000 $5,000,000

January 1, 2025

Cash

2,000.000 Deferred Revenue

2,000,000

December 31, 2025 Deferred Revenue Accounts Receivable Service Revenue

2,000,000 1,000,000

December 31, 2026 Cash

3,000,000

Accounts Receivable Service Revenue

1,000,000 2,000,000

Diff: 3 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) Argus sells auto parts. On August 1, a customer purchases parts for $3,900 cash. The parts cost Argus $1,300. Argus uses the perpetual inventory method. Required: Prepare the necessary entries to record the sale. Answer: August 1 Cash Sales Revenue August 31

Cost of Goods Sold Inventory

3,900 3,900

1,300 1,300

Diff: 2 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) Penn sells cameras. On August 1, a customer purchases a camera for $5,700 cash. The camera cost Penn $2,500. Penn uses the perpetual inventory method. Required: Prepare the necessary entries to record the sale. Answer: August 1 Cash Sales Revenue Cost of Goods Sold Inventory

5,700 5,700 2,500 2,500

Diff: 1 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) Argus sells auto parts. On August 1, a customer purchases parts for $3,900 on account. The parts cost Argus $1,300. Argus uses the perpetual inventory method. The customer paid for the parts on August 31. Required: Prepare the necessary entries to record the sale and the collection of cash at the end of the month. Answer: August 1 Accounts Receivable 3,900 Sales Revenue 3,900 Cost of Goods Sold Inventory

1,300 1,300

August 31 Cash

3,900 Accounts Receivable

3,900

Diff: 1 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

28) Penn sells cameras. On August 1, a customer purchases a camera for $5,700 on account. The camera cost Penn $2,500. Penn uses the perpetual inventory method. The customer paid for the camera at the end of the month. Required: Prepare all necessary entries to record the sale and collection of cash at the end of the month. Answer: August 1 Accounts Receivable 5,700 Sales Revenue 5,700 Cost of Goods Sold Inventory

2,500 2,500

August 31 Cash

5,700 Accounts Receivable

5,700

Diff: 1 Objective: 8.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8.7

Accounting for Long-Term Contracts

1) The two methods for recognizing revenue from long-term contracts are the percentage-of-completion method and the point-of-sale method. Answer: FALSE Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The completed-contract method recognizes gross profit over the life of the contract. Answer: FALSE Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) For information to be relevant it should have predictive value which is a primary reason to use the completed-contract method. Answer: FALSE Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The cumulative percentage of completion is found by dividing the total costs incurred to date by the estimated total cost of the project. Answer: TRUE Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The percentage-of-completion method may utilize a cost-to-cost approach or an output measure approach. Answer: TRUE Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Journal entries for the percentage-of-completion method are only made at the completion of the project. Answer: FALSE Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Under the completed-contract method, the firm only reports profit in the final year of the contract. Answer: TRUE Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Under the completed-contract method, revenues are only reported in the last year of the contract. Answer: FALSE Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Companies may use the completed-contract method for all long-term contracts. Answer: FALSE Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Two methods used to account for revenue recognition for long term contracts are the percentage-ofcompletion method and the ________. A) installment sales method B) cost recovery method C) completed-contract method D) sales method Answer: C Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) The percentage-of-completion method recognizes gross profit ________. A) over the life of the contract B) at the end of the contract C) at the beginning of the contract D) one year after completion of contract Answer: A Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) The method of reporting gross profit for long term contracts that does a better job of providing relevant information on the income statement is the ________. A) completed-contract-method B) installment sales method C) cost recovery method D) percentage-of-completion method Answer: D Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Companies may use the completed-contract method only if the contract ________. A) is for less than two years B) exceeds five years C) does not meet criteria for percentage-of-completion method D) does not meet criteria for installment sales method Answer: C Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Under the completed-contract method, revenue is recognized ________. A) each year of the contract B) only the first year of the contract C) only the last year of the contract D) only when there is a loss on the contract Answer: A Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) The major difference between the percentage-of-completion method and the completed-contract method is the timing of ________. A) revenue and cost recognition B) revenue and billing recognition C) revenue and gross profit recognition D) revenue and net profit recognition Answer: C Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Tullis Construction enters into a long-term fixed price contract to build an office tower for $10,800,000. In the first year of the contract Tullis incurs $1,800,000 of cost and the engineers determined that the remaining costs to complete the project are $4,200,000. Tullis billed $3,600,000 in year 1 and collected $3,500,000 by the end of the end of the year. How much gross profit should Tullis recognize in Year 1 assuming the use of the completed-contract method? A) $0 B) $1,800,000 C) $4,800,000 D) $6,000,000 Answer: A Explanation: In the completed-contract method, zero gross profit is reported until the project is completed. Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Tullis Construction enters into a long-term fixed price contract to build an office tower for $10,900,000. In the first year of the contract Tullis incurs $3,000,000 of cost and the engineers determined that the remaining costs to complete the project are $5,000,000. Tullis billed $5,000,000 in year 1 and collected $3,400,000 by the end of the year. How much should Tullis report as Accounts Receivable at the end of year 1 on the balance sheet assuming the use of the completed-contract method? A) $0 B) $1,600,000 C) $5,000,000 D) $8,400,000 Answer: B Explanation: Accounts receivable is debited by $5,000,000 when the customer is billed and credited $3,400,000 when cash is received (collection) resulting in an ending balance (debit) of $1,600,000. Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Tullis Construction enters into a long-term fixed price contract to build an office tower for $10,200,000. In the first year of the contract Tullis incurs $3,000,000 of cost and the engineers determined that the remaining costs to complete the project are $5,000,000. Tullis billed $4,000,000 in year 1 and collected $3,200,000 by the end of the end of the year. How should Tullis report Construction in Progress and Billings on Construction in Progress at the end of year 1 on the balance sheet assuming the use of the completed-contract method? A) liability of $1,000,000 B) asset of $1,000,000 C) asset of $800,000 D) liability of $800,000 Answer: A Explanation: The company must report the net amount of the CIP and billings on CIP on the balance sheet at each balance sheet date. An asset is reported when the CIP is greater than the billings on CIP. A liability is reported if the billings on CIP is greater than the CIP. In this case, the CIP is a $3,000,0000 (debit) balance while the billings on CIP is a $4,000,000 (credit) balance which means a liability of the net amount of $1,000,000 should be reported. Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Gleason Construction enters into a long-term fixed price contract to build an office building for $26,000,000. In the first year of the contract Gleason incurs $4,000,000 of cost and the engineers determined that the remaining costs to complete are $15,000,000. How much gross profit or loss should Gleason recognize in Year 1 assuming the use of the completed-contract method? A) $7,000,000 loss B) $3,500,000 profit C) $0 profit D) $153,846 loss Answer: C Explanation: In the completed-contract method, zero gross profit is reported until the project is completed. Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) The Construction in Progress account is what type of account? A) liability B) revenue C) asset D) expense Answer: C Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) The Billings on Construction in Progress is a/an ________. A) asset B) liability C) contra-asset D) revenue Answer: C Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Costs and recognized profits in excess of billings are carried on the balance sheet as a/an ________. A) asset B) liability C) equity D) revenue Answer: A Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) Billings in excess of costs and recognized profits are carried on the balance sheet as a/an ________. A) asset B) liability C) equity D) revenue Answer: B Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) Tullis Construction enters into a long-term fixed price contract to build an office tower for $10,400,000. In the first year of the contract Tullis incurs $2,250,000 of cost and the engineers determined that the remaining costs to complete the project are $4,000,000. Tullis billed $3,800,000 in year 1 and collected $3,500,000 by the end of the year. How much gross profit should Tullis recognize in Year 1 assuming the use of the percentage-of-completion method? (Round the gross profit percentage to 4 decimal places.) A) $0 B) $1,494,000 C) $3,744,000 D) $5,994,000 Answer: B Explanation: The percentage completed by year 1 is 36% = $2,250,000/$6,250,000. Current year Revenues = $10,400,000 × 36% = $3,744,000. Total gross profit = $3,744,000 - $2,250,000 = $1,494,000. Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) When accounting for revenue for a long-term contract, the percentage of completion used to recognize revenue in the first year usually is determined by measuring ________. A) costs incurred in the first year, divided by estimated remaining costs to complete the project B) costs incurred in the first year, divided by estimated total costs for the completed project C) costs incurred in the first year, divided by estimated gross profit D) costs incurred in the first year, divided by estimated total costs to be incurred in the remaining years of the project Answer: B Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) Camey Construction enters into a long-term fixed price contract to build an office building for $5,000,000. In the first year of the contract Camey incurs $1,400,000 of cost and the engineers determined that the remaining costs to complete the project are $2,500,000. Camey billed $2,000,000 and collected $1,000,000 in year 1. Refer to Camey Construction. How much gross profit should Camey recognize in Year 1 assuming the use of the percentage of completion method? (Round the gross profit percentage to 4 decimal places.) A) $395,000 B) $600,000 C) $502,600 D) $1,400,000 Answer: A Explanation: $395,000 is the gross profit to be recognized. The percentage of completion percentage is $1,400,000/$3,900,000 = 0.3590. Total Revenues for the year = $5,000,000 × 35.9% = $1,795,000. Total Gross Profit = $1,795,000 - $1,400,000 = $395,000. Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) Gleason Construction enters into a long-term fixed price contract to build an office building for $27,000,000. In the first year of the contract Gleason incurs $3,000,000 of cost and the engineers determined that the remaining costs to complete the project are $25,100,000. How much gross profit or loss should Gleason recognize in Year 1 assuming the use of the percentage-of-completion method? A) $1,100,000 profit B) $1,100,000 loss C) $0 D) $117,438 loss Answer: B Explanation: Gross Loss = $27,000,000 Price - $28,100,000 Costs = ($1,100,000). Following conservatism, the entire loss of $1,100,000 is recorded in Year 1. Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

28) Gleason Construction enters into a long-term fixed price contract to build an office building for $29,000,000. In the first year of the contract Gleason incurs $11,000,000 of cost and the engineers determined that the remaining costs to complete are $9,000,000. How much gross profit or loss should Gleason recognize in Year 1 assuming the use of the percentage-of-completion method? (Round the gross profit percentage to 4 decimal places) A) $18,000,000 profit B) $20,000,000 loss C) $4,950,000 profit D) $15,950,000 loss Answer: C Explanation: The percentage of completion is 55.00% = $11,000,000/$20,000,000. Total Revenues for year 1 = $29,000,000 × 0.5500 = $15,950,000. Total Gross Profit = $15,950,000 - $11,000,000 = $4,950,000 Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

29) What happens to the Construction in Progress account and the Billings on Construction in Progress accounts upon completion of a long-term contract? Answer: At the end of the construction, these two accounts are closed or zeroed out, thereby indicating the completion of the contract(project) and the turning over of the asset to the buyer. This is accomplished by crediting the Construction in Progress account and debiting the Billings on Construction in Progress account. Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

30) Jones Construction enters into a long-term fixed price contract to build an office building for $10,000,000. In the first year of the contract Jones incurs $3,000,000 of cost and the engineers determined that the remaining costs to complete the project are $5,000,000. Jones billed $3,600,000 in year 1 and collected $3,500,000 by the end of the year. How much gross profit should Jones recognize in Year 1 assuming the use of the percentage-of-completion method? (Round any intermediary percentages to the nearest hundredth percent, and round your final answer to the nearest dollar.) Answer: The percentage completed by year 1 is $3,000,000 / ($3,000,000 + $5,000,000) = 37.5% Revenue for year 1 = $10,000,000 × 37.5% = $3,750,000 Total gross profit = $3,750,000 - $3,000,000 = $750,000. Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Gordo Yachts (use the following information for the next 2 questions) At the beginning of 2025 Gordo Yachts enters into a contract to build a luxury yacht for a customer that is expected to take three years to complete. The contract price is $4,000,000. Completion is scheduled for the end of 2027. Gordo's year end is December 31. The following is a year by year summary of construction costs incurred and the estimated costs to complete the projects at the end of each year.

Actual costs incurred current year actual costs incurred prior years Cumulative actual costs incurred to date Estimated costs to complete end of year Total Costs Billings Cash Collections

2025

2026

2027

$750,000

$2,250,000

$775,000

-0-

750,000

3,000,000

750,000

3,000,000

3,775,000

2,250,000 $3,000,000 $700,000 500,000

750,000 $3,750,000 $2,600,000 2,000,000

-0$3,775,000 $700,000 1,500,000

31) Refer to Gordo Yachts. Compute the gross profit for 2025 and 2026 and 2027 using the percentageof-completion method. Answer: 2025 $1,000,000 TGP × 750,000 / 3,000,000 = $250,000 GP 2026 $250,000 TGP × 3,000,000 / 3,750,000 = $200,000 - 250,000 = ($50,000) Loss 2027 $225,000 TGP × 100% = $225,000 - 200,000 = $25,000 GP Diff: 2 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

32) Refer to Gordo Yachts. Prepare all necessary entries for 2025 assuming the use of the percentage-ofcompletion method. Answer: 2025 Construction in Progress 750,000 Cash, Supplies Inventory, or A/P 750,000 Accounts Receivable Billings on Construction in Progress

700,000

Cash

500,000

700,000

Accounts Receivable

500,000

Construction in Progress Construction Costs Revenue on Long-term Contract

250,000 750,000 1,000,000

Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

33) At the beginning of 2025 Premier Yachts enters into a contract to build a luxury yacht for a customer that is expected to take three years to complete. The contract price is $12,000,000. Completion is scheduled for the end of 2027. Premier's year end is December 31. The following is a year by year summary of construction costs incurred and the estimated costs to complete the projects at the end of each year.

Actual costs incurred current year Actual costs incurred Prior years Cumulative actual costs incurred to date Estimated costs to complete end of year Total Costs Billings Cash Collections

2025

2026

2027

$2,250,000

$6,750,000

$2,325,000

-0-

2,250,000

9,000,000

2,250,000

9,000,000

11,325,000

6,750,000 $9,000,000 $2,100,000 1,500,000

2,250,000 $11,250,000 $7,800,000 6,000,000

-0$11,325,000 $2,100,000 4,500,000

Required: Calculate the gross profit for each year assuming the percentage of completion method is used. Answer: 2025 $3,000,000 TGP × 2,250,000 / 9,000,000 = $750,000 GP 2026 $750,000 TGP × 9,000,000 / 11,250,000 = $600,000 - 750,000 = $150,000 Loss 2027 $675,000 TGP × 100% = $675,000 - ($600,000) = $75,000 GP Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Craft Construction (use the following information for the next 2 questions) Craft Construction entered into a contract to construct a generator station for a utility customer. The project was started in 2025 and completed in 2026. Cost and other information is presented below.

Costs incurred during the year Estimated costs to complete Billings during the year Cash collections during the year

2025 $225,000 450,000 200,000 150,000

2026 $550,000 -0700,000 750,000

34) Refer to Craft Construction. Assume Craft uses the percentage-of-completion method for revenue recognition. Compute the amount of gross profit for 2025 and 2026. Answer: 2025 Contract price $900,000 Actual costs to date 225,000 Estimated costs to complete 450,000 Total estimated project costs 675,000 Estimated total gross profit 225,000 Percentage of Completion 225/675 33.33% Gross profit $75,000 2026 Contract price Costs Incurred

$900,000 2025 2026

$225,000 550,000

Total Cost Total Gross Profit Recognized in 2025 Recognized in 2026

$775,000 125,000 75,000 50,000

Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

35) Refer to Craft Construction. Assume Craft uses the percentage-of-completion method for revenue recognition. Prepare all journal entries to record costs, billings, collections and profit recognition. Answer: 2025 Construction in Progress 225,000 Cash, Supplies Inventory, or A/P 225,000 Accounts Receivable Billings on Construction in Progress

200,000

Cash

150,000

200,000

Accounts Receivable

150,000

Construction in Progress Construction Costs Revenue on Long-term Contracts

75,000 225,000 300,000

2026 Construction in Progress Cash, Supplies Inventory, or A/P

550,000 550,000

Accounts Receivable Billings on Construction in Progress

700,000

Cash

750,000

700,000

Accounts Receivable

750,000

Construction in Progress Construction Costs Revenue on Long-term Contracts

50,000 550,000

Billings on Construction in Progress Construction in Progress

900,000

600,000

900,000

Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Brutus Construction started work on a new high rise building on January 1, 2025, The project completion date is December 2027. The contract price is $54,000,000. The following are the actual costs incurred and estimates of cost to complete the project. Years 2025 2026 2027

Actual costs incurred $15,000,000 22,500,000 17,500,000

Estimated costs to complete $30,000,000 22,500,000 -0-

36) Calculate gross profit or loss for 2025, 2026 and 2027 using the percentage of completion method. Answer: Gross Profit Year (Loss) Supporting Computations (in $ millions) $15,000,000 / ($15,000,000 + $30,000,000) = 33.3% $54,000,000 × 33.3% = $17,982,000 Year 1 Revenues 2025 $2,982,000 $17,982,000 - $15,000,000 costs incurred = $2,982,000 gross profit

2026

$(6,732,000)

($15,000,000 + $22,500,000) / ($15,000,000 + $22,500,000 + $22,500,000) = 62.5% $54,000,000 × 62.5% = $33,750,000 - $17,982,000 = $15,768,000 $15,768,000 – $22,500,000 costs incurred = $(6,732,000) Loss

2027

$2,750,000

$54,000,000 - $33,750,000 = $20,250,000 $20,250,000 - $17,500,000 = $2,750,000

Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

37) Explain the similarities and differences between the two methods of accounting for long-term contracts. Answer: The two methods for accounting for long-term contracts are the percentage-of-completion method and the completed-contract method. Both methods of accounting record construction in progress, receivables, billings, collections, revenue and construction costs in the same manner. However, the percentage-of-completion approach records a percentage of profit based upon the percentage of costs incurred to estimated total costs. By contrast, the completed-contract method, records no profits until the contract is completed. Both methods record losses as soon as they are incurred. Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

38) When may companies use the completed-contract method? Answer: Companies are restricted in the use of the completed-contract method, and may only use the completed-contract method when a company does not meet the criteria to use the percentage-ofcompletion method. This is especially true when it is not possible to make reasonable estimates of the progress on a contract throughout its duration. Diff: 1 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

39) At the beginning of 2025 Gordo Yachts enters into a contract to build a luxury yacht for a customer that is expected to take three years to complete. The contract price is $4,000,000. Completion is scheduled for the end of 2027. Gordo's year end is December 31. The following is a year by year summary of construction costs incurred and the estimated costs to complete the projects at the end of each year.

Actual costs incurred current year actual costs incurred prior years Cumulative actual costs incurred to date Estimated costs to complete end of year Total Costs Billings Cash Collections

2025

2026

2027

$750,000

$2,250,000

$775,000

-0-

750,000

3,000,000

750,000

3,000,000

3,775,000

2,250,000 $3,000,000 $700,000 500,000

750,000 $3,750,000 $2,600,000 2,000,000

-0$3,775,000 $700,000 1,500,000

Compute gross profit for 2025, 2026, and 2027 assuming the use of the completed- contract method. Answer: 2025 $-0- GP Comp. Cont. Method 2026 $-0- GP Comp. Cont. Method 2027 $225,000 TGP × 100% = $225,000 GP Comp. Cont. Method Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

40) At the beginning of 2022 Premier Yachts enters into a contract to build a luxury yacht for a customer that is expected to take three years to complete. The contract price is $12,000,000. Completion is scheduled for the end of 2024. Premier's year end is December 31. The following is a year by year summary of construction costs incurred and the estimated costs to complete the projects at the end of each year.

Actual costs incurred current year Actual costs incurred prior years Cumulative actual costs incurred to date Estimated costs to complete end of year Total Costs Billings Cash Collections

2022

2023

2024

$2,250,000

$6,750,000

$2,325,000

-0-

2,250,000

9,000,000

2,250,000

9,000,000

11,325,000

6,750,000 $9,000,000 $2,100,000 1,500,000

2,250,000 $11,250,000 $7,800,000 6,000,000

-0$11,325,000 $2,100,000 4,500,000

Required: Prepare the entries under the completed-contract method for 2024 Answer: 2024 Construction in Progress 2,250,000 Cash, Supplies Inventory, or A/P 2,250,000 Accounts Receivable Billings on Construction in Progress

2,100,000

Cash

1,500,000

2,100,000

Accounts Receivable

1,500,000

Construction Costs Revenue from Long-term Contracts

2,250,000 750,000

Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Costs incurred during the year Estimated costs to complete Billings during the year Cash collections during the year

2025 $225,000 450,000 200,000 150,000

2026 $550,000 -0700,000 750,000

41) Refer to Craft Construction. Assume Craft uses the completed-contract method for revenue recognition. Compute the amount of gross profit for 2025 and 2026. Answer: 2025 Contract price $900,000 Actual costs to date 225,000 Estimated costs to complete 450,000 Total estimated project costs 675,000 Estimated total gross profit 0 Gross profit 0 2026 Contract price Costs Incurred

$900,000 2025 2026

$225,000 550,000

Total Cost Total Gross Profit Recognized in 2025 Recognized in 2026

775,000 $125,000 $-0$125,000

Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

42) Refer to Craft Construction. Assume that Craft uses the completed-contract method for revenue recognition. Make the appropriate journal entries for 2025 and 2026 for Craft Company. Answer: 2025 Construction in Progress 225,000 Cash, Supplies Inventory, or A/P 225,000 Accounts Receivable Billings on Construction in Progress

200,000

Cash

150,000

200,000

Accounts Receivable

150,000

Construction Costs Revenue from Long-term Contracts

225,000 225,000

2026 Construction in Progress Cash, Supplies Inventory, or A/P

550,000 550,000

Accounts Receivable Billings on Construction in Progress

700,000

Cash

750,000

700,000

Accounts Receivable

750,000

Construction Costs Construction in Progress Revenue from Long-term Contracts

550,000 125,000

Billings on Construction in Progress Construction in Progress

900,000

675,000

900,000

Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

43) Brutus Construction started work on a new high rise building on January 1, 2024, The project completion date is December 2026. The contract price is $54,000,000. The following are the actual costs incurred and estimates of costs to complete the project. Years 2024 2025 2026

Actual costs incurred $15,000,000 22,500,000 17,500,000

Estimated costs to complete $30,000,000 22,500,000 -0-

Calculate gross profit or loss for each year using the completed-contract method. Answer: Year GP or Loss Supporting Computations 2024 $-0No profit recognized 2025 ($6,000,000) ($54 - 60) = $6 anticipated loss 2026 $5,000,000 ($54 - 55) = Total $1,000,000 loss—$5,000,000 recaptured Diff: 3 Objective: 8.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8.8

Special Issues in Revenue Recognition

1) The right of return represents a separate performance obligation. Answer: FALSE Diff: 1 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) A consignment sale is an example of a principal-agent arrangement. Answer: TRUE Diff: 1 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Transactions where a buyer accepts title and billings but delays receipt of the goods is a bill-and-hold arrangement. Answer: TRUE Diff: 1 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) A seller recognizes the amount of returns from right to return sales as a/an ________. A) liability B) asset C) revenue D) expense Answer: A Diff: 1 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Which one of the following is not an indicator of a consignment arrangement? A) Consignor controls product until a specific event occurs. B) Consignor can require the goods be returned. C) Consignee does not have an unconditional obligation to pay for product. D) Consignor cannot require goods to be returned. Answer: D Diff: 2 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Another name for channel stuffing is ________. A) trade stuffing B) trade loading C) channel loading D) trade disclosure Answer: B Diff: 1 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Louise paints seascapes and landscapes. During the current year she placed nine of her most prized paintings with the Wainwright Studio Gallery. The paintings each carried a price of $8,000, and Louise made a deal with the Gallery to pay them a 40% commission on all paintings sold. At the end of the year, three paintings had been sold. How much revenue will Louise recognize on each of the consignment sales? A) $8,000 B) $4,800 C) $3,200 D) $0 Answer: A Diff: 2 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) ABC Company is holding goods with a selling price of $100,000 which cost them $60,000. On December 3, 2025, ABC sold the goods to Timmons under a bill-and-hold arrangement. At the end of 2025, ABC still holds the goods. Assume ABC meets the four conditions necessary under a bill-and-hold arrangement to claim it has transferred control to the buyer. How much revenue should ABC recognize for 2025? A) $100,000 B) $60,000 C) $40,000 D) $0 Answer: A Diff: 2 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Fare Jewelry Company is holding goods on consignment from Tomko with a selling price of $4,000,000. Fare is promised a commission of 25% for goods sold. By the end of 2025 Fare has sold $500,000 of Tomko's goods. How much revenue should Tomko recognize for 2025 on this transaction? A) $0 B) $4,000,000 C) $3,500,000 D) $500,000 Answer: D Diff: 2 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Fare Jewelry Company is holding goods on consignment from Tomko with a selling price of $5,000,000. Fare is promised a commission of 25% for goods sold. By the end of 2025 Fare has sold $900,000 of Tomko's goods. Refer to Fare Jewelry. How much revenue should Fare recognize for 2025 on this transaction? A) $0 B) $225,000 C) $900,000 D) $5,000,000 Answer: B Explanation: The seller (Fare) earns its revenue on consigned goods based on a 25% commission. 25% of $900,000 (the selling price of the goods sold) is $225,000. Diff: 2 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) What is a consignment sale? Answer: A consignment sale is an arrangement where a seller (consignor) delivers goods to a third party (consignee), who sells the goods to a customer. A consignment sale is an example of a principalagent arrangement. The agent records only the revenue that he or she receives in commissions, while the principal records the revenue from the sale. Diff: 2 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Explain a bill-and-hold arrangement. Answer: A bill-and-hold arrangement is a transaction where a buyer accepts title and billings but delays the physical receipt of the goods. The buyer may request a delay in delivery for a number of reasons. The seller may recognize revenue if he has transferred control. There are four criteria that must be met for control to be transferred to the buyer: 1. The reason for the bill-and-hold arrangement must be substantive. 2. The product must be separately identified as belonging to the customer. 3. The product must be ready for physical transfer to the customer. 4. The selling entity cannot have the ability to use the product in any way. Diff: 2 Objective: 8.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8.9

Disclosures Related to Revenue Recognition

1) Companies provide information in only one major area with regard to revenues and that is information about its contracts with customers. Answer: FALSE Diff: 1 Objective: 8.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Companies may choose the method used to disaggregate revenues when disclosing information about revenues. Answer: TRUE Diff: 1 Objective: 8.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Companies should not provide information to financial statement users about warranties and related obligations. Answer: FALSE Diff: 1 Objective: 8.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Disclosures concerning significant judgments in revenue recognition include all of the following except ________. A) information regarding fair value of consideration exchanged B) methods used to recognize revenue C) allocation of the transaction price D) an assessment of whether an estimate of variable consideration is constrained Answer: A Diff: 2 Objective: 8.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Companies provide information about performance obligations in contracts with customers, including information about ________. A) types of warranties but not obligations B) types of warranties and obligations C) return obligations but not refund obligations D) liabilities exchanged Answer: B Diff: 2 Objective: 8.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Disclosures required for revenue include all of the following except ________. A) disaggregation of revenue B) performance obligations C) assessing constraints on variable consideration D) allocating assets Answer: D Diff: 2 Objective: 8.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) What are the required disclosures for revenue contracts with customers? Answer: The required disclosures for revenue contracts with customers include: 1. Disaggregation of revenue 2. Contract balances 3. Performance obligations 4. Transaction price allocation to remaining performance obligations Diff: 2 Objective: 8.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) What are the required disclosures concerning significant judgments in revenue recognition? Answer: With respect to judgments in revenue recognition, companies should disclose the judgments and the changes in judgments made in applying revenue recognition guidance. Companies provide descriptions of the timing of satisfaction of performance obligations, including the methods used to recognize revenue and an explanation of why the methods provide a faithful depiction of the transfer of goods and services. Companies also disclose information about the transaction price and the amounts allocated to performance obligations. Diff: 2 Objective: 8.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 9 Short-Term Operating Assets: Cash and Receivables 9.1

Accounting for Cash and Cash Equivalents

1) Cash equivalents are short-term, highly liquid investments with original maturities of one year or less. Answer: FALSE Diff: 1 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Cash equivalents may include Treasury bills and certificates of deposit. Answer: TRUE Diff: 1 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) According to U.S. GAAP, checks written in excess of the balance of a bank account are deducted from the cash account on the balance sheet. Answer: FALSE Diff: 1 Objective: 9.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) A compensating cash balance held as support of a credit agreement is not classified as cash on the balance sheet. Answer: TRUE Diff: 1 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Accounting standards require separate disclosure for cash and cash equivalents that are restricted from use in operations. Answer: TRUE Diff: 1 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which of the following is considered to be cash (not a cash equivalent)? A) treasury bill B) money market fund C) certificate of deposit D) money order Answer: D Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) What is the balance sheet classification of a bank account whose fund balance is restricted for retirement of bonds that mature in six years? A) current asset B) noncurrent asset C) current liability D) noncurrent liability Answer: B Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) What is a compensating balance? A) short-term investments with original maturities that are less than one year B) negative cash balance that occurs when a company writes a check in an amount that exceeds the account balance C) short-term liquid investment with original maturity of three months or less D) minimum cash balance required to be maintained by a credit agreement Answer: D Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) What is a cash equivalent? A) reclassification of a cash amount that is restricted from use in the current operating cycle B) negative cash balance that occurs when a company writes a check in an amount that exceeds the account balance C) short-term liquid investment with original maturity of three months or less D) minimum cash balance required to be maintained by a credit agreement Answer: C Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) What is a bank overdraft? A) reclassification of a cash amount that is restricted from use in the current operating cycle B) negative cash balance that occurs when a company writes a check in an amount that exceeds the account balance C) short-term liquid investment with original maturity of three months or less D) minimum cash balance required to be maintained by a credit agreement Answer: B Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Under U.S. GAAP, bank overdraft should generally be reported as ________. A) a decrease in the balance of Cash and Cash Equivalents B) a decrease in other current assets C) an increase in operating expenses D) an increase in current liabilities Answer: D Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Which of the following would be classified as a cash equivalent? A) Treasury bills purchased with two months until maturity that are owned by the company B) coins in the company vault C) paper currency in the cash registers used in the company stores D) checks and money orders from customers in possession but not yet deposited Answer: A Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which of the following would not be included when valuing cash and cash equivalents on the balance sheet? A) checking account balances B) Treasury bills purchased with three months until maturity C) overdraft on one of the company's checking accounts D) checks and money orders from customers in possession but not yet deposited Answer: C Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Which of the following must be disclosed in the footnotes to the financial statements? A) reclassification of a cash amount that is restricted from use in the current operating cycle B) bank overdraft listed as a current liability on the balance sheet C) short-term liquid investment with original maturity of three months or less D) minimum cash balance required to be maintained by a credit agreement Answer: A Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Grisson Enterprises provides the following information: Currency and coin 400 First Bank - Checking 1,000 Second Bank - Checking (700) First Bank - Savings * 13,000 2-month CD 12,000 5 month CD 11,000 * Restricted fund for bond retirement Following U.S. GAAP, what is the dollar amount of Cash and Cash Equivalents reported on Grisson's balance sheet? A) $24,400 B) $23,700 C) $13,400 D) $12,700 Answer: C Explanation: $13,400 = $400 + $1,000 + $12,000 Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Bordelain Company has cash in bank of $10,000, restricted cash in a separate account of $8,000, and a bank overdraft in an account at another bank of $2,000. Bordelain should report cash of ________. A) $8,000 B) $10,000 C) $16,000 D) $18,000 Answer: B Explanation: $10,000 is the only amount of cash for the balance sheet. The restricted amount of $8,000 and the bank overdraft of $2,000 are classified elsewhere on the balance sheet. Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Under what circumstances may cash in a bank account be classified as a noncurrent asset? Answer: When cash is legally restricted from use in the current operating cycle, the company reclassifies the restricted amount from the regular cash line item on the balance sheet into restricted cash. If the restriction extends beyond one year from the balance sheet date, the restricted funds account is classified as a noncurrent asset and included in the other assets section of the balance sheet. In addition, compensating balances are minimum cash balances that debtors are required to keep on deposit as support for existing credit agreements that are either part of a contractual agreement or an informal one. If the balance is held against long-term debt, reclassify the amount of cash held as a noncurrent asset on the balance sheet. Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) How do accounting standards for bank overdrafts differ under U.S. GAAP and IFRS? Answer: Under U.S. GAAP, firms typically report bank overdrafts as current liabilities on the balance sheet. Under IFRS, bank overdrafts are permitted to be included in cash and cash equivalents as a reduction if the overdraft balance is part of an integrated cash management strategy. Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Grisson Enterprises provides the following data: Currency and coins Customer checks and money orders First Bank - Checking First Bank - Savings *1 Second Bank - Checking Third Bank - Savings *2 Treasury bills – mature in 65 days *3 Note receivable – matures in 20 days 2-month CD *4 5 month CD

250 600 3,000 5,000 (1,100) 15,000 9,000 7,000 13,000 11,000

Notes related to these data include: *1 A current loan obligation to First Bank requires Grisson to maintain a $1,200 compensating balance in the Savings account. The loan obligation is noncurrent. *2 Grisson's board of directors have specified that these funds are restricted to provide for retirement of company bonds that mature in seven years. *3 Purchased 2 weeks earlier. *4 Purchased 1 month earlier. Required: a. Following U.S. GAAP, what is the dollar amount of Cash and Cash Equivalents reported on Grisson's balance sheet? b. Describe appropriate accounting treatment for any given data that is excluded from Cash and Cash Equivalents.

Answer: a. Cash and Cash Equivalents reported on Grisson's balance sheet: Currency and coins 250 Customer checks and money orders 600 First Bank - Checking 3,000 First Bank - Savings 3,800 Treasury bills – mature in 65 days 9,000 2-month CD 13,000 Total Cash and Cash Equivalents 29,650 b. Short-term Investments (Current Assets): 5 month CD

$11,000

Receivables (Current Assets): Note receivable – matures in 20 days Other Assets (Noncurrent Assets) Restricted cash for long-term loan obligation Restricted cash for Bond Retirement Fund Current Liabilities: Bank overdraft

$7,000 $1,200 $15,000 $1,100

Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Jones Company provides the following information: Currency and coin First Bank - Checking Second Bank - Checking First Bank - Savings * 2-month CD 5 month CD * Restricted fund for bond retirement

$2,000 5,000 (700) 30,000 14,000 11,000

Following U.S. GAAP, what is the dollar amount of Cash and Cash Equivalents reported on Jone's balance sheet? Answer: $21,000 Explanation: $2,000 + $5,000 + $14,000 = $21,000 Diff: 2 Objective: 9.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9.2

Accounting for Accounts Receivable: Initial Measurement

1) A trade discount reduces the list price for customers purchasing a large quantity of merchandise. Answer: FALSE Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Sales discounts are reductions granted to customers to encourage quick invoice payment. Answer: TRUE Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Under the gross method of recording accounts receivable, a customer must pay the gross amount of the invoice. Answer: FALSE Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Under the net method of recording accounts receivable, a company assumes that the customer will take the sales discount. Answer: TRUE Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The Sales Discounts Forfeited account is classified as a contra-revenue account. Answer: FALSE Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which of the following is a reduction of a catalog price whenever a company sells to a reseller in the same industry? A) trade discount B) sales discount C) net discount D) gross discount Answer: A Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The two acceptable approaches to recording sales discounts are ________. A) the net method and the aging method B) the allowance method and the aging method C) the net method and the gross method D) the allowance method and the gross method Answer: C Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) If a company employs the gross method of recording accounts receivable from customers, then sales discounts taken should be reported as ________. A) sales discounts forfeited on the income statement B) an item of "other income and expense" on the income statement C) an increase to sales revenue on the income statement D) a deduction from sales revenue on the income statement Answer: D Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) If a company employs the net method of recording accounts receivable from customers, then sales discounts forfeited should be reported as ________. A) sales discounts forfeited on the balance sheet an item of "other revenue and expense" on the income statement B) an item of "other revenue and expense" on the income statement C) an increase to sales revenue on the income statement D) a deduction from sales revenue on the income statement Answer: B Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) A company uses the gross method to account for cash discounts offered to its customers. If payment is made before the discount period expires, which of the following is correct? A) Sales discounts is debited for the amount of discounts taken by customers. B) Sales discounts is credited for the amount of discounts taken by customers. C) Accounts receivable is debited for the gross amount of cash received from customers. D) Accounts receivable is credited for the net amount of cash received from customers. Answer: A Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Frigart Company sold goods for $7,000 with terms 2/10, n/30. How much would Frigart receive if the account were paid within the discount period? A) $6,986 B) $6,860 C) $4,900 D) $6,300 Answer: B Explanation: $6,860 = $7,000 × (1 - 0.02) Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Darko Inc. made a $100,000 sale on account with terms of 1/15, n/30. If the company uses the gross method, which of the following will be included in the journal entry to record the sale on account? A) credit Accounts Receivable $100,000 B) debit Sales Discount $1,000 C) credit Sales Revenue $100,000 D) debit Cash $100,000 Answer: C Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Eurobake Inc. made a $80,000 sale on account with terms of 1/15, n/30. If the company uses the net method, which of the following will be included in the journal entry to record the sale on account? A) debit Accounts Receivable $80,000 B) debit Accounts Receivable $79,200 C) debit Sales Discount Forfeited $800 D) credit Sales Discount Forfeited $800 Answer: B Explanation: $79,200 = $80,000 × (1 - .01) Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Fraxon Inc. made a $70,000 sale on account with terms of 1/15, n/30. If the company uses the gross method, which of the following will be included in the journal entry to record customer payment within the discount period? A) credit Accounts Receivable $70,000 B) credit Sales Discount $700 C) credit Sales Revenue $70,000 D) credit Cash $69,300 Answer: A Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Gappule Corp. made a $70,000 sale on account with terms of 2/15, n/30. If the company uses the net method, which of the following will be included in the journal entry to record customer payment within the discount period? A) credit Accounts Receivable $70,000 B) debit Sales Discounts Forfeited $1,400 C) credit Sales Revenue $68,600 D) debit Cash $68,600 Answer: D Explanation: $68,600 = $70,000 × (1 - 0.02) Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Why are trade discounts not recorded in the accounts like sales discounts? Answer: Trade discounts are not recorded in the accounts because the price finally quoted is generally an accurate statement of the fair value of the product on that date. In addition, no subsequent changes can occur to affect this value from an accounting standpoint. With a sales discount, the buyer receives a choice and events subsequent to the original transaction affect the journal entries that may be needed. Diff: 2 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) ABC Inc. makes a sale to a customer for $10,000 with terms 3/15, n45. ABC Inc. uses the gross method. The customer pays ABC 12 days after the date of the invoice. What journal entry would ABC make upon receiving the payment? Answer: Accounts Debit Credit Cash $9,700 Sales Discounts $300 Accounts Receivable $10,000 To record collection on account within the discount period Diff: 2 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) On June 1, Homart Wholesalers, Inc. sells 2,000 cases of facial products for $8 per case with terms of 3/15, n/30. Homart uses the periodic inventory method. a. If Homart uses the gross method, what is the journal entry to record the sale on June 1? b. If Homart uses the gross method, what is the journal entry to record customer payment on June 12? c. If Homart uses the gross method, what is the journal entry to record customer payment on June 30? d. If Homart uses the net method, what is the journal entry to record the sale on June 1? e. If Homart uses the net method, what is the journal entry to record customer payment on June 12? f. If Homart uses the net method, what is the journal entry to record customer payment on June 30 Answer: a. Accounts Receivable 16,000 Sales 16,000 b. Cash Sales Discounts Accounts Receivable

15,520 480

c. Cash

16,000

Accounts Receivable

d. Accounts Receivable Sales

15,520

e. Cash

15,520

f. Cash

Accounts Receivable

Sales Discounts Forfeited Accounts Receivable

Diff: 2 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16,000

15,520

480 15,520

19) Cardboard Cutouts Inc. (CCI) sold $7,000 of products to a customer on account to a customer with terms of 2/10, n/30. CCI uses the expected-value method to record its credit sales and management assumes that it is 40% likely that the customer will not take the discount. (Ignore the journal entry that would typically be necessary to record the cost of goods sold and the reduction of inventory.) Record the journal entry to recognize the sale. Answer: Under the expected-value method, the company records the accounts receivable and sales at $6,916 = [($7,000 × 40%) + ($6,860 × 60%)] as follows: Expected-value Method Accounts Receivable Sales

Debit

Credit 6,916 6,916

Diff: 2 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) How does the most-likely-amount approach to recording accounts receivables differ from the expected-value method? Answer: Under the most-likely-amount method, a company records the accounts receivable at the gross amount if it anticipates that the company will not take the discount and at the net amount if it anticipates that the customer will take the discount. Under the expected-value method, the entity sums the probability-weighted amounts in a range of possible consideration amounts to arrive at the initial measurement of accounts receivable. Diff: 2 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Mason Company sold goods for $10,000 with terms 1/10, n/30. How much would Mason receive if the account were paid within the discount period? Answer: $9,900 Explanation: $10,000 × (1 - 0.01) = $9,900 Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Spencer Inc. made a $60,000 sale on account with terms of 2/15, n/30. The company uses the gross method. Record the journal entry for the sale on account. Answer: Accounts Receivable 60,000 Sales Revenue 60,000 Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) Spencer Inc. made a $60,000 sale on account with terms of 2/15, n/30. The company uses the net method. Record the journal entry for the sale on account. Answer: Accounts Receivable $60,000 × (1 - .02) 58,800 Sales Revenue 58,800 Diff: 1 Objective: 9.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9.3

Accounting for Accounts Receivable: Subsequent Measurement

1) Net realizable value (NRV) describes the estimated amount of a company's expected cost of uncollectible accounts. Answer: FALSE Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The balance-sheet value of the asset Accounts Receivable (accounts receivable less the allowance for doubtful accounts) represents the amount of cash the company is expected to collect from its customers. Answer: TRUE Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The allowance method is used to estimate not only the net realizable value of accounts receivable but also the current period's bad debt expense. Answer: TRUE Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The account Allowance for Uncollectible Accounts is classified as a contra-revenue account. Answer: FALSE Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Bad debt expense represents the amount of receivables written off during the period. Answer: FALSE Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The net realizable value of accounts receivable is calculated as ________. A) net receivables plus sales discounts forfeited B) gross receivables minus sales discounts taken C) gross receivables minus sales discounts forfeited D) gross receivables minus allowance for uncollectible accounts Answer: D Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Bad debt expense represents the amount of ________. A) gross sales that is written off during the current period B) current period sales that are expected to be uncollectible C) gross receivables that are expected to be uncollectible D) net receivables that is written off during the current period Answer: B Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) What type of account is Allowance for Uncollectible Accounts? A) current liability B) expense C) contra asset D) contra revenue Answer: C Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) What is the normal journal entry for recording bad debt expense? A) debit Bad Debt Expense, credit Allowance for Uncollectible Accounts B) debit Allowance for Uncollectible Accounts, credit Bad Debt Expense C) debit Bad Debt Expense, credit Accounts Receivable D) debit Accounts Receivable, credit Bad Debt Expense Answer: A Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Recording bad debt expense during the period when an account is determined to be uncollectible, which is generally not allowed under U.S. GAAP, is known as the ________. A) allowance method B) non-allowance method C) direct write-off method D) net write-off method Answer: C Diff: 1 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) What are the objectives of the allowance method of accounting for uncollectible receivables? Answer: There are two key objectives related to uncollectible accounts: 1. The measurement of accounts receivable on the balance sheet at estimated net realizable value. 2. The inclusion of bad debt expense related to the uncollectible accounts on the income statement in the appropriate period, so as to match the expenses with the revenues that caused those expenses to occur. Diff: 2 Objective: 9.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9.4

Uncollectible Accounts Estimates

1) The direct write-off method estimates current-period bad debt expense by focusing on balance sheet relationships. Answer: FALSE Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The aging-of-receivable method determines current-period bad debt expense by focusing on balance sheet relationships. Answer: TRUE Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The aging of accounts receivable method directly estimates the appropriate balance of the Allowance for Uncollectible Accounts. Answer: TRUE Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The aging-of-receivable method focuses on matching bad debt expense to the revenues that generated those revenues. Answer: FALSE Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) A company writes off an account receivable when it no longer expects to collect the amount due from the customer. Answer: TRUE Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The two acceptable approaches to estimating bad debt expense are ________. A) the net method and the gross method B) the aging method and the allowance method C) the gross method and the aging method D) the direct write-off method and the allowance method Answer: B Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which method of estimating bad debt expense focuses on the faithful representation of the net realizable value of receivables? A) net method B) allowance method C) aging method D) direct write-off method Answer: C Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Which method of estimating bad debt expense focuses on balance sheet relationships? A) net method B) allowance method C) aging method D) direct write-off method Answer: C Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Under the allowance method, the write-off of an uncollectible account ________. A) has no effect on the allowance for uncollectible accounts B) has no effect on net income C) increases expenses D) decreases total assets Answer: B Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Under the allowance method, the recovery of an account previously written-off ________. A) has no effect on the allowance for uncollectible accounts B) has no effect on total assets C) increases net income D) increases net realizable value of receivables Answer: B Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) How can accounting for bad debts be used for earnings management? A) changing the percentage of aged receivables that comprise the allowance balance B) using the direct write-off method to determine bad debt expense C) determining which accounts to write-off D) reversing previous write-offs Answer: A Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Lithotech, Inc. had net sales in 2022 of $800,000 . At December 31, 2022, before adjusting entries, the balances in selected accounts were: accounts receivable $124,000 debit, and allowance for doubtful accounts $1,100 credit. Lithotech estimates that 1% of its receivables will prove to be uncollectible. What is the net realizable value of the receivables reported on the statement of financial position at December 31, 2022 after adjusting entries? A) $122,760 B) $123,860 C) $124,000 D) $121,660 Answer: A Explanation: 0.01 × $124,000 = $1,240 = Allowance for Doubtful Accounts; Net Realizable Value = Accounts Receivable $124,000 – Allowance for Doubtful Accounts $1,240 = $122,760 Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Lithotech, Inc. had net sales in 2022 of $800,000. At December 31, 2022, before adjusting entries, the balances in selected accounts were: accounts receivable $121,000 debit, and allowance for doubtful accounts $1,500 debit. Lithotech estimates that 5% of its receivables will prove to be uncollectible. What is the net realizable value of the receivables reported on the statement of financial position at December 31, 2022 after adjusting entries? A) $114,950 B) $116,450 C) $113,450 D) $121,000 Answer: A Explanation: 0.05 × $121,000 = $6,050 = Allowance for Doubtful Accounts; Net Realizable Value = Accounts Receivable $121,000 – Allowance for Doubtful Accounts $6,050 = $114,950 Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Marston Company has outstanding accounts receivable totaling €9.5 million as of December 31 and sales on credit during the year of €24 million. There is also a credit balance of €12,000 in the allowance for doubtful accounts as of December 31. After aging its receivables, the company estimates that 8% of its total outstanding receivables will be uncollectible. What will be the amount of bad debt expense recognized for the year? A) €12,000 B) €760,000 C) €772,000 D) €748,000 Answer: D Explanation: €748,000 = (€9,500,000 × .08) - €12,000 Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Marston Company has outstanding accounts receivable totaling €7.5 million as of December 31 and sales on credit during the year of €20 million. There is also a credit balance of €18,000 in the allowance for doubtful accounts. After aging its receivables, the company estimates that 2% of its receivables will be uncollectible. What will be the balance for the Allowance for Uncollectible Accounts after the yearend adjustment is made to record bad debt expense? A) €418,000 B) €400,000 C) €150,000 D) €382,000 Answer: C Explanation: €150,000 = (€7.5 million × 0.2) Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Prior to adjustments, Willett Company's account balances at December 31, 2022, for Accounts Receivable and the related Allowance for Uncollectible Accounts were $2,300,000 and $120,000, respectively. An aging of accounts receivable indicated that $207,000 of the December 31, 2022, receivables may be uncollectible. The net realizable value of accounts receivable at December 31, 2022, was ________. A) $2,300,000 B) $2,180,000 C) $2,093,000 D) $1,973,000 Answer: C Explanation: $2,093,000 = $2,300,000 - $207,000 Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) During the year, Liptom Company made an entry to write off a $4,000 uncollectible account. Before this entry was made, the balance in accounts receivable was $40,000 and the balance in the allowance account was $4,900 (normal balance). What is the net realizable value of accounts receivable after the write-off entry? A) $40,000 B) $44,900 C) $35,100 D) $31,100 Answer: C Explanation: After the write-off of $4,000, the accounts receivable balance is $36,000 and the allowance account is $900 (credit balance). $36,000 - $900 = $35,100. Diff: 2 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Teeter Company began 2022 with accounts receivable of $430,000 and an allowance for uncollectible accounts of $29,000 (credit balance). Bad debt expense for the year was $34,000 and the ending balance in the allowance for uncollectible accounts account was $10,000. What was the amount of accounts receivable written off during the year? A) $19,000 B) $53,000 C) $483,000 D) $449,000 Answer: B Explanation: With a beginning balance of $29,000 (credit) for the allowance account and bad debt expense adding another $34,000 credit to that account, total credits would be $63,000. However, the account ended the year with a $10,000 credit balance and therefore, $53,000 of accounts would have been written-off ($63,000 - $10,000.) Diff: 2 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Teeter Company wrote off an account for $15,000 which was subsequently recovered. Record the journal entries upon the recovery. Answer: Answer: Accounts Debit Credit Accounts Receivable 15,000 Allowance for Doubtful Accounts 15,000 Cash Accounts Receivable

15,000 15,000

Diff: 2 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) What factors are considered when estimating bad debt expense? Answer: Estimates for uncollectible accounts are based on a firm's prior bad debt experience with consideration given to changes in credit policy, forecasted general economic conditions, industry conditions, and business conditions. Diff: 1 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) On January 1, 2022, Willett Company's account balances for Accounts Receivable and the related Allowance for Uncollectible Accounts were $3,600,000 and $90,000, respectively. During the year, sales revenue totaled $40 million, of which 70% were credit sales and the remainder were cash sales. Altogether, cash collections from all customers amounted to $30 million. Also, write-offs of accounts deemed to be uncollectible totaled $250,000. At the end of the year, an analysis of aged accounts receivable indicated that 2% of total gross receivables may be uncollectible. Required: Determine the amount of bad debt expense for the year and net realizable value of receivables at the end of the year. Answer: Summary of activity affecting the Accounts Receivable account: Summary of activity in Accounts Receivable: Beginning balance (January 1)

$3,600,000

Total credit sales = $40 million × 70%

28,000,000

Total collections

(30,000,000)

Write-offs

(250,000)

Ending balance (December 31)

$1,350,000

Summary of activity in Allowance for Doubtful Accounts: Beginning balance (January 1)

$90,000

Write-offs

(250,000)

Balance before year-end adjustment (Debit balance)

(160,000)

Bad Debt Expense = $160,000 + $27,000 =

187,000

Ending balance (December 31) = $1,350,000 × 2% =

$27,000

Summary of activity in Allowance for Doubtful Accounts: Net Realizable Value Accounts Receivable

December 31

Write-offs

$1,350,000

Balance before year-end adjustment (Debit balance) Bad Debt Expense = $160,000 + $27,000 =

27,000 $1,323,000

Bad Debt Expense is $187,000. The net realizable value is $1,323,000. Diff: 2 Objective: 9.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9.5

Financing with Accounts Receivable

1) Pledged receivables are collateral for a financing arrangement. Answer: TRUE Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Pledged receivables are reported as current assets while assigned receivables are reported as noncurrent assets. The pledged and assigned receivables are used as collateral for a long-term obligation. Answer: FALSE Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Factored receivables have been sold to another company. Answer: TRUE Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Factored receivables sold without recourse are classified as a liability. Answer: FALSE Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) To be recognized as a sale under IFRS, companies must give up effective control of factored receivables. Answer: FALSE Diff: 1 Objective: 9.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) To be recognized as a sale under IFRS, factored receivables do not have to be isolated. Answer: TRUE Diff: 1 Objective: 9.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

7) Securitization of receivables involves taking many separate receivables and bundling them into a single investment pool. Answer: TRUE Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Securitization of receivables eliminates the risk of non-collection. Answer: FALSE Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) In which of the following situations are a company's receivables sold to another entity? A) recoursing B) assigning C) factoring D) pledging Answer: C Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) In which of the following situations are a company's receivables held as collateral for a financing situation? A) collateralization B) securitization C) factoring D) pledging Answer: D Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) In which of the following transactions is a "hold back" feature applicable? A) collateralization B) securitization C) factoring D) pledging Answer: C Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Which of the following is true when accounts receivable are factored without recourse? A) The receivables are used as collateral for a promissory note issued to the factor by the owner of the receivables. B) The financing cost (interest expense) should be recognized ratably over the collection period of the receivables. C) The factor assumes the risk of collectibility and absorbs any credit losses in collecting the receivables. D) The transaction may be accounted for either as a secured borrowing or as a sale, depending upon the substance of the transaction. Answer: C Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Which of the following is not a requirement for recognizing that a transaction can be recorded as a sale of receivables? A) The factor discounts the amount remitted to the seller. B) The selling company does not maintain effective control over the receivables. C) The factor has the ability to pledge the receivables. D) The receivables are isolated from the selling company. Answer: A Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Under U.S. GAAP, which of the following would be included in the journal entry to record the sale of receivables to a factor without recourse? A) debit Accounts Receivable B) debit Loss on Sale of Receivables C) credit Cash D) credit Receivable from Factor Answer: B Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Gant Company factored its receivable with recourse to Rowlin Bank. Gant received cash as a result of this transaction. Assuming the three conditions for a sale are met, this transaction is best described as a ________. A) loan from Rowlin collateralized by Gant's accounts receivable B) loan from Rowlin to be repaid by the proceeds from Gant's accounts receivable C) sale of Gant's receivables to Rowlin with the risk of uncollectible accounts retained by Gant D) sale of Gant's receivables to Rowlin with the risk of uncollectible accounts transferred to Rowlin Answer: C Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Danzig Inc. factors $3,000,000 of its accounts receivables without recourse for a finance charge of 3%. The finance company retains an amount equal to 10% of the accounts receivable for possible adjustments. What would be recorded by Danzig as a gain (loss) on the transfer of receivables? A) gain of $90,000 B) loss of $90,000 C) loss of $300,000 D) loss of $390,000 Answer: B Explanation: $90,000 = $3,000,000 × 3% Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Ming Company factors without recourse $9,000,000 of its accounts receivable for a finance charge of 3%. The finance company retains an amount equal to 8% of the accounts receivable for possible adjustments. What amount of cash would Ming receive as a result of this initial transaction? A) $8,730,000 B) $8,280,000 C) $8,010,000 D) $9,000,000 Answer: C Explanation: $8,010,000 = $9,000,000 × (1 - (3% + 8%)) Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Popper Enterprises factors $600,000 of its accounts receivable to Third Bank with recourse for a finance charge of 3%. The finance company retains an amount equal to 7% of the accounts receivable for possible adjustments. Third Bank will return the hold back to Popper when it collects the receivables. In addition, the fair value of the recourse liability is estimated at $20,000. What amount of cash would Popper receive as a result of this transaction? A) $600,000 B) $580,000 C) $540,000 D) $570,000 Answer: C Explanation: $540,000 = $600,000 × (1 - (3% + 7%)) Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Finney Fabrics frequently factors its accounts receivable. On March 15, 2022, Finney sold without recourse $400,000 of these receivables to a factor. The factoring qualifies as a sale. The factor assessed a finance charge of 5% on the gross amount of the factored receivables and held back an additional 4% as security On June 10, the factor returned the full balance owed to Finney. Prepare Finney's journal entry to record a. the sale of the receivables on March 15, 2022; b. the receipt of cash on June 10, 2022. Answer: a. Cash Receivable from Factor ($400,000 × 4%) Loss on Sale of Receivables ($400,000 × 5%) Accounts Receivable

364,000 16,000 20,000 400,000

To record factoring without recourse of accounts receivable b. Accounts Cash

Debit 16,000

Receivable from Factor

Credit 16,000

To record collection of hold back on factoring of receivables. Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) When does a company record the transfer of accounts receivable as a sale? As a secured borrowing (a liability)? Use U.S. GAAP. Answer: A company (transferor) records the transfer of accounts receivable to a transferee as a sale when all of the following conditions are met: (1) The receivables have been isolated from the selling company. (2) The factor has the ability to pledge or exchange the receivables. (3) The transferor does not maintain effective control over the receivables. If the conditions for a sale are not met, the company records the proceeds from the transfer of accounts receivable as a secured borrowing with the receivables serving as collateral as if the company pledged the receivables. Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) What is a securitization of receivables? What are advantages and disadvantages of securitization? Answer: Securitization refers to a financing technique that involves taking many separate, and oftentimes diverse, financial assets and combining them into a single pool or bundle. Investors then purchase interests in the pool of assets rather than buying an individual asset or group of assets. Securitization allows a company to engage in a collateralized borrowing arrangement with a great number of lenders by issuing debt obligations or equity shares, rather than attempting to sell each asset. Securitization also allows a company to obtain financing at a lower cost of borrowing. The pooling of many individual assets diversifies the default risk from each individual asset, thereby enhancing an investor's ability to predict the investment's future cash flows, lowering risk, and thereby lowering the required rate of return. Securitization can also have drawbacks. Potential investors do not always have detailed knowledge on the original borrowers or their risk of default. Therefore, a company may have to offer the securities at a lower price. Even when a company can securitize its receivables, there is still the risk of noncollection. Diff: 1 Objective: 9.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9.6

Accounting for Short-Term Notes Receivable

1) Notes receivable are classified as current or noncurrent on the balance sheet based on the expected collection date. Answer: TRUE Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The market rate is the interest rate that the holder of the note will receive. Answer: FALSE Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The holder of a non-interest-bearing note does not recognize any interest revenue over the term of the note. Answer: FALSE Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) When the stated rate is equal to the market rate, the present value of future cash flows from a note is equal to the face value of the note. Answer: TRUE Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The Note Receivable account is always debited for the face value of a note. Answer: TRUE Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Discounting a note receivable is similar to pledging an account receivable. Answer: FALSE Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) When the market interest rate on a short-term note receivable is greater than the stated rate, ________. A) the present value of the note is greater than its stated value B) the present value of the note is less than its face value C) the stated value of the note is greater than its face value D) the stated value of the note is less than its face value Answer: B Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Discounting a note receivable is most similar to ________. A) factoring an account receivable B) pledging an account receivable C) securitizing an account receivable D) assigning an account receivable Answer: A Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Electroid borrowed $70,000 cash from TechCo by signing a promissory note. TechCo's entry to record the transaction should include a ________. A) debit to Accounts Receivable for $70,000 B) credit to Accounts Receivable for $70,000 C) debit to Note Receivable for $70,000 D) credit to Note Receivable for $70,000 Answer: C Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) What type of account is Discount on Note Receivable? A) revenue B) contra-revenue C) asset D) contra-asset Answer: D Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Wull Associates sold a piece of equipment to Coral Company on April 1, 2022, for $500,000. Wull agreed to accept a 9-month note with 8% interest (current market rate) due on its maturity date, December 31, 2022. Wull's journal entry to record the receipt of the note on April 1, 2022, will include a ________. A) credit to Cash for $500,000 B) debit to Cash for $500,000 C) credit to Note Receivable for $500,000 D) debit to Note Receivable for $500,000 Answer: D Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) On May 1, 2022, Fitz installed a $486,000 sound system for International Arena. Fitz agreed to accept a $481,000 six-month, noninterest bearing note due on November 1, 2022. Fitz prepares financial statements at the end of every calendar year. Fitz's journal entry to record the collection of the note plus accrued interest on November 1, 2022, will include a ________. A) credit to Interest Revenue for $481,000 B) debit to Interest Revenue for $5,000 C) credit to Note Receivable for $486,000 D) credit to Note Receivable for $481,000 Answer: D Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) On August 1, 2020, TTek installed a $560,000 computer system for Skybox.com. TTek agreed to accept a $600,000 nine-month, noninterest-bearing note due on April 30, 2021. TTek prepares financial statements at the end of every calendar year. a. Prepare TTek's journal entry to record the receipt of the note on August 1, 2020. b. Prepare the related adjusting entry on December 31, 2022. c. Prepare TTek's journal entry to record the receipt of the payment on April 30, 2021. Answer: a. Note Receivable 600,000 Discount on Note Receivable 40,000 Sales Revenue 560,000 b. Discount on Note Receivable Interest Revenue $40,000 × 5/9 = $22,222

22,222

c. Cash Discount on Note Receivable Interest Revenue Note Receivable $40,000 - $22,222 = $17,778

600,000 17,778

22,222

17,778 600,000

Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

14) On December 31, 2022, Perly Company performed environmental consulting services for Brocade Corporation. Brocade was short of cash, so Perly agreed to accept a $300,000 noninterest-bearing note due on December 31, 2024. Brocade is somewhat of a credit risk and Perly determines that 10% is an appropriate market rate. Use the present value of $1 table below: Periods 1 2 3 4

10% .90909 .82645 .75132 .68301

11% .90090 .81162 .73119 .65873

a. Prepare the journal entry to record the receipt of the note on December 31, 2022. b. Prepare the adjusting entry on December 31, 2023. Use two decimal places. c. Prepare the journal entry to record the receipt of the payment on December 31, 2024. Answer: a. Note Receivable 300,000 Discount on Note Receivable 52,065 Sales Revenue 247,935 Computation of present value of note: PV of $300,000 due in 2 years at 10% $300,000 × .82645 = $247,935 b. Discount on Note Receivable Interest Revenue

24,793.50

Computation of interest revenue: 10% of 247,935 = $24,793.50 c. Cash Discount on Note Receivable Interest Revenue Note Receivable

300,000 27,271.50

27,271.50 300,000

Computation of interest revenue: $52,065 - $24,793.50 = $27,271.50 Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) How does a note receivable differ from an account receivable? Answer: A note receivable is a written agreement to receive a certain sum of money on a specific date. Notes receivable have two attributes that accounts receivable do not have: (1) They are negotiable instruments, which means that they are legally and readily transferable among parties and may be used to satisfy debts by the holders of these instruments, and (2) they usually involve interest. Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) What is a non-interest-bearing note? How does accounting for a short-term non-interest-bearing note differ from a short-term interest-bearing note? Answer: A non-interest-bearing note is a note that does not specify an interest rate. For a short-term non-interest-bearing note, the maturity value is listed as the face value, and includes both principal and implicit interest. Therefore, the note is initially recorded at its maturity value, the total interest to be earned over the life of the note is recorded as Discount on Note Receivable, and Sales is credited for the difference. If the fiscal period ends prior to collection of the note, an adjusting entry must be made to reduce the Discount on Note Receivable and increase Interest Income. In contrast, for a short-term interest-bearing note, the Notes Receivable account is recorded at the face value of the note. After issuance, interest income is recorded as earned and is determined by multiplying the principal by the stated interest rate for the time the note has been outstanding. Diff: 1 Objective: 9.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9.7

Disclosure for Accounts Receivable and Notes Receivable

1) Companies that use the aging-of-receivables method must disclose the percentage of uncollectible amounts for each age category. Answer: FALSE Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The operating cycle is the length of time from when a product is sold until the cash is collected. Answer: FALSE Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The inventory turnover ratio is equal to 365 divided by the number of days of inventory on hand. Answer: FALSE Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The cash operating cycle is equal to (1) days accounts payable outstanding minus (2) days sales outstanding minus (3) days inventory on hand. Answer: TRUE Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Which of the following statements is true? A) Companies typically report gross receivables on the balance sheet and disclose net receivables and the allowance for uncollectible accounts in the notes to the financial statements. B) Companies typically report gross receivables and the allowance for uncollectible accounts on the balance sheet and disclose net receivables in the notes to the financial statements. C) Companies typically report net receivables on the balance sheet and disclose gross receivables and the allowance for uncollectible accounts in the notes to the financial statements. D) Companies typically report net receivables and the net allowance for uncollectible accounts on the balance sheet and disclose gross receivables in the notes to the financial statements. Answer: C Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The length of time it takes a company to generate cash from its operations is called the ________. A) operating cycle B) cash cycle C) financing cycle D) receivable cycle Answer: A Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which ratio indicates the effectiveness of a company's credit extension policy? A) inventory turnover B) accounts payable turnover C) days sales outstanding D) days inventory on hand Answer: C Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Accounts receivable turnover measures ________. A) how long it takes to sell merchandise B) the relationship between credit sales and cash sales C) the length of time it takes a company to generate cash from its operations D) how many times average receivables are collected during the year Answer: D Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) The cash operating cycle can be computed as ________. A) days accounts payable outstanding + days sales outstanding + days inventory on hand B) days accounts payable outstanding - days sales outstanding - days inventory on hand C) days accounts payable outstanding + days sales outstanding - days inventory on hand D) days accounts payable outstanding - days sales outstanding + days inventory on hand Answer: B Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Which ratio indicates the effectiveness of a company's credit extension policy? A) inventory turnover B) accounts payable turnover C) days sales outstanding D) days inventory on hand Answer: C Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) The following company information is available: Average accounts receivable Average inventories Average accounts payable Net sales Cost of goods sold Purchases

$200,000 150,000 130,000 10,000,000 1,800,000 1,140,000

What is the company's accounts receivable turnover ratio? (Assume all sales are made on credit.) A) 5.7 B) 7.3 C) 50.0 D) 9.0 Answer: C Explanation: 50.0 = $10,000,000/$200,000 Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) The following company information is available: Average accounts receivable Average inventories Average accounts payable Net sales Cost of goods sold Purchases

$400,000 150,000 100,000 4,000,000 1,200,000 1,120,000

What is the company's days sales outstanding? (Assume all sales are made on credit. Round your answer to one decimal place, X.X.) A) 36.5 B) 8.0 C) 10.0 D) 3.0 Answer: A Explanation: 36.5 = $400,000/($4,000,000/365) Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) The following company information is available: Average accounts receivable Average inventories Average accounts payable Net sales Cost of goods sold Purchases

$800,000 120,000 110,000 6,000,000 1,600,000 1,140,000

What is the company's inventory turnover ratio? (Round your answer to one decimal place, X.X.) A) 2.0 B) 13.3 C) 50.0 D) 7.5 Answer: B Explanation: 13.3 = 1,600,000/$120,000 Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) The following company information is available: Average accounts receivable Average inventories Average accounts payable Net sales Cost of goods sold Purchases

$400,000 130,000 100,000 7,000,000 1,200,000 1,120,000

What is the company's accounts payable turnover ratio? (Round your answer to one decimal place, X.X.) A) 17.5 B) 70.0 C) 11.2 D) 12.0 Answer: C Explanation: If purchases are available, then the preferred calculation for accounts payable turnover is Purchases/Average Accounts Payable. Accounts Payable Turnover = $1,120,000/$100,000 = 11.2 Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) The following company information is available: Average accounts receivable Average inventories Average accounts payable Net sales Cost of goods sold Purchases

$500,000 150,000 100,000 2,000,000 1,200,000 1,140,000

What is the company's operating cycle (in days)? (Assume all sales are made on credit. Round your answer to the nearest day.) A) 91 days B) 46 days C) 137 days D) 18 days Answer: C Explanation: The operating cycle is calculated as follows: Days Sales Outstanding + Days Inventory on Hand: 137 = 365/($2,000,000/$500,000) + 365/($1,200,000/$150,000) Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) The following company information is available: Days sales outstanding Days sales in inventory Days accounts payable outstanding

27 19 29

How long is the company's operating cycle? A) 75 days B) 56 days C) 46 days D) 8 days Answer: C Explanation: The operating cycle is calculated as follows: Days Sales Outstanding + Days Inventory on Hand: 46 = 27 + 19 Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) The following company information is available: Days sales outstanding Days sales in inventory Days accounts payable outstanding

25 16 34

How long is the company's cash operating cycle? A) -7 days B) +7 days C) -9 days D) +75 days Answer: A Explanation: Cash Operating Cycle = Days Accounts Payable Outstanding − Operating Cycle: -7 = 34 – (25 + 16) Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Complete the following disclosures of trade accounts receivables from Cheris Corp.'s notes to the financial statements. Trade Receivables Year (Ending 12/31) Trade Receivables Allowance Net Receivables

2022 $4,500 a b

2021 e 165 $3,705

Allowance for Uncollectible Accounts January 1 c $145 Bad Debt Expense 425 f Write-off d 290 December 31 $180 g Answer: Trade Receivables Year (Ending 12/31) 2022 2021 Trade Receivables $4,500 $3,870 Allowance 180 (165) Net Receivables $4,320 $3,705 Allowance for Uncollectible Accounts January 1 $165 $145 Bad Debt Expense 425 310 Write-off (410) (290) December 31 ($180) ($165) Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) What disclosures concerning accounts receivable are required? Answer: The disclosures for receivables include accounting policies and the methodology used to estimate the allowance for uncollectible accounts, such as a description of the elements that influence management's judgment and credit risk. Companies also provide a description of the policy for writing off uncollectible receivables. Companies commonly report net receivables on the balance sheet and disclose gross receivables and the allowance for uncollectible accounts in the notes to the financial statements. For the allowance, companies disclose activity during the year such as: 1. The allowance balance at the beginning and end of each period 2. Current-period bad debt expense 3. Write-offs charged against the allowance 4. Recoveries of amounts previously written-off When a company has pledged, assigned, or factored any accounts receivable, disclosures are required as to the amounts, terms, and collateral. Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Vladulac Corporation began 2022 with accounts receivable of $180,000 and an allowance for uncollectible accounts of $13,000 (credit balance). Bad debt expense for the year was $25,000 and the ending balance in the allowance for uncollectible accounts account was $16,000. The accounts receivable turnover ratio for 2022 was 10.0. NOTE: This ratio was calculated using the average of gross accounts receivable in the denominator (that is, [$180,000 + year-end accounts receivable] divided by 2). The following additional information is also available: Inventory turnover ratio 8.0 Average inventory $150,000 Gross profit ratio 40 Required: a. What was the amount of accounts receivable written off during the year? b. What was the amount of cash collected from customers during the year? Assume that all sales are made on a credit basis and that there were no collections of previously written off receivables or sales returns. Answer: a. Allowance for Doubtful Accounts = Beg. Bal. Allowance + Bad Debt Expense – Write-offs = End. Bal. Allowance Solving for write-offs: Allowance for Doubtful Accounts = Beg. Bal. Allowance + Bad Debt Expense – End. Bal. Allowance = Write-offs $13,000 (beginning allowance) + $25,000 (bad debt expense) - $16,000 (ending allowance) = $22,000 in write offs b. Inventory Turnover = COGS/Average Inventory Solving for COGS: COGS = Inventory Turnover × Average Inventory COGS = 8.0 × $150,000 = $1,200,000 Sales = Cost of Goods Sold / (1 – Gross Profit Ratio) Sales equals $1,200,000 Cost of Goods Sold / (1 - 0.40) = $2,000,000 Accounts Receivable Turnover = Sales / Average Accounts Receivable Solving for Average Accounts Receivable: Average Accounts Receivable = Sales / Accounts Receivable Turnover Average Accounts Receivable = Sales $2,000,000 / 10 Receivable Turnover = $200,000 = average receivables. Therefore, since beginning receivables are $180,000, ending receivables must be $220,000. Accounts Receivable Beg. Bal. + Credit Sales – Write-offs – Collections = Accounts Receivable End. Bal. Solving for collections: Accounts Receivable Beg. Bal. + Credit Sales – Write-offs – Accounts Receivable End. Bal. = Collections $180,000 (beginning balance) + $2,000,000 (sales) - $22,000 (write offs) - $220,000 (ending balance) = $1,938,000 (cash collections) Diff: 3 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) The following company information is available: Average accounts receivable Average inventories Average accounts payable Net sales Cost of goods sold Purchases

$100,000 150,000 200,000 2,000,000 1,400,000 1,500,000

What is the company's accounts payable turnover ratio? (Round your answer to one decimal place, X.X.) Answer: 7.5 Explanation: If purchases are available, then the preferred calculation for accounts payable turnover is Purchases/Average Accounts Payable. Accounts Payable Turnover = $1,500,000/$200,000 = 7.5 Diff: 1 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) The following company information is available: Average accounts receivable Average inventories Average accounts payable Net sales Cost of goods sold Purchases

$800,000 160,000 130,000 2,000,000 1,600,000 1,160,000

What is the company's operating cycle (in days)? (Assume all sales are made on credit. Round your answer to the nearest day.) Answer: 183 days Explanation: The operating cycle is calculated as follows: Days Sales Outstanding + Days Inventory on Hand: 183 = 365/($2,000,000/$800,000) + 365/($1,600,000/$160,000) Diff: 2 Objective: 9.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9.8

Appendix A: Internal Controls Over Cash

1) Internal controls are processes implemented in a company to ensure that key objectives are met, including the objectives of reliable financial reporting, effective and efficient operations, and compliance with regulations. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Separation of duties is one of the most critical internal controls to deter theft and misappropriation of cash. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The Sarbanes-Oxley Act of 2002 (SOX) requires that publicly traded U.S. companies maintain an effective system of internal controls. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) SOX also established the Financial Accounting Standards Board (FASB). Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) An imprest petty cash system does not provide adequate internal control over cash on hand. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Separation of duties is an internal control technique that requires all of the following except: ________. A) Any individuals who have physical custody over cash should not also handle accounting records B) Any employees handling cash should not have access to ledger accounts and bank statements C) Any employee with custody of cash should also reconcile the bank statements to the ledger accounts but should not handle the accounting for cash D) The responsibility for approving, signing, and mailing checks and handling cash disbursement documents and records should be separate functions Answer: C Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Control procedures to prevent any misappropriation and irregularities in the cash disbursements process include the following except: ________. A) Whenever possible, to minimize bank transaction fees, most disbursements should be made in the form of cash such as payments from petty cash, coin and currency B) All cash disbursements, except for immaterial payments made from petty cash, must be made by check C) Authorization is required for all cash disbursements prior to preparing a check D) The person preparing the check to pay an invoice must have all the appropriate documentation, including the vendor invoice; the approved purchase order; and the receiving report Answer: A Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Which of the following requires that publicly traded U.S. companies maintain an effective system of internal controls? A) The Sarbanes-Oxley Act of 2002 (SOX) B) Internal Revenue Service C) Securities and Exchange Act of 1934 D) AICPA Answer: A Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following could be described as follows? A comparison of the company bank statement balance to the balance in the company's general ledger cash account and a determination as to why differences between the company's books and the bank statement balance exists. A) balancing the books B) the adjustment process C) bank reconciliation D) maintenance of an imprest fund Answer: C Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) In performing a bank reconciliation, a clerk notices that a check sent to the bank for deposit at month end had not been recorded before the bank statement was prepared. In completing the bank reconciliation, the clerk should identify the amount of the check as ________. A) an outstanding check B) a deposit in transit C) a bank credit D) a bank error Answer: B Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) A customer check is received by ABC Floorcovering Inc. Detail the steps that should be taken to assure that the check is processed according to good internal control. Answer: A typical cash receipts process should include the following steps: 1. An employee will receive checks, open the envelopes, and prepare a cash receipts summary. The summary should include the customer name, account number, and the amount of the check. 2. The summary is then forwarded to the employee responsible for depositing checks. The employee responsible for making the deposit should not be the same person who receives the check in the mail and should not be the same person who records the cash receipt in the accounting records. 3. The summary is also sent to the employee in charge of preparing the cash receipts journal. Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Monochrome Printers established a $500 petty cash imprest fund at the beginning of the year. During the year, the following expenditures were paid from the petty cash fund: Postage Parking and Tolls Supplies

$200 250 30

At the end of the year, there was $10 remaining in the fund. Prepare the journal entries to record the current year's activity in the petty cash fund including the establishment of the fund and the expenses of the fund. Answer: To establish the petty cash fund: Accounts

Debit

Petty Cash Cash

Credit 500 500

At the end of the year, there should be $20 of cash left in the fund ($500 less $480). Because there is only $10 left, the fund is short $10. The journal entry to replenish the fund at the end of the year is as follows: Accounts Postage Expense Miscellaneous Expense Supplies Expense Cash Short or Over Cash

Debit

Credit 200 250 30 10 490

Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 10 Short-Term Operating Assets: Inventory 10.1

Types of Inventory and Inventory Systems

1) A perpetual inventory system always provides current information about inventory levels. Answer: TRUE Diff: 1 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) A periodic inventory system is used by most companies today due to the proliferation of computers. Answer: FALSE Diff: 1 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Beginning inventory + Net Purchases = Cost of Goods Sold. Answer: FALSE Diff: 1 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The work-in-process inventory is found on the books of a merchandising concern. Answer: FALSE Diff: 1 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The flow of a manufacturer's product costs through the inventory accounts is ________. A) Work-in-Process Inventory, Cost of Goods Sold, and Finished Goods Inventory B) Raw Materials Inventory, Cost of Goods Sold, and Finished Goods Inventory C) Raw Materials Inventory, Finished Goods Inventory, and Work-in-Process Inventory D) Raw Materials Inventory, Work-in-Process Inventory, and Finished Goods Inventory Answer: D Diff: 1 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Firms using the periodic inventory system record purchases of inventory with a ________. A) credit to Purchases B) debit to Purchases C) debit to Inventory D) credit to Inventory Answer: B Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which statement is not correct about perpetual inventory systems? A) The balance in the Inventory account is always up-to-date. B) A physical inventory count is not required. C) Current information is available for cost of goods sold. D) The Inventory account is updated for each purchase and sale. Answer: B Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Charles Company's balance sheet reports Raw Materials Inventory, $550,000; Finished Goods Inventory, $689,000; and total inventories at $1,902,000. What is the value of Work-in-Process Inventory? A) $1,763,000 B) $1,352,000 C) $663,000 D) $1,213,000 Answer: C Explanation: $1,902,000 - $550,000 - $689,000 = $663,000 Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Richard Company's financial records report beginning inventory of $543,000; ending inventory of $699,000; and cost of goods sold of $1,387,000. What is the amount of purchases? A) $1,543,000 B) $2,086,000 C) $1,242,000 D) $844,000 Answer: A Explanation: $1,387,000 + $699,000 - $543,000 = $1,543,000 Cost of Goods Sold $1,387,000 + Ending Inventory $699,000 = Cost of Goods Available for Sale $2,086,000 Cost of Goods Available for Sale $2,086,000 - Beginning Inventory $543,000 = $1,543,000 Purchases Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Destiny Industries reports beginning inventory of $255,000, purchases of $559,000, and ending inventory of $197,000. What is the cost of goods sold? A) $814,000 B) $501,000 C) $617,000 D) $1,011,000 Answer: C Explanation: Beginning Inventory $255,000 + Purchases $559,000 = Cost of Goods Available for Sale $814,000 Cost of Goods Available for Sale $814,000 - Ending Inventory $197,000 = Cost of Goods Sold $617,000 Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Donaldson Corporation uses a periodic inventory system. On January 1, inventory is $253,000. On April 5, Donaldson sells inventory with a selling price of $75,000 on account. The cost of the inventory sold is $50,000. The journal entry (entries) to record the sale is (are) ________. A) debit Cash and credit Sales Revenue B) debit Accounts Receivable and credit Sales Revenue; debit Cost of Goods Sold and credit Inventory C) debit Cash and Cost of Goods Sold and credit Sales Revenue and Inventory D) debit Accounts Receivable and credit Sales Revenue Answer: D Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Dombrose Company uses a perpetual inventory system. On January 1, inventory is $253,000. On April 5, Dombrose sells inventory with a selling price of $75,000 on account. The cost of the inventory sold is $50,000. The journal entry (entries) to record the sale is (are) ________. A) debit Cash and Cost of Goods Sold and credit Sales Revenue and Inventory B) debit Accounts Receivable and credit Sales Revenue; debit Cost of Goods Sold and credit Inventory C) debit Accounts Receivable and credit Sales Revenue D) debit Cash and credit Sales Revenue Answer: B Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) The Peggy Ahlers Company uses the perpetual inventory system and the FIFO method. At the end of the current fiscal year, December 31, the company conducted a physical count of the inventory on hand at all warehouses and stores. The FIFO cost of the physical count is $1,005,400. According to the records, ending inventory using FIFO is $1,122,000. Which journal entry is required at December 31 of the current fiscal year? A) No journal entry is required. B) Debit Inventory $116,600 and credit Allowance to Reduce Inventory $116,600. C) Debit Cost of Goods Sold $116,600 and credit Allowance to Reduce Inventory $116,600. D) Debit Loss on Inventory Shortage $116,600 and credit Inventory $116,600. Answer: D Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) A large company uses a perpetual inventory system and a sophisticated computerized system to account for its inventory over time. At the end of the accounting period, the company performs a physical count of the inventory on hand and hires hundreds of workers to carry out this task. Required: 1. Why does the company perform a physical count of inventory? 2. After the physical count of inventory is completed, describe the required journal entry and provide an example. Answer: 1. The company performs a physical count of inventory to determine the amount of inventory stolen, damaged, broken, obsolete, etc. The accounting records are unable to determine this information. 2. The journal entry will debit Loss on Inventory Shortage and credit Inventory for the loss in value of the inventory. For example, if the accounting records show ending inventory of $100,000 but a physical count only shows ending inventory of $99,000, then the dollar amount of the journal entry is $1,000. Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Carpenter Company's balance sheet reports Raw Materials Inventory, $570,000; Finished Goods Inventory, $690,000; and total inventories at $1,500,000. What is the value of Work-in-Process Inventory? Answer: $240,000 Explanation: $1,500,000 - $570,000 - $690,000 = $240,000 Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Rocky Company's financial records report beginning inventory of $500,000; ending inventory of $697,000; and cost of goods sold of $1,396,000. What is the amount of purchases? Answer: $1,593,000 Explanation: $1,396,000 + $697,000 - $500,000 = $1,593,000 Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP

AACSB: Application of knowledge

17) Dixon Industries reports beginning inventory of $200,000, purchases of $559,000, and ending inventory of $198,000. What is the cost of goods sold? Answer: $561,000 Explanation: Beginning Inventory $200,000 + Purchases $559,000 = Cost of Goods Available for Sale $759,000 Cost of Goods Available for Sale $759,000 - Ending Inventory $198,000 = Cost of Goods Sold $561,000 Diff: 2 Objective: 10.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10.2

Inventory Costing: Units and Costs Included

1) The total cost in dollars of ending inventory is equal to the number of units on hand multiplied by the cost per unit. Answer: TRUE Diff: 1 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Freight-out costs are included as part of inventory costs. Answer: FALSE Diff: 1 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Freight-in costs are treated as a selling expense. Answer: FALSE Diff: 1 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When goods are shipped f.o.b. shipping point, title passes when the goods reach the buyer's dock. Answer: FALSE Diff: 1 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Purchase returns and purchase discounts are added to purchases to calculate net purchases. Answer: FALSE Diff: 1 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Purchase returns and purchase discounts are subtracted from purchases to calculate net purchases. Answer: TRUE Diff: 1 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Jamison Company sells goods to Matthews Company. When Jamison ships goods to Matthews with terms f.o.b. shipping point, ________. A) Jamison Company reports the goods in its inventory when the goods are in transit to Matthews Company B) the title passes from Jamison Company to Matthews Company when the goods are received by Matthews Company C) the title passes from Jamison Company to Matthews Company when the goods leave Jamison Company D) Matthews Company does not include the goods in its inventory while the goods are in transit Answer: C Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Inventory costs do not include ________. A) freight-out costs B) freight-in costs C) packaging costs D) handling costs Answer: A Diff: 1 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Christian Company uses the gross method of recording purchase discounts on inventory and the perpetual inventory system. When Christian Company makes payment for the inventory within the discount period, the bookkeeper will ________. A) debit Accounts Payable, credit Inventory and credit Cash B) debit Accounts Payable and credit Inventory C) debit Inventory and credit Cash D) debit Accounts Payable and credit Purchases Answer: A Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Yankee Company uses the net method of recording purchase discounts on inventory and the perpetual inventory system. Yankee Company records a payment within the discount period. Which journal entry is prepared? A) Debit Accounts Payable and credit Cash for the gross amount of the purchase. B) Debit Accounts Payable and credit Cash for the net amount of the purchase. C) Debit Accounts Payable, credit Cash and credit Inventory. D) Debit Accounts Payable, credit Cash and credit Interest Revenue. Answer: B Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Smith-Miller Enterprises has inventory of $687,000 in its stores as of December 31. It also has two shipments in-transit that left the suppliers' warehouses by December 28. Both shipments are expected to arrive on January 5. The first shipment of $135,000 was sold f.o.b. destination and the second shipment of $80,000 was sold f.o.b. shipping point. What amount of inventory should Smith-Miller report on its balance sheet as of December 31? A) $687,000 B) $902,000 C) $822,000 D) $767,000 Answer: D Explanation: $687,000 + $80,000 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Beck Company has inventory of $754,000 in its stores as of December 31. It also has two shipments in-transit that left the suppliers' warehouses by December 28. Both shipments are expected to arrive on January 5. The first shipment of $245,000 was sold f.o.b. destination and the second shipment of $105,000 was sold f.o.b. shipping point. Beck Company also has consigned goods of $78,000 awaiting sale with Meyer Company. What amount of inventory should Beck Company report on its balance sheet as of December 31? A) $754,000 B) $937,000 C) $1,104,000 D) $1,182,000 Answer: B Explanation: $754,000 + 105,000 + 78,000 = $937,000 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Meyer Co. has the following information available: Cost of inventory Freight-in Freight-out Packaging costs Handling costs

$60,000 5,800 2,900 590 600

What amount of inventory should the company report on the balance sheet? A) $69,890 B) $66,990 C) $64,090 D) $61,190 Answer: B Explanation: $60,000 + $5,800 + $590 + $600 = $66,990 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) On June 1, Addison Company purchased $9,000 of inventory on account from Garrison Company. Garrison offers a 5% discount if payment is received within 15 days. Addison records the purchase using the gross method and the perpetual inventory system. The journal entry on June 1 by Addison Company includes ________. A) a debit to Inventory for $8,550 B) a credit to Accounts Payable for $8,550 C) a debit to Inventory for $9,000 D) a credit to Cash for $9,000 Answer: C Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) On June 1, Atkinson Company purchased $7,000 of inventory on account from Donnie Company. Donnie Company offers a 4% discount if payment is received within 15 days. Atkinson Company records the purchase using the gross method and the perpetual inventory system. Atkinson Company makes the payment for the inventory on June 10. The journal entry on June 10 by Atkinson Company includes ________. A) a debit to Cash for $7,000 B) a credit to Cash for $6,720 C) a debit to Inventory for $280 D) a credit to Interest Expense for $280 Answer: B Explanation: $7,000 × 96% = $6,720 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) On June 1, Kennedy Company purchased $10,000 of inventory on account from Sterner Company. Sterner Company offers a 5% discount if payment is received within 15 days. Kennedy Company records the purchase using the net method and the perpetual inventory system. The journal entry on June 1 by Kennedy Company includes ________. A) a debit to Inventory for $10,000 B) a credit to Accounts Payable for $10,000 C) a credit to Cash for $9,500 D) a debit to Inventory for $9,500 Answer: D Explanation: $10,000 × 95% = $9,500 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) On June 1, Johnson Company purchased $7,000 of inventory on account from Schmid Company on June 1. Schmid Company offers a 4% discount if payment is received within 15 days. Johnson Company records the purchase using the net method and the perpetual inventory system. Johnson Company paid for the inventory on June 30. The journal entry on June 30 by Johnson Company includes ________. A) a debit to Accounts Payable for $6,720 B) a debit to Accounts Payable for $7,000 C) a credit to Interest Expense for $280 D) a credit to Cash for $6,720 Answer: A Explanation: Under the net method, a credit of $6,720 ($7,000 × (1 - 0.04)) would have been made to accounts payable when the purchase was made. Therefore, upon payment, accounts payable would be debited for $6,720. Interest expense of $280 would also be debited, representing the discount lost by not paying the invoice within the discount period. Cash would be credited for $7,000. Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) On August 10, Charles Company purchased 75 refrigerators for $650 each from Appliances Wholesalers. The purchase was on account with terms of 3/10, n/30. Charles Company paid for 50 of the refrigerators on August 18 and the remaining refrigerators on August 30. Charles Company uses the gross method for purchase discounts and the perpetual inventory system to record the transactions. On August 30, Charles Company recorded ________. A) a debit to Accounts Payable and a credit to Cash B) a debit to Cash and a credit to Accounts Payable C) a debit to Accounts Payable and a credit to Inventory D) a debit to Cash and a credit to Inventory Answer: A Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Walker Company provides the following information: Beginning Inventory Purchases Freight-In Freight-Out Purchase Discounts Purchase Returns Ending Inventory

$118,000 510,000 28,000 11,000 5,500 9,000 128,000

What is the cost of goods available for sale? A) $641,500 B) $652,500 C) $769,500 D) $667,000 Answer: A Explanation: $118,000 + 510,000 + 28,000 - 5,500 - 9,000 = $641,500 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Chet Company provides the following information: Beginning Inventory Purchases Freight-In Freight-Out Purchase Discounts Purchase Returns Ending Inventory

$140,000 570,000 28,000 14,000 5,000 9,000 129,000

What is the cost of goods sold? A) $724,000 B) $595,000 C) $738,000 D) $604,000 Answer: B Explanation: $140,000 + 570,000 + 28,000 - 5,000 - 9,000 - 129,000 = $595,000 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) The Wysocki Company has undertaken a physical count of inventory on hand on December 31, 2022. The cost of the inventory on hand is $445,993. Additional information follows: 1. Wysocki Company received goods costing $32,000 on January 2, 2023. The goods were shipped f.o.b. shipping point, and left the seller's business on December 30, 2022. 2. Wysocki Company received goods costing $40,000 on January 3, 2023. The goods were shipped f.o.b. destination, and left the seller's business on December 30, 2022. 3. Wysocki Company sold goods costing $20,000 on December 29, 2022. The goods were picked up by the common carrier on December 29 and shipped f.o.b. destination. The goods arrived on January 2, 2023. The retail price of the goods was $30,000. 4. Wysocki Company sold goods costing $30,000 on December 31, 2022. The goods were picked up by the common carrier on December 31 and shipped f.o.b. shipping point. The goods were not included in Wysocki's physical count at December 31, 2022. The goods arrived on January 4, 2023. The retail price of the goods was $60,000. Wysocki paid the shipping costs of $433 on December 31. 5. Wysocki Company was the consignee for some goods from Walmart. The goods cost Walmart $100,000 and had a retail price of $300,000. These goods were included in Wysocki's physical count on December 31, 2022 at the retail price. 6. Wysocki Company had some goods on consignment at Walmart. The goods cost $50,000 and had a retail price of $100,000. These goods were not included in Wysocki's physical count at December 31, 2022 because the goods were not on the company's premises. 7. Wysocki Company sold goods costing $22,000 on December 31, 2022. The goods were not picked up by the common carrier until January 2, 2023. The retail price of the goods was $42,000; the wholesale price was $33,000. The goods were included in the physical count at December 31, 2022. The terms of the sale were f.o.b. shipping point. Required: 1. For each item listed above, indicate the amount and sign of the adjustment to the inventory balance at December 31, 2022. If no adjustment is required, for an item, enter 0. 2. Determine the correct amount of inventory for Wysocki Company at December 31, 2022. Answer: Inventory per physical count, 12/31/2022 $445,993 1. Goods in transit to Wysocki FOB Shipping point + 32,000 2. Goods in transit to Wysocki FOB Destination 0 3. Goods in transit FOB Destination from Wysocki + 20,000 4. Goods in transit FOB Shipping Point from Wysocki 0 5. Goods on consignment from Walmart included (300,000) 6. Goods on consignment at Walmart excluded + 50,000 7. Sale of goods not picked up until January 2, 2023 0 Correct Inventory Balance, 12/31/2022 $247,993 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) The following transactions occurred for MM's Jewelry Store during the month: a. On May 1, the owner purchased 100 rings on account at $6,000 each. Credit terms were 2/10, net 30. b. On May 2, the owner returned one ring. c. On May 3, the owner sold three of the rings on account at $8,000 each to one customer. The credit terms were 2/10, net 30. d. On May 9, the owner paid the debt due. e. On May 15, the customer from May 3 paid for the rings. Required: Prepare the journal entries for the above transactions. 1. The store uses the perpetual inventory system and the gross method to record purchase discounts. Explanations are not required. 2. The store uses the periodic inventory system and the net method to record purchase discounts. Explanations are not required. Answer: 1. Date Account Debit Credit May 1 Inventory 600,000 Accounts Payable 600,000 May 2

May 3

May 9

May 15

Accounts Payable Inventory

6,000

Accounts Receivable Sales Revenue

24,000

Cost of Goods Sold Inventory

18,000

Accounts Payable Cash Inventory

594,000

Cash Accounts Receivable

24,000

6,000

24,000

18,000

582,120 11,880

24,000

2. Date May 1

May 2

May 3

May 9

May 15

Account Purchases Accounts Payable

Debit 588,000

Credit 588,000

Accounts Payable Purchase Returns and Allowances

5,880

Accounts Receivable Sales Revenue

24,000

Accounts Payable Cash

582,120

Cash

24,000

5,880

24,000

582,120

Accounts Receivable

24,000

Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Wilbur Company provides the following information: Beginning Inventory Purchases Freight-In Freight-Out Purchase Discounts Purchase Returns Ending Inventory

$120,000 510,000 24,000 19,000 5,200 8,000 130,000

What is the cost of goods available for sale? Answer: $640,800 Explanation: $120,000 + 510,000 + 24,000 - 5,200 - 8,000 = $640,800 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Chang Company provides the following information: Beginning Inventory Purchases Freight-In Freight-Out Purchase Discounts Purchase Returns Ending Inventory

$130,000 550,000 20,000 14,000 5,800 8,000 128,000

What is the cost of goods sold? Answer: $558,200 Explanation: $130,000 + 550,000 + 20,000 - 5,800 - 8,000 - 128,000 = $558,200 Diff: 2 Objective: 10.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10.3

Inventory Cost-Flow Assumptions

1) The specific identification inventory method is used by companies that sell high-dollar products. Answer: TRUE Diff: 1 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The first-in, first-out inventory method assigns the most recent costs to the cost of goods sold. Answer: FALSE Diff: 1 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The moving-average method of determining inventory is used with the perpetual system of inventory. Answer: TRUE Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The inventory allocation method that assigns the most recent costs to ending inventory and the oldest costs to cost of goods sold is the ________. A) specific identification method B) LIFO method C) moving-average method D) FIFO method Answer: D Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The inventory allocation method used for companies that maintain base stocks of inventory items is the ________. A) LIFO method B) specific identification method C) FIFO method D) moving-average method Answer: A Diff: 1 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) A company using LIFO for tax purposes ________. A) can use either LIFO or FIFO for financial reporting B) must use LIFO for financial reporting C) will have more taxes to pay with LIFO than FIFO in a period of rising inventory costs and stable inventory levels D) will report higher net income with LIFO than FIFO in a period of rising inventory costs and stable inventory levels Answer: B Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) IFRS does not allow the LIFO inventory method because ________. A) of the increased taxes owed under the LIFO method B) the majority of companies do not actually sell the oldest items first C) it is viewed as unrealistic and lacks representational faithfulness of inventory flows D) the FIFO method more accurately reflects the cost of inventory Answer: C Diff: 2 Objective: 10.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) When inventory costs are falling, and inventory levels are stable, the LIFO method will generally result in ________. A) a higher gross profit than under FIFO B) a lower gross profit than under FIFO C) a lower inventory value than under FIFO D) a higher cost of goods sold than under FIFO Answer: A Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) When comparing the FIFO and LIFO inventory methods, ________. A) LIFO reports the most up-to-date inventory cost on the balance sheet B) FIFO results in the most realistic net income figure C) FIFO matches old inventory costs against revenue D) LIFO matches old inventory costs against revenue Answer: C Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Wetzel Company has the following data available: Transaction Beginning Inventory March 1 Purchase April 25 Sale June 10 Purchase July 20 Sale October 30 Purchase December 15 Sale

Units Purchased 500 200

Unit Cost $6 $8

300

$10

350

$11

Units Sold

330 240 430

If Wetzel Company uses a perpetual moving-average inventory system, the cost of the ending inventory on December 31 is ________. (Round average cost per unit to four decimal places and all other numbers to two decimal places.) A) $8,158.25 B) $3,291.72 C) $11,449.97 D) $3,850.00 Answer: B Explanation: Cost of Goods Sold Ending Inventory = $6.5714

3/1 4/25

330 × $6.5714

6/10 7/20

240 × $8.1066

10/30 12/15

430 × $9.4049

370 × $6.5714 = $2,431.42 370 × $6.5714 = $2,431.42 Add: 300 × $10 = $3,000 Total: $5,431.42/670 = $8.1066 430 × $8.1066 = $3,485.84 430 × $8.1066 = $3,485.84 Add: 350 × $11 = $3,850 Total: $7,335.84/780 = $9.4049 350 × $9.4049 = $3,291.72

Diff: 3 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Potter Company has the following data available: Transaction Beginning Inventory March 1 Purchase April 25 Sale June 10 Purchase July 20 Sale October 30 Purchase December 15 Sale

Units Purchased 500 200

Unit Cost $5 $7

300

$10

Units Sold

330 260 440

If Potter Company uses a perpetual moving-average inventory system, the cost of goods sold for the year is ________. (Round average cost per unit to four decimal places and all other numbers to two decimal places.) A) $2,248.88 B) $7,351.13 C) $9,600.01 D) $6,245.18 Answer: B Explanation: Cost of Goods Sold Ending Inventory 3/1 = $5.5714 4/25

330 × $5.5714 = $1,838.56

6/10

7/20 10/30

260 × $7.1066 = $1,847.72

12/15

440 × $8.3292 = $3,664.85

Total

$7,351.13

370 × $5.5714 = $2,061.42 370 × $5.5714 = $2,061.42 Add: 300 × $9 = $2,700 Total: $4,761.42/670 = $7.1066 410 × $7.1066 = $2,913.71 410 × $7.1066 = $2,913.71 Add: 300 × $10 = $3,000 Total: $5,913.71/710 = $8.3292 270 × $8.3292 = $2,248.88

Cost of Goods Sold: (330 × $5.5714) + (260 × $7.1066) + (440 × $8.3292) = $7,351.13 Diff: 3 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Gordon Company has the following data available: Transaction Beginning Inventory March 1 Purchase April 25 Sale June 10 Purchase July 20 Sale October 30 Purchase December 15 Sale

Units Purchased 300 230

Unit Cost $10 $12

330

$14

320

$12

Units Sold

310 220 380

If Gordon Company uses a perpetual FIFO inventory system, the cost of ending inventory on December 31 is ________. A) $9,100 B) $10,920 C) $3,240 D) $2,700 Answer: C Explanation: 270 × $12 = $3,240 Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Sample Company has the following data available: Transaction Beginning Inventory March 1 Purchase April 25 Sale June 10 Purchase July 20 Sale October 30 Purchase December 15 Sale

Units Purchased 400 200

Unit Cost $10 $12

Units Sold

350 300

$14 250

350

$17 400

If Sample Company uses a perpetual FIFO inventory system, the cost of goods sold for the year is ________. A) $13,300 B) $12,100 C) $12,300 D) $10,000 Answer: C Explanation: (400 × $10) + (200 × $12) + (300 × $14) + (100 × $17) = $12,300 Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Bombard Company has the following data available: Transaction Beginning Inventory March 1 Purchase April 25 Sale June 10 Purchase July 20 Sale October 30 Purchase December 15 Sale

Units Purchased 500 200

Unit Cost $10 $12

300

$14

350

$15

Units Sold

350 250 400

If Bombard Company uses a perpetual LIFO inventory system, the cost of goods sold for the year is ________. A) $3,500 B) $5,250 C) $16,850 D) $13,350 Answer: D Explanation: Cost of Goods Sold Ending Inventory 3/1 (500 × $10) + (200 × $12) = $7,400 4/25 200 × $12 = $2,400 350 × $10 = $3,500 150 × $10 = $1,500 6/10 350 × $10 = $3,500 Add: 300 × $14 = $4,200 7/20 250 × $14 = $3,500 (350 × $10) + (50 × $14) = $4,200 10/30 12/15 Total

350 × $15 = $5,250 50 × $14 = $700 $13,350

(350 × $10) + (50 × $14) = $4,200 Add: 350 × $15 = $5,250 350 × $10 = $3,500

Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Vaclav Company has the following data available: Transaction Beginning Inventory Oct. 1 Purchase Oct. 10 Sale Oct. 14 Purchase Oct. 20 Sale Oct. 22 Purchase Oct. 29 Sale

Units Purchased 850 325

Unit Cost $27 $29

450

$33

400

$34

Units Sold

400 600 505

If Vaclav Company uses a perpetual moving-average inventory system, the cost of ending inventory on October 31 is ________. (Round average cost per unit to four decimal places and all other numbers to two decimal places.) A) $42,127.85 B) $16,270.33 C) $44,554.74 D) $60,825.07 Answer: B Explanation: Cost of Goods Sold Ending Inventory = $27.5532

10/1 10/10

400 × $27.5532

10/14 10/20

600 × $29.5541

10/22 10/29

505 × $31.2891

775 × $27.5532 = $21,353.73 775 × $27.5532 = $21,353.73 Add: 450 × $33 = $14,850 Total: $36,203.73/1,225 = $29.5541 625 × $29.5541 = $18,471.31 625 × $29.5541 = $18,471.31 Add: 400 × $34 = $13,600 Total: $32,071.31/1,025 = $31.2891 520 × $31.2891 = $16,270.33

Diff: 3 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Maki Company has the following data available: Transaction Beginning Inventory Oct. 1 Purchase Oct. 10 Sale Oct. 14 Purchase Oct. 20 Sale Oct. 22 Purchase Oct. 29 Sale

Units Purchased 750 325

Unit Cost $30 33

450

400

Units Sold

425 600 525

If Maki Company uses a perpetual FIFO inventory system, the cost of ending inventory on October 31 is ________. A) $15,200 B) $14,250 C) $49,875 D) $50,825 Answer: B Explanation: (375 × $38) = $14,250 Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Sikich Company has the following data available: Transaction Beginning Inventory Oct. 1 Purchase Oct. 10 Sale Oct. 14 Purchase Oct. 20 Sale Oct. 22 Purchase Oct. 29 Sale

Units Purchased 650 325

Unit Cost $20 30

Units Sold

425 450

36 600

400

38 525

If Sikich Company uses a perpetual FIFO inventory system, the cost of goods sold for the month is ________. A) $58,900 B) $9,900 C) $43,700 D) $10,450 Answer: C Explanation: (650 × $20) + (325 × $30) + (450 × $36) + (125 × $38) Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Jones Company has the following data available:

Transaction Beginning Inventory Oct. 1 Purchase Oct. 10 Sale Oct. 14 Purchase Oct. 20 Sale Oct. 22 Purchase Oct. 29 Sale

Units Purchased 850 325

Unit Cost $30 32

Units Sold

400 450

36 590

400

37 525

If Jones Company uses a perpetual LIFO inventory system, the cost of ending inventory on October 31 is ________. A) $14,800 B) $18,870 C) $15,300 D) $66,900 Answer: C Explanation: Cost of Goods Sold Ending Inventory 10/1 (850 × $30) + (325 × $32) = $35,900 325 × $32 = $10,400 10/10 75 × $30 = $2,250 775 × $30 = $23,250 775 × $30 = $23,250 10/14 Add: 450 × $36 = $16,200 450 × $36 = $16,200 10/20 140 × $30 = $4,200 635 × $30 = $19,050 635 × $30 = $19,050 10/22 Add: 400 × $37 = $14,800 400 × $37 = $14,800 10/29 125 × $30 = $3,750 510 × $30 = $15,300 Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Excalibur Company uses the perpetual inventory method. Excalibur Company has the following data available for the month of January: Date Jan. 1 Jan. 9 Jan. 10 Jan. 15 Jan. 18 Jan. 24

Transaction Beginning inventory Purchase Sale Purchase Sale Purchase

Units 250 350 450 450 350 150

Unit Cost $1.01 $1.11 $1.17 $1.27

What is the Cost of Goods Sold for the month of January using LIFO? A) $899.00 B) $939.00 C) $459.00 D) $884.00 Answer: A Explanation: Cost of Goods Sold Ending Inventory 1/9 (250 × $1.01) + (350 × $1.11) = $641.00 350 × $1.11 = $388.50 1/10 100 × $1.01 = $101 150 × $1.01 = $151.50 150 × $1.01 = $151.50 1/15 Add: 450 × $1.17= $526.50 1/18 350 × $1.17 = $409.50 (150 × 1.01) + (100 × $1.17) = $268.5 (150 × $1.01) + (100 × $1.17) = $268.5 1/24 Add: 150 × $1.27 = $190.50 Total $899.00 Total Cost of Goods Sold $899.00 Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) The Exclusive Company uses the perpetual inventory system. The Exclusive Company has the following data available for the month of January: Date Jan. 1 Jan. 9 Jan. 10 Jan. 15 Jan. 18 Jan. 24

Transaction Beginning inventory Purchase Sale Purchase Sale Purchase

Units 420 320 420 420 320 420

Unit Cost $1.00 $1.10 $1.16 $1.26

What is the cost of ending inventory on January 31 using LIFO? A) $888.00 B) $1,016.40 C) $965.20 D) $823.20 Answer: C Explanation: Cost of Goods Sold Ending Inventory 1/9 (420 × $1.00) + (320 × $1.10) = $772.00 1/10

320 × $1.10 = $352.00 100 × $1.00 = $100

1/15 1/18

320 × $1.16 = $371.20

1/24 Total

$823.20

320 × $1.00 = $320.00 320 × $1.00 = $320.00 Add: 420 × $1.16 = $487.20 (320 × $1.00) + (100 × $1.16) = $436.00 (320 × $1.00) + (100 × $1.16) = $436.00 Add: 420 × $1.26 = $529.20 $436.00 + $529.20 = $965.20

Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Which inventory costing method most closely approximates current cost for each of the following line items on the financial statements? A) Ending Inventory FIFO

Cost of Goods Sold FIFO

B) Ending Inventory LIFO

Cost of Goods Sold LIFO

C) Ending Inventory FIFO

Cost of Goods Sold LIFO

D) Ending Inventory LIFO

Cost of Goods Sold FIFO

Answer: C

Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) The ABC Enterprise Company uses the perpetual inventory system. The company has the following data available for the month of April: Date April 1 April 9 April 10 April 15 April 18 April 24

Transaction Beginning inventory Purchase Sale Purchase Sale Purchase

Units 210 310 410 410 310 110

Unit Cost $1.00 $1.10 $1.16 $1.26

What is the cost of ending inventory on April 30 using moving average? (Round average cost per unit to four decimal places and all other numbers to two decimal places.) A) $377.75 B) $369.60 C) $353.03 D) $320.00 Answer: A Explanation: Cost of Goods Sold Ending Inventory 4/9 4/10

4/15 4/18

4/24

= $1.0596 410 × $1.0596 = $434.44 110 × $1.0596 = $116.56 110 × $1.0596 = $116.56 Add: 410 × $1.16 = $475.60 Total: $592.16/520 = $1.1388 310 × $1.1388 = $353.03 210 × $1.1388 = $239.15 210 × $1.1388 = $239.15 Add: 110 × $1.26 = $138.60 Total: $239.15 + $138.60 = $377.75

Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Assume inventory costs are increasing over time and inventory levels are stable. Which inventory method results in a higher net income and a higher ending inventory? A) FIFO B) average cost C) LIFO D) conventional retail Answer: A Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Flynn Company uses LIFO for tax purposes and external reporting purposes. For internal reporting purposes, Flynn Company uses FIFO. Required: List a few reasons why a company uses different inventory costing methods for different purposes. Answer: a. The LIFO conformity rule requires a company to use LIFO for external reporting if they use LIFO for tax purposes. b. A company may not think LIFO provides a faithful representation of inventory cost flows. As a result, they want to use FIFO for internal reporting. c. A company's inventory flows may not follow the LIFO assumption of last goods in are the first out. A company's inventory flows may more closely follow FIFO. d. A company may want to reduce the amount taxes paid so they use LIFO for tax purposes. LIFO offers tax advantages over other methods when costs are increasing and inventory levels are stable. e. A company may want to conserve cash so they use LIFO for tax purposes because less cash is paid for taxes. f. A company may be following a historical pattern of using FIFO internally. Management may be more comfortable using FIFO for decision making. g. Record keeping using LIFO may be difficult because the latest purchase cost may not be available if purchased goods are in transit at the end of a period. h. A company may have different goals and objectives. A company may want to minimize the taxes paid so it uses LIFO for tax purposes. At the same time, the company may want to approximate the actual flow of costs to more accurately understand operations, and as a result, uses FIFO for internal reports. Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) 1. What is the LIFO conformity rule? 2. Why is LIFO used by so many companies? 3. What is the disadvantage of LIFO? Answer: 1. The LIFO conformity rule requires that a company using LIFO for tax purposes must also use it for financial reporting. 2. When inventory costs are increasing, and inventory levels are stable, companies use LIFO to report lower net income figures. Lower net income figures result in lower taxes paid, and thus less cash outflows for taxes. This frees up a company's cash for other purposes such as expansion, capital asset purchases, etc. 3. The problem with LIFO in a period of rising costs is that lower net income figures are not desirable in the eyes of financial statement users. The lower net income figures can detract from a company's value. Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Carbondale Company had the following data available for the last six months: Beg. inventory Purchase, 3/1 Sale, 4/1 Purchase, 5/1 Sale, 6/1

10 units 30 units 25 units 25 units 20 units

$55 per unit $60 per unit $100 per unit $65 per unit $100 per unit

Operating expenses are $2,000 per month. The income tax rate is 30%. Required: 1. Compute Cost of Goods Sold for the six months ending June 30 using: a. FIFO perpetual b. LIFO perpetual 2. How much will the company save in income taxes if they use LIFO instead of FIFO? Answer: 1. a. FIFO Cost of Goods Sold: 10 × $55 $550 30 × $60 1,800 5 × $65 325 Total Cost of Goods Sold $2,675 b. LIFO Cost of Goods Sold: 25 × $60 20 × $65 Total Cost of Goods Sold

$1,500 $1,300 $2,800

2. Difference in Cost of Goods Sold × 30% = Tax Savings ($2,800 - $2,675) × 30% = $37.50 Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) The Petrowski Company uses the perpetual inventory system. The Petrowski Company has the following data available for the month of January: Date Jan. 1 Jan. 9 Jan. 10 Jan. 15 Jan. 18 Jan. 24 Jan. 30

Transaction Beginning inventory Purchase Sale Purchase Sale Purchase Sale

Units 100 300 200 400 300 100 10

Unit Cost $100 $120 $140 $160

Determine the Cost of Goods Sold for January using the following methods: a. FIFO b. LIFO c. Moving-average (Round per unit costs and all other dollar amounts to two decimal places.)

Answer: a. FIFO FIFO periodic is the same as FIFO perpetual. The company sold 510 units. Cost of Goods Sold has the earliest costs. Cost of Goods Sold: (100 × $100) $10,000 (300 × $120) $36,000 (110 × $140) $15,400 Total Cost of Goods Sold $61,400 b. LIFO Cost of Goods Sold 1/9 1/10

200 × $120 = $24,000

1/15 1/18

300 × $140 = $42,000

1/24 1/30 Total

10 × $160 = $1,600 $67,600

Ending Inventory (100 × $100) + (300 × $120) = $46,000 (100 × $100) + (100 × $120) = $22,000 (100 × $100) + (100 × $120) = $22,000 Add: 400 × $140 = $56,000 (100 × $100) + (100 × $120) + (100 × $140) = $36,000 (100 × $100) + (100 × $120) + (100 × $140) = $36,000 Add: 100 × $160 = $16,000 (100 × $100) + (100 × $120) + (100 × $140) + (90 × $160) = $50,400

Total Cost of Goods Sold: $24,000 + $42,000 + $1,600 = $67,600 c. Moving average Cost of Goods Sold 1/9 1/10

1/15 1/18

1/24 1/30 Total

Ending Inventory = $115

200 × $115 = $23,000

200 × $115 = $23,000 200 × $115 = $23,000 Add: 400 × $140 = $56,000 Total: $79,000 / 600 = $131.67 300 × $131.67 = $39,501 300 × $131.67 = $39,501 300 × $131.67 = $39,501 Add: 100 × $160 = $16,000 Total: $39,501 + $16,000 = $55,501 / 400 = $138.75 10 × $138.75 = $1,387.50 390 × $138.75 = $54,112.50 $63,888.50

Total Cost of Goods Sold: $23,000 + $39,501 + $1,387.50 = $63,888.50 Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) The Butters Company uses the FIFO perpetual inventory system. The company has the following data available for the month of January: Date Jan. 1 Jan. 9 Jan. 10 Jan. 15 Jan. 18 Jan. 24 Jan. 30

Transaction Beginning inventory Purchase Sale Purchase Sale Purchase Sale

Units 100 300 200 400 300 100 10

Unit Cost $100 $140 $160 $200

The selling price per unit is $1,000. Selling and administrative expenses for the month total $100,000. Interest expense for the month is $10,000. The tax rate is 30%. Required: Prepare the income statement for the month ending January 31, 2023 using a multiple-step format. Answer: Cost of Goods Sold: 510 units Cost of Goods Sold: (100 × $100) + (300 × $140) + (110 × $160) = $69,600 Butters Company Income Statement For the Month Ended January 31, 2023 Sales (510 × $1,000) Cost of Goods Sold Gross Profit Selling and Administrative Expenses Operating Income Other Expense: Interest Expense Income Before Taxes Income Tax Expense Net Income

$510,000 69,600 440,400 100,000 340,400 10,000 330,400 99,120 $231,280

Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) The Geewhiz Company uses the perpetual inventory system. The Geewhiz Company has the following data available for the month of January: Date Jan. 1 Jan. 9 Jan. 10 Jan. 15 Jan. 18 Jan. 24 Jan. 30

Transaction Beginning inventory Purchase Sale Purchase Sale Purchase Sale

Units 200 300 400 400 300 100 10

Unit Cost $2.00 $2.20 $2.30 $2.40

Determine the cost of the ending inventory using the following methods: a. FIFO b. LIFO c. Moving-average (Round per unit costs to four decimal places and all other dollar amounts to two decimal places.)

Answer: a. FIFO FIFO periodic is the same as FIFO perpetual. There are 1,000 units to sell. The company sold 710 units. Ending inventory has 290 units. Under FIFO, ending inventory has the latest costs: (100 × $2.40) + (190 × $2.30) = $677 b. LIFO Cost of Goods Sold 1/9 1/10

300 × $2.20 = $660 100 × $2.00 = $200

1/15 1/18

300 × $2.30 = $690

1/24 1/30

10 × $2.40 = $24

Ending Inventory (200 × $2.00) + (300 × $2.20) = $1,060 100 × $2.00 = $200 100 × $2.00 = $200 Add: 400 × $2.30 = $920 (100 × $2.00) + (100 × $2.30) = $430 (100 × $2.00) + (100 × $2.30) = $430 Add: 100 × $2.40 = $240 (100 × $2.00) + (100 × $2.30) + (90 × $2.40) = $646

Ending inventory at cost using LIFO is $646. c. Moving average Cost of Goods Sold

Ending Inventory = $2.12

1/9 1/10

400 × $2.12

1/15 1/18

300 × $2.264

1/24 1/30

10 × $2.3093

100 × $2.12 = $212 100 × $2.12 = $212 Add: 400 × $2.30 = $920 Total: $1,132 / 500 = $2.264 200 × $2.264 = $452.80 200 × $2.264 = $452.80 Add: 100 × $2.40 = $240 Total: $452.8 + $240 = $692.80 / 300 = $2.3093 290 × $2.3093 = $669.70

Ending inventory at cost using moving average is $669.70. Diff: 2 Objective: 10.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10.4

The LIFO Cost-Flow Assumption in Detail

1) The balance in the LIFO reserve account is the difference between the beginning inventory and ending inventory measured using FIFO. Answer: FALSE Diff: 2 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) If costs are declining, using LIFO will result in lower cost of goods sold and a higher net income as compared to FIFO and moving-average methods. Answer: TRUE Diff: 2 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Dollar-value LIFO computes inventory on a pool of inventory on the basis of units. Answer: FALSE Diff: 1 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The LIFO reserve is disclosed in the footnotes to the financial statements. Answer: TRUE Diff: 2 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The LIFO effect is ________. A) the change from the LIFO inventory value to the FIFO inventory value B) the difference between the ending inventory measured using LIFO and FIFO C) the change in the LIFO reserve account during the year and the impact on cost of goods sold D) the difference between the beginning inventory measured using LIFO and FIFO Answer: C Diff: 2 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Goodee Bakery is considering a change in its inventory valuation method. Goodee Bakery currently uses the FIFO method and is considering a change to the LIFO method. Goodee Bakery started the year on January 1 with inventory at a FIFO cost of $23,500 and a LIFO cost of $21,400. The ending inventory on December 31 is $25,850 at FIFO cost and $21,700 at LIFO cost. The LIFO effect is ________. A) $4,150 B) $2,100 C) $6,250 D) $2,050 Answer: D Explanation: LIFO Reserve Jan. 1: $23,500 - $21,400 = $2,100 LIFO Reserve Dec. 31: $25,850 - $21,700 = $4,150 LIFO Effect: $4,150 - $2,100 = $2,050 Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Sweet Treats is considering a change in its inventory valuation method. Sweet Treats currently uses the FIFO method and is considering a change to the LIFO method. Sweet Treats started the year on January 1 with inventory at a FIFO cost of $31,000 and a LIFO cost of $26,750. The ending inventory on December 31 is $29,790 at FIFO cost and $25,810 at LIFO cost. Cost of goods sold under the LIFO basis is $74,600 for the current year. The LIFO effect is ________. A) $4,250 B) $3,980 C) $8,230 D) $270 Answer: D Explanation: LIFO Reserve Jan. 1: $31,000 - $26,750 = $4,250 LIFO Reserve Dec. 31: $29,790- $25,810 = $3,980 LIFO Effect: $4,250 - $3,980 = $270 Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Basking Company adopted the dollar-value LIFO method in 2022. At December 31, 2022, ending inventory was $103,000, with a price index of 1.00, using dollar-value LIFO. At December 31, 2023, the ending inventory using FIFO is $129,000 and the price index is 1.16. Round all dollar amounts to the nearest dollar. Basking Company's ending inventory at December 31, 2023 on a dollar-value LIFO basis is ________. A) $103,000 B) $111,207 C) $112,520 D) $129,000 Answer: C Explanation: $129,000/1.16 = $111,207 $103,000 × 1.00 = $103,000 $8,207 × 1.16 = $9,520 Total $112,520 Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Savage Company adopted the dollar-value LIFO method in 2022. At December 31, 2022, ending inventory was $101,000, with a price index of 1.00, using dollar-value LIFO. At December 31, 2023, the ending inventory using FIFO is $123,000 and the price index is 1.16. What is the LIFO Reserve on December 31, 2023? (Round all dollar amounts to the nearest dollar.) A) $5,034 B) $16,161 C) $16,966 D) $22,000 Answer: B Explanation: $123,000 / 1.16 = $106,034 $101,000 × 1.00 = $101,000 $5,034 × 1.16 = $5,839 Total $106,839 LIFO Reserve: $123,000 - $106,839 = $16,161 Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) Michael Jones Company has adopted the dollar-value LIFO method in 2022. At December 31, 2022, the ending inventory at dollar-value LIFO is $105,000, with a price index of 1.00. At December 31, 2023, the ending inventory using FIFO is $129,000. The price index is 1.4 in 2023. Round all dollar amounts to the nearest dollar. What is the ending inventory using dollar-value LIFO at December 31, 2023? A) $105,000 B) $197,143 C) $92,143 D) $129,000 Answer: C Explanation: $129,000 /1.4 = $92,143 $92,143 × 1.00 = $92,143 This is a partial LIFO liquidation of the base layer of inventory. Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) A company begins the year with a zero balance in the LIFO Reserve account. Based on an analysis of LIFO and FIFO, the company determines the LIFO Reserve should be $20,000 at the end of the year? Which journal entry is needed? A) Debit Cost of Goods Sold for $20,000 and Credit LIFO Reserve for $20,000. B) Debit LIFO Reserve for $20,000 and Credit Cost of Goods Sold for $20,000. C) Debit Cost of Goods Sold for $20,000 and Credit Inventory for $20,000. D) Debit Inventory for $20,000 and Credit Gain on Inventory for $20,000. Answer: A Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) What are the advantages of using dollar-value LIFO? Answer: The advantages are to the use of dollar-value LIFO are: 1. Firms account for dollars not units. An extremely diverse inventory can be made homogeneous by restating the physical units into dollars. 2. It avoids problems when there are changes in the product mix. 3. It can minimize the likelihood of liquidation because the removal of one stock number is not going to liquidate an entire cost pool. Diff: 2 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) What is a LIFO liquidation? In a period of rising costs, why is a LIFO liquidation feared? Answer: A LIFO liquidation occurs when ending inventory levels decrease from one accounting period to another and a company assigns the cost of early LIFO layers to Cost of Goods Sold. Early LIFO layers have the early, low costs assigned to inventory so Cost of Goods Sold has the early, low costs. This is contrary to the reason why LIFO is used. Under LIFO, we want to have the latest costs assigned to Cost of Goods Sold because they are the highest costs available, and thus offer the highest tax advantage. With a LIFO liquidation, we lose the benefit from using LIFO. The result is an increase in net income and the taxes paid. Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Information about the New Pace Company is presented below: Date 12/31/2019 12/31/2020 12/31/2021 12/31/2022 12/31/2023 12/31/2024

Ending Inventory $160,000 $231,000 $216,000 $247,000 $308,000 $248,000

Price Index 1.00 1.05 1.20 1.30 1.40 1.42

Required: Compute the ending inventory for 2019 through 2024 using the dollar-value LIFO method. Round to the nearest dollar.

Answer: 12/31/2019 12/31/2020 12/31/2021 12/31/2022 12/31/2023 12/31/2024

$160,000 / $231,000 / $216,000 / $247,000 / $308,000 / $248,000 /

12/31/2019

$160,000 × 1.00 =

$160,000

12/31/2020

$160,000 × 1.00 = $60,000 × 1.05 = Total

$160,000 63,000 $223,000

12/31/2021

$160,000 × 1.00 = $20,000 × 1.05 = Total

$160,000 21,000 $181,000

12/31/2022

$160,000 × 1.00 = $20,000 × 1.05 = $10,000 × 1.30 = Total

$160,000 21,000 13,000 $194,000

12/31/2023

$160,000 × 1.00 = $20,000 × 1.05 = $10,000 × 1.30 = $30,000 × 1.40 = Total

$160,000 21,000 13,000 42,000 $236,000

12/31/2024

$160,000 × 1.00 = $14,648 × 1.05 = Total

$160,000 15,380 $175,380

1.00 1.05 1.20 1.30 1.40 1.42

$160,000 $220,000 $180,000 $190,000 $220,000 $174,648

Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Awesome Treats is considering a change in its inventory valuation method. Awesome Treats currently uses the FIFO method and is considering a change to the LIFO method. Awesome Treats started the year on January 1 with inventory at a FIFO cost of $35,000 and a LIFO cost of $26,000. The ending inventory on December 31 is $29,900 at FIFO cost and $25,810 at LIFO cost. Cost of goods sold under the LIFO basis is $74,600 for the current year. The LIFO effect is ________. Answer: LIFO Reserve Jan. 1: $35,000 - $26,000 = $9,000 LIFO Reserve Dec. 31: $29,900 - $25,810 = $4,090 LIFO Effect: $9,000 - $4,090 = $4,910 Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Baxter Company adopted the dollar-value LIFO method in 2022. At December 31, 2022, ending inventory was $105,000, with a price index of 1.00, using dollar-value LIFO. At December 31, 2023, the ending inventory using FIFO is $120,000 and the price index is 1.16. Round all dollar amounts to the nearest dollar. Baxter Company's ending inventory at December 31, 2023 on a dollar-value LIFO basis is ________. Answer: $120,000/1.16 = $103,448 $105,000 × 1.00 = $105,000 -$1,552 × 1.16 = -$1,800 Total ending inventory $103,200 Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Simple Company adopted the dollar-value LIFO method in 2022. At December 31, 2022, ending inventory was $100,000, with a price index of 1.00, using dollar-value LIFO. At December 31, 2023, the ending inventory using FIFO is $130,000 and the price index is 1.20. What is the LIFO Reserve on December 31, 2023? (Round all dollar amounts to the nearest dollar.) Answer: $130,000 / 1.20 = $108,333 $100,000 × 1.00 = $100,000 $8,333 × 1.20 = $10,000 Total $110,000 LIFO Reserve: $130,000 - $110,000 = $20,000 Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Michael Jones Company has adopted the dollar-value LIFO method in 2022. At December 31, 2022, the ending inventory at dollar-value LIFO is $105,000, with a price index of 1.00. At December 31, 2023, the ending inventory using FIFO is $125,000. The price index is 1.20 in 2023. Round all dollar amounts to the nearest dollar. What is the ending inventory using dollar-value LIFO at December 31, 2023? Answer: $125,000 /1.20 = $104,167 $104,167 × 1.00 = $104,167 Ending Inventory Diff: 3 Objective: 10.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10.5

The Lower-of-Cost-or-Market Rule

1) When following U.S. GAAP, the market value of inventory is always equal to the net realizable value. Answer: FALSE Diff: 1 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) A company uses FIFO. The inventory is reported at the lower of cost or the net realizable value. Answer: TRUE Diff: 1 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When writing down the inventory to market value, the direct method reports a loss as a separate line item on the income statement. Answer: FALSE Diff: 1 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When following U.S. GAAP, the lower-of-cost-or-market rule for inventory requires a firm to report ________. A) the inventory at the higher amount of cost or market on the balance sheet B) the difference between the cost basis and the market-based measure of inventory as a gain on the income statement C) the inventory at cost if the market value of inventory is higher than its cost basis D) the inventory at cost if the market value of inventory is lower than its cost basis Answer: C Diff: 2 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) When following U.S. GAAP, which of the following statements is not correct regarding the LCM rule for inventory? A) The individual-item approach to LCM is the most conservative because it results in the largest writedown. B) U.S. GAAP specifies a preference for using the individual-item approach. C) Firms can apply the LCM rule for inventory to the aggregate inventory, product lines, or individual items in inventory. D) U.S. GAAP does not specify a preference for the different methods of applying the lower-of-cost-ormarket rule. Answer: B Diff: 2 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) When following U.S. GAAP, which of the following statements is not correct regarding inventory write-downs using the lower-of-cost-or-market rule? A) If the write-down is significant, the direct method is preferred because the loss is disclosed separately from the cost of goods sold. B) Firms can use one of two methods to write down inventory to market: the direct method or the indirect method. C) The direct method writes off a loss to the inventory account and records that loss in the cost of goods sold on the income statement. D) The indirect method reports the loss as a separate line item on the income statement within income from continuing operations. Answer: A Diff: 2 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Following IFRS, which of the following statements is not correct? A) Firms determine the lower-of-cost-or-market value of inventory using individual-items or groups of items. B) IFRS inventory write-downs can be reversed later if the net realizable value of inventory increases. C) The net realizable value of inventory is calculated as the estimated selling price plus the estimated costs of completion and sale. D) IFRS-reporting firms determine if a write-down for inventory is needed by comparing the historical cost and the net realizable value of inventory. Answer: C Diff: 3 Objective: 10.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) Following IFRS, reversal of an inventory write-down ________. A) occurs when there is clear evidence of a decrease in net realizable value B) takes place when selling prices decrease following a write-down C) is limited to the amount of the original write-down D) will increase inventory but decrease reported income Answer: C Diff: 3 Objective: 10.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

9) At December 31, the Postotnik Company has ending inventory with a historical cost of $630,000. Assume the company uses the perpetual inventory system. The current replacement cost of the inventory is $608,000. The net realizable value is $650,000. The normal profit on this inventory is $50,000. Before any adjustments at the end of the period, the cost of goods sold has a balance of $900,000. Following IFRS, which journal entry is required on December 31 to adjust the ending balance of inventory if the direct method is used? A) No journal entry is required. B) Debit Cost of Goods Sold $20,000 and credit Inventory $20,000. C) Debit Inventory $20,000 and credit Cost of Goods Sold $20,000. D) Debit Cost of Goods Sold $22,000 and credit Inventory $22,000. Answer: A Explanation: The market value(net realizable value) of $650,000 exceeds the historical cost of $630,000. Diff: 3 Objective: 10.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

10) At December 31, the Selig Company has ending inventory with a historical cost of $633,000. Assume the company uses the FIFO perpetual inventory system. The net realizable value is $617,000. The normal profit on this inventory is $50,000. Before any adjustments at the end of the period, the cost of goods sold account has a balance of $900,000. Following U.S. GAAP, which journal entry is required on December 31 to adjust the ending balance of inventory if the direct method is used? A) Debit Cost of Goods Sold for $34,000 and credit Inventory for $34,000. B) Debit Inventory for $34,000 and credit Cost of Goods Sold for $34,000. C) Debit Cost of Goods Sold for $16,000 and credit Inventory for $16,000. D) Debit Inventory for $16,000 and credit Cost of Goods Sold for $16,000. Answer: C Explanation: The NRV of $617,000 is the market value. Therefore, there is a loss of value for the inventory of $16,000 (Historical cost $633,000 – NRV $617,000). The question assumes that the direct method is used. The direct method writes off the loss directly to the inventory account and records that loss in the cost of goods sold reported on the income statement. Diff: 3 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) At December 31, the Wendy Company has ending inventory with a historical cost of $633,000 valued using FIFO. Assume the company uses the perpetual inventory system. The net realizable value of the inventory is $617,000. The normal profit on this inventory is $50,000. Before any adjustments at the end of the period, the cost of goods sold account has a balance of $900,000. Following U.S. GAAP, which journal entry is required on December 31 to adjust the ending balance of inventory if the indirect method is used? A) Debit Cost of Goods Sold for $34,000 and credit Inventory for $34,000. B) Debit Inventory for $34,000 and credit Cost of Goods Sold for $34,000. C) Debit Cost of Goods Sold for $16,000 and credit Inventory for $16,000. D) Debit Loss on Inventory Writedown for $16,000 and credit Allowance to Reduce Inventory to Market for $16,000. Answer: D Explanation: The net realizable value of $617,000 is the market value of the inventory. Therefore, there is a loss of value for the inventory of $16,000 (Historical cost $633,000 – NRV $617,000). The question assumes that the indirect method is used. The indirect method reports the loss as a separate line item on the income statement within income from continuing operations (Loss on Inventory Write-down) and reduces the inventory account by the use of an allowance account. Diff: 3 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) When following U.S. GAAP, firms can use two methods to write down inventory to market, if needed. Required: 1. What are the two methods called? 2. If there is a loss, describe the journal entry for both methods. 3. If there is a significant loss, which method is preferred? Why is this the case? Answer: 1. The methods are called the direct method and the indirect method. 2. Under the direct method, Cost of Goods Sold is debited and Inventory is credited. Under the indirect method, Loss on Inventory Write-down is debited and Allowance to Reduce Inventory to Market is credited. 3. The indirect method is preferred because it discloses the loss separately from the cost of goods sold that were actually sold. When a loss is disclosed as a separate line item on the income statement, a financial statement user can easily see the loss. The direct method includes the loss in cost of goods sold and therefore it is not as transparent to the financial statement user. Diff: 3 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Cohen Company follows U.S. GAAP and uses the lower-of-cost-or-market rule for inventory. At December 31, 2022, the following data is available: Cost under LIFO Current Replacement Cost Expected Selling Price Estimated Disposal Costs Normal Profit Quantity of Ending Inventory

$420 per unit $365 per unit $400 per unit $50 per unit 25% of selling price 100,000 units

Cohen Company's balance sheet at December 31, 2022 reports the following: Inventory at cost Less: Allowance to reduce inventory to market Net

$42,000,000 5,500,000 $36,500,000

Required: Determine the correct balance for inventory at December 31, 2022. Answer: Current Replacement Cost Net Realizable Value($400 - $50) Net Realizable Value Less Normal Profit($350 - $100) Middle Value is Market Allowance to Reduce Inventory to Market($420 - $350) Inventory at cost Less: Allowance to reduce inventory to market Net

$365 per unit $350 per unit $250 per unit $350 per unit $70 per unit

$42,000,000 7,000,000 $35,000,000

Diff: 3 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) At the end of the year, Katerinos Company is applying the lower-of-cost-or-market rule to inventory. The company uses the perpetual inventory system. The company has the following data before year-end adjustments: Cost of Goods Sold Ending Inventory (FIFO cost) Ending Inventory (Current Replacement Cost) Ending Inventory (Net Realizable Value) Ending Inventory (Net Realizable Value - Normal Profit)

$500,000 $120,000 $105,000 $115,000 $100,000

Required: 1. Following U.S. GAAP, prepare the required journal entry at year-end. The company uses the direct method when applying the lower-of-cost-or-market rule. Answer: Account Debit Credit Cost of Goods Sold 15,000 Inventory 15,000 $120,000 FIFO cost - $105,000 net realizable value = $15,000 Diff: 2 Objective: 10.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

10.6

The Retail Inventory Method

1) A markdown is the amount that the firm decreases the selling price below the initial markup. Answer: FALSE Diff: 1 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) If the cost-to-retail ratio increases under the conventional retail method, the cost assigned to the retail value of ending inventory will decrease. Answer: FALSE Diff: 2 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Under the conventional retail inventory method net markups and net markdowns are both used to determine the cost to retail percentage. Answer: FALSE Diff: 1 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The retail inventory method that estimates the lower-of-cost-or-market of ending inventory is the ________. A) basic retail inventory method B) gross profit inventory method C) LCM extract method D) conventional retail inventory method Answer: D Diff: 2 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) A company uses the conventional retail method to estimate the cost of ending inventory for interim financial statements. Which of the following responses describe the correct treatment of markups and markup cancellations in the calculation of the cost-to-retail ratio? A) Markups add

Markup Cancellations subtract

Markups add

Markup Cancellations exclude

Markups add

Markup Cancellations add

Markups subtract

Markup Cancellations exclude

Answer: A

Diff: 2 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) A company uses the basic retail method to estimate the cost of ending inventory for interim financial statements. Which of the following responses describe the correct treatment of markups and markup cancellations in the calculation of the cost-to-retail ratio? A) Markups add

Markup Cancellations subtract

Markups add

Markup Cancellations exclude

Markups add

Markup Cancellations add

Markups subtract

Markup Cancellations exclude

Answer: A

Diff: 2 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) A company uses the conventional retail method to estimate the cost of ending inventory for interim financial statements. Which of the following responses describe the correct treatment of markups and markdowns in the calculation of the cost-to-retail ratio? A) Markups add

Markdowns subtract

Markups add

Markdowns exclude

Markups subtract

Markdowns add

Markups exclude

Markdowns exclude

Answer: B

Diff: 2 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) A company uses the basic retail method to estimate the cost of ending inventory for interim financial statements. Which of the following responses describe the correct treatment of markups and markdowns in the calculation of the cost-to-retail ratio? A) Markups add

Markdowns subtract

Markups add

Markdowns exclude

Markups subtract

Markdowns add

Markups exclude

Markdowns exclude

Answer: A

Diff: 2 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) The following information is available for the past month for a retail store: Sales Markups Markdowns Purchases (at cost) Purchases (at retail) Beginning inventory (at cost) Beginning inventory (at retail)

$84,000 $9,000 $10,000 $38,800 $107,000 $30,000 $48,354

What is the ending inventory at cost using the conventional retail method? (Round cost-to-retail ratios to four decimal places.) A) $29,450 B) $164,354 C) $74,000 D) $70,354 Answer: A Explanation: Cost Retail Beginning inventory $30,000 $48,354 Purchases $38,800 $107,000 Markups Subtotal for ratio Ratio $68,800 ÷ $164,354 = 41.86% Markdowns Sales(net) Ending inventory 41.86% × $70,354 =

______ $68,800

$9,000 $164,354

$29,450

($10,000) ($84,000) $70,354

Diff: 3 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) The following information is available for the past month for a retail store: Sales Markups Markdowns Purchases (at cost) Purchases (at retail) Beginning inventory (at cost) Beginning inventory (at retail)

$110,000 $10,000 $8,000 $38,800 $107,000 $37,000 $49,000

What is the ending inventory at cost using the basic retail method? (Round cost-to-retail ratios to four decimal places.) A) $23,026 B) $24,974 C) $48,000 D) $12,000 Answer: A Explanation: Cost Retail Beginning inventory $37,000 $49,000 Purchases $38,800 $107,000 Markups $10,000 Markdowns ______ ($8,000) Subtotal for ratio 75,800 158,000 Ratio ($75,800/158,000) = 47.97% Sales(net) ($110,000) Ending inventory 47.97% × $48,000 = $23,026 $48,000 Diff: 3 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) The following information is available for the past month for a retail store: Sales Markups Markdowns Purchases (at cost) Purchases (at retail) Beginning inventory (at cost) Beginning inventory (at retail)

$105,000 $10,000 $8,000 $38,800 $107,000 $34,000 $46,000

What is the ending inventory at cost using the basic retail method? (Round cost-to-retail ratios to four decimal places.) A) $23,485 B) $26,515 C) $50,000 D) $12,000 Answer: A Explanation: Cost Retail Beginning inventory $34,000 $46,000 Purchases $38,800 $107,000 Markups $10,000 Markdowns ______ ($8,000) Subtotal for ratio 72,800 155,000 Ratio ($72,800 /155,000) = 46.97% Sales(net) ($105,000) Ending inventory 46.97% × $50,000 = $23,485 $50,000 Diff: 3 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) The following information is available for the past year for a retail store: Sales Sales Returns Markups Markup cancellations Markdowns Purchases (at cost) Purchases (at retail) Beginning inventory (at cost) Beginning inventory (at retail)

$121,000 $1,000 $11,000 $1,000 $9,000 $40,000 $90,000 $30,000 $40,000

What is the cost-to-retail ratio to estimate the cost of ending inventory using the conventional retail method? (Round cost-to-retail ratios to four decimal places.) A) 50% B) 75% C) 53.85% D) 58.33% Answer: A Explanation: Cost Retail Beginning inventory $30,000 $40,000 Purchases $40,000 $90,000 Markups $11,000 Markup cancellations _______ ($1,000) Subtotal for ratio $70,000 $140,000 Ratio $70,000/$140,000 = 50% Diff: 3 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Explain the difference between the basic retail method and the conventional retail method. Answer: The difference between the two methods lies in the calculation of the cost-to-retail ratio. Under the basic retail method, the cost-to-retail ratio is calculated by adding beginning inventory at cost and purchases at cost for the numerator. The denominator adds the beginning inventory at retail, purchases at retail and net markups, and subtracts net markdowns. Under the conventional retail method, the cost-to-retail ratio is calculated by adding beginning inventory at cost and purchases at cost for the numerator. The denominator adds the beginning inventory at retail, purchases at retail, and net markups. The conventional method does not include markdowns or markdown cancellations when calculating the cost-to-retail ratio but subtracts net markdowns and sales from goods available for sale to determine ending inventory at retail. Both methods arrive at the same number for ending inventory at retail. Since both methods use different cost-to-retail ratios, the ending inventory at cost and cost of goods sold differ between the two methods. Diff: 2 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) The following information is available for the month of June for a retail store: Sales Sales Returns Markups Markup cancellations Markdowns Purchases (at cost) Purchases (at retail) Purchase returns (at cost) Purchase returns (at retail) Beginning inventory (at cost) Beginning inventory (at retail)

$79,000 $1,000 $10,000 $1,000 $9,300 $40,000 $107,000 $1,200 $2,000 $30,000 $46,000

Required: Calculate the ending inventory at cost using the conventional retail method. Round ratios to four decimal places. (For example, 0.40127 = 0.4013) Answer: Cost Retail Beginning inventory $30,000 $46,000 Purchases $40,000 $107,000 Purchase returns ($1,200) ($2,000) Markups $10,000 Markup cancellations _______ ($1,000) Subtotal for ratio $68,800 $160,000 Ratio $68,800 / $160,000 = 43.00% Markdowns ($9,300) Sales(net) ($78,000) Ending inventory 43.00% × $72,700 = $31,261 $72,700 Ending inventory at cost is $31,261. Diff: 3 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) A department store wants to estimate the cost of ending inventory using the conventional retail method. Round ratios to four decimal places. For example, 0.43677 equals 0.4368. The following data is available: Sales Sales Returns Markups Markdowns Purchases (at cost) Purchases (at retail) Purchase returns (at cost) Purchase returns (at retail) Beginning inventory (at cost) Beginning inventory (at retail)

$90,000 $1,000 $10,000 $9,000 $20,000 $50,000 $1,200 $2,000 $30,000 $46,000

Required: Using the conventional retail method, estimate the cost of ending inventory. Answer: Cost Retail Beginning inventory $30,000 $46,000 Purchases $20,000 $50,000 Purchase returns ($1,200) ($2,000) Markups ______ $10,000 Subtotal for ratio $48,800 $104,000 Ratio $48,800 / $104,000 = 46.92% Markdowns ($9,000) Sales(net) ($89,000) Ending inventory 46.92% × $6,000 = $2,815.20 $6,000 Ending inventory at cost equals $2,815.20. Diff: 3 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) The following information is available for the month of June for a retail store: Sales Sales Returns Markups Markup cancellations Markdowns Purchases (at cost) Purchases (at retail) Purchase returns (at cost) Purchase returns (at retail) Beginning inventory (at cost) Beginning inventory (at retail)

$79,000 $1,000 $10,000 $1,000 $9,300 $40,000 $107,000 $1,200 $2,000 $30,000 $46,000

Required: Calculate the ending inventory at cost using the basic retail method. Round ratios to four decimal places. (For example, 0.40127 = 0.4013) Answer: Beginning Inventory $30,000 $46,000 Purchases 40,000 107,000 Purchase Returns (1,200) (2,000) Markups 10,000 Markup Cancellations (1,000) Markdowns (9,300) Subtotal for ratio $68,800 $150,700 Ratio $68,800 / $150,700= 45.65% Net Sales (78,000) Ending Inventory .4565 × 72,700 $33,188 $72,700 Diff: 3 Objective: 10.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

10.7

Gross Profit Method of Estimating Inventory

1) The first step in applying the gross profit method of determining inventory is to take a physical count of the goods. Answer: FALSE Diff: 1 Objective: 10.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) To calculate inventory using the gross profit method, one must know the gross profit percentage. Answer: TRUE Diff: 1 Objective: 10.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The gross profit method may not be used for budgeting purposes. Answer: FALSE Diff: 1 Objective: 10.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The gross profit method is often used to estimate the cost of ending inventory. The gross profit method should not be used to ________. A) determine the cost of ending inventory during an interim period without performing a physical count B) determine the cost of ending inventory for an annual financial statement C) determine the cost of inventory that has been stolen or destroyed D) develop budgets Answer: B Diff: 2 Objective: 10.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Lorna Company has the following data available: Beginning inventory Net purchases Net sales Gross profit percentage

$170,000 $450,000 $830,000 40%

The estimated cost of the ending inventory using the gross profit method is ________. A) $122,000 B) $332,000 C) $498,000 D) $620,000 Answer: A Explanation: Cost of Goods Available $620,000 Less: Cost of Goods Sold = 60% × $830,000 = $498,000 Estimated Ending Inventory = $620,000 - $498,000 = $122,000 Diff: 2 Objective: 10.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Jesse Company has the following data for January: Beginning inventory Net purchases Net sales Gross profit percentage

$208,000 $618,000 $446,000 40%

What is the company's estimated cost of goods sold for January using the gross profit method? A) $246,000 B) $178,400 C) $247,200 D) $267,600 Answer: D Explanation: 60% × $446,000 = $267,600 Diff: 2 Objective: 10.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) A fire destroyed the warehouse of Reed Enterprises, on August 31, 20Y1. The books and records of Reed showed the following information on that date. Merchandise Inventory. Jan. 1, 20Y1 $600,000 Purchases to date 990,000 Freight - In 30,000 Sales to date $2,400,000 The gross profit ratio has averaged 60 % of sales for the past six years. Required: Use the gross profit method to estimate the cost of inventory destroyed by fire. A) $660,000 B) $1,620,000 C) $960,000 D) $1,590,000 Answer: A Explanation: $600,000 + $990,000 + $30,000 = $1,620,000 GAFS - $960,000 CGS ($2,400,000 × (1 - 0.6)) = $660,000 Diff: 2 Objective: 10.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) A fire destroyed the inventory of Barber Company. The following information is available: Beginning inventory Purchases Net Sales Revenue Gross Profit Percentage

$50,000 $170,000 $200,000 30%

Required: 1. Prepare a schedule to compute the amount of inventory lost in the fire using the gross profit method. 2. Prepare the required journal entry after the fire. Answer: 1. Beginning inventory $50,000 Add: Purchases 170,000 Cost of Goods Available for Sale 220,000 Less: Cost of Goods Sold ($200,000 × 70%) 140,000 Ending Inventory $80,000 2. Accounts Loss on Inventory due to Fire Inventory

Debit 80,000

Credit 80,000

Diff: 2 Objective: 10.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) A fire destroyed the inventory of Zabo Company. The following information is available: Beginning inventory Purchases Net Sales Revenue Gross Profit Percentage

$30,000 $140,000 $200,000 50%

Required: 1. Prepare a schedule to compute the amount of inventory lost in the fire using the gross profit method. 2. Prepare the required journal entry after the fire. Answer: 1. Beginning inventory $30,000 Add: Purchases 140,000 Cost of Goods Available for Sale 170,000 Less: Cost of Goods Sold ($200,000 × 50%) 100,000 Ending Inventory $70,000 2. Accounts Loss on Inventory due to Fire Inventory

Debit 70,000

Credit 70,000

Diff: 2 Objective: 10.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

10.8

Inventory Disclosures

1) Inventory disclosures require information about any inventory financing arrangements. Answer: TRUE Diff: 1 Objective: 10.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) LIFO Reserve = FIFO Inventory Balance - LIFO Inventory Balance. Answer: TRUE Diff: 1 Objective: 10.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) If the LIFO Reserve increases during the year, Cost of Goods Sold will be higher under LIFO than FIFO. Answer: TRUE Diff: 1 Objective: 10.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Following U.S. GAAP, required inventory disclosures in financial statements do not include ________. A) carrying amounts by type of inventory, such as raw materials inventory and finished goods inventory B) inventory financing agreements C) reversals of inventory write-downs D) the costing methods used such as FIFO or LIFO Answer: C Diff: 2 Objective: 10.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) How do inventory disclosures following IFRS differ from those following U.S. GAAP? A) Firms using IFRS are required to report the amount of reversals of inventory write-downs. B) Firms using IFRS disclose the amount of write-downs recognized as expenses or losses. C) Firms using IFRS do not disclose the market value of inventory. D) Firms using IFRS do not disclose inventory financing agreements. Answer: A Diff: 2 Objective: 10.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) When costs are increasing, and inventory levels are stable, a company will report ________. A) lower cost of goods sold under LIFO than FIFO B) lower inventory under FIFO than LIFO C) higher net income under LIFO than FIFO D) lower net income under LIFO than FIFO Answer: D Diff: 2 Objective: 10.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) An increase in the LIFO reserve is recorded as ________. A) a credit to Cost of Goods Sold B) a debit to Cost of Goods Sold C) debit to the LIFO Reserve D) credit to the Inventory account Answer: B Diff: 3 Objective: 10.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) The income taxes saved by using LIFO instead of FIFO are equal to ________. A) the tax rate times the change in the ending inventory from last year to the current year B) the tax rate times the cost to retail ratio C) the tax rate times the LIFO reserve D) the tax rate times the change in the LIFO reserve Answer: C Diff: 3 Objective: 10.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) If the LIFO reserve increases during the year, and inventory costs are increasing, ________. A) cost of goods sold will be higher under FIFO than LIFO B) cost of goods sold will be higher under LIFO than FIFO C) the journal entry will debit LIFO Reserve D) the journal entry will credit Cost of Goods Sold Answer: B Diff: 3 Objective: 10.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) The inventory turnover ratio equals ________. A) cost of goods sold divided by average inventory B) sales revenue divided by average inventory C) sales revenue divided by cost of goods sold D) 365 divided by average inventory Answer: A Diff: 3 Objective: 10.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

10.9

Appendix A: LIFO Retail Inventory Method

1) The computations for the dollar-value LIFO retail method are similar to the LIFO retail method. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The first step under the LIFO retail inventory method is computing two cost-to-retail ratios: The first layer is based on beginning inventory, and the second layer is based on the change in the ending inventory at retail. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The LIFO retail method implicitly assumes that price levels change during the year. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Smith Company uses the LIFO retail inventory method for inventory costing. Smith Company has beginning inventory with a cost of $20,000 and a retail value of $80,000. During the year, the company purchases goods with a cost basis of $50,000 and a retail basis of $60,000. Sales are $70,000 at retail. Net markups are $5,000 and net markdowns are $5,000. Under the LIFO retail inventory method, which cost-to-retail ratios are used to determine the cost of ending inventory? A) beginning inventory 25%; new layer 83.33% B) beginning inventory 25%; new layer 91.67% C) beginning inventory 25%; new layer 25% D) beginning inventory 25%; new layer 75.00% Answer: A Explanation: Cost Retail Beginning inventory $20,000 $80,000 Purchases 50,000 60,000 Net markups 5,000 Net markdowns (5,000) Current year layer 50,000 60,000 Goods available for sale 70,000 140,000 Sales (70,000) Ending inventory at retail $70,000 Ratio for beginning inventory: $20,000/ $80,000 = 25% Ratio for new layer: $50,000 / $60,000 = 83.33% Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The Henry Store has the following data for inventory: Cost $200,000 360,000

Inventory, January 1 Purchases for January Sales for January

Retail $300,000 480,000 430,000

The store uses the dollar-value LIFO retail method. The price index for the year is 1.08. The price index that pertains to the beginning inventory is 1.00. Round all ratios to four decimal places. What is the cost of the ending inventory at January 31? (Round any percentages to two decimal places, X.XX%, and your final answer to the nearest dollar.) A) $200,000 B) $219,500 C) $324,074 D) $350,000 Answer: B Explanation: Cost Retail Inventory, January 1 $200,000 $300,000 Purchases for January 360,000 480,000 Current year layer (Ratio $360,000/$480,000 = 75.00%) 360,000 480,000 Goods available for sale 560,000 780,000 Sales for January (430,000) Ending Inventory at retail $350,000 Ending inventory = $350,000 / 1.08 = $324,074 LIFO Retail $300,000 $24,074

Beginning inventory New layer = $324,074 - $300,000 Cost of new layer = $24,074 × 1.08 × 75.00% Total

Cost $200,000 $19,500 $219,500

Ratio = $360,000/$480,000 = 75.00% Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

6) The Jensen Store has the following data for inventory:

Inventory, January 1 Purchases for January Sales for January

Cost $228,000 370,000

Retail $330,000 480,000 429,000

The store uses the dollar-value LIFO retail method. The price index for the year is 1.08. The price index that pertains to the beginning inventory is 1.00. What is the retail value of the ending inventory at January 31? A) $381,000 B) $598,000 C) $909,000 D) $810,000 Answer: A Explanation: $330,000 + $480,000 - $429,000 Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

7) The Siempre Store has the following data for inventory: Cost $240,000 370,000

Inventory, March 1 Purchases for March Sales for March

Retail $350,000 900,000 500,000

The store uses the LIFO retail method. Round all ratios to four decimal places. What is the cost of the ending inventory at March 31? (Round your final answer to the nearest dollar.) A) $400,000 B) $750,000 C) $164,440 D) $404,440 Answer: D Explanation: Cost Retail Inventory, March 1 $240,000 $350,000 Purchases for March 370,000 900,000 Current year layer (Ratio $370,000/$900,000 = 41.11%) 370,000 900,000 Goods available for sale 610,000 1,250,000 Sales for March (500,000) Ending Inventory $750,000 LIFO Retail $350,000 $400,000

Beginning inventory New layer = ($750,000 - $350,000) Cost of new layer = $400,000 × 41.11% Total

Cost $240,000 $164,440 $404,440

Ratio for new layer: $370,000 /$900,000 = 41.11% Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Farm Tools Inc. (FTI) uses the LIFO retail inventory method for inventory costing. It has beginning inventory at a cost of $20,000 with a retail value of $50,000. During the year, FTI purchased inventory with a cost basis of $120,000 and a retail basis of $200,000. It had net markups of $6,000 and net markdowns of $12,000. FTI has net sales of $150,000. What is the cost of FTI's ending inventory using the LIFO retail inventory method? (Use two decimal places for percentages. Round final answer to nearest dollar.) Answer: $47,218 Cost-to-Retail Cost Retail Ratio Beginning inventory $20,000 $50,000 40.00% Purchases 120,000 200,000 Net markups 6,000 Net markdowns (12,000) Current year layer 120,000 194,000 61.86% Goods available for sale $140,000 244,000 Sales (150,000) Ending inventory at retail $94,000 Ending Ending Inventory at Ratio Inventory at Retail LIFO Cost Beginning inventory $50,000 40.00% $20,000 Increase 44,000 61.86% $27,218 Ending inventory $94,000 $47,218 Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Ferret Company uses the LIFO retail inventory method for inventory costing. Ferret Company has beginning inventory with a cost of $10,000 and a retail value of $40,000. During the year, the company purchases goods with a cost basis of $80,000 and a retail basis of $100,000. It has net markups of $5,000 and net markdowns of $5,000. Sales are $50,000 at retail. Required: What is the cost of the ending inventory using the LIFO retail inventory method? Round all ratios to four decimal places. Round all numbers to two decimal places. Answer: Cost Retail Beginning inventory $10,000 $40,000 Purchases 80,000 100,000 Net markups 5,000 Net markdowns Current year layer Goods available for sale Sales Ending inventory at retail

_____ 80,000 90,000

(5,000) 100,000 140,000 (50,000) $90,000

Ratio for beginning inventory: $10,000 / $40,000 = 25% Ratio for new layer: $80,000 / $100,000 = 80% Retail Ratio Beginning inventory $40,000 25% New layer 50,000 80% Ending inventory $90,000

LIFO Cost $10,000 40,000 $50,000

Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Andra Company uses the dollar-value LIFO retail inventory method for inventory costing. Andra Company has beginning inventory with a cost of $10,000 and a retail value of $40,000. During the year, the company purchases goods with a cost basis of $80,000 and a retail basis of $100,000. It has net markups of $10,000 and net markdowns of $5,000. Sales are $50,000 at retail. The price index for the current year is 1.04. Andra Company adopted the dollar-value LIFO method at the end of the prior year, which is the base year with a price index of 1.00. Required: What is the cost of the ending inventory using the dollar-value LIFO retail inventory method? Round all ratios to four decimal places. Round all numbers to two decimal places. Answer: Cost Retail Beginning inventory $10,000 $40,000 Purchases 80,000 100,000 Net markups 10,000 Net markdowns Current year layer Goods available for sale Sales Ending inventory at retail

_____ 80,000 90,000

(5,000) 105,000 145,000 (50,000) $95,000

$95,000 / 1.04 = $91,346 Ratio for beginning inventory: $10,000 / $40,000 = 25% Ratio for new layer: $80,000 / $105,000 = 76.19% Retail Price Index × Ratio Beginning inventory $40,000 × 1.00 × 25% = New layer 51,346 × 1.04 × 76.19% = Ending inventory $91,346

LIFO Cost $10,000 40,685 $50,685

Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 11 Long-Term Operating Assets: Acquisition, Cost Allocation, and Derecognition 11.1

Initial Measurement of Property, Plant, and Equipment

1) Property, plant, and equipment include both tangible and intangible fixed assets. Answer: FALSE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Capitalization is the process of recording an expenditure as an asset. Answer: TRUE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The cost of land includes the purchase price and land improvement costs. Answer: FALSE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) When land is purchased and an old building thereon is demolished, the total purchase price plus the demolition cost is the total capitalized value of the land. Answer: TRUE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) When land is purchased and landscaping improvements are made, the total purchase price plus the improvement cost is the total capitalized value of the land. Answer: FALSE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) When more than one different type of asset is acquired in one purchase transaction, the total purchase price is allocated among the assets in proportion to their fair values. Answer: TRUE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The amount of capitalized interest for a constructed asset is the lesser of actual interest incurred and avoidable interest. Answer: TRUE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) For constructed assets, the amount of capitalized interest is calculated as total construction costs times the applicable interest rate. Answer: FALSE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) To determine the amount of interest to capitalize, the interest rate on specific borrowings to finance construction of the asset is multiplied times the total weighted-average accumulated expenditures. Answer: FALSE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Firms capitalize interest costs from the time of the initial expenditure until the asset is actually put into service. Answer: FALSE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Firms compute the amount of avoidable interest as the weighted-average accumulated expenditures times the appropriate interest rate. Answer: TRUE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) IFRS permits capitalization of interest on specific borrowings related to both constructed and purchased assets. Answer: FALSE Diff: 1 Objective: 11.1 IFRS/GAAP: IFRS AACSB: Application of knowledge

13) IFRS permits the use of full-cost accounting to allocate a proportionate share of indirect costs to a constructed asset. Answer: TRUE Diff: 1 Objective: 11.1 IFRS/GAAP: IFRS AACSB: Application of knowledge

14) Under IFRS, there is no need to use the weighted-average accumulated expenditures to determine capitalized interest. Answer: FALSE Diff: 1 Objective: 11.1 IFRS/GAAP: IFRS AACSB: Application of knowledge

15) With basket purchases, the firm allocates one purchase price to specific assets based on fair values. Answer: TRUE Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Which of the following is not a major characteristic of a fixed asset? A) acquired for resale B) tangible in nature C) expected to be used for more than one year D) used in the production and sale of other assets Answer: A Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) A cost that is recorded as an asset is ________. A) an operating expenditure B) a tangible expenditure C) an intangible expenditure D) a capital expenditure Answer: D Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) The cost of land does not include ________. A) costs of removing old buildings B) costs of improvements with limited lives C) costs of grading and clearing the land D) legal fees and closing costs Answer: B Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) The debit for a sales tax paid on the purchase of machinery would be a charge to ________. A) accumulated depreciation for machinery B) a deferred liability account C) the machinery account D) miscellaneous tax expense Answer: C Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Construction costs for fences and driveways are reported on the statement of financial position as ________. A) current assets B) intangible assets C) land D) land improvements Answer: D Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Generally, which of the following costs are capitalized for self-constructed assets? A) materials and labor only B) labor and overhead only C) materials and overhead only D) materials, labor, and overhead Answer: D Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Assets that qualify for interest cost capitalization include ________. A) assets under construction for a company's own use B) assets not currently being used because of excess capacity C) assets that are ready for their intended use and acquired through issuance of long-term debt D) All of the above. Answer: A Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) When computing the amount of interest cost to be capitalized, the concept of "avoidable interest" refers to ________. A) that portion of average accumulated expenditures on which no interest cost was incurred B) that portion of total interest cost which would not have been incurred if expenditures for asset construction had not been made C) the amount of interest cost actually incurred on financing undertaken specifically for the acquisition of the asset D) a cost of capital charge for equity restricted to the acquisition of the specific asset Answer: B Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) The period of time for which interest is to be capitalized ends when ________. A) no additional interest cost is actually being incurred on direct financing for the acquisition of the asset B) a constructed asset is substantially complete and put into use C) a constructed asset is substantially complete and ready for its intended use D) an acquired asset is received and ready for its intended use Answer: C Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) In the context of constructing a plant asset, the interest that the company would not have paid if it had not borrowed funds to construct the asset is referred to as ________. A) avoidable interest B) marginal interest C) capital interest D) financing interest Answer: A Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Seeder Inc. made a lump-sum purchase of three pieces of machinery for $120,000 from an unaffiliated company. At the time of acquisition, Seeder paid $4000 to determine the appraised value of the machinery. The appraisal disclosed the following values: Machine A $60,000 Machine B $36,000 Machine C $24,000 What cost should be assigned to Machines A, B, and C, respectively? A) A: $60,000; B: $36,000; C: $24,000 B) A: $62,000; B: $37,200; C: $24,800 C) A: $64,000; B: $33,600; C: $22,400 D) A: $41,333; B: $41,333; C: $41,333 Answer: B Explanation: The total cost of the machinery includes the cost of the appraisal. So, the total cost that must be allocated between the three machines is $124,000 ($120,000 + $4000). The total cost can be allocated based on relative appraised values. The total appraised value is $120,000. A's cost allocation = $60,000/$120,000 × $124,000 = $62,000, B = $36,000/$120,000 × $124,000 = $37,200, C = $24,000/$120,000 × $124,000 = $24,800. Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) Ballyhigh Company purchased equipment for $20,000. Sales tax on the purchase was $1500. Other costs incurred were freight charges of $300, repairs of $350 for damage during installation, and installation costs of $450. What is the capitalized cost of the equipment? A) $21,500 B) $21,850 C) $22,250 D) $22,600 Answer: C Explanation: $20,000 + $1500 + $300 + $450 = $22,250 Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

28) Alzparker Company constructed a building at a total actual cost of $30,000,000. Weighted-average accumulated expenditures during the construction period amounted to $23,000,000. As a result of financing arrangements, actual interest was $1,820,000, and avoidable interest was $1,600,000. What is the capitalized cost of the building? A) $24,820,000 B) $31,600,000 C) $31,820,000 D) $33,420,000 Answer: B Explanation: $31,600,000 = $30,000,000 + $1,600,000 Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) Emerson Enterprises is constructing a building. Construction began in 2022, and the building was completed on December 31, 2022. Emerson made payments to the construction company of $600,000 on July 1, $1,800,000 on September 1, and $2,400,000 on December 31. What is the amount of weightedaverage accumulated expenditures that provides the basis for determining capitalized interest? A) $900,000 B) $1,100,000 C) $1,200,000 D) $1,600,000 Answer: A Explanation: $900,000 = $600,000 × 6/12 + $1,800,000 × 4/12 Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

30) During 2022, Dosekis Co. calculated weighted-average accumulated expenditures of $200,000 after construction of assets that qualified for capitalization of interest. The only debt outstanding during 2022 was a $300,000, 10%, 5-year note payable dated January 1, 2029. What is the amount of interest that should be capitalized by Dosekis during 2022? A) $10,000 B) $20,000 C) $30,000 D) $40,000 Answer: B Explanation: $200,000 × 0.1 Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) What criteria does a company use to decide whether to include an expenditure in the cost of property, plant, and equipment rather than expensing it? Provide an example of a type of expenditure included in the cost of property, plant, and equipment as a result of applying these criteria. Answer: Generally, a company capitalizes the expenditures that are necessary to obtain the benefits to be derived from the asset. Specifically, any expenditure necessary to obtain the asset and put it in operating condition is capitalized, or recorded as part of the cost of property, plant, and equipment. These expenditures include the contract price, less any discounts taken, plus freight, assembly, installation, and testing costs. Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

32) Woowee Company manufactures electric motorcycles. On April 1, it purchased a machine for its assembly line at a contract price of $300,000 with terms of 2/10, n/30. Woowee paid the contract price on April 8 and also incurred installation and transportation costs of $5,000, sales tax of $18,000, and testing costs of $4,000. During testing, the machine was accidentally damaged, so the company had to pay $2,000 to repair it. Required: (a) What characteristics are necessary for a company to include an asset in the category of property, plant, and equipment? (b) What is the capitalized cost of the machine? Answer: (a) PPE assets are: 1. Tangible in nature. 2. Expected to be used for more than one year (or more than one operating cycle, whichever is longer). 3. Used in the production and sale of other assets, for rental to others, or for administrative purposes. (b) $300,000 - ($300,000 × 0.02) + $5,000 + $18,000 + $4,000 = $321,000 Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

33) On March 1, Orono Co. began construction of a small building. The following expenditures were incurred for construction: March 1 $90,000 April 1 $80,000 May 1 180,000 June 1 300,000 July 1 200,000 The building was completed and occupied on July 1. To help pay for construction $50,000 was borrowed on March 1 on a 12%, three-year note payable. The only other debt outstanding during the year was a $500,000, 10% note issued two years ago. Required: (a) Calculate the weighted-average accumulated expenditures. (b) Calculate avoidable interest. The company follows U.S. GAAP. (c) Determine capitalized interest. Answer: (a) Capitalization Weighted-Average Date Expenditures Period Accumulated Expenditures March 1 $90,000 4/12 $30,000 April 1 80,000 3/12 20,000 May 1 180,000 2/12 30,000 June 1 300,000 1/12 25,000 July 1 200,000 0 0 $105,000 (b)

Weighted-Average Accum. Expend. $50,000 55,000 $105,000

Rate 12% 10%

Avoidable Interest $6,000 5,500 $11,500

$5,000 $50,000 $55,000

Capitalized Interest is lower of Avoidable and Actual Interest Avoidable Interest $11,500 Actual Interest $55,000

Capitalized Interest = $11,500

Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

34) On February 1, 2023, Ursa Corporation purchased a parcel of land as a factory site for $100,000. It demolished an old building on the property and began construction on a new building that was completed on October 2, 2023. Costs incurred during this period are: Demolition of old building Architect's fees Legal fees for title investigation and purchase contract Construction costs

$8,000 25,000 4,000 650,000

In addition, Ursa sold salvaged materials resulting from the demolition for $2,000. Required: a. At what amount should Ursa record the cost of the land and the new building, respectively? b. If management misclassified a portion of the building's cost as part of the cost of the land, what would be the effect on the financial statements? Answer: a. Land: Purchase price $100,000 Demolition of old building 8,000 Legal fees 4,000 Salvaged materials (2,000) Total $110,000 Building: Architect's fees Construction costs Total

$25,000 650,000 $675,000

b. If a portion of the cost of the building was misclassified as land, the amount reported for building would be understated and the amount reported for land would be overstated. However, in total, the initial amount reported for property, plant, and equipment would be correctly stated. Because depreciation would not be taken on the costs misclassified as land, total assets reported on the balance sheet would be overstated in future periods. In addition, future income statements would understate depreciation expense, resulting in an overstatement of net income and shareholders' equity. Diff: 2 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

35) Basic Company purchased equipment for $120,000. Sales tax on the purchase was $11,500. Other costs incurred were freight charges of $300, repairs of $350 for damage during installation, and installation costs of $450. What is the capitalized cost of the equipment? Answer: $120,000 + $11,500 + $300 + $450 = $132,250 Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

36) Parker Company constructed a building at a total actual cost of $30,000. Weighted-average accumulated expenditures during the construction period amounted to $23,000. As a result of financing arrangements, actual interest was $1,820, and avoidable interest was $1,600. What is the capitalized cost of the building? Answer: $30,000 + $1,600 = $31,600 Diff: 1 Objective: 11.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

11.2

Subsequent Measurement of Property, Plant, and Equipment

1) All fixed assets with a useful life of more than one year must be capitalized and depreciated. Answer: FALSE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Ordinary repairs are expenditures to maintain the operating efficiency of an asset that do not extend its original useful life. Answer: TRUE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Adding new offices to an existing office building would qualify as a capital expenditure. Answer: TRUE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Depreciation is the systematic allocation of the cost of both tangible and intangible assets to expense over the assets' expected useful lives. Answer: FALSE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Scrap value reduces the depreciable base of an asset. Answer: TRUE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Scrap value is also referred to as depreciable value. Answer: FALSE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Accumulated depreciation is a contra-expense account that represents total depreciation taken over the life of an asset. Answer: FALSE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Net book value is equal to the original cost of a plant asset minus accumulated depreciation for that asset. Answer: TRUE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Double-declining balance method charges twice the amount of straight-line depreciation expense each period. Answer: FALSE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) U.S. GAAP allows a firm to record a half year of depreciation expense for any asset acquired at any time during the year. Answer: TRUE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) The half-year convention is not applicable for the double-declining balance method of determining depreciation expense. Answer: FALSE Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) An improvement made to a machine increased its fair value and its production capacity. The cost of the improvement should be debited to ________. A) expense B) accumulated depreciation C) equipment D) intangible assets Answer: C Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Which of the following is not a method for determining depreciation expense for a specific asset? A) net method B) units-of-output method C) double-declining-balance method D) straight-line method Answer: A Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Which of the following information is not used to determine the current period depreciation expense for a specific asset when using the straight-line method? A) acquisition cost of the asset B) useful life of the asset C) residual value of the asset D) current carrying value of the asset Answer: D Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) What type of account is Accumulated Depreciation? A) contra-equity B) contra-asset C) expense D) asset Answer: B Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Which of the following is a realistic assumption of the straight-line method of depreciation? A) Depreciation is a function of usage. B) The rate of return analysis is enhanced using the straight-line method. C) The repair and maintenance expense is higher at the end of the asset's life. D) The asset's economic usefulness is the same each year. Answer: D Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Use of the double-declining balance method ________. A) ignores the scrap value of the asset for all purposes B) results in twice the depreciation expense that would be recognized by the straight-line method each period C) means that the amount of depreciation expense decreases year after year D) All of the above are true. Answer: C Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) For income statement purposes, when is depreciation expense considered to be a variable expense? A) when units-of-output method is used B) when double-declining-balance method is used C) when straight-line method is used D) Never. Answer: A Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Which of the following statements about the double-declining-balance (DDB) method is true? A) Companies that use the DDB method do not use partial-year depreciation. B) Companies that use the DDB method generally do not use scrap value to calculate current-year depreciation expense, except in the last year of an asset's life. C) Using the DDB method, the amount of depreciation expense varies from year to year depending on usage of the asset. D) All of the above statements are true. Answer: B Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) The purchase of a building would involve a number of different components, such as the foundation and frame, heating and air conditioning systems, and other non-weight-bearing parts. Which of the following statements concerning the components-based approach for determining depreciation is true? A) Both U.S. GAAP and IFRS require the components-based approach. B) Both U.S. GAAP and IFRS allow the components-based approach but do not require it. C) IFRS allows the components-based approach but does not require it; U.S. GAAP requires the components-based approach. D) U.S. GAAP allows the components-based approach but does not require it; IFRS requires the components-based approach. Answer: D Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Kaven Corporation purchased a truck at the beginning of 2022 for $85,000 which will be depreciated using the units-of-output method. The truck is estimated to have a residual value of $4000 and a useful life of 4 years and 120,000 miles. It was driven 18,000 miles in 2022 and 32,000 miles in 2023. What is the depreciation expense for 2023? (Round any intermediate calculations to the nearest cent and your final answer to the nearest dollar.) A) $21,250 B) $21,760 C) $22,720 D) $32,000 Answer: B Explanation: $85,000 - $4000)/120,000 = 0.68 per mile. $21,760 = 0.68 × 32,000 Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Lunar Products purchased a computer for $10,000 on July 1, 2022. The company intends to depreciate it over 4 years using the double-declining balance method. Residual value is $2,000. What is depreciation for 2023? A) $2,000 B) $2,500 C) $3,000 D) $3,750 Answer: D Explanation: The straight-line rate is 1/4 × 2 = .5 × $10,000 for year 1 × .5 (1/2 year) = $2,500. Beginning of 2019 book value is $7,500 × .5 = $3,750. Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) A production machine which cost $2,200,000 is acquired on October 1, 2022. Its estimated residual value is $200,000 and its expected life is 10 years or about 80,000 operating hours. During 2022, the machine was used to produce products for 3,000 operating hours during 2022 and 8,100 operating hours during 2023. Lorny does not use the half-year convention for depreciating any assets. Calculate depreciation expense for 2022 and 2023 for each of the following methods: (a) Straight-line method (b) Double-declining balance method (c) Units-of-output method Answer: a. 2022: ($2,200,000 - $200,000) / 10 years × 0.25 = $50,000 2023: ($2,200,000 - $200,000) / 10 years = $200,000 b. 2022: $2,200,000 × 20% × 0.25 = $110,000 2023: ($2,200,000 - $110,000) × 20% = $418,000 c. Depreciation rate = ($2,200,000 - $200,000) / 80,000 hours = $25 per hour 2022: 3,000 operating hours × $25/hour = $75,000 2023: 8,100 operating hours × $25/hour = $202,500 Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) a. What is the distinction between a capital and an operating expenditure? Give two examples of each. b. Distinguish between ordinary repairs and maintenance and major repairs. How should a company account for each? Answer: a. The distinction between a capital expenditure and an operating expenditure is based on whether the costs have increased the future economic benefits of the asset above those that were originally expected. If the future economic benefits of the asset are increased, the expenditure is a capital expenditure and is recorded as an increase to the asset account. The future economic benefits can be increased by extending the life of the asset, improving productivity (producing a greater quantity at the same cost or producing the same quantity of product at a lower cost), or increasing the quality of the product. If the costs maintain the existing benefits, the expenditure is an operating (or revenue) expenditure. b. The costs of ordinary repairs and maintenance are expenditures that do not increase the future economic benefits of the asset but, instead, maintain the existing benefits provided by the asset. These costs are expensed as they are incurred. Major repairs are those that cannot be foreseen and do not occur in the usual course of operations, such as emergency repairs to a machine that breaks down during production. Usually, a company expenses these costs, but care should be taken to note whether these repairs increase the future benefits of the asset. If they do, then the company capitalizes the costs. Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) Briefly describe the accounting for the acquisition and use of equipment and indicate which accounts are involved in accounting for equipment and what types of accounts are these? Answer: Initially, the most objective information regarding the value of equipment is its cost. As a result, the accountant preserves the record of historical cost in a non-current tangible asset account (Equipment) and records the estimated depreciation expense (Depreciation Expense) on the income statement and reduces the value of the equipment on the balance sheet in the separate contra-asset account (Accumulated Depreciation - Equipment). For financial statement purposes, firms report the net book value as a single line item (Equipment minus Accumulated Depreciation - Equipment). Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) Identify and briefly describe the four factors involved in determining the dollar amount of a firm's periodic charge to depreciation? Answer: 1. Acquisition cost: The purchase price and other incidental costs required to place an asset into service. 2. Estimated useful life: The number of years the asset will be productive; the period of productive service to the company. 3. Estimated scrap value: The residual value or salvage value the company expects to realize on disposal of the asset at the end of its useful life. 4. Depreciation method: The procedure for calculating the amount of the asset's value that will be reduced and charged to depreciation expense during each accounting period; ideally, the method is chosen the one that best reflects the pattern with which revenue is generated from the use of the asset. Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) Briefly explain the half-year convention for recognizing depreciation. Answer: The half-year convention is a method to compute partial-year depreciation that assumes the firm purchased all fixed assets at the mid-point of the year. The firm records a half year of depreciation for an asset acquired during the year of purchase. The company also records a half-year's depreciation in the final year of the asset's life. For example, for an asset purchased on May 1 with a five-year life, the firm takes a half year of depreciation in year 1 and year 6. Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11.3

Derecognition of Property, Plant, and Equipment

1) Companies derecognize tangible fixed assets from their accounts when they abandon the assets. Answer: TRUE Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) A company recognizes a loss on the income statement whenever it sells a fixed asset for less than its original cost. Answer: FALSE Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A company recognizes a gain on the income statement whenever it sells a fixed asset for more than the net book value of the asset. Answer: TRUE Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The loss on abandonment of a plant asset is equal to its carrying value on the date of abandonment plus disposal costs. Answer: FALSE Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) A company will never recognize a gain on the abandonment of a fixed asset. Answer: TRUE Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) When a firm sells or abandons an asset, how is the gain or loss to be recognized on the income statement measured? A) The difference between cash proceeds received and the carrying value of the asset. B) The difference between cash proceeds received and the acquisition value of the asset. C) The difference between cash proceeds received and the accumulated depreciation of the asset. D) The difference between the book value of the asset and the carrying value of the asset. Answer: A Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following statements about derecognition of an asset is true? A) Derecognition requires that the firm remove the asset acquisition value from the balance sheet but not the related accumulated depreciation. B) Derecognition increases or decreases the balance of the Allowance for Derecognition account. C) Before a gain or loss on derecognition is recognized, the firm must always first recognize current period depreciation expense. D) A loss on derecognition occurs when the amount of cash proceeds (if any) is less than the acquisition cost of the asset. Answer: C Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Which of the following situations always results in a loss on derecognition of an asset? A) The asset is abandoned. B) The cash proceeds from the sale are less than the book value of the asset. C) The carrying value of the asset is less than its book value at the time of derecognition. D) The cash proceeds from the sale (if any) are less than the acquisition cost of the asset. Answer: B Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) A fixed asset with a five-year estimated useful life and no scrap value is sold at the end of the second year of its useful life. How would using the straight-line method of depreciation instead of the doubledeclining balance method of depreciation affect a gain or loss on the sale of the plant asset? A) A gain would be greater or a loss would be less using straight-line depreciation. B) A gain would be less or a loss would be greater using straight-line depreciation. C) A gain would be less or a loss would be less using straight-line depreciation. D) Neither the gain or loss would be different using straight-line depreciation instead of doubledeclining-balance method. Answer: B Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Under what circumstances does derecognition of an asset occur? Answer: Companies remove or derecognize tangible fixed assets from their accounts when they sell or abandon items of property, plant, and equipment. Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) How is derecognition of an asset recognized in the financial statements? Answer: Derecognition requires that the firm remove all related accounts from the ledger, including the asset's cost and its accumulated depreciation. Before removing the asset from the ledger, the firm must bring the accumulated depreciation up to date at the time of derecognition. Because firms generally make an entry for depreciation expense and accumulated depreciation only when the financial statements are prepared, the firm must recognize any depreciation expense related to the use of the asset from the last financial statement date until the date of derecognition. Any gain or loss from derecognition is reported on the income statement as other gain or loss. Diff: 1 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) On December 31, 2022, Franz Company sold a piece of machinery it purchased on January 1, 2015, with an original cost of $450,000. The asset had a useful life of 15 years and a scrap value of $50,000. It sold the asset for $200,000 in cash. Franz recorded depreciation through December 31, 2021, using the straight-line method. What was the carrying value of the asset on the date of sale? What is the gain or loss on disposal? Answer: To properly calculate the gain or loss on disposal, we need to determine the carrying value of the asset when it was sold. The depreciable base equals $400,000 ($450,000 original cost less $50,000 estimated scrap value) and the asset had a useful life of 15 years. Thus, the annual depreciation expense for the machinery is $26,667 ($400,000/15). Because Franz had held the asset for seven years as of December 31, 2021, the accumulated depreciation as of the end of 2021 was $186,669 ($26,667 × 7 years). The depreciation for 2022 would also be $26,667 so that accumulated depreciation upon the sale would be: $213,336 ($186,669 + $26,667). The carrying value of the machine upon its sale would be $236,664 ($450,0000 - $213,336). There would be a loss of $36,664 upon disposal ($200,000 - $236,664.) Diff: 2 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) A company sells one of its delivery trucks that had been used in the business for $25,000 cash. At the time of the sale, the accumulated depreciation on the truck was brought up to date and had a balance of $10,000. The original cost of the truck was $32,000. What would be the journal entry to record the disposal of the delivery truck? Answer: Accounts Debit Credit Cash $25,000 Accumulated Depreciation – Delivery Truck 10,000 Gain on Sale of Truck $3,000 Delivery Truck 32,000 Diff: 2 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) On June 30, 2022, F&R Company decided to scrap a piece of machinery with an original cost of $55,000 and accumulated depreciation (brought up to the date of the disposal) of $42,400. The company paid $750 to have the asset picked up and brought to a recycling facility for proper disposal. Record the journal entry for the disposal Answer: Accounts Debit Credit Miscellaneous Expense $750 Accumulated Depreciation – Delivery Truck 42,400 Loss on Disposal of Truck 12,600 Delivery Truck 55,000 Cash 750 Diff: 2 Objective: 11.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Presented below are the components related to an office building that Lorny Manufacturing Company purchased for $10,000,000 on January, 1, 2022. Component Building structure Building systems Building interior

Useful Life 50 years 25 years 25 years

Value $6,400,000 2,800,000 800,000

a. Compute depreciation expense for 2022, assuming that Lorny uses component depreciation, uses the straight-line method of depreciation, and ignores scrap values. b. Assume that the building systems (heating, plumbing, electrical) were replaced after 20 years at a cost of $2,500,000. The company paid cash. Prepare the journal entry to record the replacement of the old component with the new component. Answer: a. Component Depreciation Expense Building structure $6,400,000 / 50 = $128,000 Building systems 2,800,000 / 25 = 112,000 Building interior 800,000 / 25 = 32,000 $272,000 b. Building Systems. (New) Accumulated Depreciation —Building Systems ($2,800,000 × 20/25) Loss on Disposal of Building Systems Building Systems (Old) Cash

2,500,000 2,240,000 560,000 2,800,000 2,500,000

Diff: 1 Objective: 11.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11.4

Disclosure of Property, Plant, and Equipment

1) Following U.S. GAAP, companies commonly report the carrying value of property, plant, and equipment in total or by major class of long-term assets on the balance sheet. Answer: TRUE Diff: 1 Objective: 11.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Following U.S. GAAP, companies are required to disclose the amount of depreciation expense for each major class of fixed assets. Answer: FALSE Diff: 1 Objective: 11.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Under U.S. GAAP, companies are required to disclose the amount of accumulated depreciation either for each major class of fixed assets or in total for all fixed assets. Answer: TRUE Diff: 1 Objective: 11.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) U.S. GAAP requires companies to reconcile the historical cost and accumulated depreciation at the beginning of the period with amounts at the end of the period. Answer: FALSE Diff: 1 Objective: 11.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) IFRS requires companies to reconcile the carrying value of property, plant and equipment at the beginning of the period with the carrying value at the end of the period. Answer: TRUE Diff: 1 Objective: 11.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) Which of the following is not a required disclosure for property, plant, and equipment under U.S. GAAP? A) the amount of depreciation expense for the period B) the accumulated depreciation at the end of the fiscal year by major class or in total C) the balances of depreciable assets by major classes at the end of the fiscal year D) the acquisition cost of each material asset acquired during the fiscal year Answer: D Diff: 1 Objective: 11.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following is a way that IFRS disclosure requirements of property, plant, and equipment differ from U.S. GAAP disclosure requirements? A) Companies disclose the accumulated depreciation at the end of the fiscal year by major class or in total. B) Companies provide a general description of the method(s) used in computing depreciation with respect to major classes of depreciable assets. C) Companies provide a reconciliation of the carrying values at the beginning of the year to the end of the year. D) Companies report the carrying value of property, plant, and equipment in total or by major class of long-term assets on the balance sheet. Answer: C Diff: 1 Objective: 11.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) How do IFRS disclosure requirements of property, plant, and equipment differ from U.S. GAAP disclosure requirements? Answer: IFRS disclosure requirements, while similar, are more comprehensive than U.S. GAAP. For each class of property, plant, and equipment, a company must disclose the historical cost and its accumulated depreciation at the beginning and the end of the period. The company is required to provide a reconciliation of the carrying amount at the beginning of the period to the end of the period. Companies must also disclose the depreciation method and useful lives (or equivalently the depreciation rate). Diff: 1 Objective: 11.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11.5

Intangible Assets: Characteristics and Types

1) Intangible assets are assets without physical substance or economic value. Answer: FALSE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The two classes of intangible assets are finite-life assets and infinite-life assets. Answer: FALSE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Indefinite-life assets include goodwill and renewable permits. Answer: TRUE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Finite-life assets include patents and trademarks. Answer: FALSE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The useful life of a patent is 20 years or less. Answer: TRUE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) A copyright is an exclusive right to reproduce and sell an original work for the creator's life plus 20 years. Answer: FALSE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) A customer list may be classified as either a finite-life asset or an indefinite-life asset. Answer: TRUE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) A franchise grants a franchisor the right to conduct business under the name of the franchisee. Answer: FALSE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Goodwill is the difference between fair value and book value for all assets a company owns. Answer: FALSE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Goodwill is recognized only when the purchase price of a company is greater than the fair value of the assets less the liabilities of that company. Answer: TRUE Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Which of the following is true of goodwill? A) It is an indefinite-life tangible asset. B) It is not subject to amortization. C) It is a definite-life intangible asset. D) It is subject to amortization. Answer: B Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Which of the following is not a characteristic of intangible assets? A) economic value B) long-term benefits C) not used in operations D) lack physical existence Answer: C Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Which of the following is a characteristic of intangible assets? A) held for resale B) long-lived C) monetary asset D) physical existence Answer: B Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Which of the following is a finite-life intangible asset? A) goodwill B) building C) trademark D) copyright Answer: D Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Which of the following is an indefinite-life intangible asset? A) land B) patent C) trademark D) copyright Answer: C Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Which of the following is the legal life of a patent? A) 17 years B) 20 years C) life of the inventor plus 20 years D) life of the inventor plus 70 years Answer: B Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Which of the following is an exclusive right to reproduce and sell an original creative work? A) copyright B) franchise C) trademark D) patent Answer: A Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Under current accounting practice, what are the two general classes of intangible assets? A) legally restricted and unrestricted B) monetary and non-monetary C) indefinite-life and finite-life D) specifically, identifiable and non-identifiable Answer: C Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Which of the following intangible assets is not subject to amortization? A) franchise B) goodwill C) copyright D) customer list Answer: B Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) List and briefly describe five types of finite-life intangible assets. Answer: Patents. A patent grants the holder an exclusive right to use a formula, product, or process for a fixed period of time, usually 20 years. Copyrights. A copyright is an exclusive right to reproduce and sell an original work for the creator's life plus 70 years. Leaseholds. A leasehold is the right to use a specific piece of property for a fixed period of time in exchange for a certain payment. Leasehold Improvements. Leasehold improvements are permanent betterments made to leased property. Customer Lists. A customer list consists of information about customers such as their names and contact information. Franchises. A franchise represents the right or privilege to sell a product or deliver a service of another entity. Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) What is goodwill and how is it accounted for? Answer: Goodwill is an intangible asset created by factors that are typically difficult to identify and measure. Because these factors are difficult to reliably measure, accounting standards allow firms to record goodwill as an asset only when a firm is acquired. When one firm buys another firm, the purchase price may be higher than the fair value of the acquired net assets, that is, its assets minus its liabilities. The premium paid at acquisition is referred to as goodwill. Because goodwill is tied to the specific business operations acquired and exists as long as these operations continue, it is not subject to amortization. Diff: 1 Objective: 11.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11.6

Initial Measurement of Intangible Assets

1) All intangible assets with economic values are recognized on a company's balance sheet. Answer: FALSE Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Under U.S. GAAP, the cost of internally developed intangible assets is charged as an expense of the period in which the costs are incurred. Answer: TRUE Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) A firm does not recognize internally generated intangible assets because their value cannot be measured reliably. Answer: TRUE Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The cost of individually acquired intangible assets is charged as an expense of the period in which the costs are incurred. Answer: FALSE Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The capitalized value of goodwill is always measured as a residual value. Answer: TRUE Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) U.S. GAAP requires that firms expense costs during a research phase but allows firms to capitalize development-phase costs under certain conditions. Answer: FALSE Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) IFRS requires that firms must expense all R&D costs as incurred. Answer: FALSE Diff: 1 Objective: 11.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) Following U.S. GAAP, acquired in-process research and development costs for projects that are not yet commercially viable should be capitalized as an indefinite-life intangible asset until the project is completed. Answer: TRUE Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Under U.S. GAAP, which of the following costs are capitalized as the asset value of an internallydeveloped patent? A) research and development costs B) legal costs for a successful patent defense C) both R&D and legal defense costs D) No costs are capitalized for internally-developed patents. Answer: B Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Goodwill is recorded as an intangible asset when ________. A) the fair value of a company's assets exceed the carrying value of those assets B) the fair value of a company's assets are greater than the cost of acquiring that company C) a company's exceptional quality, reputation, or capability enables it to generate exceptional earnings D) one company acquires another company for a cost greater than the fair value of the net assets acquired Answer: D Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Gabraile Company acquired Itsy Inc. for a price that was substantially less than the fair value of the identifiable net assets acquired. The difference between the fair value of the net identifiable assets and the bargain purchase price is ________. A) recorded as negative goodwill B) reported as a gain that increases income from continuing operations C) allocated to reduce carrying value for each purchased asset D) reported as a gain that increases other comprehensive income Answer: B Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) During its first year of operation, Dovery Company incurred $355,000 of research costs undertaken with the prospect of gaining new technical understanding about a new nanotechnology procedure. An additional $495,000 was incurred to develop a production process to use that new technology to produce a new lubricant product. Under U.S. GAAP, which of the following is the appropriate accounting for these costs? A) expense $850,000 B) expense $355,000 and capitalize $495,000 as an intangible asset C) expense $495,000 and capitalize $355,000 as an intangible asset D) capitalize $850,000 as an intangible asset Answer: A Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) During its first year of operation, Dovery Company incurred $375,000 of research costs undertaken with the prospect of gaining new technical understanding about a new nanotechnology procedure. An additional $505,000 was incurred to develop a production process to use that new technology to produce a new lubricant product. Assume development costs meet six conditions such as technical feasibility to demonstrate future economic benefit. Under IFRS, which of the following is the appropriate accounting for these costs? A) capitalize $880,000 as an intangible asset B) expense $375,000 and capitalize $505,000 as an intangible asset C) expense $505,000 and capitalize $375,000 as an intangible asset D) Any of these options can be appropriate under IFRS. Answer: B Diff: 1 Objective: 11.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

14) IFRS requires that firms expense costs during a research phase but allows firms to capitalize development-phase costs under certain conditions. Under IFRS, which of the following is not a condition that must be met for a firm to capitalize development-phase expenditures? A) The company can reliably identify the research costs incurred to bring the project to economic feasibility. B) The company can reliably measure the development costs incurred to bring the project to economic feasibility. C) The company has adequate technical, financial, and other resources to complete the development and to use or sell the intangible asset. D) The company intends to complete the project and either use or sell the intangible asset. Answer: A Diff: 1 Objective: 11.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

15) Following U.S. GAAP, which of the following costs should be capitalized in the year incurred? A) costs to successfully defend a patent B) research and development costs for a new product to be introduced later this year C) cost to internally generate goodwill D) development costs for a new product Answer: A Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Rommer Company purchases Daley Inc. for $970,000 cash on January 1, 2022. The book value of Daley Company's net assets, as reflected on its December 31, 2021 statement of financial position is $730,000. An analysis by Rommer on December 31, 2021 indicates that the fair value of Daley's tangible assets exceeded the book value by $90,000, and the fair value of identifiable intangible assets exceeded book value by $35,000. How much goodwill should be recognized by Rommer Company when recording the purchase of Daley Inc.? A) $90,000 B) $115,000 C) $150,000 D) $240,000 Answer: B Explanation: $970,000 – ($730,000 + $90,000 + $35,000) Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Candalibra Company incurred the following costs during the year ended December 31, 2022: Laboratory research aimed at discovery of new knowledge Costs of testing prototype and design modifications (economic viability not achieved) Quality control during commercial production, including routine testing of products Construction of research facilities having an estimated useful life of 12 years but no alternative future use

$300,000 55,000 210,000 440,000

What is the total amount to be classified and expensed as research and development in 2022 under U.S. GAAP? A) $265,000 B) $565,000 C) $795,000 D) $1,005,000 Answer: C Explanation: $795,000 = $300,000 + $55,000 + $440,000 Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) What is meant by a bargain purchase and how is it recorded? Answer: A company makes a bargain purchase when the fair value of the identifiable net assets in an acquisition exceeds the purchase price. The acquiring firm reports the gain from the bargain purchase as income from continuing operations on the income statement. Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Under what circumstances, if any, may R&D costs be capitalized instead of expensed? Answer: IFRS allows firms to capitalize development-phase costs under certain conditions. Under IFRS, a firm can capitalize development-phase expenditures if it can demonstrate all of the following: 1. The technical feasibility of completing the intangible asset so that it will be available for use or sale. 2. Its intention to complete the intangible asset and use or sell it. 3. Its ability to use or sell the intangible asset. 4. How the intangible asset will generate probable future economic benefits. 5. The availability of adequate technical, financial, and other resources to complete the development and to use or sell the intangible asset. 6. Its ability to measure reliably the expenditure attributable to the intangible asset during its development. Under U.S. GAAP, R&D costs are expensed. The only exceptions are long-term operating assets used in R&D projects with alternative future uses. Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Capitol Company decided to sell one of its subsidiaries, Subsidiary ABC. BiRite Inc, is the purchaser of this subsidiary. BiRite paid $2,000,000 for Subsidiary ABC. BiRite performed a valuation analysis of Subsidiary ABC's assets acquired and liabilities. The following table presents book values from Subsidiary ABC's financial statements and fair values determined by BiRite: Description Inventory Accounts Receivable Prepaid Assets Equipment Right-of-Use Building Patent Trademark Current Liabilities Lease Obligation Other Long-term Liabilities

Book Value 420,000 330,000 70,000 290,000 330,000 125,000 170,000 135,000

Fair Value $450,000 330,000 60,000 410,000 360,000 220,000 150,000 125,000 170,000 135,000

a. Prepare the journal entry made by BiRite to record the acquisition of Subsidiary ABC. b. Describe how the journal entry would be different if the acquisition price was $1 million.

Answer: a. Inventory Accounts Receivable Prepaid Assets Equipment Right-of-Use Building Patent Trademark Goodwill Current Liabilities Lease Obligation Other Long-term Liabilities Cash

$450,000 330,000 60,000 410,000 360,000 220,000 150,000 450,000 125,000 170,000 135,000 2,000,000

b. If the acquisition price was lower than the fair value of the net assets, the transaction would be considered to be a bargain purchase. In this case, instead of recognizing Goodwill of $450,000 (debit), BiRite would recognize a Gain from Bargain Purchase of $550,000 (credit). All other line items would be the same as above (except Cash). Inventory Accounts Receivable Prepaid Assets Equipment Right-of-Use Building Patent Trademark Gain from Bargain Purchase of Subsidiary Current Liabilities Lease Obligation Other Long-term Liabilities Cash

$450,000 330,000 60,000 410,000 360,000 220,000 150,000 550,000 125,000 170,000 135,000 1,000,000

Diff: 2 Objective: 11.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Rally Company purchases Dexter Inc. for $900,000 cash on January 1, 2022. The book value of Dexter Company's net assets, as reflected on its December 31, 2021 statement of financial position is $700,000. An analysis by Rally on December 31, 2021 indicates that the fair value of Dexter's tangible assets exceeded the book value by $90,000, and the fair value of identifiable intangible assets exceeded book value by $35,000. How much goodwill should be recognized by Rally Company when recording the purchase of Dexter Inc.? Answer: $900,000 – ($700,000 + $90,000 + $35,000) = $75,000 Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Carbon Company incurred the following costs during the year ended December 31, 2022: Laboratory research aimed at discovery of new knowledge Costs of testing prototype and design modifications (economic viability not achieved) Quality control during commercial production, including routine testing of products Construction of research facilities having an estimated useful life of 12 years but no alternative future use

$400,000 50,000 210,000 450,000

What is the total amount to be classified and expensed as research and development in 2022 under U.S. GAAP? Answer: $900,000 = $400,000 + $50,000 + $450,000 Diff: 1 Objective: 11.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

11.7

Subsequent Measurement and Derecognition of Intangible Assets

1) Depreciation is the systematic and rational allocation of the cost of a finite-life intangible asset to expense. Answer: FALSE Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Only finite-life intangible assets are subject to amortization. Answer: TRUE Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The period of amortization of finite-life intangible assets should be either the useful life or legal life, whichever is longer. Answer: FALSE Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) If the firm sells the intangible asset, it recognizes a gain or loss on the income statement, measured as the difference between the sales proceeds and the carrying value of the asset. Answer: TRUE Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) U.S. GAAP requires straight-line amortization of finite-life intangible assets over the useful life or legal life, whichever is shorter. Answer: FALSE Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which, if any, intangible assets are subject to amortization? A) Only finite-life intangible assets are subject to amortization. B) Only indefinite-life intangible assets are subject to amortization. C) Both finite and indefinite-life intangible assets are subject to amortization. D) No intangible assets are subject to amortization. Answer: A Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Factors considered in determining an intangible asset's useful life include all of the following except ________. A) legal provisions B) effects of technological advances C) contractual factors D) the amortization method Answer: D Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Companies should evaluate indefinite life intangible assets at least annually for ________. A) amortization B) impairment C) useful life D) gains or losses Answer: B Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following methods of amortization is normally used for intangible assets? A) straight-line method B) units-of-production method C) finite-life method D) declining-balance method Answer: A Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Finite-life intangible assets are reported on the balance sheet at their ________. A) net realizable value B) replacement cost C) acquisition cost D) carrying value Answer: D Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Over what period of time should a patent be amortized? A) twenty years B) its useful life C) twenty years or its useful life, whichever is shorter D) twenty years or its useful life, whichever is longer Answer: C Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Over what period of time should a copyright be amortized? A) life of the creator plus 70 years B) its useful economic life C) life of the creator plus 70 years or its useful life, whichever is shorter D) Copyrights are never amortized. Answer: C Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Over what period of time should goodwill be amortized? A) 40 years B) its useful economic life C) 40 years or its useful economic life, whichever is shorter D) Goodwill is never amortized. Answer: D Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Kow-Pow Company purchased a limited-life intangible asset for $180,000 on May 1, 2021. It has a useful life of 10 years. What total amount of amortization expense should have been recorded on the intangible asset by December 31, 2023? (Round any calculations to the nearest cent, and your final answer to the nearest dollar.) A) $0 B) $36,000 C) $48,000 D) $54,000 Answer: C Explanation: $180,000/120 months = $1500.00 amortization per month × 32 months = $48,000 Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Rinky-Dink Inc. incurred research and development costs of $210,000 and legal fees of $110,000 to acquire a patent. The patent has a legal life of 20 years and a useful life of 10 years. What amount should the company record as patent amortization expense in the first year? A) $11,000 B) $16,000 C) $21,000 D) $32,000 Answer: A Explanation: $110,000/10 years = $11,000 Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Rinky-Dink Inc. leased manufacturing space for a 25-year period. Prior to using the space, Rinky-Dink needed to make renovations costing $80,000 with an expected useful life of 10 years. If the company uses the straight-line method, what amount should Rink-Dink record as amortization expense in the first year? A) $8000 B) $3200 C) $4800 D) The answer cannot be determined with the information provided. Answer: A Explanation: $80,000/10 = $8000 Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) How does a firm determine the appropriate period of time over which an intangible asset should be amortized? Answer: If the asset is an indefinite-life asset such as goodwill, the asset is not amortized. To determine estimated useful lives of finite-life intangible assets, firms consider legal, regulatory, contractual, and competitive factors. The expected period of economic benefit of the asset must take into account the effects of obsolescence, demand, and technological advances. Current accounting standards do not specify either a method of amortization to use or a limit on the useful life. The period of amortization should be either the useful life or legal life, whichever is shorter. Diff: 2 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) An intangible asset with an estimated useful life of 30 years was acquired on January 1, 2009, for $540,000. On January 1, 2023, a review was made of intangible assets and their expected service lives. It was determined that this asset had an estimated useful life of 30 more years from the date of the review. What is the amount of amortization for this intangible in 2023? Answer: The total life, per revised facts, is 40 years (10 + 30). There are 30 (40 - 10) remaining years for amortization purposes. Original amortization: $540,000 / 30 years = $18,000 per year; $18,000 × 10 years expired = $180,000 accumulated amortization. Now, in 2023, the remaining useful life is 30 years and the remaining cost to be amortized is $360,000 ($540,000 - $180,000). Therefore, the amortization for 2023 and years thereafter is $360,000 / 30 = $12,000. Diff: 2 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Dixon Inc. incurred research and development costs of $310,000 and legal fees of $210,000 to acquire a patent. The patent has a legal life of 20 years and a useful life of 10 years. What amount should the company record as patent amortization expense in the first year? Answer: $210,000/10 years = $21,000 Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Dixon Inc. leased manufacturing space for a 25-year period. Prior to using the space, Dixon needed to make renovations costing $180,000 with an expected useful life of 10 years. If the company uses the straight-line method, what amount should Dixon record as amortization expense in the first year? Answer: $180,000/10 = $18,000 Diff: 1 Objective: 11.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11.8

Disclosures of Intangible Assets

1) Both U.S. GAAP and IFRS requires disclosure of the gross value of goodwill and related accumulated amortization. Answer: FALSE Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) If the intangible asset has a finite useful life, the company must include in their financial statement disclosures whether to use the useful life or the legal life. Assume U.S. GAAP is followed. Answer: TRUE Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The fixed asset turnover ratio is computed as average net fixed assets divided by total revenues. Answer: FALSE Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The average remaining life of a company's assets is computed as the balance of ending net fixed assets divided by depreciation expense. Answer: TRUE Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) A high fixed asset turnover ratio indicates a company is generating a large amount of revenue for each dollar invested in fixed assets. Answer: TRUE Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) For intangible assets, U.S. GAAP requires significant disclosures for ________. A) each indefinite-life intangible asset B) each finite-life intangible asset C) each finite and indefinite-life intangible asset D) each major type of finite and indefinite-life intangible asset Answer: D Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) U.S. GAAP requires significant disclosures for goodwill, including all of the following except ________. A) goodwill acquired B) goodwill included in the disposal of a business unit C) goodwill amortization D) goodwill impaired Answer: C Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Average age of a company's long-term operating assets is computed as ________. A) the amount of depreciation expense divided by accumulated depreciation B) the amount of accumulated depreciation divided by depreciation expense C) the amount of depreciation expense divided by the balance of ending net fixed assets D) the balance of ending net fixed assets divided by depreciation expense Answer: B Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Average remaining life of a company's long-term operating assets is computed as ________. A) the amount of depreciation expense divided by accumulated depreciation B) the amount of accumulated depreciation divided by depreciation expense C) the amount of depreciation expense divided by the balance of ending net fixed assets D) the ending balance of net fixed assets divided by depreciation expense Answer: D Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Fixed asset turnover ratio is computed as total sales revenue divided by ________. A) average net fixed assets B) ending net fixed assets C) average gross fixed assets D) ending gross fixed assets Answer: A Diff: 1 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Bakiponi Corp. provides the following data from its recent financial statements: (Dollars in millions) Beginning Gross Fixed Assets Ending Gross Fixed Assets Beginning Accumulated Depreciation Current year Depreciation Expense Current year Sales Revenue

2022 $2,140,000 2,260,000 1,210,000 240,000 3,750,000

2023 $2,260,000 2,380,000 1,450,000 290,000 4,620,000

What is the average age of the company's fixed assets as of the end of 2023? (Round your answer to two decimal places, X.XX.) A) 3.21 years B) 5.00 years C) 6.00 years D) 8.21 years Answer: C Explanation: ($1,450,000 + $290,000)/$290,000 = 6.00 years Diff: 3 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Bakiponi Corp. provides the following data from its recent financial statements: (Dollars in millions) Beginning Gross Fixed Assets Ending Gross Fixed Assets Beginning Accumulated Depreciation Current-year Depreciation Expense Current-year Sales Revenue

2022 $2,440,000 2,560,000 910,000 200,000 3,050,000

2023 $2,560,000 2,680,000 1,110,000 250,000 3,920,000

What is the average remaining life of the company's fixed assets as of the end of 2023? (Round your answer to two decimal places, X.XX.) A) 4.80 years B) 5.28 years C) 6.28 years D) 5.44 years Answer: B Explanation: ($2,680,000 - $1,110,000 - $250,000)/$250,000 = 5.28 years Diff: 3 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Bakiponi Corp. provides the following data from its recent financial statements: (Dollars in millions) Beginning Gross Fixed Assets Ending Gross Fixed Assets Beginning Accumulated Depreciation Current-year Depreciation Expense Current-year Sales Revenue

2022 $2,140,000 2,260,000 1,210,000 210,000 3,150,000

2023 $2,260,000 2,380,000 1,420,000 260,000 4,020,000

What is the fixed asset turnover ratio for 2023? (Round your answer to two decimal places, X.XX.) A) 5.74 B) 5.22 C) 4.09 D) 1.69 Answer: B Explanation: The average net fixed assets is calculated as follows: [($2,260,000 - $1,210,000 - $210,000) + ($2,380,000 - $1,420,000 – $260,000)]/2 = $770,000. Fixed asset turnover = $4,020,000/$770,000 = 5.22 times Diff: 3 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) What are IFRS disclosure requirements for intangible assets? Answer: IFRS requires that a company disclose significant classes of intangible assets. Firms must distinguish between internally generated intangible assets and other intangible assets, including the historical cost and accumulated amortization at the beginning and the end of the period. Further, the company must provide a reconciliation of the carrying amount at the beginning of the period to the end of the period. For each class, the company should also identify whether the useful lives are indefinite or finite and, if finite, the useful lives and amortization methods used. Diff: 3 Objective: 11.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

15) Baxter Corp. provides the following data from its recent financial statements: (Dollars in millions) Beginning Gross Fixed Assets Ending Gross Fixed Assets Beginning Accumulated Depreciation Current-year Depreciation Expense Current-year Sales Revenue

2022 $2,640,000 2,660,000 960,000 260,000 3,650,000

2023 $2,660,000 2,600,000 1,100,000 210,000 3,820,000

What is the average remaining life of the company's fixed assets as of the end of 2023? (Round your answer to two decimal places, X.XX.) Answer: 6.14 years Explanation: ($2,600,000 - $1,100,000 - $210,000)/$210,000 = 6.14 Diff: 3 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Baxter Corp. provides the following data from its recent financial statements: (Dollars in millions) Beginning Gross Fixed Assets Ending Gross Fixed Assets Beginning Accumulated Depreciation Current-year Depreciation Expense Current-year Sales Revenue

2022 $2,140,000 2,260,000 1,250,000 220,000 3,150,000

2023 $2,160,000 2,380,000 1,450,000 260,000 4,020,000

What is the fixed asset turnover ratio for 2023? (Round your answer to two decimal places, X.XX.) Answer: 5.91 times Explanation: The average net fixed assets is calculated as follows: [($2,160,000 - $1,250,000 - $220,000) + ($2,380,000 - $1,450,000 – $260,000)]/2 = $680,000. Fixed asset turnover = $4,020,000/$680,000 = 5.91 times Diff: 3 Objective: 11.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11.9

Appendix A: Nonmonetary Exchanges

1) When a long-term operating asset is exchanged for another long-term operating asset, and no cash is paid to the seller, there is no gain or loss for the buyer as a result of the exchange. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Firms recognize all gains and losses, computed as the difference between the carrying value and the fair value of the asset given up, on a nonmonetary exchange with commercial substance. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

3) In a nonmonetary exchange with commercial substance, if the fair value of the assets given in exchange is not readily determinable, then the fair value of the assets received is used to measure the transaction. Answer: TRUE Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

4) If an exchange lacks commercial substance and no cash is received, any gain must be deferred by adjusting the carrying value of the new asset. However, any loss must be recognized immediately. Answer: TRUE Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

5) A nonmonetary exchange has commercial substance if ________. A) future cash flows change as a result of the exchange transaction B) dissimilar assets are exchanged C) the economic position of the parties does not change as a result of the exchange transaction D) only similar assets are exchanged and those assets will continue to be utilized in a commercial enterprise Answer: A Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) A firm trades in an old truck with a fair value of $26,000 and a carrying value of $21,000 for new truck that has a list price of $33,000. To complete the transaction, the firm gives the dealer $4000 cash. At what value will the firm record the new truck? A) $4000 B) $33,000 C) $30,000 D) $26,000 Answer: C Explanation: The firm records the new asset at fair value of the assets given in the exchange, which is the fair value of the asset given up ($26,000) plus cash paid ($4000) or minus cash received. $30,000 = $26,000 + $4000. Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

7) A firm trades in an old machine with a carrying value of $20,000 for new machine that has a list price of $32,000 and a fair value of $33,000. The old machine was acquired 5 years ago at a cost of $40,000. At what value will the firm record the new machine? A) $20,000 B) $33,000 C) $40,000 D) $32,000 Answer: B Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Dice Manufacturing Inc. exchanged a forklift for a truck acquired from Lima Equipment and Logistics Ltd. Dice also received a cash consideration of $13,000. Dice expects the future cash flows to change as a result of this transaction and, therefore, the exchange has commercial substance. The carrying value and fair value of the forklift and truck at the date of the exchange are as follows:

Asset Forklift (asset given up) Truck (asset received)

Cost $66,000 $52,000

Accumulated Depreciation Carrying Value $10,000 $56,000 $5,000 $47,000

Fair Value $53,000 $60,000

Prepare the journal entry for Dice to record the transaction. Answer: The truck (the new asset) is valued at the fair value of the consideration given in the exchange minus the cash received. The new asset's value is equal to the fair value of the old asset given up less the cash received (i.e., $53,000 − $13,000 = $40,000). Dice will recognize any gain or loss on the exchange because the transaction has commercial substance. There is a $3,000 loss in this case, measured as the difference between the fair value and the carrying value of the asset given up in the exchange (i.e., $53,000 − $56,000 = $3,000). The entry to record the transaction is as follows: Truck (New) Accumulated Depreciation – Forklift (Old) Cash Loss on Exchange of Equipment Equipment – Forklift (Old)

$40,000 10,000 13,000 3,000 66,000

Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Frank's Bus Lines exchanged four of Ford buses for four GM buses. The carrying value and fair value of each fleet of vehicles on the date of the exchange are as follows: Accumulated Cost Depreciation Carrying Value $900,000 $310,000 $590,000 $880,000 $260,000 $620,000

Asset Ford Buses (Assets Given Up) GM Buses (Assets Received)

Fair Value $620,000 $595,500

Frank's received cash of $40,000 and the GM buses in exchange for the Ford buses. It is expected that the future cash flows of Frank's business will not change significantly as a result of this exchange. What amount of gain would be recognized as a result of this transaction? Answer: The total potential gain is equal to $30,000: Fair value of the asset given up − Carrying value of the asset given up = $620,000 − $590,000 = $30,000 The percentage of gain to recognize is as follows: Percent of Gain Recognized = Cash Received/Total Consideration Received = Cash Received/(Cash Received + FMV of the Assets Received) = $40,000/($40,000 + $595,500) = 6.3% Compute the portion of the gain recognized and the portion deferred: Partial Gain Recognized = $30,000 × 6.3% = $1,890 Deferred Gain = $30,000 − $1,890 = $28,110 Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

10) A firm trades in an old truck with a fair value of $35,000 and a carrying value of $21,000 for new truck that has a list price of $33,000. To complete the transaction, the firm gives the dealer $5,000 cash. At what value will the firm record the new truck? Answer: $40,000 Explanation: The firm records the new asset at fair value of the assets given in the exchange, which is the fair value of the asset given up ($35,000) plus cash paid ($5,000) or minus cash received. $35,000 + $5,000 = $40,000 Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

11) A firm trades in an old machine with a carrying value of $20,000 for new machine that has a list price of $32,000 and a fair value of $33,000. The old machine was acquired 5 years ago at a cost of $40,000. At what value will the firm record the new machine? Answer: $33,000 the fair value of new machine. Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

11.10

Appendix B: Natural Resources

1) Natural resources are initially recorded at cost and then depreciated over their economic lives. Answer: FALSE Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The process of allocating the cost of the natural resource over its useful life is referred to as depletion, similar to depreciation for tangible long-lived assets. Answer: TRUE Diff: 1 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The costs required to return property (from which a natural resource is extracted) to its original condition after the removal of the natural resource is not included in the cost of the natural resource in the books of the company. Answer: FALSE Diff: 2 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

4) A company acquires a natural resource for $1,400,000 and spends another $530,000 on development of the site and $320,000 for a nonmovable tangible asset installed at the site and $150,000 for tangible movable equipment. Both assets have an expected useful life of 10 years. The natural resource is expected to yield 140,000 units over its expected life. In year 1, 45,000 units are extracted from the resource. What depletion rate will be used? (Round your final answer to the nearest cent.) A) $10.00 per unit B) $13.79 per unit C) $16.07 per unit D) $17.14 per unit Answer: C Explanation: The depletion base is $2,250,000 = $1,400,000 + $530,000 + $320,000. The depletion rate is $16.07 = $2,250,000/140,000. Diff: 2 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

5) A company acquires a natural resource for $1,200,000 and spends another $520,000 on development of the site and $370,000 for a nonmovable tangible asset installed at the site and $150,000 for tangible movable equipment. Both assets have an expected useful life of 10 years. The natural resource is expected to yield 200,000 units over its expected life. In year 1, 10,000 units are extracted from the resource. What is the depletion expense for year 1? (Round any intermediary calculations to the nearest cent, and round your final answer to the nearest dollar.) A) $60,000 B) $86,000 C) $104,500 D) $112,000 Answer: C Explanation: The depletion base is $2,090,000 = $1,200,000 + $520,000 + $370,000. The depletion rate is $10.45 = $2,090,000/200,000. $10.45 × 10,000 = $104,500 Diff: 2 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

6) A company acquires a natural resource for $1,200,000 and spends another $520,000 on development of the site and $300,000 for a nonmovable tangible asset installed at the site and $350,000 for tangible movable equipment. Both assets have an expected useful life of 10 years. The natural resource is expected to yield 202,000 units over its expected life. In year 1, 12,000 units are extracted from the resource. What is the depletion expense for year 1? (Round any intermediary calculations to the nearest cent, and round your final answer to the nearest dollar.) Answer: The depletion base is $2,020,000 = $1,200,000 + $520,000 + $300,000. The depletion rate is $10.45 = $2,020,000/202,000. $10.00 depletion rate $10.00 × 12,000 = $120,000 depletion expense for year 1. Diff: 2 Objective: App B IFRS/GAAP: GAAP AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 12 Long-term Operating Assets: Departures from Historical Cost 12.1

Overview: Impairment of Long-term Operating Assets

1) An impairment occurs when a long-term operating asset's carrying value falls below its total future cash-generating ability. Answer: FALSE Diff: 1 Objective: 12.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) When an impairment occurs, the firm recognizes a loss on the income statement. Answer: TRUE Diff: 1 Objective: 12.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The method of accounting for the impairment of long-term assets depends upon the type of loss that occurs. Answer: FALSE Diff: 1 Objective: 12.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When a long-term operating asset is impaired, the firm will determine a new carrying amount based upon its expectation of future economic benefits. Answer: TRUE Diff: 1 Objective: 12.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Impairment of a long-term operating asset occurs when ________. A) the carrying value of the asset is systematically reduced over its useful economic life B) there is a failure to meet the legal obligations or conditions of a loan by which that asset was acquired C) an asset or part of an asset is removed from the asset portfolio D) an asset's total future cash-generating ability falls below its carrying value Answer: D Diff: 1 Objective: 12.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) When a long-term operating asset is impaired, the firm reduces the asset's carrying value on the balance sheet and recognizes the decline in value ________. A) as a loss from continuing operations on the income statement B) as an extraordinary loss on the income statement C) as an unrealized loss in other comprehensive income D) as a realized loss in other comprehensive income Answer: A Diff: 1 Objective: 12.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) All of the following are key steps related to accounting for impairments of long-term operating assets except ________. A) asset grouping B) measurement subsequent to impairment C) derecognition of impairment D) testing for impairment Answer: C Diff: 2 Objective: 12.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) An ________ occurs when an asset's total future cash-generating ability falls below its carrying value. A) asset grouping B) indefinite life C) impairment D) economic benefit Answer: C Diff: 2 Objective: 12.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) List the four key steps related to accounting for impairments of long-term operating assets. Answer: • Asset grouping • When to test for impairment • Impairment test • Measurement subsequent to impairment Diff: 1 Objective: 12.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

12.2 Accounting for Impairments: Property, Plant, and Equipment and Finite-Life Intangible Assets 1) When testing property, plant, equipment, and finite-life intangible assets for impairment, a firm must assess them as individual assets. Answer: FALSE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) When assessing property, plant and equipment for impairment in asset groups, the firm groups assets at the lowest level of identifiable and independent cash flows. Answer: TRUE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Firms conduct an impairment test whenever impairment indicators indicate that property, plant and equipment or finite-life intangibles may be impaired. Answer: TRUE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) One example of an impairment indicator for property, plant and equipment is a significant increase in the market price of an asset or asset group. Answer: FALSE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) One example of an impairment indicator for property, plant and equipment is a significant adverse change in legal factors that affect the value of an asset or asset group. Answer: TRUE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) The first step of the impairment test for property, plant and equipment is assessing asset recoverability. Answer: TRUE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) When assessing the impairment of property, plant and equipment, fair value is also referred to as replacement cost. Answer: FALSE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) After recognizing the impairment of property, plant and equipment, the firm carries the asset at its fair value less previously accumulated depreciation. Answer: FALSE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) U.S. GAAP allows for subsequent reversals of write-downs for long-term operating assets held for use in operations. Answer: FALSE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) The impairment loss for property, plant and equipment equals carrying value less fair value. Answer: TRUE Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Firms assess property, plant and equipment for impairment ________. A) as individual assets only B) in asset groups only C) as either individual assets or in asset groups D) as both individual assets and in asset groups Answer: C Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Before testing property, plant, and equipment (PPE) and finite-life intangible (FLI) assets, ________. A) the firm will assess PPE as individual assets and FLI assets in asset groups B) the firm will assess PPE in asset groups and FLI assets as individual assets C) the firm will assess both PPE and FLI assets in asset groups D) the firm will assess both PPE and FLI assets as individual assets or in asset groups Answer: D Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which of the following is an impairment indicator for property, plant and equipment? A) a significant decrease in the purchase price of an asset or asset group scheduled to be acquired in the current period B) a significant adverse change in legal factors that could affect the value of the asset or asset group C) a significant increase in the purchase price of an asset or asset group scheduled to be acquired in the current period D) a significant increase in the market price of an asset or asset group Answer: B Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Which of the following is not an impairment indicator for property, plant and equipment? A) a significant decrease in the purchase price of an asset or asset group scheduled to be acquired in the current period B) a significant adverse change in legal factors that could affect the value of the asset or asset group C) a current-period cash flow loss combined with a forecast of continuing losses associated with the use of an asset or asset group D) a significant decrease in the market price of an asset or asset group Answer: A Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) If impairment indicators suggest that property, plant and equipment might be impaired, the firm then performs a ________. A) one-step impairment test B) two-step impairment test C) three-step impairment test D) four-step impairment test Answer: B Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Which of the following statements is true about assessing recoverability of property, plant and equipment? A) If the sum of the undiscounted future cash flows exceeds the carrying value of the asset, then the asset is impaired. B) If the sum of the discounted future cash flows exceeds the carrying value of the asset, then the asset is impaired. C) If the sum of the undiscounted future cash flows exceeds the carrying value of the asset, then the asset is not impaired. D) If the sum of the discounted future cash flows exceeds the carrying value of the asset, then the asset is not impaired. Answer: C Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Doowow Chemical Company determines that an extruder machine used in its operations has suffered an impairment in value because of technological changes. An entry to record the impairment should include ________. A) a debit to the machinery accumulated depreciation account B) a debit to the machinery account C) a credit to machinery depreciation expense account D) a credit to the loss on impairment account Answer: A Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Ponzi Printing Company determines that a printing machine used in its operations has suffered an impairment in value because of technological changes. An entry to record the impairment should include a credit to ________. A) the machinery accumulated depreciation account B) the loss on impairment account C) the machinery account D) the machinery depreciation expense account Answer: C Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) In 2022, Yumster Company determined that a production machine used in its operations was impaired and an impairment loss of $110,000 was recognized. In 2022, the fair value of the asset increased by $170,000 due to an unexpected resurgence in demand for the products the machine was designed to produce. How would the gain due to increase in fair value be recognized in 2022? A) U.S. GAAP permits the recognition of this impairment reversal as income from continuing operations. B) U.S. GAAP permits the recognition of this impairment reversal as other comprehensive income. C) U.S. GAAP allows the recognition of this impairment reversal as either income from continuing operations or as other comprehensive income, depending upon management's intent. D) U.S. GAAP does not permit recognition of gains on reversal of previous impairment loss write-downs. Answer: D Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Which of the following statements regarding impairment testing of long-lived operating assets is false? A) If the carrying value of the asset is greater than the sum of the undiscounted future cash flows, an impairment loss must be recognized. B) The asset recoverability test compares the carrying value of the asset with its fair value. C) The carrying value of the asset after adjustment for impairment loss is its fair value. D) If impairment indicators are present, the company must conduct an impairment test. Answer: B Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) In 2015, Mennorah Corporation acquired production machinery at a cost of $490,000, which now has a book value of $190,000. The sum of undiscounted future cash flows from use of the machinery is $180,000. and it's fair value is $120,000. What amount should Mennorah recognize as a loss on impairment? A) $370,000 B) $60,000 C) $70,000 D) -0Answer: C Explanation: Book value $190,000 — fair value $120,000 = $70,000 impairment loss. Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) In 2016, Cilla Company acquired production machinery at a cost of $419,000, which now has accumulated depreciation of $240,000. The sum of undiscounted future cash flows from use of the machinery is $196,000 and its fair value is $145,000. What amount should Cilla recognize as a loss on impairment? A) $17,000 B) $51,000 C) $34,000 D) -0Answer: D Explanation: The book value of the machinery is its $419,000 cost less accumulated depreciation of $240,000, which equals $179,000. The book value of $179,000 is less than the sum of the undiscounted future cash flows, so there is no impairment. Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) In 2009, Cilla Company acquired production machinery at a cost of $420,000, which now has accumulated depreciation of $230,000. The sum of undiscounted future cash flows from use of the machinery is $150,000 and its fair value is $164,000. What amount should Cilla recognize as a loss on impairment? A) $40,000 B) $66,000 C) $26,000 D) $0 Answer: C Explanation: The book value of the machinery is its $420,000 cost less accumulated depreciation of $230,000, which equals $190,000. The book value of $190,000 is greater than the sum of the undiscounted future cash flows, so there is impairment. The impairment is measured at the difference between the book value of $190,000 and the fair value of $164,000, $190,000 — $164,000 = $26,000. Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) In 2015, Zee Tee Inc. acquired production machinery at a cost of $640,000, which now has a accumulated depreciation of $380,000. The sum of undiscounted future cash flows from use of the machinery is $210,000. and its fair value is $198,000. What amount should Zee Tee recognize as a loss on impairment? A) $318,000 B) $62,000 C) $50,000 D) -0Answer: B Explanation: The book value of the machinery is its $640,000 cost less accumulated depreciation of $380,000, which equals $260,000. The book value of $260,000 is greater than the sum of the undiscounted future cash flows, so there is impairment. The impairment loss is measured at the difference between the book value of $260,000 and the fair value of $198,000, $260,000 — $198,000 = $62,000. Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) In 2015, Zee Tee Inc. acquired production machinery at a cost of $650,000, which now has a accumulated depreciation of $390,000. The sum of undiscounted future cash flows from use of the machinery is $270,000. and its fair value is $195,000. What amount should Zee Tee recognize as a loss on impairment? A) $325,000 B) $65,000 C) $40,000 D) -0Answer: D Explanation: The book value of the machinery is its $650,000 cost less accumulated depreciation of $390,000, which equals $260,000. The book value of $260,000 is less than the sum of the undiscounted future cash flows, so there is no impairment. Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) In 2015, Yondoor Inc. Company acquired production machinery which now has a book value of $760,000. The sum of undiscounted future cash flows from use of the machinery is $369,000. and it's fair value is $308,000. Yondoor has determined that an impairment loss has occurred. What is the carrying value of the machinery after the journal entry to record the impairment loss has been recorded? A) $452,000 B) $391,000 C) $369,000 D) $308,000 Answer: D Explanation: The book value of $760,000 is greater than the sum of the undiscounted future cash flows of $369,000, so there is impairment. The impairment is measured at the difference between the book value of $760,000 and the fair value of $308,000, $760,000 — $308,000 = $452,000. The impairment loss of $452,000 reduces the book value of the asset to fair value, $308,000. Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Native Corporation has determined that one of its finite-life intangible assets is impaired. The asset's net carrying value on the date of impairment is $1,552,000. In order to estimate impairment, the company uses the discounted cash-flow model. The company projects the asset's future cash flows as follows: Future period Year 1 Year 2 Year 3 Year 4 Year 5

Cash-flow projection $490,000 $400,000 $180,000 $130,000 $62,000

Assuming a discount rate of 7%, which of the following is included in the journal entry to record the loss? (Use spreadsheet software or a financial calculator to calculate your answer.) A) credit Impairment Loss on Intangible Asset $290,000 B) debit Accumulated Depreciation $454,365 C) debit Intangible Asset $290,000 D) credit Intangible Asset $454,365 Answer: D Explanation: The carrying value of $1,552,000 exceeds the sum of the undiscounted future cash flows of $1,262,000, so the asset is impaired. The fair value test is used to measure impairment. In this case the impairment loss is computed as the difference between the fair value of the asset and the net carrying value of the asset. The fair value of the asset is computed as the present value of the estimated future cash flows expected from the use of the asset. Future period

Cash-flow projection

Year 1

$490,000

=PV(0.07,1,0,-490000)

$457,943.93

Year 2

$400,000

=PV(0.07,2,0,-400000)

$349,375.49

Year 3

$180,000

=PV(0.07,3,0,-180000)

$146,933.62

Year 4

$130,000

=PV(0.07,4,0,-130000)

$99,176.38

Year 5

$62,000

=PV(0.07,5,0,-62000)

$44,205.14

Total

$1,262,000

Spreadsheet formula

Discounted Cash Flow

$1,097,634.56

The impairment loss is the difference between the carrying value of $1,552,000 and the present value of the future cash flows of $1,097,635 calculated as $1,552,000 - $1,097,635 = $454,365. The entry to record the impairment loss is presented below. Impairment Loss on Intangible Asset Intangible Asset

454,365

Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) Starburst Manufacturing reports the following long-term assets for its lighting division:

Factory building (shared with other divisions) Less: Accumulated depreciation Net book value Land Manufacturing equipment for lighting division Less: Accumulated depreciation Net book value General factory equipment (used in several divisions) Less: Accumulated depreciation Net book value Total net fixed assets

Carrying value Estimated fair value $2,500,000 (1,000,000) $1,500,000 $3,800,000 $1,750,000 $3,500,000 $525,000 (150,000) $375,000 $340,000 $1,600,000 (900,000) $700,000 $4,325,000

$650,000

As a result of new technology, Starburst believes that the lighting division's equipment in the manufacturing facility is nearly obsolete. They project the following future cash flows for the lighting division's operations: Future period Year 1 Year 2 Year 3 Year 4 Year 5

Cash-flow projection $50,000 $35,000 $20,000 $12,000 $6,000

For the purposes of impairment testing, which long-term assets will be used in the calculation of the loss? A) all fixed assets B) all fixed assets with the land excluded C) manufacturing equipment for lighting division and general factory equipment D) manufacturing equipment for lighting division Answer: D Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) Starburst Manufacturing reports the following long-term assets for its lighting division:

Carrying value $2,500,000 (1,000,000) $1,500,000 $1,750,000 $534,000 (150,000) $384,000

Estimated fair value

$1,600,000 (900,000) $700,000 $4,334,000

$3,800,000 $3,500,000

$359,000

$650,000

As a result of new technology, Starburst believes that the lighting division's equipment in their manufacturing facility is nearly obsolete. They project the following future cash flows for the lighting division's operations: Future period Year 1 Year 2 Year 3 Year 4 Year 5

Cash-flow projection $56,000 $37,000 $18,000 $11,000 $9,000

What is the impairment loss, if any, for the appropriate asset group, assuming a discount rate of 8%? (Use spreadsheet software or a financial calculator to calculate your answer.) A) $112,073 B) $271,927 C) $0 D) $384,000

Answer: B Explanation: The asset group for the purposes of impairment testing is only the equipment used solely for the lighting division, as the other assets have alternative future uses. The carrying value of the equipment of $384,000 exceeds the sum of the undiscounted future cash flows of $131,000, so the equipment is impaired. Impairment is measured as the difference between the fair value of the asset and the net carrying value of the asset. The fair value of the asset is computed as the present value of the estimated future cash flows expected from the use of the asset. Future period

Cash-flow projection

Spreadsheet formula

Discounted Cash Flow

Year 1

$56,000

=PV(0.08,1,0,-56000)

$51,851.85

Year 2

$37,000

=PV(0.08,2,0,-37000)

$31,721.54

Year 3

$18,000

=PV(0.08,3,0,-18000)

$14,288.98

Year 4

$11,000

=PV(0.08,4,0,-11000)

$8,085.33

Year 5

$9,000

=PV(0.08,5,0,-9000)

$6,125.25

Total

$131,000

$112,072.95

The impairment loss is the difference between the carrying value of $384,000 and the fair value of $$112,073, calculated as Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

30) List four impairment indicators for long-term operating assets. Answer: Any four of the following: • A significant decrease in the market price of a long-lived asset (asset group). • A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition. • A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator. • An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group). • A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group). • A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) In 2015, Diller Company acquired production machinery at a cost of $860,000, which now has a book value of $380,000. The sum of undiscounted future cash flows from use of the machinery is $335,000, and its fair value is $290,000. a. Determine if an impairment loss has occurred. Explain. b. If an impairment loss has occurred, provide the journal entry to record the impairment loss. Answer: a. The sum of undiscounted future cash flows of $335,000 is less than the carrying value (book value) of $380,000. Therefore, an impairment loss has occurred. b. The amount of the impairment loss is the difference between the carrying value of the machinery and its fair value: $380,000 - $290,000 = $90,000. Therefore, the journal entry to record the impairment loss is as follows: Accumulated Depreciation - Machinery Impairment Loss on Machinery Machinery

480,000 90,000 570,000

Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

32) Native Corporation has determined that one of its finite-life intangible assets is impaired. The asset's net carrying value on the date of impairment is $1,250,000. In order to estimate impairment, the company uses the discounted cash-flow model. The company projects the asset's future cash flows as follows: Future period Year 1 Year 2 Year 3 Year 4 Year 5

Cash-flow projection $500,000 $350,000 $200,000 $120,000 $60,000

Assuming a discount rate of 7%, what is the journal entry to record the loss? Answer: The fair value test is used to measure impairment. In this case the impairment loss is computed as the difference between the fair value of the asset and the net carrying value of the asset. The fair value of the asset is computed as the present value of the estimated future cash flows expected from the use of the asset. Future period Year 1 Year 2 Year 3 Year 4 Year 5 Total

Cash-flow projection $500,000 $350,000 $200,000 $120,000 $60,000 $1,230,000

Spreadsheet formula Discounted Cash Flow =PV(0.07,1,0,-500000) $467,289.72 =PV(0.07,2,0,-350000) $305,703.55 =PV(0.07,3,0,-200000) $163,259.58 =PV(0.07,4,0,-120000) $91,547.43 =PV(0.07,5,0,-60000) $42,779.17 $1,070,579.45

The impairment loss is the difference between the carrying value of $1,250,000 and the fair value of $1,070,579, calculated as $1,250,000 - $1,070,579 = $179,421. The entry to record the impairment loss is presented below. Impairment Loss on Intangible Asset Intangible Asset

179,421

Diff: 3 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

179,421

33) Starburst Manufacturing reports the following long-term assets for its lighting division:

Carrying value $2,500,000 (1,000,000) $1,500,000 $1,750,000 $525,000 (150,000) $375,000 $1,600,000 (900,000) $700,000

Total net fixed assets

Estimated fair value

$3,800,000 $3,500,000

$340,000

$650,000

$4,325,000

Cash-flow projection $50,000 $35,000 $20,000 $12,000 $6,000

Compute the impairment loss, if any, for the appropriate asset group, assuming a discount rate of 8% and prepare the journal entry to record the loss.

Answer: The asset group for the purposes of impairment testing is only the equipment used solely for the lighting division, as the other assets have alternative future uses. The carrying value of the equipment of $375,000 exceeds the sum of the undiscounted future cash flows of $123,000, so the asset is impaired. Impairment is measured as the difference between the fair value of the asset and the net carrying value of the asset. The fair value of the asset is computed as the present value of the estimated future cash flows expected from the use of the asset. Future period Year 1 Year 2 Year 3 Year 4 Year 5 Total

Cash-flow projection Spreadsheet formula Discounted Cash Flow $50,000 =PV(0.08,1,0,-50000) $46,296.30 $35,000 =PV(0.08,2,0,-35000) $30,006.86 $20,000 =PV(0.08,3,0,-20000) $15,876.64 $12,000 $12,000 $8,820.36 $6,000 =PV(0.08,5,0,-6000) $4,083.50 $123,000 $105,083.66

The impairment loss is the difference between the carrying value of $375,000 and the fair value of $105,084, calculated as $375,000 — $105,084 = $269,916. The entry to record the impairment loss is presented below. Impairment Loss on Equipment Accumulated Depreciation - Equipment Manufacturing Equipment

269,916 150,000

Diff: 3 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

419,916

34) Briefly describe the process for determining impairment losses on property, plant, and equipment and finite-life intangible assets. Answer: 1. Evaluate whether impairment indicators are present. A variety of such indicators are provided which may suggest the asset has significantly declined in value. 2. If impairment indicators are present, the firm will then assess recoverability of the asset. The recoverability of an asset refers to the firm's ability to recover the asset's carrying value based on the sum of the undiscounted future cash flows from the use and disposal of the asset. 3. If the sum of the undiscounted future cash flows expected to be generated by the asset is less than its carrying value, the value of the asset is not expected to be recoverable and therefore, the asset is deemed to be impaired and an impairment loss must be recognized. The amount of the impairment loss is calculated as the carrying value less the fair value. Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

35) Explain how gains or losses on impaired long-term operating assets should be reported in income. How should impairment losses be recorded? Answer: Gains on impaired assets would never be reported. Losses would be reported if the asset is deemed to be impaired, which occurs if the carrying value of the asset is greater than the sum of undiscounted future cash flows from the use of that asset. Losses would be reported in income from continuing operations on the income statement. When recording the impairment loss, the firm eliminates the balance in the accumulated depreciation (or accumulated amortization) account and reduces the asset account. Specifically, it recognizes the impairment loss by: 1. Debiting the loss. 2. Debiting the accumulated depreciation or accumulated amortization for its entire balance. 3. Crediting the asset account for the sum of the loss and the accumulated depreciation or accumulated amortization. Diff: 1 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

36) In 2015, Cilla Company acquired production machinery at a cost of $500,000, which now has accumulated depreciation of $300,000. The sum of undiscounted future cash flows from use of the machinery is $130,000 and its fair value is $170,000. What amount should Cilla recognize as a loss on impairment? Answer: The book value of the machinery is its $500,000 cost less accumulated depreciation of $300,000, which equals $200,000. The book value of $200,000 is greater than the sum of the undiscounted future cash flows of $130,000, so there is impairment. The impairment loss is measured as the book value of $200,000 less the fair value of $170,000 = $30,000. Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

37) In 2015, Zee Tee Inc. acquired production machinery at a cost of $600,000, which now has a accumulated depreciation of $400,000. The sum of undiscounted future cash flows from use of the machinery is $170,000. and its fair value is $150,000. What amount should Zee Tee recognize as a loss on impairment? Answer: The book value of the machinery is its $600,000 cost less accumulated depreciation of $400,000, which equals $200,000. The book value of $200,000 is greater than the sum of the undiscounted future cash flows of $170,000, so there is impairment. The impairment loss is measured as the book value of $200,000 less the fair value of $150,000 = $50,000. Diff: 2 Objective: 12.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

12.3

Accounting for Impairments: Indefinite-Life Intangible Assets

1) U.S. GAAP requires that firms combine indefinite-life intangibles into an asset grouping if they are operated as a single asset. Answer: TRUE Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Impairment testing is conducted annually for both limited-life and indefinite-life intangible assets. Answer: FALSE Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) All intangibles are subject to periodic consideration of impairment with corresponding potential writedowns. Answer: TRUE Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) U.S. GAAP requires that firms must perform an annual impairment test of indefinite-life assets. Answer: FALSE Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) U.S. GAAP does not permit subsequent reversals of impairment losses for indefinite-life intangible assets. Answer: TRUE Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) After assessing qualitative factors to determine whether it is necessary to perform the quantitative impairment test for indefinite-life intangibles, the firm will proceed with determining fair value if impairment is deemed reasonably possible. Answer: FALSE Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Companies should evaluate indefinite life intangible assets at least annually for ________. A) amortization B) derecognition C) recoverability D) impairment Answer: D Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) A loss on impairment of an indefinite-life intangible asset is the difference between the asset's ________. A) recoverable amount and the expected future net cash flows B) book value and its fair value C) carrying amount and its recoverable amount D) carrying amount and the expected future net cash flows Answer: B Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) For which of the following does U.S. GAAP permit recognition of recovery of impairment? A) machinery used in operations B) patents held for use C) goodwill D) none of these Answer: D Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) What is the nature of the recoverability test for indefinite-life intangible assets? A) Is the carrying value of the asset greater than the sum of undiscounted future cash flows generated by the asset? B) Is the carrying value of the asset greater than the sum of future discounted cash flows generated by the asset? C) Is the carrying value of the asset greater than the fair value of the asset? D) There is no recoverability test for indefinite-life intangible assets. Answer: D Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) The journal entry to record an impairment loss for an indefinite-life intangible asset includes which of the following? A) debit the intangible asset B) credit the intangible asset C) debit accumulated amortization for the asset D) credit accumulated amortization for the asset Answer: B Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Devo Co. has an indefinite-life intangible asset with a carrying value of $785,000. The undiscounted future cash flows expected to be realized from that asset total $830,000; the discounted cash flows are $575,000; and the fair value of the asset has been determined to be $645,000. What is the amount of the impairment loss to be recorded, if any? A) $210,000 B) $140,000 C) $45,000 D) -0Answer: B Explanation: The impairment loss is measured as the difference between the carrying value of $785,000 and the fair value of $645,000 = $140,000. Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Devo Co. has an indefinite-life intangible asset with a carrying value of $786,000. The undiscounted future cash flows expected to be realized from that asset total $835,000; the discounted cash flows are $579,000; and the fair value of the asset has been determined to be $654,000. What is the new carrying value of the asset after the impairment loss has been recorded? A) $835,000 B) $654,000 C) $579,000 D) $132,000 Answer: B Explanation: The impairment loss will reduce the carrying value of the asset to its fair value, which is $654,000. Diff: 1 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) How do the standards specifying when to test for impairment for indefinite-life intangible assets differ from those standards for finite-life intangible assets? Answer: Firms conduct an impairment test for finite-life intangible assets whenever impairment indicators indicate that an asset may be impaired. For indefinite-life intangible assets, the firm has two options for determining when to test for impairment: (1) Assess qualitative factors annually to determine whether it is necessary to perform the quantitative impairment test; or (2) perform an impairment test annually. Diff: 2 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Dixon Co. has an indefinite-life intangible asset with a carrying value of $700,000. The undiscounted future cash flows expected to be realized from that asset total $720,000; the discounted cash flows are $570,000; and the fair value of the asset has been determined to be $640,000. What is the amount of the impairment loss to be recorded? Answer: The impairment loss is measured as the carrying value of $700,000 less the fair value of $640,000 = $60,000. Diff: 2 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) David Co. has an indefinite-life intangible asset with a carrying value of $780,000. The undiscounted future cash flows expected to be realized from that asset total $830,000; the discounted cash flows are $570,000; and the fair value of the asset has been determined to be $650,000. What is the new carrying value of the asset after the impairment loss has been recorded? Answer: The impairment loss will reduce the carrying value of the asset to its fair value, which is $650,000. Diff: 2 Objective: 12.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

12.4

Accounting for Impairments: Goodwill

1) Impairment testing for goodwill is the same as impairment tests for other indefinite-life assets. Answer: FALSE Diff: 1 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Firms associate goodwill with the group of net assets at the level of the operating segment or one level below the operating segment. Answer: TRUE Diff: 1 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) U.S. GAAP allows companies to make a qualitative evaluation annually to determine whether it is more likely than not that a reporting unit's goodwill is impaired. Answer: TRUE Diff: 1 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Determining the amount of goodwill impairment is a one-step impairment test. Answer: TRUE Diff: 1 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) When determining the amount of goodwill impairment, the fair value of the reporting unit is its exit price. Answer: TRUE Diff: 1 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) U.S. GAAP does not permit subsequent reversals of goodwill impairment losses. Answer: TRUE Diff: 1 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) For purposes of goodwill impairment evaluation, which of the following is not a characteristic of an operating segment of a public entity as defined in the Codification? A) It engages in business activities from which it may earn revenues and incur expenses. B) The segment has produced net profits for at least three of the last five operating cycles. C) The entity's chief decision maker regularly reviews the performance of the segment. D) The segment's discrete financial information is available. Answer: B Diff: 1 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) After an impairment loss is recorded for goodwill, what is the basis for the impaired asset? A) the recoverable amount B) the fair value C) undiscounted expected cash flows D) discounted expected cash flows Answer: B Diff: 1 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) An impairment loss for goodwill is calculated as the difference between ________. A) the implied fair value of goodwill and its book value B) the fair value of the reporting unit (including goodwill) and the fair value of its net assets (without goodwill) C) the book value of the reporting unit (including goodwill) and the book value of its net assets (without goodwill) D) the fair value of the reporting unit (including goodwill) and the book value of the reporting unit (including goodwill) Answer: D Diff: 1 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Regular Corp. has four divisions. One of them, Zolo Products, was acquired on January 1, 2020, for $440,000,000, and recorded goodwill of $53,000,000 as a result of that purchase. At December 31, 2020, Zolo Products had a fair value (including goodwill) of $379,000,000. The carrying value of the company's net assets at December 31, 2020 was $357,000,000 (including goodwill). What amount of loss on impairment of goodwill should Regular record in 2020? A) $61,000,000 B) $83,000,000 C) $22,000,000 D) -0Answer: D Explanation: There is no impairment loss for goodwill because the fair value of the reporting unit (including goodwill) of $379,000,000 exceeds the carrying value of the reporting unit (including goodwill) of $357,000,000. Diff: 2 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Regular Corp. has four divisions. One of them, Yulon Products, was acquired on January 1, 2020, for $83,000,000, and recorded goodwill of $10,000,000 as a result of that purchase. Yulon Products is a reporting unit of the company. At December 31, 2021, Yulon Products had a fair value (including goodwill) of $67,000,000. The book value of the division's net assets (including goodwill) at December 31, 2021 was $80,000,000. What was the impairment loss for goodwill at December 31, 2021? A) $80,000,000 B) $13,000,000 C) $10,000,000 D) $0 Answer: C Explanation: The impairment loss equals the carrying value of the division (with goodwill) of $80,000,000 minus the fair value of the division (with goodwill) of $67,000,000. $80,000,000 - $67,000,000 = $13,000,000. However, the loss is limited to the carrying value of goodwill of $10,000,000. Diff: 2 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Regular Corp. has four divisions. One of them, Weeble Products, was acquired on January 1, 2020, for $70,000,000, and recorded goodwill of $6,000,000 as a result of that purchase. Weeble Products is considered to be a reporting unit. At December 31, 2021, Weeble Products had a fair value (including goodwill) of $38,000,000, and the book value of the division's net assets (including goodwill) was $49,000,000. What amount of loss on impairment of goodwill should Regular record in 2021? A) -0B) $6,000,000 C) $11,000,000 D) $17,000,000 Answer: B Explanation: The impairment loss equals the carrying value of the division (with goodwill) of $49,000,000 minus the fair value of the division (with goodwill) of $38,000,000. $49,000,000 - $38,000,000 = $11,000,000. However, the loss is limited to the carrying value of goodwill of $6,000,000. Diff: 2 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Stanvid Company provided the following information: Fair value of the reporting unit, including goodwill Book value of reporting unit, excluding goodwill Add: Carrying value of goodwill Carrying value of the reporting unit, including goodwill

$1,400,000 $1,000,000 600,000 $1,600,000

The qualitative assessment of goodwill is completed and it is more likely than not that goodwill is impaired. Describe the process for determining if Stanvid needs to record a goodwill impairment loss and prepare any required journal entries. Answer: Because it is more likely than not that Stanvid's goodwill is impaired, we will perform the quantitative test. One-Step Impairment Test Measure the Impairment Loss. The impairment loss is computed as follows: Carrying value of the reporting unit, including goodwill Fair value of the reporting unit, including goodwill Impairment Loss

$1,600,000 $1,400,000 $(200,000)

Stanvid recognizes the impairment loss by making the following journal entry: Impairment Loss on Goodwill 200,000 Goodwill 200,000 Diff: 3 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Stanvid Company provided the following information: Fair value of the reporting unit, including goodwill Fair value of the reporting unit, excluding goodwill Book value of reporting unit, excluding goodwill Add: Carrying value of goodwill Carrying value of the reporting unit, including goodwill

$1,400,000 $1,200,000 $1,000,000 350,000 $1,350,000

The qualitative assessment of goodwill is completed and it is more likely than not that goodwill is impaired. Describe the process for determining if Stanvid needs to record a goodwill impairment loss and prepare any required journal entries. Answer: Because it is more likely than not that Stanvid's goodwill is impaired, we will perform the quantitative test. We compare the fair value of the reporting unit (including goodwill) to the book value of the reporting unit (including goodwill). Since the fair value of the reporting unit (including goodwill) exceeds the carrying value of the reporting unit (including goodwill), there is no impairment loss. No journal entries are required. Diff: 3 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Regular Corp. has four divisions. One of them, Yulon Products, was acquired on January 1, 2020, for $89,000,000, and recorded goodwill of $10,000,000 as a result of that purchase. Yulon Products is a reporting unit of the company. At December 31, 2021, Yulon Products had a fair value (including goodwill) of $68,000,000. The book value of the division's net assets (including goodwill) at December 31, 2021 was $81,000,000. What was the impairment loss for goodwill at December 31, 2021? Answer: $10,000,000 The impairment loss equals the carrying value of the division (with goodwill) of $79,000,000 minus the fair value of the division (with goodwill) of $68,000,000. $81,000,000 - $68,000,000 = $13,000,000. However, the loss is limited to the carrying value of goodwill of $10,000,000. Diff: 2 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Robert Corp. has four divisions. One of them, West Products, was acquired on January 1, 2020, for $80,000,000, and recorded goodwill of $9,000,000 as a result of that purchase. West Products is considered to be a reporting unit. At December 31, 2021, West Products had a fair value (including goodwill) of $38,000,000, and the book value of the division's net assets (including goodwill) was $46,000,000. What amount of loss on impairment of goodwill should Regular record in 2021? Answer: The impairment loss equals the carrying value of the division (with goodwill) of $46,000,000 minus the fair value of the division (with goodwill) of $38,000,000. $46,000,000 - $38,000,000 = $8,000,000. This is less than the carrying value of goodwill of $9,000,000 so the loss on impairment is $8,000,000. Diff: 2 Objective: 12.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

12.5 Accounting for Impairments: Property, Plant, and Equipment, Finite-Life Intangible Assets and Indefinite-Life Intangible Assets: IFRS 1) IFRS impairment testing for finite-life intangible assets is similar to impairment testing for tangible long-lived assets. Answer: TRUE Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

2) Asset grouping for impairment testing of long-term operating assets is similar under U.S. GAAP and IFRS. Answer: TRUE Diff: 1 Objective: 12.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Under IFRS, the firm may base an impairment test for an asset group called a reporting unit. Answer: FALSE Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

4) Under IFRS, impairment tests are more frequent for PPE and finite-life intangible assets than for indefinite-life intangible assets. Answer: FALSE Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

5) Under the IFRS one-step impairment test, a long-term operating asset's recoverable value is its fair value or its value in use, whichever is lower. Answer: FALSE Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) Under IFRS, when recording an impairment loss for a long-term operating asset, the firm eliminates the balance in the accumulated depreciation or accumulated amortization account, and then reduces the asset account. Answer: TRUE Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

7) IFRS allows firms to reverse impairment loss write-downs on property, plant, and equipment but not on finite-life intangible assets. Answer: FALSE Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) Under IFRS, firms report a reversal of an impairment loss on long-term operating assets as other comprehensive income. Answer: FALSE Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

9) Using IFRS for indefinite-life intangibles, impairment must be tested at least annually, even in the absence of indicators. Answer: TRUE Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

10) Under IFRS for impairment testing, the smallest identifiable group of assets that provides cash inflows is called a(n) ________. A) reporting unit B) operating unit C) cash-providing unit D) cash-generating unit Answer: D Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

11) Which of the following is not a part of the impairment test of equipment under IFRS? A) determine the asset's carrying value B) determine the asset's fair value less costs to dispose C) determine the fair value of the cash-generating unit without the asset D) determine the discounted value of the future cash flows expected to be derived from the asset Answer: C Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

12) Under IFRS, value in use of a long-life asset is ________. A) the greater of its recoverable value or its fair value less cost to sell B) the lesser of its recoverable value or its fair value less cost to sell C) the undiscounted future cash flows from use of the asset D) the discounted future cash flows from use of the asset Answer: D Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

13) Under IFRS, the impairment loss on equipment is the difference between the carrying value of the asset and ________. A) the recoverable amount of the asset B) the fair value of the asset C) the value in use of the asset D) the lesser of the fair value of the asset and its value in use Answer: A Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

14) Under IFRS, the recoverable value of a long-term operating asset is ________. A) the greater of the asset's estimated replacement value and its value in use B) the greater of the asset's estimated fair value less costs to sell and its value in use C) the lesser of the asset's estimated replacement value and its value in use D) the lesser of the asset's estimated fair value less costs to sell and its value in use Answer: B Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

15) Which of the following statements about the recoverable amount used in the IFRS impairment test of a long-lived asset is false? A) The recoverable amount may be calculated as the discounted value of expected future cash flows from the asset. B) If an asset's recoverable amount is higher than the carrying amount, no impairment loss will be reported. C) After recognizing an impairment of an asset, the firm carries the asset at its recoverable amount. D) The recoverable amount is the lesser of the fair value of the asset less costs to sell or the asset's value in use. Answer: D Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

16) In 2022, Mao Li Corporation determined that a production machine used in its operations was impaired and an impairment loss of HK$110,000 was recognized. In 2023, the fair value of the asset increased by HK$170,000 due to an unexpected resurgence in demand for the products the machine was designed to produce. How would the gain due to increase in fair value be recognized in 2023 under IFRS? A) IFRS permits the recognition of this impairment reversal as income from continuing operations. B) IFRS permits the recognition of this impairment reversal as other comprehensive income. C) IFRS allows the recognition of this impairment reversal as either income from continuing operations or as other comprehensive income, depending upon management's intent. D) IFRS does not permit recognition of gains on reversal of previous impairment loss write-downs. Answer: A Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

17) In 2015, Bambung Corporation acquired production machinery at a cost of £416,000, which now has a book value of £195,000. The discounted future cash flows from use of the machinery is £175,000 and its fair value less costs to sell is £159,000. What amount should Bambung recognize as a loss on impairment under IFRS? A) £36,000 B) £16,000 C) £20,000 D) -0Answer: C Explanation: The loss is the difference between the book value and the recoverable amount for the asset. The asset's recoverable amount is the greater of the asset's estimated fair value less the costs to sell or its value in use, which is the present value of the future cash flows the firm expects to derive from the asset. The recoverable amount is, therefore, the greater of the fair value less costs to sell of £159,000 and its value in use of £175,000. The recognized loss is the difference between the book value of £195,000 and the recoverable amount of £175,000 — resulting in a loss of £20,000. Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

18) In 2015, Heisenburg Company acquired production machinery at a cost of €624,000, which now has accumulated depreciation of €341,000. The value in use of the asset is €293,000 and its fair value less cost to sell is €247,000. What amount should Heisenburg recognize as a loss on impairment under IFRS? A) €46,000 B) €36,000 C) €10,000 D) -0Answer: D Explanation: The loss is the difference between the book value and the recoverable amount for the asset. The book value of the asset is the cost of €624,000 less accumulated depreciation of €341,000 = €283,000. The asset's recoverable amount is the greater of the asset's estimated fair value less the cost to sell or its value in use, which is the present value of the future cash flows the firm expects to derive from the asset. The recoverable amount is, therefore, the greater of the fair value less costs to sell of €247,000 and its value in use of €293,000. As the book value is less than the recoverable amount (its value in use of €293,000), no loss is recognized. Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

19) In 2015, Bellding Inc. acquired production machinery at a cost of £644,000, which now has accumulated depreciation of £380,000. The value in use of the machinery is £205,000. and its fair value less cost to sell is £218,000. What amount should Bellding recognize as a loss on impairment? A) £59,000 B) £13,000 C) £46,000 D) -0Answer: C Explanation: The loss is the difference between the book value and the recoverable amount for the asset. The book value is the cost of £644,000 less accumulated depreciation of £380,000 = £264,000. The asset's recoverable amount is the greater of the asset's estimated fair value less the cost to sell or its value in use, which is the present value of the future cash flows the firm expects to derive from the asset. The recoverable amount is, therefore, the greater of the fair value less cost to sell of £218,000 and its value in use of £205,000. The recognized loss is the difference between the book value of £264,000 and the recoverable amount of £218,000 — resulting in a loss of £46,000. Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

20) In 2015, DimDung Company acquired production machinery which now has a book value of ¥745,000. The discounted future cash flows from use of the machinery is ¥400,000 and its fair value less costs to sell is ¥350,000. DimDung has determined that an impairment loss has occurred. What is the carrying value of the machinery after the journal entry to record the impairment loss has been recorded under IFRS? A) ¥395,000 B) ¥345,000 C) ¥400,000 D) ¥350,000 Answer: C Explanation: The loss will reduce the book value of the production machinery to the recoverable amount, which is the greater of the fair value less costs to sell of ¥350,000 and the value in use of ¥400,000. As a result, the carrying value after the impairment loss is recorded will be ¥400,000. Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

21) In 2016, Bambung Corporation acquired production machinery at a cost of £420,000. In 2019, when accumulated depreciation was £103,000, Bambung reported an impairment loss of £77,000. Now, in 2023, the machinery has a book value of £193,000. The fair value less costs to sell of the machinery is £215,000 and its value in use is £192,000. During impairment testing, Bambung recognized the possibility of a reversal of the previous impairment loss. What amount, if any, should Bambung recognize as a reversal of impairment loss under IFRS? A) £77,000 B) £22,000 C) £1,000 D) -0Answer: B Explanation: IFRS allows a reversal of the impairment loss, up to amount of the recorded loss. The recoverable amount is the greater of the fair value less costs to sell of £215,000 and its value in use of £192,000. The reversal amount is the recoverable amount of £215,000 less the 2023 book value of £193,000 = £22,000. The reversal is fully allowable as it is less than the original impairment loss. Additionally, it must be verified that the newly calculated recoverable amount of £215,000 does not exceed what the original carrying amount, net of depreciation, would have been if not impaired initially. Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

22) In 2016, TallyHo Farms acquired production machinery at a cost of £430,000. In 2019, when accumulated depreciation was £180,000, Bambung reported an impairment loss of £78,000. Now, in 2023, the machinery has a book value of £142,000. The fair value less selling costs of the machinery is £273,000 and its value in use is £215,000. During impairment testing, Bambung recognized the possibility of a reversal of the previous impairment loss. What amount, if any, should Bambung recognize as a reversal of impairment loss under IFRS? A) £131,000 B) £78,000 C) £73,000 D) £58,000 Answer: B Explanation: IFRS allows a reversal of the impairment loss, up to amount of the recorded loss. The recoverable amount is the greater of the fair value less selling costs of £273,000 and its value in use of £215,000. The reversal amount is the recoverable amount of £273,000 less the 2023 book value of £142,000 = £131,000. However, the reversal is limited to the amount of the previous impairment loss - £78,000. Additionally, it must be verified that the newly calculated recoverable amount does not exceed what the original carrying amount, net of depreciation, would have been if not impaired initially. Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

23) Explain the IFRS impairment test process including determination of the amount of the impairment loss, if any, for property, plant and equipment. Answer: IFRS uses a one-step impairment test that has two parts: • Part 1: Determine the asset's recoverable amount • Part 2: Compare the asset's recoverable amount to its carrying value The asset's recoverable amount is the greater of: 1. The asset's estimated fair value less costs to sell, or 2. Its value in use, the present value of the future cash flows the firm expects to derive from an asset. Firms then compare the recoverable amount to the carrying value of the asset: 1. If the recoverable amount is less than the carrying value of the asset, then the entity is required to measure the impairment loss. 2. If the recoverable amount is greater than the carrying value of the asset, then there is no impairment loss. Under IFRS, the impairment loss is simply the difference between the recoverable amount and carrying value of the asset. Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

24) Explain the IFRS limitations on reversal of previously recognized impairment losses for property, plant, equipment and finite-life intangible assets. Answer: There are two important constraints: 1. The amount of the write-up (reversal) is limited to the amount of the original impairment loss. The reversal cannot exceed the original impairment loss. 2. The reversal cannot result in a company reporting a value that is higher than what it would be reporting if the asset had never been impaired. Firms report a reversal of an impairment loss in income. Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

25) In 2015, Sopkiewicz International acquired production machinery at a cost of €860,000, which now has a book value of €380,000. The value in use of the machinery is €335,000 and its fair value less selling costs is €290,000. The company uses IFRS. a. Determine if an impairment loss has occurred. Explain. b. If an impairment loss has occurred, provide the journal entry to record the impairment loss and determine the new carrying value of the machinery. Answer: a. The recoverable value (value in use of €335,000) is less than the carrying value (book value) of €380,000. Therefore, an impairment loss has occurred. b. The amount of the impairment loss is the difference between the carrying value of the machinery and its recoverable value: €380,000 - €335,000 = €45,000. Therefore, the journal entry to record the impairment loss is as follows: Accumulated Depreciation - Machinery Impairment Loss on Machinery Machinery

480,000 45,000 525,000

The carrying value of the machinery after the impairment loss has been recognized is €335,000 (€860,000 - €525,000) which is equal to its recoverable value. Diff: 1 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

26) In 2015, Bender Inc. acquired production machinery at a cost of £630,000, which now has accumulated depreciation of £380,000. The value in use of the machinery is £190,000. and its fair value less cost to sell is £210,000. What amount should Bender recognize as a loss on impairment? Answer: The loss is the difference between the book value and the recoverable amount for the asset. The book value is the cost of £630,000 less accumulated depreciation of £380,000 = £250,000. The asset's recoverable amount is the greater of the asset's estimated fair value less the cost to sell or its value in use, which is the present value of the future cash flows the firm expects to derive from the asset. The recoverable amount is, therefore, the greater of the fair value less cost to sell of £210,000 and its value in use of £190,000. The recognized loss is the difference between the book value of £250,000 and the recoverable amount of £210,000—resulting in a loss of £40,000. Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

27) In 2015, Dixon Company acquired production machinery which now has a book value of ¥670,000. The discounted future cash flows from use of the machinery is ¥275,000 and its fair value less costs to sell is ¥255,000. Dixon has determined that an impairment loss has occurred. What is the carrying value of the machinery after the journal entry to record the impairment loss has been recorded under IFRS? Answer: The loss will reduce the book value of the production machinery to the recoverable amount, which is the greater of the fair value less costs to sell of ¥255,000 and the value in use of ¥275,000. As a result, the carrying value after the impairment loss is recorded will be ¥275,000. Diff: 2 Objective: 12.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

12.6

Accounting for Impairments: Goodwill under IFRS

1) IFRS associates goodwill with a cash-generating unit. Answer: TRUE Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

2) IFRS requires an impairment test for goodwill at least annually. Answer: TRUE Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

3) Following IFRS, annual impairment tests for goodwill of all applicable business units must be completed on the same measurement date. Answer: FALSE Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

4) IFRS permits firms to waive the annual goodwill impairment test and instead utilize the prior year's test. Answer: TRUE Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

5) When assessing the impairment of goodwill, the recoverable amount of a cash-generating unit is the greater of its fair value less selling costs or its value in use. Answer: TRUE Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) Following IFRS, if the impairment loss is greater than the amount of reported goodwill, the firm first reduces the unit's other assets to their fair values, and then subtracts the remaining loss from goodwill. Answer: FALSE Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

7) Which of the following statements regarding IFRS impairment testing for goodwill is false? A) The firm reports an impairment loss when the recoverable amount of the cash-generating unit is less than the carrying value of the cash-generating unit, including goodwill. B) If the impairment loss is greater than the book value of goodwill, the cash-generating unit proportionally reduces the carrying value of other assets. C) The firm can perform the fair value measurement for each cash-generating unit at any time during the fiscal year, as long as it uses the measurement date consistently. D) IFRS requires an impairment test for goodwill whenever there are significant impairment indicators. Answer: D Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) When testing for the impairment of goodwill under IFRS, the recoverable amount of the cashgenerating unit is calculated as ________. A) the greater of the fair value of goodwill and the value in use of goodwill B) the greater of the fair value less selling costs of the cash-generating unit and the value in use of the cash-generating unit C) the lesser of the fair value of goodwill and the value in use of goodwill D) the lesser of the fair value of the cash-generating unit and the value in use of the cash-generating unit Answer: B Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

9) IFRS requires determination of an impairment loss for goodwill ________. A) when the fair value of the cash-generating unit (including goodwill) is greater than the book value of its net assets (including goodwill) B) when the book value of the cash-generating unit including goodwill is greater than its recoverable value C) annually D) whenever there are significant impairment indicators Answer: B Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

10) Under IFRS, the firm reports a loss from impairment of goodwill when ________. A) the recoverable amount of the cash-generating unit is less than the carrying value of the cashgenerating unit including goodwill B) the book value of goodwill is greater than the fair value of goodwill C) the three-step impairment test indicator shows goodwill has been impaired D) the two-step impairment test indicator shows goodwill has been impaired Answer: A Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

11) Under IFRS, there is never an impairment loss related to goodwill when ________. A) the value in use of the cash-generating unit is less than its fair value less cost to sell B) the value in use of the cash-generating unit is greater than its fair value less cost to sell C) the recoverable amount of the cash-generating unit less than the carrying value of the cash-generating unit D) the recoverable amount of the cash-generating unit is greater than the carrying value of the cashgenerating unit including goodwill Answer: D Diff: 1 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

12) Deluxe Corp. has four international divisions. One of them, Pere Products, was acquired on January 1, 2022, for £461,000,000, and recorded goodwill of £55,000,000 as a result of that purchase. At December 31, 2022, Pere Products had a recoverable amount of £377,000,000. The December 31, 2022 book value of Pere Products was £351,000,000 (including goodwill). What amount of loss on impairment of goodwill should Deluxe record in 2022 under IFRS? A) £110,000,000 B) £84,000,000 C) £26,000,000 D) -0Answer: D Explanation: IFRS deems goodwill to be impaired when the carrying value of the cash-generating unit exceeds the recoverable amount of the cash-generating unit. Since the current carrying value of £351,000,000 is less that the recoverable amount of £377,000,000, there is no impairment loss. Diff: 2 Objective: 12.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Deluxe Corp. has four international divisions. One of them, Qaram Corp., was acquired on January 1, 2022, for £680,000,000 and recorded goodwill of £76,000,000 as a result of that purchase. At December 31, 2022, Qaram had a book value (including goodwill) of £380,000,000. The total recoverable amount of Qaram was £360,000,000. What amount of loss on impairment of goodwill should Deluxe record in 2022 under IFRS? A) £300,000,000 B) £320,000,000 C) £20,000,000 D) -0Answer: C Explanation: IFRS deems goodwill to be impaired when the carrying value of the cash-generating unit exceeds the recoverable amount of the cash-generating unit. The book value of £380,000,000 exceeds the total recoverable amount of £360,000,000 by £20,000,000 which is the impairment loss. Diff: 2 Objective: 12.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Deluxe Corp. has four international divisions. One of them, RohrSchockt Inc., was acquired on January 1, 2022, for €710,000,000, and recorded goodwill of €85,000,000 as a result of that purchase. At December 31, 2022, RohrSchockt had value in use of €636,000,000 and a book value (including goodwill) of The total fair value of RohrSchockt was €657,000,000. What amount of loss on impairment of goodwill should Deluxe record in 2022 under IFRS? A) €41,000,000 B) €33,000,000 C) €20,000,000 D) -0Answer: C Explanation: IFRS deems goodwill to be impaired when the carrying value of the cash-generating unit exceeds the recoverable amount of the cash-generating unit. The recoverable amount is the greater of the value in use of €636,000,000 and the fair value of €657,000,000. The book value of €677,000,000 exceeds the total recoverable amount of €657,000,000 by €20,000,000 which is the impairment loss. Diff: 2 Objective: 12.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Visdant Company provided the following information: Fair value of Visdant, including goodwill Value in use of Visdant, Book value of Visdant net assets, excluding goodwill Add: Carrying value of goodwill Carrying value of Visdant, including goodwill

$2,100,000 $2,000,000 $3,000,000 600,000 $2,400,000

The qualitative assessment of goodwill is completed and it is more likely than not that goodwill is impaired. Describe the process for determining if Visdant needs to record a goodwill impairment loss and prepare any required journal entries. Visdant follows IFRS. Answer: Visdant must test for goodwill impairment at least every year. Impairment Testing. 1. Determine the recoverable amount of the cash-generating unit. The recoverable amount is the greater of the fair value (less costs to sell) or value in use of the cash-generating unit. The recoverable amount is $2,100,000, the fair value of the cash-generating unit. 2. Compare the Recoverable Amount to Carrying Value. The recoverable amount of the unit, $2,100,000 is less than its carrying value, $2,400,000 indicating there is an impairment loss. The impairment loss is $300,000 (carrying value of $2,400,000 less the $2,100,000 fair value). Visdant recognizes the impairment loss by making the following journal entry: Impairment Loss on Goodwill Goodwill

300,000

Diff: 3 Objective: 12.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

300,000

16) Dixon Corp. has four international divisions. One of them, Qaram Corp., was acquired on January 1, 2022, for £510,000,000 and recorded goodwill of £61,000,000 as a result of that purchase. At December 31, 2022, Qaram had a book value (including goodwill) of £275,000,000. The total recoverable amount of Qaram was £260,000,000. What amount of loss on impairment of goodwill should Deluxe record in 2022 under IFRS? Answer: IFRS deems goodwill to be impaired when the carrying value of the cash-generating unit exceeds the recoverable amount of the cash-generating unit. The book value of £275,000,000 exceeds the total recoverable amount of £260,000,000 by £15,000,000 which is the impairment loss. Diff: 2 Objective: 12.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Dixon Corp. has four international divisions. One of them, RohrSchockt Inc., was acquired on January 1, 2022, for €644,000,000, and recorded goodwill of €75,000,000 as a result of that purchase. At December 31, 2022, RohrSchockt had value in use of €540,000,000 and a book value (including goodwill) of €578,000,000. The total fair value of RohrSchockt was €554,000,000. What amount of loss on impairment of goodwill should Deluxe record in 2022 under IFRS? Answer: IFRS deems goodwill to be impaired when the carrying value of the cash-generating unit exceeds the recoverable amount of the cash-generating unit. The recoverable amount is the greater of the value in use of €540,000,000 and the fair value of €554,000,000. The book value of €578,000,000 exceeds the total recoverable amount of €554,000,000 by €24,000,000 which is the impairment loss. Diff: 2 Objective: 12.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

12.7

Required Disclosures for Asset Impairments

1) Following U.S. GAAP, a firm recognizing an impairment loss must separately disclose the amount of loss in the income statement. Answer: FALSE Diff: 1 Objective: 12.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Following U.S. GAAP, a firm recognizing an impairment loss must disclose both the asset or asset group impaired and the method used to estimate its fair value. Answer: TRUE Diff: 1 Objective: 12.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) IFRS disclosure requirements are identical to U.S. GAAP in every respect with respect to long-term asset impairment except requirements related to impairment recovery. Answer: FALSE Diff: 1 Objective: 12.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) IFRS requires disclosure of whether the recoverable amount of an impaired asset was fair value less selling costs or value in use. Answer: TRUE Diff: 1 Objective: 12.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

5) Which of the following is not a required disclosure requirement for long-term asset impairment under both U.S. GAAP and IFRS? A) the events and circumstances that led to the recognition of the impairment B) the method used to estimate the fair value of the asset C) the amount of any impairment loss reversal if not separately disclosed in the income statement D) the asset that was impaired Answer: C Diff: 1 Objective: 12.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which of the following disclosure requirements for long-term asset impairment apply to IFRS but not to U.S. GAAP? A) the events and circumstances that led to the recognition of the impairment B) whether the recoverable amount was fair value less costs to sell or value in use C) the amount of any impairment loss if not separately disclosed in the income statement D) the asset that was impaired Answer: B Diff: 1 Objective: 12.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) IFRS allows recoveries of impairment losses for property, plant, equipment and intangible assets. What related disclosures are required and at what organizational level are they required? Answer: IFRS requires the following additional disclosures by segment: 1. The events and circumstances that led to the recognition of the impairment loss reversal. 2. The amount of any impairment loss reversal in income or other comprehensive income. 3. The amount of any impairment loss the firm reported in other comprehensive income for assets that it has previously revalued. Diff: 2 Objective: 12.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

12.8

Long-term Operating Assets Held for Sale or Disposal

1) The accounting for long-term operating assets held for sale or disposal under U.S. GAAP and IFRS is substantially identical. Answer: TRUE Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) A company selling or disposing of a long-term operating asset measures the asset at the lower of cost or net realizable value. Answer: TRUE Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) If the company writes down the long-term operating asset in one period and still holds the asset in the next period, then the company cannot report an increase in value in the subsequent period. Answer: FALSE Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Companies must continue to depreciate or amortize long-term operating assets while holding them for sale or disposal. Answer: FALSE Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Companies must disclose the current market value of long-term operating assets held for sale or disposal. Answer: FALSE Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which of the following statements regarding long-term operating assets classified as held for sale or disposal is true? A) Long-term operating assets classified as held for disposal are valued at historical cost. B) Companies may only depreciate long-term operating assets classified as held for sale or disposal on a straight-line basis. C) If the company writes down the asset in one period, the company can report an increase in value in the subsequent period if the fair value has materially increased. D) Long-term operating assets classified as held for disposal are valued at undepreciated cost. Answer: C Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following statements regarding long-term operating assets classified as held for disposal is false? A) Long-term operating assets classified as held for disposal are valued at net realizable value. B) Companies do not depreciate long-term operating assets classified as held for disposal. C) If the company writes down the asset in one period, the company can report an increase in value in the subsequent period up to, but not exceeding, the carrying value before the write-off. D) Companies must report individual long-term operating assets classified as held for disposal separately on the balance sheet, if material in amount. Answer: A Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) A long-term asset that is retired from operations and held for disposal or sale is valued at ________. A) lower of carrying value or net realizable value B) lower of cost or market C) value in use D) replacement cost Answer: A Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) On December 31, 2022, Plattsville Plastics decided to dispose of an extrusion machine. The original cost was $470,000 and accumulated depreciation was $320,000. On December 31, 2022, the fair value of the machine was determined to be $130,000. Which of the following would be included in a related adjusting entry on December 31, 2022. A) debit Loss on Machine Held for Disposal for $150,000 B) debit Loss on Machine Held for Disposal for $20,000 C) credit Loss on Machine Held for Disposal for $150,000 D) credit Loss on Machine Held for Disposal for $20,000 Answer: B Explanation: As of December 31, 2022, the book value of the machine was its cost less accumulated depreciation, $470,000 - $320,000 = $150,000. However, at the end of 2022, the fair value of the machine is determined to be $130,000 and a loss is recorded in the amount of $20,000 (the difference between the book and fair values) as a debit entry. Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) On December 31, 2021, Plattsville Plastics recently decided to dispose of an extrusion machine. The original cost was $461,000 and accumulated depreciation was $310,389. On December 31, 2021, the fair value of the machine was determined to be $110,000. On December 31, 2022, the fair value of the machine was determined to be $164,000. Which of the following would be included in a related adjusting entry on December 31, 2022? A) credit Gain on Machine Held for Disposal for $164,000 B) credit Gain on Machine Held for Disposal for $54,000 C) credit Gain on Machine Held for Disposal for $40,611 D) No adjusting entry is required. Answer: C Explanation: As of December 31, 2021, the book value of the machine was its cost less accumulated depreciation, $461,000 - $310,389 = $150,611. However, at the end of 2021, the fair value of the machine is determined to be $110,000 and a loss is recorded in the amount of $40,611 (the difference between the book and fair values). When the fair value of the machine increases in 2022, the adjusting entry is limited to the amount of the originally recorded loss. Diff: 1 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Describe the accounting treatment for a long-term asset that is retired from operations and held for disposal or sale. Answer: If the asset's carrying value is greater than it fair value less disposal costs, the company will record a loss as the difference between carrying value and net fair value. The asset will not be depreciated thereafter. Diff: 3 Objective: 12.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) On December 31, 2022, Baker Plastics decided to dispose of an extrusion machine. The original cost was $500,000 and accumulated depreciation was $315,000. On December 31, 2022, the fair value of the machine was determined to be $150,000. What is the amount of loss on machine held for deposal on December 31, 2022. Answer: $35,000 As of December 31, 2022, the book value of the machine was its cost less accumulated depreciation, $500,000 - $315,000 = $185,000. However, at the end of 2022, the fair value of the machine is determined to be $150,000 and a loss is recorded in the amount of $35,000 (the difference between the book and fair values). Diff: 2 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) On December 31, 2021, Blue Plastics recently decided to dispose of an extrusion machine. The original cost was $460,000 and accumulated depreciation was $310,000. On December 31, 2021, the fair value of the machine was determined to be $105,000. On December 31, 2022, the fair value of the machine was determined to be $167,000. What is the amount of gain on machine held for disposal for the adjusting entry on December 31, 2022? Answer: $45,000 As of December 31, 2021, the book value of the machine was its cost less accumulated depreciation, $460,000 - $310,000 = $150,000. However, at the end of 2021, the fair value of the machine is determined to be $105,000 and a loss is recorded in the amount of $45,000 (the difference between the book and fair values). When the fair value of the machine increases in 2022, the adjusting entry gain is limited to the amount of the originally recorded loss. Diff: 2 Objective: 12.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12.9 Appendix A: Revaluation Model in IFRS Accounting for Certain Long-Term Operating Assets 1) Under IFRS, long-term operating assets can be reported on the balance sheet at fair value instead of historical cost. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

2) Under U.S. GAAP, long-term operating assets can be reported on the balance sheet at fair value instead of historical cost. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Under IFRS, long-term operating assets must be reported on the balance sheet at fair value instead of historical cost. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

4) Under U.S. GAAP, long-term operating assets must be reported on the balance sheet at fair value instead of historical cost. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Long-term operating assets can be reported on the balance sheet at fair value instead of historical cost. Does this statement apply to IFRS and U.S. GAAP? A) It applies to IFRS only. B) It applies to U.S. GAAP only. C) It applies to both IFRS and U.S. GAAP. D) It does not apply to IFRS and U.S. GAAP. Answer: A Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Long-term operating assets must be reported on the balance sheet at fair value instead of historical cost. Which of the following is true? A) It applies to IFRS only. B) It applies to U.S. GAAP only. C) It applies to both IFRS and U.S. GAAP. D) It does not apply to IFRS or U.S. GAAP. Answer: D Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Under IFRS, if equipment is revalued to fair value, then ________. A) the equipment's amortization expense per year will not be revised B) the equipment's depreciation expense per year will not be revised C) the equipment's amortization expense per year will be revised D) the equipment's depreciation expense per year will be revised Answer: D Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

8) Which statement is false? A) Under IFRS, if a machine's fair value exceeds the carrying value, the asset can be increased. B) Under U.S. GAAP, if a machine's fair value exceeds the carrying value, the asset can be increased. C) Under IFRS, if a machine's carrying value exceeds the fair value, the asset can be decreased. D) Under U.S. GAAP, if a machine's fair value exceeds the carrying value, the asset should not be adjusted. Answer: B Diff: 1 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Following IFRS, which statement is false? A) If the revaluation initially increases the long-term operating asset's carrying value, the firm records the difference between the carrying value and the fair value (the unrealized gain) in the revaluation surplus account. B) The revaluation surplus account is a specific account reported in other comprehensive income (OCI) in the statement of comprehensive income. C) The revaluation surplus account is a specific account reported as an unrealized gain in the statement of comprehensive income. D) If a long-term operating asset's fair value decreases in subsequent accounting periods, after an earlier write-up, the firm reduces the revaluation surplus if it exists. Answer: C Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

10) Following IFRS, which statement is false? A) If the revaluation initially decreases the long-term operating asset's carrying value, the firm reports the difference between the carrying value and fair value as an unrealized loss on the income statement. B) If the long-term operating asset's fair value increases in subsequent accounting periods, after an initial write-down, the firm reports the unrealized gain on the income statement, but only to the extent of previously recognized losses. C) The revaluation surplus account is reported as other comprehensive income on the statement of comprehensive income. D) If the long-term operating asset's fair value increases in subsequent accounting periods, after an initial write-down, the firm reports the unrealized gain in the revaluation surplus account. Answer: D Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

11) Smith Company is an IFRS reporter. After 3 full years of use, the Smith Company revalues equipment with a carrying value of $970,000 to its fair value of $1,190,000 using the accumulated depreciation elimination method. The original cost of the equipment is $1,390,000 and the equipment has a useful life of 10 years with no scrap value. Smith depreciates under the straight-line method. What is the new carrying value of the asset? A) $970,000 B) $1,110,000 C) $1,190,000 D) $1,390,000 Answer: C Explanation: The new carrying value is the fair value of $1,190,000. Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

12) Hale Company uses IFRS. After 5 full years of use, Hale Company revalues equipment with a carrying value of $960,000 to its fair value of $1,800,000 using the accumulated depreciation elimination method. The original cost of the equipment is $1,800,000 and the equipment has a useful life of 10 years with no scrap value. Hale Company depreciates under the straight-line method. What is the new annual depreciation expense after the revaluation? A) $0 B) $96,000 C) $180,000 D) $360,000 Answer: D Explanation: $1,800,000 / 5 = $360,000 Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

13) Sparkling Company uses IFRS. After 3 full years of use, the Sparkling Company revalues equipment with a carrying value of $990,000 to its fair value of $1,800,000 using the accumulated depreciation elimination method. The original cost of the equipment is $1,700,000 and the equipment has a useful life of 10 years with no scrap value. Sparkling Company depreciates under the straight-line method. How much is the revaluation gain or loss? Where does Sparkling Company report any unrealized gain or loss from the revaluation in the financial statements? A) $810,000 unrealized gain in continuing operations of statement of comprehensive income B) $710,000 unrealized gain in continuing operations of statement of comprehensive income C) $810,000 unrealized gain in revaluation surplus reported in other comprehensive income in statement of comprehensive income D) $710,000 recovery of unrealized loss reported in other comprehensive income in statement of comprehensive income Answer: C Explanation: $1,800,000 - $990,000 = $810,000 Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

14) Donald Company uses IFRS. After 5 full years of use, Donald Company revalues equipment with a carrying value of $1,200,000 to its fair value of $1,200,000 using the accumulated depreciation elimination method. The original cost of the equipment is $1,200,000 and the equipment has a useful life of 10 years with no scrap value. Donald Company depreciates under the straight-line method. What is the new annual depreciation expense after the revaluation? Answer: $1,200,000 / 5 years = $240,000 Explanation: $1,400,000 - $990,000 = $410,000 Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

15) Sparkling Company uses IFRS. After 3 full years of use, the Sparkling Company revalues equipment with a carrying value of $900,000 to its fair value of $1,200,000 using the accumulated depreciation elimination method. The original cost of the equipment is $1,100,000 and the equipment has a useful life of 10 years with no scrap value. Sparkling Company depreciates under the straight-line method. How much is the revaluation gain or loss? Where does Sparkling Company report any unrealized gain or loss from the revaluation in the financial statements? Answer: $300,000 unrealized gain in revaluation surplus reported in other comprehensive income in statement of comprehensive income. Explanation: $1,700,000 - $900,000 = $800,000 Diff: 2 Objective: App A IFRS/GAAP: IFRS AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 13 Operating Liabilities and Contingencies 13.1

Operating Liabilities

1) One of the three characteristics of liabilities is that they must arise from the firm's primary business obligations. Answer: FALSE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Operating liabilities are short-term obligations. Answer: TRUE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) All liabilities are probable future economic sacrifices arising from present obligations. Answer: TRUE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Accounts payable are formal, written promises to pay a certain sum of money on a specified date and typically specify a stated rate of interest. Answer: FALSE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The amount of revenue recognized from the sale of gift cards during the period is equal to gift card redemptions during the period minus estimated breakage. Answer: FALSE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Gift card breakage represents an estimate of the value of gift cards that will not be redeemed. Answer: TRUE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The deposit liability account is debited when it is determined that deposits will not be returned. Answer: TRUE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) The sales tax liability account is debited when the seller collects sales taxes from customers. Answer: FALSE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Income tax payable, as reported on a company's balance sheet, represents the amount that is owed to the governmental units. Answer: TRUE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) The obligation for compensated absences is based on services to be performed by the employee in the future. Answer: FALSE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) The obligation for compensated absences includes amounts payable for future holidays. Answer: TRUE Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Under IFRS, the obligation for compensated absences should be valued at known future wage rates. Answer: TRUE Diff: 1 Objective: 13.1 IFRS/GAAP: IFRS AACSB: Application of knowledge

13) Which of the following is not an operating liability? A) bonds payable B) unearned revenue C) customer deposits D) compensated absences Answer: A Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Which of the following represents amounts owed for goods, supplies, or services purchased? A) bonds payable B) accounts payable C) customer-related payable D) liability for compensated absences Answer: B Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Which of the following is also referred to as deferred credits? A) late fees B) sales taxes payable C) unearned revenues D) accrued revenues Answer: C Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Which of the following situations typically results in unearned revenues? A) charging customers a deposit for returnable containers B) short-term zero-interest notes payable C) providing manufacturer warranties D) selling magazine subscriptions Answer: D Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Which of the following terms refers to gift card sales that are never redeemed? A) spoilage B) breakage C) roughage D) liftage Answer: B Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) What are compensated absences? A) paid time off B) unpaid time off C) payroll deductions D) healthcare benefits Answer: A Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Which of the following is not a characteristic of a liability? A) obligation always arises from past events B) probably requires future sacrifice of resources C) requires sacrifice of cash or other current asset in the current period D) present obligation Answer: C Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) Under what conditions is an employer required to accrue a liability for sick pay? A) Sick pay benefits are reasonably estimable. B) Sick pay benefits are non-vested and reasonably estimable. C) Sick pay benefits accumulate. D) Sick pay benefits are vested. Answer: D Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Reducto Co. pays a weekly payroll of $97,000 that includes federal taxes withheld of $12,200 FICA taxes withheld of $7,260, and retirement withholdings of $6,000. What is the effect on assets and liabilities from this transaction? A) Assets decrease $97,000 and liabilities decrease $71,540. B) Assets decrease $97,000 and liabilities increase $97,000. C) Assets decrease $71,540 and liabilities decrease $25,460. D) Assets decrease $71,540 and liabilities increase $25,460. Answer: D Explanation: The journal entry to record this transaction includes a debit to the expense account for $97,000 and a credit to payable accounts for federal taxes, FICA, and retirement for a total of $25,460. Cash is credited for the difference between $97,000 and the payables for withholding in the amount of $71,540. As a result, assets decrease for cash paid and liabilities increase for the three payables. Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) On September 1, Dondra purchased $9,200 of inventory items on credit with the terms 1/15, net 30, FOB destination. Freight charges were $300. Payment for the purchase was made on September 18. Assuming Dondra uses the perpetual inventory system and the net method of accounting for purchase discounts, what amount is recorded on September 1 as accounts payable from this purchase? A) $9,500 B) $9,408 C) $9,200 D) $9,108 Answer: D Explanation: Using the net method, Dondra anticipates taking the cash discount for prompt payment. The cash discount is 1% of the purchase price of $9,200 or $92. Accounts payable is credited for $9,200 $92 discount = $9,108. Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) Pegasus Corp. signed a three-month, zero-interest-bearing $303,000 note on November 1, 2023 for the purchase of $250,000 of inventory. If Pegasus makes adjusting entries only at the end of the year, the adjusting entry made at December 31, 2023 will include a ________. A) debit to Note Payable for $17,667 B) debit to Interest Expense for $35,333 C) credit to Note Payable for $17,667 D) credit to Interest Expense for $35,333 Answer: B Explanation: Interest is recognized ratably over the life of the note. Interest is deemed to be the difference between the face value of the note and the value of inventory, $303,000 - $250,000 = $53,000. Since this is a three-month note, and two months (November and December) have passed at year end, 2/3 × $53,000 = $35,333 is recorded in the adjusting entry at year end. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) Pegasus Corp. signed a three-month, 10% note on November 1, 2023 for the purchase of $219,000 of inventory. If Pegasus makes adjusting entries only at the end of the year, the adjusting entry made at December 31, 2023 will include a ________. (Do not round any intermediary calculations. Round your final answer to the nearest dollar.) A) debit to Note Payable for $3,650 B) debit to Interest Expense for $3,650 C) credit to Note Payable for $21,900 D) debit to Interest Expense for $5,475 Answer: B Explanation: Interest is recognized ratably over the life of the note. At 2023 year end, interest expense is calculated as the principal amount ($219,000) times the rate (10%) times the time (2/12 months) or $3,650. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) Pegasus Corp. signed a three-month, 10% note on November 1, 2023 for the purchase of $300,000 of inventory. If Pegasus makes adjusting entries only at the end of the year, the entry made at January 31, 2024 will include a ________. (Do not round any intermediary calculations. Round your final answer to the nearest dollar.) A) debit to Note Payable for $300,000 B) debit to Interest Expense for $5,000 C) credit to Note Payable for $300,000 D) debit to Interest Expense for $7,500 Answer: A Explanation: Interest is recognized ratably over the life of the note. At 2023 year end, interest expense is calculated as the principal amount ($300,000) times the rate (10%) times the time (2/12 months) or $5,000. When the note is paid in 2024, interest for an additional month will be recognized, $300,000 × 10% × 1/12 = $2,500 and this amount will be debited to Interest Expense. Notes Payable will be debited for the face value of the note, as will Interest Payable for the amount accrued at the end of 2023. Cash will be credited for principal plus interest, for a total of $307,500. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) On June 1, 2022, Superior Insurance Company collected $410,000 for a 2-year insurance policy beginning on the same date. The company has a December 31 year end. What is the balance of the unearned revenue account after adjusting entries on December 31, 2022? (Do not round any intermediary calculations. Round your final answer to the nearest dollar.) A) $290,417 B) $119,583 C) $205,000 D) $85,417 Answer: A Explanation: Insurance Revenue will be recognized over the life of the contract. As of December 31, 2022, seven months of revenue will have been earned ($410,000 × 7/24 months = $119,583) and $290,417 ($410,000 - $119,583) will remain unearned. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) On June 1, 2022, Superior Insurance Company collected $420,000 for a 2-year insurance policy beginning on the same date. The company has a December 31 year end. What is the balance of the unearned revenue account after adjusting entries on December 31, 2023? (Do not round any intermediary calculations. Round your final answer to the nearest dollar.) A) $297,500 B) $122,500 C) $210,000 D) $87,500 Answer: D Explanation: Insurance Revenue will be recognized over the life of the contract. As of December 31, 2022, seven months of revenue will have been earned ($420,000 × 7/24 months = $122,500) and $297,500 ($420,000 - $122,500) will remain unearned. At the end of 2023, 12 additional months of revenue ($420,000 × 12/24 = $210,000) will have been earned, and $87,500 ($297,500 - $210,000) will remain unearned. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

28) On June 1, 2022, Superior Insurance Company collected $470,000 for a 2-year insurance policy beginning on the same date. The company has a December 31 year end. How much Insurance Revenue will be recognized in 2022? (Do not round any intermediary calculations. Round your final answer to the nearest dollar.) A) $332,917 B) $137,083 C) $235,000 D) $97,917 Answer: B Explanation: Insurance Revenue will be recognized over the life of the contract. As of December 31, 2022, seven months of revenue will have been earned ($470,000 × 7/24 months = $137,083) and $332,917 ($470,000 - $137,083) will remain unearned. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

29) Kool's Stores made cash sales during the month of May of $79,000. The sales are subject to a 4% sales tax that was also collected. Which of the following would be included in the summary journal entry to reflect the May sales transactions? A) debit Cash for $79,000 B) credit Sales Tax Payable for $75,840 C) credit Sales for $75,840 D) credit Sales Tax Payable for $3,160 Answer: D Explanation: At the time of the sales, Kool's will collect $79,000, plus sales tax in the amount of $3,160 (4% × $79,000) so cash would be debited for $82,160. The sales tax amount of $3,160, although collected in cash, will be credited to Sales Tax Payable and not Sales Revenue, as it is expected to be remitted periodically to the taxing authority. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

30) A company gives each of its 50 employees (assume they were all employed continuously through 2022 and 2023) 12 days of vacation a year if they are employed at the end of the year. The vacation accumulates and may be taken starting January 1 of the next year. The employees work 8 hours per day. In 2022, they made $17.50 per hour and in 2023 they made $20 per hour. During 2023, they took an average of 8 days of vacation each. The company's policy is to record the liability existing at the end of each year at the wage rate for that year. Under U.S. GAAP, what amount of vacation liability would be reflected on the 2022 and 2023 balance sheets, respectively? A) $84,000; $124,000 B) $96,000; $116,000 C) $84,000; $32,000 D) $96,000; $32,000 Answer: A Explanation: At the end of 2022, the company will accrue vacation liability for 50 employees × 12 days per year × 8 hours/day × $17.50 per hour = $84,000. During 2023, employees earn additional vacation and the company accrues an additional amount, calculated as 50 employees × 12 days per year × 8 hours/day × $20 per hour = $96,000. The vacation liability account is debited for actual vacation used based on the rate in place when the vacation was earned and the difference is debited as additional compensation expense. The debit for vacation used is 50 employees × 8 days per year × 8 hours/day × $17.50 per hour = $56,000. As a result, the ending balance in the vacation liability account is $84,000 + $96,000 - $56,000 = $124,000. Diff: 3 Objective: 13.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) Bull's Eye Department Stores, Inc. records $100,000 in gift card sales and receives cash in year 1. Customers redeemed 20% of the gift cards to purchase merchandise in year 2. Which of the following would be included in the summary journal entry to reflect the year 2 redemption transactions? A) debit Unearned Revenue $20,000 B) credit Unearned Revenue $20,000 C) debit Sales Revenue $80,000 D) credit Sales Revenue $80,000 Answer: A Explanation: As gift cards are redeemed, Unearned Revenue is debited and Sales Revenue is credited. The dollar value of gift cards redeemed is 20% × $100,000 = $20,000. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

32) If a company is able to estimate the rate of redemption for gift cards, they should use the ________ method to account for breakage. A) proportional B) accrual C) remote D) credit Answer: A Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

33) Bull's Eye Department Stores, Inc. records $200,000 in gift card sales and receives cash in year 1. Customers redeemed 15% of the gift cards to purchase merchandise in year 1. The company estimates breakage as 12% and uses the proportional method. How much breakage revenue should be recorded at the end of year 1? (Round any intermediary percentages two decimal places, X.XX%. Round your final answer to the nearest dollar.) A) $24,000 B) $30,000 C) $3,600 D) $4,092 Answer: D Explanation: Total breakage is estimated to be 12% × $200,000 = $24,000. Redemptions during year 1 were 15% of $200,000 = $30,000. Since $30,000 /($200,000 - $24,000) = 17.05% of the estimated gift cards to be redeemed are redeemed in year 1, 17.05% of the estimated breakage revenue should also be recognized at this time. Breakage revenue = 17.05% × $24,000 = $4,092 Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

34) National Refuse requires customers to pay $50 for each toter used for trash collection and charges this amount when delivered. When toters are returned, the amount is refunded to the customer. If a customer cancels the trash collection contract, but does not return the toter, the amount is forfeited by the customer. During the current year, 70 customers cancelled their contracts and failed to return their toter, while 115 toters are returned upon cancellation. Which of the following would be included in the journal entry to reflect the forfeiture? A) debit to Deposit Liability for $5,750 B) debit to Deposit Liability for $3,500 C) credit to Deposit Liability for $5,750 D) credit to Deposit Liability for $9,250 Answer: B Explanation: Upon forfeiture of the deposit by 70 customers, the Deposit Liability account is debited for 70 × $50 = $3,500 and a revenue account is credited. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

35) Distinguish between an interest-bearing note and a non-interest-bearing note. How are the proceeds computed for a non-interest-bearing note? Answer: Both interest-bearing and non-interest-bearing notes payable are promissory notes that require the borrower to repay a sum of money on a specific date. Both notes require the payment of interest and principal. For an interest-bearing note, the principal amount equals the face value of the note, and the interest rate is stated explicitly on the note. For a non-interest-bearing note, the face amount of the note includes both principal and interest to maturity. For a non-interest-bearing note, the borrower receives less than the face value of the note, and, therefore, the interest is implied as the difference between the face value of the note and the cash received. The cash received is equal to the present value of the note discounted at the market rate of interest. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

36) What are compensated absences? How does a company account for them? Answer: Compensated absences are employer-paid time off for vacation, illness, holidays, military service, jury duty, maternity leave, or other personal activities. A company accounts for compensated absences by recording an expense and accruing a liability if: (1) the obligation is based on employee services already performed by the employee, (2) the benefits to be paid either vest or accumulate, (3) future payment is probable, and (4) the amount of the future payment can be reasonably estimated. If the benefits are vested, compensation benefits should be accrued.If the benefits accumulate but are not vested, then the accounting treatment must address the probability of payment. Assume the likelihood that the company will pay the benefits is low or very uncertain. Because the accumulated compensated absences do not meet the definition of a liability of being a probable future sacrifice, the firm would not accrue them. With non-vested accumulated compensated absences, accountants must consider the employer's prior practices. If the employer permits employees to accumulate sick days when they are not used, the customary practice would justify the accrual of compensation expense. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

37) How do GAAP and IFRS differ in the treatment of compensated absences? Answer: Accounting for compensated absences is similar under IFRS and GAAP except that for the compensation rate used to calculate the liability. GAAP requires companies to use the compensation rate in place at the time that the compensated absences are earned, while IFRS requires the company to use future rates if these can be estimated. The difference can result in a higher liability under IFRS than under GAAP when a current cost estimate is used. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

38) What is breakage and how does it relate to the accounting for sales of gift cards? Describe two methods for estimating the amount of breakage. Answer: Breakage refers to the percentage of gift card sales that is never redeemed. When gift cards are sold, proceeds are recorded as unearned revenue which is deemed to be earned when the gift cards are redeemed. When breakage is anticipated, the company will remove the liability from its books and recognize revenue. If the company expects to be entitled to a breakage amount and it can be estimated, then it should use the proportional method to account for breakage. Otherwise, it should use the remote method which requires the seller to reliably estimate the amount of breakage. The company recognizes revenue from gift card breakage and removes the liability for the advance collection (unearned revenue) only when the probability of redemption becomes remote. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

39) Bull's Eye Department Stores, Inc. records $180,000 in gift card sales and receives cash in year 1. Customers redeemed 20% of the gift cards to purchase merchandise in year 1. The company estimates breakage as 12% and uses the proportional method. What is the proper treatment for redemption of the gift cards and recognition of breakage? Answer: At the time that the gift cards are redeemed, Unearned Revenue – Gift Cards will be debited in the amount of 20% × $180,000 = $36,000 and Sales Revenue will be credited. Total breakage is estimated to be 12% × $180,000 = $21,600. 22.73% ($36,000/($180,000-$21,600)) of the estimated gift cards to be redeemed have been redeemed, so 22.73% of the estimated breakage revenue should also be recognized at this time, with a debit to Unearned Revenue – Gift Cards and a credit to Breakage Revenue in the amount of 22.73% × $21,600 = $4,910. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

40) A company gives each of its 80 employees (assume they were all employed continuously through 2022 and 2023) 12 days of vacation a year if they are employed at the end of the year. The vacation accumulates and may be taken starting January 1 of the next year. The employees work 8 hours per day. In 2022, they made $17.50 per hour and in 2019 they made $20 per hour. During 2023, they took an average of 8 days of vacation each. The company's policy is to record the liability existing at the end of each year at the wage rate for that year. Under U.S. GAAP, what amount of vacation liability would be reflected on the 2022 and 2023 balance sheets? Answer: At the end of 2022, the company will accrue vacation liability for 80 employees × 12 days per year × 8 hours/day × $17.50 per hour = $134,400. During 2023, employees earn additional vacation and the company accrues an additional amount, calculated as 80 employees × 12 days per year × 8 hours/day × $20 per hour = $153,600. The vacation liability account is debited for actual vacation used based on the rate in place when the vacation was earned and the difference is debited as additional compensation expense. The debit for vacation used is 80 employees × 8 days per year × 8 hours/day × $17.50 per hour = $89,600. As a result the ending balance in the vacation liability account is $134,400 + $153,600 - $89,600 = $198,400. Diff: 3 Objective: 13.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

41) On September 1, Dion purchased $10,000 of inventory items on credit with the terms 2/15, net 30, FOB destination. Freight charges were $500. Payment for the purchase was made on September 18. Assuming Dion uses the perpetual inventory system and the net method of accounting for purchase discounts, what amount is recorded on September 1 as accounts payable from this purchase? Answer: $10,000 – ($10,000 × .02) = $9,800 Using the net method, Dion anticipates taking the cash discount for prompt payment. The cash discount is 2% of the purchase price of $10,000 or $200. Accounts payable is credited for $10,000 - $200 discount = $9,800. Diff: 1 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

42) On June 1, 2022, Standard Insurance Company collected $500,000 for a 4-year insurance policy beginning on the same date. The company has a December 31 year end. What is the balance of the unearned revenue account after adjusting entries on December 31, 2022? (Do not round any intermediary calculations. Round your final answer to the nearest dollar.) Answer: $427,083 Insurance Revenue will be recognized over the life of the contract. As of December 31, 2022, seven months of revenue will have been earned ($500,000 × 7/48 months = $72,917) and $427,083 ($500,000 $72,917) will remain unearned. Diff: 3 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

43) On August 1, 2022, Standard Insurance Company collected $600,000 for a 2-year insurance policy beginning on the same date. The company has a December 31 year end. What is the balance of the unearned revenue account after adjusting entries on December 31, 2023? (Do not round any intermediary calculations. Round your final answer to the nearest dollar.) Answer: $175,000 Insurance Revenue will be recognized over the life of the contract. As of December 31, 2023, seventeen months of revenue will have been earned ($600,000 × 17/24 months = $425,000) and $175,000 ($600,000 $425,000) will remain unearned. Diff: 3 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

44) Bull's Eye Department Stores, Inc. records $200,000 in gift card sales and receives cash in year 1. Customers redeemed 30% of the gift cards to purchase merchandise in year 1. The company estimates breakage as 11% and uses the proportional method. How much breakage revenue should be recorded at the end of year 1? (Round any intermediary percentages two decimal places, X.XX%. Round your final answer to the nearest dollar.) Answer: $7,416. Total breakage is estimated to be 11% × $200,000 = $22,000. Redemptions during year 1 were 30% of $200,000 = $60,000. Since $60,000/($200,000 - $22,000) = 33.71%% of the estimated gift cards to be redeemed are redeemed in year 1, 33.71% of the estimated breakage revenue should also be recognized at this time. Breakage revenue = 33.71% × $22,000 = $7,416. Diff: 2 Objective: 13.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13.2

Asset Retirement Obligations

1) Asset retirement obligations (AROs) are short-term legal obligations to dismantle and scrap assets. Answer: FALSE Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Dismantling an ocean oil-rig platform is an example of an asset retirement obligation. Answer: TRUE Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Under U.S. GAAP, accounting for an asset retirement obligation (ARO) requires estimating the fair value that the company would have to pay to retire the asset in today's market. Answer: TRUE Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When an Asset Retirement Obligation is first recognized, a liability account is credited. Answer: TRUE Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Accounting requirements for asset retirement obligation (AROs) under IFRS are the same as U.S. GAAP requirements. Answer: FALSE Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Accretion expense required by U.S. GAAP is referred to as interest expense by IFRS. Answer: TRUE Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Asset retirement obligations must be legal obligations, but not an economic obligation, under both U.S. GAAP and IFRS. Answer: FALSE Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Under IFRS, estimated costs of asset retirement obligations are discounted using an after-tax interest rate. Answer: FALSE Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Under IFRS, asset retirement obligations are considered loss contingencies. Answer: TRUE Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) According to U.S. GAAP, asset retirement obligations are ________. A) measured as the present value of past resource usage B) obligations to replace old buildings and equipment with new assets C) sinking funds for bonds or other long-term liabilities D) long-term legal requirements to restore property Answer: D Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Under U.S. GAAP, what is the expense resulting from the increase in the carrying amount of an asset retirement obligation? A) contingent expense B) accretion expense C) vested expense D) depletion expense Answer: B Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) What account is debited when the liability is initially capitalized for an asset retirement obligation to dismantle an ocean oil rig? A) a retirement expense account B) an accretion expense account C) the oil rig asset account D) a separate quasi-asset account Answer: C Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Which of the following is not a way IFRS differs from U.S. GAAP for asset retirement obligations? A) The transaction may be accounted for using either the proportional method or remote method, not just the proportional method. B) The nature of the obligation may be either economic or legal, not just legal. C) Valuation is based on estimated costs, not fair value. D) Valuation is discounted using a pre-tax rate, not an after-tax rate. Answer: A Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Lifeline Biofuels built an oil rig at a cost of $4.5 million. The company estimates the oil rig will have a useful life of 20 years (with no salvage value), after which Federal regulations require that the oil rig must be dismantled and the land area restored. The fair value of the costs of this asset retirement project is $850,000. The present value of these asset retirement costs is $265,000 based on the 6% after-tax discount rate. Under U.S. GAAP, what is the initial capitalized carrying value of the oil rig at the completion of construction? A) $4,500,000 B) $4,235,000 C) $4,765,000 D) $270,000 Answer: C Explanation: The oil rig will be capitalized at the sum of the cost of construction plus the fair value of the ARO – which is measured as the present value of the future removal costs, $4,500,000 + $265,000 = $4,765,000. Diff: 2 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Lifeline Biofuels built an oil rig at a cost of $4.5 million that it places into service on the first day of the current year. The company estimates the oil rig will have a useful life of 20 years (with no salvage value), after which Federal regulations require that the oil rig must be dismantled and the land area restored. The expected fair value of this asset retirement project is $835,000. The present value of these asset retirement costs is $124,000 based on the 10% after-tax discount rate. Under U.S. GAAP, what is the company's accretion expense for the first year? A) $12,400 B) $41,750 C) $6,200 D) $0 Answer: A Explanation: Accretion expense is calculated by multiplying the discount rate times the fair value of the ARO (the present value of the future removal costs), $124,000 × 10% = $12,400. Diff: 2 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Lifeline Biofuels built an oil rig at a cost of $4.5 million. At the time that construction was complete, the company estimated the oil rig would have a useful life of 20 years (with no salvage value), after which Federal regulations would require that the oil rig be dismantled and the land area restored. The fair value of this asset retirement project was $830,000 and the present value of these asset retirement costs was $123,000 based on the 10% after-tax discount rate. At the end of the 20-year life, the company dismantles the oil rig and restores the land at a cost of $905,000. Following U.S. GAAP, the journal entry to record the completion of the restoration process would include ________. A) credit Loss on Settlement of Asset Retirement Obligation for $782,000 B) debit Loss on Settlement of Asset Retirement Obligation for $75,000 C) credit Asset Retirement Obligation for $75,000 D) debit Loss on Settlement of Asset Retirement Obligation for $782,000 Answer: B Explanation: Over the life of the asset, Lifeline will record Accretion Expense and credit the ARO. At the end of the oil rig's 20-year life, the ARO balance will be the expected cost of $830,000. Settlement of the Asset Retirement Obligation will be recorded by debiting the ARO account at $830,000, debiting Loss on Settlement of Asset Retirement Obligation for $75,000, and crediting Cash. Diff: 2 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) How does IFRS accounting for asset retirement obligations different from U.S. GAAP accounting? Answer: Accounting for AROs under IFRS differs in three main ways from U.S. GAAP: • Under IFRS, an obligation to restore property can be a legal obligation similar to U.S. GAAP, or an economic obligation. Therefore, AROs may be reported more frequently under IFRS. • Under IFRS, the obligation is estimated based on the costs, rather than fair value (from U.S. GAAP), of dismantling and removing any items or restoring the site. • Under IFRS, estimated costs are discounted using a pre-tax interest rate and the risks specific to the liability. So, the analyses do not require the company to perform other detailed calculations on taxes. A pre-tax interest rate is higher than an after tax interest rate under U.S. GAAP, so the present value of the obligation would be lower. The accretion expense is referred to as interest expense under IFRS. Diff: 1 Objective: 13.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Texaco built an oil rig at a cost of $10 million. The company estimates the oil rig will have a useful life of 20 years (with no salvage value), after which Federal regulations require that the oil rig must be dismantled and the land area restored. The fair value of the costs of this asset retirement project is $900,000. The present value of these asset retirement costs is $300,000 based on the 6% after-tax discount rate. Under U.S. GAAP, what is the initial capitalized carrying value of the oil rig at the completion of construction? Answer: $10,300,000 Explanation: The oil rig will be capitalized at the sum of the cost of construction plus the fair value of the Asset Retirement Obligation (ARO) – which is measured as the present value of the future removal costs, $10,000,000 + $300,000 = $10,300,000. Diff: 2 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Able Company built an oil rig at a cost of $5 million that it places into service on the first day of the current year. The company estimates the oil rig will have a useful life of 20 years (with no salvage value), after which Federal regulations require that the oil rig must be dismantled and the land area restored. The expected fair value of this asset retirement project is $845,000. The present value of these asset retirement costs is $130,000 based on the 12% after-tax discount rate. Under U.S. GAAP, what is the company's accretion expense for the first year? Answer: $15,600 Explanation: Accretion expense is calculated by multiplying the discount rate times the fair value of the ARO (the present value of the future removal costs), $130,000 × 12% = $15,600. Diff: 2 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Lifeline Biofuels built an oil rig at a cost of $4.5 million. The company estimates the oil rig will have a useful life of 20 years (with no salvage value), after which Federal regulations require that the oil rig must be dismantled and the land area restored at an expected fair value of $1.3 million. The present value of these asset retirement costs is $400,000 based on the 6% after-tax discount rate. The company follows U.S. GAAP. a. Prepare the journal entry prepared at the completion of construction to value the oil rig. b. Prepare the journal entry to record the annual increase in the carrying value of the liability. c. At the end of 20 years, the company dismantles the oil rig and restores the land area at a cost of $1.5 million. Prepare the journal entry to record payment of the settlement costs in cash. Answer: a. Oil Rig $4,900,000 Asset Retirement Obligation $400,000 Cash $4,500,000 b. Accretion Expense Asset Retirement Obligation $400,000 × 6% = $24,000 c. Asset Retirement Obligation Loss on Settlement of ARO Cash

$24,000 $24,000

$1,300,000 $200,000 $1,500,000

Diff: 2 Objective: 13.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

13.3

Gain and Loss Contingencies

1) By recording a contingent gain, a company recognizes revenue when it is realized. Answer: FALSE Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Contingent gains are generally not recognized in the financial statements due to conservatism. Answer: TRUE Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A liability for a contingent loss will be accrued and reported on the balance sheet if the occurrence of the obligation is at least reasonably possible. Answer: FALSE Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) A liability for a contingent loss of a known amount will be disclosed in a footnote if the occurrence of the obligation is deemed to be probable. Answer: TRUE Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Under U.S. GAAP, a contingency is deemed to be probable if it is considered to be likely to occur. Answer: TRUE Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Some loss contingencies may be disclosed only in the footnotes even if the losses are deemed to be probable. Answer: TRUE Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) If management can only estimate a range for the loss, but cannot identify a single most likely outcome within that range, under U.S. GAAP it should accrue the midpoint of the range. Answer: FALSE Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) More contingencies are reported on the balance sheet under U.S. GAAP than under IFRS because of different definitions of "probable." Answer: FALSE Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) When a company can estimate a range for the loss, but cannot identify a single most-likely outcome within that range, IFRS requires that it accrue the midpoint of the range while U.S. GAAP requires that it accrue the minimum value of the range. Answer: TRUE Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Which of the following is the proper way to report a probable contingent asset? A) as a disclosure only B) as a deferred revenue C) as an accrued revenue D) as an increase to receivables Answer: A Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Under IFRS, provisions for contingent losses are accrued when the likelihood of an unfavorable outcome is ________. A) virtually certain B) more likely than not C) reasonably possible D) more than remote Answer: B Diff: 1 Objective: 13.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

12) Under GAAP, a provision for a contingent loss is considered to be probable if the probability of its occurrence is ________. A) slight B) likely to occur C) virtually certain D) reasonably possible Answer: B Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Onopea Inc. considered two contingencies at the end of 2022: ** a probable loss in the range of $100,000 to $500,000 ** a reasonably possible loss of $160,000 Under U.S. GAAP, what is the balance for contingent liabilities at the end of 2022? A) $100,000 B) $300,000 C) $260,000 D) $460,000 Answer: A Explanation: The reasonably possible loss will be disclosed in a footnote only, while the probable loss will be reported on the balance sheet as a contingent liability. Under GAAP, it is recorded at the minimum point of $100,000 in the range. Diff: 2 Objective: 13.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Onopea Inc. considered two contingencies at the end of 2022: ** a probable loss in the range of $400,000 to $900,000 ** a reasonably possible loss of $180,000 Under IFRS, what is the balance for contingent liabilities at the end of 2022? A) $400,000 B) $650,000 C) $580,000 D) $1,080,000 Answer: B Explanation: The reasonably possible loss will be disclosed in a footnote only, while the probable loss will be reported on the balance sheet as a contingent liability. Under IFRS, it is recorded at the midpoint in the range. ($400,000 + $900,000) / 2 = $650,000 Diff: 2 Objective: 13.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

15) Which type of contingency are companies most likely to disclose in their annual report? A) warranty B) litigation C) insurance D) government investigations Answer: B Diff: 2 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Anna Inc. considered two contingencies at the end of 2022: ** a probable loss in the range of $300,000 to $1,000,000 ** a reasonably possible loss of $170,000 Under U.S. GAAP, what is the amount for contingent liabilities at the end of 2022 on the balance sheet? Answer: $300,000 Explanation: The reasonably possible loss will be disclosed in a footnote only, while the probable loss will be reported on the balance sheet as a contingent liability. Under GAAP, it is recorded at the minimum point of $300,000 in the range. Diff: 2 Objective: 13.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Anna Inc. considered two contingencies at the end of 2022: ** a probable loss in the range of $300,000 to $1,000,000 ** a reasonably possible loss of $170,000 Under IFRS, what is the balance for contingent liabilities at the end of 2022? Answer: $650,000 Explanation: The reasonably possible loss will be disclosed in a footnote only, while the probable loss will be reported on the balance sheet as a contingent liability. Under IFRS, it is recorded at the midpoint in the range. ($300,000 + $1,000,000) / 2 = $650,000 Diff: 2 Objective: 13.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) What are the three characteristics of a liability as defined in the conceptual framework? Answer: 1. The entity will probably be required to make a future sacrifice to satisfy the obligation. 2. The entity has little or no option to avoid a future sacrifice. 3. The transaction or event giving rise to the obligation has already occurred. Diff: 1 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) How is accounting for loss contingencies different under IFRS as compared to U.S. GAAP? Answer: IFRS is similar to U.S. GAAP, except for the following three differences: • Definition of probable. Where U.S. GAAP defines probable as "likely," IFRS defines probable as "more likely than not," which is greater than 50% probable. Thus, some contingencies that would not be reported on the balance sheet under U.S. GAAP will be reported under IFRS. • Estimate in a range. When a company can estimate a range for the loss, but cannot identify a single most-likely outcome within that range, IFRS requires that it accrue the midpoint of the range rather than the minimum as under U.S. GAAP. • Discounting. IFRS reporters take into account the time value of money when evaluating contingent liabilities and discount the liability, when material. Recall that U.S. GAAP reporters can discount contingent liabilities to their present value when the amount of the liability and the timing of the payments are fixed or reliably determinable. Diff: 2 Objective: 13.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13.4

Loss Contingencies: Litigation, Warranties, and Premiums

1) In order to accrue a litigation-related liability, the company must be aware of the lawsuit before the company's year-end. Answer: FALSE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) If a litigation-related loss is not probable, it should not be accrued as a liability. Answer: TRUE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) An assurance-type warranty is also referred to as an extended warranty. Answer: FALSE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) A service-type warranty exists if the customer has the option to purchase the warranty separately. Answer: TRUE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Warranties that cover longer time periods are more likely to be assurance-type warranties. Answer: FALSE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) If the warranty is required by law, it is more likely to be an assurance-type warranty. Answer: TRUE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) When a company sells the service-type warranty contract, it records a liability for unearned revenue. Answer: TRUE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Because the sale of a service-type warranty increases sales revenue, the seller should recognize the expense of providing that warranty in the year of sale. Answer: FALSE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) The cost of promotional premiums offered to customers is accrued as part of Cost of Goods Sold in the period in which the related sales revenue is recognized. Answer: FALSE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Contingencies should not be accrued, but should be disclosed if they are either (1) probable, but not estimable, or (2) reasonably possible. Answer: TRUE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Whenever the probability of occurrence of a gain contingency is more likely than not, companies typically disclose that contingency in the footnotes. Answer: FALSE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) The quick ratio is calculated as the sum of cash and short-term marketable securities divided by current liabilities. Answer: FALSE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) The defensive interval ratio gauges liquidity based on current resources available to meet current cash expenditures. Answer: TRUE Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Which of the following would not be considered when evaluating whether to record a contingent loss for pending litigation? A) the type of litigation involved B) the ability to make a reasonable estimate of the amount of the loss C) time period in which the underlying cause of action occurred D) the probability of an unfavorable outcome Answer: A Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) In February 2023, an explosion occurred at a Dinkol Company plant, causing damage to area properties. By April 15, 2023, no claims had yet been asserted against Dinkol. However, Dinkol's management and legal counsel have concluded that it is possible but not probable that Dinkol might be held responsible for negligence. Furthermore, they have determined that a reasonable estimate for damages might be as much as $5,000,000. Dinkol's comprehensive public liability policy contains a $900,000 deductible clause. For Dinkol's December 31, 2022 financial statements, for which the auditor's fieldwork was completed in April 2023, how should this possible casualty loss be reported, if at all? A) as an accrued liability of $900,000 B) as a note disclosing a contingent loss of $900,000 C) as a note disclosing a contingent loss of $5,000,000 D) No disclosure or accrual is required. Answer: B Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) A company has a probable loss that can only be reasonably estimated within a range of outcomes. No single amount within the range is a better estimate than any other amount. Under IFRS, what amount of loss contingency should be accrued? A) the maximum amount of the range B) the midpoint amount of the range C) the minimum amount of the range D) zero Answer: B Diff: 1 Objective: 13.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

17) A company has a probable loss that can only be reasonably estimated within a range of outcomes. No single amount within the range is a better estimate than any other amount. Under U.S. GAAP, what amount of loss contingency should be accrued? A) the maximum amount of the range B) the midpoint amount of the range C) the minimum amount of the range D) zero Answer: C Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Accounting for product warranty costs under an assurance-type warranty ________. A) is required for income tax purposes B) charges an expense account when the seller performs in compliance with the warranty C) is frequently justified on the basis of expediency when warranty costs are immaterial D) charges an expense in the year of sale of the associated product Answer: D Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Which of the following best describes the accounting for assurance-type warranty costs? A) expensed when paid B) expensed when obligations are reasonably possible and estimable C) expensed based on estimates in year of sale of the associated product D) expensed when warranty claims are certain Answer: C Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) In a service-type warranty, warranty revenue is ________. A) not recognized B) recognized equally over the warranty period C) recognized only in the last year of the warranty period D) recognized in the year of sale of the associated product Answer: B Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) A promotional item offered to buyers of specific products is called ________. A) a premium B) an accretion C) an assurance-type warranty D) a service-type warranty Answer: A Diff: 1 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) During 2021, Blevert Co. introduced a new line of machines that carry a three-year warranty against manufacturer's defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 4% in the year after sale, and 5% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows:

2021 2022 2023

Actual Warranty Sales Expenditures $800,000 2,000 1,500,000 26,000 2,300,000 100,000 $4,600,000 $128,000

What amount should Blevert report as a liability at December 31, 2021? A) $2,000 B) $88,000 C) $90,000 D) $86,000 Answer: D Explanation: Warranty costs are estimated to be 11% of sales over the life of the warranty (2% + 4% + 5%). In 2021, Blevert will record warranty expense of 11% of sales of $800,000 – in the amount of $88,000 – and will credit the Contingent Warranty Liability account for this amount. The $2,000 actual repairs will be debited from this account, reducing the end of year balance to $86,000. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

23) During 2021, Blevert Co. introduced a new line of machines that carry a three-year warranty against manufacturer's defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 3% in the year after sale, and 6% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows:

2021 2022 2023

Actual Warranty Sales Expenditures $700,000 6,000 1,100,000 27,000 2,200,000 100,000 $4,000,000 $133,000

What amount should Blevert report as warranty expense for 2021? A) $6,000 B) $77,000 C) $83,000 D) $71,000 Answer: B Explanation: Warranty costs are estimated to be 11% of sales over the life of the warranty (2% + 3% + 6%). In 2021, Blevert will record warranty expense of 11% of sales of $700,000 – in the amount of $77,000 – and will credit the Contingent Warranty Liability account for this amount. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

24) During 2021, Blevert Co. introduced a new line of machines that carry a three-year warranty against manufacturer's defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 3% in the year after sale, and 6% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows:

2021 2022 2023

Actual Warranty Sales Expenditures $900,000 9,000 1,500,000 26,000 2,400,000 110,000 $4,800,000 $145,000

What amount should Blevert report as a liability at December 31, 2022? A) $165,000 B) $139,000 C) $229,000 D) $255,000 Answer: C Explanation: In 2021 the liability will initially be 11% of sales or $99,000 which will be reduced by the $9,000 of actual warranty expenditures to derive a year-end liability of $90,000. The liability will be increased by $165,000 in 2022 as a result of 2022 sales ($1,500,000 × 0.11 = $165,000) bringing the liability up to $255,000 but the actual warranty expenditures of 2022 of $26,000 will reduce the year-end liability to $229,000. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

25) During 2021, Blevert Co. introduced a new line of machines that carry a three-year warranty against manufacturer's defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 4% in the year after sale, and 7% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows:

2021 2022 2023

Actual Warranty Sales Expenditures $400,000 6,000 1,000,000 26,000 2,500,000 100,000 $3,900,000 $132,000

What amount should Blevert report as a liability at December 31, 2023? A) $325,000 B) $104,000 C) $150,000 D) $375,000 Answer: D Explanation: Warranty costs are estimated to be 13% of sales over the life of the warranty (2% + 4% + 7%). In 2021, Blevert will record warranty expense of 13% of sales of $400,000 – in the amount of $52,000 – and will credit the Contingent Warranty Liability account for this amount. The $6,000 actual repairs will be debited from this account, reducing the end of year balance to $46,000. In 2022, the company will increase the Contingent Warranty Liability account by $130,000 (13% of sales) and will decrease the account by actual warranty payments, resulting in a balance of $46,000 + $130,000 - $26,000 = $150,000. In 2023, the company will increase the Contingent Warranty Liability account by $325,000 (13% of sales) and will decrease the account by actual warranty payments, resulting in a balance of $150,000 + $325,000 $100,000 = $375,000. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

26) ShoSho Manufacturing. is being sued for illness caused to local residents as a result of negligence on the company's part in permitting the local residents to be exposed to highly toxic chemicals from its plant. ShoSho's lawyer states that it is probable that ShoSho will lose the suit and be found liable for a judgment costing ShoSho anywhere from $1,900,000 to $4,800,000. However, the lawyer states that the most probable cost is $3,900,000. As a result of the above facts, what accounting recognition, if any, should be accorded this situation under IFRS? A) ShoSho should accrue a loss contingency of $3,900,000 and disclose an additional contingency of up to $900,000. B) ShoSho should accrue a loss contingency of $1,900,000 and disclose an additional contingency of up to $2,900,000. C) ShoSho should not accrue a loss contingency but disclose a contingency of up to $1,900,000. D) ShoSho should not accrue a loss contingency or disclose any contingency. Answer: A Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

27) Mingle, Inc., a manufacturer of cleaning products, is preparing annual financial statements at December 31, 2022. Because of a recently proven health hazard in one of its cleaning products, the U.S. government has clearly indicated its intention of having Mingle recall all bottles of that product sold in the last six months. The management of Mingle estimates that this recall would cost $850,000. What accounting recognition, if any, should be accorded this situation? A) expense and equity restriction of $850,000 B) expense and contingent liability of $850,000 C) note disclosure only D) no recognition Answer: B Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

28) E-Z Electronics is running a video game promotion. For every 5 video games purchased, the customer receives a coupon upon checkout to receive a free game. The coupons expire in one year. E-Z estimates that about half of its video game customers will qualify to receive a coupon. In the past, the store has recognized a gross profit margin of 25% of the selling price on video games. What would the expected redemption percentage be to calculate the premium expense and related contingent liability? (Remember to use the gross profit margin to arrive at cost.) A) 14.00% of total video game sales B) 7.50% of total video game sales C) 20.00% of total video game sales D) 5% of total video game sales Answer: B Explanation: 50% of customers will qualify to receive coupon × 75% (COGS/Sales Price) / 5 games for one coupon = 50% × 75% / 5 = 7.50%. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

29) In December, 2022, Shooger Candy Company began including one coupon in each package of candy and offered customers a Stuffed Shooger Bear in exchange for $5 and five coupons. The stuffed bears cost Shooger $5.10 each. Eventually, it is expected that 30% of the coupons will be redeemed. During December, Shooger sold 280,000 packages of candy and no coupons were redeemed. In its December 31, 2022 balance sheet, what amount should Shooger report as estimated liability for the coupons? A) $84,000 B) $85,680 C) $16,800 D) $1,680 Answer: D Explanation: 280,000 packages sold/5 coupons per redemption = 56,000 potential redemptions. Cost of redemption is $5.10 cost for bear - $5.00 redemption price = $0.10. Redemption rate = 30%. Estimated liability = 56,000 × $0.10 × 30% = $1,680. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

30) Tony's Electronics is running a video game promotion. For every 10 video games purchased, the customer receives a coupon upon checkout to receive a free game. The coupons expire in one year. Tony estimates that about half of its video game customers will qualify to receive a coupon. In the past, the store has recognized a gross profit margin of 30% of the selling price on video games. What would the expected redemption percentage be to calculate the premium expense and related contingent liability? (Remember to use the gross profit margin to arrive at cost.) Answer: 50% × 70% / 10 games = 3.5% Explanation: 50% of customers will qualify to receive coupon × 70% (COGS/Sales Price) / 10 games for one coupon. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

31) In December, 2022, Cindy's Candy Company began including one coupon in each package of candy and offered customers a free 5 once bag of candy in exchange for $5 and four coupons. The 5 once bag of candy cost Cindy $5.20 each. Eventually, it is expected that 40% of the coupons will be redeemed. During December, Cindy sold 200,000 packages of candy and no coupons were redeemed. In its December 31, 2022 balance sheet, what amount should Cindy report as estimated liability for the coupons? Answer: 50,000 × $0.20 × 40% = $4,000. Explanation: 200,000 packages sold/4 coupons per redemption = 50,000 potential redemptions. Cost of redemption is $5.20 cost for 5 once bag - $5.00 redemption price = $0.20. Redemption rate = 40%. Estimated liability = 50,000 × $0.20 × 40% = $4,000. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

32) What is a loss contingency? What exactly is the company uncertain about? Answer: A loss contingency is an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur. The two criteria that must be met before a loss contingency is reported in a company's financial statements are: (1) it is probable that a liability has been incurred (or an asset has been impaired), and (2) the company can reasonably estimate the amount of the loss. Here, "uncertainty" means that a company is uncertain about the outcome of the future event that will either confirm or deny that a liability exists due to an event that has already taken place. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

33) Describe how to account for warranty costs if the warranty is determined to be a service-type warranty. How does this differ from accounting for an assurance-type warranty? Answer: For a service-type warranty, a company defers revenue from the sale of the warranty contract and generally recognizes it as the company satisfies its performance obligation, usually on a straight-line basis over the life of the contract. Any costs necessary to satisfy the service-type warranty are generally expensed as incurred. For an assurance-type warranty, a company recognizes the estimated warranty expense and a liability for future performance in the period of sale of the associated product. Any costs incurred to satisfy the assurance-type warranty generally reduce the warranty liability. Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

34) Big Dots provides a one-year warranty with all its products it sells. It estimates that it will sell 350,000 units of its product for the year ended December 31, 2022, and that its total revenue for the product will be $105,000,000. It also estimates that 75% of the product will have no defects, 5% will have major defects, and 20% will have minor defects. The cost of a minor defect is estimated to be $6 for each product repaired, and the cost for a major defect cost is about $21. The company also estimates that the minimum amount of warranty expense will be $1,500,000 and the maximum will be $6,000,000. Prepare the journal entry for 2022 under the warranty. Answer: Warranty Expense 787,500 Warranty Liability

787,500

Major repairs: 350,000 unit × 5% × $21 = $367,500 Minor repairs: 350,000 unit × 20% × $6 = 420,000 Total 787,500 Diff: 2 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

35) On October 1, 2022, Super Soup Corp. began offering customers a Super Soup Spoon in return for 20 soup can labels. This offer expires on March 31, 2023. The cost of each soup spoon is $1.50. Based on past experience, the company estimates that only 40% of the labels will be redeemed. During 2022, the company purchased 13,000 soup spoons and sold 600,000 cans of soup at $1.20 per can (the company uses the periodic inventory method). From these sales, 180,000 labels were returned for redemption in 2022. a. Prepare the journal entry to record the purchase of 12,000 soup spoons. b. Prepare the journal entry to record the sale of 600,000 cans of soup. c. Prepare the journal entry to estimate the premium expense for 2022. d. Prepare the journal entry to record the redemption of 180,000 labels. Answer: a. Premium Inventory (13,000 spoons × $1.50/spoon) 19,500 Cash (or Accounts Payable) 19,500 b. Cash (or Accounts Receivable)

720,000

Revenue (600,000 cans × $1.20/can) c. Premium Expense Contingent Premium Liability

720,000

18,000* 18,000*

* 600,000 cans sold × 40% = 240,000 labels expected to be redeemed 240,000 labels / 20 labels per spoon = 12,000 spoons estimated to be required 12,000 spoons × $1.50/spoon = $18,000 d. Contingent Premium Liability Premium Inventory

13,500** 13,500**

**180,000 labels redeemed / 20 labels per spoon = 9,000 spoons delivered 9,000 spoons delivered × $1.50/spoon = $13,500 Diff: 3 Objective: 13.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 14 Financing Liabilities 14.1

Notes Payable

1) Notes payable are formal credit arrangements that require the payment of a specified face amount of principal at a fixed maturity date. Answer: TRUE Diff: 1 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Short-term notes payable are reported on the balance sheet as current liabilities when they are due and payable within one year from the balance sheet date or operating cycle, whichever is longer. Answer: TRUE Diff: 1 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Short-term debt typically carries a higher interest rate than long-term notes. Answer: FALSE Diff: 1 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) A company records interest expense by debiting the expense account and crediting notes payable. Answer: FALSE Diff: 1 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Proceeds on the issuance and repayment of the principal on short-term notes payable are generally reported as financing activities on the statement of cash flows. Answer: TRUE Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Interest payments are classified as cash flows from financing activities on the statement of cash flows. Answer: FALSE Diff: 1 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) While the payment on an installment loan is the same each period, the amount applied to principal decreases each period. Answer: FALSE Diff: 1 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) A zero-interest-bearing note payable that is issued at a discount will not result in any interest expense being recognized. Answer: FALSE Diff: 1 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) If a long-term note does not have a stated rate of interest, the note is discounted at the market rate of interest. Answer: TRUE Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Harrison Corporation borrowed $33,000 from F&M Bank on June 1 of the current year. The bank required 6% interest. Interest will be paid when the nine-month note becomes due. What is the interest expense for the current year? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) $0 B) $1,980 C) $1,155 D) $990 Answer: C Explanation: $33,000 principal × 6% interest × 7/12 = $1,155 Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Harrison Corporation borrowed $32,000 from F&M Bank on June 1 of the current year. The bank required 7% interest. Interest will be paid when the nine-month note becomes due. What is the interest expense for the subsequent year in which the note is due and paid? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) $373 B) $1,680 C) $1,307 D) $1,120 Answer: A Explanation: $32,000 principal × 7% interest × 2/12 = $373 Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Harrison Corporation borrowed $39,000 from F&M Bank on June 1 of the current year. The bank required 8% interest. Interest will be paid when the nine-month note becomes due. What is the amount that will be paid upon maturity of the note? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) $39,520 B) $42,120 C) $39,000 D) $41,340 Answer: D Explanation: $39,000 principal + $2,340 interest ($39,000 × 8% interest × 9/12) = $41,340 Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Jacobsen, Inc. borrowed $800,000 from F&M Bank on June 15 of the current year. The bank required 8% interest. Interest will be paid when the 12-month note becomes due. What amount should be accrued as Interest Payable for the December 31 year-end of the current year? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) $29,333 B) $32,000 C) $34,667 D) $64,000 Answer: C Explanation: $800,000 principal × 8% interest × 6.5/12 = $34,667 Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Morrison Corporation borrowed $29,000 from Commercial Bank on June 1 of the current year. The bank required 4% interest. Interest will be paid every three months until the 9-month note is paid. What is the total Interest Expense for the year and the Interest Payable at December 31 of the current year? (Do not round intermediate calculations. Only round your final answer to the nearest cent.) A) Interest Expense $676.67; Interest Payable $676.67 B) Interest Expense $96.67; Interest Payable $96.67 C) Interest Expense $676.67; Interest Payable $96.67 D) Interest Expense $1,160.00; Interest Payable $676.67 Answer: C Explanation: Interest Expense: $29,000 principal × 4% interest × 7/12 = $676.67; Interest Payable (interest payment dates are every three months — so August 31 and November 30; interest payable represents December accrual) $29,000 principal × 4% interest × 1/12 = $96.67 Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

15) The Hudson Company borrowed $250,000 to purchase machinery and agreed to pay 8% interest for six years on an installment note. Each note payment is $54,079. How much interest is Hudson paying over the life of the loan? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) $100,000 B) $74,474 C) $27,040 D) $120,000 Answer: B Explanation: Interest is the difference between the total payments and the amount borrowed, $54,079 × 6 = $324,474 - $250,000 = $74,474. Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

16) On January 1, the Hudson Company borrowed $200,000 to purchase machinery and agreed to pay 3% interest for six years on an installment note. Each note payment is $36,920 and is due on the last day of the year. How much interest will Hudson report for the first year of the loan? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) $36,920 B) $6,000 C) $30,920 D) $1,108 Answer: B Explanation: See the amortization table below. Interest is 3% of the carrying value.

Date Jan 1 Dec 31

Total Payment

Interest Payment

Principal Payment

$36,920

$6,000

$30,920

Carrying Value $200,000 $169,080

Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

17) On January 1, the Hudson Company borrowed $130,000 to purchase machinery and agreed to pay 4% interest for six years on an installment note. Each note payment is $24,799 and is due on the last day of the year. What is the carrying value of the loan at the end of the first year? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) $105,201 B) $130,000 C) $110,401 D) $135,200 Answer: C Explanation: See the amortization table below.

Date Jan 1 Dec 31

Total Payment

Interest Payment

Principal Payment

$24,799

$5,200

$19,599

Carrying Value $130,000 $110,401

Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

18) Hornet Motors purchased a custom-made metal press for use in repairing wrecked cars. The press was installed on January 2, 2022. The press had no known market value. Hornet agreed to pay $310,000 on December 31, 2024 and asked for a 2% interest rate. At the time, Hornet's incremental borrowing rate was 9%. The seller agreed to the terms and requested interest payments on December 31 each year. What is the selling price of the machine given the terms and rates provided? (Do not round any intermediate calculations. Round your final answer to the nearest dollar.) A) $325,694 B) $255,071 C) $310,000 D) $257,977 Answer: B Explanation: The selling price of the machine is the present value of the annual interest payments and principal balance at the end of the loan, discounted at the incremental rate of 9%. N = 3, I/Y = 9%, FV = $310,000, PMT = $6,200, solve for PV = $255,071. Using Excel, the present value of the note is =PV(0.09,3,6200,310000) Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

19) Hornet Motors purchased a custom-made metal press for use in repairing wrecked cars. The press was installed on January 2, 2022. The press had no known market value. Hornet agreed to pay $330,000 on December 31, 2024 and asked for a 5% interest rate. At the time, Hornet's incremental borrowing rate was 8%. The seller agreed to the terms and requested interest payments on December 31 each year. What is the amount of cash interest paid at the end of 2022? A) $0 B) $26,400 C) $16,500 D) $9,900 Answer: C Explanation: Cash interest is based on the stated rate of 5%, .0 5 × $330,000 principal = $16,500. Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

20) Hornet Motors purchased a custom-made metal press for use in repairing wrecked cars. The press was installed on January 2, 2022. The press had no known market value. Hornet agreed to pay $340,000 on December 31, 2024 and asked for a 4% interest rate. At the time, Hornet's incremental borrowing rate was 9%. The seller agreed to the terms and requested interest payments on December 31 each year. What is the carrying value of the note at the end of 2022? (Round any intermediary calculations and your final answer to the nearest dollar.) A) $310,095 B) $296,968 C) $324,404 D) $340,000 Answer: A Explanation: Using Excel, the present value of the note is $296,968. The Excel function is = PV(0.09,3, ,-340,000) Amortization Table Date Cash Interest Effective Int. Amortization Carrying Value January 2, 2022 296,968 December 31, 2022 13,600 26,727 13,127 310,095 December 31, 2023 13,600 27,909 14,309 324,404 Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

21) Hornet Motors purchased a custom-made metal press for use in repairing wrecked cars. The press was installed on January 2, 2022. The press had no known market value. Hornet agreed to pay $290,000 on December 31, 2024 and asked for a 5% interest rate. At the time, Hornet's incremental borrowing rate was 10%. The seller agreed to the terms and requested interest payments on December 31 each year. What is the carrying value of the note at the end of the second year? (Round any intermediary calculations and your final answer to the nearest dollar.) A) $264,835 B) $253,941 C) $276,819 D) $290,000 Answer: C Explanation: Using Excel, the present value of the note is $253,941. The Excel function is =PV(0.1,3,-14,500,-290,000) Amortization Table Date Cash Interest Effective Int. Amortization Carrying Value January 2, 2022 253,941 December 31, 2022 14,500 25,394 10,894 264,835 December 31, 2023 14,500 26,484 11,984 276,819 Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

22) Hornet Motors purchased a custom-made metal press for use in repairing wrecked cars. The press had no known market value. Hornet agreed to pay $100,000 at the end of three years and asked for a 3% interest rate. At the time, Hornet's incremental borrowing rate was 7%. How should the seller and buyer record the transaction? A) Each should record the sale/purchase at $100,000. B) The seller should record the sale at $100,000 and Hornet at the present value of $100,000. C) Each should record the transaction at the present value of the note payable/receivable. D) Hornet should record the sale at $100,000 and the seller at the present value of $100,000. Answer: C Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

23) Georgia International borrowed $1,000,000 for eight months from its bank during the current year. Interest is payable in full on the due date of the note. Required: Determine the amount of interest expense for the current year based on the following borrowing dates, fiscal year end dates, and interest rates. Borrowing Date June 1 September 30 August 1 May 1

Year-End Date October 31 December 31 December 31 August 31

Interest Rate 10% 6% 8% 9%

Interest Expense

Answer: Borrowing Date June 1 September 30 August 1 May 1

Year-End Date October 31 December 31 December 31 August 31

Interest Rate 10% 6% 8% 9%

Interest Expense $41,667 $15,000 $33,333 $30,000

Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) On November 1, Yung Corp. borrowed $50,000 on a six-month note from its bank. Interest at 8% will be paid when the note is due. Record any journal entries necessary to record these transactions. Yung's fiscal year is the calendar year. Answer: Account Debit Credit November 1 Cash 50,000 Short-Term Note Payable 50,000 Short-term note due in 6 months. December 31

May 1

Interest Expense Interest Payable Accrual 2-months interest.

667

Short-term Note Payable Interest Payable Interest Expense Cash Payment in full of S-T Note

50,000 667 1,333

667

52,000

Diff: 2 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) On January 2, Zhang Company borrowed $2,000,000 on a 10-year, 7%, term loan from its bank. Required: Compute the annual interest expense and total interest expense for the loan. Answer: Annual interest expense: $2,000,000 × .07 = $140,000 Total interest for the loan: $2,000,000 × .07 × 10 years = $1,400,000 Diff: 1 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) Hornet Motors purchased a custom-made metal press for use in repairing wrecked cars. The press was installed on January 2, 2022. The press had a market value of $300,000. Hornet agreed to pay for the press in three equal installments beginning December 31, 2022. At the time, Hornet's incremental borrowing rate was 7%. Required: Compute the installment payments and prepare the three-year amortization table for the note payable. Prepare the journal entries to record the purchase of the machine, the first annual payment, and the final payment on the note. Answer: =PMT(.07,3,300000) = $114,315.50 = $114,316 N=3 I/Y = 7% PV = $300,000 FV = 0 Solve for PMT = $114,315.50 = $114,316 Amortization Table Date Cash Payment Effective Int. January 1, 2022 December 31, 2022 114,316 21,000 December 31, 2023 114,316 14,468 December 31, 2024 114,316 7,480* Totals 342,948 42,945 *adjusted for rounding errors

Principal

Carrying Value 300,000 93,315 206,685 99,847 106,838 106,838 0 300,000

Journal Entries Account Jan. 2, 2022

Dec. 31, 2022

Dec. 31, 2024

Debit 300,000

Machinery Long-Term Note Payable

Credit 300,000

Interest Expense Long-Term Note Payable Cash

21,000 93,316

Interest Expense Long-Term Note Payable Cash

7,480 106,836

114,316

Diff: 3 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) Hornet Motors purchased a custom-made metal press for use in repairing wrecked cars. The press was installed on January 2, 2022. The press had no known market value. Hornet agreed to pay $300,000 on December 31, 2024 and asked for a 3% interest rate. At the time, Hornet's incremental borrowing rate was 7%. The seller agreed to the terms and requested interest payments on December 31 each year. Required: 1. Compute the selling price of the machine. 2. Prepare the three-year amortization table for the note payable. 3. Prepare the journal entries to record the purchase of the machine, the first annual interest payment, and the final payment of interest and principal. Answer: The selling price of the machine is the present value of the annual interest payments and principal balance at the end of the loan, discounted at the incremental rate of 7%. N = 3, I/Y = 7%, FV = $300,000, PMT = $9,000, solve for PV = $268,508. The Excel function used is =PV(.07,3,-9000,-300000) = 268,508. Date January 2, 2022 December 31, 2022 December 31, 2023 December 31, 2024 Totals

Cash Payment Effective Int. 9,000 9,000 9,000 27,000

Principal

Carrying Value 268,508 9,796 278,304 10,481 288,785 11,215 300,000 31,492

18,796 19,481 20,215 58,492

Journal Entries Account Jan. 1, 2022

Dec. 31,2022

Dec. 31, 2024

Machinery Discount on Note Payable Long-Term Note Payable

Debit 268,508 31,492

Credit

300,000

Interest Expense Discount on Note Payable Cash

18,796

Long-term Note Payable Interest Expense Discount on Note Payable Cash

300,000 20,215

9,796 9,000

11,215 309,000

Diff: 3 Objective: 14.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14.2

Overview of Bonds Payable

1) When a company issues bonds, there is typically one debtor and one creditor that transact directly. Answer: FALSE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The highest Standard and Poor credit rating is a AAA rating. Answer: TRUE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A technical default occurs when a debtor misses interest and/or principal payments. Answer: FALSE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Secured bonds are also referred to as debenture bonds. Answer: FALSE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Callable bonds can be paid off and retired at the option of the issuing company at specified dates. Answer: TRUE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The face value of a bond is also referred to as its par value. Answer: TRUE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The stated interest rate is also referred to as the yield rate. Answer: FALSE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) When the stated interest rate for bonds is lower than the market rate, the bonds will be issued at a discount. Answer: TRUE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Bonds typically have a face value of $1,000. Answer: TRUE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) When a bond sells at 102, this means the bondholder has paid $102 to acquire the bond. Answer: FALSE Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) The contract between a corporation and its bondholders is a ________. A) bond indenture B) bond covenant C) restriction for compensating balances D) secured bond Answer: A Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Debt covenants include all of the following except ________. A) restrictions for holding compensating balances of cash B) restrictions on purchase of supplies C) maintaining set ratios or working capital values D) restrictions on future borrowings Answer: B Diff: 2 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Actual default by a bond issuer occurs when the debtor ________. A) violates one of the debt covenants B) fails to meet working capital ratio requirement C) fails to make interest payments D) allows the retained earnings balance to fall below required levels Answer: C Diff: 2 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Xenia Corporation issued 3,000 term bonds with a face value of $1,000 each and no additional features for $3,200,000. The bonds' selling price indicated that the bonds were paying interest that was ________. A) lower than the market rate B) the rate the bond investors wanted C) equal to par value D) higher than the market rate Answer: D Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) A bond issuer incurs a technical default when it ________. A) fails to pay interest when due B) declines to repay the principal when specified C) fails to meet required debt covenants at year end D) pays interest before it is due for payment Answer: C Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Discuss what causes bonds to sell at par, a premium, or a discount. Answer: When the market desires an interest rate that the bond is offering, the bonds will sell at par. When the market desires an interest rate higher than the bond is offering, the bonds will sell at a discount. When the market requires an interest rate lower than the bond is offering, the bonds will sell at a premium. Diff: 1 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) Determine the type of bonds that match the following bond descriptions: Bond Descriptions Bonds that holders can exchange for stock. Bonds without specific security. Bonds with options to purchase stock. Bonds with collateral. Bonds with multiple maturity dates. Bonds that the debtor can recall.

Type of Bonds

Answer: Bond Descriptions Bonds that holders can exchange for stock. Bonds without specific security. Bonds with options to purchase stock. Bonds with collateral. Bonds with multiple maturity dates. Bonds that the debtor can recall.

Type of Bonds Convertible bonds Debenture bonds Bonds with detachable stock warrants Secured bonds Serial bonds Callable bonds

Diff: 2 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Name and describe the three different prices that bonds can be issued at by a corporation. Answer: 1. Face value 2. A discount, a price below face value 3. A premium, a price above face value The discount or premium is determined by the difference between the stated or face rate of interest and the current market rate. The bond purchaser makes the investment in order to earn the current market rate of interest for an amount of comparable risk. When the stated interested rate is less than the market rate, bonds will be priced at less than the face value and the difference between face value and market value is called a discount. When the stated interested rate is more than the market rate, bonds will be priced higher than the face value and the difference between face value and market value is called a premium. Diff: 2 Objective: 14.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14.3

Accounting for Initial and Subsequent Measurement of Bonds Payable

1) When bonds are issued at par, the market rate is equal to the stated rate. Answer: TRUE Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) A bond's issue price is normally the sum of the present value of the future interest payments plus the present value of the face value of the bonds. Answer: TRUE Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) When bonds are issued at a discount, interest expense will be less than interest paid. Answer: FALSE Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Premium amortization reduces the carrying value of the bonds. Answer: TRUE Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The effective interest rate method computes interest expense by multiplying the stated interest rate by the beginning balance of the debt. Answer: FALSE Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The additional cash received when bonds are issued at a premium is accounted for as an increase of future interest expense. Answer: FALSE Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The account Discount on Bonds Payable is a contra-liability account. Answer: TRUE Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Bonds that do not pay cash interest are referred to as zero-coupon bonds. Answer: TRUE Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Under IFRS, bond discounts are recorded in a separate contra-liability account. Answer: FALSE Diff: 1 Objective: 14.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

10) Under IFRS, a bond's carrying value is the same as reported under U.S. GAAP. Answer: TRUE Diff: 1 Objective: 14.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

11) The selling price of a bond is the ________. A) par value of the bond B) par value plus the discount of the bond or minus the premium of the bond C) present value of the par value plus the present value of the interest payments D) present value of the par value minus the present value of the interest payments Answer: C Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) What is the main difference in computing the selling price of a zero-coupon bond and the selling price of a traditional bond? A) There is no difference. B) Zero coupon bonds have zero interest paid during the term of the bond. C) No present value calculations are necessary. D) Zero-coupon bonds typically sell at a premium. Answer: B Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) When determining how to compute the present value of a bond, the buyer computes the ________. A) present value of the par value discounted at the market rate and the present value of the interest discounted at the stated rate B) future value of the par value and interest discounted at the stated interest rate C) present value of the interest discounted at the market rate and the present value of the par value discounted at the stated rate D) present value of the par value and the present value of the interest discounted at the market interest rate Answer: D Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) To compute the selling price of the bond, calculate the present value of par value using the present value of $1 ________. A) and the interest payments using the present value of an ordinary annuity, discounted at the market interest rate for both B) at the stated rate and the interest payments using the present value of an ordinary annuity discounted at the market rate C) and the interest payments using the present value of an ordinary annuity, discounted at the stated rate for both D) at the market rate and the interest payments using the present value of an ordinary annuity discounted at the stated rate Answer: A Diff: 2 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) The effective interest rate properly reflects the effective cost of borrowing at the ________. A) stated rate for the bonds B) current market rate each year C) historical market rate at the date the bonds sold D) current stated rate for bonds with the same bond rating Answer: C Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) $100,000 of five-year bonds are sold for $98,000 on the issue date. Interest of $4,000 is paid each year until the bonds are repaid. What is the total interest expense to the company for issuing these bonds? A) $18,000 B) $20,000 C) $19,600 D) $22,000 Answer: D Explanation: Total interest expense is the sum of the five payments of cash interest (5 × $4,000) plus the amortization of the discount ($100,000 - $98,000) = $20,000 + $2,000 = $22,000. Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Given the following information from an amortization table, compute the interest expense and the carrying value for the next line of the table, rounding your answer to the nearest dollar: 4% Cash Interest $1,760

3% Effective Interest $1,357

Premium Amortization $403

Carrying Value $44,842

A) Interest Expense $1,345; Carrying Value $44,427 B) Interest Expense $1,345; Carrying Value $46,187 C) Interest Expense $1,357; Carrying Value $44,427 D) Interest Expense $1,357; Carrying Value $46,187 Answer: A Explanation: Interest Expense is the effective rate of 3% times the carrying value. The carrying value is decreased by the difference between the cash interest and effective interest. 4% Cash Interest $1,760 $1,760

3% Effective Interest $1,357 $1,345

Premium Amortization $403 $415

Carrying Value $44,842 $44,427

Diff: 2 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Given the following information from an amortization table, compute the interest expense, discount amortization, and the carrying value for the next line of the table, rounding your answer to the nearest dollar: 6% Cash Interest $42,000

7% Effective Interest $46,991

Discount Amortization $4,991

Carrying Value $676,288

A) Interest Expense $46,991; Discount Amortization $4,991; Carrying Value $671,297 B) Interest Expense $47,340; Discount Amortization $5,340; Carrying Value $681,628 C) Interest Expense $47,340; Discount Amortization $4,991; Carrying Value $671,297 D) Interest Expense $46,991; Discount Amortization $4,991; Carrying Value $676,288 Answer: B Explanation: Interest Expense is the effective rate of 7% times the carrying value. The carrying value is increased by the discount amortization, the difference between the cash interest and effective interest. 6% Cash Interest $42,000 $42,000

7% Effective Interest $46,991 $47,340

Discount Amortization $4,991 $5,340

Carrying Value $676,288 $681,628

Diff: 2 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) Given the following information from an amortization table for December 31, prepare the journal entry to record the payment of interest. 6% Cash Interest $42,000

7% Effective Interest $35,953

Premium Amortization $6,047

Carrying Value $507,567

A) Journal Entry December 31

Account Interest Expense Discount on Bonds Payable Cash

Debit 35,953 6,047

Account Interest Expense Discount on Bonds Payable Bonds Payable

Debit 35,953 6,047

Account Interest Expense Premium on Bonds Payable Cash

Debit 35,953 6,047

Credit

42,000

B) Journal Entry December 31

Credit

42,000

C) Journal Entry December 31

Credit

42,000

D) Journal Entry December 31

Account Interest Payable Premium on Bonds Payable Interest Expense

Debit 42,000

Credit

6,047 35,953

Answer: C

Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Given the following information from an amortization table for December 31, 2022, prepare the journal entry to record the accrual of interest at year end if the fiscal year of the company ends on September 30. Assume the last interest payment occurred on 6/30/2022, and the next interest payment on 12/31/2022. Round numbers to two decimal places. 6% Cash Interest $42,000

5% Effective Interest $35,333

Premium Amortization $6,667

Carrying Value $700,000

A) Journal Entry September 30

Account Interest Expense Premium on Bonds Payable Interest Payable

Debit 17,666.50 3,333.50

Account Interest Expense Discount on Bonds Payable Bonds Payable

Debit 17,666.50 3,333.50

Account Interest Expense Premium on Bonds Payable Cash

Debit 17,666.50 3,333.50

Credit

21,000.00

B) Journal Entry September 30

Credit

21,000.00

C) Journal Entry September 30

Credit

21,000.00

D) Journal Entry September 30

Account Interest Expense Discount on Bonds Payable Cash

Debit 17,666.50 3,333.50

Credit

21,000.00

Answer: A

Diff: 2 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

21) Given the following information from an amortization table for December 31, prepare the journal entry to record the payment of interest at year end if the fiscal year of the company ends on December 31. 6% Cash Interest $42,000

7% Effective Interest $48,114

Discount Amortization $6,114

Carrying Value $693,458

A) Journal Entry December 31

Account Interest Expense Premium on Bonds Payable Interest Payable

Debit 48,114

Account Interest Expense Premium on Bonds Payable Cash

Debit 48,114

Account Interest Expense Discount on Bonds Payable Interest Payable

Debit 48,114

Credit 6,114 42,000

B) Journal Entry December 31

Credit 6,114 42,000

C) Journal Entry December 31

Credit 6,114 42,000

D) Journal Entry December 31

Account Interest Expense Discount on Bonds Payable Cash

Debit 48,114

Answer: D

Diff: 2 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

Credit 6,114 42,000

22) On January 2, Lincoln Motors, Inc. issued 1,000, $1,000 bonds to finance a new showroom. The bonds are 5-year, 6% bonds that pay interest on December 31 each year. When issued, investors required 7% interest and the bonds are due December 31, Year 5. Required: 1. Compute the selling price of the bonds. 2. Prepare the entry to record the sale of the bonds. 3. Prepare the amortization table for the bonds. 4. Prepare the journal entries for the first annual interest payment and the final repayment of the bonds. Answer: 1. Selling price is $958,998. Using Excel, =PV(.07,5,-60000,-1000000) = $958,998 2. Date Account January 2, Yr. 1 Cash Discount on Bonds Payable Bonds Payable

Debit 958,998 41,002

Credit

1,000,000

3. Amortization Table Date Cash Payment January 2, Yr 1 December 31,Yr 1 60,000 December 31,Yr 2 60,000 December 31,Yr 3 60,000 December 31, Yr 4 60,000 December 31, Yr 5 60,000 Totals 300,000

Effective Int. Expense

Discount Amortization Carrying Value 958,998 67,130 7,130 966,128 67,629 7,629 973,757 68,163 8,163 981,920 68,734 8,734 990,654 69,346 9,346 1,000,000 341,002 41,002

4. Journal Entries Date Account December 31, Yr. 1 Interest Expense Discount on Bonds Payable Cash

Date January 2

Account Bonds Payable Cash

Debit 67,130

Credit 7,130 60,000

Debit 1,000,000

Credit 1,000,000

Diff: 3 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

23) On January 2, Andrew Corp. issued 1,000, $1,000 bonds to finance a new showroom. The bonds are 5year, 6% bonds that pay interest on December 31 each year. When issued, investors required 5% interest and the bonds are due December 31, Year 5. Required: 1. Compute the selling price of the bonds. 2. Prepare the entry to record the sale of the bonds. 3. Prepare the amortization table for the bonds. 4. Prepare the journal entries for the first annual interest payment and the final repayment of the bonds. Answer: 1. Selling price is $1,043,295. Using Excel, =PV(.05,5,-60000,-1000000) = $1,043,295. 2. Date January 2, Yr. 1 Cash

Account

Debit 1,043,295

Premium on - Bonds Payable Bonds Payable

Credit 43,295 1,000,000

3. Amortization Table Date January 2, Yr 1 December 31, Yr 1 December 31, Yr 2 December 31, Yr 3 December 31, Yr 4 December 31, Yr 5 Totals

Cash Payment

Effective Int. Expense

60,000 60,000 60,000 60,000 60,000 300,000

Premium Amortization Carrying Value 1,043,295 52,165 7,835 1,035,460 51,773 8,227 1,027,233 51,362 8,638 1,018,595 50,930 9,070 1,009,525 50,475 9,525 1,000,000 256,705 43,295

4. Journal Entries Date Account December 31 Interest Expense Premium on Bonds Payable Cash

Debit 52,165 7,835

Date December 31

Debit 1,000,000

Account Bonds Payable Cash

Credit

60,000

Credit 1,000,000

Diff: 3 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

24) $100,000 of five-year bonds are sold for $98,000 on the issue date. Interest of $3,000 is paid each year until the bonds are repaid. What is the total interest expense to the company for issuing these bonds? Answer: Total interest expense is the sum of the five payments of cash interest (5 × $3,000) plus the amortization of the discount ($100,000 - $98,000). $15,000 + $2,000 = $17,000. Diff: 1 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Given the following information from a bond premium amortization table, compute the interest expense and the carrying value for the next line of the table, rounding your answer to the nearest dollar: 2% Cash Interest $800

1% Effective Interest $452

Premium Amortization $348

Carrying Value $43,500

Answer: Interest Expense is the effective rate of 1% times the carrying value. The carrying value is decreased by the difference between the cash interest and effective interest. 2% Cash Interest $800 $800

1% Effective Interest $452 $435

Premium Amortization $348 $365

Carrying Value $43,500 $43,135

Diff: 2 Objective: 14.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

14.4

Bonds Issued between Interest Dates

1) When bonds are sold between interest dates, the issuer will pay the bondholder a lower amount of interest than the annual interest payment due on the next interest date. Answer: FALSE Diff: 1 Objective: 14.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) When bonds are sold between interest dates, the buyer must pay the issuer the amount of accrued interest from the prior interest date. Answer: TRUE Diff: 1 Objective: 14.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) When bonds are sold between interest dates, the amount of accrued interest a buyer pays is equal to the face value of the bond times the market interest rate times the portion of a year since the prior interest date. Answer: FALSE Diff: 1 Objective: 14.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) When bonds are sold between interest dates, the buyer must pay the issuer the amount of accrued interest from the prior interest date or date on the bonds to the date of the bond issue. Answer: TRUE Diff: 1 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Bonds are not always sold on their interest payment dates; market interest rate fluctuations or a depressed bond market can delay the bond issue. Answer: TRUE Diff: 1 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Wilson Corp. issued $1,000,000 of 4% bonds on April 30 at par value. The bonds were dated January 1. The company pays interest on June 30 and December 31 each year. How much will the buyer need to pay the company in accrued interest? (Round your final answer to the nearest dollar.) A) $40,000 B) $16,667 C) $20,000 D) $13,333 Answer: D Explanation: $1,000,000 principal × 4% interest × 4/12 months (January 1 to April 30 is four months) = $13,333. Diff: 2 Objective: 14.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Wilson Corp. issued $9,000,000 of 5% bonds on April 1 at par value. The bonds were dated January 1. The company pays interest on June 30 and December 31 each year. How much will the buyer need to pay the company in accrued interest at purchase and how much will the buyer receive in interest on June 30? A) pay April 1, $0; receive June 30 $225,000 B) pay April 1 $450,000; receive June 30 $450,000 C) pay April 1 $450,000; receive June 30 $225,000 D) pay April 1 $112,500; receive June 30 $225,000 Answer: D Explanation: Accrued interest at the time of purchase = $9,000,000 principal × 5% × 3/12 = $112,500; Interest received on June 30 = $9,000,000 principal × 5% × 6/12 = $225,000. Diff: 2 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Samuel's, Inc. sold $15,000 of 6% bonds to an individual on April 1 at par value. The bonds pay interest on June 30 and December 31 each year. What are the proper entries for the sale of the bonds and the June 30 payment of the interest for these bonds? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) Account Debit Credit April 1 Cash 15,225 Interest Payable 225 Bonds Payable 15,000

June 30

Account Interest Expense Interest Payable Cash

Debit 225 225

Account

Debit 15,000

Credit

450

B) April 1

Cash Bonds Payable

June 30

Credit 15,000

Account Interest Expense Cash

Debit 300

Account

Debit 525

Credit 300

C) April 1

Cash Interest Payable Bonds Payable

June 30

Account Interest Expense Interest Payable

Credit 300 225

Debit 300

Credit 300

D) Account April 1

Cash

Debit 15,150

Interest Payable Bonds Payable

June 30

Account Interest Payable Interest Expense Cash

Credit 150 15,000

Debit 150 150

Credit

300

Answer: A Explanation: Accrued interest is $15,000 principal × 6% interest × 3/12 months = $225 (3 months from January 1 to April 1). Interest expense on June 30 is $15,000 principal × 6% interest × 6/12 months = $450 (6 months from January 1 to June 30). Diff: 2 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) When bonds are sold at a discount between interest dates, the buyer ________. A) pays no interest to the issuer B) pays the issuer interest from the date on the bonds to the purchase date C) receives interest from the issuer from the date on the bonds to the purchase date D) receives a discount from the issuer for the loss of the interest before purchase Answer: B Diff: 2 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) When working with bonds issued between interest dates, the accountant must ________. A) reevaluate the actual interest rate for the entire amortization table B) assume that the bonds were issued on the intended issue date C) adjust the first period of the amortization table D) omit the first interest period from the amortization table Answer: C Diff: 2 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) Webber Corp. issued $12,000,000 of 7% bonds on March 31st at par value. The bonds were dated January 1. The company pays interest on June 30 and December 31 each year. How much will the buyer need to pay the company in accrued interest? (Round your final answer to the nearest dollar.) A) $840,000 B) $420,000 C) $210,000 D) $280,000 Answer: C Explanation: $12,000,000 principal × 7% interest × 3/12 months (January 1 to March 31 is three months) = $210,000. Diff: 2 Objective: 14.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Webber Corp. issued $5,000,000 of 5% bonds on May 1 at par value. The bonds were dated January 1. The company pays interest on June 30 and December 31 each year. How much will the buyer need to pay the company in accrued interest at purchase and how much will the buyer receive in interest on June 30? A) pay May 1, $0; receive June 30 $125,000 B) pay May 1 $83,333; receive June 30 $125,000 C) pay May 1 $125,000; receive June 30 $83,333 D) pay May 1 $125,000; receive June 30 $125,000 Answer: B Explanation: Accrued interest at the time of purchase = $5,000,000 principal × 5% × 4/12 = $83,333; Interest received on June 30 = $5,000,000 principal × 5% × 6/12 = $125,000. Diff: 2 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Susan's, Inc. sold $100,000 of 6% bonds to an individual on April 1 at par value. The bonds pay interest on June 30 and December 31 each year. What are the proper entries for the sale of the bonds and the June 30 payment of the interest for these bonds? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) Account Debit Credit April 1 Cash 101,500 Interest Payable 1,500 Bonds Payable 100,000

June 30

Account Interest Expense Interest Payable Cash

Debit 1,500 1,500

Account

Debit 100,000

Credit

3,000

B) April 1

Cash Bonds Payable

June 30

Credit 100,000

Account Interest Expense Cash

Debit 3,000

Account

Debit 103,000

Credit 3,000

C) April 1

Cash Interest Payable Bonds Payable

June 30

Account Interest Expense Interest Payable

Credit 3,000 100,000

Debit 3,000

Credit 3,000

D) Account April 1

Cash

Debit 100,090

Interest Payable Bonds Payable

June 30

Account Interest Payable Interest Expense Cash

Credit 90 100,000

Debit

Credit

90 270 360

Answer: A Explanation: Accrued interest is $100,000 principal × 6% interest × 3/12 months = $1,500 (3 months from January 1 to April 1). Interest expense on June 30 is $100,000 principal × 6% interest × 6/12 months = $3,000 (6 months from January 1 to June 30). Diff: 2 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Lincoln, Inc. issued $500,000 of 5%, 5-year bonds dated January 1, 2022 on July 1, 2022 when the market required 6% interest for bonds of similar risk. The bonds pay interest on December 31 each year. The bonds sold at $493,251 including accrued interest. Required: Prepare the journal entries for the sale of the bonds and the December 31 payment for the interest for these bonds. Answer: Accrued interest (Interest Payable) is $500,000 principal × 5% interest × 6/12 months = $12,500.

July 1, 2022

Account Cash Discount on Bonds Payable Interest Payable Bonds Payable

Debit 493,251 19,249

Credit

12,500 500,000

Account December 31, 2022 Interest Payable Discount on Bonds Payable Cash ($500,000 × 5%) *($493,251 - $12,500) × 6% × 1/2 = $14,423**$14,423 - $12,500 = $1,923

Debit 14,423* 12,500

Diff: 3 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

Credit

1,923* 25,000

15) Hudson, Inc. issued $500,000 of 5%, 5-year bonds dated January 1, 2022 on July 1, 2022 when the market required 4% interest for bonds of similar risk. The bonds pay interest on December 31 each year. The bonds sold at $532,744 including accrued interest. Required: Prepare the journal entries for the sale of the bonds and the December 31 payment for the interest for these bonds. Answer: Accrued interest (Interest Payable) is $500,000 principal × 5% interest × 6/12 months = $12,500.

Date July 1, 2022

Account

Debit 532,744

Cash

Credit

Premium on Bonds Payable Interest Payable Bonds Payable

Date Account December 31, 2022 Interest Expense Interest Payable Premium on Bonds Payable Cash($500,000 × 5%) *($532,744 - $12,500) × 4% × 0.50 = $10,405

20,244 12,500 500,000

Debit 10,405 12,500 2,095

Credit

Diff: 3 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

25,000

16) Walker, Inc. issued $600,000 of 5%, 5-year bonds dated January 1, 2022 on July 1, 2022 when the market required 6% interest for bonds of similar risk. The bonds pay interest on December 31 each year. Required: Determine the selling price of the bonds and prepare the journal entries for the issuance of the bonds and the payment of the first interest payment. Answer: Present value of the bonds for four full periods is calculated as follows: N = 4, Pmt = 30,000, FV = $600,000, I/Y = 6%; Solve for PV = $579,209. Using Excel, =PV(.06,4,-30000,-600000) = $579,209. Present value of bonds at issue is calculated as follows: Present value of bond for 4 annual interest periods + Interest for 6 months after sale = $579,209 + $15,000 = $594,209 Using Excel, =PV(.03,1,0,594209) = $576,902 N = 1, Pmt = 0, FV = 594,209 I/Y = 3% Solve for PV = 576,902

Account July 1, 2022

December 31, 2022

Debit 591,902 23,098

Cash Discount on Bonds Payable Interest Payable Bonds Payable

Credit

15,000 600,000

Account Interest Expense

Debit 17,307

Interest Payable Discount on Bonds Payable Cash

Credit

15,000 2,307 30,000

Diff: 3 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) Swanson, Inc. issued $600,000 of 5%, 5-year bonds dated January 1, 2022 on July 1, 2022 when the market required 4% interest for bonds of similar risk. The bonds pay interest on December 31 each year. Required: Determine the selling price of the bonds and prepare the journal entries for the issuance of the bonds and the payment of the first interest payment. Answer: Present value of the bonds for four full periods is calculated as follows: N = 4, Pmt = 30,000, FV = $600,000, I/Y = 4%; Solve for PV = $621,779; Using Excel, =PV(.04,4,30000,-600000) = $621,779. Present value of bonds at issue is calculated as follows: N = 1, Pmt = 0, FV = $636,779, I/Y = 2%; Solve for PV = $624,293 Present value of bond for 4 annual interest periods + Interest for 6 months after sale = $621,779 + $15,000 = $636,779. Using Excel, =PV(.02,1,0,636779) = $624,293

Account July 1, 2022

Debit 639,293

Cash Premium on Bonds Payable Interest Payable Bonds Payable

Account December 31, 2022 Interest Expense Interest Payable Premium on Bonds Payable Cash

Credit 24,293 15,000 600,000

Debit 12,486 15,000 2,514

Credit

30,000

Diff: 3 Objective: 14.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Webber Corp. issued $2,000,000 of 5% bonds on March 31st at par value. The bonds were dated January 1. The company pays interest on June 30 and December 31 each year. How much will the buyer need to pay the company in accrued interest? (Round your final answer to the nearest dollar.) Answer: $25,000 Explanation: $2,000,000 principal × 5% interest × 3/12 months (January 1 to March 31 is three months) = $25,000. Diff: 2 Objective: 14.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14.5

Bond Issue Costs

1) All companies capitalize bond issue costs which are amortized over the life of the bond issue. Answer: FALSE Diff: 1 Objective: 14.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Under U.S. GAAP, bond issue costs are capitalized and amortized over the life of the bonds. Answer: FALSE Diff: 1 Objective: 14.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Under both U.S. GAAP and IFRS, bond issue costs are deducted from the carrying value of the bond payable (by increasing the discount or decreasing the premium) and are included when determining the effective interest rate on the debt. Answer: TRUE Diff: 1 Objective: 14.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When seeking to raise capital via bond issues, companies must consider costs related to printing, accounting fees, legal fees, and underwriting. Answer: TRUE Diff: 1 Objective: 14.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) In U.S. GAAP, bond issue costs are considered ________. A) an element in determining the carrying value of the bonds outstanding B) a cost of borrowing that reduces the effective interest expense C) a period cost D) an initial cost that is expensed when the bonds are issued Answer: A Diff: 1 Objective: 14.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Jorge Corp. issued $530,000 of 6%, 10-year bonds on January 2, 2022 for $520,000. In addition, the company incurred $50,000 in bond issue costs. Interest is paid annually. What is the effective interest rate for the bonds given the information provided? Round your answer to two decimal places. A) 8.66% B) 7.66% C) 6.00% D) 6.93% Answer: B Explanation: Bond issue costs are deducted from the carrying value of the bond payable by increasing the discount or decreasing the premium and are included when determining the effective interest rate on the debt. The effective interest rate is calculated using the following inputs: N=10, PV=470,000, PMT=31,800, FV=-530,000, yielding 7.66%. The Excel function is =RATE(10,-31800,470000,-530000)= 0.077 = 7.66%. Diff: 1 Objective: 14.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Jorge Corp. issued $580,000 of 6%, 10-year bonds on January 2, 2022 for $570,000. In addition, the company incurred $50,000 in bond issue costs. Interest is paid annually on December 31. What is the correct amount of bond interest expense to be recorded on December 31, 2022 using GAAP? (Round any interest calculations two decimal places X.XX%) A) $34,800 B) $39,052 C) $44,148 D) Unable to determine. Answer: B Explanation: Bond issue costs are deducted from the carrying value of the bond payable by increasing the discount or decreasing the premium and are included when determining the effective interest rate on the debt. The effective interest rate is calculated using the following inputs: N=10, PV=520,000, PMT=34,800, FV=-580,000, yielding 7.51%. The Excel function is =RATE(10,-34800,520000,-580000) = 0.0751 = 7.51%.

Date January 2, 2022 December 31, 2022

6% Cash Interest

7.51% Effective Interest

Discount Amortization Carrying Value $520,000

$34,800

$39,052* *$520,000 × 7.51% = $39,052

$4,252

Diff: 1 Objective: 14.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

$524,252

8) Zhang Company, an IFRS company, sold $6,000,000 of 6%, 3-year bonds on January 1, 2022. The bonds pay interest each December 31. It cost the company $30,000 in bond issue costs. The bonds were sold at par. What is the effective interest rate for the bonds? A) 6.16% B) 8.55% C) 6.19% D) 5.81% Answer: C Explanation: Under both U.S. GAAP and IFRS, bond issue costs are deducted from the carrying value of the bond payable by increasing the discount or decreasing the premium and are included when determining the effective interest rate on the debt. The effective interest rate is calculated using the following inputs: N=3, PV=5,970,000, PMT=-360,000, FV=-6,000,000, yielding 6.19%. Using Excel, the function is =RATE(3,-360000,5970000,-6000000) = 0.062 = 6.19% Diff: 3 Objective: 14.5 IFRS/GAAP: IFRS AACSB: Analytical thinking

9) Describe the difference between GAAP and IFRS in accounting for bond issue costs. Answer: Both GAAP and IFRS treat the bond issue costs as a cost of borrowing. These costs increase the discount or reduce the premium. As a result, they increase the effective interest rate of the bond issue. Diff: 2 Objective: 14.5 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

10) Sheets, Inc. sold $1,000,000 of bonds at 98 on January 1, 2022. The 4-year, 6% bonds pay interest each year on December 31. Sheets incurred $35,000 in bond issue costs using GAAP. Required: Prepare the journal entries to record the issuance of the bonds and the first annual interest payment. Answer: Account Debit Credit January 1, 2022 Cash 945,000 Discount on Bonds Payable 55,000 Bonds Payable 1,000,000 To calculate interest expense, the effective interest rate must be computed using the following inputs: N=4, PV=945,000, PMT=-60000, FV=-1000000, yielding 7.65%. The Excel function is =RATE(4,60000,945000,-1000000) = .0765 = 7.65%. December 31, 2022 Interest Expense (7.65% × 945,000) Discount on Bonds Payable Cash

72,293

Diff: 1 Objective: 14.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

12,294 60,000

11) Miller, Inc. sold $1,000,000 of bonds at par on January 1, 2022. The 3-year, 6% bonds pay interest each year on December 31. Miller incurred $40,000 in bond issue costs and records transactions using IFRS. Required: 1. Compute the effective interest rate of the bond issue. 2. Prepare the journal entry to record the bond issuance. Answer: 1. N = 3 PV = 960,000 FV = $1,000,000 PMT = $60,000 Solve for Rate = 7.54% Using Excel, the function used is: =RATE(3,-60000,960000,-1000000) = .0754 = 7.54% 2. Account Debit Credit January 1, 2022 Cash 960,000 Bonds Payable-Carrying Value 960,000 Diff: 3 Objective: 14.5 IFRS/GAAP: IFRS AACSB: Analytical thinking

12) Miller, Inc. sold $2,000,000 of bonds at par on January 1, 2022. The 3-year, 5% bonds pay interest each year on December 31. Miller incurred $50,000 in bond issue costs and records transactions using IFRS. Required: 1. Compute the effective interest rate of the bond issue. 2. Prepare the journal entry to record the bond issuance. Answer: 1. N = 3 PV = 1,950,000 FV = $2,000,000 PMT = $100,000 Solve for Rate = 5.93% Using Excel, the function is: RATE(3,-100000,1950000,-2000000) = .0593 = 5.93% 2. January 1, 2022

Account Cash Bonds Payable-Carrying Value

Debit 1,950,000

Credit 1,950,000

Diff: 3 Objective: 14.5 IFRS/GAAP: IFRS AACSB: Analytical thinking

14.6

Early Retirement of Bonds Payable

1) When a company retires bonds before their due date, it is referred to as debt extinguishment. Answer: TRUE Diff: 1 Objective: 14.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) There is a gain on early retirement of bonds if the retirement price is greater than the net carrying value. Answer: FALSE Diff: 1 Objective: 14.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Before computing the gain or loss on the early extinguishment of bonds payable, the company must amortize any discount or premium up to the retirement date. Answer: TRUE Diff: 1 Objective: 14.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Companies might be motivated to extinguish an existing debt when the stated rate of interest is higher than the current market rate. Answer: TRUE Diff: 1 Objective: 14.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Derecognition of debt occurs when all of the following occur, except when the ________. A) bonds mature B) bonds are revalued to fair market value C) bonds are retired early to take advantage of lower market rates of interest D) bondholders elect to convert the bonds to common stock Answer: B Diff: 1 Objective: 14.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Acme Entertainment had $1,300,000 of 6%, $1,000 par callable bonds outstanding on December 31, 2023, with a carrying value of $1,400,000. Acme decides to call the bonds on January 2, 2024. The call price is 102. Compute the gain or loss on early extinguishment of debt. A) no gain or loss B) loss of $100,000 C) gain of $74,000 D) loss of $26,000 Answer: C Explanation: Bonds are retired at 102% of the par value of $1,300,000, 102% × $1,300,000 = $1,326,000. The carrying value was $1,400,000, so there is a gain of $1,400,000 - $1,326,000 = $74,000 on the early extinguishment of debt. Diff: 3 Objective: 14.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

7) Zambrano Corp. decided to go into the market to repurchase bonds before their due date. The following are the balances of the accounts on the date of the retirement: Bonds Payable Discount on Bonds Payable

$5,000,000 $80,000

If Zambrano pays $4,893,000 to retire the bond, what is the gain or loss on the early extinguishment of the debt? A) $87,000 loss B) $80,000 loss C) $27,000 gain D) No gain or loss is recognized. Answer: C Explanation: Amount paid $4,893,000 — carrying value $4,920,000 ($5,000,000 — $80,000 discount) = $27,000 gain, as amount paid is less than carrying value. Diff: 2 Objective: 14.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

8) Darouich Industries decided to retire an $1,000,000 bond issue before its due date. The bonds were callable by the company at 104. At the same time, the bonds were selling at 103 on the open market. The company was able to buy $500,000 of the bonds at 103 and called the remaining bonds. At that time, there was $125,000 in the Discount on Bonds Payable account. Compute the gain or loss on the retirement of the called bonds. A) $77,500 gain B) $77,500 loss C) $82,500 gain D) $82,500 loss Answer: D Explanation: Amount paid on call $520,000 ($500,000 × 104%) less carrying value $437,500 ($500,000 par value - $62,500) Discount attributable to half the issue) = $82,500 loss. Diff: 2 Objective: 14.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Darouich Industries decided to retire an $6,000,000 bond issue before its due date. The bonds were callable by the company at 105. At the same time, the bonds were selling at 104 on the open market. The company was able to buy $3,000,000 of the bonds at 104 and called the remaining bonds. At that time, there was $750,000 in the Discount on Bonds Payable account. Compute the gain or loss on the retirement of the bonds repurchased in the market at 104. A) $495,000 gain B) $495,000 loss C) $525,000 gain D) $525,000 loss Answer: B Explanation: Amount paid on market $3,120,000 ($3,000,000 × 104%) less carrying value $2,625,000 ($3,000,000 par value - $375,000 Discount attributable to half the issue) = $495,000 loss. Diff: 2 Objective: 14.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) Under what circumstances would an early extinguishment of a bond issue result in a gain or a loss? Answer: A gain occurs in an early extinguishment of bonds when the price paid for the redemption is less than the net carrying value of the bonds. Likewise, a loss occurs when the price paid for the redemption is more than the net carrying value of the bonds. Diff: 1 Objective: 14.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Elmira, Inc. had $20,000,000 of callable bonds outstanding on December 31, 2022. The ten-year bonds were issued on January 1, 2016 for $21,000,000. Elmira can call the bonds at 102 any time after January 1, 2022. At the end of 2022, the Premium on Bonds Payable account had a credit balance of $346,000. Acme decides to call the bonds on January 2, 2023. Required: 1. Compute the gain or loss on early extinguishment of debt. 2. Prepare the journal entry to record the debt extinguishment. Answer: 1. Carrying value of the bonds: Bonds Payable + $20,000,000 Premium on Bonds Payable + $346,000 Net Carrying Value of Bonds $20,346,000 Amount Paid for Bonds $20,400,000 Net Loss on Bond Extinguishment $54,000 2. Date Account January 2, 2023 Bonds Payable Premium on Bonds Payable Loss on Bond Extinguishment Cash

Debit 20,000,000 346,000 54,000

Credit

20,400,000

Diff: 2 Objective: 14.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Abby Entertainment had $1,000,000 of 5%, $1,000 par callable bonds outstanding on December 31, 2023, with a carrying value of $1,100,000. Acme decides to call the bonds on January 2, 2024. The call price is 103. Compute the gain or loss on early extinguishment of debt. Answer: Gain of $70,000. Explanation: Bonds are retired at 103% of the par value of $1,000,000, 103% × $1,000,000 = $1,030,000. The carrying value was $1,100,000, so there is a gain $70,000 on the early extinguishment of the debt ($1,100,000 - $1,030,000 = $70,000 gain.) Diff: 3 Objective: 14.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Zac Corp. decided to go into the market to repurchase bonds before their due date. The following are the balances of the accounts on the date of the retirement: Bonds Payable Discount on Bonds Payable

$4,000,000 $50,000

If Zac Corp. pays $3,900,000 to retire the bond, what is the gain or loss on the early extinguishment of the debt? Answer: $50,000 gain. Explanation: Amount paid $3,900,000 — carrying value $3,950,000 ($4,000,000 — $50,000 discount) = $50,000 gain on early retirement of bonds, as amount paid is less than carrying value. Diff: 2 Objective: 14.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

14.7

Convertible Bonds

1) When convertible bonds are converted to equity, the company records a gain on conversion when the bond carrying value is greater than the par value of the equity. Answer: FALSE Diff: 1 Objective: 14.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Convertible bonds are one type of hybrid security. Answer: TRUE Diff: 1 Objective: 14.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A beneficial conversion option is an option to convert the debt to equity that is considered to be in the money. Answer: TRUE Diff: 1 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) A bond conversion option is "in the money" if the exercise price exceeds the market price of the stock. Answer: FALSE Diff: 1 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) U.S. GAAP always allocates proceeds from issuing convertible bonds between a debt component and an equity component. Answer: FALSE Diff: 1 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) IFRS determines the debt component from issuing convertible bonds as the present value of the bond's future cash flows discounted at the market interest rate at the time of issuance. Answer: TRUE Diff: 1 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) When convertible bonds are converted, the fair value of the equity issued is not taken into consideration. Answer: TRUE Diff: 1 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) When the convertible bonds are issued with a beneficial conversion option, U.S. GAAP typically increases additional paid-in capital and IFRS typically increases other capital reserves. Answer: TRUE Diff: 1 Objective: 14.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Arco, Inc. issued $300,000 of 4%, 10-year convertible bonds at par on July 1, 2022. Each bond has a par value of $1,000. The bonds include the option for bondholders to convert each bond into 50 $1 par value shares of common stock beginning two years after the date of issue. The market price of the stock at the time of issue is $28 per share. What is the correct journal entry for the issue? A) Date Account Debit Credit July 1, 2022 Cash 300,000 Discount on Bonds Payable 120,000 Bonds Payable 300,000 Add. Paid-in Capital—Bene. Conv. Option 120,000 B) Date July 1, 2022

Account

Debit 420,000

Cash Premium on Bonds Payable Bonds Payable

Credit 120,000 300,000

C) Date July 1, 2022

Account

Debit 420,000

Cash Bonds Payable Add. Paid-in Capital—Bene. Conv. Option

Credit 300,000 120,000

D) Date July 1, 2022

Account

Debit 300,000 120,000

Cash Discount on Bonds Payable Bonds Payable

Credit

420,000

Answer: A Explanation: The implied exercise price is the par value of the bond divided by the number of shares to be issued at conversion, $1,000/50 = $20. The value of the option is the difference between the market price and the implied exercise price, $28 - $20 = $8/share. Because the market price exceeds the implied exercise price, the bonds are issued with a beneficial conversion option valued at $8 × 50 shares = $400 × 300 bonds = $120,000. Diff: 2 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Arco, Inc. issued $300,000 of 4%, 10-year convertible bonds at par on July 1, 2022. Each bond has a par value of $1,000. The bonds include the option for bondholders to convert each bond into 50 $1 par value shares of common stock beginning two years after the date of issue. The market price of the stock at the time of issue is $25 per share and the beneficial conversion option is valued at $75,000. On July 2, 2024, when the market price of the stock is $35 and the balance in the Discount account is $66,000, all of the bondholders convert the bonds. What is the proper entry to record the conversion of the bonds? A) Date Account Debit Credit July 2, 2024 Bonds Payable 300,000 Discount on Bonds Payable 75,000 Common Stock, $1 par, 15,000 shares 300,000 Add. Paid-in Capital—Bene. Conv. Option 75,000 B) Date July 2, 2024

Account Bonds Payable Add. Paid-in Capital—Bene. Conv. Option Discount on Bonds Payable Common Stock, $1 par, 15,000 shares Add. Paid-in Capital in Excess of ParCommon

Debit 300,000 75,000

Credit

66,000 15,000 294,000

C) Date July 2, 2024

Account Bonds Payable Beneficial Conversion Option Discount on Bonds Payable Add. Paid-in Capital in Excess of ParCommon

Debit 300,000 60,000

Account Bonds Payable Discount on Bonds Payable Common Stock, $1 par, 15,000 shares Add. Paid-in Capital in Excess of ParCommon

Debit 300,000 66,000

Credit

66,000 294,000

D) Date July 2, 2024

Credit

15,000 351,000

Answer: B Explanation: To record the conversion, Bonds Payable and Additional Paid-in Capital--Beneficial Conversion Option must be debited to close the accounts, and the Discount account will be credited. Common Stock is credited at par value and the Additional Paid-in Capital in Excess of Par-Common account is credited for the balancing value, $300,000 + $75,000 - $66,000 - $15,000 = $60,000. Diff: 3 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) When bondholders decide to exercise their convertible bonds, the company values the common stock at the ________. Assume there is no beneficial conversion option at bond issue. A) market value of the stock B) par value of the stock C) carrying value of the bonds D) par value of the bonds Answer: C Diff: 2 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) A beneficial conversion option for convertible bonds payable is ________. A) a conversion option that is in the money on the issue date B) any conversion option with a bond C) a conversion option that becomes in the money after the issue date D) a conversion option that is eventually profitable to the bondholder Answer: A Diff: 1 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) If a $2,000 bond is issued with a conversion feature that allows the bond to be convertible into 40 shares of common stock, what is the implied exercise price of the shares? A) $0 B) $2,000 C) $50 D) $40 Answer: C Explanation: The implied exercise price is the par value of the bond divided by the number of shares to be issued at conversion, $2,000/40 = $50. Diff: 2 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Mainord Corporation issues $1,800,000 of 10-year, 6% convertible bonds. Each $1,000 bond is convertible into 26 common shares. On the date of the issue, the shares had a par value of $50 per share. How many shares will be issued at conversion? A) 1,800 B) 28 C) 46,800 D) 26 Answer: C Explanation: 1,800 bonds × 26 shares of common stock each = 46,800 shares Diff: 2 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) Mainord Corporation issues $1,700,000 of 10-year, 6% convertible bonds. Each $1,000 bond is convertible into 28 common shares. On the date of the issue, the shares had a par value of $25 per share. The conversion happens two years later. What is the amount that will be credited to common stock from this transaction? A) $1,190,000 B) $47,600 C) $1,700,000 D) $1,000 Answer: A Explanation: 1,700 bonds × 28 shares of common stock each = 47,600 shares 47,600 shares × $25 par = $1,190,000 Diff: 2 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) When bonds issued under GAAP with a beneficial conversion option are converted, the Additional Paid-In Capital—Beneficial Conversion Feature ________. A) remains unchanged B) is recorded as a loss C) is appropriately removed D) is added in full to the paid-in capital in excess of par - common Answer: C Diff: 2 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) When accounting for a convertible bond issue using IFRS, any equity component is ________. A) ignored B) the present value of the future cash flows C) measured the same as GAAP D) the selling price minus the debt component Answer: D Diff: 1 Objective: 14.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

18) The debt component of convertible bonds issued using IFRS is the ________. A) present value of the future cash flows of the bonds at the market interest rate B) present value of the future cash flows of the bonds at the stated interest rate C) market value of similar bonds without a conversion feature D) same as the calculation for GAAP Answer: A Diff: 2 Objective: 14.7 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

19) Describe the difference between the valuation of convertible bonds at issue using GAAP and IFRS. Answer: Using U.S. GAAP, convertible bonds without a beneficial conversion option ignore the conversion feature. Convertible bonds with a beneficial conversion option separate the value of the bonds from the beneficial conversion feature. GAAP values the beneficial conversion feature as the excess of the market price of the stock at issue minus the implied exercise price of the stock in the beneficial conversion feature. The positive difference is credited to Additional Paid-in Capital, Beneficial Conversion Option and the bond's effective interest rate is recalculated. Using IFRS, the value of the debt and conversion feature are bifurcated. The bonds are valued at the present value of the future cash flows of the bonds at the market rate of interest. The issue price of the convertible bonds minus the debt component is the value of the conversion feature and is credited to Other Capital Reserves. Diff: 2 Objective: 14.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) On January 2, 2021, Zamarano, Inc. issued 5,000 10-year, 6%, $1,000 bonds at par. Interest is paid each December 31. Each bond is convertible into 25 shares of Zamarano $2 Par Value common stock after two years. The market value of the stock on the date of the issue was $45. On January 2, 2025, when the carrying value of the bonds was $4,570,301, all of the bondholders converted the bonds to stock. Zamarano reports under GAAP. Required: 1. Prepare the journal entry to record the issuance of the bonds. 2. Recompute the interest rate of the bond issue. 3. Record the first interest payment. 4. Record the conversion of the bonds. Answer: 1. Bond Issue Date Account Debit January 2, 2021 Cash 5,000,000 Discount on Bonds Payable 625,000 Bonds Payable Add. Paid-in Capital—Bene. Conv. Option

Credit

5,000,000 625,000

The implied exercise price is the par value of the bond divided by the number of shares to be issued at conversion, $1,000/25 = $40. The value of the option is the difference between the market price and the implied exercise price, $45 - $40 = $5/share. Because the market price exceeds the implied exercise price, the bonds are issued with a beneficial conversion option valued at $5 × 25 shares = $125 × 5,000 bonds = $625,000.

2. Recompute the interest rate for the bonds. N = 10 PV = $4,375,000 PMT = $300,000 FV = $5,000,000 Solve for I/Y = 7.858% Using Excel, =RATE(10,-300000,4375000,-5000000) = .0785 = 7.85% Amortization table: Interest Payment Date Cash Interest 31-Dec-2021 31-Dec-2022 31-Dec-2023 31-Dec-2024

$300,000 $300,000 $300,000 $300,000

Interest Expense

Discount Amortization

$343,43 $346,847 $350,525 $354,491

$43,438 $46,847 $50,525 $54,491

3. Interest Payment Date Account December 31, 2021 Interest Expense Discount on Bonds Payable Cash 4. Bond Conversion Date Account January 2, 2025 Bonds Payable Add. Paid-in Capital—Bene. Conv. Option Discount on Bonds Payable Common Stock Additional Paid-in-Capital in Excess of Par—Common

Bond Carrying Value $4,375,000 $4,418,438 $4,465,285 $4,515,810 $4,570,301

Debit 343,438

Credit 43,438 300,000

Debit 5,000,000

Credit

625,000

Diff: 3 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

429,699 250,000 4,945,301

21) On January 2, 2021, Zamarano, Inc. issued 5,000 10-year, 6%, $1,000 bonds for $5,500,000. Interest is paid each December 31. The market rate of interest for non-convertible bonds is 5%. Each bond is convertible into 25 shares of Zamarano $2 Par Value common stock after two years. The market value of the stock on the date of the issue was $45. On January 2, 2025, when the carrying value of the bonds was $5,253,785, all of the bondholders converted the bonds to stock. Zamarano reports under IFRS. Required: 1. Compute the present value of the bond issue. 2. Prepare the journal entry to record the issuance of the bonds. 3. Record the conversion of the bonds. Answer: 1. Compute the present value of the Bonds N = 10 I/Y = 5% PMT = $300,000 FV = $5,000,000 Solve for PV = $5,386,087 Using Excel, =PV(.05,10,-300000,-5000000) = 5,386,087 2. Bond Issue Date January 2, 2021 Cash

Account

Debit 5,500,000

Bonds Payable Other Capital Reserves

Credit 5,386,087 113,913

3. Bond Conversion Date Account January 2, 2025 Bonds Payable Other Capital Reserves Share Capital-Par Value Share Premium

Debit 5,253,785 113,913

Credit

250,000 5,117,698

Diff: 3 Objective: 14.7 IFRS/GAAP: IFRS AACSB: Analytical thinking

22) If a $10,000 bond is issued with a conversion feature that allows the bond to be convertible into 250 shares of common stock, what is the implied exercise price of the shares? Answer: $40 per share Explanation: The implied exercise price is the par value of the bond divided by the number of shares to be issued at conversion, $10,000/250 shares = $40. Diff: 2 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Mason Corporation issues $10,000 of 10-year, 6% convertible bonds. Each $100 bond is convertible into 10 common shares with $5 par value. Mason received $12,000 for the bonds when issued. Two year later, the bonds were converted to common stock when the carrying value was $11,000. 1. What is the journal entry for the issuance of the bonds? 2. What is the journal entry for the conversion? Answer: 1. Cash 12,000 Bonds Payable 10,000 Premium on Bonds Payable 2,000 2. Bonds Payable Premium on Bonds Payable Common Stock – Par Value ($100 × 10 × $5 par) Additional Paid-in-Capital in Excess of Par – Common

10,000 1,000 5,000 6,000

Diff: 3 Objective: 14.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

14.8

Bonds with Stock Warrants

1) Nondetachable stock warrants issued with bonds payable may be sold separately in the capital markets. Answer: FALSE Diff: 1 Objective: 14.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) When bonds are sold with nondetachable stock warrants, the issuing company does not recognize the value of the stock warrants. Answer: TRUE Diff: 1 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When allocating proceeds from the issuance of bonds with stock warrants, U.S. GAAP allocates the proceeds between the debt and equity components using the proportional method when detachable stock warrants have a determinable market value. Answer: TRUE Diff: 1 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The incremental method allocates proceeds from the issuance of bonds with detachable warrants between debt and equity based on the relative fair values of the bonds and warrants. Answer: FALSE Diff: 1 Objective: 14.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) When exercising detachable warrants issued with bonds, the firm removes the Additional Paid-in Capital—Stock Warrants account, debits Cash, credits Common Stock for the par value, and credits the remainder to Additional Paid-in Capital in Excess of Par. Answer: TRUE Diff: 1 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) IFRS does not separate the debt and equity components for bonds issued with detachable warrants. Answer: FALSE Diff: 1 Objective: 14.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

7) Nondetachable stock warrants issued with bonds are, in essence, convertible bonds. Answer: TRUE Diff: 2 Objective: 14.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Jackson Mechanics issues $9,000,000 of bonds with nondetachable stock warrants. For the investors, this means that the bondholders ________. A) will own both the bonds and the stock B) will own either the bonds or the stock C) can sell the bonds and keep the stock warrants D) can sell the stock warrants and keep the bonds Answer: B Diff: 2 Objective: 14.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Ripa, Inc. issued $5,000,000 of bonds at par. The bonds contained nondetachable stock warrants. Similar bonds without the warrants were selling at 99. By what amount will Additional Paid-in Capital— Stock Warrants be credited? A) $0 B) $200,000 C) $4,700,000 D) $100,000 Answer: A Diff: 1 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Barker Industries issued 3,000 $1,000 bonds at 104. Each bond contains 20 detachable stock warrants that allow the bondholder to purchase a share of Barker's common stock for $50. Immediately after the issue, the warrants were selling for $4 each and the bonds without the warrants were selling for $985. How much will be credited to Additional Paid-in Capital—Stock Warrants? (Round intermediate calculations to four decimal places and your final answer to the nearest dollar.) Use the proportional method. A) $0 B) $120,000 C) $234,365 D) $240,000 Answer: C Explanation: The proceeds from the sale of the bonds is 104% × $3,000,000 = $3,120,000. The market value of the bonds without the warrants is $985 × 3,000 bonds = $2,955,000 and the market value of the warrants is 3,000 bonds × 20 warrants each × $4 = $240,000. The total of the market values is $2,955,000 + $240,000 = $3,195,000. Warrants represent $240,000/$3,195,000 = 7.5117% of the total value, so 7.5117% of the $3,120,000 = $234,365. Diff: 2 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) Barker Industries issued 5,000 $1,000 bonds at 103. Each bond contains 20 detachable stock warrants that allow the bondholder to purchase a share of Barker's common stock for $50. Immediately after the issue, the warrants were selling for $4 each and the bonds without the warrants were selling for $988. What will be the carrying value of Bonds Payable on the issue date? (Round intermediate calculations to four decimal places and your final answer to the nearest dollar.) A) $4,764,234 B) $5,201,236 C) $4,940,000 D) $5,150,000 Answer: A Explanation: The proceeds from the sale of the bonds is 103% × $5,000,000 = $5,150,000. The market value of the bonds without the warrants is $988 × 5,000 bonds = $4,940,000 and the market value of the warrants is 5,000 bonds × 20 warrants each × $4 = $400,000. The total of the market values is $4,940,000 + $400,000 = $5,340,000. Bonds represent $4,940,000/$5,340,000 = 92.5094% of the total value, so 92.5094% of the $5,150,000 = $4,764,234. Diff: 2 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Neil Corporation issued 5,000 $1,000 bonds at 103. Each bond contains 15 detachable stock warrants that allow the bondholder to purchase a share of Neil's common stock for $50. Immediately after the issue, the bonds without the warrants were selling for $1,009. The stock warrants had no readily determinable value. How much will be credited to Additional Paid-in Capital—Stock Warrants? A) $0 B) $5,045,000 C) $45,000 D) $105,000 Answer: D Explanation: Because the warrants have no readily ascertainable value, Additional Paid-in Capital— Stock Warrants is credited for the difference between the issue price of 5,000 × $1,000 × 103% = $5,150,000 and the market value of the bonds without the warrants of 5,000 × $1,009 = $5,045,000. $5,150,000 $5,045,000 = $105,000 allocated to Additional Paid-in Capital—Stock Warrants. Diff: 2 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Neil Corporation issued 2,000 $1,000 bonds at 103. Each bond contains 15 detachable stock warrants that allow the bondholder to purchase a share of Neil's common stock for $50. Immediately after the issue, the bonds without the warrants were selling for $1,003. The stock warrants had no readily determinable value. How much will be credited to Bonds Payable? A) $0 B) $2,006,000 C) 2,054,000 D) 2,000,000 Answer: D Explanation: Bonds Payable and Premium on Bonds Payable will be credited for the market value of the bonds without the warrants of 2,000 × $1,003 = $2,006,000. Bonds Payable are always recorded at face value = 2,000 × $1,000 = $2,000,000. Diff: 2 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) On July 1, 2023, Madrid Plastics issued bonds that included 20 detachable stock warrants for each bond. The warrants were appropriately valued at $4 each at the time the bonds were issued. Each warrant allows the warrant holder to purchase a share of $5 par common stock for $32 per share. A holder of 868 warrants decided to exercise all warrants and purchased 868 shares of stock when the market price of the shares was $41. What is the proper journal entry for Madrid to record this transaction? A) Date Account Debit Credit July 1, 2023 Cash 27,776 Additional Paid-in Capital—Stock Warrants 3,472 Common Stock 4,340 Additional Paid-in Capital in Excess of Par–Common 26,908 B) Date July 1, 2023

Account

Debit 27,776

Cash

Stock

Common Stock Paid-in-Capital—Common

Credit 4,340 23,436

C) Date July 1, 2023

Account

Debit 27,776 3,472

Cash Paid-in Capital—Stock Warrants Common Stock Paid-in-Capital—Common Stock

Credit

27,776 3,472

D) Date July 1, 2023

Account

Debit 27,776 3,472

Cash Paid-in Capital—Stock Warrants Common Stock

Credit

31,248

Answer: A Explanation: Cash = 868 × $32 = 27,776; APIC-Stock Warrants = 868 × $4 = 3,472; Common Stock 868 × $5 = 4,340; APIC in excess of par = plug Diff: 2 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) Distinguish between convertible bonds and bonds issued with detachable stock warrants. Answer: Convertible bonds restrict the ownership of the security to either the bonds or the common stock but require no additional cash if the bondholder decides to convert the bonds to stock. Bonds issued with detachable stock warrants allow the owner of the bonds to maintain ownership of both the bonds and the warrants. The owner can sell either of the securities and keep the other. If the owner keeps the stock warrants, they can exercise them and purchase common stock at a potentially bargain purchase price. Future cash is required to own the common stock. Diff: 1 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) On January 2, 2022, Rushmore, Inc. issued 8,000 bonds at $1,080 each. Each bond contains 40 stock warrants, each of which gives the owner the right to purchase one share of Rushmore $10 par value common stock at $50. The current selling price of common stock is $40 per share. Rushmore bonds without stock warrants are currently selling for $1,025. Required: 1. Prepare the journal entry to record the sale of the bonds if the warrants are nondetachable. 2. Prepare the journal entry to record the sale of the bonds if the warrants are detachable using the incremental method. 3. Prepare the journal entry to record the exercise of all detachable warrants on October 5, 2024, when the market price of the stock was $60, using the incremental method. Answer: 1. Date Account Debit Credit January 2, 2022 Cash 8,640,000 Bonds Payable 8,000,000 Premium on Bonds Payable 640,000 2. Date January 2, 2022 Cash

Account

Debit 8,640,000

Bonds Payable Premium on Bonds Payable Additional Paid-in Capital—Stock Warrants

Credit 8,000,000 200,000 440,000

Calculation: Current market price of bonds without warrants = $1,025/bond × 8,000 bonds = $8,200,000, resulting in credit to Bonds Payable of par value of $8,000,000 and remainder of market value to Premium. Difference between market value without warrants and sales price is attributed to warrants. 3. Date Account October 5, 2024 Cash Additional Paid-in Capital—Stock Warrants Common Stock Additional Paid-in Capital in Excess of Par–Common

Debit 16,000,000

Credit

440,000

Diff: 3 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

3,200,000 13,240,000

17) On January 2, 2022, Winston, Inc. issued 10,000 $1,000 par bonds at $1,055 each. Each bond contains 25 stock warrants, each of which gives the owner the right to purchase one share of Winston's $2 par value common stock at $35. The current selling price of common stock is $25 per share. Winston bonds without stock warrants are currently selling for $1,035. Required: 1. Prepare the journal entry to record the sale of the bonds if the warrants are nondetachable. 2. Prepare the journal entry to record the sale of the bonds if the warrants are detachable using the incremental method. 3. Prepare the journal entry to record the exercise of all detachable warrants on May 16, 2025, when the market price of the stock was $52, using the incremental method. 4. What is the market value of the new stock? Answer: 1. Date Account Debit Credit January 2, 2022 Cash 10,550,000 Bonds Payable 10,000,000 Premium on Bonds Payable 550,000 2. Date January 2, 2022 Cash

Account

Debit 10,550,000

Bonds Payable Premium on Bonds Payable Additional Paid-in Capital—Stock Warrants

Credit 10,000,000 350,000 200,000

Calculation: Current market price without warrants = $1,035/bond × 10,000 bonds = $10,350,000, resulting in credit to Bonds Payable of par value of $10,000,000 and remainder of market value to Premium. Difference between market value without warrants and sales price is attributed to warrants. 3. Date May 16, 2025

Account Cash Additional Paid-in Capital—Stock Warrants Common Stock Additional Paid-in-Capital in Excess of Par–Common

Debit 8,750,000

Credit

200,000

4. 250,000 shares × $52 = $13,000,000 Diff: 2 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

500,000 8,450,000

18) On January 2, 2022, Weston, Inc. issued 5,000 bonds at $1,060 each. Each bond contains 20 detachable stock warrants, each of which gives the owner the right to purchase one share of Weston $5 par value common stock at $40. The current selling price of common stock is $30 per share. Weston bonds without stock warrants are currently selling for $1,025 and it has additional warrants on the market selling for $20. Required: 1. Prepare the journal entry to record the sale of the bonds using the proportional method. Round percentages to four decimal places. 2. Prepare the journal entry to record the exercise of all warrants on October 8, 2023, when the market price of the stock was $50. Answer: 1. Date Account Debit Credit January 2, 2022 Cash 5,300,000 Discount on Bonds Payable 1,187,721 Bonds Payable 5,000,000 Additional Paid-in Capital–Stock Warrants 1,487,721 (Bonds value $5,125,000/$7,125,000 = 71.9298% of Total Price. Stock warrants value $2,000,000/$7,125,000 = 28.0702% of Total Price.) Bonds: 0.719298 × $5,300,000 = $3,812,279; Discount = $5,000,000 — $3,812,279 = $1,187,721 Warrants: $5,300,000 — $3,812,279 = $1,487,721 2. Date Account October 8, 2023 Cash ($40 × 5,000 × 20) Paid-in Capital—Stock Warrants Common Stock Additional Paid-in Capital in Excess of Par–Common

Debit 4,000,000 1,487,721

Diff: 3 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

Credit

500,000 4,987,721

19) On January 2, 2021, Edmond, Inc. issued 8,000 bonds at $1,040 each. Each bond contains 20 detachable stock warrants, each of which gives the owner the right to purchase one share of Edmond's $1 par value common stock at $35. The current selling price of common stock is $25 per share. Edmond's bonds without stock warrants are currently selling for $1,025 and it has additional warrants on the market selling for $15. Required: 1. Prepare the journal entry to record the sale of the bonds using the proportional method. 2. Prepare the journal entry to record the exercise of all warrants on March 19, 2023, when the market price of the stock was $50. Answer: 1. Date Account Debit Credit January 2, 2021 Cash 8,320,000 Discount on Bonds Payable 1,563,773 Bonds Payable 8,000,000 Additional Paid-in Capital–Stock Warrants 1,883,773 (Bonds value 77.3585% of Total Price. Stock warrants value 22.6415% of Total Price.) 2. Date Account Debit Credit March 19, 2023 Cash 5,600,000 Additional Paid-in Capital–Stock Warrants 1,883,773 Common Stock (8,000 × 20 × $1) 160,000 Additional Paid-in Capital in Excess of Par–Common 7,323,773 Diff: 3 Objective: 14.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

14.9

Reclassification of Financing Liabilities

1) For U. S. GAAP reporters, when a long-term obligation becomes payable within the next year, it should be reclassified as a current liability if it will be paid with current assets or the creation of another current liability. Answer: TRUE Diff: 1 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) A company can reclassify long-term debt as short-term but it cannot reclassify short-term debt as longterm. Answer: FALSE Diff: 1 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) For U.S. GAAP reporters, a company can reclassify short-term debt as long-term debt if it intends to refinance or replace the debt with long-term debt or equity securities, and can demonstrate the ability to consummate the refinancing. Answer: TRUE Diff: 1 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Callable obligations are liabilities for which the creditor can require immediate payment when specified conditions exist. Answer: TRUE Diff: 1 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Debtors in technical default may be required to reclassify long-term debt as short-term debt unless the creditor waives or loses the right to demand payment. Answer: TRUE Diff: 1 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Under U.S. GAAP, debtors in technical default may continue to classify their debt as long-term if the creditor grants a waiver before the balance sheet date. Answer: TRUE Diff: 1 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Under IFRS, debtors in technical default may continue to classify their debt as long-term if the creditor grants a waiver any time before the financial statements are issued. Answer: FALSE Diff: 1 Objective: 14.9 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) When a company has current debt that can be reclassified as long-term, it should do so because ________. A) the debt will no longer require the use of current assets or the creation of another current liability B) short-term debt improves the financial position of the company C) it improves the credit rating of the company D) it is a more conservative approach to the balance sheet Answer: A Diff: 1 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Barauch Corporation issued $10,000,000 of 10-year bonds on January 1, 2015. The bonds have a bond sinking fund with a balance of $800,000. At December 31,2022, the bonds should be classified as ________. A) Short-term $9,200,000; Long-term $800,000 B) Short-term $10,000,000 C) Long-term $10,000,000 D) Short-term $800,000; Long-term $9,200,000 Answer: A Diff: 2 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) A primary benefit of reclassification of short-term debt into long-term debt is to improve ________. A) solvency ratios B) liquidity ratios C) cash flow D) profitability Answer: B Diff: 1 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) IFRS rules for reclassification of short-term debt are similar to U.S. GAAP except the short-term debt refinancing must occur ________. A) by the balance sheet date B) before the end of the year-end C) by the balance sheet date unless the company has an existing arrangement D) at any time before the financial statements are issued Answer: C Diff: 1 Objective: 14.9 IFRS/GAAP: IFRS AACSB: Application of knowledge

12) For U.S. GAAP reporters, short-term debt can be reclassified as long-term when the company intends to refinance on a long-term basis and the company can ________. A) pay-off the note by the day the financial statements are completed B) set up a long-term financing agreement after the financial statements are issued C) extend the debt term after the release of the financial statements D) demonstrate the ability to consummate the refinancing Answer: D Diff: 1 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Martin, Inc. is preparing its financial statements for December 31, 2022. Martin has a $3,600,000 shortterm note that is due in June, 2023. Martin has an existing long-term line of credit of $1,000,000, which will be used to remove part of the short-term debt. Due to the existing long-term line of credit, the company will report how much short-term liability? A) $0 B) $2,600,000 C) $3,600,000 D) $1,000,000 Answer: B Explanation: $3,600,000 - $1,000,000 = $2,600,000 Diff: 2 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) How do U.S. GAAP and IFRS differ in the treatment of short-term debt that is expected to be refinanced? Answer: When short-term debt is expected to be refinanced before year-end, both U.S. GAAP and IFRS classify the debt as long-term. However, if the expected refinancing date is after the financial statements date but before the financial statements are issued, IFRS continues to classify the debt as short-term while U.S. GAAP will classify the debt as long-term. It is notable that IFRS does not allow a future event to change the reporting of a contractual obligation that a company had at a point in time. Diff: 2 Objective: 14.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) When might a debtor in technical default be required to reclassify long-term debt as short-term? Answer: Reclassification is required when: 1. The debtor violated a provision of the debt agreement, making the debt callable at the balance sheet date, or 2. The debtor violated a debt agreement that, if not addressed within a specified grace period, will make the obligation callable. Diff: 2 Objective: 14.9 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Mason, Inc. is preparing its financial statements for December 31, 2022. Martin has a $3,200,000 shortterm note that is due in June 2023. Martin has an existing long-term line of credit of $1,100,000, which will be used to remove part of the short-term debt. Due to the existing long-term line of credit, the company will report how much short-term liability? Answer: $2,100,000 Explanation: $3,200,000 - $1,100,000 = $2,100,000 Diff: 2 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

14.10

The Fair Value Option to Value Liabilities

1) Under the fair value option, companies can elect to value most types of financial assets and obligations at fair value even if they are not required to do so. Answer: TRUE Diff: 1 Objective: 14.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) If a company elects the fair value option for some liabilities, it must use the fair value option for all liabilities. Answer: FALSE Diff: 1 Objective: 14.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Companies use a fair value adjustment account to adjust the related liability account when remeasuring the liability to its fair value. Answer: TRUE Diff: 1 Objective: 14.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) IFRS does not permit the use of the fair value option. Answer: FALSE Diff: 1 Objective: 14.10 IFRS/GAAP: IFRS AACSB: Application of knowledge

5) The fair value option for reporting some liabilities is normally chosen ________. A) at the time of borrowing and is irrevocable B) on the first balance sheet and is revocable C) at the end of each year and is revocable D) at the time of borrowing and is revocable Answer: A Diff: 1 Objective: 14.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) The fair value option for liabilities reports unrealized gains and losses that are not related to changes in instrument-specific credit risk ________. A) as other comprehensive income B) directly to retained earnings C) in net income D) as long-term capital gains Answer: C Diff: 1 Objective: 14.10 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Muir, Ltd. measures its trading securities at fair value. It has liabilities that it also measures using the fair value option. Muir has bonds outstanding (originally sold for $4,080,000) in the face amount of $3,400,000 with a current bond premium of $578,000. The bonds were selling at 101 on the market at its year end. If the company elects the fair value option for these bonds, at what value should it report for these bonds on its balance sheet at year end? A) $3,434,000 B) $3,740,000 C) $3,978,000 D) $4,080,000 Answer: A Explanation: Bonds will be reported at fair value of 101% × $3,400,000 = $3,434,000. Diff: 2 Objective: 14.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Parrish Industries has bonds outstanding (originally sold for $4,340,000) in the face amount of $4,900,000 with a current bond discount of $200,000. The bonds were selling at 104 on the market at its year end. If Parrish elects the fair value option for these bonds, at what value should it report these bonds on its balance sheet at year end? A) $4,900,000 B) $5,100,000 C) $4,700,000 D) $5,096,000 Answer: D Explanation: Bonds are reported at fair value of 104% × $4,900,000 = $5,096,000 Diff: 2 Objective: 14.10 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Muir, Ltd. measures its trading securities at fair value. It has liabilities that it also measures using the fair value option. Muir has bonds outstanding (originally sold for $2,400,000) in the amount of $2,000,000 with a current bond premium of $352,000. The bonds were selling at 101 on the market on December 31. If its Fair Value Adjustment on Bonds Payable account currently contains a debit amount of $440,000, what adjustment is necessary to report the value of the bonds under the fair value option. A) Date December 31

Account Unrealized Loss on Bonds Payable Fair Value Adjustment on Bonds Payable

Debit 88,000

Account Unrealized Loss on Bonds Payable Fair Value Adjustment on Bonds Payable

Debit 108,000

Account Fair Value Adjustment on Bonds Payable Unrealized Gain on Bonds Payable

Debit

Account Fair Value Adjustment on Bonds Payable Unrealized Gain on Bonds Payable

Debit

Credit

88,000

B) Date December 31

Credit

108,000

C) Date December 31

Credit

108,000 108,000

D) Date December 31

Credit

88,000 88,000

Answer: B Explanation: Current carrying value = $2,352,000; Current fair value = $2,000,000 × 1.01 = $2,020,000; Fair value adjustment needed $2,352,000 - $2,020,000 = $332,000 Debit (Debit because writing down liability with credit balance). Fair value adjustment has $440,000 Debit so it is too high. We only need $332,000. So we must credit Fair value adjustment for $108,000. The debit is to Unrealized Loss on Bonds Payable (Net Income) because the change is due to interest rate changes that affect net income. Diff: 3 Objective: 14.10 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) Parrish Industries has bonds outstanding (originally sold for $5,400,000) in the face amount of $6,000,000 with a current bond discount of $100,000. The bonds were selling at 104 on the market at its year end. What should be the balance of the Fair Value Adjustment on Bonds Payable? A) $340,000 debit balance B) $100,000 debit balance C) $100,000 credit balance D) $340,000 credit balance Answer: D Explanation: Carrying value of bonds $5,900,000 — market value $6,240,000 (104% × $6,000,000) = $340,000. Fair value adjustment has a credit balance because it increases bonds (which have a credit balance) to market value. Diff: 2 Objective: 14.10 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) Mason, Ltd. measures its trading securities at fair value. It has liabilities that it also measures using the fair value option. Mason has bonds outstanding (originally sold for $4,620,000) in the face amount of $4,000,000 with a current bond premium of $612,000. At year end, the bonds were selling at 102. If the company elects the fair value option for these bonds, at what value should it report for these bonds on its balance sheet at year end? Answer: $4,080,000 Explanation: Bonds will be reported at fair value of 102% × $4,000,000 = $4,080,000. Diff: 2 Objective: 14.10 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Pander Industries has bonds outstanding (originally sold for $4,620,000) in the face amount of $5,000,000 with a current bond discount of $200,000. The bonds were selling at 97 on the market at its year end. If the company elects the fair value option for these bonds, at what value should it report these bonds on its balance sheet at year end? Answer: $4,850,000 Explanation: Bonds are reported at fair value of 97% × $5,000,000 = $4,850,000 Diff: 2 Objective: 14.10 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Mason, Ltd. measures its trading securities at fair value. It has liabilities that it also measures using the fair value option. Mason has bonds outstanding (originally sold for $2,500,000) in the amount of $2,000,000 with a current bond premium of $449,000. The bonds were selling at 102 on the market on December 31. If its Fair Value Adjustment on Bonds Payable account currently contains a debit amount of $420,000, what adjustment is necessary to report the value of the bonds under the fair value option. Answer: Date Account Debit Credit December 31 Unrealized Loss on Bonds Payable 11,000 Fair Value Adjustment on Bonds Payable 11,000 Explanation: Current carrying value = $2,449,000 ($2,000,000 + $449,000) Current fair value = $2,000,000 × 1.02 = $2,040,000 Fair value adjustment needed $2,449,000 - $2,040,000 = $409,000 Debit (Debit because writing down liability with credit balance). Fair value adjustment has $420,000 Debit so it is too high. We only need $409,000. So we must credit Fair value adjustment for $11,000 ($420,000 - $409,000). The debit is to Unrealized Loss on Bonds Payable (Net Income) because the change is due to interest rate changes that affect net income. Diff: 3 Objective: 14.10 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Parker Industries has bonds outstanding (originally sold for $5,400,000) in the face amount of $5,700,000 with a current bond discount of $200,000. The bonds were selling at 102 on the market at its year end. What should be the balance of the Fair Value Adjustment on Bonds Payable? Answer: $314,000 credit balance Explanation: Carrying value of bonds $5,500,000 ($5,700,000 - $200,000) $5,500,000 - market value $5,814,000 (102% × $5,700,000) = $314,000. Fair value adjustment has a credit balance because it increases bonds (which have a credit balance) to market value. Diff: 2 Objective: 14.10 IFRS/GAAP: GAAP AACSB: Analytical thinking

14.11

Disclosures for Financing Liabilities

1) Companies disclose a detailed listing and description of each significant debt issue, including the names of significant creditors. Answer: FALSE Diff: 1 Objective: 14.11 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) A sinking fund is cash or other assets held in a separate bank account used to retire debt at maturity. Answer: TRUE Diff: 1 Objective: 14.11 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Separate disclosures are required for the debt and equity components of hybrid securities that are separated on the balance sheet. Answer: TRUE Diff: 1 Objective: 14.11 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) The assessment of business risk includes analyzing a company's risk tolerance and capital structure. Answer: FALSE Diff: 1 Objective: 14.11 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Companies using fair value disclosures must disclose the valuation methods used and assumptions made to arrive at the fair value of the liabilities. Answer: TRUE Diff: 1 Objective: 14.11 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) When using the fair value valuation for liabilities, a company must disclose both the issue price and the fair value of the debt. Answer: FALSE Diff: 1 Objective: 14.11 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Credit ratings have a direct impact on the interest rate demanded by lenders because it is a measure of risk to the lender. Answer: TRUE Diff: 1 Objective: 14.11 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

8) Financing liabilities require disclosure for all of the following except ________. A) detailed disclosures of creditors B) the types and outstanding balances of debt C) interest rates and payment terms D) maturity dates and sinking fund disclosures Answer: A Diff: 1 Objective: 14.11 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Disclosures for convertible debt include ________. A) information about detachable stock warrants B) the detailed information about the conversion terms C) fair value disclosures even if fair value is not used for valuation D) only cash interest paid and effective interest amounts Answer: B Diff: 2 Objective: 14.11 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14.12

Appendix A: The Straight-Line Method of Amortization

1) The straight-line method of amortization can be used when the results are not significantly different from the effective interest method. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Analytical thinking

2) The straight-line method of amortization is theoretically superior to the effective interest method as it allocates the discount equally over the life of the bond. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Analytical thinking

3) Under IFRS, the straight-line method of amortization can be used when the results are not significantly different from the effective interest method. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: IFRS AACSB: Analytical thinking

4) When is the straight-line method of amortization acceptable under U.S. GAAP? A) when the results are not significantly different from the effective interest method B) when the straight-line method produces a higher level of net income C) when the effective interest method produces a higher level of net income D) when the company uses straight-line depreciation on long-term assets Answer: A Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Analytical thinking

5) Gordon Corporation issued $200,000 par value, 4%, 5-year bonds on January 1, 2023. The bonds mature on December 31, 2027 and pay semi-annual interest. The market rate on the date of issue is 6%. Gordon has elected to use the straight-line method for discount amortization. What is the bond issue price for the Gordon bonds? A) $200,000 B) $182,940 C) $217,965 D) $170,560 Answer: B Explanation: The issue price is calculated as the present value of the interest payments and the par value at maturity, discounted at the market rate of interest. As the bonds pay interest semi-annually, the appropriate interest rate is 6%/2 = 3% and the number of periods is 5 years × 2 = 10 periods. Semi-annual interest payments are the par value times the stated rate divided by 2, $200,000 × 4% / 2 = $4,000, and the future value is the par value of $200,000. Using the Excel formula =PV(0.03,10,-4000,-200000), the issue price is $182,940. Diff: 3 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Gordon Corporation issued $800,000 par value, 2%, 5-year bonds on January 1, 2023. The bonds mature on December 31, 2027 and pay semi-annual interest. The market rate on the date of issue is 4%. Gordon has elected to use the straight-line method for discount amortization. What is the discount on bonds payable on the date of issue? A) $75,770 B) $63,861 C) $71,861 D) $129,774 Answer: C Explanation: The issue price is calculated as the present value of the interest payments and the par value at maturity, discounted at the market rate of interest. As the bonds pay interest semi-annually, the appropriate interest rate is 4%/2 = 2% and the number of periods is 5 years × 2 = 10 periods. Semi-annual interest payments are the par value times the stated rate divided by 2, $800,000 × 2% / 2 = $8,000, and the future value is the par value of $800,000. Using the Excel formula =PV(0.02,10,-8000,-800000), the issue price is $728,139. Discount on bonds payable is the difference between the par value and the issue price, $800,000 - $728,139 = $71,861. Diff: 3 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Gordon Corporation issued $500,000 par value, 2%, 5-year bonds on January 1, 2023. The bonds mature on December 31, 2027 and pay semi-annual interest. The market rate on the date of issue is 4%. Assuming that Gordon uses the straight-line method, what amount of discount amortization is recorded on June 30, 2023? A) $4,735.70 B) $3,991.30 C) $8,110.90 D) $4,491.30 Answer: D Explanation: The issue price is calculated as the present value of the interest payments and the par value at maturity, discounted at the market rate of interest. As the bonds pay interest semi-annually, the appropriate interest rate is 4%/2 = 2% and the number of periods is 5 years × 2 = 10 periods. Semi-annual interest payments are the par value times the stated rate divided by 2, $500,000 × 2% / 2 = $5,000, and the future value is the par value of $500,000. Using the Excel formula =PV(0.02,10,-5000,-500000), the issue price is $455,087. Discount on bonds payable is the difference between the par value and the issue price, $500,000 - $455,087 = $44,913. Under the straight-line method, this is allocated equally over the 10 interest payments, $44,913/10 = $4,491.30. Diff: 3 Objective: App A IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Gordon Corporation issued $100,000 par value, 6%, 5-year bonds on January 1, 2023. The bonds mature on December 31, 2027 and pay semi-annual interest on June 30 and December 31. The market rate on the date of issue is 8%. Prepare the journal entries for the issuance of the bond and payment of the first interest payment, assuming that Gordon uses the straight-line method of discount amortization. Answer: The issue price is calculated as the present value of the interest payments and the par value at maturity, discounted at the market rate of interest. As the bonds pay interest semi-annually, the appropriate interest rate is 8%/2 = 4% and the number of periods is 5 years × 2 = 10 periods. Semi-annual interest payments are the par value times the stated rate divided by 2, $100,000 × 6% / 2 = $3,000, and the future value is the par value of $100,000. Using the Excel formula =PV(4%,10,-3000,-100000), the issue price is $91,889. Discount on bonds payable is the difference between the par value and the issue price, $100,000 - $91,889 = $8,111. Date Jan. 1, 2023

Account Cash Discount on Bonds Payable Bonds Payable

Debit 91,889 8,111

Credit

100,000

Under the straight-line method, the discount is allocated equally over the 10 interest payments, $8,111/10 = $811. Date June 30, 2023

Account Interest Expense Discount on Bonds Payable Cash

Debit

Credit 3,811 811 3,000

Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 15 Accounting for Stockholders' Equity 15.1

Overview of Stockholders' Equity

1) Stockholders' equity represents the interest in a corporation held by the investors. Answer: TRUE Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Contributed capital includes amounts earned from the operations of a business. Answer: FALSE Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) U.S. GAAP and IFRS use the same terminology for stockholders' equity components. Answer: FALSE Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Stockholders' equity is also called ________. A) net assets B) book assets C) capital assets D) none of the above Answer: A Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) ________ is a major component/section of stockholders' equity on the balance sheet. A) Common stock B) Preferred stock C) Contributed capital D) Retained earnings Answer: C Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) ________ receive dividend distributions after the company has paid all other providers of capital their return on investment. A) Contributing shareholders B) Common shareholders C) Preferred shareholders D) Primary shareholders Answer: B Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) ________ represents the amounts that common and preferred shareholders contribute in excess of the stated or par value. A) Par value B) Retained earnings C) Accumulated income D) Additional paid-in capital Answer: D Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Caesar Company issued 1600 shares of its $2 par value common stock for $16 per share. They will record ________ in the common stock account at par value and ________ as additional paid-in capital in excess of par-common. A) $3200; $25,600 B) $25,600; $3200 C) $3200; $22,400 D) $22,400; $25,600 Answer: C Explanation: Common stock account is credited for par value 1600 × $2 = $3200. Sale price is 1600 × $16 = $25,600. Difference between sale price and common stock is credited to additional paid-in capital. Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Woods, Inc. issued 150 shares of its $8 par value common stock for $19 per share. They will record ________ in the common stock account at par value and ________ as additional paid-in capital in excess of par-common. A) $1200; $1650 B) $1200; $2850 C) $1650; $1200 D) $2850; $1200 Answer: A Explanation: Common stock account is credited for par value 150 × $8 = $1200. Sale price is 150 × $19 = $2850. Difference between sale price and common stock is credited to additional paid-in capital. Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) C&S Corporation issued 2000 shares of its $7 par value common stock for $12 per share. What amount would they record as additional paid-in capital in excess of par-common? A) $2000 B) $14,000 C) $10,000 D) $24,000 Answer: C Explanation: Common stock account is credited for par value 2000 × $7 = $14,000. Sale price is 2000 × $12 = $24,000. Difference between sale price and common stock is credited to additional paid-in capital. Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) TLR Productions issued 800 shares of its $4 par value common stock for $12 per share. What amount would they record as additional paid-in capital in excess of par-common? A) $800 B) $3200 C) $6400 D) $9600 Answer: C Explanation: Common stock account is credited for par value 800 × $4 = $3200. Sale price is 800 × $12 = $9600. Difference between sale price and common stock is credited to additional paid-in capital. Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Identify whether the stockholders' equity terminology belongs to U.S. GAAP, IFRS, or both. Term Contributed capital Share capital Retained earnings Common stock Answer:

Term Contributed capital Share capital Retained earnings Common stock

GAAP, IFRS, or Both

GAAP, IFRS, or Both GAAP IFRS GAAP GAAP

Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Casper Company issued 2,000 shares of its $10 par value common stock for $12 per share. How much will be recorded in the common stock account at par value? How much is recorded as additional paid-in capital in excess of par-common? Answer: Commons stock account is credited for par value of 2,000 shares × $10 par value = $20,000. The additional paid-in capital in excess of par-common is 2,000 shares × ($12 issue price - $10 par value) = $4,000. Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Baxter, Inc. issued 150 shares of its $8 par value common stock for $10 per share. How much will be recorded in the common stock account at par value? How much is recorded as additional paid-in capital in excess of par-common? Answer: Commons stock account is credited for par value of 150 shares × $8 par value = $1,200. The additional paid-in capital in excess of par-common is 150 shares × ($10 issue price - $8 par value) = $300. Diff: 1 Objective: 15.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

15.2

Accounting for Common Stock

1) A change in stated value per share does not require shareholder approval and filings with the state. Answer: TRUE Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) If a corporation wishes to change the par value per share on its common stock, it must amend its articles of incorporation. Answer: TRUE Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The number of outstanding shares of common stock may be reduced by shares held in the treasury. Answer: TRUE Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) A stock split reduces retained earnings. Answer: FALSE Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The total number of shares that a firm can legally issue are called ________. A) allocated shares B) authorized shares C) outstanding shares D) common shares Answer: B Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Stock issue costs are treated as a(n) ________. A) addition to the common stock account B) reduction of additional paid-in capital C) increase in outstanding shares D) decrease in treasury stock Answer: B Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) When issuing common stock for noncash consideration, how does a company determine the value of the shares issued? A) management judgment B) the fair value of the stock issued C) the fair value of the consideration received D) all of the above Answer: D Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) ________ is the corporation's own shares repurchased by the corporation and held for some future use. A) Authorized stock B) Common stock C) Treasury stock D) Preferred stock Answer: C Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Hawks, Inc. has 79,000 shares authorized, 50,000 shares issued, and 13,000 shares of treasury stock. ________ shares are outstanding, and ________ shares are unissued. A) 37,000; 29,000 B) 66,000; 13,000 C) 29,000; 37,000 D) 13,000; 66,000 Answer: A Explanation: Outstanding shares = 50,000 issued – 13,000 treasury stock = 37,000. Unissued shares = 79,000 authorized – 50,000 issued = 29,000. Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Fitzgerald Corporation has 58,000 shares authorized, 41,000 shares issued, and 8000 shares of treasury stock. ________ shares are outstanding, and ________ shares are unissued. A) 50,000; 8000 B) 33,000; 17,000 C) 8000; 50,000 D) 17,000; 33,000 Answer: B Explanation: Outstanding shares = 41,000 issued – 8000 treasury stock = 33,000. Unissued shares = 58,000 authorized – 41,000 issued = 17,000. Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) S & C Company issues 1500 shares of its no-par common stock. The issue price of the stock is $20 per share. What is the journal entry required to record the issuance of the shares? A) Common Stock Addl. Paid-in Capital in Excess of Par—Common B) Cash

1500 1500

1500 Common Stock - no par

1500

C) Cash

30,000 Common Stock - no par Addl. Paid-in Capital in Excess of Par—Common

D) Cash

1500 28,500

30,000 Common Stock—no par

30,000

Answer: D Explanation: Issue price = $20 × 1500 = $30,000 Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) S & C Company issues 1800 shares of common stock with a $2 par value. The issue price of the stock is $15 per share. What is the journal entry required to record the issuance of the shares? A) Cash

3600 Common Stock

3600

B) Cash

27,000 Common Stock—$2 par Addl. Paid-in Capital in Excess of Par—Common

C) Cash

3600 23,400

27,000 Common Stock -$2 par Addl. Paid-in Capital in Excess of Par—Common

D) Cash

1800 25,200

27,000 Common Stock

27,000

Answer: B Explanation: Common Stock is credited for number of shares issued times par value, 1800 × $2 = $3600. Sale price is $15 per share × 1800 shares = $27,000. Difference $27,000 - $3600 = $23,400 is credited to Additional Paid-in Capital in Excess of Par – Common. Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) S & C Company issues 2400 shares of common stock with a $6 par value. The issue price of the stock is $14 per share, and the company paid an underwriter $800 in stock issue costs. What is the journal entry required to record the issuance of the shares? A) Cash

33,600 Common Stock—$6 par Addl. Paid-in Capital in Excess of Par—Common

B) Cash

14,400 19,200

33,600 Common Stock—$6 par Addl. Paid-in Capital in Excess of Par—Common

C) Cash

13,600 20,000

32,800 Common Stock—$6 par Addl. Paid-in Capital in Excess of Par—Common

D) Cash

14,400 18,400

32,000 Common Stock—$6 par Addl. Paid-in Capital in Excess of Par—Common

13,600 18,400

Answer: C Explanation: Common Stock is credited for number of shares issued times par value, 2400 × $6 = $14,400. Sale price is $14 per share × 2400 shares = $33,600, less $800 in stock issue costs, yielding $32,800. Difference $32,800 - $14,400 = $18,400 is credited to Additional Paid-in Capital in Excess of Par – Common. Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Caesar Cruise Lines, Inc. issues 8000 shares of its no-par common stock. The issue price of the stock is $24 per share. What is the journal entry required to record the issuance of the shares? A) Cash

192,000 Common Stock—no par

192,000

B) Cash

8000 Common Stock—no par

8000

C) Cash

192,000 Common Stock—no par Addl. Paid-in Capital in Excess of Par—Common

D) Common Stock Addl. Paid-in Capital in Excess of Par—Common

8000 184,000

8000

Answer: A

Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

8000

15) Caesar Cruise Lines, Inc. issues 6000 shares of common stock with a $1 par value. The issue price of the stock is $20 per share. What is the journal entry required to record the issuance of the shares? A) Cash

120,000 Common Stock—$1 par Addl. Paid-in Capital in Excess of Par—Common

B) Cash

6000 114,000

6000 Common Stock

6000

C) Cash

20,000 Common Stock—$1 par Addl. Paid-in Capital in Excess of Par—Common

D) Cash

6000 14,000

120,000 Common Stock

120,000

Answer: A Explanation: Common Stock is credited for number of shares issued times par value, 6000 × $1 = $6000. Sale price is $20 per share × 6000 shares = $120,000. Difference $120,000 - $6000 = $114,000 is credited to Additional Paid-in Capital in Excess of Par – Common. Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Caesar Cruise Lines, Inc. issues 7000 shares of common stock with a $2 par value. The issue price of the stock is $28 per share, and the company paid an underwriter $500 in stock issue costs. What is the journal entry required to record the issuance of the shares? A) Cash

196,000 Common Stock—$2 par Addl. Paid-in Capital in Excess of Par—Common

B) Cash

14,000 182,000

195,500 Common Stock—$2 par Addl. Paid-in Capital in Excess of Par—Common

C) Cash

13,500 182,000

195,500 Common Stock—$2 par Addl. Paid-in Capital in Excess of Par—Common

D) Cash

2800 192,700

195,500 Common Stock—$2 par Addl. Paid-in Capital in Excess of Par—Common

14,000 181,500

Answer: D Explanation: Common Stock is credited for number of shares issued times par value, 7000 × $2 = $14,000. Sale price is $28 per share × 7000 shares = $196,000, less $500 in stock issue costs, yielding $195,500. Difference $195,500 - $14,000 = $181,500 is credited to Additional Paid-in Capital in Excess of Par – Common. Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Woods, Inc. issues common stock in exchange for legal services received. The common stock has a fair value of $9000 and a par value of $600. What is the journal entry required to record this transaction? A) Cash

9000 Common Stock Addl. Paid-in Capital in Excess of Par—Common

B) Legal Fees Expense Common Stock Addl. Paid-in Capital in Excess of Par—Common C) Cash

600 8400

9000 600 8400

9000 Common Stock Addl. Paid-in Capital in Excess of Par—Common

D) Legal Fees Expense Common Stock Addl. Paid-in Capital in Excess of Par—Common

8400 600

9000 8400 600

Answer: B Explanation: Common Stock is credited for the par value of the stock issued ($600). Legal Fees Expense is debited for the value of services provided, which is approximately equal to the fair value of the stock ($9000). Additional Paid-in Capital in Excess of Par – Common is credited for the difference. Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) TLR Productions hires a consultant for a new project, and issues common stock with a par value of $900 in exchange for consulting services received. The common stock has a fair value of $3300. What is the journal entry required to record this transaction? A) Cash

3300 Consulting Fees

3300

B) Cash

3300 Common Stock Addl. Paid-in Capital in Excess of Par—Common

C) Cash

2400 900

3300 Common Stock Addl. Paid-in Capital in Excess of Par—Common

D) Consulting Fees Expense Common Stock Addl. Paid-in Capital in Excess of Par—Common

900 2400

3300 900 2400

Answer: D Explanation: Common Stock is credited for the par value of the stock issued. Consulting Fees Expense is debited for the value of services provided, which is estimated by the fair value of the stock ($3300). Additional Paid-in Capital in Excess of Par – Common is credited for the difference. Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Danio Fisheries issued 420,000 shares of $4 par value stock. On August 1, Danio Fisheries implements a two-for-one stock split. After the stock split, the total number of shares outstanding is ________ and the total par value is ________. A) 840,000; $1,680,000 B) 210,000; $1,680,000 C) 840,000; $3,360,000 D) 420,000; $3,360,000 Answer: A Explanation: The total number shares outstanding is 2 times the original number of shares, 2 × 420,000 = 840,000. The par value of the shares is divided by 2, $4 / 2 = $2.00. The total par value equals $2.00 × 840,000 = $1,680,000. Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Danio Fisheries issued 320,000 shares of $7 par value stock. The book value of Danio's common stockholders' equity is equal to $60 million. On August 1, Danio Fisheries implements a two-for-one stock split. After the stock split, the par value per share is ________ and the total book value is ________. A) $14.00; $60 million B) $3.50; $120 million C) $7.00; $30 million D) $3.50; $60 million Answer: D Explanation: The total number shares outstanding is 2 times the original number of shares, 2 × 320,000 = 640,000. The par value of the shares is divided by 2, $7 / 2 = $3.50. The total book value is unchanged by the split. Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Why would a company issue a stock split? Answer: The primary reason a company will issue a stock split is that they feel the stock it is trading at too high a price to attract a wide investor base. Companies issue stock to raise capital; therefore, being able to attract more investors is in the best interest of the company. If the price per share is too high, the investor base will be limited. Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

22) Discuss how stock is valued when issued in exchange for noncash consideration. Answer: When common stock is issued in exchange for noncash assets or services, the stock will be recorded using the fair value of the stock, or the fair value of the asset or service, whichever is most objectively ascertainable. When it is more challenging to come up with a fair value, management will need to exercise judgment when determining an appropriate fair value amount. Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

23) Leo & Sons, Inc. is authorized to issue 50,000 shares of $2 par value common stock. Prepare the journal entries for the following transactions (omit explanations): a. Issued 15,000 shares at $30 per share. b. Issued 250 shares in exchange for legal services valued at $9,000. c. Issued 5,000 shares at $40 per share, paying an underwriter $500 in stock issuance costs. Answer: a. Cash 450,000 Common Stock—$2 par 30,000 Addl. Paid-in Capital in Excess of Par— Common 420,000 b. Legal Fees Expense Common Stock—$2 par Addl. Paid-in Capital in Excess of Par— Common c. Cash

Common Stock—$2 par Addl. Paid-in Capital in Excess of Par—

9,000

500 8,500

199,500

Common

10,000 189,500

Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

24) TNT Corporation is authorized to issue 75,000 shares of $1 par value common stock. Prepare the journal entries for the following transactions (omit explanations): a. Issued 50,000 shares at $25 per share. b. Issued 500 shares in exchange for consulting services; the estimated fair value is $20 per share. c. Issued 7,000 shares at $30 per share, paying an underwriter $800 in stock issuance costs. Answer: a. Cash 1,250,000 Common Stock—$1 par 50,000 Addl. Paid-in Capital in Excess of Par— Common 1,200,000 b. Consulting Fees Expense Common Stock—$1 par Addl. Paid-in Capital in Excess of Par— Common c. Cash Common Stock—$1 par Addl. Paid-in Capital in Excess of Par— Common

10,000

500 9,500

209,200

Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

7,000 202,200

25) Betta Corporation issued 300,000 shares of $2 par value stock. The book value of Betta's common stockholders' equity is equal to $30 million. Betta implements a two-for-one stock split. Complete the following table: Before the After the 2-for-1 split 2-for-1 split Shares outstanding Total par value Par value per share Total book value Book value per share Answer:

Shares outstanding Total par value Par value per share Total book value Book value per share

Before the 2-for-1 split 300,000 $600,000 $2 $30,000,000 $100

After the 2-for-1 split 600,000 $600,000 $1 $30,000,000 $50

Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

26) Charmed, Inc. issued 100,000 shares of $4 par value stock. The book value of Charmed, Inc.'s common stockholders' equity is equal to $25 million. Charmed implements a two-for-one stock split. Complete the following table: Before the After the 2-for-1 split 2-for-1 split Shares outstanding Total par value Par value per share Total book value Book value per share Answer:

Shares outstanding Total par value Par value per share Total book value Book value per share

Before the 2-for-1 split 100,000 $400,000 $4 $25,000,000 $250

After the 2-for-1 split 200,000 $400,000 $2 $25,000,000 $125

Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

27) Harris, Inc. has 80,000 shares authorized, 50,000 shares issued, and 15,000 shares of treasury stock. How many shares are outstanding? How many shares are unissued? Answer: Outstanding shares = 50,000 issued – 15,000 treasury stock = 35,000. Unissued shares = 80,000 authorized – 50,000 issued = 30,000. Diff: 1 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) Danio Fisheries has 30,000 shares issued and outstanding of $6 par value stock. On August 1, Danio Fisheries implements a two-for-one stock split. After the stock split, what is the total number of shares outstanding? After the stock split, what is the par value per share? Answer: The total number shares outstanding is 2 times the original number of shares, 2 × 300,000 = 600,000. The par value per share would be $6 par value before split / 2 = $3 par value per share after split. Diff: 2 Objective: 15.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

15.3

Accounting for Share Repurchase Transactions

1) The two methods of accounting for treasury stock are the cost method and the fair value method. Answer: FALSE Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The par value method is the most popular method for reporting treasury stock transactions. Answer: FALSE Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When treasury shares are retired, the number of shares issued is reduced. Answer: TRUE Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Treasury shares are considered to be ________. A) unauthorized shares B) retired shares C) issued shares D) outstanding shares Answer: C Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) When a company purchases and sells treasury shares for amounts above and below cost, it reports these "gains" and "losses" ________. A) on the income statement B) on the balance sheet C) on the income statement and balance sheet D) only in a footnote Answer: B Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Treasury shares reduce the number of shares ________. A) issued B) authorized C) outstanding D) available Answer: C Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) The most popular method of accounting for treasury stock is the ________ method. A) par value B) cost C) fair value D) A and B are utilized equally Answer: B Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Veneto Vineyards reacquired 18,000 shares of its $1 par common stock for $15 per share. What is the journal entry necessary to record this transaction? A) No entry required. B) Treasury Stock Cash

270,000 270,000

C) Cash

270,000 Treasury Stock

270,000

D) Treasury Stock Addl. Paid-in Capital

18,000 18,000

Answer: B Explanation: 18,000 × $15 = $270,000 Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Pollyanna & Partners reacquired 40,000 shares of its $1 par common stock for $25 per share. What is the journal entry needed to record this transaction? A) Treasury Stock Cash B) Cash

1,000,000 1,000,000

1,000,000 Treasury Stock

1,000,000

C) Cash

40,000 Addl. Paid-in Capital

40,000

D) No entry required. Answer: A Explanation: 40,000 × $25 = $1,000,000 Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Dante, Inc. reacquired 57,000 shares of its $1 par common stock for $19 per share on January 31. On March 1 they sold 9000 treasury shares for $28 per share. On April 1 they sold 5000 treasury shares for $15 per share. What is the necessary journal entry for March 1? A) Cash

252,000

Treasury Stock Addl. Paid-in Capital from Treasury Stock Transactions

171,000 81,000

B) Cash

252,000 Treasury Stock

252,000

C) Cash

75,000 Treasury Stock

75,000

D) Cash

252,000

Treasury Stock Addl. Paid-in Capital from Treasury Stock Transactions

135,000 117,000

Answer: A Explanation: Cash 9000 × $28 = $252,000; Treasury Stock 9000 × $19 = $171,000; Additional Paid-in Capital from Treasury Stock Transactions $252,000 - $171,000 = $81,000 Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Dante, Inc. reacquired 30,000 shares of its $1 par common stock for $19 per share on January 31. On March 1 they sold 7000 treasury shares for $29 per share. On April 1 they sold 6000 treasury shares for $16 per share. What is the necessary journal entry for April 1? A) Cash 570,000 Treasury Stock 480,000 Addl. Paid-in Capital from Treasury Stock Transactions 90,000 B) Cash Addl. Paid-in Capital from Treasury Stock Transactions Treasury Stock

96,000 18,000

C) Retained Earnings Treasury Stock

96,000

D) Cash Retained Earnings Treasury Stock

96,000 18,000

114,000

96,000

114,000

Answer: B Explanation: Cash 6000 × $16 = $96,000; Treasury Stock 6000 × $19 = $114,000; Additional Paid-in Capital from Treasury Stock Transactions $114,000 - $96,000 = $18,000 (from March 1 journal entry) Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Renoir Corporation reacquired 40,000 shares of its $1 par common stock for $19 per share on July 1. On August 1 they sold 10,000 treasury shares for $22 per share. What is the necessary journal entry for the August transaction? A) Cash

40,000 Treasury Stock

40,000

B) Cash

760,000

Treasury Stock Addl. Paid-in Capital from Treasury Stock Transactions

540,000 220,000

C) Cash

220,000

Treasury Stock Addl. Paid-in Capital from Treasury Stock Transactions

190,000 30,000

D) Cash

220,000 Retained Earnings

220,000

Answer: C Explanation: Cash 10,000 × $22 = $220,000; Treasury Stock 10,000 × $19 = $190,000; Additional Paid-in Capital from Treasury Stock Transactions $220,000 - $190,000 = $30,000 Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Monet's Minions, Inc. reacquired 10,000 shares of its $1 par common stock for $11 per share on August 1. On October 31 they sold 9000 treasury shares for $7 per share. Assuming a zero balance in the Additional Paid-in Capital from Treasury Stock Transactions account, what is the necessary journal entry for the October transaction? A) Cash

110,000 Treasury Stock

110,000

B) Cash

63,000

Treasury Stock Addl. Paid-in Capital from Treasury Stock Transactions

54,000 9000

C) Cash

110,000 Treasury Stock Retained Earnings

63,000 47,000

D) Cash Retained Earnings Treasury Stock

63,000 36,000 99,000

Answer: D Explanation: Cash 9000 × $7 = $63,000; Treasury Stock 9000 × $11 = $99,000; Retained Earnings $99,000 $63,000 = $54,000. Retained Earnings is debited because Additional Paid-in Capital from Treasury Stock Transactions is zero. Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Illusions, Inc. reacquired 26,000 shares of its common stock for $16 per share on June 1. On July 1 they sold 7000 treasury shares for $23 per share. On August 1 they sold 9000 treasury shares for $13 per share. Assuming no prior balance in the Additional Paid-in Capital from Treasury Stock Transactions account, what is the ending balance in this account following these transactions? A) $7000 debit balance B) $9000 credit balance C) $22,000 debit balance D) $22,000 credit balance Answer: D Explanation: July 1 transaction includes $49,000 credit to Additional Paid-in Capital from Treasury Stock Transactions; August 1 transaction includes $27,000 debit to the account. With no prior balance, the ending balance in the account after transactions is $22,000 credit. Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Caesar & Company reacquired 60,000 shares of its $1 par common stock for $10 per share on March 1. On April 1 they sold 10,000 treasury shares for $15 per share. On May 1 they sold 7000 treasury shares for $6 per share. Assuming no prior balance in the Additional Paid-in Capital from Treasury Stock Transactions, what is the ending balance in this account following these transactions? A) $22,000 debit B) $28,000 debit C) $22,000 credit D) $50,000 credit Answer: C Explanation: The April 1 transaction is a $50,000 credit to the account; the May 1 transaction is a $28,000 debit to the account. Resulting balance is $50,000 credit - $28,000 debit = $22,000 credit. Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Why would a company repurchase shares of its own common stock? Answer: There are a number of reasons why a company repurchases shares of its own common stock. Listed below are some common uses for treasury shares: 1. Stock option plans, stock bonus plans, and employee stock purchase plans. 2. Exchange for another firm's voting shares in mergers and/or acquisitions. 3. To support the market price of the stock by reducing the supply and raising the price. 4. To prevent takeover attempts either through raising the price or increasing the voting power of major shareholders. 5. To distribute cash to shareholders without formally increasing the cash dividend. Diff: 1 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) When treasury stock is sold above or below cost, why isn't this reported on the income statement as a gain or loss? Answer: While these may appear similar to gains or losses, they are actually capital transactions. Gains or losses arise from the use of assets/resources in operating and investing activities. Treasury stock is typically treated as a reduction in stockholders' equity, not an asset. Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Dali's Dessert Company provides the following information from the Stockholders' Equity Section of the Balance Sheet: Common Stock, $1 par value, 100,000 shares issued and outstanding Additional Paid-in Capital in Excess of Par—Common Additional Paid-in Capital-Retired Shares Retained Earnings Total Stockholders' Equity

$100,000 900,000 15,000 1,125,000 $2,140,000

Dali acquired 15,000 shares of common stock in the open market at a price of $12 per share and retired the shares. What is the journal entry to record this transaction? Answer: Common Stock—$1 par 15,000 Addl. Paid-in Capital in Excess of Par—Common 135,000 Addl. Paid-in Capital-Retired Shares 15,000 Retained Earnings 15,000 Cash 180,000 Calculations: Debit Common Stock $1 par × 15,000 = $15,000 Debit Additional Paid-in Capital in Excess of Par—Common $900,000/100,000 × 15,000 = $135,000 Debit Additional Paid-in Capital—Retired Shares for existing balance Credit Cash 15,000 × $12 = $180,000 Debit Retained Earnings for remaining amount to balance journal entry. Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Coyote Company reacquired 25,000 shares of its $1 par common stock for $15 per share on June 1. On July 1 they sold 10,000 treasury shares for $20 per share. On August 1 they sold 5,000 treasury shares for $12 per share. Prepare the necessary journal entries (omit explanations). Answer: 6/1 Treasury Stock 375,000 Cash 375,000 7/1

Cash

200,000

Treasury stock Add. Paid-in Capital from Treasury Stock Transactions 8/1

Cash Add. Paid-in Capital from Treasury Stock Transactions. Treasury Stock

150,000 50,000 60,000 15,000

Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

75,000

20) The Magic Flute Company provides the following information from the Stockholders' Equity section of the balance sheet: Common Stock, $1 par value, 200,000 shares issued and outstanding Additional Paid-in Capital in Excess of Par—Common Retained Earnings Total Stockholders' Equity

$200,000 1,400,000 1,520,000 $3,120,000

Magic Flute had the following transactions related to treasury shares: January 1 Acquired 30,000 shares of its common stock in the open market for $12 per share March 1 Sold 5,000 treasury shares for $16 April 1 Sold 5,000 treasury shares for $6 May 1 Retired 5,000 treasury shares Prepare the necessary journal entries to record all treasury stock transactions. Answer: Jan 1 Treasury Stock 360,000 Cash Mar 1

Cash

80,000

Treasury stock Additional Paid-in Capital from Treasury Stock Transactions Apr 1

May 1

360,000

60,000 20,000

Cash Additional Paid-in Capital from Treasury Stock Transactions Retained Earnings Treasury Stock

30,000

Common Stock Additional Paid-in Capital in Excess of Par-common Retained Earnings Treasury Stock

5,000 35,000 20,000

20,000 10,000 60,000

Diff: 3 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

60,000

21) Illusions, Inc. reacquired 30,000 shares of its common stock for $15 per share on June 1. On July 1 they sold 5,000 treasury shares for $20 per share. On August 1 they sold 9,000 treasury shares for $10 per share. Assuming no prior balance in the Additional Paid-in Capital from Treasury Stock Transactions account, what is the ending balance in this account following these transactions? Is this a debit or credit balance? Answer: $20,000 debit balance. Cost of the Treasury is $15 per share. When 5,000 shares are sold on July 1, there is a credit to Additional Paid-in Capital from Treasury Stock Transactions of $25,000 [5,000 shares × ($20 - $15)]. When 9,000 shares are sold below the cost of $15 on August 1, there is a debit to Additional Paid-in Capital from Treasury stock of $45,000 [9,000 × ($15 - $10)]. So, $25,000 credit - $45,000 debit = $20,000 debit balance after the transactions. Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Taylor Company reacquired 100,000 shares of its $1 par common stock for $10 per share on March 1. On April 1 they sold 10,000 treasury shares for $15 per share. On May 1 they sold 7,000 treasury shares for $6 per share. Assuming no prior balance in the Additional Paid-in Capital from Treasury Stock Transactions, what is the ending balance in this account following these transactions? Answer: $22,000 credit balance. Explanation: The April 1 transaction is a $50,000 credit to the account; the May 1 transaction is a $28,000 debit to the account. Resulting balance is $50,000 credit - $28,000 debit = $22,000 credit. Diff: 2 Objective: 15.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15.4

Accounting for Preferred Stock

1) Preferred shares are generally voting and pay a fixed dividend. Answer: FALSE Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) When issuing preferred shares instead of debt, corporations lose out on a valuable tax deduction. Answer: TRUE Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Convertible preferred shares are often accounted for as a liability under both GAAP and IFRS. Answer: FALSE Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) ________ preferred shares contain a provision requiring that preferred shareholders share ratably in distributions with common shareholders. A) Cumulative B) Participating C) Convertible D) Redeemable Answer: B Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Under U.S. GAAP, ________ preferred shares are classified as a liability. A) convertible B) callable C) mandatorily redeemable D) non-mandatorily redeemable Answer: C Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) ________ preferred stock shares allow the shareholder to convert his shares to common shares at a predetermined rate or exchange ratio. A) Convertible B) Callable C) Mandatorily redeemable D) Cumulative Answer: A Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) ________ preferred stock contains a provision that stipulates that, if the board of directors do not declare a dividend, the dividends to preferred accumulate. A) Convertible B) Callable C) Mandatorily redeemable D) Cumulative Answer: D Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) ________ preferred shares are shares for which the issuing entity has the right to buy back the shares at a specified price and future date. A) Convertible B) Callable C) Mandatorily redeemable D) Cumulative Answer: B Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) ________ preferred shares are preferred shares for which redemption is certain at a specified price on a specified date. A) Convertible B) Callable C) Mandatorily redeemable D) Cumulative Answer: C Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Where are dividends in arrears reported? A) notes to the financial statements B) income statement C) balance sheet D) statement of stockholders' equity Answer: A Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) When accounting for non-mandatorily redeemable preferred shares, ________ will report them as a liability. A) IFRS B) U.S. GAAP C) Both A & B D) Neither A nor B Answer: A Diff: 1 Objective: 15.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

12) ________ are shares for which the issuing entity has the right to "buy back" the shares at a specified price and future date. A) Convertible preferred shares B) Callable preferred shares C) Redeemable preferred shares D) Cumulative preferred shares Answer: B Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Purrfect Paws Company issues 1,000 shares of $50 par preferred stock for $250,000. The company is not required to buy back the preferred stock. However, the preferred stock includes a redemption feature that gives the holder the option to redeem the shares for cash at specified dates. This would be classified as ________ under U.S. GAAP and ________ under IFRS. A) debt; equity B) debt; debt C) equity; debt D) equity; equity Answer: C Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Stinson Corporation has 6% participating preferred shares. In 2022, the company pays common shareholders dividends that are 10% of common par value. What, if any, additional dividend will preferred shareholders receive? A) 4% B) 10% C) 100% D) none Answer: A Diff: 1 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Mozart & Company issued 2500 shares of 5%, $60 par value, preferred stock for $190,000. The board of directors declared preferred dividends for one year on December 30, to be paid in January. What journal entry is necessary to record the declaration of dividends? A) Dividends — Preferred Cash

9500

B) Dividends Dividends Payable-Preferred

9500

C) Dividends — Preferred Cash

7500

D) Dividends — preferred Dividends payable-preferred

7500

9500

7500

Answer: D Explanation: 2500 × $60 × 5% = $7500 Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Bach, Inc. issued 1600 shares of 8%, $140 par value, preferred stock for $150,000. The board of directors declared preferred dividends for one year on December 30, to be paid in January. What journal entry is necessary to record the payment of dividends? A) Dividends — Preferred Dividends Payable - Preferred

17,920

B) Dividends Payable - Preferred Cash

17,920

C) Dividends — Preferred Dividends Payable - Preferred

12,000

D) Dividends Payable - Preferred Cash

12,000

17,920

12,000

Answer: B Explanation: 1600 shares × $140 par × 8% = $17,920 Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) On January 1, 2020, Warhol Company issued 3000 shares of 10%, $200 par value, cumulative preferred stock for $700,000. No preferred dividends were declared in 2020 and 2021. On December 30, 2022, the Board declared $3000 in dividends. How much of the dividend is allocated to preferred and common shareholders? A) $0 preferred, $3000 common B) $1500 preferred, $1500 common C) $3000 preferred, $0 common D) $1200 preferred, $1800 common Answer: C Explanation: [3000 × ($200 × 10%)] × 3 years = $180,000 cumulative dividend owed to preferred stockholders. Entire amount of $3000 dividends allocated to preferred and $177,000 in arrears. Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) On January 1, 2020, Warhol Company issued 1000 shares of 10%, $200 par value, cumulative preferred stock for $300,000. No preferred dividends were declared in 2020 and 2021. On December 30, 2022, the Board declared $10,000 in dividends. What amount, if any, of preferred dividends are in arrears as of December 31, 2022? A) $0 B) $50,000 C) $60,000 D) $4000 Answer: B Explanation: [1000 × ($200 × 10%)] × 3 years = $60,000 cumulative dividend owed to preferred stockholders. Entire amount of $10,000 dividends allocated to preferred and $50,000 in arrears. Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Mozart & Company paid cash dividends totaling $160,000 in 2020 and $85,000 in 2021. In 2022, the company will pay cash dividends of $800,000. There were no dividends in arrears as of January 1, 2020. There are 25,000 shares of common stock outstanding and 100,000 shares of 6 percent, $50 par cumulative preferred stock outstanding. What is the amount of cash dividends payable to common stockholders in 2022? A) $145,000 B) $140,000 C) $355,000 D) $800,000 Answer: A Explanation: Preferred dividends per year: 100,000 shares × 6% × $50 par = $300,000 2020: paid $160,000; in arrears: $140,000 2021: paid $85,000; in arrears: $140,000 from 2020 and $215,000 from 2021 = $355,000 2022: paid arrears of $355,000 and current $300,000 = $655,000 to preferred—so of the $800,000, there is $145,000 left for common stockholders; $800,000 - $655,000 preferred = $145,000 common Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) The Magic Flute Company paid cash dividends totaling $260,000 in 2020 and $210,000 in 2021. In 2022, the company will pay cash dividends of $980,000. There were no dividends in arrears as of January 1, 2020. There are 25,000 shares of common stock outstanding and 70,000 shares of 6 percent, $100 par cumulative preferred stock outstanding. What is the amount of cash dividends payable to common stockholders in 2022? A) $0 B) $190,000 C) $420,000 D) $980,000 Answer: B Explanation: Preferred dividends per year: 70,000 shares × 6% × $100 par = $420,000 2020: paid $260,000; in arrears $160,000 2021: paid $210,000; in arrears $210,000 + $160,000 (from 2020) = $370,000 2022: paid arrears of $370,000 and current $420,000—so of the $980,000 there is $190,000 left for common stockholders; $980,000 – ($370,000 + $420,000) = $190,000 Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Betta Corp. has 65,000 shares of $3 par common stock and 25,000 shares of $20 par 7% cumulative preferred stock. The company declares cash dividends of $80,000 during the current year and there are $8000 dividends in arrears. What will be the total dividend payment to common stockholders? A) $37,000 B) $8000 C) $43,000 D) $80,000 Answer: A Explanation: Preferred: [(25,000 × $20) × 7%] + $8000 = $43,000 Common: $80,000 - $43,000 = $37,000 Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) On January 1, 2022, TNT, Inc. issued 1500 shares of $80 par value, convertible preferred shares for $200,000. Each preferred share is convertible into one share of $10 par common stock. What is the necessary journal entry to record this transaction? A) Cash

B) Cash

C) Cash

D) Cash

Convertible Preferred Stock —$80 Par Addl. Paid-in Capital in Excess of Par—Preferred

200,000

Preferred Stock—Convertible

Preferred Stock —$80 Par Addl. Paid-in Capital in Excess of Par—Preferred

200,000

120,000

Preferred Stock—Convertible

Answer: A

Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

120,000 80,000

200,000

15,000 185,000

120,000

23) On January 1, 2022, TNT, Inc. issued 2100 shares of $50 par value, convertible preferred shares for $200,000. Each preferred share is convertible into one share of $10 par common stock. On August 1, 2022, all preferred shareholders converted their shares into common stock. What is the necessary journal entry to record the August 1st transaction? A) Common Stock—Par Preferred Stock

200,000

B) Convertible Preferred Stock Addl. Paid-in Capital in Excess of Par—Preferred Common Stock Add. Paid-in Capital in Excess of Par—Common C) Preferred Stock Common Stock—Par

200,000

105,000 95,000 21,000 179,000

200,000 200,000

D) Preferred Stock Addl. Paid-in Capital in Excess of Par—Preferred Common Stock Add. Paid-in Capital in Excess of Par—Common

179,000 2100

Answer: B

Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2100 179,000

24) On January 1, 2022, Illusions, Inc. issued 900 shares of $90 par value, callable preferred shares for $150,000. Illusions has the right to call the shares on January 1, 2023 for $100 per share. What is the necessary journal entry to record the issuance of the callable shares? A) Cash

B) Cash

C) Cash

D) Cash

Preferred Stock—$90 Par Add. Paid-in Capital in Excess of Par—Preferred

150,000

Preferred Stock—$90 Par

150,000

Callable Stock

Preferred Stock—$90 Par Add. Paid-in Capital in Excess of Par—Preferred

150,000

Answer: D

Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

69,000 81,000

150,000

81,000 69,000

25) On January 1, 2022, Illusions, Inc. issued 800 shares of $95 par value, callable preferred shares for $110,000, with the right to call the shares on January 1, 2023 for $100 per share. The company calls all 800 shares on January 1, 2023. What is the necessary journal entry to record this transaction for 2023? A) Cash

Preferred Stock—$95 Par Add. Paid-in Capital in Excess of Par—Preferred

B) Preferred Stock—$95 Par Add. Paid-in Capital in Excess of Par—Preferred Common Stock

76,000 34,000

76,000 34,000 110,000

C) Preferred Stock—$95 Par Add. Paid-in Capital in Excess of Par—Preferred Cash Additional Paid-in Capital from Retirement of Preferred Stock D) Cash

110,000

76,000 34,000 80,000

30,000

110,000

Preferred Stock—$95 Par Common Stock

Answer: C

Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

34,000 76,000

26) On January 1, 2020, Moulin Company issued 1,200 shares of $60 par callable preferred shares for $180,000. According to the preferred share agreement, Moulin can call these preferred shares on January 1, 2022, for $150 per share. On January 1, 2022, Moulin calls the shares. a. What is the journal entry to record the issuance of the preferred shares? b. What is the journal entry when Moulin calls the preferred shares? Answer: a. Cash 180,000 Preferred Stock—$60 Par Addl. Paid-in Capital in Excess of Par—Preferred b. Preferred Stock—$60 Par 72,000 Additional Paid-in Capital in Excess of Par—Preferred 108,000 Cash Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

72,000 108,000

180,000

27) Bach Company has issued both common and preferred stock. The preferred stock is convertible into common stock. The following information is provided for Bach Company's Stockholders' equity: Convertible Preferred Stock, $14 par, 25,000 shares issues and outstanding Additional Paid-in Capital in Excess of Par—Preferred Common Stock, $9 par, 125,000 shares issued and outstanding Additional Paid-in Capital in Excess of Par—Common Retained Earnings

$350,000 100,000 1,125,000 875,000 1,600,000

What is the necessary journal entry if 5,000 shares of preferred are converted under each independent scenario: a. Preferred shares are convertible into common stock on a share-for-share basis. b. Each share of convertible preferred stock is convertible into 1.5 shares of common stock. Answer: a. Convertible Preferred Stock—$14 par (5,000 × $14) 70,000 Addl. Paid-in Capital in Excess of Par—Preferred 20,000 Common Stock—$9 par (5,000 shares × $9) 45,000 Add. Paid-in Capital in Excess of Par—Common 45,000 b. Preferred Stock—$14 par (5,000 × $14) 70,000 Addl. Paid-in Capital in Excess of Par—Preferred 20,000 Common Stock—$9 par (7,500 shares × $9) 67,500 Add Paid-in Capital in Excess of Par—Common 22,500 Diff: 3 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) Omega Company has issued both common and preferred stock. The preferred stock is convertible into common stock. The following information is provided for Omega Company's Stockholders' equity: Convertible Preferred Stock, $30 par, 25,000 shares issued and outstanding Additional Paid-in Capital in Excess of Par—Preferred Common Stock, $2 par, 125,000 shares issued and outstanding Additional Paid-in Capital in Excess of Par—Common Retained Earnings

$750,000 150,000 250,000 3,125,000 1,600,000

What is the necessary journal entry if 5,000 shares of preferred are converted under each independent scenario: a. Each share of convertible stock is convertible into 1.5 shares of common stock. b. Each share of convertible stock is convertible into 4 shares of common stock. Answer: a. Convertible Preferred Stock—$30 par (5,000 × $30) 150,000 Addl. Paid-in Capital in Excess of Par—Preferred 30,000* Common Stock—$2 par (7,500 shares × $2) 15,000 Add. Paid-in Capital in Excess of Par—Common 165,000 *Additional Paid-in Capital in Excess of Par—Preferred = [$150,000/25,000] × 5,000 = $30,000 b. Convertible Preferred Stock—$30 par (5,000 × $30) 150,000 Addl. Paid-in Capital in Excess of Par—Preferred 30,000* Common Stock—$2 par (20,000 shares × $2) 40,000 Add. Paid-in Capital in Excess of Par—Common 140,000 *Additional Paid-in Capital in Excess of Par—Preferred = [$150,000/25,000] × 5,000 = $30,000 Diff: 3 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) How do U.S. GAAP and IFRS differ in their presentation of preferred stock on the balance sheet? Answer: There are three primary differences in the treatment of preferred stock under IFRS. 1. Convertible preferred shares: IFRS classification depends on the terms of the conversion feature. If there are fixed number of shares to be delivered upon conversion, the shares are classified as equity. Otherwise, the shares are classified as debt. 2. Non-mandatorily redeemable preferred shares: Under IFRS, when the preferred stockholder has the option to require redemption, the firm reports redeemable preferred shares as a liability. Here, the company may not be able to avoid paying cash, so it reports the preferred stock as a liability. In this case, the possible requirement to distribute cash is not under the control of the issuing corporation. 3. Fixed-dividend preferred shares: Under IFRS, the shares are classified as a liability because there is a contractual obligation and a fixed payment is required. Following U.S. GAAP, all of the above types of preferred stock are reported as equity on the balance sheet. Diff: 3 Objective: 15.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

30) Mitchell Company paid cash dividends totaling $210,000 in 2020 and $210,000 in 2021. In 2022, the company will pay cash dividends of $900,000. There were no dividends in arrears as of January 1, 2020. There are 25,000 shares of common stock outstanding and 50,000 shares of 5 percent, $100 par cumulative preferred stock outstanding. What is the amount of total cash dividends payable to preferred and common stockholders in 2020, 2021, and 2022? Answer: Preferred dividends per year: 50,000 shares × 5% × $100 par = $250,000 2020: paid to preferred $210,000; in arrears $40,000; paid to common $0 2021: paid to preferred $210,000; in arrears $40,000 + $40,000 (from 2020) = $290,000; paid to common $0 2022: paid to preferred $330,000 (arrears of $80,000 and current $250,000; paid to common $570,000 ($900,000 - $330,000 to preferred) Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) On January 1, 2020, Weston Company issued 5,000 shares of 10%, $100 par value, cumulative preferred stock for $600,000. No preferred dividends were declared or paid in 2020 and 2021. On December 30, 2022, the Board declared $320,000 in dividends. How much of the dividend is allocated to preferred and common shareholders? Answer: [5,000 × ($100 × 10%)] × 3 years = $150,000 cumulative dividend owed to preferred stockholders. Common stockholders will get $170,000 ($320,000 - $150,000). Diff: 2 Objective: 15.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

15.5

Accounting for Retained Earnings

1) Retained earnings are amounts invested by the equity holders of the company. Answer: FALSE Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Corrections to past years' financial statements are called prior-period adjustments. Answer: TRUE Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Small stock dividends are valued at the market price per share of stock at the date of declaration. Answer: TRUE Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Large stock dividends are valued at the market price per share of stock at the date of declaration. Answer: FALSE Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) When accounting for cash dividends, a formal journal entry is made for which dates? A) the declaration date and record date B) the record date and payment date C) the ex-dividend date and declaration date D) the declaration date and payment date Answer: D Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following is not a type of dividend? A) cash dividend B) liquidating dividend C) property dividend D) wage dividend Answer: D Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) ________ are paid from contributed capital instead of retained earnings. A) Liquidating dividends B) Property dividends C) Stock dividends D) Fund dividends Answer: A Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) A firm is under no legal obligation to distribute a ________ dividend, even after declaring one. A) cash B) stock C) wealth D) both A & B Answer: B Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) On July 15, 2022, Renoir Corporation declared and issued a 15 percent stock dividend. Prior to this dividend, Renoir had 50,000 shares of $10 par value common stock issued and outstanding. The market value of Renoir's common stock on July 15, 2022, was $21 per share. As a result of this stock dividend, by what amount would Renoir's total stockholders' equity increase or decrease? A) $0 B) $75,000 increase C) $75,000 decrease D) $157,500 decrease Answer: A Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) On August 1, 2022, Omega Co. declared and issued a 15 percent common stock dividend. Prior to this, Omega Co. had 50,000 outstanding shares of $2 par value common stock. The market value of Omega Co.'s stock was $18 per share at the time the dividend was issued. As a result of this stock dividend, Omega Co.'s total stockholders' equity ________. A) increased by $15,000 B) decreased by $135,000 C) decreased by $7,500 D) did not change Answer: D Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) On August 1, 2022, Omega Co. declared and issued a 30 percent common stock dividend. Prior to this, Omega Co. had 50,000 outstanding shares of $2 par value common stock. The market value of Omega Co.'s stock was $18 per share at the time the dividend was issued. As a result of this stock dividend, Omega Co.'s total stockholders' equity ________. A) increased by $15,000 B) decreased by $135,000 C) decreased by $7,500 D) did not change Answer: D Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Sheldon, Inc. declared a stock dividend of 50,000 shares on a date when the company's common stock was selling for $21 per share. Prior to this date, Sheldon had 500,000 outstanding shares of $1 par value common stock. As a result of this stock dividend, Sheldon's common stock will ________, the additional paid-in capital will ________, and the retained earnings will ________. A) decrease $50,000; decrease $1,000,000; increase $1,050,000 B) increase $1,050,000; not change; decrease $1,050,000 C) increase $50,000; increase $1,000,000; decrease $1,050,000 D) decrease $1,000,000; decrease $1,000,000; not change Answer: C Explanation: Common Stock 50,000 × $1 par = increase $50,000; 50,000 × $20 APIC = $1,000,000 increase; 50,000 × $21 market value = $1,050,000 decrease as transfer from RE to contributed capital. This is a small stock dividend. Diff: 2 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Sheldon, Inc. declared a stock dividend of 100,000 shares on a date when the company's common stock was selling for $19 per share. Prior to this date, Sheldon had 100,000 outstanding shares of $1 par value common stock. As a result of this stock dividend, Sheldon's common stock will ________, the additional paid-in capital will ________, and the retained earnings will ________. A) decrease $100,000; decrease $850,000; increase $950,000 B) increase $100,000; not change; decrease $100,000 C) increase $100,000; increase $850,000; decrease $950,000 D) decrease $850,000; decrease $850,000; not change Answer: B Explanation: Common Stock 100,000 × $1 par = increase $100,000; 100,000 × $1 par value = $100,000 decrease as transfer from RE to contributed capital. This is a large stock dividend. Diff: 2 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Archer, Inc. declared a stock dividend of 100,000 shares. Prior to the declaration, the company has 450,000 shares, $1 par value common stock issued and outstanding. At the date of the declaration, the company's common stock was selling for $15 per share. Prepare the required journal entries to account for the declaration as if the 100,000 shares were considered: a. a small stock dividend b. a large stock dividend Answer: a. Small Stock Dividend Dividends 1,500,000 Common Stock Dividends Distributable 100,000 Additional Paid-in Capital in Excess of Par— Common 1,400,000 b. Large Stock Dividend Dividends Common Stock Dividends Distributable

100,000 100,000

Diff: 2 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) On December 15, Caesar & Company's accountant found a mistake that was made in the previous year's depreciation expense computation. The mistake resulted in depreciation expense that was reported too high last year. Based on the following information (and ignoring taxes), what will the correct ending balance in Retained Earnings be this year? Retained Earnings balance at the end of last year was $45,000. Depreciation Expense last year overstated by $5,000. Net income current year is $15,000. Cash dividends declared and paid this year $4,000. Answer: Answer: $61,000 (computation below) Retained earnings beginning of year (unadjusted) Add prior period adjustment Retained earnings adjusted beginning balance Add net income Subtotal Deduct: dividends Retained earnings, correct ending balance

$45,000 5,000 $50,000 15,000 $65,000 4,000 $61,000

Diff: 2 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Molly's Brewery declared a cash dividend of $2,400 on July 1, 2022. It sets the record date as July 17, 2022, the ex-dividend date as July 15, 2022, and the payment date as August 5, 2022. Prepare all necessary journal entries to record this dividend. Answer: July 1 Dividends 2,400 Dividends Payable 2,400 August 5

Dividends Payable Cash

2,400 2,400

Diff: 1 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Rouge Corp. has 75,000 shares of $2 par common stock and 30,000 shares of $14 par 8% cumulative preferred stock. The company declares cash dividends of $60,000 during the current year and there are $8,000 dividends in arrears. What will be the total dividend payment to common and preferred shareholders? Answer: Preferred shareholders: (30,000 × $14) × 8% = $33,600 + $8,000 arrears = $41,600. Common shareholders: $60,000 - $41,600 = $18,400. Diff: 2 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Sheldon, Inc. declared a stock dividend of 60,000 shares on a date when the company's common stock was selling for $20 per share. Prior to this date, Sheldon had 600,000 outstanding shares of $2 par value common stock. As a result of this stock dividend: 1) How much will Sheldon's common stock account balance go up or down by? 2) How much will the additional paid-in capital account balance go up or down by? 3) How much will the retained earnings go up or down by? Answer: 1) Common Stock will increase by $120,000 (60,000 shares × $2 par value) 2) APIC will increase by 1,080,000 [60,000 shares × ($20 - $2)] 3) Retained Earnings would decrease by $1,200,000 (60,000 shares × $20) Diff: 2 Objective: 15.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

15.6

Accounting for Other Comprehensive Income

1) Comprehensive income includes all changes in equity during a period from all sources. Answer: FALSE Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Other comprehensive income includes income items that bypass the income statement. Answer: TRUE Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Unrealized gains and losses on trading debt securities are included in other comprehensive income. Answer: FALSE Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The two major components of comprehensive income are ________ and ________. A) stockholders' equity; retained earnings B) net income; other comprehensive income C) retained earnings; net income D) dividends; prior-period adjustments Answer: B Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Which of the following is not a part of Other Comprehensive Income? A) unrealized gains on available-for-sale debt securities B) foreign currency translation adjustments C) unrecognized pension costs D) gains on the sale of equipment Answer: D Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

6) Syd's Co. reported comprehensive income of $8700 for the current year. It had unrealized losses on available-for-sale debt securities of $1700 after tax, and a foreign currency translation gain of $1900 after tax. What is net income for the current year? A) $8500 B) $8900 C) $7000 D) $10,600 Answer: A Explanation: Solve for net income: Net income ($8700 – $1900 + $1700) $8500 Unrealized loss on available-for-sale debt securities (1700) Foreign currency translation gain (equity increase) 1900 Comprehensive income $8700 Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Price Co. reported net income of $18,000 for the current year. It had unrealized losses on available-forsale debt securities of $1700 after tax, and a foreign currency translation loss of $1000 after tax. What is comprehensive income for the current year? A) $19,000 B) $16,300 C) $15,300 D) $17,000 Answer: C Explanation: Solve for comprehensive income: Net income $18,000 Unrealized loss on available-for-sale debt securities (1700) Foreign currency translation loss (equity decrease) (1000) Comprehensive income $15,300 Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Price Co. reported net income of $18,000 for the current year. It had unrealized losses on available-forsale debt securities of $1700 after tax, and a foreign currency translation loss of $700 after tax. What is comprehensive income for the current year? A) $18,700 B) $16,300 C) $15,600 D) $17,300 Answer: C Explanation: Solve for comprehensive income: Net income $18,000 Unrealized loss on available-for-sale debt securities (1700) Foreign currency translation loss (equity decrease) (700) Comprehensive income $15,600 Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Explain the reasons for reporting other comprehensive income separately from net income. Answer: Answers will vary, but should include points from the "conceptual framework" section: 1. OCI items have a low probability of cash flow realization in the short term and therefore should not be included in net income. Including these items would further remove net income from the underlying cash flows of the firm. 2. The temporary nature of OCI items would create earnings volatility (when these temporary events reverse) if included in net income. 3. OCI events are not part of normal business operations so they should not be included in net income. Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) Baxtor Co. reported net income of $20,000 for the current year. It had unrealized losses on availablefor-sale debt securities of $1,800 after tax, and a foreign currency translation loss of $1,100 after tax. What is comprehensive income for the current year? Answer: Net income $20,000 Unrealized loss on available-for-sale debt securities (1,800) Foreign currency translation loss (equity decrease) (1,100) Comprehensive income $17,100 Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Boxer Co. reported net income of $25,000 for the current year. It had unrealized losses on availablefor-sale debt securities of $1,600 after tax, and a foreign currency translation loss of $600 after tax. What is comprehensive income for the current year? Answer: Net income $25,000 Unrealized loss on available-for-sale debt securities (1,600) Foreign currency translation loss (equity decrease) (600) Comprehensive income $22,800 Diff: 1 Objective: 15.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

15.7

Stockholders' Equity Disclosures

1) The disclosures for stockholders' equity must include the pertinent rights and privileges of the various securities outstanding. Answer: TRUE Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) IFRS requires a company to disclose information that enables users to assess its objectives, policies, and processes for managing capital. Answer: TRUE Diff: 1 Objective: 15.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

3) The total amount of stockholders' equity reported on the balance sheet is often ________. A) close to fair value of the company B) not representative of the value of the company to its stockholders C) too hard for the average investor to locate D) all of the above Answer: B Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Investors' perceptions of a firm's expected future profitability and prospects is reflected in the ________. A) firm's net assets B) par value of a firm's common stock C) market value of a firm's common stock D) dividends paid Answer: C Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

5) When a company has unusually high or low net income, the ________ is not the most useful valuation ratio. A) Current Ratio B) Price to Earnings Ratio C) Quick Ratio D) Price to Book Ratio Answer: B Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

6) When earnings are volatile, the ________ ratio can be useful in evaluating a company because ________ value is generally more stable than net income. A) Price to Earnings; market B) Price to Earnings; book C) Price to Book; book D) Price to Book; market Answer: C Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Fancy Flights has 200,000 common shares outstanding, and they are currently trading at $47 per share. Net income is $235,000. What is the Price-to-Earnings Ratio? (Round your answers to two decimal places, X.XX.) A) 47.00 B) 40.00 C) 0.85 D) 0.03 Answer: B Explanation: Market price $47/EPS $1.18 ($235,000 net income/200,000 shares) = 40 Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Bitters Co.'s net income is $14,000, the market value of common stock is $160,000, and the book value of common stockholders' equity is $100,000. What is the Price to Book Ratio for Bitters Co.? (Round your answer to two decimal places, X.XX.) A) 0.63 B) 0.14 C) 1.60 D) 7.14 Answer: C Explanation: Market value $160,000/Book value $100,000 = 1.6 Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Dali Design's net income is $19,000, the market value of common stock is $150,000, and the book value of common stockholders' equity is $60,000. What is the Price to Earnings Ratio for Dali's? (Round your answer to two decimal places, X.XX.) A) 3.16 B) 7.89 C) 0.13 D) 0.32 Answer: B Explanation: Market value $150,000/Net income $19,000 = 7.89 Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Gustav & Co.'s net income is $13,000, the market value of common stock is $131,000, and the book value of common stockholders' equity is $70,000. Gustav's P/E Ratio is ________ and the Price to Book Ratio is ________. (Round your answer to two decimal places, X.XX.) A) 10.08; 1.87 B) 0.19; 0.53 C) 1.87; 10.08 D) 0.53; 0.19 Answer: A Explanation: P/E - Market value $131,000/Net income $13,000 = 10.08; Price to Book – Market value $131,000/Book $70,000 = 1.87 Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) TLR Productions' net income is $12,000, the market value of common stock is $108,000, and the book value of common stockholders' equity is $63,000. TLR's P/E Ratio is ________ and the Price to Book Ratio is ________. (Round your answer to two decimal places, X.XX.) A) 1.71; 9 B) 0.19; 0.11 C) 0.11; 0.19 D) 9; 1.71 Answer: D Explanation: P/E - Market value $108,000/Net income $12,000 = 9; Price to Book – Market value $108,000/Book $63,000 = 1.71 Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) What must a company disclose concerning convertible equity securities? Answer: A company must provide adequate disclosure regarding significant terms of the conversion features of a contingently convertible security. The disclosures include all of the following: 1. Events or changes in circumstances that would cause the contingency to be met. 2. Any significant features necessary to understand the conversion rights and the timing of those rights (e.g., the periods in which the contingency might be met and the securities that may be converted if the contingency is not met). 3. The conversion price and the number of shares into which a security is potentially convertible. 4. Events or changes in circumstances, if any, that could adjust or change the contingency, conversion price, or number of shares, including significant terms of those changes. 5. The manner of settlement upon conversion and any alternative settlement methods (e.g., cash, shares, or a combination). Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Boxer Co.'s net income is $15,000, the market value of common stock is $140,000, and the book value of common stockholders' equity is $110,000. What is the Price to Book Ratio? (Round your answer to two decimal places, X.XX.) Answer: Market value $140,000/Book value $110,000 = 1.27 Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Dixon Design's net income is $25,000, the market value of common stock is $160,000, and the book value of common stockholders' equity is $60,000. What is the Price to Earnings Ratio? (Round your answer to two decimal places, X.XX.) Answer: Market value $160,000/Net income $25,000 = 6.40 Diff: 1 Objective: 15.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 16 Investments in Financial Assets 16.1

Overview of Investments in Debt and Equity

1) Debt securities represent an investment by one company into the common or preferred shares of another company. Answer: FALSE Diff: 1 Objective: 16.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

2) Yield is the actual return investors receive on investments in bonds. Answer: TRUE Diff: 1 Objective: 16.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

3) Investments in securities of other companies are classified as either debt securities or equity securities. Answer: TRUE Diff: 1 Objective: 16.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Bonds are priced such that their yield will be the same as the stated rate of interest. Answer: FALSE Diff: 1 Objective: 16.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Equity securities are an investment in the common or preferred shares of another company. Answer: TRUE Diff: 1 Objective: 16.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Bonds are priced in the market so that their ________ is the same as the market rate of interest. A) yield B) stated rate C) par value D) discount Answer: A Diff: 1 Objective: 16.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

7) Zenith Corporation reports its investments in debt securities at cost. This method of accounting is consistent with the qualitative characteristic of ________ from the conceptual framework. A) faithful representation B) relevance C) both faithful representation and relevance D) neither representation nor relevance Answer: A Diff: 1 Objective: 16.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

8) Altima Corporation actively manages a portfolio of publicly traded stock funded with excess cash. The purpose of the portfolio is to generate gains on sales and the portfolio is reported at fair value. This method of accounting is consistent with the qualitative characteristic of ________ from the conceptual framework. A) relevance B) faithful representation C) both faithful representation and relevance D) neither representation nor relevance Answer: A Diff: 1 Objective: 16.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

9) All of the following are key questions that must be addressed when accounting for investments in debt and equity securities except ________. A) How long does management intend to hold the investment? B) Is the fair value of the equity investment readily determinable? C) How is return on equity impacted by this investment? D) How much control does the investor have over the investee company for this equity investment? Answer: C Diff: 1 Objective: 16.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

10) What key questions must be addressed when accounting for investments in debt and equity securities? Answer: Accounting for investments in debt and equity securities involved addressing four key questions: 1. Is the investment a debt security or an equity security? 2. How long does management intend to hold the investment? 3. If the investment is an equity security, how much control does the investor have over the investee company? 4. If the investment is an equity security, is the fair value readily determinable? Diff: 2 Objective: 16.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

11) How do the qualitative characteristics of relevance and faithful representation relate to the measurement bases used for investments? Answer: The standard setters' requirements for cost or fair value accounting for investments involve a trade-off between the two fundamental qualitative characteristics in the conceptual framework of relevance and faithful representation. The cost-basis method of valuation clearly provides a faithful representation of an asset's value. While there is a high degree of accuracy, it is often not relevant. On the other hand, fair value is highly relevant in that it reflects future economic benefits associated with the asset. However, in many cases, the fair value is subjective and, thus, may not provide a faithful representation. Diff: 2 Objective: 14.9 IFRS/GAAP: GAAP AACSB: Reflective thinking

16.2

Investments in Debt Securities

1) Companies classify debt securities in one of two ways: available-for-sale or held-to-maturity. Answer: FALSE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

2) Companies determine the cost of held-to-maturity debt securities as the present value of the future cash flows, discounted at the market rate of interest. Answer: TRUE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Reflective thinking

3) Companies determine the cost of held-to-maturity debt securities as the present value of the future cash flows, discounted at the stated rate of interest. Answer: FALSE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Reflective thinking

4) Changes in the fair value of trading debt securities are reported in other comprehensive income. Answer: FALSE Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

5) Available-for-sale debt securities are reported at fair value, with unrealized gains or losses reported in other comprehensive income. Answer: TRUE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Reflective thinking

6) A company reports unrealized gains or losses from trading debt securities in other comprehensive income. Answer: FALSE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) A separate fair value adjustment account is typically used to reflect the difference between the fair value and the cost of the investment so as to avoid excessive changes in the investment account itself. Answer: TRUE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Both trading debt securities and held-to-maturity debt securities are valued at fair value. Answer: FALSE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Only debt securities can be classified as held-to-maturity securities. Answer: TRUE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) A company generally classifies securities as available-for-sale when it plans to actively buy and sell securities with the objective of generating a gain on the sale. Answer: FALSE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) If a debt security is not classified as held-to-maturity or trading, then it is classified as an availablefor-sale security. Answer: TRUE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Realized gains and losses occur when a company holds securities that experience a change in fair value. Answer: FALSE Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Which of the following is a debt security that a company intends to hold only for the short term? A) trading security B) available-for-sale security C) held-to-maturity security D) Not enough information to classify this security. Answer: A Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Investments in debt securities that cannot be readily classified in two reporting categories are classified as ________. A) available-for-sale securities B) trading securities C) held-to-maturity securities D) minority securities Answer: A Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Which of the following is a debt security for which management has both the positive intent and ability to hold the debt investment until all principal and interest is fully paid? A) trading security B) held-to-maturity security C) available-for-sale security D) Not enough information to classify this security. Answer: B Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) Jules & Associates purchased the bonds of Jay Bird Retailers during the year. Jules intends to hold onto these bonds to collect all principal and interest, but due to financial constraints, will most likely have to sell this investment on the open market within the next year. How should Jules classify this investment? A) held-to-maturity debt investment B) available-for-sale equity investment C) trading debt investment D) available-for-sale debt investment Answer: D Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Goo Goo Enterprises invested in the bonds of Greater Glouster. These bonds pay interest of 2%. The effective rate of interest for similar bonds on the date of investment was 6%. Did Goo Goo purchase the bonds at a discount or premium? A) These bonds were purchased at a discount because the stated rate exceeds the market rate. B) These bonds were purchased at a premium because the stated rate exceeds the market rate. C) These bonds were purchased at a discount because the market rate exceeds the stated rate. D) These bonds were purchased at a premium because the market rate exceeds the stated rate. Answer: C Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Cassa & Associates purchased the bonds of JayBird. These bonds pay 6% interest semi-annually. The effective rate of interest at the date of investment was 3%. Did Cassa & Associates purchase these bonds at a discount or premium? A) These bonds were purchased at a discount because the stated rate exceeds the market rate. B) These bonds were purchased at a premium because the stated rate exceeds the market rate. C) These bonds were purchased at a discount because the market rate exceeds the stated rate. D) These bonds were purchased at a premium because the market rate exceeds the stated rate. Answer: B Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) Bateman Enterprises invested in the bonds of Greater Gloucester on January 1, 2022. These 10-year, $300,000 bonds pay interest of 3% with semiannual payments every June 30 and December 31. The effective rate of interest for similar bonds on January 1 was 4%. What is the semi-annual interest payment received by Bateman for these bonds? A) $4500 B) $9000 C) $3750 D) $5250 Answer: A Explanation: $300,000 par value × 3% annual interest rate × 6/12 months Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Price Enterprises invested in the bonds of Greater Gloucester on January 1, 2022. These 60 year, $600000 bonds pay interest of 3% every June 30 and December 31. The effective rate of interest for similar bonds on January 1 was 4%. What is the purchase price of these bonds? A) $600,000 B) $582,000 C) $624,000 D) $463,934 Answer: D Explanation: Present value of the bond was calculated using the Present Value (PV) function in Excel with the following inputs: rate = 2% (4% market rate / 2 payments per year) nper = 120 (60 years × 2 payment per year) pmt = $9000 ($600,000 × .03 × 6/12) fv = 600,000 Excel Formula =PV(.02,120,9000,600000) = $463,934 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Cox Corporation invested in the bonds of Latif Industries on January 1, 2022. These 10 year, $100,000 bonds pay interest of 6% every June 30 and December 31. The effective rate of interest for similar bonds on January 1 was 4%. What is the purchase price of these bonds? A) $100,000 B) $94,000 C) $104,000 D) $116,351 Answer: D Explanation: Present value of the bond was calculated using the Present Value (PV) function in Excel with the following inputs: rate = 2% (4% market rate / 2 payments per year) nper = 20 (10 years × 2 payments per year) pmt = $3000 ($100,000 × 6% × 6/12) fv = 100,000 Excel Formula =PV(0.02,20,3000,100,000) = $116,351 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) On April 1, 2022, Ellucian Corporation invested in the bonds issued by the City of Westminster on January 1, 2022. These 10-year, $700,000 bonds pay interest of 2% with semiannual payments every June 30 and December 31. Ellucian paid par value plus accrued interest. What is the amount of accrued interest paid at the time of purchase? A) $3500 B) $14,000 C) $4666.67 D) $7000 Answer: A Explanation: $700,000 par value × 2% annual interest rate × 3/12 months = $3500 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) On April 1, 2022, Ellucian Corporation invested in the bonds issued by the City of Westminster on January 1, 2022. These 10-year, $300,000 bonds pay interest of 2% with semiannual payments every June 30 and December 31. Ellucian paid par value plus accrued interest. What is the total amount paid by Ellucian for the City of Westminster bonds? A) $301,500 B) $300,000 C) $298,500 D) $303,000 Answer: A Explanation: ($300,000 par value × 2% annual interest rate × 3/12 months) accrued interest + par value = $1500 + 300,000 = $301,500 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) On April 1, 2022, Ellucian Corporation invested in the bonds issued by the City of Westminster on January 1, 2022. These 10-year, $600,000 bonds pay interest of 2% with semiannual payments every June 30 and December 31. Ellucian paid par value plus accrued interest. Ellucian's fiscal year ends on December 31. What is Ellucian's net interest revenue for 2022? A) $9000 B) $12,000 C) $3000 D) $6000 Answer: A Explanation: $600,000 par value × 2% annual interest rate × 9/12 months = $9000 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Which of the following statements regarding available-for-sale debt securities is true? A) Fair value adjustments are treated as adjustments to net income. B) Fair value adjustments are treated as adjustments to other comprehensive income. C) Available-for-sale securities are valued on the balance sheet at historical cost. D) Interest revenue and fair value adjustments are netted to determine the effect on net income. Answer: B Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Which of the following statements regarding trading debt securities is false? A) If a trading debt security is purchased at a premium, the premium must be amortized on a periodic basis. B) Fair value adjustments are treated as adjustments to net income. C) If the fair value of trading debt securities is less than the amortized cost, the fair value adjustment account will have a credit balance. D) Fair value adjustments are treated as adjustments to other comprehensive income. Answer: D Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) On January 1, Year 1, Gibson Corporation purchased bonds issued by Williamson Company. These bonds were classified as held-to-maturity securities. The face value of these bonds is $100,000, pay 8% interest and were purchased to yield 6%. The bonds mature in 10 years and pay interest on an annual basis. If Gibson Corporation paid $114,720 for these bonds, how much interest revenue should it report on the bonds at December 31, Year 1? Assume that Gibson used the effective interest method. A) $9178 B) $8000 C) $6000 D) $6883 Answer: D Explanation: $114,720 × 6% = $6883 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

28) On July 1, Year 1, Fairfield Company purchased $5 million of Hampton Corporation's 6% bonds for $3,932,522. The bonds were purchased to yield 8% interest and were classified as held-to-maturity securities. The bonds mature in 25 years and pay interest annually on July 1. Assuming that Fairfield uses the effective interest method of amortization, what amount should it report for its investment in bonds on December 31, Year 1? (Round all calculations to the nearest cent, and your final answer to the nearest dollar.) A) $4,232,522 B) $3,939,823 C) $3,947,124 D) $3,925,221 Answer: B Explanation: $3,932,522 carrying value + discount amortization ($3,932,522 × 8% × 1/2) - ($5,000,000 × 6% × 1/2) = $3,939,823 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

29) Where are changes in fair value for trading debt securities reported? A) as operating income or loss on the income statement B) as income or loss from peripheral activities on the income statement C) as a component of accumulated other comprehensive income on the balance sheet D) as a prior period adjustment to retained earnings on the balance sheet Answer: B Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

30) During 2022, Arnold Corporation purchased $6.2 million of 10 year municipal bonds at face value. On December 31, 2024, the bonds had a market value of $6,900,000. Arnold reclassified the bonds from heldto-maturity to trading securities. Arnold's balance sheet and income statement for December 31, 2024 will reflect which of the following? A) Investment in municipal bonds $6,200,000

Income statement gain on investments $0

Investment in municipal bonds $6,200,000

Income statement Unrealized gain on investments $700,000

Investment in municipal bonds $6,900,000

Income statement gain on investments $0

Investment in municipal bonds $6,900,000

Income statement Unrealized gain on investments $700,000

Answer: D

Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

31) Olympic Corporation purchased a debt security for $500,000 on July 1, 2024 and properly classified it as a trading security. As of the last day of 2024, the fair value of the security was $494,000. The proper journal entry on this date includes ________. A) a credit to Fair Value Adjustment - Trading Debt Investments for $6000 B) a debit to Fair Value Adjustment - Trading Debt Investments for $494,000 C) a debit to Unrealized Loss - Net Income for $494,000 D) a credit to Unrealized Loss - Net Income for $6000 Answer: A Diff: 2 Objective: 16.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

32) On July 1, Year 1, Walters Corporation purchased as a short-term investment a $2 million face amount Kempff 6% bond for $1,792,146 plus accrued interest to yield 8%. The bonds mature on January 1, Year 11, and pay interest annually on January 1. On December 31, Year 5, the bonds had a fair value of $1,810,000. On March 1, Year 6, Walters sold the bond for $1,830,000. At what amount should Walters report the bond in its December 31, Year 5 balance sheet if it is classified as an available-for-sale security? A) $1,792,146 B) $1,830,000 C) $1,810,000 D) $2,000,000 Answer: C Explanation: For an available-for-sale security, the fair value is the reported value. Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

33) Fair values and subsequent growth of an investment are not relevant for reporting for which category of investments? A) held-to-maturity B) securities accounted for under the equity method C) trading D) available-for-sale Answer: A Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

34) On September 30, 2023, Angel Outfitters invested in 10-year, $900,000, 7% bonds of ABC Co. These bonds were dated January 1, 2023, and pay interest annually on December 31. Angel paid face value plus accrued interest for these bonds, and intends to hold these bonds until maturity. Which of the following is the correct journal entry to record this investment? A) Held-to-Maturity Debt Investment - Cost Interest Receivable Cash

900,000 47,250

B) Held-to-Maturity Debt Investment - Cost Discount on Held-to-Maturity Investment Cash

900,000 47,250

C) Available-for-Sale Debt Investment - Cost Discount on Held-to-Maturity Investment Cash

900,000 47,250

D) Available-for-Sale Debt Investment - Cost Discount on Available-for-Sale Investment Cash

900,000 47,250

947,250

Answer: A Explanation: Accrued interest is $900,000 × 7% × 9/12 = $47,250. Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

35) Kelemen Asset Management invested in the bonds of DEF Co. on 1/1/2023. Kelemen intends to hold the bonds until maturity. These 5-year bonds had a face value of $500,000, pay 5% interest on 6/30 and 12/31 of each year, and were issued when the market rate of interest was 6%, resulting in a cost of $478,674. How much interest revenue will Kelemen record on 6/30/2023? A) $11,967 B) $12,500 C) $25,000 D) $14,360 Answer: D Explanation: $478,674 × .06 × 6/12 = $14,360 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

36) Leotis Asset Management invested in the bonds of DEF Co. on 1/1/22. Leotis intends to hold the bonds until maturity. These 5-year bonds had a face value of $900,000, pay 5% interest on 6/30 and 12/31 of each year, and were issued when the market rate of interest was 6%, resulting in a cost of $861,614. Which of the following is the correct journal entry to record the receipt of the interest payment on 6/30/22? A) Interest Receivable Held-to-Maturity Debt Investment - DEF Bonds Interest Revenue B) Cash Held-to-Maturity Debt Investment - DEF Bonds Interest Revenue

22,500 16,742 5758

22,500 3348 25,848

C) Interest Receivable Held-to-Maturity Debt Investment - DEF Bonds Interest Revenue D) Cash Held-to-Maturity Debt Investment - DEF Bonds Interest Revenue

45,000 4819 40,181

45,000 6697 51,697

Answer: B Explanation: Cash interest = $900,000 × 5% × 6/12 = $22,500. Effective interest = $861,614 × 6% × 6/12 = $25,848, Discount Amortization (added to carrying value) = $25,848 - $22,500 = $3348. Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

37) Where are changes in fair value for available for sale securities reported? A) as operating income or loss on the income statement B) as income or loss from peripheral activities on the income statement C) as a component of accumulated other comprehensive income on the balance sheet D) as a prior period adjustment to retained earnings on the balance sheet Answer: C Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

38) As of 12/31/21, XYZ Inc. had available-for-sale debt investments with a fair value of $505,000, an amortized cost of $542,000, and a debit balance in the Fair Value Adjustment - Available for Sale Debt Investments account of $7200. What is the amount of gain or loss reported by XYZ related to these available-for-sale debt investments and how should it be reported? A) Unrealized Loss of $37,000, reported as part of Other Comprehensive Income. B) Unrealized Loss of $44,200, reported as part of Net Income. C) Unrealized Loss of $44,200, reported as part of Other Comprehensive Income. D) Unrealized Loss of $37,000, reported as part of Net Income. Answer: C Explanation: Unrealized losses on available-for-sale debt investments are always reported as part of Other Comprehensive Income. The Fair Value Adjustment account should have a $37,000 desired credit balance ($505,000 - $542,000 = $37,000). The Fair Value Adjustment account has a debit balance of $7200. The Fair Value Adjustment account must be credited for $44,200 in order to reach the desired 37,000 credit balance ($7200 + $37,000), resulting in an Unrealized Loss of $44,200 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

39) As of 12/31/24, XYZ Inc. had available-for-sale debt investments with a fair value of $509,000, an amortized cost of $530,000, and a credit balance in the Fair Value Adjustment - Available for Sale Debt Investments account of $7200. What is the amount of gain or loss reported by XYZ related to these available-for-sale debt investments and how should it be reported? A) Unrealized Loss of $13,800 reported as part of Other Comprehensive Income. B) Unrealized Loss of $28,200, reported as part of Net Income. C) Unrealized Loss of $28,200, reported as part of Other Comprehensive Income. D) Unrealized Loss of $13,800, reported as part of Net Income. Answer: A Explanation: Unrealized losses on available-for-sale debt investments are always reported as part of Other Comprehensive Income. The Fair Value Adjustment account is calculated as: $509,000 - $530,000 = $(21,000) desired credit balance in the Fair Value Adjustment account. The Fair Value Adjustment account has a credit balance of $7200. The Fair Value Adjustment account must be credited for $13,800 in order to reach the desired $21,000 credit balance ($21,000 - $7200), resulting an Unrealized Loss of $13,800. Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

40) What types of gains and losses from investments must companies report? Answer: Companies must report two types of gains and losses related to investments: 1. Realized gains and losses if the company actually sells the investment 2. If the company holds the securities, the change in fair value is an unrealized gain or loss. Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

41) Cross Clothiers invested $200,000 in a debt security that it properly classified as a trading security on 12/20/2024. At 12/31/2024, this trading security had a fair value of $201,500. Record the journal entries needed for this investment assuming this is the first and only trading debt security for Cross Clothiers. Answer: 12/20 Trading Debt Investment - Cost 200,000 Cash 200,000 12/31

Fair Value Adjustment - Trading Debt Inv. Unrealized Gain - Net Income

1,500 1,500

Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

42) On January 1, Year 1 Alcorn Corporation purchased $95,000 of 9% bonds at face value. The bonds are classified as a held-to-maturity investment. The bonds pay interest semiannually on January 1 and July 1. On December 31, Year 1, the fair value of the bonds is $98,000. Alcorn's fiscal year ends on December 31. Required: 1. Prepare the journal entries to record the acquisition of the bonds and the first two interest payments. Include any year-end adjusting entries. 2. If the bonds were classified as an available for sale security, what additional adjusting entry would be made on December 31? Answer: 1. Jan 1, Year 1 Held-to-Maturity Debt Investments 95,000 Cash 95,000 July 1

Dec 31 Jan 1 Year 2

Cash ($95,000 × 9% × 1/2) Interest Revenue

4,275

Interest Receivable Interest Revenue

4,275

Cash

4,275

Interest Receivable

4,275

2. Dec 31

Fair Value Adjustment — Available-for-Sale Debt Investments Unrealized Gain - OCI

3,000

Diff: 3 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

3,000

43) On January 1, Seahawk Company purchased $770,000 of 12% bonds at face value. At December 31, the market value of the bonds was $810,000. Required: Prepare the fair value adjusting entry on December 31 of the current year assuming that the bonds are classified as: 1. Trading securities 2. Available-for-sale securities 3. Held-to-maturity securities Answer: (1) Account Debit Credit Fair Value Adjustment — Trading Debt Investments 40,000 Unrealized Gain–Net Income 40,000 ($810,000 - $770,000) (2) Account Fair Value Adjustment — Available-for-Sale Debt Investments Unrealized Gain–Other Comprehensive Income ($810,000 - $770,000) (3)

Debit

Credit 40,000 40,000

No entry. Held-to-maturity securities are not adjusted to fair value.

Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

44) Eagles Auto invested in bonds of ABC, which it intends to hold until maturity 1/1/2027. These 5-year bonds were dated 1/1/2022, had a face value of $75,000, and pay 4% interest annually on 12/31. Eagles purchased these bonds when the market rate of interest was 3%. Complete the entire amortization table for this investment and record all entries for the life of the investment, rounding all values to the nearest dollar. (Use Excel to determine the purchase price.)

Answer: Cost of the investment calculated using Excel Present Value function with the following inputs: rate: 3% nper: 5 pmt: $3,000 ($75,000 × .04) fv: $75,000 Excel function: =PV(.03,5,3000,75000) = $78,435 Investment Amortization Table:

Date 1/1/2022 12/31/2022 12/31/2023 12/31/2024 12/31/2025 12/31/2026

Cash Interest 3,000 3,000 3,000 3,000 3,000

Effective Premium Amortized Interest Amortization Cost 78,435 2,353 647 77,788 2,334 666 77,122 2,314 686 76,435 2,293 707 75,728 2,271 729 75,000

Journal Entries: 1/1/2022 Held-to-Maturity Debt Investment - ABC Bonds Cash

78,435

12/31/2022

Cash

3,000

12/31/2023

Cash

12/31/2024

Cash

12/31/2025

Cash

Held-to-Maturity Debt Investments - ABC Bonds Interest Revenue

3,000

Cash

666 2,334

686 2,314

707 2,293 3,000

Held-to-Maturity Debt Investments - ABC Bonds Interest Revenue 1/1/2027

647 2,353

3,000 Held-to-Maturity Debt Investments - ABC Bonds Interest Revenue

12/31/2026

78,435

Held-to-Maturity Debt Investments - ABC Bonds

Diff: 3 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

729 2,271 75,000

75,000

45) Spike's Auto invested in bonds of DEF, which it intends to hold until maturity 1/1/2027. These 5-year bonds were dated 1/1/2022, had a face value of $100,000, and pay 4% interest annually on 12/31. Spike's purchased these bonds when the market rate of interest was 6%. Complete the entire amortization table for this investment and record all entries for the life of the investment, rounding all values to the nearest dollar.

Answer: Cost of the investment calculated using Excel Present Value function with the following inputs: rate: 6% nper: 5 pmt: $4,000 ($100,000 × .04) fv: $100,000 Excel function: =PV(.06,5,4000,100000) = $91,575 Investment Amortization Table:

Date 1/1/2022 12/31/2022 12/31/2023 12/31/2024 12/31/2025 12/31/2026

Cash Interest

Effective Interest

Discount Amortization

4,000 4,000 4,000 4,000 4,000

5,495 5,584 5,679 5,780 5,887

1,495 1,584 1,679 1,780 1,887

Amortized Cost 91,575 93,070 94,654 96,333 98,113 100,000

Journal Entries: 1/1/2022 Held-to-Maturity Debt Investments - DEF Bonds Cash 12/31/2022

12/31/2023

12/31/2024

12/31/2025

12/31/2026

1/1/2027

Cash Held-to-Maturity Debt Investments - DEF Bonds Interest Revenue

91,575

1,495

Cash Held-to-Maturity Debt Investments - DEF Bonds Interest Revenue

4,000 1,584

Cash Held-to-Maturity Debt Investments - DEF Bonds Interest Revenue

4,000 1,679

Cash Held-to-Maturity Debt Investments- DEF Bonds Interest Revenue

4,000 1,780

Cash Held-to-Maturity Debt Investments - DEF Bonds Interest Revenue

4,000 1,887

Cash

Held-to-Maturity Debt Investments - DEF Bonds

Diff: 3 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

100,000

91,575 4,000 5,495

5,584

5,679

5,780

5,887

100,000

46) How are debt and equity investments classified when the company does not exercise significant influence? Answer: 1. Held to maturity securities—This classification includes only debt investments. Investments are classified as held-to-maturity if a company has both positive intent and the ability to hold a debt investment until it matures. 2. Trading securities—A debt or equity instrument that a company intends to hold only for the short term with the object of generating a gain on the sale. 3. Available-for-sale securities—If a security is not classified as held-to-maturity or trading, it is classified as available for sale. Diff: 1 Objective: 16.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

47) On January 1, Year 1, Gordon Corporation purchased bonds issued by Walter Company. These bonds were classified as held-to-maturity securities. The face value of these bonds is $200,000, pay 8% interest and were purchased to yield 5%. The bonds mature in 10 years and pay interest on an annual basis. If Gordon Corporation paid $220,000 for these bonds, how much interest revenue should it report on the bonds at December 31, Year 1? Assume that Gordon used the effective interest method. Answer: $220,000 × 5% = $11,000 Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

48) On July 1, Year 1, Floyd Company purchased $4 million of Harris Corporation's 5% bonds for $3,800,000. The bonds were purchased to yield 7% interest and were classified as held-to-maturity securities. The bonds mature in 25 years and pay interest annually on July 1. Assuming that Floyd uses the effective interest method of amortization, what amount should it report for its investment in bonds on December 31, Year 1? (Round all calculations to the nearest cent, and your final answer to the nearest dollar.) Answer: $3,800,000 carrying value + discount amortization ($3,800,000 × 7% × 1/2) - ($4,000,000 × 5% × 1/2) = $3,833,000. Diff: 2 Objective: 16.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

16.3

Investments in Equity Securities: No Significant Influence

1) The appropriate accounting method for equity investments depends on the investor's level of influence over the investee company. Answer: TRUE Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

2) Significant influence is typically gained by an investor company owning more than 50% of the voting shares of the investee company. Answer: FALSE Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

3) Unrealized gains and losses from fair value adjustments for equity investments with no significant influence and a readily determinable fair value are reported as part of other comprehensive income, while gains and losses from the sale of these investments are reported in net income. Answer: FALSE Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

4) If an investor company has significant influence over an investee company, the investment is valued at the fair value of the stock on the balance sheet date. Answer: FALSE Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) If an investor company has control over an investee company, the investment is valued at the fair value of the stock on the balance sheet date. Answer: FALSE Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Both realized and unrealized gains and losses for equity securities with no significant influence and a readily determinable fair value are classified as other income on the income statement. Answer: TRUE Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) For equity securities where the investor does not have significant influence, and the equity has a readily determinable fair value, realized gains/losses are reported in net income. Answer: TRUE Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Companies report equity investments with no significant influence and no readily determinable fair value at their historical cost. Answer: FALSE Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following statements is incorrect? A) If the investor has significant influence over the investee, the investor must use the equity method of accounting for the investment. B) If the investor has control over the investee, financial statements for the two companies must be consolidated. C) If the investor has no significant influence over the investee, and can readily determine the fair value of the investment, the investor should report the investment at fair value. D) If the investor has no significant influence over the investee company, and the investment has no readily determinable fair value, the investment is reported at cost with unrealized gains and losses reported as part of other comprehensive income. Answer: D Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

10) Which of the following is a difference between U.S. GAAP and IFRS in accounting for equity investments with no significant influence and a readily determinable fair value? A) IFRS requires all equity securities to be reported at cost, and allows companies to report gains and losses only when those securities are sold. B) Under IFRS, equity investments with no significant influence and a readily determinable fair value are reported at fair value. C) Under IFRS, unrealized gains and losses can be reported as part of other comprehensive income instead of net income, if elected. D) IFRS requires companies to report all equity securities at adjusted cost. Answer: B Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

11) What is the initial reporting basis for all equity investment securities? A) Cost B) Discounted Present Value C) Fair Value D) Equity Value Answer: A Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Rhoads purchased common shares of Company A and B for $10,000 and $10,000, respectively on 12/15. Rhoads intends to sell these securities within 30 days. At 12/31, Investments in Company A & B had a fair value of $9,000 and $18,000, respectively. Assuming Rhoads has no significant influence over the investee companies, what is the unrealized gain or loss for these securities and how is it reported? A) Unrealized Loss of $1,000, Unrealized Gain of $8000, both reported as part of Net Income B) Unrealized Gain of $7000, reported as part of Other Comprehensive Income C) Unrealized Loss of $1,000, Unrealized Gain of $8000, both reported as part of Other Comprehensive Income D) Unrealized Gain of $7000, reported as part of Net Income Answer: D Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) L & J purchased common shares of Company A and B for $10,000 and $9000, respectively on 12/15. L & J intends to sell these securities within 30 days. At 12/31, Investments in Company A & B had a fair value of $9,000 and $15,000, respectively. L & J does not have significant influence over the investees. Assuming an existing $1100 credit balance in Fair Value Adjustment - Equity Investments, what is the unrealized gain or loss for these securities and how is it reported? A) Unrealized Gain of $1100, reported as part of Net Income B) Unrealized Gain of $6100, reported as part of Net Income C) Unrealized Gain of $1100, reported as part of Other Comprehensive Income D) Unrealized Gain of $6100, reported as part of Other Comprehensive Income Answer: B Explanation: The desired balance in the Fair Value Adjustment account is the fair value of A & B less the cost of A & B. ($15,000 + $9,000) - ($10,000 + $9000) = $5000 desired debit balance Since there is a previous credit balance of $1100, this must be added to the desired debit balance of $5000 and the company reports an Unrealized Gain of $6100. Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Brightney purchased common shares of Company A and B for $7000 and $12,000, respectively on 12/15. Brightney intends to sell these securities within 30 days. At 12/31, Investments in Company A & B had a fair value of $9,000 and $15,000, respectively. Brightney does not have significant influence over the investees. Assuming an existing $1100 debit balance in Fair Value Adjustment - Equity Investments, what is the unrealized gain or loss for these securities and how is it reported? A) Unrealized Gain of $3900, reported as part of Net Income B) Unrealized Gain of $5000, reported as part of Net Income C) Unrealized Gain of $3900, reported as part of Other Comprehensive Income D) Unrealized Gain of $5000, reported as part of Other Comprehensive Income Answer: A Explanation: The desired balance in the Fair Value Adjustment account is the fair value of A & B less the cost of A & B. ($15,000 + $9,000) - ($7000 + $12,000) = $5000 desired debit balance Since there is a previous debit balance of $1100, this is subtracted from the desired debit balance of $5000 for an Unrealized Gain of $3900. Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) PM Distributors began Year 2 with Equity Investments of $8100 (which consisted of a single investment) as well as a debit balance of $1000 in the Fair Value Adjustment - Equity Investments account. PM does not have significant influence over the investee, and the investment has a readily determinable fair value. This trading security was sold for $9100 during Year 2. How much was the gain or loss for the sale of this investments and how is it recorded? A) No gain or loss reported, as the investment was sold for the adjusted fair value B) Unrealized Gain of $1000, reported as part of Other Comprehensive Income C) Realized Loss of $1000, reported as part of Net Income D) Realized Gain of $1000, reported as part of Net Income Answer: D Explanation: $9100 selling price - $8100 initial cost = $1000. An adjusting entry at year end will reconcile the Fair Value Adjustment — Equity Investments account. Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Investments in equity securities whereby the investor does not have significant influence over the investees require ________ percentage of ownership in the investees. A) less than 20% B) 20% to 50% C) 51% to 74% D) 75% or greater Answer: A Diff: 1 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) On January 1 of the current year, Beta Company paid $200,000 for 10,000 shares of Gamma Company common stock. Beta owns 10% of Gamma Company. Gamma reported net income of $66,000 for December 31 of the current year. The fair value of the Gamma stock on that date was $27. What amount will be reported in Beta's balance sheet for the investment in Gamma at December 31? A) $204,000 B) $266,000 C) $270,000 D) $336,000 Answer: C Explanation: For an equity security where there is no significant influence and a readily determinable fair value, the investment will be reported at fair value. Multiply the number of shares times the December 31 market price per share = 10,000 × $27 = $270,000. Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) On January 7, 2022, Webb Industries purchased an equity investment in Bloomberg Corporation for $520,000. Webb does not have significant influence or control over Bloomberg. Bloomberg Corporation stock is not actively traded and does not have a readily determinable fair value. At December 31, 2022, a Level 2 fair value of $470,000 is available based on a comparable security in the same industry as Bloomberg Corporation. At December 31, 2022, a Level 3 fair value of $507,000 is available based on a cash flow model of Bloomberg Corporation. On December 12, 2023, Webb Industries sells the Bloomberg stock for $621,000. What is the amount of the fair value adjustment on December 31, 2022? A) $0 B) $101,000 C) $50,000 D) $37,000 Answer: C Explanation: These securities should be reported at fair value determined at Level 2, $470,000. Loss = $520,000 - $470,000 = $50,000. Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

19) On January 7, 2022, Webb Industries purchased an equity investment in Bloomberg Corporation for $540,000. Webb does not have significant influence or control over Bloomberg. Bloomberg Corporation stock is not actively traded and does not have a readily determinable fair value. At December 31, 2022, a Level 2 fair value of $493,000 is available based on a comparable security in the same industry as Bloomberg Corporation. At December 31, 2022, a Level 3 fair value of $528,000 is available based on a cash flow model of Bloomberg Corporation. On December 12, 2023, Webb Industries sells the Bloomberg stock for $638,000. What is the gain that is reported on the sale of Bloomberg Corporation in 2023? A) $0 B) $98,000 C) $47,000 D) $35,000 Answer: B Explanation: The full gain of $638,000 sales price - $540,000 purchase price = $98,000 is recognized at the time of the sale. Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

20) On January 7, 2022, Webb Industries purchased 1,000 shares of Class A common stock in Bloomberg Corporation for $50,000. Webb does not have significant influence or control over Bloomberg. Although Class A shares are not actively traded, Class B shares are traded and are nearly identical aside from being publicly traded. At the end of 2022, Class B shares are trading for $54 per share. If Webb makes the appropriate election to measure the investment based on observable price changes for similar securities, what Fair Value Adjustment should be made at the end of 2022? A) $0 B) $4000 debit C) $4000 credit D) $8000 credit Answer: B Explanation: If Webb makes the appropriate election, a fair value adjustment will be made based on the value of the nearly identical stock. The value of the investment at year end is 1,000 shares × $54 observed price = $54,000. The Fair Value Adjustment — Equity Investments adjustment is a $54,000 - $50,000 = $4000 debit. Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

21) On January 7, 2022, Webb Industries purchased 1,000 shares of Class A common stock in Bloomberg Corporation for $50,000. Webb does not have significant influence or control over Bloomberg. Although Class A shares are not actively traded, Class B shares are traded and are nearly identical aside from being publicly traded. At the end of 2022, Class B shares are trading for $59 per share. Webb makes the appropriate election to measure the investment based on observable price changes for similar securities. On December 12, 2023, Webb Industries sells the Bloomberg stock for $63,000. What is the gain that is reported on the sale of Bloomberg Corporation in 2023? A) $0 B) $13,000 C) $4000 D) $9000 Answer: B Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

22) Texan Textiles invested in two equity securities in December 2022. Neither investment represented significant influence. The company's fair value adjustment account has a balance of $0. The following information related to these securities: Security 1 2

Purchase Date 12/1/2022 12/3/2022

Cost $27,300 44,600

Fair Value - 12/31/2022 $32,500 37,750

Record journal entries needed for December relating to these securities. Answer: Date Account Debit Credit 12/1 Equity Investments - Cost 27,300 Cash 27,300 12/3

Equity Investments - Cost Cash

44,600

12/31 Unrealized Loss - Net Income Fair Value Adjustment - Equity Investments Security 1 2 Total $71,900 - $70,250 = $1,650

1,650

Cost $27,300 44,600 $71,900

44,600

1,650

Fair Value $32,500 37,750 $70,250

Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Falcon Wholesalers purchased equity securities during 2023 and 2024, with no significant influence in any of the investments. It had not purchased equity securities prior to 2023, and has purchased no other equity securities besides the following: Purchase Security Date 1 12/3/2023 2 12/10/2023 3 12/4/2024 4 12/13/2024

Purchase Price $20,000 24,000 16,000 33,000

Fair Value 12/31/2023 $22,000 18,000 N/A N/A

Fair Value 12/31/2024 N/A N/A 19,000 37,000

Date Sold 1/3/2024 1/7/2024 1/9/2025 1/8/2025

Selling Price $21,000 20,000 19,000 42,000

Prepare all necessary journal entries for 2023 and 2024 related to these securities. Answer: Date Account Debit 12/3/2023 Equity Investments - Cost 20,000 Cash 12/10/2023

Equity Investments - Cost Cash

24,000

12/31/2023

Unrealized Loss - Net Income Fair Value Adjustment - Equity Investments ((20,000 + 24,000) - (22,000 + 18,000))

4,000

1/3/2024

Cash

21,000

1/7/2024

Cash Realized Loss - Net Income Equity Investments - Cost (20,000 - 24,000)

20,000 4,000

12/4/2024

Equity Investments - Cost Cash

16,000

12/13/2024

Equity Investments - Cost Cash

33,000

12/31/2024

Fair Value Adjustment - Equity Investments 11,000 Unrealized Gain - Net Income ((19,000 + 37,000) - (16,000 + 33,000) = 7,000 desired debit balance) (7,000 desired debit balance + 4,000 credit balance)

Realized Gain - Net Income Equity Investments - Cost (21,000 - 20,000)

Credit 20,000

24,000

4,000

1,000 20,000

24,000

Diff: 3 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16,000

33,000

11,000

24) On January 7, 2022, Webb Industries purchased 1,000 shares of Class A common stock in Bloomberg Corporation for $50,000. Webb does not have significant influence or control over Bloomberg. Although Class A shares are not actively traded, Class B shares are traded and are nearly identical aside from being publicly traded. At the end of 2022, Class B shares are trading for $56 per share. Webb makes the appropriate election to measure the investment based on observable price changes for similar securities. On December 12, 2023, Webb Industries sells the Bloomberg stock for $60,000. As of the end of 2023, Webb has no investments in equity securities. Prepare the journal entries to record the purchase of the stock, the sales of the stocks, and any required adjustments at the end of 2022 and 2023. Answer: 1/7/2022Equity Investments -Cost 50,000 Cash 50,000 12/31/2022

Fair Value Adjustment - Equity Investments Unrealized Gain — Net Income ((1,000 × $56) - $50,000 = $6,000))

6,000

12/12/2023

Cash Realized Gain - Net Income Equity Investments - Cost

60,000

Unrealized Loss - Net Income Fair Value Adjustment - Equity Investments

6,000

12/31/2023

6,000

10,000 50,000

Diff: 3 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

6,000

25) How does IFRS account for equity investments when there is no significant influence? Answer: Unlike U.S. GAAP, IFRS does not distinguish between investments with and without a readily determinable fair value. Under IFRS, these investments are typically measured at fair value with unrealized gains and losses reported in net income similar to U.S. GAAP. However, under certain circumstances, a company can elect to report gains and losses in other comprehensive income, called fair value through other comprehensive income (FVOCI). If the company makes this election, then all gains and losses–both realized and unrealized–are reported in other comprehensive income. A company can make this election under two circumstances, specifically, when the equity investment is: • Not held for trading • Not part of contingent consideration in a business combination when it could possibly be given as additional payment on the purchase of a business after it is acquired This election to designate an equity investment as FVOCI is irrevocable and is made on an investment-byinvestment basis. Diff: 3 Objective: 16.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) On January 7, 2022, Walters Industries purchased an equity investment in Bloom Corporation for $640,000. Walters does not have significant influence or control over Bloom. Bloom Corporation stock is not actively traded and does not have a readily determinable fair value. At December 31, 2022, a Level 2 fair value of $593,000 is available based on a comparable security in the same industry as Bloom Corporation. At December 31, 2022, a Level 3 fair value of $628,000 is available based on a cash flow model of Bloom Corporation. On December 12, 2023, Walters Industries sells the Bloom stock for $670,000. What is the gain that is reported on the sale of Bloom Corporation in 2023? Answer: The full gain of $670,000 sales price - $640,000 purchase price = $30,000 gain is recognized at the time of the sale. Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

27) On January 7, 2022, Walters Industries purchased 2,000 shares of Class A common stock in Bloom Corporation for $105,000. Walters does not have significant influence or control over Bloom. Although Class A shares are not actively traded, Class B shares are traded and are nearly identical aside from being publicly traded. At the end of 2022, Class B shares are trading for $55 per share. If Walters makes the appropriate election to measure the investment based on observable price changes for similar securities, what Fair Value Adjustment should be made at the end of 2022? Answer: If Walters makes the appropriate election, a fair value adjustment will be made based on the value of the nearly identical stock. The value of the investment at year end is 2,000 shares × $55 observed price = $110,000. The Fair Value Adjustment — Equity Investments adjustment is a $110,000 - $105,000 = $5,000 debit. Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

28) On January 7, 2022, Walters Industries purchased 2,000 shares of Class A common stock in Bloom Corporation for $105,000. Walters does not have significant influence or control over Bloom. Although Class A shares are not actively traded, Class B shares are traded and are nearly identical aside from being publicly traded. At the end of 2022, Class B shares are trading for $59 per share. Walters makes the appropriate election to measure the investment based on observable price changes for similar securities. On December 12, 2023, Walters Industries sells the Bloom stock for $115,000. What is the gain that is reported on the sale of Bloom Corporation in 2023? Answer: $115,000 - $105,000 = $10,000 gain Diff: 2 Objective: 16.3 IFRS/GAAP: GAAP AACSB: Reflective thinking

16.4

Investments in Equity Securities: Significant Influence

1) If an investor has significant influence over an investee, but doesn't control the decisions that are made, the investor must use the equity method to account for this investment. Answer: TRUE Diff: 1 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Reflective thinking

2) Under the equity method of accounting for investments, dividends received from the investee are credited to Dividend Revenue for the investor. Answer: FALSE Diff: 1 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Reflective thinking

3) Under the equity method, the investor decreases the value of the investment when it receives cash dividends. Answer: TRUE Diff: 1 Objective: 16.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) If the book value of an investee's net assets are not equal to their fair value, an additional adjustment is required under the equity method of accounting for investments. Answer: TRUE Diff: 1 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Reflective thinking

5) Under the equity method, cash dividends received by the investor from the investee should be treated as ________. A) an adjustment to other comprehensive income B) a reduction in the investment account C) an increase in the investment account D) dividend income Answer: B Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Sheehan & Co. purchased 35% of the outstanding shares of Jules & Associates. Jules then declared dividends at year end. How will these dividends effect the investment account for Sheehan? A) Dividends received will increase the investment account. B) Dividends received will reduce the investment account. C) Dividends received will have no impact on the investment account; it will increase Cash and Dividend Revenue. D) Dividends received will have no impact on the investment account; it will increase Realized Gain - Net Income. Answer: B Diff: 1 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Reflective thinking

7) When should a company use the equity method to account for an investment in another company's common stock? A) The investor intends to hold the common stock for an indefinite period. B) The investor has voting control over the investee. C) The investor exerts significant influence over the investee. D) The investor exerts managerial control over the investee. Answer: C Diff: 1 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Pepper Company owns 40% of the common stock and exercises significant influence over Salt Company. Pepper Company ________. A) would decrease its investment account when Salt Company declares dividends B) would record goodwill as investment income each year C) would record dividends received from Salt Company as investment revenue D) would file a consolidated financial statement with Salt Company Answer: A Diff: 1 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Packer Publications purchased $160,000 of the outstanding 400,000 shares of Bear Homes. How should Packer account for this investment? A) Packer should account for this investment using the equity method, as Packer has significant influence over the investee. B) Packer has control over Bear, so it must consolidate all financial statements. C) Packer should classify this investment as an equity investment with no determinable fair value. D) Packer should classify this investment as an equity investment with no significant influence. Answer: A Diff: 1 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Reflective thinking

10) Which of the following statements is incorrect in regard to the equity method of accounting for investments? The fair value option approach is not used. A) The investment account is increased by the percentage of the investee's net income. B) The investment account is decreased by the percentage of the investee's dividends declared. C) The investment account is adjusted to fair value at the end of the reporting period. D) The investment account is decreased by the percentage of the investee's net loss. Answer: C Diff: 1 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) JayBird Jewelers purchased 3,000,000 of the outstanding 10,000,000 shares of Angel & Associates. At the time of the acquisition, the book value of Angel's net assets equals their fair market value. Angel declared dividends of $276,000 during the year. How will JayBird record the last transaction? A) JayBird will increase the investment account by $82,800. B) JayBird will increase Dividend Revenue by $82,800. C) JayBird will increase Dividend Revenue by $276,000. D) JayBird will decrease the investment account by $82,800. Answer: D Explanation: (3,000,000 / 10,000,000) × $276,000 Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Cider Jewelers purchased 3,000,000 of the outstanding 10,000,000 shares of Angel & Associates. At the time of the acquisition, the book value of Angel's net assets equals their fair market value. Angel declared and paid dividends of $285,000 during the year. Which of the following is the correct journal entry for this transaction? A) Cash

85,500 Investment in Angel & Associates

85,500

B) Investment in Angel & Associates Dividend Revenue

85,500 85,500

C) Cash

285,000 Investment in Angel & Associates

285,000

D) Investment in Angel & Associates Dividend Revenue

285,000 285,000

Answer: A Explanation: (3,000,000 / 10,000,000) × $285,000 Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Keller Jewelers purchased 3,000,000 of the outstanding 10,000,000 shares of Angel & Associates. At the time of the acquisition, the book value of Angel's net assets equals their fair market value. Angel declared Net Income of $2,250,000 for the year. How will Angel's Net Income impact Keller's books? A) Keller will increase the Investment account and Income from the Investment for $675,000. B) Keller will increase Cash and increase Income from Investment for $675,000. C) Keller will increase Cash and decrease the Investment Account for $675,000. D) Keller will increase the Investment Account and increase Cash for $675,000. Answer: A Explanation: Keller owns 3,000,000/10,000,000 = 30% of Angel. Since Keller has significant influence over Angel, it will use the equity method. It will increase the Investment account by 30% × $2,250,000 net income = $675,000. Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Jardon Jewelers purchased 3,000,000 of the outstanding 10,000,000 shares of Angel & Associates. At the time of the acquisition, the book value of Angel's net assets equals their fair market value. Angel declared Net Income of $2,250,000 for the year. How will Angel's Net Income be recorded by Jardon? A) Cash

675,000 Income from Investment

675,000

B) Cash

2,250,000 Investment in Angel & Associates

2,250,000

C) Investment in Angel & Associates Income from Investment

675,000

D) Investment in Angel & Associates Income from Investment

2,250,000

675,000

2,250,000

Answer: C Explanation: (3,000,000 / 10,000,000) × 2,250,000 Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Zeng Jewelers purchased 6,000,000 of the outstanding 20,000,000 shares of Angel & Associates. Zeng has significant influence over Angel, so Zeng will account for this investment using the equity method. On the purchase date, Angel had net assets with a book value of $7,300,000 and a fair value of $7,800,000. The difference in fair value is a result of the higher fair value of equipment than its book value. The remaining useful life of this equipment is 25 years. Assuming this investment was purchased on 1/1, how will Zeng record the difference in net assets for this investment on 12/31? A) The higher fair value will allow Zeng to increase the Investment account and Income from Investment by $20,000 each year. B) The additional depreciation expense will decrease the Income from Investment as well as the Investment account by $6000. C) The higher fair value will allow Zeng to increase the Investment account and Income from Investment by $6000 each year. D) The additional depreciation expense will decrease the Income from Investment as well as the Investment account by $20,000. Answer: B Explanation: $7,800,000 - 7,300,000 = $500,000 / 25 = $20,000 depr. exp. $20,000 × (6,000,000 / 20,000,000) = $6000 Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Meyer Jewelers purchased 18,000,000 of the outstanding 60,000,000 shares of Angel & Associates. Meyer has significant influence over Angel, so Meyer will account for this investment using the equity method. On the purchase date, Angel had net assets with a book value of $7,300,000 and a fair value of $7,900,000. The difference in fair value is a result of the higher fair value of equipment than its book value. The remaining useful life of this equipment is 25 years. Assuming this investment was purchased on 1/1, which of the following is the correct journal entry to record the difference in net assets for this investment on 12/31? A) Investment in Angel & Associates Income from Investment

7200 7200

B) Depreciation Expense Accumulated Depreciation - Investment Assets

24,000 24,000

C) Depreciation Expense Investment in Angel & Associates

24,000

D) Income from Investment Investment in Angel & Associates

7200

24,000

7200

Answer: D Explanation: $7,900,000 - $7,300,000 = $600,000 / 25 = $24,000 depr. exp. $24,000 × (18,000,000 / 60,000,000) = $7200 Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Eagle Exporters purchased 80,000 of the 200,000 outstanding shares of Giant Distributors for $3,000,000. Eagle has significant influence over Giant and will account for this investment using the equity method. During the year, Giant declared dividends of $100,000 and reported Net Income of $780,000. What is the balance in the Investment in Giant account at year end? A) $2,648,000 B) $2,728,000 C) $3,352,000 D) $3,272,000 Answer: D Explanation: 80,000 / 200,000 = 40% ownership share, so use equity method 3,000,000 - (100,000 × .4) + (780,000 × .4) = $3,272,000 Diff: 3 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) On January 3, 2023, Sheppard Corporation purchased 15% of Meredith Corporation's common stock for $62,000. Meredith's net income for the years ended December 31, 2023 and 2024 were $18,000 and $56,000 respectively. Meredith declared no dividends during 2023; however, during 2024, the company declared a $70,000 dividend. On December 31, 2023, the fair value of Meredith's stock that Sheppard Corporation owned had increased to $74,000; in 2024, it increased again to $76,000. What will be the balance in the investment account at the end of December 31, 2023? A) $62,000 B) $92,000 C) $76,000 D) $74,000 Answer: D Explanation: Because Sheppard's investment in Meredith is 15% of the value of the stock, they will not use the equity method. At the end of the year, the account will be adjusted to fair value. Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) On January 3, 2023, Sheppard Corporation purchased 15% of Meredith Corporation's common stock for $62,000. Meredith's net income for the years ended December 31, 2023 and 2024 were $18,000 and $56,000 respectively. Meredith declared no dividends during 2023; however, during 2024, the company declared a $70,000 dividend. On December 31, 2023, the fair value of Meredith's stock that Sheppard Corporation owned had increased to $73,000; in 2024, it increased again to $79,000. What will be the carrying value of the investment at the end of December 31, 2024? A) $62,000 B) $73,000 C) $135,000 D) $79,000 Answer: D Explanation: Because Sheppard's investment in Meredith is 15% of the value of the stock, they will not use the equity method. At the end of the year, the account will be adjusted to fair value. Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

20) On January 3, 2023, Sheppard Corporation purchased 25% of Meredith Corporation's common stock for $65,000. The net asset's book value is equal to the fair market value. Meredith's net income for the years ended December 31, 2023 and 2024 were $18,000 and $56,000 respectively. Meredith declared no dividends during 2023; however, during 2024, the company declared a $70,000 dividend. On December 31, 2023, the fair value of Meredith's stock that Sheppard Corporation owned had increased to $72,000; in 2024, it increased again to $80,000. What would be the balance in the investment account as of December 31, 2023? A) $65,000 B) $69,500 C) $72,000 D) $80,000 Answer: B Explanation: $65,000 + ($18,000 × 25%) = $69,500 Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

21) On January 3, 2023, Sheppard Corporation purchased 25% of Meredith Corporation's common stock for $64,000. The net asset's book value is equal to the fair market value. Meredith's net income for the years ended December 31, 2023 and 2024 were $18,000 and $56,000 respectively. Meredith declared no dividends during 2023; however, during 2024, the company declared a $70,000 dividend. On December 31, 2023, the fair value of Meredith's stock that Sheppard Corporation owned had increased to $71,000; in 2024, it increased again to $76,000. What would be the balance in the investment account as of December 31, 2024? A) $64,000 B) $65,000 C) $71,000 D) $76,000 Answer: B Explanation: $64,000 + ($18,000 × 25%) + ($56,000 × 25%) - ($70,000 × 25%) = $65,000 Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

22) Crush Enterprises purchased 200,000 of the 400,000 outstanding shares of Carly Casualties for $4,400,000 on 1/1/2023. On the date of the investment, Carly had net assets with a book value of $9,500,000 and fair value of $10,000,000. This difference is the result of equipment (remaining 10-year life) with a higher fair value than book value. Crush has significant influence over Carly and will account for this investment using the equity method. During the year, Carly declared dividends of $125,000 and reported Net Income of $1,200,000. What is the balance in the Investment in Carly account at year end? A) $4,937,500 B) $4,975,000 C) $4,912,500 D) $4,962,500 Answer: C Explanation: Proportion of Ownership = 200,000 / 400,000 = 50%, so use equity method Share of Dividends = $125,000 × 50% = $62,500 Share of Net Income = $1,200,000 × 50% = $600,000 Share of Additional Depreciation Expense = ($10,000,000 - $9,500,000) / 10 = $50,000 × 50% = $25,000 Investment Balance = $4,400,000 - 62,500 + $600,000 - 25,000 = $4,912,500 Diff: 3 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Boston Exporters purchased 40,000 of the 100,000 outstanding shares of Giant Distributors for $2,000,000. Boston has significant influence over Giant and will account for this investment using the equity method. During the year, Giant declared dividends of $140,000 and reported Net Income of $800,000. Record all necessary journal entries for Boston related to this investment for the year. Then, calculate the ending balance of the Investment in Giant account. Answer: Investment Investment in Giant 2,000,000 Cash 2,000,000 Share of Dividends Cash Investment in Giant ((40,000 / 100,000) × $140,000)

56,000

Share of Net Income Investment in Giant Income from Investment ((40,000 / 100,000) × $800,000)

320,000

56,000

320,000

Ending Balance of Investment in Giant $2,000,000 - $56,000 + $320,000 = $2,264,000 Diff: 3 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) On January 1, Austin Corporation purchased 30% of the outstanding voting common stock of San Marcos Industries common stock for $270,000 cash. On that date, the book value and fair value of the net assets of San Marcos Industries were $900,000. On June 30, San Marcos paid cash dividends of $20,000 to its shareholders. San Marcos' net income as of December 31 was $120,000. The fair value of the shares on December 31 was $300,000. Prepare the journal entries necessary to record the above transactions on Austin Corporation's books during the year. Answer: Jan 1 Investment in San Marcos Industries 270,000 Cash 270,000 June 30

Dec 31

Cash ($20,000 × 30%)) Investment in San Marcos Industries

Investment in San Marcos Industries ($120,000 × 30%) Income from Investment

6,000

36,000

Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

6,000

36,000

25) Crush Enterprises purchased 500,000 of the 1,000,000 outstanding shares of Carly Casualties for $4,500,000 on 1/1/2023. On the date of the investment, Carly had net assets with a book value of $9,500,000 and fair value of $10,000,000. This difference is the result of equipment (remaining 10-year life) with a higher fair value than book value. Crush has significant influence over Carly and will account for this investment using the equity method. During the year, Carly declared dividends of $125,000 and reported Net Income of $1,300,000. Prepare all necessary journal entries for Crush related to this investment. Then, calculate the ending balance in the Investment in Carly account. Answer: Investment Investment in Carly 4,500,000 Cash 4,500,000 Share of Dividends Cash Investment in Carly ((500,000 / 1,000,000) × $125,000)

62,500

Share of Net Income Investment in Carly Income from Investment ((500,000 / 1,000,000) × $1,300,000)

650,000

Share of additional Depreciation Expense Income from Investment 25,000 Investment in Carly ((9,500,000 - 9,000,000) / 10) = $50,000 × (500,000 / 1,000,000)

62,500

650,000

25,000

Ending Balance of Investment in Carly $4,500,000 - $62,500 + $650,000 - $25,000 = $5,062,500 Diff: 3 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) What factors should be considered when deciding whether an investor has significant influence over an investee? Answer: While the general guideline is that the investor has significant influence if it holds 20% or more of the investee voting stock, other factors should be considered. These include: 1. Controlling representation on the company's board of directors. 2. Participation in policy-making decisions, including participation in decisions about dividends and other distributions. 3. Material transactions with the company. 4. Interchange of management personnel. 5. Provision of essential technical information. Diff: 3 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Reflective thinking

27) What are the three levels of influence that an investor can have over an investee company? What is the appropriate accounting treatment for each level of influence? Answer: 1. No significant influence–This applies to investments of less than 20% of another company. These investments are recorded initially at cost. Dividends received are recorded as investment revenue. At the end of every reporting period, the investment is adjusted to fair value. If fair value is not readily determinable, fair value should be obtained from Levels 2 and 3 from the fair value hierarchy or the investment can be adjusted using price changes in similar securities from same issuer. Unrealized gains and losses from fair value adjustments and realized gains and losses from sales are reported on the income statement. 2. Significant influence–This applies to investments from 20 - 50%. These investments are recorded at cost and adjusted for changes related to the investor's share of the investee's income or loss. They are also decreased by the investor's share of dividend payments. If there is an excess of fair value over book value of the investee's net assets, the investment account is adjusted for the investor's share of the excess. There is no fair value adjustment made unless the investor uses the fair value option. 3. Control–This applies to investments of greater than 50%. These investments are accounted for by filing consolidated income statements. Diff: 3 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) On January 3, 2023, Sheppard Corporation purchased 25% of Meredith Corporation's common stock for $70,000. The net asset's book value is equal to the fair market value. Meredith's net income for the years ended December 31, 2023 and 2024 were $20,000 and $60,000 respectively. Meredith declared no dividends during 2023; however, during 2024, the company declared a $30,000 dividend. On December 31, 2023, the fair value of Meredith's stock that Sheppard Corporation owned had increased to $71,000; in 2024, it increased again to $76,000. What would be the balance in the investment account as of December 31, 2024? Answer: $70,000 + ($20,000 × 25%) + ($60,000 × 25%) - ($30,000 × 25%) = $82,500 Diff: 2 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

29) Crush Enterprises purchased 200,000 of the 500,000 outstanding shares of Carly Casualties for $4,000,000 on 1/1/2023. On the date of the investment, Carly had net assets with a book value of $9,400,000 and fair value of $10,000,000. This difference is the result of equipment (remaining 10-year life) with a higher fair value than book value. Crush has significant influence over Carly and will account for this investment using the equity method. During the year, Carly declared dividends of $120,000 and reported Net Income of $1,100,000. What is the balance in the Investment in Carly account at year end? Answer: Proportion of ownership = 200,000 / 500,000 = 40%, so use equity method Share of Dividends = $120,000 × 40% = $48,000 Share of Net Income = $1,100,000 × 40% = $440,000 Share of Additional Depreciation Expense = ($10,000,000 - $9,400,000) / 10 = $60,000 × 40% = $24,000 Investment Balance = $4,000,000 – 48,000 + $440,000 - 24,000 = $4,368,000 Diff: 3 Objective: 16.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16.5

Long-Term Notes Receivable

1) The face value and present value of a long-term note receivable are always different and require present value techniques to calculate this difference. Answer: FALSE Diff: 1 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Reflective thinking

2) If interest payment dates associated with notes receivable do not coincide with a company's fiscal yearend, the company must accrue the amount of interest revenue earned as of the fiscal year-end even though it is not receiving the interest payment on this date. Answer: TRUE Diff: 1 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Reflective thinking

3) If the stated interest rate of a note is higher than the prevailing market rate, a resulting discount on notes receivable will be recorded. Answer: FALSE Diff: 1 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Reflective thinking

4) A Discount on Notes Receivable results from a stated rate of interest that is lower than the prevailing market rate of interest. Answer: TRUE Diff: 1 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Reflective thinking

5) When a note's stated interest rate is less than the market rate, the note is valued at a premium. Answer: FALSE Diff: 1 Objective: 16.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Amortization of a Discount on Notes Receivable results in receiving less in Cash interest payments than earned Interest Revenue. Answer: TRUE Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

7) When a note receivable is issued at a discount, ________. A) the face value of the note equals the proceeds B) the carrying value of the note decreases over the life of the note receivable C) the market rate of interest exceeds the stated rate D) the amount of discount amortized decreases each year over the life of the note Answer: C Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) If a note's stated interest rate is equal to the prevailing market rate of interest, which of the following is true? A) The note's face value is less than the note's present value. B) The note's face value is more than the note's present value. C) The note's face value and present value are equal. D) There is not enough information provided to make this determination. Answer: C Diff: 1 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) What type of account is Discount on Notes Receivable? A) contra-Asset account B) contra-revenue account C) liability account D) expense account Answer: A Diff: 1 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Reflective thinking

10) Which of the following is(are) the primary effect(s) of amortizing a discount on notes receivable? A) It increases the interest revenue so that the corporation's effective rate of return is brought up to the higher market rate. B) It reduces the discount and increases the carrying value of the note receivable until the carrying value is equal to the face value of the note. C) Both A & B are the primary effects of amortizing a discount. D) None of the above are accurate. Answer: C Diff: 1 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Reflective thinking

11) Bosworth Corporation accepted a 5-year note receivable from Steelman Company on January 1, Year 1. The maturity value of the note is $800,000. The note has a stated interest rate of 10%. However, the prevailing market interest rate is 12%. The note requires interest payments on June 30 and December 31. What is the present value of this note at inception? A) $741,119 B) $446,716 C) $800,000 D) $1,035,523 Answer: A Explanation: Using Excel, rate = 12%/2 = 6% nper = 5 years × 2 payments per year = 10 pmt = 10% × $800,000 × 1/2 = $40,000 fv = $800,000 Formula: =PV.06,10,40000, 800000) PV = $741,119 Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Bosworth Corporation accepted a 5-year note receivable from Steelman Company on January 1, Year 1. The maturity value of the note is $750,000. The note has a stated interest rate of 10%. However, the prevailing market interest rate is 12%. The note requires interest payments on June 30 and December 31. What will be the interest revenue recorded on June 30, Year 1? A) $37,500 B) $45,000 C) $75,000 D) $41,688 Answer: D Explanation: Using Excel, begin by finding the present value of the notes receivable: rate = 12%/2 = 6% nper = 5 years × 2 payments per year = 10 pmt = 10% × $750,000 × 1/2 = $37,500 fv = $$750,000 Formula: =PV(.06,10,37500,750000) PV = $694,799 Interest revenue for the first payment is the carrying value of the note times the market rate of interest times 1/2, because interest is paid semi-annually. Interest revenue = $694,799 × 12% × 1/2 = $41,688 Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Bosworth Corporation accepted a 5-year note receivable from Steelman Company on January 1, Year 1. The maturity value of the note is $800,000. The note has a stated interest rate of 10%. However, the prevailing market interest rate is 12%. The note requires interest payments on June 30 and December 31. What will be the note balance at December 31, Year 1? A) $741,119 B) $745,586 C) $800,000 D) $750,321 Answer: D Explanation: Using Excel, =PV(.06,10,40000,800000) = $741,119 Interest Effective Discount Note Date Received Interest Amortization Balance 741,119 June 30 Year 1 40,000 44,467 4467 745,586 December 31 Year 1 40,000 44,735 4735 750,321 Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) HdG, Inc. accepts a $500,000, 5% note from Aberdeen Unlimited on April 1, 2023, and lends money to Aberdeen. Aberdeen agrees to pay 5 equal annual payments on this note beginning March 31, 2024. The market rate at the date of issuance of this note was 5%. What is the annual payment that HdG will receive for this note? A) $25,000 B) $115,487 C) $6250 D) $109,988 Answer: B Explanation: Calculate using Excel using the following inputs: rate = .05 nper = 5 pv = $500,000 Excel Formula: =PMT(.05, 5, 500000) = $115,487 Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) HdG, Inc. accepts a $800,000, 7% note from Aberdeen Unlimited on April 1, 2023, and lends money to Aberdeen. Aberdeen agrees to pay 5 equal annual payments on this note beginning March 31, 2024. The market rate at the date of issuance of this note was 7%. How much Interest Revenue will HdG record on December 31, 2023, the end of its fiscal year? A) HdG will not record Interest Revenue until it receives the first installment payment on this note on March 31, 2024. B) $28,000 C) $56,000 D) $42,000 Answer: D Explanation: $800,000 × .07 × 9/12 Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) HdG, Inc. accepts a $200,000, 8% note from Aberdeen Unlimited on April 1, 2023, and lends money to Aberdeen. Aberdeen agrees to pay 5 equal annual payments on this note beginning March 31, 2024. The market rate on the date of issuance of this note was 8%. HdG has a fiscal year end of December 31. How much Interest Revenue will HdG record on March 31, 2024, the first annual installment payment date? A) $4000 B) $16,000 C) $1333 D) $8000 Answer: A Explanation: $200,000 × .08 × 3/12 Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Trader Trust accepts a $600,000 non-interest bearing 20-year note from Coffee Co. in exchange for cash on 1/1/2023. Coffee Co. promises to repay $600,000 at maturity. The market rate on 1/1/2023 was 4%. How much cash will Trader loan Coffee in exchange for this note? A) $600,000 B) $24,000 C) $277,193 D) $273,832 Answer: D Explanation: Calculate using Excel PV function with the following inputs: rate = 4% nper = 20 pmt = $0 fv = $600,000 Excel Formula: = PV(4%,20,0,600000) = $273,832 Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Trader Trust accepts a $500,000 non-interest bearing 10-year note from Coffee Co. in exchange for Cash on 1/1/2023. Coffee Co. promises to repay $500,000 at maturity. The market rate on 1/1/2023 was 4%. How much Interest Revenue will Trader Trust record on this note in 2023? A) $0, this is a non-interest-bearing note receivable. B) $13,511 C) $20,000 D) $13,891 Answer: B Explanation: Calculate using Excel PV function with the following inputs: rate = 4% nper = 10 pmt = $0 fv = $500,000 Excel Formula: = PV(.04,10,0,500000) PV = $337,782 Interest revenue = $337,782 × 4% = $13,511 Diff: 3 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Trader Trust accepts a $500,000 non-interest bearing 20-year note from Coffee Co. in exchange for Cash on 1/1/2023. Coffee Co. promises to repay $500,000 at maturity. The market rate on 1/1/2023 was 4%. What is the carrying value of this note on the balance sheet on 12/31/2023? A) $500,000 B) $228,193 C) $237,321 D) $262,679 Answer: C Explanation: Calculate using Excel PV function with the following inputs: rate = 4% nper = 20 pmt = $0 fv = $500,000 Excel Formula: = PV(.04,20,0,500000) PV = $228,193 Interest revenue = $228,193 × 4% = $9128 $228,193 + $9128 = $237,321 Diff: 3 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) On 1/1/2023, Lantana Loan Co., a calendar-year company, accepts a 4%, $200,000 three-year loan that pays interest semi-annually on 6/30 and 12/31 from Diamond Distributors, when the market rate of interest was 6%. In exchange for the note, Diamond agrees to make semi-annual interest payments and repay the full $200,000 at maturity. How much cash will Diamond receive in exchange for this note? A) $200,000 B) $196,000 C) $189,308 D) $189,166 Answer: D Explanation: Calculated using Excel PV function with the following inputs: rate = 6%/2 = 3% nper = 3 years × 2 payments per year = 6 pmt = 4000 (200,000 × 4% × 6/12) fv = $200,000 Excel Formula: = PV(.03,6,4000,200000) = $189,166 Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) On 1/1/2023, Lantana Loan Co., a calendar-year company, accepts a 6%, $300,000 three-year loan that pays interest semi-annually on 6/30 and 12/31 from Diamond Distributors, when the market rate of interest was 10%. In exchange for the note, Diamond agrees to make semi-annual interest payments and repay the full $300,000 at maturity. What is the amount of discount amortized and the amount of Interest Revenue recorded on 6/30/2023, the date of the first interest payment? (Round any intermediate calculations and your final answer to the nearest dollar.) A) Discount Amortized, $4477; Interest Revenue, $13,477 B) Discount Amortized, $4477; Interest Revenue, $9000 C) Discount Amortized, $9000; Interest Revenue, $13,477 D) Discount Amortized, $9000; Interest Revenue, $9000 Answer: A Explanation: First, calculate the PV of the note using Excel PV function with the following inputs: rate = 10% /2 = 5% nper = 3 years × 2 payments per year = 6 pmt = $9000 (300,000 × 6% × 6/12) fv = $300,000 Excel Formula: = PV(.05,6,9000,300000) = $269,546

Date Jan. 1, 2023 June 30, 2023

Cash Interest

Effective Interest

Discount Amortization

$9000

$13,477

$4477

Based on this PV, the first amortization entry would be: Account Debit Cash ($300,000 × 6% × 6/12) 9000 Discount on Notes Receivable $4477 Interest Revenue (($269,546 × 10% × 6/12)

Note Balance $269,546 274,023

Credit

13,477

Diff: 3 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) What are the primary effects of amortizing a discount on notes receivable? Answer: There are two primary effects of discount amortization: 1. Amortization increases the interest revenue so that the corporation's effective rate of return is brought up to the higher market rate. 2. Amortization reduces the discount and increases the carrying value of the note receivable until the carrying value is brought up to its face value at the maturity date. Diff: 2 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Reflective thinking

23) ABC accepts a $400,000, 9%, two-year note from DEF on July 1, 2023, and lends cash to DEF. This note matures on June 30, 2025, and requires annual installment payments each June 30 until maturity. The market rate of interest on the date of issue was 9%. Calculate the required annual payment and complete the amortization table for this note receivable, and then complete all necessary journal entries for 2023, 2024, and 2025. ABC is a calendar-year company that files financial statements annually. Answer: Payment calculated using Excel function with the following inputs: rate = 9%; nper = 2; pv = $400,000; Excel Formula: = PMT(.09,2,400000) = $227,388. Amortization Table:

Date 7/1/2023 6/30/2024 6/30/2025

Effective Interest

Principal Received

Payment

Payment Balance

$36,000 18,776

$191,388 208,612

$227,388 227,388

208,612 0

Journal Entries: Date Account 7/1/2023 Notes Receivable Cash

Debit 400,000

12/31/2023

18,000

Interest Receivable Interest Revenue ($400,000 × .09 × 6/12)

6/30/2024 Cash

Notes Receivable Interest Receivable Interest Revenue

227,388

12/31/2024

Interest Receivable Interest Revenue ($208,612 × .09 × 6/12)

6/30/2025 Cash

9,388

Note $400,000

Credit 400,000

18,000

191,388 18,000 18,000

9,388

227,388 Notes Receivable Interest Receivable Interest Revenue

208,612 9,388 9,388

Diff: 3 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Trader Trust accepts a $500,000 non-interest bearing 10-year note from Coffee Co. in exchange for Cash on 1/1/2023. Coffee Co. promises to repay $500,000 at maturity. The market rate on 1/1/2023 was 4%. Calculate the value of the note and complete the entire amortization table for this note, then record journal entries for 2023 (assuming Trader is a calendar-year company). Answer: Note balance calculated using Excel PV function with the following inputs: rate = 4%; nper = 10; pmt = $0; fv = $500,000 Excel Formula: = PV(.04,10,0,500000) = $337,782 Amortization Table: Interest Date Received 1/1/2023 12/31/2023 $0 12/31/2024 0 12/31/2025 0 12/31/2026 0 12/31/2027 0 12/31/2028 0 12/31/2029 0 12/31/2030 0 12/31/2031 0 12/31/2032 0

Effective Interest

Discount Amortized

$13,511 14,052 14,614 15,198 15,806 16,439 17,096 17,780 18,491 19,231

Journal Entries: 1/1/2023 Notes Receivable Discount on Notes Receivable Cash 12/31/2023

Note Balance $337,782 351,293 365,345 379,959 395,157 410,9643 427,402 444,498 462,278 480,769 500,000

500,000

Discount on Notes Receivable Interest Revenue

162,218 337,782

13,511 13,511

Diff: 3 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) On July 1, Year 1, Broadway Financing agrees to loan Choctaw Investment Group money in exchange for a non-interest bearing note with a face value of $800,000, due in four years. The current market interest rate is 11%. Broadway has a fiscal year that ends on December 31. Required: 1. What are the proceeds of the note? 2. Prepare the journal entry to record the issuance of the note. 3. Prepare the adjusting journal entries for December 31 Year 1 and Year 2. 4. What is the carrying value of the note at the end of Year 2? Answer: 1. The present value of the note is $526,985, calculated using the following inputs: rate = 11%; nper= 4; pmt = $0; fv = $800,000 Excel formula: =PV(.11,4,0,800000) 7/1/Yr 1

Notes Receivable Discount on Notes Receivable Cash

800,000 273,015 526,985

12/31/Yr 1 December 31, Year 1 Adjusting Entry Discount on Notes Receivable Interest Revenue (526,985 × 11% × 1/2) = $57,968 × 1/2 12/31/Yr 2 December 31 Year 2 Adjusting Entry Discount on Notes Receivable Interest Revenue ($57,968 × 1/2) + ($64,345 × 1/2)

28,984 28,984

61,157 61,157

4. The carrying value of the note at the end of Year 2 is $617,126. Carrying value = $526,985 + $28,984 + $61,157 = $617,126.

Date July 1, Year 1 Dec. 31, Year 1 Dec. 31, Year 2

Discount Amortization 28,984 $61,157

Note Carrying Value $526,985 $555,969 $617,126

Diff: 3 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

26) On 1/1/2023, Lantana Loan Co., a calendar-year company, accepts a 5%, $500,000 three-year loan that pays interest semi-annually on 6/30 and 12/31 from Diamond Distributors, when the market rate of interest was 10%. In exchange for the note, Diamond agrees to make semi-annual interest payments and repay the full $500,000 at maturity. Complete the amortization table for this note, then complete all journal entries for 2023. Answer: Beginning note balance is calculated using Excel PV function with the following inputs: rate = 5%; nper = 6; pmt = $12,500 (500,000 × .05 × 6/12); fv = $500,000 Excel Formula: =PV(.05,6,12500,500000) = $436,554 Amortization Table:

Date 1/1/2023 6/30/2023 12/31/2023 6/30/2024 12/31/2024 6/30/2025 12/31/2025

Interest Received

Effective Interest

Discount Amortized

$12,500 12,500 12,500 12,500 12,500 12,500

$21,828 22,294 22,784 23,298 23,838 24,404

$9,328 9,794 10,284 10,798 11,338 11,904

Journal Entries: 1/1/2023 Notes Receivable Discount on Notes Receivable Cash

Note Balance $436,554 445,882 455,676 465,960 476,758 488,096 500,000

500,000

6/30/2023 Cash Discount on Notes Receivable Interest Revenue

12,500 9,328

12/31/2023 Cash Discount on Notes Receivable Interest Revenue

12,500 9,794

Diff: 3 Objective: 16.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

63,446 436,554

21,828

22,294

16.6

The Fair Value Option for Reporting Investments

1) A company can choose the fair value option for reporting some assets, while choosing to report other assets at cost. Answer: TRUE Diff: 1 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Reflective thinking

2) Companies can elect to switch to the fair value option for reporting assets at any point during the asset's life. Answer: FALSE Diff: 1 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Reflective thinking

3) If a company elects to use the fair value option for a financial asset at the initial acquisition date, unrealized gains and losses at year-end are reported as part of other comprehensive income. Answer: FALSE Diff: 1 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Reflective thinking

4) IFRS allows companies to use the fair value option for all assets except investments being accounted for using the equity method. Answer: TRUE Diff: 1 Objective: 16.6 IFRS/GAAP: IFRS AACSB: Reflective thinking

5) Which of the following statements is correct about the fair value option under IFRS? A) The fair value method increases volatility in retained earnings. B) Using the fair value method promotes mismatches because assets and liabilities are measured under different bases. C) IFRS does not allow fair value reporting for investments under the equity method. D) IFRS allows a company to revoke the fair value option at any time. Answer: C Diff: 2 Objective: 16.6 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) When must a company generally elect the fair value option for reporting financial assets? A) A company can elect the fair value option at any point in the asset's life, but cannot then revert back to accounting for those assets at cost. B) A company must typically elect the fair value option at acquisition. C) A company can typically choose the cost or fair value for each asset each year at the balance sheet date. D) Companies may not account for assets at fair value. GAAP requires these be recorded at cost. Answer: B Diff: 1 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Reflective thinking

7) If a company has elected the fair value option, where are gains and losses resulting from adjusting these accounts to fair value reported? A) Unrealized Gains are reported as part of Other Comprehensive Income while Unrealized losses are reported as part of Net Income. B) Unrealized Gains are reported as part of Net Income, while Unrealized Losses are reported as part of Other Comprehensive Income. C) Unrealized Gains and Losses are both reported as part of Net Income. D) Unrealized Gains and Losses are both reported as part of Other Comprehensive Income. Answer: C Diff: 1 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Reflective thinking

8) If a company elects the fair value option to account for equity securities, what will be recorded differently when there is no significant influence? A) Unrealized Gains and Losses will now be reported as part of Net Income instead of Other Comprehensive Income. B) Dividends received from the investee will now be credited to Dividend Revenue instead of as a reduction to the investment account. C) A proportionate share of net income will no longer need to be recorded for these equity securities. D) There is no difference in accounting for equity securities with no significant influence as these are already accounted for using the fair value method. Answer: D Diff: 1 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Reflective thinking

9) Ewok Enterprises recently elected the fair value option to account for its investment in Yoda Inc. Ewok purchased the shares for $203,000 and the shares are currently trading for $193,000 at year-end. What is the amount of gain or loss reported at year-end for this investment and where is this gain or loss reported? A) Unrealized Loss of $10,000, reported as part of Net Income. B) Unrealized Loss of $10,000, reported as part of Other Comprehensive Income. C) Unrealized Gain of $10,000, reported as part of Net Income. D) Unrealized Gain of $10,000, reported as part of Other Comprehensive Income. Answer: A Diff: 1 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Ewok Enterprises recently elected the fair value option to account for its investment in Yoda Inc. Ewok purchased the shares for $204,000 and the shares are currently trading for $190,000 at year-end. What is the carrying value of this investment on the balance sheet of Ewok? A) $204,000 B) $14,000 C) $394,000 D) $190,000 Answer: D Diff: 1 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Skywalker Limited purchased shares of Jedi Jewelers during 2022 for $124,000. Skywalker elected the fair value option for accounting for this investment. At year end 2022, 2023, and 2024, this investment had a fair value of $120,000, $134,000, and $137,000, respectively. What is the amount of unrealized gain or loss reported on this investment at year-end 2024? A) Unrealized Gain of $17,000 B) Unrealized Gain of $3000 C) Unrealized Loss of $10,000 D) Unrealized Gain of $14,000 Answer: B Explanation: Unrealized Gain is the difference in Fair Value from 2024 ($137,000) and 2023 ($134,000), or $3000. Diff: 2 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Skywalker Limited purchased an equity investment in Jedi Jewelers during 2022 for $131,000. Skywalker has significant influence over Jedi. Skywalker elected the fair value option for accounting for this investment. At year end 2022, 2023, and 2024, this investment had a fair value of $120,000, $130,000, and $138,000, respectively. How will this investment be reported on the Balance Sheet at year-end, 2024? A) Investment in Jedi - $138,000 B) Investment in Jedi - $130,000, plus Fair Value Adjustment - Fair Value Option - $7000 C) Investment in Jedi - $131,000 D) Investment in Jedi - $131,000, plus Fair Value Adjustment - Fair Value Option - $7000 Answer: D Explanation: Investment account maintained at cost ($131,000); FV Adjustment Account balance is 2024 FV less cost ($138,000 - $131,000 = $7000) Diff: 2 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) The fair value option improves financial reporting by enabling entities to offset volatility in reported earnings. How is this accomplished? Answer: Very often, assets and liabilities are interrelated on the financial statements. If the liability is reported at fair value and the related asset is not, then the company will report an earnings stream that is more volatile than if the related asset and liability were both reported at fair value. Diff: 2 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Reflective thinking

14) Accounting for equity securities with no significant influence remains unchanged if a company elects the fair value option for reporting this investment. Why? Answer: Equity securities with no significant influence are already accounted for using the fair value method. While unrealized gains and losses for other investments are reported as part of other comprehensive income, unrealized gains and losses for equity securities with no significant influence are already reported as part of net income. Therefore, the accounting for them is already completed using the fair value option. The only exception is equity securities with no significant influence and no readily determinable fair value that are accounted for by adjusted cost. Diff: 1 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Reflective thinking

15) Ewok Enterprises recently elected the fair value option to account for its investment in Yoda Inc. Ewok has significant influence over Yoda. Ewok purchased the shares for $210,000 and the shares are currently trading for $195,000 at year-end. Record the journal entries needed to purchase the investment, and then adjust it to fair value. Then, show how this investment will be reported on the balance sheet at year-end. Answer: Journal Entries Equity Investment in Yoda Cash

210,000

Unrealized Loss on Equity Investment - Fair Value Option (Net Income) Fair Value Adjustment - Fair Value Option

15,000

210,000

15,000

Balance Sheet Presentation: Equity Investment in Yoda Less Fair Value Adjustment - Fair Value Option Equity Investment in Yoda - Fair Value

$210,000 (15,000) $195,000

Diff: 2 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Skywalker Limited purchased shares of Jedi Jewelers during 2022 for $124,000 and has significant influence. Skywalker elected the fair value option for accounting for this investment. At year end 2022, 2023, and 2024, this investment had a fair value of $120,000, $130,000, and $135,000, respectively. Record the journal entries for the purchase of this investment and the adjustment to fair value for each of the three years listed. Answer: Equity Investment in Jedi 124,000 Cash 124,000 2022 Fair Value Adjustment Unrealized Loss on Equity Investment - Fair Value Option - Net Income Fair Value Adjustment - Fair Value Option ($124,000 - $120,000)

4,000

2023 Fair Value Adjustment Fair Value Adjustment - Fair Value Option 10,000 Unrealized Gain on Equity Investment - Fair Value Option - Net Income 10,000 (FV, $130,000, less previous fair value $120,000 = $10,000 adjustment) 2024 Fair Value Adjustment Fair Value Adjustment - Fair Value Option 5,000 Unrealized Gain on Equity Investment - Fair Value Option - Net Income (FV, $135,000, less previous fair value, $130,000 = $5,000 adjustment)

5,000

Diff: 3 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Sampson Limited purchased shares of Jackson Company during 2022 for $124,000. Sampson elected the fair value option for accounting for this investment. At year end 2022, 2023, and 2024, this investment had a fair value of $125,000, $135,000, and $147,000, respectively. What is the amount of unrealized gain or loss reported on this investment at year-end 2024? Answer: Unrealized gain of $12,000 Explanation: Unrealized Gain is the difference in Fair Value from 2024 ($147,000) and 2023 ($135,000), or $12,000. Diff: 2 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Sampson Limited purchased an equity investment in Jones Company during 2022 for $120,000. Sampson has significant influence over Jones Company. Sampson elected the fair value option for accounting for this investment. At year-end 2022, 2023, and 2024, this investment had a fair value of $120,000, $130,000, and $140,000, respectively. How will this investment be reported on the Balance Sheet at year-end, 2024 (include the balances in the Investment in Jones account and Fair Value Adjustment account)? Answer: Investment in Jones Company - $120,000, plus Fair Value Adjustment - Fair Value Option $20,000 Investment account maintained at cost ($120,000); FV Adjustment Account balance is 2024 FV less cost ($140,000 - $120,000 = $20,000) Diff: 2 Objective: 16.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

16.7

Disclosures for Investments in Financial Assets

1) Companies generally provide both qualitative and quantitative disclosures of investing assets in the annual report. Answer: TRUE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Reflective thinking

2) For held-to-maturity securities, companies must disclose the amortized cost, the aggregate fair value, the total unrealized gains and losses reported in net income. Answer: FALSE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Reflective thinking

3) For trading securities, companies must disclose the amortized cost, the aggregate fair value, the total unrealized gains and losses reported in net income. Answer: TRUE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Reflective thinking

4) For available-for-sale securities, companies must disclose whether the conversion of convertible securities of the investee would have a significant effect on the reported income from the investment. Answer: FALSE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Reflective thinking

5) IFRS requires additional disclosures of summarized financial information of the investee, including total assets, liabilities, revenue, and net income or loss. Answer: TRUE Diff: 1 Objective: 16.7 IFRS/GAAP: IFRS AACSB: Reflective thinking

6) Quantitative disclosures for investing assets include the nature and extent of risks arising from financial assets. Answer: FALSE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) For securities classified as held-to-maturity, companies must disclose the aggregate fair value of those securities in the notes to its financial statements. Answer: TRUE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) For securities classified as trading, companies disclose the maturity value of those securities in the notes to its financial statements. Answer: FALSE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) For investments accounted for under the equity method, companies disclose the fair value for those investments. Answer: TRUE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) For companies with equity investments, IFRS requires disclosure of summarized financial information of the investee, including the amounts of total assets, total liabilities, revenues, and net income (loss). Answer: TRUE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Companies report securities based on a fair value hierarchy in which Level 3 is the most reliable estimates of inputs used and Level 1 fair value input estimates require the most judgment. Answer: FALSE Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Which of the following would not be disclosed for held-to-maturity securities? A) aggregate fair value B) gross realized gains and losses C) gross unrecognized holding gains and losses D) amortized cost basis Answer: B Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Which of the following must be disclosed for held-to-maturity securities? A) the name of the investee and the percentage ownership B) net carrying amount C) total gains and losses accumulated in other comprehensive income D) difference between the carrying value of the investment and the amount of underlying equity in net assets Answer: B Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Which of the following would not be disclosed for trading securities? A) aggregate fair value B) gross realized gains and losses C) amortized cost basis D) any impairment loss and where reported Answer: D Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) Which of the following would not be disclosed for available-for-sale securities? A) aggregate fair value B) date of acquisition C) amortized cost basis D) any impairment loss and where reported Answer: B Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) Which of the following must be disclosed for available-for-sale securities? A) the name of the investee and the percentage ownership B) amortized cost basis C) market price D) difference between the carrying value of the investment and the amount of underlying equity in net assets Answer: B Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) How are equity method investment disclosures different for IFRS companies than for U.S. GAAP companies? A) IFRS requires additional disclosure related to fair value measurement used when the fair value option was elected. B) IFRS require all fair values to be reported, while GAAP only requires disclosures of fair value if the fair value option was elected. C) IFRS requires additional disclosures for summarized financial information of the investee, including total assets, liabilities, income and loss. D) IFRS requires more detailed disclosures explaining the areas where significant influence was exerted over the investee during the reporting period. Answer: C Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP/IFRS AACSB: Reflective thinking

18) Which of the following is not a consideration for a company in determining whether to disclose more detail by security type? A) geographic concentration B) economic characteristic C) business sector D) total return on investment to date Answer: D Diff: 1 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Reflective thinking

19) For investing assets reported at fair value, companies disclose information to enable users to assess the fair value estimates and reasonableness of assumptions made in determining fair value. How is this accomplished? Answer: Companies report securities based on a fair value hierarchy that reflects the reliability of significant inputs used in making fair value measurements. The levels are ranked from most reliable to those fair values that required the most judgment. The levels are: Level 1: Fair values are determined based on quoted prices in active markets for identical assets. Level 2: Fair values are determined using significant other observable inputs. Other observable input could include securities dealer quotes, or prices based on similar assets in the open markets. Level 3: Fair values are determined using significant unobservable inputs. For instance, fair values in this group could be estimated based on pricing models such as discounted cash flows. Diff: 2 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Reflective thinking

20) For securities classified as held-to-maturity, what do companies disclose in the notes to the financial statements? Answer: For held-to-maturity securities, companies disclose the following by major security type: - Amortized cost basis - Aggregate fair value - Gross unrecognized holding gains (losses) - Net carrying amount - Information about the maturity of debt securities - Any impairment loss and where reported Diff: 2 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Reflective thinking

21) For securities classified as trading, what do companies disclose in the notes to the financial statements? Answer: For securities classified as trading, companies disclose the following by major security type: - Amortized cost basis - Aggregate fair value - Total gains (losses) for securities with net gains (losses) reported in net income and the portion that relates to securities still held. Diff: 2 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Reflective thinking

22) For securities classified as available-for-sale, what do companies disclose in the notes to the financial statements? Answer: For securities classified as available-for-sale, companies disclose the following by major security type: - Amortized cost basis - Aggregate fair value - Gross realized gains (losses) reported in net income and sales proceeds - Net unrealized holding gains (losses) included in accumulated other comprehensive income for the period - Gains and losses reclassified out of accumulated other comprehensive income into income for the period - Total gains (losses) for securities with net gains (losses) in accumulated other comprehensive income - Information about the maturity of debt securities - Any impairment loss and where reported Diff: 2 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Reflective thinking

23) Summarize the financial disclosure requirements for investments accounted for under the equity method. Answer: For investments accounted for under the equity method, companies disclose the following information: 1. The name of the investee and percentage of ownership. 2. Investments held with less than 20% ownership that are accounted for under the equity method and why. 3. Investments held with greater than 20% ownership that are not accounted for by the equity method and why. 4. Any differences between the carrying value of the investment and the amount of underlying equity in net assets. 5. The fair value for those investments with a quoted market price. 6. Whether the conversion of convertible securities of the investee would have significant effect on the reported income from the investment. Diff: 3 Objective: 16.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

16.8

Appendix A: Impairments of Investment Securities

1) Testing for impairments of debt investments is a three step process: Measure the impairment loss, determine where to present it, and assess whether there is a reversal needed in later periods. Answer: FALSE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Reflective thinking

2) Firms must assess every asset on the balance sheet to ensure that all provide future economic benefit to the firm at an amount commensurate with the amount reported on the balance sheet. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Reflective thinking

3) An impairment occurs when an asset's total future cash-generating ability falls below its carrying value. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Reflective thinking

4) With an impairment, the portion of the difference between the carrying value and the fair value that is due to the credit loss is not reported on the financial statements for a held to maturity security. Answer: FALSE Explanation: It is reported on the income statement. Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Reflective thinking

5) If the investor plans on selling the investment or if it is more likely than not that the investor will be required to sell the asset before it recovers the amortized cost, then the investment is written down to its fair value with the entire amount reported in net income. Answer: TRUE Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Reflective thinking

6) Which of the following is not an impairment indicator for investment securities? A) fluctuating stock prices B) deterioration of earnings C) decline in credit rating D) adverse changes in the economy Answer: A Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Reflective thinking

7) Can impairment losses recorded on held-to-maturity debt investments be reversed at a later date? A) Yes, prior unrealized losses can be reversed, but the reversal is limited to the balance in the account, Allowance for Credit Loss: Held-to-Maturity Debt Investment. B) No, impairment losses cannot be reversed. C) Yes, but only non-credit losses recorded in Other Comprehensive Income. D) Yes, but only credit losses recorded in Other Comprehensive Income. Answer: A Diff: 1 Objective: App A IFRS/GAAP: GAAP AACSB: Reflective thinking

8) Grey Co. holds a held-to-maturity debt investment at an amortized cost of $50,000. At 12/31/2022, the fair value of the investment is $49,000 and the present value of the future cash flows is $48,000. Has an impairment loss occurred? If so, how much is the impairment loss to be recorded? A) Yes, the present value of future cash flows are less than the amortized cost, so an impairment loss for the difference must be recorded, $2000. B) Yes, the present value of future cash flows are less than the amortized cost, however, the loss cannot be calculated without knowing if this difference is temporary or other-than-temporary. C) No, the fair value of the investment is less than its amortized cost, so an impairment has not occurred. D) There is not enough information to determine if an impairment loss has occurred. Answer: A Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Pink Partners holds equity investment with a carrying value of $39,000. The investment has no readily determinable value. The current fair value of the investment is $24,000. There is objective evidence of an impairment. Should an impairment loss be recorded? How much of this loss should be classified in net income and how much should be classified in other comprehensive income? A) Yes, the $15,000 impairment loss should be reported as part of net income. B) No, an impairment loss should not be recorded because this is an equity investment. C) Yes, the $15,000 impairment loss should be split evenly between net income and other comprehensive income. D) Yes, there is an impairment loss of $15,000 which should be reported as Other Comprehensive Income. Answer: A Explanation: Impairment Loss = $39,000 - $24,000 = $15,000 Diff: 2 Objective: App A IFRS/GAAP: GAAP AACSB: Analytical thinking

10) Blue Co. holds a debt investment at an amortized cost of $250,000. The present value of future cash flows from the investment at year end is $220,000. Blue classified this investment as held-to-maturity. Determine if an impairment exists and record any necessary resulting journal entries. Answer: Step 1: COMPUTE THE EXPECTED AMOUNT TO BE COLLECTED The expected amount to be collected is the present value of future cash flows of $220,000. Step 2: COMPUTE AN ALLOWANCE FOR CREDIT LOSS The allowance for credit loss is equal to the amortized cost less the present value of future cash flows, $250,000 - $220,000, which equals $30,000. Step 3: REPORT THE CHANGE FOR THE ALLOWANCE FOR CREDIT LOSS IN NET INCOME The entire loss is reported in net income. Journal Entry Impairment Loss - Net Income 30,000 Allowance for Credit Loss: Held-to-Maturity Debt Investment Diff: 3 Objective: App A IFRS/GAAP: GAAP AACSB: Application of knowledge

30,000

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 17 Accounting for Income Taxes 17.1

No Differences between Book and Tax Reporting

1) Book income refers to the amount of income reported on a company's tax return. Answer: FALSE Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Taxable income refers to the amount of income reported on a company's tax return. Answer: TRUE Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The amount of income a company reports in its financial statements is known as ________. A) book income B) net operable income C) taxable income D) revenue income Answer: A Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The amount of income that a company reports on its tax return is known as ________. A) refundable income B) taxable income C) deductible income D) net income Answer: B Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Greene Co. has book income of $425,000, and a tax rate of 30%. Assuming there are no book-tax differences, what will the journal entry be to record the income tax expense? A) Income Tax Expense Income Tax Payable

127,500

B) Income Tax Expense Income Tax Payable

255,000

C) Income Tax Payable Income Tax Expense

127,500

D) Income Tax Payable Income Tax Expense

255,000

127,500

255,000

127,500

255,000

Answer: A Explanation: $425,000 × 30% = $127,500 Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) TLR Productions has book income of $450,000, and a tax rate of 35%. Assuming there are no book-tax differences, what is TLR's income tax expense? A) $144,000 B) $157,500 C) $189,000 D) $292,500 Answer: B Explanation: $450,000 × 35% Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) TNT Corporation's income tax payable is $230,000 and its tax rate is 30%. Assuming no book-tax differences, what is TNT's income before taxes? (Round your answer to the nearest whole dollar.) A) $69,000 B) $230,000 C) $766,667 D) $328,571 Answer: C Explanation: $230,000/30% Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) TNT Corporation's income tax payable is $240,000 and its tax rate is 30%. Assuming no book-tax differences, what is TNT's net income? (Round your answer to the nearest whole dollar.) A) $72,000 B) $240,000 C) $800,000 D) $560,000 Answer: D Explanation: Income before taxes ($240,000/30% = $800,000) less income taxes expense ($240,000) = net income ($560,000). Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) S & C Inc.'s income tax payable is $290,000 and its tax rate is 30%. Assuming no book-tax differences, what is S & C's net income? (Round your answer to the nearest whole dollar.) A) $676,667 B) $87,000 C) $377,000 D) $966,667 Answer: A Explanation: Income before taxes ($290,000/30% = $966,667) less income taxes expense ($290,000) = net income ($676,667). Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Betta Group's net income is $400,000 and its tax rate is 25%. Assuming no book-tax differences, what is Betta's taxes payable? (Round your answer to the nearest whole dollar.) A) $100,000 B) $133,333 C) $1,600,000 D) $533,333 Answer: B Explanation: Income before taxes = $400,000 /( 1 - 25%) = $533,333; Taxes payable = Income before taxes $533,333 - Net income $400,000 = Tax Expense (Payable) = $133,333 Diff: 2 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Brown Inc.'s net income is $300,000 and its tax rate is 25%. Assuming no book-tax differences, what is the journal entry to record income tax expense? (Do not round intermediate calculations. Only round your final answer to the nearest whole dollar.) A) Income Tax Expense 75,000 Income Tax Payable 75,000 B) Income Tax Expense Income Tax Payable

400,000

C) Income Tax Expense Income Tax Payable

300,000

D) Income Tax Expense Income Tax Payable

100,000

400,000

300,000

100,000

Answer: D Explanation: Income before taxes = net income/(1 - tax rate) = $300,000/0.75 = $400,000 Income tax expense = income before taxes - net income = $400,000 - $300,000 = $100,000 Diff: 2 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Gasper Co. has book income of $200,000, and a tax rate of 25%. Assuming there are no book-tax differences, what will the journal entry be to record the income tax expense? Answer: Income Tax Expense ($200,000 × 25%) 50,000 Income Tax Payable 50,000 Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Tiger Productions has book income of $400,000, and a tax rate of 30%. Assuming there are no book-tax differences, what is Tigers income tax expense? Answer: $400,000 × .30 = $120,000 Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Tiger Corporation's income tax payable is $250,000 and its tax rate is 30%. Assuming no book-tax differences, what is Tiger's income before taxes? (Round your answer to the nearest whole dollar.) Answer: $250,000 / 30% = $833,333 Explanation: $230,000/30% Diff: 1 Objective: 17.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

17.2

Permanent Differences between Book and Tax Reporting

1) The effective tax rate is the legally imposed rate in a given taxing jurisdiction. Answer: FALSE Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The statutory tax rate is the legally imposed rate in a given taxing jurisdiction. Answer: TRUE Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) U.S. GAAP requires companies to reconcile the federal statutory income tax rate to the effective tax rate. Answer: TRUE Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) ________ differences between book income and taxable income result in an effective tax rate that differs from the statutory tax rate. A) Temporary B) Permanent C) Short-term D) Long-term Answer: B Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Which of the following statements best describes the effective tax rate? A) It is the legally imposed rate in a given taxing jurisdiction. B) It can be calculated by dividing income tax expense by book income before taxes. C) It changes annually based on provisions from Congress. D) It is calculated as book income divided by taxable income. Answer: B Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Caesar Corporation reports municipal interest income on their financial statements. What (if any) book-tax difference will result? A) Temporary difference; book income greater than taxable income. B) Temporary difference; taxable income greater than book income. C) Permanent difference; book income greater than taxable income. D) No difference; municipal interest is taxable income. Answer: C Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Dante Inc. reported fines and penalties on their income statement this year. What (if any) book-tax difference will result? A) Temporary difference; book income less than taxable income. B) Permanent difference; book income greater than taxable income. C) Permanent difference; book income less than taxable income. D) No difference; fines and penalties are tax deductible. Answer: C Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Olympics Inc. recorded a dividends received deduction on their tax return this year. What (if any) book-tax difference will result? A) Temporary difference; book income less than taxable income. B) Permanent difference; book income less than taxable income. C) Permanent difference; book income greater than taxable income. D) Temporary difference; book income greater than taxable income. Answer: C Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Media Corporation incurred $25,000 in expenses associated with tax-exempt income this year. What (if any) book-tax difference will result? A) Temporary difference; book income less than taxable income. B) Permanent difference; book income less than taxable income. C) Permanent difference; book income greater than taxable income. D) Temporary difference; book income greater than taxable income. Answer: B Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Charmed Inc.'s income before taxes is $720,000 and its tax rate is 25%. Charmed included $30,000 in non-deductible life insurance premiums in the $720,000. There are no other book-tax differences. What is the journal entry to record income tax expense? A) Income Tax Expense Income Tax Payable

7500

B) Income Tax Expense Income Tax Payable

172,500

C) Income Tax Expense Income Tax Payable

180,000

D) Income Tax Expense Income Tax Payable

187,500

7500

172,500

180,000

187,500

Answer: D Explanation: ($720,000 + $30,000) × 0.25 Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Lyon Group's income before taxes is $420,000 and its tax rate is 40%. Lyon included $30,000 in fines and penalties in the $420,000. There are no other book-tax differences. What is income tax payable for Lyon Group? A) $168,000 B) $180,000 C) $156,000 D) $12,000 Answer: B Explanation: ($420,000 + $30,000) × 0.4 Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Tom-Kat Inc.'s income before taxes is $360,000 and its tax rate is 30%. Tom-Kat included $60,000 of interest from municipal bonds in the $360,000. There are no other book-tax differences. What is the journal entry to record income tax expense? A) Income Tax Expense Income Tax Payable

90,000

B) Income Tax Expense Income Tax Payable

108,000

C) Income Tax Expense Income Tax Payable

126,000

D) Income Tax Expense Income Tax Payable

18,000

90,000

108,000

126,000

18,000

Answer: A Explanation: ($360,000 - $60,000) × 0.3 Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Purrfect Pet Industries' income before taxes is $810,000 and its tax rate is 50%. Purrfect Pet included $50,000 of fully deductible inter-corporate dividends received in the $810,000. There are no other book-tax differences. What is the income tax payable for Purrfect Pet? A) $405,000 B) $430,000 C) $25,000 D) $380,000 Answer: D Explanation: ($810,000 - $50,000) × 50% Diff: 1 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Danio Inc.'s income before taxes is $550,000 and its tax rate is 30%. Danio included $30,000 of interest from municipal bonds in the $550,000. There are no other book-tax differences. What is the effective tax rate for Danio Inc.? (Do not round intermediate calculations. Only round your final answer to the nearest percent.) A) 27% B) 28% C) 30% D) 32% Answer: B Explanation: [($550,000 - $30,000) × 30%] / $550,000 Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Blue Company's income before taxes is $410,000 and its tax rate is 40%. Blue included $50,000 of fines and penalties in the $410,000. There are no other book-tax differences. What is the effective tax rate for Blue Company? (Do not round intermediate calculations. Only round your final answer to the nearest percent.) A) 35% B) 40% C) 45% D) 51% Answer: C Explanation: [($410,000 + $50,000) × 40%] / $410,000 Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Kravitz Corporation had income before taxes of $900,000 and a tax rate of 25%. Included in the income are $70,000 in municipal bond interest and $10,000 in fines and penalties. There are no other book-tax differences. Refer to Kravitz Corporation. What is the net amount of Kravitz's book-tax difference? A) Book income that is $60,000 greater than taxable income B) Book income that is $70,000 greater than taxable income C) Taxable income that is $10,000 greater than book income D) Taxable income that is $60,000 greater than book income Answer: A Explanation: Municipal bond interest creates permanent difference – book income $70,000 greater – reduced by permanent difference from fines and penalties – book income $10,000 less – for a net difference of $60,000. Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) Kravitz Corporation had income before taxes of $900,000 and a tax rate of 45%. Included in the income are $80,000 in municipal bond interest and $10,000 in fines and penalties. There are no other book-tax differences. Refer to Kravitz Corporation. What is Kravitz's taxable income? A) $910,000 B) $820,000 C) $830,000 D) $900,000 Answer: C Explanation: Book income $900,000 - $80,000 municipal bond interest + $10,000 fines and penalties = $830,000 taxable income. Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Kravitz Corporation had income before taxes of $890,000 and a tax rate of 45%. Included in the income are $40,000 in municipal bond interest and $20,000 in fines and penalties. There are no other book-tax differences. Refer to Kravitz Corporation. What is Kravitz's effective income tax rate? (Do not round intermediate calculations. Only round your final answer to the nearest tenth percent.) A) 44% B) 46% C) 45% D) 48% Answer: A Explanation: Book income $890,000 - $40,000 municipal bond interest + $20,000 fines and penalties = $870,000 taxable income. Tax = 45% × $870,000 = $391,500. Effective rate = $391,500/$890,000 book income = 44%. Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) Piper Inc.'s income before taxes is $550,000 and its tax rate is 40%. Piper included $30,000 of interest from municipal bonds in the $550,000. There are no other book-tax differences. Prepare the journal entry to record income tax expense and a reconciliation of the statutory tax rate to the effective tax rate. (Do not round intermediate calculations. Only round your final answer to the nearest tenth percent.) Answer: Journal Entry: Income Tax Expense 208,000 Income Tax Payable 208,000 ($550,000 - $30,000) × 40% Reconciliation: Description Income tax at statutory rate Tax savings from municipal interest Tax at the effective rate

Dollars $220,000* $(12,000**) $208,000

Percentage 40.0% (2.2%***) 37.8%****

* $550,000 × 40% ** $30,000 × 40% *** $12,000 / $550,000 **** $208,000 / $550,000 Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Gallagher Corporation's book income before taxes is $600,000 and its tax rate is 35%. Included in the income before taxes is $50,000 in fines and penalties. There are no other book-tax differences. Prepare the journal entry to record income tax expense and a reconciliation of the statutory tax rate to the effective tax rate. (Do not round intermediate calculations. Only round your final answer to the nearest tenth percent.) Answer: Journal Entry: Income Tax Expense 227,500 Income Tax Payable 227,500 ($600,000 + $50,000) × 35% Reconciliation: Description Income tax at statutory rate Tax expense from fines and penalties Tax at the effective rate

Dollars $210,000* $17,500** $227,500

Percentage 35.0% 2.9%*** 37.9%****

* $600,000 × 35% ** $50,000 × 35% *** $17,500 / $600,000 **** $227,500 / $600,000 Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Betz Corporation's income before taxes is $725,000 and its tax rate is 40%. Included in this amount is $50,000 in municipal bond interest and $15,000 in officers' life insurance. There are no other book-tax differences. Prepare the journal entry to record income tax expense and a reconciliation of the statutory tax rate to the effective tax rate. (Do not round intermediate calculations. Only round your final answer to the nearest tenth percent.) Answer: Journal Entry: Income Tax Expense 276,000 Income Tax Payable 276,000 ($725,000 + $15,000 - $50,000) × 40% Reconciliation: Description Income tax at statutory rate Tax savings from municipal interest Tax increase from life insurance Tax at the effective rate

Dollars $290,000* $(20,000**) 6,000****

Percentage 40.0% (2.8%***) .8%*****

$276,000

38.1%******

* $725,000 × 40% ** $50,000 × 40% *** $20,000 / $725,000 **** $15,000 × 40% ***** $6,000/$725,000 ****** $276,000 / $725,000 Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Johnson Corporation had income before taxes of $800,000 and a tax rate of 40%. Included in the income are $60,000 in municipal bond interest and $20,000 in fines and penalties. There are no other book-tax differences. What is Johnson's taxable income? Answer: Book income $800,000 - $60,000 municipal bond interest + $20,000 fines and penalties = $760,000 taxable income. Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

23) Johnson Corporation had income before taxes of $900,000 and a tax rate of 40%. Included in the income are $40,000 in municipal bond interest and $20,000 in fines and penalties. There are no other book-tax differences. What is Johnson's effective income tax rate? (Do not round intermediate calculations. Only round your final answer to the nearest tenth percent.) Answer: Book income = $900,000 - $40,000 municipal bond interest + $20,000 fines and penalties = $880,000 taxable income. Tax = 40% × $880,000 = $352,000. Effective rate = $352,000/$880,000 book income = 40.0%. Diff: 2 Objective: 17.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

17.3

Temporary Differences between Book and Tax Reporting

1) Under U.S. GAAP, companies generally use a cash flow approach to account for temporary differences between book and tax treatment of transactions. Answer: FALSE Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Under U.S. GAAP, companies generally use a balance sheet approach to account for temporary differences between book and tax treatment of transactions. Answer: TRUE Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Temporary differences between the book and tax treatment of transactions create deferred tax assets or deferred tax liabilities. Answer: TRUE Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) A deferred tax asset represents a future reduction in income taxes payable. Answer: TRUE Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Temporary differences cause the effective income tax rate to vary from the statutory rate. Answer: FALSE Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) A deferred tax asset exists when ________. A) the book basis of assets is greater than the tax basis of assets B) the book basis of liabilities is greater than the tax basis of liabilities C) the book basis of assets is equal to the tax basis of assets D) the book basis of liabilities is less than the tax basis of liabilities Answer: B Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) A deferred tax liability is created when ________. A) the book basis of assets is greater than the tax basis of assets B) the book basis of liabilities is greater than the tax basis of liabilities C) the book basis of assets is equal to the tax basis of assets D) the book basis of assets is less than the tax basis of liabilities Answer: A Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Under U.S. GAAP, if a firm writes down inventory for obsolescence, which of the following is created? A) a deferred tax asset B) a deferred tax liability C) a book basis of assets that is greater than the tax basis D) a book basis of liabilities that is less than the tax basis Answer: A Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) When a company depreciates a fixed asset at a faster rate for tax purposes than book purposes, this creates a ________. A) deferred tax asset B) higher tax basis than book basis of assets in the early years C) deferred tax liability D) lower tax basis than book basis of liabilities in the early years Answer: C Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) When a company pays taxes that were previously recorded as a deferred tax liability, the temporary difference ________. A) originates B) reverses C) increases D) decreases Answer: B Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) All of the following are examples of facts that may create temporary book-tax differences except ________. A) contingent liabilities B) depreciation C) product warranty costs D) payment of premiums for life insurance Answer: D Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) All of the following are examples of situations that may create temporary book-tax differences except ________. A) amortization of goodwill B) writing off bad debt C) installment sales D) receipt of municipal bond interest Answer: D Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Greene Co. has pretax book income for the year ended December 31, 2022 in the amount of $285,000 and has a tax rate of 40%. Depreciation for tax purposes exceeded book depreciation by $13,500. What should Greene Co. record as its federal income tax liability for 2022? A) $114,000 B) $78,750 C) $108,600 D) $119,400 Answer: C Explanation: ($285,000 - $13,500) × 40% Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Greene Co. has pretax book income for the year ended December 31, 2022 in the amount of $315,000 and has a tax rate of 30%. Depreciation for tax purposes exceeded book depreciation by $10,500. What should Greene Co. record as its deferred tax liability for 2022? A) $0 B) $3150 C) $91,350 D) $94,500 Answer: B Explanation: $10,500 × 30% Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Inferno Inc. is embroiled in a lawsuit. In 2022, they recognize that a loss of $65,000 is probable. Given a tax rate of 40%, how will this be treated in the accounting records? A) deferred tax asset of $26,000 B) deferred tax liability of $26,000 C) deferred tax asset of $65,000 D) deferred tax liability of $65,000 Answer: A Explanation: book liability exceeds tax liability; $65,000 × 40% Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) S & C Company reported $220,000 depreciation on its 2022 tax return However, they reported $40,000 depreciation expense on their 2022 income statement. The difference in depreciation is a temporary difference that will reverse over time. Assuming S & C's tax rate is constant at 20%, what amount should be added to the deferred income tax liability in S & C's December 31, 2022, balance sheet? A) $8000 B) $36,000 C) $44,000 D) $52,000 Answer: B Explanation: ($220,000 - $40,000) × 20% Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) The following information applies to the operations of MK Inc. for 2022 and 2023. Assume a tax rate of 25% for both years. 2022 information: Sales on account in the amount of $660,000 Warranty expense and associated liability in the amount of $110,000 No other expenses incurred. 2023 information: Sales on account in the amount of $205,000 Warranty repairs made in the amount of $63,000 No expenses incurred. What is MK's book income for 2022? A) $550,000 B) $660,000 C) $770,000 D) $597,000 Answer: A Explanation: Book income = revenues - expenses = $660,000 - $110,000 = $550,000 Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) The following information applies to the operations of MK Inc. for 2022 and 2023. Assume a tax rate of 30% for both years. 2022 information: Sales on account in the amount of $650,000 Warranty expense and associated liability in the amount of $105,000 No other expenses incurred. 2023 information: Sales on account in the amount of $225,000 Warranty repairs made in the amount of $68,000 No expenses incurred. What is MK's taxable income for 2022? A) $545,000 B) $650,000 C) $755,000 D) $582,000 Answer: B Explanation: Warranty expenses are not deductible for tax purposes until actually incurred, so taxable income is $650,000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) The following information applies to the operations of MK Inc. for 2022 and 2023. Assume a tax rate of 20% for both years. 2022 information: Sales on account in the amount of $675,000 Warranty expense and associated liability in the amount of $145,000 No other expenses incurred. 2023 information: Sales on account in the amount of $210,000 Warranty repairs made in the amount of $69,000 No expenses incurred. What is MK's income tax expense for 2022? A) $106,000 B) $135,000 C) $164,000 D) $121,200 Answer: A Explanation: Income tax expense is calculated from book income. Book income = revenues - expenses = $675,000 - $145,000 = $530,000. Income tax expense = $530,000 × 20% = $106,000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) The following information applies to the operations of MK Inc. for 2022 and 2023. Assume a tax rate of 25% for both years. 2022 information: Sales on account in the amount of $675,000 Warranty expense and associated liability in the amount of $135,000 No other expenses incurred. 2023 information: Sales on account in the amount of $215,000 Warranty repairs made in the amount of $60,000 No expenses incurred. What is MK's income tax payable for 2022? A) $135,000 B) $168,750 C) $202,500 D) $153,750 Answer: B Explanation: Warranty expenses are not deductible for tax purposes until actually incurred, so taxable income is $675,000. Income tax payable = taxable income $675,000 × 25% = $168,750. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) The following information applies to the operations of MK Inc. for 2022 and 2023. Assume a tax rate of 30% for both years. 2022 information: Sales on account in the amount of $700,000 Warranty expense and associated liability in the amount of $130,000 No other expenses incurred. 2023 information: Sales on account in the amount of $230,000 Warranty repairs made in the amount of $61,000 No expenses incurred. What is the amount of MK's deferred tax asset or deferred tax liability for 2022? A) $11,700 B) $39,000 C) $91,000 D) $18,300 Answer: B Explanation: A deferred tax asset is created when income tax payable exceeds income tax expense. Income tax expense is calculated from book income. Book income = revenues - expenses = $700,000 $130,000 = $570,000. Income tax expense = $570,000 × 30% = $171,000. Warranty expenses are not deductible for tax purposes until actually incurred, so taxable income is $700,000. Income tax payable = taxable income $700,000 × 30% = $210,000. Deferred tax asset = $210,000 - $171,000 = $39,000 Deferred tax asset =Warranty liability for book $130,000 – Warranty liability for tax $0 = $130,000 × 30% = $39,000 Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Greenville Industries uses the accrual basis to account for all sales transactions. Sales for 2022 total $590,000. Included in this amount is $80,000 in receivables from sales on installment. Installment sales are considered revenue for book purposes, but not for tax purposes. Operating expenses total $180,000 and are treated the same for book and tax purposes. What is Greenville's book basis in the installment sale receivable? A) $80,000 B) $0 C) $40,000 D) $180,000 Answer: A Explanation: Since the installment sale is considered revenue for book purposes, the book basis of the receivable is $80,000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Greenville Industries uses the accrual basis to account for all sales transactions. Sales for 2022 total $560,000. Included in this amount is $25,000 in receivables from sales on installment. Installment sales are considered revenue for book purposes, but not for tax purposes. Operating expenses total $120,000 and are treated the same for book and tax purposes. What is Greenville's tax basis in the installment sale receivable? A) $25,000 B) $0 C) $12,500 D) $120,000 Answer: B Explanation: Since the installment sale is not considered revenue for tax purposes, the tax basis of the receivable is $0. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Greenville Industries uses the accrual basis to account for all sales transactions. Sales for 2022 total $580,000. Included in this amount is $60,000 in receivables from sales on installment. Installment sales are considered revenue for book purposes, but not for tax purposes. Operating expenses total $100,000 and are treated the same for book and tax purposes. What is Greenville's book income? A) $420,000 B) $480,000 C) $520,000 D) $580,000 Answer: B Explanation: Book income = $580,000 sales revenue (including installment sale) - $100,000 operating expenses = $480,000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Greenville Industries uses the accrual basis to account for all sales transactions. Sales for 2022 total $540,000. Included in this amount is $15,000 in receivables from sales on installment. Installment sales are considered revenue for book purposes, but not for tax purposes. Operating expenses total $140,000 and are treated the same for book and tax purposes. What is Greenville's taxable income? A) $385,000 B) $400,000 C) $525,000 D) $540,000 Answer: A Explanation: Since the installment sale is not considered revenue for tax purposes, sales are $540,000 $15,000 = $525,000 and expenses are $140,000, resulting in taxable income of $385,000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Greenville Industries uses the accrual basis to account for all sales transactions. Sales for 2022 total $500,000. Included in this amount is $85,000 in receivables from sales on installment. Installment sales are considered revenue for book purposes, but not for tax purposes. Operating expenses total $170,000 and are treated the same for book and tax purposes. Assuming a 40% tax rate, what is Greenville's income tax expense? A) $98,000 B) $132,000 C) $166,000 D) $200,000 Answer: B Explanation: Book income = $500,000 sales revenue (including installment sale) - $170,000 operating expenses = $330,000. Income tax expense computed on book income $330,000 × 40% = $132,000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Greenville Industries uses the accrual basis to account for all sales transactions. Sales for 2022 total $500,000. Included in this amount is $75,000 in receivables from sales on installment. Installment sales are considered revenue for book purposes, but not for tax purposes. Operating expenses total $140,000 and are treated the same for book and tax purposes. Assuming a 35% tax rate, what is Greenville's income tax payable? A) $99,750 B) $126,000 C) $148,750 D) $175,000 Answer: A Explanation: Since the installment sale is not considered revenue for tax purposes, sales are $500,000 $75,000 = $425,000 and expenses are $140,000, resulting in taxable income of $285,000. Income tax payable computed on taxable income $285,000 × 35% = $99,750. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) Greenville Industries uses the accrual basis to account for all sales transactions. Sales for 2022 total $600,000. Included in this amount is $20,000 in receivables from sales on installment. Installment sales are considered revenue for book purposes, but not for tax purposes. Operating expenses total $200,000 and are treated the same for book and tax purposes. Assuming a 35% tax rate, what is the amount of Greenville's deferred tax asset or liability? A) $7000 deferred tax asset B) $7000 deferred tax liability C) $4000 deferred tax asset D) $4000 deferred tax liability Answer: B Explanation: Deferred tax liability is created by installment sales. Amount is $20,000 recognized for book but not tax times 35% tax rate = $7000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) Infinity Production acquired a new machine at the beginning of the current year. The machine cost $720,000 with no residual value expected. Infinity uses the straight-line method for financial reporting, assuming a 6-year useful life. The firm classifies the equipment as 5-year MACRS property for tax purposes using the following percentages. Year 1 2 3 4 5 6

MACRS (%) 20.00% 32.00 19.20 11.52 11.52 5.76

The company is subject to a 40% income tax rate and has no other book-tax differences. Income before depreciation and tax is presented below:

Year 1 2 3 4 5 6

Income before Tax and Depreciation $360,000 410,000 480,000 700,000 820,000 950,000

What is Infinity's book income for year 1? A) $235,000 B) $240,000 C) $216,000 D) $360,000 Answer: B Explanation: Book income = $360,000 income before tax and depreciation - $120,000 depreciation ($720,000/6 years) = $240,000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

30) Infinity Production acquired a new machine at the beginning of the current year. The machine cost $840,000 with no residual value expected. Infinity uses the straight-line method for financial reporting, assuming a 6-year useful life. The firm classifies the equipment as 5-year MACRS property for tax purposes using the following percentages. Year 1 2 3 4 5 6

MACRS (%) 20.00% 32.00 19.20 11.52 11.52 5.76

The company is subject to a 30% income tax rate and has no other book-tax differences. Income before depreciation and tax is presented below:

Year 1 2 3 4 5 6

Income before Tax and Depreciation $410,000 460,000 530,000 700,000 820,000 950,000

What is Infinity's taxable income for year 1? A) $265,000 B) $270,000 C) $242,000 D) $410,000 Answer: C Explanation: Taxable income = $410,000 income before tax and depreciation - $168,000 depreciation ($840,000 × 20%) = $242,000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) Infinity Production acquired a new machine at the beginning of the current year. The machine cost $840,000 with no residual value expected. Infinity uses the straight-line method for financial reporting, assuming a 6-year useful life. The firm classifies the equipment as 5-year MACRS property for tax purposes using the following percentages. Year 1 2 3 4 5 6

MACRS (%) 20.00% 32.00 19.20 11.52 11.52 5.76

The company is subject to a 20% income tax rate and has no other book-tax differences. Income before depreciation and tax is presented below:

Year 1 2 3 4 5 6

Income before Tax and Depreciation $450,000 500,000 570,000 700,000 820,000 950,000

What is Infinity's deferred tax asset or deferred tax liability at the end of year 1? A) $5600 deferred tax liability B) $28,000 deferred tax liability C) $672,000 deferred tax asset D) $28,000 deferred tax asset Answer: A Explanation: Deferred tax liability = Asset book basis $700,000 ($840,000 - $140,000) – Asset tax basis $672,000 ($840,000 - $168,000) = $28,000 × 20% = $5600 deferred tax liability. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

32) Infinity Production acquired a new machine at the beginning of the current year. The machine cost $900,000 with no residual value expected. Infinity uses the straight-line method for financial reporting, assuming a 6-year useful life. The firm classifies the equipment as 5-year MACRS property for tax purposes using the following percentages. Year 1 2 3 4 5 6

MACRS (%) 20.00% 32.00 19.20 11.52 11.52 5.76

The company is subject to a 20% income tax rate and has no other book-tax differences. Income before depreciation and tax is presented below:

Year 1 2 3 4 5 6

Income before Tax and Depreciation $450,000 500,000 570,000 700,000 820,000 950,000

What is Infinity's deferred tax asset or deferred tax liability at the end of year 3? A) $2760 deferred tax liability B) $38,160 deferred tax liability C) $38,160 deferred tax asset D) $2760 deferred tax asset Answer: B Explanation: Deferred tax liability = Asset book basis $450,000 – Asset tax basis $259,200 = $190,800 × 20% tax rate = $38,160 deferred tax liability. Asset book basis = $900,000 – ($150,000 × 3) = $450,000 Asset tax basis = $900,000 – (20% × $900,000) – (32% × $900,000) – (19.20% × $900,000) = $259,200 Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

33) Infinity Production acquired a new machine at the beginning of the current year. The machine cost $900,000 with no residual value expected. Infinity uses the straight-line method for financial reporting, assuming a 6-year useful life. The firm classifies the equipment as 5-year MACRS property for tax purposes using the following percentages. Year 1 2 3 4 5 6

MACRS (%) 20.00% 32.00 19.20 11.52 11.52 5.76

The company is subject to a 25% income tax rate and has no other book-tax differences. Income before depreciation and tax is presented below:

Year 1 2 3 4 5 6

Income before Tax and Depreciation $370,000 420,000 490,000 700,000 820,000 950,000

What is Infinity's income tax expense for year 1? A) $220,000 B) $55,000 C) $47,500 D) $92,500 Answer: B Explanation: Income tax expense is computed on book income. Book income = $370,000 income before tax and depreciation - $150,000 depreciation ($900,000/6 years) = $220,000. Income tax expense = $220,000 × 25% = $55,000. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

34) Infinity Production acquired a new machine at the beginning of the current year. The machine cost $780,000 with no residual value expected. Infinity uses the straight-line method for financial reporting, assuming a 6-year useful life. The firm classifies the equipment as 5-year MACRS property for tax purposes using the following percentages. Year 1 2 3 4 5 6

MACRS (%) 20.00% 32.00 19.20 11.52 11.52 5.76

The company is subject to a 25% income tax rate and has no other book-tax differences. Income before depreciation and tax is presented below:

Year 1 2 3 4 5 6

Income before Tax and Depreciation $390,000 440,000 510,000 700,000 820,000 950,000

What is Infinity's income tax payable for year 1? A) $234,000 B) $65,000 C) $58,500 D) $97,500 Answer: C Explanation: Income tax payable is computed on taxable income. Taxable income = $390,000 income before tax and depreciation - $156,000 depreciation ($780,000 × 20%) = $234,000. Income tax payable = $234,000 × 25% = $58,500. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

35) Infinity Production acquired a new machine at the beginning of the current year. The machine cost $600,000 with no residual value expected. Infinity uses the straight-line method for financial reporting, assuming a 6-year useful life. The firm classifies the equipment as 5-year MACRS property for tax purposes using the following percentages. Year 1 2 3 4 5 6

MACRS (%) 20.00% 32.00 19.20 11.52 11.52 5.76

The company is subject to a 20% income tax rate and has no other book-tax differences. Income before depreciation and tax is presented below:

Year 1 2 3 4 5 6

Income before Tax and Depreciation $430,000 480,000 550,000 700,000 820,000 950,000

What is the increase or decrease in the deferred tax liability for year 3? A) $3040 increase B) $25,440 increase C) $14,560 decrease D) $37,600 increase Answer: A Explanation: Deferred tax liability, end of 3rd year= Asset book basis $300,000 – Asset tax basis $172,800 = $127,200 × 20% tax rate = $25,440 deferred tax liability. Asset book basis = $600,000 – ($100,000 × 3) = $300,000 Asset tax basis = $600,000 – (20% × $600,000) – (32% × $600,000) – (19.20% × $600,000) = $172,800 Deferred tax liability, end of 2nd year= Asset book basis $400,000 – Asset tax basis $288,000 = $112,000 × 20% tax rate = $22,400 deferred tax liability. Asset book basis = $600,000 – ($100,000 × 2) = $400,000 Asset tax basis = $600,000 – (20% × $600,000) – (32% × $600,000) = $288,000 Increase in Deferred Tax Liability = $25,440 - $22,400 = $3040 Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

36) Discuss the relationship between temporary differences, and the statutory and effective tax rates. Answer: Temporary differences do not cause the effective tax rate to vary from the statutory tax rate as permanent differences do. Therefore, there is no effective tax rate to calculate when there are temporary differences only. Temporary differences only affect the timing of revenue and expense recognition. Diff: 1 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

37) There are questions as to whether or not deferred tax assets and liabilities should be recorded. Based on your understanding of the concepts and accounting terminology, are deferred tax assets and tax liabilities real assets and liabilities? Answer: Answers will vary — but should include a discussion about conceptual framework definitions, and that yes — they do meet the definition of a true asset/liability. For example, a deferred tax asset is the amount of taxes that will be reduced in future years. It is a future economic benefit. Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

38) Gustav, Inc. uses the accrual basis to account for all sales transactions. Sales for 2022 total $500,000. Included in this amount is $75,000 in receivables from sales on installment. Installment sales are considered revenue for book purposes, but not for tax purposes. Operating expenses total $150,000 and are treated the same for book and tax purposes. Complete the following: a. What is the book basis of the installment sales receivable? b. What is the tax basis of the installment sales receivable? c. Assuming a 30% tax rate, compute income tax expense, the deferred tax provision, and income tax payable for 2022. d. Prepare the journal entry to record the 2022 income tax expense. Answer: a. Since the installment sale is considered revenue for book purposes, the book basis of the receivable is $75,000. b. Since the installment sale is not considered revenue for tax purposes, the tax basis of the receivable is $0. c. A deferred tax liability is created when income tax expense exceeds income tax payable. Income tax expense is calculated from book income. Since the installment sale is considered revenue for book purposes, sales are $500,000 and expenses are $150,000, resulting in book income of $350,000. Income tax expense is $350,000 × 30% = $105,000. Income tax payable is calculated from taxable income. Since the installment sale is not considered revenue for tax purposes, sales are $500,000 - $75,000 = $425,000 and expenses are $150,000, resulting in taxable income of $275,000. Income tax payable is $275,000 × 30% = $82,500. Deferred tax liability = Asset book basis $75,000 – Asset tax basis $0 = $75,000 × 30% tax rate = $22,500 d. Journal entry: Income Tax Expense Deferred Tax Liability Income Tax Payable

105,000

22,500 82,500

Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

39) Bach. Co. presents the following information for 2022 and 2023. 2022 information: Sales on account in the amount of $645,000 Warranty expense and associated liability in the amount of $125,000 No other expenses incurred. 2023 information: Sales on account in the amount of $225,000 Warranty payments made in the amount of $65,000 No expenses incurred. Prepare the journal entries for 2022 and 2023 to record the sales, warranty, and income tax transactions, assume a 40% tax rate. Answer: 2022 Accounts Receivable 645,000 Sales Revenue 645,000 Warranty Expense Estimated Warranty Payable

125,000

Income Tax Expense* Deferred Tax Asset** Income Tax Payable***

208,000 50,000

125,000

258,000

* (645,000 - 125,000) × 40% ** 125,000 × 40% *** 645,000 × 40% 2023 Accounts Receivable Sales Revenue

225,000 225,000

Warranty Payable Cash

65,000

Income Tax Expense* Deferred Tax Asset** Income Tax Payable***

90,000

65,000

26,000 64,000

* 225,000 × 40% ** 65,000 × 40% *** (225,000 - 65,000) × 40%

Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

40) Infinity Production acquired a new machine at the beginning of the current year. The machine cost $720,000 with no residual value expected. Infinity uses the straight-line method for financial reporting, assuming a 6-year useful life. The firm classifies the equipment as 5-year MACRS property for tax purposes using the following percentages. Year 1 2 3 4 5 6

MACRS (%) 20.00% 32.00 19.20 11.52 11.52 5.76

The company is subject to a 40% income tax rate and has no other book-tax differences. Income before depreciation and tax is presented below:

Year 1 2 3 4 5 6

Income before Tax and Depreciation $400,000 450,000 520,000 700,000 820,000 950,000

Complete the following table for Infinity Production.

Year 1 2 3 4 5 6

Book Book Tax income depreciation depreciation before tax

Taxable Deferred income Income tax tax liability before tax expense balance

Answer: Book depreciation is straight-line, computed as $720,000 price/6 year useful life = $120,000 per year. Tax depreciation is calculated based on $720,000 purchase price and MACRS percentages. Book income before tax is computed from income before tax and depreciation given in problem less book depreciation. Taxable income before tax is computed from income before tax and depreciation given in problem less tax depreciation. Income tax expense is computed as 40% of book income. Deferred tax liability is difference between (book basis asset and tax basis asset) × tax rate.

Year 1 2 3 4 5 6

Book Taxable Deferred Book Tax income income Income tax tax liability depreciation depreciation before tax before tax expense balance $120,000 $144,000 $280,000 $256,000 $112,000 $9,600 $120,000 $230,400 $330,000 $219,600 $132,000 $53,760 $120,000 $138,240 $400,000 $381,760 $160,000 $61,056 $120,000 $82,944 $580,000 $617,056 $232,000 $46,234 $120,000 $82,944 $700,000 $737,056 $280,000 $31,412 $120,000 $41,472 $830,000 $908,528 $332,000 $0

Year 1 2 3 4 5 6

Asset Book Basis – Deferred Book Asset Book Tax Asset Tax Asset Tax tax liability depreciation Basis depreciation Basis Basis balance $120,000 $600,000 $144,000 $576,000 $24,000 $9,600 $120,000 $480,000 $230,400 $345,600 $134,400 $53,760 $120,000 $360,000 $138,240 $207,360 $152,640 $61,056 $120,000 $240,000 $82,944 $124,416 $115,584 $46,234 $120,000 $120,000 $82,944 $41,472 $78,528 $31,412 $120,000 $0 $41,472 $0 $0 $0

Diff: 2 Objective: 17.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

17.4

Realizability of Deferred Tax Assets: Assessing and Reporting

1) IFRS uses a two step process in recording the realizability of deferred tax assets. Answer: FALSE Diff: 1 Objective: 17.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

2) Under U.S. GAAP, when a firm determines that all or a portion of a deferred tax asset is not realizable, they will use a valuation allowance to reduce the balance. Answer: TRUE Explanation: Per ASC 740. Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When a firm records a deferred tax asset, it is required to consider the likelihood that it will actually receive economic benefit from that asset. That is, the firm must consider whether it will ever realize a reduction in its income taxes paid to the government. Answer: TRUE Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) U.S. GAAP specifies that if it is "more likely than not" that the firm will not realize some portion of the deferred tax asset, the firm must reduce the deferred tax asset to its net realizable value. U.S. GAAP defines "more likely than not" as a likelihood of slightly more than 50%. Answer: TRUE Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The valuation allowance is a contra-asset to the deferred tax expense the income statement. Answer: FALSE Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) When assessing realizability of deferred tax assets, management must consider positive and negative evidence. All of the following would be considered positive evidence except ________. A) taxable income in prior carryback year(s) if carryback is permitted under the tax law B) future reversals of existing taxable temporary differences C) unsettled circumstances that could adversely affect future operations D) an excess of appreciated asset value over the tax basis of the entity's net assets Answer: C Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) When assessing realizability of deferred tax assets, management must consider positive and negative evidence. Which of the following would be considered negative evidence? A) existing contracts or firm sales backlog B) a carryback or carryforward period that is so brief it could limit realization of tax benefits C) taxable income in prior carryback year(s) if carryback is permitted under the tax law D) a strong earnings history exclusive of the loss that created the future deductible amount Answer: B Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) If the valuation allowance for a deferred tax asset is decreased, there is a(n) ________ to income tax expense, which is a(n) ________ to income tax benefit. A) decrease; increase B) increase; increase C) increase; decrease D) decrease; decrease Answer: A Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) When defining the portion of a deferred tax asset that a firm will not realize, IFRS uses the term ________. A) likely B) possible C) more likely than not D) probable Answer: D Diff: 1 Objective: 17.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

10) The contra-asset to the Deferred Tax Asset account is called ________. A) Income Tax Benefit B) Valuation Allowance for Deferred Tax Asset C) Deferred Tax Liability D) Allowance for Doubtful Accounts Answer: B Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Violet, Inc. recorded a deferred tax asset of $43,000 due to a book-tax difference in warranty liabilities. Management has assessed that it is more likely than not that the firm will not realize 45% of the deferred tax asset. What is the necessary journal entry to record the valuation allowance? A) Income Tax Expense 19,350 Valuation Allowance for Deferred Tax Asset 19,350 B) Deferred Tax Asset Valuation Allowance for Deferred Tax Asset

19,350

C) Income Tax Expense Valuation Allowance for Deferred Tax Asset

43,000

D) Deferred Tax Asset Valuation Allowance for Deferred Tax Asset

43,000

Answer: A Explanation: $43,000 × 45%

Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

19,350

43,000

12) The Wolf Group recorded a deferred tax asset of $60,000 due to a book-tax difference in warranty liabilities. Management has assessed that it is more likely than not that the firm will not realize 30% of the deferred tax asset. After recording the valuation allowance, Wolf's net income will ________ and assets will ________. A) increase by $18,000; decrease by $60,000 B) increase by $18,000; increase by $18,000 C) decrease by $60,000; increase by $18,000 D) decrease by $18,000; decrease by $18,000 Answer: D Explanation: $60,000 × 30% increase to income tax expense, reduction in net income, and decrease in net deferred tax asset. Diff: 1 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Cougar, Inc., an IFRS reporter, estimates a deferred tax asset of $80,000 due to a book-tax difference in warranty liabilities. Management has assessed that it is probable that the firm will not realize 20% of the deferred tax asset. After recording the net deferred tax asset, Cougar's net income will ________ and assets will ________. A) increase by $16,000; increase by $16,000 B) decrease by $16,000; decrease by $16,000 C) increase by $80,000; decrease by $80,000 D) decrease by $80,000; increase by $80,000 Answer: B Explanation: Does not expect to collect $80,000 × 20% — this increases income tax expense — reducing net income. Diff: 1 Objective: 17.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

14) Blue Corporation is an IFRS reporter. Blue's taxable income is $700,000 and the company estimates a deferred tax asset of $45,000 due to a book-tax difference in warranty liabilities. Management has assessed that it is probable that it will not realize 30% of the deferred tax asset. Assuming a 40% tax rate, how should the realizable deferred tax asset be recorded? A) Income Tax Expense Deferred Tax Asset Income Tax Payable

235,000 45,000

B) Income Tax Expense Deferred Tax Asset Income Tax Payable

248,500 31,500

C) Deferred Tax Asset Valuation Allowance for Deferred Tax

13,500

D) Income Tax Expense Deferred Tax Asset Valuation Allowance– for Deferred Tax

13,500 31,500

280,000

13,500

45,000

Answer: B Explanation: Expects to realize 70% of the deferred tax asset: $45,000 × 70% = $31,500. Diff: 2 Objective: 17.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

15) S & C Company's income before taxes is $410,000, and income tax expense is $115,000. S & C has a deferred tax asset of $100,000 and records a valuation allowance of $25,000. What is S & C's effective tax rate before and after recording the valuation allowance? (Do not round intermediate calculations. Round your final answer to the nearest whole percent.) A) 28% and 22% respectively B) 22% and 34% respectively C) 28% and 34% respectively D) There would not be a change in ETR because these are due to temporary differences. Answer: C Explanation: Before valuation allowance: $115,000/$410,000; After valuation allowance: ($115,000 + $25,000)/$410,000 Diff: 2 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) List the four possible sources of taxable income that a company should consider when assessing the realizability of a deferred tax asset under U.S. GAAP. Answer: 1. Future reversals of existing taxable temporary differences. 2. Future taxable income exclusive of reversing temporary differences and carryforwards. 3. Taxable income in prior carryback year(s) if carryback is permitted under the tax law. 4. Tax planning strategies that would, if necessary, be implemented. Diff: 2 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) The Betta Group reports taxable income in the amount of $625,000 and has a 30% tax rate. Additionally, the company estimates a deferred tax asset of $45,000 due to a book-tax difference in warranty liabilities. After reviewing all available evidence, management determines that only 60% of this amount will ultimately result in tax-deductible expenses over the warranty period. Prepare the necessary journal entries to record the tax provision and valuation allowance for Betta Group under (a) U.S. GAAP and (b) IFRS. Answer: (a) U.S. GAAP Income Tax Expense 142,500 Deferred Tax Asset 45,000 Income Tax Payable 187,500 Income Tax Expense Valuation Allowance for Deferred Tax Asset

18,000 18,000

(b) IFRS Income Tax Expense Deferred Tax Asset Income Tax Payable

160,500 27,000 187,500

Under IAS 12 there is no valuation allowance. Diff: 2 Objective: 17.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Lyon Ltd., a U.S. GAAP reporter, provides the following information: Sales on account $800,000 Associated warranty expense/liability $200,000 No warranty repairs made to date; Lyon cannot deduct warranty expense for tax purposes until repairs are made. Management estimates that it is more likely than not that the firm will not realize 25% of the deferred tax asset. Tax rate of 35% Prepare a simplified income statement, including the effective tax rate, both with and without the valuation allowance. Round percentages to the nearest whole number. Answer: Without V.A. With V.A. Partial income statement Sales revenue $800,000 $800,000 Warranty expense (200,000) (200,000) Income before taxes $600,000 $600,000 Income tax expense 210,000 227,500 Net income $390,000 $372,500 Effective tax rate 35% 38% (Deferred tax asset: $200,000 × 35%; valuation allowance: $70,000 × 25%) Diff: 2 Objective: 17.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17.5

Changes in Tax Rates

1) When a company adjusts the balance of a deferred tax account to reflect changes in the tax rate, priorperiod financial statements will need to be adjusted to reflect this. Answer: FALSE Diff: 1 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The adjustment for a change in tax rates is treated as a change in accounting estimate. Answer: TRUE Diff: 1 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Properly valuing deferred tax assets and deferred tax liabilities requires measuring deferred tax accounts at the statutory income tax rate expected to be in effect at the future reversal date. Answer: TRUE Diff: 1 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Firms must adjust the balance of the deferred tax accounts in the year of tax rate change to reflect the change in tax rate. Answer: TRUE Diff: 1 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) On December 31, 2022, Big Bear Corporation reports liabilities with a tax basis of $1,200,000 and a book basis of $1,700,000. There was no difference in the asset basis. The difference in liability basis arose from temporary differences that would reverse in the following years: 2023 2024 2025 2026 2027

$120,000 $110,000 $112,000 $80,000 $78,000

Assuming a tax rate of 40% for 2022 - 2025 and a rate of 45% for 2026 - 2027, what should Big Bear report on its balance sheet on December 31, 2022? A) deferred tax liability of $200,000 B) deferred tax asset of $200,000 C) deferred tax liability of $207,900 D) deferred tax asset of $207,900 Answer: D Explanation: Deferred tax asset: a liability with book basis > tax basis; [($120,000 + $110,000 + $112,000) × 40%] + [($80,000 + $78,000) × 45%] Diff: 3 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) On December 31, 2022, the Magic Flute Company reports liabilities with a tax basis of $600,000 and a book basis of $400,000. There was no difference in the asset basis. The difference in liability basis arose from temporary differences that would reverse in the following years: 2023 2024 2025 2026 2027

$60,000 $50,000 $52,000 $20,000 $18,000

Assuming a tax rate of 25% for 2022 - 2024 and a rate of 30% for 2025 - 2027, The Magic Flute Co. should report a deferred tax ________ in the amount of ________ on December 31, 2022. A) liability; $51,900 B) asset; $50,000 C) liability; $54,500 D) asset; $60,000 Answer: C Explanation: Deferred tax liability: a liability with tax basis > book basis; [($60,000 + $50,000) × 25%] + [($52,000 + $20,000 + $18,000) × 30%] Diff: 3 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) When a company adjusts the balance of a deferred tax account to reflect changes in their tax rate, this impacts ________. A) income tax expense B) income tax payable C) effective tax rate D) both A & C Answer: D Diff: 1 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) How will a change in statutory tax rates affect prior period financial statements and current year income tax expense? A) Changes in statutory tax rates affect current year income tax expense but do not affect prior period financial statements. B) Changes in statutory tax rates affect both current year income tax expense and prior period financial statements. C) Changes in statutory tax rates do not affect current year income tax expense or prior period financial statements. D) Changes in statutory tax rates do not affect current year income tax expense but do affect prior period financial statements. Answer: A Diff: 1 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Tetra Corp. recorded book income of $215,000 in 2022. It does not have any permanent differences and the only temporary difference relates to $36,000 unearned income that it recorded for book purposes. Tetra anticipates satisfying this liability equally over the following three years. The current enacted tax rate is 36%. The enacted tax rates for the following three years are 33%, 38%, and 43%, respectively. Under U.S. GAAP, what deferred tax amount should Tetra Corp. record for this temporary difference? A) $12,840 B) $12,960 C) $13,680 D) $15,480 Answer: C Explanation: ($12,000 × 33%) + ($12,000 × 38%) + ($12,000 × 43%) = $13,680 Diff: 2 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) In 2021, Squirrel Corp. recorded book income of $165,000. It has one temporary difference which relates to a $30,000 warranty expense that it recorded for book purposes, and no permanent differences. Squirrel anticipates satisfying this liability equally over the following two years. The current enacted tax rate is 36%. The enacted tax rates for the following years are 2021: 26%, 2022: 31%, 2023: 26% and 2024: 36%, respectively. Under U.S. GAAP, what deferred tax amount should Squirrel Corp. record for this temporary difference? A) $8550 B) $7800 C) $9300 D) $10,050 Answer: A Explanation: ($15,000 × 26%) + ($15,000 × 31%); additional info included as "red herring" Diff: 2 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Piper, Inc. reported a net deferred tax asset balance of $166,650 resulting from an estimated warranty expense accrual for book purposes. The total book-tax difference related to the bases of the estimated warranty liability is $505,000. The enacted statutory tax rate related to this balance changed from 33% to 28%, effective immediately. What journal entry will Piper need to make to adjust for this change in tax rates? A) Deferred Tax Asset Income Tax Payable

46,662

B) Income Tax Expense Deferred Tax Asset

46,662

C) Income Tax Expense Deferred Tax Asset

25,250

D) Deferred Tax Asset Income Tax Payable

25,250

46,662

25,250

Answer: C Explanation: $505,000(33% - 28%) Diff: 2 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Tommy Corp. reported a net deferred tax asset balance of $176,400 resulting from an estimated warranty expense accrual for book purposes. The total book-tax difference related to the bases of the estimated warranty liability is $490,000. The enacted statutory tax rate related to this balance changed from 36% to 31%, effective immediately. By what amount will the deferred asset balance change? A) increase by $33,320 B) decrease by $24,500 C) increase by $24,500 D) decrease by $33,320 Answer: B Explanation: $490,000(36% - 31%) Diff: 2 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) In 2022 Charmed, Inc. recorded book income of $390,000. The company's only temporary difference relates to a $66,000 installment sale that it recorded for book purposes; there are no permanent differences. Charmed anticipates receiving payments equally over the following three years. The current enacted tax rate in 2022 is 40%. The substantively enacted tax rates for the following three years are 35%, 40%, and 48%, respectively. Under U.S. GAAP, what deferred tax amount should Charmed record for this temporary difference? A) $25,300 B) $27,060 C) $26,400 D) $31,680 Answer: C Explanation: For U.S. GAAP, current tax rates are used to value the deferred tax account when future tax rates are not fully enacted. $66,000 × 40% = $26,400 Diff: 2 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) In 2022 Charmed, Inc. recorded book income of $420,000. The company's only temporary difference relates to a $66,000 installment sale that it recorded for book purposes; there are no permanent differences. Charmed anticipates receiving payments equally over the following three years. The current enacted tax rate in 2022 is 39%. The substantively enacted tax rates for the following three years are 34%, 39%, and 47%, respectively. Under IFRS, what deferred tax amount should Charmed record for this temporary difference? A) $24,640 B) $26,400 C) $25,740 D) $31,020 Answer: B Explanation: ($22,000 × 34%) + ($22,000 × 39%) + ($22,000 × 47%). For IFRS, substantively, but not fully enacted rates, are used to value the deferred tax account. Diff: 2 Objective: 17.5 IFRS/GAAP: IFRS AACSB: Application of knowledge

15) Red Lantern Corp. reported a net deferred tax asset balance of $247,000 resulting from an estimated warranty expense accrual for book purposes. The enacted statutory tax rate related to this balance changed from 38% to 32%, effective immediately. Prepare the necessary journal entry to account for this change in tax rates if Red Lantern is an IFRS reporter. Answer: Income Tax Expense 39,000 Deferred Tax Asset 39,000 The temporary difference is calculated as $247,000 / 38% = $650,000 Applying the new tax rates, the change in the value of the deferred tax asset is calculated as $650,000 × (38% - 32%)= $39,000 Diff: 2 Objective: 17.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Clunker Car Corporation reported a $3 million contingent liability on its 2022 financial statements from a lawsuit over faulty ignition switches. The tax rate for 2022 is 40% However the enacted tax rates for the following three years are 37%, 35%, and 33% respectively. How will the deferred tax asset be measured if the case is expected to be resolved in 2023? How will it be measured if the case is expected to be resolved in 2021? What accounts for this difference? Answer: If the case is resolved in 2023 it will be measured at $1,110,000 ($3 million × 37%). If the case is resolved in 2021 it will be measured at $990,000 ($3 million × 33%). The difference is due to the fact that the deferred tax asset needs to be recorded as the book-tax difference in the contingent liability times the tax rate that will be in effect at the time of the reversal. Diff: 2 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) Taylor Corp. recorded book income of $215,000 in 2022. It does not have any permanent differences and the only temporary difference relates to $39,000 unearned income that it recorded for book purposes. Taylor anticipates satisfying this liability equally over the following three years. The current enacted tax rate is 36%. The enacted tax rates for the following three years are 33%, 38%, and 41%, respectively. Under U.S. GAAP, what deferred tax amount should Taylor Corp. record for this temporary difference? Answer: ($13,000 × 33%) + ($13,000 × 38%) + ($13,000 × 41%) = $14,560 Diff: 2 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) In 2021, Smith Corp. recorded book income of $165,000. It has one temporary difference which relates to a $36,000 warranty expense that it recorded for book purposes, and no permanent differences. Smith anticipates satisfying this liability equally over the following two years. The current enacted tax rate is 36%. The enacted tax rates for the following years are 2021: 26%, 2022: 31%, 2023: 26% and 2024: 36%, respectively. Under U.S. GAAP, what deferred tax amount should Smith Corp. record for this temporary difference? Answer: ($18,000 × 26%) + ($18,000 × 31%) = $10,260 Diff: 2 Objective: 17.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

17.6

Accounting for Net Operating Losses

1) When a company carries forward a net operating loss (NOL), the income tax expense will be reduced in future years, but not income tax payable. Answer: FALSE Diff: 1 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) A net operating loss (NOL) is a net loss for tax purposes that occurs when tax-deductible expenses exceed taxable revenues. Answer: TRUE Diff: 1 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) An NOL carryback allows a company to offset the current tax loss against prior years' taxable income and claim a refund for taxes previously paid on the amount offset. Answer: TRUE Diff: 1 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Under U.S. federal tax law, companies are permitted to carryforward losses indefinitely but cannot carryback NOLs. However, there is an 50% income limitation on the NOL carryforward. Answer: FALSE Explanation: The limitation is 80%. Diff: 1 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) In which of the following instances would a company most likely choose the carryforward option for a net operating loss? A) The company expects lower tax rates in the future compared to the past. B) The company expects higher tax rates in the future compared to the past. C) The company expects lower earnings in the future compared to the past. D) The company expects higher losses in the future compared to the past. Answer: B Diff: 1 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

6) If a company chooses to carryback a net operating loss (NOL), but is not able to fully offset the loss, they will ________. A) forgo the carryback option and carryforward the entire NOL B) forfeit the unused amount C) carry forward the remaining balance D) both A & C are viable options Answer: D Diff: 1 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

7) A company may carry back a tax loss for ________ years and carry forward a tax loss for ________ years. A) 20; 2 B) 1; 15 C) 2; 20 D) 15; 1 Answer: C Diff: 1 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Caesar Corporation reported income before taxes of $220,000 for the years 2020, 2021, and 2022. In 2023 they experienced a loss of $220,000. The company had a tax rate of 35% in 2020 and 2021, and a rate of 45% in 2022 and 2023. Assuming Caesar uses the carryback provisions for the net operating loss, by what amount will the income tax benefit reduce the net loss in 2023? A) $77,000 B) $88,000 C) $99,000 D) $220,000 Answer: A Explanation: 2021 rate of 35% × ($220,000) from 2021 Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) TLR Productions reported income before taxes of $205,000 for the years 2020, 2021, and 2022. In 2023 they experienced a loss of $500,000. TLR had a tax rate of 35% in 2020 and 2021, and a rate of 45% in 2022 and 2023. Assuming the company uses the carryback provisions for the net operating loss and that the jurisdiction allows losses to be carried back two years, what amount should be reported as Income Tax Refund Receivable in 2023? A) $71,750 B) $164,000 C) $204,500 D) $225,000 Answer: B Explanation: 2021: ($205,000 × 35%) + 2022: ($205,000 × 45%) = $164,000 Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) S & C Company reported income before taxes of $91,000 for the years 2020, 2021, and 2022. In 2023 they experienced a loss of $182,000. S & C had a tax rate of 30% in 2020 and 2021, and a rate of 40% is 2022 and 2023. The company elects to carry back the loss. What is the necessary journal entry to record the NOL carryback in the year of the loss? A) Income Tax Refund Receivable Income Tax Benefit

54,600

B) Income Tax Refund Receivable Income Tax Benefit

63,700

C) Income Tax Refund Receivable Income Tax Benefit

72,800

D) Income Tax Refund Receivable Income Tax Benefit

91,000

54,600

63,700

72,800

91,000

Answer: B Explanation: ($91,000 × 30%) + ($91,000 × 40%) = $63,700. The NOL is carried back to the two prior years, 2021 and 2022. Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Big Bear Sporting Goods opened in 2022. They reported sales revenue of $375,000 and expenses of $460,000. There are no permanent or temporary differences, so the book loss and taxable loss will be the same. Big Bear plans on carrying forward the net operating loss (NOL). Assuming a 32% tax rate, what is the necessary journal entry in 2022 to record the NOL carryforward? A) Income Tax Refund Receivable Income Tax Benefit

120,000

B) Deferred Tax Asset Income Tax Benefit

120,000

C) Income Tax Refund Receivable Income Tax Benefit

27,200

D) Deferred Tax Asset Income Tax Benefit

27,200

120,000

27,200

Answer: D Explanation: (Sales revenue $375,000 - Expenses $460,000) × 32% = $27,200 Diff: 1 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Illusions Inc. just completed its second year of operations and has a deferred tax asset of $43,700 related to a net operating loss of $115,000 from the previous year. In the current year Illusions generates $390,000 in revenues and incurs $260,000 in expenses. There are no permanent or temporary book-tax differences. Assuming the same tax rate as last year, what amount will Illusions record for Income Tax Payable in the current year? A) $5700 B) $49,400 C) $148,200 D) Cannot be determined from the information provided. Answer: A Explanation: Step 1: Calculate prior year tax rate - $43,700/$115,000 = 38% tax rate. Step 2: Calculate Income Tax Payable - $130,000 income - $115,000 carryforward = $15,000 × 38% = $5700 Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Betta Group just completed its second year of operations and has a deferred tax asset of $82,000 related to a net operating loss of $205,000 from the previous year. In the current year Betta generates $635,000 in revenues and incurs $341,000 in expenses. There are no permanent or temporary book-tax differences. Assuming the same tax rate as last year, what is the tax related journal entry for the current year? A) Income Tax Refund Receivable Deferred Tax Asset

82,000

B) Deferred Tax Asset Income Tax Benefit

82,000

C) Income Tax Expense Income Tax Payable Deferred Tax Asset D) Income Tax Expense Income Tax Payable Deferred Tax Asset

82,000

117,600

254,000

35,600 82,000

172,000 82,000

Answer: C Explanation: Prior year tax rate: $82,000/$205,000 = 40%. Income Tax Expense: $294,000 × 40% = $117,600; Income Tax Payable ($294,000 - $205,000) × 40% = $35,600. Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Violet Corporation reported a loss in 2022 of $630,000. The company reported taxable income of $189,000 in 2020 and $205,000 in 2021. It has no permanent or temporary differences and its tax rate is 30%. If Violet Corporation carries back and forward the loss from 2022 to appropriate years, what is the necessary journal entry for 2022? A) Income Tax Refund Receivable 189,000 Income Tax Payable 118,200 Deferred Tax Asset 70,800 B) Income Tax Refund Receivable Deferred Tax Asset Income Tax Benefit

118,200 70,800

C) Income Tax Refund Receivable Deferred Tax Asset

118,200

D) Deferred Tax Asset Income Tax Benefit

189,000

118,200

189,000

Answer: B Explanation: Income Tax Refund Receivable is 2020 and 2021 income times the tax rate ($189,000 + $205,000) × 30%. The Income Tax Benefit is the loss times the tax rate ($630,000 × 30%) and the Deferred Tax Asset is the difference. Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Violet Corporation reported a loss in 2022 of $610,000 and carried back the loss to the extent allowed. The company reported taxable income of $215,000 in 2020 and $245,000 in 2021. It has no permanent or temporary differences and its tax rate is 30%. Violet reported taxable income of $345,000 in 2023. What is the necessary journal entry for 2023? A) Income Tax Refund Receivable Deferred Tax Asset Income Tax Benefit B) Income Tax Refund Receivable Deferred Tax Asset Income Tax Benefit C) Income Tax Expense Income Tax Payable Deferred Tax Asset D) Income Tax Expense Income Tax Payable Deferred Tax Asset

138,000 45,000

58,500 45,000

183,000

103,500

183,000

103,500

138,000 45,000

58,500 45,000

Answer: D Explanation: Income Tax Expense for 2023 is the book income times the tax rate: $345,000 × 30% = $103,500. The NOL from 2022 is carried back 2 years, with the remaining balance is carried forward to 2023. Deferred Tax Asset = $150,000 × 30% = $45,000. $610,000 - $215,000 - $245,000 = $150,000 loss carryforward. Income Tax Payable is Taxable Income less the remaining NOL times the tax rate: ($345,000 - $150,000) × 30% = $58,500. Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) In 2022, its first year of operations, Neuro Inc. experienced a $214,000 net operating loss and recorded a deferred tax asset of $81,320. Neuro decides that it is more likely than not that it will only be able to generate $195,000 of taxable income during the carryforward period. As a result, without generating additional future taxable income it will not be able to fully realize the NOL carryforward benefit. In order to account for this, what amount will Neuro Inc. record as a valuation allowance, assuming that the tax rate is unchanged? A) $7220 B) $4476 C) $30,902 D) Cannot be determined with the information provided. Answer: A Explanation: The tax rate for 2022 is $81,320/$214,000 = 38% and the problem states that it remains unchanged for the current year. The valuation allowance is the difference between the NOL and the expected income times the tax rate ($214,000 - $195,000) × 38% = $7220. Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) What purpose does a carryback or carryforward serve to a company with a volatile earnings stream? Answer: It provides a means of smoothing taxable income. Diff: 1 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Red Lantern Company experienced a net operating loss of $654,000 in 2022. The company reported taxable income of $543,000 in 2020 and $321,000 in 2021. The tax rate for all years is 35%. Assuming the company uses the carryback provisions for the net operating loss, prepare the following for the year of the loss: a) The necessary journal entry to record the NOL carryback. b) A partial income statement beginning with the net loss before benefit. Answer: a) Journal Entry: Income Tax Refund Receivable 228,900 Income Tax Benefit 228,900* *(654,000 × 35%) b) Partial Income Statement: Net loss before tax benefit Income tax benefit Net loss after tax benefit

Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

($654,000) 228,900 ($425,100)

19) Muckingjay Inc. opened in 2022. The company reported sales revenue of $486,000 and expenses of $574,000. The revenue is on account, and no cash has been received or paid out for expenses. There are no permanent or temporary differences, so the book loss and taxable loss will be the same. Muckingjay plans to carry forward the net operating loss (NOL). The company has a 38% tax rate, and a valuation allowance is not required. Prepare the following for 2022: a) The necessary journal entry to record the NOL carryforward. b) A partial income statement beginning with sales revenue. Answer: a) Journal Entry: Deferred Tax Asset 33,440 Income Tax Benefit 33,440* *[($486,000 - $574,000) × 38%] b) Partial Income Statement: Sales revenue Operating Expenses Net Loss before tax benefit Income tax benefit Net loss after tax benefit

Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

$486,000 (574,000) (88,000) 33,440 ($54,560)

20) In 2022 Tetra Corp. generated $583,000 in revenues and incurs $276,000 in expenses. There are no permanent or temporary book-tax differences. Tetra has a deferred tax asset of $61,250 related to a net operating loss of $175,000 from the previous year. Assuming a 35% tax rate, prepare the tax related journal entry for the current year. Answer: Income Tax Expense 107,450 Income Tax Payable 46,200 Deferred Tax Asset 61,250 Income Tax Expense = ($583,000 - $276,000) × 35% = $107,450 Income Tax Payable = ($583,000 - $276,000 - $175,000) × 35% = $46,200 Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Greene Co. reported a loss in 2022 of $595,000 and carried the loss back is allowed. The company reported taxable income of $183,000 in 2020 and $200,000 in 2021. It has no permanent or temporary differences and its tax rate is 40%. Greene reported taxable income of $287,000 in 2023. Prepare the necessary journal entries for 2022 and 2023. Answer: 2022 Journal Entry: Income Tax Refund Receivable 153,200** Deferred Tax Asset 84,800 Income Tax Benefit 238,000* *Income Tax Benefit = $595,000 loss × 40% tax rate = $238,000 **Income Tax Refund Receivable = ($183,000 [2020 income] + $200,000 [2021 income]) × 40% = $153,200 2023 Journal Entry: Income Tax Expense Income Tax Payable Deferred Tax Asset

114,800***

30,000 84,800

***Income Tax Expense = $287,000 × 40% = $114,800 Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) In 2022, its first year of operations, Moulin & Company experienced a $326,000 net operating loss and recorded a deferred tax asset of $117,360. Moulin decides that it is more likely than not that it will only be able to generate $250,000 of taxable income during the carryforward period. As a result, without generating additional future taxable income it will not be able to fully realize the NOL carryforward benefit. Prepare the necessary journal entries to record the net deferred tax asset in 2022. Answer: Deferred Tax Asset 117,360 Income Tax Benefit 117,360 Income Tax Benefit Valuation Allowance for Deferred Tax Asset

27,360 27,360*

*Compute the implicit tax rate: $117,360 / $326,000 = 36% and multiply this by the difference between the NOL and the amount that is expected to be used during the carryforward period ($326,000 - $250,000) × 36% = $27,360. Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Caesar Corporation reported income before taxes of $200,000 for the years 2020, 2021, and 2022. In 2023 they experienced a loss of $200,000. The company had a tax rate of 34% in 2020 and 2021, and a rate of 45% in 2022 and 2023. Assuming Caesar uses the carryback provisions for the net operating loss, by what amount will the income tax benefit reduce the net loss in 2023? Answer: 2021 rate of 34% × ($200,000) from 2021 = $68,000 Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) TLR Productions reported income before taxes of $205,000 for the years 2020, 2021, and 2022. In 2023 they experienced a loss of $500,000. TLR had a tax rate of 34% in 2020 and 2021, and a rate of 41% in 2022 and 2023. Assuming the company uses the carryback provisions for the net operating loss and that the jurisdiction allows losses to be carried back two years, what amount should be reported as Income Tax Refund Receivable in 2023? Answer: 2021: ($205,000 × 34%) + 2022: ($205,000 × 41%) = $153,750 Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

25) Illusions Inc. just completed its second year of operations and has a deferred tax asset of $36,800 related to a net operating loss of $115,000 from the previous year. In the current year Illusions generates $390,000 in revenues and incurs $240,000 in expenses. There are no permanent or temporary book-tax differences. Assuming the same tax rate as last year, what amount will Illusions record for Income Tax Payable in the current year? Answer: Step 1: Calculate prior year tax rate: $36,800/$115,000 = 32% tax rate. Step 2: Calculate Income Tax Payable: $150,000 income - $115,000 carryforward = $35,000 × 32% = $11,200 Diff: 2 Objective: 17.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

17.7

Uncertain Tax Positions

1) Excluding potentially taxable income from a tax return is an example of an uncertain tax position. Answer: TRUE Diff: 1 Objective: 17.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) In many cases, tax authorities can disallow all or a portion of a particular position taken by a company on its tax return. Answer: TRUE Diff: 1 Objective: 17.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) IFRS treats uncertain tax positions the same as U.S. GAAP. Answer: FALSE Diff: 1 Objective: 17.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) In general, accounting under U.S. GAAP is intended to be a "principles-based" methodology requiring significant judgment by management, attorneys, and auditors. Answer: TRUE Diff: 1 Objective: 17.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Uncertain tax positions may result in a ________. A) tax deferral B) tax contingency C) tax refund D) tax asset Answer: B Diff: 1 Objective: 17.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Accounting for uncertain tax positions under U.S. GAAP involves a two-step approach: ________. A) measurement and classification B) recognition and qualification C) classification and computation D) recognition and measurement Answer: D Diff: 1 Objective: 17.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Accounting for uncertain tax positions under IFRS involves all of the following except ________. A) measuring tax assets at the amount expected to be paid B) assessing if a present obligation exists and is the result of a past event C) utilizing a two step approach which involves classification and measurement D) reliance on standards for accounting for contingencies for guidance Answer: C Diff: 1 Objective: 17.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) Sonic Speaker Co. took an aggressive tax position in its current year's tax return, claiming a $400,000 deduction. The company reported $750,000 in taxable income before considering the tax deduction, and is subject to a 28% income tax rate. Tax authorities have challenged this type of tax deduction in the past and Sonic Speaker Co. is now concerned about the realizability of this tax deduction in the future. However, management believes that it is more likely than not that the firm will sustain the tax benefits upon examination by tax authorities. The company provides the following analysis regarding the probabilities of sustaining the tax deduction:

Possible estimated outcome $400,000 $385,000 $300,000 $175,000 $89,000

Individual probability of occurring 7% 23% 30% 25% 15%

Refer to Sonic Speaker Company. What is the largest amount of tax benefit allowed? A) $84,000 B) $112,000 C) $49,000 D) $107,800 Answer: A Explanation: The tax benefit is the largest amount of a benefit that is greater than 50% likely of being realized upon ultimate settlement. The cumulative probability at $300,000 is 60% and the tax benefit is this amount multiplied by 28%. $300,000 × 28% = $84,000 = Tax Benefit Diff: 1 Objective: 17.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Sonic Speaker Co. took an aggressive tax position in its current year's tax return, claiming a $500,000 deduction. The company reported $950,000 in taxable income before considering the tax deduction, and is subject to a 38% income tax rate. Tax authorities have challenged this type of tax deduction in the past and Sonic Speaker Co. is now concerned about the realizability of this tax deduction in the future. However, management believes that it is more likely than not that the firm will sustain the tax benefits upon examination by tax authorities. The company provides the following analysis regarding the probabilities of sustaining the tax deduction:

Possible estimated outcome $500,000 $385,000 $290,000 $155,000 $109,000

Individual probability of occurring 7% 23% 30% 25% 15%

Refer to Sonic Speaker Company. What is the journal entry to record the current year's tax provision and the liability for the uncertain tax provision? A) Income Tax Expense Income Tax Payable Deferred Tax Asset B) Income Tax Expense Income Tax Payable Tax Contingency C) Income Tax Expense Income Tax Payable Tax Contingency D) Income Tax Expense Income Tax Payable

250,800

171,000 79,800

250,800 171,000 79,800

229,900 171,000 58,900

361,000 361,000

Answer: B Explanation: The tax benefit (in this case a deduction) is the largest amount of a benefit that is greater than 50% likely of being realized upon ultimate settlement. The cumulative probability at $290,000 is 60%. Income Tax Expense: ($950,000 income - $290,000 expected deduction) × 38% tax rate) = $250,800. Income Tax Contingency is difference between the full and expected deduction: ($500,000 - $290,000) × 38% = $79,800. Income Tax Payable is the taxable income times the tax rate = ($950,000 income - $500,000 deduction) × 38% = $171,000. Diff: 2 Objective: 17.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Identify and explain the steps in U.S. GAAP's approach to accounting for uncertain tax positions. Answer: Step 1 - Recognition: the company will evaluate all evidence and determine if it is more likely than not that the tax position will be sustained. Step 2 - Measurement: the company measures the amount to be recognized based on cumulative probability computations, without considering the time value of money in the computation. See Topic 740, which followed FASB FIN No. 48. Diff: 1 Objective: 17.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) How does IFRS account for uncertain tax positions? Answer: IFRS does not specifically address uncertain tax positions. Rather, it requires firms to measure tax assets and tax liabilities at the amount expected to be paid. As such, IFRS reporters rely on standards for accounting for contingencies as guidance. Under this guidance, the company: 1. Assesses whether it has a present obligation as a result of a past event. 2. Determines whether it is probable that it will use resources to settle the obligation and if can reliably estimate the obligation. Diff: 1 Objective: 17.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

12) Kramerica Corporation took an aggressive tax position in its current year's tax return, claiming a $370,000 deduction. The company reported $770,000 in taxable income before considering the tax deduction, and is subject to a 33% income tax rate. Tax authorities have challenged this type of tax deduction in the past and Kramerica is now concerned about the realizability of this tax deduction in the future. However, management believes that it is more likely than not that the firm will sustain the tax benefits upon examination by tax authorities. The company provides the following analysis regarding the probabilities of sustaining the tax deduction: Individual probability Possible estimated outcome of occurring $370,000 10% $333,000 12% $275,000 29% $142,000 26% $101,000 23% Prepare the journal entry to record the current year's tax provision and the liability for the uncertain tax provision. Answer: Income Tax Expense 163,350 Income Tax Payable 132,000 Tax Contingency 31,350 The tax benefit (in this case a deduction) is the largest amount of a benefit that is greater than 50% likely of being realized upon ultimate settlement. The cumulative probability at $275,000 is 51%. Income Tax Expense is calculated as expected taxable income ($770,000 - $275,000 deduction) = $495,000 × 33% tax rate = $163,350. Income Tax Payable is the reported taxable income ($770,000 - $370,000 = $400,000) times the tax rate 33% = $132,000. Income Tax Contingency is the difference between these amounts or the difference between the reported and expected deductions times the tax rate.: ($370,000 - $275,000) × 33% = $31,350 Diff: 2 Objective: 17.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

17.8

Financial Statement Presentation

1) Under IFRS, the balance sheet presentation for deferred taxes is to report them as either current or noncurrent. Answer: FALSE Diff: 1 Objective: 17.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

2) Under GAAP, the balance sheet presentation for deferred taxes is to report them as either current or non-current. Answer: FALSE Diff: 1 Objective: 17.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Netting deferred tax assets and liabilities is permitted as long as the right to offset exists. Answer: TRUE Diff: 1 Objective: 17.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Under U.S. GAAP, companies classify individual deferred tax assets or liabilities as ________. A) current or noncurrent based on the underlying asset or liability B) noncurrent only C) current only D) current or noncurrent based on the reversal date Answer: B Diff: 1 Objective: 17.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) An intraperiod tax allocation ________. A) results when different income statement items are taxed at different rates B) occurs when certain revenues and expenses appear in the financial statements either before or after they are included in the income tax return C) allocates income tax expense to different sections of the comprehensive income statement D) deals with allocation of taxes between current and future periods Answer: C Diff: 1 Objective: 17.8 IFRS/GAAP: GAAP AACSB: Analytical thinking

6) Crystal Critters, Inc., a U.S. GAAP reporter, has the deferred tax assets and liabilities presented below:

Item Excess of warranty expense over warranty deductions Accelerated depreciation for tax purposes Installment sales receivable Contingent liability

Classification on the Balance Sheet of Related Deferred Tax Account Associated with Item Current

$74,000 Asset

Noncurrent Current Current

$84,000 Liability $44,000 Liability $34,000 Asset

Assuming it meets the conditions to net assets and liabilities, how will the company report deferred taxes on the balance sheet? A) current liability: deferred tax liability $64,000; noncurrent liability: deferred tax liability $84,000 B) noncurrent liability: deferred tax liability $20,000 C) current asset: deferred tax asset $108,000; noncurrent liability: deferred tax liability $128,000 D) current liability: deferred tax liability $44,000; noncurrent asset: deferred tax asset $84,000 Answer: B Explanation: All are noncurrent. Deferred tax assets = $74,000 + $34,000 = $108,000. Deferred Tax Liabilities = $84,000 + $44,000 = $128,000. Netting: Deferred Tax Liabilities $20,000. Diff: 1 Objective: 17.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Tetra Corp, an IFRS reporter, has the deferred tax assets and liabilities presented below:

Item Excess of warranty expense over warranty deductions Accelerated depreciation for tax purposes Installment sales receivable Contingent liability

Classification on the Balance Sheet of Related Deferred Tax Account Associated with Item Current

$69,000 Asset

Noncurrent Current Current

$79,000 Liability $39,000 Liability $29,000 Asset

What will the company report for deferred taxes on the balance sheet? A) current assets: deferred tax asset $59,000; noncurrent liabilities: deferred tax liability $79,000 B) noncurrent assets: deferred tax asset $20,000 C) noncurrent liabilities: deferred tax liability $20,000 D) Companies do not report deferred taxes on the balance sheet under IFRS. Answer: C Explanation: Under IFRS, all deferred tax items are classified as noncurrent: $69,000 + $29,000 - $79,000 $39,000 = ($20,000). Total liabilities exceed total assets so it nets to a liability. Diff: 1 Objective: 17.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

8) Ivy Group reported income from continuing operations before taxes of $648,000 and income from discontinued operations of $224,000. Ivy also reported $78,000 of unrealized gains from available-for-sale debt investments (fair value accounting adjustments) recorded as other comprehensive income. The company is subject to a 28% tax rate and reports no permanent differences. How much income tax expense does Ivy report as a line item directly below "Income from Continuing Operations before Taxes"? A) $266,000 B) $244,160 C) $203,280 D) $181,440 Answer: D Explanation: $648,000 × 28% = $181,440 Diff: 1 Objective: 17.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Lyon Corp reported income from continuing operations before taxes of $774,000 and income from discontinued operations of $198,000. Lyon also reported $77,000 of unrealized gains from available-forsale debt investments (fair value accounting adjustments) recorded as other comprehensive income. The company is subject to a 35% tax rate and reports no permanent differences. Prepare a partial income statement including comprehensive income. Answer: Income from continuing operations before taxes Income tax expense Income from continuing operations Discontinued operations: Income from discontinued operations - net of tax $69,300 Net income Other comprehensive income: Unrealized gains from available-for-sale debt investments - net of tax $26,950 Comprehensive income

$774,000 270,900 503,100 128,700 $631,800

50,050 $681,850

Diff: 2 Objective: 17.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) In 2022, the MoosePants Corporation reported income from continuing operations before taxes of $865,500 and income from discontinued operations of $213,000. MoosePants also reported $82,000 of unrealized gains from available-for-sale debt investments (fair value accounting adjustments) recorded as other comprehensive income. The company is subject to a 34% tax rate and reports no permanent differences. Prepare a partial income statement including comprehensive income. Answer: Income from continuing operations before taxes $865,500 Income tax expense 294,270 Income from continuing operations 571,230 Discontinued operations: Income from discontinued operation - net of tax $72,420 140,580 Net income 711,810 Other comprehensive income: Unrealized gain from available-for-sale debt investments - net of tax $27,880 54,120 Comprehensive income $765,930 Diff: 2 Objective: 17.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

17.9

Income Tax Financial Statement Disclosures

1) A firm is not required to reconcile the federal statutory tax rate to its effective tax rate. Answer: FALSE Diff: 1 Objective: 17.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Income tax rate reconciliation under IFRS must begin with the U.S. statutory income tax rate. Answer: FALSE Diff: 1 Objective: 17.9 IFRS/GAAP: IFRS AACSB: Application of knowledge

3) Moose Company has a high conservatism ratio. This could indicate that the company will have to pay higher taxes in the future relative to the present. Answer: TRUE Diff: 1 Objective: 17.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Companies are required to disclose the amount of income tax expense that is ________. A) current B) noncurrent C) allocated to financial statement elements that are not part of income from continuing operations D) All of the above are disclosed. Answer: D Diff: 1 Objective: 17.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

5) With regard to deferred tax items, a company must disclose all of the following except ________. A) the amount and expiration of carryforwards for net operating losses and unused tax credits B) the amount of the valuation allowance or any change in valuation allowance C) the individual components of all significant deferred tax assets and deferred tax liabilities D) All of the above must be disclosed. Answer: C Explanation: The individual components of deferred tax assets and liabilities must be disclosed only if significant. Diff: 1 Objective: 17.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Woods Company reports income before taxes in the amount of $925,000. The current tax expense is $365,375 and the effective tax rate is 27%. What is the conservatism ratio for Woods Company? A) 0.68 B) 0.19 C) 0.45 D) 0.40 Answer: A Explanation: Taxable income = $365,375/27% = $1,353,241 Conservatism ratio = $925,000/$1,353,241 = 0.68 Diff: 2 Objective: 17.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Explain the conflicting incentives that relate to reporting of taxes. What might the related strategies signal to investors? Answer: Companies want to maximize net income while also minimizing the amount of taxes paid. Minimizing taxes paid keeps more cash to use in business operations. However, investors may note that companies are using income-increasing accounting strategies to increase the book net income — while not actually increasing income from operations. An increase in deferred tax liabilities or decrease in deferred tax assets could indicate to financial statement users that a company is making incomeincreasing accounting choices as opposed to increasing income from its operations. Diff: 1 Objective: 17.9 IFRS/GAAP: GAAP AACSB: Analytical thinking

8) Woods Company reports income before taxes in the amount of $950,000. The current tax expense is $360,000 and the effective tax rate is 26%. What is the taxable income and conservatism ratio for Woods Company (round taxable income to nearest dollar, round the conservatism ratio to two decimal places)? Answer: Taxable income = $360,000/0.26 = $1,384,616 Conservatism ratio = $950,000/$1,384,616 = 0.69 Diff: 2 Objective: 17.9 IFRS/GAAP: GAAP AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 18 Accounting for Leases 18.1

Leases: Overview

1) In general, the cost of an asset over the life of the lease is lower than if the lessee purchased the asset. Answer: FALSE Diff: 1 Objective: 18.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

2) When a company purchases equipment by issuing a long-term note, the interest element of the payment is tax deductible. However, if the company leases equipment, the entire lease payment may be tax deductible. Answer: TRUE Diff: 1 Objective: 18.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

3) Which of the following is not an advantage for leasing for the lessee? A) Overall cost of the asset of lease compare to purchase of an asset. B) Business and financial flexibility. C) Tax benefits. D) Complete financing of asset. Answer: A Diff: 2 Objective: 18.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The concept of substance over form can be applied to leases. Which lease terms are most important to understanding the economic substance of the lease contract? Answer: The amount and timing of lease payments; the length of the lease; the economic life of the leased asset; whether the lease transfers ownership of the leased asset to the lessee at the end of the lease; and whether the lessee can, and is likely to, buy the leased item at the end of the lease. Diff: 1 Objective: 18.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

5) List 4 advantages of leasing for the lessee. Answer: 1. Complete Financing 2. Lessor bears the risk of obsolescence 3. Business and financial flexibility 4. Tax benefits Diff: 1 Objective: 18.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

6) List 2 disadvantages of leasing for the lessee. Answer: 1. Overall cost of the asset is higher than if purchased 2. Lack of ownership of the asset Diff: 1 Objective: 18.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

7) What are the key steps in the least transaction? Answer: Step 1. Identify a lease contract. Step 2. Identify lease and nonlease components and allocate costs to each component. Step 3. Classify the lease. Step 4. Recognize and initially measure the lease transaction. Step 5. Determine subsequent measurement of the lease transaction. Diff: 2 Objective: 18.1 IFRS/GAAP: GAAP AACSB: Reflective thinking

18.2

Lease Contracts, Lease Components, and Contract Consideration

1) After identifying a lease, both the lessee and the lessor are required to separate the various lease and nonlease components and allocate consideration to these components. Answer: TRUE Diff: 1 Objective: 18.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) When there are several assets as part of the lease, only some must be separately identified. Answer: FALSE Diff: 1 Objective: 18.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Which of the following assets is always considered a separate lease component in a lease, unless the impact on the financial statements of not separating it from the other asset(s) is insignificant? A) land B) services associated with the lease C) fully depreciated assets D) All of the above Answer: A Diff: 2 Objective: 18.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) In cases where the standalone price is highly variable or uncertain, the lessee may use what type of method for determining standalone prices? A) market method B) residual method C) component method D) Both A & C are correct. Answer: B Diff: 2 Objective: 18.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Which of the following items are not examples of initial direct lease costs? A) commissions B) legal fees resulting from the execution of the lease C) costs to prepare documents after the execution of the lease D) All of the above are examples of indirect lease costs. Answer: D Diff: 1 Objective: 18.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) In instances where there is not an observable standalone selling price, the lessor must use an estimate of the standalone selling price and allocate it based on which of the following methods? A) adjusted market assessment approach B) expected-cost-plus-a-margin approach C) residual approach D) any of the above approaches Answer: D Diff: 1 Objective: 18.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Alpha Company has three components in their lease agreement: the building, the equipment and the maintenance service. Total consideration in the contract is $500,000 per year. Alpha Company has identified the following standalone prices: Component Building Equipment Maintenance/Service Total

Standalone Price $400,000 100,000 50,000 $550,000

Calculate the percentages and allocate the consideration to each component. Answer: As the total consideration in the contract is not equal to the sum of the standalone prices, Alpha Company uses the relative standalone prices to allocate the total consideration to each component. The $500,000 total consideration is allocated as follows: (Round percentages to two decimal places.)

Component Building Equipment Maintenance/Service Total

Standalone Price $400,000 100,000 50,000 $550,000

Percentage 72.73% 18.18% 9.09%

Allocated Consideration $363,650 90,900 45,450 $500,000

Diff: 2 Objective: 18.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

18.3

Lease Classifications

1) Present value of lease payments + Present value of guaranteed or unguaranteed residual asset = Fair value of leased asset + Deferred initial direct costs. Answer: TRUE Diff: 2 Objective: 18.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The initial direct costs cannot be deferred and the lessor must expense initial direct costs at the lease commencement. Answer: FALSE Diff: 2 Objective: 18.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) IFRS does not classify leases as operating and financing and does not distinguish two types of leases. Rather, lessee accounting treatment is the same for all leases under IFRS. Answer: TRUE Diff: 1 Objective: 18.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

4) The Group II criteria seem like a simple way to achieve a reporting outcome. FASB wanted lessors to recognize a profit at lease commencement from nonoperating lease treatment due partly to a third-party residual value guarantee. Answer: FALSE Diff: 2 Objective: 18.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The ________ date is when the lease agreement is signed. The ________ date is the date on which the lessee is allowed to begin using the leased asset. A) lease inception; lease commencement B) lease consideration; lease commencement C) lease inception; lease finalization D) Both A & B are correct. Answer: A Diff: 1 Objective: 18.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) If the lessor meets any one of the five Group I criteria, then the lessor classifies the lease as a(n) ________. If the lessor meets both of the Group II criteria, but none of the Group I criteria, then the lessor classifies the lease as a(n) ________. If the transaction does not meet either the Group I or Group II criteria, then the lessor classifies the lease as a(n) ________. A) operating lease; direct financing lease; sales-type lease B) sales-type lease; direct financing lease; operating lease C) standalone price lease; sales-type lease; direct financing lease D) direct financing lease; operating lease; sales-type lease Answer: B Diff: 2 Objective: 18.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Prior to 2019, lessees did not include the right-of-use asset and the lease liability for operating leases on their balance sheets. Both FASB and IASB wrote new standards to require that lessees nearly always report an asset and liability on their balance sheets when they engage in a lease transaction. This accounting results in which of the following? A) a more reliable estimation of the lease's value B) a more faithful representation of the rights and obligations arising from leases C) a better determination on whether the lessor held the risks and rewards of the leased asset's ownership D) All of the above Answer: B Diff: 2 Objective: 18.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Kataran Company enters into a 4-year lease transaction, with payments due at the beginning of each year. The lease payments are $78,000 per year. The fair value of the leased asset is $290,000. The lessor's deferred initial direct costs are equal to $24,000. The lessor's estimate of the unguaranteed residual asset is $115,000. Based on the above information, what is the implicit rate in the lease for Kataran? A) 11.48% B) 21.81% C) 14.77% D) 16.54% Answer: D Explanation: Kataran should apply time value of money concepts to identify the terms needed to solve for the implicit rate. The present value, PV, is the present value of the lease payments plus the expected residual value which equals the fair value of the leased asset plus the deferred initial direct costs: Present Value of Lease Payments + Present Value of Estimated Residual Value = $290,000 Fair Value of Leased Asset + $24,000 Initial Direct Costs = $314,000 The number of periods, N, is 4 years. The payments each period, PMT, are $78,000. The future value, FV, is the residual value of $115,000. Using the RATE function in Excel, (=RATE(4,78000,-314000,115000,1)), the implicit rate in the lease is 16.54%. Diff: 2 Objective: 18.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Kataran Company enters into a 4-year lease transaction, with payments due at the beginning of each year. The lease payments are $68,000 per year. The fair value of the leased asset is $280,000. The lessor's deferred initial direct costs are equal to $14,000. The lessor's estimate of the unguaranteed residual asset is $125,000. Based on the information above, what is the implicit rate? Answer: Kataran should apply time value of money concepts to identify the terms needed to solve for the implicit rate. The present value, PV, is the present value of the lease payments plus the expected residual value which equals the fair value of the leased asset plus the deferred initial direct costs: Present Value of Lease Payments + Present Value of Estimated Residual Value = $280,000 Fair Value of Leased Asset + $14,000 Initial Direct Costs = $294,000. The number of periods, N, is 4 years. The payments each period, PMT, are $68,000. The future value, FV, is the residual value of $125,000. Using the RATE function in Excel (=RATE(4,68000,-294000,125000,1)), the implicit rate in the lease is 15.14%. Diff: 3 Objective: 18.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Group I criteria provide guidance to operationalize the concept of ownership and control of an asset. To meet the Group I criteria, a transaction only needs to meet one of the five criteria. List those five criteria. Answer: 1. The lease transfers ownership of the leased asset to the lessee at the end of the lease term. If the lease transfers ownership, then the lessee firm has, in essence, purchased the asset. 2. The lessee is given an option to purchase the asset that the lessee is reasonably certain to exercise. For example, it might be reasonably certain that the lessee would exercise a purchase option if the specified purchase price is well below the expected value of the leased asset at the completion of the lease term. 3. The lease term is for a major part of the economic life of the asset. If the lease term provides the lessee the use and control over substantially all of the asset's useful life, then the agreement should be considered equivalent to purchasing the asset. 4. The present value of the sum of the lease payments and any residual value the lessee guarantees to pay (that is not otherwise included in the lease payments) is equal to substantially all of the asset's fair value. The present value computation includes lease payments in the renewal periods, if any. Meeting this criterion implies that the lessee is providing the lessor compensation that is equivalent to the purchase of the asset. 5. The leased asset is of a specialized nature. An asset with a specialized nature has no alternative use to the lessor at the end of the lease term. Because the asset has no alternative use to the lessor, its specialized nature implies that the lessor must have transferred control over the asset to the lessee. Diff: 2 Objective: 18.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) List the three additional indicators that IFRS recognizes individually or in combination that could lead to classifying a lease as a finance lease. Answer: 1. The lessee bears the lessor's losses if the lessee cancels the lease. 2. The lessee absorbs the gains or losses from fluctuations in the fair value of the residual value of the asset. 3. The lessee may extend the lease for a secondary period at a rent substantially below the market rent in a renewal option. Diff: 2 Objective: 18.3 IFRS/GAAP: IFRS AACSB: Application of knowledge

12) Keiter Company enters into a 4-year lease transaction, with payments due at the beginning of each year. The lease payments are $78,000 per year. The fair value of the leased asset is $300,000. The lessor's deferred initial direct costs are equal to $25,000. The lessor's estimate of the unguaranteed residual asset is $115,000. Based on the above information, what is the implicit rate in the lease for Keiter? Answer: 14.40% Explanation: Keiter should apply time value of money concepts to identify the terms needed to solve for the implicit rate. The present value, PV, is the present value of the lease payments plus the expected residual value which equals the fair value of the leased asset plus the deferred initial direct costs: Present Value of Lease Payments + Present Value of Estimated Residual Value = $300,000 Fair Value of Leased Asset + $25,000 Initial Direct Costs = $325,000 The number of periods, N, is 4 years. The payments each period, PMT, are $78,000. The future value, FV, is the residual value of $115,000. Using the RATE function in Excel, (=RATE(4,78000,-325000,115000,1)), the implicit rate in the lease is 14.40%. Diff: 2 Objective: 18.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

18.4

Accounting for Operating Leases: Lessee and Lessor

1) Measuring the right-of-use asset includes the following components: the lease liability determined as the future value of the remaining lease payments, lease payments the lessee makes to the lessor at or before the commencement date, a reduction for any lease incentives the lessee receives and any initial direct costs the lessee incurs. Answer: FALSE Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The right-of-use asset is initially measured to reflect the lessee's net cash outflows related to the lease. Answer: TRUE Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When a lease term is 12 months or less, the lessee can make a policy election not to record the lease liability and the right-of-use asset. The FASB included this exemption based on the cost constraint. That is, the costs of measuring and reporting the lease liability and the right-of-use asset outweigh the benefits of reporting these amounts on the lessee's balance sheet for a lease with a term of 1 year or less. Answer: TRUE Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) For an operating lease, the lessee will record a(n) ________ and an associated lease liability on the balance sheet. A) intangible asset B) capital adjustment C) contra-liability account D) right-of-use asset Answer: D Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) On the balance sheet, the lease liability is measured as ________. A) the present value of the lease payments plus the present value of the guaranteed residual value if the lessee guarantees it(if any) B) the present value of the lease payments less the present value of the guaranteed residual value (if any) C) the future value of the lease payments plus the future value of the guaranteed residual value (if any) D) the present value of the lease payments plus the future value of the guaranteed residual value (if any) Answer: A Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following statements is true? A) The right-of-use asset is increased by prepaid lease payments, but reduced by lease incentives and the lessee's initial direct costs. B) The right-of-use asset is increased by prepaid lease payments and the lessee's initial direct costs, but reduced by lease incentives. C) The right-of-use asset is reduced by the lessee's initial direct costs, but increased by lease incentives and prepaid lease payments. D) The right-of-use asset is reduced by prepaid lease payments and the lessee's initial direct costs, but increased by lease incentives. Answer: B Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Leewin Brokerage enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $77,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Leewin will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Leewin made a lease payment of $10,900 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,900, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 7% and is known by Leewin. There is no purchase option, no lease incentives, no residual value guarantees, and no transfer of ownership. Leewin incurs initial direct costs of $1200. Assuming that this is classified as an operating lease, what is the amount of the lease liability on January 1, 2023 before the lease payment? A) $47,821 B) $45,892 C) $44,692 D) $64,200 Answer: A Explanation: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 7%, 5 periods, and payments at the beginning of each period of $10,900, is $47,821. The Excel formula: =PV(0.07,5,-10900,0,1) = $47,821. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Leewin Brokerage enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $71,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Leewin will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Leewin made a lease payment of $10,000 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,000, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 4% and is known by Leewin. There is no purchase option, no lease incentives, no residual value guarantees, and no transfer of ownership. Leewin incurs initial direct costs of $1500. Compute the present value of the lease payments in order to determine if the lease meets the fourth Group I criterion. Calculate the present value of each payment individually. Assuming that this is classified as an operating lease, what is the value of the right-of-use asset at the lease's commencement? A) $44,518 B) $46,018 C) $57,799 D) $47,799 Answer: C Explanation: The right-of-use asset is valued as the initial measurement of the lease liability (the present value of the future lease payments) plus prepayments plus initial direct costs. Using Excel, the present value of the future lease payments, based on a rate of 4%, 5 periods, and payments at the beginning of each period of $10,000, is $46,299. The value of the right-of-use asset is $46,299 + $10,000 + $1500 = $57,799. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Leewin Brokerage enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $77,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Leewin will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Leewin made a lease payment of $10,900 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,900, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 6% and is known by Leewin. There is no purchase option, no lease incentives, no residual value guarantees, and no transfer of ownership. Leewin incurs initial direct costs of $1100. Assuming that this is classified as an operating lease, what is the annual lease expense reported on the income statement? A) $10,900 B) $13,300 C) $12,000 D) $11,120 Answer: B Explanation: To calculate the annual lease expense, the first step is to calculate the total payments over the life of the lease, which include prepaid payments, annual payments and initial direct costs. Total payments are $10,900 + (5 × $10,900) + $1100 = $66,500. Annual lease expense is calculated by allocating this amount equally over the 5 year lease life, $66,500 / 5 = $13,300. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Leewin Brokerage enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $76,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Leewin will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Leewin made a lease payment of $10,000 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,000, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 6% and is known by Leewin. There is no purchase option, no lease incentives, no residual value guarantees, and no transfer of ownership. Leewin incurs initial direct costs of $1100. In addition to the information provided above, assume that Bumble provided a $6000 incentive. Assuming that this is classified as an operating lease, what is the annual lease expense reported on the income statement? A) $10,000 B) $12,220 C) $11,100 D) $11,020 Answer: D Explanation: To calculate the annual lease expense, the first step is to calculate the total payments over the life of the lease, which include prepaid and annual payments and initial direct costs, less lease incentives. Total payments are $10,000 + (5 × $10,000) + $1100 - $6000 = $55,100. Annual lease expense is calculated by allocating this amount equally over the 5 year lease life, $55,100 / 5 = $11,020. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Leewin Brokerage enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $78,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Leewin will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Leewin made a lease payment of $10,700 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,700, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 4% and is known by Leewin. There is no purchase option, no lease incentives, no residual value guarantees, and no transfer of ownership. Leewin incurs initial direct costs of $2000. Assuming that this is classified as an operating lease, how much interest expense is recorded in 2023? A) $1982 B) $0 C) $2140 D) $1554 Answer: D Explanation: Interest for 2023 is calculated based on the lease liability reduced by the first payment of $10,700 times the interest rate. The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 4%, 5 periods, and payments at the beginning of each period of $10,700, is $49,540. ($49,540 - $10,700) × 4% = $1554. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Leewin Brokerage enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $80,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Leewin will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Leewin made a lease payment of $10,800 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,800, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 4% and is known by Leewin. There is no purchase option, no lease incentives, no residual value guarantees, and no transfer of ownership. Leewin incurs initial direct costs of $1100. Assuming that this is classified as an operating lease, how much amortization is recorded on the right-ofuse asset in 2023? A) $11,612 B) $0 C) $13,180 D) $1568 Answer: A Explanation: Amortization is the difference between the lease expense for the year and interest for the year. To calculate the annual lease expense, the first step is to calculate the total payments over the life of the lease, which include prepaid and annual payments and initial direct costs. Total payments are $10,800 + (5 × $10,800) + $1100 = $65,900. Annual lease expense is calculated by allocating this amount equally over the 5 year lease life, $65,900 / 5 = $13,180. Interest for 2023 is calculated based on the lease liability reduced by the first payment of 5 times the interest rate. The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 4%, 5 periods, and payments at the beginning of each period of $10,800, is $50,003. ($50,003 - $10,800) × 4% = $1568. Therefore, amortization is $13,180 - $1568 = $11,612. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Starboard Industries enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $73,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Starboard will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Starboard made a lease payment of $10,300 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,300, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 4% and is known by Starboard. Starboard guarantees a residual value of $3000 and incurs initial direct costs of $1700. Assuming that this is classified as an operating lease, what is the amount of the lease liability on January 1, 2023 before the lease payment? A) $47,688 B) $50,154 C) $45,854 D) $60,100 Answer: B Explanation: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 4%, 5 periods, payments at the beginning of each period of $10,300, and a future value of $3000 is $50,154. The Excel formula is =PV(0.04,5,-10300,-3000,1) = $50,154. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Starboard Industries enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $73,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Starboard will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Starboard made a lease payment of $10,400 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,400, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 5% and is known by Starboard. Starboard guarantees a residual value of $4500 and incurs initial direct costs of $1600. Assuming that this is classified as an operating lease, what is the value of the right-of-use asset at the lease's commencement? A) $45,027 B) $46,627 C) $59,278 D) $62,804 Answer: D Explanation: Initial measurement of the lease liability $50,804 Payments lessee makes to the lessor prior to the lease commencement date 10,400 Lease incentives received 0 Initial direct costs incurred by the lessee 1600 Initial measurement of the right-of-use asset $62,804 The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 5%, 5 periods, payments at the beginning of each period of $10,400, and a future value of $4500 is $50,804. The Excel formula is =PV(0.05,5,-10400,-4500,1) = $50,804. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

Leewin Brokerage Leewin Brokerage enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $75,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Leewin will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Leewin made a lease payment of $10,000 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,000, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 7% and is known by Leewin. There is no purchase option, no lease incentives, no residual value guarantees, and no transfer of ownership. Leewin incurs initial direct costs of $2,000. 15) Assuming that this is classified as an operating lease, what is the amount of the lease liability at January 1, 2023 before the payment? Answer: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 7%, 5 periods, and payments at the beginning of each period of $10,000, is $43,872. The Excel formula is: =PV(.07,5,-10000,0,1) = $43,872. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Based on the above information, calculate the right-of-use asset on January 1, 2023. Answer: Initial measurement of the lease liability $43,872 Payments lessee makes to the lessor prior to the lease commencement date 10,000 Lease incentives received 0 Initial direct costs incurred by the lessee 2,000 Initial measurement of the right-of-use asset $55,872 *The lease liability is found using the Excel formula: =PV(.07,5,-10000,0,1) = $43,872. Diff: 1 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Based on the above information, what is the journal entry Leewin made to record the initial payment of $10,000? Answer: Account December 20, 2022 Prepaid Lease Payment 10,000 Cash 10,000 Diff: 1 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Based on the above information, record the lessee's journal entry for the payment of initial direct costs. Answer: Account January 1, 2023 Prepaid Initial Direct Costs 2,000 Cash 2,000 Diff: 1 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Assuming this is an operating lease, what journal entries does Leewin make on January 1, 2023? Answer: January 1, 2023 Account Debit Credit Prepaid Initial Direct Costs 2,000 Cash 2,000

Account Right-of-Use Asset Prepaid Lease Payment Prepaid Initial Direct Costs Lease Liability

Account Lease Liability Cash

January 1, 2023 55,872 10,000 2,000 43,872

January 1, 2023 Debit 10,000

Credit 10,000

The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 7%, 5 periods, and payments at the beginning of each period of $10,000, is $43,872. The Excel formula is =PV(.07,5,-10000,0,1) = $43,872. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) What journal entry does Leewin make on January 1, 2023 to record the annual lease payment? Answer: Account January 1, 2023 Lease Liability 10,000 Cash 10,000 Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Assuming that this is classified as an operating lease, what is the annual lease expense reported on the income statement? Answer: To calculate the annual lease expense, the first step is to calculate the total payments over the life of the lease, which include initial and annual payments and indirect costs. Total payments are $10,000 + (5 × $10,000) + $2,000 = $62,000. Annual lease expense is calculated by allocating this amount equally over the 5 year lease life, $62,000 / 5 = $12,400. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Assuming that this is classified as an operating lease, create an amortization table for periodic interest and reduction in the liability. Periodic Interest and Reduction in the Liability Payment

Interest

Reduction in Lease Liability

Balance

Lease commencement: 1/1/2023 1/1/2024 1/1/2025 1/1/2026 1/1/2027 Answer: Periodic Interest and Reduction in the Liability Payment Interest Lease commencement: 1/1/2023 1/1/2024 1/1/2025 1/1/2026 1/1/2027

10,000 10,000 10,000 10,000 10,000

2,371 1,837 1,266 654

Reduction 10,000 7,629 8,163 8,734 9,346

Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

Balance 43,872 33,872 26,243 18,080 9,346 (0)

23) Assuming that this is classified as an operating lease, create an amortization table for the right-of-use asset. Amortization of Right-of-Use Asset Lease Expense

Interest

Amortization of Rightof-Use Asset

Interest 2,371 1,837 1,266 654 0 6,128

Amortization of Rightof-Use Asset 10,029 10,563 11,134 11,746 12,400 55,872

12/31/2023 12/31/2024 12/31/2025 12/31/2026 12/31/2027 Total Answer: Amortization of Right-of-Use Asset

12/31/2023 12/31/2024 12/31/2025 12/31/2026 12/31/2027 Total

Lease Expense 12,400 12,400 12,400 12,400 12,400 62,000

Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Prepare the journal entry required on December 31, 2023. Assume this is an operating lease. Answer: Date Account Debit Credit 12/31/2023 Lease Expense 12,400 Lease Liability 7,629 Accumulated Amortization–Right-of-Use Asset 10,029 Accrued Lease Payable 10,000 Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

Starboard Industries Starboard Industries enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $75,000 under a 5-year lease on December 20, 2022. The lease commences on January 1, 2023, and Starboard will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Starboard made a lease payment of $10,000 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,000, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 7% and is known by Starboard. Starboard guarantees a residual value of $5,000 and incurs initial direct costs of $2,000. 25) Assuming that this is classified as an operating lease, what is the amount of the lease liability on January 1, 2023 before the lease payment? Answer: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 7%, 5 periods, payments at the beginning of each period of $10,000, and a future value of $5,000 is $47,437. The Excel formula is: =PV(.07,5,-10000,5000,1) = $47,437. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Based on the above information, calculate the right-of-use asset on January 1, 2023. Answer: Initial measurement of the lease liability $47,437* Payments lessee makes to the lessor prior to the lease commencement date 10,000 Lease incentives received 0 Initial direct costs incurred by the lessee 2,000 Initial measurement of the right-of-use asset $59,437 *Using Excel, =PV(.07,5,-10000,-5000,1) = $47,437 Diff: 1 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Assuming this is an operating lease, what journal entries does Starboard make on January 1, 2023? Answer: January 1, 2023 Account Debit Credit Prepaid Initial Direct Costs 2,000 Cash 2,000 Account Right-of-Use Asset Prepaid Lease Payment Prepaid Initial Direct Costs Lease Liability

January 1, 2023 59,437 10,000 2,000 47,437

The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 7%, 5 periods, payments at the beginning of each period of $10,000, and a future value of $5,000 is $47,437.

Account Lease Liability Cash

January 1, 2023 Debit 10,000

Credit 10,000

Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

Incentive Industries Incentive Industries enters into a lease agreement with Bumble Motors to lease an automobile with a fair value of $75,000 under a 5-year lease on December 20, 2022. Bumble provides Incentive Industries with a lease incentive in the amount of $6,000 to terminate another lease. The lease commences on January 1, 2023, and Incentive will return the automobile to Bumble on December 31, 2027. The automobile has an estimated useful life of 7 years. Incentive made a lease payment of $10,000 on December 20, 2022. In addition, the lease agreement stipulates annual payments of $10,000, due on January 1 of 2023, 2024, 2025, 2026, and 2027. The implicit rate of the lease is 7% and is known by Incentive. Incentive incurs initial direct costs of $2,000. 28) Assuming that this is classified as an operating lease, what is the amount of the lease liability at on January 1, 2023 before the lease payment? Answer: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 7%, 5 periods, and payments at the beginning of each period of $10,000 = $43,872. The Excel formula is: =PV(.07,5,-10000,0,1) = $43,872. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) Based on the above information, calculate the right-of-use asset on January 1, 2023. Answer: Initial measurement of the lease liability $43,872* Payments lessee makes to the lessor prior to the lease commencement date 10,000 Lease incentives received (6,000) Initial direct costs incurred by the lessee 2,000 Initial measurement of the right-of-use asset $49,872 *The Excel formula is: =PV(.07,5,-10000,0,1) = $43,872. Diff: 1 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

30) What journal entries does Incentive make on January 1? Assume this is an operating lease. Answer: January 1, 2023 Account Debit Credit Prepaid Initial Direct Costs 2,000 Cash 2,000

Account Right-of-Use Asset Liability for Lease Incentive Prepaid Lease Payment Prepaid Initial Direct Costs Lease Liability

January 1, 2023 49,872 6,000 10,000 2,000 43,872

The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 7%, 5 periods, and payments at the beginning of each period of $10,000 = $43,872. The Excel formula is: =PV(.07,5,-10000,0,1) = $43,872.

Account Lease Liability Cash

January 1, 2023 Debit 10,000

Credit 10,000

Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) What journal entry does Incentive make on January 1, 2023 to record the annual lease payment? Answer: Account January 1, 2023 Lease Liability 10,000 Cash 10,000 Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

32) Assuming that this is classified as an operating lease, what is the annual lease expense reported on the income statement? Answer: To calculate the annual lease expense, the first step is to calculate the total payments over the life of the lease, which include prepaid and annual payments and initial direct costs, and reduced by the lease incentive. Total payments are $10,000 + (5 × $10,000) + $2,000 - $6,000 = $56,000. Annual lease expense is calculated by allocating this amount equally over the 5 year lease life, $56,000 / 5 = $11,200. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

33) Assuming that this is classified as an operating lease, create an amortization table for periodic interest and reduction in the liability. Periodic Interest and Reduction in the Liability Payment

Interest

Reduction

Balance

Answer: Periodic Interest and Reduction in the Liability Payment Interest

Reduction

Balance 43,872 33,872 26,243 18,080 9,346 (0)

Lease commencement: 1/1/2023 1/1/2024 1/1/2025 1/1/2026 1/1/2027

10,000 10,000 10,000 10,000 10,000

2,371 1,837 1,266 654

10,000 7,629 8,163 8,734 9,346

Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

34) Incentive Industries enters into a lease agreement with Bumble Motors to lease an automobile with a fair Assuming that this is classified as an operating lease, create an amortization table for the right-of-use asset? Amortization of Right-of-Use Asset Lease Expense

Interest

Amortization of Rightof-Use Asset

Interest 2,371 1,837 1,266 654 0 6,128

Amortization of Rightof-Use Asset 8,829 9,363 9,934 10,546 11,200 49,872

12/31/2023 12/31/2024 12/31/2025 12/31/2026 12/31/2027 Total Answer: Amortization of Right-of-Use Asset

12/31/2023 12/31/2024 12/31/2025 12/31/2026 12/31/2027 Total

Lease Expense 11,200 11,200 11,200 11,200 11,200 56,000

Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

35) Prepare the journal entry required on December 31, 2023. Assume this is an operating lease. Answer: Date Account Debit Credit 12/31/2023 Lease Expense 11,200 Lease Liability 7,629 Accumulated Amortization–Right-of-Use Asset 8,829 Accrued Lease Payable 10,000 Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

36) Lexus Company rents a copier from Heavenly Co on January 1, 2022. Under the terms of the agreement, Lexus Company will pay rentals of $7,000 per month for a 6-month period. Lexus Company will make these payments at the beginning of every month, beginning on January 1, 2022. Lexus Company elects to apply the exemption for short-term leases. That is, Lexus Company makes a policy election not to record the lease liability and the right-of-use asset. What journal entry will Lexus Company make each month to record the rental payments? Answer: The monthly journal entry follows: Account Rent Expense 7,000 Cash 7,000 Diff: 1 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

37) On January 1, 2022, Jones AutoWorld, Inc. leases an SUV to Mains Company. The lease term is 4 years with no renewal options and the economic life of the SUV is 7 years. The fair value of the automobile is $65,000 and Jones' cost or carrying value is also $65,000. There are no lease incentives. The lease calls for monthly payments of $800 at the end of each month. Mains incurs initial direct costs of $2,400 on January 1, 2022. The implicit rate in the lease is 5%. There is no transfer of ownership at the end of the lease term. Lease payment collection is probable. To determine whether Jones, the lessor, should classify the lease as operating, direct financing, or salestype, we assess both Group I and Group II criteria. Complete the below table and draw a conclusion about how the lease should be classified. Group I Criteria Transfer of ownership? Purchase option likely to be exercised? Lease term major part of economic life? Present value substantial part of fair value? Asset is specialized?

Met?

Explanation

Group II Criteria Present value including third-party guarantees substantially all of fair value? Lease payment collection probable? Answer: We have information to assess all of the criteria except for the fourth criterion of Group I. The present value of an ordinary annuity of the 48 remaining lease payments of $800 at a discount rate of 0.4167% per period (5%/12) is $34,738. The Excel formula is: =PV(.004166667,48,-800) = $34,738. Group I Criteria Transfer of ownership? Purchase option likely to be exercised?

Met? No No

Lease term major part of economic life?

Present value substantial part of fair value? Asset is specialized?

No No

Explanation

The lease term is 57% (4 yrs./7 yrs.) of economic life The PV of $34,738 is 53% of the $65,000 fair value.

Group II Criteria Present value including third-party guarantees No substantially all of fair value? Lease payment collection probable? Yes

The PV of $34,738 is 53% of fair value.

The lease does not meet the Group I or both of the Group II criteria and thus it is an operating lease. Diff: 2 Objective: 18.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

18.5

Accounting for Finance Leases: Lessee

1) For both finance and operating leases, if the residual value is guaranteed by a third party or is unguaranteed, then the residual value does not impact the lessee's accounting treatment. Answer: TRUE Diff: 1 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) If a lease provides a residual value guarantee, the lessee includes the present value of the residual value guarantee in the initial measurement of the lease liability. Answer: TRUE Diff: 1 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The primary difference in IFRS and U.S. GAAP related to lessee accounting is that IFRS does not distinguish operating from finance leases in the same way that U.S. GAAP does. Answer: TRUE Diff: 1 Objective: 18.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) IFRS uses the U.S. GAAP accounting for finance leases for operating leases, but not for finance leases. Answer: FALSE Diff: 1 Objective: 18.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Each period of a finance lease, the lessee records a lease expense that includes which of the following? A) Interest expense on the lease liability, using the effective interest rate method and the discount rate it used to compute the present value of the liability at the lease commencement date; variable lease payments not included in the lease liability in the period in which the obligation for the variable payments is incurred. B) Interest expense on the lease liability, using the effective interest rate method and the discount rate it used to compute the present value of the liability at the lease commencement date; variable lease payments not included in the lease liability in the period in which the obligation for the variable payments is incurred; and changes in variable lease payments that depend on an index or rate. C) Neither A nor B is correct. D) Both A & B are correct. Answer: B Diff: 3 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Nace Manufacturing Company leased a piece of nonspecialized equipment for use in its operations from Righteous Leasing on January 1, 2023. The 10 year lease requires lease payments of $4,000, beginning on January 1, 2023, and at each December 31 thereafter through 2031. The equipment is estimated to have a 10 year life, is depreciated on the straight-line basis and will have no residual value at the end of the lease term. Nace's incremental borrowing rate is 11%. Initial direct costs of $1,000 are incurred by the lessee on January 1, 2023. Righteous Leasing acquired the asset just prior to the lease term at a cost of $27,000. Collection of all lease payments is reasonably assured. What is the proper classification of the lease to Nace? A) Sales-type lease B) Finance lease C) Operating lease D) Either A or B Answer: B Explanation: The lease is classified as a finance lease as the lease term is equal to the asset's useful life and because the present value of the lease payments is 97% of the fair value of the asset. Using Excel, the formula is =PV(.11,10,-4000,0,1) = $26,148. Calculation: $26,148/$27,000 = 97%. Diff: 3 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Nace Manufacturing Company leased a piece of nonspecialized equipment for use in its operations from Righteous Leasing on January 1, 2023. The 10 year lease requires lease payments of $8000, beginning on January 1, 2023, and at each December 31 thereafter through 2031. The equipment is estimated to have a 10 year life, is depreciated on the straight-line basis and will have no residual value at the end of the lease term. Nace's incremental borrowing rate is 6%. Initial direct costs of $1400 are incurred by the lessee on January 1, 2023. Righteous Leasing acquired the asset just prior to the lease term at a cost of $63,468. Collection of all lease payments is reasonably assured. What is the amount of the lease liability recorded by Nace at the lease's commencement? A) $58,881 B) $62,414 C) $63,468 D) $64,868 Answer: B Explanation: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 6%, 10 periods, and payments at the beginning of each period of $8000, is $62,414. Using Excel, the formula is =PV(0.06,10,-8000,0,1) = $62,414. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Nace Manufacturing Company leased a piece of nonspecialized equipment for use in its operations from Righteous Leasing on January 1, 2023. The 10 year lease requires lease payments of $4000, beginning on January 1, 2023, and at each December 31 thereafter through 2031. The equipment is estimated to have a 10 year life, is depreciated on the straight-line basis and will have no residual value at the end of the lease term. Nace's incremental borrowing rate is 9%. Initial direct costs of $1000 are incurred by the lessee on January 1, 2023. Righteous Leasing acquired the asset just prior to the lease term at a cost of $29,035. Collection of all lease payments is reasonably assured. What is the value of the right-of-use asset to Nace at the lease's commencement? A) $30,035 B) $26,981 C) $26,671 D) $28,981 Answer: D Explanation: Initial measurement of the lease liability $27,981 Initial direct costs incurred by the lessee $1000 Initial measurement of the right-of-use asset $28,981 The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 9%, 10 periods, and payments at the beginning of each period of $4000, is $27,981. Using Excel, the formula is =PV(0.09,10,-4000,0,1) = $27,981. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Nace Manufacturing Company leased a piece of nonspecialized equipment for use in its operations from Righteous Leasing on January 1, 2023. The 10 year lease requires lease payments of $6000, beginning on January 1, 2023, and at each December 31 thereafter through 2031. The equipment is estimated to have a 10 year life, is depreciated on the straight-line basis and will have no residual value at the end of the lease term. Nace's incremental borrowing rate is 10%. Initial direct costs of $1100 are incurred by the lessee on January 1, 2023. Righteous Leasing acquired the asset just prior to the lease term at a cost of $41,608. Collection of all lease payments is reasonably assured. What is the reduction in the lease liability recorded with the first and second lease payments, respectively? A) $6000; $2545 B) $4165; $4165 C) $36,499; $2350 D) $4055; $3650 Answer: A Explanation: The first payment is made on the commencement of the lease, so the entire payment reduces the lease liability. See the following amortization table, using the effective interest method: Payment Interest Reduction Balance Commencement 40,554 1-Jan-2023 6000 6000 34,554 31-Dec-2023 6000 3455 2545 32,009 Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Nace Manufacturing Company leased a piece of nonspecialized equipment for use in its operations from Righteous Leasing on January 1, 2023. The 10 year lease requires lease payments of $7000, beginning on January 1, 2023, and at each December 31 thereafter through 2031. The equipment is estimated to have a 10 year life, is depreciated on the straight-line basis and will have no residual value at the end of the lease term. Nace's incremental borrowing rate is 11%. Initial direct costs of $1000 are incurred by the lessee on January 1, 2023. Righteous Leasing acquired the asset just prior to the lease term at a cost of $46,813. Collection of all lease payments is reasonably assured. What is the amortization of the right-of-use asset recorded in 2023 and 2024, respectively? A) $7000; $2737 B) $4676; $4676 C) $4480; $2520 D) $5033; $4480 Answer: B Explanation: The right-of-use asset is amortized on a straight-line basis over the lease term. Right-of-use asset = $45,759 + $1000 = $46,759. $46,759 / 10 = $4676. Using Excel, the formula is =PV(0.11,10,-7000,0,1) = $45,759. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Nice Manufacturing Company leased a piece of nonspecialized equipment for use in its operations from Righteous Leasing on January 1, 2023. The 10 year lease requires lease payments of $9500, beginning on January 1, 2023, and at each December 31 thereafter through 2031. The equipment is estimated to have a 10 year life, is depreciated on the straight-line basis and will have a $2000 residual value at the end of the lease term on December 31, 2032, which is guaranteed by Nice. Nice's incremental borrowing rate is 7%. Initial direct costs of $2500 are incurred on January 1, 2023. Righteous Leasing acquired the asset just prior to the lease term at a cost of $64,012. Collection of all lease payments is reasonably assured. What is the amount of the lease liability recorded by Nice at the lease's commencement? A) $67,741 B) $72,412 C) $74,912 D) $22,500 Answer: B Explanation: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 7%, 10 periods, payments at the beginning of each period of $9500, and a $2000 residual value is $72,412. Using Excel, the formula is: =PV(0.07,10,-9500,-2000,1) = $72,412. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Describe the accounting for a finance lease by the lessee if the lessee provides a residual value guarantee. Answer: If the lessee provides a residual value guarantee, the lessee includes the present value of the residual value guarantee in the initial measurement of the lease liability. As is the case with an operating lease, if the residual value is guaranteed by a third party or is unguaranteed, then the residual value does not impact the lessee's accounting treatment. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) For a finance lease, what are the components of lease expense recorded by the lessee? Answer: 1. Interest expense on the lease liability, using the effective interest rate method and the discount rate it used to compute the present value of the liability at the lease commencement date. 2. Variable lease payments not included in the lease liability in the period in which the obligation for the variable payments is incurred. 3. Changes in variable lease payments that depend on an index or rate. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Since IFRS makes an exception for leased assets that have low values, reporters may account for leased assets with values of less than $5,000 as a rental agreement rather than recognizing a right-of-use asset and a lease liability. For example, suppose a company leases a $4,800 computer for 2.5 years. How does IFRS differ from how U.S. GAAP would record this? Answer: Under U.S. GAAP, the company records a right-of-use asset and a lease liability because the lease term is greater than 1 year. Under IFRS, the company does not record the right-of-use asset and a lease liability because the value of the leased asset is less than $5,000, and it is a simple rental agreement. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

Nace Manufacturing Company Nace Manufacturing Company leased a piece of nonspecialized equipment for use in its operations from Righteous Leasing on January 1, 2023. The 10 year lease requires lease payments of $4,000, beginning on January 1, 2023, and at each December 31 thereafter through 2031. The equipment is estimated to have a 10 year life, is depreciated on the straight-line basis and will have no residual value at the end of the lease term. Nace's incremental borrowing rate is 11%. Initial direct costs of $1,000 are incurred on January 1, 2023. Righteous Leasing acquired the asset just prior to the lease term at a cost of $27,000. Collection of all lease payments is reasonably assured. 15) What is the proper classification of the lease to Nace? Answer: The lease is classified as a finance lease as the lease term is equal to the asset's useful life and because the present value of the lease payments is 97% of the fair value of the asset. Using Excel, the formula is =PV(.11,10,-4000,0,1) = $26,148. Calculation: $26,148/$27,000 = 97%. Diff: 3 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) What is the amount of the lease liability recorded by Nace at the lease's commencement? Answer: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 11%, 10 periods, and payments at the beginning of each period of $4,000, is $26,148. Using Excel, the formula is =PV(.11,10,-4000,0,1) = $26,148. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) What is the value of the right-of-use asset to Nace at the lease's commencement? Answer: Initial measurement of the lease liability $26,148 Initial direct costs incurred by the lessee 1,000 Initial measurement of the right-of-use asset $27,148 The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 11%, 10 periods, and payments at the beginning of each period of $4,000, is $26,148. Using Excel, the formula is =PV(.11,10,-4000,0,1) = $26,148. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Based on the above information, prepare an amortization table for the Nace Manufacturing's lease liability. Payment

Interest

Reduction

Balance

Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029 31-Dec-2030 31-Dec-2031 Answer: Payment Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029 31-Dec-2030 31-Dec-2031

Interest

4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000

Reduction

2,436 2,264 2,073 1,861 1,626 1,365 1,075 753 399

4,000 1,564 1,736 1,927 2,139 2,374 2,635 2,925 3,247 3,601

Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

Balance 26,148 22,148 20,584 18,848 16,921 14,782 12,408 9,773 6,848 3,601 (0)

19) Based on the above information, prepare Nace Manufacturing's journal entries at the commencement of the lease, January 1 and December 31, 2023 payments, and amortization of the right-of-use asset. Answer: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 11%, 10 periods, and payments at the beginning of each period of $4,000, is $26,148. Using Excel, the formula is: =PV(.11,10,-4000,0,1) = $26,148. The following entries are made by the lessee during the first year of the lease: Lease commencement: Account January 1, 2023 Prepaid Initial Direct Costs 1,000 Cash 1,000 Account January 1, 2023 Right-of-Use Asset 27,148 Prepaid Initial Direct Costs 1,000 Lease Liability 26,148 Initial payment: Account Lease Liability Cash

January 1, 2023 4,000 4,000

End of year payment: Account Interest Expense Lease Liability Cash

December 31, 2023 2,436 1,564 4,000

**Interest Expense = 11% × ($26,148 - $4,000) Amortization of right-of-use asset: Account Amortization Expense–Right-of-Use Asset Accumulated Amortization–Right-of-Use Asset

December 31, 2023 2,715 2,715

Right-of-use asset is amortized on a straight-line basis over the life of the asset. $27,148/10 = $2,715. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

Nice Manufacturing Company Nice Manufacturing Company leased a piece of nonspecialized equipment for use in its operations from Righteous Leasing on January 1, 2023. The 10 year lease requires lease payments of $8,000, beginning on January 1, 2023, and at each December 31 thereafter through 2031. The equipment is estimated to have a 10 year life, is depreciated on the straight-line basis and will have a $5,000 residual value at the end of the lease term on December 31, 2032, which is guaranteed by Nice. Nice's incremental borrowing rate is 9%. Initial direct costs of $2,000 are incurred by the lessee on January 1, 2023. Righteous Leasing acquired the asset just prior to the lease term at a cost of $27,000. Collection of all lease payments is reasonably assured. 20) What is the amount of the lease liability recorded by Nice at the lease's commencement? Answer: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 9%, 10 periods, payments at the beginning of each period of $8,000, and a $5,000 residual value is $58,074. The Excel formula is: =PV(.09,10,-8000,5000,1) = $58,074. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) What is the value of the right-of-use asset to Nice at the lease's commencement? Answer: Initial measurement of the lease liability $58,074 Initial direct costs incurred by the lessee 2,000 Initial measurement of the right-of-use asset $60,074 The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 9%, 10 periods, payments at the beginning of each period of $8,000, and a $5,000 residual value is $58,074. The Excel formula is: =PV(.09,10,-8000,-5000,1) = $58,074. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Based on the above information, prepare an amortization table for the Nice Manufacturing's lease liability. Payment

Interest

Reduction

Balance

Payment

Interest

Reduction

$ $ $ $ $ $ $ $ $ $ $

$ $ $ $ $ $ $ $ $ $

$ $ $ $ $ $ $ $ $ $ $

Balance $ 58,074 $ 50,074 $ 46,581 $ 42,773 $ 38,623 $ 34,099 $ 29,168 $ 23,793 $ 17,934 $ 11,548 $ 4,587 $ (0)

Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029 31-Dec-2030 31-Dec-2031 31-Dec-2032 Answer: Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029 31-Dec-2030 31-Dec-2031 31-Dec-2032

8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 5,000

4,507 4,192 3,850 3,476 3,069 2,625 2,141 1,614 1,039 413

8,000 3,493 3,808 4,150 4,524 4,931 5,375 5,859 6,386 6,961 4,587

The Excel formula is: =PV(.09,10,-8000,-5000,1) = $58,074. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Based on the above information, prepare Nice Manufacturing's journal entries at the commencement of the lease, January 1 and December 31, 2023 payments, and amortization of the right-of-use asset. Answer: The lease liability is calculated as the present value of the future payments. Using Excel, the present value of the future lease payments, based on a rate of 9%, 10 periods, payments at the beginning of each period of $8,000, and a $5,000 residual value is $58,074. The Excel formula is: =PV(.09,10,-8000,5000,1) = $58,074. The following entries are made by the lessee during the first year of the lease: Lease commencement: Account Prepaid Initial Direct Costs Cash

January 1, 2023 1,000 1,000

Account January 1, 2023 Right-of-Use Asset 60,074 Prepaid Initial Direct Costs Lease Liability

2,000 58,074

Initial payment: Account Lease Liability Cash

January 1, 2023 8,000 8,000

End of year payment: Account December 31, 2023 Interest Expense 4,507 Lease Liability 3,493 Cash 8,000 **Interest Expense = 9% × ($58,074 - $8,000) Amortization of right-of-use asset: Account Amortization Expense–Right-of-Use Asset Accumulated Amortization–Right-of-Use Asset

December 31, 2023 5,507 5,507

Right-of-use asset is amortized on a straight-line basis (reduced by the guaranteed residual) over the life of the asset. ($60,074 - $5,000) = $55,074. $55,074/10 = $5,507. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Based on the information provided above, what are the journal entries on the lease termination date of December 31, 2032, assuming that Nice must pay the guaranteed residual value? Answer: Using the following amortization table:

Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029 31-Dec-2030 31-Dec-2031 31-Dec-2032

Payment

Interest

Reduction

$ $ $ $ $ $ $ $ $ $ $

$ $ $ $ $ $ $ $ $ $

$ $ $ $ $ $ $ $ $ $ $

8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 5,000

4,507 4,192 3,850 3,476 3,069 2,625 2,141 1,614 1,039 413

8,000 3,493 3,808 4,150 4,524 4,931 5,375 5,859 6,386 6,961 4,587

Balance $ 58,074 $ 50,074 $ 46,581 $ 42,773 $ 38,623 $ 34,099 $ 29,168 $ 23,793 $ 17,934 $ 11,548 $ 4,587 $ (0)

Amortization of right-of-use asset: Account Amortization Expense–Right-of-Use Asset Accumulated Amortization–Right-of-Use Asset

December 31, 2032 5,507 5,507

Account Lease Liability Interest Expense Accumulated Amortization–Right-of-Use Asset Loss on Lease Right-of-Use Asset Cash

December 31, 2032 4,587 413 55,074 5,000 60,074 5,000

Right-of-use asset is amortized on a straight-line basis (reduced by the guaranteed residual) over the life of the asset. ($60,074 - $5,000) = $55,074 Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Based on the information provided above, what are the journal entries on the lease termination date of December 31, 2032, assuming that Nice does not have to pay the guaranteed residual value? Answer: Using the following amortization table:

Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029 31-Dec-2030 31-Dec-2031 31-Dec-2032

Payment

Interest

Reduction

$ $ $ $ $ $ $ $ $ $ $

$ $ $ $ $ $ $ $ $ $

$ $ $ $ $ $ $ $ $ $ $

8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 5,000

4,507 4,192 3,850 3,476 3,069 2,625 2,141 1,614 1,039 413

8,000 3,493 3,808 4,150 4,524 4,931 5,375 5,859 6,386 6,961 4,587

Balance $ 58,074 $ 50,074 $ 46,581 $ 42,773 $ 38,623 $ 34,099 $ 29,168 $ 23,793 $ 17,934 $ 11,548 $ 4,587 $ (0)

Amortization of right-of-use asset: Account Amortization Expense–Right-of-Use Asset Accumulated Amortization–Right-of-Use Asset

December 31, 2032 5,507 5,507

Account Lease Liability Interest Expense Accumulated Amortization–Right-of-Use Asset Right-of-Use Asset

December 31, 2032 4,587 413 55,074 60,074

Right-of-use asset is amortized on a straight-line basis (reduced by the guaranteed residual) over the life of the asset. ($60,074 - $5,000) = $55,074. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) With respect to lessees, how do IFRS and U.S. GAAP differ in the accounting treatment of operating and finance leases? Answer: The primary difference in IFRS and U.S. GAAP related to lessee accounting is that IFRS does not distinguish operating from finance leases in the same way that U.S. GAAP does. Under IFRS, lessees use the same accounting treatment for both types of leases. Specifically, IFRS uses the U.S. GAAP accounting for finance leases for both operating and finance leases. Thus, under IFRS, lessees report interest expense and amortization expense on all leases. In addition to the short-term policy election to account for a lease as a rental agreement, IFRS makes an exception for leased assets that have low values. IFRS reporters may account for leased assets with original costs of less than $5,000 as rental agreements. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) Nixon Manufacturing Company leased a piece of nonspecialized equipment for use in its operations from Robert's Leasing on January 1, 2023. The 10-year lease requires lease payments of $8,000, beginning on January 1, 2023, and at each December 31 thereafter through 2031. The equipment is estimated to have a 10-year life, is depreciated on the straight-line basis and will have no residual value at the end of the lease term. Nixon's incremental borrowing rate is 12%. Initial direct costs of $1,000 are incurred by the lessee on January 1, 2023. Robert's Leasing acquired the asset just prior to the lease term at a cost of $46,813. Collection of all lease payments is reasonably assured. What is the amortization of the right-of-use asset recorded in 2023 and 2024, respectively? Answer: $5,163 and $5,163. Explanation: The right-of-use asset is amortized on a straight-line basis over the lease term. Right-of-use asset = $50,626 + $1,000 = $51,626. $51,626 / 10 = $5,163. Using Excel, the formula is =PV(0.12,10,-8000,0,1) = $50,626. Diff: 2 Objective: 18.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

18.6

Accounting for Sales-Type Leases: Lessor

1) For lessors of sales-type leases, cost of goods sold is equal to the carrying value of the leased asset less the present value of any unguaranteed residual asset plus any deferred initial direct costs paid by the lessor. Answer: TRUE Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) For lessors of sales-type leases, the lease receivable is the present value of payments to be received plus the present value of residual value guarantees. Answer: TRUE Diff: 1 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The lessor of a sales-type lease records the following items in net income, if they are part of the lease agreement: Interest revenue on the net investment in the lease for a sales-type lease and any variable payments received that were not included in the net investment. Answer: TRUE Diff: 1 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) For a(n) ________ lease, a lessor recognizes revenue on the sale and records the asset, ________ lease. It also removes the leased asset from its accounts and records the ________. A) sales-type; finance; revenue B) operating; net investment in lease–sales-type; cost of goods sold C) finance; gross investment in lease–sales-type; cost of goods sold D) sales-type; net investment in lease–sales-type; cost of goods sold Answer: D Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The net investment in the lease for a sales-type lease reflects the assets related to the lease transaction and is comprised of the following: ________. A) the lease receivable and the present value of any unguaranteed residual asset B) the lease receivable and the present value of any guaranteed residual asset C) the lease receivable and the future value of any unguaranteed residual asset D) the lease receivable and the future value of any guaranteed residual asset Answer: A Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Revenue for a sales-type lease is the lower of ________. A) the fair value of the leased asset or the sum of the lease receivable and any lease payments paid before the lease commencement date B) the present value of the leased asset or the sum of the lease payable and any lease payments paid before the lease commencement date C) the fair value of the leased asset or the sum of the lease receivable and lease payments paid after the lease commencement date D) the present value of the leased asset or the sum of the lease payable and any lease payments paid after the lease commencement date Answer: A Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Plessings Company leased a piece of machinery to Banana, Inc. on January 1, 2023. The lease is correctly classified as a sales-type lease. Plessings will receive three annual lease payments of $20,100, with the first one received on January 1, 2023. There is no guaranteed or unguaranteed residual value. The fair value of the machine is $50,000 and Plessings incurs initial direct costs of $5,000. What is the implicit rate assuming the initial direct costs are expensed? A) 22.22% B) 9.97% C) 4.74% D) 9.98% Answer: A Explanation: To solve for the rate using Excel and the RATE function, the following inputs are used: N=3, PMT=20,100, PV=-50000 TYPE=1. As a result, the implicit rate is 22.22%. The Excel formula is: =Rate(3,20100,-50000,0,1) = 22.22%. Diff: 3 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Plessings Company leased a piece of machinery to Banana, Inc. on January 1, 2023. The lease is correctly classified as a sales-type lease. Plessings will receive three annual lease payments of $20,700, with the first one received on January 1, 2023. There is no guaranteed or unguaranteed residual value. The fair value of the machine is $50,000 and Plessings incurs initial direct costs of $5,000. What is the implicit rate assuming the initial direct costs are deferred? A) 26.5% B) 13.51% C) 6.33% D) 11.67% Answer: B Explanation: To solve for the rate using Excel and the RATE function, the following inputs are used: N=3, PMT=20,700, PV=-55000 TYPE=1. As a result, the implicit rate is 13.51%. The Excel formula is: =Rate(3,20700,-55000,0,1) = 13.51%. Diff: 3 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Elton Electronics leases testing equipment to Startup Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $103,000. The cost of the equipment to Elton is $98,000 and the expected life of the testing equipment is 8 years. Elton incurs initial direct costs of $10,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Elton's implicit rate is 8% and they expect that collection of the $13,000 lease payments is probable. What is the principal balance in the Net Investment in Lease — Sale Type account at the commencement of the lease? A) $80,683 B) $67,683 C) $98,000 D) $60,098 Answer: A Explanation: The present value of the lease payments, calculated using Excel, are $80,683, using the following inputs: rate=8%, periods=8, payment=13,000. The Excel formula is: =PV(0.08,8,13000,0,1) = $80,683. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Elton Electronics leases testing equipment to Startup Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $113,000. The cost of the equipment to Elton is $108,000 and the expected life of the testing equipment is 8 years. Elton incurs initial direct costs of $10,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Elton's implicit rate is 9% and they expect that collection of the $14,000 lease payments is probable. What is the principal balance in the Net Investment in Lease — Sale Type account after the first payment? A) $84,461 B) $70,461 C) $108,000 D) $62,802 Answer: B Explanation: The present value of the lease payments, calculated using Excel, are $84,461, using the following inputs: rate=9%, periods=8, payment=14,000, = PV(0.09,8,-14000,0,1). The first payment of $14,000 reduces the principal balance with nothing allocated to interest, as it is made on the date that the lease commences. $84,461 - $14,000 = $70,461. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Elton Electronics leases testing equipment to Startup Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $118,000. The cost of the equipment to Elton is $113,000 and the expected life of the testing equipment is 8 years. Elton incurs initial direct costs of $10,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Elton's implicit rate is 5% and they expect that collection of the $14,500 lease payments is probable. What is the principal balance in the Net Investment in Lease — Sale Type account after the second payment on December 31, 2023? A) $98,402 B) $83,902 C) $113,000 D) $73,597 Answer: D Explanation: See amortization table. Date Payment Interest Principal NIL-ST Balance Commencement $98,402 1-Jan-2023 $14,500 $14,500 $83,902 31-Dec-2023 $14,500 $4195 $10,305 $73,597 Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Elton Electronics leases testing equipment to Startup Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $98,000. The cost of the equipment to Elton is $93,000 and the expected life of the testing equipment is 8 years. Elton incurs initial direct costs of $10,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Elton's implicit rate is 8% and they expect that collection of the $12,500 lease payments is probable. How much interest will Elton record for 2023? A) $12,500 B) $7294 C) $5206 D) $6206 Answer: C Explanation: See amortization table. Date Payment Interest Principal NIL-ST Balance Commencement $77,580 1-Jan-2023 $12,500 $12,500 $65,080 31-Dec-2023 $12,500 $5206 $7294 $57,786 Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Northern Equipment leases cooling towers to Warmup Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $180,000. The cost of the equipment to Northern is $170,000 and the expected life of the testing equipment is 8 years. At the end of the useful life, it is expected that the equipment will have a residual value of $20,000, although the lessee guarantees only $15,000. Northern incurs initial direct costs of $20,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Northern's implicit rate is 8% and they expect that collection of the $30,000 payments is probable. The lease is properly classified as a sales-type lease. What is Northern's implicit rate for the lease? (Round any intermediate calculations to the nearest dollar, and round your final percentage two decimal places, X.XX%.) A) 9.64% B) 9.85% C) 7.6% D) 7.33% Answer: B Explanation: Because the lease contains a residual value, the implicit rate must be recalculated including the residual amount as a future value. Using Excel, the first step is to calculate the present value of the future lease payments, using the following formula in Excel: =PV(.08,8,30000,0,1) = $186,191. This value is used in a rate calculation, using this amount as the present value and the residual value as the future value. Using the Excel formula =RATE(8,30000,-186191,20000,1), the new implicit rate is 9.85%. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Northern Equipment leases cooling towers to Warmup Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $180,000. The cost of the equipment to Northern is $170,000 and the expected life of the testing equipment is 8 years. At the end of the useful life, it is expected that the equipment will have a residual value of $20,000, although the lessee guarantees only $15,000. Northern incurs initial direct costs of $20,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Northern's implicit rate is 8% and they expect that collection of the $26,000 payments is probable. The lease is properly classified as a sales-type lease. What is the amount of the lease receivable? (Round any present value calculations to the nearest dollar, and round any percentages two decimal places, X.XX%.) A) $159,064 B) $180,000 C) $167,686 D) $172,314 Answer: A Explanation: The lease receivable is the present value of the payments and any guaranteed residual value, using the recomputed implicit rate. Because the lease contains a residual value, the implicit rate must be recalculated including the residual amount as a future value. Using Excel, the first step is to calculate the present value of the future lease payments, using the following formula in Excel: =PV(.08,8,26000,0,1) = $161,366. This value is used in a rate calculation, using this amount as the present value and the residual value as the future value. Using the Excel formula =RATE(8,26000,-161366,20000,1), the new implicit rate is 10.11%. The lease receivable is calculated using the new implicit rate, payments as outlined in the lease, and a future value equal to the guaranteed residual value. Using the formula the lease receivable is $159,064. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Northern Equipment leases cooling towers to Warmup Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $180,000. The cost of the equipment to Northern is $170,000 and the expected life of the testing equipment is 8 years. At the end of the useful life, it is expected that the equipment will have a residual value of $20,000, although the lessee guarantees only $15,000. Northern incurs initial direct costs of $20,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Northern's implicit rate is 8% and they expect that collection of the $23,000 payments is probable. The lease is properly classified as a sales-type lease. What amount will be recorded for cost of goods sold? (Round any present value calculations to the nearest dollar, and round any percentages two decimal places, X.XX%.) A) $140,476 B) $180,000 C) $167,728 D) $172,272 Answer: C Explanation: Cost of goods sold will be the cost of the equipment to Northern less the present value of the unguaranteed residual value at the implicit rate. Using Excel, the present value of the unguaranteed residual value is calculated as =PV(0.1036,8,0,5000) = $2272 and cost of goods sold is $167,728 = $170,000 $2272. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Plessings Company leased a piece of machinery to Banana, Inc. on January 1, 2023. The lease is correctly classified as a sales-type lease. Plessings will receive three annual lease payments of $20,000, with the first one received on January 1, 2023. There is no guaranteed or unguaranteed residual value. The fair value of the machine is $50,000 and Plessings incurs initial direct costs of $5,000. Compute the implicit rate assuming the initial direct costs are expensed. Answer: To solve for the rate using Excel and the RATE function, the following inputs are used: N=3, PMT=20000, PV=-50000, TYPE=1. The Excel formula is: =RATE(3,20000,-50000,0,1) = 21.53%. As a result, the implicit rate is 21.53%. Diff: 3 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Plessings Company leased a piece of machinery to Banana, Inc. on January 1, 2023. The lease is correctly classified as a sales-type lease. Plessings will receive three annual lease payments of $20,000, with the first one received on January 1, 2023. There is no guaranteed or unguaranteed residual value. The fair value of the machine is $50,000 and Plessings incurs initial direct costs of $5,000. Compute the implicit rate assuming the initial direct costs are deferred. Answer: To solve for the rate using Excel and the RATE function, the following inputs are used: N=3, PMT=20000, PV=-55000, TYPE=1. The Excel formula: =RATE(3,20000,-55000,0,1) = 9.38%. As a result, the implicit rate is 9.38%. Diff: 3 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

Elton Electronics Elton Electronics leases testing equipment to Startup Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $90,000. The cost of the equipment to Elton is $85,000 and the expected life of the testing equipment is 8 years. Elton incurs initial direct costs of $10,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Elton's implicit rate is 8% and they expect that collection of the eight payments of $14,500 payments is probable. 18) How will Elton Electronics classify this lease? Answer: Elton will classify this as a sales type lease, as two of the Group I criteria are met. First, the lease term is equal to the economic life, and the present value of the lease payments is substantially equal to the fair value ($89,992/$90,000 = 100%). The present value of the lease payments, calculated using Excel, is $89,992, using the following inputs: rate=8%, periods=8, payment=14500. The Excel formula is: =PV(.08,8,14500,0,1) = $89,992. Diff: 3 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Prepare the journal entries for the lessor to record the commencement of the lease, the expensing of initial direct costs, and receipt of the first payment on January 1, 2023. Answer: The present value of the lease payments, calculated using Excel, are $89,992, using the following inputs: rate=8%, periods=8, payment=14500, type=1 (payments at beginning of period). The Excel formula is: =PV(.08,8,14500,0,1) = $89,992. Account Net Investment in Lease — Sales Type Cost of Goods Sold Sales Revenue Inventory of Testing Equipment

January 1, 2023 89,992 85,000

Account Initial Direct Costs Expense Cash

January 1, 2023 10,000

Account Cash Net Investment in Lease — Sales Type

January 1, 2023 14,500

89,992 85,000

10,000

14,500

Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Prepare an amortization table for Elton's net investment. Date Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029 Answer: Date Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029

Payment

Interest

Principal

NIL-ST Balance

Payment

Interest

Principal

NIL-ST Balance

$14,500 $14,500 $14,500 $14,500 $14,500 $14,500 $14,500 $14,500

$6,039 $5,362 $4,631 $3,842 $2,989 $2,068 $1,077

$14,500 $8,461 $9,138 $9,869 $10,658 $11,511 $12,432 $13,423

Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

$89,992 $75,492 $67,031 $57,893 $48,024 $37,366 $25,855 $13,423 $0

21) Based on the above information, what is the journal entry for the lessor on 12/31/2023? Answer: Account December 31, 2023 Cash 14,500 Interest Revenue 6,039 Net Investment in Lease – Sales-Type 8,461

Date Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029

Payment

Interest

$14,500 $14,500 $14,500 $14,500 $14,500 $14,500 $14,500 $14,500

Principal

$6,039 $5,362 $4,631 $3,842 $2,989 $2,068 $1,077

$14,500 $8,461 $9,138 $9,869 $10,658 $11,511 $12,432 $13,423

NIL-ST Balance $89,992 $75,492 $67,031 $57,893 $48,024 $37,366 $25,855 $13,423 $0

Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Based on the above information, what is the journal entry for the lessor on 12/31/2024? Answer: Account December 31, 2024 Cash 14,500 Interest Revenue 5,362 Net Investment in Lease — 9,138 Sales-Type Date Commencement 1-Jan-2023 31-Dec-2023 31-Dec-2024 31-Dec-2025 31-Dec-2026 31-Dec-2027 31-Dec-2028 31-Dec-2029

Payment

Interest

$14,500 $14,500 $14,500 $14,500 $14,500 $14,500 $14,500 $14,500

Principal

$6,039 $5,362 $4,631 $3,842 $2,989 $2,068 $1,077

$14,500 $8,461 $9,138 $9,869 $10,658 $11,511 $12,432 $13,423

NIL-ST Balance $89,992 $75,492 $67,031 $57,893 $48,024 $37,366 $25,855 $13,423 $0

Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) How does a residual value affect accounting for a sales-type lease? Answer: Including residual values has two implications for lease accounting. First, it changes the implicit rate in the lease, which is defined as the interest rate at which the present value of the lease payments plus the present value of the amount that a lessor expects to derive from the leased asset at the end of the lease term equals the sum of the asset's fair value plus any deferred initial direct costs of the lessor. Second, the cost of goods sold is affected only by an unguaranteed residual value. Specifically, the cost of goods sold is defined as the carrying value of the leased asset less the present value of any unguaranteed residual asset plus any deferred initial direct costs of the lessor. As a result, the inclusion of a residual value guarantee does not impact cost of goods sold; only the inclusion of an unguaranteed residual asset reduces cost of goods sold. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

Northern Equipment Northern Equipment leases cooling towers to Warmup Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $180,000. The cost of the equipment to Northern is $170,000 and the expected life of the testing equipment is 8 years. At the end of the useful life, it is expected that the equipment will have a residual value of $20,000, although the lessee guarantees only $15,000. Northern incurs initial direct costs of $20,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Northern's implicit rate is 8% and they expect that collection of the $29,002 payments is probable. The lease is properly classified as a sales-type lease. 24) Calculate Northern's implicit rate for the lease. Answer: Because the lease contains a residual value, the implicit rate must be recalculated including the residual amount as a future value. Using Excel, the first step is to calculate the present value of the future lease payments, using the following formula in Excel: =PV(8%,8,29002,0,1) = $179,997. This value is used in a rate calculation, using this amount as the present value and the residual value as the future value. Using the Excel formula =RATE(8,29002,-179997,20000,1), the new implicit rate is 9.91%. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) What is the amount of the lease receivable? Answer: The lease receivable is the present value of the payments and any guaranteed residual value, using the recomputed implicit rate. Because the lease contains a residual value, the implicit rate must be recalculated including the residual amount as a future value. Using Excel, the first step is to calculate the present value of the future lease payments, using the following formula in Excel: =PV(8%,8, 29002,0,1) = $179,997. This value is used in a rate calculation, using this amount as the present value and the residual value as the future value. Using the Excel formula =RATE(8,29002,-179997,20000,1), the new implicit rate is 9.91%. The lease receivable is calculated using the new implicit rate, payments as outlined in the lease, and a future value equal to the guaranteed residual value. Using the formula =PV(9.91%,8,29002,15000,1), the lease receivable is $177,659. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) What amount will be recorded for cost of goods sold? Answer: Cost of goods sold will be the cost of the equipment to Northern less the present value of the unguaranteed residual value at the implicit rate. Using Excel, the present value of the unguaranteed residual value is calculated as =PV(9.91%,8,0,5000) = $2,348 and cost of goods sold is $167,652. Because the lease contains a residual value, the implicit rate must be recalculated including the residual amount as a future value. Using Excel, the first step is to calculate the present value of the future lease payments, using the following formula in Excel: =PV(8%,8, 29002,0,1) = $179,997. This value is used in a rate calculation, using this amount as the present value and the residual value as the future value. Using the Excel formula =RATE(8,29002,-179997,20000,1), the new implicit rate is 9.91%. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Northern Equipment leases cooling towers to Warren Corporation. The equipment is not specialized and is delivered on January 1, 2023. The fair value of the equipment is $200,000. The cost of the equipment to Northern is $170,000 and the expected life of the testing equipment is 8 years. At the end of the useful life, it is expected that the equipment will have a residual value of $20,000, although the lessee guarantees only $15,000. Northern incurs initial direct costs of $20,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2023 and ending on December 31, 2029. Northern's implicit rate is 9% and they expect that collection of the $30,000 payments is probable. The lease is properly classified as a sales-type lease. What is Northern's implicit rate for the lease? (Round any intermediate calculations to the nearest dollar, and round your final percentage two decimal places, X.XX%.) Answer: 10.82% Explanation: Because the lease contains a residual value, the implicit rate must be recalculated including the residual amount as a future value. Using Excel, the first step is to calculate the present value of the future lease payments, using the following formula in Excel: =PV(9%,8,30000,0,1) = $180,989. This value is used in a rate calculation, using this amount as the present value and the residual value as the future value. Using the Excel formula =RATE(8,30000,-180989,20000,1), the new implicit rate is 10.82%. Diff: 2 Objective: 18.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

18.7

Accounting for Direct Financing Leases: Lessor

1) A direct financing lease meets the Group I but not the Group II criteria. Answer: FALSE Diff: 1 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) If the risks and rewards have been transferred, then IFRS classifies the lease as a finance lease. Answer: TRUE Diff: 1 Objective: 18.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

3) For a direct financing lease, the lessor removes the leased asset from its balance sheet and records the net investment in the lease as an asset at the commencement of the lease. Answer: TRUE Diff: 1 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Just like with U.S. GAAP, IFRS distinguishes sales-type leases from direct financing leases. Answer: FALSE Diff: 1 Objective: 18.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

5) For a dealer or manufacturer lessor, the use of a nonoperating lease is preferred because it recognizes financing income and also accelerates revenue recognition in the form of the gross profit on the sale in the year of commencement. Under an operating lease treatment, the lessor only records rental income each year, spreading the revenue flow over the lease term. Answer: TRUE Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Revenue for a direct financing lease is calculated as ________. A) the lower of (1) the fair value of the leased asset or (2) the sum of the lease receivable and any lease payments paid before the lease commencement date B) the higher of (1) the fair value of the leased asset or (2) the sum of the lease receivable and any lease payments paid before the lease commencement date C) the lower of (1) the residual value of the asset or (2) the sum of the lease receivable and any lease payments paid before the lease commencement date D) None of the above. Answer: A Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Net investment in the lease for a direct financing lease (NIL-DF) is comprised of ________. A) the lease receivable, the future value of any unguaranteed residual asset and a reduction for any deferred profit B) the lease receivable, the present value of any unguaranteed residual asset, and a reduction for any deferred profit C) the lease receivable, the future value of any unguaranteed residual asset, and an addition for any deferred profit D) the lease receivable, the present value of any unguaranteed residual asset, and an addition for any deferred profit Answer: B Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) In subsequent measurement of a direct financing lease, the lessor computes interest revenue using the ________ method. The lessor allocates lease payments first to cover the ________ and then to ________ the NIL-DF. The interest revenue, which is reported on the income statement, is the amount that produces a constant periodic discount rate on the remaining balance of the NIL-DF. A) straight-line interest; interest; reduce B) straight-line interest; interest; increase C) effective interest rate; interest; reduce D) effective interest rate; interest; increase Answer: C Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) The lessor would most likely prefer a ________ or ________ lease to an operating lease. Nonoperating lease treatment would permit a financial service company lessor to remove heavy machinery and equipment, jet airlines, oceangoing vessels, and such from its balance sheet and replace it with the ________, a financial asset compatible with the nature of its business. In addition, the nonoperating lease results in the recognition of ________, rather than ________ revenue. A) standalone price; sales-type; fair value of the leased asset; financing income; unearned B) standalone; operating; fair value of the leased asset; interest income; rent C) direct financing; sales-type; net investment in the lease; interest income; rent D) direct financing; operating; net investment in the lease; financing income; unearned Answer: C Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) On January 1, 2023, Precision Pumps leases nonspecialized pumping equipment to Mega Construction. The equipment is delivered on January 1. The lease term is 4 years with no renewal or purchase options, and title to the leased asset is retained by the lessor at the end of the lease term. The lease requires annual fixed rental payments of $7,000 per year beginning on January 1, 2023, and then December 31 of each year starting on December 31, 2023. The fair value of the equipment is $37,592 and has a carrying amount on Precision's books of $22,000. The equipment has a remaining life of 8 years. The estimated residual value of the equipment is $15,000. The lessee does not guarantee the residual value, but Precision secured an unrelated third party to guarantee $15,000; collection of this guaranteed residual value and lease payments are reasonably certain. The rate implicit in the lease is 6%. There are no prepaid rentals, and neither party to the agreement pays initial direct costs. What is the proper classification of this lease for Precision Pumps? A) sales-type lease B) direct financing lease C) operating lease D) finance lease Answer: B Explanation: This lease is classified as a direct financing lease by Precision Pumps. None of the Group I criteria are met, such as transfer of ownership, likely exercise of purchase option, or specialized asset. The lease term is only 50% of the remaining economic life and the present value of the lease payments (Excel =PV(6%,4,7000,0,1) = $25,711) represents only $25,711/$37,592 = 68% of the fair value. However, the lease meets both Group 2 criteria. The present value of the lease payments and third-party guarantees (Excel =PV(6%,4,7000,15000,1) = $37,592) is equal to 100% of the fair value and collection of the lease payments is probable. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) On January 1, 2023, Precision Pumps leases nonspecialized pumping equipment to Mega Construction. The equipment is delivered on January 1. The lease term is 4 years with no renewal or purchase options, and title to the leased asset is retained by the lessor at the end of the lease term. The lease requires annual fixed rental payments of $9000 per year beginning on January 1, 2023, and then December 31 of each year starting on December 31, 2023. The fair value of the equipment is $45,176 and has a carrying amount on Precision's books of $30,720. The equipment has a remaining life of 8 years. The estimated residual value of the equipment is $15,300. The lessee does not guarantee the residual value, but Precision secured an unrelated third party to guarantee $15,300; collection of this guaranteed residual value and lease payments are reasonably certain. The rate implicit in the lease is 6%. There are no prepaid rentals, and neither party to the agreement pays initial direct costs. What amount of Sales Revenue is recorded at commencement of the lease? A) $36,000 B) $33,057 C) $45,176 D) $30,720 Answer: C Explanation: Sales revenue and net investment in the lease are calculated as the present value of the lease payments plus the guaranteed residual. The present value of the lease payments and third-party guarantees can be calculated in Excel, =PV(0.06,4,9000,15300,1) = $45,176. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) On January 1, 2023, Precision Pumps leases nonspecialized pumping equipment to Mega Construction. The equipment is delivered on January 1. The lease term is 4 years with no renewal or purchase options, and title to the leased asset is retained by the lessor at the end of the lease term. The lease requires annual fixed rental payments of $6000 per year beginning on January 1, 2023, and then December 31 of each year starting on December 31, 2023. The fair value of the equipment is $32,268 and has a carrying amount on Precision's books of $21,942. The equipment has a remaining life of 8 years. The estimated residual value of the equipment is $14,700. The lessee does not guarantee the residual value, but Precision secured an unrelated third party to guarantee $14,700; collection of this guaranteed residual value and lease payments are reasonably certain. The rate implicit in the lease is 8%. There are no prepaid rentals, and neither party to the agreement pays initial direct costs. What amount is recorded for net investment in the lease at commencement of the lease? A) $24,000 B) $21,463 C) $32,268 D) $21,942 Answer: C Explanation: Sales revenue and net investment in the lease are calculated as the present value of the lease payments plus the guaranteed residual. The present value of the lease payments and third-party guarantees can be calculated in Excel, =PV(0.08,4,6000,14700,1) = $32,268. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) On January 1, 2023, Precision Pumps leases nonspecialized pumping equipment to Mega Construction. The equipment is delivered on January 1. The lease term is 4 years with no renewal or purchase options, and title to the leased asset is retained by the lessor at the end of the lease term. The lease requires annual fixed rental payments of $5000 per year beginning on January 1, 2023, and then December 31 of each year starting on December 31, 2023. The fair value of the equipment is $29,850 and has a carrying amount on Precision's books of $20,298. The equipment has a remaining life of 8 years. The estimated residual value of the equipment is $14,500. The lessee does not guarantee the residual value, but Precision secured an unrelated third party to guarantee $14,500; collection of this guaranteed residual value and lease payments are reasonably certain. The rate implicit in the lease is 6%. There are no prepaid rentals, and neither party to the agreement pays initial direct costs. What is the balance in the net investment in the lease account after the first payment? A) $21,341 B) $13,365 C) $24,850 D) $28,359 Answer: C Explanation: The beginning balance of the net investment in the lease account is the present value of the lease payments and third-party guarantees, which can be calculated in Excel, = $29,850. Since the first lease payment is made on the date on which the lease commences, the entire payment reduces this amount and there is no interest. As a result, the balance in the account after the first payment is $24,850. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) On January 1, 2023, Precision Pumps leases nonspecialized pumping equipment to Mega Construction. The equipment is delivered on January 1. The lease term is 4 years with no renewal or purchase options, and title to the leased asset is retained by the lessor at the end of the lease term. The lease requires annual fixed rental payments of $8500 per year beginning on January 1, 2023, and then December 31 of each year starting on December 31, 2023. The fair value of the equipment is $40,430 and has a carrying amount on Precision's books of $27,492. The equipment has a remaining life of 8 years. The estimated residual value of the equipment is $14,700. The lessee does not guarantee the residual value, but Precision secured an unrelated third party to guarantee $14,700; collection of this guaranteed residual value and lease payments are reasonably certain. The rate implicit in the lease is 9%. There are no prepaid rentals, and neither party to the agreement pays initial direct costs. What is the balance in the net investment in the lease account after the second payment on December 31, 2023? A) $26,304 B) $21,516 C) $31,930 D) $37,556 Answer: A Explanation: The beginning balance of the net investment in the lease account is the present value of the lease payments and third-party guarantees, which can be calculated in Excel, = $40,430. Since the first lease payment is made on the date on which the lease commences, the entire payment reduces this amount and there is no interest. As a result, the balance in the account after the first payment is $31,930. Interest of $31,930 × 9% = $2874. From the $8500 payment, $2874 represents interest and $5626 reduces the principal balance to $26,304. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) List U.S. GAAP Lease Classification Criteria for both Group I and Group II. Answer: Group I 1. The lease transfers ownership of the leased asset to the lessee at the end of the lease term. 2. The lessee is given an option to purchase the asset that the lessee is reasonably certain to exercise. 3. The lease term is for a major part of the economic life of the asset. 4. The present value of the sum of the lease payments and any residual value guaranteed by the lessee, that is not otherwise included in the lease payments, is equal to substantially all of the fair value of the asset. 5. The leased asset is of a specialized nature. Group II 1. The present value of the sum of the lease payments and any residual value guarantee (from both the lessee and a third party in combination) that is not otherwise included in the lease payments is equal to substantially all of the fair value of the asset. 2. It is probable that the lessor will collect the lease payments plus any amount necessary to satisfy a residual value guarantee. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

Precision Pumps On January 1, 2023, Precision Pumps leases nonspecialized pumping equipment to Mega Construction. The equipment is delivered on January 1. The lease term is 4 years with no renewal or purchase options, and title to the leased asset is retained by the lessor at the end of the lease term. The lease requires annual fixed rental payments of $7,000 per year beginning on January 1, 2023, and then December 31 of each year starting on December 31, 2023. The fair value of the equipment is $37,592 and has a carrying amount on Precision's books of $22,000. The equipment has a remaining life of 8 years. The estimated residual value of the equipment is $15,000. The lessee does not guarantee the residual value, but Precision secured an unrelated third party to guarantee $15,000; collection of this guaranteed residual value and lease payments is reasonably certain. The rate implicit in the lease is 6%. There are no prepaid rentals, and neither party to the agreement pays initial direct costs. 16) What is the proper classification of this lease for Precision Pumps? Answer: This lease is classified as a direct financing lease by Precision Pumps. None of the Group I criteria are met, such as transfer of ownership, likely exercise of purchase option, or specialized asset. The lease term is only 50% of the remaining economic life and the present value of the lease payments (Excel =PV(6%,4, 7000,0,1) = $25,711) represents only $25,711/$37,592 = 68% of the fair value. However, the lease meets both Group 2 criteria. The present value of the lease payments and third-party guarantees (Excel =PV(6%,4, 7000,15000,1) = $37,592) is equal to 100% of the fair value and collection of the lease payments is probable. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Assuming that Precision Pumps classifies this lease as a direct financing lease, prepare the journal entries for the commencement of the lease and the payment of the first and second lease payments. Answer: Commencement of the lease January 1, 2023 Net Investment in Lease–Direct Financing 22,000 Inventory of Equipment 22,000 First lease payment January 1, 2023 Cash Net Investment in Lease — Direct Financing

7,000

Second lease payment December 31, 2023 Cash Interest Revenue Net Investment in Lease — Direct Financing

7,000

6,016 984

Sales revenue and net investment in the lease are calculated as the present value of the lease payments plus the guaranteed residual. The present value of the lease payments and third-party guarantees can be calculated in Excel, =PV(6%,4,7000,15000,1) = $37,592. The Sales Revenue is the lower of the lease receivable or fair value of the asset. Revenue is $37,592. Cost of goods sold is the carrying value of the leased asset less the present value of unguaranteed residual value. Cost of goods sold is $22,000. The Profit is Sales Revenue $37,592 — Cost of Goods Sold $22,000 = $15,592. In the case of a direct financing lease, the profit is deferred and it reduces the net investment. The net investment is the present value of lease payments less the deferred profit, which equals $37,592 - $15,592 = $22,000. A new interest rate must be determined. Using Excel, the formula is: =Rate(4,7000,-22000,15000,1) = 40.1072%. Since the first lease payment is made on the date on which the lease commences, the entire payment reduces the net investment in lease and there is no interest. As a result, the balance in the net investment in lease after the first payment is $15,000. Interest of $15,000 × 40.1072% = $6,016. From the $7,000 payment, $6,016 represents interest and $984 reduces the principal balance to $14,016. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) How does IFRS differ from U.S. GAAP for direct financing leases? Answer: IFRS does not distinguish sales-type leases from direct financing leases. IFRS classifies leases based on whether the risks and rewards of ownership have been transferred to the lessee. If the risks and rewards have been transferred, IFRS classifies the lease as a finance lease. The lessor's accounting for IFRS finance leases is similar to the U.S. GAAP accounting for sales-type leases. There are two types of lessors under IFRS: (1) manufacturers and dealers and (2) everyone else. Under IFRS, at the lease commencement manufacturers and dealers report a profit computed the same way as lessors compute profit under U.S. GAAP. Manufacturers and dealers always immediately expense initial direct costs. All other lessors do not recognize a profit at lease commencement and defer initial direct costs. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) On January 1, 2023, Parker Corporation leases nonspecialized pumping equipment to Mason Construction. The equipment is delivered on January 1. The lease term is 4 years with no renewal or purchase options, and title to the leased asset is retained by the lessor at the end of the lease term. The lease requires annual fixed rental payments of $10,000 per year beginning on January 1, 2023, and then December 31 of each year starting on December 31, 2023. The fair value of the equipment is $41,627 and has a carrying amount on Precision's books of $28,306. The equipment has a remaining life of 8 years. The estimated residual value of the equipment is $15,000. The lessee does not guarantee the residual value, but Parker secured an unrelated third party to guarantee $15,000; collection of this guaranteed residual value and lease payments are reasonably certain. The rate implicit in the lease is 11%. There are no prepaid rentals, and neither party to the agreement pays initial direct costs. What amount of Sales Revenue is recorded at commencement of the lease? Answer: $44,318 Explanation: Sales revenue and net investment in the lease are calculated as the present value of the lease payments plus the guaranteed residual. The present value of the lease payments and third-party guarantees can be calculated in Excel, =PV(11%,4,10000,15000,1) = $44,318. Diff: 2 Objective: 18.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

18.8

Lease Disclosures

1) Generally, lease disclosures vary by the type of lease and whether the party to the lease is the lessee or the lessor. Answer: TRUE Diff: 1 Objective: 18.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) With finance leases, interest payments decrease cash flows from operating activities. Answer: TRUE Diff: 1 Objective: 18.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) For operating leases, lessors disclose lease income relating to lease payments and variable lease payments are included in the measurement of all types of lease receivables. Answer: FALSE Diff: 1 Objective: 18.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) IFRS disclosures are similar to those of U.S. GAAP. However, because lease classifications are different, IFRS reporters provide disclosure related to the types of leases they have. Answer: TRUE Diff: 1 Objective: 18.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

5) On the balance sheet, the right-of-use asset under an operating lease is ________. A) amortized by straight line B) reduced to present value C) amortized later than with a finance lease D) not included Answer: C Diff: 1 Objective: 18.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) On the statement of cash flows, the total lease payment reduces cash flow from operating activities for the operating lease. Only the ________ reduces operating cash flows under the ________ lease. Therefore, cash flows from operating activities are ________ under the finance lease each year and in total. A) liability portion; finance; lower B) interest portion; finance; higher C) liability portion; operating; lower D) interest portion; operating; higher Answer: B Diff: 2 Objective: 18.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) List the lessee's disclosures that provide the user with information about the nature of leases. Answer: · Determination of variable lease payments · Existence, terms, and conditions of options to extend or terminate the lease · Existence, terms, and conditions of residual value guarantees · Restrictions or covenants imposed by leases such as limits on dividends or incurring additional financial obligations Diff: 1 Objective: 18.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Why is operating income higher under a finance lease in the early years of the lease? Answer: Because lease costs under an operating lease are usually higher than the amortization expense under a finance lease in the early years of a lease, operating income will be higher under a finance lease. Diff: 2 Objective: 18.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) How does IFRS report leased assets with low values? Answer: IFRS makes an exception for leased assets that have low values. Leased assets with values of less than $5,000 can be accounted for as a rental agreement rather than recognized and measured as a right-of-use asset and lease liability. Diff: 1 Objective: 18.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

18.9

Appendix A: Complexities in Accounting for Lease Transactions

1) If at the lease commencement date it is likely that the lessee will exercise the purchase option, then the amount of the purchase option is included in the computation of the lease payments. Answer: TRUE Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Lessees typically make leasehold improvements, which are improvements made to leased property that are not movable and revert to the lessor when the lease expires. Answer: TRUE Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Lessees often incur costs related to the ownership of a leased asset. These costs, referred to as Leasehold Improvement Costs, include items such as sales and property taxes, insurance, and maintenance. Answer: FALSE Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The lessee depreciates leasehold improvements over the shorter of the life of the improvements or the lease term. Answer: TRUE Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

Sidekick Services Sidekick Services leases several computer servers from Lycoming Computing Company. The lease agreement includes consulting and training updates. The standalone prices charged by Lycoming for each separate component are $750,000 for the servers and $250,000 for the consulting and training updates. The lease is a 5 year lease with fixed payments of $400,000 per year. There are also variable payments required amounting to $7,000 per year, on average, based on the metered usage of the servers. There is no minimum charge included in the contract. 5) Using the above information, the total consideration in this contract ________ the variable payments. A) increases B) decreases C) excludes D) includes Answer: C Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Using the above information and assuming that Sidekick allocates consideration based on relative standalone selling prices, determine the allocation of the total consideration to the computer servers and the consulting and training services. Answer: Standalone Allocation of Allocation of Contract Selling Percentage Total Contract Annual Lease Component Prices Consideration Payment Server (Computer Equipment): Lease 75% × $2,000,000 = 75% × $400,000 = Component $750,000 75% $1,500,000 $300,000 Consulting and Training Services: 25% × $2,000,000 = 25% × $400,000 = Nonlease Component 250,000 25% 500,000 100,000 Total $1,000,000 100% $2,000,000 $400,000 Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Lessees often incur costs related to the ownership of the leased asset. These costs, referred to as, ________ include items such as property tax, insurance, and maintenance. A) expenses B) executory costs C) overhead costs D) All of the above Answer: B Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Which of the following costs is a nonlease component for the lessee? A) insurance B) taxes C) maintenance D) all of the above Answer: C Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

9) On January 1, 2023, Murray Manufacturing leased a building for use in its operations from Associated Realty. The 7-year, noncancellable lease requires annual lease payments of $17,000, beginning January 1, 2023, and at each December 31 thereafter through 2028. The lease payment includes costs related to property taxes of $2000. They also include payments for common area maintenance. The observable standalone price for the lease (including the property taxes) is $15,000 and the observable standalone price for the common area maintenance is $4000. In addition, Murray agrees to pay insurance on the building. Murray pays the insurance each year when it receives an invoice from Associated Realty for the insurance amount. On December 15, 2023, Murray was billed and paid $2500 for this insurance. Murray does not make the election to account for each separate lease component, along with its associated nonlease components, as a single lease component. The lease agreement does not transfer ownership, nor does it contain a purchase option. The building has a fair value of $87,000 and an estimated remaining life of 8 years. Associated Realty's implicit rate of 10% is known to Murray. Round percentages to one decimal place. What amount of the $17,000 lease payment is used to compute the lease obligation? A) $17,000 B) $13,000 C) $13,413 D) $12,938 Answer: C Explanation: Insurance is a variable expense that is not dependent on an index or a rate and is not included in the computation of the lease payment or lease liability. Common area maintenance is a nonlease component, so the $17,000 must be allocated to the lease and nonlease components.

Component Lease Nonlease (maintenance)

Standalone Price $15,000

Percentage 78.9%

Allocated Consideration $13,413

$4000 $19,000

21.1% 100%

$3587 $17,000

Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

10) On January 1, 2023, Murray Manufacturing leased a building for use in its operations from Associated Realty. The 7-year, noncancellable lease requires annual lease payments of $22,000, beginning January 1, 2023, and at each December 31 thereafter through 2028. The lease payment includes costs related to property taxes of $2000. They also include payments for common area maintenance. The observable standalone price for the lease (including the property taxes) is $20,000 and the observable standalone price for the common area maintenance is $4000. In addition, Murray agrees to pay insurance on the building. Murray pays the insurance each year when it receives an invoice from Associated Realty for the insurance amount. On December 15, 2023, Murray was billed and paid $2500 for this insurance. Murray does not make the election to account for each separate lease component, along with its associated nonlease components, as a single lease component. The lease agreement does not transfer ownership, nor does it contain a purchase option. The building has a fair value of $80,000 and an estimated remaining life of 8 years. Associated Realty's implicit rate of 10% is known to Murray. Round percentages to one decimal place. Assuming this is classified by Murray as a finance lease, at what amount should the right-of-use asset and lease liability be recorded? A) $117,816 B) $96,395 C) $18,326 D) $98,141 Answer: D Explanation: The right-of-use asset and lease liability will be recorded at the present value of the lease payments. See computation of lease payment below. Use Excel to calculate the present value, given 7 periods, 10% interest, and a payment of $18,326, with payments at the beginning of the period. Using Excel, the formula is: =PV(.10,7,-18326,0,1) = $98,141. Insurance is a variable expense that is not dependent on an index or a rate and is not included in the computation of the lease payment or lease liability. Common area maintenance is a nonlease component, so the $22,000 must be allocated to the lease and nonlease components.

Component Lease Nonlease (maintenance)

Standalone Price $20,000

Percentage 83.3%

Allocated Consideration $18,326

$4000 $24,000

16.7% 100%

$3674 $22,000

Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

11) On January 1, 2023, Wynn Manufacturing leased a floor of a building for use in its North American operations from Easymoney Bank. The 9-year, noncancellable lease requires annual lease payments of $12,000, beginning January 1, 2023, and at each January 1 thereafter through 2031. The lease agreement does not transfer ownership, nor does it contain a purchase option. The floor of the building has a fair value of $85,000 and an estimated remaining life of 10 years. Easymoney Bank's implicit rate of 11% is known to Wynn. What is the type of lease for the lessee? A) sales-type lease B) operating lease C) finance lease D) direct financing lease Answer: C Explanation: This is classified as a finance lease because the lease term of 9 years is 90% of the 10 years remaining in the asset's useful life. Diff: 2 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

12) On January 1, 2023, Wynn Manufacturing leased a floor of a building for use in its North American operations from Easymoney Bank. The 9-year, noncancellable lease requires annual lease payments of $12,000, beginning January 1, 2023, and at each January 1 thereafter through 2031. The lease agreement does not transfer ownership, nor does it contain a purchase option. The floor of the building has a fair value of $85,000 and an estimated remaining life of 10 years. Easymoney Bank's implicit rate of 10% is known to Wynn. At what amount is the lease liability recorded at lease commencement? A) $81,108 B) $76,019 C) $108,000 D) $85,735 Answer: B Explanation: The lease liability is recorded at $76,019, based on the following Excel formula: = PV(0.1,9,-12000,0,1) = $76,019. Diff: 2 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

13) On January 1, 2023, Wynn Manufacturing leased a floor of a building for use in its North American operations from Easymoney Bank. The 9-year, noncancellable lease requires annual lease payments of $12,000, beginning January 1, 2023, and at each January 1 thereafter through 2031. The lease agreement does not transfer ownership, nor does it contain a purchase option. The floor of the building has a fair value of $85,000 and an estimated remaining life of 10 years. Easymoney Bank's implicit rate of 11% is known to Wynn. At the end of 2023, which of the following journal entries will be used by Wynn to record Interest Expense? A) debit to Interest Expense and credit to Interest Payable B) debit to Interest Expense and Lease Liability and credit to Cash C) debit to Lease Liability and credit to Interest Expense D) No entry — payment is made on January 1, 2020. Answer: A Diff: 2 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Elliott Brothers enters into a lease agreement with Central Leasing for a piece of equipment. The terms of the 5-year lease state that payments of $19,500 will be made annually on January 1, commencing with the date that the lease begins. The lease contains a provision that Elliott Brothers may purchase the equipment at the end of the lease period for $19,000, which is well below the expected fair value at the end of the lease. As such, it is expected that Elliott Brothers will exercise this option. The implicit rate in the lease is 9%. If this lease is treated as a finance lease for Elliott Brothers, at what value will the right-ofuse asset be recorded? A) $95,024 B) $12,349 C) $82,675 D) $75,848 Answer: A Explanation: The right-of-use asset will be valued at the sum of the present value of the lease payments and the present value of the purchase option at lease termination. The present value of the 5 lease payments is $82,675, calculated using the following Excel formula: The present value of the purchase option at the end of 5 years is $12,349, calculated using the following Excel formula: The sum of these two amounts is $95,024 (rounded). Alternatively, the Excel formula is: = $95,024. Diff: 2 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

15) What is the proper accounting treatment to record improvements to leased property for a lessee? A) Expense in the year in which expenses are incurred and increase basis of asset. B) Capitalize and depreciate over the greater of the life of the improvement or lease term. C) Expense in the year in which expenses are incurred. D) Capitalize and depreciate over the lesser of the life of the improvement or lease term. Answer: D Diff: 2 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

16) What is the proper accounting treatment to record a variable lease payment indexed off the CPI? A) Calculate the lease liability based on expected payments over the life of the lease after considering increases in the CPI. B) Calculate the lease liability based on the base payment and debit an additional expense in subsequent years based on the change in the CPI. C) Record the lease liability based on highest annual increase in the CPI for the past 10 years. D) Capitalize and depreciate the increased payments based on CPI indexing. Answer: B Diff: 2 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Assume that Constance Industries leases equipment for 3 years with fixed rentals of $10,000 per year. The agreement also requires that Constance purchase consumables such as drive belts, etc. directly from the lessor and must spend a minimum of $1,500 per year over the lease term. What are the lease payments to be used to classify the lease? Answer: In this case, the $1,500 per year is unavoidable and therefore at the lease commencement date, the annual payments are $11,500 ($10,000 + $1,500).The total lease payments over the lease term consists of $34,500 total rentals, which are computed as $30,000 ($10,000 per year for 3 years) plus the $4,500 ($1,500 minimum guaranteed payments per year for 3 years for repair parts). Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

Captive Leasing Company Captive Leasing Company recently leased machinery to VonBurn Building Associates. The 5 year lease contract requires rental payments of $10,000 at the beginning of each year. The lease meets at least one of the Group I criteria. The 9% implicit rate on the lease is known at VonBurn. There is a $4,000 guaranteed residual value by the lessee, which is equal to the expected residual value at the end of the lease term. Therefore, there is no unguaranteed residual asset. 18) Based on the above information, calculate the value of the leased asset at the lease commencement date. Answer: The PV of the lease payments is computed as follows: N Given

I/Y 9.00%

Solve For PV

PMT -10,000

FV -4,000

Excel Formula = PV (0.09,5,-10,000,4000,1)

44,997

Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Based on the above information, calculate the present value of the guaranteed residual value on the lease commencement date. Answer: The PV of the guaranteed residual value is computed as follows:

Given

N 5

I/Y 9.00%

Solve For PV

PMT 0

FV -4,000

2,600

Excel Formula

= PV (0.09,5,0,-4,000,0)

Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Catwalk Enterprises is currently leasing land with a lease that expires in 20 years. On January 1 of the current year, Catwalk built a barn on the land costing $10,000 that is expected to last for 40 years. Catwalk depreciates its assets using the straight-line method. What is the journal entry to record the leasehold improvement? Answer: Account January 1, 20XX Leasehold Improvement 10,000 Cash 10,000 Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Catwalk Enterprises is currently leasing land with a lease that expires in 20 years. On January 1 of the current year, Catwalk built a barn on the land costing $10,000 that is expected to last for 40 years. Catwalk depreciates its assets using the straight-line method. What is the journal entry to record the depreciation for the barn every year? Answer: Catwalk depreciates the barn over 20 years, which is the shorter of the life of the asset and the life of the lease. Thus, it depreciates $500 per year ($10,000/20). Account December 31 Depreciation Expense – Leasehold Improvement 500 Accumulated Depreciation – Leasehold Improvement 500 Diff: 1 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

Wynn Manufacturing On January 1, 2023, Wynn Manufacturing leased a floor of a building for use in its North American operations from Easymoney Bank. The 9-year, noncancellable lease requires annual lease payments of $12,000, beginning January 1, 2023, and at each December 31 thereafter through 2030. The lease payment includes costs related to property taxes of $3,000. They also include payments for common area maintenance. The observable standalone price for the lease (including the property taxes) is $16,000 and the observable standalone price for the common area maintenance is $2,000. In addition, Wynn agrees to pay insurance on the floor of the building. Wynn pays the insurance each year when it receives an invoice from Easymoney Bank for the insurance amount. On December 15, 2023, Wynn was billed and paid $1,500 for this insurance. Wynn does not make the election to account for each separate lease component, along with its associated nonlease components, as a single lease component. The lease agreement does not transfer ownership, nor does it contain a purchase option. The floor of the building has a fair value of $85,000 and an estimated remaining life of 10 years. Easymoney Bank's implicit rate of 11% is known to Wynn. Round percentages to two decimal places. 22) Based on the above information, what is the present value of the leased asset on the lease commencement date? Answer: The lease is a finance lease for the lessee because the lease term of 9 years equals 90% of the life of the leased asset (10 years). The lease payment of $12,000 should be allocated between lease and nonlease components. Lease component: $12,000 × $16,000/($16,000 + $2,000) = $10,667. Using Excel, the present value of the leased asset on January 1, 2023 is: =PV(0.11,9,-10667,0,1) = $65,561. Diff: 2 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

23) Based on the above information, create the Journal Entry for the lessee on the lease commencement date. Answer: The lease is a finance lease for the lessee because the lease term of 9 years equals 90% of the life of the leased asset (10 years). The lease payment of $12,000 should be allocated between lease and nonlease components. Lease component: $12,000 × $16,000/($16,000 + $2,000) = $10,667. Using Excel, the present value of the leased asset on January 1, 2023 is: =PV(0.11,9,-10667,0,1) = $65,561. Account Right-of-Use Asset Lease Liability

January 1, 2023 65,561 65,561

Diff: 2 Objective: 18.A IFRS/GAAP: GAAP AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 19 Accounting for Employee Compensation and Benefits 19.1

Overview of Stock-Based Compensation

1) The first step in measuring compensation expense from granting employee stock options is to determine the fair value on the date of grant. Answer: TRUE Diff: 1 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The fair value of stock options on the date of grant is usually readily determinable. Answer: FALSE Diff: 1 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The value of stock options expected to be forfeited reduce compensation expense. Answer: TRUE Diff: 1 Objective: 19.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) An employee will generally exercise stock options only when the current market price is above the exercise price of the option. Answer: TRUE Diff: 2 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The fixed price paid by an employee to acquire a share of stock under an option plan is the ________. A) exercise price B) market price C) historical price D) book price Answer: A Diff: 1 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following items is generally not specified by a compensation arrangement involving stock options? A) number of options granted B) current market price C) exercise price D) vesting period Answer: B Diff: 2 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following statements regarding stock options is true? A) An employee will exercise a stock option only when the current market price of the stock is less than the option price. B) Unexercised options may be sold or transferred in the open market. C) Employee stock options are a restricted form of a call option. D) Companies expense stock-based compensation at the fair value of the stock on the expected date of exercise. Answer: C Diff: 2 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Compensation expense associated with stock options is ________. A) based upon the book value of the options B) based upon the estimated fair value of the options C) recorded on the date that the options are granted D) allocated as expense over the time period until the options expire Answer: B Diff: 2 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Among Fortune 500 companies, which of the following compensation plans is most common? A) stock options B) profit-sharing C) employee stock ownership D) deferred compensation Answer: A Diff: 1 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Companies expense stock-based compensation on the income statement at ________. A) fair value B) intrinsic value C) exercise price D) strike price Answer: A Diff: 1 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) The exercise price or ________ is the fixed amount paid to acquire a share of stock based on the terms of the option plan. A) fair value B) intrinsic value C) exercise price D) strike price Answer: D Diff: 1 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) List and explain the terms that are required to account for the issuance of stock options. Answer: 1. Exercise price or strike price—the fixed amount paid to acquire a share of stock based on the terms of the option plan. 2. Vesting period or service period—the time that the employee must remain with the company before exercising the option. 3. Expiration date—the point where the employee can no longer exercise the option. 4. Compensation arrangement—specifies the number of options granted, the exercise price, the vesting period, and the expiration date. Diff: 2 Objective: 19.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

19.2

Equity-Classified Stock-Based Compensation

1) An employee who receives an equity-classified award of stock options has the right to receive shares of stock. Answer: TRUE Diff: 1 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The initial journal entry to record an equity-classified award of stock options increases stockholders' equity on the balance sheet. Answer: FALSE Diff: 1 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) To account for the issuance of an equity-classified award, a company first computes the fair value of the award. Answer: TRUE Diff: 1 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) A stock option plan is generally revalued whenever there is a change in the estimated percentage of options that will be forfeited. Answer: TRUE Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) The compensation associated with equity-classified awards of stock options is ________. A) the estimated book value of the options B) the estimated fair value of the options C) allocated to compensation expense until the options expire D) recorded as compensation expense when the options are granted Answer: B Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) If an unexpected forfeiture of options occurs under a stock option plan, the change in compensation is treated as ________. A) a change in estimate B) an adjustment to additional paid in capital C) an adjustment to deferred compensation D) a change in other comprehensive income Answer: A Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) For an equity-classified award of stock options, what journal entry is made at the date of grant? A) No journal entry is prepared. B) Compensation Expense APIC—Stock Options C) Deferred Compensation Common Stock D) Compensation Expense Deferred Compensation Answer: A

Diff: 1 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) What is the effect of an equity-classified award of stock options on the grant date? A) no change in total equity or net income B) increase in total equity and increase in net income C) decrease in total equity and decrease in net income D) increase in total equity and decrease in net income Answer: A Explanation: An equity-classified award does not result in a journal entry on the grant date. Compensation expense is recognized over the life of the award with adjusting entries. Diff: 1 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) When compensation is recognized under an equity-classified award of stock options, the expiration of stock options is treated as ________. A) a prior period adjustment B) an adjustment to compensation expense C) a reclassification of shareholders' equity D) a change in accounting estimate Answer: C Explanation: Expiration of stock options results in reclassification of Additional Paid-In Capital - Stock Options to Additional Paid-in Capital - Expired Stock Options. Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) On January 1, Year 1, Fields Corporation granted 500,000 stock options to certain executives. The options are exercisable no sooner than December 31, Year 3 and expire on January 1, Year 7. The vesting period is 3 years. Each option can be exercised to acquire one share of $10 par common stock for $15. An appropriate option-pricing model estimates the fair value of each option to be $12 on the date of grant. What amount should Fields recognize as compensation expense for Year 1? A) $0 B) $2,000,000 C) $750,000 D) $6,000,000 Answer: B Explanation: 500,000 × $12 = $6,000,000/3 = $2,000,000 Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) On January 1, Year 1, Fields Corporation granted 300,000 stock options to certain executives. The vesting period is 3 years. The options are exercisable no sooner than December 31, Year 3 and expire on January 1, Year 7. Each option can be exercised to acquire one share of $10 par common stock for $15. An appropriate option-pricing model estimates the fair value of each option to be $13 on the date of grant. What is the fair value of the award? A) $3,900,000 B) $3,000,000 C) $900,000 D) $4,500,000 Answer: A Explanation: 300,000 options × $13 = $3,900,000. Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) On January 1, Year 1, Fields Corporation granted 200,000 stock options to certain executives. The vesting period is 3 years. The options are exercisable no sooner than December 31, Year 3 and expire on January 1, Year 7. Each option can be exercised to acquire one share of $10 par common stock for $15. An appropriate option-pricing model estimates the fair value of each option to be $11 on the date of grant. Fields chooses to adjust the fair value of the options for the estimated forfeitures. If unexpected turnover in Year 2 caused Fields to estimate that 12% of the options would be forfeited, what amount of compensation expense should Fields recognize in Year 2? (Round intermediate calculations and your final answer to the nearest dollar.) A) $0 B) $1,290,667 C) $733,333 D) $557,334 Answer: D Explanation: Compensation expense recognized in Year 1 = (200,000 × $11 = $2,200,000)/3 = $733,333. Expected value of options at end of Year 2 = 200,000 × $11 = $2,200,000 × 88% = $1,936,000 Cumulative compensation expense at end of Year 2 = $1,936,000 × 2/3 = $1,290,667 Compensation expense for Year 2 = Cumulative expense $1,290,667 recognized in Year 1 $733,333 = $557,334 Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) On January 1, Year 1, Davenport Corporation granted an employee 10,000 options to purchase 10,000 shares of Davenport's $10 par common stock at $30 per share. The options became exercisable on December 31, Year 3, after the employee completed three years of service. The option was exercised on February 1, Year 4. The market prices of Davenport's stock were as follows: January 1, Year 1, $40; December 31, Year 3, $60; and February 1, Year 4, $55. An options pricing model estimated the value of the options at $20 each on the grant date. For Year 1, Davenport should recognize compensation expense of ________. (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) $0 B) $66,667 C) $100,000 D) $200,000 Answer: B Explanation: (10,000 × $20) = $200,000/3 years = $66,667 Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) On January 1, Year 1, Gallagher Corporation issued 700,000 stock options for 700,000 shares to a division manager. The options have an estimated fair value of $10 each. These options are not exercisable unless division revenue increases by 8% in four years. Gallagher estimates that it is probable that the goal will be achieved. What is pretax compensation expense for year 1? A) $0 B) $1,750,000 C) $2,333,333 D) $7,000,000 Answer: B Explanation: (700,000 × $10) / 4 years = $1,750,000 Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) On January 1, Year 1, Freeman Corporation granted 120,000 stock options to key employees which allowed these employees to purchase 120,000 shares of the corporation's common stock at $30 per share. These options are intended to compensate employees for the next three years. The options may be exercised within a four-year period beginning January 1, Year 4, by the grantees still employed by the company. No options were terminated during Year 1, but Freeman does have an experience of 5% forfeitures over the life of the stock options. Freeman uses the estimated forfeiture rate to estimate compensation expense. The market price of the stock was $35 per share at the date of grant. Freeman used an appropriate pricing model and estimated the value of an option at $20. What amount should be charged to compensation expense for the year ended December 31, Year 1? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) $3,600,000 B) $800,000 C) $760,000 D) $2,400,000 Answer: C Explanation: (120,000 × $20) = ($2,400,000 × 95%)/3 = $760,000 Diff: 3 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) Schmidt Electronics offered an incentive stock plan to its employees. On January 1, Year 1, 110,000 options were granted for 110,000 $1 par common shares. The exercise price equals the $6 market price of the common stock on the grant date. The vesting period is 3 years. The options cannot be exercised before January 1, Year 4, and expire on December 31, Year 5. Each option has a value of $4 based upon an option pricing model. What is the fair value of the award? A) $110,000 B) $330,000 C) $440,000 D) $660,000 Answer: C Explanation: 110,000 × $4 = $440,000 Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) Schmidt Electronics offered an incentive stock plan to its employees. On January 1, Year 1, 110,000 options were granted for 110,000 $1 par common shares. The exercise price equals the $6 market price of the common stock on the grant date. The vesting period is 3 years. The options cannot be exercised before January 1, Year 4, and expire on December 31, Year 5. Each option has a value of $5 based upon an option pricing model. What is the journal entry to record compensation expense for Year 1? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) Deferred Compensation APIC - Stock Options

183,333

B) Compensation Expense Common Stock

183,333

C) Compensation Expense APIC - Stock Options

550,000

D) Compensation Expense APIC- Stock Options

183,333

550,000

183,333

Answer: D Explanation: 110,000 options × $5 per option = $550,000 fair value of the award, amortized equally over three years. Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Schmidt Electronics offered an incentive stock plan to its employees. On January 1, Year 1, 90,000 options were granted for 90,000 $1 par common shares. The exercise price equals the $6 market price of the common stock on the grant date. The vesting period is 3 years. The options cannot be exercised before January 1, Year 4, and expire on December 31, Year 5. Each option has a value of $3 based upon an option pricing model. At the end of the first year, it is expected that 100% of employees will exercise the options. By the end of Year 2, it is expected that only 80% of the options will be exercised. Assume that Schmidt chooses to adjust the fair value of the options for the estimated forfeitures. What is the journal entry to recognize compensation expense and record the change in vesting probability in Year 2? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) Deferred Compensation APIC - Stock Options

54,000

B) Compensation Expense Common Stock

90,000

C) Compensation Expense APIC - Stock Options

54,000

D) APIC - Stock Options Deferred Compensation

54,000

90,000

54,000

54,000 54,000

Answer: C Explanation: The total fair value of the options is the number of options times the fair value, 90,000 × $3 = $270,000. Compensation expense for the first year is 1/3 of this amount or $90,000. In the second year, we expect that only 80% of the options will vest, so the expected compensation expense is At the end of the 2nd year, 2/3 of $216,000, or $144,000 should be expensed. $144,000 cumulative amount - $90,000 recognized in the first year = $54,000 compensation expense for Year 2. Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) Schmidt Electronics offered an incentive stock plan to its employees. On January 1, Year 1, 90,000 options were granted for 90,000 $1 par common shares. The exercise price equals the $6 market price of the common stock on the grant date. The vesting period is 3 years. The options cannot be exercised before January 1, Year 4, and expire on December 31, Year 5. Each option has a value of $3 based upon an option pricing model. At the end of the first year, it is expected that 100% of employees will exercise the options. By the end of Year 2, it is expected that only 80% of the options will be exercised. Schmidt chooses to adjust the fair value of the options for the estimated forfeitures. What is the journal entry to record compensation expense for year 2? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) A) Deferred Compensation Compensation Expense B) Compensation Expense Deferred Compensation C) Compensation Expense APIC - Stock Options D) Compensation Expense Deferred Compensation

54,000 54,000

216,000 216,000

54,000 54,000

Answer: C Explanation: Description: Total compensation expense at fair value (90,000 × $3) Vesting probability Expected compensation expense Cumulative rate of amortization Cumulative compensation expense Less: Expense recognized in prior years Compensation expense (income): Current year

Year 1 $270,000 × 100% $270,000

Year 2 $270,000 × 80% $216,000

1/3 $90,000 $90,000

2/3 $144,000 (90,000) $54,000

Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

20) Schmidt Electronics offered an incentive stock plan to its employees. On January 1, Year 1, 120,000 options were granted for 120,000 $1 par common shares. The exercise price equals the $8 market price of the common stock on the grant date. The vesting period is 3 years. The options cannot be exercised before January 1, Year 4, and expire on December 31, Year 5. Each option has a value of $4 based upon an option pricing model. What is the journal entry to record the exercise of 85% of the options during Year 4 when the market price of the stock was $10. A) Cash APIC - Stock Options Common Stock APIC in Excess of Par - Common B) Cash APIC—Stock Options Common Stock APIC in Excess of Par - Common C) Cash APIC—Stock Options Common Stock APIC in Excess of Par - Common D) Cash APIC—Stock Options Common Stock APIC in Excess of Par - Common

816,000 408,000 102,000 1,122,000

816,000 408,000 120,000 1,104,000

408,000 102,000 102,000 408,000

120,000 102,000 120,000 102,000

Answer: A Explanation: Compensation expense is recognized as the stock options vest. At the end of three years, APIC - Stock Options has been credited for the number of options times the fair value per option, which equals $480,000 (120,000 × $4). When the 85% of the options are exercised, the company receives cash of $8 per option times 85% exercise rate × 120,000 options. Cash 120,000 options × 85% × $8 = $816,000; APIC–Stock Options $480,000 × 85% = $408,000; Common Stock 120,000 shs × 85% × $1 = $102,000; APIC in Excess of Par-Common = $816,000 + $408,000 - $102,000 = $1,122,000 Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

21) Schmidt Electronics offered an incentive stock plan to its employees. On January 1, Year 1, 120,000 options were granted for 120,000 $1 par common shares. The exercise price equals the $6 market price of the common stock on the grant date. The vesting period is 3 years. The options cannot be exercised before January 1, Year 4, and expire on December 31, Year 5. Each option has a value of $3 based upon an option pricing model. What is the entry to record the expiration of 15% of the options on December 31, Year 5? A) APIC-Stock Options APIC—Expired Stock Options

54,000 54,000

B) APIC-Stock Options Retained Earnings

54,000

C) APIC-Stock Options Compensation Expense

54,000

D) Stock Options Receivable Common Stock APIC

54,000

90,000 30,000 60,000

Answer: A Explanation: 120,000 × 15% = 18,000 × $3 = $54,000 Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

Walker, Incorporated Walker, Incorporated uses stock options as a compensation incentive for its top executives. On January 1, Year 1, 25,000 options were granted, each giving the holder the right to acquire one $5 par common share. The exercise price is $60 per share. The vesting period is 4 years. Options vest on January 1, Year 5 and cannot be exercised before that date and will expire on December 31, Year 8. The fair value of the 25,000 options, estimated by an appropriate option pricing model is $50 per option. 22) Refer to Walker Corporation. Make the journal entries to record compensation expense for Year 1. Answer: Fair value = 25,000 options × $50 = $1,250,000. Compensation Expense for Year 1 = $1,250,000 / 4 years = $312,500 Compensation Expense APIC — Stock Options Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

312,500

23) Refer to Walker Corporation. On April 1, Year 7, when the market price of Walker's stock was $20 per share, 15,000 of the options were exercised. Make the appropriate journal entry to record this transaction. Answer: Cash 900,000 APIC - Stock Options 750,000 Common Stock 75,000 APIC in Excess of Par—Common 1,575 ,000 Cash = 15,000 options × $60 exercise price = $900,000 APIC — Stock Options = 15,000 options × $50 fair value at the time of grant = $750,000 Common Stock = 15,000 shares × $5 par = $75,000 Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

24) Refer to Walker Corporation. Assuming that all compensation expense has been recorded, record the journal entry to reflect the expiration of 3,000 options that were never exercised. Answer: APIC—Stock Options 150,000 APIC —Expired Stock Options 150,000 *3,000 options × $50 fair value at the time of grant date = $150,000 Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

25) Allied Electronics offered an incentive stock plan to its employees. On January 1, Year 1, 100,000 options were granted for 100,000 $10 par common shares. The exercise price equals the $25 market price of the common stock on the grant date. The vesting period is 3 years. The options cannot be exercised before January 1, Year 4, and expire on December 31, Year 5. Each option has a value of $15 based upon an option pricing model. At the end of the first year, it is expected that 100% of employees will exercise the options. By the end of Year 2, it is expected that only 80% of the options will be exercised. Allied chooses to adjust the fair value of options for the estimated forfeitures. What are the journal entries to reflect the first year and second years' compensation expense? (Do not round intermediate calculations. Only round your final answer to the nearest dollar.) Answer: End of 1st year: Amortize 1/3 of compensation expense= $1,500,000/3 = $500,0000 Account Compensation Expense Additional Paid-in Capital–Stock Options

Debit 500,000

Credit 500,000

End of 2nd year: Expected compensation expense = $1,500,000 × 80% = $1,200,000 Cumulative compensation expense = 2/3 × $1,200,000 = $800,000 Expense recognized in Year 1 = $500,000 Compensation expense for Year 2 = $800,000 - $500,000 = $300,000 Account Compensation Expense Additional Paid-in Capital–Stock Options

Debit 300,000

Credit 300,000

Diff: 2 Objective: 19.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

19.3

Liability-Classified Stock-Based Compensation

1) When a company grants a liability-classified award, it does not make an entry at the grant date. Answer: TRUE Diff: 1 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) The carrying value of liability-classified awards is not adjusted for changes in fair value. Answer: FALSE Diff: 1 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) An employee will not redeem a liability-classified award when the stock is out of the money. Answer: TRUE Diff: 1 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) An employee will not redeem a liability-classified award when the market price is less than the exercise price. Answer: TRUE Diff: 1 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) When liability-classified stock options expire, additional paid-in capital is increased. Answer: TRUE Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following is not a situation in which employee compensation is classified as a liability? A) The option is granted for the acquisition of securities classified as equity securities. B) The option is granted for the acquisition of securities classified as liabilities, such as redeemable preferred stock. C) The employee can sell back the acquired shares to the employer corporation at the exercise price within a reasonable period of time. D) The compensation is in the form of cash-settled stock appreciation rights. Answer: A Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following statements about liability-classified awards is true? A) When a company records compensation expense, it will adjust additional paid-in capital at the grant date. B) In accounting for liability-classified awards, a company records deferred compensation at the grant date. C) The value of a liability-classified award is typically based on the company's equity. D) The value of liability classified awards remains unchanged until the award is settled. Answer: C Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) On January 1, Year 1, Axis Corporation granted employees 48,000 stock options for 48,000 shares of $2 par value common stock. The exercise price on the date of issue was equal to the market price of $23. There is a two year vesting period and the options expire in four years. Employees have the right to sell back the shares to the corporation within six months of exercise. The fair value of the options has been estimated to be $31 per option and the company does not expect any forfeitures of the options. What is the amount of compensation expense for Year 1? A) $744,000 B) $0 C) $1,488,000 D) $1,104,000 Answer: A Explanation: Because the employee has the right to sell back the acquired shares within 6 months of exercise, these options are liability-classified awards. The options have no intrinsic value, as the market price is equal to the exercise price on the date of issue. The company must recognize compensation expense equal to the number of options times the fair value, and this amount is amortized over the vesting period. 48,000 options × $31/option = $1,488,000. $1,488,000 / 2 years = $744,000 per year compensation expense. Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) On January 1, Year 1, Axis Corporation granted employees 53,500 stock options for 53,500 shares of $3 par value common stock. The exercise price on the date of issue was equal to the market price of $24. There is a two year vesting period and the options expire in four years. Employees have the right to sell back the shares to the corporation within six months of exercise. The fair value of the options has been estimated to be $39 per option and the company does not expect any forfeitures of the options. What is the journal entry for compensation expense for Year 1? A) Compensation Expense Liability for Stock-based Compensation

1,043,250

B) Compensation Expense Liability for Stock-based Compensation

1,284,000

C) Compensation Expense Deferred Compensation

1,043,250

D) Compensation Expense Deferred Compensation

1,284,000

1,043,250

1,284,000

1,043,250

1,284,000

10) On January 1, Year 1, Axis Corporation granted employees 66,000 stock options for 66,000 shares of $3 par value common stock. The exercise price on the date of issue was equal to the market price of $20. There is a two year vesting period and the options expire in four years. Employees have the right to sell back the shares to the corporation within six months of exercise. The fair value of the options has been estimated to be $39 per option and the company does not expect any forfeitures of the options. At the end of Year 2, the fair value of each option is $44. What is the journal entry for compensation expense for Year 2? A) Compensation Expense 1,617,000 Liability for Stock-based Compensation 1,617,000 B) Compensation Expense Liability for Stock-based Compensation

1,320,000

C) Compensation Expense Deferred Compensation

1,617,000

D) Compensation Expense Deferred Compensation

1,320,000

1,617,000

1,320,000

Answer: A Explanation: Because the employee has the right to sell back the acquired shares within 6 months of exercise, these options are liability-classified awards. The options have no intrinsic value, as the market price is equal to the exercise price on the date of issue. The company must recognize compensation expense equal to the number of options times the fair value, and this amount is amortized over the vesting period. 66,000 options × $39/option = $2,574,000. $2,574,000 / 2 years = $1,287,000 per year compensation expense. This is the amount recorded in the first year. In the second year, the full value of the options is 66,000 options × $44 fair value = $2,904,000. As $1,287,000 of compensation has already been recognized, the remaining $2,904,000 - $1,287,000 = $1,617,000 is recognized. Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) On January 1, Year 1, Axis Corporation granted employees 63,000 stock options for 63,000 shares of $3 par value common stock. The exercise price on the date of issue was equal to the market price of $24. There is a two year vesting period and the options expire in four years. Employees have the right to sell back the shares to the corporation within six months of exercise. At the time of issue, the fair value of the options is estimated to be $31 per option. Two years later, the options are exercised. What is the appropriate journal entry? A) Cash Liability for Stock-based Compensation Common Stock APIC in Excess of Par - Common B) Cash

1,512,000 1,953,000 189,000 3,276,000

1,512,000 Common Stock APIC in Excess of Par - Common

189,000 1,323,000

C) Cash

976,500 Common Stock APIC in Excess of Par - Common

D) Cash Liability for Stock-based Compensation Common Stock APIC in Excess of Par - Common

189,000 787,500

189,000 1,953,000 189,000 1,953,000

Answer: A Explanation: Because the employee has the right to sell back the acquired shares within 6 months of exercise, these options are liability-classified awards. The options have no intrinsic value, as the market price is equal to the exercise price on the date of issue. The company will recognize compensation expense and a liability for stock-based compensation equal to the number of options times the fair value, and this amount is amortized over the vesting period. 63,000 options × $31/option = $1,953,000. $1,953,000 = liability for stock-based compensation. Upon exercise, the company receives cash of 63,000 options × $24 per option = $1,512,000. They debit the liability account for the full amount. Common stock is credited for 63,000 shares × $3 par value per share = $189,000 and the remaining amount goes to APIC in Excess of Par-Common. Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) On January 1, Year 1, Axis Corporation granted employees 82,000 stock options for 82,000 shares of $2 par value common stock. The exercise price on the date of issue was equal to the market price of $22. There is a two year vesting period and the options expire in four years. Employees have the right to sell back the shares to the corporation within six months of exercise. At the time of issue, the fair value of the options is estimated to be $31 per option. Unfortunately, the company experiences a series of setbacks and the stock price falls in Year 4. At December 31, Year 4, the options have a fair value of $18 per option. At the end of four years, none of the options have been exercised. What is the appropriate journal entry to record the expiration of the options? A) Liability for Stock-based Compensation APIC - Expired Stock Options

1,476,000

B) APIC - Expired Stock Options Compensation Expense

2,542,000

C) APIC - Expired Stock Options Compensation Expense

1,271,000

1,476,000

2,542,000

1,271,000

D) Liability for Stock-based Compensation Common Stock APIC - Common

1,271,000 164,000 1,107,000

Answer: A Explanation: Because the employee has the right to sell back the acquired shares within 6 months of exercise, these options are liability-classified awards. The options have no intrinsic value, as the market price is equal to the exercise price on the date of issue. The company will recognize compensation expense and a liability for stock-based compensation equal to the number of options times the fair value, and this amount is amortized over the vesting period. 82,000 options × $31/option = $2,542,000. $2,542,000 = liability for stock-based compensation. By December 31, Year 4, the options are valued at fair value which is $18 × 82,000 = $1,476,000. Liability-based awards are adjusted to fair value until the options are settled or expire. When the options expire, the liability account is debited for the full amount and APICExpired Stock Options is credited. Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which of the following statements is true concerning adjustments to Compensation Expense? A) Compensation Expense is adjusted when there is a change in vesting probability for both equityclassified and liability-classified awards. B) Compensation Expense is adjusted when there is a change in fair value for equity-classified and liability-classified awards. C) Compensation Expense is adjusted for equity-classified awards when there is a change in vesting probability or change in fair value. D) Compensation Expense is adjusted when there is a change in fair value for a liability-classified award, but not for a change in vesting probability. Answer: A Explanation: See Exhibit 19.2 for a summary. Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) List the conditions in which employee compensation is classified as a liability under liability classified awards. Answer: 1. The option is granted for the acquisition of securities classified as liabilities, such as redeemable preferred stock. 2. The employee can sell back the acquired shares to the employer corporation at the exercise price within a reasonable amount of time. 3. The compensation is in the form of cash-settled share appreciation rights (SAR) where the employee receives cash for the amount of the increase in share value over a pre-established price over a fixed period of time. Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) On January 1, Year 1, Axis Corporation granted employees 50,000 stock options for 50,000 shares of $2 par value common stock. The exercise price on the date of issue was equal to the market price of $24. There is a two year vesting period and the options expire in four years. Employees have the right to sell back the shares to the corporation within six months of exercise. At the time of issue, the fair value of the options is estimated to be $38 per option. Two years later, on January 1, Year 3, the options are exercised. What are the appropriate journal entries on the date that the options are granted, at the end of Year 1, at the end of Year 2, and on the date that the options are exercised? Answer: January 1, Year 1 (Issue Date): Because the employee has the right to sell back the acquired shares within 6 months of exercise, these options are liability-classified awards. The options have no intrinsic value, as the market price is equal to the exercise price on the date of issue. The company must recognize compensation expense equal to the number of options times the fair value, and this amount is amortized over the vesting period. 50,000 options × $38/option = $1,900,000. $1,900,000 / 2 years = $950,000 per year compensation expense. December 31, Year 1: Compensation Expense Liability for Stock-based Compensation

950,000

December 31, Year 2: Compensation Expense Liability for Stock-based Compensation

950,000

January 1, Year 3 (Exercise Date): Upon exercise, the company receives cash of 50,000 options × $24 per option = $1,200,000. They debit the liability account for the full amount. Common stock is credited for 50,000 shares × $2 par value per share = $100,000 and the remaining amount goes to APIC in Excess of Par-Common. Cash Liability for Stock-based Compensation Common Stock APIC in Excess of Par- Common

1,200,000 1,900,000 100,000 3,000,000

Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) On January 1, Year 1, Alexie Corporation granted employees 50,000 stock options for 50,000 shares of $2 par value common stock. The exercise price on the date of issue was equal to the market price of $25. There is a two-year vesting period and the options expire in four years. Employees have the right to sell back the shares to the corporation within six months of exercise. The fair value of the options has been estimated to be $30 per option and the company does not expect any forfeitures of the options. What is the amount of compensation expense for Year 1? Answer: $750,000 per year compensation expense. Explanation: Because the employee has the right to sell back the acquired shares within 6 months of exercise, these options are liability-classified awards. The options have no intrinsic value, as the market price is equal to the exercise price on the date of issue. The company must recognize compensation expense equal to the number of options times the fair value, and this amount is amortized over the vesting period. 50,000 options × $30 per option = $1,500,000. $1,500,000 / 2 years = $750,000 per year compensation expense. Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) On January 1, Year 1, Alexis Corporation granted employees 53,000 stock options for 53,000 shares of $3 par value common stock. The exercise price on the date of issue was equal to the market price of $25. There is a two-year vesting period and the options expire in four years. Employees have the right to sell back the shares to the corporation within six months of exercise. The fair value of the options has been estimated to be $40 per option and the company does not expect any forfeitures of the options. What is the journal entry for compensation expense for Year 1? Answer: Compensation Expense 1,060,000 Liability for Stock-based Compensation 1,060,000 Explanation: Because the employee has the right to sell back the acquired shares within 6 months of exercise, these options are liability-classified awards. The options have no intrinsic value, as the market price is equal to the exercise price on the date of issue. The company must recognize compensation expense equal to the number of options times the fair value, and this amount is amortized over the vesting period. 53,000 options × $40 per option = $2,120,000. $2,120,000 / 2 years = $1,060,000 per year compensation expense. Diff: 2 Objective: 19.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

19.4

Other Types of Stock-Based Compensation

1) An employee who is awarded stock appreciation rights must purchase the related shares. Answer: FALSE Diff: 1 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) To account for stock appreciation rights settled with cash, a company records compensation expense and a related liability. Answer: TRUE Diff: 1 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) In non-compensatory employee stock purchase plans, a company will record the amount of the discount below the regular market price as compensation expense. Answer: FALSE Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Restricted stock plans are less dilutive than stock option plans. Answer: TRUE Diff: 1 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Which of the following statements is false? A) Stock appreciation rights are a form of compensation similar to a bonus. B) Employees holding stock appreciation rights are required to purchase shares on the vesting date. C) The employee benefits from stock appreciation rights only if the stock price increases. D) The liability for a SAR is measured as the difference between the stock price and the pre-established price. Answer: B Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) On January 1, 2021, Cable Corporation issues 11,500 stock-appreciation rights to its key executives. The terms of the plan state that the holders of the rights will receive a cash payment equal to the difference between the market price of the stock on the date of exercise and the pre-established price of $9 per share. There is a three-year vesting period and the rights may be exercised on January 1, 2024. The rights expire on January 1, 2026. The closing market prices follow: December 31, 2021 December 31, 2022 December 31, 2023

$12 per share $15 per share $14 per share

What is the appropriate journal entry on December 31, 2021? (Do not round any intermediate calculations. Round your final answer to the nearest dollar.) A) Compensation Expense Obligation under SAR Plan

11,500

B) Obligation under SAR Plan Deferred Compensation

103,500

C) Compensation Expense Obligation under SAR Plan

138,000

D) Compensation Expense APIC - SAR

15,333

11,500

103,500

138,000

15,333

7) On January 1, 2021, Cable Corporation issues 6000 stock-appreciation rights to its key executives. The terms of the plan state that the holders of the rights will receive a cash payment equal to the difference between the market price of the stock on the date of exercise and the pre-established price of $9 per share. There is a three-year vesting period and the rights may be exercised on January 1, 2024. The rights expire on January 1, 2026. The closing market prices follow: December 31, 2021 December 31, 2022 December 31, 2023

$12 per share $15 per share $14 per share

What is the appropriate journal entry on December 31, 2022? (Do not round any intermediate calculations. Round your final answer to the nearest dollar.) A) Compensation Expense Obligation under SAR Plan B) Obligation under SAR Plan Deferred Compensation

18,000

6000 6000

C) Compensation Expense Obligation under SAR Plan D) Compensation Expense APIC - SAR

18,000

72,000 72,000

2000 2000

8) On January 1, 2021, Cable Corporation issues 15,000 stock-appreciation rights to its key executives. The terms of the plan state that the holders of the rights will receive a cash payment equal to the difference between the market price of the stock on the date of exercise and the pre-established price of $9 per share. There is a three-year vesting period and the rights may be exercised on January 1, 2024. The rights expire on January 1, 2026. The closing market prices follow: December 31, 2021 December 31, 2022 December 31, 2023

$12 per share $15 per share $13 per share

What is the appropriate journal entry on December 31, 2023? (Do not round any intermediate calculations. Round your final answer to the nearest dollar.) A) No journal entry. B) Obligation under SAR Plan Deferred Compensation

15,000

C) Compensation Expense Obligation under SAR Plan

195,000

D) Compensation Expense APIC - SAR

19,500

15,000

195,000

19,500

Answer: A Explanation: As of December 31, 2021, the fair value of the rights is the difference between the market price of $12 and the pre-established floor of $9. Therefore, the total fair value is 15,000 rights × ($12 - $9) = $45,000. Since there is a 3 year vesting period, only 1/3 of this amount is debited to Compensation Expense in the first year. As of December 31, 2022, the fair value of the rights is the difference between the market price of $15 and the pre-established floor of $9. Therefore, the total fair value is 15,000 rights × ($15 - $9) = $90,000. Since there is a 3 year vesting period and this is the second year, 2/3 of this expense should be accrued (2/3 × $90,000 = $60,000). This amount is reduced by the $15,000 accrued in 2021. On December 31, 2023, the fair value of the rights is the difference between the market price of $13 and the pre-established floor of $9. Therefore, the total fair value is 15,000 rights × ($13 - $9) = $60,000. Since there is a 3 year vesting period and the vesting period is complete, Compensation Expense is the full $60,000 reduced by the $15,000 and $45,000 previously accrued. As a result, there is no additional Compensation Expense for 2023. Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) On January 1, 2021, Cable Corporation issues 12,500 stock-appreciation rights to its key executives. The terms of the plan state that the holders of the rights will receive a cash payment equal to the difference between the market price of the stock on the date of exercise and the pre-established price of $8 per share. There is a three-year vesting period and the rights may be exercised on January 1, 2024. The rights expire on January 1, 2026. The closing market prices follow: December 31, 2021 December 31, 2022 December 31, 2023

$11 per share $14 per share $12 per share

What is the appropriate journal entry when the stock-appreciation rights are exercised on January 1, 2024 when the market price is $12 per share? A) Obligation under SAR Plan Cash

50,000

B) Obligation under SAR Plan Deferred Compensation

150,000

C) Compensation Expense Obligation under SAR Plan

150,000

D) Cash

50,000

150,000

15,000 APIC - SAR

15,000

Answer: A Explanation: When the stock-appreciation rights are exercised, Obligation under SAR Plan, which will have a balance equal to the number of rights times the difference between the market price and the preestablished price, will be debited and Cash will be credited. 12,500 × ($12 - $8) = $50,000 Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Which of the following is not a characteristic of a restricted stock plan? A) The employee cannot sell the awarded shares until the vesting period has expired. B) A restricted stock plan has value as long as the underlying shares are selling above zero. C) Restricted shares are not stock options. D) The employee is taxed on the stock award when it is granted. Answer: D Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) The compensation associated with a share of stock under a restricted stock plan is computed as ________. A) the market price of a share of a similar security B) the book value of an unrestricted share of the same stock C) the market price of an unrestricted share of the same stock D) the book value of a share of similar stock Answer: C Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Which of the following conditions is not required for an employee stock purchase plan to be noncompensatory? A) The plan is made available to substantially all employees. B) After the plan is established, there is a maximum one month period to elect to participate in the plan. C) The discount is not larger than 5% of the open market price. D) Top-level employees may purchase no more than a set percentage of shares available. Answer: D Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) On January 1, 2021, Bubert Corporation issues 8500 shares of $2 par restricted stock to its key executives. The market value of unrestricted shares of the same stock on the date of issue is $25 and there is a four year vesting period. What is the amount of deferred compensation recorded on January 1, 2021? A) $212,500 B) $195,500 C) $17,000 D) $178,500 Answer: A Explanation: On the date that the restricted shares are issued, Deferred Compensation is debited for the number of shares times the market price. Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) On January 1, 2021, Bubert Corporation issues 12,500 shares of $2 par restricted stock to its key executives. The market value of unrestricted shares of the same stock on the date of issue is $19 and there is a four year vesting period. What is the amount of compensation expense recorded on December 31, 2021? A) $59,375 B) $53,125 C) $237,500 D) $25,000 Answer: A Explanation: On the date that the restricted shares are issued, Deferred Compensation is debited for the number of shares times the market price, 12,500 shares × $19 = $237,500. This amount is amortized over the four year vesting period and compensation expense for each year is $237,500 / 4 = $59,375. Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) On January 1, 2021, Smart Corporation issues 12,500 shares of $2 par restricted stock to a key executive. The market value of unrestricted shares of the same stock on the date of issue is $18 and there is a four year vesting period. On January 1, 2022, the executive leaves and forfeits the restricted stock award. The journal entry to record the forfeiture includes which of the following? A) credit Deferred Compensation $56,250 B) credit Common Stock $25,000 C) debit Deferred Compensation for $25,000 D) credit Compensation Expense for $56,250 Answer: D Explanation: On the date that the restricted shares are issued, Deferred Compensation is debited for the number of shares times the market price, 12,500 shares × $18 = $225,000. At the same time, Common Stock is credited at par for $25,000 and APIC in Excess of Par — Common is credited for the difference, $200,000. Deferred Compensation is amortized over the four year vesting period and Compensation Expense for each year is $225,000 / 4 = $56,250. After debiting Compensation Expense and crediting Deferred Compensation, the balance in Deferred Compensation is $168,750 ($225,000 - $56,250). When the shares are forfeited after Year 1, the following journal entry is recorded: Common Stock APIC in Excess of Par — Common Deferred Compensation Compensation Expense Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

25,000 200,000 168,750 56,250

16) Teague Corporation permits any of its employees to buy shares directly from the company through payroll deduction. There are no brokerage fees and shares can be purchased at a 10% discount. During July, employees purchased 33,000 shares at a time when the established market price was $26 per share. Teague will record compensation expense associated with July purchases of ________. A) $0 B) $85,800 C) $772,200 D) $858,000 Answer: B Explanation: The compensation expense is 33,000 × $26 × 10% = $85,800 Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) Teague Corporation permits any of its employees to buy shares directly from the company through payroll deduction. There are no brokerage fees and shares can be purchased at a 10% discount. During July, employees purchased 40,000 shares at a time when the established market price was $26 per share. Teague will record an increase in cash of ________ associated with July purchases. A) $0 B) $104,000 C) $936,000 D) $1,040,000 Answer: C Explanation: 40,000 shares × $26/share × 90% = $936,000. Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Block Corporation permits key employees to buy shares directly from the company through payroll deduction. There are no brokerage fees and shares can be purchased at a 10% discount. During July, employees purchased 36,000 shares at a time when the established market price was $31 per share. Block will record salary expense associated with July purchases of ________. A) $0 B) $111,600 C) $1,004,400 D) $1,116,000 Answer: B Explanation: Salary expense = 36,000 × $31 × 10% = $111,600 The plan appears to be compensatory since it is available to only select employees, so salary expense is 10% × $31 × 36,000. As a result, the company records $111,600 in salary expense. Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) On January 1, 2021, Cable Corporation issues 10,000 stock-appreciation rights to its key executives. The terms of the plan state that the holders of the rights will receive a cash payment equal to the difference between the market price of the stock on the date of exercise and the pre-established price of $10 per share. There is a three-year vesting period and the rights may be exercised on January 1, 2024. The rights expire on January 1, 2026. The closing market prices follow: December 31, 2021 December 31, 2022 December 31, 2023

$13 per share $16 per share $14 per share

The rights are exercised on January 1, 2024. What is the appropriate journal entry on December 31, 2021, December 31, 2022, December 31, 2023, and January 1, 2024? Answer: December 31, 2021 Compensation Expense 10,000 Obligation under SAR Plan 10,000 December 31, 2022 Compensation Expense Obligation under SAR Plan

30,000 30,000

December 31, 2023 No entry. January 1, 2024

Obligation under SAR Plan Cash

40,000 40,000

As of December 31, 2021, the fair value of the rights is the difference between the market price of $13 and the pre-established floor of $10. Therefore, the total fair value is 10,000 rights × ($13 - $10) = $30,000. Since there is a 3 year vesting period, only 1/3 of this amount is debited to Compensation Expense in the first year. As of December 31, 2022, the fair value of the rights is the difference between the market price of $16 and the pre-established floor of $10. Therefore, the total fair value is 10,000 rights × ($16 - $10) = $60,000. Since there is a 3 year vesting period and this is the second year, 2/3 of this expense should be accrued (2/3 × $60,000 = $40,000). This amount is reduced by the $10,000 accrued in 2021. On December 31, 2023, the fair value of the rights is the difference between the market price of $14 and the pre-established floor of $10. Therefore, the total fair value is 10,000 rights × ($14 - $10) = $40,000. Since there is a 3 year vesting period and the vesting period is complete, Compensation Expense is the full $40,000 reduced by the $10,000 and $30,000 previously accrued. As a result, there is no additional Compensation Expense for 2023. When the stock-appreciation rights are exercised, Obligation under SAR Plan, has a balance equal to $40,000, which will be debited and Cash will be credited for $40,000. Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) On January 1, 2021, Bubert Corporation issues 10,000 shares of $5 par restricted stock to its key executives. The market value of unrestricted shares of the same stock on the date of issue is $25 and there is a four year vesting period. Record the journal entries for the issuance of the restricted shares, as well as compensation expense for the first year. Answer: January 1, 2021 Deferred Compensation - Restricted Stock 250,000 Common Stock (10,000 shares × $5 par) 50,000 APIC in Excess of Par- Common 200,000 December 31, 2021 Compensation Expense (250,000/4 years) 62,500 Deferred Compensation - Restricted Stock Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

62,500

21) On January 1, 2021, Smart Corporation issues 10,000 shares of $5 par restricted stock to an executive. The market value of unrestricted shares of the same stock on the date of issue is $25 and there is a fouryear vesting period. On January 1, 2022, the executive leaves and forfeits the restricted stock award. Record the journal entries for the issuance of the restricted shares, compensation expense for the first year, and forfeiture of the restricted stock. Answer: January 1, 2021: Deferred Compensation - Restricted Stock 250,000 Common Stock (10,000 shares × $5 par) 50,000 APIC in Excess of Par — Common 200,000 December 31, 2021: Compensation Expense (250,000/4 years) Deferred Compensation - Restricted Stock January 1, 2022: Common Stock APIC in Excess of Par — Common Deferred Compensation Compensation Expense

62,500

50,000 200,000

Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

62,500

187,500 62,500

22) Teague Corporation permits key employees to buy shares directly from the company through payroll deduction. There are no brokerage fees and shares can be purchased at a 10% discount. During July, employees purchased 20,000 $2 par shares of common stock at a time when the established market price was $30 per share. What is the journal entry to record issuance of these shares? Answer: This is a compensatory plan, since it is limited to key employees. Cash (20,000 × $30 × 90%) 540,000 Compensation Expense 60,000 Common Stock (20,000 × $2) 40,000 APIC in Excess of Par - Common 560,000 Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

23) Teague Corporation permits any of its employees to buy shares directly from the company through payroll deduction. There are no brokerage fees and shares can be purchased at a 10% discount. During July, employees purchased 20,000 $2 par shares of common stock at a time when the established market price was $30 per share. What is the journal entry to record issuance of these shares? Answer: This appears to be a compensatory plan because the discount exceeds 5%. Account Cash (20,000 × $30 × 90%) Salary Expense (20,000 × $30 × 10%) Common Stock (20,000 × $2) Additional Paid-in Capital in Excess of Par– Common

Debit 540,000 60,000

Credit

40,000 560,000

Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

24) On January 1, 2021, Bubert Corporation issues 10,000 shares of $5 par restricted stock to its key executives. The market value of unrestricted shares of the same stock on the date of issue is $20 and there is a four-year vesting period. What is the amount of deferred compensation recorded on January 1, 2021? Answer: $200,000 Explanation: $200,000 = 10,000 shares at $20 market price per share. On the date that the restricted shares are issued, Deferred Compensation (contra-shareholders' equity account) is debited for the number of shares times the market price. Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) On January 1, 2021, Bubert Corporation issues 10,000 shares of $5 par restricted stock to its key executives. The market value of unrestricted shares of the same stock on the date of issue is $20 and there is a four-year vesting period. What is the amount of compensation expense recorded on December 31, 2021? Answer: $50,000 Explanation: On the date that the restricted shares are issued, Deferred Compensation is debited for the number of shares times the market price, 10,000 shares × $20 = $200,000. This amount is amortized over the four-year vesting period and compensation expense for each year is $200,000/4 = $50,000. Diff: 2 Objective: 19.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

19.5

Stock-Based Compensation Disclosures

1) Companies are required to disclose the intrinsic values of outstanding stock options granted. Answer: TRUE Diff: 1 Objective: 19.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Accountants must make a judgment about the probability of forfeiture in a stock-based compensation plan. Answer: TRUE Diff: 1 Objective: 19.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Which of the following statements regarding disclosures for stock-based compensation plans is false? A) An entity is required to disclose the intrinsic values of outstanding stock options granted. B) The effect on the stock-based compensation plans on the entity's cash flows must be disclosed. C) An entity must disclose information only for vested shares that are exercised and exercisable. D) An entity must provide a reconciliation of beginning and ending amounts for the number and weighted average exercise price of share options. Answer: C Diff: 2 Objective: 19.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) List the four key areas that minimum disclosures for stock-based compensation plans must address. Answer: 1. The nature and terms of the stock-based compensation plans that existed during the periods covered by the financial statements. 2. The methods used to estimate the required fair values, including models and assumptions used in valuing options. 3, The income statement effect of the compensation cost arising from the entity's stock-based compensation plan. 4. The effect of the stock-based compensation plans on the entity's cash flow. Diff: 2 Objective: 19.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) In what ways must an accountant exercise judgment in relation to stock-based compensation plans? Answer: Accountants make two important judgments regarding stock-based compensation: 1. Measurement of the options at fair value–Option pricing models estimate the fair value of the options which is used to report the compensation expense for the options in the income statement. However, even the best models provide only an estimate of the fair value of the options. Ultimately, the final decision is based upon the judgment of the accountant. 2. Estimating how many options will be forfeited is also a matter of the accountant's judgment. Companies only record the amount of the expense related to the amount of the options that will not be forfeited. Both of these judgments can be used by management to alter income in such a way that would benefit management. Management has an incentive to select an option pricing model with low option values, which will lead to lower compensation expense and higher net income. Management has an incentive to estimate high forfeiture rates, which will lead to lower compensation expense and higher net income. Diff: 2 Objective: 19.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

19.6

Overview of Pensions

1) In a noncontributory pension plan, employees must fund some or all pension benefits. Answer: FALSE Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) In a contributory pension plan, employees must fund some or all of their pension costs. Answer: TRUE Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) The vested benefit obligation uses future salary levels. Answer: FALSE Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The accumulated benefit obligation reflects only current salary levels. Answer: TRUE Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Under a defined-contribution pension plan, the contribution is fixed but benefits can vary. Answer: TRUE Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Under a defined-benefit pension plan, employees are responsible for losses on plan assets. Answer: FALSE Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Under a defined-benefit plan, the contribution is fixed but benefits can vary. Answer: FALSE Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Which of the following is not a method of measuring a company's pension benefit obligation to a company? A) projected benefit obligation B) vested benefit obligation C) future benefit obligation D) accumulated benefit obligation Answer: C Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Which of the following is a characteristic of a defined-contribution pension plan? A) Employer contributions are typically based upon salary levels of employees. B) Employers must make contributions for prior service costs to a defined contribution plan. C) Pension plan assets draw interest that may be used to reduce annual contributions to the plan. D) Employers bear the risk of loss on pension fund assets. Answer: A Diff: 2 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Which of the following is a characteristic of a defined-benefit pension plan? A) It raises few accounting issues for employers. B) Retirement benefits are based on the plan benefit formula. C) It is simple to construct. D) Retirement benefits are contingent on how much an employee has accumulated in a retirement account. Answer: B Diff: 2 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) Which of the following is not a factor in calculating a defined benefit for a pension? A) percentage B) current salary level C) return on plan assets D) credits for years of service Answer: C Diff: 2 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) Which of the following measures of benefit obligations does the FASB require for pension computations? A) vested benefit obligation B) accumulated benefit obligation C) projected benefit obligation D) future benefit obligation Answer: C Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) Which of the following is a characteristic of the projected benefit obligation measurement? A) It considers only vested employees. B) It uses projected future salary levels. C) It is the smallest estimate of the pension obligation. D) It considers only current employees. Answer: B Diff: 2 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) Which of the following is a characteristic of the accumulated benefit obligation measurement? A) It considers only vested employees. B) It does not use projected future salary levels. C) It is required by GAAP for measurement of the pension obligation. D) It considers only current employees. Answer: B Diff: 2 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) The net pension liability is decreased by ________. A) amortization of prior service costs B) service costs C) expected return on plan assets D) amortization of net gain in other comprehensive net income Answer: C Diff: 1 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) The portion of the obligation than plan participants are entitled to receive regardless of their continued employment is called the ________. A) retiree benefit obligation B) projected benefit obligation C) accumulated benefit obligation D) vested benefit obligation Answer: D Diff: 2 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) List and explain the three methods used to measure a company's pension obligation to its employees. Answer: 1. Vested benefit obligation (VBO)–This method bases the defined-benefit obligation on the vested benefits that accrue to current employees. The employer computes the VBO based on current salary levels and includes only vested benefits. Because the vested benefits must be paid even if the plan is discontinued or the employees are terminated, the VBO is considered a termination-based obligation. 2. Accumulated benefit obligation (ABO)—This method estimates the pension obligation based on years of service performed by all employees under the plan, both vested and non-vested, using current salary levels. It only reflects current salaries and does not factor in projected increases in compensation. 3. Projected benefit obligation (PBO)—This method considers all employees, both vested and non-vested, using estimated future salary levels. The PBO considers all employees and future compensation rates. It is the largest estimate of the pension obligation. It is required by the FASB for use in pension computation. Diff: 3 Objective: 19.6 IFRS/GAAP: GAAP AACSB: Application of knowledge

19.7

Defined-Benefit Pension Plan Accounting

1) The difference between pension plan assets and the PBO is equal to the funded status of the plan. Answer: TRUE Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) A net pension liability is the excess of the projected benefit obligation over the plan assets. Answer: TRUE Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Under the corridor approach, a company only amortizes the net accumulated unamortized actuarial gain or loss when the beginning accumulated unamortized balance of the net actuarial gain or loss exceeds the corridor. Answer: TRUE Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Prior service cost is recognized as pension expense over a period of several years under U.S. GAAP. Answer: TRUE Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Prior service cost is recognized as pension expense over a period of several years under IFRS. Answer: FALSE Diff: 1 Objective: 19.7 IFRS/GAAP: IFRS AACSB: Application of knowledge

6) Which of the following is not a key element of pension expense under a defined-benefit pension plan? A) amortization of future benefit obligations B) service cost C) expected return on plan assets D) interest on projected benefit obligation Answer: A Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) The increase in the projected benefit obligation from one additional year of service from employees is referred to as ________. A) employer contribution B) service cost C) expected return on plan assets D) prior service cost Answer: B Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) When a company amends their existing pension plan to increase the defined-benefit rate, the associated expense is referred to as ________. A) employer contribution B) service cost C) expected return on plan assets D) prior service cost Answer: D Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) What is the proper treatment of prior service costs? A) Prior service costs are included in other comprehensive income and amortized over future periods. B) Prior service costs are included in other comprehensive income and amortized retroactively over the most recent three periods. C) Prior service costs are included in net income and expensed in the current year. D) Prior service costs are included in net income and amortized over future periods. Answer: A Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Interest cost will ________. A) increase pension expense and reduce plan assets B) increase the PBO and reduce plan assets C) increase the PBO and increase pension expense D) increase pension expense and reduce the return on plan assets Answer: C Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) The projected benefit obligation (PBO) is decreased by ________. A) payment of retirement benefits B) a return on plan assets that is higher than expected C) an increase in the average life expectancy of employees D) a decrease in the actuary's assumed discount rate Answer: A Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) If a pension plan is underfunded, it means that the ________. A) ABO exceeds plan assets B) PBO is less than plan assets C) ABO is less than plan assets D) PBO exceeds plan assets Answer: D Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) When a pension plan is amended to recognize previous service of currently employed employees, what component of pension expense is created? A) transition costs B) amendment costs C) past service costs D) prior service costs Answer: D Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

14) How is interest cost calculated for a defined benefit pension plan? A) Multiply the beginning balance PBO by the settlement rate. B) Multiply the beginning balance ABO by the settlement rate. C) Multiply the PBO by the expected return on the plan assets. D) Multiply the ABO by the expected return on the plan assets. Answer: A Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

15) Merciful Industries has a beginning PBO balance of $600,000 and a settlement rate of 6%. What is the journal entry to record interest expense on the pension obligation? A) Pension Expense Projected Benefit Obligation

36,000

B) Pension Expense Other Comprehensive Income

36,000

C) Pension Expense Projected Benefit Obligation

600,000

D) Pension Expense Other Comprehensive Income

600,000

36,000

600,000

Answer: A Explanation: Pension Expense is 6% settlement rate × $600,000 PBO = $36,000 Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

16) Merciful Industries has a beginning PBO balance of $500,000 and a settlement rate of 6%. As a result of an amendment to the current union contract, there are prior service costs of $49,000. What is the journal entry to record the change to the current union contract? A) Pension Expense Projected Benefit Obligation

2940

B) Pension Expense Other Comprehensive Income

30,000

C) Other Comprehensive Income–Prior Service Costs Projected Benefit Obligation

49,000

D) Pension Expense Other Comprehensive Income

46,060

2940

30,000

49,000

46,060

Answer: C

Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Merciful Industries has a beginning PBO balance of $500,000 and a settlement rate of 7%. As a result of an amendment to the current union contract, there are prior service costs of $46,500. What is the journal entry to record amortization of the prior service costs for the second year, assuming that the company uses a 5 year amortization period. A) Pension Expense Projected Benefit Obligation

3255

B) Pension Expense Other Comprehensive Income

35,000

3255

35,000

C) Other Comprehensive Income–Prior Service Costs Projected Benefit Obligation

9300 9300

D) Pension Expense Other Comprehensive Income–Prior Service Costs

9300 9300

Answer: D Explanation: Prior service costs are amortized over 5 years, so $46,500/5 = $9300 per year. Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) Merciful Industries has a beginning PBO balance of $600,000 and a settlement rate of 6%. As a result of an amendment to the current union contract, there are prior service costs of $52,000. What is the journal entry to record interest expense on the pension obligation? A) Pension Expense Projected Benefit Obligation

39,120

B) Pension Expense Other Comprehensive Income

36,000

C) Pension Expense Projected Benefit Obligation

130,400

D) Pension Expense Other Comprehensive Income

48,880

39,120

36,000

130,400

48,880

Answer: A Explanation: Prior service costs increase PBO balance to $652,000. Pension Expense = $652,000 × 6% = $39,120. Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

19) Merciful Industries has a beginning PBO balance of $900,000 and a settlement rate of 6%. The expected return is 7%. The beginning balance of pension plan assets is $1,000,000. What is the journal entry to record the expected return on plan assets? A) Pension Plan Assets Pension Expense - Expected Return

70,000 70,000

B) Pension Expense Other Comprehensive Income

63,000

C) Pension Expense Pension Plan Assets

66,500

63,000

66,500

D) Pension Expense Other Comprehensive Income

9000 9000

Answer: A Explanation: Expected return = 7% × $1,000,000 = $70,000 Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Amortizing a net actuarial loss for pensions will ________. A) increase retained earnings and increase accumulated other comprehensive income B) increase retained earnings and decrease accumulated other comprehensive income C) decrease retained earnings and decrease accumulated other comprehensive income D) decrease retained earnings and increase accumulated other comprehensive income Answer: D Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Amortizing a net actuarial gain for pensions will ________. A) increase retained earnings and increase accumulated other comprehensive income B) increase retained earnings and decrease accumulated other comprehensive income C) decrease retained earnings and decrease accumulated other comprehensive income D) decrease retained earnings and increase accumulated other comprehensive income Answer: B Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) At December 31, Year 1, Musslewhite Corporation reported a net loss of $2.5 million related to its pension plan, because the actuarial assumptions related to future salary levels changed. Musslewhite's entry to record the results of this change will include ________. A) a debit to OCI — Actuarial Gains/Losses and a credit to Projected Benefit Obligation B) a debit to Projected Benefit Obligation and a credit to OCI - Loss C) a debit to pension expense and a credit to Projected Benefit Obligation D) a debit to pension expense and a credit to OCI - Loss Answer: A Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) If a pension plan is overfunded, it means that the ________. A) ABO exceeds plan assets B) PBO is less than plan assets C) ABO is less than plan assets D) PBO exceeds plan assets Answer: B Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Which of the following is not a component of annual pension expense? A) service cost B) amortization of prior service costs C) actual return on plan assets D) interest on the projected benefit obligation Answer: C Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

25) Apple Plumbing reports actual returns on plan assets of $140,000, while the expected return was $121,000. In addition, an employee wellness program has resulted in changes in actuarial assumptions that result in an increase in the PBO of $24,000. What is the journal entry to record the gain on plan assets? A) Pension Plan Assets OCI - Actuarial Gains/Losses

19,000

B) Pension Plan Assets Retained Earnings

19,000

C) Pension Plan Assets OCI - Pension Plan Gains/Losses

19,000

D) OCI - Pension Plan Gains/Losses Pension Plan Assets

19,000

Answer: A Explanation: $140,000 - $121,000 = $19,000 Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) Apple Plumbing reports actual returns on plan assets of $200,000, while the expected return was $181,000. In addition, an employee wellness program has resulted in changes in actuarial assumptions that result in an increase in the PBO of $24,000. What is the journal entry to record the change in actuarial assumptions? A) OCI - Actuarial Gains/Losses Projected Benefit Obligation

24,000

B) Pension Plan Assets OCI - Actuarial Gains/Losses

43,000

C) Pension Plan Assets OCI - Pension Plan Gains/Losses

24,000

D) Pension Plan Assets Pension Plan Assets

5000

24,000

43,000

24,000

5000

Answer: A

Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Premier Sports Inc has a beginning PBO balance of $615,000 and a beginning market-related value of plan assets of $550,000. The net actuarial gain at the beginning of the period is $89,000 and the average employee base has a remaining service life of 20 years. What is the corridor? A) $61,500 B) $55,000 C) $27,500 D) $58,250 Answer: A Explanation: The corridor is 10% of the larger of the beginning balance of the PBO or the beginning balance of the plan assets at market-related value. Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) Premier Sports Inc has a beginning PBO balance of $628,000 and a beginning market-related value of plan assets of $560,000. The net actuarial gain at the beginning of the period is $87,500 and the average employee base has a remaining service life of 20 years. What is the required amortization of actuarial gains or losses for the current year? A) $1235 B) $3140 C) $4375 D) $24,700 Answer: A Explanation: The corridor is 10% of the larger of the beginning balance of the PBO or the beginning balance of the plan assets at market-related value. Since the PBO is larger, the corridor is 10% × $628,000 = $62,800. The net actuarial gain of $87,500 exceeds this by $24,700. This difference is amortized over the remaining service life of 20 years, with amortization of $24,700/20 = $1235. Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

29) A company's defined-benefit pension plan had a projected benefit obligation (PBO) of $380,000 on January 1, Year 1. During Year 1, pension benefits paid were $70,000. The settlement rate for the plan for Year 1 was 12%. Service cost for the year was $109,000. Plan assets (fair value) increased during the year by $50,000. What was the PBO at December 31, Year 1? A) $310,000 B) $425,600 C) $489,000 D) $464,600 Answer: D Explanation: PBO, January 1 $380,000 Service Cost 109,000 Interest Cost 45,600 ($380,000 × 12%) Benefits Paid (70,000) PBO, December 31 $464,600 Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

30) How does IFRS differ from GAAP when accounting for defined-benefit pension plans? A) IFRS requires current period expensing of prior service costs while GAAP amortizes prior service costs over time. B) GAAP allows companies to add interest cost and deduct expected return from pension expense in nonoperating income. IFRS allows the net interest (from PBO and plan assets) to be reported in operating or financing income. C) GAAP requires separate rates of interest for the PBO and expected return on plan assets. IFRS uses the same rate for both. D) GAAP amortizes current year net actuarial gains and losses using the corridor approach, while IFRS does not amortize actuarial gains/losses. IFRS reports actuarial gains/losses in other comprehensive income. Answer: A Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

31) Mega Corporation sponsors a defined-benefit plan for its employees. The beginning balance of the unamortized net actuarial gain is $250,000. The plan's custodian reports that the beginning balance of the PBO is $1,450,000 and the beginning balance of the market-related value of the plan assets is $1,100,000. The average remaining service life of Mega's pension plan eligible employees is 10 years. Compute the current year's amortization required by the corridor method and prepare the journal entry. Answer: The corridor is 10% of the larger of the PBO or beginning plan assets. Since the PBO is larger, the corridor is 10% × $1,450,000 = $145,000. The cumulative unamortized net gain is $250,000 and this exceeds the corridor by $105,000. This amount is amortized over the average remaining service life of 10 years, resulting in current year amortization of $10,500. OCI - Actuarial Gains/Losses Pension Expense

Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

10,500

32) Mega Corporation sponsors a defined-benefit plan for its employees. Compute the pension cost for the year, given the following information: Service cost Interest on beginning PBO Expected return on plan assets Amortization of prior service costs Amortization of net actuarial gain

$30,000 $16,000 $45,000 $5,000 $12,000

Answer: Service cost Interest on beginning PBO Expected return on plan assets Amortization of prior service costs Amortization of net actuarial gain Pension cost(benefit) for the year

$30,000 $16,000 ($45,000) $5,000 ($12,000) ($6,000)

Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

33) Explain the differences between accounting for defined benefit pension plans under IFRS and under GAAP. Answer: Accounting for defined benefit pension plans under IFRS differs from US GAAP in three major areas: 1. Under IFRS, prior service costs are expensed when plan amendments are made. Under GAAP, these costs are amortized over time. Additionally, IFRS refers to prior service costs as past service costs. 2. Under IFRS, the computation of interest on the PBO and the expected return on plan assets are combined into net interest on the net defined liability or asset. Under US GAAP, companies can use one interest rate to compute interest expense and another one to determine the expected return on plan assets; IFRS requires application of one interest rate to both. Additionally, under US GAAP, companies add the interest cost and deduct expected return from the pension expense in non-operating income. Under IFRS, companies have the choice to report the interest on the net defined benefits liability (asset) in operating or financing income. 3. Under IFRS, a company reports all current year actuarial gains or losses in other comprehensive income. Unlike U.S. GAAP, they are not amortized. Under U.S. GAAP, net actuarial gains and losses are amortized. Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

34) List and describe the five components of annual pension expense. Answer: 1. Service cost—Service cost is the increase in projected benefit obligation resulting from one additional year of service from employees. It is measured as the present value of the cost of providing pension benefits for one additional year of service using all employees and estimated future salary rates. 2. Prior service costs—Prior service costs represent service benefits provided to current employees on the initial adoption or amendment of an existing defined-benefit pension plan. Prior service costs increase the liability balance. 3. Interest on the projected benefit obligation–This is computed by multiplying the settlement rate by the balance of the projected benefit obligation at the beginning of the year. An actuary determines the settlement rate, which is the interest rate used to compute the interest on the PBO. 4. Expected return on pension plan assets–This amount decreases the pension expense. The invested plan assets earn interest, dividends, and capital gains upon sale. Every plan has an expected return on plan assets, which is the return based on expectations for interest, dividends, and fluctuations in the market value of the fund assets. The expected return is the beginning plan assets at fair value multiplied by an expected rate of return. 5. Current year net gains and losses—There are two sources of current year net gains and losses: a) The difference between the expected return and the actual return on plan assets and b) Changes in actuarial assumptions related to the projected benefit obligation. In general, companies only amortize the accumulated amount of the net actuarial gain or loss if it exceeds the corridor. The corridor is defined as 10% of the larger of the beginning balance of the projected benefit obligation or the beginning balance of the plan assets at market related value. Diff: 3 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

35) Palmer Sports Inc has a beginning PBO balance of $600,000 and a beginning market-related value of plan assets of $650,000. The net actuarial gain at the beginning of the period is $79,000 and the average employee base has a remaining service life of 20 years. What is the corridor? Answer: ($650,000 × 10%) = $65,000. Explanation: The corridor is 10% of the larger of the beginning balance of the PBO or the beginning balance of the plan assets at market-related value. Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

36) Baxter Sports Inc has a beginning PBO balance of $630,000 and a beginning market-related value of plan assets of $560,000. The net actuarial gain at the beginning of the period is $87,000 and the average employee base has a remaining service life of 20 years. What is the required amortization of actuarial gains or losses for the current year? Answer: $1,200. Explanation: The corridor is 10% of the larger of the beginning balance of the PBO or the beginning balance of the plan assets at market-related value. Since the PBO is larger, the corridor is 10% × $630,000 = $63,000. The net actuarial gain of $87,000 exceeds this by $24,000. This difference is amortized over the remaining service life of 20 years, with amortization of $24,000/20 = $1,200. Diff: 1 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

37) A company's defined-benefit pension plan had a projected benefit obligation (PBO) of $400,000 on January 1, Year 1. During Year 1, pension benefits paid were $70,000. The settlement rate for the plan for Year 1 was 11%. Service cost for the year was $100,000. Plan assets (fair value) increased during the year by $50,000. What was the PBO at December 31, Year 1? Answer: PBO, January 1 $400,000 Service Cost 100,000 Interest Cost 44,000 ($400,000 × 11 %) Benefits Paid (70,000) PBO, December 31 $474,000 Diff: 2 Objective: 19.7 IFRS/GAAP: GAAP AACSB: Application of knowledge

19.8

Defined-Benefit Pension Plan Disclosure Requirements

1) When pension plan assets exceed pension plan obligations, the pension plan is overfunded. Answer: TRUE Diff: 1 Objective: 19.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) An underfunded pension plan increases a company's leverage. Answer: TRUE Diff: 1 Objective: 19.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) A higher than expected return on plan assets increases pension costs. Answer: FALSE Diff: 1 Objective: 19.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Nonpublic entities are not required to separately disclose the components of net periodic benefit cost for pensions. Answer: TRUE Diff: 2 Objective: 19.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Which of the following statements about pension plan disclosures is true? A) The difference between the projected benefit obligation and the plan assets at fair value represents the unfunded status of the plan reported on the balance sheet. B) Public entities are not required to disclose the components of net pension benefit cost. C) The footnote must disclose assumptions used for discount rates and expected return on assets on a weighted average basis. D) Nonpublic entities must separately disclose the components of net pension benefit cost. Answer: C Diff: 2 Objective: 19.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Which of the following areas is not an area that financial statements users seek to analyze in a company's defined benefit pension plan? A) funded status B) actuarial gains and losses in other comprehensive income C) settlement rate and return on plan asset assumptions D) future payout assumptions. Answer: D Diff: 2 Objective: 19.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which of the following statements about defined benefit pension plans is correct? A) Deferring actuarial gains and losses tends to smooth earnings. B) An overfunded pension plan increases a company's leverage. C) When the settlement rate is higher, the computed pension obligation increases. D) Expected return on plan assets increases pension costs. Answer: A Diff: 2 Objective: 19.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Which of the following is not an element of pension cost that must be disclosed? A) actual return on plan assets B) service cost C) interest cost D) amortization of prior service cost Answer: A Diff: 1 Objective: 19.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Which of the following statements regarding IFRS disclosures for defined benefit pension plans is incorrect? A) Most IFRS reporters classify the service cost component of pension cost in operating income. B) IFRS reporters must report interest costs and return on plan assets as a part of operating income. C) IFRS disclosures and reporting for defined benefit pension plans are similar to those for US GAAP. D) Under IFRS, a defined benefit pension plan may be viewed as borrowing from employees. Answer: B Diff: 2 Objective: 19.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) What is the primary difference in defined-benefit pension disclosures between U.S. GAAP and IFRS? Answer: Under U.S. GAAP, one pension cost components is reported in operating income and the rest are reported in non-operating income. Service cost is reported in operating income but the rest of the components are reported in non-operating income. Under IFRS, service cost is reported in operating income, because it relates to employee services received in the current year. However, interest costs and expected return on plan assets can be reported either under operating income or non-operating income (financing) activities, because it is consistent with borrowing from employees to be paid back after retirement. Diff: 2 Objective: 19.8 IFRS/GAAP: IFRS AACSB: Application of knowledge

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 20 Earnings per Share 20.1

Basic Earnings per Share

1) Earnings per share is the most often quoted financial statistic in the business media. Answer: TRUE Diff: 1 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) When companies release EPS information, it does not influence stock prices. Answer: FALSE Diff: 1 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) A company may show EPS information either on the Income Statement or in the Notes to Financial Statements, whichever it prefers. Answer: FALSE Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Basic EPS measures the earnings available to common shareholders based on the weighted-average number of common shares outstanding during the period. Answer: TRUE Diff: 1 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

5) The numerator for basic EPS is net income less preferred dividend requirements. Answer: TRUE Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) For share issuances that occur before a stock split or dividend, the retroactive assumption assumes that the split or dividend occurred at the time of the issuance. Answer: TRUE Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) The denominator for basic EPS is based on the weighted-average number of common shares outstanding during the year. Answer: TRUE Diff: 1 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) When a stock split or stock dividend occurs during the year, it is retroactive to the beginning of the year, if the common shares were outstanding as of the beginning of the year. Answer: TRUE Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Retroactive application of stock splits and stock dividends to the weighted-average number of common shares makes EPS comparable for prior and current periods of one entity. Answer: TRUE Diff: 1 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) When computing basic EPS, the numerator includes net income minus the ________. A) present value of stock options B) current year preferred dividends paid and current year preferred dividends in arrears C) cost of interest paid on bonds, net of tax D) cash paid for dividends during the year Answer: B Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) The denominator of the basic EPS equation contains the ________. A) weighted-average number of shares of common stock outstanding for the year B) number of shares of common stock outstanding at the end of the year C) largest number of common shares outstanding during the year D) total of common and preferred shares outstanding during the year Answer: A Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) The retroactive assumption for stock splits and stock dividends assumes that all splits and stock dividends occur at the beginning of the year, if the stock is outstanding at the beginning of the year. The retroactive assumption is also retroactive to ________. A) the prior year B) all prior years C) the date of issue of the common shares D) the past five years reported in the current annual report Answer: C Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

13) The retroactive assumption for stock dividends and splits helps financial statement users to ________. A) recompute their net worth in the company B) be assured that management is effective C) hold management accountable for poor timing in the decision D) compare the company's EPS changes over time Answer: D Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Which one of the following items is not a way for management to influence EPS computations to meet target goals? A) measurements of impairments on plant, property and equipment B) determination of tax contingencies C) recording the sale of merchandise on account D) choice of inventory cost flow assumptions Answer: C Diff: 1 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) George Manufacturing had net income of $225,000 and declared preferred dividends of $20,000 during the current year. George began the year with 20,000 common shares outstanding. It issued 70,000 shares on June 30 and repurchased 12,000 of the newly issued shares on November 1. Compute George's weighted-average common shares outstanding for the year. A) 78,000 B) 53,000 C) 88,000 D) 90,000 Answer: B Explanation: (20,000 × 12/12) + (70,000 × 6/12) - (12,000 × 2/12) = 53,000 shares Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) George Manufacturing had net income of $250,000 and declared preferred dividends of $25,000 during the current year. George began the year with 17,000 common shares outstanding. It issued 50,000 shares on June 30 and repurchased 6,000 of the newly issued shares on November 1. Compute George's basic EPS for the year. (Round your answer to the nearest cent.) A) $6.10 B) $13.24 C) $5.49 D) $5.36 Answer: C Explanation: Weighted average number of shares = (17,000 × 12/12) + (50,000 × 6/12) - (6,000 × 2/12) = 41,000 shares EPS = ($250,000 - $25,000)/41,000 = $5.49 Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) Charlotte Engineering had net income of $500,000 for the year. It declared $40,000 in preferred dividends on December 23. It began the year with 100,000 common shares outstanding. On July 1, Charlotte declared a 5% common stock dividend. Compute the weighted-average common shares outstanding for the year. A) 100,000 B) 95,000 C) 105,000 D) 110,000 Answer: C Explanation: Stock dividends are applied retroactively, so the weighted average number of shares is 100,000 × 1.05 = 105,000. Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Charlotte Engineering reported net income of $500,000 for the year. It declared $35,000 in preferred dividends on December 23. It began the year with 800,000 common shares outstanding. On July 1, Charlotte declared a 5% common stock dividend. Compute the basic EPS for the year. (Round your answer to the nearest cent.) A) $0.55 B) $0.58 C) $0.61 D) $0.57 Answer: A Explanation: Stock dividends are applied retroactively, so the weighted average number of shares is 800,000 × 1.05 = 840,000. EPS = ($500,000 - $35,000)/840,000 = $0.55 Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Edmond Biometrics reported net income of $500,000 for both last year and the current year. The shares outstanding for the prior year were 100,000 shares for the whole year. On December 1 of the current year, Edmond declared a two for one stock split. There were no other stock transactions in either year. Compute the EPS that would be shown on a comparative income statement for Years 1 and 2. (Round your answer to the nearest cent.) A) Year 1 $5.00; Year 2 $2.50 B) Year 1 $2.50; Year 2 $2.50 C) Year 1 $5.00; Year 2 $1.11 D) Year 1 $5.00; Year 2 $0.91 Answer: B Explanation: The weighted-average number of shares for Year 1 was 100,000. The stock split in Year 2 is applied retroactively, making the weighted-average number of shares 100,000 × 2 = 200,000. EPS for each year is $500,000/ 200,000 = $2.50. Diff: 3 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

20) Hudson Motors reported $535,000 net income for the current year. Beginning common shares outstanding were 130,000. Hudson also had 10,000, 6% nonconvertible, cumulative, $100 par value preferred shares outstanding for the entire year. No cash dividends were declared. Compute basic earnings per share. (Round your answer to the nearest cent.) A) $4.12 B) $4.11 C) $3.65 D) $3.39 Answer: C Explanation: When calculating EPS, net income is reduced by preferred dividends paid or in arrears. [$535,000 - (10,000 shares × 6% × $100 par)]/130,000 = $3.65 Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

21) Hornet Motors reported $735,000 net income for the current year. Beginning common shares outstanding were 150,000. Hornet also had 10,000, 6% nonconvertible, cumulative, $100 par value preferred shares outstanding for the entire year. No cash dividends were declared but Hornet did declare and distribute a 10% stock dividend on common shares on July 1. Compute basic earnings per share. (Round your answer to the nearest cent.) A) $4.82 B) $4.45 C) $4.50 D) $4.09 Answer: D Explanation: Stock dividends are applied retroactively to the beginning of the year, so the number of shares outstanding is 150,000 × 110% = 165,000 When calculating EPS, net income is reduced by preferred dividends paid or in arrears. [$735,000 - (10,000 shares × 6% × $100 par)]/165,000 = $4.09. Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

22) Greenwell Coffee Company began operations on the first day of the year. On that day they issued 10,000 shares. On March 1 they issued 21,000 shares and on July 1, another 20,000 shares. On December 1, Greenwell repurchased 5,000 shares of outstanding shares. Compute the weighted-average shares of stock for the first year of operation. (Round your final answer to the nearest whole number.) A) 46,000 B) 37,917 C) 37,083 D) 37,500 Answer: C Explanation: Weighted average number of shares = (10,000 × 12/12) + (21,000 × 10/12) + (5,000 × 1/12) = 37,083 shares Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

23) Interurban Company began operations on the first day of the year. On that day they issued 10,000 shares. On March 1 they issued 100,000 shares and on July 1, another 20,000 shares. On December 1, Interurban repurchased 6,000 shares of outstanding shares. Compute basic EPS for the first year of operation if net income was $110,000. (Round number of shares to the nearest whole number, and your final answer to the nearest cent.) A) $11.00 B) $1.07 C) $1.18 D) $2.34 Answer: B Explanation: Weighted average number of shares = (10,000 × 12/12) + (100,000 × 10/12) + (6,000 × 1/12) = 23,000 shares EPS = $110,000/102,833 = $1.07 Diff: 3 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

24) Robertson Corporation reported net income for Year 1 of $220,000 and Year 2 of $400,000. The weighted-average common shares outstanding 270,000 in Year 1 and 120,000 in Year 2. Robertson also has 10,000 shares of $100 par value, cumulative, 5% preferred stock outstanding in both years. Dividends were not declared in Year 1, but both years' dividends were declared and paid in Year 2. Compute EPS for both years. (Round your answers to the nearest cent.) A) Year 1, $0.63; Year 2, $0.63 B) Year 1, $0.63; Year 2, $2.92 C) Year 1, $0.63; Year 2, $3.33 D) Year 1, $0.81; Year 2, $3.33 Answer: B Explanation: For each year, preferred dividends are 10,000 shares × $100 par value × 5% = $50,000. When calculating EPS, preferred dividends are subtracted from net income when paid or in arrears, so net income for each year is reduced by this amount. Year 1 EPS: ($220,000 - $50,000)/270,000 = $0.63 Year 2 EPS: ($400,000 - $50,000)/120,000 = $2.92 Diff: 3 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

25) Why does the numerator of the basic EPS formula subtract the amount of preferred dividends for some preferred shares and not for others? Answer: A more proper definition of EPS is earnings per common share. Preferred dividends for cumulative preferred shares will never be payable to common shareholders so they are always deducted from net income. Preferred dividends for noncumulative preferred shares are deducted only when declared, because if not declared, the preferred shareholders lose their right to receive dividends for that year. Preferred dividends for cumulative preferred stock are deducted whether they are paid or not because they must be paid at some point. Diff: 1 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) Describe how managers can manipulate EPS to increase their compensation and give at least three examples. Answer: Managers have incentives to meet analysts ' projected earnings to avoid decreases in the market value of their company's stock. They can also be motivated to increase their bonus and compensation plans when either are based on income or stock prices. By using a variety of schemes, managers can manipulate net earnings. Examples include: 1) measurement adjustments for revenue recognition, accrued expenses, inventory methods, impairments, valuation allowances, compensation, pension expenses, provisions for income taxes, and contingent liabilities and 2) changes in depreciation, amortization and depletion methods, and classification of investments. Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

27) Jenks Corp. began the year with 200,000 shares of common stock and 30,000 shares of 7%, $100 par value, cumulative, nonconvertible preferred stock. On March 1 it declared a 5% stock dividend on common shares. On June 30, it purchased 10,000 shares of treasury stock. On October 1, Jenks declared a 2 for 1 stock split. Net income for the year was $650,000. Compute weighted average shares of common stock for the year and basic EPS. Instructions: Write the EPS formula. Show all computations used in your solution. Answer: EPS =

EPS =

EPS = EPS = $1.07 Weighted-Average Shares Outstanding: Weighted Number of Number of Shares Months Date Event Outstanding Outstanding January 1 Beginning Balance 200,000 12/12 Retroactive March 1 5% Stock Dividend × 1.05 application Subtotal after Stock Dividend 210,000 June 30 Purchased 10,000 Treasury Shares (10,000) 6/12 Subtotal after Purchase 200,000 October 1 2-1 Stock Split ×2 December 31 Balance 400,000 Diff: 3 Objective: 20.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

Weighted Avg. Shares Outstanding 200,000 × 1.05 210,000 (5,000) 205,000 ×2 410,000

28) Sumner Industries began the year with 140,000 shares of common stock and 10,000 shares of 6%, $100 par value, cumulative, nonconvertible preferred stock. On April 1 it declared a 10% stock dividend on common shares. On June 1, it purchased 15,000 shares of treasury stock. On December 1, Sumner declared a 2 for 1 stock split. Net income for the year was $570,000. Compute weighted average shares of common stock for the year and basic EPS. Instructions: Write the EPS formula. Show all computations used in your solution. Answer: EPS =

EPS =

EPS = EPS = $1.76 Weighted-Average Shares Outstanding: Weighted Number of Number of Shares Months Date Event Outstanding Outstanding January 1 Beginning Balance 140,000 12/12 Retroactive April 1 10% Stock Dividend × 1.10 application Subtotal after Stock Dividend 154,000 June 1 Purchased 15,000 Treasury Shares (15,000) 7/12 Subtotal after Purchase 139,000 December 1 2-1 Stock Split ×2 December 31 Balance 278,000 Diff: 3 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

Weighted Avg. Shares Outstanding 140,000 × 1.10 154,000 (8,750) 145,250 ×2 290,500

29) Interurban Company began operations on the first day of the year. On that day they issued 90,000 shares. On March 1 they issued 60,000 shares and on July 1, another 20,000 shares. On December 1, Interurban repurchased 6,000 shares of outstanding shares. Compute basic EPS for the first year of operation if net income was $100,000. (Round number of shares to the nearest whole number, and your final answer to the nearest cent.) Answer: Weighted average number of shares = (90,000 × 12/12) + (60,000 × 10/12) + (20,000 × 6/12) - (6,000 × 1/12) = 149,500 shares EPS = $100,000/149,500 = $0.67 Diff: 3 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

30) Robertson Corporation reported net income for Year 1 of $200,000 and Year 2 of $400,000. The weighted-average common shares outstanding 330,000 in Year 1 and 120,000 in Year 2. Robertson also has 10,000 shares of $100 par value, cumulative, 5% preferred stock outstanding in both years. Dividends were not declared in Year 1, but both years' dividends were declared and paid in Year 2. Compute EPS for both years. (Round your answers to the nearest cent.) Answer: For each year, preferred dividends are 10,000 shares × $100 par value × 5% = $50,000. When calculating EPS, preferred dividends are subtracted from net income when paid or required to be paid, so net income for each year is reduced by this amount. Year 1 EPS: ($200,000 - $50,000)/330,000 = $0.45 Year 2 EPS: ($400,000 - $50,000)/120,000 = $2.92 Diff: 3 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

31) Harrison Motors reported $600,000 net income for the current year. Beginning common shares outstanding were 120,000. Harrison also had 10,000, 6% nonconvertible, cumulative, $100 par value preferred shares outstanding for the entire year. No cash dividends were declared but Harrison did declare and distribute a 10% stock dividend on common shares on July 1. Compute basic earnings per share. (Round your answer to the nearest cent.) Answer: $4.09 per share. Explanation: Stock dividends are applied retroactively to the beginning of the year, so the number of shares outstanding is 120,000 × 110% = 132,000 When calculating EPS, net income is reduced by preferred dividends paid or in arrears. [[$600,000 - (10,000 shares × 6% × $100 par)]/132,000 = $4.09. Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

32) Greenwell Coffee Company began operations on the first day of the year. On that day they issued 120,000 shares. On March 1 they issued 25,000 shares and on July 1, another 30,000 shares. On December 1, Greenwell repurchased 6,000 shares of outstanding shares. Compute the weighted-average shares of stock for the first year of operation. (Round your final answer to the nearest whole number.) Answer: 155,333 shares Explanation: Weighted average number of shares = (120,000 × 12/12) + (25,000 × 10/12) + (30,000 × 6/12) (6,000 × 1/12) = 155,333 shares Diff: 2 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

20.2

Diluted Earnings per Share

1) A simple capital structure contains no potentially dilutive securities. Answer: TRUE Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) A complex capital would include only convertible debt and convertible preferred stock. Answer: FALSE Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When applying the if-converted assumption, the company assumes conversion at the beginning of the year for a convertible bond or convertible preferred stock outstanding at the beginning of the year. Answer: TRUE Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) When applying the if-converted assumption, the company assumes conversion at the beginning of the year when a convertible bond or convertible preferred stock is issued during the year. Answer: FALSE Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Convertible securities in a capital structure may require the adjustment of both the numerator and denominator of the basic EPS formula. Answer: TRUE Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

6) Basic EPS must be computed before diluted earnings per share can be properly computed. Answer: TRUE Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

7) When computing diluted EPS, convertible preferred stock issued during the year are treated as if they were issued on the first day of the year. Answer: FALSE Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

8) If convertible debt is issued during the year, the total interest expense for the entire year must be added to the numerator of the diluted EPS calculation. Answer: FALSE Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Stock options and stock warrants affect only the denominator of the diluted EPS calculation. Answer: TRUE Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Stock options and warrants differ from convertible debt and convertible preferred stock in that they generally provide cash to the issuing entity. Answer: TRUE Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) U.S. GAAP assumes that all potential dilutive shares in diluted earnings per share computations use the treasury stock method. Answer: FALSE Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Which one of the following does not require the computation of diluted earnings per share? A) convertible bonds B) stock warrants C) preferred stock D) stock options Answer: C Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

13) When applying the if-converted assumption for potentially dilutive securities, conversions are assumed to occur at the ________. A) end of the prior year for hypothetical conversions B) beginning of the year for hypothetical conversions C) middle of the current year for actual conversions D) beginning of the current year or on the issue date of the dilutive security if issued during the current year Answer: D Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

14) A company with convertible bonds outstanding will assume hypothetical conversion at the earliest point of the year to compute diluted EPS. The numerator is ________. A) increased by the interest paid on the bonds during the fiscal year B) increased by the after-tax interest expense on the bonds for the fiscal year C) decreased by the interest paid on the bonds during the fiscal year D) decreased by the after-tax interest paid on the bonds during the fiscal year Answer: B Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

15) A company with convertible bonds outstanding will need to adjust the denominator of the diluted EPS equation. If the bonds are outstanding all year, the adjustment will consist of the ________. A) number of bonds in the the debt issue B) conversion ratio times the number of bonds outstanding net of taxes C) conversion ratio times the number of bonds outstanding D) number of bonds issued during the current year Answer: C Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

16) Gray Corporation reported $400,000 in interest expense for the current year for bonds that were issued in prior years. Gray's tax rate is 30%. By what amount is the numerator of diluted EPS positively adjusted? A) $0 B) $120,000 C) $280,000 D) $400,000 Answer: C Explanation: After-tax interest savings on bond conversion is interest expense reduced by taxes on this amount: $400,000 – (30% × $400,000) = $280,000. Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

17) Terrell Foods reported $770,000 in net income and its weighted average shares outstanding for the year is 100,000 shares. In prior years it sold $1,000,000 of 8% long-term convertible bonds at par which are still outstanding. The bonds are convertible into 20,000 shares of common stock. The tax rate for all years is 40%. If Terrell has no other potentially dilutive securities and no preferred stock, and no conversions occur during the year, what are basic and diluted EPS? (Round your final answers to the nearest cent.) A) basic EPS $7.70; diluted EPS $6.82 B) basic EPS $6.42; diluted EPS $6.82 C) basic EPS $7.70; diluted EPS $8.18 D) basic EPS $6.42; diluted EPS $8.18 Answer: A Explanation: Basic EPS = $770,000/100,000 = $7.70 After-tax interest savings on bond conversion is interest expense reduced by taxes on this amount. Bond interest expense is $1,000,000 × 8% = $80,000. After-tax interest expense = $80,000 – ($80,000 × 40%) = $48,000. Bonds potentially convert into 20,000 shares of common stock, so total shares is 120,000. Diluted EPS = ($770,000 + $48,000)/120,000 = $6.82. Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

18) Terrell Foods reported $780,000 in net income (not considering interest expense) and its weightedaverage shares outstanding for the year is 100,000 shares. In prior years it sold $1,500,000 of 8% long-term convertible bonds at par which are still outstanding at the start of the year. The bonds are convertible into 50,000 shares of common stock. The tax rate for all years is 40%. Bondholders convert the bonds on July 1 of the current year. If Terrell has no other potentially dilutive securities and no preferred stock, what is the numerator for basic and diluted EPS? (Round your final answers to the nearest cent.) A) basic $744,000.00; diluted $780,000.00 B) basic $780,000.00; diluted $744,000.00 C) basic $816,000.00; diluted $816,000.00 D) basic $744,000.00; diluted $816,000.00 Answer: A Explanation: Basic EPS: Net income is decreased by after-tax interest for 6/12 year. Interest = $1,500,000 × 8% × 6/12 = $60,000. Tax savings = 40% × $60,000 = $24,000. After-tax interest expense = $60,000 - $24,000 = $36,000. Net income for basic = $780,000 - $36,000 = $744,000.00. Diluted EPS: If-converted assumption assumes that all were converted at the beginning of the year, so there is no interest expense and net income is $780,000. Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

19) Terrell Foods reported $950,000 in net income (not considering interest expense) and its weightedaverage shares outstanding for the year is 200,000 shares. In prior years it sold $1,000,000 of 8% long-term convertible bonds at par which are still outstanding at the start of the year. The bonds are convertible into 50,000 shares of common stock. The tax rate for all years is 40%. Bondholders convert the bonds on July 1 of the current year. If Terrell has no other potentially dilutive securities and no preferred stock, what is the denominator for basic and diluted EPS? A) basic 225,000; diluted 250,000 B) basic 200,000; diluted 250,000 C) basic 250,000; diluted 250,000 D) basic 200,000; diluted 225,000 Answer: A Explanation: Basic EPS: Denominator is weighted-average number of shares outstanding = (200,000 × 12/12 months) + (50,000 × 6/12 months) = 225,000. Diluted EPS: Denominator assumes that all shares are converted at the beginning of the year, so weighted-average number of shares is 200,000 + 50,000 converted = 250,000 Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

20) Terrell Foods reported $800,000 in net income (not considering interest expense) and its weightedaverage shares outstanding for the year is 100,000 shares. In prior years it sold $1,000,000 of 8% long-term convertible bonds at par which are still outstanding at the start of the year. The bonds are convertible into 10,000 shares of common stock. The tax rate for all years is 40%. Bondholders convert the bonds on July 1 of the current year. If Terrell has no other potentially dilutive securities and no preferred stock, what are basic and diluted EPS? (Round your final answers to the nearest cent.) A) basic EPS $7.39 diluted EPS $7.27 B) basic EPS $7.05 diluted EPS $7.39 C) basic EPS $7.27 diluted EPS $7.05 D) basic EPS $7.05 diluted EPS $7.05 Answer: A Explanation: Basic EPS: Net income is decreased by after-tax interest for 6/12 year. Interest = 1,000,000 × 8% × 6/12 = $40,000. Tax savings = 40% × $40,000 = $16,000. After-tax interest expense = $40,000 - $16,000 = $24,000. Net income for basic = $800,000 - $24,000 = $776,000.00 Denominator is weighted-average number of shares outstanding = (100,000 × 12/12 months) + (10,000 × 6/12 months) = 105,000.00. Basic EPS = $776,000.00/105,000.00 = $7.39 Diluted EPS: If-converted assumption assumes that all were converted at the beginning of the year, so there is no interest expense and net income is $800,000. Denominator assumes that all shares are converted at the beginning of the year, so weighted-average number of shares is 100,000 + 10,000 converted = 110,000.00. Diluted EPS = $800,000/110,000.00. = $7.27 Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

21) Pennock Inc. has convertible preferred stock outstanding. To compute the diluted EPS, it must adjust ________. A) only the numerator B) only the denominator C) both the numerator and denominator D) neither the numerator nor the denominator Answer: C Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

22) Austin Products reported $320,000 net income for the year with 100,000 common shares outstanding all year. Austin also had 10,000 shares of $100, 8% convertible preferred shares outstanding all year. Each preferred share is convertible into 10 shares of common stock. Determine the numerator for both basic and diluted EPS. A) basic EPS $320,000 - (10,000 × $100 × 8%); diluted EPS $320,000 - (10,000 × $100 × 8%) B) basic EPS $320,000 - (10,000 × $100 × 8%); diluted EPS $320,000 C) basic EPS $320,000 - (10,000 × $100 × 8%); diluted EPS $320,000 + (10,000 × $100 × 8%) D) basic EPS $320,000; diluted EPS $320,000 Answer: B Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

23) Austin Products reported $300,000 net income for the year with 100,000 common shares outstanding all year. Austin also had 27,000 shares of $100, 8% convertible preferred shares outstanding all year. Each preferred share is convertible into 10 shares of common stock. Determine the numerator for both basic and diluted EPS. A) basic EPS $216,000; diluted EPS $84,000 B) basic EPS $84,000; diluted EPS $300,000 C) basic EPS $84,000; diluted EPS $384,000 D) basic EPS $300,000; diluted EPS $300,000 Answer: B Explanation: Basic EPS: $300,000 - (27,000 × $100 × 8%) = $84,000 Diff: 3 Objective: 20.1 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

24) Austin Products reported $340,000 net income for the year with 100,000 common shares outstanding all year. Austin issued 60,000 shares of $100, 8% convertible preferred shares on March 1. Each preferred share is convertible into 10 shares of common stock. Determine the numerator for both basic and diluted EPS. A) basic EPS $340,000 - [(60,000 × $100 × 8%) (2/12)]; diluted EPS $340,000 B) basic EPS $340,000 - [(60,000 × $100 × 8%) (2/12)]; diluted EPS $340,000 - (60,000 × $100 × 8%) C) basic EPS $340,000; diluted EPS $340,000 D) basic EPS $340,000 - [(60,000 × $100 × 8%) (10/12)]; diluted EPS $340,000 Answer: D Diff: 3 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

25) Austin Products reported $390,000 net income for the year with 100,000 common shares outstanding all year. Austin issued 23,000 shares of $100, 8% convertible preferred shares on March 1. Each preferred share is convertible into 10 shares of common stock. Determine the numerator for both basic and diluted EPS. (Do not round any intermediate calculations. Round your final answers to the nearest dollar.) A) basic EPS $359,333; diluted EPS $236,667 B) basic EPS $359,333; diluted EPS $206,000 C) basic EPS $390,000; diluted EPS $390,000 D) basic EPS $236,667; diluted EPS $390,000 Answer: D Explanation: Basic EPS $390,000 – dividends to preferred [10/12 × (23,000 × $100 × 8%)] = $236,667 Diluted EPS assumes conversion happens at the date of issue on March 1 and no preferred dividends are owed, so diluted EPS is $390,000. Diff: 3 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

26) Baker Instruments reported $7,000,000 in net income for the current year. The company had $200,000 of 10% cumulative, non-convertible preferred stock outstanding all year, and issued $2,000,000 of 6% convertible bonds on June 1. Determine the numerator for both basic and diluted EPS when the tax rate is 40%. A) basic EPS $7,000,000 - $20,000; diluted EPS $7,000,000 - $20,000 + ($120,000 × 5/12)(1 - .40) B) basic EPS $7,000,000 - $20,000; diluted EPS $7,000,000 - $20,000 + ($120,000 × 7/12)(1 - .40) C) basic EPS $7,000,000 - $20,000 (7/12); diluted EPS $7,000,000 - $20,000 (7/12) + ($120,000 × 7/12) (1 - .40) D) basic EPS $7,000,000 - $20,000 (5/12); diluted EPS $7,000,000 - $20,000 (5/12) + ($120,000 × 5/12) (1 - .40) Answer: B Explanation: Preferred Dividend $200,000 × 10% = $20,000; Convertible Bonds Interest Expense $2,000,000 × 6% = $120,000; after-tax interest expense = $120,000 × 60% × 7/12. Diff: 3 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

27) Smith Instruments reported $6,000,000 in net income for the current year. The company had $500,000 of 10% cumulative, non-convertible preferred stock outstanding all year, and issued $5,000,000 of 6% convertible bonds on June 1. Each $1,000 bond is convertible into 10 shares of common stock. 300,000 common shares were outstanding all year. Determine the denominator for both basic and diluted EPS when the tax rate is 40%. A) basic EPS 300,000; diluted EPS 300,000 + (5,000 × 10) (5/12) B) basic EPS 300,000 (7/12); diluted EPS 300,000 + (5,000 × 10) (7/12) C) basic EPS 300,000; diluted EPS 300,000 + (5,000 × 10) (7/12) D) basic EPS 300,000 (5/12); diluted EPS [300,000 + (5,000 × 10)] (5/12) Answer: C Diff: 3 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

28) Stock options and warrants affect the diluted EPS calculation by changing the ________. A) numerator only B) denominator only C) both the numerator and denominator D) neither the numerator and denominator Answer: B Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

29) Harvey Inc. reported net earnings of $200,000 for the year. Harvey has 200,000 shares of common stock outstanding all year. Two years ago the company granted 20,000 stock options that allow employees to purchase 20,000 shares for $15 each. The company stock has averaged $20 in the market during the year. Compute the basic and diluted EPS. A) basic EPS $1.00; diluted EPS $0.98 B) basic EPS $1.00; diluted EPS $1.00 C) basic EPS $0.98; diluted EPS $0.98 D) basic EPS $1.00; diluted EPS $0.67 Answer: A Explanation: Stock options affect only the denominator. Basic EPS = $200,000/200,000 = $1.00. For diluted EPS, denominator includes weighted-average number of shares outstanding + incremental common shares on exercise of option. Number of shares issued from assumed exercise × exercise price = 20,000 × $15 = $300,000. Dividing this by the market price of $20, we presume that treasury shares from presumed purchase are $300,000/$20 = 15,000 and incremental shares are 20,000 shares from exercise of options less 15,000 treasury shares from assumed purchase = 5,000 shares. Diluted EPS = $200,000/(200,000 + 5,000) = $0.98. Diff: 3 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

30) McManus Inc. reported net earnings of $600,000 for the year. McManus has 200,000 shares of common stock outstanding all year. On March 31, the company granted 40,000 stock options that allow employees to purchase 40,000 shares for $15 each. The company stock has averaged $20 in the market during the year. Compute the basic and diluted EPS. A) basic EPS $3.00; diluted EPS $2.86 B) basic EPS $3.00; diluted EPS $3.00 C) basic EPS $3.00; diluted EPS $2.89 D) basic EPS $2.89; diluted EPS $2.89 Answer: C Explanation: Stock options affect only the denominator. Basic EPS = $600,000/200,000 = $3.00. For diluted EPS, denominator includes weighted-average number of shares outstanding + incremental common shares on exercise of option. Number of shares issued from assumed exercise × exercise price = 40,000 × $15 = $600,000. Dividing this by the market price of $20, we presume that treasury shares from presumed purchase are $600,000/$20 = 30,000 and incremental shares are 40,000 shares from exercise of options less 30,000 treasury shares from assumed purchase = 10,000 shares. The options are outstanding 9/12 of the year, so 10,000 × 9/12 = 7,500. Diluted EPS = $600,000/(200,000 + 7,500) = $2.89. Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

31) The treasury stock method is used when the organizational structure includes ________. A) convertible preferred stock B) convertible bonds C) only stock options D) stock options or warrants Answer: D Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

32) When must a firm use the treasury stock method for earnings per share calculations? Answer: The treasury stock method is used to adjust earnings per share for the dilutive effect of options and warrants. Options and warrants are different from convertible securities because they produce cash for the company when exercised. Convertible securities do not involve cash. The treasury stock method assumes that the hypothetical cash from the proceeds of exercise would be used to repurchase stock in the open market. The computation reduces the new shares by the number of shares the cash proceeds could repurchase. Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

33) Describe which potentially dilutive securities require after-tax adjustments to the numerator or denominator of the EPS formula. Answer: The only potentially dilutive security that may require an after-tax adjustment is for corporate bonds. Bonds payable require interest payments to the bondholders, which are tax deductible expenses to the issuing corporation. If the bonds are assumed converted at the beginning of the year, or the date of issue during the current year, the company would not have any interest expense and would lose its tax deduction. Therefore, the after-tax interest expense is added back to the numerator of the EPS equation. The after-tax consideration does not apply to the denominator. Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

34) How does IFRS differ from GAAP with diluted earnings per share? Answer: GAAP and IFRS are very similar. For convertible bonds, GAAP assumes conversion unless there is evidence to the contrary. IFRS assumes that only shares will be issued to settle the conversion. There could be a lower diluted EPS for IFRS, if the GAAP computation assumes a cash settlement instead of conversion. Diff: 1 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

35) Terrell Foods reported $950,000 in net income and its weighted average shares outstanding for the year is 200,000 shares. In prior years it sold $1,000,000 of 8% long-term convertible bonds at par which are still outstanding. The bonds are convertible into 20,000 shares of common stock. The tax rate for all years is 40%. If Terrell has no other potentially dilutive securities and no preferred stock, and no conversions occur during the year, what are basic and diluted EPS? (Round your final answers to the nearest cent.) Answer: Basic EPS = $950,000/200,000 = $4.75 After-tax interest savings on bond conversion is interest expense reduced by taxes on this amount. Bond interest expense is $1,000,000 × 8% = $80,000. After-tax interest expense = $80,000 – ($80,000 × 40%) = $48,000. Bonds potentially convert into 20,000 shares of common stock, so total shares are 220,000. Diluted EPS = ($950,000 + $48,000)/220,000 = $4.54. Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

36) Lewis, Inc. began the year with 300,000 shares of common stock and 25,000 shares of 6%, $100 par value, cumulative, convertible preferred stock. Each share of preferred stock is convertible into 2 shares of common stock. On June 30, it purchased 10,000 shares of treasury stock. On November 1, Lewis declared a 2 for 1 stock split. Net income for the year was $850,000. Compute weighted average shares of common stock for the year, basic EPS, and diluted EPS. Answer: Basic EPS =

Basic EPS =

Basic EPS = Basic EPS = $1.19 Diluted EPS = Diluted EPS = $1.33* *Note: $1.33 is greater than $1.19 (Basic EPS), so convertible preferred stock is antidilutive and should not be converted. Diluted EPS = Basic EPS = $1.19. Final answer: Basic EPS = $1.19 Diluted EPS = $1.19 Weighted-Average Shares Outstanding:

Date January 1 June 30

Number of Shares Event Outstanding Beginning Balance 300,000 Purchased 10,000 Treasury Shares (10,000) Subtotal after Purchase 290,000

November 1 2-1 Stock Split December 31 Balance Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

×2 580,000

Weighted Number of Months Outstanding 12/12 6/12 Retroactive Application

Weighted Avg. Shares Outstanding 300,000 (5,000) 295,000 ×2 590,000

37) Kansas Instruments reported $7,000,000 in net income for the current year. The company had $7,000,000 of 9% cumulative, non-convertible preferred stock outstanding all year, and issued $5,000,000 of 7% convertible bonds on May 1. Each $1,000 bond is convertible into 40 shares of common stock. Common shares outstanding all year were 2,000,000. Compute both basic and diluted EPS when the tax rate is 40%. Answer: Basic EPS =

Basic EPS =

Basic EPS = Basic EPS = $3.19 Diluted EPS =

Diluted EPS = Diluted EPS = $3.05

Diff: 2 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

38) Medical Instruments reported $7,000,000 in net income for the current year. The company had $6,000,000 of 8% cumulative, non-convertible preferred stock outstanding all year, and issued $10,000,000 of 7% convertible bonds on July 1. Each $1,000 bond is convertible into 30 shares of common stock. Common shares outstanding at the beginning of the year was 1,000,000, but on December 15, the company declared a 2 for 1 stock split. Compute both basic and diluted EPS when the tax rate is 40%. Answer: Basic EPS =

Basic EPS =

Basic EPS = Basic EPS = $3.26 Diluted EPS =

Diluted EPS = Diluted EPS = $3.13

Diff: 3 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

39) Ozarka Products reported $9,500,000 in net income for the current year. The company had $5,000,000 of 7% cumulative, preferred stock outstanding all year, along with, $10,000,000 of 6% bonds. Each $1,000 bond had 4 detachable stock warrants and each warrant allowed the warrant holders to buy a share of stock for $60. The average share price for the year was $80. Common shares outstanding at the beginning of the year was 4,000,000, but on June 15, the company declared a 10% stock dividend. Compute both basic and diluted EPS when the tax rate is 40%. Answer: Basic EPS =

Basic EPS =

Basic EPS = Basic EPS = $2.08 For diluted EPS, we use the treasury stock method and assume that if the warrants were exercised, cash was used to repurchase the shares at the average share price. Diluted EPS =

Diluted EPS = Diluted EPS = $2.07

Diff: 3 Objective: 20.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

20.3

Antidilutive Securities

1) Antidilutive securities are excluded from the diluted EPS equation. Answer: TRUE Diff: 1 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) A security is antidilutive if decreases the diluted EPS below basic EPS. Answer: FALSE Diff: 1 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) When options and warrants are in the money, they will be dilutive. Answer: TRUE Diff: 2 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

4) The order for antidilutive sequencing is ranking the least dilutive security first, ascending to the most dilutive security last. Answer: FALSE Diff: 2 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

5) Potentially dilutive securities should not be included in dilutive EPS computations when net income from continuing operations is negative. Answer: TRUE Diff: 1 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Normally dilutive securities will become antidilutive if income from continuing operations is a net loss. Answer: TRUE Diff: 1 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) When a potentially dilutive security is present, a company must test the security to see if it is dilutive or antidilutive. Antidilutive securities occur when diluted EPS is ________. A) greater than basic EPS B) less than basic EPS C) equal to basic EPS D) less than or equal to basic EPS Answer: A Diff: 1 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) When computing diluted EPS, both the numerator and denominator are affected by ________. A) stock options B) stock warrants C) preferred stock D) convertible bonds Answer: D Diff: 2 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) When computing diluted EPS, only the denominator is affected by ________. A) warrants and options B) convertible preferred stock C) preferred stock D) convertible bonds Answer: A Diff: 1 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) When a company has a net loss from continuing operations, it should include ________. A) all potentially dilutive securities in diluted EPS B) no potentially dilutive securities in diluted EPS C) only in the money warrants and options in diluted EPS D) only convertible issues in diluted EPS Answer: B Diff: 2 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) When there are multiple dilutive securities in a firm, the antidilution test for the sequence should be from ________. A) most dilutive to least dilutive B) least dilutive to most dilutive C) convertibles first and warrants last D) convertibles debt first and options last Answer: A Diff: 3 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Ace Corporation has 10,000 shares of $100, 6%, convertible preferred shares outstanding for the whole year. Each preferred share is convertible into 4 shares of common stock. What is the incremental income per common share from the preferred stock? A) $25.00 B) $1.00 C) $1.50 D) $6.00 Answer: C Explanation: (10,000 shares × $100 par × 6%)/(10,000 shares × 4 shares common for each share of preferred) Diff: 3 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Executrain has 50,000, 6%, bonds outstanding for the second half of the year. Each $1,000 bond, sold July 1 at par, is convertible into 2 shares of common stock. The corporate tax rate is 40%. What is the incremental income per common share from the convertible bonds? A) $30.00 B) $9.00 C) $1.20 D) $18.00 Answer: B Explanation: (50,000 bonds × $1,000 par × 6%)(1 - 40%)(6/12)/(50,000 bonds × 2 shares common for each bond × 6/12) Diff: 3 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Realty1 has 40,000 outstanding stock options. Its net income for the year is $250,000. Each option allows the holder to purchase a share of stock for $13. The average market value of the shares for the year was $16. What is the incremental income per common from the options? A) $0.00 B) $1.00 C) $3.00 D) $13.00 Answer: A Explanation: There is no incremental income from stock options. Diff: 1 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) Edwards Corporation has three potentially dilutive securities. Computation of the antidilution sequencing recorded the following: Security Convertible Preferred Stock Stock Warrants Convertible Bonds

Increase in Income $30,000 $0 $20,000

Increase in Common Shares 18,000 9,000 2,000

What is the correct order of entry into the EPS computation? (Round any calculations to the nearest cent.) A) convertible preferred stock, stock warrants, convertible bonds B) stock warrants, convertible preferred stock, convertible bonds C) convertible bonds, convertible preferred stock, stock warrants D) stock warrants, convertible bonds, convertible preferred stock Answer: B Explanation: Determination of Earnings per Incremental Share Increase in the Rank: Order of Potentially Number of Earnings per Entry into the Dilutive Increase in Common Incremental EPS Security Income Shares Share Computation Warrants $-09,000 $-01st Convertible preferred stock Convertible bonds

$30,000

18,000

$1.67

2nd

$20,000

2,000

$10.00

3rd

Diff: 2 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) Carrolton, Inc. has four potentially dilutive securities. Computation of the antidilution sequencing recorded the following: Security Convertible Preferred Stock Stock Warrants Stock Options Convertible Bonds

Increase in Income $34,000 $0 $0 $18,000

Increase in Common Shares 8,000 9,000 (7,000) 9,000

What is the correct order of entry into the EPS computation? (Round any calculations to the nearest cent.) A) convertible preferred stock, stock warrants, convertible bonds B) stock warrants, convertible preferred stock, convertible bonds C) convertible bonds, convertible preferred stock, stock warrants D) stock warrants, convertible bonds, convertible preferred stock Answer: D Explanation: Determination of Earnings per Incremental Share Increase in the Rank: Order of Potentially Number of Earnings per Entry into the Dilutive Increase in Common Incremental EPS Security Income Shares Share Computation Warrants $-09,000 $-01st Convertible bonds Convertible preferred stock

$18,000

9,000

$2.00

2nd

$34,000

8,000

$4.25

3rd

Diff: 3 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) Smythe, Inc. has four potentially dilutive securities. Computation of the antidilution sequencing recorded the following: Security Convertible Preferred Stock Stock Warrants Stock Options Convertible Bonds

Increase in Income $40,000 $0 $0 $15,000

Increase in Common Shares 12,000 4,000 12,000 5,000

What is the correct order of entry into the EPS computation? (Round any calculations to the nearest cent.) A) convertible preferred stock, stock warrants, convertible bonds, stock options B) stock options, stock warrants, convertible bonds, convertible preferred stock C) convertible bonds, convertible preferred stock, stock warrants D) stock options, convertible bonds, convertible preferred stock, stock warrants Answer: B Explanation: Determination of Earnings per Incremental Share Increase in the Rank: Order of Potentially Number of Earnings per Entry into the Dilutive Increase in Common Incremental EPS Security Income Shares Share Computation Options $-012,000 $-01st Warrants Convertible bond Convertible preferred stock

$-0-

4,000

$-0-

2nd

$15,000

5,000

$3.00

3rd

$40,000

12,000

$3.33

4th

Diff: 3 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Colselo has 200,000 common shares outstanding for the year and net income of $400,000. It has issued options to acquire 10,000 shares of common stock and has 20,000 shares of $100, 6% cumulative nonconvertible preferred stock, both of which were outstanding for the entire year. The exercise price for the options is $20 per share and the average market price during the year is $15 per share. Compute basic and diluted EPS. A) basic EPS $2.00; diluted EPS $1.90 B) basic EPS $2.00; diluted EPS $1.33 C) basic EPS $1.40; diluted EPS $1.40 D) basic EPS $1.40; diluted EPS $1.90 Answer: C Explanation: Basic EPS = (net income - dividends to preferred)/common shares outstanding = [$400,000 (20,000 × $100 par × 6%)]/200,000 shares = $1.40. Diluted EPS = (net income - dividends to preferred)/(common shares outstanding + shares from options if exercised) = [$400,000 - (20,000 × $100 par × 6%)]/(200,000 shares) = $1.40. Diff: 2 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) When is a potentially dilutive security dilutive? Answer: A potentially dilutive security is dilutive when adding it to the basic EPS calculation reduces the earnings per share amount. (Options and warrants are always dilutive if they are in the money.) Diff: 1 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) When is a potentially dilutive security antidilutive? Answer: A potentially dilutive security is antidilutive when adding it to the basic EPS calculation increases the earnings per share amount above the basic EPS. (Warrants and options are always antidilutive if they are out of the money.) Diff: 1 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) What is the protocol to determine if multiple potentially dilutive securities are actually dilutive or antidilutive? Answer: When multiple potentially dilutive securities are present, determine the sequencing order for each of the securities by computing the incremental income per share and then ranking the order of entry for each. The incremental income per share is the increase in income divided by the increase in common shares caused by the security. Order the results from the lowest incremental income per share to the highest as you compute diluted EPS. Diff: 2 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

22) Centurion, Inc. has four potentially dilutive securities. Net income for the year is $900,000 and the weighted average common shares outstanding is 600,000 shares. Computation of the antidilution sequencing recorded the following: Security Convertible Preferred Stock Stock Warrants Stock Options Convertible Bonds

Increase in Income $30,000 $0 $0 $95,000

Increase in Common Shares 12,000 7,000 (8,000) 80,000

Required: Write the basic equation for EPS and compute basic EPS. Determine the order of entry into the EPS computation. Compute final diluted EPS and show all computations to determine your final answer. Answer: Basic EPS =

Basic EPS =

= $1.45

Basic EPS = $1.45

Security Convertible Preferred Stock Stock Warrants Stock Options Convertible Bonds

Increase in Income

Increase in Common Shares

Incremental Income/Share

Rank Order of Entry to EPS

$30,000 $0 $0

12,000 7,000 (8,000)

$2.50 $0.00 $0.00

3rd 1st Antidilutive

$95,000

80,000

$1.19

2nd

Basic EPS =

= $1.45

1st Stock Warrants =

= $1.43 Dilutive

2nd Conv. Bonds =

= $1.40 Dilutive

3rd Conv. Preferred =

= $1.42 Antidilutive

Diluted EPS = $1.40

Diff: 3 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

23) Walker Corporation has three potentially dilutive securities. Net income for the year is $500,000 and the weighted average common shares outstanding is 200,000 shares. Computation of the antidilution sequencing recorded the following: Security Convertible Preferred Stock Stock Warrants Convertible Bonds

Increase in Income $30,000 $0 $15,000

Increase in Common Shares 10,000 5,000 20,000

Basic EPS =

Security Convertible Preferred Stock Stock Warrants Convertible Bonds

= $2.35 Increase in Income

Increase in Common Shares

Incremental Income/Share

Rank Order of Entry to EPS

$30,000 $0

10,000 5,000

$3.00 $0.00

3rd 1st

$15,000

20,000

0.75

2nd

Basic EPS =

= $2.35

1st Stock Warrants =

= $2.29 Dilutive

2nd Conv. Bonds =

= $2.16 Dilutive

3rd Conv. Preferred =

= $2.19 Antidilutive

Diluted EPS = $2.16

Diff: 2 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

24) Freewheelers, Inc. has four potentially dilutive securities. Net income for the year is $5,600,000 and the weighted average common shares outstanding is 1,000,000 shares. Computation of the antidilution sequencing recorded the following: Security Convertible Preferred Stock Stock Warrants Stock Options Convertible Bonds

Increase in Income $50,000 $0 $0 $200,000

Increase in Common Shares 20,000 40,000 10,000 100,000

Basic EPS =

Security Convertible Preferred Stock Stock Warrants Stock Options Convertible Bonds

= $5.55 Increase in Income

Increase in Common Shares

Incremental Income/Share

Rank Order of Entry to EPS

$50,000 $0

20,000 40,000

$2.50 $0.00

4th 1st

10,000

$0.00

2nd

$200,000

100,000

$2.00

3rd

Basic EPS =

1st Stock Warrants

2nd Stock Options =

= $5.55

= $5.34 Dilutive

= $5.29 Dilutive

3rd Conv. Bonds =

3rd Conv. Pref. =

= $5.00 Dilutive

Diluted EPS = $4.96

Diff: 3 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

= $4.96 Dilutive

25) Dynamic Motors, Inc. has two potentially dilutive securities. Loss from continuing operations for the year is $(250,000), income from discontinued operations is $100,000 (net of tax), and the weighted average common shares outstanding is 100,000 shares. Also outstanding during the year are $5,000,000 of 6% bonds convertible into 10,000 shares of common stock. The bonds also have two detachable stock warrants for each bond which allow the bondholder to buy a share of stock for $30. The average market price of Dynamic Motors stock was $28 for the year. The tax rate is 40%. Required: Write the basic equation for EPS and compute basic EPS. Using the order of entry, determine diluted EPS calculations. Show all computations to prepare the appropriate Income Statement presentation of basic and diluted EPS. Answer: Basic EPS = Basic EPS: Loss from Continuing Operations $(250,000) / 100,000 Income from Discontinued Operations $100,000 / 100,000 Net Loss

$(2.50) 1.00 $(1.50)

Diluted EPS with stock warrants: Stock warrants are out of the money and therefore automatically antidilutive. Since we have a loss from continuing operations, the convertible bonds are antidilutive, and should not be considered for diluted EPS. Diluted EPS with convertible bonds: Bonds increase the numerator by [(1 - .40) × ($5,000,000 × 6%)] = $180,000 and increase the denominator by 10,000. Continuing Operations [($250,000) + 180,000] / 110,000 $(.64) Discontinued Operations $100,000 / 100,000 1.00 Net Income $.36 Convertible bonds are antidilutive because they change the net loss into net income. Therefore, the only presentation will be basic EPS as written below: Basic EPS: Net Loss from Continuing Operations ($250,000) / 100,000 Income from Discontinued Operations $100,000 / 10,0000 Net Loss Diff: 3 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

($2.50) 1.00 ($1.50)

26) Anita Corporation has 20,000 shares of $100, 6%, convertible preferred shares outstanding for the whole year. Each preferred share is convertible into 3 shares of common stock. What is the incremental income per common share from the preferred stock? Answer: $2.00 incremental income per common share from the preferred stock. Explanation: (20,000 shares × $100 par × 6%)/(20,000 shares × 3 shares common for each share of preferred) Diff: 3 Objective: 20.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

20.4

Earnings per Share Presentation and Disclosures

1) Standard setters require that firms provide basic EPS in the Notes to Financial Statements for at least ten years. Answer: FALSE Diff: 1 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Companies are required to provide basic EPS on the income statement for each period for which they provide financial information. Answer: TRUE Diff: 1 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) If a company provides basic and diluted EPS on the income statement for each year presented, it has no further information requirements. Answer: FALSE Diff: 1 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) The income statement requires presentation of basic and diluted earnings per share for each year presented, plus additional information to be disclosed in the notes to the financial statements for all years presented. Answer: TRUE Diff: 2 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Footnote disclosures for EPS are concerned only with current and prior years, such that subsequent events after the close of the year are ignored. Answer: FALSE Diff: 2 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Any events that would have a material impact on the denominator of the EPS calculation that occur after the close of the period would require disclosure in the notes to the financial statements. Answer: TRUE Diff: 2 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

7) Accounting standards require which one of the following groups of presentations on the income statement? A) basic and diluted EPS for all periods presented for income from continuing operations, discontinued operations, and net income B) basic and diluted EPS for all periods presented for net income only C) basic EPS for three periods for income from continuing operations and net income only D) basic and diluted EPS for the current period only for income from continuing operations, discontinued operations, and net income Answer: A Diff: 2 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

8) Which one of the following is required in the notes to the financial statements for EPS? A) detailed calculations of weighted average shares outstanding for the period B) a discussion of antidilutive securities that were excluded from the computation of diluted EPS C) all stockholder transactions that occurred after the close of the year D) adjustments to the denominator for preferred dividends Answer: B Diff: 2 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Describe how users utilize the EPS ratios. Answer: Although EPS cannot be used to compare different companies, many investors use the EPS information to help them price the stocks they consider purchasing. EPS is also a good indicator of the progress or problematic issues within a company. Shareholders want profitability in their investments, and EPS helps them to make decisions about their participation. Diff: 1 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) How can managers manipulate EPS? Answer: Analysts frequently forecast a company's EPS. Company management tries its best to meet such forecasts. By manipulating estimates of some asset and expense accounts, it is conceivable to fine tune costs and income to meet the numbers. Officers and managers may have bonuses contingent on achieving forecasted EPS and they can carefully craft a strategy to receive their bonuses. They can also buy back or issue corporate shares to manipulate the denominator. Diff: 2 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) Why should shareholders pay attention to the diluted EPS? Answer: Diluted EPS tells the shareholders that there is a potential for the value of their shares to decline. They should make their investment decisions with the diluted EPS in mind. If the dilution does occur, the market value of their shares will probably decline. Diff: 2 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Hora Corporation has three potentially dilutive securities. Net income for the year is $500,000 and the weighted average common shares outstanding is 200,000 shares. Computation of the antidilution sequencing recorded the following: Security Convertible Preferred Stock Stock Warrants Convertible Bonds

Increase in Income $30,000 $0 $15,000

Increase in Common Shares 10,000 5,000 20,000

Required: Write the basic equation for EPS and compute basic EPS. Determine the order of entry into the diluted EPS computation. Compute diluted EPS and show all computations to determine your final answer. Prepare all required disclosures for the income statement. Answer: Basic EPS =

Basic EPS = Security Convertible Preferred Stock Stock Warrants Convertible Bonds

= $2.35 Increase in Income

Increase in Incremental Common Shares Income/Share

Rank Order of Entry to EPS

$30,000 $0

10,000 5,000

$3.00 $0.00

3rd 1st

$15,000

20,000

$0.75

2nd

Basic EPS =

= $2.35

1st Stock Warrants =

= $2.29 Dilutive

2nd Conv. Bonds =

= $2.16 Dilutive

3rd Conv. Preferred =

= $2.19 Antidilutive

Diluted EPS = $2.16 Income Statement Presentation: Net Income Basic EPS Diluted EPS

$500,000 $2.35 $2.16

Additional Notes to Financial Statements disclosure: Convertible preferred shares were tested and found to be antidilutive. Assumed conversion of the preferred shares increased the numerator by $30,000 and increased the denominator by 10,000 shares. Therefore, they were eliminated from the computation for the diluted EPS. Reconciliation of the numerator and denominator of basic EPS to diluted EPS:

Net Income Less Preferred Dividends

Income $500,000 (30,000)

Basic EPS Income available to common shareholders

$470,000

200,000

Effect of Dilutive Securities Stock Warrants Convertible Bonds

0 $15,000

5,000 20,000

Diluted EPS Income available to common shareholders including the effect of assumed conversions and exercise of warrants

$485,000

225,000

Diff: 3 Objective: 20.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

Per Share Amount

$2.35

$2.16

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 21 Accounting Changes and Error Analysis 21.1

Overview of Accounting Changes

1) There are four types of accounting changes — principles, estimates, entities and errors. Answer: FALSE Diff: 1 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Retrospective changes require restatement of all periods reported in the annual report as if it had been used in those prior years. Answer: TRUE Diff: 1 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Prospective changes require changes be made to the current year and all future years affected. Answer: TRUE Diff: 1 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Accounting principle changes are generally handled retrospectively. Answer: TRUE Diff: 1 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Accounting estimate changes are handled prospectively. Answer: TRUE Diff: 1 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Accounting entity changes are handled prospectively. Answer: FALSE Diff: 1 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Which one of the following changes is not an accounting change? A) principle B) estimate C) error D) entity Answer: C Diff: 1 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) Accounting changes detract from which one of the following enhancing qualitative characteristics of accounting information? A) comparability B) relevance C) representational faithfulness D) materiality Answer: A Diff: 2 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Accounting changes are only permitted when ________. A) the effect is material B) adequate disclosures are made so financial statement users can restore comparability with prior-years financial statements C) the method used is prospective D) the company has not made prior changes Answer: B Diff: 2 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Retrospective changes require all but which of the following? A) restatement of financial statements to reflect the effects of the change for each period presented B) adjustments to assets and liabilities to reflect the cumulative effect of the change on periods prior to those presented C) detailed numerical comparisons of all prior periods to restated statements D) retained earnings restated for the cumulative effect of the change on income for periods prior to those presented Answer: C Diff: 2 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) Explain why comparability and consistency are considerations for accounting changes. Answer: Comparability is an enhancing qualitative characteristic in the accounting conceptual framework and it enhances the usefulness of relevant and faithfully representative accounting information. Consistency refers to using the same accounting methods from year to year. When a company changes methods, comparability becomes difficult because there is not a consistent application of principles. Changes in accounting principles should be infrequent and adequately disclosed so that readers understand the implications of the changes for all years presented. Diff: 2 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) Describe the two methods for reporting accounting changes and how they differ. Answer: The two methods of reporting accounting changes are retrospective and prospective. Retrospective changes require restatement of the financial statements for all prior years affected that are presented in the current annual report. Such changes frequently require adjustments to retained earnings. Prospective changes occur in the current year and will possibly affect future years. Both methods require full disclosure of the nature and the reason for the change and how they affected past or future financial statements. Diff: 2 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Name and describe the three main types of accounting changes. Answer: 1. Changes in accounting principle, which are changes from one generally accepted accounting method to another generally accepted accounting method. 2. Changes in accounting estimate, which involve revisions of estimates used in accounting. 3. Changes in the reporting entity, which occur when a company reports financial statements that are, in effect, financial statements for a different reporting entity. Diff: 2 Objective: 21.1 IFRS/GAAP: GAAP AACSB: Analytical thinking

21.2

Changes in Accounting Principle

1) Changes in accounting principles can be mandatory or voluntary. Answer: TRUE Diff: 1 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) When making a voluntary accounting change, a firm must explain the justification for the change on the basis that it more accurately portrays its financial position and performance. Answer: TRUE Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

3) Mandatory accounting changes require retrospective application of the new accounting standard. Answer: FALSE Diff: 1 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) If a mandatory accounting change requires too much work for a firm to use the retrospective approach, then the firm can choose to use the prospective approach. Answer: FALSE Diff: 1 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

5) Direct effects of changes in an accounting principle are those necessary to implement the change and are applied retrospectively. Answer: TRUE Diff: 1 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Indirect effects of changes in an accounting principle are those that change current or future cash flows and are applied prospectively. Answer: TRUE Diff: 1 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) A firm may choose to apply indirect effects of an accounting principle change either prospectively or retrospectively. Answer: FALSE Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

8) Which one of the following would not be affected by a change in revenue recognition requiring a retrospective change? A) cash B) revenue C) unearned revenue D) deferred taxes Answer: A Diff: 3 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Which one of the following might be affected by a change in revenue recognition requiring a prospective change? A) retained earnings B) management compensation C) unearned revenue D) deferred taxes Answer: B Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) Which one of the following would not be a required disclosure for a change in accounting principle? A) description of the nature of the change B) management's justification for the change C) the estimated effect on future earnings per share D) cumulative effect of the change on retained earnings for the first year presented Answer: C Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) When a firm decides to change an accounting principle, but does not have sufficient information to use the retrospective approach, it may ________. A) estimate the numbers to do so B) declare the change to be impractical C) be forced to abandon the change D) use the prospective approach Answer: D Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) When a company makes a change in an accounting principle, IFRS additionally requires a company to report ________. A) three years of all financial statements B) two years of all financial statements C) two years of balance sheets and two years of income statements D) three years of balance sheets and two years of other financial statements Answer: D Diff: 3 Objective: 21.2 IFRS/GAAP: IFRS AACSB: Application of knowledge

13) Anzelmo Corporation invested in Jones Manufacturing by purchasing a 10% interest in the company. Anzelmo had no significant influence in Jones. Over time, Anzelmo acquired more shares in Jones, and in 2023, Anzelmo's president became a member of the board of directors when its ownership interest reached 30% of Jones. This change is ________. A) an accounting principle change requiring retrospective adjustment B) an accounting principle change requiring prospective adjustment C) a correction of an error D) a change in estimate Answer: A Explanation: When Anzelmo's ownership of Jones increased from 10% to 30%, their level of influence changed from no significant influence to significant influence. As a result, Anzelmo will need to switch to the equity method of accounting for its investment in Jones. (See Chapter 16.) Diff: 3 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Johnston Controls began operation in 2021 using FIFO inventory methods. In 2022, management decided they should have chosen LIFO to more accurately portray financial position and performance. The beginning 2022 inventory using FIFO was $260,000. Under the LIFO method the beginning inventory would have been $270,000. The adjustment to inventory for the accounting principle change for 2021 would be ________. A) $0 B) $5,000 debit C) $10,000 credit D) $10,000 debit Answer: A Explanation: Adjustment to inventory occurs in 2022. Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) Energy, Inc began operations in 2022 using LIFO inventory methods. In 2023, management decided they should have chosen FIFO. The beginning inventory for 2023 using LIFO was $130,000. Under the FIFO method, the beginning inventory would have been $140,000. The adjustment to inventory for the change in accounting principle for 2023 would be ________. A) $0 B) $10,000 debit C) $10,000 credit D) $20,000 debit Answer: B Explanation: Inventory must be increased (debited) by $140,000 - $130,000 = $10,000. Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) Hampton's Construction, Inc. decided to change from the completed-contract method of accounting to the percentage-of-completion method. The following information is available for net income. Ignore income tax effects: Net Income Year Ended Percentage of Completion Completed Contract December 31, 2022 $145,000 $135,000 December 31, 2023 190,000 150,000 December 31, 2024 201,000 180,000 What is the journal entry to record the change in accounting principle on January 1, 2024? A) No entry needed. B) Construction in Progress Deferred Tax Liability

50,000

C) Retained Earnings Construction in Progress

71,000

D) Construction in Progress Retained Earnings

50,000

71,000

50,000

Answer: D Explanation: If the company had been using percentage-of-completion, net income over the prior two years, the construction in progress and retained earnings at the end of the two years would have been higher by ($145,000 + $190,000) – ($135,000 + $150,000) = $50,000. Diff: 3 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) On January 1, 2024, Hampton's Construction, Inc. decided to change from the completed-contract method of accounting to the percentage-of-completion method. Hampton will continue to use the completed-contract method for income tax purposes. The following information is available for net income. The income tax rate for all years is 35%. Net Income Year Ended Percentage of Completion Completed Contract December 31, 2022 $145,000 $125,000 December 31, 2023 179,000 159,000 December 31, 2024 267,000 181,000 What is the journal entry to record the change in accounting principle on January 1, 2024? A) No entry needed. B) Construction in Progress Retained Earnings

40,000

C) Retained Earnings 55,900 Deferred Tax Asset 30,100 Construction in Progress 86,000 D) Construction in Progress 40,000 Deferred Tax Liability 14,000 Retained Earnings 26,000 Answer: D Explanation: If the company had been using percentage-of-completion, net income over the prior two years and construction in progress at the end of the two years would have been higher by ( $145,000 + $179,000) – ($125,000 + $159,000) = $40,000. However, since the company will continue to use completedcontract for income tax purposes, a deferred tax liability for $40,000 × 35% = $14,000 is created. Diff: 3 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) Butler Products decided in 2024 to change inventory methods to more effectively report its results of operations. In the past, management has measured its ending inventories by the average-cost method and they now believe that FIFO is a better representation of its profitability. Year Ended December 31, 2022 December 31, 2023 December 31, 2024

FIFO Inventory $250,000 385,000 240,000

Average-Cost Inventory $195,000 320,000 190,000

Ignoring income tax, which one of the following journal entries correctly records the change in the accounting principle at January 1, 2024? A) No journal entry needed for a prospective application of the change in principle. B) Retained Earnings Inventory

65,000

C) Inventory Retained Earnings

65,000

D) Inventory Retained Earnings

60,000

65,000

60,000

Answer: C Explanation: Inventory under FIFO is greater than average-cost by $385,000 - $320,000 = $65,000. Similarly, cost of goods sold would have been lower by this same amount, resulting in an increase in net income and retained earnings. Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) Butler Products decided to change inventory methods on January 1, 2024 to more effectively report its results of operations. In the past, management has measured its ending inventories by the average-cost method and they now believe that FIFO is a better representation of its financial position and profitability. Butler's tax rate is 35% for all years. FIFO

Year Ended

Inventory

Average-Cost Inventory

December 31, 2022

$256,000

$211,000

December 31, 2023

390,000

315,000

December 31, 2024

240,000

190,000

Which one of the following journal entries correctly records the change in the accounting principle? A) No entry needed. B) Retained Earnings Deferred Tax Asset Inventory C) Inventory Deferred Tax Liability Retained Earnings

48,750 26,250

75,000

26,250 48,750

D) Deferred Tax Asset 48,750 Retained Earnings 26,250 Inventory 75,000 Answer: C Explanation: Inventory under FIFO is greater than average-cost by $390,000 - $315,000 = $75,000. Similarly, cost of goods sold would have been lower by this same amount, resulting in an increase in net income and retained earnings, adjusted by the deferred tax liability of $75,000 × 35% = $26,250. Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

20) Johnston Controls began operations in 2022 using FIFO inventory methods. On January 1, 2023, management decided they should have chosen to use LIFO, as it more accurately reflects income. The beginning 2023 inventory using FIFO was $100,000. Under the LIFO method the beginning inventory would have been $120,000. Required: Prepare the journal entry to record the change in accounting principle and discuss the required disclosures. Answer: Ignoring taxes, the journal entry would debit inventory for $20,000 and credit Retained Earnings for $20,000. This assumes cost data is available for the LIFO method. Standard disclosures include: (1) the description of the nature of the change, (2) justification for the change, (3) the method of applying the change which is retrospective, (4) the effect of the change on income from continuing operations, net income, per share amounts, and any other affected line item, (5) a description of any adjusted prior-period information, and (6) the cumulative effect of the change on retained earnings for the first balance sheet presented. If it is impractical to obtain LIFO data, then beginning 2023 FIFO inventory becomes the beginning LIFO inventory. No journal entry would be prepared to record the change. Standard disclosures are the same for any other accounting principle change except there are no prior period information and no cumulative effect of the change on retained earnings for the first year presented. Management must still provide: (1) the description of the nature of the change, (2) justification for the change, (3) the method of applying the change which is prospective, and (4) the effect of the change on income from continuing operations, net income, per share amounts, and any other affected line item. Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

21) Fields Construction decides to change from the completed-contract method to the percentage-ofcompletion method of recording construction projects. It also has a compensation plan for bonuses to supervisors for three percent of net income, which are retroactive for changes in prior years' net income. Discuss the direct and indirect effects of this change. Answer: The change from completed-contract to percentage-of-completion method has a direct effect and requires retroactive application to restate prior years. It has an effect on retained earnings, construction-in-progress, and deferred tax liabilities. The change in prior years' income triggers an indirect effect in bonuses due to supervisors that are handled prospectively. Upon completion of the change in method, a current journal entry should be created to recognize the additional bonuses as an expense and current liability. Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

22) For each of the following situations, determine the accounting method that should be employed. Type of Accounting Changes Change in Principle Change in Estimate Change in Entities Change in Accounting Estimate effected by a Change in Accounting Principle Answer: Type of Accounting Changes Change in Principle Change in Estimate Change in Entities Change in Accounting Estimate effected by a Change in Accounting Principle

Accounting Methods

Accounting Methods Retrospective Prospective Retrospective Prospective

Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

23) Complete the following table by selecting the appropriate type of change and the accounting method appropriate for each event. Event Change from LIFO to FIFO. Change in the warranty expense provision. Change from completedcontract to percentage-ofcompletion method. Purchase of a new subsidiary with 60% ownership that is five years old. Change from reporting inventory from the aggregate method to the individual item method. Change in the life and salvage value of a depreciable asset. Change from straight-line to declining balance depreciation.

Type of Change

Accounting Method

Answer: Event Type of Change Change from LIFO to FIFO. Principle Change in the warranty expense provision. Estimate Change from completedcontract to percentage-ofcompletion method. Principle Purchase of a new subsidiary with 60% ownership that is five years old. Not an accounting change Change from reporting inventory from the aggregate method to the individual item method. Principle Change in the life and salvage value of a depreciable asset. Change in Estimate Change in estimate effected Change from straight-line to by a change in accounting declining balance depreciation. principle

Accounting Method Retrospective Prospective

Retrospective

Not applicable

Retrospective Prospective

Prospective

Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

24) Energy, Inc began operations in 2022 using LIFO inventory methods. In 2023, management decided they should have chosen FIFO. The beginning inventory for 2023 using LIFO was $128,000. Under the FIFO method, the beginning inventory would have been $158,000. What would be the adjustment to inventory for the change in accounting principle for 2023 (indicate amount and if a debit or credit entry to inventory)? Answer: Inventory must be increased (debited) by $158,000 - $128,000 = $30,000 debit entry to inventory. Diff: 2 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

25) Hampton's Construction, Inc. decided to change from the completed-contract method of accounting to the percentage-of-completion method. The following information is available for net income. Ignore income tax effects: Net Income Year Ended Percentage of Completion Completed Contract December 31, 2022 $170,000 $120,000 December 31, 2023 200,000 151,000 December 31, 2024 211,000 180,000 What is the journal entry to record the change in accounting principle on January 1, 2024? Answer: Construction in Progress $99,000 Retained Earnings $99,000 Explanation: If the company had been using percentage-of-completion, net income over the prior two years, the construction in progress and retained earnings at the end of the two years would have been higher by ($170,000 + $200,000) – ($120,000 + $151,000) = $99,000. Diff: 3 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

26) Bronco Construction, Inc. decided to change from the completed-contract method of accounting to the percentage-of-completion method. The following information is available for net income. Ignore income tax effects: Net Income Year Ended Percentage of Completion Completed Contract December 31, 2022 $145,000 $125,000 December 31, 2023 185,000 154,000 December 31, 2024 201,000 180,000 Required: 1) Prepare the journal entry required to record the accounting change on January 1, 2024. 2) Prepare the footnote disclosure for the change from the completed-contract method to the percentage-of-completion method. Designate the note as "Note A: Change in Method of Accounting for Bronco Construction, Inc." Answer: 1) Journal entry for the year of the change: January 1, 2024 Account Construction in Progress Retained Earnings

Debit $51,000

Credit $51,000

Cumulative effect of the change: $20,000 (2022) + $31,000 (2023) = $51,000 2) Note A: Change in Method of Accounting for Bronco Construction, Inc. On January 1, 2024 the company changed its method of accounting for long-term construction from the completed-contract method to the percentage of completion method. The new method of accounting is considered preferable because it better reflects changes in the nature of the company's operations. Comparative financial statements have been adjusted to apply the new method retrospectively. Net income is increased by $31,000 and $20,000 in the years ended December 31, 2023 and 2022, respectively. As a result of the change to the percentage-of-completion method, the current year's net income is higher by $21,000 as compared to the results obtained if the completed-contract method was still used. Construction in progress has been increased by $51,000 as of the beginning of the current year. The cumulative effect of the change is to increase beginning retained earnings on January 1, 2024 by $51,000. The accounting change in principle is reported retrospectively. Diff: 3 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

27) Machino, Inc. began operations on January 1, 2022. During 2024, management decided to change from average-cost method to FIFO for its merchandise inventories. The change was effective at January 1, 2024. Management determined that cost of goods sold for each method would be: Cost of Goods Sold Average cost method FIFO method

2024 $160,000 $120,000

2023 $130,000 $110,000

2022 $140,000 $115,000

The company's statements as reported under average-cost before implementing the accounting change for 2024, 2023, and 2022, respectively, are presented below. The income tax rate for Machino is 40%. Machino, Inc Comparative Income Statements For the Years Ended December 31 2024 2023 Sales $550,000 $475,000 Cost of Goods Sold (160,000) (130,000) Operating Expenses (70,000) (50,000) Income before Taxes $320,000 $295,000 Tax Expense (40%) (128,000) (118,000) Net Income $192,000 $177,000

2022 $445,000 (140,000) (35,000) $270,000 (108,000) $162,000

Required: 1) Prepare the comparative income statements for Machino, Inc. after the change to FIFO. 2) Determine the after-tax cumulative effect in retained earnings at January 1, 2024. 3) Prepare the journal entry on January 1, 2024 for the change in accounting principle. Answer: 1) Machino, Inc. Comparative Income Statements For the Years Ended December 31 2024 2023* 2022* Sales $550,000 $475,000 $445,000 Cost of Goods Sold (120,000) (110,000) (115,000) Operating Expenses (70,000) (50,000) (35,000) Income before Taxes $360,000 $315,000 $295,000 Tax Expense (40%) (144,000) (126,000) (118,000) Net Income $216,000 $189,000 $177,000 *Restated 2) The first balance sheet presented under the new method is December 31, 2022. The cumulative effect after tax in retained earnings is computed as follows: Cost of Goods Sold Average cost FIFO - new Pretax cumulative effect

2022 $140,000 115,000 $25,000

2023 $130,000 110,000 $20,000

Tax (40%) Cumulative effect after tax

10,000 $15,000

8,000 $12,000

The cumulative effect of the change is $15,000 plus $12,000 equals $27,000. 3) Journal entry on January 1, 2024 to effect the change in principle is: Account Inventory Deferred Tax Liability Retained Earnings

Debit 45,000

Credit 18,000 27,000

Diff: 3 Objective: 21.2 IFRS/GAAP: GAAP AACSB: Analytical thinking

21.3

Changes in Accounting Estimates

1) Changes in amortization, depletion, and depreciation methods effected by a change in accounting principle are accounted for prospectively. Answer: TRUE Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

2) Changes in depreciation methods are changes in accounting principle that are accounted for retrospectively. Answer: FALSE Diff: 1 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

3) Changes in accounting principle may be handled prospectively if insufficient information is available to properly account for the change. Answer: TRUE Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Georgio, Inc. decided to move its business from its current location to another larger plant. Management should examine the salvage value of the building in the future and the change in the useful life to see if a change in the depreciation of the current building is warranted. Answer: TRUE Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

5) A change in depreciation method is a change in estimate effected by a change in accounting principle, and is accounted for prospectively. Answer: TRUE Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

6) If a company has recorded a liability for a lawsuit, and the amount of the settlement is more than the provision in the liability, it must consider this an error and retrospectively correct it. Answer: FALSE Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

7) Prior years' financial statements are restated for changes in material accounting estimates. Answer: FALSE Diff: 1 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

8) Disclosures are required for all changes in accounting estimate made in normal operations. Answer: FALSE Diff: 1 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) Which of the following is not an estimate that might be revised as a natural part of the accounting process? A) salary expense B) bad debt expense C) depreciation expense D) pension expense Answer: A Diff: 1 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) Which one of the following is a change in estimate effected by a change in an accounting principle? A) change in salvage value of an asset B) change in estimated life of an asset C) change from declining-balance to straight-line depreciation D) changes in pension plan asset revenues Answer: C Diff: 1 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

11) For which one of the following changes is it appropriate to use the prospective method? A) change in principle B) change in entity C) correction of error D) change in estimate Answer: D Diff: 1 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Application of knowledge

12) John Pickens writes mystery novels. His publisher pays him royalties for the number of books sold each year. He is paid royalties for the first half of the year on September 30 and the second half of the year on March 31 of the following year. He received $42,000 in September, 2022. The publisher estimated that his royalties for the second half of the year would be $53,000. On March 31, 2023, he received $57,500. Assuming that he recorded $53,000 in royalties at December 31, 2022, how would you account for this change? A) as an error B) as a change in estimate C) as a prior period error correction D) as a change in accounting principle Answer: B Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Emma's Clothes, Inc. has accounts receivable of $210,000. In the current economy, she has noticed an increase in uncollectible accounts. In 2022, her sales were $3,480,000 and in 2023, sales were $3,970,000. Before 2023, she estimated that 3% of sales would eventually be uncollectible. In 2023, Emma believes that her losses were closer to 4% in 2022. What should be the bad debt expense for 2022 and 2023 in the comparative income statements for 2022 and 2023? A) 2022, $139,200; 2023, $158,800 B) 2022, $104,400; 2023, $158,800 C) 2022, $104,400; 2023, $298,000 D) 2022, $139,200; 2023, $298,000 Answer: B Explanation: 2022: 3% × $3,480,000 = $104,400; 2023: 4% × $3,970,000 = $158,800. This is a prospective change implemented in the year of the new estimate and all future years. It is not applied retrospectively. Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) Brown Furniture Company decided to go after the younger market to create a newer customer base. In doing so, Ms. Brown offered a liberal credit policy and estimated she would have a 6% bad debt expense. In 2022, sales under this promotion were $600,000. Accordingly, she estimated a bad debt expense of $36,000. Her actual bad debt expenses were far less than expected, at about 2%, and this rate will be used for 2023. Her 2023 sales under the program are $860,000. How much bad debt expense should be reported on the comparative income statements based on this information? A) 2022, $12,000; 2023, $17,200 B) 2022, $36,000; 2023, $36,000 C) 2022, $36,000; 2023, $17,200 D) 2022, $36,000; 2023, $51,600 Answer: C Explanation: 2022: 6% × $600,000 = $36,000; 2023: 2% × $860,000 = $17,200. This is a prospective change implemented in the year of the new estimate and all future years. It is not applied retrospectively. Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) Peoples Corporation purchased a building on December 29, 2018 that cost $1,200,000 and occupied it on January 2, 2019. The owner estimated that the building would last 40 years with a salvage value of $150,000 using straight-line depreciation. In early 2022, Mr. Peoples learned that due to a permanent highway closure, the company needs to relocate at the end of 2024. He believes that the salvage value of the building at that time will be $800,000. Compute the amount of depreciation to record during 2022, and each of the two years thereafter. (Round your final answer to the nearest dollar.) A) $26,250 B) $133,333 C) $107,083 D) $150,000 Answer: C Explanation: Straight-line depreciation recorded beginning in 2018 is ($1,200,000 - $150,000) / 40 years = $26,250/year. Accumulated depreciation at the end of 2021 (3 years) is $78,750 and book value is $1,200,000 - $78,750 = $1,121,250. Depreciation beginning in 2022 is ($1,121,250 book value - $800,000 salvage value)/3 years = $107,083. Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) Miller Manufacturing purchased a packaging machine for $390,000 on January 2, 2019. The seller assumed that the machine would be functional for at least five years with no salvage value. In 2022, Miller decided that the machine would last an additional five years with a salvage value of $25,000. The company uses straight-line depreciation for all assets. What amount of depreciation should Miller record in 2022 and following years? A) $26,200 B) $73,000 C) $39,000 D) $78,000 Answer: A Explanation: Straight-line depreciation recorded beginning in 2019 is $390,000/ 5 years = $78,000/year. Accumulated depreciation at the end of 2021 (3 years) is $234,000 and book value is $390,000 - $234,000 = $156,000. Depreciation beginning in 2022 is ($156,000 book value - $25,000 salvage value)/5 years = $26,200. Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) The State of Alabama filed suit against Edwards Chemical Company for violations of water pollution laws in 2022. During 2022, the company accrued a $320,000 loss for litigation. At the end of 2023, Edwards was able to settle with the State for $255,000. What entry should Edwards make when it pays the State in December, 2023? A) Litigation Liability Gain on Litigation Cash B) Litigation Liability Cash C) Litigation Liability Recovery of a Loss Cash D) Litigation Liability Retained Earnings Cash Answer: A

320,000

65,000 255,000

255,000 255,000

320,000

65,000 255,000

Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) The auditor for Universal Tools, Inc. discovered in 2023 that the warranty liability account showed a $25,000 debit balance. She investigated and discovered that the 2% estimate based on sales for warranty expense was recorded and understated, and it was more likely 3.5%. Sales for 2023 were $5,750,000. What is the appropriate journal entry as a result of this discovery? A) Warranty Liability Warranty Expense

25,000

B) Warranty Expense Warranty Liability

86,250

C) Warranty Liability Warranty Expense

86,250

25,000

86,250

D) Warranty Expense 201,250 Warranty Liability Answer: B Explanation: $5,750,000 × (3.5% - 2%) = $86,250

201,250

Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) John Pickens writes mystery novels. His publisher pays him royalties for books sold each year. He is paid royalties for the first half of the year on September 30 and the second half of the year on March 31 of the following year. He received $42,000 in September, 2022. The publisher estimated that his royalties for the second half of the year would be $53,000. On March 31, 2023, he received $60,000. Assuming that he recorded $53,000 at December 31, 2022, which one of the following is the correct journal entry on March 31, 2023? His tax rate is 35%. A) Cash

B) Cash

C) Cash

Royalties Receivable Royalty Revenue

Royalty Revenue

Royalties Receivable Retained Earnings

D) Cash

Royalties Receivable Retained Earnings Income Taxes Payable Answer: A

60,000

53,000 7,000

60,000

53,000 7,000

53,000 4,550 2,450

Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

20) Humphrey Contractors purchased customized equipment in January, 2021 for $700,000. The manufacturer warranted the equipment for six years. Humphrey used double-declining balance depreciation with a useful life of eight years and no salvage value. After two full years, he now believes that the equipment will only last a total of five years. Compute his depreciation expense for 2023 if he switches to straight-line depreciation. (Round any intermediate calculations to the nearest cent and your final answer to the nearest dollar.) A) $87,500 B) $105,000 C) $131,250 D) $140,000 Answer: C Explanation: In the 2021, the company would have recorded double-declining balance depreciation of 2/8 × $700,000 = $175,000, leaving a book value of $525,000. In 2022, the company would record depreciation of 2/8 × $525,000 = $131,250 and the book value would be $393,750. Straight-line depreciation recorded beginning in 2023 is $393,750 / 3 years = $131,250/year. Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

21) The IRS is investigating Miller Productions' tax returns for 2021 and 2022. Based on the IRS audit procedures, the company accrued a $46,000 loss for additional tax assessments in 2022 for the 2021 tax year. At the end of 2022, Miller was able to settle with IRS for $61,000. What entry should Miller make when it pays the deficiency in December, 2022? A) Income Taxes Payable 46,000 Retained Earnings 15,000 Cash 61,000 B) Income Taxes Payable Income Tax Expense Cash C) Income Taxes Payable Retained Earnings Cash D) Income Taxes Payable Cash Answer: B

46,000 15,000

61,000

46,000 15,000 31,000

61,000 61,000

Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

22) Jenkins, Inc. builds custom machines for manufacturers using robotic equipment. In 2022, the company decided to change from straight-line to double-declining balance depreciation for its robotic equipment. It changed the life expectancy as follows: Original cost of robotic equipment Accumulated depreciation thru 2021

$2,500,000 780,000

Original life in years

Remaining life in years

Determine the correct amount of depreciation to expense for 2022. A) $312,500 B) $430,000 C) $390,000 D) $860,000 Answer: D Explanation: Book value at the end of 2021 is $2,500,000 - 780,000 = $1,720,000. Double-declining balance depreciation for 2022 is book value $1,720,000 × 2/4 = $860,000. Diff: 3 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

23) Highland Corporation has always used double-declining balance depreciation for its equipment. Beginning in 2022, the company has decided to use straight-line depreciation for all new equipment purchases. How should the company report this decision? Describe any journal entries and disclosures that need to be made for this change. Answer: A change in depreciation methods is a change in an accounting estimate effected by a change in accounting principle. The change in estimate is inseparable from the principle change. This is handled prospectively. No adjustments are made to prior periods and equipment in service before 2022 continue with the same depreciation method used in prior periods. Disclosure requirements are the same as those for changes in accounting principles, except it contains no changes to retained earnings, or prior periods' income and EPS information. Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

24) Emma's Clothes, Inc. has accounts receivable of $210,000. In the current economy, she has noticed an increase in uncollectible accounts. In 2022, her sales were $3,200,000 and in 2023, sales were $3,800,000. Before 2023, she estimated that 2% of sales would eventually be uncollectible. In 2023, Emma believes that her losses were closer to 3% in 2022. She has recorded bad debt expense of 2% for 2022. Does she need to make a retroactive correction for 2022, and should she add an additional adjustment to 2023? If so, write the journal entry for the year-end adjustment in 2023. She has already recorded 2% of sales for bad debts in 2023 for 2023 sales. Answer: Estimates frequently need to be adjusted for changes in the business environment. Emma should not make any adjustment for 2022 because the estimate was made in good faith relying on information at that time. Neither should she make an additional change from 2022 during 2023. If Emma believes that the best rate for 2023 is 3%, she should record a journal entry to increase the 2023 estimate of 2% to 3% of 2023 sales. The journal entry for December 31, 2023 to adjust the estimated expense is:

Bad Debt Expense Allowance for Bad Debts $3,800,000 × 1% additional equals $38,000.

Debit 38,000

Credit 38,000

Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

25) In reconciling information to complete its financial statements, Flying High Corporation discovered the following situations: Income before taxes and the changes

$400,000

Income tax rate Bad debt expense increased Sales Equipment original cost Equipment accumulated depreciation

35% 1% of sales $900,000 $500,000 $200,000

Method of depreciation unchanged Remaining life changed from 5 years to

DDB 3 years

Required: Assuming that no depreciation had been recorded, recompute depreciation expense, bad debt expense, income before taxes, income tax expense, and net income. Answer: Depreciation Expense: Cost $500,000 Less: Accumulated depreciation (200,000) Remaining depreciable base $300,000 Method DDB Depreciation expense ($300,000 / 3 × 2) $200,000 Bad Debt Expense: Sales Additional 1% Bad debt expense

$900,000 $9,000

Income Tax Expense and Net Income: Original income before taxes and changes Less: Depreciation Less: Additional bad dept expense Updated income before taxes Income Taxes @ 35% Net Income

$400,000 (200,000) (9,000) $191,000 (66,850) $124,150

Diff: 3 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

26) In reconciling information to complete its financial statements, Biltmore, Inc. discovered the following situations: Income before taxes and the changes Income tax rate Warranty expense decreased

$1,000,000 40% 1% of sales

Sales

$6,000,000

Equipment original cost

$800,000

Equipment accumulated depreciation

$200,000

Method of depreciation unchanged

Remaining life changed from 5 years to

6 years

Required: Assuming that no depreciation had been recorded, recompute depreciation expense, warranty expense change, income before taxes, income tax expense, and net income. Answer: Depreciation Expense: Cost $800,000 Less: Accumulated depreciation (200,000) Remaining depreciable base $600,000 Method SL Depreciation expense ($600,000 / 6) $100,000 Warranty Expense: Sales Reduction of 1% Warranty expense

$6,000,000 $(60,000)

Income Tax Expense and Net Income: Original income before taxes and changes Less: Depreciation Add: Reduction in warranty expense Updated income before taxes Income Taxes @ 40% Net Income

$1,000,000 (100,000) 60,000 $960,000 (384,000) $576,000

Diff: 3 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

27) Brown Furniture Company decided to go after the younger market to create a newer customer base. In doing so, Ms. Brown offered a liberal credit policy and estimated she would have a 4% bad debt expense. In 2022, sales under this promotion were $650,000. Accordingly, she estimated a bad debt expense of $26,000. Her actual bad debt expenses were far less than expected, at about 3%, and this rate will be used for 2023. Her 2023 sales under the program are $800,000. How much bad debt expense should be reported on the comparative income statements based on this information for 2022 and 2023? Answer: 2022: 4% × $650,000 = $26,000 2023: 3% × $800,000 = $24,000. Explanation: This is a prospective change implemented in the year of the new estimate and all future years. It is not applied retrospectively. Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

28) Peoples Corporation purchased a building on December 29, 2018 that cost $1,500,000 and occupied it on January 2, 2019. The owner estimated that the building would last 20 years with a salvage value of $200,000 using straight-line depreciation. In early 2022, Mr. Peoples learned that due to a permanent highway closure, the company needs to relocate at the end of 2024. He believes that the salvage value of the building at that time will be $600,000. Compute the amount of depreciation to record during years 2019, 2020, 2021 and 2022, and each of the two years thereafter. (Round your final answer to the nearest dollar.) Answer: 2019 = $65,000 2020 = $65,000 2021 = $65,000 2022 and each of the two years after = $235,000 Explanation: Straight-line depreciation recorded beginning for 2019, 2020, and 2021 is ($1,500,000 - $200,000) / 20 years = $65,000/year. Accumulated depreciation at the end of 2021 (3 years) is $195,000 and book value is $1,500,000 - $195,000 = $1,305,000. Depreciation beginning in 2022 is ($1,305,000 book value - $600,000 salvage value)/3 years = $235,000. Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

29) The auditor for Universal Tools, Inc. discovered in 2023 that the warranty liability account showed a $25,000 debit balance. She investigated and discovered that the 3% estimate based on sales for warranty expense was recorded and understated, and it was more likely 4%. Sales for 2023 were $5,000,000. What is the appropriate journal entry as a result of this discovery? Answer: Warranty Expense 50,000 Warranty Liability 50,000 Explanation: $5,000,000 × (4% - 3%) = $50,000 Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

30) John Pickens writes mystery novels. His publisher pays him royalties for books sold each year. He is paid royalties for the first half of the year on September 30 and the second half of the year on March 31 of the following year. He received $42,000 in September 2022. The publisher estimated that his royalties for the second half of the year would be $54,000. On March 31, 2023, he received $60,000. Assuming that he recorded $54,000 at December 31, 2022, which one of the following is the correct journal entry on March 31, 2023? His tax rate is 35%. Answer: Cash 60,000 Royalties Receivable 54,000 Royalty Revenue 6,000 Diff: 2 Objective: 21.3 IFRS/GAAP: GAAP AACSB: Analytical thinking

21.4

Changes in Accounting Reporting Entity

1) Presenting consolidated statements instead of individual financial statements is a change in a reporting entity. Answer: TRUE Diff: 1 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) Changes in reporting entities are accounted for prospectively. Answer: FALSE Diff: 1 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) A change in the specific subsidiaries that make up the group of entities for which consolidated financial statements are presented is a change in a reporting entity. Answer: TRUE Diff: 2 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

4) When a large corporation purchases a new business, which is included in the consolidated statements for the year, it is not a change in a reporting entity, and it is accounted for prospectively. Answer: TRUE Diff: 2 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

5) A change in reporting entity must be treated retrospectively for all years presented in the financial statements. Answer: TRUE Diff: 2 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

6) A change in reporting entity must be treated retrospectively for a maximum of two prior years. Answer: FALSE Diff: 1 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

7) Which one of the following is not a change in a reporting entity? A) the purchase of a new subsidiary B) presenting a consolidated statement for the first time C) changing the specific subsidiaries that make up the group of entities presented in the financial statements D) changing the entities in combined financial statements Answer: A Diff: 2 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

8) When a firm has a change in reporting entity, it must disclose ________. A) the individual financial statements for each component entity B) the effect of the change on net income and EPS for each year presented C) the reasons that the company chose to purchase a new business unit D) the reasons for the lack of comparability to prior financial statements Answer: B Diff: 3 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

9) Which one of the following is not a required disclosure for a change in reporting entity? A) the nature of the change and the reason for the change B) the effect of the change on income from continuing operations C) the effect of the change on operating expenses D) the effect of the change on other comprehensive income Answer: C Diff: 2 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

10) Describe a change in reporting entity and discuss its accounting treatment and its required disclosures. Answer: A change in reporting entity occurs when a company presents consolidated or combined statements in the current year that do not include the same companies as in prior years. Changes in reporting entity are always retrospectively reported. In the year of change, the disclosures required include the nature of the change and the reason for the change. The firm must disclose the effects on income from continuing operations, net income, other comprehensive income, and related per share amounts for all periods presented. Diff: 1 Objective: 21.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

21.5

Errors and Error Analysis

1) Fraud is a type of accounting error. Answer: FALSE Diff: 1 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

2) When accountants discover material errors, they must be corrected. Answer: TRUE Diff: 1 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

3) Many errors are due to misapplication of accounting policies. Answer: TRUE Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

4) Material error corrections are retrospectively applied but do not require adjustments to retained earnings as prior-period adjustments. Answer: FALSE Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

5) A financial statement can provide a faithful representation even if it is not perfectly accurate as long as the process used to produce the information is selected and applied with no errors and the description of the transaction is free from error. Answer: TRUE Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Balance sheet errors are typically the result of misclassification of accounts in the process of recording a transaction and require correction upon discovery. Answer: TRUE Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) Self-correcting errors do not require any journal entries regardless of the length of time involved. Answer: FALSE Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

8) A self-correcting error must self-correct within two years. Answer: TRUE Diff: 1 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) A material error is one that, if not corrected, would impact a user's decisions. Answer: TRUE Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

10) A self-correcting error, discovered after the books are closed in the second year, still requires a journal entry. Answer: FALSE Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

11) Firms account for material error corrections ________. A) with the retrospective method B) using the prospective method C) only after they self correct D) only when both the income statement and balance sheet are affected Answer: A Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

12) The bookkeeper for Phillips, Inc. mistakenly recorded a $300,000 one-year trade note receivable as a long-term note receivable in 2021. Interest revenue was correctly recorded. The error was discovered in 2023 by the company's auditors. What is the proper way to correct the error? A) Ignore the error because it is not material in amount. B) Correct the classification in 2023 retrospectively for comparative balance sheets. C) Use a footnote disclosure only because it does not change working capital. D) Correct the classification and adjust retained earnings for 2021 and 2022. Answer: B Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

13) Material income statement errors that occur in the current year and do not affect the balance sheet ________. A) require adjustment to retained earnings B) affect future years retained earnings C) must be corrected D) affect the statement of cash flows in prior years Answer: C Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

14) When an income statement error that does not affect the balance sheet is not found until after the books are closed, an entry ________. A) must be made to correct the error during the next year B) must be made to correct the error by reopening the books C) is not necessary, but financial statements must be recalled immediately D) is not necessary, but the income statement must be corrected before issue Answer: D Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

15) When a self-correcting error is discovered after closing the books for the second year ________. A) no entry is necessary because all permanent accounts are correctly stated B) an entry is necessary to correct the permanent accounts C) an entry must be made to correct both the income statement and balance sheet accounts D) an entry must be made to correct the income statement Answer: A Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

16) If a firm discovers a self-correcting error in the second year, and the books are still open, it ________. A) need not correct the error because it will reverse itself at the end of the year B) should correct beginning retained earnings and any remaining accounts needed to correct the error for both years C) must recall the previous year's financial statements, correct them, and reissue the financials D) should only correct the second year's error and leave beginning retained earnings unadjusted Answer: B Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

17) At the end of 2021, the payroll supervisor for Claro, Inc. failed to accrue $24,790 in commissions for the outside salespersons. The cost was recorded in 2022 when the commissions were paid and Commission Expense was debited and Cash credited for the full amount. The error was not discovered until late in 2022 while reconciling year-end expenses for 2022. What is the proper treatment to correct the error? (Ignore income taxes.) A) Do nothing, the error has counterbalanced. B) Accrue $24,790 in Commission Expense for 2022. C) Debit 2022 beginning Retained Earnings and credit Commission Expense for $24,790. D) There is no error in either year because the commissions are recorded when paid. Answer: C Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

18) During 2021, a $50,000 loss on the sale of machinery was incorrectly recorded as a factory equipment repair. The error was not discovered until the books were closed and the financial statements were issued for 2022. What adjustment is necessary? A) No adjustment is necessary to books or financial statements. B) Record a correction to the books for 2021 and 2022 and recall prior financial statements. C) Since only income statement accounts are affected, make no entry to the books but recall the 2021 income statement. D) Make no entry, but if $50,000 is a material amount, retrospectively adjust the 2021 comparative income statement. Answer: D Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

19) When the purchase of a material seven-year depreciable asset is recorded by debiting an expense account, which one of the following statements is correct? A) It is a self-correcting error and no adjustment is necessary. B) The error will eventually self-correct, but the financial statements will be in error for seven years. C) If the company uses a rapid depreciation method, the error will self-correct quickly so no adjustment is necessary. D) Since it affects only the income statement, no adjustment is required. Answer: B Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) A material error in ending inventory requires special analysis because it ________. A) affects two years of cost of goods sold, income tax expense, net income, and retained earnings B) counter balances over a minimum of three years C) affects the balance sheet as well as the income statement for one year D) reflects poorly on the quality of the company's accounting reliability Answer: A Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

21) Langley Corporation replaced an HVAC system in one of its warehouses in July, 2021, at a cost of $430,000. The accountant recording the purchase charged it to repairs and maintenance expense. The error was discovered late in 2022 while reconciling depreciation expense for 2022. The system should last about 7 years with no salvage value. What entry should be made before the 2022 books are closed if the company uses straight-line depreciation? (Round intermediate calculations to the nearest cent and your final answer to the nearest dollar.) A) Warehouse 430,000 Accumulated Depreciation -Warehouse 61,429 Retained Earnings—Prior Period Adjustment 368,571 B) Retained Earnings—Prior Period Adjustment Depreciation Expense—Warehouse Warehouse

430,000 61,429

C) Warehouse 430,000 Depreciation Expense (2022)— Warehouse 61,429 Accumulated Depreciation—Warehouse Retained Earnings—Prior Period Adjustment

491,429

92,144 399,285

D) Warehouse 430,000 Depreciation Expense—Warehouse 61,429 Retained Earnings 491,429 Answer: C Explanation: If properly recorded, depreciation expense for 2021 would have been ($430,000 / 7 years) × 6/12 months = $30,715. As a result of recording the entire amount as an expense, net income was understated by $430,000 - $30,715 = $399,285. In 2022, depreciation expense is $430,000 / 7 years = $61,429. To correct the error, the accountant must record the purchase of the HVAC for the warehouse and associated accumulated depreciation for 2021 and 2022, as well as recognize depreciation expense for 2022 and correct the error in retained earnings. Diff: 3 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Woods, Inc. purchased a new engine for a long-distance truck in January, 2021. The engine cost $240,000 and should give the truck an additional 500,000 miles of life. Inadvertently, the engine was charged to truck repairs expense. The error was found in December, 2022. The company records depreciation based on miles driven with no salvage value. Miles driven in 2021 were 80,000 and 70,000 in 2022. Which one of the following entries properly corrects all the errors through December 31, 2022? (Ignore income taxes.) (Round any intermediate calculations and your final answers to the nearest dollar.) A) Truck 240,000 Accumulated Depreciation - Truck 33,600 Retained Earnings 206,400 B) Retained Earnings Depreciation Expense (2021) -Truck Truck C) Truck Depreciation Expense (2021) -Truck Retained Earnings

201,600 38,400

240,000

240,000 38,400

278,400

D) Truck 240,000 Depreciation Expense--Truck (2022) 33,600 Accumulated Depreciation -Truck 72,000 Retained Earnings 201,600 Answer: D Explanation: If properly recorded, depreciation expense for 2021 would have been $240,000 × 80,000/500,000 = $38,400. As a result of recording the entire amount as an expense, net income was understated by $240,000 - $38,400 = $201,600. In 2022, depreciation expense is $240,000 × 70,000/500,000 = $33,600. To correct the error, the accountant must record the purchase of the engine and associated accumulated depreciation for 2021 and 2022, as well as recognize depreciation expense for 2022 and correct the error in retained earnings. Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

23) At the end of 2021, the payroll supervisor for Claro, Inc. failed to accrue $26,800 in commissions for their outside salespersons. The cost was recorded in 2022 when the commissions were paid and Commission Expense was debited and Cash credited for the full amount. The error was not discovered until late in 2022 while reconciling year-end expenses for 2022. The tax rate for both years was 40%. What is the proper journal entry to correct the error for 2022? A) Retained Earnings Taxes Receivable Commission Expense

16,080 10,720

B) Retained Earnings Commission Expense

26,800

C) Commission Expense Taxes Payable Retained Earnings

26,800

26,800 10,720 16,080

D) No entry required. The error has self corrected. Answer: A Explanation: In 2021, expenses were understated and net income was overstated by the after-tax expense of $26,800 × (1 – 40%) = $16,080. To correct the error, retained earnings must be decreased by this amount. However, correction of the error will generate a tax savings of $26,800 × 40% = $10,720, represented as a receivable. Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

24) Jett Company purchased an umbrella liability policy in January, 2021 and paid a five-year premium for $250,000. It was recorded as Insurance Expense. The error was discovered late in 2021 when the accountants were reconciling 2021 for adjusting entries. What is the proper entry to correct the error at December 31, 2021? (Ignore income taxes.) A) No entry required because it will self-correct in two more years. B) Prepaid Insurance Insurance Expense (2021) Retained Earnings

100,000 50,000

C) Prepaid Insurance Insurance Expense

200,000

150,000

200,000

D) Prepaid Insurance 150,000 Insurance Expense (2021) 50,000 Retained Earnings 200,000 Answer: C Explanation: Since the books are not closed, an entry is needed to correct the current–year income statement and balance sheet accounts. Of the total $250,000 paid, $50,000 is attributable to Insurance Expense for the year. Insurance Expense, therefore, needs to be reduced from $250,000 to $50,000, a credit of $200,000. Prepaid Insurance of $200,000, the amount that is still prepaid at the end of the year, should be recorded with a debit. Diff: 3 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

25) Braun Corp. purchased a service vehicle liability policy in July, 2021 and paid a five-year premium for $300,000. It was recorded as Insurance Expense. The error was discovered late in 2021 when the accountants were reconciling 2021 for adjusting entries. What is the proper entry to correct the errors in 2021 if the tax rate for all years is 35%? A) No entry needed because it will self-correct in two more years. B) Prepaid Insurance Prepaid Income Taxes Retained Earnings

210,000 73,500

C) Prepaid Insurance (End 2021) Insurance Expense

270,000

D) Prepaid Insurance (End 2021) Income Taxes Payable Retained Earnings

283,500

270,000

150,000 60,000 90,000

Answer: C Explanation: Since the books are not closed, an entry is needed to correct the current–year income statement and balance sheet accounts. Of the total $300,000 paid, $30,000 [($300,000/ 5 years) × 6/12 months] is attributable to Insurance Expense for the year. Insurance Expense, therefore, needs to be reduced from $300,000 to $30,000, a credit of $270,000. Prepaid Insurance of $270,000, the amount that is still prepaid at the end of the year, should be recorded with a debit. Diff: 3 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

26) In completing the adjusting entries for 2021 in early 2022, the internal auditor discovered that a patent, with an estimated eight year life that was registered in January, 2021 had not been amortized. The patent cost $370,000. The income tax rate is 40%. The books are still open in 2021. What is the journal entry to correct the error? A) Amortization Expense-Patent Retained Earnings

46,250

B) Patent Income Taxes Receivable Retained Earnings

46,250 18,500

64,750

C) Amortization Expense-Patent Income Taxes Payable Retained Earnings

46,250

18,500 27,750

D) Amortization Expense-Patent 46,250 Patent 46,250 Answer: D Explanation: Since the books have not been closed, income statement and balance sheet accounts are adjusted to proper amounts. $370,000/8 = $46,250. Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) In April, 2022, Norman Industries sold available-for-sale debt securities that cost $560,000 and received a check from its broker for $795,000. When the check was deposited, the accounting clerk debited cash and credited Available-for-Sale Debt Investments for the full amount. The CFO questioned the entry in December, 2022. If this is an error, what is the proper correcting entry? (Tax rate is 40%.) A) Available-for-Sale Debt Investments 235,000 Realized Gain 235,000 B) Available-for-Sale Debt Investments Realized Gain Retained Earnings-Prior Period Adj.

795,000

235,000 560,000

C) Available-for-Sale Debt Investments Income Tax Expense Retained Earnings

235,000

94,000 141,000

D) Realized Gain 235,000 Available-for-Sale Debt Investments 235,000 Answer: A Explanation: Explanation: Because of the erroneous entries, in April, the Available-for-Sale Debt Investments account would have a credit balance of $235,000. A debit to that account of $235,000 would correctly close the account and because the gain on the sale was not recognize, a credit to Realized Gain for $235,000 must also be made to correct the April entry made in error. Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

28) Austin Motor Works declared and distributed a 5% stock dividend in 2022 when the stock was selling for $18 per share. There were 6,000,000 shares outstanding at the time of the dividend declaration. The controller recorded the distribution at par value ($1 per share) resulting in a debit to Dividends and a credit to Common Stock for $300,000. Upon review in early 2023 when the 2022 books were still open, the CFO made which of the following correcting entries? (Abbreviations used: APIC = Additional Paid-In Capital) A) He made no entry because the controller was correct. B) Dividends APIC in Excess of Par-Common

5,100,000

C) Dividends Common Stock

5,100,000

D) APIC in Excess of Par-Common 5,100,000 Common Stock 5,100,000 Answer: B Explanation: Total dividend = 6,000,000 × 5% × $18 = $5,400,000; Additional Paid-in Capital in Excess of Par—Common = $5,400,000 - $300,000 Common Stock = $5,100,000. Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

29) JAT Corp. loaned $580,000 for three years to a major supplier on July 1, 2021. The note stipulated 24% interest to be paid annually each June 30. Since this was an unusual transaction, no one billed the supplier for the interest in 2022 or recorded the accrued interest at the year-end (December). The supplier did not send in any interest in 2022. On March 1, 2023, after the 2022 books were closed, the CFO found the error. Which one of the following is the correct journal entry to correct the errors thru March 1, 2023? (Ignore income taxes.) A) Since it has not been billed, no entry should be made until June 30, 2023. B) Interest Receivable 208,800 Retained Earnings – Prior-Period Adjustment

208,800

C) Interest Receivable 232,000 Interest Revenue Retained Earnings – Prior-Period Adjustment

23,200 208,800

D) Interest Receivable 208,800 Interest Revenue 208,800 Answer: C Explanation: Interest Revenue is computed as the principal amount times the interest rate times 2/12 months, $580,000 × 24% × 2/12 = $23,200. Retained Earnings is credited for the interest revenue that should have been recorded for 6 months of 2021 ($580,000 × 24% × 6/12 = $69,600) and 12 months in 2022 ($580,000 × 24% × 12/12 = $139,200). Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

30) Tarleton Company discovered ending inventory errors in 2021 and 2022. The 2021 ending inventory was overstated by $245,000 whereas the 2022 ending inventory was understated by $95,000. Ignoring income tax effects, by what amount should the beginning retained earnings be adjusted on January 1, 2023? A) $95,000 debit B) $95,000 credit C) $150,000 debit D) $245,000 credit Answer: B Explanation: Understated inventory of $95,000 means a correcting entry needs to be made as a debit to inventory and credit to retained earnings. Diff: 3 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

31) In 2021, Antiques, Inc. incorrectly recorded ending inventory as $1,200,000 instead of $800,000. The controller discovered the error in 2023 when reviewing final entries for 2022 financial statements. The books are not closed in 2022. The 2022 ending inventory amount was correct. The tax rate for all years is 40%. Which one of the following entries is correctly written and dated? A) December 31, 2021 Retained Earnings-Prior Period Adj. 240,000 Income Tax Receivable 160,000 Inventory 400,000 B) December 31, 2022 Inventory Income Tax Payable Retained Earnings-Prior Period Adj.

400,000

C) January 1, 2023 Inventory Income Tax Payable Retained Earnings-Prior Period Adj.

400,000

D) December 31, 2022 Retained Earnings-Prior Period Adj. Income Tax Receivable Inventory

160,000 240,000

240,000 160,000 400,000

Answer: D Explanation: Overstatement of ending inventory must be corrected by a credit for the difference, $1,200,000 - $800,000 = $400,000. Assuming that cost of goods sold was understated, then net income was overstated. The correction for net income is a prior-period adjustment to retained earnings in the amount of the overstatement of net income net of tax. The tax on the $400,000 overstatement of net income is calculated at 40%. Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

32) While completing the adjusting entries for 2021 in early 2022, the internal auditor discovered that a trademark, with an estimated eight-year life that was registered on January 1, 2021 had not been amortized. The trademark cost $400,000. (The income tax rate is 40%.) The books are still open in 2021. Required: Describe the steps to correct the error. Answer: Since the error occurred in 2021 and the books are still open, the error can be corrected in a timely fashion. The error is the failure to amortize the trademark costs over the first of eight years. There is no past year that needs correction so the solution is to record on December 31, 2021 the following entry: Amortization Expense—of Trademark Trademark

50,000 50,000

No disclosure of the error is required after the entry is made. Diff: 1 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

33) Bauer Corp. purchased an insurance policy on its plant with liability for harm to its employees in the case of a catastrophe in January, 2021 and paid a five-year premium for $300,000. The whole amount was recorded as Insurance Expense. The error was discovered in early 2024 when the accountants were reconciling 2023 for adjusting entries. The books are still open in 2023. (The tax rate is 40% for all years.) Income before taxes for 2021 is $1,040,000 and 2022 is $1,220,000. Required: Describe the steps to properly accounting for this error correction. Prepare the necessary journal entries on December 31, 2023. Answer: This situation is a self-correcting error that exceeds two years. The proper way to handle this is to compute the errors that occurred before 2023 and correct those with an adjustment to retained earnings. This error affects both the income statements and balance sheets for 2021 and 2022. If material in amounts, the financial statements must be restated retrospectively for 2021 and 2022 if presented on a comparative basis. To compute the errors, the following analysis is required: Correction to 2021: Pre-tax income as presented Correction of Insurance Expense ($300,000 - 60,000) Pre-tax income as corrected Adjusted income tax expense ($1,280,000 × 40%) Corrected net income

$1,040,000 240,000 $1,280,000 (512,000) $768,000

Correction to 2022: Pre-tax income as presented Correction of Insurance Expense ($0 + 60,000) Pre-tax income as corrected Adjusted income tax expense ($1,160,000 × 40%) Corrected net income

$1,220,000 (60,000) $1,160,000 (464,000) $696,000

Correction to 2023: Two journal entries are required for 2023. (A) To correct the 2021 and 2022 errors: Account Debit Prepaid Insurance (*) 180,000 Retained Earnings – Prior-Period Adj. Income Taxes Payable (*) Remaining Prepaid Insurance is 60% of $300,000. (B) To record the insurance expense for 2023: Account Insurance Expense Prepaid Plant Insurance

Debit 60,000

Credit 108,000 72,000

Credit 60,000

Diff: 3 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

34) For each of the following situations, determine the accounting method that should be employed. Type of Accounting Changes Change in Principle Change in Estimate Change in Estimate effected by a Principle change Change in Entities Error Correction

Accounting Methods

Answer: Type of Accounting Changes Change in Principle Change in Estimate Change in Estimate effected by a Principle change Change in Entities Error Correction

Accounting Methods Retrospective Prospective Prospective Retrospective Retrospective

Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

35) Complete the following table by selecting the appropriate type of change and the accounting method appropriate for each event. Event Change from FIFO to LIFO. Change in the warranty expense provision. Multi-year insurance policy charged to insurance expense. Change from percentage-ofcompletion to completedcontract to method. Patent not amortized because it is not expected to decline in value. Purchase of a new subsidiary with 60% ownership that is three years old. Change from reporting inventory from the aggregate method to the individual item method. Change from writing off bad debts as they become uncollectible to the allowance method. Change in the life and salvage value of a depreciable asset. Failure to record the correct ending inventory balance. Change from straight-line to declining balance depreciation.

Type of Change

Accounting Method

Answer: Event

Type of Change

Change from FIFO to LIFO. Principle Change in the warranty expense provision. Estimate Multi-year insurance policy charged to insurance expense. Error correction Change from percentage-ofcompletion to completedcontract to method. Principle Patent not amortized because it is not expected to decline in value. Error correction Purchase of a new subsidiary with 60% ownership that is three years old. None Change from reporting inventory from the aggregate method to the individual item method. Principle Change from writing off bad debts as they become uncollectible to the allowance method. Error correction Change in the life and salvage value of a depreciable asset. Estimate change Failure to record the correct ending inventory balance. Error correction Change from straight-line to Estimate change effected by a declining balance depreciation. change in principle

Accounting Method Retrospective unless impractical Prospective Retrospective

Retrospective

Not applicable

Retrospective

Retrospective Prospective Retrospective Prospective

Diff: 2 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

36) Vieta, Inc.'s CFO discovered a program error in its inventory program in early 2024, when she was making year-end adjustments to the financial statements for 2023. The books are still open in 2023 . The errors began in 2021. Below is a summary of the sales and cost of goods sold on income statement items for the three years: Year Sales Cost of Goods Sold: Beginning Inventory Net Purchases Cost of Goods Available for Sale Ending Inventory Cost of Goods Sold Gross Profit

2021 $980,000

2022 $1,090,000

2023 $1,210,000

210,000 402,000 612,000 205,000 407,000 $573,000

205,000 507,000 712,000 307,000 405,000 $685,000

307,000 611,000 918,000 322,000 596,000 $614,000

Upon further analysis, the CFO determined that each of the years had ending inventory errors. The correct amounts for the years were: 2021, $231,000; 2022, $350,000; and 2023, $474,000. The amounts for 2021 beginning inventory and all purchases are correct as stated. Required: 1) Reconstruct the table with corrected amounts. Year Sales Cost of Goods Sold: Beginning Inventory Net Purchases Cost of Goods Available for Sale Ending Inventory Cost of Goods Sold Gross Profit

2021 $980,000

2022 $1,090,000

2023 $1,210,000

210,000 402,000 612,000

507,000

611,000

2) Make the journal entry to correct the errors using the proper date. Account

Debit

Credit

3) Determine the required disclosures for this series of errors.

Answer: 1) Reconstruct the table with corrected amounts. Year Sales Cost of Goods Sold: Beginning Inventory Net Purchases Goods Available for Sale Ending Inventory Cost of Goods Sold Gross Profit

2021 $980,000

2022 $1,090,000

2023 $1,210,000

210,000 402,000 612,000 231,000 381,000 $599,000

231,000 507,000 738,000 350,000 388,000 $702,000

350,000 611,000 961,000 474,000 487,000 $723,000

2) Make the journal entry to correct the errors using the proper date. Account December 31, 2023 Inventory ($350,000 - $307,000) Retained Earnings-Prior Period Adj. Inventory ($474,000 - $322,000) Cost of Goods Sold

Debit

Credit

43,000 43,000 152,000 152,000

3) The CFO must disclose the reason for the error correction, include a reconstruction of the income statements and balance sheets indicating the change in income before taxes, income taxes, net income, and earnings per share. Comparative income statements and balance sheets should be retrospectively adjusted to reflect the corrected data. Diff: 3 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Application of knowledge

37) Courtney's Cafes, Inc.'s CFO discovered a series of errors in its inventory system in early 2024, when he was making year-end adjustments to the financial statements for 2023. The books are still open in 2023. The errors began in 2021. Below is a summary of the sales and cost of goods sold on income statement items for the three years: Year Sales Cost of Goods Sold: Beginning Inventory Net Purchases Cost of Goods Available for Sale Ending Inventory Cost of Goods Sold Gross Profit

2021 $510,000

2022 $690,000

2023 $805,000

52,000 162,000 214,000 75,000 139,000 $371,000

75,000 185,000 260,000 84,000 176,000 $514,000

84,000 224,000 308,000 96,000 212,000 $593,000

Upon further analysis, the CFO determined that each of the years had ending inventory errors. The correct amounts for the years were: 2021, $63,000; 2022, $101,000; and 2023, $106,000. The amounts for 2017 beginning inventory and all purchases are correct as stated. Required: 1) Reconstruct the table with corrected amounts. Year Sales Cost of Goods Sold: Beginning Inventory Net Purchases Cost of Goods Available for Sale Ending Inventory Cost of Goods Sold Gross Profit

2021 $510,000

2022 $690,000

2023 $805,000

52,000 162,000 214,000

185,000

224,000

2) Make the journal entry to correct the errors using the proper date. Account

Debit

Credit

3) Determine the required disclosures for this series of errors.

Answer: 1) Reconstruct the table with corrected amounts. Year Sales Cost of Goods Sold: Beginning Inventory Net Purchases Cost of Goods Available for Sale Ending Inventory Cost of Goods Sold Gross Profit

2021 $510,000

2022 $690,000

2023 $805,000

52,000 162,000 214,000 63,000 151,000 $359,000

63,000 185,000 248,000 101,000 147,000 $543,000

101,000 224,000 325,000 106,000 219,000 $586,000

2) Make the journal entry to correct the errors using the proper date. Account December 31, 2023 Inventory ($101,000 - $84,000) Retained Earnings-Prior Period Adj.

Debit

Credit

17,000 17,000

Inventory ($106,000 - $96,000) Cost of Goods Sold

10,000 10,000

3) The CFO must disclose the reason for the error correction, include a reconstruction of the income statements and balance sheets indicating the change in income before taxes, income taxes, net income, and earnings per share. Comparative income statements and balance sheets should be retrospectively adjusted to reflect the corrected data for each year presented. Diff: 3 Objective: 21.5 IFRS/GAAP: GAAP AACSB: Analytical thinking

Intermediate Accounting, 3e (Gordon/Raedy/Sannella) Chapter 22 The Statement of Cash Flows 22.1

Overview of the Statement of Cash Flows

1) The statement of cash flows summarizes a firm's cash inflows and outflows at a point in time. Answer: FALSE Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) One purpose of the cash flow statement is to determine the firm's need for external financing. Answer: TRUE Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Cash equivalents are short-term, highly liquid investments with original maturities of one year or less when acquired. Answer: FALSE Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Under both U.S. GAAP and IFRS, bank overdrafts are netted against the other positive balances included in cash and cash equivalents. Answer: FALSE Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Under U.S. GAAP, bank overdrafts are typically considered to be liabilities. Answer: TRUE Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) Bank overdrafts are considered to be a reduction of cash under IFRS, but not under U.S. GAAP. Answer: TRUE Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) The primary objective of the statement of cash flows is to ________. A) provide information about a company's cash receipts and cash payments for operating, financing, and investing activities over a period of time B) disclose changes in asset and equity accounts over a period of time C) disclose changes in working capital over a period of time D) provide information about a company's cash-basis revenue and expenses activities over a period of time Answer: A Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Which of the following questions would not be answered by the annual cash flow statement? A) What was cash used for during the year? B) What was the change in the cash balance during the year? C) Where did cash come from during the year? D) How did cash expenditures benefit the firm during the year? Answer: D Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Which of the following is considered to be a part of cash and cash equivalents under IFRS, but not U.S. GAAP? A) treasury bills B) bank overdrafts C) commercial paper D) money market funds Answer: B Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) The statement of cash flows assists financial statement users in all of the following ways except ________. A) determining the entity's need for external financing B) evaluating the ability of the entity to meet its obligations C) assessing the ability of the entity to satisfy its customers D) identifying the entity's investing transactions during the period Answer: C Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Which of the following is not a cash equivalent? A) accounts receivable expected to be collected in 30 days B) treasury bill with a maturity of 2 months C) commercial paper maturing in 45 days D) mutual fund deposits Answer: A Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) List five ways that the statement of cash flows assists the users of financial statements? Answer: 1. Assessing the ability of the firm to generate future cash flows, particularly related to its operating activities. 2. Evaluating the ability of the entity to meet its obligations and pay dividends. 3. Determining the entity's need for external financing. 4. Understanding the differences between net income and the associated cash receipts and payments. 5. Identifying the entity's investing and financing transactions during the period. Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) How do U.S. GAAP and IFRS differ in measuring cash and cash equivalents? Answer: The U.S. GAAP and IFRS definitions of cash equivalents are similar with the exception of bank overdrafts. U.S. GAAP does not specifically address bank overdrafts, although they are typically considered to be liabilities. As a result, a company cannot report a negative cash balance on the asset side of the balance sheet under U.S. GAAP. Under IFRS, firms include bank overdrafts as cash and cash equivalents and net them against the positive balance included in cash and cash equivalents. Diff: 1 Objective: 22.1 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22.2

Format of the Cash Flow Statement

1) The statement of cash flows is divided into three sections under U.S. GAAP and four sections under IFRS. Answer: FALSE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) On the statement of cash flows, operating cash flows include cash flows that relate to the production and delivery of goods and services. Answer: TRUE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) When preparing the statement of cash flows, IFRS will allow companies to classify some cash flows classified as investing or financing activities under U.S. GAAP as operating activities under IFRS. Answer: TRUE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) On the statement of cash flows, the three classifications of cash flows are reporting, investing, and financing. Answer: FALSE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) On the statement of cash flows, cash receipts of dividends are classified as investing activities under U.S. GAAP. Answer: FALSE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

6) On the statement of cash flows, cash receipts of dividends are classified as operating activities under U.S. GAAP. Answer: TRUE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

7) On the statement of cash flows, cash receipts from the collection of notes receivable are classified as investing activities. Answer: TRUE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) On the statement of cash flows, cash payments of the principal portion of promissory notes are classified as financing activities. Answer: TRUE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) The "bottom line" of the cash flow statement is Net Increase (Decrease) in Cash and Cash Equivalents. Answer: FALSE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) IFRS does not require that the increase or decrease in cash and cash equivalents explained in the statement of cash flows agree to the line item Cash and Cash Equivalents, ending balance, in the balance sheet. Answer: TRUE Diff: 1 Objective: 22.2 IFRS/GAAP: IFRS AACSB: Application of knowledge

11) An acquisition of a plant asset financed by the issuance of long-term debt is not incorporated into the body of the statement of cash flows. Answer: TRUE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Significant noncash transactions involving investing and financing activities are not required to be disclosed in the body of the statement of cash flows. Answer: TRUE Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Which of the following is not a required section of the cash flow statement? A) financing activities section B) operating activities section C) funding activities section D) investing activities section Answer: C Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Which of the following sections of the statement of cash flows includes cash flows that relate to the acquisition and disposal of noncurrent assets? A) financing activities section B) operating activities section C) funding activities section D) investing activities section Answer: D Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Which of the following sections of the statement of cash flows includes cash flows that relate to the production and delivery of goods and services? A) financing activities section B) operating activities section C) funding activities section D) investing activities section Answer: B Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Which of the following is not included in the operating activities section of the cash flow statement under U.S. GAAP? A) payments of income taxes B) payments of dividends C) payments of interest D) payments of executive salaries Answer: B Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

17) Under U.S. GAAP, which of the following may be included in the financing activities section of the cash flow statement? A) receipt of dividends B) payment of dividends C) receipt of interest D) payment of interest Answer: B Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP AACSB: Application of knowledge

18) All of the following would appear as significant noncash investing and financing transactions in the notes or supplementary schedules to the financial statements except ________. A) issuing preferred stock for cash B) converting bonds into capital stock C) exchanging land for a building D) signing a capital finance lease Answer: A Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) On the statement of cash flows, cash flows from investing activities should include ________. A) the factoring of accounts receivable B) the receipt of stock dividends C) the issuance of common stock in exchange for land D) the major repair of a fixed asset Answer: D Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

20) List and briefly describe the various sections of the statement of cash flows. Answer: • Operating activities include cash flows that relate to the production and delivery of goods and services. • Investing activities include cash flows that relate to the acquisition and disposal of noncurrent assets and short-term investments not classified as cash equivalents. • Financing activities include cash flows that relate to the cash receipts and payments of principal from short- and long-term debt, equity financing and payments of dividends to owners. Diff: 1 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

21) Identify under U.S. GAAP and IFRS if the following would be classified as an Operating, Investing, or Financing activity. Some may have more than one option, so indicate all options with any explanation. U.S. GAAP

IFRS

U.S. GAAP

IFRS

Operating

Operating or Investing Operating unless they can be specifically identified with financing or investing activities Operating or Financing Operating or Financing

Cash receipts from interest and dividends Cash payments for taxes Cash payments for interest Cash payments for dividends to owners Answer: Cash receipts from interest and dividends

Cash payments for taxes Operating Cash payments for interest Operating Cash payments for dividends to owners Financing Diff: 2 Objective: 22.2 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22.3

Conceptual Model for the Statement of Cash Flows

1) The conceptual model for the statement of cash flows is based on the accounting equation. Answer: TRUE Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The conceptual model for the statement of cash flows is based on the income statement equation. Answer: FALSE Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A decrease in a liability generally results in an increase in cash. Answer: FALSE Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) An increase in accounts receivable generally results in an increase in cash. Answer: FALSE Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Changes in current liabilities are reflected in the financing activities section of the statement of cash flows. Answer: FALSE Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Changes in current assets excluding cash are reflected in the operating activities section of the statement of cash flows. Answer: TRUE Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Changes in noncurrent liabilities are reflected in the financing activities section of the statement of cash flows. Answer: TRUE Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Changes in retained earnings are always reflected in the operating activities section of the statement of cash flows. Answer: FALSE Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) The conceptual model for the statement of cash flows is based on which of the following equations? A) Cash Flows = Operating Activities + Financing Activities - Investing Activities B) Net Income = Revenues - Expenses + Gains - Losses C) Assets = Liabilities + Equity D) Change in Retained Earnings = Net Income - Dividends Answer: C Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Which of the following equations represent the relationship between the change in Cash and cash equivalents (Cash) and the changes in Other Current Assets (OCA), Current Liabilities (CL), Noncurrent Assets (NCA), Noncurrent Liabilities (NCL), Capital Stock (CS) and Retained Earnings (RE)? A) ΔCash = ΔCL + ΔNCL − ΔOCA −ΔNCA + ΔCS + ΔRE B) ΔCash = ΔOCA + ΔNCA −ΔCL −ΔNCL + ΔCS + ΔRE C) ΔCash = ΔCL + ΔNCL − ΔOCA −ΔNCA - ΔCS - ΔRE D) ΔCash = ΔOCA + ΔNCA −ΔCL −ΔNCL - ΔCS - ΔRE Answer: A Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Changes in which of the following are included in financing activities on the statement of cash flows? A) accounts payable B) bonds payable C) accounts receivable D) property, plant, and equipment Answer: B Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Changes in which of the following are included in operating activities on the statement of cash flows? A) accounts payable B) bonds payable C) treasury stock D) property, plant, and equipment Answer: A Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Explain the conceptual model for the statement of cash flows. Answer: Firms can prepare the cash flows statement based on changes in balance sheet accounts in terms of the accounting equation: Assets = Liabilities + Stockholders' Equity. This accounting equation can be disaggregated into its various components: Cash and cash equivalents (Cash), Other Current Assets (OCA), Current Liabilities (CL), Noncurrent Assets (NCA), Noncurrent Liabilities (NCL), Capital Stock (CS) and Retained Earnings (RE) to express the changes in cash in terms of changes in the other components: ΔCash = ΔCL + ΔNCL − ΔOCA − ΔNCA + ΔCS + ΔRE. For each account, the firm identifies whether the change relates to operating, investing, or financing activities. Diff: 1 Objective: 22.3 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22.4

Operating Cash Flows

1) When preparing the operating activities section of the statement of cash flows, both FASB and IASB prefer the direct method over the indirect method. Answer: TRUE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) The indirect method of formatting the statement of cash flow is also referred to as the income statement format. Answer: FALSE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The direct method of formatting the statement of cash flow is also referred to as the reconciliation format. Answer: FALSE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) A company reconciles net income to net cash flow from operating activities when using the direct method. Answer: FALSE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Under the indirect method, adjustments to net income are based on accounting equation relationships. Answer: TRUE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Decreases in current assets cause operating cash flows to be higher than accrual-basis net income. Answer: TRUE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Increases in current liabilities cause operating cash flows to be lower than accrual-basis net income. Answer: FALSE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Under IFRS, the operating activities section may begin with something other than net income when using the indirect method. Answer: TRUE Diff: 1 Objective: 22.4 IFRS/GAAP: IFRS AACSB: Application of knowledge

9) Under the direct method, items included in the operating activities section of the statement of cash flows include cash collected from customers and cash collected from the sale of operating plant assets. Answer: FALSE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Cash collected from customers is calculated as net sales revenue minus increases in accounts receivable. Answer: TRUE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Cash paid for merchandise is calculated as purchases plus increases in inventory minus decreases in accounts payable for inventory. Answer: FALSE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) Cash paid to employees is calculated as salary and wage expense minus increases in salaries and wages payable. Answer: TRUE Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) A company borrows $10,000 and signs a 90-day nontrade note payable. How would this event be reflected in the statement of cash flows? A) cash outflow from investing activities B) cash inflow from investing activities C) cash outflow from financing activities D) cash inflow from financing activities Answer: D Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) Under the indirect method, which of the following would be added to net income when determining net cash flows from operations? A) gain on the sale of a used truck B) amortization expense C) increase in inventory D) decrease in accounts payable Answer: B Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) Under the indirect method, which of the following would be subtracted from net income when determining net cash flows from operations? A) gain on the sale of a used truck B) amortization expense C) decrease in prepaid rent D) increase in salaries payable Answer: A Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) In determining net cash flow from operating activities, a decrease in accounts payable during a period ________. A) does not require an adjustment under the indirect method B) does not require an adjustment under the direct method C) requires a subtraction adjustment to net income under the indirect method D) requires a subtraction adjustment to payments for merchandise under the direct method Answer: C Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) In determining net cash flow from operating activities, an increase in merchandise inventory during a period ________. A) requires a subtraction adjustment to financing cash flows under the indirect method B) requires a subtraction adjustment to sales to customers under the direct method C) requires an addition adjustment to net income under the indirect method D) requires an addition adjustment to payments for merchandise under the direct method Answer: D Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

18) Which of the following statements is true? A) Standard setters encourage the use of the direct method over the indirect method. B) The direct method is known as the reconciliation method. C) Under U.S. GAAP, the indirect method starts with income before income taxes. D) All of these statements are true. Answer: A Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

19) Volutia Corporation's comparative financial statements included the following amounts for the current year: Depreciation expense Loss on sale of fixed assets Decrease in fixed assets Increase in accounts receivable Decrease in accounts payable Decrease in inventory Increase in taxes payable Net income

$102,000 38,000 155,000 37,000 42,000 71,000 19,000 72,000

Compute net cash provided by operating activities using the indirect method. A) $223,000 B) $22,000 C) $185,000 D) $68,000 Answer: A Explanation: To calculate net cash provided by operating activities, net income is adjusted as follows: Net income Add: Depreciation expense Add: Loss on sale of fixed assets Deduct: Increase in accounts receivable Deduct: Decrease in accounts payable Add: Decrease in inventory Add: Increase in taxes payable Net cash provided by operating activities

$72,000 102,000 38,000 (37,000) (42,000) 71,000 19,000 $223,000

Diff: 2 Objective: 22.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

20) Worldwide Corp.'s statement of financial position accounts as of December 31, 2023 and 2022 and information relating to 2023 activities are presented below. December 31, 2023 2022 Assets Cash $440,000 $160,000 Short-term investments 800,000 – Accounts receivable (net) 1,130,000 1,230,000 Inventory 1,210,000 1,050,000 Long-term investments 400,000 600,000 Plant assets 3,100,000 2,000,000 Accumulated depreciation (700,000) (900,000) Patent 280,000 300,000 Total assets $6,660,000 $4,440,000 Liabilities and Equity Accounts payable $1,620,000 $1,330,000 Other accrued liabilities 200,000 250,000 Notes payable (nontrade) 560,000 – Common Stock-$10 par 1,600,000 1,400,000 Additional paid-in capital 800,000 500,000 Retained earnings 1,880,000 960,000 Total liabilities and equity $6,660,000 $4,440,000 Information relating to 2023 activities: • Net income for 2023 was $1,250,000. This amount includes net sales revenue of $4,500,000 and cost of goods sold of $2,100,000. • Equipment costing $1,000,000 and having a carrying amount of $320,000 was sold in 2023 for $360,000. • A long-term investment was sold in 2023 for $345,000. There were no other transactions affecting long-term investments in 2023. • 20,000 ordinary shares were issued in 2023 for $25 a share. • Short-term investments consist of treasury bills maturing on 9/30/24. Compute net cash provided by operating activities. A) $1,745,000 B) $3,470,000 C) $1,450,000 D) $2,595,000

Answer: A Explanation: Net income Depreciation exp. (700,000 + 680,000 - 900,000) Patent amortization Gain on sale of equipment Gain on sale of long-term investment Add: Decrease in accounts receivable Add: Increase in accounts payable Deduct: Increase in inventory Deduct: Decrease in other accrued liabilities Net cash provided by operating activities

$1,250,000 480,000 20,000 (40,000) (145,000) 100,000 290,000 (160,000) (50,000) $1,745,000

Diff: 2 Objective: 22.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

21) Worldwide Corp.'s statement of financial position accounts as of December 31, 2023 and 2022 and information relating to 2023 activities are presented below. December 31, 2023 2022 Assets Cash $440,000 $160,000 Short-term investments 800,000 – Accounts receivable (net) 1,150,000 1,270,000 Inventory 1,130,000 1,000,000 Long-term investments 400,000 600,000 Plant assets 3,100,000 2,000,000 Accumulated depreciation (700,000) (900,000) Patent 280,000 300,000 Total assets $6,620,000 $4,430,000 Liabilities and Equity Accounts payable $1,580,000 $1,320,000 Other accrued liabilities 200,000 250,000 Notes payable (nontrade) 560,000 – Common Stock-$10 par 1,600,000 1,400,000 Additional paid-in capital 800,000 500,000 Retained earnings 1,880,000 960,000 Total equity and liabilities $6,620,000 $4,430,000 Information relating to 2023 activities: • Net income for 2023 was $1,220,000. This amount includes net sales revenue of $4,540,000 and cost of goods sold of $2,100,000. • Equipment costing $1,000,000 and having a carrying amount of $320,000 was sold in 2023 for $360,000. • A long-term investment was sold in 2019 for $345,000. There were no other transactions affecting long-term investments in 2023. • 20,000 ordinary shares were issued in 2023 for $25 a share. • Short-term investments consist of treasury bills maturing on 9/30/24. Compute cash collected from customers. A) $4,420,000 B) $4,540,000 C) $4,660,000 D) $3,390,000 Answer: C Diff: 2 Objective: 22.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

22) Worldwide Corp.'s statement of financial position accounts as of December 31, 2023 and 2022 and information relating to 2019 activities are presented below. December 31, 2023 2022 Assets Cash $440,000 $160,000 Short-term investments 800,000 – Accounts receivable (net) 1,050,000 1,140,000 Inventory 1,160,000 1,020,000 Long-term investments 400,000 600,000 Plant assets 3,100,000 2,000,000 Accumulated depreciation (700,000) (900,000) Patent 280,000 300,000 Total assets $6,530,000 $4,320,000 Liabilities and Equity Accounts payable $1,490,000 $1,210,000 Other accrued liabilities 200,000 250,000 Notes payable (nontrade) 560,000 – Common Stock-$10 par 1,600,000 1,400,000 Additional paid-in capital 800,000 500,000 Retained earnings 1,880,000 960,000 Total equity and liabilities $6,530,000 $4,320,000 Information relating to 2023 activities: • Net income for 2023 was $1,220,000. This amount includes net sales revenue of $4,500,000 and cost of goods sold of $2,200,000. • Equipment costing $1,000,000 and having a carrying amount of $320,000 was sold in 2023 for $360,000. • A long-term investment was sold in 2023 for $345,000. There were no other transactions affecting long-term investments in 2023. • 20,000 ordinary shares were issued in 2023 for $25 a share. • Short-term investments consist of treasury bills maturing on 9/30/24. Compute cash paid for merchandise. A) $2,060,000 B) $2,200,000 C) $2,340,000 D) $2,620,000

Answer: A Explanation: Cash paid for merchandise is computed as follows: Cost of Goods Sold Add: Increase in Inventory Purchases on the Accrual Basis Less: Increase in Accounts Payable Cash Paid for Merchandise Diff: 2 Objective: 22.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

$2,200,000 140,000 2,340,000 280,000 $2,060,000

23) How are the direct method and the indirect method alike for the statement of cash flows? Answer: Both methods are acceptable formats for the operating activities section of the cash flow statement. Both methods report the same amount of net cash provided or used by operating activities. Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

24) Contrast the differences between the indirect method and the direct method for the statement of cash flows by explaining each. Answer: The indirect method adjusts accrual-basis net income to a cash basis. This is done by starting with accrual-basis net income and adding or subtracting noncash items and changes in current assets and current liabilities, excluding cash and cash equivalents. The direct method reports the amount of cash received from various sources and the amount paid for various uses, essentially providing a cash-basis income statement for ongoing operations. Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) Volutia Corporation's comparative financial statements included the following amounts for the current year: Depreciation expense Loss on sale of fixed assets Decrease in fixed assets Increase in accounts receivable Decrease in accounts payable Decrease in inventory Increase in taxes payable Net income

$102,000 38,000 155,000 37,000 42,000 65,000 19,000 720,000

Prepare the operating activities section of the statement of cash flows using the indirect method. Answer: Net income $720,000 Add: Depreciation expense 102,000 Add: Loss on sale of fixed assets 38,000 Deduct: Increase in accounts receivable (37,000) Deduct: Decrease in accounts payable (42,000) Add: Decrease in inventory 65,000 Add: Increase in taxes payable 19,000 Net cash provided by operating activities $865,000 Diff: 2 Objective: 22.4 IFRS/GAAP: GAAP AACSB: Analytical thinking

26) Comparative financial statements for Tomtric Company follow: Tomtric Company Balance Sheets December 31, 2022 and 2023 Assets

2022

2023

Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets

$18,000 25,000 22,000 10,000 75,000

$15,000 22,000 20,000 14,000 71,000

Long-term assets Property, plant, and equipment Less: Accumulated depreciation Net property, plant, and equipment Total assets

25,000 80,000 (64,000) 16,000 $116,000

7,000 77,000 (61,000) 16,000 $94,000

$8,000 15,000 23,000 18,000 15,000 56,000

$6,000 6,400 12,400 12,000 4,000 28,400

20,000 40,000 60,000 $116,000

30,000 35,600 65,600 $94,000

Liabilities and Stockholders' Equity Current liabilities: Accounts payable Accrued liabilities Total current liabilities Bonds payable Deferred tax liability Total liabilities Stockholders' equity: Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders' equity

Tomtric Company Income Statement For the year ended December 31, 2023 Sales Cost of goods sold Gross margin Depreciation expense Other operating expenses Operating income Loss on sale of equipment Income before taxes Income tax expense Net income

$70,000 40,000 30,000 5,000 15,000 10,000 4,000 6,000 2,400 $3,600

Additional data on activities during 2023 are as follows: • During 2023, Tomtric Company sold used equipment for $3,000 that had cost $15,000 with accumulated depreciation of $8,000. • New equipment was purchased for $12,000 cash. • Cash dividends totaling $8,000 were paid. • Long-term investments that had cost $18,000 when purchased were sold for $18,000. • Common stock was issued for $10,000. Prepare the operating activities section of the statement of cash flows using the indirect method. Answer: Tomtric Company Statement of Cash Flows For the year ended December 31, 2023 Operating activities: Net income $3,600 Adjustments to reconcile net income to net cash used by operating activities: Depreciation expense 5,000 Decrease in accounts receivable 3,000 Decrease in inventories 2,000 Increase in prepaid expense (4,000) Decrease in accounts payable (2,000) Decrease in accrued liabilities (8,600) Loss on sale of equipment 4,000 Decrease in deferred tax liability (11,000) Net cash used by operating activities $(8,000) Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

27) Comparative financial statements for Tomtric Company follow: Tomtric Company Balance Sheets December 31, 2022 and 2023 Assets

2022

2023

Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets

$18,000 25,000 22,000 10,000 75,000

$15,000 22,000 20,000 14,000 71,000

Long-term assets Property, plant, and equipment Less: Accumulated depreciation Net property, plant, and equipment Total assets

25,000 80,000 (64,000) 16,000 $116,000

7,000 77,000 (61,000) 16,000 $94,000

$8,000 15,000 23,000 18,000 15,000 56,000

$6,000 6,400 12,400 12,000 4,000 28,400

20,000 40,000 60,000 $116,000

30,000 35,600 65,600 $94,000

$70,000 40,000 30,000 5,000 15,000 10,000 4,000 6,000 2,400 $3,600

Answer:

Tomtric Company Statement of Cash Flows For the year ended December 31, 2023

Operating Activities: Cash collected from customers Cash paid for merchandise Cash paid to other suppliers Cash paid for income taxes Net Cash Used by Operating Activities

$73,000 (40,000) (27,600) (13,400) $(8,000)

Detailed calculations: Sales revenue (as reported) Add: Decrease in accounts receivable Cash collected from customers

$70,000 3,000

Cost of goods sold (as reported) Less: Decrease in inventory Add: Decrease in accounts payable Cash paid for merchandise

40,000 (2,000) 2,000

Operating expenses (as reported) Add: Increase in prepaid expenses Add: Decrease in accrued liabilities Cash paid to other suppliers

15,000 4,000 8,600

Income tax expense (as reported) Add: Decrease in Deferred Tax Liability Income taxes paid

2,400 11,000

$73,000

40,000

27,600

Diff: 1 Objective: 22.4 IFRS/GAAP: GAAP AACSB: Application of knowledge

13,400

22.5

Investing Cash Flows

1) Cash flows from investing activities on the statement of cash flows include receipts of cash from the collection of notes receivable and from the sale of fixed assets. Answer: TRUE Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Cash flows from investing activities on the statement of cash flows include receipts of cash from the sale of investments and from issuing bonds. Answer: FALSE Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) The calculation of cash flows from investing activities on the statement of cash flows begins with net income. Answer: FALSE Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) When preparing the investing activities section of the cash flow statement under both U.S. GAAP and IFRS, firms report acquisitions of fixed assets separate from sales of fixed assets. Answer: TRUE Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) The investing cash flows section of the statement of cash flows is based on an analysis of the balance sheet accounts for noncurrent assets and noncurrent liabilities. Answer: FALSE Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which of the following is a cash outflow from investing activities? A) lending cash B) payment of dividends C) proceeds from sale of fixed assets D) purchase of merchandise inventory Answer: A Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following is not a cash inflow from investing activities? A) sale of fixed assets B) collection of notes receivable C) purchase of treasury stock D) sale of held-to-maturity bond investment Answer: C Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) In a statement of cash flows, the cash flows from investing activities section should report ________. A) the factoring of accounts receivable B) a major overhaul of equipment C) stock dividends received D) the issuance of common stock in exchange for a factory building Answer: B Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) Firms report cash flows from investing activities using the ________. A) gross method B) net method C) indirect method D) direct method Answer: A Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Ralirali Corporation's financial statements included the following amounts for the current year: Issued new shares of preferred stock Loaned cash to key supplier Bought new delivery truck for cash Proceeds from the sale of used production machinery Sold treasury stock

$98,000 24,000 59,000 29,000 31,000

Based on this information, what is the amount of net cash provided (used) by investing activities? A) $30,000 net inflow B) $54,000 net inflow C) $54,000 net outflow D) $5,000 net outflow Answer: C Explanation: Loaned cash to key supplier $(24,000) Purchased new delivery truck (59,000) Proceeds from sale of machinery 29,000 Net cash used by investing activities $(54,000) Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Tandoor Inc. financial statements included the following amounts for the current year: Retired bonds Proceeds from collection of note receivable Dividends received Acquired production machinery with cash Sold treasury stock

$73,000 31,000 45,000 59,000 39,000

Based on this information, what is the amount of net cash provided (used) by investing activities? A) $90,000 net inflow B) $14,000 net inflow C) $28,000 net outflow D) $34,000 net outflow Answer: C Explanation: Proceeds from collection of note receivable $31,000 Acquisition of production machinery (59,000) Net cash used by investing activities $(28,000) Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) What types of accounts are typically affected by investing cash flows in the statement of cash flows? Answer: The investing cash flows section is based on an analysis of the balance sheet accounts for property, plant, and equipment; short-term investments other than cash equivalents; long-term investments; intangible assets; and other long-term assets such as long-term receivables. Diff: 1 Objective: 22.5 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Comparative financial statements for Tomtric Company follow: Tomtric Company Balance Sheets December 31, 2022 and 2023 Assets

2022

2023

Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets

$18,000 25,000 22,000 10,000 75,000

$15,000 22,000 20,000 14,000 71,000

Long-term assets Property, plant, and equipment Less: Accumulated depreciation Net property, plant, and equipment Total assets

25,000 80,000 (64,000) 16,000 $116,000

7,000 77,000 (61,000) 16,000 $94,000

$8,000 15,000 23,000 18,000 15,000 56,000

$6,000 6,400 12,400 12,000 4,000 28,400

20,000 40,000 60,000 $116,000

30,000 35,600 65,600 $94,000

$70,000 40,000 30,000 5,000 15,000 10,000 4,000 6,000 2,400 $3,600

22.6

Financing Cash Flows

1) On the statement of cash flows, the financing activities section is based on an analysis of the balance sheet accounts for noncurrent liabilities and equity. Answer: TRUE Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) On the statement of cash flows, cash flows from financing activities include receipts of cash from issuing bonds and capital stock. Answer: TRUE Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) On the statement of cash flows, the purchase of treasury stock is a source of cash from financing activities. Answer: FALSE Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) When preparing the financing activities section of the cash flow statement, dividends paid and dividends received are reported as separate line items in the financing section. Answer: FALSE Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Which of the following items would be reported in the financing activities section of the statement of cash flows? A) payment of dividends B) receipt of dividends C) lending cash to a customer D) receipt of cash from note receivable Answer: A Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which of the following items would not be reported in the financing activities section of the statement of cash flows? A) payment of dividends B) receipt from note receivable C) resale of treasury stock D) retirement of bonds payable Answer: B Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following is not a cash inflow from financing activities? A) issuance of stock B) sale of treasury stock C) purchase of bond investment D) sale of bonds payable Answer: C Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Svengool Inc. financial statements included the following amounts for the current year: Retired bonds Proceeds from collection of note receivable Dividends received Acquired production machinery Sold treasury stock

$68,000 40,000 11,000 59,000 42,000

Based on this information, what is the amount of net cash flows from financing activities? A) $110,000 net inflow B) $93,000 net inflow C) $42,000 net outflow D) $26,000 net outflow Answer: D Explanation: Net cash flows from financing is calculated based on the cash outflow for the retirement of bonds and cash inflows from the sale of treasury stock. Since the amount paid to retire bonds exceeds the proceeds from the sale of treasury stock, the net result is a cash outflow. $68,000 - $42,000 = $26,000. Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) PipCo financial statements included the following amounts for the current year: Retired preferred stock Loaned cash to key supplier Dividends paid Sold used delivery truck Issued new bonds

$60,000 17,000 23,000 44,000 71,000

Based on this information, what is the amount of net cash flows from financing activities? A) $88,000 net inflow B) $12,000 net inflow C) $12,000 net outflow D) $11,000 net outflow Answer: C Explanation: Net cash flows from financing is calculated based on the cash outflows from the retirement of preferred stock ($60,000) and the payment of dividends ($23,000) and the cash inflow from the issuance of new bonds ($71,000). Since the sum of the amounts paid to retire preferred stock and pay dividends ($60,000 + $23,000 = $83,000) is greater than the cash inflow from the issuance of new bonds ($71,000), the result is a net cash outflow of $12,000. Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) What types of accounts are typically affected by financing cash flows in the statement of cash flows? Answer: The financing cash flows section is based on an analysis of the long-term debt and equity balance sheet accounts. Diff: 1 Objective: 22.6 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Comparative financial statements for Tomtric Company follow: Tomtric Company Balance Sheets December 31, 2022 and 2023 Assets

2022

2023

Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets

$18,000 25,000 22,000 10,000 75,000

$15,000 22,000 20,000 14,000 71,000

Long-term assets Property, plant, and equipment Less: Accumulated depreciation Net property, plant, and equipment Total assets

25,000 80,000 (64,000) 16,000 $116,000

7,000 77,000 (61,000) 16,000 $94,000

$8,000 15,000 23,000 18,000 15,000 56,000

$6,000 6,400 12,400 12,000 4,000 28,400

20,000 40,000 60,000 $116,000

30,000 35,600 65,600 $94,000

$70,000 40,000 30,000 5,000 15,000 10,000 4,000 6,000 2,400 $3,600

12) Worldwide Corp.'s statement of financial position accounts as of December 31, 2023 and 2022 and information relating to 2023 activities are presented below. December 31, 2023 2022 Assets Cash $440,000 $160,000 Short-term investments 800,000 – Accounts receivable (net) 1,050,000 1,140,000 Inventory 1,130,000 1,000,000 Long-term investments 400,000 600,000 Plant assets 3,100,000 2,000,000 Accumulated depreciation (700,000) (900,000) Patent 280,000 300,000 Total assets $6,500,000 $4,300,000 Liabilities and Equity Accounts payable $1,460,000 $1,190,000 Other accrued liabilities 200,000 250,000 Notes payable (nontrade) 560,000 – Common Stock-$10 par 1,600,000 1,400,000 Additional paid-in capital 800,000 500,000 Retained earnings 1,880,000 960,000 Total liabilities and equity $6,500,000 $4,300,000 Information relating to 2023 activities: • Net income for 2023 was $1,220,000. • Equipment costing $1,000,000 and having a carrying amount of $320,000 was sold in 2023 for $360,000. New plant assets were acquired with cash in 2023. • A long-term investment was sold in 2023 for $345,000. There were no other transactions affecting longterm investments in 2023. • 20,000 ordinary shares were issued in 2023 for $25 a share. • Short-term investments consist of treasury bills maturing on 9/30/2024. a. What is the amount of net cash flows from operating activities, using the indirect method? b. What is the amount of net cash flows from financing activities? c. What is the amount of net cash flows from investing activities? d. Reconcile ending cash balance with beginning cash balance.

Answer: a. Net income Depreciation exp. (700,000+ 680,000 - 900,000) Patent amortization Gain on sale of fixed assets Gain on sale of long-term investment Add: Decrease in accounts receivable Add: Increase in accounts payable Deduct: Increase in inventory Deduct: Decrease in other accrued liabilities Net cash provided by operating activities

$1,220,000 480,000 20,000 (40,000) (145,000) 90,000 270,000 (130,000) (50,000) $1,715,000

b. Issue common stock Issue note payable Paid dividends (960,000 + 1,220,000 - 1,880,000) Net cash provided by financing activities

$500,000 560,000 (300,000) $760,000

c. Sell equipment Sell long-term investment Acquire short-term investments Acquire new plant assets Net cash used by investing activities

$360,000 345,000 (800,000) (2,100,000) $(2,195,000)

d. Cash, December 31, 2022 Net increase in cash*

$160,000 280,000

Cash, December 31, 2023 Net cash flows from operating activities Net cash flows from financing activities Net cash flows from investing activities *Net increase in cash

$440,000 $1,715,000 760,000 (2,195,000) $280,000

Diff: 2 Objective: 22.6 IFRS/GAAP: GAAP AACSB: Analytical thinking

22.7

Complexities in Determining Cash Flows

1) Under the indirect method, firms treat gains/losses from the sale of long-term assets as decreases/increases to net income in the operating activities section of the cash flow statement. Answer: TRUE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) An increase in a deferred tax liability is deducted from the accrual-basis tax expense to arrive at cash paid for income taxes. Answer: TRUE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) A decrease in a deferred tax asset is added to the accrual-basis tax expense to arrive at cash paid for income taxes. Answer: FALSE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Under the direct method, bad debt expense is ignored because it is a noncash expense. Answer: FALSE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) Unrealized gains and losses associated with available-for-sale investments reported through other comprehensive income do not have any cash flow effects. Answer: TRUE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Income from equity method investments must be added to net income to determine cash flows from operations under the indirect method. Answer: FALSE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Bad debt expense and share-based compensation expense must be added to net income to determine cash flows from operations under the indirect method. Answer: TRUE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) The total amount of share-based compensation expense and pension expense must be added to net income to determine cash flows from operations under the indirect method. Answer: FALSE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

9) When computing cash interest paid under the direct method, firms subtract the sum of bond discount amortization and the increase in interest payable from interest expense. Answer: TRUE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) Under the indirect method,bond discount amortization is subtracted from net income to arrive at operating cash flows. Answer: FALSE Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Which of the following is not treated differently for the direct and indirect methods of reporting cash flows on the statement of cash flows? A) share based compensation B) bad debts expense C) unrealized gains or losses for available-for-sale securities D) income from equity method investment Answer: C Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

12) When preparing the statement of cash flows using the indirect method, which of the following is subtracted from net income to determine cash flows from operations? A) losses from equity method investments B) increases in deferred-tax assets C) bond discount amortization D) unrealized gains from available-for-sale securities Answer: B Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) When preparing the statement of cash flows using the indirect method, which of the following is added to net income to determine cash flows from operations? A) payments to suppliers B) receipts from customers C) bond premium amortization D) unrealized losses from trading securities Answer: D Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

14) When using the indirect method to prepare the operating section of a statement of cash flows, which of the following is added to net income to compute cash flows from operating activities? A) gain on sale of long-term asset B) decrease in deferred tax liability C) bond discount amortization D) All of the above. Answer: C Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

15) How is net income adjusted for pension costs under the indirect method of preparing the statement of cash flows? A) If pension expense is greater than the amount funded, the difference between the two is added to net income. B) If pension expense is less than the amount funded, the difference between the two is added to net income. C) If pension expense is greater than the amount funded, the sum of the two is added to net income. D) If pension expense is less than the amount funded, the sum of the two is added to net income. Answer: A Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

16) Which of the following statements concerning the statement of cash flows is true? A) When pension expense exceeds cash funding, the difference is deducted from investing activities on the statement of cash flows. B) IFRS requires companies to classify all income taxes paid as operating cash outflows. C) Companies may report the cash flows from purchases and sales of trading investments as cash flows from operating activities. D) Under IFRS, the purchase of land by issuing common shares will be shown as a cash outflow under investing activities and a cash inflow under financing activities. Answer: C Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

17) In 2023, BayKing Company sold used equipment for $20,000. The equipment had an original cost of $90,000 and accumulated depreciation as of the date of sale was $69,000. BayKing also purchased held-tomaturity securities for $7,000. What is the gain or loss on the sale of the equipment? A) $14,000 loss B) $34,000 gain C) $1,000 loss D) $21,000 gain Answer: C Explanation: Sale price $20,000 – carrying value $21,000 ($90,000 - $69,000) = $1,000 loss. Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

18) In 2023, BayKing Company sold used equipment for $17,000. The equipment had an original cost of $80,000 and accumulated depreciation as of the date of sale was $60,000. BayKing also purchased held-tomaturity securities for $7,000. Net income for the year was $78,000. There were no other transactions conducted during the period. What are the 2023 net operating cash flows for BayKing under the indirect method? A) $75,000 B) $78,000 C) $81,000 D) $95,000 Answer: C Explanation: Sale price $17,000 – carrying value $20,000 ($80,000 - $60,000) = $3,000 loss. Net operating cash flow = Net income for year $78,000 plus the $3,000 loss on the sale of the equipment = $81,000. Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

19) In 2023, BayKing Company sold used equipment for $20,000. The equipment had an original cost of $80,000 and accumulated depreciation as of the date of sale was $60,000. BayKing also purchased held-tomaturity securities for $5,000. Net income for the year was $74,000. There were no other transactions conducted during the period. What are the net investing cash flows for BayKing? A) $25,000 B) $20,000 C) $5,000 D) $15,000 Answer: D Explanation: Net investing cash flow $5,000 = inflow from sale of equipment $20,000 less outflow for purchase of held-to-maturity securities $15,000. Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

20) In its first year of operations, Badonna Corp. reported Income Tax Expense of $52,000 and Income Tax Payable of $10,000. At the end of the year, Badonna reported a noncurrent Deferred Tax Liability of $5,000. What is the amount of cash paid for income taxes during the year? A) $37,000 B) $47,000 C) $17,000 D) $7,000 Answer: A Explanation: To calculate cash paid for income taxes using the direct method, income tax expense $52,000 is decreased by the increase in income tax payable of $10,000 and the increase in deferred tax liability of $5,000. Cash paid for taxes = $52,000 - $10,000 - $5,000 = $37,000. Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

21) Which of the following is added to net income when computing net cash from operating activities under the indirect method? A) increase in income tax payable B) increase in deferred tax asset C) decrease in deferred tax liability D) increase in income tax expense Answer: A Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

22) Tasbet Company reported net income of $400,000 for the current year. Included in the computation of net income was: Depreciation expense Amortization of a patent Income from an equity-method investment Dividends received on equity-method investment Amortization of a bond discount Paid a dividend on preferred stock

$70,000 32,000 35,000 0 15,000 80,000

What is the amount of net cash provided by operating activities that would be reported as a result of these transactions? A) $400,000 B) $482,000 C) $520,000 D) $537,000 Answer: B Explanation: To arrive at net cash from operating activities, net income is increased by depreciation expense ($70,000), amortization of a patent ($32,000), and amortization of a bond discount ($15,000). Net income is decreased by the excess of income from an equity-method investment ($35,000) over dividends received (which are $0 in this problem). Dividends paid are a financing activity. Net cash provided by operating activities = $400,000 + $70,000 + $32,000 + $15,000 - $35,000 = $482,000. Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

23) In 2023, Quintin Corp. reported net income of $254,000. Other transactions included: Depreciation expense Amortization of a bond premium Income from an equity-method investment Dividends received from equity-method investment Purchase of treasury shares Paid a dividend on preferred stock

$50,000 9,500 36,000 0 125,000 60,000

What is the amount of net cash flows from operations? A) $254,000 B) $258,500 C) $158,500 D) $249,500 Answer: B Explanation: To compute net cash from operations, net income is increased by depreciation expense and decreased by amortization of a bond premium as well as the excess of income from an equity-method investment over dividends received ($0 in this problem). The purchase of treasury shares and payment of dividends are not operating activities. Net cash provided by operating activities = Net income $254,000 + Depreciation $50,000 – Bond premium Amortization $9,500 – Income from equity-method investment $36,000 = $258,500. Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

24) What is the proper treatment of pension expense when computing net cash from operating activities using the indirect method? A) net income is increased by the excess of the expense over the cash used to fund the plan B) net income is increased by the sum of the expense plus the cash used to fund the plan C) net income is increased by pension expense D) net income is decreased by the cash used to fund the plan Answer: A Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

25) Explain how the treatment of gains and losses on the sale of long-term assets differ between the indirect and direct methods when preparing the statement of cash flows. Answer: Under the indirect method, firms treat gains and losses as adjustments to net income (deducting gains and adding losses) and report the total cash proceeds from the sale of long-term assets in the investing activities section. Under the direct method, firms include all of the cash proceeds from the sale of property, plant, and equipment in the investing section of the statement of cash flows, with no adjustment needed in operating activities. Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

26) Explain how the treatment of deferred tax assets and liabilities differ between the indirect and direct methods when preparing the statement of cash flows. Answer: Under the direct method, in the operating activities section, income tax expense is adjusted by adding a decrease in a deferred tax liability or an increase in a deferred tax asset or subtracting an increase in a deferred tax liability or a decrease in a deferred tax asset. Under the indirect method, in the operating activities section, net income is adjusted by subtracting a decrease in a deferred tax liability or an increase in a deferred tax asset or adding an increase in a deferred tax liability or a decrease in a deferred tax asset. Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

27) What are the cash flow effects of unrealized gains or losses from available-for-sale securities reported through other comprehensive income? Explain. Answer: Unrealized gains and losses from available-for-sale securities reported through other comprehensive income do not have any cash flow effects. The write-up or write-down to fair value changes the carrying value of the investment, with the unrealized gain or loss reported in accumulated other comprehensive income in the equity section of the balance sheet. The unrealized gains and losses are not reported on the statement of cash flows. Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

28) In 2023, BayKing Company sold used equipment for $17,000. The equipment had an original cost of $80,000 and accumulated depreciation as of the date of sale was $60,000. BayKing also purchased held-tomaturity securities for $7,000. Net income for the year was $75,000. There were no other transactions conducted during the period. 1. What is the gain or loss on the sale of the equipment? 2. What are the 2023 net operating cash flows for BayKing? 3. What are the 2023 net investing cash flows for BayKing? Answer: 1. The book value of the equipment is $80,000 original cost - $60,000 accumulated depreciation = $20,000. Since it was sold for $17,000, there was a loss of $17,000 sale price - $20,000 book value = $3,000 loss. 2. Losses are added back to net income to arrive at operating cash flows, making net operating cash flow = $75,000 + $3,000 = $78,000. 3. There is a $17,000 investing cash inflow from the sale of the equipment less the $7,000 cash outflow for the purchase of securities, for a net investing cash inflow of $10,000. Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

29) Horton Industries reported net income of $150,000 for the current year. The balances in its accounts receivable and allowance for bad debts accounts are shown below: Account Accounts Receivable Allowance for Uncollectible Accounts

12/31/2023 $52,000 10,000

1/1/2023 $45,000 7,000

In addition, the company recorded $11,000 of bad debt expense and wrote off $8,000 of uncollectible accounts. There are no other relevant transactions or account balances. Prepare the operating section of the cash flow statement under the indirect method. Answer: Net Income $150,000 Add: Bad Debt Expense 11,000 Less: Increase in Accounts Receivable* (15,000) Net Cash Provided by Operating Activities $146,000 * Ending A/R - Beginning A/R + Write-off = $52,000 - $45,000 + $8,000 = $15,000

Diff: 1 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

30) In its first year of operations, Badonna Corp. reported Income Tax Expense of $50,000 and Income Tax Payable of $16,000. At the end of the year, Badonna reported a noncurrent Deferred Tax Liability of $5,000. What is the amount of cash paid for income taxes during the year? Answer: Income Tax Expense $50,000 - Increase in Income Tax Payable (16,000) - Increase in Deferred Tax Liability (5,000) Cash Paid for Income Taxes $29,000 Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP/IFRS AACSB: Analytical thinking

31) Larkin Company reported net income of $500,000 for the current year. Included in the computation of net income were: Depreciation expense Amortization of a patent Income from an equity-method investment Dividend received from equity-method investment Amortization of a bond discount Paid a dividend on preferred stock

$100,000 30,000 50,000 5,000 40,000 80,000

What is the amount of net cash provided by operating activities that would be reported as a result of these transactions? Answer: Net income $500,000 + Depreciation expense 100,000 + Amortization of a patent 30,000 + Amortization of a bond discount 40,000 - Excess of income from an equity-method investment over dividends received (45,000) Net cash provided by operating activities $625,000 Diff: 2 Objective: 22.7 IFRS/GAAP: GAAP AACSB: Analytical thinking

22.8

Cash Flow Statement Disclosures

1) Both U.S. GAAP and IFRS require that an entity disclose its policy regarding cash equivalents. Answer: TRUE Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

2) Disclosures about noncash financing and investing activities must be presented in a summary schedule below the statement of cash flows. Answer: FALSE Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

3) Even if the firm uses the indirect method for the statement of cash flows, it must disclose the total amount of income taxes paid during the period. Answer: TRUE Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

4) Both U.S. GAAP and IFRS require a reconciliation of net income to net cash provided by operations, when using the direct method for the statement of cash flows. Answer: FALSE Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

5) IFRS, but not U.S. GAAP, requires that companies disclose any cash balances that are held but not available for use. Answer: TRUE Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

6) Which of the following is not a required disclosure item for the statement of cash flows? A) interest and taxes paid when the indirect method is used B) reconciliation of net income to total net cash flows C) all significant noncash investing and financing activities D) policy regarding cash equivalents Answer: B Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

7) Which of the following is not a required disclosure item for the statement of cash flows? A) interest and taxes paid when the indirect method is used B) reconciliation of net income to net cash provided by operating activities under the direct method C) all noncash investing and financing activities D) policy regarding cash equivalents Answer: C Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

8) Which of the following is not a cash flow disclosure required by IFRS? A) a reconciliation of net income to net cash provided by operations under the direct method B) any cash balances that are held but not available for use C) policy regarding cash equivalents D) all significant noncash investing and financing activities Answer: A Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP AACSB: Application of knowledge

9) List each of the four disclosure items for the statement of cash flows required by both U.S. GAAP and IFRS. Answer: Both U.S. GAAP and IFRS require that an entity disclose its policy regarding cash equivalents, all significant noncash investing and financing activities, interest and taxes paid when the indirect method is used and restrictions on cash and cash equivalents. Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

10) How does IFRS differ from U.S. GAAP with respect to disclosures for the statement of cash flows? Answer: IFRS does not require a reconciliation of net income to net cash provided by operations under the direct method, but it has additional disclosure requirements. IFRS requires that companies disclose any cash balances that are held but not available for use. For example, a company may operate a subsidiary in a country where there are foreign exchange controls or other legal restrictions prohibiting the conversion of cash. IFRS also requires that the entity provide adequate disclosure to explain changes in financing liabilities arising from both cash and noncash changes. Finally, IFRS encourages management to comment on any additional information that could be relevant to users in understanding a company's financial position and its liquidity, such as available borrowing arrangements and cash flows by business segments. Diff: 1 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

11) Comparative financial statements for Tomtric Company follow: Tomtric Company Balance Sheets December 31, 2022 and 2023 Assets

2022

2023

Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets

$18,000 25,000 22,000 10,000 75,000

$15,000 22,000 20,000 14,000 71,000

Long-term assets Property, plant, and equipment Less: Accumulated depreciation Net property, plant, and equipment Total assets

25,000 80,000 (64,000) 16,000 $116,000

7,000 77,000 (61,000) 16,000 $94,000

$8,000 15,000 23,000 18,000 15,000 56,000

$6,000 6,400 12,400 12,000 4,000 28,400

20,000 40,000 60,000 $116,000

30,000 35,600 65,600 $94,000

$70,000 40,000 30,000 5,000 15,000 10,000 4,000 6,000 2,400 $3,600

Additional data on activities during 2023 are as follows: • During 2023, Tomtric Company sold used equipment for $3,000 that had cost $15,000 with accumulated depreciation of $8,000. • New equipment was purchased for $12,000 cash. • Cash dividends totaling $8,000 were paid. • Long-term investments that had cost $18,000 when purchased were sold for $18,000. • Common stock was issued for $10,000. Required: a. Prepare the operating activities section of the statement of cash flows using the indirect method. b. Prepare the operating activities section of the statement of cash flows using the direct method. c. Prepare the investing activities section of the statement of cash flows. d. Prepare the financing activities section of the statement of cash flows. Answer: a. Tomtric Company Statement of Cash Flows For the year ended December 31, 2023 Operating activities: Net income $3,600 Adjustments to reconcile net income to net cash used by operating activities: Depreciation expense 5,000 Decrease in accounts receivable 3,000 Decrease in inventories 2,000 Increase in prepaid expense (4,000) Decrease in accounts payable (2,000) Decrease in accrued liabilities (8,600) Loss on sale of equipment 4,000 Decrease in deferred tax liability (11,000) Net cash used by operating activities $(8,000)

Tomtric Company Statement of Cash Flows For the year ended December 31, 2023

Operating activities: Cash collected from customers Cash paid for merchandise Cash paid to other suppliers Cash paid for taxes Net cash used by operating activities Calculations (not part of statement): Sales revenue (as reported) Add: Decrease Accounts Receivable Cash collected from customers

$73,000 (40,000) (27,600) (13,400) ($8,000)

$70,000 3,000

Cost of goods sold (as reported) Less: Decrease in inventory Add: Decrease in accounts payable Cash paid for merchandise

40,000 (2,000) 2,000

Paid to suppliers Operating expenses (as reported) Adjustments to a cash basis: Add: Increase in prepaid expenses Add: Decrease in accrued liabilities Cash paid to other suppliers

d. Financing activities: Sale of common stock Paid dividends to owners Paid off bonds payable Net cash used for financing activities Diff: 3 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

40,000

15,000 4,000 8,600

Income tax expense (as reported) Add: Decrease Deferred Tax Liability Income taxes paid c. Investing activities: Sale of long-term investment Sale of equipment Purchase equipment Net cash provided from investing activities

$73,000

(27,600)

2,400 11,000 13,400

$18,000 3,000 (12,000)

$10,000 (8,000) (6,000)

$9,000

$(4,000)

12) Comparative financial statements for Jackson Company follow: Jackson Company Balance Sheets December 31, 2022 and 2023 Assets

2022

2023

Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets

$20,000 25,000 23,000 10,000 78,000

$15,000 22,000 20,000 19,000 76,000

Long-term assets Property, plant, and equipment Less: Accumulated depreciation Net property, plant, and equipment Total assets

31,400 80,000 (64,000) 47,400 $125,400

7,000 77,000 (61,000) 23,000 $99,000

$9,000 15,000 24,000 26,400 15,000 65,400

$6,000 6,400 12,400 12,000 4,000 28,400

20,000 40,000 60,000 $125,400

35,000 35,600 70,600 $99,000

Jackson Company Income Statement For the year ended December 31, 2023 Sales Cost of goods sold Gross margin Depreciation expense Other operating expenses Operating income Loss on sale of equipment Income before taxes Income tax expense Net income

$85,000 50,000 35,000 6,000 15,000 14,000 4,000 10,000 3,000 $7,000

Additional data on activities during 2023 are as follows: • During 2023, Jackson Company sold used equipment for $3,000 that had cost $15,000 with accumulated depreciation of $8,000. • New equipment was purchased for $15,000 cash. • Cash dividends totaling $5,000 were paid. • Long-term investments that had cost $20,000 when purchased were sold for $20,000 cash. • Common stock was issued for $15,000. Required: Prepare the entire statement of cash flows using the indirect method.

Answer:

Jackson Company Statement of Cash Flows For the year ended December 31, 2023

Operating activities: Net income Adjustments to reconcile net income to net cash used by operating activities: Depreciation expense Decrease in accounts receivable Decrease in inventories Increase in prepaid expense Decrease in accounts payable Decrease in accrued liabilities Loss on sale of equipment Decrease in deferred tax liability Net cash used by operating activities

$7,000

6,000 3,000 3,000 (9,000) (3,000) (8,600) 4,000 (11,000) $(8,600)

Investing activities: Sale of long-term investment Sale of equipment Purchase equipment Net cash provided from investing activities

$20,000 3,000 (15,000)

Financing activities: Sale of common stock Paid dividends to owners Paid off bonds payable Net cash used for financing

$15,000 (5,000) (14,400)

$8,000

$(4,400)

Decrease in Cash Beginning Cash Balance Ending Cash Balance

($5,000) $20,000 $15,000

Diff: 3 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge

13) Comparative financial statements for Jackson Company follow: Jackson Company Balance Sheets December 31, 2022 and 2023 Assets

2022

2023

Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets

$20,000 25,000 23,000 10,000 78,000

$15,000 22,000 20,000 19,000 76,000

Long-term assets Property, plant, and equipment Less: Accumulated depreciation Net property, plant, and equipment Total assets

31,400 80,000 (64,000) 47,400 $125,400

7,000 77,000 (61,000) 23,000 $99,000

$9,000 15,000 24,000 26,400 15,000 65,400

$6,000 6,400 12,400 12,000 4,000 28,400

20,000 40,000 60,000 $125,400

35,000 35,600 70,600 $99,000

$85,000 50,000 35,000 6,000 15,000 14,000 4,000 10,000 3,000 $7,000

Answer:

Jackson Company Statement of Cash Flows For the year ended December 31, 2023

Operating activities: Cash collected from customers* Cash paid for merchandise** Cash paid to other suppliers*** Cash paid for taxes**** Net cash used by operating activities

$88,000 (50,000) (32,600) (14,000)

Investing activities: Sale of long-term investment Sale of equipment Purchase equipment Net cash provided from investing activities

$20,000 3,000 (15,000)

Financing activities: Sale of common stock Paid dividends to owners Paid off bonds payable Net cash used for financing

$15,000 (5,000) (14,400)

$(8,600)

$8,000

$(4,400)

Decrease in Cash Beginning Cash Balance Ending Cash Balance

($5,000) $20,000 $15,000

Calculations for Operating activities: *Cash collected from customers Sales revenue Add: Decrease Accounts Receivable Cash collected from customers

$85,000 3,000 $88,000

**Cash paid for merchandise Cost of goods sold Less: Decrease in inventory Add: Decrease in accounts payable Cash paid for merchandise

$50,000 (3,000) 3,000 $50,000

***Cash paid to other suppliers Operating expenses Add: Increase in prepaid expenses Add: Decrease in accrued liabilities Cash paid to other suppliers

$15,000 9,000 8,600 $32,600

****Cash paid for taxes Income tax expense Add: Decrease Deferred Tax Liability Cash paid for taxes

3,000 11,000 $14,000

Diff: 3 Objective: 22.8 IFRS/GAAP: GAAP/IFRS AACSB: Application of knowledge