TEST BANK for Financial Reporting and Analysis, 8th Edition. By Revsine, Collins, Johnson, Mittelsta by StudyGuide

CHAPTER 1_ TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The role of financial accounting information is to facilitate economic transactions and to foster efficient allocation of resources among businesses and individuals. ⊚ ⊚

true false

2) Financial reports provide information that can reduce investors’ uncertainty about the company’s opportunities and risks, thereby raising the company’s cost of capital. ⊚ ⊚

true false

3) Comparability across companies allows analysts to identify real economic similarities in and differences between underlying economic events because those similarities or differences are not obscured by accounting methods or disclosure practices. ⊚ ⊚

true false

4) Executive compensation contracts seldom contain annual bonus and longer term pay components tied to financial statement results, but instead usually rely on stock options as a means to reward managers in a manner that is less subject to manipulation by management. ⊚ ⊚

true false

5) Congress stipulated that the SEC develop rules for companies to disclose information on use of “conflict minerals.”

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true false

6) The public and private sector regulatory agencies establish and enforce financial reporting requirements designed to ensure that companies meet certain minimum levels of financial disclosure. ⊚ ⊚

true false

7) Although the SEC has the ultimate legal authority to set accounting principles in the U.S., it has looked to private-sector organizations (e.g., the FASB) to establish and enforce these principles. ⊚ ⊚

true false

8) Management has considerable discretion over the particular accounting procedures used in the financial statements and over the details contained in related note disclosures. ⊚ ⊚

true false

9) Accounting standard-setting in the U.S. is a technical process and thus little affected by political considerations. ⊚ ⊚

true false

10) Government regulation provides the primary motivation for firms to disclose sustainability-related information. ⊚ ⊚

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true false

11) While an increasing percentage of companies report on sustainability, consistency in reporting continues to provide challenges for information users. ⊚ ⊚

true false

12) The IASB and FASB have worked together to develop a single set of high-quality, understandable, enforceable and globally accepted international financial reporting standards. ⊚ ⊚

true false

13) Foreign companies registered with the SEC that use IFRS no longer have to reconcile their financial statements to U.S. GAAP. ⊚ ⊚

true false

14) U.S. GAAP has been criticized as being too "rules-based" thus allowing managers to invent "loopholes" that conform to the letter of a standard but simultaneously violate its spirit. ⊚ ⊚

true false

15) The goal of the movement toward international convergence of accounting standards is a single set of accounting standards accepted worldwide and superior to the choices presently available. ⊚ ⊚

true false

16) Regulators of industries granted monopoly privileges use financial statement data in setting the rates companies are permitted to charge for the services these industries provide. ⊚ ⊚

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true false

17) Owners and managers have an economic incentive to supply the amount and type of financial information that will enable the company to raise capital at the lowest cost. ⊚ ⊚

true false

18) Financial statement information can help customers monitor a supplier’s manufacturing processes and thus evaluate the quality of its products. ⊚ ⊚

19)

true false

The conceptual framework for financial reporting includes the standards of GAAP. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 20) A company’s financial statements reflect information about:

A) future projections of sales, expenses, and other future economic events. B) product information and competitive positions. C) the general economy of the industry in which the company operates. D) economic events that affect a company that can be translated into accounting numbers.

21)

All financial statements:

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A) provide a picture of the company at a moment in time. B) describe changes that took place over a period of time. C) help to evaluate what happened in the past. D) contain the most up to date information about the company.

22)

A firm’s financial statements contain trends that give users insight into the firm’s:

A) future market share. B) position within its industry. C) profitability, productivity, and liquidity. D) current market price for common and preferred stock.

23)

The ability to raise additional cash by selling assets, issuing stock, or borrowing more is:

A) financial flexibility. B) a credit risk indicator. C) a stock price predictor. D) one way to project earnings.

24) Creditors assess credit risk by comparing a firm’s required principal and interest payments to estimates of the firm’s current and future:

A) net assets. B) gross income. C) net income. D) cash flows.

25) Professional analysts need information on a company’s future earnings and cash flow to evaluate audit vulnerabilities, to assess debt repayment prospects and to:

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A) certify good values in the stock market. B) indemnify creditors against losses. C) certify that no fraud exists in the company. D) value its equity securities.

26)

The costs of providing financial information is ultimately borne by:

A) management. B) shareholders. C) auditors. D) professional analysts.

27) Which of the following statements is not correct regarding a company's financial statements?

A) They may present a picture of the company at a moment in time. B) They may describe changes that took place over a period of time . C) They reflect economic events that affect the company. D) They are comparable to the statements of other companies as all publicly held companies follow the very precise science of accounting.

28) Which of the following are correct with respect to information contained in financial statements?

A) Information asymmetry occurs when management has access to more and better information than is presented in the financial statements. B) Financial statements cannot solve the issue of information asymmetry. C) Financial statements eliminate the issue of and any concern over information asymmetry. D) Financial statements help solve the issue of information asymmetry which is when management has access to more and better information than do people outside the company.

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29)

Which is not correct regarding Regulation Fair Disclosure (Reg FD)?

A) It helps level the playing field between individual and institutional investors. B) It does not limit what management can say in private conversations with analysts or investors. C) It was passed by the SEC. D) It limits what management can say in private conversations with analysts and investors.

30) Companies that have projected operating cash flows that are more than sufficient to meet debt payments are

A) financially risky. B) good credit risk companies. C) undervalued. D) overvalued.

31) Investors who compare a firm’s discounted future cash flows to the current market price of a stock are using the:

A) efficient market hypothesis. B) market-to-market approach. C) fundamental analysis approach. D) technical analysis approach.

32)

A company’s financial statements can be used for all of the following purposes except:

A) as a scorecard on the company’s social responsibility. B) as a management report card. C) as an early warning signal. D) as a measure of accountability.

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33)

The market analysis known as fundamental analysis:

predicts future trends in the financial drivers of a company’s economic success or

failure. B) relies on price and volume movement of stock. C) has no insights about company value beyond current market price. D) uses microeconomic data to forecast stock values.

34)

Investors who follow a fundamental analysis approach:

A) determine the value the company’s assets would yield if sold individually. B) estimate the value of a stock by assessing the amount, timing, and uncertainty of future cash flows that will accrue to the issuing company. C) assess the company’s ability to meet its debt-related financial obligations. D) assess the company’s ability to raise additional cash by selling assets, issuing stock, or borrowing more.

35)

In designing audit procedures the auditor will include all of the following except:

A) Industry conditions. B) Global economic trends. C) Assessing the reasonableness of the numbers in relation to the company's activities. D) Fraud risk factors that may be present.

36)

Analytical review procedures include all of the following except:

A) simple ratio and trend analysis. B) complex statistical techniques. C) general reasonableness tests. D) comparison of the company’s reported financial results to benchmarks established by the SEC.

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37)

Relevant financial information:

A) is free from bias and error. B) is measured in a similar manner among different companies. C) can be independently verified. D) is capable of making a difference in a decision.

38)

To achieve faithful representation, the financial information must be:

A) consistent, unbiased, and relevant. B) relevant, comparable, and timely. C) relevant, consistent, and timely. D) complete, neutral, and free from material error.

39) Financial information that is provided to decision makers before it loses its capacity to influence their decisions is:

A) neutral. B) verifiable. C) timely. D) consistent.

40)

Financial information which does not favor one set of interested parties over another is:

A) relevant. B) verifiable. C) neutral. D) faithfully represented.

41)

Employees demand financial information for all of the following except:

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A) Monitoring profit sharing and stock ownership plans. B) Monitoring current payroll tax liabilities. C) Monitoring the health of company pension plans. D) Monitoring union contracts that link negotiated wage increases to company financial performance.

42) Which of the following statements is correct with respect to economic incentives to release financial information?

A) Because companies have an economic incentive to supply information investors want, regulatory groups have little influence over the amount and type of financial information that companies disclose. B) Because financial disclosures are regulated, owners and managers have little economic incentive to supply the amount and type of financial information that will enable them to raise capital most cheaply. C) Companies have an economic incentive to supply the information investors want in order to raise capital at the lowest possible cost. D) Owners and managers do not have an economic incentive to supply the amount and type of financial information because it has no effect on the company’s ability to raise capital atthe lowest cost.

43)

Which statement below describes efficient market investors?

A) They presume they have no insight beyond the share price. B) They believe that any new development is quickly and correctly reflected in the stock price. C) They use financial statements to assess risk and dividend yields to make portfolio decisions. D) All of these answer choices are correct.

44) Which of the following create a competitive disadvantage according to the full disclosure principle?

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A) Details about the company’s strategies, plans and tactics. B) Information about the company’s technological and managerial innovations. C) Detailed information about the company’s operations. D) All of these answer choices are correct.

45) When independent measurers get similar results when using the same accounting measurement methods, the financial information is:

A) relevant. B) verifiable. C) timely. D) faithfully represented.

46)

Being verifiable and neutral is part of what makes financial information:

A) useful. B) consistent. C) comparable. D) relevant.

47) If a company fails to disclose information about a lawsuit because it might be embarrassing to the company, it is violating:

A) relevance. B) verifiability. C) neutrality. D) timeliness.

48) Which of the following is not an accurate statement related to the demand for financial reporting?

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A) Economically realistic reporting standards are low when there are few important capital providers. B) Cross-country differences have no impact on capital funding opportunities and financial reporting practices. C) External investors who provide capital demand a reporting system that accurately depicts a company past economic performance and its future prospects. D) Comprehensive financial data is demanded when there is a broad base of external investors.

49)

Financial information capable of making a difference in a decision is:

A) relevant. B) verifiable. C) consistent. D) neutral.

50) Business enterprises enter into many different types of contracts. Examples of such contracts that often contain language that refers to verifiable financial statement numbers include all of the following except:

A) royalty contracts with inventors. B) sales contracts with customers. C) compensation contracts with managers. D) debt contracts with bankers.

51) What type of trends and relationships can be gleaned from a company's financial statements?

A) Rates of sales and accounts receivable growth. B) Rates of expense growth and expenses as a percentage of sales. C) How the company's growth rates compare to their competitors. D) All of these answer choices are correct.

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52) The type of analysis that uses financial statements to assess a company’s current market price is:

A) valuation analysis. B) efficient market analysis. C) fundamental analysis. D) technical analysis.

53) When financial statements are used by shareholders and investors to evaluate the performance of a company’s top executives it is referred to as the function of financial reports.

A) proxy. B) fundamental. C) technical. D) stewardship.

54)

Which statement is not true regarding the conservatism convention in accounting?

A) Conservatism guides us to choose the approach that leads to lower assets or higher liabilities. B) Conservatism means we only record that of which we are 100% certain. C) Conservatism is sometimes used to defend poor accounting judgments. D) Conservatism strives to ensure that business risks and uncertainties are adequately reflected in the financial statements.

55) Investors who presume that they have no insights about company value beyond the current market price and use financial statement data to assess firm-specific attributes believe in the:

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A) market-to-market hypothesis. B) efficient market hypothesis. C) fundamental market hypothesis. D) technical market hypothesis.

56) Which of the following people outside the company do not demand financial statement information as a key input?

A) Suppliers and Lenders. B) Government and Regulatory Agencies. C) Competitors. D) Customers.

57)

Which item below does not describe a politically vulnerable firm?

A) The firm has contracts controlled by the government. B) The firm may face antitrust litigation or loss of protective import quotas. C) The firm is in a highly visible industry such as oil & gas or pharmaceuticals. D) The firm may be attacked in the financial and popular press for generating high earnings.

58) Which of the following are primary qualitative characteristics of accounting information?

A) Relevance and Timeliness. B) Relevance and Faithful Representation. C) Comparability and Timeliness. D) Verifiability and Understandability.

59) To achieve Faithful Representation, accounting information presented must meet which of the following requirements?

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A) It must be comparable so that analysts can use it. B) It must have predictive and confirmatory value. C) It must depict the underlying economic event, be complete, neutral, and free from material error. D) It must meet a materiality threshold.

60)

The amounts of executive compensation and bonuses are often determined by:

A) auditor’s recommendations. B) evaluations by subordinates. C) company compensation contracts. D) industry guidelines.

61) Whose responsibility is it to ensure that the company’s financial information is properly assembled, classified, characterized, and presented clearly and concisely in order to make it understandable?

A) The public accounting firm performing the audit. B) The SEC by enforcing reporting standards. C) Management of the company publishing the statements. D) FASB when drafting generally accepted accounting principles.

62) Which of the following is not an action taken by shareholders when the earnings and share price fall below acceptable levels?

A) Letters to management and outside directors. B) Phone calls to management and outside directors. C) Launching a proxy contest. D) Filing a lawsuit for the lost value of the share price.

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63) Employees demand financial statement information because the firm’s performance is often linked to all of the following except:

A) negotiated wage increases in union contracts. B) social security benefits. C) pension plan benefits. D) employee profit sharing.

64) When a borrower violates a loan covenant that requires minimum achievement of an accounting measure in the financial statements, the lender can:

A) immediately seize the loan collateral. B) fire the chief operating officer of the borrower. C) report the borrower to the IRS. D) call for immediate repayment of the loan.

65) Investors and analysts must have certain capabilities regarding financial reporting which include:

A) an understanding of current financial reporting standards. B) recognition that management selects the financial reporting standards used. C) an ability to recognize that financial statement information reported is grounded in judgment as well as facts. D) all of these answer choices are correct.

66) Kunze Company, an information technology firm, routinely discloses internet traffic to its product line-up site. Financial statement users may be using this information to help predict future

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A) equity. B) assets. C) liabilities. D) cash outflows.

67) The goal of generally accepted accounting principles is to ensure that a company’s financial statements:

A) do not contain any representation that could jeopardize management. B) provide stockholders all of the information they need to assess management’s performance. C) are accurate and free from fraud. D) clearly represent its economic condition and performance of the company.

68) Timeliness is a qualitative characteristic of accounting information that indicates that information should be provided to users:

A) within one month after the close of the books. B) before it loses its capacity to influence their decisions. C) before statutory deadlines. D) every month.

69) Which one of the following types of disclosure costs is the cost of disclosing the company’s pricing strategies?

A) Political cost B) Litigation cost C) Competitive disadvantage cost D) Information collection, processing, and dissemination cost

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70) If the financial reporting environment were unregulated, disclosure would occur voluntarily:

A) as long as other companies in the reporting company’s industry voluntarily disclosed financial information. B) only to analysts that the company believes will report favorably on the company’s prospects. C) only when managers wanted to raise additional capital. D) as long as the incremental benefits to the company from supplying financial information exceeded the incremental costs of providing the information.

71)

Companies offering higher risk securities have incentives to mask their true condition by:

A) supplying overly optimistic financial information. B) not having their financial statements audited. C) listing on foreign exchanges where reporting requirements are less stringent than those in the U.S. D) including testimonials from well-known executives in their financial statements.

72) One financial disclosure cost is the possibility that competitors may use the information to harm the company providing the disclosure. All of the following disclosures might create a competitive disadvantage except:

A) detailed information about company operations, such as sales and cost figures for individual product lines. B) information about the company’s technological and managerial innovations. C) information showing the company’s amount of spending on research and development. D) details about the company’s strategies, plans and tactics.

73)

It is common for shareholders to initiate litigation when:

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A) the company reports record profits, but does not declare dividends. B) there is a sudden drop in stock price shortly after the company released new financial information. C) the company introduces new products that are found to be harmful to the environment. D) rumors about the company appear in the media that, if true, would result in slower growth in future profits.

74) When comparing U.S. GAAP and IFRS standards, which of the following is not correct?

A) IFRS is principles-based while U.S. GAAP is rules-based. B) U.S. GAAP standards provide too many scope exceptions. C) IFRS provides more detailed guidance than U.S. GAAP. D) U.S. GAAP provides more detailed guidance than IFRS.

75) Using the same accounting methods to record and report similar events from period to period demonstrates:

A) consistency. B) comparability. C) neutrality. D) faithful representation.

76) Which one of the following has statutory authority to determine accounting rules for companies whose securities are owned by the general public?

A) American Institute of Certified Public Accountants B) State Boards of Accountancy C) Securities and Exchange Commission D) Financial Accounting Standards Board

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77) Which of the following does not describe how FASB endeavors to draft pronouncements?

A) Provide enough implementation guidance for consistent application. B) Explain the accounting principles being applied. C) Clearly define bright-line rules. D) Avoid bright line rules.

78) The growth of global investing has spurred development of worldwide accounting standards that are written by the:

A) American Institute of Certified Public Accountants. B) Institute of Global Auditors. C) Global Committee on Accounting Standards. D) International Accounting Standards Board.

79) The organization responsible for establishing auditing standards and inspecting and investigating auditing practices of public accounting firms is:

A) Congress under the authority of the Sarbanes-Oxley Act (SOX). B) the American Institute of Certified Public Accountants (AICPA). C) the Securities and Exchange Commission (SEC). D) the Public Company Accounting Oversight Board (PCAOB).

80) The only authoritative source of U.S. GAAP is created by FASB and exists in a single database known as:

A) the accounting standards database. B) FASB financial reporting standards. C) the converged accounting standards. D) the accounting standards codification.

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81) The ASC uses a structure in which the FASB’s authoritative accounting guidance is organized into all of the following except:

A) chapters. B) topics. C) sections. D) paragraphs.

82)

ASC content is organized:

A) alphabetically by topic. B) in chronological order based on the issue date of the major pronouncement on which the content is based. C) without numerical reference to the original standard from which the content was derived. D) in the manner prescribed by the IASB.

83)

GAAP’s flexibility in its reporting standards allows companies to:

A) smooth reported earnings over several reporting periods. B) change accounting estimates to meet target sales or earnings. C) change accounting principles to improve reported earnings. D) avoid adopting specific accounting techniques and reporting procedures.

84)

Financial statements follow:

A) rigid guidelines that require specific adherence to regulated procedures. B) generally accepted guidelines that allow management a degree of flexibility in choices. C) general guidelines with little choice among different procedures. D) legal requirements for uniform presentation and disclosure.

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85) A company manages a large portfolio of marketable securities and sells only stocks with substantial gains in poor income years or sells only stocks with substantial losses in good income years. This strategy is an indication of:

A) securities fraud. B) unstable portfolio management. C) income smoothing. D) violating security trading laws.

86) Identify the correct order of the three steps constituting the FASB’s "due process" procedure.

A) Public-hearing stage, exposure-draft stage, and voting stage. B) Discussion-memorandum stage, public-hearing stage, and voting stage. C) Exposure-draft stage, discussion-memorandum stage, and voting stage. D) Discussion-memorandum stage, exposure-draft stage, and voting stage.

87)

The Securities and Exchange Act of 1934 required all publicly traded firms to:

A) purchase insurance against corporate bankruptcy. B) register with an authorized stock exchange. C) provide annual financial statements audited by independent accountants. D) file balance sheets, income statements, and statements of cash flow with the SEC each year.

88) The Financial Accounting Standards Board has responsibility for the establishment of U.S. accounting standards and:

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A) full statutory power to enforce compliance with GAAP. B) authority from the SEC to enforce compliance with GAAP. C) no authority or responsibility to enforce compliance with GAAP. D) responsibility imposed by AICPA to enforce compliance with GAAP.

89) When financial information is measured and reported in a similar manner across different companies in the same industry it is:

A) consistent. B) comparable. C) neutral. D) faithfully represented.

90) When a company changes from straight-line to the declining balance method of accounting for depreciation, the financial statements lack:

A) comparability. B) consistency. C) neutrality. D) faithful representation.

91) The network of conventions, rules, guidelines, and procedures used by the accounting profession is known as generally accepted:

A) auditing standards. B) accounting procedures. C) accounting principles. D) auditing principles.

92) Omissions or misstatements within a financial statement which could influence the decisions of the user of the statement violates:

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A) neutrality. B) consistency. C) conservatism. D) materiality.

93) Which of the following organizations provides industry-specific frameworks to help assess and measure companies’ sustainability-related performance?

A) GRI. B) SASB. C) SEC. D) CDP.

94)

In the U.S., disclosure of climate change risks and performance is:

A) Required by law. B) Required by FASB. C) Required by the SASB. D) Voluntary.

95) Munster Inc, a U.S.-based multinational company, voluntarily issues a sustainability report consistent with the guidelines of the Global Reporting Initiative (GRI). The company’s report is audited by one of the Big 4 accounting firms. Munster reports significant detail related to the company’s environmental impact, use of renewable energy, and programs that benefit the community. Consistent with GRI guidelines, Munster Inc. also should report information on the following issues:

A) Corporate strategies. B) Governance. C) Stakeholder engagement. D) All of the these must be reported consistent with GRI guidelines.

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96) Which of the following most accurately describes the SEC’s current role in sustainability reporting? The SEC:

A) requires that all public companies report on their impact on climate change. B) has outlined how climate change could affect Regulation S-K disclosures. C) requires that Fortune 500 companies issue formal sustainability reports. D) is working closely with the GRI on uniform sustainability-related disclosure requirements.

97) Some countries’ philosophy of financial reporting differs from U.S. GAAP because their financial reports are required to:

A) be verifiable. B) conform to tax and/or commercial law. C) be reported and measured in a similar manner across companies. D) use the same accounting methods for similar events period to period.

98)

Differences between IFRS and U.S. GAAP include all of the following except:

A) Reversal of inventory write-downs. B) Carrying value of investment property. C) Revenue recognition. D) Research and development costs.

99) Financial reporting philosophies differ across countries. These philosophies evolve from and reflect several factors including all of the following except:

A) the language(s) spoken in the country. B) the specific political institutions within the country. C) the specific financial institutions within the country. D) the country’s social customs.

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100) Companies needing to access new and ever larger sources of capital in response to increased international competitiveness face a severe disadvantage if their financial reporting:

A) is in accordance with IFRS. B) is in accordance with U.S. GAAP. C) is based on a commercial and tax law approach. D) is based on an economic performance approach.

101) Which of the following accounting standards permit(s) companies to apply short-term lease accounting rules to low-value assets?

A) U.S. GAAP only. B) IFRS only. C) Both U.S. GAAP and IFRS. D) Neither U.S. GAAP nor IFRS.

102)

International financial reporting standards are currently established by the:

A) IASC. B) IASB. C) FASB. D) PCAOB.

103)

IFRS frequently:

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A) are automatically approved for any foreign listed company, as soon as a new standard is issued. B) permit only one accounting treatment for similar business transactions and events to promote comparability. C) allow firms less latitude when compared to U.S. GAAP. D) follow a more generalized overview approach than do U.S. GAAP counterpart standards.

104)

International Financial Reporting Standards (IFRS) are

A) built on broad principles. B) rules-based. C) narrowly defined, detailed standards. D) seldom different than those issued by the FASB.

105)

Which of the following statements regarding IFRS is incorrect?

A) All companies listed on the London Stock Exchange must use IFRS. B) The SEC-required Form 20-F must be filed with the SEC by foreign issuers within 30 days. C) The European Commission must "endorse" IFRS for required use by EU companies. D) The SEC has expressed concern that transitioning to IFRS might be prohibitively expensive and might lessen U.S. influence over standard setting.

106)

Accounting information is heavily regulated:

A) To increase reporting efficiency. B) With the intention of preventing market failure. C) To prevent abuse given that the incentives of information producers are not necessarily aligned with those of users. D) All of these answer choices are correct.

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107) When is it permissible to issue financial statements that contain a material departure from GAAP?

A) It is never permitted. B) When it is a non-US corporation. C) When the auditor can demonstrate that due to unusual circumstances the financial statements would otherwise have been misleading. D) When management does not like the GAAP results.

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Answer Key Test name: chapter 1 1) TRUE 2) FALSE 3) TRUE 4) FALSE 5) TRUE 6) TRUE 7) FALSE 8) TRUE 9) FALSE 10) FALSE 11) TRUE 12) TRUE 13) FALSE 14) TRUE 15) TRUE 16) TRUE 17) TRUE 18) FALSE 19) FALSE 20) D 21) C 22) C 23) A 24) D 25) D 26) B Version 1

27) D 28) D 29) B 30) B 31) C 32) A 33) A 34) B 35) B 36) D 37) D 38) D 39) C 40) C 41) B 42) C 43) D 44) D 45) B 46) A 47) C 48) B 49) A 50) B 51) D 52) C 53) D 54) B 55) B 56) C Version 1

57) A 58) B 59) C 60) C 61) C 62) D 63) B 64) D 65) D 66) D 67) D 68) B 69) C 70) D 71) A 72) C 73) B 74) C 75) A 76) C 77) C 78) D 79) D 80) D 81) A 82) C 83) A 84) B 85) C 86) D Version 1

87) C 88) C 89) B 90) B 91) C 92) D 93) B 94) D 95) D 96) B 97) B 98) C 99) A 100) C 101) B 102) B 103) D 104) A 105) B 106) D 107) C

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CHAPTER 2: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Accrual accounting decouples measured earnings from operating cash inflows and outflows. ⊚ ⊚

Cash-basis accounting provides the most useful measure of future operating performance. ⊚ ⊚

true false

Net asset valuation and net income determination are inextricably intertwined. ⊚ ⊚

true false

4) While the earnings process is the result of many separate activities, it is generally acknowledged that there is usually one critical event or key stage considered to be absolutely essential to the ultimate increase in net asset value of the firm. ⊚ ⊚

true false

5) The matching principle says that expenses are matched to the revenue recognized during the period, not that revenue is matched to the period’s expenses. ⊚ ⊚

true false

6) Period costs would include costs like advertising or insurance where the linkage between these costs and individual sales is difficult to establish. ⊚ ⊚

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true false

Traditional financial reporting presents forecasted cash flow information. ⊚ ⊚

true false

8) Gains and losses from continuing operations that are not typical recurring costs are presented as a separate line in the income from continuing operations section of the income statement. ⊚ ⊚

true false

9) A firm that owns a controlling interest in another company separately reports “income attributed to noncontrolling shareholders” on its consolidated income statement. ⊚ ⊚

true false

10) Each set of EPS numbers includes separately reported numbers for income from continuing operations and the items that appear below it on the income statement. ⊚ ⊚

true false

11) The change in equity of an entity during a period from transactions and other events from non-owner sources is known as comprehensive income. ⊚ ⊚

true false

12) Selected unrealized gains (or losses) sometimes bypass the income statement and are reported as direct adjustments to a stockholders’ equity account. ⊚ ⊚

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true false

13)

The basic accounting equation may be expressed as assets = liabilities – owners’ equity. ⊚ ⊚

14)

true false

To get revenue and expense account balances to zero an adjusting entry is made. ⊚ ⊚

true false

15) For each transaction, the dollar total of the debits must equal the dollar total of the credits. ⊚ ⊚

true false

16) U.S. GAAP permits companies to report components of other comprehensive income (OCI) as part of the statement of changes in stockholders’ equity. ⊚ ⊚

true false

17) The point within the operating cycle when the company satisfied its contractual obligation is the point when revenue should be recognized. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 18) Which of the following statements best describes expenses?

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A) They are recorded in the accounting period when they are “purchased.” B) They consist of amounts paid for consumable items and services rendered to the organization during the accounting period. C) They are the expired costs or assets "used up" during the accounting period. D) They consist of cash payments to employees during the period for services rendered.

19)

The expense matching principle states that:

A) Expenses are recognized when paid. B) All expenses are recognized when the corresponding revenue is recorded. C) Some expenses are recognized when the corresponding revenue is recognized and some are spread over time. D) Expenses are recognized when the invoice is received.

20) The Canon Corporation sells ten copiers to the Title Company on October 15 for $40,000. Canon delivers the copiers to Title on October 20 and Title pays $16,000, agreeing to pay the balance on November 10. Under the cash basis, how much revenue should Canon recognize in October?

A) B) C) D)

$0 $16,000 $24,000 $40,000

21) The Canon Corporation sells ten copiers to the Title Company on October 15 for $40,000. Canon delivers the copiers to Title on October 20 and Title pays $16,000, agreeing to pay the balance on November 10. Under the accrual basis, how much revenue should Canon recognize in November?

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A) B) C) D)

$0 $16,000 $24,000 $40,000

22) The Canon Corporation sells ten copiers to the Title Company on October 15 for $40,000. Canon delivers the copiers to Title on October 20 and Title pays $16,000, agreeing to pay the balance on November 10. Using the accrual basis, which one of the following entries would properly record Canon’s revenue recognition for October?

A) B) C) D)

23)

DR Cash 40,000 CR Copier sales 40,000 DR Cash 16,000 CR Copier sales 16,000 DR Cash 16,000 DR Accounts receivable 24,000 CR Copier sales 40,000 DR Accounts receivable 40,000 CR Copier sales 40,000

Hickory Furniture Company paid for the following costs during the month of May:

Inventory purchases

$ 40,000

Advertising costs

8,000

Delivery costs

2,000

Hickory sold $32,000 of the inventory and has agreed to pay warranty expenses for its customers. These are expected to be $1,600 and occur evenly over the next four months (i.e., starting in June).What is the amount of Hickory’s cash-basis expenses for the month of May?

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A) B) C) D)

24)

$33,600 $42,400 $50,000 $51,600

Hickory Furniture Company paid for the following costs during the month of May:

Inventory purchases

$ 40,000

Advertising costs

8,000

Delivery costs

2,000

A) B) C) D)

25)

$33,600 $42,400 $43,600 $50,000

Which statement below best describes when to record an expense?

A) When the expense is paid. B) When the resource is consumed or a benefit is derived. C) Always taken in one period only. D) Never is recognized before revenue is recognized.

26) Exeter Company reports all revenues and expenses of Gregg Company on its consolidated income statement. Which of the following conditions must have been met? Version 1

A) Exeter owns 100% of Gregg Company’s common stock. B) Exeter owns 90% or more of Gregg Company’s common stock. C) Exeter owns 50% of Gregg Company’s common stock. D) Exeter owns more than 50% of Gregg Company’s common stock.

27) Michel Company owns 75% of the outstanding common stock of Aber Corp. On its current consolidated income statement, Michel Company should report:

A) 100% of Aber’s revenue and expenses. B) 75% of Aber’s revenue and expenses. C) 75% of Aber’s net income. D) none of Aber’s revenue, expenses, and income.

28)

Which of the following may cause fully diluted EPS to differ from basic EPS?

A) Convertible preferred stock. B) Warrants. C) Management stock options. D) All of these answer choices are correct.

29)

Which of the following is not correct with respect to accrual accounting?

A) Accrual accounting can produce large discrepancies between the firm’s reported profit performance and the amount of cash generated from operations. B) The principles that govern revenue and expense recognition under accrual accounting are designed to alleviate the mismatching problems that exist under cash-basis accounting. C) Reported accrual accounting net income for a period always provides an accurate picture of underlying economic performance. D) Accrual accounting does not decouple measured earnings from operating cash inflows and outflows.

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30)

Hickory Furniture Company paid for the following costs during the month of May:

Inventory purchases

$ 40,000

Advertising costs

8,000

Delivery costs

2,000

A) Product cost B) Traceable cost C) Inventory cost D) Period cost

31)

Revenue is recognized when:

A) a contract is signed by both parties. B) the seller completes performance required by an agreement. C) the buyer completes payment required under an agreement. D) the buyer accepts delivery and completes required payments.

32)

Net income recognition always increases:

A) assets. B) net assets. C) liabilities. D) net liabilities.

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33)

The real accounting issue in net income recognition is the:

A) quantity of income recognized. B) type of income recognized. C) timing of the recognition. D) basis of net income recognition.

34)

The matching principle requires that expenses be recognized:

A) in the same period in which all the assets are used up. B) in the same period in which the revenue generated by these expenses is recognized. C) when the costs are paid by the entity. D) in the same period in which the revenue generated by these expenses is received.

35)

Traceable costs are also called:

A) period costs. B) expired costs. C) product costs. D) administrative costs.

36) The statement, "linkage between these costs and individual sales is difficult to establish," refers to

A) period costs. B) expired costs. C) product costs. D) traceable costs.

37)

Income statements are classified into sections to:

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A) separate revenue recognized from deferred revenue. B) distinguish between sustainable and transitory income. C) separate real income from book income. D) distinguish between book income and taxable income.

38) Which item is not correct with respect to the treatment of sustainable and transitory items and a company's income statement?

A) Financial reporting assists statement users in forecasting future cash flows by providing an income statement format that segregates components of net income. B) Income statements prepared in accordance with GAAP differentiate between income components that are believed to be sustainable and those that are transitory. C) The income statement isolates a key figure called “income from sustainable operations.” D) Transitory items are disclosed separately on the income statement so that statement users can place less weight on these earnings components when forecasting future profitability.

39) The rationale behind the rules for multiple-step income statements is to subdivide the income in a manner that facilitates:

A) cash flows. B) forecasting. C) tax return preparation. D) audits.

40)

The best measure of a firm’s sustainable income is:

A) income from continuing operations. B) income before income tax. C) income before unusual items and change in accounting principle. D) net income.

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41)

On the income statement, income from discontinued operations is shown:

A) as a separate section of income from continuing operations. B) as an accounting principle change. C) without any income tax effect. D) net of taxes after income from continuing operations.

42) When transitory earnings are present, which of the following correctly depicts the order used on the income statement?

A) Income from continuing operations, unusual items, income tax expense, discontinued operations, net income. B) Income from continuing operations, discontinued operations, income tax expense, net income. C) Income tax expense, income from continuing operations, discontinued operations, net income. D) Income tax expense, income from continuing operations, unusual items, discontinued operations, net income.

43) Vogel Inc. reports income related to discontinued operations in its current-year multiplestep income statement. Financial statement users should expect that the line item “income tax expense”:

A) relates only to income from continuing operations. B) includes all income tax from continuing as well as discontinued operations. C) related only to income derived from gross profit. D) relates only to income from discontinued operations.

44) Black & Decker decides to discontinue producing toasters in lieu of more versatile toaster ovens. In the process of discontinuing this line, the company disposes of the old production equipment and buys new equipment. The disposal of the old equipment would be reported in the income statement as:

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A) gain or loss on the sale of equipment as part of continuing operations. B) gain or loss on the sale of production equipment as part of cost of goods manufactured and sold. C) gain or loss on the disposal of discontinued business component. D) income from operation of a discontinued business component.

45) Smidt Company reports a loss related to a recent warehouse flood. Financial statement users should expect to find the related loss reported on the Smidt’s multiple-step income statement as part of:

A) income from discontinued operations. B) income from continuing operations. C) income from extraordinary events. D) other comprehensive income.

46) Margot reviews the financial statements of a potential investment target. She notices that in the company’s multiple-step income statement a separately listed gain is reported as part of “income from continuing operations.” Based on this information, Margot should:

A) not assume that the gain will recur regularly. B) assume that the gain will recur regularly. C) assume that the gain will never recur. D) make no assumption regarding the validity of the information.

47) When reporting unusual or infrequent items in the income statement which of the following is not correct?

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A) If a material event is either unusual in nature or an infrequent occurrence it is classified on the income statement as a special or unusual item in continuing operations. B) If a material event is either unusual in nature or an infrequent occurrence—such as a one-time charge resulting from a major restructuring—it may be classified on the income statement as a special or unusual item in continuing operations or treated as an extraordinary item if it has been a number of years since the company’s last major restructuring. C) Firms that use early debt retirement will report the associated gains and losses as part of income from continuing operations with separate line-item disclosure. D) The write-off of obsolete inventory would be reported on the income statement as a special item in continuing operations.

48)

A component of an entity may be a/an:

A) reportable or operating segment. B) subsidiary. C) asset group. D) reportable or operating segment, subsidiary, or asset group.

49) Which of the following statements is correct regarding reporting of “Extraordinary gains and losses” as a separate category on the income statement?

A) It is no longer permitted under U.S. GAAP. B) It is permitted under U.S. GAAP, if the related event is both unusual in nature and infrequent in occurrence. C) Is permitted under IFRS, but not U.S. GAAP. D) It is permitted under U.S. GAAP, but not IFRS.

50)

Which of the following best describes the reporting for discontinued operations?

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A) Discontinued operations will not generate future cash flows and thus the results of transactions related to operations the firm intends to discontinue, or has already discontinued, must be reported separately from other income items on the income statement. B) Discontinued operations presentation is used only when a component of an entity has been sold. C) There are 4 criteria that must be met to classify a disposal group as held for sale. D) Discontinued operations may generate future cash flows and thus there will be results of transactions related to operations the firm intends to discontinue. If the firm does generate future transactions before disposing of the disposal group, it will report that revenue in continuing operations revenue.

51) The discontinued operations section of the income statement is comprised of which one of the following?

A) Income from the operation of a discontinued business component and gain or loss from the disposal of the discontinued component. B) Income from the operation of a discontinued business component, net of tax, and gain or loss from the disposal of the discontinued component, net of tax. C) Income from the operation of a discontinued business component, net of tax, and gain or loss from the disposal of the discontinued component. D) Gain or loss from the disposal of the discontinued component, net of tax.

52) Which of the following is not considered an unusual or infrequently occurring item on an income statement?

A) Corporate restructuring charges. B) Gains and losses from sales of investments. C) Operating income or loss from discontinued operations. D) Foreign currency transaction gains and losses.

53) For a disposal group to be considered held for sale, which of the following conditions are required to be met?

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A) Management has committed to a plan to see the component. B) The sale is probable and is expected to be completed within one year. C) The component is available for immediate sale in its present condition subject only to usual and customary terms for such sales. D) All of these conditions must be met.

54)

Which one of the following events would be considered an unusual or infrequent event?

A) a tornado in Kansas. B) an earthquake in New York. C) a flood in St. Louis near the Mississippi River. D) an earthquake in southern California.

55) A special one-time charge resulting from corporate restructurings would be reported on the income statement as a/an:

A) operating item before gross profit. B) special item in continuing operations. C) special item in continuing operations, shown net of tax. D) special item in discontinued operations, shown net of tax.

56) Donna is reviewing the income statement of Brier Company. She notices that Brier’s income statement includes an item labeled “income attributable to noncontrolling interests.” Donna should assume that Brier Company:

A) is not partially owned by another company. B) owns 100% of the outstanding shares of another company. C) owns a controlling interest in another company that is less than 100%. D) sold a subsidiary during the current fiscal period.

57)

For what reasons does management have incentive to meet analysts’ expectations?

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A) To build credibility with capital markets. B) To convey future earnings prospects to investors. C) To increase stock price. D) All of these answer choices are correct.

58)

Which statement below is not correct with respect to earnings management?

A) It is increasingly common because of the pressure to meet analysts’ expectations. B) More firms just beat rather than just miss the analyst expectations. C) In a recent survey, more than 65% of CFOs surveyed indicated that reporting a profit is an important benchmark. D) In a recent survey, more than 80% of CFOs surveyed indicated that meeting or beating consensus EPS is an important benchmark.

59) GAAP requires that each set of EPS numbers includes separately reported numbers for all of the following except:

A) special or unusual items. B) income from continuing operations. C) discontinued operations. D) net income.

60) When analysts provide basic EPS for income from continuing operations that exclude the effects of special (i.e., nonrecurring) gains or losses and certain other non-cash charges, such earnings are frequently referred to as:

A) normal earnings. B) pro forma earnings. C) sustainable earnings. D) real earnings.

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61) The change in equity of an entity during a period from transactions and other events from non-owner sources is known as:

A) net income. B) net operating income. C) comprehensive income. D) net change in assets.

62)

Which one of the following is part of other comprehensive income (OCI)?

A) Unrealized gains resulting from remeasuring foreign currency financial statements of majority-owned subsidiaries to U.S. dollar amounts. B) Gains on sales of treasury stock. C) Receipt of land donated by a governmental unit. D) Sale of common stock above par.

63)

GAAP requires firms to report comprehensive income:

A) at the end of the income statement. B) as one separate statement of comprehensive income. C) in the statement of changes in stockholders’ equity. D) in a statement that is displayed with the same prominence as other financial statements.

64) Current U.S. GAAP permits firms to display the components of other comprehensive income in which of the following formats?

A) as a schedule appearing in the notes to the financial statements. B) in a two-statement approach, one in which net income comprises one statement and a second, which presents a separate statement of comprehensive income. C) as part of the statement of changes in stockholders’ equity. D) as a part of the statement of cash flows.

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65)

Other comprehensive income is closed to:

A) Retained earnings. B) The related asset account. C) Accumulated Comprehensive Income. D) Accumulated Other Comprehensive Income.

66)

Accumulated other comprehensive income increases or decreases

A) Net income. B) Income from continuing operations. C) Shareholders’ Equity. D) Earnings per share.

67) Other Comprehensive Income (OCI) is used both in U.S. GAAP and IFRS. Which of the following statements is correct?

A) As a general rule, U.S. GAAP allows more opportunities for managers to change balance sheet valuations of certain assets even when management has no intention to sell these assets. B) Changes in the valuation of property, plant, and equipment create a Revaluation Surplus used in both IFRS and U.S. GAAP. C) Both IFRS and U.S. GAAP require companies to report in other comprehensive income each period the valuation changes from changes in actuarial estimates affecting defined benefit pension plans. D) U.S. GAAP requires a separate statement of OCI to immediately follow the income statement in the financial reporting statement.

68)

The basic accounting equation may be expressed as:

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A) assets = liabilities − owners’ equity B) liabilities = assets + owners’ equity C) owners’ equity = assets − liabilities D) assets = owners’ equity − liabilities

69)

Any increase in an asset may be offset by:

A) a corresponding decrease in a liability. B) a decrease in some other asset account. C) a corresponding decrease in owner’ equity. D) an increase in another asset account.

70)

Which of the following statements is correct regarding revenue and expense accounts?

A) These are really owners’ equity accounts. B) These are really contributed capital accounts. C) They have no impact on the balance sheet. D) These are balance sheet accounts.

71)

A debit:

A) increases Accounts Payable. B) increases Cost of Goods Sold. C) decreases Accounts Receivable. D) decreases Equipment.

72)

Adjusting entries must be made:

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A) to correct errors in the accounts. B) to reconcile the accounts to the budget. C) because auditing standards require them. D) because certain types of events will otherwise not be recorded in the accounts.

73)

Accumulated depreciation is a/an:

A) expense account. B) liability account. C) contra-asset account. D) owners’ equity account.

74) Entering the DR or CR amount in the appropriate left or right side of the affected Taccount is called:

A) posting. B) cross-referencing. C) journalizing. D) recording.

75)

A debit does which of the following?

A) Increases the value in an asset account. B) Increased the value in a contra-asset account. C) Decreases the value in a liability account. D) Increases the value in an asset account and also decreases the value in a liability account.

76)

Which of the following is a true statement?

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A) Revenue decreases owners’ equity and increases liabilities. B) Expenses increase owners’ equity and decrease liabilities. C) Revenue increases owners’ equity and expenses decrease owners’ equity. D) Revenue decreases owners’ equity and expenses increase owners’ equity.

77)

To get revenue and expense account balances to zero requires a/an:

A) adjusting entry. B) closing entry. C) operating entry. D) reversing entry.

78) T-account analysis can be used to gain insights into why accrual basis earnings and cash basis earnings differ and to:

A) journalize future transactions. B) reconstruct transactions that have occurred during a given reporting period. C) post transactions that have occurred during a given reporting period. D) determine the current market price of common stock.

79)

Working capital accounts include:

A) all assets. B) all assets and liabilities. C) current assets and all liabilities. D) current assets and current liabilities.

80)

Adjusting entries are used in all but which of the following situations?

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A) Prepayments. B) Deferred Revenue and Expenses. C) Accrued Revenue and Expenses. D) Prepayments, Deferred Revenue, Accrued Expenses, Accrued Revenue.

81)

accounting standards require companies to group items within OCI based on :

A) U.S. GAAP; whether they will be reclassified subsequently into net income or whether they will be subsequently reclassified into income when specific conditions are met. B) IFRS; whether they will be reclassified subsequently into net income or whether they will be subsequently reclassified into income when specific conditions are met. C) U.S. GAAP; their expected future categorization on the income statement into income from continuing operations and discontinued operations. D) IFRS; their expected future categorization on the income statement into income from continuing operations and discontinued operations.

82)

When actuarial estimates related to defined benefit pension plans are adjusted:

A) Both U.S. GAAP and IFRS require companies to report these valuation changes in OCI each period. B) Only U.S. GAAP requires companies to report these valuation changes in OCI each period. C) Only IFRS requires companies to report these valuation changes in OCI each period. D) Neither U.S. GAAP nor IFRS requires companies to report these valuation changes in the financial statements.

83)

Earnings management can occur through a variety of manipulations including:

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A) Manipulating accrual estimates to impact expenses. B) Misapplications of GAAP deemed immaterial on an account by account basis. C) Big bath restructuring charges. D) All of these answer choices are correct.

84)

Which of the following would not be considered a revenue recognition abuse?

A) Recording goods on consignment as part of inventory when there is a right of return. B) Recording goods on layaway for a customer as a final sale. C) Recording revenue on a large shipment to a customer whose ability to pay is not reasonably assured. D) Recording revenue on goods produced during the current period.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 85) In its accrual-basis income statement for the year ended December 31, 20X2, Ralph Company reported revenue of $2,565,000. Additional information was as follows:

Accounts receivable 12/31/X1 Uncollectible accounts written off during 2X2 Accounts receivable 12/31/X2

$ 418,500 17,200 391,700

Required: Under the cash basis of net income determination, how much should Ralph report as revenue for 20X2?

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86) John Hamilton, D.D.S. keeps his accounting records on the cash basis. During 20X2 Dr. Hamilton collected $220,000 in fees from his patients. At December 31, 20X1, Dr. Hamilton had accounts receivable of $30,000. At December 31, 20X2 Dr. Hamilton had accounts receivable of $35,000 and had collected deferred fee revenue of $8,000.Required:On the accrual basis, what was Dr. Hamilton’s patient service revenue for 20X2?

87) Under Bart Company’s accounting system, all insurance premiums paid are debited to prepaid insurance. For interim reports, Bart makes monthly estimated charges to insurance expense with credits to prepaid insurance. Additional information for the year ended December 20X2 is as follows:

Prepaid insurance at December 31, 20X1 Charges to insurance expense during 20X2, including a year-end adjustment of $50,000 Unexpired insurance premiums at December 31, 20X2

$ 310,000 975,000 265,000

Required: What was the total amount of insurance premiums paid by Bart during 20X2?

88) Schlegel Department Store sells gift certificates—redeemable for store merchandise—that expire one year after their issuance. Schlegel has the following information pertaining to its gift certificates sales and redemptions:

Unredeemed certificates at 12/31/X1

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90,000

20X2 sales

400,000

20X2 redemptions of prior year sales

60,000

20X2 redemptions of current year sales

325,000

Schlegel’s experience indicates that 10% of gift certificates will not be redeemed. The company’s policy is to record revenue on gift certificates when they are redeemed or expire.Required:In its 20X2 income statement, what amount should Schlegel report as gift certificate revenue?

89) Lazer Industries, Inc. manufactures medical equipment parts and accessories. Assume all amounts are pre-tax and a 21% tax rate for 20X1.

Net sales Interest expense Gain on sale of discontinued operations Cost of goods sold Selling, general and administrative expenses Gain on sale of investments Restructuring charges

$ 1,200,000 $ 150,000 $ 400,000 $ 300,000 $ 170,000 $ 30,000 $ 20,000

Required:Prepare a multiple-step income statement for Lazer Industries, Inc. based on the available information for the year ended December 31, 20X1. Indicate all negative numbers using parentheses, and include all subtotals, appropriately labeled, to present your income statement in good form.

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90) Berg, Inc. provides exotic wedding planning services. Berg’s facilities are located in an elevated area with a dry climate. Assume all amounts are pre-tax and a 21% tax rate for the year.

Interest expense Cost of goods sold Flood damage to facilities Revenue

30,000 900,000 60,000 2,100,000

Office salaries expense

150,000

Advertising expense

180,000

Rent expense

100,000

Restructuring charges

80,000

Required:Based on the available information, provide a multiple-step income statement for Berg, Inc. for the year ended December 31. Indicate all negative numbers using parentheses, and include all subtotals, appropriately labeled, to present your income statement in good form.

91) On August 1, 20X1, Alpha Co. approved a plan to dispose of an unprofitable segment of its business. Alpha expected that the sale would occur on April 30, 20X2, at an estimated gain of $250,000. The segment had actual and estimated operating profits (losses) as follows:

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Realized loss from 1/1X1 to 7/31X1 Realized loss from 8/1X1 to 12/31X1

$ (400,000 ) (250,000 )

Expected loss from 1/1/X2 to 4/30/X2

(300,000 )

Assume Alpha’s tax rate is 21%.

Required:In its 20X1 income statement, what should Alpha report as profit or loss from discontinued operations (net of tax effects)?

92) On November 15, 20X1 Jones Co. sold a segment of its business for $2,750,000. The net book value of the segment at the time of its disposal was $2,900,000. Jones had pretax income from operations of $1,750,000 for 20X1 which included $360,000 recognized by the discontinued segment prior to its disposal. Assume Jones’ tax rate is 21%. Required: Prepare a partial income statement for Jones Co. for 20X1, beginning with pretax income from continuing operations.

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93) An analyst gathered the following information about a company whose fiscal year end is December 31. Net income for the year was $23.7 million. Preferred stock dividends of $3 million were paid for the year. Common stock dividends of $6 million were paid for the year. There were 10 million shares of common stock outstanding on January 1. The company issued 6 million new shares of common stock on July 1. The capital structure does not include any potentially dilutive securities. Required:Calculate the company’s basic earnings per share.

94) Primo Landscaping commenced its business on January 1. On December 31, Primo Landscaping did not record any adjusting entries with respect to the following transactions:During the first year of its operations, Primo purchased supplies in the amount of $10,000 (debited to “Supplies expense”), and of this amount, $3,000 were unused as of December 31.On March 15, Primo received $36,000 for landscape maintenance services to be rendered for 24 months (beginning July 1). This amount was credited to “Landscaping revenue.”The company’s fuel bill for $1,300 for the month of December was not received until January 15 of the following year.The company borrowed $100,000 from First Bank on April 1at an interest rate of 12% per year. The principal, along with all of the interest, is due on March 30, 2019.On January 17, the company purchased a backhoe for $65,000. The backhoe is expected to last for 10,000 hours and have no salvage value. During the year, Primo operated the backhoe for 500 hours.Required: Complete the table below, showing the effect of the omission of each year-end adjusting entry on assets, liabilities, and net income. Use “OS” for overstated, “US” for understated, and “NE” for no effect. Item Number Effect of Omission a. Direction of effect

Assets

Liabilities

Net Income

Dollar amount of effect Direction of effect Dollar amount of effect

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Direction of effect

Dollar amount of effect Direction of effect

Dollar amount of effect Direction of effect Dollar amount of effect

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Answer Key Test name: chapter 2 1) TRUE 2) FALSE 3) TRUE 4) TRUE 5) TRUE 6) TRUE 7) FALSE 8) TRUE 9) TRUE 10) TRUE 11) TRUE 12) TRUE 13) FALSE 14) FALSE 15) TRUE 16) FALSE 17) TRUE 18) C 19) C 20) B 21) A 22) C 23) C 24) C 25) C 26) D Version 1

27) A 28) D 29) D 30) D 31) B 32) B 33) C 34) B 35) C 36) A 37) B 38) C 39) B 40) A 41) D 42) C 43) A 44) A 45) B 46) A 47) B 48) D 49) A 50) A 51) B 52) C 53) D 54) B 55) B 56) C Version 1

57) D 58) D 59) A 60) B 61) C 62) A 63) D 64) B 65) D 66) C 67) C 68) C 69) B 70) A 71) B 72) D 73) C 74) A 75) D 76) C 77) B 78) B 79) D 80) B 81) B 82) A 83) D 84) A 85)

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Accrual basis revenue

$ 2,565,000

+ Beginning accounts receivable balance

418,500

− Ending accounts receivable balance

(391,700 )

− Write-offs of accounts receivable

(17,200 )

Cash basis revenue (cash collections on accounts receivable)

$ 2,574,600

Under the cash basis of net income determination, the company would not regard its accounts receivable as revenue. To find cash basis revenue, add the decrease in accounts receivable to the revenue figure and subtract the write-offs to determine cash collections on accounts receivable. 86) Cash basis revenue

$ 220,000

− Beginning accounts receivable (12/31/X1)

(30,000 )

+ Ending accounts receivable (12/31/X2)

35,000

− Deferred fee revenue on 12/31/X2

(8,000 )

= Accrual basis revenue

$ 217,000

To change Dr. Hamilton’s revenue from cash basis to an accrual basis, add the recognized but uncollected accounts receivable and subtract the beginning accounts receivable collected in 20X2 but recognized in 20X1. Also, subtract fees collected in 20X2 but not recognized until after 20X2 (deferred fee revenue at 12/31/X2). 87)

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Charges to insurance expense during 20X2

$ 975,000

− Decrease in prepaid insurance ($310,000 − $265,000)

(45,000 )

= Insurance premiums paid in 20X2

$ 930,000

The total amount of insurance premiums paid in 20X2 is equal to the insurance expense for 20X2 less the decline in the balance in prepaid insurance. 88) 20X1 sales redeemed or expired in 20X2

20X2 sales redeemed in 20X2 20X2 gift certificate revenue

90,000 325,000

415,000

Any 20X1 certificates unredeemed at 1/1/X2 will either be redeemed or expire in 20X2 and thus should be included in 20X2 net income along with the dollar amount of certificates sold and redeemed in 20X2. 89) Lazer Industries, Inc. Income Statement For the year ended December 31, 20X1 Net sales

$ 1,200,000

Cost of goods sold

(300,000 )

Gross profit

900,000

Selling, general and administrative expenses

(170,000 )

Unusual or infrequently occurring items: Interest expense

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(150,000 )

Gain on sale of investments

30,000

Restructuring charges

(20,000 )

Income from continuing operations before income tax

590,000

Income tax expense

(123,900 )

Income from continuing operations

466,100

Discontinued operations: Gain on sale of discontinued operations, net of tax Net income

316,000 $

782,100

90) Berg, Inc. Income Statement For the year ended December 31 Revenue

$ 2,100,000

Cost of goods sold

(900,000 )

Gross profit

1,200,000

Selling, general and administrative expenses: Office salaries expense

(150,000 )

Advertising expense

(180,000 )

Rent expense

(100,000 )

Unusual or infrequently occurring items: Interest expense

(30,000 )

Flood damage to facilities

(60,000 )

Restructuring charges

(80,000 )

Income from continuing operations before income tax

600,000

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Income tax expense Net income

(126,000 ) $

474,000

91) Realized loss from 1/1X1 to 7/31X1 Realized loss from 8/1X1 to 12/31X1

$ (400,000 ) (250,000 )

Total pre-tax loss

(650,000 )

Tax benefit at 21%

136,500

Loss from discontinued operations, net of tax effect

$ (513,500 )

Under GAAP, results of operations on an operating segment or component of an entity classified as held for sale are to be reported in discontinued operations in the periods in which they occur (net of tax effects). None of the expected profit from operating the segment or component of the entity in 20X2 or the estimated gain on sale is recognized in 20X1. These amounts will be recognized in 20X2 as they occur. 92) Income from continuing operations ($1,750,000 − $360,000) Income tax expense ($1,390,000 × 0.21) Income from continuing operations

$ 1,390,000 291,900 1,098,100

Discontinued operations: Income from discontinued operations (net of taxes of $75,600) from 1/1X1 through 11/15X1 Loss on disposal of discontinued operations (net of tax benefit of $31,500)

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284,400 (118,500 )

Net income

$ 1,264,000

Sale price of segment − book value of segment = gain (loss) on disposal = $2,750,000 − $2,900,000 = $(150,000) pretax loss. 93) Net income – Preferred stock dividend = $23.7 − $3.0 = $20.7 million.Weighted Average number of common shares = (0.5 × 10) + (0.5 × 16) = 13 million shares.EPS = $20.7 million net income ÷ 13 million shares = $1.59 per share. 94) Item Number Effect of Omission a. Direction of effect

Assets US $ 3,000

Dollar amount of effect Direction of effect

Dollar amount of effect Direction of effect Dollar amount of effect

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Liabilities NE

$ 3,000

$ 27,000

1,300

$ 1,300

9,000

$ 9,000

NE $ NE $ OS $ 3,250

Net Income US

$ 3,250

Asset not recorded = $3,000 supplies on hand at 12/31.Deferred revenue not adjusted for = $1,500 per month for services to be rendered from 1/1/2019 to 6/30/2020.Fuel expense not recorded = $1,300.Interest expense for 9 months not accrued = $100,000 × 0.12 × 9/12 = $9,000.Depreciation expense not recorded = $65,000 ÷ 100,000 hours = $6.50/hour depreciation rate × 500 hours used during the year = $3,250.

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CHAPTER 3: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The underlying principal in ASC Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration expected to be exchanged for those goods or services. ⊚ ⊚

true false

2) Amounts received from the sale of gift cards should be recognized by the seller at the time of sale. ⊚ ⊚

true false

3) Under a consignment arrangement, revenue is not recognized until the consigned goods are sold to a third party. ⊚ ⊚

true false

4) ASC Topic 606 provides a five-step model for evaluating how and when revenue should be recognized rather than providing detailed industry-by-industry standards. ⊚ ⊚

true false

5) Ann Smith just saw her doctor. After the appointment, she was informed by the receptionist that the fee for the visit is $75 and that her insurance company will be billed for the visit. Ann was also notified that her insurance company will pay all of the fee except for the $20 co-pay, which she pays with her debit card right away. Because the doctor’s office has not entered into a contract, it would not record revenue until it verifies that the insurance company will pay. ⊚ ⊚

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true false

6) Gamebox sells video-gaming devices, games, and online game subscriptions. The Gamebox system normally sells for $250 and comes prepackaged with one game. The average price for games is $30. The company also sells its online game subscription package, which allows members to download and play one new game per month, for $240. During the holiday season, the company provides a package deal which includes the gaming system with two games and a free one-year game subscription for $400. The company should allocate $192.92 of the $400 package purchase price to the gaming system. ⊚ ⊚

true false

7) Assuming that revenue related to a long-term construction project is properly recognize over time, the amount debited to “construction expense” each period is the actual construction costs incurred in that period. ⊚ ⊚

true false

8) Both public U.S. companies and companies reporting under IFRS were required to begin reporting revenue based on ASC Topic 606 in January 2018. Early adoption was permitted under both U.S. GAAP and IFRS. ⊚ ⊚

true false

9) Sell4U is an online site that allows its clients to post items for sale. Sell4U charges a 5% brokerage fee for use of the site, payable within 10 days of the sale. As an agent, Sell4U may recognize revenue for the brokerage fee as soon as an item is sold. ⊚ ⊚

true false

10) Evans Equipment sells, installs, and maintains manufacturing equipment. The typical sales contract includes the purchase of the equipment, installation, and a five-year maintenance contract. Most customers choose to trade in the equipment for the new model at the end of the five-year contract. Evans Equipment should amortize the cost of installation over five years. Version 1

⊚ ⊚

true false

11) Gamebox, a seller of video-gaming systems, games and online gaming subscriptions, recently made available a coupon that allows its gaming subscription members to extend their subscriptions by three months at no charge. Subscribers need only to login to the website using their user name and password and provide the coupon code. Because this contract modification (from 12 months to 15 months) does not add distinct goods or services from the original contract, Gamebox need only make a cumulative catch-up adjustment. ⊚ ⊚

true false

12) A survey by Connor Group examining the financial statement impact of ASC 606 found that under the new standard, technology companies are more likely to recognize revenue over time than they did under prior GAAP. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 13) The time that the performance obligation is satisfied for revenue recognition is usually:

A) before the sale. B) after the sale. C) at the time of sale. D) when payment is received.

14) If consideration is received before a contract is identified and the consideration is nonrefundable, revenue may be recognized if:

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A) the contract has been terminated. B) goods have been delivered. C) there is no remaining obligation to transfer goods. D) any of these answer choices is correct.

15) Under ASC Topic 606 guidance for revenue recognition, all of the following conditions must be met to account for a contract with a customer, except:

A) the contract has commercial substance. B) collection is likely. C) each party’s rights are identified regarding goods or services to be exchanged. D) all parties to the contract have approved the contract.

16) Assuming the requirements for recognizing revenue over time are met, the measure of completion is computed by dividing

A) profits earned to date by estimated total profits. B) costs incurred to date by estimated total costs. C) costs incurred to date by the contract price. D) profits earned to date by the contract price.

17) Assuming the requirements for recognizing revenue over time are met, the profit to be recognized in any year is based on the completion ratio of:

A) incurred contract costs divided by estimated total contract costs. B) incurred contract costs multiplied by estimated total contract costs. C) estimated total contract costs divided by incurred contract costs. D) estimated total contract costs multiplied by incurred contract costs.

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18) Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project and the requirements for recognizing revenue over time are met. The total estimated cost of the project is $4,000,000 and the following information is available: ($ in thousands)

Year 1

Year 2

Year 3

Costs incurred

$ 1,000

$ 1,500

$ 1,250

Estimated completion costs

$ 3,000

$ 1,500

Billings

750

$ 1,750

$ 2,500

Cash collected

500

$ 1,500

$ 3,000

Assuming revenue is recognized over time, how much income is recognized in Year 2?

A) B) C) D)

$250,000 $375,000 $625,000 $3,125,000

19) Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project and the requirements for recognizing revenue over time are met. The total estimated cost of the project is $4,000,000 and the following information is available: ($ in thousands)

Year 1

Year 2

Year 3

Costs incurred

$ 1,000

$ 1,500

$ 1,250

Estimated completion costs

$ 3,000

$ 1,500

Billings

750

$ 1,750

$ 2,500

Cash collected

500

$ 1,500

$ 3,000

Assuming that revenue is recognized over time, how much income is recognized in Year 3?

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A) B) C) D)

$375,000 $625,000 $1,000,000 $1,250,000

20) Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project and the requirements for recognizing revenue over time are met. The total estimated cost of the project is $4,000,000 and the following information is available: ($ in thousands)

Year 1

Year 2

Year 3

Costs incurred

$ 1,000

$ 1,500

$ 1,250

Estimated completion costs

$ 3,000

$ 1,500

Billings

750

$ 1,750

$ 2,500

Cash collected

500

$ 1,500

$ 3,000

Which one of the following entries would be made in Year 1 to record the costs incurred assuming revenue is recognized over time?

A) DR Inventory: Construction in progress $1,000,000 CR Accounts payable, cash, etc. $1,000,000 B) DR Inventory: Construction in progress $1,000,000 CR Income on long-term construction contract $1,000,000 C) DR Inventory: Construction in progress $1,000,000 CR Billings $1,000,000 D) DR Income on long-term construction contract $1,000,000 CR Accounts payable, cash, etc. $1,000,000

21) Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project and the requirements for recognizing revenue over time are met. The total estimated cost of the project is $4,000,000 and the following information is available:

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($ in thousands)

Year 1

Year 2

Year 3

Costs incurred

$ 1,000

$ 1,500

$ 1,250

Estimated completion costs

$ 3,000

$ 1,500

Billings

750

$ 1,750

$ 2,500

Cash collected

500

$ 1,500

$ 3,000

Which one of the following entries would be made in Year 1 to record the income recognized assuming that revenue is recognized over time?

A) DR Inventory: Construction in progress $250,000 DR Construction expense $1,000,000 CR Construction revenue $1,250,000 B) DR Inventory: Construction in progress $375,000 CR Billings on construction in progress $375,000 C) DR Inventory: Construction in progress $675,000 CR Billings on construction in progress $675,000 D) DR Income on long-term construction contract $3,125,000 CR Accounts payable, cash, etc. $3,125,000

22) Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project and the requirements for recognizing revenue over time are met. The total estimated cost of the project is $4,000,000 and the following information is available: ($ in thousands)

Year 1

Year 2

Year 3

Costs incurred

$ 1,000

$ 1,500

$ 1,250

Estimated completion costs

$ 3,000

$ 1,500

Billings

750

$ 1,750

$ 2,500

Cash collected

500

$ 1,500

$ 3,000

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Which one of the following entries would be made in Year 2 to record customer billing assuming revenue recognition over time?

A) DR Accounts receivable $1,500,000 B) DR Accounts receivable $1,500,000 C) DR Accounts receivable $1,750,000 contract $1,750,000 D) DR Accounts receivable $1,750,000

CR Cash $1,500,000 CR Billings $1,500,000 CR Income on long-term construction CR Billings $1,750,000

23) Noah Construction Company is building a large complex for a contract price of $5,000,000. This is a three-year project and the requirements for recognizing revenue over time are met. The total estimated cost of the project is $4,000,000 and the following information is available: ($ in thousands)

Year 1

Year 2

Year 3

Costs incurred

$ 1,000

$ 1,500

$ 1,250

Estimated completion costs

$ 3,000

$ 1,500

Billings

750

$ 1,750

$ 2,500

Cash collected

500

$ 1,500

$ 3,000

Assuming that the conditions for revenue recognition over time were not met, which of the following entries would be made in Year 3 to record the completion and acceptance of the project?

A) DR Inventory: Construction in progress $5,000,000 CR Billings $5,000,000 B) DR Billings $5,000,000 CR Inventory: Construction in progress $3,750,000 CR Income on long-term construction contract $1,250,000 C) DR Inventory: Construction in progress $3,750,000 DR Income on long-term construction contract $1,250,000 CR Billings $5,000,000 D) DR Billings $1,250,000 CR Inventory: Construction in progress $1,250,000

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24) A survey by Connor Group examining the financial statement impact of ASC 606 found that under the new revenue recognition standard, technology companies tend to recognize revenue on sales involving multiple-element arrangements:

A) earlier than under previous GAAP. B) later than under previous GAAP. C) at about the time as under previous GAAP. D) when the related cash is collected.

25) Muenster Company sells its network servers with a warranty than includes preventive maintenance. Muenster should account for the warranty as a(n):

A) integral part of the equipment sales. B) separate contract. C) separate performance obligation. D) accrued expense.

26) Donald Company, which operates in the life sciences industry, routinely fulfills services subject to ongoing negotiations that determine reimbursement of regulated rates. Donald properly applies the “variable revenue” guidance under ASC 606. Donald should:

A) defer revenue until the reimbursement rate is fixed. B) recognize revenue over time. C) recognize revenue at the inception of the related contract. D) defer revenue until the reimbursement rate can be estimated with 90% certainty.

27) Public companies were required to adopt ASC Topic 606 for fiscal periods beginning after December 15, , while non-public companies were required to adopt the standard for fiscal periods ending after December 15, .

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A) B) C) D)

2018, 2019 2019, 2018 2017, 2018 2018, 2017

28) Borden Construction entered into the following contracts with Lovely Landscaping, LLP: (1) construct a paver patio, (2) plant trees, and (3) landscape planting beds for a new home construction project. Lovely Landscaping should treat the contracts:

A) as a single contract. B) as three separate contracts. C) as two contracts—one for hardscaping and one for landscaping. D) None of the answer choices are correct.

29) Which of the following is not a permitted simpler approach to revenue recognition under ASC Topic 606 for revenue recognition?

A) Applying the 5-step model to a portfolio of similar contracts. B) Using the previous revenue recognition rules instead of the 5-step model. C) Not adjusting for significant financial components if the contract period is one year or less. D)

Recognizing revenue for the amount invoiced to the customer.

30) Burgers and More operates a chain of fast-food restaurants across the United States. The restaurants are franchised operations. Under the franchise agreement, restaurant owners have the right to use the Burgers and More trade name, financing arrangements for franchisees, and management training at the corporate headquarters as well as the right to use training videos for their employees. The Burgers and More franchise contracts contain the following separate performance obligations:

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A) intellectual property, training B) intellectual property, financing, and training C) intellectual property D) financing and training

31) Which of the following criteria must be met to recognize revenue under a bill-and-hold arrangement?

A) The reason for the bill-and-hold arrangement is substantive. B) The product is identified separately as belonging to the customer. C) The product is ready for physical transfer to the customer. D) All of these criteria must be met to recognize revenue under a bill-and-hold arrangement.

32) Which of the following is not a factor that indicates multiple performance obligations in a contract?

A) The integration of multiple goods and services provides a significant service to the customer. B) One or more of the goods or services significantly modifies other goods or services promised in the contract. C) The goods or services in the contract are highly interdependent or interrelated. D) All of these are factors.

33) CPA Now developed an app to help prepare for the CPA exam. Customers may separately purchase (a) the app, (b) updates to the app, and (c) coaching support for the exam, or a package that includes the app and free updates coaching support until they pass the exam. The package deal includes performance obligation(s).

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A) one B) two C) three D) zero

34) Yashito Corporation sells cameras and accessories. The company’s newest model, popular with preteens, takes wallet-sized instant photos. The wholesale price for this camera is $50. In addition, the company sells carrying cases ($25), film cartridges ($15), and selfie lenses ($10) made especially for this camera. During the holiday season, Yashito offers the camera, film, carrying case, and selfie lens as a package for $75. For each package sold, the transaction price allocated to the camera is:

A) B) C) D)

$100. $75. $50. $37.50.

35) Under ASC Topic 606 for revenue recognition, a performance obligation is considered satisfied when control over the goods and services is transferred to the customer. Which of the following is not an indicator that control has transferred?

A) The customer is legally obligated to pay for the goods or services. B) The customer has legal title of the goods. C) The customer has accepted the goods and has physical possession of the goods. D) All of these are indicators that control has transferred.

36) Hargren Publishing offers its Accounting textbooks as e-texts through its online homework management system. Purchase of an access code provides the student with access to the e-text and online learning materials for six months. During that time, students have access to updates to the text and learning materials. Hargren should recognize revenue for purchases of access codes:

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A) at the end of the six-month access period. B) when they occur. C) over the six-month period during which the customer has access. D) at the beginning of the semester in which the student will use the access code.

37) In 2017, Borden Construction was contracted to build an apartment complex for its client, Deer Park Realty Management. The project was estimated to cost $15 million; however, on December 31, 2017, when the project was 75% complete, Borden estimated that the project costs would be much less, and agreed to adjust the contract price to $10 million. Prior to December 31, 2017, Borden Construction had recognized revenue of $10 million. At year end, Borden should:

A) make a correction for $2.5 million in over-recognized revenue. B) record nothing. C) record additional $5 million in revenue. D) make a correction for $5 million in over-recognized revenue.

38) The key accounting issue related to bundled products such as software licenses and technical support:

A) is the method of revenue recognition. B) is the amount of revenue to recognize over the life of the contract. C) depends on whether the customer is able to pay for the contracted services. D) concerns the amount of transaction price to allocate to each contract element.

39) Under ASC Topic 606 for revenue recognition, which of the following statements is not accurate regarding performance obligations?

A) Firms must disclose qualitative information about their performance obligations. B) Firms must disclose warranties provided. C) Firms are not required to disclose any judgments used to apply the standard. D) Firms must disclose the aggregate amount of the transaction price allocated to unsatisfied performance obligations.

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40)

Examples of variable consideration include all of the following except:

A) penalties for not completing performing on a contract on time. B) bonuses for completing performance on a contract early. C) discounts on transaction prices. D) all of the answer choices are correct.

41)

A right of return exists when:

A) the customer is entitled to a full or partial refund. B) the customer is entitled to a credit against amounts owed. C) the customer is entitled to another product in exchange. D) any one of these conditions is met.

42) Under ASC Topic 606 for revenue recognition, which of the following factors is not an indicator of the principal/agent determination?

A) Inventory risk. B) Credit risk. C) Shipping terms. D) Control of prices of the goods or services.

43) Which of the following disclosures is not required by ASC Topic 606 guidance for revenue recognition?

A) Explanation of significant changes in contract assets and liabilities. B) Beginning and ending balances of contract assets and liabilities. C) Amount of revenue recognized in the current period that was included in the beginning contract liability balance. D) Financial stability of major customers.

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44) Under the new revenue recognition guidance in ASC Topic 606, a performance obligation is satisfied over time if:

A) the customer simultaneously receives and consumes the goods and services provided by the firm. B) the firm’s performance creates or enhances an asset under the customer’s control. C) the firm’s performance does not create an asset with an alternative use and the firm has a right to receive payment for its performance to date. D) any of these answer choices is correct.

45) Which of the following statements is not applicable to revenue recognition guidance under ASC Topic 606?

A) Firms must disaggregate revenues into categories that depict how revenue is affected by economic factors. B) The standard applies a minimum number of categories that must be provided. C) Disaggregated revenues are to be disclosed in a note to the financial statements. D) Revenue may be disaggregated by geographic region.

46) Which of the following statements is not applicable to contract acquisition costs under ASC Topic 606 guidance for revenue recognition?

A) Incremental costs of acquiring a contract must be capitalized and amortized over the life of the contract. B) Costs that would be incurred regardless of whether a contract is obtained are not capitalized. C) The capitalization requirement is subject to a practical expedient. D) Costs must be capitalized even if the amortization period is one year or less.

47) Which of the following statements is not applicable to ASC Topic 606 guidance for revenue recognition?

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A) A contract asset is written down if it is deemed impaired and any related loss is recognized. B) A contract asset is impaired if the carrying amount exceeds the recoverable amount. C) The recoverable amount is the remaining expected consideration to be received less the costs of providing the goods and services that have not yet been expensed. D) A contract asset is written down if it is deemed impaired and any related loss is deferred.

48)

The new ASC Topic 606 provides a model for revenue recognition that includes:

A) five steps. B) four steps. C) three steps. D) two steps.

49)

Under ASC Topic 606, which of the following is not a criteria for revenue recognition?

A) Rights regarding goods or services have been identified. B) Delivery has occurred or services have been rendered. C) Collectability is probable. D) The shipping terms are clearly stated in the contract.

50) Revenue for goods to be sold under a consignment arrangement of a manufacturer and a retail store should be recognized by the manufacturer when:

A) the manufacturer delivers the product to a retail store. B) the seller promises to pay the manufacturer. C) the goods are sold by the retail store. D) the seller receives payment for the goods.

51)

In the case of sales where the customer is billed before delivery of the goods,

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A) the seller should always recognize revenue before the products are delivered to the customer. B) the goods belong to the customer and revenue recognition is deferred until delivery. C) the seller may recognize revenue if control of the goods has been transferred to the customer even though physical delivery has not taken place. D) revenue will not be recognized until the goods are shipped to the customer.

52)

In the case of goods delivered to a consignee under a consignment arrangement,

the consignor should not recognize revenue until the goods are transferred to a third

party. B) the cash received to date should be recognized by the consignor as deferred revenue until merchandise is delivered to the consignee. C) revenue should be recognized when the consignor collects payment from the consignee. D) the seller should recognize revenue although the goods have not yet been transferred to a third party.

53)

Payments to a customer for slotting fees:

A) can never be recognized. B) must be expensed immediately. C) might be considered a reduction in the selling price of goods sold to the customer. D) are always expensed over the period benefited for the right to shelf space.

54) Internet companies that simply act as agent or broker for the transfer of goods must record revenue based on:

A) the cost of the product sold. B) the fees it charges sellers. C) the sales price of the product. D) the gross profit of the product sold.

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55) Which of the following statements does not apply to the principal/agent relationship under ASC Topic 606 guidance for revenue recognition?

A) An agent reports revenue only for the net amount retained. B) An agent may recognize revenue when its performance obligation to the principal is satisfied. C) A principal recognizes revenue for the gross amount paid by the customer. D) Inventory risk is not an important factor in determining the relationship.

56)

Under ASC Topic 606, revenue should be recognized for services when:

A) the customer promises to pay for the service and the service date is confirmed. B) the service contract is in writing and signed. C) the service performance obligation is satisfied. D) it is assured that there will be no need for warranty performance after service is rendered.

57)

The cost-plus approach:

A) refers to contracts that are modified from their original terms during the course of the contract. B) refers to contracts where the contractor is not expected to recover all costs incurred in completing the project. C) is not allowed under ASC Topic 606 guidance for revenue recognition. D) uses an assumed reasonable profit margin to determine the stand-alone price.

58)

Examples of variable consideration include the following except:

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A) rebates. B) slotting fees. C) performance bonuses. D) volume discounts.

59) Wilson, Inc. sells, installs and maintains manufacturing equipment. The contract with its customers to purchase equipment includes installation and includes a one-year maintenance contract, renewable for up to five years. Because the useful life of the equipment is expected to be five years, the company can reasonably expect its customers to renew the maintenance contracts for the full five years. Wilson records the cost of installation of the equipment as a capitalized contract and amortizes the cost over the five-year maintenance agreement period. Because of a defect in model A5403, Wilson anticipates that many of its customers will trade in the model and not renew the maintenance contracts. Wilson, Inc. should:

write down the full amount received for maintenance contracts for the full five

years. B) write down the full amount of installation costs. C) write down the contract asset and recognize a loss equal to the difference between the amount of maintenance contracts expected and the carrying amount. D) do nothing until the customers fail to renew the maintenance contracts.

60)

The new ASC Topic 606 for revenue recognition:

A) addresses when and how revenue should be recognized in contracts that provide both goods and services to customers. B) eliminates both the percentage-of-completion method and the installment sales method of revenue recognition. C) will require companies to recognize a net liability contract position on all new contracts; revenue will then arise from increases in the net contract position over the life of the contract. D) is more rules based than are existing standards.

61)

Which of the following statements is not true regarding ASC Topic 606?

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A) Long-term construction contracts is an area where the new standard clearly differs from existing guidance. B) Adoption for calendar reporting public entities is first required for calendar 2018. C) Current guidance on long-term contracts gives more flexibility to firms for determining when revenue is recognized. D) The new standard precludes the use of percentage-of-completion method for longterm construction contracts.

62) Which of the following methods can be used to recognize revenue when a performance obligation is satisfied over time?

A) The output method. B) The present value method. C) The future value method. D) The fair value method.

63) Which of the following statements is true regarding the new ASC Topic 606 for revenue recognition?

A) The focus is on when the firm has earned the consideration to which it is entitled. B) Early adoption is not allowed. C) The new rules are more rules-based than principle-oriented. D) Under IFRS, both public and non-public firms must adopt by 2018.

64) Which of the following statements is true regarding the five-step model in the ASC Topic 606 guidance for revenue recognition?

A) The sale itself is the sole criterion for recognizing revenue. B) If a sale is not paid for on time, the seller should not recognize revenue. C) The performance obligations in the contract need to be identified. D) The transaction price is not relevant.

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65) Which of the following is not a necessary condition for a firm to account for a customer contract under the ASC Topic 606 guidance for revenue recognition?

A) The contract has commercial substance. B) Collection is probable. C) Payment terms may not include a variable component. D) The rights of each party can be identified.

66)

Contracts must be:

A) legally enforceable. B) in writing. C) communicated verbally. D) drafted by an attorney.

67) The residual approach to allocate transaction prices to multiple performance obligations in a contract is appropriate when:

A) The stand-along price of one or more of the goods or services is highly variable or uncertain. B) None of the goods and services included in the contract are not sold on a stand-alone basis. C) The stand-alone price of all of the goods or services is known. D) None of the answer choices are correct.

68) A patient of Dr. Jones presents his Medicare card after his appointment. The total charge for the services was $100; however, Medicare will pay only $60 for this service and the patient is to pay $20. Acceptance of the patient’s Medicare insurance creates a contract:

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A) for payment of $100, regardless of what Medicare will pay. B) for $20 and an $80 discount or price concession. C) for payment of $80 and a $20 discount or price concession. D) for payment of $60 and a price concession of $40.

69) Under the ASC Topic 606, which of the following statements is not a criteria that may determine whether revenue may be recognized over time?

A) The customer receives and consumes the goods and services as the performance obligations are satisfied. B) The firm’s performance creates or enhances an asset under the customer’s control. C) Satisfying the performance obligations does not create an asset with an alternative use and the firm has a right to receive payment for performance to date. D) All of these are criteria that may be used to determine whether the percentage of completion method may be used.

70) According to revenue recognition under ASC Topic 606, which of the following is a factor applicable to identifying performance obligations in a contract?

A) The length of the contract. B) The obligation is distinct in the context of the contract. C) The payment terms of the contract. D) The shipping terms of the contract.

71) Regarding ASC Topic 606 guidance for revenue recognition, which of the following statements is not true?

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A) Prior to ASC Topic 606, U.S. GAAP related to revenue recognition was generally based on industry-specific guidance. B) The FASB was involved with deciding to create a single, unifying framework for revenue recognition. C) ASC Topic 606 is based on principles that are radically different from prior guidance. D) A goal was to create a framework that could be applied to any industry and provide similar results for similar fact sets.

72) Which of the following statements is not true regarding ASC Topic 606 guidance for revenue recognition?

A) ASC Topic 606 applies to the sales of used equipment. B) ASC Topic 606 includes the definition of a customer. C) ASC Topic 606 allows for the combination of certain separate contracts. D) ASC Topic 606 covers contract modifications.

73) Which of the following statements is true regarding contracts in ASC Topic 606 guidance for revenue recognition?

A) Contracts need to be legally enforceable to be considered under ASC Topic 606. B) Contracts need to be in written form to be considered under ASC Topic 606. C) No consideration can be received before a contract exists. D) No price concessions can be made to an existing contract.

74) Which of the following statements is not true regarding the software developer example provided in ASC Topic 606 guidance for revenue recognition?

A) The example deals with the license of software. B) Software installation, software updates, and technical support are not addressed. C) The example covers four distinct performance obligations. D) All the performance obligations can be separately identified.

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75) Which of the following statements is not true regarding the treatment of warranties under the new revenue recognition guidance in ASC Topic 606?

A) A warranty that assures the product is free of defects is not a distinct performance obligation. B) Warranties that provide services beyond assuring the product is defect-free at the time of sale are separate performance obligations. C) A warranty that covers services that are normally considered routine maintenance is an assurance warranty. D) The length of the warranty period should be considered.

76) Under the new revenue recognition guidance in ASC Topic 606, which of the following statements is true regarding contracts with customer options?

A) In some cases where customers have an option to acquire additional goods or services, an evaluation is required to determine if the option creates an additional performance obligation. B) An additional performance obligation is created if the customer could obtain the same rights to additional goods or services without entering the contract. C) An additional performance obligation is created if the option provides the customer a right to purchase the goods or services at the stand-alone selling price for those goods or services. D) It is generally not considered a performance obligation when a retailer grants a "customer appreciation dividend" to a customer.

77) Under ASC Topic 606 guidance for revenue recognition, which of the following factors is not a consideration when determining the transaction price of a contract?

A) Variable consideration. B) Shipping terms. C) Significant financing components. D) Whether the firm is a principal or an agent.

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78) Under the new revenue recognition guidelines in ASC Topic 606, which of the following statements is not true regarding performance obligations satisfied over time?

A) The firm must determine at each reporting date the extent to which the performance obligation has been satisfied. B) Output and input methods may be used for measurement purposes. C) To obtain quality measurement, input methods must always be closely related to the transfer of the goods or services to the customer. D) Usable input measures include labor hours, costs incurred, and time elapsed.

79) Which of the following statements is not true regarding transactions involving intellectual property?

A) A transaction involving intellectual property can represent a sale or a license. B) The revenue recognition approach depends on whether the transaction is considered a sale or a license. C) If a contract is considered a license, the firm must determine if the license is a distinct performance obligation. D) If the customer’s right to use the intellectual property is not limited, the contract is considered a license.

80) Which of the following statements is not true regarding revenue recognition regarding gift cards?

A) "Breakage" refers to the unused portion of gift card balances. B) "Breakage" can only be recognized as revenue to the extent that it is probable a reversal will not be necessary. C) The amount received from the sale of gift cards is required to be recognized as revenue when the gift cards are sold. D) It is typical that a portion of gift card sales will go unused by customers.

81) Under ASC Topic 606, which of the following statements is not true regarding the use of practical expedients in applying the revenue recognition model?

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A) A firm can file an application to use a practical expedient on a large contract if it is under severe time pressure. B) One expedient is to use a portfolio approach to numerous contracts with similar characteristics. C) Determining the use of an expedient is dependent on whether there would not be a material difference in the financial statements from a more vigorous application of the standard. D) A firm is not required to adjust the transaction price for a significant financing component if at the contract inception, the period between the payment and the transfer of goods or services is expected to be a year or less.

82) Which of the following statements is not true regarding the adoption of ASC Topic 606 guidance for revenue recognition?

A) Upon adoption, entities can choose between the retrospective approach or the cumulative effect approach. B) When using the cumulative approach, the prior three years of financial statements need to be restated. C) Under the cumulative effect, the firm determines how the balance sheet would differ as of the first day of the year of adoption. D) Under the retrospective approach, each period presented is restated to what the financial statements would have been had the new standard always been in place.

83) Under IFRS in accounting for revenue recognition, for collection to be probable in order for revenue to be recognized on a contract, "probable" means:

A) Likely to occur. B) More likely to occur. C) Most likely than not to occur. D) More likely than not to occur.

84) In accounting for revenue recognition under ASC Topic 606, a contract modification is considered a new, separate contract when:

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A) The modification adds distinct goods or services to the agreement. B) The revised contract price reflects the original contract price cost of the additional goods or services. C) The revised contract adds distinct goods or services and the revised contract price reflects the allocated transaction price for the additional goods or services. D) The revised contract adds distinct goods or services and the revised contract price reflects the stand-alone selling price of the additional goods or services.

85) In accounting for revenue recognition under ASC Topic 606, when there is a modification of a contract, which of the following is correct?

A) If the modification adds distinct goods or services to the original contract, then a new contract must be created. B) If the new contract price does not reflect the stand-alone selling price of the additional goods or services to be exchanged, then a new contract must be created. C) If the modification adds distinct goods or services to the original contract and the change in the original contract price reflects the stand-alone price of the additional goods or services to be exchanged, then a new contract need not be created. D) If the modification adds distinct goods or services to the original contract and the change in the original contract price reflects the stand-alone price of the additional goods or services to be exchanged, then a new contract must be created.

86) In accounting for revenue recognition under ASC Topic 606, revenue can be recognized before a contract exists when cash has been received and:

A) Goods have already been delivered to a customer, and there is no further obligation for the seller to deliver goods or services. B) The cash has been received for goods identified to be delivered and the cash is refundable. C) The cash has been received for goods or services to be delivered and the cash is nonrefundable. D) Revenue should never be recognized before a contract exists.

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87) According to ASC Topic 606 guidance for revenue recognition, which of the following statements is true regarding customer options when identifying performance obligations in a contract?

A) There is an additional performance obligation for additional goods or services if the customer could obtain the same rights to additional goods or services without entering into the current contract agreement. B) There is an additional performance obligation for additional goods or services if the option in the contract provides for the additional goods or services at their stand-alone selling price. C) There is an additional performance obligation for additional goods or services if the customer could obtain the same rights to additional goods or services elsewhere but the additional good or services are provided for free or at a discount in the current contract. D) There is no additional performance obligation for additional goods or services if they will be received for free or at a discount, as long as the goods or services are similar to the other goods in the current contract.

88) Sew & More sells sewing machines and sewing supplies. The company recently ran a sales promotion on sewing machines that allowed customers to purchase a new sewing machine using store credit. The terms of the contract stated that customers would make 12 monthly payments that included a 6% annual interest rate. On the date of each sale, Sew & More should record.

A) No revenue until the contract is paid in full. B) Sales revenue equal to the sales price of the sewing machine, interest revenue equal to the total amount of interest for the contract, and a receivable for the total of the sales price plus the interest. C) revenue equal to the sales price of the sewing machine plus the total interest to be collected and a receivable for the same amount. D) revenue equal to the sales price of the sewing machine and a receivable for the same amount.

89) For long-term construction projects, the amount of “billings” is reported in the balance sheet by:

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A) netting it against “construction in progress.” B) adding it to “construction in progress.” C) adding it to “accounts receivable.” D) netting it against “accounts receivable.”

90) As part of a new franchise agreement, the franchisor provides quarterly training of the franchisee’s employees, periodic promotion of the franchisee’s weekly specials, annual seminars for the franchisee’s key personnel, as well as allowing the franchisee to utilize the franchisor’s name and logo. This agreement likely includes:

A) one performance obligation. B) two performance obligations. C) three performance obligations. D) four performance obligations.

91) Elaine Company, a clothing store, sells clothing for a total selling price of $50,000 with a related cost of $35,000. Customers have a right of return within 30 days. Elaine Company estimates that 10% of the sales will be returned by customers.The journal entry to recognize the sales will include:

A) Sales revenue of $50,000. B) Sales revenue of $35,000. C) Sales revenue of $45,000. D) No sales revenue until the return period has lapsed.

92) Elaine Company, a clothing store, sells clothing for a total selling price of $50,000 with a related cost of $35,000. Customers have a right of return within 30 days. Elaine Company estimates that 10% of the sales will be returned by customers.The journal entry to recognize the sales will include a credit to:

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A) Unearned sales revenue. B) Refund liability. C) Sales returns and allowances. D) Inventory recovery

93) Elaine Company, a clothing store, sells clothing for a total selling price of $50,000 with a related cost of $35,000. Customers have a right of return within 30 days. Elaine Company estimates that 10% of the sales will be returned by customers.The entry to recognize the cost of inventory sold will include a credit to “inventory” and a debit to cost of goods sold for:

A) B) C) D)

$30,000. $31,500. $35,000. $38,500.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 94) One of the conditions that must be met to apply the five-step model under ASC Topic 606 is that collection of the contract-related consideration is “probable.”Required:A. Does this condition apply to IFRS?B. For which standard is this condition easier or earlier met? Why?

95) CPA Now sells print materials and an app to help its customers prepare for the CPA exam. Along with these products, the company also provides updates to the app and coaching services. The stand-alone prices for these goods and services are: Good/Service Print materials App App updates Coaching services

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Price $100 per exam section (4 exam sections total) $100 (contains questions for all 4 sections) Not sold separately Not sold separately

CPA Now provides a package deal for Accounting students that includes the print materials for all four exam sections, the app, and free updates and coaching until the student passes the exam. The cost of the package is $1,000. Customers download an average of two updates to the app while using it. Using the residual approach, the company estimates the value of an app update to be $25 and the value of the coaching services to be $1,050.Required:How many separate performance obligations are included in the package deal?How much of the package price of $1,050 should CPA Now allocate to each of the performance obligations?

96) Peachpit Software Developers shipped its accounting package to a customer on September 10, 20X1. In addition to the software, Peachpit’s contract requires the company to provide: (1) training to the customer’s accounting staff during October of 20X1 and again in January 20X2 when the upgrade is released—75% of the training hours are provided during October, (2) technical product support for one year starting October 1, 20X1, and (3) a major upgrade to the software early in 20X2. The customer paid the total contract price of $80,000 upon receipt of the invoice on September 17, 20X1. Peachpit would charge the following if these individual contract elements were sold separately: Fair Value Accounting package (software)

65,000

Training customer’s staff

10,000

Customer support

15,000

Accounting software upgrade

10,000

Totals

100,000

Required:a. Prepare a journal entry to record receipt of the cash payment.b. Determine the amount of revenue to be recognized in 20X1 and prepare the necessary journal entry.

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Answer Key Test name: chapter 3 1) TRUE 2) FALSE 3) TRUE 4) TRUE 5) FALSE 6) TRUE 7) TRUE 8) TRUE 9) TRUE 10) TRUE 11) TRUE 12) FALSE 13) C 14) D 15) B 16) B 17) A 18) B 19) B 20) A 21) A 22) D 23) B 24) A 25) C 26) B Version 1

27) C 28) A 29) B 30) B 31) D 32) D 33) C 34) D 35) D 36) C 37) A 38) D 39) C 40) D 41) D 42) C 43) D 44) D 45) B 46) D 47) D 48) A 49) D 50) C 51) C 52) A 53) C 54) B 55) D 56) C Version 1

57) D 58) B 59) C 60) A 61) D 62) A 63) D 64) C 65) C 66) A 67) A 68) C 69) D 70) B 71) C 72) A 73) A 74) B 75) C 76) A 77) B 78) C 79) D 80) C 81) A 82) B 83) D 84) D 85) C 86) A Version 1

87) C 88) D 89) A 90) D 91) C 92) B 93) B 94) A: Yes, both IFRS and U.S. include this condition.B: On average, this condition is earlier or easier met under IFRS. IFRS defines “probable” as “more likely than not,” which means a probability of more than 50%. U.S. GAAP does not define “probable.” However, “probable” is commonly interpreted as 70%. 95) a. 4 separate performance obligations: (1) print materials, (2) app, (3) updates, (4) coachingb. print materials:

400

app

100

updates

coaching

525

total

$ 1,050

relative stand-alone prices: print materials $100 × 4 sections = $ app $

400 100

total

500

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package price

$ 1,050

stand-alone prices price to allocate

(500 ) $

550

estimated price of app updates

50 *

estimated price of coaching

$ 1,050

total

$ 1,100

*(2 * $25)** 50/1,100 = 0.045455 * $550 = $ 50 0.954545 * $550 = $525 96) a.To record cash receipt for bundled sale: DR

Cash

Unearned revenue

0.045455 ** $

0.954545 ** $ 525

1,050/1,100 =

$ 80,000 $ 80,000

b. To determine revenue to be recognized on bundled sales, first allocate the total revenue to the various elements being sold based on the relative fair values of the elements if they were sold separately as follows: Percent of Total Fair Value

Contract Price Allocation

65 %

$ 52,000

Fair value Accounting package (software)

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65,000

Training customer’s staff

10,000

10 %

8,000

Customer support

15,000

15 %

12,000

Accounting software upgrade

10,000

10 %

8,000

Totals

100,000

$ 80,000

Revenue to be recognized in 20X1 is based on the percentage of each element that has been rendered in 20X1 as follows: Contract

Percentage

Revenue

Price

Rendered

Recognized

Allocation

in 20X1

$ 52,000

100 %

$ 52,000

Training customer’s staff

8,000

75 %

6,000

Customer support (Oct.–Dec.)

12,000

25 %

3,000

Software upgrade

8,000

Accounting package (software)

Totals

$ 85,000

$ 61,000

To record revenue from bundled sale earned in 20X1: DR

Unearned revenue

Revenue

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$ 61,000 $ 61,000

CHAPTER 4: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Liquidity refers to how quickly noncurrent assets will be converted into cash to pay liabilities. ⊚ ⊚

true false

A common-size balance sheet presents each item as a percentage of total assets. ⊚ ⊚

true false

3) Companies having cash denominated in foreign currency units will not translate those units into U.S. dollars because cash has the same value in all currencies. ⊚ ⊚

Inventory and accounts receivable are both carried at net realizable value. ⊚ ⊚

true false

Deferred income taxes will be reported as either a noncurrent asset or noncurrent liability. ⊚ ⊚

true false

6) It is permissible for a firm that reports in accordance with IFRS to emphasize its liquidity by placing current assets and current liabilities in close proximity to one another on the balance sheet. ⊚ ⊚

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true false

7) Restricted cash should be reported on the balance sheet as part of cash and cash equivalents. ⊚ ⊚

true false

8) Stanley is considering investing in a fast-growing toy manufacturing company—Spiele Inc. Stanley is aware of recent lawsuits involving the safety of trendy new toys manufactured by one of Spiele’s primary competitors. He reviews Spiele’s comparative balance sheet and discovers that the company did not report any estimated loss liabilities for the current and previous fiscal years. Based on this information, Stanley should feel confident that Spiele Inc. has no pending loss litigation. ⊚ ⊚

true false

9) The statement of cash flows shows the user why a firm’s investments and financial structure have changed between two balance sheets dates. ⊚ ⊚

true false

10) The cash flow statement explains why a firm’s cash position has changed between successive balance sheet dates while simultaneously explaining the changes that have taken place in the firm’s noncash asset, liability, and stockholders’ equity accounts over the same period. ⊚ ⊚

true false

11) Investing activities include the cash effects of selling stocks and bonds to raise capital to purchase fixed assets. ⊚ ⊚

true false

12) Depreciation is added back to net income to determine cash from operating activities under the indirect method. Version 1

⊚ ⊚

true false

13) Under the direct method for cash flow statement preparation, net cash flows from operating activities is calculated by adjusting net income for the differences between accrualbasis revenues and expenses and cash inflows and outflows during the period. ⊚ ⊚

true false

14) Under U.S. GAAP, cash interest from investments is reported on the statement of cash flows as part of investing activities whereas under IFRS, cash interest from investments is reported as part of financing activities. ⊚ ⊚

true false

15) When adjusting accrual earnings to obtain cash flows from operations, an increase in Prepaid Rent Expense is subtracted to arrive at cash flow from operations. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) Probable future economic benefits obtained or controlled by an entity as a result of past transactions or events defines:

A) assets. B) liabilities. C) equity. D) retained earnings.

17) The residual interest in the resources of an entity that remains after deducting its debts to third parties defines:

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A) assets. B) liabilities. C) equity. D) retained earnings.

18) Probable future sacrifices of economic benefits arising from an entity’s present obligations to transfer resources or provide services to other entities in the future as a result of past transactions or events defines:

A) assets. B) liabilities. C) equity. D) retained earnings.

19)

The balance sheet provides information on all of the following except:

A) how management invested its money. B) where the money came from. C) assessing rates of return. D) the market price of the company’s stock.

20)

Contributed capital might be a negative dollar amount because:

A) net losses exceeded net income over the years. B) excess liabilities reduced contributed capital. C) treasury stock was in excess of stock originally issued. D) dividends paid were in excess of net income accumulated in retained earnings.

21)

Accrued liabilities represent:

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A) income that has not yet been recognized on the income statement. B) expenses that have not yet been recognized on the income statement. C) expenses that have been recognized on the income statement but not yet been paid. D) income that has been recognized on the income statement but not yet collected.

22)

Balance sheet amounts would not be measured as:

A) effective value. B) fair value. C) present value. D) historical cost value.

23)

Goodwill arising from a business combination is reported on the balance sheet as a(n):

A) current asset. B) fair value asset. C) impaired asset. D) intangible asset.

24) Balance sheets prepared in other countries using international accounting standards (IFRS) might use different account titles than are allowed for US. GAAP, such as:

A) Capital reserve. B) Share premium. C) Hedging reserve. D) all of these answer choices might be used in balance sheets prepared using IFRS.

25)

Balance sheets prepared in compliance with U.S. GAAP reflect a mixture of:

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A) historical cost and future cash values. B) current value and discounted future cash flows. C) discounted cash flows and future values. D) historical cost, fair value, net realizable value, and discounted present values.

26)

Current assets are assets expected to:

A) be converted to cash within twelve months. B) be converted to cash within twelve months or one operating cycle if the operating cycle is longer than twelve months. C) remain on the books for at least twelve months. D) remain on the books for at least twelve months or one operating cycle if the operating cycle is longer than twelve months.

27)

Cash is always measured for the balance sheet at:

A) future transaction value. B) current market value. C) realizable future value. D) net transaction value.

28) Joe Carie, head accountant, is using the indirect method and the account balance from the balance sheet and income statement to prepare a statement of cash flows. He notices that the Retained Earnings account increased from the beginning of the year. This information is used to:

A) increase cash flow from financing as it indicates receipt of payments from customers. B) decrease cash flow from investing as it indicates payment of debt. C) increase cash flow from operations as it signifies a net income. D) decrease cash flow from operations as it indicates a net loss.

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29) Joe Carie, head accountant, is using the indirect method and the account balance from the balance sheet and income statement to prepare a statement of cash flows. Joe would use an increase in Accumulated Depreciation to:

A) increase cash flow from operating activities. B) increase cash flow from investing activities. C) decrease cash flow from investing activities. D) decrease cash flow from operating activities.

30) Joe Carie, head accountant, is using the indirect method and the account balance from the balance sheet and income statement to prepare a statement of cash flows. An increase in the Computer Equipment account would:

A) decrease cash flow from financing activities. B) decrease cash flow from investing activities. C) increase cash flow from operating activities. D) increase cash flow from investing activities.

31) Joe Carie, head accountant, is using the indirect method and the account balance from the balance sheet and income statement to prepare a statement of cash flows. A decrease in the balance of the Accounts Receivable account would:

A) decrease cash flow from financing activities. B) increase cash flow from investing activities. C) decrease cash flow from operating activities. D) increase cash flow from operating activities.

32)

Net property, plant and equipment are reported on the balance sheet at:

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A) current market value. B) historical cost. C) historical cost minus accumulated depreciation. D) net realizable value.

33)

Current liabilities are reported on the balance sheet at:

A) current market value. B) historical cost. C) discounted present value. D) future value.

34)

Long-term debt is reported on the balance sheet at:

A) current market value. B) net realizable value. C) present value. D) future value.

35) Cash interest from investments is recorded as in statements of cash flows for U.S. GAAP, but can be recorded as when using IFRS.

A) cash flows from investing activities / cash flows from financing activities B) cash flows from financing activities / cash flows from operating activities C) cash flows from operating activities / cash flows from financing activities D) cash flows from operating activities / cash flows from investing activities

36)

Balance sheets developed under US GAAP:

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A) may, but are not required to, list assets from most liquid to least liquid. B) must list assets from most liquid to least liquid. C) must list assets from least liquid to most liquid. D) must list assets in alphabetical order.

37)

Balance sheets prepared under IFRS:

A) may list assets and liabilities from least liquid to most liquid. B) must list assets, but not liabilities in order of liquidity. C) must list assets and liabilities from least liquid to most liquid. D) must list liabilities, but not assets, from most to least liquid.

38)

The Common Stock account is reported on the balance sheet at the:

A) par value of the stock. B) current market value of the stock. C) net realizable value of the stock. D) discounted present value of the future dividends.

39)

The Additional Paid-In Capital account is reported on the balance sheet at the

A) current market value of the stock minus par value. B) original sales price of the stock minus the par value. C) net realizable value of the stock minus par value. D) discounted present value of the future dividends minus par value.

40)

The Retained Earnings account is comprised of

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A) cash retained in the business. B) cash reinvested in the business by shareholders. C) the cumulative earnings less dividends since the inception of the corporation. D) the earnings of the corporation for the current year.

41)

Retained earnings are reported on the balance sheet at:

A) historical cost. B) current market value. C) net realizable value. D) a mixture of different measurement bases.

42) In a common-size balance sheet, each balance sheet account is expressed as a percentage of total:

A) liabilities. B) assets. C) shareholders’ equity. D) assets plus shareholders’ equity.

43)

Common-size balance sheets may be used for all the following except:

A) gaining insights into the nature of a company’s operations. B) analyzing a company’s asset and financial structure. C) determining how management assesses the risks a company faces. D) learning about the underlying economics of an industry.

44)

Under U.S. GAAP, assets are presented in decreasing order of liquidity. Under IFRS,

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A) tangible assets may be presented first followed by the current assets displayed in increasing order of liquidity. B) the current assets are displayed in increasing order of liquidity. C) investments are listed first in descending order of maturity. D) a company may present its assets in alphabetical order if it so desires.

45) The term "consolidated" is used in financial statements under U.S. GAAP to refer to the financial reporting for a parent and its subsidiaries. The equivalent term used on balance sheets in the United Kingdom is:

A) cooperative. B) satellite. C) consolidated. D) group.

46) Which one of the following equations explains why successive balance sheets can be used to prepare a firm’s cash flow statement?

A) Assets = Liabilities − Equity B) Cash - Noncash assets = Liabilities − Equity C) Δ Cash = Δ Liabilities − Δ Noncash assets + Δ Stockholders’ equity D) Δ Cash = Δ Liabilities + Δ Stockholders’ equity

47) The change in a firm’s cash position between successive balance sheet dates will not equal the reported net income for that period for all the following reasons except:

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A) Reported net income usually will not equal cash flow from operating activities because noncash revenues and expenses are often recognized as part of accrual income. B) Reported net income usually will not equal cash flow from operating activities because certain operating cash inflows and outflows are not recorded as revenues or expenses under accrual accounting in the same period the cash flows occur. C) Changes in cash are also caused by nonoperating-related investing activities like the purchase of treasury stock. D) Additional changes in cash are caused by financing activities like the repayment of a bank loan.

48)

Operating activities result from the cash effects of:

A) producing and delivering goods and services. B) purchasing and disposing of fixed assets used in production of revenue. C) borrowing and repaying loans used in the production of revenue. D) selling stocks and bonds to raise capital for the generation of revenue.

49)

Investing activities include the cash effects of:

A) producing and delivering goods and services. B) purchasing and disposing of productive assets used in production of revenue. C) borrowing and repaying loans used to purchase equipment. D) selling stocks and bonds to raise capital to purchase land.

50)

Financing activities include the cash effects of:

A) producing and delivering goods and services. B) purchasing and disposing of productive assets used in production of revenue. C) purchasing and disposing of debt securities of other companies. D) selling stocks and bonds to raise capital used to produce revenue.

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51)

Cash flows from operating activities include:

A) cash payments received from customers. B) increases in Accumulated Depreciation. C) deferred income taxes. D) All of these would be included in cash flows from operating activities.

52) Selected data for Kris Corporation’s comparative balance sheets for Year 1 and Year 2 are as follows: Year 1

Year 2

Assets Cash

$ 100,000 $ (50,000 )

Accounts receivable (net)

50,000

100,000

Inventory

100,000

250,000

Equipment (net)

300,000

350,000

Total assets

$ 550,000 $ 650,000

Liabilities and Equity Accounts payable

$ 150,000 $ 100,000

Income taxes payable

80,000

30,000

Bonds payable

100,000

80,000

Common stock

100,000

200,000

Retained earnings

120,000

240,000

Total liabilities and Equity

$ 550,000 $ 650,000

Using the indirect method to create the operating activities section of the statement of cash flows, the cash flow from accounts receivable would be recorded as: Version 1

A) B) C) D)

an increase of $50,000 an increase of $150,000 a decrease of $50,000 a decrease of $150,000

53) Selected data for Kris Corporation’s comparative balance sheets for Year 1 and Year 2 are as follows: Year 1

Year 2

Assets Cash

$ 100,000 $ (50,000 )

Accounts receivable (net)

50,000

100,000

Inventory

100,000

250,000

Equipment (net)

300,000

350,000

Total assets

$ 550,000 $ 650,000

Liabilities and Equity Accounts payable

$ 150,000 $ 100,000

Income taxes payable

80,000

30,000

Bonds payable

100,000

80,000

Common stock

100,000

200,000

Retained earnings

120,000

240,000

Total liabilities and Equity

$ 550,000 $ 650,000

Using the indirect method to create the operating activities section of the statement of cash flows, the cash flow recorded based on the change in inventory would be:

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A) B) C) D)

a decrease of $400,000 an increase of $400,000 an increase of $150,000 a decrease of $150,000

54) Selected data for Kris Corporation’s comparative balance sheets for Year 1 and Year 2 are as follows: Year 1

Year 2

Assets Cash

$ 100,000 $ (50,000 )

Accounts receivable (net)

50,000

100,000

Inventory

100,000

250,000

Equipment (net)

300,000

350,000

Total assets

$ 550,000 $ 650,000

Liabilities and Equity Accounts payable

$ 150,000 $ 100,000

Income taxes payable

80,000

30,000

Bonds payable

100,000

80,000

Common stock

100,000

200,000

Retained earnings

120,000

240,000

Total liabilities and Equity

$ 550,000 $ 650,000

The change in the balance of the common stock account would be recorded on the statement of cash flows as:

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A) B) C) D)

an increase of $100,000 under financing activities. an increase of $100,000 under investing activities. an increase of $100,000 under operating activities. an increase of $300,000 under financing activities.

55) Selected data for Kris Corporation’s comparative balance sheets for Year 1 and Year 2 are as follows: Year 1

Year 2

Assets Cash

$ 100,000 $ (50,000 )

Accounts receivable (net)

50,000

100,000

Inventory

100,000

250,000

Equipment (net)

300,000

350,000

Total assets

$ 550,000 $ 650,000

Liabilities and Equity Accounts payable

$ 150,000 $ 100,000

Income taxes payable

80,000

30,000

Bonds payable

100,000

80,000

Common stock

100,000

200,000

Retained earnings

120,000

240,000

Total liabilities and Equity

$ 550,000 $ 650,000

The changes in the Accounts Payable balance would be recorded on the statement of cash flows as:

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A) B) C) D)

an increase of $50,000 under financing activities. a decrease of $50,000 under financing activities. an increase of $50,000 under operating activities. an decrease of $50,000 under operating activities.

56) Selected data for Kris Corporation’s comparative balance sheets for Year 1 and Year 2 are as follows: Year 1

Year 2

Assets Cash

$ 100,000 $ (50,000 )

Accounts receivable (net)

50,000

100,000

Inventory

100,000

250,000

Equipment (net)

300,000

350,000

Total assets

$ 550,000 $ 650,000

Liabilities and Equity Accounts payable

$ 150,000 $ 100,000

Income taxes payable

80,000

30,000

Bonds payable

100,000

80,000

Common stock

100,000

200,000

Retained earnings

120,000

240,000

Total liabilities and Equity

$ 550,000 $ 650,000

The change in the equipment balance would be recorded on the statement of cash flows as:

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A) B) C) D)

a decrease of $50,000 under investing activities. an increase of $50,000 under investing activities. a decrease of $150,000 under investing activities. an increase of $150,000 under operating activities.

57) Selected data for Kris Corporation’s comparative balance sheets for Year 1 and Year 2 are as follows: Year 1

Year 2

Assets Cash

$ 100,000 $ (50,000 )

Accounts receivable (net)

50,000

100,000

Inventory

100,000

250,000

Equipment (net)

300,000

350,000

Total assets

$ 550,000 $ 650,000

Liabilities and Equity Accounts payable

$ 150,000 $ 100,000

Income taxes payable

80,000

30,000

Bonds payable

100,000

80,000

Common stock

100,000

200,000

Retained earnings

120,000

240,000

Total liabilities and Equity

$ 550,000 $ 650,000

The change in the balance of the Bonds Payable account would be recorded on the statement of cash flows as:

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A) B) C) D)

58)

an increase of $20,000 under financing activities. an increase of $80,000 under investing activities. a decrease of $20,000 under financing activities. a decrease of $80,000 under operating activities.

Which of the following statements is not true?

A) The indirect method begins with net income. B) Cash flows from operating activities will differ between the direct and indirect methods. C) Most firms use the indirect method to prepare the statement of cash flows. D) The direct method presents cash inflows and outflows.

59)

The Barden Company provides the following trial balance as of December 31, 20X1. Debit

Cash and cash equivalents

Credit

$ 345,000

Accounts receivable

115,000

Inventory

120,000

Prepaid insurance

7,500

Prepaid rent

40,000

Equipment

265,000

Accumulated depreciation – Equipment

65,000

Accounts payable

45,000

Accrued liabilities

10,000

Notes payable, due in 2020

135,000

Common stock

300,000

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Additional paid-in capital

87,500

Retained earnings

250,000

Total

$ 892,500 $ 892,500

What would Barden report as current assets on its balance sheet?

A) B) C) D)

60)

$460,000 $580,000 $892,500 $627,500

The Barden Company provides the following trial balance as of December 31, 20X1. Debit

Cash and cash equivalents

Credit

$ 345,000

Accounts receivable

115,000

Inventory

120,000

Prepaid insurance

7,500

Prepaid rent

40,000

Equipment

265,000

Accumulated depreciation – Equipment

65,000

Accounts payable

45,000

Accrued liabilities

10,000

Notes payable, due in 2020

135,000

Common stock

300,000

Additional paid-in capital

87,500

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Retained earnings Total

250,000 $ 892,500 $ 892,500

What would Barden report as total stockholders’ equity on its balance sheet?

A) B) C) D)

$300,000 $387,500 $637,500 $87,500

61) The account “revaluation reserve” can be found on balance sheets prepared consistent with:

A) IFRS only B) U.S. GAAP only C) IFRS and U.S. GAAP D) Cash accounting

62)

A consolidated balance sheet:

A) includes the net assets of the parent company and all of its subsidiaries. B) reports separately the net assets of the parent company and its subsidiaries. C) includes the net assets of the parent company and all components in which it owns more than 75% of the outstanding voting stock. D) includes the net assets of only the subsidiary companies.

63)

Which of the following statements about retained earnings is not true?

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A) Retained earnings reflect the net income of previous accounting periods only. B) Retained earnings measures the cumulative earnings of the company since inception, minus dividends distributed. C) Retained earnings represents cumulative earnings that have been reinvested in the business. D) Retained earnings may represent a large portion of stockholders’ equity.

64)

Information found on a company’s balance sheet can tell a story about:

A) the company and its strategies. B) the company’s industry. C) the company’s performance. D) All of these can be derived from the information on the balance sheet.

65)

The U.K. Equity account "Share premium" is reported on U.S. GAAP balance sheets as:

A) capital reserve. B) revaluation reserve. C) capital in excess of par. D) an accumulated other comprehensive income account.

66)

The U.K. Equity account "Hedging reserve" is reported on a U.S. GAAP balance sheet as

A) capital reserve. B) revaluation reserve. C) capital in excess of par. D) an accumulated other comprehensive income account.

67)

When adjusting accrual earnings to obtain cash flows from operations,

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A) an increase in Accounts Payable is added to determine cash flow from operations. B) a decrease in Accounts Payable is added to determine cash flow from operations. C) an increase in Accounts Payable is deducted to determine cash flows from operations. D) it is not necessary to consider any changes to Accounts Payable.

68)

Cash collected from customers can be derived:

A) by analyzing changes in the Accounts Payable balance. B) by appropriately adjusting revenue for changes in accounts receivable. C) by appropriately adjusting revenue for changes in accounts payable. D) by analyzing changes to the reserve for doubtful accounts.

69)

The sale of productive assets:

A) does not impact the period cash flows. B) represents a financing activity. C) represents an investing activity. D) represents an operating activity.

70)

Paying dividends to stockholders:

A) represents an investing activity. B) does not impact the period cash flows. C) represents an operating activity. D) represents a financing activity.

71)

Operating activities result from the cash effects of:

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A) paying dividends to shareholders. B) producing and delivering goods. C) selling equipment. D) issuing long-term debt.

72)

The cash flow from operating activities:

A) is required to be presented using the direct method by U.S. GAAP and IFRS. B) can be presented by using either the direct method or the indirect method. C) comprises only the increase in cash arising from the firm’s profit-making activities. D) can vary depending on whether the presentation is done under the direct method or the indirect method.

73)

The balance sheet:

A) provides a summary of a firm’s assets, liabilities, equity and cash flows as of a specific date. B) classifies assets as current if they are expected to be converted into cash within 24 months. C) is an expression of the accounting equation. D) is comprised of items shown only at historical costs.

74) The following information is available from Moran Industries’ accounting system for the year ended December 31, 20X1.

Cash received from customers

$ 750,000

Cash paid to suppliers

$ 300,000

Cash paid to employees

$ 150,000

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Taxes paid

25,000

Cash dividends paid

50,000

What would the company’s statement of cash flows report as cash flow from operations?

A) B) C) D)

75)

$225,000 $275,000 $300,000 $250,000

Liabilities represent amounts that are:

A) probable future economic sacrifices obtained or controlled by an entity as a result of past transactions or events. B) always classified as current on the balance sheet. C) never shown on the balance sheet at historical cost. D) netted against assets on the balance sheet.

76)

On balance sheets prepared in accordance with U.S. GAAP:

A) assets are generally listed from least liquid to most liquid. B) liabilities are generally netted against assets. C) assets are generally listed from most liquid to least liquid. D) both tangible and intangible long-lived assets can be revalued upward periodically.

77)

A balance sheet prepared in accordance with U.S. GAAP typically:

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A) includes both "noncurrent liability" and "long-term obligation" sections. B) reports inventory at historical costs. C) reports cash at its current market value. D) reports retained earnings comprised of the cumulative earnings less dividends since the inception of the entity.

78)

A balance sheet prepared in accordance with U.S. GAAP typically:

A) reports common stock at the current market price of the stock. B) provides critical information for understanding a firm’s capital structure. C) helps to determine the proper mix of debt and equity financing. D) provides critical information for understanding a firm’s profitability.

79)

A temporary difference is the result of:

A) a revenue or expense item reported in different periods for book purposes and tax purposes. B) fluctuations in the exchange rate. C) adjustments between the trial balance and general ledger. D) delays between the sale of a product and the recording of the account receivable.

80)

The indirect method of presenting cash flow from operating activities:

A) is strongly recommended by both U.S. GAAP and IFRS. B) focuses on how cash flows deviate from a natural benchmark – net income. C) presents cash transactions related to the determination of net income. D) is more difficult than the direct method to incorporate working capital changes into a financial model.

81)

Properly prepared statements of cash flows:

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A) include stock issued for cash as an investing activity. B) present depreciation as a subtraction from net income to arrive at a firm’s cash flow from operations under the indirect method. C) are frequently used by investment analysts to cash flows from operations across two or more companies. D) will show the change in cash during a period to be equal to the net income for the period.

82)

On a balance sheet prepared under U.S. GAAP:

A) accounts receivable is presented at net realizable value. B) inventories are presented at current market price. C) any cash denominated in a foreign currency is disclosed in a footnote. D) most short-term investments are presented at historical cost.

83)

Long-term debt:

A) sheet date. B) C) D)

consists of monetary obligations that fall due beyond two years from the balance when issued, is carried at an amount based on the proceeds received. usually has an effective yield that is much different than the cost of borrowing. never has any portion classified as a current liability.

84) A contingent liability that is probable and can be reasonably estimated will immediately result in:

A) an increase in both liabilities and stockholders’ equity. B) an increase in liabilities and a decrease in net income. C) an increase in liabilities without any need for financial statement disclosure. D) an increase in liabilities and a decrease in assets.

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85) Which of the following statements is not correct with respect to accounting for Guarantees?

A) When one company guarantees the debt of another company, that contingency must be disclosed even if the contingency is only remotely possible. B) The Guarantee liability account represents deferred revenue associated with the stand ready fee. C) Both the “stand ready obligation” and the contingent future obligation are recorded at fair value. D) The Guarantee liability account decreases over the life of the loan as revenue is earned.

86) Which of the following statements regarding the recognition of contingencies is not correct?

A) IFRS guidance is built around a balance sheet perspective. B) Both IFRS and U.S. GAAP require recognition of a contingent liability when it is both probable and can be reasonably estimated. C) U.S. GAAP relies on an income statement perspective. D) Only U.S. GAAP requires recognition of a contingent liability.

87)

Which of the following regarding the recognition of contingencies is a correct statement?

A) IFRS uses the term contingent liability to include possible but unrecognized contingent obligations. B) U.S. GAAP discloses contingent liabilities in the notes to the financial statements only for recognized contingent loss obligations. C) The threshold for recognition of a contingent obligation is the same under both GAAP and IFRS. D) If the estimated liability is a range in which no value is deemed more reliable than another – both IFRS and GAAP will record the mid-point of the range as the value.

88)

Which one of the following contingencies must be accrued on the balance sheet?

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A) The likely loss on a lawsuit that the firm’s attorneys believe will be dropped. B) The probable loss on a lawsuit that the firm’s attorneys believe will be settled for $50,000. C) The reasonably possible loss on a lawsuit that the firm’s attorneys believe will be dropped. D) The reasonably possible loss on a lawsuit that the firm’s attorneys believe will be settled for $50,000.

89)

Which one of the following contingencies requires financial statement disclosure?

A) A lawsuit that the firm’s attorneys believe will be dropped. B) A lawsuit that the firm’s attorneys believe will probably be settled for $75,000. C) A reasonably possible loss on a lawsuit that the firm’s attorneys cannot estimate the loss. D) A reasonably possible loss on a lawsuit that the firm’s attorneys believe will be settled for $100,000.

90)

Losses must be accrued if they are:

A) remote and estimable. B) reasonably possible and estimable. C) probable and reasonably estimable. D) probable and not estimable.

91)

Losses must be disclosed if they are:

A) remote and estimable. B) reasonably possible and estimable. C) probable and reasonably estimable. D) reasonably possible but not estimable.

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92)

Goodwill:

A) is a tangible asset recognized as part of a business combination. B) is not subject to impairment. C) is initially measured as the difference between the consideration given in an acquisition and the fair value of the separately identifiable net assets acquired on the acquisition date. D) is classified on the balance sheet as a current asset.

93)

Other comprehensive income

A) consists of certain gains and losses included in comprehensive income but not yet recognized in the income statement. B) is never adjusted for tax effects. C) does not include gains and losses. D) is consistently defined in international balance sheet presentation.

94) Peter Inc. currently holds cash denominated in Euros. In its consolidated balance sheet, Peter Inc. should report the cash

A) in Euros. B) in Dollars. C) at its present value. D) at its future value.

95) A contingent liability requires that the related event that may give rise to a future loss relates to a

A) past event. B) future event. C) certain event. D) potential event.

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96) Under U.S. GAAP, contingent gains are not recognized until certain. This is most consistent with the principle or concept of:

A) Matching B) Relevance C) Consistency D) Conservatism

97)

The rules used for determining taxable income in various countries:

A) have the same objective as the rules used for determining income for financial reporting purposes. B) have an objective designed to provide a basis for funding government operations. C) are not the result of a political process. D) measure changes in a firm’s underlying economic condition.

98) Which of the following statements is not true regarding cash flow from operating activities?

A) Most firms use the indirect method for presentation. B) Each line item in a direct method Statement of Cash Flows is actually a cash flow. C) The direct method begins with net income and then shows the differences between operating cash flow and net income. D) There are two methods for presenting cash flow from operating activities.

99)

A balance sheet prepared under U.S. GAAP includes the following elements except

A) an asset section B) a liabilities section C) an equity section D) a cash flow section

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100) A balance sheet prepared under U.S. GAAP can have amounts presented in the following measurement bases except:

A) foreign currency B) historical costs C) discounted present values D) current replacement costs

101)

Which of the following statements is not true regarding the cash flow statement?

A) The cash flow statement provides information about changes in all the balance sheet accounts. B) The change in cash is classified into cash flow from three categories: operating activities, investing activities and financing activities. C) The cash flow statement generally shows that cash flows and accrual earnings are substantially the same. D) The cash flow statement explains the causes for year-to-year changes in cash and cash equivalents.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 102) Blimpy’s Doughnuts, Inc.’s adjusted trial balance appears below.Required: Prepare a classified balance sheet at December 31, 20X1 for Blimpy’s. Hint: Account categories for several of the items listed are found in parentheses. Blimpy’s Doughnuts, Inc. Adjusted Trial Balance (alphabetical order) December 31, 20X1 Debits Accounts and notes receivable Accounts payable

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Credits

27,603 $

7,874

Accrued litigation settlement (current liability) Accumulated deficit

86,772 191,010

Accumulated other comprehensive income Cash and cash equivalents

1,266 36,242

Common stock

310,942

Current maturities of long-term debt Deferred income taxes (noncurrent asset)

1,730 20

Deferred income taxes (current liability)

Depreciation and amortization

21,046

Direct operating expenses

389,379

Equity in (losses) of equity method franchisees General and administrative expenses

48,860

Goodwill and other intangible assets

28,934

Impairment charges and lease termination costs Insurance recovery receivable (current asset) Interest expense

12,519

842

34,967 20,334

Interest income

1,627

Inventories

21,006

Investments in equity method franchisees

3,224

Long-term debt, less current maturities

105,966

Other accrued liabilities

38,474

Other assets

16,842

Other current assets

12,000

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Other income

5,105

Other long-term obligations

29,694

Property and equipment Provision for income taxes

168,654 1,211

Revenues Settlement of litigation (expense) Totals

461,195 15,972 $ 1,050,665

$ 1,050,665

103) Harry’s Clothing, Inc. used the following headings on the company’s December 31, 20X1 balance sheet:(A) Current assets(B) Long-term investments(C) Property and equipment(D) Intangible assets(E) Other assets(F) Current liabilities(G) Long-term debt(H) Shareholders’ equityRequired: For each of the following items, indicate its normal balance sheet classification category. Use (NA) for items that would not appear on the face of the balance sheet, but would be discussed in the notes to the financial statements. 1. Accounts receivable 2. Accrued interest on notes payable (20X2 maturity) 3. Accumulated depreciation 4. Goodwill 5. Preferred stock 6. Common stock 7. Customer deposits on products to be shipped in a few months 8. Depreciation methods and estimated lives of equipment 9. Prepaid insurance 10. Assets (surplus production equipment) held for sale

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104) Below are the condensed balance sheets and income statement for the Beltway Company, Inc. Reformat the balance sheet as a common-size balance sheet and evaluate the company’s performance by responding to the questions provided. Condensed balance sheet December 31, 20X2 20X1

20X2

$ 15

Accounts receivable

Inventory

Prepaid insurance

Property plant and equipment

140

150

Accumulated depreciation

(45 )

(55 )

Net PP&E

$ 213

$ 211

$ 35

$ 21

Wages payable

Interest payable

Taxes payable

Long-term debt

Common stock

Retained earnings

Assets: Current assets Cash

Total assets

Liabilities: Accounts payable

Equity:

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Total liabilities and equity

$ 213

$ 211

Required:Reformat the balance sheet to be a common-sized balance sheetRespond to the following question: a.What does the common-size balance sheet suggest about the company’s performance? [Hint: Review items that show a significant difference—as a percentage—from 20X1 to 20X2.]

105) Below are the condensed balance sheet and income statement for the Beltway Company, Inc. Assuming there were no disposals of fixed assets during the year 20X2 provide a statement of cash flows using the indirect method for the year ended December 31, 20X2. Condensed balance sheet December 31, 20X2 20X1

20X2

$ 15

Accounts receivable

Inventory

Prepaid insurance

Property plant and equipment

140

150

Accumulated depreciation

(45 )

(55 )

Net PP&E

$ 213

$ 211

Assets: Current assets Cash

Total assets

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Liabilities: Accounts payable

$ 35

Wages payable

Interest payable

Taxes payable

Long-term debt

Common stock

Retained earnings

$ 213

$ 211

Equity:

Total liabilities and equity

Condensed income statement for year ended December 31, 20X2 20X2 Sales

$ 480

COGS

328

Operating expenses: Wages

103

Utilities

Insurance

Depreciation

Operating income

Interest

Income before tax

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Tax Net income

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3 $ 10

Answer Key Test name: chapter 4 1) FALSE 2) TRUE 3) FALSE 4) FALSE 5) TRUE 6) TRUE 7) TRUE 8) FALSE 9) TRUE 10) TRUE 11) FALSE 12) TRUE 13) FALSE 14) FALSE 15) TRUE 16) A 17) C 18) B 19) D 20) C 21) C 22) A 23) D 24) D 25) D 26) B Version 1

27) B 28) C 29) A 30) B 31) D 32) C 33) B 34) C 35) D 36) B 37) A 38) A 39) B 40) C 41) D 42) B 43) C 44) A 45) D 46) C 47) C 48) A 49) B 50) D 51) D 52) C 53) D 54) A 55) D 56) A Version 1

57) C 58) B 59) D 60) C 61) A 62) A 63) A 64) D 65) C 66) D 67) A 68) B 69) C 70) D 71) B 72) B 73) C 74) B 75) A 76) C 77) D 78) B 79) A 80) B 81) C 82) A 83) B 84) B 85) C 86) D Version 1

87) A 88) B 89) D 90) C 91) B 92) C 93) A 94) B 95) A 96) D 97) B 98) C 99) D 100) A 101) C 102) Blimpy’s Doughnuts, Inc. Consolidated Balance Sheet December 31, 2018

ASSETS Current Assets: Cash and cash equivalents

36,242

Accounts and notes receivable

27,603

Inventories

21,006

Insurance recovery receivable

34,967

Other current assets

12,000

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Total current assets

131,818

Property and equipment

168,654

Investments in equity method franchisees

3,224

Goodwill and other intangible assets

28,934

Deferred income taxes

Other assets Total assets

16,842 $

349,492

1,730

LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities: Current maturities of long-term debt Accounts payable

7,874

Accrued litigation settlement

86,772

Deferred income taxes

Other accrued liabilities

38,474

Total current liabilities

134,870

Long-term debt, less current maturities

105,966

Other long-term obligations

29,694

Shareholders’ equity: Common stock Accumulated other comprehensive income Accumulated deficit Total shareholders' equity

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310,942 1,266 (233,246 ) 78,962

Total liabilities and shareholders' equity

349,492

103) A 1. Accounts receivable F 2. Accrued interest on notes payable (20X2 maturity) C 3. Accumulated depreciation D 4. Goodwill H 5. Preferred stock H 6. Common stock F 7. Customer deposits on products to be shipped in a few months NA 8. Depreciation methods and estimated lives of equipment A 9. Prepaid insurance A or E 10. Assets (surplus production equipment) held for sale 104) a. Collections from customers $480 − 5 = $475b. Payments to suppliers $328 − 12 + 14 = $330c. Insurance premium payment $3 − 2 = $1d. Interest payment $12 + 3 = $15e. Utility payments $11f. Wages payment $103 − 4 = $99g. Capital expenditures $10 20X2

20X1

11 %

$ 15

6 %

Accounts receivable

19 %

23 %

Inventory

20 %

16 %

Prepaid insurance

2 %

1 %

Property, plant and equipment

30 %

37 %

- 17 %

- 55

- 23 %

36 %

39 %

$ 265

100 %

$ 243

100 %

23 %

$ 46

19 %

Assets: Current assets Cash

Accumulated depreciation

Net PP&E Total assets Liabilities: Accounts payable

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Wages payable

5 %

7 %

Interest payable

2 %

4 %

Taxes payable

2 %

Long-term debt

35 %

38 %

Common stock

28 %

21 %

Retained earnings

6 %

11 %

$ 265

100 %

$ 243

100 %

Equity:

Total liabilities and equity

Student responses to the question will differ, but may include discussion about:The decrease in A/R suggests that the company is doing a better job of collecting it’s a/r.The increase in Inventory as a % of total sales suggests that inventory sales may be decreasing.The increase in A/P as a % of total sales suggests that the company is either purchasing more with debt or that it might be struggling to meet its short-term obligations.The decrease in PP&E as a % of total assets suggests that the company disposed of some of its long-term assets.The decrease in longterm debt as a % of total assets suggests that the company is paying off some of its long-term debt.The decrease in retained earnings as a % of total assets suggests that the company’s profit decreased or that it paid dividends. 105) Beltway Company, Inc. Statement of Cash Flows For the year ended December 31, 20X2 Net income

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Depreciation

10 $ 20

Increase in A/R

– 5

Decrease in inventory

Decrease in prepaid insurance

Decrease in A/P

Increase in wages payable

Decrease in interest payable Increase in taxes payable

– 3 1

Net cash provided by operating activities

$ 17

Capital expenditures: PP&E acquisitions

– 10

Cash flow from investing activities

– 10

Cash flow from financing activities

Change in cash balance

$ 7

Cash balance 12/31/20X1

Cash balance 12/31/20X2

$ 15

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CHAPTER 5: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) All changes in accounting principle must be treated retrospectively. ⊚ ⊚

true false

2) A financial analyst will carefully review company financial statements for evidence of transactions involving related parties in part because such transactions may create the risk of wealth transfer to single stockholders. ⊚ ⊚

true false

3) Including non-GAAP metrics in a company’s annual report is acceptable and may provide useful information for decision makers. ⊚ ⊚

true false

4) A related party transaction occurs when a company enters a transaction with individuals or other companies that are connected in some way with it or its management. ⊚ ⊚

true false

5) Events that occur after the financial statements are issued are referred to as subsequent events. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 6) Which of the following represents a change in accounting principle?

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A) Adopting a new standard issued by FASB. B) Switching from a non-GAAP method to a GAAP method. C) Changing from one GAAP depreciation method to another GAAP method. D) Adjusting the Cost of Goods Sold account for the difference between the inventory balance and the inventory on hand.

Adoption of ASC Topic 606 related to revenue recognition represents a

A) mandatory change in accounting principle. B) voluntary change in accounting principle. C) mandatory change in accounting estimate. D) voluntary change in accounting estimate.

Adoption of ASC Topic 842 related to leases represents a

A) mandatory change in accounting estimate. B) voluntary change in accounting estimate. C) mandatory change in accounting principle. D) voluntary change in accounting principle.

What is the primary accounting and reporting issue arising from accounting changes?

A) The effect of the change on net income. B) The cost associated with the accounting change. C) The timelines or reporting of the accounting change. D) The transition rules applying to the accounting change.

10)

Which of the following characterize(s) financial statement notes?

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A) They pertain to the financial statements as a whole. B) They explain specific financial statement amounts. C) They provide extensive additional information. D) All of these are characteristics of financial statement notes.

11) Bertram Inc. purchased new state-of-the-art equipment. Its previously used equipment, which was recently retired, was depreciated over a useful (service) life of ten years. The firm’s accounting manager continued depreciating the new equipment over a ten-year useful life. Two years after acquisition, an audit reveals that a five to six-year useful life would have been more appropriate. Addressing this issue represents a

A) change in accounting principle. B) change in accounting estimate. C) change in entity. D) correction of error.

12)

Roberts Inc. acquired a controlling interest in Pernell LLC. This situation represents

A) change in accounting principle. B) change in estimate. C) change in entity. D) correction of error.

13)

Accounting changes may be

A) voluntary. B) mandatory. C) voluntary or mandatory. D) Predetermined.

14)

Which of the following situations is not a change in reporting entity?

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A) Issuing consolidated financial statements for the first time B) Disposing of one of the company’s four subsidiaries. C) Purchasing 10% of the outstanding shares of a supplier. D) All of these answer choices are correct.

15) Which of the following situations does not properly state the reporting requirements when a change in reporting entity occurs?

A) Comparative financial statements for prior years must be restated to reflect the new reporting entity as if it had been inexistence during all the years presented. B) Comparative financial statements for the prior year only must be restated to reflect the new reporting entity. C) The effect of the change on income before extraordinary items, net income and other comprehensive income must be restated. D) Per share amounts must be disclosed for all periods presented.

16) When reporting a change in an accounting principle, the general rule requires that the current year’s income from continuing operations reflect

A) use of the newly adopted principle for the current year recognition. B) use of the old principle for the current year recognition. C) management’s choice of either the old or newly adopted principle for the current year recognition. D) FASB’s designation of either the old or newly-adopted principle based on the item being changed.

17)

Non-GAAP measures typically are found

A) on the face of the financial statements. B) in the financial statement notes. C) in the management discussion and analysis section. D) In the proxy statement.

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18)

Accounting treatment for changes in accounting principle are best described as:

A) Changes in accounting principle that are only permitted when FASB issues a standard that revises GAAP. B) Changes in accounting principle that are always accounted for using the retrospective approach which requires only a restatement of prior years’ presented financial information. C) Changes in accounting principle that may require both a restatement of prior years’ financial information and the recording of a cumulative adjustment to retained earnings. D) Tax effects are ignored when reporting changes in accounting principles.

19)

A cumulative effect of a change in an accounting principle is measured as

A) the difference between prior periods’ net income under the old method and what would have been reported if the new method had been used in the prior years. B) the after-tax difference between prior periods’ net income under the old method and what would have been reported if the new method had been used in the prior years. C) the difference between prior periods’ net income and current net income under the old method and what would have been reported if the new method had been used in the prior years and the current year. D) the after-tax difference between prior periods’ net income and current net income under the old method and what would have been reported if the new method had been used in the prior years and the current year.

20) When using the retrospective approach for a change in accounting principle, disclosure rules require that

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A) prior years’ income statements presented for comparative purposes be restated to reflect use of the new principle unless it is impractical to do so. B) all prior years’ income statements be restated to reflect use of the new principle, and include a pro forma net income figure of the previously reported income. C) no prior years’ income statements be restated, but a pro forma net income figure be provided to reflect use of the new principle for each year presented. D) no prior years’ income statements be restated, and no pro forma net income figures be provided.

21)

Which of the following items is not a type of accounting change?

A) Change in accounting principles used; for example, a change from LIFO to FIFO. B) Change in the majority owner of the company. C) Change in accounting estimate; for example, a change in the useful life or salvage value of a depreciable asset. D) Change to consolidated financial statements from individual financial statements.

22) Mackintosh recognized warranty expense equal to five percent of net sales revenue generated on the sale of its newest product. One year after introducing the new product, Mackintosh determines that significantly fewer units than predicted were returned by customers for repair or replacement and that this justifies an accounting change. Mackintosh should account for this change

A) prospectively. B) retrospectively. C) by restating prior years’ financial statements. D) ignoring the revised estimate.

23) When a company changes from LIFO to another inventory method, the change is reported

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A) prospectively because it is impractical to determine the effects of this change on prior years’ net income. B) as an error correction. C) as a change in an accounting estimate. D) using the retrospective approach.

24) When a company changes from straight-line depreciation to double-declining-balance depreciation, the change is reported

25)

When a company changes from any inventory method to LIFO, the change is reported

A) prospectively because it is usually impractical to determine the effects of this change on prior years’ net income. B) as an error correction. C) as a change in an accounting estimate. D) using the retrospective approach.

26)

Which of the following accounting principle changes typically is reported prospectively?

A) Changing inventory method from LIFO to FIFO. B) Changing inventory method from FIFO to LIFO. C) Changing reporting of investments from the equity method to the fair value method. D) Adopting ASC topic 606 on revenue recognition on the standard’s effective date.

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27) Royal, Inc. discovered that equipment purchased on January 1, 20X1 for $300,000 will not last as long as originally estimated. The firm was depreciating the equipment at the rate of $40,000 per year with an estimated salvage value of $20,000. Revised estimates on January 1, 20X4 indicate that the equipment will last a total of five years with no salvage value. How much should Royal, Inc. record as depreciation in 20X4?

A) B) C) D)

$40,000 $60,000 $90,000 $120,000

28) Which of the following are commonly excluded from non-GAAP income-related metrics presented in 10-K or 10-Q reports?

A) Interest, taxes, depreciation, and amortization B) Accrual related to contingent losses C) Write-offs related to obsolete inventory D) Salaries paid to top executives

29) When reporting a change in an accounting principle, the general rule requires that the current year’s income from continuing operations reflect

30)

An increase in the useful life of equipment currently in use represents a(n)

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A) change in accounting principle. B) change in entity. C) change in accounting estimate. D) correction of error.

31)

A change from the LIFO to the FIFO inventory method represents a(n)

A) change in accounting principle. B) change in entity. C) change in accounting estimate. D) correction of error.

32)

Acquiring controlling interest in another company represents a(n)

A) change in accounting principle. B) change in entity. C) change in accounting estimate. D) correction of error.

33)

Accounting errors or irregularities can occur for which reasons?

A) simple oversight. B) misapplication of GAAP. C) management exploitation of the flexibility in GAAP. D) all of these answer choices are correct.

34) Which of the following parties are responsible for the detection of errors and accounting irregularities in a company’s financial statements?

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A) external auditors. B) the SEC staff during their review process. C) internal audit staff and audit committee of the board of directors. D) all of these answer choices are correct.

35) Revision restatements differ from reissuance restatements in that revision restatements address misstatements

A) affecting only one prior reporting period. B) that are less severe than those requiring reissuance restatements. C) that increased income. D) that decreased income.

36) Select the statement that is not correct regarding financial statement misstatements that require reissuance of previously issued reports.

A) Information regarding misstatements must be reported to the SEC within four days of discovery of the misstatement(s). B) Reissuance of financial statements is required for severe misstatements of reported information. C) All investors must be informed by the company in writing. D) Notice of reissuance of prior period financial statements must be made in subsequent filings.

37)

Which of the following situations may create an accounting error?

A) Simple oversight. B) Parties disagree on accounting for a transaction resulting in a misapplication of GAAP. C) Management exploits the flexibility in GAAP to inflate earnings. D) All of these answer choices are correct.

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38) On December 31, 20X1, Katherine Company purchases merchandise with shipping terms FOB destination. The company’s accountant records the purchase on the day the order is placed. The merchandise is not included in the ending inventory. No additional journal entry is made when the merchandise arrives on January 5, 20X2. As a result of this error, Katherine Company’s 20X1

A) income will be overstated. B) income will be understated. C) ending inventory is understated. D) ending inventory is overstated.

39) On December 31, 20X1, Katherine Company purchases merchandise with shipping terms FOB destination. The company’s accountant records the purchase on the day the order is placed. The merchandise is not included in the ending inventory. No additional journal entry is made when the merchandise arrives on January 5, 20X2.Assume that Katherine Company discovers the error at the beginning of 20X2. What journal entry should be made to correct the prior-year error?

A) Debit Retained Earnings, Credit Inventory B) Debit Inventory, Credit Retained Earnings C) Debit Inventory, Credit Cost of Goods Sold D) No journal entry is necessary

40) On December 31, 20X1, Katherine Company purchases merchandise with shipping terms FOB destination. The company’s accountant records the purchase on the day the order is placed. The merchandise is not included in the ending inventory. No additional journal entry is made when the merchandise arrives on January 5, 20X2. Assume that the error is not discovered. As a result of this error, Katherine Company’s 20X2:

A) income will be overstated. B) income will be understated. C) ending inventory is understated. D) ending inventory is overstated.

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41) On December 31, 20X1, Katherine Company purchases merchandise with shipping terms FOB destination. The company’s accountant records the purchase on the day the order is placed. The merchandise is not included in the ending inventory. No additional journal entry is made when the merchandise arrives on January 5, 20X2. Assume that Katherine Company discovers the error is discovered at the beginning of 20X3. What journal entry should be made to correct the 20X1 error?

A) Debit Retained Earnings, Credit Inventory B) Debit Inventory, Credit Retained Earnings C) Debit Inventory, Credit Cost of Goods Sold D) No journal entry is necessary

42) On December 31, 20X1, Katherine Company purchases merchandise with shipping terms FOB destination. The company’s accountant records the purchase on the day the order is placed. The merchandise is not included in the ending inventory. No additional journal entry is made when the merchandise arrives on January 5, 20X2. Assume that Katherine Company discovers the error is discovered at the beginning of 20X3. What journal entry should be made to correct the 20X1 error?

A) Debit Retained Earnings, Credit Inventory B) Debit Inventory, Credit Retained Earnings C) Debit Inventory, Credit Cost of Goods Sold D) No journal entry is necessary

43) All the following disclosures would appear in the Summary of Significant Accounting Policies except:

A) inventory method. B) depreciation method. C) revenue recognition method. D) financing method.

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44)

Notes to the financial statements typically contain all the following except

A) a summary of significant accounting policies. B) disclosure of important subsequent events. C) management’s discussion and analysis. D) related-party transactions.

45)

The Summary of Significant Accounting Policies

A) explains the important accounting choices the reporting entity uses to account for selected transactions and accounts. B) does not contain an explanation of the company’s revenue recognition policies. C) is generally a part of the equity section of the balance sheet. D) is only required as part of a prospectus for the sale of new shares of stock.

46)

Subsequent events

A) are those significant events that occur after the financial statements are issued. B) are subject to optional disclosure based on a recommendation from top management. C) are required to be disclosed if they are material and likely to influence investors’ appraisal of the risk and return prospects of the reporting entity. D) are those significant events that occur in the last quarter of the reporting period.

47)

A related-party transaction

A) is assumed to be an arms-length transaction. B) can take place between subsidiaries of a common parent. C) does not need to be disclosed in financial statements prepared under U.S. GAAP. D) presents less risk than a similar transaction with a third party.

48)

Which of the following is not true regarding the tax note to the financial statements?

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A) The tax note is never required to include any information on foreign tax rate implications. B) The tax note can describe how financial reporting differs from tax accounting. C) The tax note can describe how tax disputes may affect future tax payments. D) The tax note can explain how foreign tax rates affect income tax expense.

49)

The summary of significant accounting policies does not help explain

A) the cost flow assumptions for valuing inventory. B) management’s assessment of the financial condition of the firm. C) the method used for determining depreciation expense. D) whether certain investments are accounted for using the equity method.

50) Angela Dams purchases new equipment for $66,000 with an estimated useful (service) life of 6 years and a salvage value of $6,000. The company depreciates the equipment over six years. After two years, the company revises its estimate to total useful life of 8 years, with no change in salvage value. Depreciation for year 3 will be:

A) B) C) D)

51)

10,000 7,666 7,500 6,667

ASC Topic 606 on Revenue Recognition requires which transition method?

A) Full retrospective restatement B) Modified retrospective approach C) Full retrospective restatement or modified retrospective approach D) Retrospective restatement or prospective approach

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 52) Delta Co. began operations on January 1, 20X1. During 20X1 and 20X2, the company used the weighted-average method for its inventory costing. In 20X3, the company changed its method of inventory costing to FIFO so that its financial statements would be more comparable to those of other firms in its industry. If the FIFO method had been used, Delta’s cost of goods sold would have been $45,000 less in 20X1 and $35,000 less in 20X2. Delta’s income statements, as originally presented, appear below. Delta’s tax rate is 21%. 20X1 Sales

$ 1,000,000

20X2

20X3

$ 1,100,000 $ 1,210,000

Cost of goods sold

645,000

695,000

726,000

Gross profit

355,000

405,000

484,000

Selling, general and administrative expenses Depreciation expense

250,000

255,000

265,000

55,000

Income before tax

50,000

95,000

164,000

Income tax expense

10,500

19,950

34,440

75,050 $

129,560

Net income

$ 39,500

Required: Assume that for comparison purposes Delta presents 20X1 and 20X2 income statements in its 20X3 annual report. Revise Delta’s 20X1 and 20X2 income statements to appear as they should in the 20X3 annual report.

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53) Primo Landscaping commenced its business on January 1, 20X1. On December 31, 20X1, Primo Landscaping did not record any adjusting entries with respect to the following transactions: During the first year of its operations, Primo purchased supplies in the amount of $10,000 (debited to “Supplies expense”), and of this amount, $3,000 were unused as of December 31, 20X1.On March 15, 20X1 Primo received $36,000 for landscape maintenance services to be rendered for 24 months (beginning July 1, 20X1). This amount was credited to “Landscaping revenue.”The company’s fuel bill for $1,300 for the month of December 20X1 was not received until January 15, 20X2.The company borrowed $100,000 from First Bank on April 1, 20X1 at an interest rate of 12% per year. The principal, along with all of the interest, is due on March 30, 20X2.On January 17, 20X1 the company purchased a backhoe for $65,000. The backhoe is expected to last for 10,000 hours and have no salvage value. During the year, Primo operated the backhoe for 500 hours.Required: A. Complete the table below, showing the effect of the omission of each year-end adjusting entry on assets, liabilities, and net income for 20X1. Use “OS” for overstated, “US” for understated, and “NE” for no effect. Item Number Effect of Omission a. Direction of effect

Dollar amount of effect Direction of effect

Assets

Liabilities

Net Income

Dollar amount of effect

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54) The following errors occurred during 20X1. Inventory costing $3,000, purchased on December 29, FOB shipping point was not included in the ending inventory count. The inventory and related invoice arrived on January 2, 20X2.On January 2, the cost of maintaining equipment in the amount of $40,000 was debited to the Equipment account. The company depreciates equipment over four years, with no estimated salvage value.The cost of supplies purchased during the year was expensed as incurred. No adjusting entry was made for supplies costing $1,000 that were still on hand at December 31.Assume that the errors were not discovered. Complete the following tables, indicating the effect on Financial Statement categories for 20X1. Effect on 20X1 financial statement categories Error No.

Assets

Liabilities

Equity

Net Income

1 2 3

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55) The following errors occurred during 20X1. Inventory costing $3,000, purchased on December 29, FOB shipping point was not included in the ending inventory count. The inventory and related invoice arrived on January 2, 20X2.On January 2, the cost of maintaining equipment in the amount of $40,000 was debited to the Equipment account. The company depreciates equipment over four years, with no estimated salvage value.The cost of supplies purchased during the year was expensed as incurred. No adjusting entry was made for supplies costing $1,000 that were still on hand at December 31. Assume that the errors were not discovered. Complete the following tables, indicating the effect on Financial Statement categories for 20X2. Effect on 20X2 financial statement categories Error No.

Assets

Liabilities

Equity

Net Income

1 2 3

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Answer Key Test name: chapter 5 1) FALSE 2) TRUE 3) TRUE 4) TRUE 5) FALSE 6) A 7) A 8) C 9) D 10) D 11) D 12) C 13) C 14) C 15) B 16) A 17) C 18) C 19) B 20) A 21) B 22) A 23) D 24) C 25) A 26) B Version 1

27) C 28) A 29) A 30) C 31) A 32) B 33) D 34) D 35) B 36) C 37) D 38) B 39) B 40) A 41) D 42) D 43) D 44) C 45) A 46) C 47) B 48) A 49) B 50) D 51) C 52) Sales Cost of goods sold

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20X1

20X2

20X3

$ 1,000,000

$ 1,100,000

$ 1,210,000

600,000

660,000

726,000

Gross profit

400,000

440,000

484,000

Selling, general and administrative expenses Depreciation expense

250,000

255,000

265,000

55,000

Income before taxes

95,000

130,000

164,000

Income tax expense

19,950

27,300

34,440

Net income

75,050

102,700

129,560

Adjustment to inventory = cost of goods sold as originally reported under weighted-average – cost of goods sold under FIFO = ($645,000 + $695,000) − ($600,000 + $660,000) = $80,000 over the two-year period of 20X1 and 20X2. Since pretax income—as restated for the two years—is increased by $80,000, taxes on the increase @ 21% = $16,800 total for the two years. 53) Item Number Effect of Omission a. Direction of effect

Assets US $ 3,000

Dollar amount of effect Direction of effect

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Liabilities NE

$ 3,000

$ 27,000

1,300

$ 1,300

9,000

$ 9,000

NE $ NE $ OS

Net Income US

Dollar amount of effect

$ 3,250

Asset not recorded = $3,000 supplies on hand at 12/31/20X1.Deferred revenue not adjusted for = $1,500 per month for services to be rendered from 1/1/20X2 to 6/30/20X3.Fuel expense not recorded = $1,300.Interest expense for 9 months not accrued = $100,000 × 0.12 × 9/12 = $9,000.Depreciation expense not recorded = $65,000 ÷ 100,000 hours = $6.50/hour depreciation rate × 500 hours used in 20X1 = $3,250. 54) Error No.

Assets

U $

3,000 O

$ 3

U $

Equity

Net Income

3,000 NE

30,000 U

Liabilities

$ NE

1,000

30,000

U $

1,000

30,000 U

1,000

A: Effect on 20X1: Error 1: No effect on income since both ending inventory and purchases are understated by the same amount; assets (inventory) are understated and so are liabilities (accounts payable). Error 2: Capitalizing expenses overstates assets, equity and income. The effect is mitigated by the depreciation that was recorded. Error 3. Supplies on hand should have been recognized as assets, reducing expenses. 55) Effect on 20X2 financial statement categories Error No.

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Assets

Liabilities

Equity

Net Income

$ 3

20,000 NE

$ NE

20,000

10,000

Error 1: Inventory and accounts payable were recorded when the inventory arrived, thus correcting the prior year error. Error 2: Assets and equity continue to be overstated until the error counterbalances in year 4 (the end of the life of the asset). Income is understated because depreciation expense is recognized.

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CHAPTER 6: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) An analyst interested in learning the degree to which a company’s earnings have fluctuated historically in relation to changes in economic growth would employ cross-sectional analysis. ⊚ ⊚

true false

A benchmark comparison is an analytic tool similar in approach to time-series analysis. ⊚ ⊚

true false

3) Operating and administrative efficiencies that result in lower expenses per dollar of sales possibly explain a trend where net income grows faster than sales. ⊚ ⊚

true false

4) Return on assets will generally equal return on common equity except when the company has no long-term debt. ⊚ ⊚

true false

5) Financial leverage is beneficial when the company earns more than the incremental aftertax cost of debt. ⊚ ⊚

true false

6) Both common and preferred stock dividends are subtracted in arriving at net income available to common stockholders.

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⊚ ⊚

7) low.

When return on assets is high at a highly levered firm, return on common equity will be

⊚ ⊚

true false

Activity ratios describe the profitability of a company. ⊚ ⊚

true false

9) The Z-score model combines five financial ratios in a precise way to estimate a company’s default risk. ⊚ ⊚

true false

10) Days payable outstanding helps analysts understand the company’s pattern of cash receipts from customers. ⊚ ⊚

true false

11) A low-credit-risk company generates operating cash flows substantially in excess of what are required to sustain its business activities. ⊚ ⊚

true false

12) Although a company’s earnings are important, an analysis of its cash flows is central to credit evaluations and lending decisions.

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⊚ ⊚

true false

13) Credit risk analysis uses financial ratios that focus on an assessment of liquidity and solvency. ⊚ ⊚

true false

14) In the highest-risk Standard & Poor’s rating category that is a CCC/C rating, more than half of the firms default within a year. ⊚ ⊚

true false

15) When analyzing a company’s risk of bankruptcy using Altman’s Z-score, a high Z-score indicates low risk of default. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) All of the following are used as financial analysis tools except

A) managements’ discussion and analysis. B) common-size statements. C) trend statements. D) financial ratios.

17)

Time-series analysis helps identify financial trends:

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A) across companies at a single point in time. B) across business units at a single point in time. C) over time for a single company or business unit. D) among the companies that comprise an industry group.

18) A type of analysis that helps identify similarities and differences across companies or business units at a single moment in time is:

A) trend analysis. B) common-size statements analysis. C) time-series analysis. D) cross-sectional analysis.

19) Which of the following is not correct with respect to an analyst’s use of financial information?

A) Analysts use financial statement information to assess the economic activities of a company and its condition. B) The first step to informed financial statement analysis is a careful examination of the auditor’s opinion. C) Analysts need to understand what accounting data do and do not reveal about a company’s economic activities and condition. D) Analysts must always be vigilant about the possibility that accounting distortions are present and complicate the interpretation of financial ratios, percentage relations, and trend indices.

20)

Which of the following does not reflect disclosures in financial statements?

A) Related party transactions must be disclosed. B) GAAP disclosure by segment is required only for some companies. C) GAAP limits how much a company can disclose in their financial statements. D) Management may disclose more than GAAP requires.

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21)

Common-size financial statements recast each statement item as:

A) a percentage using industry averages for the "base number." B) a percentage using a base year number for each line item. C) a percentage of some "base number" on the financial statement in question. D) a percentage of the "bottom line."

22) An analytical tool that measures a company’s performance against a predetermined standard is a/an:

A) benchmark comparison analysis. B) profitability analysis. C) time-series analysis. D) common-size statement.

23)

The financial statement reporting "filter" is

A) SEC reporting regulations that vary from GAAP for publicly traded companies. B) SEC required reporting regulations for all entities. C) management’s distortion of accounting data. D) management’s discretion to choose alternative accounting procedures within GAAP

24)

Which one of the following helps the analyst remove the effects of an information filter?

A) Financial statements. B) SEC Form 10-K. C) Note disclosures in financial statements. D) Trend analysis.

25)

Trend statements help the user

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A) determine the reason(s) for changes over time in each financial statement line item. B) spot relationships among financial statement items. C) spot changes over time in each financial statement line item. D) identify variations between companies in financial statement line items.

26)

Manero Company included the following information in its annual report:

20X3

20X2

20X1

$ 178,400

$ 162,500

$ 155,500

Cost of goods sold

115,000

102,500

100,000

Operating expenses

50,000

45,000

Operating income

13,400

10,000

10,500

Sales

In a common-size income statement for 20X3, the operating expenses are expressed as

A) B) C) D)

27)

28.0% 30.3% 43.8% 100.0%

Manero Company included the following information in its annual report:

Sales Cost of goods sold

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20X3

20X2

20X1

$ 178,400

$ 162,500

$ 155,500

115,000

102,500

100,000

Operating expenses

50,000

45,000

Operating income

13,400

10,000

10,500

In a common-size income statement for 20X1, the cost of goods sold is expressed as

A) B) C) D)

28)

40.0% 64.3% 100.0% 230.0%

Manero Company included the following information in its annual report:

20X3

20X2

20X1

$ 178,400

$ 162,500

$ 155,500

Cost of goods sold

115,000

102,500

100,000

Operating expenses

50,000

45,000

Operating income

13,400

10,000

10,500

Sales

In a common-size income statement for 20X3, the cost of goods sold is expressed as:

A) B) C) D)

29)

64.5% 100.0% 112.3% 130.0%

Manero Company included the following information in its annual report:

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20X3

20X2

20X1

$ 178,400

$ 162,500

$ 155,500

Cost of goods sold

115,000

102,500

100,000

Operating expenses

50,000

45,000

Operating income

13,400

10,000

10,500

Sales

In a trend income statement for 20X1, where 20X1 is the base year, sales are expressed as

A) B) C) D)

30)

84.4% 92.6% 100.0% 150.5%

Manero Company included the following information in its annual report:

20X3

20X2

20X1

$ 178,400

$ 162,500

$ 155,500

Cost of goods sold

115,000

102,500

100,000

Operating expenses

50,000

45,000

Operating income

13,400

10,000

10,500

Sales

In a trend income statement for 20X3, where 20X1 is the base year, sales are expressed as

A) B) C) D)

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87.2% 100.0% 114.7% 148.7%

31)

Manero Company included the following information in its annual report: 20X3

20X2

20X1

$ 178,400

$ 162,500

$ 155,500

Cost of goods sold

115,000

102,500

100,000

Operating expenses

50,000

45,000

Operating income

13,400

10,000

10,500

Sales

In comparison to year 20X2 the increase in operating income of 20X3 was primarily caused by (ignore taxes):

A) the effect of sales growth. B) the effect of cost of goods sold growth. C) the effect of margin growth. D) the answer cannot be derived from the information provided.

32)

Manero Company included the following information in its annual report:

20X3

20X2

20X1

$ 178,400

$ 162,500

$ 155,500

Cost of goods sold

115,000

102,500

100,000

Operating expenses

50,000

45,000

Operating income

13,400

10,000

10,500

Sales

In comparison to year 20X2, the increase in operating income of 20X3 was primarily caused by the effect of margin increase of (ignore taxes):

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A) B) C) D)

33)

$978. $1,194. $2,422. $3,400.

Manero Company included the following information in its annual report: 20X3

20X2

20X1

$ 178,400

$ 162,500

$ 155,500

Cost of goods sold

115,000

102,500

100,000

Operating expenses

50,000

45,000

Operating income

13,400

10,000

10,500

Sales

In comparison to year 20X1, the effect of sales growth on operating income of 20X2 was (ignore taxes):

A) B) C) D)

34)

$473. $431. $6,667. $7,000.

In a common-size balance sheet, all items are expressed as a percentage of

A) total assets. B) total liabilities. C) total equity. D) total sales.

35)

In a trend balance sheet, each balance sheet item is expressed as a percentage of

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A) B) C) D)

36)

total assets. the base year item. sales. equity.

Hansel Corporation’s condensed balance sheets appear below:

20X3

20X2

(Base Year) 20X1

$ 55,000

$ 56,500

$ 70,000

Plant & equipment, net

495,000

410,000

440,000

Intangible assets, net

20,000

27,500

40,000

Total assets

$ 570,000

$ 494,000

$ 550,000

Liabilities & Stockholders’ Equity: Current liabilities

$ 40,000

$ 35,000

$ 32,500

Long-term liabilities

395,000

310,000

375,000

Stockholders’ equity

135,000

149,000

142,500

$ 570,000

$ 494,000

$ 550,000

Assets: Current assets

Total liabilities & equity

In a common size balance sheet for 20X2, plant and equipment (net) is expressed as

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A) B) C) D)

37)

83.0% 83.6% 91.1% 100.0%

Hansel Corporation’s condensed balance sheets appear below: 20X3

20X2

20X1

$ 55,000

$ 56,500

$ 70,000

Plant & equipment, net

495,000

410,000

440,000

Intangible assets, net

20,000

27,500

40,000

Total assets

$ 570,000

$ 494,000

$ 550,000

Liabilities & Stockholders’ Equity: Current liabilities

$ 40,000

$ 35,000

$ 32,500

Long-term liabilities

395,000

310,000

375,000

Stockholders’ equity

135,000

149,000

142,500

$ 570,000

$ 494,000

$ 550,000

Assets: Current assets

Total liabilities & equity

In a common size balance sheet for 20X3, total liabilities and equity are expressed as

A) B) C) D)

Version 1

89.9% 96.5% 100.0% 111.3%

38)

Hansel Corporation’s condensed balance sheets appear below: 20X3

20X2

20X1

$ 55,000

$ 56,500

$ 70,000

Plant & equipment, net

495,000

410,000

440,000

Intangible assets, net

20,000

27,500

40,000

Total assets

$ 570,000

$ 494,000

$ 550,000

Liabilities & Stockholders’ Equity: Current liabilities

$ 40,000

$ 35,000

$ 32,500

Long-term liabilities

395,000

310,000

375,000

Stockholders’ equity

135,000

149,000

142,500

$ 570,000

$ 494,000

$ 550,000

Assets: Current assets

Total liabilities & equity

In a trend balance sheet for 20X3, long-term liabilities are expressed as

A) B) C) D)

39)

69.3% 100.0% 105.3% 127.4%

In a trend balance sheet for 20X2, stockholders’ equity is expressed as

A) B) C) D)

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10.2% 100.0% 104.6% 110.4%

40) Trend statements are better than common size statements at indicating which of the following?

A) stability. B) monetary changes. C) profitability. D) growth and decline.

41)

In a common size cash flow statement, all items are expressed as a percentage of

A) sales. B) total assets. C) net income. D) total equity.

42)

Which statement below is not correct with respect to a company’s strategy?

A) There are numerous strategies for achieving superior performance in any business. B) Developing customer loyalty while controlling costs are conflicting strategies. C) Low-cost leadership along with product and service differentiation create strategic advantage for companies. D) Strategy is never dependent upon the company's industry.

43) Advanced technology and performance capabilities, consistent quality, availability in multiple colors and sizes, prompt delivery, technical support services, customer financing, distribution channels, or some other feature of importance to customers are examples of:

A) competitive advantage. B) differentiation. C) product leadership. D) low-cost leadership.

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44) Earnings Before Interest (EBI) adjusts net income for which one of the following groups of items?

A) Nonrecurring items, interest, and distortions related to accounting quality concerns. B) Nonoperating items, after-tax interest, and distortions related to accounting quality concerns. C) Nonoperating items, nonrecurring items, and after-tax interest. D) Nonrecurring items, after-tax interest, and distortions related to accounting quality concerns.

45)

Return on Assets (ROA) measures a firm’s

A) cost effectiveness of its operating activities. B) profitable use of its assets. C) profitability of sales. D) return on shareholders’ investment.

46)

Which of the following items will not cause the company’s ROA to increase?

A) Reducing company assets without impacting sales. B) Reducing costs. C) Increasing the selling price per unit. D) Increasing company assets.

47) and

Return on Assets (ROA) can be broken down into these two components: profit margin

A) asset utilization margin. B) asset turnover. C) common earnings leverage. D) financial structure leverage.

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48) Which one of the following successful strategies will increase the Return on Assets (ROA)?

A) Increase the investment in assets used in the business. B) Increase the profit margin. C) Decrease sales volume. D) Increase the annual depreciation amounts of long-lived assets.

49)

The ratio that captures information about property, plant, and equipment utilization is:

A) current asset turnover. B) long-term asset turnover. C) asset turnover. D) property turnover.

50)

Which of the following is not a valid statement?

A) Competitive ceiling is the rate of return that would be earned in the economist’s "perfectly competitive" industry. B) Companies that consistently earn rates of return above the floor are said to have a competitive advantage. C) Competition in an industry continually works to drive down the rate of return on assets toward the competitive floor. D) Rates of return that are higher than the industry floor stimulate more competition as existing companies innovate and expand their market reach or as new companies enter the industry.

51) Companies that consistently earn rates of return above the competitive floor in the industry are considered to possess a

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A) dominant market share. B) niche market. C) competitive advantage. D) monopolistic advantage.

52)

Strategies to gain a competitive advantage include product differentiation and

A) low-cost leadership. B) building brand loyalty. C) developing superior products. D) improving product quality and reliability.

53)

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

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Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The return on assets ratio for 20X2 is (rounded):

A) B) C) D)

54)

16.3% 16.9% 17.7% 18.2%

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

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Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The profit margin used to calculate return on assets for 20X2 is (rounded):

A) B) C) D)

55)

7.9% 8.2% 8.5% 16.3%

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales Cost of goods sold

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20X1

1,640,000 982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The total asset turnover ratio for 20X2 is (rounded):

A) 1.7 times. B) 2.0 times. C) 2.2 times. D) 2.4 times

56)

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

Version 1

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

If there is no preferred stock, the return on common equity for 20X2 is (rounded):

A) B) C) D)

57)

25.8% 27.9% 41.4% 43.4%

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

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20X1

Long-term liabilities

77,500

Sales

75,000

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

In a common size income statement for 20X2, cost of goods sold is expressed as:

A) B) C) D)

58)

92.0% 60.0% 119% 167%

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

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20X1

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

In a common size balance sheet for 20X2, accounts receivable is expressed as:

A) B) C) D)

59)

86%. 116.3%. 32.4%. 16.3%.

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

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20X1

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The current ratio for 20X2 is (rounded):

A) 1.4 to 1 B) 2.0 to 1 C) 2.7 to 1 D) 3.4 to 1

60)

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

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20X1

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The quick ratio for 20X2 is (rounded): (Assume that total current assets include cash, marketable securities, accounts receivable and inventory).

A) 1.1 to 1 B) 1.4 to 1 C) 1.6 to 1 D) 2.8 to 1

61)

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

Version 1

267,500

20X1 $ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The accounts receivable turnover for 20X2 is (rounded): (Assume all sales are on account.)

A) 2.0 times. B) 6.4 times. C) 6.6 times. D) 7.1 times.

62)

Condensed financial data are presented below for the Phoenix Corporation:

Version 1

20X2 Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The days receivable outstanding for 20X2 is (rounded):

A) 51 days. B) 55 days. C) 60 days. D) 183 days.

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63)

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The inventory turnover for 20X2 is (rounded):

A) 2.61 times. B) 3.12 times. C) 3.45 times. D) 3.80 times.

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64)

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The days inventory held for 20X2 is (rounded):

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A) 96 days. B) 106 days. C) 116 days. D) 138 days.

65)

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

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30 %

The long-term debt to assets for 20X2 is (rounded):

A) B) C) D)

66)

9.4% 10.2% 40.0% 43.4%

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

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30 %

If the intangible assets in 20X2 are $50,000, then the long-term debt to tangible assets for 20X2 is:

A) B) C) D)

67)

10.0% 10.2% 30.7% 42.5%

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

Cash flow from investing activities

(6,000 )

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Cash flow from financing activities

(62,500 )

Tax rate

30 %

The interest coverage for 20X2 is:

A) 12.8 times. B) 13.8 times. C) 20.5 times. D) 21.5 times.

68)

Condensed financial data are presented below for the Phoenix Corporation: 20X2

Accounts receivable

267,500

$ 230,000

Inventory

312,500

257,500

Total current assets

670,000

565,000

Intangible assets

50,000

60,000

Total assets

825,000

695,000

Current liabilities

252,500

200,000

Long-term liabilities

77,500

75,000

Sales

20X1

1,640,000

Cost of goods sold

982,500

Interest expense

10,000

Income tax expense

77,500

Net income

127,500

Cash flow from operations

71,000

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Cash flow from investing activities

(6,000 )

Cash flow from financing activities

(62,500 )

Tax rate

30 %

The operating cash flows to total liabilities for 20X2 is (rounded):

A) B) C) D)

69)

13.4% 21.5% 23.4% 28.1%

With respect to asset utilization, which of the following is not correct?

A) Efficiency gains arise from improvements in managing accounts receivable. B) How efficient the company is in utilizing its property, plant, and equipment is reflected in the long-term asset turnover ratio. C) Asset turnover is only one part of the ROA calculation. D) Issues with inventory obsolescence will be evidenced in the current asset turnover ratio.

70)

Financial ratios used to determine credit risk include an assessment of:

A) liquidity and asset utilization. B) asset utilization and profitability. C) solvency and liquidity. D) profitability and solvency.

71)

Which of the following is not correct with respect to computing ROCE?

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A) Both common and preferred stock dividends are subtracted in arriving at net income available to common stockholders. B) ROCE is affected by both ROA and the degree of financial leverage employed by the company. C) The capital provided by common shareholders during the period can be computed by averaging total common shareholders’ equity at the beginning and end of the period. D) Interest charged on loans, and dividends declared on preferred stock, are both subtracted in arriving at net income available to common shareholders.

72)

With respect to financial leverage which of the following is not a valid statement?

A) Financial leverage makes bad years look worse by decreasing the shareholder return. B) Return on assets will generally equal return on common equity except when the company has no long-term debt. C) Financial leverage makes good years look better by increasing the shareholder return. D) Financial leverage is beneficial when the company earns more than the incremental after-tax cost of debt.

73) Post Corporation purchases from suppliers on net 30 day terms, has an Accounts Receivable Turnover of 8 times, and an Inventory Turnover of 12 times. Cash inflows and outflows are

A) evenly matched. B) negatively mismatched by 60 days. C) positively mismatched by 30 days. D) negatively mismatched by 45 days.

74)

The percentage of assets financed by long-term debt is best described by the:

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A) debt to equity ratio. B) interest coverage ratio. C) long-term debt to asset ratio. D) long-term debt to tangible assets ratio.

75) When operating earnings and cash flows from operations are dissimilar, which of the following ratios is a better measure of long-term solvency?

A) Interest coverage B) Long-term debt to asset C) Long-term debt to tangible assets D) Operating cash flow to total liabilities

76)

Which of the following financial ratios is not a component of the Z-score model?

A) Working capital/total assets. B) Sales/total assets. C) Common stock/total assets. D) Retained earnings/total assets.

77)

When assessing a company's credit risk:

Analysts use only financial ratios and do not need to review the statement of cash

flows. B) Analysts use only the statement of cash flows. C) Both liquidity and solvency must be reviewed. D) The assessment involves looking only at the operating and cash conversion cycles.

78)

Which of the following best describes measures of immediate liquidity?

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A) The current ratio and the quick ratio will always have different results regardless of the industry in which the company operates. B) The quick ratio excludes inventory in the denominator because most businesses cannot readily convert inventory to cash. C) The current ratio reflects existing cash as well as amounts to be converted to cash in the normal operating cycle. D) The quick ratio reflects existing cash as well as amounts to be converted to cash in the normal operating cycle.

79)

The accounts receivable turnover ratio

A) is not useful in determining changes in customer payment patterns. B) uses total sales and not just credit sales in the computation. C) is computed using net credit sales and average accounts receivable. D) is computed using net credit sales and ending accounts receivable.

80)

Changes in a company’s capital expenditures or fixed asset sales over time must

A) be carefully analyzed for changes in the company’s strategy. B) be indicative of changes in the company’s strategy. C) indicate incompetent management. D) raise the company’s risk of default on its debt.

81) Select one of the following statements that best reflects the relationship between the operating cycle and the cash conversion cycle:

A) The operating cycle reflects how long it takes to sell inventory. B) The two cycles will always match. C) The cash conversion cycle includes the operating cycle and the number of days related to the purchase of inventory. D) A mismatch between the two cycles indicates the company is headed for bankruptcy.

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82)

Which of the following is not correct with respect to the debt to assets ratio?

A) Cyclical companies (those whose sales fluctuate widely due to changing economic conditions) generally have a smaller debt to assets ratio. B) Cyclical companies (those whose sales fluctuate widely due to changing economic conditions) generally have a higher debt to assets ratio. C) The percentage of long-term debt to assets would be higher for a utility company than for a retailer. D) A high debt ratio increases long-term solvency risk.

83)

Solvency refers to:

A) short-term ability to fund the company's operating needs. B) long-term ability to generate cash to for plant capacity needs and to fuel growth. C) long-term ability to generate sufficient cash to satisfy plant capacity needs, fuel growth, and to repay debt when due. D) the company's ability to generate sufficient cash to repay debt when due.

84) Which of the following does not describe the impact of a firm's capital structure on ROA and ROCE?

A) For a high-debt firm experiencing a profitable year, ROCE will likely be lower than ROA if the debt was not used to support operations. B) A highly levered firm can be advantageous to common stockholders. C) For a firm with no debt, ROCE will likely be the same as the ROA. D) For a high-debt firm experiencing a profitable year, ROCE will likely be higher than ROA if the debt was used to support operations.

85) Although a company’s earnings are important in financial statement analysis, with respect to credit evaluations and lending decisions an analysis of its cash flows is:

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A) optional. B) central. C) only important if the company has a high debt/equity ratio. D) required by banking regulations.

86)

Financially healthy companies

A) will always generate positive operating cash flows. B) should generate positive operating cash flows in most years. C) should generate positive investing cash flows. D) should always see total cash inflows exceed total cash outflows.

87)

Which of the following factors does not negatively impact operating cash flows?

A) Accounts receivable are increasing. B) Inventories are increasing. C) Operating costs are increasing faster than sales. D) Sales are increasing faster than operating costs.

88)

Debt financing

A) is always a better choice than equity financing because of the tax deductibility of interest expense. B) is only used by emerging growth companies with no access to equity capital. C) is one option available to both established and emerging companies. D) is only used by established growth companies because they are able to secure a low interest rate.

89) Financial ratio, percentage, and trend comparisons can be distorted by all of the following except

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A) the presence of nonrecurring items among the firms being analyzed. B) aggressive revenue recognition practices. C) the timing of asset purchases. D) accounting for similar economic fundamentals in similar fashion.

90)

With respect to financial ratios:

A) numbers". B) C) D)

91)

There may be accounting distortions which require the analyst to get "behind the There is only one correct way to compute many financial ratios. Analysts make adjustments in computing financial ratios only for industry practice. Financial ratios give analysts the answers they are searching for.

Which of the following does not properly describe the Altman Z-score?

A) The Z-score is a multiple discriminant analysis using five financial ratios to estimate default risk. B) The Z-score was originally designed only for publicly traded manufacturing firms. C) Each ratio has its own unique weight in calculating the final score. D) A high score is an indication of default risk.

92) Which of the following actions is not an option for the lender when the borrower is in default?

A) Petition a court to judge the borrower insolvent. B) Adjust the loan payment schedule to better suit the company’s anticipated operating cash flows. C) Modify the payment schedule in exchange for an increased interest rate or additional collateral, such as receivables, inventory, or equipment. D) Contact the borrower’s customers and collect their receivables.

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 93) Panera Bread Company is a national bakery-cafe concept with 1,380 Company-owned and franchise-operated bakery-cafe locations in 40 states and in Ontario, Canada. The company has grown from serving approximately 60 customers a day at its first bakery-cafe to currently serving nearly six million customers a week system-wide, becoming one of the largest food service companies in the United States. Sara Lee Corporation is a global manufacturer and marketer of high-quality, brand-name products for consumers throughout the world focused primarily on the meats, bakery and beverage categories. Selected financial information about each company follows: Sara Lee

Panera Bread

Sales

$ 10,793 million

$ 1,353.5 million

Net Income

527 million

86.8 million

Return on Assets (ROA)

8.32 %

11.55 %

Profit margin

7.05 %

6.45 %

Asset turnover

1.18 %

1.79

Required:Why is Sara Lee less profitable than Panera Bread?Return on assets and return on sales in the bakery industry are 4.85% and 8.16%, respectively. How do these two companies compare to their industry and what might explain any noted differences?

94)

Selected data of the Peninsula Company follow: As of December 31 Balance Sheet Data

Accounts receivable Allowance for doubtful accounts

Version 1

20X2 $

671,000 31,000

20X1 $

642,000 22,000

Net accounts receivable

640,000

620,000

Inventories—lower of cost or market

542,500

642,500

Year Ended December 31 Income Statement Data

20X2

20X1

$ 3,150,000

$ 3,000,000

800,000

600,000

Net sales

$ 3,950,000

$ 3,600,000

Cost of goods sold

$ 2,370,000

$ 2,160,000

475,000

350,000

150,000

125,000

Total operating expenses

$ 2,995,000

$ 2,635,000

Net income

Net credit sales Net cash sales

Selling, general, and administrative expenses Other

955,000

965,000

Required: a. What is the accounts receivable turnover for 20X2?b. What is the inventory turnover for 20X2?

95) Selected information taken from the 20X2 annual report of Aardvark Company follows. During 20X2, the company had no nonoperating or nonrecurring items included in income and had no outstanding preferred stock. ($ in millions)

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20X2

20X1

Sales

$ 19,903

$ 18,781

130

169

Net income

1,153

1,088

Total assets

12,673

12,461

Interest expense

Dividends Total stockholders’ equity Assumed tax rate

(153 ) $

4,288 35 %

Industry ROA

7.32 %

Industry operating profit margin

6.1 %

(131 ) $

4,007 35 %

Required: a. For 20X2, calculate: ROA, ROCE, operating profit margin, and asset turnover. Round your percentage answers to one decimal place. For example, 0.1234 = 12.3%.b. Based on the industry data provided, does Aardvark appear to have a competitive advantage (briefly explain your answer)? If so, what strategy is the firm apparently following?

96) In comparison of 20X2 to 20X1 performance, Weir Company’s inventory turnover decreased substantially, although sales and inventory amounts were essentially unchanged.Required:Which of the following statements best explains the decreased inventory turnover ratio? Explain your answer choice.Cost of goods sold increased.Gross profit percentage increased.Accounts receivable turnover decreased.Total asset turnover decreased.

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97) On January 1, Creek Company’s beginning inventory was $500,000. During the year, the company purchased $2,400,000 of additional inventory, and on December 31, Creek’s ending inventory was $300,000.Required: What was Creek’s inventory turnover for year?

98) Rome Company’s net accounts receivable was $200,000 at December 31, 20X1 and $350,000 at December 31, 20X2. Net cash sales for 20X2 were $250,000. The accounts receivable turnover for 20X2 was 8.0, and this turnover figure was computed from net credit sales for the year.Required:What were Rome’s total net sales for 20X2?

99)

Crue Company’s merchandise inventory and other related accounts for 20X1 follow:

Sales Cost of goods sold

$ 3,937,500 2,756,250

Merchandise inventory: Beginning of year

750,000

End of year

825,000

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Required:Calculate Crue’s inventory turnover during 20X1 assuming that the merchandise inventory buildup was relatively constant during the year.

100)

Selected information taken from the accounting records of Rigor Company follows:

Net accounts receivable at December 31, 20X1

$ 8,000,000

Net accounts receivable at December 31, 20X2

$ 9,000,000

Accounts receivable turnover

7 to 1

Inventories at December 31, 20X1

$ 1,000,000

Inventories at December 31, 20X2

$ 1,200,000

Inventory turnover

3 to 1

Required:a. What was Rigor’s gross margin for 20X2?b. Suppose there are 360 business days in the year. What was the number of days’ sales outstanding in average receivables and the number of days’ sales outstanding in average inventories for 20X2, respectively?

101) Jones Corporation wrote off $150,000 of obsolete inventory at December 31, 20X1.Required:Describe the effect of this write-off on the company’s 20X1 current and quick ratios. Version 1

102) Vince Corporation has current assets of $300,000 and current liabilities of $175,000. Required:Compute the effect of each of the following transactions on Vince’s current ratio:Refinanced a $50,000 long-term mortgage with a short-term note.Purchasing $80,000 of merchandise inventory with short-term accounts payable.Paying $30,000 of short-term accounts payable.Collecting $40,000 of short-term accounts receivable.

103) The following data were taken from the financial records of Happy Corporation for 20X1:

Sales

$ 3,600,000

Bond interest expense

100,000

Income taxes

700,000

Net income

900,000

Required:How many times was bond interest covered in 20X1?

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Answer Key Test name: chapter 6 1) FALSE 2) FALSE 3) TRUE 4) FALSE 5) TRUE 6) FALSE 7) FALSE 8) FALSE 9) TRUE 10) FALSE 11) TRUE 12) TRUE 13) TRUE 14) FALSE 15) TRUE 16) A 17) C 18) D 19) B 20) C 21) C 22) A 23) D 24) C 25) C 26) A Version 1

27) B 28) A 29) C 30) C 31) C 32) C 33) A 34) A 35) B 36) A 37) C 38) C 39) C 40) D 41) A 42) C 43) B 44) D 45) B 46) D 47) B 48) B 49) B 50) A 51) C 52) A 53) C 54) B 55) C 56) B Version 1

57) B 58) C 59) C 60) B 61) C 62) B 63) C 64) B 65) A 66) A 67) D 68) C 69) D 70) C 71) A 72) B 73) D 74) C 75) D 76) C 77) C 78) C 79) C 80) A 81) C 82) A 83) C 84) A 85) B 86) B Version 1

87) D 88) C 89) D 90) A 91) D 92) D 93) a.) Return on assets, the measure of profitability in this case, is a function of both profit margin and asset turnover. While Sara Lee has a slightly higher profit margin than Panera Bread (7.05% vs. 6.45%), its asset turnover is much lower than Panera Bread’s which explains the lower return on assets. b.) Neither beats the industry average profit margin, but both are quite a bit better with respect to ROA; thus, both must have asset turnovers that are significantly higher than the industry average.ROA = Profit margin × asset turnover. For example, for Sara Lee, 8.32 = 7.05 × 1.18. 94) a.) Accounts receivable turnover = 5.0 times. b.) Inventory turnover = 4.0 times.Average trade receivables = ($640,000 + $620,000) ÷ 2 = $630,000Accounts receivable turnover = Net credit sales ÷ Average trade receivables = $3,150,000 ÷ $630,000 = 5.0 times.Average inventory = ($542,500 + $642,500) ÷ 2 = $592,500Inventory turnover = Cost of goods sold ÷ average inventory = $2,370,000 ÷ $592,500 = 4.0 times. 95) a. Aardvark ROA

9.8 %

ROCE

27.8 %

Operating profit margin

6.2 %

Asset turnover

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1.584 times

Industry 7.3 %

6.1 % 1.2 times

b.) Aardvark does appear to have a competitive advantage because the company’s ROA exceeds that of its industry. To gain insight into the company’s strategy, first determine the asset turnover for the industry by dividing the industry ROA by the industry operating profit margin: 7.32% ÷ 6.1 = 1.2 times. Next, compare Aardvark’s operating profit margin and asset turnover to the industry’s statistics where it becomes apparent that the primary difference is Aardvark’s higher asset turnover. Higher asset turnovers are normally found in firms that adopt a low-cost leadership strategy. Thus, that appears to be Aardvark’s strategy.a.) First, calculate EBI which equals after-tax operating profits plus aftertax interest charges = $1,153 + [130 × (1 − 0.35)] = $1,237.5ROA = EBI ÷ Average assets = $1,237.5 ÷ [($12,673 + $12,461) ÷ 2] = 9.8%ROCE = (Net income − Preferred dividends) ÷ Average common stockholders’ equity = ($1,153 − $0) ÷ (($4,288 + $4,007) ÷ 2) = 27.8%Operating profit margin = EBI ÷ Sales = $1,237.5 ÷ $19,903 = 6.2%Asset turnover = Sales ÷ Average assets = $19,903 ÷ (($12,673 + $12,461) ÷ 2) = 1.584 96) Statement (b) best explains the decreased inventory turnover ratio. The gross profit margin increased. Sales were unchanged, so the gross profit margin increase would be due to decreased cost of goods sold. If inventory were also unchanged, the lower cost of goods sold would result in lower inventory turnover. 97) 6.5 times. Cost of goods sold = $500,000 + $2,400,000 – $300,000 = $2,600,000Average inventory = ($500,000 + $300,000) ÷ 2 = $400,000Inventory turnover = Cost of goods sold ÷ average inventory = $2,600,000 ÷ $400,000 = 6.5 times.

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98) Total net sales equals total credit sales plus total cash sales. The accounts receivable ratio is used to find total credit sales. Average receivables = ($200,000 + $350,000) ÷ 2 = $275,000. Accounts receivable turnover = Total credit sales ÷ average receivables. 8.0 = Total credit sales ÷ $275,000. Total credit sales = $2,200,000. Total net sales = $2,200,000 + $250,000 = $2,450,000 99) Average inventory = ($750,000 + $825,000) ÷ 2 = $787,500Inventory turnover = Cost of goods sold ÷ Average inventory = $2,756,250 ÷ $787,500 = 3.5 times 100) a.) Gross margin equals net sales minus cost of goods sold. Net sales can be found by using the accounts receivable turnover ratio:Accounts receivable turnover = Net sales ÷ Average receivables7.0 = Net sales ÷ (($800,000 + $900,000) ÷ 2). Net sales = $5,950,000.Cost of goods sold can be found by using the inventory turnover ratio:Inventory turnover = Cost of goods sold ÷ Average inventory3.0 = Cost of goods sold ÷ (($1,000,000 + $1,200,000) ÷ 2). Cost of goods sold = $3,300,000. Gross margin = $5,950,000 − $3,300,000 = $2,650,000.b.) Days’ sales in average receivables = 360 ÷ 7.0 = 51.4 days; Days’ sales in average inventories = 360 ÷ 3.0 = 120 days. 101) The write-off of obsolete inventory would decrease Todd Corporation’s current assets, thus decreasing the current ratio. The quick ratio would be unaffected by the inventory write-off because the quick ratio takes only the most liquid assets (cash, marketable securities, and receivables) into account.

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102) The refinancing of a $50,000 long-term mortgage with a short-term note would increase Vince’s current liabilities, decreasing the current ratio to 1.33 (= $300,000 ÷ $225,000) from the current ratio of 1.71 prior to this transaction.Purchasing $80,000 of inventory with a short-term account payable would increase Vince’s current assets to $380,000, and increase the current liabilities to $255,000, making the current ratio 1.49 which is a decrease from the current ratio of 1.71 prior to this transaction.Paying $30,000 of short-term accounts payable decreases both the current assets and liabilities by $30,000, making the current ratio 1.86 which is an increase from the current ratio of 1.71 prior to this transaction.Collection of $40,000 of short-term accounts receivable has no effect on Vince’s current ratio. 103) Interest Coverage = Operating income before interest and taxes ÷ Interest expense = ($900,000 + $700,000 + $100,000) ÷ $100,000 = 17 times.

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CHAPTER 7: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The discounted cash flow valuation approach expresses current value of a firm as the discounted present value of expected future cash flows. ⊚ ⊚

true false

2) In applying the free cash flow valuation model, the discount rate used is the weightedaverage cost of capital. ⊚ ⊚

true false

3) Accrual accounting produces an earnings number that depicts the effects of economic events on cash flows in the period in which the effects occur and provides an estimate of sustainable long-run future free cash flows. ⊚ ⊚

true false

4) In the flows to equity model of valuation, and using simplifying assumptions, the current stock price estimate can be expressed as a capitalization rate (1 × r) multiplied by a perpetuity equal to cash flow after paying debtholders and preferred shareholders. ⊚ ⊚

true false

5) The two most significant explanations for variations in the earnings multiple are risk differences and maturity of the firm. ⊚ ⊚

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true false

6) The value of the future growth opportunities of a firm can be determined by considering the firm’s potential earnings from reinvesting current earnings in new projects that will eventually earn a rate of return more than the cost of equity capital. ⊚ ⊚

true false

7) Return on assets (ROA) can be used to assess whether a firm is likely to earn a return on reinvested earnings that exceeds its cost of equity capital. ⊚ ⊚

true false

8) A component that is unrelated to future free cash flows or future earnings and is not pertinent to assessing current share price is a noise component. ⊚ ⊚

true false

9) The degree of conservatism associated with a firm’s accounting choices will have a direct bearing on the relationships among share price, earnings, and the firm’s equity book value components of the abnormal earnings valuation approach. ⊚ ⊚

true false

10) Much of the information needed for assessing the quality and value-relevance of a company’s reported accounting numbers cannot be found in the company’s Form 10-K. ⊚ ⊚

true false

11) Under the GAAP hierarchy of approaches used in measuring fair value, Level 3 uses quoted prices from active markets for identical assets or liabilities to determine fair value. ⊚ ⊚

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true false

12) Because income from discontinued operations is not likely to be recurring, it would be considered transitory earnings and be valued at a lower multiple than recurring components (such as income from operations). ⊚ ⊚

true false

13) If securities markets are rational and efficient in that they fully and correctly include all available information into a company’s stock price, the resulting price will reflect investors’ unbiased expectations about the company’s future earnings and cash flows. ⊚ ⊚

true false

14) Lenders form opinions about a firm’s credit risk by comparing current and future debtservice requirements to the estimates of the firm’s current and expected future cash flows. ⊚ ⊚

true false

15) The starting point for developing comprehensive financial statement forecasts is a detailed understanding of the company, its recent financial performance and its health. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) The fundamental valuation approach to business valuation uses basic accounting measures to assess the amount, timing and:

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A) certainty of a firm’s past operating cash flows or earnings. B) certainty of a firm’s future non-operating cash flows or earnings. C) uncertainty of a firm’s future operating cash flows or earnings. D) uncertainty of a firm’s future non-operating cash flows or earnings.

17) The steps involved in business valuation are forecasting the future values of a financial attribute that drives a company’s value, determining the risk associated with that forecasted value and determining the:

A) future values of the value-relevant attribute. B) certain future value of earnings. C) present value of a firm’s earnings. D) discounted present value of the expected future amounts using a discount rate that reflects the risk or uncertainty.

18)

Cash flow assessment plays a central role in analyzing:

A) the credit risk of a company. B) management’s effectiveness. C) the future earnings potential of a company. D) the firm’s investment potential.

19) Valuing an entire company, an operating division of that company or its ownership shares involves three basic steps. These steps include all of the following except:

A) Forecasting future amounts of a value-relevant attribute. B) Determining the risk or uncertainty associated with the forecasted future amounts. C) Determining the discounted present value of the expected future amounts using an appropriate discount rate. D) Determining the dividends the company will pay in the future based on the company’s dividend policy and expected future earnings.

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20) When using the discounted flows to equity valuation model, the market value of common shares depends upon investors’:

A) future expectations about the future economic prospects of cash flows before payments to debtholders and preferred shareholders. B) current expectations about the future economic prospects of cash flows after payments to debtholders and preferred shareholders. C) future expectations about the current economic prospects of cash flows to both debtholders and preferred shareholders. D) current expectations about the current economic prospects of cash flows to both debtholders and preferred shareholders.

21) A simplified version of the discounted free cash flow valuation model assumes a zerogrowth perpetuity for future cash flows. This assumption is best applied to:

A) start-up firms with stable cash flow patterns. B) growth firms with increasing cash flow patterns. C) growth firms with stable cash flow patterns. D) mature firms with stable cash flow patterns.

22)

To apply the discounted free cash flow model, the analyst needs to estimate:

A) net cash flows from operations for each future period, starting one period from now. B) free cash flows for each future period, starting one period from now. C) free cash flows for approximately ten years as the present value of cash flows occurring beyond that point are insignificant. D) net cash flows from operations for approximately ten years as the present value of cash flows occurring beyond that point are insignificant.

23) The FASB stresses that the primary objective of financial reporting is to provide information useful to investors and creditors in assessing the amount, timing and uncertainty of future net cash flows. The FASB contends that:

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A) users pay attention to firms’ accounting earnings because this accrual measure of periodic firm performance improves their ability to forecast future cash flows. B) information about current cash receipts and payments is the best indicator for this task. C) users pay attention to managements’ estimates of free cash flows because this information improves their ability to forecast future cash flows. D) current cash flows outperform current earnings in predicting future cash flows.

24)

By using accruals and deferrals, accrual accounting:

A) produces a cash flow number that reflects only cash earnings. B) produces information about current cash receipts and payments. C) enables management to estimate future free cash flows. D) produces an earnings number that depicts the effects of economic events on cash flows.

25)

Research indicates that stock returns correlate better with:

A) accrual earnings than realized operating cash flows. B) cash basis earnings than realized operating cash flows. C) realized operating cash flows than accrual earnings. D) future operating cash flows than accrual earnings.

26) The reciprocal of the risk-adjusted equity cost of capital used to discount future earnings is the:

A) return on assets. B) return on common equity. C) price/earnings ratio. D) profit margin on sales.

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27) If a company currently earns $5.00 per share, and has a risk-adjusted equity cost of capital of 9%, a share of common stock should theoretically sell for approximately:

A) B) C) D)

$0.45 $5.00 $48.00 $55.55

28) If a company currently earns $6.00 per share and has a risk-adjusted equity cost of capital of 12.5%, a share of common stock should theoretically sell for:

A) B) C) D)

$0.75 $6.00 $48.00 $75.75

29) If most firms’ price/earnings ratios are between 10 and 15, what is the range of the riskadjusted interest rate?

A) B) C) D)

6.67% to 10% 6.67% to 15% 10% to 15% 10% to 16.67%

30) Risky firms have a higher risk-adjusted cost of capital. Which one of the following factors would contribute to a risky firm also having a relatively high price/earnings ratio?

A) The firm has a high earnings per share. B) The firm has a low earnings per share. C) The firm has strong growth opportunities. D) The firm has a significant amount of long-term debt.

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31) To obtain a better current price, the net present value of future growth opportunities (NPVGO) can be calculated and:

A) added to the price per share calculated from the P/E ratio. B) subtracted from the price per share calculated from the P/E ratio. C) multiplied by the price per share calculated from the P/E ratio. D) divided into the price per share calculated from the P/E ratio.

32) The net present value of future growth opportunities (NPVGO) will contribute to an above average P/E multiple when the additional share value created is:

A) positive and the return on new investment is lower than the cost of equity capital. B) positive and the return on new investment is greater than the cost of equity capital. C) negative and the return on new investment is lower than the cost of equity capital. D) negative and the return on new investment is greater than the cost of equity capital.

33) In general, the growth rate in earnings will depend on the portion of earnings reinvested each period and:

A) the earnings retention rate. B) the rate of return earned on new investment. C) the firm’s cost of equity capital. D) the firm’s weighted average cost of capital.

34)

A component that is valuation-relevant, but is not expected to persist into the future is a:

A) permanent earnings component. B) transitory earnings component. C) noise component. D) quiet component.

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35) Income from continuing operations, excluding special or nonrecurring items, is generally regarded as:

A) permanent earnings. B) transitory earnings. C) value-irrelevant earnings. D) abnormal earnings.

36)

Income or loss from discontinued operations is regarded as:

A) permanent earnings. B) transitory earnings. C) value-irrelevant earnings. D) abnormal earnings.

37)

An adjustment to income due to a non-recurring item is regarded as:

A) permanent earnings. B) transitory earnings. C) value-irrelevant earnings. D) abnormal earnings.

38)

Consider the following table of Earnings Components:

Reported EPS

Firm A

Firm B

Firm C

$ 12

$ 15

$ 18

Analyst’s EPS composition: Permanent component (βP = 5)

80 %

60 %

75 %

Transitory component (βT = 1)

10 %

35 %

25 %

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Value-irrelevant component (β0 = 0)

10 %

Firm A

Firm B

Firm C

$ 12

$ 15

$ 18

The implied share price of Firm A’s stock is:

A) B) C) D)

39)

$12.00 $48.00 $49.20 $54.40

Consider the following table of Earnings Components:

Reported EPS Analyst’s EPS composition: Permanent component (βP = 5)

80 %

60 %

75 %

Transitory component (βT = 1)

10 %

35 %

25 %

Value-irrelevant component (β0 = 0)

10 %

Firm A

Firm B

Firm C

$ 12

$ 15

$ 18

The implied share price of Firm B’s stock is:

A) B) C) D)

40)

$15.00 $45.00 $50.25 $55.25

Consider the following table of Earnings Components:

Reported EPS

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Analyst’s EPS composition: Permanent component (βP = 5)

80 %

60 %

75 %

Transitory component (βT = 1)

10 %

35 %

25 %

Value-irrelevant component (β0 = 0)

10 %

Firm A

Firm B

Firm C

$ 12

$ 15

$ 18

The implied share price of Firm C’s stock is:

A) B) C) D)

41)

$18.00 $63.00 $72.00 $90.00

Consider the following table of Earnings Components:

Reported EPS Analyst’s EPS composition: Permanent component (βP = 5)

80 %

60 %

75 %

Transitory component (βT = 1)

10 %

35 %

25 %

Value-irrelevant component (β0 = 0)

10 %

The implied total earnings multiple of Firm A is:

A) B) C) D)

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1.00. 4.10. 5.00. 10.00

42)

Consider the following table of Earnings Components:

Reported EPS

Firm A

Firm B

Firm C

$ 12

$ 15

$ 18

Analyst’s EPS composition: Permanent component (βP = 5)

80 %

60 %

75 %

Transitory component (βT = 1)

10 %

35 %

25 %

Value-irrelevant component (β0 = 0)

10 %

Firm A

Firm B

Firm C

$ 12

$ 15

$ 18

The implied total earnings multiple of Firm B is:

A) B) C) D)

43)

1.00. 3.00. 3.35. 12.00

Consider the following table of Earnings Components:

Reported EPS Analyst’s EPS composition: Permanent component (βP = 5)

80 %

60 %

75 %

Transitory component (βT = 1)

10 %

35 %

25 %

Value-irrelevant component (β0 = 0)

10 %

The implied total earnings multiple of Firm C is:

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A) B) C) D)

1.00. 3.75. 4.00. 15.00

44) Reported earnings numbers often contain three distinctly different components possibly subject to different earnings capitalization rates. Which of the following is not one of these components?

A) A permanent earnings component. B) A transitory earnings component. C) A restructured earnings component. D) A value-irrelevant earnings component.

45)

Which one of the following is an example of sustainable earnings?

A) Loss from debt retirement. B) Expenditures for advertising. C) Earnings from repeat customers. D) Gain from corporate restructuring.

46) As transitory components become a more important part of a firm’s reported earnings, the reported earnings:

A) become a more reliable indicator of sustainable cash flows. B) are more quality enhanced. C) are a more reliable indicator of fundamental value. D) are a less reliable indicator of sustainable cash flows.

47) The assessment of earnings quality to calculate an implied share price is best accomplished using which of the following?

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A) Single-step financial statement. B) Multiple-step income statement. C) Cash flow statement. D) Single-step income statement, balance sheet, and cash flow statement.

48) As transitory or value-irrelevant components become a larger part of a firm’s reported earnings, which of the following effects would you not expect to witness?

A) The quality of those reported earnings is eroded. B) The firm’s stock price rises in the year such components are reported proportionate to their impact on income. C) Reported earnings become a less reliable indicator of the company’s long-run sustainable cash flows. D) Earnings are a less reliable indicator of the firm’s fundamental value.

49) Under the abnormal earnings approach of equity valuation, investors willingly pay a premium for those firms that:

A) earn less than the cost of equity capital. B) produce negative abnormal earnings. C) produce positive abnormal earnings. D) earn an amount equal to the equity cost of capital.

50)

One popular approach to estimating the equity cost of capital is:

A) the asset pricing model (APM). B) the equity costing model (ECM). C) the cost of equity pricing model (CEPM). D) the capital asset pricing model (CAPM).

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51) When calculating forecasted cash flows available to common stockholders (CF) under the flows to equity model,:

A) cash interest payments and preferred dividends are added. B) preferred dividends are added. C) cash interest payments, debt repayments, and preferred dividends are subtracted. D) cash interest payments, debt repayments, and preferred dividends are not included.

52) The expected abnormal earnings of a firm that has earnings of $40,000 with a required equity cost of capital of 8% and a beginning book value of $800,000 is:

A) B) C) D)

53)

$(24,000) $(64,000) $40,000 $104,000

Consider the following table of Actual earnings: Firm A

Actual earnings

6,000

10 %

BVt-1

$ 100,000

Firm B $

14,000 8%

$ 150,000

Firm C $

18,000 12 %

$ 190,000

What are the abnormal earnings for Firm A?

A) B) C) D)

54)

$(4,000) $(6,000) $4,000 $6,000

Consider the following table of Actual earnings:

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Firm A Actual earnings

6,000

Firm B $

10 %

BVt-1

$ 100,000

14,000

Firm C $

18,000 12 %

$ 150,000

$ 190,000

Firm B

Firm C

What are the abnormal earnings for Firm B?

A) B) C) D)

55)

$1,000 $2,000 $12,000 $14,000

Consider the following table of Actual earnings: Firm A

Actual earnings

6,000

10 %

BVt-1

$ 100,000

14,000 8%

18,000 12 %

$ 150,000

$ 190,000

Firm B

Firm C

What are the abnormal earnings for Firm C?

A) B) C) D)

56)

$(2,400) $(4,800) $4,800 $9,600

Consider the following table of Actual earnings: Firm A

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Actual earnings

6,000

10 %

BVt-1

$ 100,000

14,000

18,000

8% $ 150,000

12 % $ 190,000

Assume that Firm A can increase earnings $4,000 by cutting costs. Abnormal earnings would be:

A) B) C) D)

57)

$(1,000) $0 $1,000 $1,500

Consider the following table of Actual earnings: Firm A

Actual earnings r

6,000 10 %

BVt-1

$ 100,000

Firm B $

14,000

Firm C $

18,000

8% $ 150,000

12 % $ 190,000

Assume that at the beginning of the year, Firm B divested itself of $20,000 of unproductive capital and earnings for the year fell by only $3,000. Abnormal earnings are:

A) B) C) D)

$200 $400 $600 $800

58) A company with a return on equity that consistently exceeds the industry average ROCE will generally have shares that sell at a:

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A) market-to-book ratio equal to the industry average. B) lower market-to-book ratio than the industry average. C) higher market-to-book ratio than the industry average. D) higher market price than its competitors.

59)

Per U.S. GAAP, fair value for accounting purposes is:

A) an entry price. B) an exit price. C) the market price in a forced sale. D) always easily determinable.

60)

Carrying amounts in a GAAP balance sheet are measured using all the following except:

A) historical cost. B) net realizable value. C) discounted present value. D) projected ROI.

61)

In the process of determining fair value, the exit price refers to:

A) the amount the firm would receive if it sold a given asset. B) the amount the firm would pay if it bought an asset of the same type and condition as the one being valued. C) the sum of the future cash flows expected to be generated by continuing to use the asset. D) the expected sale price of the stock in a corporate buy-out.

62)

When determining the fair value of an asset using an exit price approach,

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A) fair value is determined by how the company uses the asset. B) management may choose to reduce the fair value of the asset by the approximate amount of expected transaction costs (i.e., costs to dispose of the asset) if such costs are deemed to be material. C) transaction costs do not reduce the asset’s fair value. D) transaction costs reduce the asset’s fair value.

63) Prior to the announcement of unexpected bad earnings (a negative earnings surprise), a firm’s stock price will generally exhibit:

A) a negative drift downward. B) no change in stock price. C) a negative drift downward followed by an immediate upward drift. D) a positive drift upward.

64)

An earnings surprise:

A) usually precedes a negative drift downward in a firm’s stock price. B) means that some bias must exist since unbiased means that the market’s earnings expectations will be correct. C) demonstrates the inherent inefficiency of securities markets. D) occurs when earnings deviate from investors’ expectations.

65) that:

The fact that a firm’s stock price does not change when earnings are announced indicates

A) per share earnings were the same as the previous quarter. B) the securities markets are rational and efficient. C) the information contained in the earnings release was fully anticipated by investors. D) the earnings deviate from investors’ expectations.

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66)

The interest rate on a revolving loan will usually:

A) be below the prime interest rate. B) be equal to the prime interest rate. C) remain fixed. D) float.

67)

Short-term notes sold directly to investors by large, highly rated companies are called:

A) commercial paper. B) secured notes. C) bonds. D) debentures.

68)

A bond that is considered unsecured is referred to as a:

A) debenture. B) sinking fund bond. C) senior bond. D) callable bond.

69) A qualitative assessment of the business, its customers and suppliers, and management’s character and capability is known as:

A) covenant waivers. B) due diligence. C) indenture evaluation. D) a debenture.

70) as:

The degree to which cash needs can be satisfied during periods of fiscal stress is known

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A) credit availability. B) credit worthiness. C) working capital. D) financial flexibility.

71)

The two ways to implement the discounted cash flow valuation approach are:

A) CAPM and the weighted average cost of capital. B) the free cash flow model and the flows to equity model. C) the price/earnings model and the cash flows model. D) the weighted cash flows model and the capital assets model.

72) The interest rate charged on bank loans must be sufficient to cover all the following except:

A) a risk premium when loans are personally guaranteed by the borrower. B) the lender’s cost of borrowing funds. C) the costs of administering, monitoring, and servicing the loan. D) a premium for exposure to default risk.

73)

Financial statement forecasts are:

A) one of the required note disclosures found in each company’s annual report. B) filed annually with the SEC by all public companies. C) frequently used in determining management compensation. D) essential ingredients of business valuation and credit risk analysis.

74) Preparing comprehensive financial statement forecasts involves six steps. Among these steps are all the following except:

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A) Forecast sales revenue for each period in the forecast horizon. B) Forecast depreciation expense and tax expense for each period. C) Forecast the company’s financial structure and dividend policy for each period. D) Forecast the market price per share for the company’s common stock for each period.

75) Which of the following statements is false regarding the global vantage point of fair value measurement?

A) The FASB revised ASC 820-10 to make the U.S. fair value disclosure rules more consistent with IFRS. B) IFRS 13 “Fair Value Measurement” is not in agreement with U.S. GAAP. C) ASC Topic 820 provides fair value guidance for companies, investors, and company auditors. D) The FASB and the IASB worked together on a joint convergence project for fair value measurement and disclosure.

76) Common value-relevant attributes for determining the value of a company include all the following except:

A) Fair value of fixed assets. B) Balance sheet book values. C) Accounting earnings. D) Free cash flows.

77)

Which of the following statements is false regarding the flows to equity model?

A) The forecasted cash flow stream to be discounted is reduced by flows to preferred shareholders. B) The flows are reduced by cash interest payments. C) The flows are increased by debt repayments. D) The flows calculation begins with free cash flow.

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78)

Which of the following statements is false regarding the FASB’S view on valuation?

A) The FASB believes that current cash flows are more useful than current accrual accounting earnings in predicting future cash flows. B) The FASB contends that users pay attention to a firm’s accounting earnings because this measure improves their ability to forecast future cash flows. C) The FASB believes that a reliable valuation needs to rely on more than an analysis of cash receipts and payments during a certain period. D) The FASB stresses that the primary objective of financial reporting is to provide useful information to investors and creditors in assessing the amount, timing, and uncertainty of future net cash flows.

79) Which of the following statements is false regarding the abnormal earnings approach to valuation?

A) The method uses earnings and equity book value numbers as direct inputs in the valuation process. B) The method uses the cost of capital as a fundamental economic benchmark. C) This approach produces results that are generally equivalent to the free cash flow model. D) This approach is based on the notion that the value of a company is driven primarily by the level of earnings.

80)

Which of the following statements is false regarding credit risk analysis?

A) A comprehensive credit risk analysis involves evaluating and summarizing the various individual risks associated with a loan. B) Credit risk is not affected by the aggressive application of accounting standards since cash flows are not impacted by financial reporting choices. C) A simple alternative to credit risk analysis is to rely on credit reports issued by third parties. D) Certain financial statement ratios are very useful in predicting loan default.

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81)

Which of the following statements is false regarding credit risk analysis?

A) A lender is protected against credit risks by a loan’s covenant provisions since the interest rate is fixed by the Federal Reserve Bank. B) High-quality financial statements help a credit analyst to see the true performance at a company. C) Greater default risk is determined to exist when there is significant organizational reliance on a certain individual or customer. D) An estimate of a firm’s future financial condition is very important to most lending decisions.

82)

Which of the following statements is false regarding traditional lending products?

A) A term lending agreement has an original maturity of more than one year with maturities ranging from two to five years being the most common. B) The written agreement between the between the borrowing company and its lenders is referred to as the indenture. C) A bond that has collateral to protect the bondholder is referred to as a debenture bond. D) A call provision allows the borrowing company to repurchase part or all the debt at a stated price over a specific period.

83)

Which of the following statements is false regarding the business valuation process?

A) Credit valuation involves estimating the worth of a company, one of its operating units, or its ownership shares. B) Business valuation involves estimating the intrinsic value of a company or one of its operating units. C) Fundamental valuation uses basic accounting measures to assess the amount, timing, and uncertainty of a firm’s future operating cash flows or earnings. D) Operating cash flow minus cash outlays to replace operating capacity represents free cash flow.

84)

Which of the following statements is false regarding the business valuation process?

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A) If a company is currently generating a sustainable free cash flow of $10 per share and the discount rate is 10%, the estimated share price is $100. B) FASB contends that current accrual earnings are a proxy for free cash flow. C) A simplified version of the discounted free cash flow valuation model assumes a zero-growth perpetuity for future cash flows. This approach is best applied to growth companies with stable cash flow patterns. D) One popular approach to estimate a firm’s equity cost of capital is the capital asset pricing model.

85)

Which of the following statements is false regarding the business valuation process?

A) Income or loss from discontinued operations is considered a transitory component of a firm’s earnings. B) Forecasting future cash flows requires calculations using factors from future value tables. C) A component of earnings that is unrelated to future free cash flows or future earnings and is not pertinent to assessing current share price is considered a noise component. D) Firms that earn less than the cost of equity capital produce negative abnormal earnings and generally have a share price below book value.

86) to:

Consistent with FASB Concept Statement No. 8, accounting information should be useful

A) lenders. B) other creditors. C) investors. D) all are stakeholders for whom the information should be useful.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 87) Briefly define “free cash flows” and describe the key features of the free cash flow model for business valuation.

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88)

Describe the general role of accounting numbers in business valuation.

89) P/E ratios are a useful indicator and tool when performing valuation and comparing firms. List three factors that should be considered or adjusted for when comparing P/E ratios among different firms.

90)

What is meant by sustainable earnings?

91) Briefly discuss how a firm’s P/E ratio is related to the firm’s choice of accounting methods, estimates, and timing of discretionary expenditures.

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92) Briefly discuss how a firm’s P/E ratio is related to the present value of growth opportunities available to the firm.

Recent values of P0 (current stock price), X0 (current reported EPS), and r (equity cost of 93) capital) for Alpha Company follow: P0 $23.50

X0 $1.47

r 0.150

Required: Compute Alpha’s NPVGO (net present value of future growth opportunities).

94) One measure for determining expected earnings for the current quarter could be considering earnings for the same quarter last year. List some of the disadvantages to using this measure.

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95) List some possible techniques that management can use to improve a company’s reported performance in the short run.

96)

Give at least three examples of low-quality earnings items.

97)

Below is data for calendar 20X1 for two companies. Company A

Company B

Actual earnings

79,632

176,341

BVt-1

$ 504,000

943,000

Cost of equity capital

0.167

0.175

Required:Calculate each firm’s abnormal earnings and indicate which firm was better managed during calendar year 20X1.

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98) Briefly define “abnormal earnings” and describe the key features of the abnormal earnings approach to valuation.

99) Why do the stock returns of firms reporting “good news” drift upwards before the earnings announcement date?

100) Briefly define an earnings surprise and explain how the surprise can impact the value of a firm’s equity.

101)

The quarterly cash flows from operations for two technology companies are as follows: 20X1

20X2

Firm 1

$ 451.2

$ 220.8

$ 703.5

$ 475.5

$ 601.2

Firm 2

$ 165.9

$ 240.7

$ 698.8

$ (91.8 )

$ (173.3 )

Required:Explain why Firm 2 has more credit risk than Firm 1.

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Answer Key Test name: chapter 7 1) TRUE 2) TRUE 3) TRUE 4) FALSE 5) FALSE 6) TRUE 7) FALSE 8) TRUE 9) TRUE 10) FALSE 11) FALSE 12) TRUE 13) TRUE 14) TRUE 15) TRUE 16) C 17) D 18) A 19) D 20) B 21) D 22) B 23) A 24) D 25) A 26) C Version 1

27) D 28) C 29) A 30) C 31) A 32) B 33) B 34) B 35) A 36) B 37) B 38) C 39) C 40) C 41) B 42) C 43) C 44) C 45) C 46) D 47) B 48) B 49) C 50) D 51) C 52) A 53) A 54) B 55) B 56) B Version 1

57) C 58) C 59) B 60) D 61) A 62) C 63) A 64) D 65) C 66) D 67) A 68) A 69) B 70) D 71) B 72) A 73) D 74) D 75) B 76) A 77) C 78) A 79) D 80) B 81) A 82) C 83) A 84) C 85) B 86) D Version 1

87) Free cash flow is operating cash flow minus cash outlays for operating capacity such as buildings, equipment, and furnishings. A company’s free cash flow consequently represents the amount available to finance planned expansion of operating capacity, reduce debt, pay dividends or repurchase stock. Under the free cash flow model for business valuation, the value of a firm’s stock and debt at a certain time is equal to the sum of the future stream of expected free cash flow discounted back to the present at the firm’s weighted-average cost of capital. In summary, the free cash flow model expresses today’s intrinsic value as a function of investors’ current expectations of the firm’s future economic prospects as measured by its expected future free cash flows. 88) Business valuation involves estimating the worth of a company, one of its operating units or its ownership shares. Some equity valuation models are based on discounting a firm’s future earnings or free cash flows. In such settings, the role of accounting numbers (i.e., the information disclosed in financial statements) is to aid in the development of forecasts of the firm’s future earnings and cash flows. These forecasts are then discounted at the firm’s risk-adjusted cost of equity capital to arrive at an estimate of the equity’s value. The book value from the balance sheet of the firm is used for the abnormal earnings approach to valuation. Components of the income statement are categorized for calculating an implied share price of the business. Earnings per share is used for calculating an implied earnings multiple to use in assessing earnings quality and comparing one company to another. 89) Possible answers include risk differences, growth opportunities, earnings components (valuation irrelevant, permanent, and transitory) as well as differences in accounting policies.

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90) Sustainable earnings comprise the component of earnings that is valuation-relevant and is expected to persist into the future. The sustainable component of a company’s earnings is represented by recurring income from continuing operations and would fall into the permanent earnings category for valuation. Earnings generated from repeat customers or from a high-quality product that enjoys steady customer demand are examples of drivers behind sustainable earnings. 91) The denominator of the P/E ratio is earnings and so the lower the earnings, the greater the P/E ratio. Firms that use conservative accounting methods and recognize lower net income (i.e., those that tend to recognize expenses sooner rather than later or recognize revenues later rather than sooner) will generally report lower earnings. Conversely, firms that use aggressive accounting methods (i.e., those that tend to recognize expenses later rather than sooner and revenues sooner rather than later) tend to report higher earnings. Thus, choice of accounting methods such as for inventory and for depreciation, and for estimates of uncollectibles, and timing of discretionary expenses and can affect net income and thus the P/E ratio.

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92) Price-earnings ratios are positively related to the present value of a firm’s growth opportunities. The market values the firm’s potential earnings from reinvesting current earnings in new projects that will eventually earn a rate of return in excess of the firm’s cost of equity capital. The net present value of growth opportunities (NPVGO) adds a positive increment to the firm’s stock price which results in higher P/E multiples. Consequently, as growth opportunities increase, so do P/E ratios. The firm’s stock value is a function of the present value of earnings from assets in place in addition to the firm’s future growth opportunities. Thus, firms with little or no current earnings may still have very high P/E ratios because they have substantial future growth opportunities. Examples include companies in the biotechnology, computer software and computer hardware industries. 93) To find the NPVGO for Alpha Company, solve the following equation:%media:formula3.mml% Rearranging terms yields: %media:formula4.mml% = $23.50 − ($1.47 ÷ 0.15) = $13.70 NPVGO 94) Some disadvantages include: this measure (a) does not consider nonrecurring items that were included in previous corresponding period earnings, and (b) does not consider new information and events that occurred after the previous corresponding period. 95) Management can improve reported earnings in the short-term by:(a.) Changing accounting methods.(b.) Adjusting expense estimates (e.g., increasing estimated useful lives of fixed assets or reducing bad debt or warranty expense estimates).(c.) Altering the timing of revenue or expense recognition (i.e., shifting revenues or expenses from one period to the next).(d.) Initiating business transactions that produce one-time gains or losses; e.g., sell real estate.(e.) Reducing or eliminating expenditures for advertising, R&D, etc.

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96) Examples of low-quality earnings items include:(a.) One-time gains and losses from asset sales.(b.) Liberal accounting choices that increase short-term profits.(c.) Changes in discretionary expenditures for R&D, advertising, and maintenance.(d.) Illusory profits from LIFO liquidations.(e.) Changes in accounting estimates. A variety of other examples could be listed here. 97) Company A

Company B

Actual earnings

79,632

176,341

BVt-1

$ 504,000

943,000

Cost of equity capital

0.167

0.175

Return on capital

0.158

0.187

Expected earnings

84,168

165,025

Abnormal earnings

(4,536 )

11,316

Company B created value by generating positive abnormal earnings while Company A eroded value due to negative abnormal earnings. Consequently, Company B was the better managed of the two companies for 20X1.

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98) Abnormal earnings is the difference between actual earnings for the period and stockholders’ required dollar return on invested capital for the period. Investors willingly pay a premium only for the stocks of firms that earn more than their cost of equity capital (i.e., firms that earn positive abnormal earnings). Conversely, investors will generally pay less than book value for firms that earn negative abnormal earnings. As described in the text, the abnormal earnings valuation model is: Price of equity at time 0 = Book value of equity at time 0 + Present value of expected abnormal earnings in all future periods. The discount rate that is applied to the future abnormal earnings is the cost of equity capital. 99) “Good news” firms are those that report earnings better than expected when they actually announce their earnings and these are firms that are performing well during the quarter leading up to the earnings announcement date. One possible reason for the upward drift during the quarter is that accounting earnings announced at the end of the quarter is not the sole source of value-relevant information about the firm. During the quarter, other information will generally become available to indicate that the firm is doing better than previously expected. Consequently, investors can anticipate good earnings from the firm and will tend to buy more of their stock which will lead to an increase in the stock price of the firm. This good performance is then confirmed at the end of the quarter when the firm reports earnings greater than expected at the beginning of the quarter.

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100) An earnings surprise occurs when new information is conveyed to investors at the time of a firm’s quarterly or annual earnings announcement. An earnings surprise occurs when a firm’s reported earnings are different from what the market was expecting the firm to report. Investors use earnings surprises to revise their expectations of the firm’s future earnings and cash flow prospects. The stock price change will generally be positive when the earnings surprise is “good news” (i.e., reported earnings exceed what the market had expected). The stock price change will generally be negative when the earnings surprise is “bad news” (i.e., reported earnings are less than what the market had expected). 101) The quarterly operating cash flows of both firms fluctuate seasonally, i.e., operating cash flow levels change from quarter to quarter and the changes are not all positive. Seasonal patterns in sales and operating cash flow are common in many industries, and the cash flow volatility produced by seasonal sales is one of the contributors to increased credit risk. In addition, Firm 2’s operating cash flows are lower than those of Firm 1 and are negative in the two most recent quarters. These two features of Firm 2’s operating cash flow make it a greater credit risk than Firm 1.

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CHAPTER 8: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Contract terms can be designed to eliminate or reduce conflicting incentives that arise in business relationships. ⊚ ⊚

true false

2) Contracts include financial reporting information and create incentives for earnings management. ⊚ ⊚

true false

3) Debt covenants help guard against conflicts of interest between creditors and bank regulators. ⊚ ⊚

true false

4) Some debt covenants preserve repayment capacity by preventing mergers and acquisitions unless the debt is first repaid. ⊚ ⊚

true false

5) Negative covenants tend to be less significant than affirmative covenants because they place direct restrictions on the actions lenders can take. ⊚ ⊚

true false

6) Managers wishing to avoid loan covenant violations may resort to making accounting changes that increase reported earnings. ⊚ ⊚ Version 1

true false 1

7) Potential conflicts of interest between managers and owners can be overcome if compensation packages are tied to improvement in firm value. ⊚ ⊚

true false

8) Most compensation packages involve a base salary, an annual incentive, and a short-term incentive. ⊚ ⊚

true false

9) When restricted stock is granted as executive compensation, the recipient must wait for collecting dividends and exercising voting rights until the restriction period ends. ⊚ ⊚

true false

10) Research shows that managers sometimes use accounting flexibility to evade contract constraints in order to gain bonus benefits. ⊚ ⊚

true false

11) A factor that can affect managers’ incentives for short-term focus on performance is that a compensation committee oversees incentive plans and can intervene when circumstances warrant modification of the scheduled incentive award. ⊚ ⊚

true false

12) Banks and other financial institutions are required by federal and state regulatory agencies to meet minimum lending requirements.

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⊚ ⊚

13)

true false

Under RAP, loan charge-offs decrease bank capital and also reduce bank net income. ⊚ ⊚

true false

14) Many managers believe that meeting earnings benchmarks helps to build credibility with investors. ⊚ ⊚

true false

15) A difference of one penny between reported EPS and analysts’ expectations of EPS matters a lot to investors. ⊚ ⊚

true false

16) Increasingly, information on social issues is included in required financial reporting in the U.S. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 17) Loan provisions that are specifically designed to restrict dividend payments to shareholders are called:

A) debt covenants. B) debt obligations. C) stock covenants. D) stock agreements.

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18) A lender may be protected from deterioration of the borrower’s creditworthiness if the commercial lending agreement requires the borrower to maintain a:

A) specified return on equity. B) specified earnings per share (EPS). C) fixed charge ratio above a certain level. D) fixed charge ratio below a certain level.

19) A borrower that violates one or more loan covenants but makes all interest and principal payments timely:

A) is in payment default. B) is in trigger default. C) is in technical default. D) is not in default.

20)

Which of the following is not a purpose served by debt covenants?

A) Preservation of repayment capacity B) Protection against credit damaging events C) Triggers and signals D) Guarantee of no default by the creditor

21) When one party to a business relationship can make decisions that benefit him or her but harm another other party in the relationship:

A) a lawsuit is automatically filed. B) a contract arises. C) a conflict of interest arises. D) a contingent liability arises.

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22)

Potential conflicts of interest permeate:

A) few business relationships. B) only relationships between investors and managers. C) only relationships between borrowers and lenders. D) many business relationships.

23)

Contract terms:

A) confer the rights and obligations of the borrower. B) depend on data in financial statements that are issued before the contract is executed. C) cannot be designed to eliminate or reduce conflicting incentives. D) do not use financial accounting numbers to monitor compliance with contract terms.

24)

A typical rate formula for a public utility includes:

A) revenue, operating costs, and taxes. B) operating costs, depreciation, and taxes. C) advertising, depreciation, and taxes. D) operating costs, bad debt provisions, and depreciation.

25) When agents do not act in the best interest of their principals, the cost is borne by which of the following?

A) Only the principal. B) Only the agent. C) Both the principal and agent. D) There is no cost of an agent not acting on behalf of their principal.

26) When conflicts of interest exist, lenders generally take all of the following actions at the creation of a contract except: Version 1

A) impose higher interest rates to reflect greater default risk. B) ensure that affirmative covenants are in the contract. C) accept the risk and set up a reserve for potential future issues. D) ensure that negative covenants are in the contract.

27) a/an:

A covenant that specifies a required minimum level of net worth and working capital is

A) compliance covenant. B) financial covenant. C) implicit covenant. D) negative covenant.

28)

Affirmative covenants generally would not include which of the following stipulations?

A) The lender has the right to inspect business assets and business contracts. B) Limits on the borrower’s total indebtedness. C) The borrower must maintain insurance on business properties. D) Specific financial covenants and reporting requirements.

29)

Many loan agreements have financial covenants that rely on:

A) floating GAAP. B) fixed GAAP. C) flexible GAAP. D) regulatory accounting procedures (RAP).

30) What purpose is served by including covenants that place strict limits on new borrowing, prohibit stock repurchases and dividends without prior lender approval, or ensure that cash generated both from ongoing operations and from asset sales will not be diverted away from servicing debt?

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A) Signal B) Protection against credit-damaging events C) Preservation of repayment capital D) Trigger

31)

Which of the following is not an example of a negative covenant provision?

A) Limits on capital expenditures. B) Limits on the borrower’s total indebtedness. C) Limits the use of the loan to an agreed-upon purpose. D) Restricts the payment of cash dividends.

32) Based on a comprehensive survey of U.S. companies, the most common financial performance measure used in annual and long-term incentive plans for senior executives is:

A) return on equity. B) economic value added. C) return on capital. D) net income or revenues.

33)

Which of the following situations does not lead to default of a loan contract?

A) Impairment of capital B) Failure to abide by a covenant C) Paying interest and principal when due D) Failure to pay other debts when due

34)

Debt covenants benefit:

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A) lenders. B) borrowers. C) both lenders and borrowers. D) neither borrowers nor lenders, but are required by the SEC as a condition of issuing debt securities.

35)

Which one of the following is not a broad function served by debt covenants?

A) Debt covenants usually preclude the borrower from being a merger target. B) Debt covenants serve as both signals and triggers, thereby assuring a steady flow of information from borrower to lender. C) Debt covenants are designed to preserve the borrower’s repayment capacity. D) Debt covenants offer the lender some protection against credit-damaging events affecting the borrower.

36)

A financial covenant would stipulate all of the following except:

A) financial statements must be prepared in accordance with GAAP. B) specific levels of performance to be met. C) which accounting methods are to be used. D) conditions that must be met.

37)

In the event of a default, lenders may do all of the following except:

A) modify the contract terms. B) take immediate full control of the creditor. C) initiate bankruptcy proceedings. D) seize the collateral.

38)

In using financial statements to monitor compliance with debt covenants:

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A) mandatory changes in accounting principles can be ignored in all cases. B) many loan agreements have financial covenants that rely on the accounting rules in place when the loan is first granted. C) the lender is in default if not enforcing the borrower’s compliance with the most recent accounting principles. D) the lender must renegotiate the covenants if a new accounting principle harms the borrower’s compliance.

39) A lender’s requirement for a borrower to maintain a certain level of fixed charge coverage:

A) directly enhances the borrower’s ability to pay dividends. B) indirectly enhances the borrower’s ability to pay dividends. C) directly limits the borrower’s ability to pay dividends. D) indirectly limits the borrower’s ability to pay dividends.

40)

Covenants that place direct restrictions on managerial decisions are called:

A) affirmative restrictions. B) affirmative covenants. C) negative restrictions. D) negative covenants.

41)

Which one of the following is an example of a negative covenant?

A) Compliance with laws. B) Maintenance of insurance. C) Limit on capital expenditures. D) Rights of inspection.

42)

Which of the following is not an example of an affirmative covenant?

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A) Allowing the lender to inspect business assets and business contracts. B) Limiting new business ventures. C) Complying with laws. D) Providing periodic, audited financial statements.

43)

A requirement that a company maintain a fixed-charge coverage ratio:

A) cannot limit the company’s ability to pay dividends. B) is an example of a negative covenant. C) is an example of an affirmative covenant. D) cannot limit the company’s ability to spend replacement capital.

44) The section of a loan agreement that describes circumstances in which the creditor obtains additional rights is called the:

A) events of compliance section. B) certificate of compliance section. C) events of termination section. D) events of default section.

45) The failure of a company to pay other debts, such as payables or other loans, when due is called:

A) routine default. B) non-default. C) cross default. D) compliance default.

46)

Which statement below best describes a technical default?

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A) The borrower violates one or more loan covenants but has made all interest and principal payments. B) The borrower has not violated any covenants but has missed both an interest and principal payment. C) The borrower violates one or more loan covenants but has made all principal payments. D) The borrower violates one or more loan covenants but has made all interest payments.

47) According to the SEC, any breach of a loan covenant that existed at the balance sheet date that has not subsequently been cured should:

A) be recorded as an adjustment to the financial statements. B) be disclosed in the notes to the financial statements. C) be disclosed in the audit report. D) not be disclosed.

48)

When a debt covenant is violated, the related debt must be classified as current if it is:

A) probable that the borrower will not be able to cure the default within the next twelve months. B) probable that the borrower will not be able to cure the default within the next fifteen months. C) probable that the borrower will be able to cure the default in the next twelve months. D) probable that the borrower will be able to cure the default in the next fifteen months.

49) Company A’s interest ratio has fallen below the level required by its lender. The lender may not take which action?

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A) Gain representation on the company’s board of directors. B) Replace the CEO of the company. C) Demand repayment of the loan. D) Veto payment of a dividend.

50) Which accounting choice would not be used to reduce the likelihood of a technical default?

A) Bad debt provisions B) When to sell assets C) Inventory valuation method D) Management compensation plans

51) When a borrower is unable to make a scheduled interest payment, the type of default that occurs is a:

A) technical default. B) covenant default. C) payment default. D) transitory default.

52) A study examining how incentives arising out of debt contracts affect managers’ accounting choices found that the most common violations of accounting-based covenants occurred with:

A) net worth and working capital restrictions. B) mergers and acquisitions restrictions. C) leveraged buyout restrictions. D) debt restructures.

53)

Discretionary accounting accruals are:

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A) cash financial statement adjustments, which accrue revenue or expenses. B) noncash financial statement adjustments, which accrue revenue or expenses. C) cash financial statement adjustments, which accrue only revenue. D) noncash financial statement adjustments, which accrue only expenses.

54) A study of discretionary accounting accruals found that abnormal accruals in the year prior to reporting covenant violations:

A) significantly decreased the company’s current ratio but significantly increased the company’s reported earnings. B) significantly decreased the company’s net worth. C) significantly increased reported earnings and increased working capital. D) significantly increased reported earnings and decreased working capital.

55) Studies seem to suggest that management tends to make accounting changes and/or manipulate discretionary accruals to:

A) enhance technical defaults. B) eliminate debt covenants. C) violate debt covenants. D) avoid violation of debt covenants.

56) Potential conflicts of interest between shareholders and managers may be overcome if managers are given incentives which cause them to behave as if they were:

A) creditors. B) owners. C) debtors. D) vendors.

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57) Firms must provide detailed disclosure of three broad executive pay categories. Which of the following is not one of these categories?

A) Retirement and other postemployment compensation B) Costs incurred by the corporation for executive travel, entertainment, and other "expense account" items C) Compensation for the last fiscal year and the two preceding years D) Holdings of equity-related interests that relate to compensation

58) Information about a company’s executive compensation practices can be found in a company’s:

A) annual report. B) form 10-K. C) proxy statement. D) form 10-Q.

59)

A decrease in market-wide interest rates will result in a/an:

A) increase in the cost of equity capital. B) decrease in the cost of equity capital. C) increase in the cost of debt. D) decrease in the demand for fixed-rate bond investments.

60) Compensation incentives that motivate and reward executives for three to seven years of growth and prosperity are called:

A) base salaries. B) short-term incentives. C) long-term incentives. D) executive compensation packages.

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61) Which of the following is not an accurate statement regarding the compensation committee?

A) It selects the performance metrics used. B) It may adjust a calculated award up or down at its discretion. C) It is comprised of both internal and external directors. D) It selects the annual or multiyear performance goals.

62)

Stock options:

A) have value only if the market price of the stock declines. B) have value only if the market price of the stock rises. C) are taxed at ordinary rates. D) do not qualify for favorable tax treatment.

63) An award of stock that is not transferable or subject to forfeiture for a period of years is called:

A) phantom stock. B) treasury stock. C) restricted stock. D) preferred stock.

64)

Most executive compensation plans link bonus awards to one or more:

A) non-accounting based performance measures. B) accounting-based performance measures. C) marketing-based performance measures. D) management-based performance measures.

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65) The widespread use of accounting-based incentives for executive compensation is controversial for which one of the following reasons?

A) earnings growth does not automatically increase shareholder value. B) accounting-based incentive plans can encourage managers to adopt a long-term business focus. C) executives cannot use their discretion over the accounting policies. D) managers do not have accounting flexibility.

66)

Several studies show that incoming CEOs have an incentive to:

A) increase earnings in the year of the executive change as well as in years subsequent to the change. B) decrease earnings in the year of executive change and increase earnings in the next year. C) decrease earnings for a few years after taking over to establish a low "bonus baseline." D) take actions that will make his/her predecessor look incompetent thus validating the board’s decision to change CEOs.

67)

Which statement best describes stock options?

A) Stock options are not an expense on the company’s profit and loss statement. B) Stock options obligate the holder to purchase shares at a stated price. C) Stock options give the holder the right to purchase shares at a stated price. D) Stock options have been replaced by restricted stock.

68) Managers believe it is important to meet earnings benchmarks. When a number of executives were asked-within the parameters of GAAP-which choices your company might make to hit an earnings target, the most popular choice was to:

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A) decrease discretionary spending. B) alter accrual assumptions (such as allowances). C) postpone taking an accounting charge. D) draw down on reserves previously set aside.

69)

A clawback provision in an employment contract:

A) requires managers to become more conservative in their business decision-making. B) requires managers to respond to compensation committee requests for information. C) requires managers to return bonuses received in the event of a financial statement restatement. D) requires managers to refrain from making discretionary accruals.

70)

With respect to executive pay, which of the following is not correct?

A) The proportion of pay "at risk" falls off steeply for executives on lower rungs of the corporate ladder. B) Top executive bonus opportuni•ties have a maximum payout of 200%. C) Most executive compensation packages involve a base salary, an annual incentive, and a long-term incentive. D) Long-term incentives are designed to counterbalance the inherently short-term orientation of other incentives.

71) Research has shown that research and development expenditures during the years immediately prior to a CEO’s retirement tend to:

A) increase by a large amount. B) increase by a small amount. C) decline. D) show no change.

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72)

Compensation plans should:

A) not link incentive plans to financial performance. B) not be based on long-term business goals. C) align shareholders’ incentives with the objectives of managers. D) align managers’ incentives with the objectives of shareholders.

73) Long-term incentive components of executive compensation plans should include stock options:

A) to enhance the short-term focus of executives. B) to mitigate the short-term focus of executives. C) to mitigate the long-term focus of executives. D) to encourage better performance by low-level staff.

74)

With respect to executive compensation, which statement is not valid?

A) Compensation packages are designed to minimize conflicts of interest. B) Stock returns are the best way to align managers’ and owners’ interests since management’s actions control the share price in both the short and long term. C) Executive compensation components are generally linked to stock returns and/or financial performance measures. D) Use of accounting earnings should not be used due to its reliance on valuations that involve subjectivity and judgments.

75)

A compensation committee should be comprised of:

A) the CEO and the CFO of the company. B) the CEO of the company and the outside attorney. C) members of the Board of Directors who are also officers of the company. D) members of the Board of Directors who are outside (non-management) directors.

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76) Regulatory accounting principles are important to those outside the regulatory agencies because:

A) GAAP may allow reporting for assets and liabilities consistent with the way in which regulators establish rates. B) GAAP does not allow reporting for assets and liabilities consistent with the way in which regulators establish rates. C) regulatory accounting principles are not compatible with GAAP. D) the SEC requires them.

77) Banks that fail to comply with regulations, including the failure to maintain an adequate capital adequacy ratio, face:

A) higher costs. B) lower costs. C) mergers and expansion of services. D) incarceration of officers.

78) The use of a bank manager’s discretion in the timing and amount of loan loss provisions and loan charge-offs can falsely understate the losses and:

A) decrease net income. B) decrease bank obligations. C) improve the bank’s debt adequacy ratio. D) improve the bank’s capital adequacy ratio.

79) the:

In the banking industry, the ratio of investor capital/gross assets, as defined by RAP, is

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A) capital asset ratio. B) capital adequacy ratio. C) gross asset ratio. D) indirect capital ratio.

80)

A bank’s estimated bad debt expense associated with its loan receivables is the:

A) loan loss provision. B) loan charge-offs. C) allowance for loans. D) accumulated loan loss.

81) In the utilities industry, rate formulas are established to allow the utilities to set total allowed revenues to recover:

A) only the administrative costs of operations. B) only the operating costs associated with operations. C) all operating costs, depreciation, taxes, and a fair return on invested capital. D) all operating costs other than depreciation and taxes, and a fair return on invested capital.

82)

In the utilities industry, image advertising and customer safety advertising are:

A) both paid for by customers. B) both paid for by shareholders. C) both treated as operating expenses under RAP. D) both treated as operating expenses under GAAP.

83)

Rate regulation provides incentives for public utility managers to:

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A) artificially decrease the asset base. B) artificially increase the asset base. C) artificially decrease operating expenses. D) artificially decrease taxes.

84)

IRS regulations govern the:

A) computation of net income for GAAP. B) computation of net income for tax purposes. C) computation of gross profit for GAAP. D) computation of net income for the SEC.

85)

Regulatory Accounting Principles (RAP) can be used:

A) to set the prices customers may be charged. B) as a basis for supervisory action. C) as a source of statistical information. D) to determine the amount of dividend to be paid.

86) Which of the following does not properly represent the relation of tax and GAAP accounting?

A) Companies using FIFO for financial statements prefer FIFO for tax purposes because FIFO results in a lower taxable income. B) GAAP and tax depreciation expense will rarely be equal. C) If LIFO is used for inventory valuation for taxes, LIFO must also be used for GAAP financial reporting. D) The accounting methods used for tax are permitted to differ from GAAP rules.

87) Which of the following statements does not reflect the provisions of ASU 2016-01 related to fair value measurement?

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A) It requires minority-passive equity investments (generally less than 20% ownership) to be measured at fair value with changes in fair value recognized in net income, unless there is no readily determinable fair value. B) It simplifies the impairment assessment of equity investments that do not have readily determin•able fair values. C) It requires an entity applying the fair value option to its own liabilities to recognize in net income the change in fair value attributable to the entity’s creditworthiness. D) It requires an entity applying the fair value option to its own liabilities to recognize in other comprehensive income (not net income) the change in fair value attributable to the entity’s creditworthiness.

88)

Which of the following did not contribute to the 2008 financial meltdown?

A) the packaging/bundling of traditional mortgages to be sold as investments. B) the speculative bubble related to housing demand drove up prices which proved to be unsustainable. C) an increase in traditional 30 year mortgages. D) the issuance of high-risk/subprime mortgage loans.

89) Banking regulators have a powerful weapon to encourage compliance with minimum capital guidelines as they can compel a noncomplying bank to do any or all of the following except:

A) require the bank to increase the number of outside directors on its board. B) require the bank to submit a plan describing how and when its capital will be increased. C) subject the bank to more frequent examinations by the regulator. D) deny a request to merge, open new branches, or expand services.

90)

The prevalence of stock options in executive pay packages:

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A) eliminates managers’ incentives to engage in short-term earnings management. B) is frowned upon by the SEC. C) may actually contribute to, rather than moderate, managers’ short-term focus. D) has been widely cited as the main cause of the financial system meltdown that occurred in 2008.

91) Managers cater to Wall Street (i.e., try to meet earnings benchmarks) for which of the following reasons?

A) To build credibility with the capital market. B) To maintain or increase the firm’s stock price. C) To build the external reputation of management. D) All of these are reasons managers cite for meeting earnings benchmarks.

92) When faced with falling short of a desired earnings target, financial executives reportedly might consider any of the following actions except:

A) prematurely taking an accounting charge. B) providing incentives for customers to buy more product this quarter. C) decreasing discretionary spending. D) delaying the start of a new project.

93) Which of the following does not represent the impact of changes in EPS on the stock price?

A) Small differences in reported EPS to expected EPS will not affect the stock price. B) Penny differences in EPS matter a lot to investors. C) Management makes accounting choices to get to an EPS number rather than EPS being a random result around analyst’s expectations. D) It is better to be $.01 over EPS target than at or $.01 below the target.

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94) Which of the following is an accounting strategy most likely used by management to meet EPS guidance?

A) Postpone taking an accounting charge. B) Draw down accounting reserves. C) Delay R&D expense to the next quarter or year. D) Alter assumptions such as those relating to the allowance for doubtful accounts.

95) Consistent with IRS revenue code 162(m), companies were able to deduct nonperformance-based compensation for a single executive to the extent that it does not exceed $1 million. Under the new Tax Cuts and Jobs Act, this limit has been

A) increased to $5 million. B) increased to $10 million. C) decreased to $500,000. D) eliminated.

96) Consistent with the Tax Cut and Jobs Act, which companies are subject to restriction on the deductibility of non-performance compensation?

A) Only private companies B) Only public companies C) Companies with market capitalization in excess of $75 million D) All companies that sold registered securities in a public offering

97)

With respect to executive compensation, the Dodd-Frank Act requires that shareholders:

A) vote on executive compensation at least once every three years. B) vote on executive compensation every fiscal period. C) determine the annual executive compensation package for key executives. D) not discuss any aspects of executive compensation with-non shareholders.

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98)

The two basic incentive compensation plans are referred to as “plan within a plan” and:

A) top-down plan B) bottom-up plan C) plan outside plan D) limited plan

99) A company must disclose the median pay of employees and the CEO pay ratio consistent with the:

A) Dodd-Frank Act. B) Sarbanes-Oxley Act. C) SEC Act of 1933. D) SEC Act of 1934.

100) Consistent with Dodd-Frank legislation, the SEC requires disclosures related to the followings issue, which is not directly related to its core mission to protect investors:

A) conflict minerals B) agriculture land use C) recycling of waste D) carbon foot print

101) Consistent with Dodd-Frank legislation, the SEC requires disclosures related to the followings issue, which is not directly related to its core mission to protect investors:

A) water usage B) mine safety C) recycling of waste D) carbon disclosure

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 102) Explain the difference between affirmative and negative debt covenants and provide two examples of each.

103) Why do loan agreements often contain covenants tied to accounting numbers? Are there any disadvantages to this common practice?

104) On October 31, 20X1 Sterling Construction Company entered into a credit agreement with Comerica Bank. The following appeared among the agreement’s financial covenants: “Commencing with the fiscal quarter ending December 31, 20X1, maintain as of the end of each fiscal quarter a Fixed Charge Coverage Ratio of not less than 1.25 to 1.00.” The credit agreement also contained a “definitions” section where this item was listed: “ ‘Fixed Charge Coverage Ratio’ shall mean as of any date of determination a ratio the numerator of which is EBITDA for the Applicable Measuring Period, minus cash taxes and cash tax distributions with respect to such period and the denominator of which is the sum of Current Maturities of Long Term Debt plus interest paid during the trailing twelve month period, plus twenty-five percent (25%) of the daily average total non-amortizing debt during the trailing twelve month period.” Required:a. What is a minimum fixed charge coverage ratio and what purpose does it serve in the company’s loan agreements?b. Why is it necessary for the loan agreement to precisely define “Fixed Charge Coverage Ratio?”

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105) Sam Jones is the president of Apollo Finance, a payday lender. The company’s proxy statement contains the following description of Mr. Jones’ pay package.Mr. Jones is eligible for an annual incentive bonus equal to 1% of Net Income of the company and is eligible for an additional bonus based upon annual increases in EPS only after earnings exceed 15% over the prior year. The additional bonus is determined as follows: EPS Growth EPS increases up to 14.9% EPS increases of 15.0% to 24.9% EPS increases of 25.0% to 34.9% EPS increases above 35.0%

Additional Bonus $0 2% of the earnings increase from the prior year 3% of the earnings increase from the prior year 4% of the earnings increase from the prior year

Assume no change in the number of shares of outstanding stock during the year. Required: a. Suppose that Apollo Finance had $75 million of Net Income for the year. How much of a bonus would Mr. Jones receive if the EPS increase for the year was 12%?b. Suppose that Apollo Finance had $75 million of Net Income for the year. How much of a bonus would Mr. Jones receive if the EPS increase for the year was 28%?

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106) Duke Power & Light just spent $10 million to repair one of its electrical grid substations that was heavily damaged by a lightning strike. The loss was not insured. Required:Why would a utility ask the public service commission for approval to treat the $10 million as an asset for rate-making purposes rather than as an allowed expense?

107) Define the term “minimum capital requirements” and explain why banks and insurance companies are required by regulators to maintain such capital minimums.

108) Firms may meet earnings benchmarks via operational excellence or by taking real actions to maintain accounting appearances. Explain why the latter approach may be detrimental to a firm’s stockholders.

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Answer Key Test name: chapter 8 1) TRUE 2) TRUE 3) FALSE 4) FALSE 5) FALSE 6) TRUE 7) TRUE 8) FALSE 9) FALSE 10) TRUE 11) TRUE 12) FALSE 13) FALSE 14) TRUE 15) TRUE 16) TRUE 17) A 18) C 19) C 20) D 21) C 22) D 23) A 24) B 25) C 26) C Version 1

27) B 28) B 29) B 30) C 31) C 32) D 33) C 34) C 35) A 36) C 37) B 38) B 39) D 40) D 41) C 42) B 43) C 44) D 45) C 46) A 47) B 48) A 49) B 50) D 51) C 52) A 53) B 54) C 55) D 56) B Version 1

57) B 58) C 59) B 60) C 61) C 62) B 63) C 64) B 65) A 66) B 67) C 68) A 69) C 70) B 71) C 72) D 73) B 74) B 75) D 76) A 77) A 78) D 79) B 80) A 81) C 82) D 83) B 84) B 85) D 86) A Version 1

87) C 88) C 89) A 90) C 91) D 92) A 93) A 94) C 95) D 96) D 97) A 98) B 99) A 100) A 101) B 102) Affirmative covenants describe actions that the borrower must take while negative covenants describe actions that the borrower may be limited in, or restricted from, taking. Examples of affirmative covenants include: using the loan for the agreed-upon purpose (i.e., not substituting a more risky investment in place of the original investment the loan was sought for); having the company’s financial statements audited by an independent accounting firm; providing those statements to the lender on a timely basis, complying with all laws and regulations (e.g., environmental regulations); allowing the lender to inspect the borrower’s financial records or physical assets; and maintaining insurance on assets and key employees. Examples of negative covenants include: limits on total debt, capital expenditures, loans and advances to affiliated companies, cash dividends, share repurchases, mergers, and asset sales while the loan is outstanding.

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103) Accounting uses a set of generally accepted principles to measure a wide array of business activity. It is hard to conceive of some action that management might take that does not directly, or indirectly, affect accounting numbers. Thus, accounting numbers are a convenient way to monitor management’s actions or measure their success at running the company. Because the financial statements are audited by independent accounting firms, lenders can be assured that the reported numbers are relatively free from error and material misstatements. In addition, the borrower (company) must produce financial statements anyway, so there is no added out-of-pocket cost to using these same statements as a basis for loan agreements. There are, however, some disadvantages to using accounting numbers in loan covenants. Even though the financial statements are audited, management still has some discretion over the reported amounts and note disclosures. Opportunistic reporting can never be completely ruled out. Examples include voluntary accounting method changes and changes in accounting estimates. Another potentially negative factor to consider is that accounting-based loan covenants can be influenced by mandatory accounting changes imposed by the FASB or other regulatory group. Lenders may feel that such changes detract from the ability of accounting numbers to accurately portray changes in a borrower’s credit risk. Also, mandatory accounting changes may cause borrowers to be in technical violation of debt covenants even though there has been no real change in underlying default risk.

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104) a. The Fixed Charge Coverage Ratio is a ratio that indicates a firm's ability to satisfy fixed financing expenses or other fixed charges. Creditors desire such provisions in loan covenants because their interests are protected when the borrower maintains this ratio above some acceptable minimum level.b. A quick Google search for the term turned up the definitions below, neither of which is the same as the one appearing in the Sterling credit agreement or the TCBY example illustrated in the text. Thus, to avoid misunderstandings or violation of (intended) covenant terms, it is important to carefully define all ratios and other financial measures used in loan agreements that may be subject to interpretation, etc.The Fixed Charge Coverage Ratio is “the ratio of (Earnings before interest, depreciation and amortization minus unfunded capital expenditures and distributions) divided by total debt service (annual principal and interest payments). Notice that lease payments are sometimes included in the calculations.”The Fixed Charge Coverage Ratio is “the ratio of (net earnings before taxes plus interest charges paid plus long-term lease payments) to (interest charges paid plus long-term lease payments).”

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105) a. According to the bonus formula, Mr. Jones would receive a bonus of $750,000 if the company reports net income of $75 million and the EPS increase is 12 percent.Basic bonus = 1% of $75 million = $750,000Additional bonus = zerob. According to the bonus formula, Mr. Jones would receive a bonus of $1,242,188 if the company reports net after-tax earnings of $75 million and the EPS increase is 28 percent.Basic bonus = 1% of $75 million = $750,000Additional bonus = 3% of $16,406,250 = $492,188 Since the company has not issued or repurchased stock during the year, a 28% increase in EPS must also mean that net income increased 28%. In other words, $75 million = (1 + 0.28) × earnings last year. So, earnings last year must equal $75 million ÷ (1.28) or $58,593,750. The increase in net income would then be $16,406,250 = ($75 million − $58,593,750).

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106) After studying the effect of this request on the utility’s revenues (using the typical rate formula presented in the text and reproduced below) it should become apparent that this request may not be in the utility’s best interests. Whether it is or not depends in large part upon when, and how frequently, utility rates are revised.Allowed revenue = Operating costs + Depreciation + Taxes + (ROA × Asset base). If the repair is treated as an operating cost, Duke can recover the entire $10 million in the current year and again every year thereafter until the rates are revised. Thus, if rates are to be revised in the current year, but not again for a few years, Duke is better off to expense the repair. On the other hand, if the repair is expensed in the current year and rates are not revised until some year in the future, the $10 million will never be recovered from the utility’s customers. If the repair is added to the asset base, some of the amount of the repair will be reflected in increased depreciation charges and the asset base will be increased thus increasing the allowable return on assets. Both of these effects will raise revenue, and for a number of years in the future. However, the amount of this revenue increase will not be as great as the increase that occurs if the costs are expensed—although the increase may be more enduring, and time value of money needs to be considered as well due to the extended cost recovery period. 107) Minimum capital is defined by regulatory accounting principles and refers to the minimum required amount of investor capital the institution must maintain. Banks and insurance companies are required to maintain minimum levels of investor capital for two reasons. First, it provides a cushion to ensure that funds are available to pay depositors and beneficiaries. Second, investors who are also managers will make less risky business decisions when some of their own money is at risk.

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108) Many of the actions management can take to maintain accounting appearances result in a sacrifice of long-term firm value. For example, management may choose to decrease discretionary spending (e.g. R&D, advertising, or maintenance) to lower expenses in the current period. However, these decreases probably have long-term adverse effects. Lowered levels of R&D may result in fewer new products coming to market in future years. Reduced advertising erodes brand awareness and future sales. Deferred maintenance expenditures can lead to premature, and costly, equipment failures. Or take the case where management engages in channel stuffing. Sales that might normally occur in the future are shifted into the present, but at the cost of whatever incentives management provided to get the customers’ orders sooner rather than later.

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CHAPTER 9: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Under the sales revenue approach to estimating uncollectible accounts receivable, a loss percentage is applied to gross accounts receivable. ⊚ ⊚

true false

The direct write-off method is used only for tax reporting purposes. ⊚ ⊚

true false

3) In practice, estimated sales returns and allowances are seldom material in relation to accounts receivable. ⊚ ⊚

true false

4) A company’s independent auditor is required to perform very detailed and stringent procedures for accounts receivable. ⊚ ⊚

true false

5) An increase in receivables growth exceeding sales growth could indicate aggressive revenue recognition policies. ⊚ ⊚

true false

6) For long-term credit sales transactions utilizing notes receivable, interest income is recorded each period over the note’s term to maturity using the prevailing borrowing rate. ⊚ ⊚

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true false

7) Most companies establish credit policies by weighing the expected cost of credit sales against the benefit of increased interest income. ⊚ ⊚

true false

8) Interest must be imputed whenever the stated rate is higher than the prevailing borrowing rates at the time of the transaction. ⊚ ⊚

true false

9) Under U.S. GAAP, firms have the option to record accounts and notes receivable at fair value. ⊚ ⊚

true false

10) In a transaction where the transferor surrenders control over its receivables, the transaction is treated as a collateralized borrowing and any gain or loss is recognized in earnings. ⊚ ⊚

true false

11) A securitization entity is a trust or corporation that is legally distinct from the transferor and is created solely to execute securitization transactions. ⊚ ⊚

true false

12) Because the securitization entity's credit rating is based on the quality of the transferred receivables, it will generally be the same as the rating of the transferor’s general debt. ⊚ ⊚

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true false

13) A restructuring of debt constitutes a troubled debt restructuring if the creditor, for legal or economic reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would otherwise not consider. ⊚ ⊚

true false

14) Under IFRS, firms may elect the fair value option only in cases where it eliminates an accounting mismatch or when a group of assets is managed and evaluated using fair values. ⊚ ⊚

true false

15) Under IFRS, firms are required to report short-term receivables at fair value and to disclose their net realizable value in the notes to the financial statements. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) Net realizable value of receivables is gross receivables minus

A) provision for credit losses and sales returns. B) provision for credit losses and estimated returns and allowances. C) estimated provision for credit losses and estimated returns and allowances. D) proven credit losses and estimated returns and allowances.

17) If sales terms, customer creditworthiness, and accounting methods remain constant, the percentage change in sales and the percentage change in accounts receivable:

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A) should be about equal. B) should drift farther apart. C) will be zero. D) None of these answer choices are correct.

18)

The allowance for credit losses account is

A) added to gross accounts receivable. B) added to net accounts receivable. C) subtracted from gross accounts receivable. D) subtracted from net account receivable.

19) Edsel Inc. has the following unadjusted year end trial balance information available for 20X1:

Credit sales

$ 600,000

Ending accounts receivable balance

$ 180,000

Ending allowance for credit losses balance

1,500

Estimated uncollectibles

If Edsel uses the sales revenue approach for estimating the allowance for credit losses, the income statement should show an expense of

A) B) C) D)

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$10,000 $12,000 $14,000 $20,000

20) Edsel Inc. has the following unadjusted year end trial balance information available for 20X1:

Credit sales

$ 600,000

Ending accounts receivable balance

$ 180,000

Ending allowance for credit losses balance

1,500

Estimated uncollectibles

If Edsel uses the gross accounts receivable approach for estimating the allowance for credit losses, the income statement will show an expense of

A) B) C) D)

$2,100 $3,600 $5,100 $8,500

21) Edsel Inc. has the following unadjusted year end trial balance information available for 20X1:

Credit sales

$ 600,000

Ending accounts receivable balance

$ 180,000

Ending allowance for credit losses balance

1,500

Estimated uncollectibles

If Edsel uses the sales revenue approach for estimating the allowance for credit losses, the allowance for credit losses, after the proper adjustments to the accounts are recorded, should show a balance of Version 1

A) B) C) D)

$11,500 $13,500 $15,500 $21,500

22) Edsel Inc. has the following unadjusted year end trial balance information available for 20X1:

Credit sales

$ 600,000

Ending accounts receivable balance

$ 180,000

Ending allowance for credit losses balance

1,500

Estimated uncollectibles

If Edsel uses the gross accounts receivable approach for estimating the allowance for credit losses, the allowance for credit losses account, after the proper adjustments to the accounts are recorded, should show a balance of

A) B) C) D)

23)

$2,600 $3,600 $5,600 $6,200

When a specific account receivable is written off, the entry

A) increases net income. B) decreases net income. C) can either decrease or increase net income. D) has no effect on net income.

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24) Management must periodically assess the reasonableness of the allowance for credit losses if it uses the

A) direct write-off method. B) percent of sales method only. C) percent of gross receivables method only. D) percent of sales or the percent of gross receivables method.

25) Echo Company’s 20X1 beginning and ending accounts receivable balances were $72,500 and $41,250 respectively. During 20X1, the company’s credit sales amounted to $857,250. Per Echo’s 20X1 cash flow statement, $873,500 was collected from customers while $18,750 related to uncollectible accounts was listed among the “non-cash expenses.” If Echo’s beginning balance in the allowance for credit losses was $17,600, the ending balance in this account must be

A) $15,000 B) $21,350 C) $36,350 D) The required “allowance for credit losses” balance cannot be determined from the data given.

26)

The allowance for credit losses account is classified as

A) a contra-asset account. B) a contra-revenue account. C) a contra-expense account. D) a contra-equity account.

27) Smith Company is a manufacturer of medical devices and has an excellent quality control department, thus defective product returns are rare. In 20X1, Smith reported sales of $276,344,000. The company did, however, have two returns in 20X1 related to the wrong product model being shipped. Smith’s 20X1 journal entry to record a $37,500 return from a customer (Foxtrot Medical) would be:

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A) DR Sales returns and allowances $37,500 CR Accounts receivable—Foxtrot Medical $37,500 B) DR Sales returns and allowances $37,500 CR Sales $37,500 C) DR Sales $37,500 CR Accounts receivable—Foxtrot Medical $37,500 D) DR Sales returns expense $37,500 CR Accounts receivable—Foxtrot Medical $37,500

28) An analyst notes that ABC Inc.’s allowance for credit losses as a percentage of year-end accounts receivable has changed. Which of the following would not be a plausible explanation for the change?

A) ABC’s management expects a default rate on outstanding receivables different than prior years. B) ABC’s management is using the allowance for credit losses to “manage” earnings. C) The company ages its receivables and the distribution of accounts receivable over the various age categories is different than prior years. D) The company has stopped making sales on credit.

29)

Research evidence suggests that

A) companies increase their allowance for credit losses when earnings are otherwise low and then decrease the provision when earnings are high. B) companies reduce their allowance for credit losses when earnings are otherwise low and then increase the provision when earnings are high. C) companies reduce their allowance for credit losses when earnings are otherwise high and then increase the provision when earnings are low. D) companies increase their allowance for credit losses when earnings are otherwise high and then decrease the provision when earnings are low.

30) XYZ Co.’s 20X2 ratio of allowance for credit losses to gross receivables has declined from the ratio at the end of 20X1. To help evaluate whether the reduction in XYZ’s ratio is reasonable, an analyst should do all of the following except:

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A) compare the ratio to other firms in XYZ’s industry. B) look for additional discussion in XYZ’s annual report. C) contact the SEC for more information. D) listen to the company’s earnings briefing for the analysts.

31) Which one of the following explanations for the growth of accounts receivable outstripping the growth of sales represents a red flag?

A) The firm adopts new credit terms that lengthen the payment terms to the industry average. B) The firm adopts an aggressive revenue recognition policy. C) The firm develops an attractive credit policy for first time buyers. D) The firm changes its timing of revenue recognition to a more conservative approach.

32)

Which one of the following is an example of an aggressive revenue recognition policy?

A) A firm recognizes revenue at time of collection. B) A firm recognizes revenue at the expiration of the sales returns period. C) A firm with a liberal sales return policy recognizes revenue at shipment. D) A firm with a liberal sales return policy recognizes revenue at shipment with a corresponding allowance for returns and allowances.

33) When a note receivable has a stated interest rate that is lower than the prevailing rate for similar loans, it is recorded at:

A) present value based on the stated interest rate. B) present value based on the prevailing rate of interest. C) maturity value. D) net realizable value.

34)

Non-interest bearing notes are initially recorded at

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A) historical cost. B) maturity value because they bear no interest. C) present value, based on the prevailing interest for loans of this type. D) future value, based on the prevailing interest for loans of this type.

35) The Palmer Corporation sells goods to its customers on a note basis with 10% credit terms and interest payable at the end of each quarter. All notes are due in one year. Palmer makes the following sales on July 1, 20X1: Customer J.Perez

Note Maturity Interest Due Interest Rate $ 100,000 Quarterly 10%

P.Berg

$ 100,000

—

Negotiated

To encourage sales, Berg was given a special deal on interest. Additional information:Future value of $100,000 in one year (quarterly interest) is $110,381.Present value of $100,000 for one year (quarterly interest) is $90,595.What amount will Palmer use to record the sale to Perez?

A) B) C) D)

$90,000 $90,595 $100,000 $110,381

36) The Palmer Corporation sells goods to its customers on a note basis with 10% credit terms and interest payable at the end of each quarter. All notes are due in one year. Palmer makes the following sales on July 1, 20X1: Customer J.Perez P.Berg

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Note Maturity Interest Due Interest Rate $ 100,000 Quarterly 10% $ 100,000

—

Negotiated

A) B) C) D)

$90,000 $90,595 $100,000 $110,382

37) The Palmer Corporation sells goods to its customers on a note basis with 10% credit terms and interest payable at the end of each quarter. All notes are due in one year. Palmer makes the following sales on July 1, 20X1: Customer J.Perez P.Berg

Note Maturity Interest Due Interest Rate $ 100,000 Quarterly 10% $ 100,000

—

Negotiated

To encourage sales, Berg was given a special deal on interest. Additional information:Future value of $100,000 in one year (quarterly interest) is $110,381.Present value of $100,000 for one year (quarterly interest) is $90,595.At the end of the first quarter, which of the following entries will be made to record the interest earned by Palmer on the Perez note?

A) DR Cash $2,500 CR Interest income $2,500 B) DR Accrued interest receivable $2,500 CR Interest income $2,500 C) DR Notes receivable—Perez $2,265 CR Interest income $2,265 D) DR Cash $2,265 CR Accrued interest receivable $2,265

38) The Palmer Corporation sells goods to its customers on a note basis with 10% credit terms and interest payable at the end of each quarter. All notes are due in one year. Palmer makes the following sales on July 1, 20X1: Customer J.Perez

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Note Maturity Interest Due Interest Rate $ 100,000 Quarterly 10%

P.Berg

$ 100,000

—

Negotiated

To encourage sales, Berg was given a special deal on interest. Additional information:Future value of $100,000 in one year (quarterly interest) is $110,381.Present value of $100,000 for one year (quarterly interest) is $90,595.At the end of the first quarter, which one of the following entries will be made to record the interest earned by Palmer on the Berg note?

A) DR Cash $2,500 CR Interest income $2,500 B) DR Accrued interest receivable $2,500 CR Interest income $2,500 C) DR Notes receivable—Berg $2,265 CR Interest income $2,265 D) There is no entry because the note is non—interest bearing.

39) On January 2, 20X1, Jensen Corporation sells equipment it manufactured to Lewisburg Fabricators in exchange for an $80,000 note due in five years. The note bears no stated interest rate, but requires the entire $80,000 to be repaid at the end of five years. Jensen recently sold the same equipment to another company for $54,447. When Lewisburg Fabricators sought bank financing for this purchase the company was offered the funds at 8%, but decided to let Jensen hold the note.What amount will Jensen recognize as interest income during 20X1?

A) B) C) D)

$4,356 $4,704 $5,111 $0

40) On January 2, 20X1, Jensen Corporation sells equipment it manufactured to Lewisburg Fabricators in exchange for an $80,000 note due in five years. The note bears no stated interest rate, but requires the entire $80,000 to be repaid at the end of five years. Jensen recently sold the same equipment to another company for $54,447. When Lewisburg Fabricators sought bank financing for this purchase the company was offered the funds at 8%, but decided to let Jensen hold the note.What amount will Jensen recognize as interest income during 20X2?

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A) B) C) D)

$4,356 $4,704 $5,111 $0

41) On January 2, 20X1, Jensen Corporation sells equipment it manufactured to Lewisburg Fabricators in exchange for an $80,000 note due in five years. The note bears no stated interest rate, but requires the entire $80,000 to be repaid at the end of five years. Jensen recently sold the same equipment to another company for $54,447. When Lewisburg Fabricators sought bank financing for this purchase the company was offered the funds at 8%, but decided to let Jensen hold the note. What will be the balance in the Notes Receivable—Lewisburg Fabricators account at the end of 20X2?

A) B) C) D)

42)

$54,447 $58,802 $63,507 $80,000

Accounting for long-term credit sales transactions utilizing notes receivable

A) ignores interest unless an interest rate is specified in the note. B) makes it difficult to assess the degree to which a company’s overall earnings are due to profitable credit sales versus profitable customer financing. C) achieves a clear separation between income from credit sales and interest earned. D) is controversial because it necessitates use of an assumed interest rate.

43) Guthrie Corporation reports accounts receivable at a net realizable value of $2,940,000 (gross receivable of $3,000,000 minus allowance for credit losses accounts of $60,000). Assume that there is an active market for these types of receivables and that the price is 94% of face value. To adjust the receivable’s carrying value to fair value, Guthrie would make which of the following entries?

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A) DR Realized loss on receivables $180,000 CR Accounts receivable $180,000 B) DR Unrealized loss on receivables $120,000 CR Fair value adjustment--accounts receivable $120,000 C) DR Unrealized loss on receivables $180,000 CR Fair value adjustment--accounts receivable $180,000 D) DR Realized loss on receivables $120,000 CR Accounts receivable $120,000

44)

The Fair value adjustment—accounts receivable account is an asset valuation account

A) that would be adjusted upward or downward as fair values change and as the receivables are collected. B) that is created when fair value accounting is adopted but is not subsequently adjusted. C) that can only be adjusted downward. D) that is unaffected by the subsequent collection of receivables.

45)

When a firm does not adopt the fair value option, it

A) need not disclose the fair value of its long-term notes receivable or accounts receivable B) still must disclose the fair value of its long-term notes receivable but need not disclose the accounts receivable fair value if the fair values approximates the reported value C) must disclose the fair value of its long-term notes receivable only if the reported value exceeds fair value D) must disclose both the fair value of both notes and accounts receivable under all circumstances

46)

The sale of receivables to a third party is called:

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A) factoring. B) collateralizing. C) discounting. D) securitization.

47)

With a loan collateralized by receivables,

A) the bank makes the loan without recourse. B) the bank has recourse against the accounts receivable customers. C) a company receives cash and is not responsible for repaying the loan. D) a company receives cash and is responsible for repaying the loan.

48) Frank Ritter, Inc. enters into an arrangement with Hisker Enterprises whereby Hisker will assume $100,000 of Ritter’s receivables for a 6% fee. These receivables have a related allowance for credit losses of $3,500.Assuming the transaction was a factoring arrangement without recourse, which one of the following entries will Ritter make?

A) DR Cash $100,000 CR Accounts receivable $100,000 B) DR Cash $94,000 DR Loss on sale of receivables 6,000 CR Accounts receivable $100,000 C) DR Cash $94,000 DR Allowance for credit losses 3,500 DR Loss on sale of receivables 2,500 CR Accounts receivable $100,000 D) DR Cash $94,000 DR Loss on sale of receivables 6,000 CR Due to Hisker Enterprises $100,000

49) Frank Ritter, Inc. enters into an arrangement with Hisker Enterprises whereby Hisker will assume $100,000 of Ritter’s receivables for a 6% fee. These receivables have a related allowance for credit losses of $3,500.Assume that the transaction was a factoring arrangement with recourse and included a holdback of $6,000. If the fair value of the recourse obligation is equal to the allowance of $3,500, which one of the following entries will Ritter make to record this transaction?

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A) DR Cash $100,000 DR Allowance for credit losses 3,500 CR Accounts receivable $100,000 CR Recourse obligation 3,500 B) DR Cash $88,000 DR Loss on sale of receivables 6,000 DR Allowance for credit losses 3,500 DR Due from Hisker Enterprises 6,000 CR Accounts receivable $100,000 CR Recourse obligation 3,500 C) DR Cash $88,000 DR Loss on sale of receivables 12,000 CR Accounts receivable $100,000 D) DR Cash $88,000 DR Loss on sale of receivables 12,000 CR Due to Hisker Enterprises $100,000

50) Frank Ritter, Inc. enters into an arrangement with Hisker Enterprises whereby Hisker will assume $100,000 of Ritter’s receivables for a 6% fee. These receivables have a related allowance for credit losses of $3,500.Assuming the transaction was a collateralized loan, which one of the following entries will Ritter make to record this transaction?

A) DR Cash $94,000 DR Prepaid interest 6,000 CR Accounts receivable $100,000 B) DR Cash $94,000 DR Interest expense 6,000 CR Loan Payable—Hisker Enterprises $100,000 C) DR Cash $94,000 DR Prepaid interest 6,000 CR Loan Payable—Hisker Enterprises $100,000 D) DR Cash $94,000 CR Loan Payable—Hisker $94,000

51) Harry Jones accepted a six-month, 8%, $40,000 note receivable from a customer on July 1, 20X1. Jones has an arrangement with the National Bank to discount selected customer notes at 10% without recourse. On August 1, 20X1, Jones discounted the note under the arrangement with National Bank. What was the amount of proceeds Jones received from the discounted note?

A) B) C) D)

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$38,267 $39,867 $40,000 $41,600

52) Harry Jones accepted a six-month, 8%, $40,000 note receivable from a customer on July 1, 20X1. Jones has an arrangement with the National Bank to discount selected customer notes at 10% without recourse. If the note were discounted on August 1 under the terms of agreement with National Bank, which one of the following journal entries would Jones record?

A) DR Cash $39,867 CR Note payable—National Bank $39,867 B) DR Cash $40,000 CR Note receivable $40,000 C) DR Cash $39,867 DR Interest expense 123 CR Note receivable $40,000 D) DR Cash $39,867 DR Loss on sale of note receivable 123 CR Note payable— National Bank $40,000

53) If a note receivable from a customer is discounted at a bank with recourse and the customer defaults on final payment, the seller:

A) has no obligation to the bank. B) must repay the full amount of the note plus interest to the bank. C) must refund the proceeds of the discounting to the bank. D) must repay the principal only to the bank.

54) Per authoritative accounting literature, the determination of whether a transfer of receivables is a sale or collateralized borrowing hinges on whether the:

A) transfer was with or without recourse. B) transferor collects payments directly from the customer. C) transferor surrenders control over the receivable. D) customer ultimately defaults.

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55) Jones Co. sells on credit and maintains an allowance for credit losses equal to 2% of the company’s total $3,450,000 receivables balance as an estimate of accounts eventually becoming actually uncollectible. Due to a cash shortfall, Jones sells $275,000 of its receivables with recourse to Ninth National Bank and the bank withholds $12,000 from the factoring proceeds to cover possible noncollections. At the time of discounting, the $12,000 was agreed upon as a reasonable estimate and there was no recourse obligation recorded. If the noncollections eventually amount to $15,000, the entry on Jones’ books when notified of this fact would be:

A) DR Allowance for credit losses $3,000 CR Accounts receivable (specific customers) $3,000 B) DR Allowance for credit losses $15,000 CR Accounts receivable (specific customers) $15,000 C) DR Credit loss expense $3,000 CR Cash $3,000 D) DR Allowance for credit losses $15,000 CR Due from Ninth National Bank $12,000 CR Cash 3,000

56) Ambiguity can arise as to whether receivables have been sold or instead are being used as collateral for a loan whenever certain obligations, duties, or rights regarding the transferred receivables are retained by the transferor. In distinguishing between sales and collateralized borrowings using receivables, the critical issue:

A) is whether the terms regarding the transfer were initiated by the transferor or transferee. B) is whether the transferor surrenders control over the receivables. C) comes down to how clearly the rights, etc. being retained are specified in the transfer agreement. D) is whether any gain or loss related to the transfer is recognized in earnings.

57)

If a transfer of receivables is actually a borrowing but is erroneously treated as a sale,

A) both assets and liabilities are understated. B) both assets and liabilities are overstated. C) both assets and equity are understated. D) ratios like debt-to-equity are consequently distorted by the overstatements.

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58) Regan, Inc. implemented a program to improve the collection of its receivables. Over the past two years, the company has collected 88% of its receivables, up from 80%. A review of the company’s financial statements would be expected to show:

A) a reduction in the percentage of the allowance for credit losses to receivables. B) an increase in the percentage of the allowance for credit losses to receivables. C) no difference in the percentage of the allowance for credit losses to receivables. D) None of these answer choices are correct.

59) When receivables are bundled and transferred to another organization that issues securities collateralized by the transferred receivables, the arrangement is defined as:

A) collateralization. B) discounting. C) factoring. D) securitization.

60)

Which of the following is not a reason a company might accelerate cash collections?

A) The company may have an immediate need for cash but be short of it. B) Current GAAP allows "off-balance sheet" treatment of factored receivables and collateralized borrowings, thus enabling management to "window dress" the company’s financial position. C) There may be an imbalance between the credit terms of the company’s suppliers and the time required to collect customer receivables. D) Competitive conditions require credit sales, but the company is unwilling to bear the cost of processing and collecting receivables.

61) If a bank sells a mortgage portfolio at a price that yields the purchasers a return that is lower than the average yield on the mortgages in the portfolio, the selling price:

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A) is equal to the carrying value of the mortgages on the bank’s books. B) is lower than the carrying value of the mortgages on the bank’s books. C) is higher than the carrying value of the mortgages on the bank’s books. D) cannot be determined by examining the carrying value of the mortgages on the bank’s books because the selling price is determined purely by the market.

62) Under current U.S. GAAP, the transferor of receivables to a securitization entity (SE) that it has formed should treat the transfer as a collateralized borrowing instead of a sale if the transferor has:

A) the power to direct the activities of the SE and the right to participate in the SE’s gains and losses. B) the power to direct the activities of the SE but not the right to participate in the SE’s gains and losses. C) limited control over the sale of the securities. D) None of these answer choices are correct.

63) Corona Industries purchased a stamping machine on January 2, 20X1, for $100,000. It made an initial payment of $20,000 and financed the balance over 5 years at State Bank. The loan terms were for annual payments of $16,000 plus 10% interest, payable on December 31 each year. The year 20X4 proves to be a difficult year and on December 1, 20X4 Corona negotiates a debt restructuring with State Bank. The settlement calls for cash payment of accrued interest plus $4,000 on December 1 and the transfer of 200 acres of land held by Corona that cost $15,000. The land has a current fair value of $22,000.On December 1, 20X4, how much interest is accrued on this loan?

A) B) C) D)

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$2,933 $3,200 $6,933 $18,933

64) Corona Industries purchased a stamping machine on January 2, 20X1, for $100,000. It made an initial payment of $20,000 and financed the balance over 5 years at State Bank. The loan terms were for annual payments of $16,000 plus 10% interest, payable on December 31 each year. The year 20X4 proves to be a difficult year and on December 1, 20X4 Corona negotiates a debt restructuring with State Bank. The settlement calls for cash payment of accrued interest plus $4,000 on December 1 and the transfer of 200 acres of land held by Corona that cost $15,000. The land has a current fair value of $22,000.Which one of the following entries will Corona make to adjust for the land just prior to transfer?

A) DR Land $7,000 CR Note payable—State Bank $7,000 B) DR Loss on disposal of asset $7,000 CR Land $7,000 C) DR Land $7,000 CR Gain on disposal of asset $7,000 D) DR Note payable—State Bank $7,000 CR Gain on disposal of asset $7,000

65) Corona Industries purchased a stamping machine on January 2, 20X1, for $100,000. It made an initial payment of $20,000 and financed the balance over 5 years at State Bank. The loan terms were for annual payments of $16,000 plus 10% interest, payable on December 31 each year. The year 20X4 proves to be a difficult year and on December 1, 20X4 Corona negotiates a debt restructuring with State Bank. The settlement calls for cash payment of accrued interest plus $4,000 on December 1 and the transfer of 200 acres of land held by Corona that cost $15,000. The land has a current fair value of $22,000.What is the amount of the restructuring gain or loss to Corona?

A) B) C) D)

$6,000 loss $6,000 gain $8,933 loss $13,000 gain

66) Corona Industries purchased a stamping machine on January 2, 20X1, for $100,000. It made an initial payment of $20,000 and financed the balance over 5 years at State Bank. The loan terms were for annual payments of $16,000 plus 10% interest, payable on December 31 each year. The year 20X4 proves to be a difficult year and on December 1, 20X4 Corona negotiates a debt restructuring with State Bank. The settlement calls for cash payment of accrued interest plus $4,000 on December 1 and the transfer of 200 acres of land held by Corona that cost $15,000. The land has a current fair value of $22,000.What is the amount of the receivable restructuring gain or loss to State Bank? Version 1

A) B) C) D)

$6,000 loss $6,000 gain $13,000 loss $8,933 gain

67) The determining factor for accounting treatment of a troubled debt restructuring when there is a continuation with modification of terms is whether:

A) there is a gain or loss on the transaction to the debtor. B) there is a gain or loss on the transaction to the lender. C) the undiscounted sum of the future cash flows under the restructured note is above or below the note’s carrying value (including accrued interest) at the restructuring date. D) the discounted sum of the future cash flows under the restructured note is above or below the note’s carrying value (including accrued interest) at the restructuring date.

68) When the sum of the future cash flows of a restructured note is above the current note’s carrying value, the debtor recognizes:

A) a gain on the debt restructure. B) a loss on the debt restructure. C) neither a gain nor a loss on the debt restructure. D) both a restructure gain and an early extinguishment loss.

69) Island Corporation owes Mutual Bank a 10% note payable for $100,000 plus $8,000 accrued interest. On October 1, 20X1. Island and Mutual Bank execute an agreement whereby Island will pay Mutual $128,000 on the due date of the note on October 1, 20X3.Island will record this transaction to recognize:

A) a debt restructuring gain of $20,000. B) a debt restructuring loss of $20,000. C) a debt restructuring gain of $8,000. D) neither a gain nor a loss from debt restructuring.

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70) Island Corporation owes Mutual Bank a 10% note payable for $100,000 plus $8,000 accrued interest. On October 1, 20X1. Island and Mutual Bank execute an agreement whereby Island will pay Mutual $128,000 on the due date of the note on October 1, 20X3.What will be Island’s carrying value of the restructured note?

A) B) C) D)

$100,000 $108,000 $118,000 $128,000

71) Island Corporation owes Mutual Bank a 10% note payable for $100,000 plus $8,000 accrued interest. On October 1, 20X1. Island and Mutual Bank execute an agreement whereby Island will pay Mutual $128,000 on the due date of the note on October 1, 20X3.What effective interest rate will Island use for the restructured note?

A) B) C) D)

8.7% 8.9% 10.0% 13.1%

72) Island Corporation owes Mutual Bank a 10% note payable for $100,000 plus $8,000 accrued interest. On October 1, 20X1. Island and Mutual Bank execute an agreement whereby Island will pay Mutual $128,000 on the due date of the note on October 1, 20X3.If the present value interest factor for two years at 10% is 0.82645, what will be the new note receivable balance for Mutual Bank?

A) B) C) D)

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$89,256 $105,786 $108,000 $128,000

73) Island Corporation owes Mutual Bank a 10% note payable for $100,000 plus $8,000 accrued interest. On October 1, 20X1. Island and Mutual Bank execute an agreement whereby Island will pay Mutual $128,000 on the due date of the note on October 1, 20X3.Mutual Bank will record this transaction to recognize:

A) a receivable restructuring gain of $2,214. B) a debt restructuring loss of $8,000. C) neither a gain nor a lost from debt restructuring. D) a debt restructuring loss of $2,214.

74) Island Corporation owes Mutual Bank a 10% note payable for $100,000 plus $8,000 accrued interest. On October 1, 20X1. Island and Mutual Bank execute an agreement whereby Island will pay Mutual $128,000 on the due date of the note on October 1, 20X3.What effective interest rate will Mutual Bank use for the restructured note?

A) B) C) D)

8.7% 8.9% 10.0% 13.1%

75) In a troubled debt restructuring, the restructured loan can differ from the original loan in any of the ways listed below except:

A) Scheduled interest and principal payments may be reduced or eliminated. B) The repayment schedule may be extended over a longer time period. C) The repayment schedule is shortened and the interest rate is significantly increased. D) The customer and lender can settle the loan.

76) When troubled debt is restructured via continuation with modification of debt terms, the original loan is:

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A) continued but interest and principal payments may be reduced or eliminated. B) continued but the repayment schedule may be extended over a longer time period. C) continued but the amount of collateral securing the loan is increased. D) cancelled and a new loan agreement is signed.

77)

Under IFRS, the general accounting for accounts and notes receivable:

A) presumes off-balance sheet treatment when these assets are sold. B) has yet to be determined by the IASB. C) is different than U.S. GAAP in that IFRS does not allow the fair value option. D) is similar to the accounting under U.S. GAAP.

78)

Which of the following is false regarding uncollectible accounts?

A) Most companies establish credit policies by weighing the expected cost of credit sales against the expected benefit of increased sales. B) Accrual accounting requires that some estimate of uncollectible receivables be offset against current period sales. C) Companies are generally not able to adopt stringent credit standards to keep credit losses at a minimum. D) To manage credit losses, companies often choose a profit-maximizing balance which makes uncollectible accounts unavoidable.

79)

Which of the following statements is true regarding a troubled debt restructuring?

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A) In a troubled debt restructuring, there is a lack of symmetry in the financialreporting of the borrower and lender. B) A troubled debt restructuring can only be accomplished through a continuation with modification of debt terms including cancelation of the original loan and execution of a new loan agreement. C) In a troubled debt restructuring, GAAP restructuring gains and losses for accounting are equal to real economic gains and losses for the companies involved. D) All accounting aspects of a troubled debt restructuring are explicitly covered by IFRS.

80) Regarding accounts receivable and an allowance for credit losses account, which of the following statements is false?

A) Net realizable value equals the sales price of an item less reasonable further costs to both make the item ready to sell and to sell it. B) An aging of accounts receivable is a determination of how long each receivable has been on the books. C) The net realizable value of accounts receivable is decreased when a credit loss is written off. D) Receivables that result from transactions other than trade receivables, if material, are to be separately disclosed on the balance sheet.

81)

Which of the following statements is true regarding sales returns and allowances?

A) Ignoring estimated future returns and allowances has a minimal impact on reported earnings when the amount of actual returns and allowances is not material and does not vary greatly from year-to-year. B) The sales returns and allowances account is a contra-asset account. C) When sales returns occur, they should be debited to the sales account. D) Estimated sales returns and allowances are often material in relation to accounts receivable.

82)

Which of the following statements is false regarding accounts receivable reporting?

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A) Growth in accounts receivable could exceed sales growth because a firm allows its customers more time to pay. B) Many irregularities in receivables recognition can be discovered by tracking the relationship between changes in sales and changes in receivables. C) When a company adopts an aggressive revenue recognition policy, it can lead to significant journal entries of sales returns in later periods. D) When a firm’s sales growth exceeds its growth in receivables, it could be an indication of aggressive revenue recognition policies.

83)

Which of the following statements is false regarding interest on receivables?

A) Interest must be imputed when the stated rate is lower the prevailing borrowing rate at the time of the transaction. B) Interest must be accounted for on all long-term notes receivable whether the interest rate is stated or not. C) Interest must be imputed when the stated rate is higher than the prevailing borrowing rate at the time of the transaction. D) For long-term credit sales transactions using notes receivable, interest income should be recorded over the term of the note using the prevailing borrowing rate at the time of the transaction.

84)

Which of the following statements is true regarding the fair value option?

A) If a company does not elect the fair value option, it still must disclose the fair value of all its notes receivable. B) A firm may choose the fair value option for either a single financial instrument or a group of financial instruments. C) If a company does not elect the fair value option, it still must disclose the fair value of all its accounts receivable. D) Under U.S. GAAP, the only option a firm has is to value notes and accounts receivable is net realizable value.

85)

Which of the following statements is false regarding factoring receivables?

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A) When a company factors its receivables with recourse, it cannot be required to make a payment to the factor if a customer’s account proves to be uncollectible. B) When a company accepts credit cards, it is engaging in a form of factoring. C) Factoring can be done either with or without recourse. D) When a company sells its accounts receivable to a factor with recourse, a recourse obligation that is recorded would be a credit entry on its books.

86)

Accounts receivables initially are recognized at

A) the present value of the related future cash flows. B) amortized cost. C) net realizable value. D) the future value.

87) Prior to 2020 and consistent with the “incurred loss model,” public companies recognized credit losses, when they were

A) realized. B) probable. C) certain. D) confirmed by a third party.

88)

Consistent with ASC topic 326, expected credit losses are recognized as

A) a reduction of the related revenue. B) an addition to cost of goods sold. C) an aggregated expense. D) a separately reported loss.

89) Bloom Inc. estimates credit losses of $25,000 and $32,500, associated with accounts receivables and notes receivables, respectively. The two credit losses should be reported

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A) separately by category. B) in aggregate for both categories. C) when the specific creditors refuse to pay. D) as off-sets to the related revenue.

90) Mannheim Company assesses the net realizable value of accounts receivable using an aging method. Consistent with ASC Topic 326, Mannheim should base its aging of accounts receivables percentages on

A) historical credit losses. B) forecasted credit losses. C) realized credit losses. D) industry-specific historical credit losses.

91) Information about credit quality, amortization cost by credit quality indicator for the prior five years and in the aggregate, and the methodology for estimating credit losses must be disclosed for

A) all receivables reported at amortized cost B) only receivables expected to be collected within one year C) only receivables expected to be collected over a period exceeding one year D) only interest-bearing notes

92)

Which of the following must be disclosed for all categories of receivables?

A) Future expected receivables B) Financing options available for major customers C) Use of notes receivables to attract new clients D) Changes in risk factors, policies, or methodologies

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93) Donau Inc. performs services with a normal contract price of $265,000 for a new customer. The customer signs a non-interest bearing note of $300,000. The differences between the normal contract price and the face amount of the note is considered

A) a sales discount. B) a credit allowance. C) imputed interest. D) additional service revenue.

94) Consistent with IFRS No. 7, the fair value must be disclosed for receivables and loans with the following characteristics:

A) short-term maturity B) long-term maturity C) recognized at amortized cost D) All of these choices are correct

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 95) For the month of December 20X1, the records of Seal Corporation show the following information:

Cash received on accounts receivable

$ 57,000

Cash sales

47,000

Accounts receivable, December 1, 20X1

70,000

Accounts receivable, December 31, 20X1

65,000

Accounts receivable written off as uncollectible

2,500

Sales returns & allowances

1,850

Required: Determine the net sales for the month of December 20X1.

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96)

The following information relates to Kay Company’s accounts receivable for 20X1.

Accounts receivable 1/1/X1 Credit sales for 20X1

425,000 3,265,000

Sales returns during 20X1

29,000

Accounts written off during 20X1

18,500

Collections from customers during 20X1

3,348,000

Estimated future sales returns at 12/31/X1

40,000

Estimated uncollectible accounts at 12/31/X1

90,000

Required:a. Determine the amount should Kay report as gross accounts receivable at December 31, 20X1.b. Determine the amount should Kay report as net accounts receivable at December 31, 20X1.

97) Foal Company’s had the following account balances at December 31, 20X1, with regard to accounts receivable:

Accounts receivable (net)

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2,000,000

Allowance for credit losses

250,000

Required:Foal has elected to report its receivables using the fair value option. At December 31, 20X1, the pricing in the active market for receivables is 90% of face value. Prepare the adjustment required at December 31, 20X1.

98) On December 31, 20X1, Zale Company had an unadjusted debit balance of $1,000 in its allowance for credit losses accounts. An analysis of Zale’s trade accounts receivable at that date revealed the following: Age

Amount

% Estimated Uncollectible

0-30 days

$ 125,000

31-60 days

34,000

61-90 days

8,500

20 %

Over 90 days

4,700

50 %

Required:a. Determine the amount Zale should report as allowance for credit losses accounts in its December 31, 20X1 balance sheet.b. Prepare any necessary adjusting entry at December 31, 20X1 related to this analysis.

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99) On December 31, 20X2, the close of its third year of operations, the Runner Company had receivables of $350,000, which were net of the related allowance for credit losses. During 20X2, the company had additions to allowance for credit losses of $50,000 and wrote off, as uncollectible, accounts receivable of $22,000. Runner had a balance in its allowance for credit losses accounts at December 31, 20X1 of $8,100.Required:Determine the amount that Runner should report on its balance sheet at December 31, 20X1,as accounts receivable, before the allowance for credit losses accounts.

100)

The following information is available for the Bench Company:

Credit sales during 20X2

$ 463,500

Allowance for credit losses at December 31, 20X1

3,800

Accounts receivable written off during 20X2

6,400

During 20X2, Bench estimated that its allowance for credit losses should be 1% of all credit sales and made the appropriate monthly adjusting entries. As a result of a review and aging of accounts receivable in early January 20X3, it has been determined that an allowance for credit losses accounts of $3,200 is needed at December 31, 20X3.Required:Prepare the journal entry that Bench should make after the aging is completed.

101) Playworld, Inc. sells playground equipment to schools and municipalities. Invoices are mailed at the end of each month for all goods shipped during that month; credit terms are net 30 days. Sales and accounts receivable data for 20X1, 20X2, and 20X3 were as follows:

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20X1

20X2

20X3

Sales

$ 2,560,975

$ 2,663,414

$ 2,903,121

Year-end receivables

328,330

342,120

396,859

Required: a. Calculate the growth rates in sales and receivables during 20X2 and 20X3.b. Do your calculations indicate any potential problems with Playworld’s receivables? If so, suggest a possible explanation for your findings.

102) The Pond Company sold some machinery for $500,000 to the Vista Company on January 1, 20X1. Vista executed an installment sales contract with Pond at an interest rate of 10%. The contract required payments of $114,804 annually over six years, with the first payment due on December 31, 20X1.Required:Prepare an amortization schedule for the first two scheduled payments that shows (a) what portion of each payment will be included in interest income, and (b) the loan balance after each payment is made.

103) On December 31, 20X1, Benton Company sold equipment to Cleveland, Inc., accepting a $400,000 non-interest bearing note receivable in exchange for the equipment. The note is due on December 31, 20X4. Cleveland, Inc. normally pays 10% for its borrowed funds. The equipment is carried in Benton’s perpetual inventory records at 50% of its cash selling price. The present value of $1 to be received n periods in the future = 1 ÷ (1 + r) n where r is the rate of interest per period.Required:a. Prepare Benton’s journal entries to record the sale on December 31, 20X1.b. Prepare Benton’s journal entry on December 31, 20X2 necessitated by this transaction.c. Determine the carrying value of this note on Benton’s December 31, 20X2 balance sheet.

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104) In January of 20X1, Perez Company sold equipment to Gomez in exchange for a note that called for three equal annual principal payments of $100,000 plus annual interest payments of $4,000. Because the market rate of interest for companies with Gomez’ credit standing was 6% at the time of the sale, Perez recorded the note at its present value of $277,993. After receiving the first payment, Perez learns that the market rate of interest on loans of this type has fallen to 5%. Assume that there is an active market for these types of notes. The present value of $1 to be received n periods in the future = 1 ÷ (1 + r)n where r is the rate of interest per period.Required:a. Prepare the journal entry for Perez to adjust the carrying value of the note to its fair value.b. Determine the carrying value of this note on Perez Company’s December 31, 20X1 balance sheet.

105) On February 1, 20X1, Singer, Inc. received a $100,000, nine-month, 10% interest-bearing note from a customer. The note was discounted on April 1, 20X1 at Second National Bank at 12%. Required:a. Compute the amount of cash received by Singer from the bank.b. Prepare the journal entry to record the discounting of the note.

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106) Packwood, Inc. sells $250,000 of its accounts receivable to M&B Finance with recourse. M&B charges a fee of 2% and withholds 8% of the face amount of the receivables to cover possible uncollectible accounts and sales returns. Packwood estimates the fair value of the recourse obligation is equal to the $13,500 allowance for credit losses associated with these accounts.Required:a. Prepare the journal entry Packwood, Inc. would make to record the factoring.b. Prepare Packwood’s journal entry to record any subsequent cash received from M&B if M&B collects all the receivables except for $6,500 due to a sales return and $12,000 resulting from a credit loss.

107) When selling receivables with recourse, what is the required disclosure, assuming the amounts are material? Explain the importance of this point.

108) On December 31, 20X1, Barbie Bank securitized $3,000,000 of notes receivable using a securitization entity it had established. The cash received from the securitization entity was exactly $3,000,000, so Barbie recognized no gain or loss on the transaction. Barbie Bank has the following account balances at December 31, 20X1 before the securitization was recorded:

Assets Notes receivable All other assets Total assets

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5,000,000 15,000,000

$ 20,000,000

Liabilities and equity Liabilities

$ 14,000,000

Equity

6,000,000

Total liabilities and equity

$ 20,000,000

Net income for the year ended December 31, 20X1

1,600,000

Required:a. Compute Barbie Bank’s return-on-assets ratio and debt-to-equity ratio after completing this transaction assuming the transaction was viewed as a sale under U.S. GAAP.b. Compute Barbie Bank’s return-on-assets ratio and debt-to-equity ratio after completing this transaction assuming the transaction was viewed as a collateralized borrowing under U.S. GAAP.

109) Jensen Homes purchased $160,000 of scaffolding from Lewisburg Builders Supply on January 2, 20X0. Jensen paid $30,000 in cash and signed a three-year 10% note for the remaining $130,000 of the purchase price. The note specifies that payments of $26,000 plus interest be made each year on the anniversary date of the loan. Jensen made the required January 2, 20X0payment, but was unable to make the second payment on January 2, 20X1 because of a downturn in the construction industry. At January 2, 20X1, Jensen owed Lewisburg Builders Supply $104,000 plus $10,400 interest that had been accrued by both companies on December 31, 20X0 Rather than write off the note, Lewisburg Builders Supply agreed to restructure the loan as follows: one payment of $95,000 on January 2, 20X2 would satisfy the restructured note. The present value of $1 to be received n periods in the future = 1 ÷ (1 + r)n where r is the rate of interest per period. Required:Prepare the journal entries made by each company on January 2, 20X1 to record the restructuring of the note.

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Answer Key Test name: chapter 9 1) FALSE 2) TRUE 3) TRUE 4) TRUE 5) TRUE 6) TRUE 7) FALSE 8) FALSE 9) TRUE 10) FALSE 11) TRUE 12) FALSE 13) TRUE 14) TRUE 15) FALSE 16) C 17) A 18) C 19) B 20) A 21) B 22) B 23) D 24) D 25) B 26) A Version 1

27) A 28) D 29) B 30) C 31) B 32) C 33) B 34) C 35) C 36) B 37) A 38) C 39) A 40) B 41) C 42) C 43) C 44) A 45) B 46) A 47) D 48) C 49) B 50) D 51) B 52) C 53) B 54) C 55) D 56) B Version 1

57) A 58) A 59) D 60) B 61) C 62) A 63) A 64) C 65) B 66) A 67) C 68) C 69) D 70) B 71) B 72) B 73) D 74) C 75) C 76) D 77) D 78) C 79) A 80) C 81) A 82) D 83) C 84) B 85) A 86) B Version 1

87) B 88) D 89) A 90) B 91) A 92) D 93) C 94) D 95) Find the amount of gross sales by determining credit sales with the accounts receivable T-account below. Accounts Receivable Beginning AR

$70,000

Credit sales

X $2,500 57,000

Ending AR

Accounts written off Cash collected

$65,000

$70,000 + X − $2,500 − $57,000 = $65,000X = $54,500 = credit sales. Add cash sales to credit sales to determine gross sales: Credit sales

54,500

Cash sales

47,000

Gross sales

101,500

− Sales returns & allowances

(1,850 )

= Net sales

99,650

96) a. Accounts Receivable Beginning balance Credit sales for

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425,000 $ 3,265,000

29,000 Sales returns for 20X1 18,500 Accounts written off

20X1

Ending balance

during 20X1 3,348,000 Collections from customers during 20X1 X

Ending A/R = $425,000 + $3,265,000 − $29,000 − $18,500 − $3,348,000 = $294,500 b. Gross accounts receivable at 12/31/X1

$ 294,500

− Allowance for sales returns

40,000

− Allowance for credit losses

90,000

= Net accounts receivable

$ 164,500

97) Unrealized loss on receivables

$ 200,000

Fair value adjustment-Accounts receivable

$ 200,000

The company would have an unrealized loss of $200,000:

Gross receivables balance

$ 2,000,000

Fair value of receivables (90%)

1,800,000

Unrealized loss on receivables

200,000

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98) a. Age

Amount

% Estimated Uncollectible

$ Estimated Uncollectible

0-30 days 3160 days 6190 days Over 90 days

$ 125,000

34,000

1,700

8,500

20 %

1,700

4,700

50 %

2,350

Uncollectible accounts balance at 12/31/X1

2,500

8,250

b. Credit loss expense

$ 9,250

Allowance for credit losses

$ 9,250

99) Allowance for credit losses

Write offs

</div>

Beginning balance

$50,000

Allowance for credit losses

$36,100

Ending balance

$22,000

Net accounts receivable

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$8,100

$ 350,000

Allowance for credit losses

36,100

Gross accounts receivable

$ 386,100

100) Credit loss

expense

$ 1,165 $ 1,165

Allowance for credit losses

Allowance for credit losses Accounts $3,800 Beginning balance Accounts written off

$6,400

4,635 Provision for credit loss (1% of sales) X Additional provision for credit loss $3,200

Ending balance (desired)

$3,800 + $4,635 − $6,400 + X = $3,200 X = $1,165 101) a. 20X1

20X2

20X3

Sales

$ 2,560,975

$ 2,663,414

$ 2,903,121

Year-end receivables

Sales growth rate Receivables growth rate

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328,330

342,120

396,859

4.2 %

16 %

b. Sales grew by 4% in 20X2 ([$2,663,414 − $2,560,975] ÷ $2,560,975) while receivables grew by 4.2% ([$342,120 − $328,330] ÷ $328,330). However, sales grew by 9% in 20X3 ([$2,903,121 − $2,663,414] ÷ $2,663,414) while receivables grew by 16% ([$396,859 − $342,120] ÷ $342,120). The data in 2017 does not suggest any potential problems because growth rates in sales and accounts receivable should be roughly equal in the absence of changes in sales terms, customer credit standing or accounting methods. However, the growth rate disparity in 20X3 suggests that one or more of these factors has come into play.Assuming that sales occur more or less uniformly over the course of each month, approximately 15 days, on average, lapse before invoices are mailed. Add these 15 days to the net 30 days credit terms to get average days sales in receivables that should be outstanding if all customers pay on time. The 46.5 days sales in receivables outstanding at the end of 20X3 is consistent with this explanation. (Average receivables: 342,120 + 396,859 = 369,490. Sales 2,903,121 ÷ average accounts receivable 369,490 = 7.86 turns. 365 days ÷ 7.86 turns = 46.5 days) 102) Date

Payments

Interest Income

Reduction of Principal

Loan Balance

1/1/X1

$ 500,000

12/31/X1

$ 114,804

$ 50,000

$ 64,804

435,196

12/31/X2

114,804

43,520

71,284

363,912

103) a. Notes receivable—Cleveland, Inc.

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$ 300,526

Sales revenue

$ 300,526

Cost of goods sold

$ 150,263

Inventory

$ 150,263

b. Notes receivable—Cleveland, Inc.

$ 30,053

Interest revenue

$ 30,053

c. Notes receivable—Cleveland, Inc.

$ 330,579

Present value of $1 for n = 3, r = 10%: 0.751315 The cash selling price of the equipment is found by taking the present value of the non-interest bearing note ($400,000 × 0.751315 = $300,526). The carrying value of the equipment in Benton’s inventory: $300,526 × 0.5 = $150,263 Data needed for the solution of this problem is found in the following amortization table.

12/31/20X1

Annual Payment $0

12/31/20X2

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Interest on previous balance

30,053

Ending loan balance $ 300,526 $

330,579

12/31/20X3

33,058

363,637

12/31/20X4

36,363

400,000

104) a. Fair value adjustment—Note receivable

$ 2,706

Unrealized gain on note receivable

$ 2,706

b. $193,379 Present value of $104,000 (principal and interest) for n = 3, r = 6% = $277,993 = original carrying value of note (given in the problem). Journal entry to record first payment (not explicitly required of students): a. Cash Interest revenue ($277,993 × 6%) Note receivable ($104,000 − $16,680)

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$ 104,000 $ 16,680 87,320

Carrying value of note after 1st payment = $277,993 − $87,320 = $190,673. Carrying value of note should be $193,379 @ 5% market rate (see below). Therefore, an adjustment of $193,379 − 190,673 = $2,706 is required to adjust the note to market. b. Present value of $104,000 (principal and interest) for n = 2, r = 5%: $193,379 = fair value of remaining payments @ 5% new market rate. 105) a. Maturity value = principal + interest for nine months = $100,000 + ($100,000 × 0.1 × 9 / 12) = $107,500. Cash proceeds = maturity value − discount = $107,500 − ($107,500 × 0.12 × 7 / 12) = $99,975 b. Cash Loss on sale of note receivable

$ 99,975 25 $ 100,000

Notes receivable

106) a. Cash ($250,000 − $5,000 − $20,000)

$ 225,000

Due from M&B finance($250,000 × 0.08)

20,000

Allowance for credit losses accounts

13,500

Loss on sale of receivables ($250,000 × 0.02)

5,000

Accounts receivable

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$ 250,000

Recourse obligation

13,500

b. Sales returns and allowances

6,500

Recourse obligation

13,500

Cash

1,500

Due from M&B finance Gain on sale of receivables

$ 20,000 1,500

The credit to the loss on sale of receivables results from the actual amount of credit loss (estimated credit losses were expensed when the allowance was established) being less than the amount of the estimated allowance for credit losses in the recourse obligation. 107) For material transactions, ASC 860-10-50-3 requires firms to provide financial statement users with an understanding of how the transfer of receivables affects the company’s financial position, performance, and cash flow under both of the following circumstances:a. Transfers accounted for as sales, if a transferor has continuing involvement with the transferred financial assets. b. Transfers of financial assets accounted for as secured borrowings. This is important as firms which sell their receivables in effect are understating receivables on their financial statements. The disclosures required assist users in understanding the true relationship of sales and accounts receivable. 108) The following table contains the data needed to compute the required ratios.

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Assets Notes receivable

Before Transaction Transaction as Transaction as a sale a borrowing $ 5,000,000 $ 2,000,000 $ 5,000,000

All other assets Total assets

15,000,000

18,000,000

$ 20,000,000 $ 20,000,000 $

23,000,000

$ 14,000,000 $ 14,000,000 $

17,000,000

Liabilities and equity Liabilities Equity

6,000,000

Total liabilities and equity

$ 20,000,000 $ 20,000,000 $

23,000,000

Net income for the year ended December 31, 20X1

1,600,000

1,600,000 $

a.Return-on-assets ratio = $1,600,000 ÷ $20,000,000 = 8% Debt-toequity ratio = $14,000,000 ÷ $6,000,000 = 2.333b.Return-on-assets ratio = $1,600,000 ÷ $23,000,000 = 6.96% Debt-to-equity ratio = $17,000,000 ÷ $6,000,000 = 2.833 109) Jensen Homes (borrower) To record the modified note (restructured cash flows less than note book value): Notes payable Interest payable Restructured note payable Gain on troubled debt restructuring

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$ 104,000 10,400 $ 95,000 19,400

Lewisburg Builders Supply (lender)To record the modified note (restructured cash flows less than note book value):

Restructured note receivable ($95,000 × 0.909091) Loss on receivable restructuring (plug) Notes receivable Interest receivable

$ 86,364 28,036 $ 104,000 10,400

The lender records the restructured note as the present value of the future cash flows from the modified note using the effective interest rate from the original note.The present value of a payment due in one year at a 10% discount rate is 0.909091.

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CHAPTER 10: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Cost of goods available for sale is always the same regardless of the inventory cost flow assumption in use. ⊚ ⊚

true false

2) Under a periodic inventory system, cost of goods sold automatically includes the cost of inventory “shrinkage.” ⊚ ⊚

true false

3) All inventory items to which the firm has legal title should be included in the inventory account although most firms record inventory only when they physically receive it. ⊚ ⊚

true false

4) Generally accepted accounting principles do not allow variable costing to be used in external financial statements because absorption costing makes it easier for financial statement users to interpret year-to-year changes in reported net income. ⊚ ⊚

true false

5) Absorption costing makes it difficult for financial statement users to interpret year-toyear changes in cost of goods sold when production levels significantly change between one year and the next. ⊚ ⊚

true false

6) GAAP requires the cost flow assumption to correspond to the actual physical flow of inventory.

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⊚ ⊚

true false

7) For ratio analysis, a distortion in the current ratio under LIFO inventory costing may be adjusted by subtracting the LIFO reserve from current assets. ⊚ ⊚

true false

8) When a LIFO firm liquidates old LIFO layers, the net income number under LIFO can be seriously distorted because the older costs in the LIFO layers that are liquidated are matched against sales dollars that are stated at higher current prices. ⊚ ⊚

true false

9) U.S. tax rules specify that if LIFO is used for tax purposes, the external financial statements must also use LIFO. ⊚ ⊚

true false

10) During periods of rising inventory costs, LIFO cost of goods sold is understated because of the inventory holding gains that have occurred during the period. ⊚ ⊚

true false

11) When using LIFO, management occasionally deliberately stops normal purchases for the last few weeks of the year in an attempt to boost profits. ⊚ ⊚

true false

12) In the LIFO-LCM approach to valuing inventory, the ceiling is the inventory’s net realizable value.

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⊚ ⊚

true false

13) For international financial reporting, the accounting standard IAS 2 permits the use of either the FIFO or weighted average cost flow assumption, but prohibits the use of LIFO. ⊚ ⊚

14)

true false

IFRS only permits the use of either the FIFO or weighted average cost flow assumption. ⊚ ⊚

true false

15) Dollar-value LIFO avoids much of the detailed recordkeeping required under standard LIFO. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) The major issue in inventory accounting is

A) determining whether to take inventory using cycle counts instead of counting all inventory only at the end of the year. B) deciding whether to maintain records on a periodic or perpetual basis. C) determining what goods to include in inventory. D) choosing the method for allocating goods available for sale to ending inventory and cost of goods sold.

17)

Goods available for sale is determined by

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adding the cost of any beginning inventory and the cost of purchases during the

period. B) subtracting the cost of any ending inventory from the cost of any beginning inventory. C) subtracting the cost of any beginning inventory from the cost of any ending inventory. D) subtracting the cost of any beginning inventory from the cost of purchases during the period.

18) In an actual business, which of the following is an inventory accounting issue that frequently arises?

A) How should physical quantities in inventory be determined? B) What items should be included in ending inventory? C) What costs should be included in inventory purchases? D) All of these answer choices are correct.

19)

If an inventory error is discovered during the reporting year,

A) it should be deferred and discussed with the external auditors. B) it should be corrected immediately. C) a certification of inventory is required. D) a running inventory balance should be implemented immediately.

20)

A periodic system of inventory:

A) reduces record keeping. B) increases record keeping. C) increases the cost of maintaining inventory. D) eliminates the need for a physical count.

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21)

The use of perpetual inventory systems is preferred where a:

A) large number of expensive inventory units exist. B) small number of expensive inventory units exist. C) large number of inexpensive inventory units exist. D) small number of inexpensive inventory units exist.

22)

A perpetual inventory system:

A) usually maintains inventory records only in terms of physical units on hand. B) uses a purchases account to record additions to inventory. C) eliminates the need to periodically take a physical inventory count. D) keeps a running record of the amount of inventory on hand.

23)

Goods held on consignment are included in the inventory valuation of:

A) the consignor. B) the consignee. C) both the consignor and the consignee. D) neither the consignor nor the consignee.

24)

Manufacturing costs not considered to be closely associated with production are called:

A) period costs. B) product costs. C) absorption costs. D) variable costs.

25)

The carrying cost of inventory should include all the following costs except:

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A) purchase costs. B) sales taxes and transportation costs paid by the purchaser. C) general administrative costs associated with the purchase of inventory. D) insurance and storage costs.

26) The inventory accounts of a manufacturer would include all the following accounts except:

A) raw materials inventory. B) work-in-process inventory. C) finished goods inventory. D) sold goods awaiting shipment inventory.

27)

Which of the following statements regarding inventory accounting is false?

A) The tax advantage of LIFO is that it provides a lower net income than FIFO during periods of rising prices and decreasing inventory quantities. B) Managers can avoid the negative tax implications of LIFO liquidations by purchasing enough inventory before year-end to bring inventory up to the level at the start of the year. C) The size of the difference between cost of goods sold under FIFO and cost of goods sold under replacement cost depends on the amount of change in input cost as well as the inventory turnover. D) To avoid providing an incentive for managers to engage in intentional LIFO liquidations, bonus contracts should subtract out any profits from LIFO liquidations.

28)

When a company uses absorption costing:

A) only fixed costs are inventoried. B) only variable costs are inventoried. C) all production costs are inventoried. D) fixed costs are expensed as incurred.

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29) Analysts must be aware that with the use of absorption costing, as inventory absorbs more fixed costs, reported net income tends to:

A) increase. B) decrease. C) remain the same. D) become highly volatile.

30)

Examples of variable costs include all the following except:

A) raw materials costs. B) the plant manager’s salary. C) direct labor costs. D) electricity used in running production machinery.

31)

The mechanics of absorption costing can lead to year-to-year income changes:

A) whenever inventory levels remain fairly constant. B) if the productivity of factory workers improves. C) if production and sales levels are not the same. D) when raw material prices are increasing.

32) Analysts must recognize that the use of the specific identification method to value inventory has a serious deficiency because it:

A) allows manipulation of net income. B) allows manipulation of period costs. C) allows manipulation of selling expenses. D) allows manipulation of administrative expenses.

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33)

Goods available for sale needs to be allocated between

A) beginning inventory and inventory purchases. B) beginning inventory and ending inventory. C) ending inventory and cost of goods sold. D) inventory purchases and cost of goods sold.

34) Financial analysts recognize that the deficiency of the FIFO cost flow assumption is the failure to

A) match current costs with current revenues. B) match current costs with oldest revenues. C) match oldest costs with current revenues. D) match oldest costs with oldest revenues.

35) The input cost changes that occur after the purchase of inventory items in a current cost accounting system are recognized as

A) realized gains and losses. B) unrealized holding gains and losses. C) extraordinary gains and losses. D) costs of goods sold.

36)

The following information pertains to the Fan Company’s inventory item B1008:

March

1 Inventory Balance 5 Purchase

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400 units

@ $ 3.10

1,400 units @ $ 3.20

14 Purchase

280 units

31 Inventory Balance

520 units

@ $ 3.25

In a periodic inventory system, the ending LIFO inventory is: A) B) C) D)

37)

$1,624. $1,655. $1,678. $1,733.

The following information pertains to the Fan Company’s inventory item B1008:

March

1 Inventory Balance 5 Purchase

400 units

@ $ 3.10

1,400 units @ $ 3.20

14 Purchase

280 units

31 Inventory Balance

520 units

@ $ 3.25

In a periodic inventory system, the LIFO cost of goods sold is:

A) B) C) D)

38)

$4,952. $4,967. $4,993. $5,006.

The following information pertains to the Fan Company’s inventory item B1008:

March

1 Inventory Balance 5 Purchase 14 Purchase

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400 units

@ $ 3.10

1,400 units @ $ 3.20 280 units

@ $ 3.25

31 Inventory Balance

520 units

In a periodic inventory system, the FIFO cost of goods sold is

A) B) C) D)

39)

$4,952. $4,967. $4,993. $5,006.

The following information pertains to the Fan Company’s inventory item B1008:

March

1 Inventory Balance 5 Purchase

400 units

@ $ 3.10

1,400 units @ $ 3.20

14 Purchase

280 units

31 Inventory Balance

520 units

@ $ 3.25

In a periodic inventory system, the ending FIFO inventory is

A) B) C) D)

$1,624. $1,655. $1,678. $1,733.

40) The Wheat Company has used the LIFO method for inventory valuation since the start of business 15 years ago. The current year ending inventory is $375,000. If the FIFO method of inventory had been used, the inventory would be $450,000. If Wheat Company had used the FIFO inventory method, pre-tax income would have been:

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A) $75,000 higher over the 15-year period. B) $75,000 lower over the 15-year period. C) $75,000 higher in the current year. D) $75,000 lower in the current year.

41)

The LIFO reserve disclosure is required because LIFO inventory costs are:

A) higher than FIFO inventory costs. B) lower than FIFO inventory costs. C) equal to FIFO inventory costs. D) usually of no consequence.

42) The conversion of a LIFO inventory to approximate the inventory at FIFO is accomplished through application of which one of the following formulas?

A) FIFO inventory = LIFO inventory × LIFO reserve B) FIFO inventory = LIFO inventory ÷ LIFO reserve C) FIFO inventory = LIFO inventory − LIFO reserve D) FIFO inventory = LIFO inventory + LIFO reserve

43) The formula to convert the cost of goods sold LIFO to an estimate of the cost of goods sold FIFO is:

A) cost of goods sold LIFO + increase in LIFO reserve = cost of goods sold FIFO B) cost of goods sold LIFO− increase in LIFO reserve = cost of goods sold FIFO C) cost of goods sold LIFO− decrease in LIFO reserve = cost of goods sold FIFO D) cost of goods sold LIFO + beginning LIFO reserve = cost of goods sold FIFO

44) The Xano Company reported merchandise inventory at LIFO of $450,000 on the yearend financial statements. The company also reported a LIFO reserve of $34,000. An estimate of the inventory balance if the inventory had been reported using the FIFO assumption is Version 1

A) B) C) D)

$382,000. $416,000. $461,000. $484,000.

45) The Skone Corporation reported a LIFO reserve of $25,000 at the end of the year. The beginning LIFO reserve was $20,000. The cost of goods sold was $197,500 under LIFO. The cost of goods sold under FIFO should be:

A) B) C) D)

$192,500. $197,500. $202,500. $222,500.

46) The Mick Company reported a LIFO cost of goods sold for the year of $100,000. The LIFO reserve decreased by $30,000 for the year. An estimate of the cost of goods sold under FIFO is:

A) B) C) D)

$70,000. $130,000. $160,000. $200,000.

47) The Johnson Corporation reported a LIFO reserve of $45,000 at the end of the year. The beginning LIFO reserve was $60,000. The cost of goods sold was $260,000 under LIFO. The cost of goods sold under FIFO should be:

A) B) C) D)

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$245,000. $260,000. $275,000. $305,000.

48)

Inventory turnover distortion under LIFO inventory costing may be adjusted by:

A) adding the LIFO reserve amounts to cost of goods sold and adjusting beginning and ending inventory for pre-tax LIFO liquidation profits whenever LIFO liquidation occurs. B) subtracting the LIFO reserve amounts from cost of goods sold and adjusting beginning and ending inventory for pre-tax LIFO liquidation profits whenever LIFO liquidation occurs. C) adding the LIFO reserve amounts to beginning and ending inventory and adjusting cost of goods sold for pre-tax LIFO liquidation profits whenever LIFO liquidation occurs. D) subtracting the LIFO reserve amounts from beginning and ending inventory and adjusting cost of goods sold for pre-tax LIFO liquidation profits whenever LIFO liquidation occurs.

49) As a firm liquidates old LIFO layers of inventory, the lower costs of the LIFO layers are matched against current sales dollars resulting in a profit margin that is:

A) inflated. B) deflated. C) lower than normal. D) always the same as under FIFO.

50)

Current ratio distortion under LIFO inventory costing may be adjusted by:

A) adding the LIFO reserve to current assets. B) subtracting the LIFO reserve from current assets. C) adding the LIFO reserve to current liabilities. D) subtracting the LIFO reserve from current liabilities.

51) When the income effect of a LIFO liquidation is material, the SEC requires that the 10-K report disclose:

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A) the dollar impact of LIFO liquidation on both a pre-tax and after-tax basis. B) the dollar impact of LIFO liquidation on the year-end inventory balance. C) this fact following a prescribed disclosure format. D) the dollar impact of LIFO liquidation on net income.

52) For a firm using LIFO, the numerator of the inventory turnover ratio is predominantly current period costs:

A) and the denominator consists of old LIFO costs. B) and it must be adjusted to conform to the old LIFO costs in the denominator. C) and the denominator must be adjusted by adding the LIFO reserve to ending inventory. D) and the denominator must be adjusted by subtracting the LIFO reserve from both beginning and ending inventory.

53)

The LIFO conformity rule states that:

if LIFO is used for tax purposes, the external financial statements must also use

if FIFO is used for tax purposes, the external financial statements must also use

LIFO. FIFO. C) if LIFO is used for tax purposes, the external financial statements must use FIFO. D) if FIFO is used for tax purposes, the external financial statements must use LIFO.

54)

LIFO’s tax advantage is that:

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A) it provides a higher net income than FIFO during periods of rising prices and level inventory quantities. B) it provides a lower net income than FIFO during periods of rising prices and level inventory quantities. C) it provides a lower net income than FIFO during periods of falling prices and level inventory quantities. D) it provides a lower net income than FIFO during periods of rising prices and decreasing inventory quantities.

55) Firms that use FIFO inventory cost assumptions always include some realized holding gains in reported income in periods of:

A) level prices. B) deflation. C) falling prices. D) rising prices.

56) The size of the divergence between FIFO cost of goods sold and replacement cost of goods sold depends on the rapidity of the inventory turnover and the:

A) change in accounts receivable turnover. B) divergence of total asset turnover from previous periods. C) severity of input cost change. D) rapidity of fixed asset turnover.

57) The World Company’s financial statements for 20X2 and 20X1 contain the following errors: 20X2

20X1

Ending Inventory

$ 6,000 overstated

$ 16,000

overstated

Insurance Expense

$ 4,000 understated

$ 12,000

overstated

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If the proper correcting entries were made at the end of 20X1, how much will 20X2 income before taxes be overstated or understated?

A) $2,000 understated B) $2,000 overstated C) $10,000 understated D) $10,000 overstated

58) The World Company’s financial statements for 20X2 and 20X1 contain the following errors: 20X2

20X1

Ending Inventory

$ 6,000 overstated

$ 16,000

overstated

Insurance Expense

$ 4,000 understated

$ 12,000

overstated

If no correcting entries were made at the end of 20X1, how much will retained earnings be overstated or understated at the end of 20X2? (Ignore income tax.)

A) $2,000 understated B) $2,000 overstated C) $10,000 understated D) $10,000 overstated

59) The use of the lower of cost or net realizable value (LCNRV) method to value inventory for reporting purposes is a departure from the accounting principle of:

A) going concern. B) conservatism. C) matching. D) historical cost.

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60) TAD, Inc. uses the LIFO-lower of cost or market method to value inventory. If the inventory value is replacement cost, which one of the following statements is true?

A) Historical cost is less than replacement cost. B) Replacement cost is greater than net realizable value less a normal profit margin. C) Replacement cost is greater than historical cost. D) Net realizable value is greater than historical cost.

61) When applying the lower of cost or net realizable value (LCNRV) method, inventory value reported cannot exceed the:

A) market floor. B) selling price less the expected cost of completion and disposal. C) selling price less a normal profit margin. D) replacement cost.

62) The use of the lower of cost or market (LIFO--LCM) method to value inventory indicates a probable loss has been sustained. This is an application of the accounting principle of:

A) matching. B) going concern. C) conservatism. D) consistency.

63) The use of the lower of cost or net realizable value (LCNRV) method to value inventory for reporting purposes employs the accounting principle of:

A) cost-benefit. B) matching. C) historical cost. D) conservatism.

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64) Konan, Inc. needs to determine its inventory value. The following information pertains to the individual products in ending inventory: Product

Cost

Replacement Cost $ 38

Selling Price $ 50

Cost of Completion $ 2

Normal Profit $ 11

L-19

$ 40

M-23

N-05

Assuming Konan uses the LIFO method for costing its inventory, the maximum limit for market value of product L-19 is:

A) B) C) D)

$37. $38. $48. $50.

65) Konan, Inc. needs to determine its inventory value. The following information pertains to the individual products in ending inventory: Product

Cost

L-19 M-23 N-05

$40 52 20

Replacement Cost $38 40 24

Selling Price $50 60 30

Cost of Completion $2 10 2

Normal Profit $11 8 6

Assuming Konan uses the LIFO method for costing its inventory, the minimum limit for market value of product M-23 is:

Version 1

A) B) C) D)

$42. $52. $50. $60.

66) Konan, Inc. needs to determine its inventory value. The following information pertains to the individual products in ending inventory: Product

Cost

L-19 M-23 N-05

$40 52 20

Replacement Cost $38 40 24

Selling Price $50 60 30

Cost of Completion $2 10 2

Normal Profit $11 8 6

Assuming Konan uses the LIFO method for costing its inventory, the lower of cost or market for product N-05 is:

A) B) C) D)

$20. $22. $24. $28.

67) Konan, Inc. needs to determine its inventory value. The following information pertains to the individual products in ending inventory Product

Cost

L-19 M-23 N-05

$40 52 20

Replacement Cost $38 40 24

Selling Price $50 60 30

Cost of Completion $2 10 2

Normal Profit $11 8 6

Assuming Konan uses the LIFO method for costing its inventory, the lower of cost or market for item M-23 is:

Version 1

A) B) C) D)

$40. $42. $46. $52.

68) Konan, Inc. needs to determine its inventory value. The following information pertains to the individual products in ending inventory: Product

Cost

L-19 M-23 N-05

$40 52 20

Replacement Cost $38 40 24

Selling Price $50 60 30

Cost of Completion $2 10 2

Normal Profit $11 8 6

Assuming Konan uses the LIFO method for costing its inventory, the “market” value for item N05 is:

A) B) C) D)

$20. $24. $28. $30.

69) Konan, Inc. needs to determine its inventory value. The following information pertains to the individual products in ending inventory: Product

Cost

L-19 M-23 N-05

$40 52 20

Replacement Cost $38 40 24

Selling Price $50 60 30

Cost of Completion $2 10 2

Normal Profit $11 8 6

Assuming Konan uses the FIFO method for costing its inventory, the net realizable value for product L-19 is:

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A) B) C) D)

$37. $38. $48. $50.

70) Konan, Inc. needs to determine its inventory value. The following information pertains to the individual products in ending inventory: Product

Cost

L-19 M-23 N-05

$40 52 20

Replacement Cost $38 40 24

Selling Price $50 60 30

Cost of Completion $2 10 2

Normal Profit $11 8 6

Assuming Konan uses the FIFO method for costing its inventory, the reported value of product M-23 is:

A) B) C) D)

$42. $52. $50. $60.

71) Konan, Inc. needs to determine its inventory value. The following information pertains to the individual products in ending inventory: Product

Cost

L-19 M-23 N-05

$40 52 20

Replacement Cost $38 40 24

Selling Price $50 60 30

Cost of Completion $2 10 2

Normal Profit $11 8 6

Assuming Konan uses the FIFO method for costing its inventory, write-down of inventory value for item M-23 is

Version 1

A) B) C) D)

$10. $8. $2. $0.

72) Konan, Inc. needs to determine its inventory value. The following information pertains to the individual products in ending inventory: Product

Cost

L-19 M-23 N-05

$40 52 20

Replacement Cost $38 40 24

Selling Price $50 60 30

Cost of Completion $2 10 2

Normal Profit $11 8 6

Assuming Konan uses the FIFO method for costing its inventory, the writedown of inventory value for Product N-05 is

A) B) C) D)

73)

$6. $2. $8. $0.

Similarities between U.S. GAAP and IFRS include which of the following?

A) Both U.S. GAAP and IFRS permit the same cost flow assumptions. B) Inventory is carried at the lower of cost or net realizable value under both U.S. GAAP and IFRS. C) Direct costing is required under both U.S. GAAP and IFRS. D) The definition of inventory is similar in both U.S. GAAP and IFRS.

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74) IFRS accounting for inventory (IAS 2) does not permit which of the following cost flow assumptions?

A) LIFO. B) FIFO. C) Weighted average. D) Specific identification.

75)

When applying lower of cost or market under IFRS, market is defined as:

A) net realizable value less normal markup. B) replacement cost. C) net realizable value. D) the middle value among the above three alternatives.

76) Reported income for FIFO firms includes some realized holding gains during periods of rising inventory costs. Which of the following terms (when inserted in the blank) makes the previous sentence a true statement?

A) always. B) sometimes. C) usually. D) never.

77)

Analysts try to remove holding gains from reported FIFO income because

A) the code of professional ethics to which they must comply requires that they do so if possible. B) holding gains understate management’s true performance. C) they are potentially unsustainable. D) they are always unsustainable.

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78) The size of the divergence between FIFO cost of goods sold and replacement cost of goods sold depends on:

A) the severity of input cost changes. B) the rapidity of physical inventory turnover. C) both the severity of input cost changes and the rapidity of physical inventory turnover. D) the rate of inflation.

79) ABC Company has elected to adopt the dollar-value LIFO inventory method when the inventory is valued at $125,000. The adoption takes place as of January 1, 20X1 when the entire inventory represents a single pool. ABC Company determined that the inventory at December 31, 20X1 was $144,375 at current year cost and $131,250 at base year cost using a relevant price index of 1.10. The inventory at December 31, 20X1 under dollar value LIFO is

A) B) C) D)

$139,438. $131,875. $138,125. $144,375.

80) The Shill Company uses the dollar-value LIFO method for valuing inventory. The following inventory information is available at the end of the year: Year

Year-End Price

$ 200,000

Price Index 100

250,000

105

296,000

108

286,000

110

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The inventory at the end of Year 2 under dollar-value LIFO is:

A) B) C) D)

$238,095. $240,000. $250,000. $262,500.

81) The Shill Company uses the dollar-value LIFO method for valuing inventory. The following inventory information is available at the end of the year: Year

Year-End Price

$ 200,000

Price Index 100

250,000

105

296,000

108

286,000

110

The inventory under dollar-value LIFO at the end of Year 3 is:

A) B) C) D)

$274,074. $276,800. $278,857. $300,000.

82) The Shill Company uses the dollar-value LIFO method for valuing inventory. The following inventory information is available at the end of the year: Year

Year-End Price

$ 200,000

Version 1

Price Index 100

250,000

105

296,000

108

286,000

110

The inventory under dollar-value LIFO at the end of Year 4 is:

A) B) C) D)

83)

$260,000. $263,657. $274,074. $286,000.

LIFO layers are more likely to be liquidated when inventory records arekept on:

A) an inventory group basis. B) a total inventory basis. C) an item-by-item basis. D) a specific identification basis.

84)

Which of the following statements regarding inventory accounting is false?

A) The choice of method for allocating the cost of goods available for sale between ending inventory and cost of goods sold represents the major issue in inventory accounting. B) The input cost changes that occur after the purchase of inventory items in a current cost accounting system are recognized as unrealized holding gains. C) If the cost of inventory never changed, the FIFO, LIFO and weighted average cost flow would produce the same financial statement result. D) Although many firms use the LIFO cost flow assumption, there are no examples where the actual physical flow of units is also last-in, first-out.

85)

Which of the following statements regarding inventory accounting is true?

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A) In a perpetual inventory system, losses related to inventory must be recorded in the accounts. B) A periodic inventory system provides management a greater degree of control over inventory. C) In a perpetual inventory system, purchases are debited to a purchases account. D) A periodic system of inventory is generally used when inventory volumes are low and per unit costs are high.

86)

Which of the following statements regarding inventory accounting is false?

A) The inventory carrying cost should include storage costs. B) A manufacturing firm that uses a just-in-time system, and wants to avoid “stockouts” if possible, would prefer a periodic inventory system. C) The use of computerized optical scanning equipment has led to the adoption of perpetual inventory systems in high-volume settings. D) Inventory carrying cost should include transportation costs that are paid by the purchaser.

87)

Which of the following statements regarding inventory accounting is false?

A) A cash purchase discount that is lost due to a late payment should be recorded as interest expense rather than a cost of acquiring inventory. B) Vendor allowances should be used by the buyer to lower the cost of inventory and the cost of goods sold. C) U.S. GAAP requires that inventory costs should include the costs of the purchasing department and other administrative costs incurred with the acquisition and distribution of inventory. D) Product costs, i.e. raw material, labor and certain overhead items, should be assigned to inventory and treated as assets until the inventory is sold.

88)

Which of the following statements regarding inventory accounting is true?

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A) When using the absorption costing method, all production costs should be inventoried. B) Use of the variable costing method is preferred under GAAP. C) When variable costing is used, fixed production costs are included as a part of inventory cost. D) Companies frequently disclose the effects of absorption costing on reported net income.

89)

Which of the following statements regarding inventory accounting is true?

A) Analysts should be aware that when a company uses absorption costing, reported income tends to decrease as inventory absorbs more of the fixed costs. B) Variable costing includes more than the variable costs of production in the valuation of inventory. C) When physical inventory levels are decreasing and a company uses the absorption cost method, net income tends to increase. D) When physical inventory levels are increasing and a company uses the absorption cost method, net income tends to increase.

90)

Which of the following statements regarding inventory accounting is false?

A) Under U.S. GAAP, the cost flow assumption does not need to conform to the actual flow of the goods. B) Under U.S. GAAP, current cost (replacement cost) accounting may be used at the discretion of management with proper disclosure. C) The FIFO method of inventory valuation assumes that the first unit purchased is the first unit sold. D) The weighted average cost flow assumption generates numbers that are between the LIFO and FIFO assumptions.

91)

Which of the following statements regarding inventory accounting is true?

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A) FIFO charges the most recent costs against revenues on the income statement. B) In the U.S., FASB prefers replacement cost accounting because it records holding gains on the financial statements as they arise. C) The primary difference between FIFO and LIFO is that each method makes a different choice regarding which financial statement element is shown at the out-of-date cost. D) The specific identification method of inventory accounting is generally considered to be the most prevalent.

92)

The double extension method is an alternate term for

A) Weighted average cost flow assumption B) Specific identification method C) Dollar-value LIFO D) FIFO cost flow assumption

93)

Which of the following statements regarding inventory accounting is false?

A) By charging the oldest costs to the income statement, LIFO automatically includes in income any holding gains on the units that are sold. B) Under either FIFO or LIFO it is not possible to simultaneously reflect both the balance sheet inventory and cost of goods sold at current cost. C) When purchases and sales occur continuously, the costs incurred most recently will be virtually identical to current replacement cost so LIFO provides a good match between current costs and current revenues. D) To get the most recent prices into cost of goods sold, a company using LIFO will use the periodic inventory system, rather than a perpetual system, to compute its ending inventory and cost of goods sold.

94) Which of the following companies is most likely to utilize the LIFO cost flow assumption?

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A) A small manufacturer B) A mid-size manufacturer C) A large service provider D) A Fortune 500 company

95) Petroleum, pharmaceutical, chemical, and other large manufacturing companies are more likely to use this inventory cost flow assumption, than companies operating in other industries.

A) LIFO B) FIFO C) Weighted-average D) LCM

96)

Which of the following statements regarding inventory accounting is false?

A) Firms that use LIFO must disclose the dollar magnitude of the difference between LIFO and FIFO cost. B) The LIFO reserve disclosure requirement is intended to help investors compare LIFO versus FIFO firms in a meaningful manner. C) The formula to convert the cost of goods sold under LIFO to an estimate of the cost of goods sold under FIFO is: LIFO cost of goods sold minus increase in LIFO reserve equals FIFO cost of goods sold. D) U.S. GAAP prescribes a standardized format for disclosing the LIFO reserve.

97)

Which of the following statements regarding inventory accounting is false?

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A) IFRS requires the use of absorption costing. B) Both U.S. GAAP and IFRS apply lower of cost or market in the same manner when accounting for inventory. C) IFRS permits inventory reductions due to lower of cost or market write-downs to be reversed if the market recovers. D) Since the use of LIFO is not allowed under IFRS, inventory holding gains are included in income.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 98) For the year 20X1, the gross profit of Alpha Company was $80,000; the cost of goods manufactured was $400,000; the beginning inventories of goods in process and finished goods were $28,000 and $50,000, respectively; and the ending inventories of goods in process and finished goods were $38,000 and $75,000, respectively. Required:What is the dollar amount of Alpha’s sales for 20X1?

99) Information from Hope Company’s records for the year ended December 31, 20X1 is available as follows:

Net sales

$ 2,800,000

Cost of goods manufactured: Variable

$ 1,260,000

Fixed

630,000

196,000

Operating expenses: Variable

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Fixed

240,000

Units manufactured

70,000

Units sold

60,000

Finished goods inventory, 1/1/20X1

Hope had no work-in-process inventories at either the beginning or end of 20X1.Required:a. What would be Hope’s finished goods inventory cost under the variable (direct) costing method at December 31, 20X1?b. What would Hope’s operating income be under the absorption costing method?

100) Tool City, Inc. had 300 cordless screwdrivers on hand at January 1, 20X1 costing $45 each. Purchases and sales of cordless screwdrivers during the month of January were as follows: Date January 9

Purchases

January 14

100 @ $47

January 23 January 25 January 30

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Sales 200 @ $75

75 @ $76 100 @ $48 75 @ $77

Tool City does not maintain perpetual inventory records. Based on a physical count, 150 cordless screwdrivers were on hand at January 31, 20X1. Required:a. What is the cost of the inventory at January 31, 20X1 under the FIFO method?b. What is the cost of the inventory at January 31, 20X1 under the LIFO method?c. What is the cost of the inventory at January 31, 20X1 under the FIFO method if only 145 cordless screwdrivers were on hand at the time of the physical count? Based on the data given, what is the most likely explanation for the fact that only 145 cordless screwdrivers were actually counted?

101) Yarnco, Inc. is a diversified North American producer and processor of multi-filament polyester and nylon yarns, including specialty yarns with enhanced performance characteristics. The Company manufactures partially oriented, textured, dyed, twisted and beamed polyester yarns as well as textured nylon and nylon covered spandex products. Refer to the excerpts of the 2018 Yarnco, Inc. Annual Report. All questions relate to 2018 unless stated otherwise. Assume a 35% corporate tax rate where necessary. Yarnco, Inc. Consolidated Income Statement Fiscal Years Ended ($ in thousands)

June 24,2018 $ 690,308

June 25,2017 $ 738,665

Cost of sales

652,743

696,055

Selling, general, and administrative expenses

44,886

41,534

Provision for bad debts

7,174

1,256

Interest expense

25,518

19,266

Interest income

(3,187 )

(6,320 )

Other (income) expense, net

(2,576 )

(1,466 )

Equity in (earnings) losses of unconsolidated affiliates

4,292

(825 )

Net sales

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Restructuring reversal of prior accrual

(157 )

(254 )

Writedown of long-lived assets

16,731

2,366

Writedown of investment in equity affiliate

84,742

Loss from early extinguishment of debt

2949

Loss from continuing operations before income taxes and discontinued operations Income tax expense (benefit)

(139,858 )

(15,896 )

(22,088 )

(1,170 )

Loss before discontinued operations

(117,770 )

(14,726 )

Income (loss) from discontinued operations, net of tax Net Loss

1,465

360

$ (116,305 ) $ (14,366 )

Inventories. The Company utilizes the last-in, first-out (“LIFO”) method for valuing certain inventories representing 38.6% and 38.2% of all inventories at June 24, 2018, and June 25, 2017, respectively, and the first-in, first-out (“FIFO”) method for all other inventories. Inventories are valued at lower of cost or market for LIFO inventories and at lower of cost or net realizable value for FIFO inventories, including a provision for slow moving and obsolete items. Market is considered net realizable value. Inventories valued at current or replacement cost would have been approximately $8.2 million and $7.3 million in excess of the LIFO valuation at June 24, 2018, and June 25, 2017, respectively. The Company did not have LIFO liquidations during fiscal year 2018 and fiscal year 2017. The Company maintains reserves for inventories valued utilizing the FIFO method and may provide for additional reserves over and above the LIFO reserve for inventories valued at LIFO. Such reserves for both FIFO and LIFO valued inventories can be specific to certain inventory or general based on judgments about the overall condition of the inventory. General reserves are established based on percentage markdowns applied to inventories aged for certain time periods. Specific reserves are established based on a determination of the obsolescence of the inventory and whether the inventory value exceeds amounts to be recovered through expected sales prices, less selling costs; and, for inventory subject to LIFO, the amount of existing LIFO reserves. The total inventory reserves on the Company’s books, including LIFO reserves, at June 24, 2018 and June 25, 2017 were $15.7 million and $10.7 million, respectively. The following table reflects the composition of the Company’s inventory at June 24, 2018 and June 25, 2017:

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($ in thousands) Raw materials and supplies

June 24, June 25, 2018 2017 $ 47,201 $ 48,594

Work in process

7,573

10,144

Finished goods

69,353

57,280

124,127 $

116,018

Required:a. What is the value of inventory reported on the balance sheet at June 24, 2018?b. Compute Yarnco’s cost of goods sold for the year ending June 24, 2018, using FIFO instead of LIFO.c. Compute the amount of the cumulative tax deferral resulting from LIFO existing at the end of 2018.d. Compute how the use of LIFO affects Yarnco’s book value (common stockholders’ equity) at the end of 2018.e. Compute the inventory turnover ratio to approximate physical unit flow for 2018. Show your work.

102) Salvadore Land& Pineapple Company,Inc. is a corporation that consists of a landholding and operating parent company and its principal subsidiaries, including Salvadore Pineapple Company, Ltd. and Kapawau Land Company, Ltd. Refer to the excerpts that follow from the December 31, 2018 annual report. All questions relate to the year ended December 31, 2018 unless stated otherwise. Assume a 35% corporate tax rate where necessary. SALVADORE LAND & PINEAPPLE COMPANY, INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Years EndedDecember31, 2018 2017 2016 (inthousands) OPERATING REVENUES Net Sales

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$ 137,741

$ 149,204

$ 115,715

39,413

33,679

35,182

Operating Income

1,743

3,797

2,352

178,897

186,680

153,249

Cost of sales

65,488

73,537

71,226

Operating expenses

39,253

36,418

36,177

Shipping and marketing

16,528

14,446

15,621

General and administrative

41,939

38,425

29,347

Total Operating Costs and Expenses

163,208

162,826

152,371

Operating Income

15,689

23,854

878

Equity in losses of affiliates

(5,340 )

(484 )

(727 )

Interest expense

(775 )

(521 )

(1,159 )

Interest income

1,367

443

Income (Loss) From Continuing Operations Before Income Taxes

10,941

23,292

(985 )

Income Tax Expense (Benefit)

3,716

8,723

(528 )

Income (Loss) From Continuing Operations Income From Discontinued Operations (net of income tax expense of $46)

7,225

14,569

(457 )

Other Income Total Operating Revenues OPERATING COSTS AND EXPENSES

NET INCOME (LOSS)

74 $

7,225

$ 14,569

(383 )

INVENTORIES: Inventories of tinplate, cans, ends and processed pineapple products are stated at cost, not in excess of market value, using the dollar value last-in, first-out (“LIFO”) method. Agriculture product inventories were comprised of the following components at December 31, 2018 and 2017:

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2018

2017

(inthousands) Finished Goods

$ 1,416

$ 2,425

Work In Progress

299

367

Raw Materials

492

861

$ 2,207

$ 3,653

Total

The replacement cost of agriculture product inventories at year-end approximated $8 million in 2018 and $10 million in 2017. In 2018 and 2017, there were partial liquidations of LIFO inventories; thus, cost of sales included prior years’ inventory costs, which were lower than current costs. Had current costs been charged to cost of sales, income from continuing operations before income taxes for 2018 and 2017 would have decreased by $2.3 million and $2.9 million, respectively. Required:a. What amount of agricultural products inventory is on the balance sheet at December 31, 2018?b. Assume that ending inventory was overstated at December 31, 2018. Explain how net income would be affected by the error.c. The inventory note states that inventory amounts are “stated at cost, not in excess of market value, using the dollar value lastin, first-out (“LIFO”) method.” Which accounting principle or concept justifies writing down assets when market prices are lower than cost, but leaving them at cost when market prices are higher than cost?d. How much has Salvadore Land & Pineapple Company deferred in income taxes since being on LIFO?e. What impact did LIFO liquidations have on net income for the year ended December 31, 2018? Explain why investors would want to know about this impact.f. Compute the inventory turnover ratio to approximate physical unit flow for the year ended December 31, 2018.

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103) Jones Bros. Tools, Inc. had the following layers in its LIFO table saw inventory at January 1, 20X4. The company sets its selling price at 200% of replacement cost at the time of sale. Replacement cost as of January 1, 20X4 was $835 per unit and remained unchanged throughout 20X4. During 20X4, the company purchased 650 units and sold 1,125 units. Year LIFO Layer Added 20X1

Units

Unit Cost

200

$ 740

20X2

180

780

20X3

175

820

Required:Calculate the difference between Jones Bros. Tools, Inc.’s current cost operating margin (on a replacement cost basis) and the LIFO margin as reported by the company in 20X4. What does the difference represent?

104) The following inventory valuation errors have been discovered for Jellison Corporation:• The 20X1 year-end inventory was overstated by $19,000.• The 20X2 year-end inventory was overstated by $46,000.• The 20X3 year-end inventory was understated by $22,000.Jellison’s reported income before income taxes in these years was as follows: Year 20X1

Income Before Taxes $ 175,000

20X2

208,000

20X3

191,000

Determine what income before taxes for 20X1, 20X2, 20X3 should have been after correcting for the errors.

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105) Cramer Corporation has two products in its LIFO ending inventory and uses lower of cost or market to account for each. Cramer normally prices its products to maintain a 30% gross profit margin. Specific data for each product follows: Product A Product B Historical cost

Replacement cost

Estimated cost to dispose

Estimated selling price

200

Required:Using the lower of cost or market rule (LIFO-LCM), what unit values should Cramer use to value Products A and B in its ending inventory?

106) Jenkins RV Sales has been selling large recreational vehicles for 20 years. On January 1, 20X1, the company had $4,630,000 in inventory (based on a FIFO valuation). While the number of recreational vehicles in Jenkins’ inventory remained fairly constant throughout 20X1, by December 31, 20X1 RV prices were 6% higher than at the beginning of the year. The company reported cost of goods sold for 20X1 of $19,500,000. Required:Calculate the amount of realized holding gains in 20X1 income for Jenkins RV Sales.

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107) The Bravo Company manufactures a single product. On December 31, 20X1 Bravo adopted the dollar-value LIFO inventory method. The inventory on that date using the dollarvalue LIFO inventory method was determined to be $500,000. Inventory data for succeeding years are as follows: Year Ended December 31 20X1

Inventory at Respective Year-end Prices $ 500,000

Relevant Price Index (Base Year 20X1) 1.00

20X2

527,000

1.08

20X3

635,000

1.15

20X4

645,000

1.21

Required: Compute the inventory amount at December 31, 20X2, 20X3, and 20X4 using the dollar-value LIFO inventory method for each year. (Round all amounts to the nearest dollar.)

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Answer Key Test name: chapter 10 1) FALSE 2) TRUE 3) TRUE 4) FALSE 5) TRUE 6) FALSE 7) FALSE 8) TRUE 9) TRUE 10) FALSE 11) TRUE 12) TRUE 13) TRUE 14) FALSE 15) TRUE 16) D 17) A 18) D 19) B 20) A 21) B 22) D 23) A 24) A 25) C 26) D Version 1

27) A 28) C 29) A 30) B 31) C 32) A 33) C 34) A 35) B 36) A 37) D 38) A 39) C 40) A 41) B 42) D 43) B 44) D 45) A 46) B 47) C 48) C 49) A 50) A 51) D 52) A 53) A 54) B 55) D 56) C Version 1

57) D 58) A 59) D 60) B 61) B 62) C 63) D 64) C 65) A 66) A 67) B 68) B 69) C 70) C 71) C 72) D 73) D 74) A 75) C 76) A 77) C 78) C 79) B 80) B 81) C 82) B 83) C 84) D 85) A 86) B Version 1

87) C 88) A 89) D 90) B 91) C 92) C 93) A 94) D 95) A 96) D 97) B 98) To find Alphas’ sales for 20X1, first look at the inventory Taccount. Finished Goods Inventory Beginning balance

$50,000

Cost of goods manufactured

400,000

Ending balance

$75,000

Solve for: Cost of goods sold

Since cost of goods manufactured is specified, there is no need to analyze work in process inventory.Solve for cost of goods sold: $50,000 + $400,000 − X = $75,000 X = $375,000After finding cost of goods sold, solve for sales using this figure and the gross profit amount given. Gross profit is the difference between sales revenue and cost of goods sold. So to find sales, add cost of goods sold to gross profit. Sales in 20X1 would be:$375,000 + $80,000 = $455,000 99) a. Hope’s finished goods inventory under variable (direct) costing = $180,000. Finished Goods Inventory

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Beginning balance Cost of goods manufactured

0 1,260,000 ?

Ending balance

Cost of goods sold

Cost of goods manufactured and the beginning balance are given. Cost of goods sold needs to be found to determine ending inventory. To do this, identify the cost to make one unit. This number is obtained by dividing the variable cost of goods manufactured ($1,260,000) by the number of units manufactured (70,000). Based on this calculation, $18 per unit is the variable cost. Use this number to find cost of goods sold which is equal to the cost to produce each unit multiplied by the number of units sold, 60,000. So cost of goods sold is $18 × 60,000 = $1,080,000. Using cost of goods sold, solve for ending inventory as follows: Beginning inventory

+ Cost of goods manufactured

1,260,000

Total goods available for sale

1,260,000

− Ending inventory (solved for)

180,000

Cost of goods sold

$ 1,080,000

b. Operating income under absorption costing is: Net sales

2,800,000

Cost of goods sold: Variable

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1,080,000

Fixed (derived below)

540,000 (1,620,000 )

Gross margin

1,180,000

Operating expenses: Variable

196,000

Fixed

240,000 (436,000 )

Operating income

744,000

Absorption costing includes fixed manufacturing costs in inventory.To find the fixed manufacturing cost portion of cost of goods sold:$630,000 ÷ 70,000 units produced = $9.00 × 60,000 units sold = $540,000Under absorption costing, operating (SG&A) expenses are treated as period costs. Therefore, the entire amount ($436,000) is expensed. 100) a. FIFO January 25

100 @ $48

$ 4,800

January 14

50 @ $47

$ 2,350

Ending Inventory under FIFO

150 Units

$ 7,150

Beginning Inventory

150 @ $45

$ 6,750

Ending Inventory under LIFO

150 Units

$ 6,750

b. LIFO

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c. FIFO January 25

100 @ $48

$ 4,800

January 14

45 @ $47

$ 2,115

Ending Inventory under FIFO

145 Units

$ 6,915

The 5 units are most likely missing due to inventory shrinkage. 101) a. $124,127,000 from the table showing the composition of the company’s inventory at June, 24, 2018. b. Reported cost of goods sold − increase in LIFO reserve = $652,743,000 − $900,000 = $651,843,000 c. LIFO reserve × tax rate = $8,200,000 × 0.35 = $2,870,000d. LIFO reserve × (1 − tax rate) = $8,200,000 × 0.65 = $5,330,000 decreasee. Reported cost of goods sold ÷ average FIFO inventory = $652,743,000 ÷ [(($124,127,000 + $8,200,000) + ($116,018,000 + $7,300,000)) ÷ 2] = 5.11

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102) a. $2,207,000 from the table of inventory composition. b. Since ending inventory is overstated, cost of goods sold is understated and, thus, income is overstated by the amount of the error, net of tax. c. Conservatismd. Replacement cost − LIFO inventory = LIFO reserve × tax rate = $8,000,000 − $2,207,000 = $5,793,000 × 0.35 = $2,027,550. e. The $2.3 million boost in pre-tax income should be viewed as transitory. Consequently, cost of goods sold will be higher in future periods—holding sales constant; also, the resulting gross margin for 2018 is not comparable to 2017 (which also experienced a LIFO liquidation) or future periods. Investors should factor this information into their projections when valuing Salvadore Land & Pineapple Company. f. (Reported cost of goods sold + pretax LIFO liquidation) ÷ average FIFO inventory = ($65,488,000 + $2,300,000) ÷ [($8,000,000 + $10,000,000) ÷ 2] = 7.53. 103) Sales revenues, 1,125 units @ $1,670 ($835 replacement cost × 200%) Replacement cost of goods sold = 1,125 units × $835 replacement cost

$ 1,878,750

Current cost operating margin

Sales revenues = 1,125 @ $835 × 200%

$ 1,878,750

939,375 939,375

Cost of goods sold: 20X4 purchases,650 @ $835

$ 542,750

20X3 purchases,175 @ $820

143,500

20X2 purchases,180 @ $780

140,400

20X1 purchases,120 @ $740

88,800

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1,125

915,450

LIFO gross margin (as reported)

963,300

LIFO gross margin (as reported)

963,300

Current operating cost margin

939,375

Difference between current operating and LIFO cost margins

23,925

The $23,925 difference between the company’s current cost operating margin and the LIFO gross margin represents the amount of mismatching of revenues and expenses that occurred in 20X4 due to LIFO liquidation. In technical terms, this is the “inventory profit” or “realized holding gains” that arose from the mismatching. The income statement matching advantages of LIFO fail to exist when there is LIFO liquidation. LIFO cost of goods sold does not approximate replacement cost of goods sold when there is LIFO liquidation. 104) Starting with the 20X1 error and assuming beginning 20X1 inventory was correctly stated: 20X1 Error Beginning inventory

None

+ Purchases

None

= Goods available for sale

None

− Ending inventory

Overstated by $ 19,000

= Cost of goods sold

Understated by $ 19,000

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Since cost of goods sold is understated due to the ending inventory overstatement, income for 20X1 is overstated by $19,000.Corrected 20X1 income is = $175,000 − $19,000 = $156,000.Moving on to 20X2, the December 31, 20X1 ending inventory becomes the beginning 20X2 inventory. Therefore, two adjustments must be made to 20X2 income— one for the roll-forward effect of the 20X1 error and another for the $46,000 overstatement in 20X2. Beginning inventory

Overstated by

+ Purchases

$ 19,000

From 20X1 error

None

= Goods available for sale − Ending inventory

Overstated by

$ 19,000

From 20X1 error

Overstated by

$ 46,000

From 20X2 error

= Cost of goods sold

Understated by

$ (27,000 )

Therefore, 20X2 cost of goods sold is understated by $27,000 and income is overstated by this amount.Corrected 20X2 income = $208,000 − $27,000 = $181,000. Beginning inventory

Overstated by

+ Purchases

$ 46,000 From 20X2 error None None

= Goods available for sale − Ending inventory

Overstated by

$ 46,000 From 20X2 error

Understated by

$ 22,000 From 20X3 error

= Cost of goods sold

Overstated by

$ 68,000

Therefore, 20X3 cost of goods sold is overstated by $68,000.20X3 corrected income = $191,000 + $68,000 = $259,000. Version 1

105) Product A: Net realizable value (ceiling) = selling price of $60 − estimated cost to dispose $10 = $50. Floor = Net realizable value $50 − profit margin of $18 ($60 sales price × 30% margin) = $32. Replacement cost is less than the floor and therefore market is designated as $32 and this is less than historical cost so Cramer should use the market of $32 to value Product A. Product B: Net realizable value (ceiling) = selling price of $200 &ndash; estimated cost to dispose $52 = $148. Floor = Net realizable value $148 − profit margin of $60 ($200 sales price × 30% margin) = $88. Replacement cost between the floor and the ceiling therefore market is designated as $32 and this is less than historical cost so Cramer should use the market of $32 to value Product A. The replacement cost of $92 is between the ceiling ($148) and floor ($88) and is higher than historical cost. Cramer should use the historical cost of $90 to value Product B. 106) (1)Reported cost of goods sold—FIFO

$ 19,500,000

(2)Beginning inventory

4,630,000

(3)Rate of increase in purchase costs

(4)Cost of goods sold @ current costs = (1)+((2)×(3)) Realized holding gain in 2018 = (4)−(1)

19,777,800 $

277,800

107) To compute ending inventory at base year prices, divide the yearend prices of each year by the respective price index, then separate the layers to compute ending inventory at LIFO cost. Here are the computations: Year Ended December 31

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Inventory at Respective Year-end Prices

External Price Inventory at Base Index (Base Year Year (20X1) Prices 20X1)

20X2

$ 527,000

1.08

$ 487,963

20X3

635,000

1.15

552,174

20X4

645,000

1.21

533,058

Dollar-value LIFO Inventory December 31, 20X2: Base layer (Dollar-value LIFO @ December 31, 20X2)

$ 487,963

December 31, 20X3: Base layer 20X3 layer @ 20X3 cost: ($552,174 − $487,963 = $64,211 × 1.15 Dollar-value LIFO @ December 31, 20X3

$ 487,963 73,843 $ 561,806

December 31, 20X4 Base layer 20X3 layer @ 20X3 cost: ($533,058 − $487,963 = $45,095 × 1.15 Dollar-value LIFO @ December 31, 20X4

$ 487,963 51,859 $ 539,822

Notice that the base layer was partially depleted in 20X2 and that the 20X3 layer was partially depleted in 20X4.

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CHAPTER 11: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The method of measuring long-lived assets at their estimated value in an output market is the expected benefit approach. ⊚ ⊚

true false

2) Replacement or current cost is an example of the economic sacrifice approach for valuing long-lived assets. ⊚ ⊚

true false

3) Because of interest capitalization, an increase in capital expenditures can temporarily decrease the amount of interest expense shown on the income statement. ⊚ ⊚

true false

4) The balance sheet carrying value for internally generated intangibles is often below the value of the property rights. ⊚ ⊚

true false

5) Firms are required to disclose total R&D expense recognized in pretax income; thus, analysts can use these disclosures to reconstruct what asset and amortization amounts would be if GAAP allowed R&D to be capitalized. Disclosures of marketing and advertising expenditures are also required and thus permit a similar adjustment approach for trademarks and brands. ⊚ ⊚

true false

6) Accounting for a long-lived asset whose carrying value exceeds its expected future economic benefits is guided by the concept of verifiability.

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⊚ ⊚

true false

7) For purposes of impairment tests, the fair value of an asset is defined by U.S. GAAP as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. ⊚ ⊚

true false

8) Depreciation is the apportionment of the cost of a long-lived tangible asset to the future periods in which it provides benefits. ⊚ ⊚

true false

9) MACRS, a method of accelerated depreciation, is almost universally used for tax purposes in the U.S. ⊚ ⊚

true false

10) “Accretion expense,” classified as an operating item, reflects the current period’s growth in an asset retirement obligation. ⊚ ⊚

true false

11) When a firm disposes of a long-lived asset before the end of its useful life, the difference between the net book value of the asset and the sale proceeds is a gain or loss from a discontinued item. ⊚ ⊚

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true false

12) Gains and losses from sales of assets comprising a clearly distinguishable component of an entity are shown in the discontinued operations section of the income statement. ⊚ ⊚

true false

13) GAAP requires that all exchange transactions be recorded at the fair value of the exchanged assets. Thus, except in the rare case that the book value and the fair value of exchanged assets are identical, gains (or losses) on exchanges should be expected to be recognized. ⊚ ⊚

true false

14) When companies following IFRS write up an asset to its current fair value, subsequent depreciation of the asset should still be based on the original cost of the asset. ⊚ ⊚

true false

15) IFRS requires that research be expensed but does permit capitalization of some development expenditures. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) Long-lived assets are:

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A) non-operating assets expected to yield their economic benefits (or service potential) over a period longer than one year. B) operating assets expected to yield their economic benefits (or service potential) over a period longer than one year. C) non-operating assets expected to yield their economic benefits (or service potential) over a period longer than five years. D) operating assets expected to yield their economic benefits (or service potential) over a period longer than two years.

17) Which one of the following is an example of the expected benefit approach for valuing long-lived assets?

A) Historical cost. B) Current replacement value. C) Salvage value. D) Discounted present value.

18) the:

The method of measuring long-lived assets at their estimated value in an input market is

A) expected benefit approach. B) economic sacrifice approach. C) discounted present value approach. D) net realizable value approach.

19)

The dominant method under GAAP for measuring long-lived assets is the:

A) expected benefit approach. B) discounted present value approach. C) historical cost approach. D) replacement cost approach.

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20) Expected benefit approaches for valuing long-lived assets are not used in current U.S. GAAP because the numbers generated under these methods are inaccurate and:

A) fictitious. B) objective. C) not verifiable. D) neutral.

21) are:

Expenditures included in the initial balance sheet carrying amount of a long-lived asset

A) charge-off costs. B) expensed costs. C) intangible costs. D) capitalized costs.

22) Which one of the following items would be charged to the cost of a building rather than the cost of land?

A) Architectural fees. B) Grading of land. C) Demolition of an existing structure. D) Cost of hauling material from a demolished structure.

23) Which one of the following items would be charged to the cost of land rather than the cost of a building?

A) Demolition of an existing structure. B) Capitalization of interest. C) Architectural fees. D) Cost of the foundation.

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24) Capitalization of interest for the construction of long-lived assets is limited to interest arising from actual borrowings from:

A) owners. B) stockholders. C) outsiders. D) the board of directors.

25) Which of the following does not present a challenge to analysts using financial statements?

A) The return-on-asset ratio increases if a firm does not modernize and innovate. B) U.S. GAAP allows upward adjustments to long-lived assets. C) The use of historical cost makes comparisons of new and old firms in the same industry difficult. D) The expected benefit of a long-lived asset may increase over time.

26) In comparing firms in the same industry, which of the following does not present a challenge for analysts?

A) Differences in estimates of useful lives. B) The age of the companies being compared. C) The use of different depreciation methods. D) Each of these answer choices presents a challenge for analysts.

27) The Reid Co. acquired a piece of land for a new factory paying $100,000. Reid demolished the old building at a cost of $20,000, and sold scrapped material salvaged from the old building for $5,000. The architect’s fees were $25,000, and the title insurance upon acquisition of the land was $1,000. The construction period interest was $8,000, and the contractor received $300,000 for the building. A pavement assessment made by the city cost Reid $2,000 at the purchase date.The cost of the land recorded by Reid Co. is:

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A) B) C) D)

$100,000 $115,000 $116,000 $118,000

28) The Reid Co. acquired a piece of land for a new factory paying $100,000. Reid demolished the old building at a cost of $20,000, and sold scrapped material salvaged from the old building for $5,000. The architect’s fees were $25,000, and the title insurance upon acquisition of the land was $1,000. The construction period interest was $8,000, and the contractor received $300,000 for the building. A pavement assessment made by the city cost Reid $2,000 at the purchase date.The cost of the building recorded by Reid Co. is:

A) B) C) D)

$300,000 $326,000 $333,000 $335,000

29) Staley Enterprises purchased a machine for $260,000. The seller paid $900 freight to deliver the machine. Staley used $4,600 of staff mechanics’ time to install the machine and employee training cost $7,000. The state charged a 5% sales tax on the invoice price. What is the capitalized cost of the machine?

A) B) C) D)

30)

$260,000 $264,600 $271,600 $284,600

An expenditure that increases a long-lived asset’s useful life should be:

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A) capitalized. B) expensed. C) ignored. D) written off immediately.

31) Kitty Co. broke ground on its new building on March 1, 20X1, and completed construction November 30, 20X1. Kitty made the following expenditures in conjunction with this project: Date April 1, 20X1

Expenditure $ 450,000

June 1, 20X1

200,000

September 1, 20X1

400,000

November 30, 20X1

100,000

Kitty’s cumulative weighted average expenditures on this project would be

A) B) C) D)

$287,500 $500,000 $508,333 $595,833

32) Doggy Co. began construction of a new cutter for the U.S. Coast Guard on January 1, 20X1 and completed construction of the ship on October 31, 20X2. To finance construction, Doggy took out an $8,000,000, 2-year, 6% construction loan on February 1, 20X1. Interest on the loan was to be paid annually on the anniversary date of the loan. Doggy has no other outstanding interest-bearing debt. Doggy made the following expenditures in conjunction with this construction project: Date 2/1/20X1

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Amount $ 1,050,000

3/31/20X9

900,000

6/1/20X1

750,000

10/1/20X1

1,000,000

12/31/20X1

600,000

3/1/20X2

900,000

9/1/20X2

250,000

What is the amount of Doggy’s cumulative weighted average expenditures during 20X1 related to the cutter project?

A) $2,150,000 B) $2,325,000 C) $2,536,364 D) $4,300,000

33) Doggy Co. began construction of a new cutter for the U.S. Coast Guard on January 1, 20X1 and completed construction of the ship on October 31, 20X2. To finance construction, Doggy took out an $8,000,000, 2-year, 6% construction loan on February 1, 20X1. Interest on the loan was to be paid annually on the anniversary date of the loan. Doggy has no other outstanding interest-bearing debt. Doggy made the following expenditures in conjunction with this construction project: Date 2/1/20X1

Amount $ 1,050,000

3/31/20X1

900,000

6/1/20X1

750,000

10/1/20X1

1,000,000

12/31/20X1

600,000

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3/1/20X 10 9/1/20X2

900,000 250,000

How much interest should Doggy capitalize in 20X1 related to the cutter project?

A) B) C) D)

$129,000 $139,500 $440,000 $480,000

34) Doggy Co. began construction of a new cutter for the U.S. Coast Guard on January 1, 20X1 and completed construction of the ship on October 31, 20X2. To finance construction, Doggy took out an $8,000,000, 2-year, 6% construction loan on February 1, 20X1. Interest on the loan was to be paid annually on the anniversary date of the loan. Doggy has no other outstanding interest-bearing debt. Doggy made the following expenditures in conjunction with this construction project: Date 2/1/20X1

Amount $ 1,050,000

3/31/20X1

900,000

6/1/20X1

750,000

10/1/20X1

1,000,000

12/31/20X1

600,000

3/1/20X2

900,000

9/1/20X2

250,000

How much interest should Doggy expense in 20X1?

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A) B) C) D)

$220,000 $300,500 $340,500 $440,000

35) Doggy Co. began construction of a new cutter for the U.S. Coast Guard on January 1, 20X1 and completed construction of the ship on October 31, 20X2. To finance construction, Doggy took out an $8,000,000, 2-year, 6% construction loan on February 1, 20X1. Interest on the loan was to be paid annually on the anniversary date of the loan. Doggy has no other outstanding interest-bearing debt. Doggy made the following expenditures in conjunction with this construction project: Date 2/1/20X1

Amount $ 1,050,000

3/31/20X1

900,000

6/1/20X1

750,000

10/1/20X1

1,000,000

12/31/20X1

600,000

3/1/20X2

900,000

9/1/20X2

250,000

What is the amount of Doggy’s cumulative weighted average expenditures during 20X2 related to the cutter project?

A) B) C) D)

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$2,966,667 $4,341,250 $4,941,667 $5,450,000

36) Doggy Co. began construction of a new cutter for the U.S. Coast Guard on January 1, 20X1 and completed construction of the ship on October 31, 20X2. To finance construction, Doggy took out an $8,000,000, 2-year, 6% construction loan on February 1, 20X1. Interest on the loan was to be paid annually on the anniversary date of the loan. Doggy has no other outstanding interest-bearing debt. Doggy made the following expenditures in conjunction with this construction project: Date

Expenditure

2/1/20X1

$ 1,050,000

3/31/20X1

900,000

6/1/20X1

750,000

10/1/20X1

1,000,000

12/31/20X1

600,000

3/1/20X2

900,000

9/1/20X2

250,000

What amount would appear in Doggy’s construction in progress (CIP) account at December 31, 20X1?

A) B) C) D)

$2,325,000 $4,300,000 $4,439,500 $4,740,000

37) U.S. GAAP capitalizes expenditures to upgrade long-lived assets when the expenditure causes any of the following conditions except:

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A) The useful life of the asset is extended. B) The capacity of the asset is increased. C) The efficiency of the asset is increased. D) There is an increase in the non-economic benefits associated with owning the asset (such as an increase in the appearance of the company’s offices).

38) Which one of the following factors makes it difficult for financial analysts to use trend analysis?

A) Decreasing costs and prices. B) Deflation. C) An aging asset base. D) A relatively new asset base.

39) U.S. GAAP for long-lived assets significantly impedes rate-of-return comparisons across companies unless the firms:

A) apply the same depreciation methods and the same useful lives among similar groups of assets. B) market their products to the same customers. C) are of approximately the same size. D) have similar operating cycles.

40) U.S. GAAP requires that virtually all costs incurred for research and development of an internally generated patent be:

A) capitalized. B) expensed. C) amortized over 40 years. D) ignored.

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41)

Which of the following statements about research and development costs is not valid?

A) As long as a firm continues to invest in R&D, total assets and total shareholders’ equity will be understated. B) Asset utilization ratios of R&D-intensive firms will be higher than those of nonR&D- intensive firms. C) Decreases in R&D expenditures can be used to boost current period income. D) Asset utilization ratios of R&D-intensive firms will be lower than those of nonR&D -intensive firms.

42)

Under U. S. GAAP, software development costs are capitalized as intangible assets:

A) from the beginning of development. B) after a copyright is obtained. C) once the product is introduced into the marketplace. D) once the technological feasibility of the product is established.

43) Research findings almost uniformly indicate that existing U.S. GAAP for both R&D and software development is:

A) satisfactory as written. B) objective. C) conservative. D) liberal.

44)

Amortizable intangible assets include all of the following except:

A) goodwill. B) patents. C) copyrights. D) employment contracts.

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45)

Goodwill represents:

A) management’s estimate of the value of the firm’s “unidentified” intangible assets. B) the difference between the total fair value of an acquired business and the fair value of its identifiable net assets. C) the difference between the acquisition value of an acquired business and the book value of its identifiable net assets. D) the sum of the acquisition value of an acquired business and the fair value of its identifiable net assets.

46) According to U.S. GAAP, technological feasibility is established when an entity has completed all of the following activities necessary to establish that a product can be produced, except:

A) Coding. B) Designing. C) Measuring. D) Planning.

47) Which of the following is not true with regard to the relationship between R&D expenses and the value of the company’s stock shares, as perceived by investors and analysts?

A) There is no evidence that R&D expenses represent value-relevant information to investors. B) There is a causal relationship between R&D expenditures and future financial benefits. C) A $1 increase in R&D expenditures leads to a $5 increase in the market value of the company’s stock shares. D) Analysts adjust estimates of unrecorded R&D assets which are then used to adjust reported earnings and book values.

48) Which of the following is an accurate statement regarding testing for impairments of tangible assets and amortizable intangible assets? Version 1

A) the group. B) C) D)

Assets may be tested as a group if they are used in combination with other assets in Assets are to be tested only as individual assets. Assets may be tested as a group only if they were purchased as a group. Assets need not to be tested for impairment annually.

49) Which of the following is used to measure the amount of the write-down that must be recognized on an impaired asset such as depreciable equipment?

A) Undiscounted total future cash inflows minus future outflows. B) Undiscounted total future cash inflows minus the current carrying value of the asset. C) Fair value of the asset minus the current carrying value of the asset. D) Discounted total future cash inflows minus future outflows.

50) Henry Co. manufactures DVD players. At the end of Year 1, Henry’s management believes the growing popularity of streaming video content will reduce the demand for Henry’s DVD players. The DVD players are manufactured using specialized equipment with a historical cost of $3,000,000 and accumulated depreciation of $1,520,000. The managers estimate the equipment has a remaining useful life of 4 years and will generate the following undiscounted cash flows:

Year 2

$ 540,000

Year 3

420,000

Year 4

190,000

Year 5

125,000

Salvage value

50,000

If the equipment were sold today, the sales price would be $1,600,000. Is the equipment considered impaired? Why, or why not?

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A) Yes, the equipment is impaired. The undiscounted cash flows are lower than the carrying amount of the asset by $155,000. B) No, the equipment is not impaired. The fair value of the equipment is greater than the carrying value of the asset by $120,000. C) Yes, the equipment is impaired. The undiscounted cash flows are less than the fair value of the equipment by $275,000. D) Cannot determine impairment without discounted cash flows.

51) If a long-lived amortizable intangible asset’s future undiscounted net cash flows fall below the asset’s net book value, the asset is considered to be a/an:

A) discontinued asset. B) discontinued operation. C) valuable asset. D) impaired asset.

52)

An impairment loss is the difference between the carrying value of the asset and the:

A) historical cost of the asset. B) fair value of an asset. C) future value of the asset. D) price-level adjusted value of the asset.

53)

An impairment loss is reported on the income statement as:

A) part of income from continuing operations. B) an extraordinary item. C) part of income from discontinued operations. D) an accounting change.

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54) The FASB has been able to guard against management manipulation of earnings as a result of asset impairments by:

A) fining any managers found guilty of such manipulation. B) requiring restoration of previously recognized impairment losses. C) prohibiting restoration of previously recognized impairment losses. D) relying on State Boards of Public Accountancy to police the transactions.

55) The Simon Company acquired equipment three years ago at a cost of $125,000. Two years later the equipment sustained impairment in value. At the time of the impairment, the fair value of the equipment was $25,000 and the carrying value was $50,000. The entry to record the impairment would be:

A) DR Retained earnings 25,000 CR Accumulated depreciation 25,000 B) DR Impairment loss 25,000 CR Equipment 25,000 C) DR Equipment 25,000 CR Impairment loss 25,000 D) DR Retained earnings 25,000 CR Equipment 25,000

56) Evaluation of indefinite-lived intangible assets for impairment occurs under all of the following scenarios except:

A) annually. B) no less than every three (3) years. C) when there is a deterioration in the business climate. D) when there is a significant decrease in the asset’s fair value.

57)

Evaluation and testing for impairment assessments of indefinite-lived intangible assets:

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A) follows the same process as required for impairment evaluation and testing for tangible assets. B) requires only assessment of qualitative factors. C) requires a quantitative impairment test if, after a qualitative assessment, it is more likely than not that the asset is impaired. D) requires a two-step process to be completed for all impairment assessments.

58) Which of the following is not an accurate statement regarding asset retirement obligations (AROs)?

A) A liability is recorded at its present value and the liability increases over time. B) A liability is computed using a credit-adjusted risk-free rate. C) A liability is recorded with a credit entry in a contra-asset account. D) An annual expense is recorded as accretion expense.

59)

Which of the following does not represent guidance for assets held for sale?

A) They are reported in the discontinued section of the income statement. B) They are reported at the lower of book value or fair value. C) They are expected to be sold within one year. D) They are reported at the lower of book value or fair value less costs to sell.

60)

The allocation of the cost of equipment to future periods of benefit is termed as:

A) depletion. B) amortization. C) depreciation. D) allocation.

61)

The allocation of the cost of a copyright to future periods of benefit is termed as:

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A) depletion. B) amortization. C) depreciation. D) allocation.

62)

The allocation of the cost of a wasting asset to future periods of benefit is termed as:

A) depletion. B) amortization. C) depreciation. D) allocation.

63) Deuce Company purchased a truck for $50,000 on January 2, 20X1. The asset has an expected salvage value of $5,000 at the end of its five-year useful life. What depreciation method is used if depreciation expense is $6,000 in 20X4?

A) Straight-line. B) Sum of years’ digits. C) Double-declining balance. D) Composite.

64) Deuce Company purchased a truck for $50,000 on January 2, 20X1. The asset has an expected salvage value of $5,000 at the end of its five-year useful life. How much is the depreciation expense in 20X2 if double-declining balance depreciation is used?

A) B) C) D)

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$6,000 $9,000 $12,000 $15,000

65) Deuce Company purchased a truck for $50,000 on January 2, 20X1. The asset has an expected salvage value of $5,000 at the end of its five-year useful life. How much is the depreciation expense in 20X2 if sum-of-years digits depreciation is used?

A) B) C) D)

$6,000 $9,000 $12,000 $15,000

66) Deuce Company purchased a truck for $50,000 on January 2, 20X1. The asset has an expected salvage value of $5,000 at the end of its five-year useful life. How much is the depreciation expense in 20X5 if double-declining balance depreciation is used for 20X1-20X2 and there is a switch to straight-line in year 20X3?

A) B) C) D)

$4,333.33 $3,000 $9,000 $12,000

67) According to the 2012 AICPA survey of 2011 annual reports, the most favored method of depreciation for financial reporting purposes is:

A) declining-balance. B) sum-of-the-years’ digits. C) straight-line. D) units-of-production.

68)

The most widely-used depreciation method for U.S. income tax purposes is:

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A) sum-of-the-years’ digits. B) MACRS. C) straight-line. D) units-of-production.

69) A major problem facing financial analysts who compare long-lived assets on balance sheets of various companies is that different companies often use different:

A) formats of balance sheet. B) estimated lives. C) salvage values. D) tax methods of depreciation.

70) When the differences in useful lives of long-lived assets reflect real economic differences, the attempt on the part of financial analysts to undo these differences may:

A) impede profit and loss comparisons. B) enhance profit comparisons. C) enhance profit comparisons, but impede loss comparisons. D) enhance profit and loss comparisons.

71) Financial analysts can make comparisons between the long-lived assets of two companies, both of which use straight-line depreciation, by computing the average useful life of assets with which one of the following formulas?

A) Net depreciable property, plant, and equipment/average useful life. B) Gross depreciable property, plant, and equipment/average useful life. C) Gross depreciable property, plant, and equipment/straight-line depreciation expense. D) Straight-line depreciation expense/net depreciable property, plant, and equipment.

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72) When a financial analyst adjusts a company’s reported depreciation expense to improve comparisons of profitability with another firm that uses the same depreciation method, the analyst assumes all of the following to be true except that:

A) the useful lives differences are “real”. B) the dollar breakdown within asset categories is similar for both firms (i.e., both have similar amounts of buildings vs. leasehold improvements, etc.). C) salvage value proportions are roughly equivalent for both firms. D) the useful life differences are artificial.

73) When firms dispose of a long-lived asset by selling it before the end of its useful life, the difference between the net book value of the asset and the disposition proceeds is a/an:

A) cost of goods gain or loss. B) gain or loss from continuing operations. C) gain or loss from a discontinued item. D) gain or loss from a prior period.

74) Devine Company sold a machine for $6,000 that originally cost $34,000 and had accumulated depreciation of $27,000. Devine had a/an:

A) gain of $1,000. B) sales revenue of $6,000. C) loss of $1,000. D) cost of goods sold of $1,000.

75) In assessing whether an exchange transaction has commercial substance, the firm’s future cash flows are expected to change significantly as a result of the exchange. Which item below does not describe whether a significant change in cash flow is expected?

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A) The risk, timing and amount of the future cash flows differs significantly from the future cash flows of the asset transferred. B) The entity-specific value of the asset differs from that of the asset transferred. C) The difference between the entity-specific value of the asset(s) received and the entity-specific value of the asset(s) transferred is significant in relation to the fair values of the assets. D) Only the timing and amount of future cash flows is required to be significant – risk and entity-specific value are optional.

76) When two companies exchange products to facilitate sales to customers and the exchange also includes a cash payment, which of the following is the proper treatment of the transaction by the recipient of the cash?

A) No gain or loss is recorded. B) A portion of any gain is recorded. C) The inventory received is recorded at the same value as the inventory relinquished. D) All the cash received is recognized as a gain.

77) The Key Company sold a machine. The machine had accumulated depreciation of $50,000 and a salvage value of $6,000. If the machine sold for $16,000 and a gain of $4,000 is recognized, the original cost of the asset is:

A) B) C) D)

$54,000 $62,000 $66,000 $70,000

78) When certain kinds of assets are built that require public welfare and safety expenditures at the end of the asset’s life,

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these estimated future expenditures are subtracted from the carrying value of the

asset. B) these “asset retirement” costs are expensed when asset retirement occurs. C) this fact is only reported in the notes to the financial statements. D) a liability simultaneously arises for those future expenditures.

79) To preclude firms from generating artificial gains on exchange transactions being recorded at fair value, U.S. GAAP requires that the transaction:

A) must possess commercial substance. B) have future cash flows that remain substantially the same. C) be reviewed and approved by the SEC. D) All of these answer choice criteria must be met to book an exchange transaction at the fair value of the exchanged assets.

80) Presume that an asset exchange transaction does not culminate an earning process and that the transaction does not involve cash. In such a case:

A) a gain will be recognized only when the fair value of the acquired assets exceeds the book value of the relinquished assets. B) a loss will be recognized only when the fair value of the acquired assets exceeds the book value of the relinquished assets. C) the assets acquired are recorded at the book value of the assets relinquished. D) a gain will be recognized only when the fair value of the acquired assets exceeds the fair value of the relinquished assets.

81)

Under IFRS, when an asset is revalued upward, subsequent depreciation is based on:

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A) the asset’s original cost. B) the method used for determining depreciation on the company’s tax returns. C) the asset’s revaluation net book value which is the fair value at the time of revaluation. D) the amount of future cash flows the asset is expected to generate.

82) Which of the following is not part of the IFRS revaluation rules for tangible long-lived assets?

A) A company can elect to revalue individual assets. B) If a company elects to revalue any assets, all assets of a similar class must be revalued. C) Once assets are revalued, they must be kept up to date through regular reassessments. D) If an asset is written up, the revaluation surplus account must be reclassified each year to retained earnings.

83)

When an asset’s fair value has increased and a firm elects the revaluation method,

A) the amount of the necessary write-up is credited to a contra-asset account called revaluation surplus. B) subsequent depreciation is based on the asset’s original cost. C) under U.S. GAAP, the accumulated depreciation account is removed and the revalued amount becomes the new book value. D) under IFRS, the accumulated depreciation account is removed and the revalued amount becomes the new book value.

84) Which of the following is not a difference between U.S. GAAP and IFRS treatment of impaired assets?

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A) The use of discounted cash flow. B) Due to differences, U.S. GAAP may trigger an impairment loss that would not be triggered by IFRS. C) The right to reverse prior impairment losses when there is a change in the estimates used to measure the loss. D) In determining the valuation, costs to sell are deducted from fair value.

85) Under IFRS, research must be expensed but some development expenditures may be capitalized. To capitalize development expenditures, firms must demonstrate several factors that include all of the following except:

A) technical feasibility. B) length of time the intangible asset is expected to provide benefits. C) ability to use or sell the asset. D) how the intangible asset will generate probable future economic benefits.

86) Erickson Company currently holds crypto currency. On its classified balance sheet, Erickson should report the crypto currency as

A) cash and equivalents. B) current receivable. C) current investment. D) intangible asset.

87)

Subsequent to acquisition, crypto currency should be

A) amortized over time. B) tested for impairment. C) expensed as incurred. D) depreciation over time.

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88) Gwen Inc. operates in a regulated industry. Recently passed regulation will require an additional expenditure of $54,000 to dispose of one of Gwen Inc.’s operational assets, which is expected to be retired in four years. The asset was acquired five years ago, with a nine-year estimated service life. A liability related to the newly legislated disposal cost should be recognized

A) retrospective to the date of acquisition. B) at the date new regulation was passed. C) over the service life of the asset. D) at the end of the asset’s service life.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 89) On June 30, 20X1 Howard Company acquired a 5-acre tract of land. On the tract was a warehouse that Howard intended to use as a distribution center. At the time of the purchase, the land had an assessed tax valuation of $2,250,000 and the building had an assessed tax value of $7,750,000. Howard paid $16,750,000 for the land and building. After the purchase the company paid $750,000 to have various modifications made to the building.Required:At what amount should Howard record the land and building?For financial reporting purposes, why might the managers of Howard prefer to assign a larger portion of the $16,750,000 to the land rather than the building?

90) Denver Co. acquired a large rotary forge to be used in its manufacturing process from a competitor that was going out of business. The following costs were incurred by Denver in connection with the acquisition:

List price

$ 375,000

Finder’s fee

1,500

Transportation to Denver’s plant

13,000

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Cleaning and repainting the forge

1,800

Installation costs

21,000

Costs to repair a control panel damaged during installation

900

Required:How much should Denver Co. capitalize to the machinery account?

91) Bonzo Co. owns a building in Pennsylvania. The historical cost of the building is $1,050,000 and $540,000 of accumulated depreciation has been recorded to date. During 20X1, Bonzo incurred the following expenses related to the building:

Repaired a broken water main

81,500

Major improvement to the HVAC system

75,000

Added a 6,000 square foot employees’ lounge

197,500

Replaced the carpet in the purchasing department offices

21,300

Repainted the building

25,000

Required:Which of the building related costs incurred by Bonzo Co. should be capitalized in 20X1?What is the subsequent carrying amount of the building?

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92) Delilah Manufacturing Company, a calendar year reporting company, purchased a machine for $80,000 on January 1, 20X1. At the date of purchase, Delilah incurred the following additional costs:

Loss on sale of old machinery Freight-in Installation cost

$ 1,500 800 2,300

Sales tax paid on new machine

500

Testing costs prior to regular operation

300

The estimated salvage value of the machine was $5,000, and Delilah estimated the machine would have a useful life of 15 years, with depreciation being computed using the straight-line method. In January 20X3, accessories costing $5,200 were added to the machine in order to reduce operating costs and improve the machine’s output. These accessories neither prolonged the machine’s life nor provided any additional salvage value.Required:What should Delilah record as depreciation expense for 20X3?

93) Brick Company started construction on a new office building on January 1, 20X1, and moved into the finished building on July 1, 20X2. Of the building’s $3,000,000 total cost, $2,000,000 was incurred in 20X1 evenly throughout the year. The remaining $1,000,000 was paid in installments of $500,000 each on February 1, 20X2 and June 30, 20X2. Brick’s incremental borrowing rate was 12% throughout the construction period and the total amount of interest incurred by Brick during 20X1 and 20X2 was $200,000 and $210,000 respectively.Required:What amount of capitalized interest should Brick report as part of its building account at December 31, 20X1?What amount of capitalized interest should Brick report as part of its building account at December 31, 20X2?

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94) King Company began constructing a building for its own use in January 20X1. During 20X1 King incurred interest of $60,000 on specific construction debt and $12,000 on other borrowings. Interest computed on the weighted-average amount of accumulated expenditures for the building during 20X1 as $50,000.Required:What amount of interest should King capitalize?Prepare the journal entry to record payment of the interest.

95) Jade, Inc. develops and markets computer software. During 20X1, one of Jade’s engineers began developing a new and very innovative software product. On April 1, 20X2, a team of Jade’s engineers determined that the software product was technologically feasible. Jade engineers continued to ready the software for general release and in January 20X3 the first product sales were made. Total costs incurred were as follows: 20X1 $4,750,000 (evenly throughout the year) 20X2 $2,800,000 (evenly throughout the year) Required:How should Jade account for the costs incurred during 20X1 and what is the rationale for your answer?How should Jade account for the costs incurred during 20X2? If your answer differs from your answer in requirement a, explain why.

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96) On January 2, 20X1 Lamp, Inc. purchased a patent for a new consumer product for $120,000. At the time of purchase, the patent was valid for 14 years; however, the patent’s useful life was estimated to be only 10 years due to the competitive nature of the product. On December 31, 20X4 the product was permanently withdrawn from sale under governmental order because of a potential health hazard in the product. Required:Record any loss on impairment that Lamp should record in 20X4 related to this patent.What should the total charge against income be in 20X4 on this patent?

97) Four years ago Alpha Products, Inc. acquired a computer-controlled milling machine to use in its medical device manufacturing operations at a cost of $5,000,000. The firm expected the machine to have an eight-year useful life and zero salvage value. The company has been using straight-line depreciation for the asset. Due to the rapid rate of technological change in the industry, at the end of Year 5, Alpha estimates that the machine is capable of generating (undiscounted) future cash flows of $1,500,000. Based on the quoted market prices of similar assets, Alpha estimates the machine to have a fair value of $1,200,000.Required:What is the book value of the machine at the end of Year 5?Should Alpha recognize an impairment of this asset? Why or why not? If yes, what is the amount of the impairment loss that should be recognized?At the end of Year 5, at what amount should the machine appear in Alpha’s balance sheet?What would your answer to requirement (b.) have been if Alpha’s estimate of the machine’s (undiscounted) future cash flows was $2,000,000?

98) Rick Company uses straight-line depreciation for its property, plant, and equipment which—stated at cost—consisted of the following: 20X1 Land

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25,000

20X2 $

25,000

Buildings

195,000

Machinery and equipment

795,000

750,000

1,015,000

970,000

(420,000 )

(400,000 )

− Accumulated depreciation Net book value

595,000

570,000

Rick’s depreciation expense for 20X2 and 20X1 was $115,000 and $110,000 respectively.Required:What amount was debited to accumulated depreciation during 20X2 because of property, plant, and equipment retirements?

99) In January 20X1, Rock Company purchased a copper mine for $8,500,000, with removable ore estimated at 2,400,000 tons. After it has extracted all the ore, Rock will be required by law to restore the land to its original condition at an estimated cost of $500,000. Rock believes it will be able to then sell the property for $200,000. During 20X1, Rock incurred $750,000 of development costs to prepare the mine for production, and it removed and sold 80,000 tons of ore. Required: What amount should Rock capitalize as the cost of the mine?What amount should Rock report as depletion expense in its 20X1 income statement?

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100) Mackerel Company purchased equipment on January 2, 20X1 for $100,000. The equipment had an estimated eight-year service life and $5,000 salvage value. Mackerel’s policy for “eight-year assets” is to use double-declining balance depreciation for the first five years of the asset’s life and then switch to the straight-line depreciation method.Required:In its December 31, 20X3 balance sheet, what amount should Mackerel report as net book value for this equipment?

101) Nadir Company purchased a milling machine on January 3, Year 1 for $55,000. The machine was being depreciated on the straight-line method over an estimated useful life of 10 years, with $5,000 salvage value. At the beginning of Year 9, the company paid $15,000 to overhaul the machine. As a result of this expenditure, the company estimated that the remaining useful life of the machine was now 8 years with no salvage value.Required:What should be the depreciation expense recorded for this machine in Year 9 and what is the asset’s December 31, Year 9 book value?

102) Roadrunner Co. is building a waste landfill in the desert near Phoenix, AZ. Roadrunner estimates that this landfill will be in operation for 4 years, will cost $175,000,000 to build, and will generate $600 million in revenues during its useful life. Federal law requires that Roadrunner decommission and decontaminate the site at the end of its useful life. A team of engineers has studied the decontamination procedure and has estimated that Roadrunner will have to spend $20,000,000 on the decommissioning process when the landfill is shut down four years from now. Roadrunner’s credit-adjusted risk-free rate of interest is 10%; the PV factor for 4 periods at 10% equals 0.683013.Required:In accordance with U.S. GAAP, how should Roadrunner Co. account for the costs associated with the decommissioning process? Prepare the journal entry required and prepare an amortization table for the asset retirement obligation.How are the costs associated with the decommissioning process reflected on the income statement? Explain how this accounting treatment improves the matching process. Version 1

103) Harrison Company owns a manufacturing plant with a fair value of $3,500,000, a recorded cost of $6,200,000, and accumulated depreciation of $2,400,000. Pablo Company owns a warehouse with a fair value of $3,000,000, a recorded cost of $5,500,000, and accumulated depreciation of $2,800,000. Harrison and Pablo exchange assets with Harrison also receiving cash of $500,000 from Pablo. The exchange is considered to have commercial substance.Required:Record the exchange on the books of:Harrison.Pablo.

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Answer Key Test name: chapter 11 1) TRUE 2) TRUE 3) TRUE 4) TRUE 5) FALSE 6) FALSE 7) TRUE 8) TRUE 9) TRUE 10) TRUE 11) FALSE 12) TRUE 13) FALSE 14) FALSE 15) TRUE 16) B 17) D 18) B 19) C 20) C 21) D 22) A 23) A 24) C 25) B 26) D Version 1

27) D 28) C 29) D 30) A 31) B 32) B 33) B 34) B 35) B 36) C 37) D 38) C 39) A 40) B 41) D 42) D 43) C 44) A 45) B 46) C 47) A 48) A 49) C 50) A 51) D 52) B 53) A 54) C 55) B 56) B Version 1

57) C 58) C 59) B 60) C 61) B 62) A 63) B 64) C 65) C 66) A 67) C 68) B 69) B 70) A 71) C 72) A 73) B 74) C 75) D 76) B 77) B 78) D 79) A 80) C 81) C 82) A 83) D 84) B 85) B 86) D Version 1

87) B 88) B 89) a. Allocate the lump-sum cost to the land and building and then add the modification cost to the building. Land: FV of land ÷ (FV of land + building) × lump-sum purchase price = $2,250,000 ÷ ($2,250,000 + $7,750,000) × $16,750,000 = $3,768,750 Building: FV of building ÷ (FV of land + building) × lump-sum purchase price = $7,750,000 ÷ ($2,250,000 + $7,750,000) × $16,750,000 = $12,981,250 + $750,000 = $13,731,250 Note that tax assessed values may not be the same as fair values; however, the allocation methodology only requires values that are “fair” relative to each other thus the tax assessments can be used. b. Depreciation is not recorded on land. Thus, the higher the amount assigned to the land, the lower will be future years’ depreciation expense, and the higher will be the net income of such years. 90) List price

$ 375,000

Finder’s fee

1,500

Transportation to Denver’s plant

13,000

Cleaning and repainting the forge

1,800

Installation costs

21,000

Total capitalized costs

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$ 412,300

The list price, finder’s fee, transportation costs, cleaning and repainting costs, and installation costs are all necessary to get the asset (machinery) into place and ready for its intended use and are therefore capitalized costs. The damage repair is expensed as incurred since it is not an ordinary and necessary cost to acquire and make the machinery ready for use. 91) a. Capitalize the following costs: Major improvement to the HVAC system

$ 75,000

Added a 6,000 square foot employees’ lounge

197,500

Total

$ 272,500

b. The new carrying value of the building: Historical cost

$ 1,050,000

+ Improvements

272,500

− Accumulated depreciation

(540,000 )

New carrying value

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782,500

U.S. GAAP requires a company to capitalize expenditures that extend an asset’s useful life, increase its capacity or efficiency, or cause any other increase in its economic benefits. A major improvement to the HVAC system and a building addition meet these criteria and are capitalized costs. The painting, carpet, and repair costs are expensed since they do not improve efficiency or extend the productive life of the building. 92) Purchase price

$ 80,000

Freight-in

800

Installation cost

2,300

Sales tax paid on new machine

500

Testing costs prior to regular operation

300

Total cost of machine − Salvage value Depreciation base

$ 83,900 (5,000 ) $ 78,900

Depreciation expense for 20X1 and 20X2 = $78,900 ÷ 15 years = $5,260/year

Depreciation base January 1, 20X1

$ 78,900

20X1 Depreciation

(5,260 )

20X2 Depreciation

(5,260 )

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Depreciation base January 1, 20X3

68,380

+ Cost of accessories

5,200

Adjusted depreciation base January 1, 20X3

$ 73,580

÷ Remaining useful life (15 years − 2 years)

13 years

Depreciation expense for 20X3 and remaining years of $ 5,660 asset’s life

The cost of accessories improved the asset’s efficiency and therefore is added to the capitalized base, and depreciation is recomputed using the new base and remaining years of life. 93) a. The avoidable interest during 20X1 is: Cost incurred evenly over the year

$ 2,000,000 ×

0.50

Average cost during the year

$ 1,000,000

Incremental borrowing rate

0.12

Avoidable interest during 20X1

120,000

Since the actual interest incurred ($200,000) was higher than avoidable interest, Brick should capitalize $120,000 interest at December 31, 20X1. b. The avoidable interest during 20X2 is: Date

Expenditure

Portion of Year

Expenditures in prior $ 2,120,000

× 6/12 =

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Weighted Average Accumulated Expenditure $ 1,060,000

year February 1, 20X2

500,000

× 5/12 =

208,333

June 30, 20X2

500,000

× 0/12 =

Weighted average accumulated expenditure during 20X2

1,268,333

Weighted average accumulated expenditure during 20X2 $ 1,268,333 Incremental borrowing rate

0.12

Avoidable interest during 20X2

152,200

Since the actual interest incurred ($210,000) was higher than avoidable interest, Brick should capitalize $152,200 interest at December 31, 20X2. Interest in building account at December 31, 20X2 = interest capitalized in 20X1 + interest capitalized in 20X2 = $120,000 + $152,200 = $272,200. 94) The interest on weighted average accumulated expenditures is the amount of avoidable interest. Since the avoidable interest ($50,000) is less than the interest actually incurred $60,000 only the avoidable interest is capitalized.Total interest expense will include the difference in incurred vs. capitalized for the building (60,000 − 50,000) plus the 12,000 interest on other borrowings DR Building (capitalized interest)

50,000

DR Interest expense

22,000

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CR Cash (or interest payable)

72,000

95) a. All costs incurred during 20X1 ($4,750,000) are expensed as part of research and development (R&D) expense in 20X1. Until technological feasibility is achieved, all costs associated with software development are expensed as incurred. b. During 20X2, Jade should expense 1/4 of the costs ($700,000) as R&D and should capitalize the remaining 3/4 of the costs ($2,100,000) as “Capitalized Computer Software Costs” in accordance with U.S. GAAP. The difference in method vs. 20X1 is because on April 1, 20X2, Jade engineers determined that the product was technologically feasible. GAAP requires companies to capitalize computer software costs once this milestone has been reached. 96) a.Find the book value of the patent at 12/31/21. The patent is amortized over its useful life (10 yrs.) instead of its valid legal life (14 yrs.) because the useful life is shorter. December 31 Amortization amount ($120,000 ÷ 10 years) Book value of patent

20X1 $ 12,000

20X2 $ 12,000

20X3 $ 12,000

20X4 $ 12,000

$ 108,000

$ 96,000

$ 84,000

$ 72,000

On December 31, 20X4 the patent has a book value of $72,000. If the product is permanently withdrawn from the market, then the patent becomes worthless. Lamp would incur a loss on impairment for the entire book value of the patent, $72,000. The journal entry to record this impairment is:

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DR Loss on impairment of patent

72,000

CR Patent

72,000

b.The total charge to income in 20X4 is $84,000, i.e., $72,000 impairment loss + $12,000 amortization expense. 97) a. Book value = $5,000,000 − [($5,000,000 ÷ 8) × 5] = $5,000,000 − $3,125,000 = $1,875,000b. Yes, the asset is impaired because the book value of $1,875,000 is greater than the undiscounted future cash flows of $1,500,000. The impairment loss to be reported on the income statement = book value − fair value of the asset = $1,875,000 − $1,200,000 = $675,000c. The balance sheet amount at the end of year 5 is $1,200,000, the asset’s fair market value. Alpha would depreciate this amount over the asset’s remaining useful life.d. Had Alpha’s estimate of the undiscounted future cash flows been $2,000,000 (instead of $1,500,000), the asset would not be deemed impaired because the book value would then be less than the cash flow estimate. 98) To determine the amount debited in 20X2, reconstruct the accumulated depreciation T-account: Accumulated Depreciation

Accumulated depreciation from retirement of PP&E

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$400,000

Beginning balance (1/1/X2)

115,000

Depreciation expense

$420,000

Ending balance (12/31/X2)

$400,000 + $115,000 − X = $420,000 X = $95,000 Rick Company must have debited accumulated depreciation $95,000 during 20X2 because of property, plant, and equipment retirements. 99) a. To determine the depletion base, we need to add together the costs associated with the mine and subtract any salvage value:

Purchase price of mine

$ 8,500,000

Development costs

750,000

Restoration costs

500,000

− salvage value

(200,000 )

Depletion base

$ 9,550,000

b. Depletion cost per unit = depletion base ÷ total estimated recoverable units = $9,550,000 ÷ 2,400,000 tons = $3.98/ton (rounded). Depletion expense in 20X1 = tons removed × depletion/ton = 80,000 × $3.98 = $318,400 (rounded). 100) December 31 20X1

Depreciation Expense $ 25,000

Accumulated Depreciation $ 25,000

Net Book Value $ 75,000

20X2

18,750

43,750

56,250

20X3

14,063

57,813

42,187

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The straight-line depreciation rate is 1/8, or 12.5%. Double this rate is 25% which is multiplied by the book value of the asset of the beginning of each period to arrive at the annual depreciation expense. 101) Depreciation schedule for the machine prior to the overhaul:

January 3, Year 1

Depreciation Expense ---

Full year Year 1

$ 5,000

Year 2

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Accumulated Depreciation --$

Book Value of Machine $ 55,000

5,000

50,000

$ 5,000

10,000

45,000

Year 3

$ 5,000

15,000

40,000

Year 4

$ 5,000

20,000

35,000

Year 5

$ 5,000

25,000

30,000

Year 6

$ 5,000

30,000

25,000

Year 7

$ 5,000

35,000

20,000

Year 8

$ 5,000

40,000

15,000

The italicized number is the book value of the machine at January 1, Year 9. The $15,000 overhaul increases the value of the machine by $15,000, so the new book value is $30,000 ($15,000 + $15,000). After the overhaul, the remaining useful life of the machine at January, Year 9 is 8 years. To find the depreciation expense for Year 9, take the new book value ($30,000) divided by the remaining useful life of the machine (8 years). $30,000 ÷ 8 years = $3,750 = Depreciation expense for Year 9 After the overhaul expenditure, the cost of the machine stands at $70,000 ($55,000 + $15,000). Accumulated depreciation at the end of Year 9 = $43,750 ($40,000 + $3,750). Book value = cost − accumulated depreciation = $70,000 − $43,750 = $26,250 102) a. GAAP requires companies to recognize an asset retirement obligation (ARO) when a reasonable estimate of its fair value can be made. These legal obligations arise when a company builds or buys an asset that requires mandatory expenditures at the end of the asset’s useful life to protect public welfare or improve safety. Roadrunner Co. can estimate the fair value of this obligation as the present value of the estimated future cash outflows.

Decommissioning payment

× PV factor, 4 periods, at 10% = Present value of the ARO

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20,000,000 0.683013

13,660,260

DR Asset retirement cost—landfill

$13,660,260

CR Asset retirement obligation

$13,660,260

(a)

(b)

(c)

Present Value of

Accretion

Present Value of

Year 1

ARO at 1/1 $ 13,660,260

Expense $ 1,366,026

ARO at 12/31 $ 15,026,286

$ 15,026,286

$ 1,502,629

$ 16,528,915

$ 1,652,892

$ 18,181,807

$ 1,818,193

$ 20,000,000

b. The costs associated with the decommissioning of the landfill will be shown on the income statement as both: (1) increased depreciation expense each period as a result of recording and depreciating the asset retirement cost asset of $13,660,260, and (2) accretion expense each period as shown in column (b) of the amortization table in requirement a. The entry to record the accretion (for example) in year 1 is:

DR Accretion expense CR Asset retirement obligation

$1,366,026 $1,366,026

The $20,000,000 total decontamination cost is shown as part of the expense of operating the landfill and is matched with the revenue generated by the landfill over its productive life. Version 1

103) Requirement 1: Harrison’s entry to record the exchange: DR Warehouse (fair value)

$ 3,000,000

DR Cash

500,000

DR Loss on exchange

300,000

DR Accumulated depreciation

2,400,000

CR Manufacturing plant

$ 6,200,000

Requirement 2: Pablo’s entry to record the exchange: DR Manufacturing plant (fair value) DR Accumulated depreciation CR Warehouse

$ 3,500,000 2,800,000 $ 5,500,000

CR Cash

500,000

CR Gain

300,000

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CHAPTER 12: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) A liability that is satisfied through the payment of cash is referred to as a denominational liability. ⊚ ⊚

true false

2) A current monetary liability is shown on the financial statements at the undiscounted amount due. ⊚ ⊚

true false

3) A product warranty provided with the sale of an item of merchandise gives rise to a nonmonetary liability. ⊚ ⊚

true false

Consistent with GAAP, bonds are reported on the balance sheet at market value. ⊚ ⊚

true false

5) A rise in the market rate of interest will cause the value of a financial instrument such as a bond to rise. ⊚ ⊚

true false

6) When market rates of interest increase, the use of floating-rate debt benefits the issuing company. ⊚ ⊚

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true false

7) The retirement of a bond that has a $250,000 maturity value and a $10,000 balance in premium on bonds payable (bond premium) creates a $15,000 gain if the bond is retired at a cost of $245,000. ⊚ ⊚

true false

8) The gain or loss on the early retirement of a bond is the difference between the amount paid to retire the bond and the bond’s carrying value at the date of retirement. ⊚ ⊚

true false

9) GAAP guidelines eliminate reporting income statement gains associated with many debtfor-debt and debt-for-equity swaps and instead require disclosure of the effects of the swaps. ⊚ ⊚

true false

10) A debt-for-debt swap of debts with equal maturity values that occurs when the market rate of interest is higher than the stated rate of the old debt will give rise to a gain on debt extinguishments. ⊚ ⊚

11)

true false

Bond issue costs are recognized as a reduction of the proceeds from selling the bonds. ⊚ ⊚

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true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 12) Salt Corporation issues bonds with a face amount of $10 million and a stated interest rate of 8%. The market interest rate associated with the bonds is 6%. Bond issue costs are $200,000. The bond issue costs should be recognized as a:

A) deferred charge. B) period expense. C) reduction of the bond premium. D) bond discount.

13) Neuberg Corporation issues bonds with a face amount of $12 million and a stated interest rate of 5%. The bonds sell at face amount. In addition, the company incurs bond issue costs of $320,000. The journal entry to record the issuance of the bonds includes a debit to:

A) bond discount for $320,000. B) bond discount for $12,000,000. C) bond premium for 320,000. D) bonds payable for $320,000.

14) Gross Company sold $100,000 of long-term bonds in the open market for $108,000. The entry to record the transaction would be:

DR Cash DR Premium on Bonds Payable CR Bonds payable

100,000 8,000 108,000

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DR Bonds payable

108,000

CR Cash

108,000

DR Accounts payable

108,000

CR Bonds payable

108,000

DR Cash

108,000

CR Premium on Bonds Payable CR Bonds payable

8,000 100,000

15) Using the effective interest method, amortization of a discount or premium behave in this manner over the life of the outstanding bonds.

A) Increase for premium bond, decrease for discounted bond B) Increase for premium bond, increase for discounted bond C) Decrease for premium bond, decrease for discounted bond D) Decrease for premium bond, increase for discounted bond

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16) A probable future sacrifice of an economic benefit arising from a present obligation to transfer assets or provide services to other entities in the future as a result of a past transaction is a/an:

A) asset. B) liability. C) equity. D) expense.

17)

Which of the following is a correct statement about preparing a balance sheet?

A) All current liabilities must be due within the current calendar year. B) Bonds payable are reported in long-term liabilities with the current year portion shown separately in that section of the balance sheet. C) Some financial instruments possess the characteristics of both debt and equity. D) A financial instrument’s legal form will define how it is classified on the balance sheet.

18)

Noncurrent monetary liabilities are initially recorded at their:

A) future value. B) historical value. C) present value when incurred. D) undiscounted amount due.

19)

Which of the following would only be found in current liabilities on the balance sheet?

A) Bonds payable. B) Accrued compensation for services already rendered by employees. C) Income tax liabilities. D) Deferred revenue.

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20)

When the market rate of interest is below the stated rate of interest, a bond sells at:

A) par. B) a premium. C) a discount. D) stated value.

21) Strauss Company sold $100,000 of long-term bonds in the open market for $100,000. The entry to record the transaction would be:

DR Cash

100,000

CR Bonds payable

100,000

DR Bonds payable

100,000

CR Cash

100,000

DR Accounts payable CR Bonds payable

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100,000 100,000

DR Cash CR Interest payable

100,000 100,000

22) When the effective yield of a bond is the same as the stated rate on the bond, the bond is sold at:

A) a discount. B) a premium. C) par. D) a price above par.

23) Theta Company has prepared to sell bonds with a stated rate of 6% when the market rate is 8%. These bonds will sell in the market at:

A) par. B) a discount. C) a premium. D) stated value.

24) Theta Company has prepared to sell bonds with a stated rate of 6% when the market rate is 5%. These bonds will sell in the market at:

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A) par. B) a discount. C) a premium. D) stated value.

25) When computing the issue price of a bond that has a stated rate of 8% payable semiannually and a market rate of 10%, the discount rate used would be:

A) B) C) D)

8%. 10%. 4%. 5%.

26) Amortization of discount on bonds payable (bond discount) results in which of the following?

A) A decrease in bond interest expense. B) An increase in net income. C) An increase in the carrying value of the bond. D) An increase in stockholders’ equity due to the decrease in bond interest expense.

27) Generally accepted accounting principles require that when bonds are sold at a discount, the discount must be allocated to interest expense using the:

A) cash interest method. B) effective interest method. C) bond yield method. D) cumulative interest method.

28) Baker Company issued $200,000 of ten-year bonds to yield 11% when the stated rate of the bonds was 9%. Present value interest factors (PVIF) are:

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PVIF of $1, 10 years PVIF of Annuity of $1, 10 years

11%

0.42241 6.41766

0.35218 5.88923

The entry to record the bond issuance would be

DR Cash

176,442

DR Bond premium

23,558

CR Bonds payable

200,000

DR Cash

176,442

DR Bond discount

23,558

CR Bonds payable

200,000

DR Cash

223,558

CR Bond premium

23,558

CR Bonds payable

200,000

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DR Cash

223,558

CR Bond discount

23,558

CR Bonds payable

200,000

29) Hocker Company issues $200,000 of ten-year, 8% bonds to yield 10% on January 1, 20X1. The bonds pay interest annually on December 31. The bonds were sold at a discount of $24,578.The bond carrying amount at the end of 20X1 is:

A) B) C) D)

$175,422. $176,964. $200,000. $201,542.

30) Hocker Company issues $200,000 of ten-year, 8% bonds to yield 10% on January 1, 20X1. The bonds pay interest annually on December 31. The bonds were sold at a discount of $24,578.The bond interest expense for 20X1 is:

A) B) C) D)

$16,000. $17,542. $20,000. $21,542.

31) Hocker Company issues $200,000 of ten-year, 8% bonds to yield 10% on January 1, 20X1. The bonds pay interest annually on December 31. The bonds were sold at a discount of $24,578.The amount of cash interest paid in 20X1 on the bonds is:

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A) B) C) D)

$14,458. $16,000. $17,542. $20,000.

32) Hocker Company issues $200,000 of ten-year, 8% bonds to yield 10% on January 1, 20X1. The bonds pay interest annually on December 31. The bonds were sold at a discount of $24,578.The bond carrying value at the end of 20X2 is:

A) B) C) D)

$175,422. $178,660. $200,000. $203,238.

33) Hocker Company issues $200,000 of ten-year, 8% bonds to yield 10% on January 1, 20X1. The bonds pay interest annually on December 31. The bonds were sold at a discount of $24,578.The amount of bond discount amortization for 20X2 is:

A) B) C) D)

$1,696. $2,458. $3,080. $4,000.

34) Hocker Company issues $200,000 of ten-year, 8% bonds to yield 10% on January 1, 20X1. The bonds pay interest annually on December 31. The bonds were sold at a discount of $24,578.The amount of cash interest paid in 20X2 is:

A) B) C) D)

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$16,000. $18,000. $19,080. $20,000.

35) Hocker Company issues $200,000 of ten-year, 8% bonds to yield 10% on January 1, 20X1. The bonds pay interest annually on December 31. The bonds were sold at a discount of $24,578.The amount of bond interest expense for 20X2 is:

A) B) C) D)

$16,000. $17,696. $18,458. $19,280.

36) The Ness Company sells $5,000,000 of five-year, 10% bonds at the start of the year. The bonds have an effective yield of 9%. Present value factors are below:

PV $1 factor 1 year PV $1 factor 2 years PV $1 factor 3 years PV $1 factor 4 years PV $1 factor 5 years

10%

0.90909 0.82645 0.75131 0.68301 0.62092

0.91743 0.84168 0.77218 0.70843 0.64993

The bonds will sell for:

A) B) C) D)

$4,805,525. $5,000,000. $5,050,000. $5,194,475.

37) The Ness Company sells $5,000,000 of five-year, 10% bonds at the start of the year. The bonds have an effective yield of 9%. Present value factors are below:

PV $1 factor 1 year PV $1 factor 2 years PV $1 factor 3 years PV $1 factor 4 years

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10%

0.90909 0.82645 0.75131 0.68301

0.91743 0.84168 0.77218 0.70843 12

PV $1 factor 5 years

0.62092

0.64993

The bond interest expense for Year 1 is:

A) B) C) D)

$467,503. $500,000. $532,497. $538,895.

38) The Ness Company sells $5,000,000 of five-year, 10% bonds at the start of the year. The bonds have an effective yield of 9%. Present value factors are below:

PV $1 factor 1 year PV $1 factor 2 years PV $1 factor 3 years PV $1 factor 4 years PV $1 factor 5 years

10%

0.90909 0.82645 0.75131 0.68301 0.62092

0.91743 0.84168 0.77218 0.70843 0.64993

The amount of cash interest paid in Year 1 on the bonds is:

A) B) C) D)

$450,000. $467,503. $500,000. $538,895.

39) The Ness Company sells $5,000,000 of five-year, 10% bonds at the start of the year. The bonds have an effective yield of 9%. Present value factors are below:

PV $1 factor 1 year PV $1 factor 2 years PV $1 factor 3 years PV $1 factor 4 years

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10%

0.90909 0.82645 0.75131 0.68301

0.91743 0.84168 0.77218 0.70843

PV $1 factor 5 years

0.62092

0.64993

The bond carrying value at the end of Year 1 is:

A) B) C) D)

$4,500,000. $5,000,000. $5,126,556. $5,161,978.

40) The Ness Company sells $5,000,000 of five-year, 10% bonds at the start of the year. The bonds have an effective yield of 9%. Present value factors are below:

PV $1 factor 1 year PV $1 factor 2 years PV $1 factor 3 years PV $1 factor 4 years PV $1 factor 5 years

10%

0.90909 0.82645 0.75131 0.68301 0.62092

0.91743 0.84168 0.77218 0.70843 0.64993

The amount of bond premium amortization for Year 2 is:

A) B) C) D)

$32,497. $35,422. $38,895. $50,000.

41) The Ness Company sells $5,000,000 of five-year, 10% bonds at the start of the year. The bonds have an effective yield of 9%. Present value factors are below:

PV $1 factor 1 year PV $1 factor 2 years PV $1 factor 3 years PV $1 factor 4 years

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10%

0.90909 0.82645 0.75131 0.68301

0.91743 0.84168 0.77218 0.70843

PV $1 factor 5 years

0.62092

0.64993

The bond carrying value at the end of Year 2 is:

A) B) C) D)

$4,805,525. $5,000,000. $5,126,556. $5,194,475.

42) The Ness Company sells $5,000,000 of five-year, 10% bonds at the start of the year. The bonds have an effective yield of 9%. Present value factors are below:

PV $1 factor 1 year PV $1 factor 2 years PV $1 factor 3 years PV $1 factor 4 years PV $1 factor 5 years

10%

0.90909 0.82645 0.75131 0.68301 0.62092

0.91743 0.84168 0.77218 0.70843 0.64993

The amount of bond interest expense for Year 2 is:

A) B) C) D)

$450,000. $464,578. $500,000. $535,422.

43) A bond with a maturity value of $700,000 was initially issued for $715,000. The bond has a stated rate of 10% and matures in ten years. The total interest expense over the life of the bond is:

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A) B) C) D)

$700,000 $715,000 $685,000 not determinable without knowing the bond’s effective yield.

44) On January 1, 20X1 when the effective interest rate was 14%, a company issued bonds with a maturity value of $1,000,000. The stated rate of interest is 12%, the bonds pay interest semi-annually and sold for $893,640. The amount of bond discount amortized on July 1, 20X1 is approximately:

A) B) C) D)

45)

$1,000 $2,555 $2,000 $5,110

Which of the following statements is correct?

A) Amortization of discount on bonds payable (bond discount) results in an increase in a bond’s carrying value. B) Amortization of discount on bonds payable (bond discount) results in a decrease in bond interest expense. C) Amortization of premium on bonds payable (bond premium) results in an increase in a bond’s carrying value. D) Amortization of premium on bonds payable (bond premium) results in an increase in bond interest expense.

46)

When a bond is sold at a discount the effective interest rate is:

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A) equal to the stated rate. B) above the stated rate. C) below the stated rate. D) equal to the stated rate for a period of time and then above the stated rate for a period of time.

47) Which of the following statements is not correct regarding amortization when using the effective interest method (basis)?

A) Amortization of discount on bonds payable (bond discount) increases in later years relative to earlier years of a bond’s life. B) Amortization of premium on bonds payable (bond premium) increases in later years relative to earlier years of a bond’s life. C) Amortization of both premium on bonds payable (bond premium) and discount on bonds payable (bond discount) decreases in later years relative to earlier years of a bonds life. D) Amortization of discount on bonds payable (bond discount) results in an increase in interest expense and in an increase in the bond’s carrying value.

48)

When a bond is sold at a premium the:

A) effective interest rate is less than the stated rate. B) effective interest rate is greater than the stated rate. C) effective interest rate relative to the stated rate is not known. D) interest expense during the life of the bond exceeds the amount of cash interest payments during the life of the bond.

49) Floating-rate debt is the most common method for lenders to protect themselves from losses that may arise as a result of:

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A) increases in the market interest rate. B) decreases in the market interest rate. C) increases in the stated interest rate on bonds. D) decreases in the stated rate on bonds.

50)

The market value of floating-rate debt of $200,000 will:

A) rise by $2,000 with a 1% rise in interest rates. B) fall by $2,000 with a 1% fall in interest rates. C) remain unchanged with a change in interest rates. D) will rise in the short run and fall in the long run with a change in interest rates.

51)

Which of the following statements with respect to floating-rate debt is incorrect?

A) If the market rate of interest increases, the market value of the floating-rate debt will remain the same. B) If the market rate of interest decreases, the cash interest payment required by the issuing company would decrease. C) If the market rate of interest increases, the investors benefit while the issuing corporation does not benefit. D) If the market rate of interest decreases, both the issuing company and the investors benefit.

52)

When market rates of interest decrease, the use of floating-rate debt benefits:

A) investors. B) issuing companies. C) all parties. D) no one.

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53) Dot Company issued $200,000 of bonds on January 1, 20X1 with interest payable each year. The bonds had a stated rate of 8%. The bonds were set up as floating-rate debt with the rated pegged to LIBOR plus 3%.Which of the following will be the interest expense for year 1 if LIBOR is 5% ?

A) B) C) D)

$6,000 $10,000 $16,000 $18,000

54) Dot Company issued $200,000 of bonds on January 1, 20X1 with interest payable each year. The bonds had a stated rate of 8%. The bonds were set up as floating-rate debt with the rated pegged to LIBOR plus 3%.Which of the following will be the interest expense for year 1 if LIBOR is 7%?

A) B) C) D)

55)

$6,000 $14,000 $16,000 $20,000

Which of the following is not a valid statement regarding floating-rate debt?

A) The accounting entries are more complex due to the risk-sharing characteristics of floating rate debt. B) Floating-rate debt may benefit the issuing company if market rates fall. C) Floating-rate debt can protect the investor if market rates increase. D) Floating-rate debt is used to lower the company’s overall borrowing cost.

56) Which of the following statements is not accurate with respect to the reporting requirements regarding the fair value accounting option?

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A) Firms may elect the fair value option for a single eligible instrument without electing it for other identical instruments. B) Once the choice is made to adopt the fair value option, the decision is irrevocable. C) Financial statement disclosures must include management’s rationale for electing the fair value option. D) The fair value option is not available for security investments that are accounted for using the equity method.

57) On January 1, 20X1, Ross Corporation issued bonds with a maturity value of $200,000; the bond’s stated rate of interest equaled the market interest rate on the issue date. On December 31, 20X1, the market value of the bonds was $188,926; on December 31, 20X2, the market value of the bonds was $191,325. Which of the following correctly describes Ross Corporation’s financial reporting if Ross elects to measure the bond liability using the fair value accounting option?

A) For the year ending December 31, 20X1, Ross will report an unrealized holding loss of $11,074 in its income statement. B) For the year ending December 31, 20X2, Ross will report an unrealized holding gain of $8,675 in its income statement. C) For the year ending December 31, 20X2, Ross will report an unrealized holding loss of $8,675 in its income statement. D) For the year ending December 31, 20X2, Ross will report an unrealized holding loss of $2,399 in its income statement.

58) Which of the following is not an accurate description of the controversies surrounding the fair value accounting option?

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A) Advocates argue that accounting-induced volatility is eliminated and financial statement transparency is improved. B) Critics argue that opportunities are enhanced for companies to manipulate their earnings and balance sheet. C) Critics argue that companies that can use the fair value option in situations where there is not necessarily a relationship between the financial assets and liabilities which promotes the opportunity to manage earnings. D) Advocates argue that financial reporting is more accurate and transparent for those companies in financial distress.

59)

When a company retires debt, which of the following is not an accurate statement?

A) If the debt is retired at maturity, there is no opportunity for a gain or loss. B) If the debt was recorded using the fair value accounting option, there is no opportunity for a gain or loss. C) If a company retires debt early by issuing new debt at a lower market rate of interest, a gain on the extinguishment of debt will be recorded if the company did not elect to use the fair value accounting option. D) If a company finances the early retirement of debt by issuing new debt, GAAP prohibits recording a gain on the early retirement.

60) A bond with a $500,000 maturity value is immediately retired for $515,000 plus accrued interest. The premium on bonds payable (bond premium) at the retirement date is $17,500. Which of the following statements is correct?

A) The loss on the debt extinguishment is $32,500. B) The gain on the debt extinguishment is $2,500. C) The gain on the debt extinguishment is $32,500. D) The gain or loss on the debt extinguishment can’t be determined without knowing the dollar amount of the accrued interest.

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61) A bond with a $750,000 maturity value is immediately retired for $745,000 plus accrued interest. The discount on bonds payable (bond discount) at the retirement date is $25,500. Which of the following statements is correct?

A) The gain on the debt extinguishment is $5,000. B) The loss on the debt extinguishment is $20,500. C) The gain on the debt extinguishment is $30,500. D) The gain or loss on the debt extinguishment can’t be determined without knowing the dollar amount of the accrued interest.

62)

When interest rates have increased and bonds are retired before maturity, market value is:

A) below book value generating an accounting gain. B) below book value generating an accounting loss. C) above book value generating an accounting gain. D) above book value generating an accounting loss.

63)

Which of the following is not a true statement regarding the fair value accounting option?

A) The fair value option mutes earnings volatility. B) The fair value option reduces the need to comply with complex hedge accounting guidance. C) The fair value option increases earning volatility. D) The fair value option converges U.S. GAAP and IFRS by having an identical standard.

64) Which of the statements is not true when applying both IFRS and U.S. GAAP accounting for long-term debt?

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A) Periodic interest expense is computed using the contractual interest rate. B) Fixed-rate bonds are recorded at the amount of the net proceeds. C) The balance sheet carrying value is amortized cost determined using the effective interest rate at the issue date. D) Changes in interest rates after the issue date do not alter the carrying value unless fair value accounting is used.

65) Some financial analysts contend that reporting debt at amortized historical cost rather than at fair value:

A) makes it more difficult to manipulate accounting numbers. B) makes it easier to manipulate accounting numbers. C) has no impact on the accounting numbers. D) makes it impossible to manipulate the accounting numbers.

66) Special financial statement disclosures are required so that investors and analysts can understand all of the following except:

A) management’s rationale for electing the fair value accounting option. B) the impact of changes in fair values on earnings for the period. C) management’s rationale for not electing the fair value accounting option. D) the difference between fair values and contractual cash flows for certain items.

67)

Which of the following represent(s) a bond valuation account?

A) Bond premium B) Bond discount C) Bond interest D) Both bond premium and discount

68)

Which of the following is not an accurate statement regarding the retirement of debt?

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A) When debt is retired on the maturity date, the book value is always equal to the market value. B) The gain or loss on the extinguishment of debt is categorized on the income statement as part of continuing operations. C) When debt is retired before the maturity date, a loss occurs if the market rate of interest increased subsequent to the issue of the bond. D) When debt is retired before the maturity date, a gain occurs if the market rate of interest increased subsequent to the issue of the bond.

69) Investors need to review transactions involving debt-for-debt swaps carefully to ensure that there is an underlying:

A) loss. B) gain. C) rationale. D) economic benefit.

70)

Debentures are bonds that:

A) have no maturity date. B) do not pay periodic interest. C) that are unsecured. D) that can be converted to common stock.

71)

The most common types of bonds are unsecured bonds that also are referred to as:

A) debentures. B) indentures. C) term bonds. D) bearer bonds.

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72)

Secured bonds are

by assets held by the bond issuer.

A) promised B) transferred C) collateralized D) insured

73)

The use of the fair value option tends to:

A) increase income volatility. B) decrease income volatility. C) increase financial statement conservatism. D) decrease the relevance of information presented in the financial statements.

74) Klein Company issues a four-year note in exchange for a license agreement with fair value of $100,000. The contract requires payment of $27,956 at the beginning of each of the four years. The approximate effective interest rate associated with the notes payable is:

A) B) C) D)

10%. 8%. 7%. 6%.

75) Gross Inc. signs a five-year licensing agreement with Maiger Company. Gross Inc. will pay Maiger annual installment payments of $10,500 at the beginning of each of the five years. The fair value of the contract is $48,000. Over the five-year contract period, Gross Inc. will pay interest of:

A) B) C) D)

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$48,000 $10,500 $4,500 0

76) On January 2, 20X1, Ziegler Company issues a four-year note in exchange for a license agreement requiring four annual payments of $27,956. The market value of the four-year agreement is $100,000. The first payment is due on the day the agreement is signed. The effective interest rate is 8%. The first payment includes interest expense of:

A) B) C) D)

0 $27,956. $8,000. $11,824.

77) On January 2, 20X1, Ziegler Company issues a four-year note in exchange for a license agreement requiring four annual payments of $27,956. The market value of the four-year agreement is $100,000. The first payment is due on the day the agreement is signed. The effective interest rate is 8%. The second payment includes interest of:

A) B) C) D)

0 $5,764 $8,000 $11,824

78) Which of the following statements is correct with respect to the use of fair value accounting for liabilities under IFRS?

A) Both IFRS and U.S. GAAP require changes in credit quality to be recorded in operating income. B) The fair value option is permitted under IFRS only under two specific sets of circumstances. C) U.S. GAAP is more restrictive than IFRS regarding the use of fair value accounting for liabilities. D) Fair value accounting under IFRS is only permitted if the liabilities are actively managed on a fair value basis as part of the company’s documented risk management or investment strategy.

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79) On January 1, 20X1 when the effective interest rate was 12%, Philips Co. issued bonds with a maturity value of $200,000. The stated rate of interest is 12% and the bonds pay interest semi-annually. Philips Co. paid $2,000 in bond issue costs on this date. Under IFRS the bonds will be recorded on the January 1, 20X1 balance sheet of Philips Co. at:

A) B) C) D)

$200,000 $202,000 $198,000 Cannot be determined based on the information provided.

80) On January 1, 20X1 when the effective interest rate was 12%, Philips Co. issued bonds with a maturity value of $200,000. The stated rate of interest is 12% and the bonds pay interest semi-annually. Philips Co. paid $2,000 in bond issue costs on this date.If Philips Co. uses IFRS, the effective interest rate will be:

A) B) C) D)

slightly lower than 12%. slightly higher than 12%. 12%. Cannot be determined based on the information provided.

81) Dora Company issues a three-year non-interest bearing note in exchange for a piece of equipment. Dora should record the note at:

A) face value. B) the present value of the face amount. C) the fair value of the equipment. D) the equipment’s estimated value in use.

82) Roberts owns 100 shares of $1,000 face amount convertible bonds issued by Bearny Inc. Choose the statement that correctly describes this transaction.

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A) Roberts may choose to exchange the bonds for Bearny Inc. common stock, or retain the bonds until maturity. B) Roberts must exchange the bonds for Bearny Inc. common stock prior to maturity. C) Roberts must exchange the bonds for Bearny Inc. common stock at maturity. D) Bearney Inc. may require that Roberts exchange the bonds for its common stock.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 83) On January 1, 20X1, Sharp Company issued bonds with a face value of $500,000. The bonds mature in ten years and have a stated rate of 8%.Requirements:Determine the selling price of the bonds if the market rate of interest was 10%.Determine the selling price of the bonds if the market rate of interest was 6%.

84) The following information pertains to a bond issue of the Atomic Corporation:Maturity value: $1,000,000Maturity date: January 1, 2023Stated interest rate: 8%Interest payments are made annually on December 31stDate of issue: January 1, 20X1The bond is dated January 1, 20X1Effective (market) interest rate: 10%Requirements:At what price were the bonds issued?Using the effective interest method, prepare an amortization schedule showing annual interest expense, annual discount or premium amortization, and carrying value through December 31, 20X3.Prepare the necessary journal entries on January 1, 20X1 and December 31, 20X2.How should the bonds be shown on Atomic’s December 31, 20X1 balance sheet?

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85) On January 1, 20X1, when the market rate of interest was 12%, Habs Company issued five–year bonds with a maturity value of $750,000. The bonds have a 10% stated rate and pay interest semi-annually on July 1 and December 31.Requirements:Calculate the bond discount as of the date of issue.Calculate the bond discount balance as of January 1, 20X1.

86) On July 1, 20X1, The Wings Corporation paid $460,000 plus accrued interest to retire bonds with a maturity value of $500,000. The bonds had a book value of $475,131 on January 1, 20X1. The stated interest rate is 8% with interest payments being made annually on December 31; the bonds were issued at a time when the market interest rate was 10%.Requirement:Determine the gain or loss on the bond retirement.

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Answer Key Test name: chapter 12 1) FALSE 2) TRUE 3) TRUE 4) FALSE 5) FALSE 6) FALSE 7) TRUE 8) TRUE 9) FALSE 10) TRUE 11) TRUE 12) C 13) A 14) D 15) B 16) B 17) C 18) C 19) B 20) B 21) A 22) C 23) B 24) C 25) D 26) C Version 1

27) B 28) B 29) B 30) B 31) B 32) B 33) A 34) A 35) B 36) D 37) A 38) C 39) D 40) B 41) C 42) B 43) C 44) B 45) A 46) B 47) C 48) A 49) A 50) C 51) D 52) B 53) C 54) D 55) A 56) D Version 1

57) A 58) D 59) D 60) B 61) B 62) A 63) C 64) A 65) B 66) C 67) D 68) C 69) D 70) C 71) A 72) C 73) B 74) B 75) C 76) A 77) B 78) B 79) C 80) B 81) C 82) A 83) 1. $438,553 = ($500,000 × 0.38554) + ($40,000 × 6.14457) 2. $573,599 = ($500,000 × 0.55839) + ($40,000 × 7.36009)

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84) 1. $924,184 = $80,000 × 3.790787 (Present value of an ordinary annuity, 10%, 5 periods) + $1,000,000 × 0.620921 (Present value of a single sum, 10%, 5 periods). 2. Bond Amortization Schedule Date

Interest Expense

Cash Payment

12/31/X1

$ 92,418

$ 80,000

12/31/X2

93,660

12/31/X3

95,026

Discount Amortization

Book Value $ 924,184

01/01/X1 $

12,418

936,602

80,000

13,660

950,262

80,000

15,026

965,288

3. January 1, 20X1 Cash

924,184

Bond premium

75,816

Bonds payable

1,000,000

December 31, 20X2 Interest expense

93,660

Bond Discount

13,660

Cash

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80,00

4. December 31, 20X1 Balance Sheet Bonds payable

$ 1,000,000

(Bond discount) Book value

(63,398 ) $

936,602

85) 1. $55,204 = $750,000 − $694,796 [($750,000 × 0.55839) + ($37,500 × 7.36009)] 2. $46,577 = $55,204 − $4,188 (July 1, 20X1 amortization) −$4,439 (December 31, 20X1 amortization) 86) July 1, 20X1 Interest expense Discount on bonds payable

23,757 ($475,131 × 0.05) 3,757

Interest payable Bonds payable

20,000 ($500,000 × 0.04) 500,000

Discount on bonds payable Carrying value Cash (bonds only)

21,112 ($24,869 [$500,000 − $475,131] − $3,757) 478,888 ($500,000 − $21,112) 460,000

Gain on bond retirement

18,888 ($460,000 − $478,888)

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CHAPTER 13: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Consistent with ASC 842, accounting for assets and liabilities associated with a longterm operating leases is identical to accounting for financing leases. ⊚ ⊚

true false

2) Under ASC 842, when accounting for a long-term operating lease, a liability is recognized on the lease commencement date. ⊚ ⊚

true false

3) Under ASC Topic 840 and IFRS 16, FASB and IASB revised lease accounting rules to address off -balance sheet financing. ⊚ ⊚

true false

4) Loan covenants are one reason lessees prefered operating lease treatment under prior lease accounting standards. ⊚ ⊚

true false

5) Consistent with ASC Topic 842, the lessee of a finance lease must amortize a leased asset over the lease term assuming that any one of the lease criteria applicable to the lessee are met. ⊚ ⊚

true false

6) The annual interest expense associated with a finance lease decreases over the term of the lease. ⊚ ⊚ Version 1

true false 1

7) A lessee’s minimum lease payments includes the present value of a residual value guarantee. ⊚ ⊚

true false

8) The new lease accounting standard ASC Topic 842 is effective for U.S. public companies beginning with fiscal periods starting January 1, 2019. ⊚ ⊚

true false

Managers in lessee companies tend to prefer that leases be treated as finance leases. ⊚ ⊚

true false

10) IFRS-compliant public companies must implement IFRS No. 16 effective January 1, 2019. ⊚ ⊚

true false

11) The lessor’s Net investment in leased asset balance is the same at the end of the lease term whether the residual value is guaranteed or unguaranteed. ⊚ ⊚

true false

12) For a lease classified as a sales-type lease where collectability is probable, the lessor derecognizes the asset whether or not a manufacturing profit is involved. ⊚ ⊚

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true false

13) Under ASC 842 for sale and leaseback transactions, if the seller-lessee does not relinquish control of the asset, then the seller-lessee would record the cash received as a loan payable rather than as revenue. ⊚ ⊚

true false

14) Consistent with ASC 842, the lessor records all leases that meet one of the five classification criteria as sales-type lease, whether or not a manufacturing profit is derived. ⊚ ⊚

true false

15) Under ASC 842 and IFRS 16, the standards are converged in that there are five criteria to determine whether a lease qualifies as a finance lease for the lessee. ⊚ ⊚

true false

16) Under ASC 842, long-term operating leases are reported on the lessee’s balance sheet, and depreciation expense will be recorded for the right-of-use asset. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 17) Adoption of new GAAP for leases is expected to have this estimated effect on the financial statements of U.S. companies.

A) Increase in liabilities and assets of $200 million B) Increase in liabilities and assets of $2 billion C) Increase in liabilities and assets of $2 trillion D) No significant effect on financial statements is expected

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18)

Consistent with ASC Topic 842, lease contracts are classified in these categories:

A) Financing leases B) Operating leases C) Short-term leases D) All are lease contract categories under ASC Topic 842

19)

Consistent with ASC Topic 842 and IFRS 16, leases should be accounted for under the assumption.

A) property rights B) executory rights C) unilateral D) temporary

20) When accounting for a long-term operating lease under ASC 842, which one of the following accounts are charged with the expense on the lessee’s income statement?

A) Depreciation Expense B) Amortization Expense C) Rent Expense D) Lease Expense

21) Blume Corporation leases equipment for a ten-month period. The entire related lease payment is due at the end of the ten-month period. The journal entry to recognize the monthly accrual related to the lease will include a debit to:

A) short-term lease expense. B) accrued lease expense. C) leased equipment. D) interest expense.

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22) Consistent with ASC Topic 842, at the inception of the lease, lessees must recognize a “right-of-use” asset for which type of lease(s)?

A) Finance leases B) Finance leases and short-term leases C) Finance leases and operating leases D) Finance, short-term, and operating leases

23)

Consistent with ASC Topic 842, operating lease expense is equal to

A) the amortization expense recognized for financing leases. B) the interest expense recognized for financing leases. C) the lease expense that would have been recognized if classified as a short-term lease. D) the amortization expense recognized if the asset had been purchased by lessee.

24) a(n)

Consistent with ASC Topic 842, the amortization of the right-to-use asset fluctuates for

A) operating lease. B) financing lease. C) short-term lease. D) amortization tends to fluctuate for all types of leases.

25) If a corporation signs a ten-year lease for a building and the present value of the lease payments is $250,000, the lease is a finance lease under ASC 842 if the:

A) fair value of the building is $1,000,000. B) remaining useful life of the building is 20 years. C) lessor can purchase the building for $5,000 at the end of the lease when the fair value is estimated to be $25,000. D) building reverts back to the lessor at the end of the lease.

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26) GAAP establishes specific criteria for the treatment of leases under ASC 842. If any of the criteria are met, the lessee

A) must treat the lease as an operating lease. B) must treat the lease as a finance lease. C) may choose the treatment if two or less criteria are met. D) may elect to treat the lease as an operating lease if only one criterion is met.

27) GAAP establishes specific criteria for the treatment of leases under ASC 842. Which of the following does not accurately describe the criteria applicable to a lessee?

A) The lease agreement includes a bargain purchase option that the lessee is likely to exercise. B) The lease term allows the lessee to derive substantially all the remaining benefits associated with the asset. C) The lease agreement transfers title of the leased asset to the lessee at the end of the lease term. D) The present value of the minimum lease payments is equal to or greater than 75% of the leased asset’s fair value.

28) Over the lease term, the total income derived from a lease is classified as a sales-type lease instead of an operating lease.

if the lease is

A) higher B) the same C) lower D) depends on the interest rate applied to the lease

29) When a lessee has a finance lease under ASC 842, the amount shown for the asset and the amount shown for the related liability are equal

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A) only at the lease inception. B) throughout the life of the lease. C) only at the termination of the lease. D) throughout the life of the lease, but only when there is an unguaranteed residual value.

30) A lease that is properly classified as an operating lease consistent with ASC Topic 842 has the following payment structure over the five-year lease period:

20X1:

20X2:

$ 10,000

20X3-20X5:

30,000 /year

Operating expense recognized for 20X1 should be

A) B) C) D)

31)

$0 $10,000 $20,000 $30,000

Unequal lease payments relating to an operating lease should be

A) allocated equally to expense over the lease term. B) expensed when paid. C) allocated based on the utility of the asset. D) used to adjust the lease liability.

32) A lessor mistakenly treated a direct financing lease as an operating lease. How does this mistake impact the following at the end of the first year of the lease term?

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Rent/Lease Revenue

Interest Revenue

Overstated

Understated

Overstated

Understated

Overstated

33) A lessor mistakenly treated a sales-type lease without manufacturing profit as an operating lease (the lessor uses straight-line depreciation). How does this mistake impact the following at the end of the first year of the lease term? Net Income

Interest Revenue

Overstated

Understated

Overstated

Understated

Overstated

34) Which of the following is NOT considered an executory cost associated with a leased asset?

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A) Maintenance B) Insurance C) Taxes D) Amortization

35) An operating lease has unequal payments over the lease term. During the first year, the payment is $14,000; total payments over the five-year lease term are $120,000. Based on the present value of the total lease payments and the implicit interest rate, interest expense incurred during the first year is $6,000. Amortization of the right-to-use asset for year 1 should be:

A) B) C) D)

36)

$0 $8,000 $20,000 $24,000

Executory costs of a lease are treated by the lessee as:

A) capitalized costs of the lease. B) additional interest expense. C) operating expenses. D) deferred revenue.

37)

If a lease contains a residual value guarantee, the lessee must:

A) add the guaranteed amount to the present value of the minimum lease payments. B) add the present value of the guaranteed amount to the present value of the minimum lease payments. C) include the guaranteed amount in the minimum lease payments only if the lessee intends to keep the asset at the end of the lease. D) ignore the guaranteed amount if the lessee intends to keep the asset at the end of the lease.

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38) All the following statements about residual value guarantees are correct about residual value guarantees, except that they:

A) protect lessors against lessees who abuse leased assets. B) protect lessees against lessors who abuse leased assets. C) protects lessors against technological changes. D) protects lessors against marketplace changes.

39) Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor’s implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 842 guidelines for lease accounting.Present value interest factors are:

PV factor of $1 for 10 periods PV factor for ordinary annuity for 10 periods

10%

12%

0.38554 6.14457

0.32197 5.65022

To value the lease asset, Pepper should use a discount rate of:

A) B) C) D)

10%. 11%. 12%. prime rate.

40) Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor’s implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 842 guidelines for lease accounting.Present value interest factors are: Version 1

PV factor of $1 for 10 periods PV factor for ordinary annuity for 10 periods

10%

12%

0.38554 6.14457

0.32197 5.65022

The Pepper lease is a(n):

A) operating lease because ownership does not automatically transfer to the lessee at the end of the lease term. B) short-term lease because the lease value is less than the fair value of the asset. C) operating lease because the asset reverts to Blue at the end of the lease. D) finance lease because the lease term covers the major part of the economic life of the asset.

41) Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor’s implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 842 guidelines for lease accounting.Present value interest factors are:

PV factor of $1 for 10 periods PV factor for ordinary annuity for 10 periods

10%

12%

0.38554 6.14457

0.32197 5.65022

Upon acquisition, the leased equipment will be valued on Pepper’s balance sheet at (Round intermediate and final answer to the nearest whole dollar amount.)

A) B) C) D)

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$144,475. $157,469. $175,000. $250,000.

42) Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor’s implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 842 guidelines for lease accounting.Present value interest factors are:

PV factor of $1 for 10 periods PV factor for ordinary annuity for 10 periods

10%

12%

0.38554 6.14457

0.32197 5.65022

The lease liability will be valued on Pepper’s balance sheet at (Round intermediate and final answer to the nearest whole dollar amount.)

A) B) C) D)

$144,475. $157,469. $175,000. $250,000.

43) Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor’s implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 842 guidelines for lease accounting. Present value interest factors are:

PV factor of $1 for 10 periods PV factor for ordinary annuity for 10 periods

10%

12%

0.38554 6.14457

0.32197 5.65022

The entry to record this lease on Pepper’s books is (Round intermediate and final answer to the nearest whole dollar amount.)

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A) DR Right-to-use asset—finance lease 144,475 CR Finance lease liability 144,475 B) DR Right-to-use asset—finance lease 157,469 CR Finance lease liability 157,469 C) DR Right-to-use asset—finance lease — 157,469 DR Discount on lease obligation 92,531 CR Finance lease liability 250,000 D) DR Right-to-use asset—finance lease 167,469 DR Discount on lease obligation 82,531 CR Finance lease liability 250,000

44) Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor’s implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 842 guidelines for lease accounting.Present value interest factors are:

PV factor of $1 for 10 periods PV factor for ordinary annuity for 10 periods

10%

12%

0.38554 6.14457

0.32197 5.65022

At the end of Year 1, Pepper will make a payment of $30,000. Which one of the following entries will properly record this payment? (Round intermediate and final answer to the nearest whole dollar amount.)

A) DR Finance lease liability 30,000 CR Cash 30,000 B) DR Finance lease liability 14,253 DR Interest expense 15,747 CR Cash 30,000 C) DR Finance lease liability 9,253 DR Maintenance expense 5,000 DR Interest expense 15,747 CR Cash 30,000 D) DR Finance lease liability 25,000 DR Maintenance expense 5,000 CR Cash 30,000

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45) Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor’s implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 842 guidelines for lease accounting. Present value interest factors are:

PV factor of $1 for 10 periods PV factor for ordinary annuity for 10 periods

10%

12%

0.38554 6.14457

0.32197 5.65022

How much straight-line amortization expense will Pepper record for Year 1? (Round intermediate and final answer to the nearest whole dollar amount.)

A) B) C) D)

$14,747 $15,362 $15,747 $17,500

46) Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor’s implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 842 guidelines for lease accounting.Present value interest factors are:

PV factor of $1 for 10 periods PV factor for ordinary annuity for 10 periods

10%

12%

0.38554 6.14457

0.32197 5.65022

If the equipment is worth $12,500 at the end of the lease, Pepper will make which one of the following journal entries?

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A) DR Finance lease liability 12,500 CR Right-to-use asset 12,500 B) DR Finance lease liability 10,000 CR Right-to-use asset 10,000 C) DR Finance lease liability 10,000 CR Lease amortization 10,000 D) No entry required.

47) Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor’s implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 842 guidelines for lease accounting.Present value interest factors are:

PV factor of $1 for 10 periods PV factor for ordinary annuity for 10 periods

10%

12%

0.38554 6.14457

0.32197 5.65022

If the equipment is worth $7,500 at the end of the lease, Pepper will make which one of the following journal entries?

A) DR Finance lease liability 7,500 CR Right-to-use asset 7,500 B) DR Finance lease liability 12,500 CR Right-to-use asset 10,000 CR Cash 2,500 C) DR Finance lease liability 10,000 DR Loss on residual value guarantee 2,500 CR Right-to-use asset 10,000 CR Cash 2,500 D) No entry required.

48)

Under ASC 842, over the life of a lease, the amount charged to expense is:

A) greater for an operating lease. B) greater for a finance lease. C) the same for a finance or operating lease. D) less for a finance lease.

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49) Under ASC 842, the difference between the expense charged relating to a finance lease and an operating lease is:

A) the amount of total expense, with a finance lease higher than an operating lease. B) the amount of total expense, with an operating lease higher than a finance lease. C) the number of years that recognize expense. D) the timing of the expense recognition.

50) To adjust for distortions that arise from off-balance sheet leases when comparing among firms, analysts relied on

A) the balance sheet. B) the income statement. C) the statement of stockholders’ equity. D) required note disclosures.

51)

Which one of the following ratios increases with the lessee’s capitalization of a lease?

A) Current ratio B) Return on equity C) Inventory turnover D) financial leverage

52)

Which of the following does not describe a difference between ASC 842 and IFRS16?

A) IFRS allows some right-of-use assets to be carried at fair value. B) IFRS does not provide for operating leases. C) IFRS permits early adoption only if firms have adopted IFRS 15, the new revenue recognition standard. D) ASC 842 limits the recognized gain to that of the residual interest retained by the buyer-lessor.

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53) If a car dealership leases cars for four years with guaranteed purchase options, guaranteed residual values, and insured financing agreements, the dealership classifies the lease as a(n):

A) operating lease. B) short-term lease. C) sales-type lease. D) finance lease.

54) Blue Manufacturing produces lathes at an inventory cost of $25,000 each that sell for $32,000 each. For credit-approved customers, Blue leases the lathes for $8,500 per year for five years. The lathes are guaranteed to last four years and generally have a six-year life. Collection is predictable and reasonably assured. Additionally, the lessor is aware of all costs to be incurred under the lease that will not be reimbursed by the lessor.Blue Manufacturing treats a lathe lease as a(an)

A) operating lease. B) short-term lease. C) sales-type lease. D) direct-financing lease.

55) Blue Manufacturing produces lathes at an inventory cost of $25,000 each that sell for $32,000 each. For credit-approved customers, Blue leases the lathes for $8,500 per year for five years. The lathes are guaranteed to last four years and generally have a six-year life. Collection is predictable and reasonably assured. Additionally, the lessor is aware of all costs to be incurred under the lease that will not be reimbursed by the lessor.What is the manufacturing profit of Blue Manufacturing on a leased lathe?

A) B) C) D)

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$7,000 $8,500 $10,500 $17,500

56) Blue Manufacturing produces lathes at an inventory cost of $25,000 each that sell for $32,000 each. For credit-approved customers, Blue leases the lathes for $8,500 per year for five years. The lathes are guaranteed to last four years and generally have a six-year life. Collection is predictable and reasonably assured. Additionally, the lessor is aware of all costs to be incurred under the lease that will not be reimbursed by the lessor.What is the financing profit of Blue Manufacturing on a leased lathe?

A) B) C) D)

$7,000 $8,500 $10,500 $17,500

57) On January 1, 20X1, Lessee Corporation entered into a ten-year lease agreement. The lease terms required annual year-end payments of $160,000. The lease agreement does not contain either a bargain purchase option or a transfer of title. The fair value of the equipment at the inception of the lease was $1,100,000; estimated life of the leased assets was fourteen years. Lessee Corporation’s incremental borrowing rate was 10%; the implicit rate of interest, known to the lessee, was 12%. Applicable time value of money values are as follows:

Ten-year, 10% ordinary annuity Ten-year, 12% ordinary annuity Ten-year, 10% annuity due Ten-year, 12% annuity due

6.144 5.650 6.759 6.328

Lessee Corporation should classify this lease agreement as a(n):

A) Operating lease B) Financing lease C) Short-term lease D) Sales-type lease

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58) Ford signs a non-cancelable 8-year equipment lease with Ray. The lease has an implicit rate of return of 10% to Ray, the lessor. This rate is known to Ford. Ray’s incremental borrowing rate is 8.5%. Ford has a 9% incremental borrowing rate. Ray believes that the equipment has a 10-year service life but has reason to suspect that a major overhaul might be required in the fifth to seventh year. Since this is the first year of the equipment’s production, Ray warrants equipment for eight full years anyway.On Ray’s books, this lease is treated as a(n):

A) operating lease. B) short-term lease. C) finance capital lease. D) sales-type capital lease.

59) Ford signs a non-cancelable 8-year equipment lease with Ray. The lease has an implicit rate of return of 10% to Ray, the lessor. This rate is known to Ford. Ray’s incremental borrowing rate is 8.5%. Ford has a 9% incremental borrowing rate. Ray believes that the equipment has a 10-year service life but has reason to suspect that a major overhaul might be required in the fifth to seventh year. Since this is the first year of the equipment’s production, Ray warrants equipment for eight full years anyway.On Ford’s books, this lease is treated as a/an:

A) operating lease. B) short-term lease. C) finance lease. D) sales-type capital lease.

60) Ford signs a non-cancelable 8-year equipment lease with Ray. The lease has an implicit rate of return of 10% to Ray, the lessor. This rate is known to Ford. Ray’s incremental borrowing rate is 8.5%. Ford has a 9% incremental borrowing rate. Ray believes that the equipment has a 10-year service life but has reason to suspect that a major overhaul might be required in the fifth to seventh year. Since this is the first year of the equipment’s production, Ray warrants equipment for eight full years anyway.Ford uses which one of the following interest rates to record this lease?

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A) Use 9.0% because it is the lessee’s incremental borrowing rate. B) Use 10.0% because it is the implicit lease rate of return to the lessor. C) Use 8.5% because it is the lesser of the implicit rate and Ray’s incremental borrowing rate. D) Use 9.0% because it is the lesser of the implicit rate and Ford’s incremental borrowing rate.

61) Ford signs a non-cancelable 8-year equipment lease with Ray. The lease has an implicit rate of return of 10% to Ray, the lessor. This rate is known to Ford. Ray’s incremental borrowing rate is 8.5%. Ford has a 9% incremental borrowing rate. Ray believes that the equipment has a 10-year service life but has reason to suspect that a major overhaul might be required in the fifth to seventh year. Since this is the first year of the equipment’s production, Ray warrants equipment for eight full years anyway.Assuming that the lease is a sales-type lease for Ray, which one of the following interest rates will Ray use to record this lease?

A) Use 8.5% because it is the lessor’s incremental borrowing rate. B) Use 9.0% because it is the lessee’s incremental borrowing rate. C) Use 10.0% because it is the implicit lease rate of return to the lessor. D) Use 8.5% because it is the lesser of the implicit rate and Ray’s incremental borrowing rate.

62) Morey Corporation leases a tractor from Equity Leasing with a five-year non-cancelable lease on January 1, 20X1 under the following terms: Five payments of $26,379.74 (a 9% implicit rate, known to Morey) due at the end each year.The payments were calculated based on the fair value (which is also the book value for Equity) of the tractor.The lease is nonrenewable and the tractor reverts to Equity at the end of the lease term.The tractor has a six-year economic life.Morey has an excellent credit rating.Equity offers no warranty on the tractor other than the manufacturer’s two-year warranty that is handled directly with the manufacturer.For Equity Leasing, this is treated as a(n)

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A) operating lease. B) short-term lease. C) finance capital lease. D) sales-type capital lease.

63) Morey Corporation leases a tractor from Equity Leasing with a five-year non-cancelable lease on January 1, 20X1 under the following terms: Five payments of $26,379.74 (a 9% implicit rate, known to Morey) due at the end each year.The payments were calculated based on the fair value (which is also the book value for Equity) of the tractor.The lease is nonrenewable and the tractor reverts to Equity at the end of the lease term.The tractor has a six-year economic life.Morey has an excellent credit rating.Equity offers no warranty on the tractor other than the manufacturer’s two-year warranty that is handled directly with the manufacturer. For Morey, this lease is treated as a(n)

A) operating lease. B) short-term lease. C) finance lease. D) sales-type capital lease.

64) Morey Corporation leases a tractor from Equity Leasing with a five-year non-cancelable lease on January 1, 20X1 under the following terms: Five payments of $26,379.74 (a 9% implicit rate, known to Morey) due at the end each year.The payments were calculated based on the fair value (which is also the book value for Equity) of the tractor.The lease is nonrenewable and the tractor reverts to Equity at the end of the lease term.The tractor has a six-year economic life.Morey has an excellent credit rating.Equity offers no warranty on the tractor other than the manufacturer’s two-year warranty that is handled directly with the manufacturer.Equity records this lease with which one of the following journal entries?

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A) DR Lease receivable 102,607.95 CR Equipment 102,607.95 B) DR Net investment in leased assets 131,898.70 CR Equipment 102,607.95 CR Unearned financing income—Leases 29,290.75 C) DR Accounts receivable—Lease 131,898.70 CR Cash 26,379.74 CR Equipment 105,518.96 D) DR Gross investment in leased assets 131,898.70 CR Equipment 105,518.96 CR Cash 26,379.74

65) Morey Corporation leases a tractor from Equity Leasing with a five-year non-cancelable lease on January 1, 20X1 under the following terms: Five payments of $26,379.74 (a 9% implicit rate, known to Morey) due at the end each year.The payments were calculated based on the fair value (which is also the book value for Equity) of the tractor.The lease is nonrenewable and the tractor reverts to Equity at the end of the lease term.The tractor has a six-year economic life.Morey has an excellent credit rating.Equity offers no warranty on the tractor other than the manufacturer’s two-year warranty that is handled directly with the manufacturer.Which of the following entries will Morey prepare to record the lease of the tractor on January 1, 20X1?

A) DR Right-of-use asset 102,607.95 CR Finance lease liability 102,607.95 B) DR Right-of-use asset 131,898.70 CR Cash 26,379.74 CR Finance lease liability 105,518.96 C) DR Right-of-use asset 131,898.70 CR Cash 131,898.70 D) DR Rent expense 26,379.74 CR Cash 26,379.74

66) Morey Corporation leases a tractor from Equity Leasing with a five-year non-cancelable lease on January 1, 20X1 under the following terms: Five payments of $26,379.74 (a 9% implicit rate, known to Morey) due at the end each year.The payments were calculated based on the fair value (which is also the book value for Equity) of the tractor.The lease is nonrenewable and the tractor reverts to Equity at the end of the lease term.The tractor has a six-year economic life.Morey has an excellent credit rating.Equity offers no warranty on the tractor other than the manufacturer’s two-year warranty that is handled directly with the manufacturer. Which of the following entries will Equity Leasing prepare to record the receipt of the first payment on December 31, 20X1?

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A) DR Cash 26,379.74 B) DR Cash 26,379.74 income-Leases 9,234.72 C) DR Cash 26,379.74 D) DR Cash 26,379.74

CR Financing (interest) income-Leases 26,379.74 CR Lease receivable 17,145.02 CR Financing (interest) CR Leased equipment 26,379.74 CR Lease receivable 26,379.74

67) Morey Corporation leases a tractor from Equity Leasing with a five-year non-cancelable lease on January 1, 20X1 under the following terms: Five payments of $26,379.74 (a 9% implicit rate, known to Morey) due at the end each year.The payments were calculated based on the fair value (which is also the book value for Equity) of the tractor.The lease is nonrenewable and the tractor reverts to Equity at the end of the lease term.The tractor has a six-year economic life.Morey has an excellent credit rating.Equity offers no warranty on the tractor other than the manufacturer’s two-year warranty that is handled directly with the manufacturer.With which of the following entries will Morey prepare for the second payment December 31, 20X2?

A) DR Finance lease liability 26,379.74 CR Cash 26,379.74 B) DR Finance lease liability 17,145.02 DR Interest expense 9,234.72 CR Cash 26,379.74 C) DR Finance lease liability 18,688.08 DR Interest expense 7,691.66 CR Cash 26,379.74 D) DR Finance lease liability 7,691.66 DR Investment in leased asset 18,688.08 CR Cash 26,379.74

68) Hatfield Corporation leases a tractor from Star Leasing with a five-year non-cancelable lease on January 1, 20X1 under the following terms. Five payments of $26,379.74 (a 9% implicit rate) due at the end each year.The fair value of the tractor is $100,000.The lease is nonrenewable and the tractor reverts to Star at the end of the lease term.The tractor has a six-year economic life.Hatfield has an excellent credit rating.Star offers no warranty on the tractor other than the manufacturer’s two-year warranty that is handled directly with the manufacturer.If Hatfield’s incremental borrowing rate is 11% and the implicit rate is not known to the lessee, what interest rate will Hatfield use to account for this lease?

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A) B) C) D)

9% 10% 11% Cannot be determined from information given.

69) Hatfield Corporation leases a tractor from Star Leasing with a five-year non-cancelable lease on January 1, 20X1 under the following terms. Five payments of $26,379.74 (a 9% implicit rate) due at the end each year.The fair value of the tractor is $100,000.The lease is nonrenewable and the tractor reverts to Star at the end of the lease term.The tractor has a six-year economic life.Hatfield has an excellent credit rating.Star offers no warranty on the tractor other than the manufacturer’s two-year warranty that is handled directly with the manufacturer. With which one of the following entries will Hatfield prepare to record the payment on December 31, 20X1?

A) DR Finance lease liability 16,379.74 DR Interest expense 10,000.00 CR Cash 26,379.74 B) DR Finance lease liability 10,000.00 DR Interest expense 16,379.74 CR Cash 26,379.74 C) DR Finance lease liability 26,379.74 CR Cash 26,379.74 D) DR Interest expense 26,379.74 CR Cash 26,379.74

70) On January 1, 20X1 Lessee Company entered into a five-year lease which required annual payments of $60,000. The first payment was due at the inception of the lease. The present value of the minimum lease payments to record the lease was $250,192; the applicable discount rate was 10%. What is the balance of Lessee Company’s lease liability as of December 31, 20X1?

A) B) C) D)

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$209,211 $275,211 $190,192 $149,211

71) On January 1, 20X1, Lessee Company entered into a five-year lease which required annual payments of $120,000. The first payment was due at the inception of the lease. The present value of the mini-mum lease payments to initially record the lease was $500,384; the applicable discount rate was 10%. Lessee Company treated the lease as a finance lease under ASC 842. What is the balance of Lessee Company’s lease liability immediately after the January 1, 20X2 payment was made?

A) B) C) D)

$430,422 $260,384 $298,422 $380,384

72) On January 1, 20X1, Lessee Corporation entered into a ten-year lease. The lease terms required annual year-end payments of $160,000. The lease agreement does not contain either a bargain purchase option or a transfer of title. The fair value of the equipment at the inception of the lease was $1,100,000; estimated life of the leased assets was fourteen years. Lessee Corporation’s incremental borrowing rate was 10%; the implicit rate of interest, known to the lessee, was 12%. Applicable time value of money values are as follows:

Ten-year, 10% ordinary annuity Ten-year, 12% ordinary annuity Ten-year, 10% annuity due Ten-year, 12% annuity due

6.144 5.650 6.759 6.328

Lessee Corporation should initially capitalize the lease at what amount?

A) B) C) D)

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$0, the lease should not be capitalized $983,040 $1,081,440 $904,000

73) On January 1, 20X1, Lessor Corporation entered into a lease which was treated as a sales-type lease by Lessor Corporation. The leased asset’s book value within Lessor Corporation’s financial statements was $350,000 as of January 1, 20X1. The lease required the lessee to make ten annual payments of $50,000; the first payment was due at the beginning of the lease term and each January 1 thereafter. The present value of the minimum lease payments was $362,345. The implicit rate of interest, known to the lessee, was 8%, while the lessee’s incremental borrowing rate was 10%. The increase in Lessor Corporation’s net income for the year ended December 31, 20X1 was approximately

A) B) C) D)

$12,345. $37,333. $41,333. $24,988.

74) The difference in the lessor’s income recognition over the life of the lease, between an operating lease and a sales-type lease is:

A) zero. B) the amount of the interest revenue. C) the financing revenue minus the depreciation. D) the depreciation expense.

75) Which of the following is not a qualifier for a lease to be considered a finance lease under ASC 842?

A) The lease grants an option to purchase that is reasonably certain to occur. B) The lease transfers ownership at the end of the lease. C) The asset is not a specialized asset and will have alternative use to the lessor. D) The lease term is for the major part of the remaining economic life of the asset.

76) Under ASC 842 for lease accounting, which statement below is not accurate with respect to financial reporting?

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A) Finance leases show separate amounts for amortization and interest expense. B) Lease expense is shown in the operating section of the statement of cash flows. C) Operating leases show total lease expenses as a single line item. D) Lease expense is shown in the financing section of the statement of cash flows.

77) Klear Manufacturing sells its plant with a cost of $1.2 million to Burt Company for $1.4 million and immediately leases it back for a 15-year term. The transaction does not meet the revenue recognition criteria under ASC Topic 606. At the inception of the sale and leaseback, Klear should debit cash and credit

A) the asset. B) notes payable. C) sales revenue. D) lease liability.

78)

Which of the following is correct with respect to ASU 842 for lease accounting?

A) It retained the distinction between operating and finance leases for lessees. B) It is mandatory for fiscal years beginning after December 15, 2020 and may not be adopted early. C) It requires the lessee to record a prepaid asset and a lease liability. D) It allows the lessee to decide what borrowing rate to use to value the lease obligation.

79) Which of the following statement is not correct with respect to accounting for operating leases under ASC 842?

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A) The new standard is similar to the treatment of capital leases reported under prior GAAP (Topic 840) on the balance sheet. B) The new standard is similar to the treatment of operating leases reported under prior GAAP (Topic 840) on the income statement. C) The new standard is not similar to an operating lease reported under prior GAAP (Topic 840) on the income statement. D) The new standard is similar to an operating lease reported under prior GAAP (Topic 840) on the statement of cash flows.

80) Which of the following statements is not correct for sale-and-leaseback transactions consistent ASC Topic 842?

A) Seller-lessees have higher motivation to enter into a finance lease under ASC 842 than they did under prior GAAP (ASC 840). B) If the seller-lessee has the option to repurchase the asset at less than fair value of the asset at time of exercise, the transaction is not treated as a sale. C) If control of the asset has not been given up, the transaction is not a sale. D) The changes in ASC 842 give seller-lessees less incentive to enter into sale-andleaseback transactions.

81) 842?

Which of the following is not defined as qualitative disclosure information under ASC

A) Renewal and purchase options. B) Maturity information. C) Lease covenants and restrictions. D) Assumptions and judgments.

82) A seller/lessee who enters into a sale and leaseback agreement that does not meet revenue recognition criteria under ASC Topic 606 must account for the lease as a

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A) finance lease. B) operating lease. C) short-term lease. D) sales-type lease.

83) A seller/lessee who enters into a sale and leaseback agreement that meets revenue recognition criteria under ASC Topic 606

A) recognizes the profit margin on the sold/leased asset over the leaseback term. B) recognizes the profit margin on the sold/leased asset immediately. C) accounts for the leased asset as a finance lease. D) accounts for the leased asset a sale-type lease.

84) Consistent with ASC Topic 842, if a company sells an asset for a profit of $175,000 and immediately leases it back, the gain is recognized

A) immediately as an ordinary gain, assuming that criteria are met consist with ASC Topic 606. B) immediately as a gain to include in discontinued operations. C) over the life of the lease in proportion to the rental payment. D) over the life of the lease using the same rate and life used to amortize the leased asset.

85) The seller/lessee under a sales leaseback agreement that meets the criteria consistent with ASC Topic 606 must treat the leaseback portion as a(n)

A) operating lease. B) short-term lease. C) finance lease. D) sales-type capital lease.

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86)

Which item below is not an accurate description of lessor disclosures under ASC 842?

A) Disclosure includes qualitative and quantitative information. B) Disclosure includes the same maturity information required under ASC Topic 840, the lease standard. C) Disclosure includes operating lease income only for amounts that are variable payments. D) Disclosure includes the profit or loss associated with a sales type lease.

87) Which of the following does not properly describe the presentation by the lessor under ASC 842?

A) Sales type lease assets are presented as combined with other assets of the same category. B) For operating leases, income is presented on a straight-line basis on the income statement. C) A lease used as a method of selling manufactured products will include selling profit as the difference between revenue and cost of goods sold. D) Cash receipts from leases are shown in the operating activities section of the statement of cash flows.

88) Prior to FASB issuing pre-codified Statement of Financial Accounting Standards (SFAS) No. 13, lessees classified virtually all leases as leases, which under current GAAP is consistent with accounting for leases.

A) operating, finance B) finance, operating C) operating, short-term D) short-term, operating

89) Which of the following is a reason why lease accounting under U.S. GAAP and IFRS were revised?

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A) It was too easy for firms to circumvent lease capitalization criteria. B) To enhance comparability for analyzing different companies’ financial statements. C) Operating leases were a popular means of off-balance sheet financing. D) All of these answer choices are correct.

90) Samson Inc. leases equipment from Gerhard for a six-year period. The lease contract includes a purchase option, the conditions of which make it likely that Samson will exercise the option. The equipment’s estimated useful life is eight years. Samson should amortize the associated right-to-use asset over

A) 8 years. B) 6 years. C) 7 years. D) either 6 or 8 years.

91)

A lessor classifies leases that do not meet one of the five lease classification criteria as

A) operating lease. B) financing lease. C) sales-type lease. D) short-term lease.

92) Margot leases equipment with an estimated useful life of five years, for a term of four years. Margot should classify this lease as a (n)

A) operating lease. B) finance lease. C) short-term lease. D) purchase.

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93) Goff Industries has asked you to determine the financial statement effect of capitalizing its existing long-term leases, classified under prior GAAP, ASC Topic 840, as operating leases. The following information is available from Goff’s financial statements for the year ended December 31, 20X1: (Round all intermediate calculations to the nearest whole dollar.) Minimum operating lease payments: 20X2 $ 1,000 20X3

900

20X4

820

20X5

760

20X6

700

20X7 – 20Y1

2,500

Assuming that Goff’s long-term debt rate is 10%, what amount would be capitalizing the leases consistent with ASC Topic 842?

A) B) C) D)

$ - 0 – since the company has no finance leases. $6,680. $11,504. $3,223.

94) Flimm Company leases an asset over its estimated useful life of six years. At the inception of the lease, the present value of the lease payments is $240,000. The market value of the leased asset is $258,000. Flimm’s journal entry to recognize the inception of the lease includes a debit to

A) Equipment for $258,000 B) Equipment for $240,000 C) Right-to-use assets for $258,000 D) Right-to-use asset for $240,000

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95) Flimm Company leases an asset over its estimated useful life of six years. At the inception of the lease, the present value of the lease payments is $240,000. The market value of the leased asset is $258,000. Flimm’s journal entry to recognize the inception of the lease includes a credit to

A) Lease liability for $258,000. B) Lease liability for $240,000. C) Accrued lease payable for 43,000. D) Accrued lease payable for 40,000.

96) Flimm Company leases an asset over its estimated useful life of six years. At the inception of the lease, the present value of the lease payments is $240,000. The market value of the leased asset is $258,000. Flimm uses the straight-line method to allocate lease-related assets to accounting periods during which benefits are derived from the leased assets. To allocate the costs of the related asset, Flinn should debit

A) amortization expense for $43,000 B) amortization expense for $40,000 C) depreciation expense for $43,000 D) depreciation expense for $40,000

97) Flimm Company leases an asset over its estimated useful life of six years. At the inception of the lease, the present value of the lease payments is $240,000. The market value of the leased asset is $258,000. Assuming that the lease contract includes a highly favorable option for Flinn to purchase the leased equipment at the end of the lease term, Flinn should allocate the cost of the related asset by debiting

A) amortization expense for $43,000 B) amortization expense for $40,000 C) depreciation expense for $43,000 D) depreciation expense for $40,000

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98) Flimm Company leases an asset over its estimated useful life of six years. At the inception of the lease, the present value of the lease payments is $240,000. The market value of the leased asset is $258,000. The “property rights approach” is evident under ASB Topic 842 and IFRS No. 16 because both standards require that the

A) lessee recognize an asset and a liability for leases exceeding one year. B) leased property is transferred to the lessee at the end of the lease term. C) lessor must transfer the leased property at the inception of the lease. D) lessee must guarantee a residual value of the leased property.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 99) On October 1, 20X1, Kelly Company leased a boat from Grant Company. The lease is noncancelable and requires five equal annual payments of $50,000 each. The lease payments are due each October 1, beginning October 1, 20X1. The boat is recorded on Grant’s books at $207,542, which is equal to its fair value. Grant expects that the boat’s residual value at the end of the lease term will be $10,000, but it is not guaranteed by Kelly. However, Kelly has an option to purchase the boat for $10,000 at the end of the lease term. At the inception of the lease, the boat has a remaining economic life of six years with a $2,500 estimated salvage value at the end of its life. Both firms use the straight-line method of amortization and have December 31 yearends for financial reporting purposes. The interest rate used by Grant Company to calculate the annual lease payment is 12%, and known by Kelly. Collection of the lease payments is reasonably predictable by Grant. Required:Complete the following table for Grant’s and Kelly’s December 31, 20X1 income statements: Grant (Lessor)

Kelly (Lessee)

Sales Interest income Rent revenue Amortization expense Rent expense Interest expense

Be sure to show and clearly label all calculations. Version 1

100) Fischer Corporation leased new equipment to Swix Company on January 1, 20X1. The lease is for an eight-year period and requires equal annual payments of $35,000 due on January 1 of each year. The first payment was made at the inception of the lease. The fair value of the equipment and the present value of the payments was $217,223. The implicit interest rate is 8%. The equipment cost Fischer Corporation $160,000, has an estimated eight-year life, and a residual value of zero. Fischer Corporation uses straight-line depreciation. Fischer Corporation should have recorded the lease as a sales-type lease but mistakenly recorded the lease as an operating lease.Required:Determine the amount of the lease classification error on the following financial statement elements of Fischer Corporation, and whether the amount is overstated or understated:1) Net Income for the year ended 12/31/X1 2) Total assets as of 12/31/X2

101) Conroy Company leased equipment on January 1. Information pertinent to the lease is as follows: The lease term is 6 years.Annual payments of $60,000 are due on January 1 of each year; the first payment was made at the inception of the lease.Conroy’s incremental borrowing rate is 12%.The implicit interest rate is 10%; Conroy knew the implicit interest rate.The unguaranteed residual value is $50,000.The useful life of the equipment is 10 years.Conroy uses the straight-line depreciation method.The fair value of the equipment is $325,000.The lease agreement did not contain either a bargain purchase option or a transfer of title.Required: Prepare all the necessary journal entries for the year ended December 31, 20X1 with respect to Conroy Company’s lease.

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102) On January 1, 20X1, Cole Corporation entered into a ten-year lease agreement. The following summarizes the agreement: Payments of $30,000 are due at the beginning of each year; the first payment was made on January 1, 20X1.The leased asset has an estimated useful life of 15 years.Title to the leased asset is transferred to Cole at the end of the lease term.The implicit interest rate known by Cole is 10%.Cole’s incremental borrowing rate is 12%.Cole uses the straight-line depreciation method.The asset’s estimated salvage value is $50,000 after 10 years and is $15,000 after 15 years.Required:Determine the interest expense associated with the lease for the year ended December 31, 20X1.Determine the amortization expense for the year ended December 31, 20X1.

103) On January 1, 20X2, Coleus Corporation entered into a ten-year lease agreement. The following summarizes the agreement: Payments of $30,000 are due at the beginning of each year; the first payment was made on January 1, 20X2.The leased asset has an estimated useful life of 15 years.Title to the leased asset is transferred to Coleus at the end of the lease term.The implicit interest rate known by Coleus is 10%.Coleus’s incremental borrowing rate is 12%.Coleus uses the straight-line depreciation method.The asset’s estimated salvage value is $50,000 after 10 years and is $15,000 after 15 years.Required:Determine the interest expense associated with the lease for the year ended December 31, 20X2.Determine the amortization expense for the year ended December 31, 20X2.

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104) Flat Iron Corporation, a lessor, entered into a lease agreement on November 1, 20X1. The lease was for 6 years and required the lessee to make annual payments of $187,800 on November 1st of each year; the first payment was received by Flat Iron on November 1, 20X1. The leased asset cost Flat Iron $600,000, the implicit interest rate was 9%, and the asset’s useful life was 6 years. There were not any uncertainties regarding the collection of the lease payments and Flat Iron’s performance was considered to be complete as of November 1, 20X1. Flat Iron accounts for leases under ASC 840. Required:Determine the amount of income that will be reported by Flat Iron for the year ended December 31, 20X1.Prepare the necessary journal entries for the year ended December 31, 20X1.

105) On January 1, 20X1, Avalanche Company entered into an agreement to lease equipment for a ten-year period. The lease requires Avalanche to pay $220,000 on January first of each year, with the first payment required at the lease inception. Included within the $220,000 annual payment are executory costs totaling $15,000. Avalanche has the option to purchase the equipment at the end of the lease term for $55,000; the fair value of the equipment at the end of the lease term is estimated to be $120,000. The equipment’s useful life is estimated to be 12 years and the salvage value after 12 years is estimated to be $10,000. Avalanche’s incremental borrowing rate is 8% and the implicit rate known by Avalanche is 7%. Required: Determine the lease liability immediately after the January 1, 20X2 payment was made.Determine the book value of the leased asset as of December 31, 20X2.Determine the total expenses to be reported on the income statement for the year ended December 31, 20X2.

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106) On July 1, 20X2, Colber Company sold equipment to Chopper Corporation and simultaneously leased it back for five years. The equipment’s fair value on July 1, 20X2 was $875,000. Its original cost to Colber was $1,000,000 and it was being depreciated over 10 years on a straight-line basis. Colber has owned the equipment of three years and its book value was $700,000. Colber and Chopper agreed to an 8% interest rate with respect to the lease transaction. The equipment has a remaining life of five years and an estimated salvage value of zero after five years. Colber is required to make annual payments of $202,916 beginning July 1, 20X2. Required: Assume that the lease does not meet the criteria of ASC Topic 606. Prepare the necessary journal entries for Colber Company to record the sale-leaseback for the year ended December 31, 20X2. As-sume that the lease qualifies as a capital lease from Colber’s perspective. Colber accounts for leases under ASC 842.

107) Describe the criteria that the lessee must utilize when determining whether a lease is to be treated as a finance lease or as an operating lease according to ASC 842.

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Answer Key Test name: chapter 13 1) FALSE 2) TRUE 3) TRUE 4) TRUE 5) FALSE 6) TRUE 7) TRUE 8) FALSE 9) FALSE 10) TRUE 11) TRUE 12) TRUE 13) TRUE 14) TRUE 15) TRUE 16) FALSE 17) C 18) D 19) A 20) D 21) A 22) C 23) C 24) A 25) C 26) B Version 1

27) D 28) B 29) A 30) C 31) A 32) A 33) B 34) D 35) B 36) C 37) B 38) B 39) A 40) D 41) B 42) B 43) B 44) C 45) A 46) B 47) C 48) C 49) D 50) D 51) D 52) D 53) C 54) C 55) A 56) C Version 1

57) A 58) D 59) C 60) B 61) C 62) D 63) C 64) A 65) A 66) B 67) C 68) B 69) A 70) C 71) C 72) D 73) B 74) A 75) C 76) D 77) B 78) A 79) C 80) A 81) B 82) A 83) B 84) A 85) A 86) C Version 1

87) A 88) C 89) D 90) A 91) A 92) B 93) C 94) D 95) B 96) B 97) A 98) A 99) Grant (Lessor) Sales

Interest income Rent revenue Amortization Expense Rent expense Interest expense

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Kelly (Lessee)

(50,000 × PV Annuity Due 5, 12%) = 201,868; (10,000 × PV $15, 12%)= 5,674; 201,868 – 5,674 = 196,194 0.12 × (207,542 – 50,000) × 3/12 = 4,726 0 0 0 0

0 0 (201,868/5)× 3/12 = 10,093 0 (201,868 – 50,000) × 0.12 × 3/12 = 4,556

100) 1) Net income for the year ended 12/31/X1: $56,801 understand Sales-type lease net income should be $71,801. $71,801 = $57,223 (gross profit $217,223 − $160,000) + $14,578 (interest income ($221,723 − $35,000 first payment) × 8%). Operating lease net income is $15,000. $15,000 = $35,000 (revenue) − $20,000 (depreciation expense $160,000 ÷ 8 years). Sales-type lease income $71,801 − Operating lease income $15,000 = $56,801. 2) Total assets as of 12/31/X2: $54,745 understated Net investment in leased asset (sales-type lease) should be $174,745. $174,745 = $217,223 − $35,000 (1/1/X1 payment) + $14,578 (20X1 interest) − second payment 1/1/X2 of $35,000 + $12,944 interest for year 20X2. Interest for year 20X2 = ($217,223 − $35,000 + $14,578 − $35,000) × 8% = $12,944). Equipment book value (operating lease) is $120,000. $120,000 = $160,000 (original cost) − $40,000 (accumulated depreciation). Total assets under sales-type lease $174,745 − Total assets under operating lease $120,000 = $54,745. 101) January 1, 20X1:

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Right-to-use asset

287,447

Operating lease liability January 1, 20X1:

Operating lease liability

287,447 60,000

Cash December 31, 20X1:

Lease expense Interest payable

60,000 22,745 22,745

The lease does not meet the criteria of a finance lease given that there isn’t a bargain purchase option or a transfer of title; in addition, the lease term is not sufficiently long for the lessee to derive the major portion of the remaining benefit, nor does the present value of the lease payments exceed or is nearly equal to the fair value of the asset.Lease expense: $(287,447 − 60,000) × 0.10 = 22,745 102) The present value of the lease payments is $202,771 ($30,000 × 6.75902). The lease must be capitalized because of the transfer of title; as a result, the leased asset is to be depreciated over the useful life of the asset.Interest expense for 20X1 is $17,277 [($202,771 − $30,000) × 10%].Amortization expense for 20X1 is $12,518 [($202,771 − $15,000) ÷ 15 years]. 103) The present value of the lease payments is $202,771 ($30,000 × 6.75902). The lease must be accounted for as a finance lease because of the transfer of title; as a result, the right-of-use asset is to be amortized over the useful life of the asset.Interest expense for 20X2 is $17,277 [($202,771 − $30,000) × 10%].Amortization expense for 20X2 is $12,518 [($202,771 − $15,000)/15 years]. 104) The present value of the lease payments is $918,276 ($187,800 × 4.88965). 1.

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Dealer's profit Interest income 20X1 income

$ 318,276 ($918,276 − $600,000) $ 10,957 [($918,276 − $187,800) × 9% × 2/12] $ 329,233

2. November 1, 20X1 Net investment in leased asset

918,276

Cost of goods sold

600,000

Sales revenue

918,276

Inventory

600,000

Cash

187,800

Net investment in leased asset

187,800

December 31, 20X1 To accrue interest for two months: Net investment in leased asset Financing income—leases

10,957 10,957

105) The present value of the minimum lease payments is $1,568,581 [($205,000 × 7.51523) + (55,000 × .50835)]. 1.

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January 1, 20X1 liability

$ 1,568,581

January 1, 20X1 payment

−

205,000

20X1 interest accrual*

95,451

January 1, 20X2 payment

−

205,000

January 1, 20X2 liability

$ 1,254,032

[($1,568,581 − $205,000) × 7%] = $95,451

2. January 1, 20X1 book value

$ 1,568,581

20X1 amortization expense

−

129,882

20X2 amortization expense

−

129,882

December 31, 20X2 book value

$ 1,308,817

($1,568,581 − $10,000)/12 years = −$129,882

3. Amortization expense

$ 129,882

Interest expense*

87,782

Executory costs

15,000

Total expenses

$ 232,664

($1,568,581 − $205,000 + $95,451 − $205,000) × 0.07 = $87,782.

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106) July 1, 20X2 Cash

875,000

Loan payable

Loan payable Cash

875,000

202,916 202,916

December 31, 20X2 Interest expense*

26,883

Loan payable

Depreciation expense**

26,883

50,000

Accumulated depreciation

50,000

($875,000 − 202,916 = 672,084) × 8% × 6/12) = $26,883 ** ($1,000,000/10 years × 6/12) = $50,000 *

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107) The lessee and lessor will first ask the following four questions: Is there a transfer of title at the end of the lease?Is there a bargain purchase option?Is the lease term is for the major part of the remaining economic life of the asset?Is the present value of the minimum lease payments is equal to or exceeds substantially all of the fair value of the underlying asset?The underlying asset is of a highly specialized nature and the lessor has not alternative use at the end of the lease term. If the answer is no to all five questions, the lessee will treat the lease as an operating lease. If the answer is yes to any one of the five questions, the lessee will treat the lease as a finance lease.

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CHAPTER 14: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Taxable income is governed by the doctrine of constructive receipt or ability to pay. ⊚ ⊚

true false

Statutory depletion in excess of cost depletion is an example of a permanent difference. ⊚ ⊚

true false

3) Treating the taxes paid each year as an expense in the income statement could result in an inappropriate matching between pre-tax book income and income tax expense. ⊚ ⊚

true false

4) Income tax expense when interperiod tax allocation is used creates a more stable effective tax rate over time relative to using tax payments as income tax expense. ⊚ ⊚

true false

5) When using interperiod tax allocation, tax expense based on pre-tax income results in a proper matching of revenues and expenses in the income statement. ⊚ ⊚

true false

6) Creation of the deferred tax asset valuation allowance account is subjective and therefore provides management the opportunity to manage earnings. ⊚ ⊚

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true false

7) Once a deferred tax asset valuation allowance is established, it can be either increased or decreased in future years. ⊚ ⊚

true false

8) When the income tax rate changes, the full change in the amount of future liability for income taxes is recognized as a change to income tax expense in the year that the change becomes effective. ⊚ ⊚

true false

9) When future income tax rates change, the effect of the change on net income will be consistent across most companies regardless of their deferred tax balances. ⊚ ⊚

true false

10) A corporation that incurs a net operating loss may carry the loss back to earlier years before it can carry the loss forward. ⊚ ⊚

true false

11) The income tax benefit associated with a net operating loss carryforward is recorded as an adjustment to income tax expense in the year of the loss. ⊚ ⊚

true false

12) GAAP requires a disclosure that reconciles a company’s effective income tax rate and the U.S. statutory income tax rate. ⊚ ⊚

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true false

13) Financial statement disclosures concerning income taxes provides financial analysts with information regarding the transactions that had an impact on the year-end deferred income taxesbalance. ⊚ ⊚

true false

14) A significant decrease in the deferred tax asset account is relevant with respect to assessing earnings quality. ⊚ ⊚

true false

15) Under IFRS rules, deferred tax assets and deferred tax liabilities are always reported as noncurrent in a classified balance sheet. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) The GAAP solution for avoiding distortions that would result from setting income tax expense equal to taxes owed is called:

A) intraperiod tax allocation. B) interperiod tax allocation. C) book income allocation. D) intraperiod book allocation of income.

17) The allocation of income tax expense across periods when book and tax income differ is called:

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A) interperiod tax allocation. B) intraperiod tax allocation. C) current income tax allocation. D) constructive receipt allocation.

18) Changes in deferred tax assets and liabilities from one year to the next that are not included in the income tax entry based on continuing operations are explained by:

A) interperiod tax allocation. B) intraperiod tax allocation. C) current income tax allocation. D) constructive receipt allocation.

19) The two broad categories of differences that result from determining the pre-tax book income and the taxable income are:

A) temporary differences and originating differences. B) temporary differences and reversing differences. C) temporary differences and permanent differences. D) permanent differences and deferred differences.

20) Temporary differences that will cause taxable income in future periods to be higher than pre-tax book income in future periods give rise to:

A) deferred tax assets. B) deferred tax liabilities. C) permanent differences. D) tax refund receivable.

21) Temporary differences that will cause taxable income in future periods to be lower than pre-tax book income in future periods give rise to:

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A) deferred tax assets. B) deferred tax liabilities. C) permanent differences. D) expense.

22)

Which one of the following is a permanent difference between book and taxable income?

A) Interest received on municipal bonds B) Installment sales C) Bad debts expense D) Warranty expense

23) A temporary difference that causes book income to be greater than or less than taxable income when it is initially recorded is a/an:

A) reversing temporary difference. B) originating temporary difference. C) permanent difference. D) minor difference.

24)

Which of the following would not create a temporary difference?

A) A revenue included in the determination of book income this year but not included in taxable income until next year. B) An expense included in the determination of taxable income this year but not included in book income until next year. C) A revenue included in the determination of book income this year but never included in taxable income. D) A revenue item that causes book income to be more (less) than taxable income when it is initially recorded.

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25)

Which of the following items does not create a temporary difference?

A) The accrual of pension and OPEB expenses B) Installment sales C) Revenues received in advance D) The payment of life insurance premiums on company executives

26) A temporary difference created this year causes book income to be greater than taxable income; in future years, book income will be less than taxable income. The temporary difference in the future years’ incomes is referred to as:

A) reversing temporary difference. B) originating temporary difference. C) permanent difference. D) minor difference.

27)

Which of the following transactions would not create a temporary difference?

A) The cash payment to acquire a three-year insurance policy. B) The accrual of warranty expense. C) The accrual of bad debt expense. D) The cash collection of interest earned on a municipal bond.

28) Which of the following transactions would create a deferred tax liability on foreign income?

A) A U.S. company sells its products in a foreign country. B) A U.S. company earns income in a different country and pays the foreign government an income tax less than the U.S. corporate tax rate. C) A U.S. company earns income in a foreign country that it does not expect to repatriate back to the U.S. D) A foreign-based company sells its products to customers in the U.S.

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29)

Which of the following statements is not correct?

A) Temporary differences causing taxable income in future periods to be higher than book income in future periods create deferred tax liabilities. B) Temporary differences causing taxable income in future periods to be lower than book income in future periods create deferred tax assets. C) A permanent difference results when a revenue enters into the determination of book income in one period but affects taxable income in a different period. D) A temporary difference causing book income to be less than taxable income when initially recorded is described as an originating difference.

30) the:

The accounting principle violated if temporary differences are not taken into account is

A) historical cost principle. B) matching principle. C) conservatism principle. D) cost/benefit principle.

31) When income tax expense equals current income tax payable to the government plus (minus) the increase (decrease) in deferred tax liabilities, income tax expense is properly matched for the:

A) current period. B) previous period. C) future period. D) tax return.

32) Smith Company reported $350,000 in book income before income tax during 20X1, its first year of operation. The tax depreciation exceeded its book depreciation by $30,000. The tax rate for 20X1 and all future years was 21%.What amount of deferred tax liability should Smith report in its December 31, 20X1, balance sheet?

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A) B) C) D)

$6,300 $9,000 $10,000 $30,000

33) Smith Company reported $350,000 in book income before income tax during 20X1, its first year of operation. The tax depreciation exceeded its book depreciation by $30,000. The tax rate for 20X1 and all future years was 21%.If Smith paid no estimated taxes, what amount of income tax payable should Smith report in its December 31, 20X1, balance sheet?

A) B) C) D)

$52,500 $67,200 $73,500 $79,800

34) Smith Company reported $350,000 in book income before income tax during 20X1, its first year of operation. The tax depreciation exceeded its book depreciation by $30,000. The tax rate for 20X1 and all future years was 21%.Income tax expense reported in the income statement for the year ending December 31, 20X1 would be:

A) B) C) D)

$52,500. $67,200. $73,500. $79,800.

35) Stone Company reported pre-tax book income of $700,000 in 20X1, the first year of operation. The tax depreciation exceeded the book depreciation by $90,000. The tax rate for 20X1 and all future years was 21%.What amount of deferred tax liability should Stone report in its December 31, 20X1, balance sheet?

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A) B) C) D)

$3,500 $6,300 $14,000 $18,900

36) Stone Company reported pre-tax book income of $700,000 in 20X1, the first year of operation. The tax depreciation exceeded the book depreciation by $90,000. The tax rate for 20X1 and all future years was 21%.If Stone paid no estimated taxes, what amount of income tax payable should Stone report in its December 31, 20X1, balance sheet?

A) B) C) D)

$105,000 $112,000 $128,100 $147,000

37) Stone Company reported pre-tax book income of $700,000 in 20X1, the first year of operation. The tax depreciation exceeded the book depreciation by $90,000. The tax rate for 20X1 and all future years was 21%.Income tax expense reported in the income statement for the year ending December 31, 20X1 would be:

A) B) C) D)

$100,000. $120,000. $183,000. $147,000.

38) During 20X1, a company reported an increase in the deferred tax liability account of $77,990, an increase in the deferred tax asset account of $35,325, and an income tax liability as per the 20X1 income tax return of $398,555. What is the income tax expense to be reported in the income statement for the year ending December 31, 20X1?

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A) B) C) D)

$398,555 $441,220 $511,870 $285,555

39) During 20X1, a company reported an increase in the deferred tax liability account of $47,790, a decrease in the deferred tax asset account of $17,225, and an income tax liability as per the 20X1 income tax return of $198,375. What is the income tax expense to be reported on the income statement for the year ending December 31, 20X1?

A) $263,390 B) $228,940 C) $167,810 D) $198,375

40) Beginning in 2017 for calendar-year public firms, all deferred tax assets and liabilities are classified as:

A) current assets and liabilities. B) noncurrent assets and liabilities. C) income tax expense. D) none of these choices are correct.

41) During its first year of operations a company recorded accrued expenses totaling $250,000 for book purposes. For tax purposes, $100,000 of the expenses are deductible during the first year of operations and $150,000 are deductible during the second year of operations. The income tax rate for both years is 21%. The balance sheet at the end of the first year of operations will report a deferred tax:

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A) asset of $31,500. B) liability of $31,500. C) liability of $21,000. D) asset of $100,00.

42) During its first year of operations a company recorded accrued expenses totaling $375,000 for book purposes. For tax purposes, $175,000 of the expenses are deductible during the first year of operations and $200,000 are deductible during the second year of operations. The enacted income tax rate was 21% during the first year of operations and 25% during the second year of operations. The balance sheet at the end of the first year of operations will report a deferred tax:

A) asset of $42,000. B) liability of $42,000. C) liability of $50,000. D) asset of $50,000.

43) During its first year of operations a company recorded accrued warranty expense totaling $75,000 for book purposes. For tax purposes, $25,000 of the expenses are deductible during the first year of operations and $50,000 are deductible during the second year of operations. Book income from operations during the first year was $750,000. The enacted income tax rate was 21% during the first year of operations and 25% during the second year of operations. The income tax expense to be reported in the income statement for the first year of operations is:

A) B) C) D)

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$155,500. $168,000. $180,500. $200,000.

44) During 20X1, its first year of operations, a company recorded depreciation expense of $50,000 for book purposes. For tax purposes during 20X1, $100,000 of depreciation expense was deducted. The temporary difference created during 20X1 will reverse equally during 20X2 and 20X3. Book income from operations during the first year was $570,000. The income tax rate is 21%. The income tax expense to be reported in the income statement for the first year of operations is

A) B) C) D)

$119,700. $109,200. $130,200. $152,300.

45) For the year ending December 31, 20X1, the RJ Corporation reported book income before taxes of $579,000. During 20X1: RJ’s book depreciation expense was $25,000 greater than what was allowed for tax purposes due to a reversing difference; RJ accrued $17,750 of warranty expense which is not deductible for tax purposes until 20X2; RJ recognized a $29,000 unrealized loss on an investment which is not deductible for tax purposes until the investment is sold; and RJ’s book income included municipal bond interest of $19,500. What was RJ Corporation’s 20X1 income tax expense assuming a tax rate of 21%?

A) B) C) D)

$252,500 $132,563 $127,995 $123,375

46) Sand engaged in operations at the start of 20X1 and reported $550,000 in pre-tax book income for the year. Tax depreciation for Sand exceeded book depreciation by $50,000. The tax rate for 20X1 was 25%, and Congress had enacted a tax rate of 21% for the years after 20X1. What is the deferred tax liability for Sand at December 31, 20X1?

A) B) C) D)

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$10,500 $15,750 $21,000 $42,000

47) Sand engaged in operations at the start of 20X1 and reported $550,000 in pre-tax book income for the year. Tax depreciation for Sand exceeded book depreciation by $50,000. The tax rate for 20X1 was 25%, and Congress had enacted a tax rate of 21% for the years after 20X1. What is the current portion of the income tax expense for Sand for 20X1?

A) B) C) D)

$83,333 $125,000 $137,500 $150,000

48) Sand engaged in operations at the start of 20X1 and reported $550,000 in pre-tax book income for the year. Tax depreciation for Sand exceeded book depreciation by $50,000. The tax rate for 20X1 was 25%, and Congress had enacted a tax rate of 21% for the years after 20X1. What is the total income tax expense for Sand for 20X1?

A) B) C) D)

$112,500 $125,000 $135,500 $150,000

49) Sand engaged in operations at the start of 20X1 and reported $550,000 in pre-tax book income for the year. Tax depreciation for Sand exceeded book depreciation by $50,000. The tax rate for 20X1 was 25%, and Congress had enacted a tax rate of 21% for the years after 20X1.If Sand paid no estimated taxes, what is the amount of income tax payable for Sand at the end of 20X1?

A) B) C) D)

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$10,500 $30,500 $125,000 $135,500

50) Sand engaged in operations at the start of 20X1 and reported $550,000 in pre-tax book income for the year. Tax depreciation for Sand exceeded book depreciation by $50,000. The tax rate for 20X1 was 25%, and Congress had enacted a tax rate of 21% for the years after 20X1.The journal entry to record the taxes for Sand Company at December 31, 20X1 would be:

A) DR Income tax expense 146,000 CR Deferred tax liability 10,500 CR Income tax payable 135,500 B) DR Income tax expense 125,000 CR Cash 125,000 C) DR Income tax expense 135,500 CR Cash 135,500 D) DR Income tax expense 135,500 CR Deferred tax liability 10,500 CR Income tax payable 125,000

51) Taylor Company began manufacturing operations on January 2, 20X1. During 20X1 Taylor reported pre-tax book income of $150,000 and had taxable income of $200,000. Taylor had a temporary difference relating to accrued product warranty costs which are expected to be paid as follows:

20X2 20X3 20X4

$ $ $

30,000 15,000 5,000

The enacted tax rates are 21% for 20X1 and 20X2; and 25% for 20X3 and 20X4. The deferred tax asset at the end of 20X1 is:

A) B) C) D)

$6,000. $10,500. $11,300. $15,000.

52) Taylor Company began manufacturing operations on January 2, 20X1. During 20X1 Taylor reported pre-tax book income of $150,000 and had taxable income of $200,000. Taylor had a temporary difference relating to accrued product warranty costs which are expected to be paid as follows:

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20X2 20X3 20X4

$ $ $

30,000 15,000 5,000

If Taylor paid no estimated taxes, the income tax payable at the end of 20X1 is:

A) B) C) D)

$42,000. $43,750. $45,500. $46,900.

53) Taylor Company began manufacturing operations on January 2, 20X1. During 20X1 Taylor reported pre-tax book income of $150,000 and had taxable income of $200,000. Taylor had a temporary difference relating to accrued product warranty costs which are expected to be paid as follows:

20X2 20X3 20X4

$ $ $

30,000 15,000 5,000

Income tax expense for 20X1 is:

A) B) C) D)

$30,700. $45,000. $65,000. $67,000.

54) Davis Company began manufacturing operations on January 2, 20X1. During 20X1 Davis reported pre-tax book income of $85,000 and had taxable income of $75,000. Davis had a temporary difference relating to a prepaid asset which will be expensed as follows for book purposes:

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20X2 20X3

$ $

7,500 2,500

The enacted tax rates are 21% for 20X1 and 20X2; and 25% for subsequent years.If no other temporary differences occurred subsequent to 20X1, the deferred liability at the beginning of 20X3 is:

A) B) C) D)

$625. $1,000. $2,500. $1,350.

55) Davis Company began manufacturing operations on January 2, 20X1. During 20X1 Davis reported pre-tax book income of $85,000 and had taxable income of $75,000. Davis had a temporary difference relating to a prepaid asset which will be expensed as follows for book purposes:

20X2 20X3

$ $

7,500 2,500

The enacted tax rates are 21% for 20X1 and 20X2; and 25% for subsequent years.If Davis paid no estimated taxes, income tax payable at the end of 20X1 is:

A) B) C) D)

$15,570. $21,000. $25,200. $19,250.

56) Davis Company began manufacturing operations on January 2, 20X1. During 20X1 Davis reported pre-tax book income of $85,000 and had taxable income of $75,000. Davis had a temporary difference relating to a prepaid asset which will be expensed as follows for book purposes: Version 1

20X2 20X3

$ $

7,500 2,500

The enacted tax rates are 21% for 20X1 and 20X2; and 25% for subsequent years.Income tax expense for 20X1 is:

A) B) C) D)

57)

$17,850. $15,570. $17,770. $17,950.

GAAP specifies that when the tax rates change, the:

A) asset approach be adopted. B) balance sheet approach be adopted. C) retained earnings approach be adopted. D) income approach be adopted.

58) Under the balance sheet approach, the full change in the amount of future liability is recognized as an increase or decrease in income tax expense in the year the:

A) tax rate change is debated. B) tax law is proposed. C) tax law becomes effective. D) tax law is enacted.

59) At December 31, 20X1, the Rare Corporation reported a $23,000 deferred tax liability pertaining to a $100,000 temporary difference which will reverse equally during the next four years. On December 31, 20X1, after determining the deferred tax liability, Rare’s management was informed that the income tax rate for years subsequent to 20X1 had been changed to 21%. As a result of the tax rate change, Rare’s 20X1 income tax expense will

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A) not change. B) decrease $2000. C) increase $2,000. D) increase $1,200.

60) At December 31, 20X1, the Floyd Company reported a $29,600 deferred tax asset pertaining to a $80,000 temporary difference which will reverse equally during the next four years; Floyd also reported a $7,400 deferred tax liability pertaining to a $20,000 temporary difference which will reverse during 20X2. After determining the deferred tax asset and liability on December 31, 20X1, Floyd’s management was informed that the income tax rate for years subsequent to 20X1 had been changed to 21%. As a result of the tax rate change, Floyd’s 20X1 income tax expense will

A) increase $9,600. B) decrease $9,600. C) decrease $5,400. D) increase $5,400.

61) A company reported income tax payable of $79,500, an increase of $7,900 in its deferred tax asset, and an increase of $19,750 in deferred tax liability. What is the income tax expense?

A) B) C) D)

$91,350 $107,150 $51,850 $67,650

62) Which of the following is not a correct statement regarding deferred tax asset valuation allowance?

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A) The determination of whether or not a valuation allowance is necessary is based on subjective assessment. B) Profitable companies will never have valuation allowances against deferred tax assets. C) If a deferred tax asset may not be fully realized in future periods, a valuation allowance is required to reduce the asset to the amount that is more likely than not to be realized. D) Companies without a history of profitability may generate negative income tax expense in the year they first generate a profit if they have a valuation allowance that is reversed in the year of profitability.

63) If it is more likely than not that future benefits from a deferred tax asset will not be realized in its entirety, a(n):

A) revenue is established. B) valuation allowance is established. C) expense allowance is established. D) equity account is increased.

64)

A corporation that incurs a pre-tax operating loss must:

A) carryback the loss for tax purposes. B) carryforward the loss for tax purposes. C) choose to both carryback and carryforward the loss or to only carryback the loss. D) choose to both carryback and carryforward the loss or to only carryforward the loss.

65)

A corporation that incurs a net operating loss may carry the loss forward for

A) 10 years. B) 12 years. C) 20 years. D) an unlimited number of years.

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66) During its first three years of operations a company reported pre-tax book income of $1,000,000 in year 1, ($1,800,000) in year 2, and $3,000,000 in year 3. The income tax rate applicable to each of the years was 21%.Assume that there weren’t any temporary differences and a valuation allowance was not necessary.Which of the following is incorrect regarding the Tax Cuts and Jobs Act of 2017?

A) The corporate tax rate decreased significantly. B) U.S. GAAP changed in response to the tax law changes. C) Many companies needed to adjust existing deferred tax assets and liabilities. D) Income tax payable decreased for many corporations in 2017.

67) During its first three years of operations a company reported pre-tax book income of $1,000,000 in year 1, ($1,800,000) in year 2, and $3,000,000 in year 3. The income tax rate applicable to each of the years was 21%.Assume that there weren’t any temporary differences and a valuation allowance was not necessary.What amount of income tax expense was reported by the company in year 3 with respect to the net operating loss carryforward?

A) B) C) D)

68)

$880,000 $ 630,000 $ 378,000 $ 252,000

Consistent with ASU 2018-02, stranded tax effects may be

A) reclassified from AOCI to Retained earnings. B) recognized in current year income. C) amortized over the remaining life of the related tax item. D) written off against tax expense.

69)

Increases in deferred tax liability balances represent a potential:

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A) benefit. B) deterioration of earnings quality. C) source of cash flow. D) source of capital.

70) Analysts can use the deferred tax portion of the income tax note to the financial statements to undo differences in financial reporting choices across firms and thereby:

A) denigrate interfirm comparisons. B) improve interfirm comparisons. C) make interfirm comparisons impossible. D) make intracompany comparisons meaningful.

71) Which of the following statements does not correctly describe required income tax disclosures in the notes to the financial statements?

A) The statutory tax rate and the effective tax rate are disclosed. B) The sources that created deferred tax assets and deferred tax liabilities is a required disclosure. C) The effective tax rate applicable to firms in the same industry is a required disclosure. D) The expiration date of net operating loss carryforwards must be disclosed.

72) Which of the following does not properly describe the comparison of the effective income tax rate and the statutory income tax rate?

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A) The rates could differ due to the tax jurisdiction that a firm operates in. B) Permanent differences that cause book income to be higher than taxable income will cause the effective rate to be lower than the statutory rate. C) The reconciliation between the rates can reflect information pertaining to a firm’s tax policy decisions. D) A firm with aggressive tax policies will most likely have an effective tax rate that is much higher than the statutory rate.

73) Which of the following can’t be assessed by analyzing a company’s deferred tax note to the financial statements?

A) Earnings quality. B) The effective income tax rate. C) Future income tax expense. D) The impact of economic changes on deferred taxes.

74) Which of the following is not a proper description with respect to the financial accounting and reporting of income taxes?

A) A permanent difference does not create a deferred tax asset or liability. B) An originating temporary difference will eventually create a reversing temporary difference. C) A net operating loss carryforward does not have any impact on income tax expense for the year the loss occurs. D) Income tax expense changes during the year that future tax rate increases are enacted.

75) Which of the following results in an increase in income tax expense for a particular time period?

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A) An increase in the deferred tax asset account during the period. B) An increase in the income tax rate for future years that was enacted during the time period for a company reporting a deferred tax asset at the end of the period. C) A decrease in the deferred liability account during the period. D) An increase in the income tax rate for future years that was enacted during the time period for a company reporting a deferred tax liability at the end of the period.

76)

Financial accounting and reporting for deferred taxes:

A) results in a mismatching of revenues and expenses. B) does not allow investors to evaluate a firm’s earnings quality. C) does not require disclosure of a firm’s effective income tax rate. D) sometimes requires the creation of a liability for unrecognized tax benefits with respect to uncertain tax positions.

77)

A review of the balance sheet of growing companies will likely show:

A) an increase in deferred tax liabilities. B) a decrease in deferred tax liabilities. C) steady tax liabilities. D) no deferred tax liabilities.

78)

Which of the following statements is not true?

A) Generating deferred tax liabilities always increases cash flows. B) The use of certain tax accounting methods (such as accelerated depreciation) increases cash flows in the early years. C) Tax strategy, regardless of the generation of deferred tax liabilities, affects cash flow. D) All of these answer choices are true statements.

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79)

Uncertain tax positions:

A) are prohibited under GAAP. B) are recognized if they might be sustained solely on technical merits. C) require a two-step process to determine how much benefit should be recognized. D) are measured as the smallest amount of benefit that is cumulatively greater than 50 percent likely of being realized.

80)

Which of the following is included in the definition of a "tax position"?

A) It applies to only previously filed tax returns. B) It is reflected in measuring only current income tax payable. C) It applies only to annual periods. D) It includes both current and deferred taxes and applies to future tax periods as well as previously filed tax returns.

81) Klapper Company claimed a tax deduction which was uncertain when it was deducted in 20X1 but is relatively certain of receiving the deduction over a five-year period. Which of the following is not correct in accounting for the uncertain tax item?

A) As the company will ultimately get 100% of the deduction, no contingency reserve is required. B) A contingency reserve will be set up at the same amount as the deferred tax asset if the firm is certain it may claim 100% of the deduction over time. C) The contingency reserve is reduced each year with the offset to the deferred tax account. D) Income tax expense in the first year is the current portion of income tax expense minus the increase in the deferred tax asset.

82) Which of the following statements does not accurately describe disclosures of uncertain tax positions?

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A) Disclosures are not mandatory under U.S. GAAP. B) Disclosures are generally presented by year. C) Increases and decreases are disclosed separately. D) Each uncertain tax position is separately disclosed.

83) An analyst has reviewed Blunt Company’s note disclosures for its deferred taxes and noted a large increase in Blunt’s deferred tax liability. This increase could be caused by:

A) growth in capital expenditures. B) tax law changes that limit accelerated depreciation. C) GAAP warranty expenses that exceed tax warranty expenses. D) shortening the estimated useful lives of its fixed assets.

84)

Which of the following is not a correct statement?

A) Increases in deferred tax liability balances may indicate deteriorating earnings quality. B) Materiality guidelines for reporting changes in deferred tax assets and liabilities are specified in GAAP. C) Companies can artificially inflate earnings by using undisclosed estimate changes (e.g., warranty expense). D) While financial reporting choices may differ among firms, all firms will select tax policies that minimize the present value of their tax payments.

85) Which of the following items used for resolving intra-firm comparisons is not generally disclosed?

A) Depreciation methodology – straight line or accelerated. B) Deferred tax assets related to property plant and equipment. C) Adjustments to deferred tax assets related to asset sales. D) Differences between book and tax depreciation.

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86) Everwood Co. had net income of $1,000,000 for the year ending December 31, 20X1, its first year of operations. During this time period, Everwood also had a permanent tax difference of $120,000 and its adjusted pre-tax book income is $1,220,000. Analysts have approximated Everwood’s taxable income at $735,000 for the year ending December 31, 20X1. Which of the following most likely caused the difference between Everwood’s book and tax income?

A) Accrued warranty expenses not yet deductible on the tax return. B) A net operating loss carryback. C) Purchases of long-lived capital assets. D) Premiums paid on life insurance on key executives where the company is the beneficiary.

87) Which of the following correctly describes the tax rates used under U.S. GAAP and IFRS for deferred taxes?

GAAP uses enacted tax rates while IFRS uses enacted or substantively enacted tax

GAAP uses enacted or substantively enacted rates while IFRS uses only enacted tax

rates. rates. C) Both GAAP and IFRS use only enacted tax rates. D) Both GAAP and IFRS use substantively enacted tax rates.

88)

Which of the following is not a difference between IFRS and U.S. GAAP?

A) The use of a valuation allowance which must be separately disclosed. B) The required reconciliation of statutory and effective tax rates. C) The use of aggregate tax rates in reconciling statutory and effective tax rates. D) The required disclosure of the aggregate amount of current and deferred income taxes charged or credited directly to equity through Other comprehensive income.

89) Key differences between U.S. GAAP and IFRS regarding deferred taxes include all of the following except:

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A) reporting of deferred taxes on the balance sheet. B) uncertain tax positions. C) reconciliation of statutory and effective tax rates. D) use of the asset-liability approach.

90)

Under IFRS, deferred tax assets:

A) are not recognized. B) require a valuation allowance if it’s more likely than not that the deferred tax asset will not be realized. C) are recognized only to the extent it is deemed probable that they will be realized. D) are reported as current or noncurrent based on the expected date of the reversal of the temporary difference.

91)

Under IFRS, deferred taxes:

A) are netted into one net current amount or one net noncurrent amount. B) are always reported as noncurrent. C) are reported as one net amount per taxable entity. D) that will be realized are deemed current.

92) year

A net operating loss may offset this percentage in taxable income of a specific subsequent

A) B) C) D)

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100% 80% 60% 50%

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 93) The Matrix Company began operations as of the beginning of 20X1. During 20X1, Matrix reported GAAP (book) income before taxes of $789,500. For income tax purposes, depreciation expense was $150,000; for GAAP (book) purposes, depreciation expense was $74,000. Matrix accrued $900,000 of revenue for GAAP (book) purposes during 20X1; $600,000 of the accrued revenue was taxable during 20X1. Matrix earned interest of $79,800 from a municipal bond investment during 20X1. Matrix’s marginal income tax rate is 21%. Matrix did not make any income tax payments during 20X1. Requirements:1. Determine Matrix’s taxable income for the year ended December 31, 20X1.2. Prepare the 20X1 year-end journal entry to record income tax expense.

94) Smith company records pre-tax book income of $500,000 after accruing $1,000,000 in warranty expense in its first year of operations. No warranty claims were paid in the first year. The tax rate is 21%. Prepare the following:Amount of deferred tax assetAmount of income tax payableAmount of income tax expenseJournal entry to record income tax

95) Smith company records pre-tax book income of $500,000 after accruing $1,000,000 in warranty expense in its first year of operations. No warranty claims were paid in the first year. The tax rate is 21%.Suppose that prior to completing its first year’s financial statements Smith determines it is unlikely to earn enough taxable income in future years to realize more than $200,000 of its deferred tax asset.Prepare an appropriate journal entry to recognize this information.

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96) The Sting Company began operations at the beginning of 20X1 and had GAAP (book) income of $350,000 and taxable income of $280,000. During 20X1, depreciation expense for tax purposes exceeded GAAP (book) depreciation expense by $210,000, while warranty expense for GAAP (book) purposes exceeded warranty expense for tax purposes by $140,000. These two temporary differences will reverse as follows: Depreciation 20X2

Warranty

35,000

70,000

20X3

70,000

56,000

20X4

105,000

$ 14,000

The enacted income tax rate for 20X1 and 20X2 is 21%, while the enacted income tax rate for 20X3 and 20X4 is 25%. Sting did not make any income tax payments during 20X1.Requirement:Prepare the journal entry to record income tax expense for the year ended December 31, 20X1.

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97) On January 1, 20X1, Sun Company’s balance sheet reported a deferred tax liability of $115,500 and a deferred tax asset of $63,000. The future taxable amounts that existed as of January 1, 20X1, will reverse equally over the next four years beginning in 20X1, while the future deductible amounts that existed as of January 1, 20X1, will reverse equally over the next three years beginning in 20X1. The enacted income tax rate for all tax years as of January 1, 20X1, was 21%. On February 1, 20X1 the tax laws were amended resulting in income tax rates of 22% for 20X1 and 20X2; the income tax rate will be 23% for tax years 20X3 and later..Requirement:Prepare the journal entry on February 1, 20X1 to record the impact of the amended income tax rates.

98) Tyler Company, which began operations at the beginning of 20X1, has provided you with the following information:GAAP (book) income before taxes was $1,600,000 during 20X1 and $2,000,000 during 20X2Municipal bond interest of $40,000 was earned in both 20X1 and 20X2.Depreciation expense for tax purposes exceeded depreciation for GAAP (book) purposes by $180,000 during 20X1 and by $150,000 during 20X2. The depreciation temporary difference created during 20X1 and 20X2 will reverse equally during the next three years (20X3 – 20X5).A three-year insurance policy costing $54,000 was purchased using cash at the beginning of 20X1. The policy was deducted in the income statement equally for each year of the policy. The amount allowable as a deduction for tax purposes of $24,000 was taken in 20X1, and $15,000 will each be deducted in 20X2 and in 20X3.Revenues of $600,000 from various long-term construction contracts was recognized for GAAP (book) purposes during 20X1. For tax purposes, $100,000 of those revenues were recognized during 20X1, the remaining revenues will be recognized equally during 20X2 and 20X3.During 20X2, a customer paid $325,000 in advance for services to be provided during 20X2 and 20X3. Services valued at $120,000 were provided during 20X2.The income tax rate was 21% during 20X1 and 20X2 and 25% for all subsequent years.Requirements:Determine taxable income for 20X1.Prepare the journal entry to record income tax expense for the year ended December 31, 20X1.Determine taxable income for 20X2.Prepare the journal entry to record income tax expense for the year ended December 31, 20X2.

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99) Toner Company, which began operations at the beginning of 20X1, has provided you with the following information:GAAP (book) income before taxes was $1,600,000 during 20X1 and $2,000,000 during 20X2.Municipal bond interest of $40,000 was earned in both 20X1 and 20X2.Depreciation expense for tax purposes exceeded depreciation for GAAP (book) purposes by $180,000 during 20X1 and by $150,000 during 20X2.A three-year insurance policy costing $54,000 was purchased using cash at the beginning of 20X1. The policy was deducted in the income statement equally for each year of the policy. For tax purposes, $24,000 was allowable as a deduction in 20X1, and the remainder will be deducted equally in 20X2 and in 20X3.Revenues of $600,000 from various long-term construction contracts were recognized for GAAP (book) purposes during 20X1. For tax purposes, $100,000 of those revenues were recognized during 20X1, the remaining revenues will be recognized equally during 20X2 and 20X3.During 20X2, a customer paid $325,000 in advance for services to be provided during 20X2 and 20X3. Services valued at $120,000 were provided during 20X2.The income tax rate was 21% for all years.Requirements:Determine taxable income for 20X1.Prepare the journal entry to record income tax expense for the year ended December 31, 20X1.Determine taxable income for 20X2.Prepare the journal entry to record income tax expense for the year ended December 31, 20X2.

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100) For each of the items below, determine whether the items are temporary differences or permanent differences. Also, for each temporary difference, determine whether a deferred tax asset or deferred tax liability is created by the temporary difference described. Assume that each of the temporary differences described is an originating difference.Municipal bond interestAccrued warranty expenseSales revenues received in advancePrepaid insurance where the tax deduction in future years will be less than the book expenseTax depreciation expense exceeds GAAP (book) depreciation expenseAccrued bad debt expenseThe dividends received deductionSales revenue recognized currently for GAAP, recognized for tax purposes in future years)Life insurance payments for executives for which the company is the beneficiaryFines paid for law violations

101) K. Shuman purchased a landscape maintenance firm on 1/2/20X1 and renamed the firm Shuman Enterprises. Information regarding the firm for the first two years of operation is shown below:Pretax GAAP income was $100,000 in 20X1 and $150,000 in 20X2.Heavy equipment acquired in the purchase was valued at $120,000. The equipment had a life of 4 years and no salvage value. Depreciation for tax purposes was $48,000 in 20X1 and $36,000 in 20X2. Depreciation for GAAP purposes was $30,000 in each year.In 20X2, pretax GAAP income included $12,500 of interest on State of Indiana Bonds. This interest is not taxable for U.S. federal purposes.During 20X1, $40,000 was collected in advance for landscape maintenance to be performed in 20X2. This amount was included in 20X1 taxable income but was not included in GAAP income until 20X2. In 20X2, $25,000 was collected in advanced for work to be performed in 20X3. This amount was recognized as income for tax purposes in 20X2 but will not be recognized as income for GAAP purposes until 20X3.The enacted tax rate for 20X1 was 21%. The newly enacted tax rate for 20X2 and subsequent years is 25%.At December 31, 20X1, the Deferred tax asset account had a $12,000 debit balance, and the Deferred tax liability account had a $5,400 credit balance.Required:1. Compute Shuman’s GAAP income tax expense for the year ended December 31, 20X2.

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102) Spitzer Corporation manufactures supplies for drycleaning services. On October 1, 20X1, it purchased a new machine at a cost of $10 million. For financial reporting purposes, it depreciates the machine over its expected useful life of 20 years on a straight-line basis with no salvage value. Because of the timing of the purchase, depreciation is taken for one-fourth of a year in 20X1.For tax purposes, the machine qualifies as “10-year property.” For 10-year property, depreciation rates (all as a percentage of the initial investment) are 10% in the year the property was acquired, 18% the next year, then 14.4%, 11.52%, 9.22%, 7.37%, 6.55%, 6.55%, 6.56%, 6.55%, 3.28%. Note that depreciation of 10% is taken for tax purposes in the year of acquisition regardless of when during the year the asset was acquired.Ignore any deferred tax items that arise from any other sources. Assume a 21% tax rate.Required:What is the amount of Spitzer’s depreciation expense for financial reporting purposes in 20X1?What is the amount of Spitzer’s depreciation expense for tax purposes in 20X1?What is the amount of Spitzer’s depreciation expense for financial reporting purposes in 20X2?What is the amount of Spitzer’s depreciation expense for tax purposes in 20X2?Determine whether Spitzer has a deferred tax asset or a deferred tax liability as of December 31, 20X1. What is the balance of this item at December 31, 20X1?What is the amount of Spitzer’s deferred tax asset or deferred tax liability as of December 31, 20X2?What is the amount of the deferred portion of Spitzer’s 20 income tax expense?

103) The following analysis was adapted from KrisKraft’s 2017 Form 10-K. Use it to answer the questions that follow. KrisKraft reported income taxes payable of $151 million at December 31, 2016 and $100 million at December 31, 2017. 2017

2016

2015

(in millions) Earnings from continuing operations before income taxes: United States

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2,454

2,754

2,774

Outside United States Total

1,273

1,257

1,339

3,727

4,011

4,113

722

613

876

Provision for income taxes: United States federal: Current Deferred

(306 )

(150 )

(210 )

416

463

666

State and local (all current)

116

115

Total United States

532

558

781

Current

660

411

466

Deferred

(55 )

(18 )

(38 )

605

393

428

Outside United States:

Total outside United States Total provision for income taxes

1,137

951

1,209

Required:a) What was the total amount of income tax due to all jurisdictions during 2017?b) What was the total amount of income tax payments KrisKraft made to all jurisdictions during 2017?c) What was the total deferred tax asset or deferred tax liability for 2017? Select whether deferred tax asset or deferred tax liability in addition to providing the amount.d) What was the amount of income tax expense that appeared on KrisKraft’s 2017 income statement? Use the proper title found in the note disclosure for the total amount.

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Answer Key Test name: chapter 14 1) TRUE 2) TRUE 3) TRUE 4) TRUE 5) TRUE 6) TRUE 7) TRUE 8) FALSE 9) FALSE 10) FALSE 11) TRUE 12) TRUE 13) TRUE 14) TRUE 15) TRUE 16) B 17) A 18) B 19) C 20) B 21) A 22) A 23) B 24) C 25) D 26) A Version 1

27) D 28) B 29) C 30) B 31) A 32) A 33) B 34) C 35) D 36) C 37) D 38) B 39) A 40) B 41) A 42) D 43) A 44) A 45) B 46) A 47) B 48) C 49) C 50) D 51) C 52) A 53) A 54) A 55) A 56) D Version 1

57) B 58) D 59) B 60) A 61) A 62) B 63) B 64) B 65) D 66) B 67) B 68) A 69) B 70) B 71) C 72) D 73) D 74) C 75) D 76) D 77) A 78) A 79) C 80) D 81) A 82) A 83) A 84) B 85) C 86) C Version 1

87) A 88) B 89) D 90) C 91) B 92) B 93) 1. GAAP income

789,500

Excess tax depreciation expense

(76,000 )

Excess GAAP revenue

(300,000 )

Municipal bond interest

(79,800 )

Taxable income

333,700

2. December 31, 20X1 Income tax expense Income tax payable Deferred tax liability

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149,037 70,077 ($333,700 × 0.21 ) 78,960 ($376,000 × 0.21 )

94) a. Deferred tax asset = warranty expense × tax rate = $1,000,000 × 0.21 = $210,000 b. Income tax payable = book income + warranty expense = $1,500,000 × 0.21 = $315,000 c. Income tax expense (payable of $315,000 − deferred tax asset $210,000) = $105,000

Income tax expense

105,000

Deferred tax asset

210,000

Income tax payable

315,000

95) Income tax expense

10,000

Allowance to reduce deferred tax asset to expected realizable value

10,000

96) December 31, 20X1

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Income tax expense

77,700

Deferred tax asset

32,200 (1)

Deferred tax liability

51,100 (2)

Income tax payable

58,800 (3)

(1) ($70,000 × 0.21) + ($56,000 × 0.25) + ($14,000 × 0.25) (2) ($35,000 × 0.21) + ($70,000 × 0.25) + ($105,000 × 0.25) (3) ($280,000 × 0.21) 97) February 1, 20X1

Deferred tax asset

4,000 (1)

Income tax expense

750

Deferred tax liability

3,250 (2)

(1) The $63,000 deferred tax asset balance was calculated by multiplying the income tax rate by the dollar amount of the future deductible amounts (X); therefore, 0.21X = $63,000, and X equals $300,000. The $300,000 future deductible amount will reverse equally ($100,000) over the next three years, creating a deferred tax asset of $67,000 [($100,000 × 0.22) + ($100,000 × 0.22) + ($100,000 × 0.23)] given the new income tax rates. The debit to the deferred tax asset account is necessary to increase it from $63,000 to $67,000. (2) The $185,000 deferred tax liability balance was calculated by multiplying the income tax rate by the dollar amount of the future taxable amounts (X); therefore, 0.21X = $115,500, and X equals $550,000. The $550,000 future taxable amount will reverse equally ($137,500) over the next four years, including 20X1, creating a deferred tax liability of $112,250 [($137,500 × 0.22) + ($137,500 × 0.22) + ($137,500 × 0.23) + ($137,500 × 0.23)] given the new income tax rates. The credit to the deferred tax liability account is necessary to increase it from $115,500 to $112,250. 98) 1. 20X1

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GAAP(book)income before taxes

$ 1,600,000

Municipal bond interest

(40,000 )

Excess depreciation expense

(180,000 )

Insurance expense ($24,000 − $18,000)

(6,000 )

Revenues ($600,000 − $100,000)

(500,000 )

20X1 taxable income

Income tax expense

874,000

344,920

Deferred tax liability Income tax payable

161,380* 183,540 ($874,000 × 0.21)

*($180,000 × 0.25) + ($3,000 × 0.21) + ($3,000 × 0.25) + ($250,000 × 0.35) + ($250,000 × 0.25)3. 20X2 GAAP (book) income before taxes

$ 2,000,000

Municipal bond interest

(40,000 )

Excess depreciation expense

(150,000 )

Insurance expense

3,000

Revenues

250,000

Advance payment ($325,000 − $120,000)

205,000

20X2 taxable income

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$ 2,268,000

4. Income tax expense Deferred tax liability Deferred tax asset Income tax payable

409,400 15,630* 51,250 ($205,000 revenues × 0.25) 476,280 ($2,268,000 × 0.21)

*The account balance at the end of 20X2 should cumulatively be $145,750 [($330,000 × 0.25) depreciation + ($3,000 × 0.25) insurance + ($250,000 × 0.25) revenues]. The account balance prior to adjustment was $161,380 (see requirement 2); therefore, the account needs to be reduced by $15,630. 99) 1. 20X1 GAAP (book) income before taxes

$ 1,600,000

Municipal bond interest

(40,000 )

Excess depreciation expense

(180,000 )

Insurance expense: ($24,000 − $18,000)

(6,000 )

Revenues ($600,000 − $100,000)

(500,000 )

20X1 taxable income

Income tax expense

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874,000

327,600

Deferred tax liability

144,060*

Income tax payable

183,540 ($874,000 × 0.21)

*($180,000+ $6,000+ $500,000) × 0.213. 20X2 GAAP (book) income before taxes

$ 2,000,000

Municipal bond interest

(40,000 )

Excess depreciation expense

(150,000 )

Insurance expense: ($18,000 books; $15,000 tax)

3,000

Revenues

250,000

Advance payment ($325,000 − $120,000)

205,000

20X2 taxable income

$ 2,268,000

Income tax expense

586,200

Deferred tax liability Deferred tax asset

32,700*

Income tax payable

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43,050 ($205,000 × 0.21) 476,280 ($2,268,000 × 0.21)

*The account balance at the end of 20X2 should cumulatively be $233,200 [($330,000 additional depreciation – $3,000 reversal of insurance + $250,000 revenues) × 0.21 = $121,170]. The account balance prior to adjustment was $144,060 (see requirement 2); therefore, the account needs to be reduced by $22,890. 100) Permanent differenceTemporary difference, deferred tax assetTemporary difference, deferred tax assetTemporary difference, deferred tax liabilityTemporary difference, deferred tax liabilityTemporary difference, deferred tax assetPermanent differenceTemporary difference, deferred tax liabilityPermanent differencePermanent difference 101) 1. See following tables. Current provision

Pretax GAAP income

150,000

Depreciation

(6,000 )

Deferred revenue

(40,000 )

Deferred revenue

25,000

Interest income (permanent)

(12,500 )

Taxable income Tax rate Current provision

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116,500 25% 29,125

Deferred Provision Asset/Liability 20X1 Year-end Temporary Difference Equipment (18,000 ) Deferred revenue Deferred revenue Total

40,000

20X2 Change in Temporary Difference (6,000 )

20X2 Deferred Tax Asset

20X2 Deferred Tax (Liability) (24,000 )

(40,000 ) 25,000

25,000 25,000

Rate Ending balance

(24,000 )

25%

6,250

(6,000 )

Deferred Tax Asset 12,000

Deferred Tax Liability 5,400

20X2 Deferred tax provision

(5,750 )

600

20X2 End. Bal.

6,250

6,000

20X2 Beg. Bal.

Dr. Income tax expense—Deferred

6,350

Deferred tax liability

600

Deferred tax asset

Income tax expense - current

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Cr.

5,750

29,125

Income tax payable

29,125

102) a) $10 million / 20 × 0.25 = $125,000.b) $10 million × 10% = $1,000,000.c) $10 million / 20 = $500,000.d) $10 million × 18% = $1,800,000.e) Cumulative temporary difference = $1,000,000 – $125,000 = $875,000.Deferred tax liability = $875,000 × 21% = $183,750.f) Cumulative temporary difference = ($1,000,000 + $1,800,000) – ($125,000 + $500,000) = $2,175,000. Deferred tax liability = $2,175,000 × 21% = $456,750.g) Deferred portion of 20X1 income tax expense = increase in deferred tax liability = $456,750 – $183,750 = $273,000. 103) a) (in millions) 722 $

United States federal State and local

116

Outside United States

660

Total income tax due

1,498

b) Total income tax due from part (a):

(in millions) $ 1,498

Income tax payable, 12/31/16

151

Income tax payable, 12/31/17

(100 )

Total tax payments during 2017

1,549

(in millions)

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United States federal

722

State and local

116

Outside United States

660

Total deferred tax asset

1,498

c) United States federal

(in millions) 306 $

State and local

Outside United States

Total current tax provision

361

d) United States federal

(in millions) $ 416

State and local

116

Outside United States

605

Total provision for income taxes

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1,137

CHAPTER 15: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The return on the pension fund impacts the employer’s periodic pension expense for defined contribution pension plans. ⊚ ⊚

true false

2) The parties involved in a defined benefit plan are the same as those in a defined contribution plan. ⊚ ⊚

true false

3) Most of the factors used to determine specific expense accruals for defined benefit pension plans are based upon actuarial assumptions and present values. ⊚ ⊚

true false

4) Service cost is the increase in the discounted present value of the pension benefits ultimately payable that is attributable to an additional year’s employment. ⊚ ⊚

true false

5) Companies can influence the calculation of pension expense by choosing a higher or lower discount rate and/or by choosing a higher or lower expected rate of return on plan assets. ⊚ ⊚

true false

6) The difference between the actual and expected return on plan assets during year two is a component of pension expense for year two.

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⊚ ⊚

true false

7) A pension plan is underfunded if the projected benefit obligation exceeds the fair value of the pension plan assets. ⊚ ⊚

true false

8) The pension asset/liability reported within the balance sheet must reflect the funded status of the pension plan. ⊚ ⊚

true false

9) Under current GAAP, volatility in asset returns translates directly into net income volatility because the actual return on plan assets reduces pension expense. ⊚ ⊚

true false

10) The funded status of the pension plan at a given date is the difference between the fair value of the plan assets and the projected benefit obligation. ⊚ ⊚

true false

11) Higher marginal income tax rates create an incentive for companies to underfund their pension plans. ⊚ ⊚

true false

12) The pension liability that must be shown on the balance sheet of the plan sponsor is the excess of the projected benefit obligation over the plan assets at fair value.

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⊚ ⊚

true false

13) ERISA created the Pension Benefit Guaranty Corporation to protect employees from losing their retirement funds if the sponsor goes into bankruptcy. ⊚ ⊚

true false

14) Companies are required to disclose the dollar amount of pension retirement benefits they expect to pay in each of the next ten years. ⊚ ⊚

true false

15) Pension expense is likely to be both more volatile and lower under IFRS than pension expense computed under U.S. GAAP. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) A company instituted an IRS-approved plan to fund a percentage of each employee’s salary to a plan that would pay benefits to the employee after termination of services. This plan is a:

A) defined benefit pension plan. B) defined contribution pension plan. C) government sponsored pension plan. D) postretirement benefit plan.

17) A company instituted an IRS-approved plan to contribute monies to a plan that would pay each employee a percentage of his or her highest year of salary for each year of service upon termination of services. This plan is a:

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A) defined benefit pension plan. B) defined contribution pension plan. C) government sponsored pension plan. D) postretirement benefit plan.

18) A company contributes to its defined contribution plan. Which one of the following journal entries properly records this transaction?

A) DR Pension asset CR Cash B) DR Projected minimum liability CR Cash C) DR Pension expense CR Cash D) DR Minimum pension liability CR Cash

19) Which of the following statements does not properly describe a defined benefit pension plan?

A) Many assumptions are made in the determination of pension expense. B) The employee bears little risk with respect to estimating the amount of the annual contributions to the plan. C) The employer bears little risk with respect to estimating the amount of the annual contributions to the plan. D) A pension plan asset is not recorded on the employer’s balance sheet.

20) Which of the following is not a factor in the determination of pension expense when the employer sponsors a defined benefit pension plan?

A) The amount of retirement benefits that will vest. B) The rate of return on the pension fund investment. C) The rate that salaries will increase until retirement. D) The amount of funding during a particular period.

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21)

Which of the following statements is not correct about defined contribution plans?

A) No explicit promise is made about the size of the periodic benefits the employee will receive during retirement. B) The promise is the amount of contribu•tions the employer will make periodically. C) The size of payments depends on success of investments. D) The employer controls the investment choices on the employees’ behalf.

22)

Which of the following statements is correct with respect to a defined contribution plan?

A) The payments made by the employer to fund a defined contribution pension plan create a pension fund asset on the balance sheet of the employer. B) The employer receives a tax deduction for amounts contributed to the pension plan trust, and subsequent investment returns do not generate tax for the employer. C) The anticipated life span of the employees after retirement must be taken into consideration in determination of pension expense for a defined contribution pension plan. D) The return on the pension fund impacts the employer’s periodic pension expense for defined contribution pension plans.

23)

Which of the following is not an example of a defined contribution plan?

A) money purchase plan. B) profit-sharing plan. C) cash balance plan. D) 401(k) plan.

24) Defined contribution plans are preferred by companies for all except which of the following reasons?

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A) Defined contribution plans carry less risk for the employee. B) Defined contribution plans cost less to manage. C) Defined contribution plans improve job mobility for the employee. D) Defined contribution plans may not be at risk if the employer declares bankruptcy.

25)

The components of pension expense are:

A) service cost, plus interest cost, plus net amortization. B) service cost, plus interest cost, plus return on plan assets, plus net amortization. C) service cost, plus interest cost, minus expected return on plan assets, plus (or minus) net amortization. D) service cost, plus interest cost, minus return on plan assets, minus net amortization.

26)

The service cost of a defined benefit pension plan is the:

A) annual fee charged by the plan administrator. B) change in the pension liability caused by plan amendments. C) change in the pension liability caused by one additional year of employee service. D) the retirement benefit earned by the employees for services provided to date.

27)

The service cost component of a defined benefit pension plan is computed as the:

A) present value of the change in the accrued pension liability. B) actual value of the change in the accrued pension liability. C) present value of the change in pension liability from additional employee service. D) undiscounted change in pension liability from additional employee service.

28) Which of the following does not cause an increase in the pension expense for a defined benefit plan?

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A) Service cost B) Expected return on pension plan assets C) Recognized prior service cost amortization D) Interest cost

29)

Which statement below is not correct regarding the Projected Benefit Obligation (PBO)?

A) The PBO represents the present value of the retirement benefits earned to date. B) The PBO is based on future salary levels. C) A higher discount rate assumption increases the projected benefit obligation. D) Benefits paid to retirees do not affect the PBO.

30) Which of the following is not a correct statement with respect to the interest cost component of pension expense?

A) The same interest rate is used to compute service cost, interest cost, and return on plan assets. B) The interest cost component of a defined benefit pension plan is the portion of expense due to the passage of time. C) The interest cost component of pension expense in year two is determined by multiplying the projected benefit obligation at the beginning of year two by the discount rate. D) The interest cost increases the PBO and also increases the pension expense.

31)

The interest cost component of a defined benefit pension plan is computed as the:

A) ending accrued pension liability times the discount rate. B) beginning accrued pension liability times the discount rate. C) beginning projected benefit obligation times the discount rate. D) beginning accumulated pension liability times the discount rate.

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32) The return on plan assets component of pension expense for a defined benefit pension plan is:

A) the reduction in pension expense created by expected earnings of the plan. B) the reduction in pension expense created by actual earnings of the plan. C) the change in the plan asset value resulting from the actual return on plan assets. D) not a factor in the determination of pension expense.

33) Pona, Inc. has a defined benefit pension plan for its employees. The plan assets and projected benefit obligation at the beginning of the year were $608,000. The accumulated benefit obligation at the beginning of the year was $456,000. The expected return on plan assets was 8% while the actual return was 9%. The service cost for the year was $130,841. The actuarially assumed discount rate was 7% and amortization of prior service costs was $17,750.The interest cost for the year is:

A) B) C) D)

$42,560. $31,920. $36,480. $41,040.

34) Pona, Inc. has a defined benefit pension plan for its employees. The plan assets and projected benefit obligation at the beginning of the year were $608,000. The accumulated benefit obligation at the beginning of the year was $456,000. The expected return on plan assets was 8% while the actual return was 9%. The service cost for the year was $130,841. The actuarially assumed discount rate was 7% and amortization of prior service costs was $17,750.The total pension expense for the year is:

A) B) C) D)

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$124,761. $131,451. $136,431. $142,511.

35) The Shasti Corporation reported the following for the year ending December 31, 20X1:Service cost: $142,610Plan assets, January 1, 20X1: $1,200,000Prior service cost amortization: $21,150Expected return on plan assets: 9%Actual return on plan assets: 8.5%Pension expense: $175,760Actuarially determined discount rate: 8%What was the projected benefit obligation on January 1, 20X1?

A) B) C) D)

$1,500,000 $1,425,000 $1,200,000 $1,333,333

36) The Carrasco Company has provided you the following information pertaining to its defined benefit pension plan that was adopted on January 1, 20X1:The service cost was $750,000 during 20X1 and $1,125,000 during 20X2.The contribution to the pension plan was $600,000 on December 31, 20X1 and $1,200,000 on December 31, 20X2.The actuarially determined discount rate and the expected return on plan assets are both 10%.The actual return on plan assets was 10.5%.Retirement benefits pertaining to years of service prior to 20X1 were not granted to the employees.What is the pension expense for the year ended December 31, 20X2?

A) B) C) D)

$1,140,000 $1,065,000 $1,200,000 $1,137,000

37) The Carrasco Company has provided you the following information pertaining to its defined benefit pension plan that was adopted on January 1, 20X1:The service cost was $750,000 during 20X1 and $1,125,000 during 20X2.The contribution to the pension plan was $600,000 on December 31, 20X1 and $1,200,000 on December 31, 20X2.The actuarially determined discount rate and the expected return on plan assets are both 10%.The actual return on plan assets was 10.5%.Retirement benefits pertaining to years of service prior to 20X1 were not granted to the employees.What is the balance of the projected benefit obligation as of December 31, 20X2?

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A) B) C) D)

$1,875,000 $1,200,000 $1,950,000 $2,062,500

38) The Carrasco Company has provided you the following information pertaining to its defined benefit pension plan that was adopted on January 1, 20X1:The service cost was $750,000 during 20X1 and $1,125,000 during 20X2.The contribution to the pension plan was $600,000 on December 31, 20X1 and $1,200,000 on December 31, 20X2.The actuarially determined discount rate and the expected return on plan assets are both 10%.The actual return on plan assets was 10.5%.Retirement benefits pertaining to years of service prior to 20X1 were not granted to the employees.What is the balance of the pension plan assets as of December 31, 20X2?

A) B) C) D)

39)

$1,863,000 $1,800,000 $1,953,750 $1,860,000

Current accounting standards require that the discount rate used for pension plans be:

A) current market rate for the year. B) the average market rate since the beginning of the plan. C) the rates at which the pension benefits could effectively be settled. D) estimated future average market rates.

40)

Changes in the discount rate on pension plans cause material differences in:

A) pension expense and pension obligations. B) interest expense and pension expense. C) pension expense and trust fund recorded on the sponsor’s balance sheet. D) interest expense and the plan assets.

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41)

The smoothing of pension expense is:

A) unethical and not allowed by GAAP. B) allowed through amortization and deferral to prevent volatility in earnings. C) not allowed by GAAP if the sole purpose is to prevent earnings volatility. D) illegal and prohibited by SEC.

42)

Smith, Inc. has a pension plan with the following data available for 20X1 and 20X2: 20X1

20X2

Service cost

30,000

34,000

Interest cost

18,000

20,000

Actual return on plan assets

15,000

21,600

Beginning of year plan assets

$ 200,000

$ 240,000

Discount rate

Expected return on plan assets

Smith’s pension expense for 20X1 is:

A) B) C) D)

43)

$30,000. $32,000. $33,000. $48,000.

Smith, Inc. has a pension plan with the following data available for 20X1 and 20X2: 20X1

Service cost

Version 1

30,000

20X2 $

34,000

Interest cost

18,000

20,000

Actual return on plan assets

15,000

21,600

Beginning of year plan assets

$ 200,000

$ 240,000

Discount rate

Expected return on plan assets

Smith’s pension expense for 20X2 is:

A) B) C) D)

44)

$32,400. $34,000. $34,800. $54,000.

Smith, Inc. has a pension plan with the following data available for 20X1 and 20X2: 20X1

20X2

Service cost

30,000

34,000

Interest cost

18,000

20,000

Actual return on plan assets

15,000

21,600

Beginning of year plan assets

$ 200,000

$ 240,000

Discount rate

Expected return on plan assets

The adjustment to OCI for gain or loss from the return on plan assets for 20X1 is:

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A) B) C) D)

45)

$0. $1,000 gain. $1,000 loss. unknown from information provided.

Smith, Inc. has a pension plan with the following data available for 20X1 and 20X2: 20X1

20X2

Service cost

30,000

34,000

Interest cost

18,000

20,000

Actual return on plan assets

15,000

21,600

Beginning of year plan assets

$ 200,000

$ 240,000

Discount rate

Expected return on plan assets

The adjustment to OCI for gain or loss from the return on plan assets for 20X2 is:

A) B) C) D)

46)

$0. $2,400 gain. $2,400 loss. unknown from information provided.

Smith, Inc. has a pension plan with the following data available for 20X1 and 20X2: 20X1

20X2

Service cost

30,000

34,000

Interest cost

18,000

20,000

Actual return on plan assets

15,000

21,600

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Beginning of year plan assets

$ 200,000

$ 240,000

Discount rate

Expected return on plan assets

If the beginning cumulative net actuarial gains are $30,000, the fair value of the plan assets is $200,000 at the beginning of 20X1, and the average remaining service period of active employees is 10 years, the amortization of actuarial gains for 20X1 is:

A) B) C) D)

47)

$0. $750. $1,000. $2,000.

Smith, Inc. has a pension plan with the following data available for 20X1 and 20X2: 20X1

20X2

Service cost

30,000

34,000

Interest cost

18,000

20,000

Actual return on plan assets

15,000

21,600

Beginning of year plan assets

$ 200,000

$ 240,000

Discount rate

Expected return on plan assets

If the market-related value of the plan assets is $260,000 at the beginning of 20X2, the beginning of the year projected benefit obligation is $250,000, the cumulative net actuarial gains in AOCI are $30,000 at the beginning of 20X1 and $28,250 at the beginning of 20X2, and the average remaining service period of active employees is 10 years, then the amortization of actuarial gains for 20X2 is:

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A) B) C) D)

$0. $200. $225. $2,600.

48) To compute the amortization on the cumulative net actuarial gains and losses in AOCI for a pension plan, the corridor is computed as 10% of the:

A) average of the beginning balances of the plan assets and the projected benefit obligation. B) higher of the beginning balances of the plan assets or the accumulated benefit obligation. C) higher of the beginning market-related value of the plan assets or the projected benefit obligation. D) lower of the beginning market-related value of the plan assets or the projected benefit obligation.

49) At the beginning of 20X1, Moony, Inc. has a cumulative net actuarial loss in AOCI of $50,000 in its pension plan. The estimated remaining service period of active employees is 12 years for both years. 20X1

20X2

$ 335,000

$ 350,000

Beginning projected benefit obligation

325,000

385,000

Current year gain or (loss)

(37,500 )

25,000

Beginning plan asset value

The amortization of the cumulative net actuarial loss for 20X1 is

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A) B) C) D)

$0. $1,375. $3,350. $4,500.

50) At the beginning of 20X1, Moony, Inc. has a cumulative net actuarial loss in AOCI of $50,000 in its pension plan. The estimated remaining service period of active employees is 12 years for both years. 20X1

20X2

$ 335,000

$ 350,000

Beginning projected benefit obligation

325,000

385,000

Current year gain or (loss)

(37,500 )

25,000

Beginning plan asset value

The corridor for amortization for 20X2 is

A) B) C) D)

$0. $25,000. $35,000. $38,500.

51) When employers retroactively amend pension plans to increase benefits to participants, which one of the following is created?

A) Prior service cost B) Cumulative obligation gain or loss C) Transition asset D) Transition liability

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52) TKE Corporation established a defined benefit pension plan in 2016. TKE has provided the following information for the year ended December 31, 20X1:

Service cost

90,000

Interest cost

$ 120,000

Actual return on plan assets

70,000

Expected return on plan assets

80,000

Amortization of prior service costs

30,000

The pension expense for 20X1 is

A) B) C) D)

$90,000. $120,000. $160,000. $170,000.

53) TKE Corporation established a defined benefit pension plan in 2016. TKE has provided the following information for the year ended December 31, 20X1:

Service cost

90,000

Interest cost

$ 120,000

Actual return on plan assets

70,000

Expected return on plan assets

80,000

Amortization of prior service costs

30,000

If the company contributes $160,000 cash to the pension plan trustee, which one of the following journal entries properly records the pension plan activity for 2018?

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A) DR Pension expense 130,000 DR Pension asset (liability) 30,000 CR Cash 160,000 B) DR Pension expense 160,000 DR Pension asset (liability) 43,000 CR Cash 160,000 CR Other comprehensive income 30,000 C) DR Pension expense 160,000DR Pension asset (liability) 20,000 CR Cash 160,000 CR Other comprehensive income 20,000 D) DR Pension expense 170,000 DR Pension asset (liability) 30,000 CR Cash 160,000 CR Other comprehensive income 40,000

54) TKE Corporation established a defined benefit pension plan in 2016. TKE has provided the following information for the year ended December 31, 20X1:

Service cost

90,000

Interest cost

$ 120,000

Actual return on plan assets

70,000

Expected return on plan assets

80,000

Amortization of prior service costs

30,000

If the company contributes $130,000 cash to the pension plan trustee, which one of the following journal entries properly records the payment?

A) DR Pension expense 90,000 DR Pension asset (liability) 40,000 CR Cash 130,000 B) DR Pension expense 120,000 DR Pension asset 10,000 CR Cash 130,000 C) DR Pension expense 130,000 CR Cash 130,000 D) DR Pension expense 160,000 CR Cash 130,000 CR Pension asset (liability) 30,000

55) TKE Corporation established a defined benefit pension plan in 2016. TKE has provided the following information for the year ended December 31, 20X1:

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Service cost

90,000

Interest cost

$ 120,000

Actual return on plan assets

70,000

Expected return on plan assets

80,000

Amortization of prior service costs

30,000

If the company contributes $170,000 cash to the pension plan trustee, which one of the following journal entries properly records the payment?

A) DR Pension expense 90,000 DR Pension asset 80,000 CR Cash 170,000 B) DR Pension expense 120,000 DR Pension asset (liability) 50,000 CR Cash 170,000 C) DR Pension expense 160,000 DR Pension asset (liability) 10,000 CR Cash 170,000 D) DR Pension expense 170,000 CR Cash 170,000

56)

For income tax purposes, pension plan sponsors deduct the amount of the:

A) pension expense. B) service cost. C) plan contribution. D) service cost plus net amortization and deferral.

57) U. S. tax law limits the deductibility of contributions to pension plans for firms whose plans:

A) are underfunded. B) are overfunded. C) have no current benefit recipients. D) are part of a benefits package.

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58) The trustee for the Bronson Corporation defined benefit pension plan sent a report to the CEO with the following information for the fiscal year:

Beginning balance of plan assets at fair value

$ 1,560,000

Actual return on plan assets

210,000

Employer’s contribution

150,000

Distributions to retirees

75,000

Service cost

125,000

Interest cost

156,000

Loss from changes in benefits or assumptions

35,000

Beginning balance of the PBO

$ 1,580,000

The ending balance of plan assets is:

A) B) C) D)

$1,770,000. $1,845,000. $1,920,000. $1,955,000.

59) The trustee for the Bronson Corporation defined benefit pension plan sent a report to the CEO with the following information for the fiscal year:

Beginning balance of plan assets at fair value

$ 1,560,000

Actual return on plan assets

210,000

Employer’s contribution

150,000

Distributions to retirees

75,000

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Service cost

125,000

Interest cost

156,000

Loss from changes in benefits or assumptions

35,000

Beginning balance of the PBO

$ 1,580,000

The ending balance of the projected benefit obligation (PBO) is:

A) B) C) D)

$1,730,000. $1,821,000. $1,896,000. $1,971,000.

60) The trustee for the Bronson Corporation defined benefit pension plan sent a report to the CEO with the following information for the fiscal year:

Beginning balance of plan assets at fair value

$ 1,560,000

Actual return on plan assets

210,000

Employer’s contribution

150,000

Distributions to retirees

75,000

Service cost

125,000

Interest cost

156,000

Loss from changes in benefits or assumptions

35,000

Beginning balance of the PBO

$ 1,580,000

At the beginning of the year, the pension plan is:

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A) underfunded by $20,000. B) overfunded by $20,000. C) underfunded by $35,000. D) overfunded by $35,000.

61) The trustee for the Bronson Corporation defined benefit pension plan sent a report to the CEO with the following information for the fiscal year:

Beginning balance of plan assets at fair value

$ 1,560,000

Actual return on plan assets

210,000

Employer’s contribution

150,000

Distributions to retirees

75,000

Service cost

125,000

Interest cost

156,000

Loss from changes in benefits or assumptions

35,000

Beginning balance of the PBO

$ 1,580,000

At the end of the year, the pension plan is:

A) underfunded by $20,000. B) overfunded by $20,000. C) underfunded by $24,000. D) overfunded by $24,000.

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62) The Marino Company has provided you the following information pertaining to its defined benefit pension plan that was adopted on January 1, 20X1:The service cost was $950,000 during 20X1 and $1,045,000 during 20X2.The prior service cost amortization each year was $290,000.The contribution to the pension plan was $1,500,000 on December 31, 20X1 and $1,800,000 on December 31, 20X2.The actuarially determined discount rate and the expected return on plan assets was 10%.The actual return on plan assets was 9.5%.Retirement benefits pertaining to years of service prior to 20X1 were granted to the employees. The prior service cost is being amortized over the remaining ten-year life of the employees.What is the pension expense for the year ended December 31, 20X1?

A) B) C) D)

$1,240,000 $1,530,000 $950,000 $1,380,000

63) The Marino Company has provided you the following information pertaining to its defined benefit pension plan that was adopted on January 1, 20X1:The service cost was $950,000 during 20X1 and $1,045,000 during 20X2.The prior service cost amortization each year was $290,000.The contribution to the pension plan was $1,500,000 on December 31, 20X1 and $1,800,000 on December 31, 20X2.The actuarially determined discount rate and the expected return on plan assets was 10%.The actual return on plan assets was 9.5%.Retirement benefits pertaining to years of service prior to 20X1 were granted to the employees. The prior service cost is being amortized over the remaining ten-year life of the employees.What is the pension expense for the year ended December 31, 20X2?

A) B) C) D)

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$1,335,000 $1,280,000 $1,185,000 $1,599,000

64) The Marino Company has provided you the following information pertaining to its defined benefit pension plan that was adopted on January 1, 20X1:The service cost was $950,000 during 20X1 and $1,045,000 during 20X2.The prior service cost amortization each year was $290,000.The contribution to the pension plan was $1,500,000 on December 31, 20X1 and $1,800,000 on December 31, 20X2.The actuarially determined discount rate and the expected return on plan assets was 10%.The actual return on plan assets was 9.5%.Retirement benefits pertaining to years of service prior to 20X1 were granted to the employees. The prior service cost is being amortized over the remaining ten-year life of the employees.What is the balance of the projected benefit obligation as of December 31, 20X2?

A) B) C) D)

$5,599,000 $2,090,000 $2,575,000 $4,895,000

65) The Brand Corporation’s January 1, 20X1 balance sheet reports a net pension liability of $243,000. On December 31, 20X1, the projected benefit obligation was $4,975,000, the fair value of the plan assets was $4,679,000, and the accumulated benefit obligation was $3,482,500. The December 31, 20X1 balance sheet should report a net pension liability totaling:

A) B) C) D)

$243,000 $296,000 $4,975,000 $3,482,500

66) The Canton Corporation’s January 1, 20X1 balance sheet reports a net pension asset of $397,500. On December 31, 20X1, the projected benefit obligation was $6,479,000, the fair value of the plan assets was $6,747,000, and the accumulated benefit obligation was $3,482,500. The December 31, 20X1 balance sheet should report:

A) net pension asset of $397,500. B) net pension asset of $268,000. C) net pension liability of $3,482,500. D) net pension liability of $3,264,500.

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67) the:

The net pension liability that must be shown on the balance sheet of the plan sponsor is

A) accumulated benefit obligation. B) projected benefit obligation. C) excess of the accumulated benefit obligation over the plan assets at fair value. D) excess of the projected benefit obligation over the fair value of plan assets.

68)

New actuarial losses arising in the current year would:

A) increase the PBO and increase OCI. B) decrease OCI and decrease plan assets. C) increase PBO and decrease OCI. D) decrease plan assets and increase pension expense.

69)

The present value of the expected pension benefits that will ultimately be paid is the:

A) accumulated benefit obligation. B) projected benefit obligation. C) minimum balance sheet liability. D) accrued pension liability.

70)

Which of the following is not correct regarding prior service costs?

A) They result from retroactive changes to a pension plan. B) They can result in either an increase or decrease in the pension benefit obligation. C) Unlike the minimum amortization method for actuarial gains or losses, there is no corridor concept for prior service cost amortization. D) A corridor concept similar to that for actuarial gains and losses is used for prior service.

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71) Which of the following statements does not properly describe accounting for OPEB plans?

A) Losses related to OPEB arise from a decrease in the discount rate assumptions. B) OPEB plans are deemed to be riskier than other debt instruments. C) OPEB plans are mandatorily funded under the same ERISA rules as pension plans. D) Losses related to OPEB arise from an increase in the life expectancy assumptions.

72)

Which of the following statements is not correct?

A) The U.S. income tax code influences pension fund contributions. B) The U.S. income tax code creates incentives for firms to overfund their pension plans. C) The earnings from pension fund investments are taxable to the pension plan sponsor. D) Firms with larger union memberships tend to have higher pension funding ratios.

73) Which of the following statements best describes how U.S. tax laws affect company funding of pension plans?

A) The tax laws limit the deductibility of contributions to pension plans for firms whose plans are underfunded. B) The tax laws encourage companies to overfund their pension plans. C) Higher marginal tax rates incentivized companies to underfund their pension plans. D) The tax laws have little to no impact on the funding of pension plans.

74)

Which of the following does not apply to the ERISA law?

A) ERISA mandates that employers with over 1,000 employees offer a pension plan. B) ERISA limits pension investments in the employer’s stock to 10% of plan assets. C) ERISA created the PBGC. D) ERISA introduced minimum funding requirements.

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75) Which of the following is not a required disclosure pertaining to defined benefit pension plans?

A) A reconciliation of the beginning and ending projected benefit obligation balances. B) The retirement benefits that are expected to be paid in the next five years. C) The amount of pension expense and its components. D) The contributions to be made into the pension fund for each of the next ten years.

76) Which of the following statements pertaining to defined benefit pension plans is not correct?

A) Pension expense may be allocated to different categories of expenses within an income statement. B) A company may have multiple pension plans of which some may be overfunded and some may be underfunded and they are netted together to report the overall pension asset (liability). C) A small change in the pension discount rate can shift the funded status of the pension from year to year. D) A curtailment loss may occur because a division of a company is sold.

77)

Which of the following statements is correct?

A) Firms with high marginal tax rates tend to have lower funding ratios. B) The short-term pension risk ratio is calculated by dividing the projected benefit obligation by the market value of common stock. C) The funded status of a pension plan does not throw light on cash flow problems. D) Firms with less stringent capital constraints tend to have higher funding ratios.

78) Analysts reporting on companies will pay close attention to the disclosures regarding pension benefits. Key points include all of the following except:

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A) the common rule of thumb is that a 1% decrease in discount rate would increase PBO by 17.0% whereas a 1% increase would decrease it by 14.5%. B) while companies with overfunded plans can suspend funding for long periods and use the cash for other operating purposes, underfunded plans may reflect past and continuing cash flow difficulties. C) to help analysts determine whether fund assets are large enough to sat•isfy currently anticipated pension benefit payouts, FASB ASC Topic 715 requires firms to provide a table that lists the dollar benefits expected to be paid in each of the ensuing five years and in the aggregate for the five years thereafter. D) because of high assumed discount rates, most pension plans have remained underfunded with funding ratios ranging between 69% and 86% since 2008.

79) When assessing pension risk, analysts compute ratios for both long- and short-term risk. Which statement below is not correct?

A) For both long and short term the denominator is the market value of common stock. B) Pension assets are deducted from the PBO in only the long term calculation. C) Pension assets are deducted from the PBO in only the short term calculation. D) The computed ratios are generally compared to a median (e.g. Compustat data).

80) risk?

Which item is not a component included by analysts in assessing short-term pension

A) Union negotiations B) Declines in interest rates C) Debt downgrades D) Liquidity problems

81) Which of the following is not a proper description of the pension Accumulated Benefit Obligation (ABO)?

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A) If excludes projected salary increases between the statement date and the employee’s expected retirement date. B) If the pension plan was frozen the company would only have to pay the ABO. C) The difference between the ABO and PBO represents the losses workers would suffer if they leave the company prior to retirement. D) The ABO may be used for balance sheet and income statement presentation under US GAAP.

82) Which of the following is not a similarity between the accounting for a defined benefit pension plan and accounting for other postretirement benefit plans?

A) The financial statement disclosures. B) Actuarial assumptions are extensively used. C) The funding requirements. D) The applicable GAAP standards.

83) A major difference between accounting for pension plans and accounting for other postretirement benefit plans is that:

A) postretirement benefit plans other than pensions are not required to be funded. B) postretirement benefit plans other than pensions do not create a liability to be shown on the plan sponsor’s balance sheet. C) postretirement benefit plans other than pensions do not deduct the return on plan assets when funded. D) there is no accumulated postretirement benefit obligation for other postretirement plans other than pensions.

84) When accounting for funded postretirement benefit plans other than pensions (OPEB), which one of the following is subtracted in the calculation of postretirement benefit expense?

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A) Interest cost B) Actual return on plan assets C) Expected return on plan assets D) Service cost

85)

Postretirement benefits other than pensions (OPEB) are computed based upon:

A) current salary amounts. B) current benefit amounts. C) future salary amounts. D) future benefit amounts.

86) Which of the following is often not a component of other post retirement benefit (OPEB) expense?

A) Service cost. B) Interest cost. C) Prior service cost amortization. D) Actual return on plan assets.

87)

The income statement reporting for other postretirement benefits (OPEB) is based on the:

A) cash basis of accounting. B) accrual basis of accounting. C) cash or accrual basis of accounting. D) regulations established by the tax code.

88) Which of the following statements is not accurate with respect to accounting for other post-retirement plan benefits (OPEB)?

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A) Firms are required to make sensitivity disclosures regarding the effect of a 1% increase or decrease in the health care trend rate assumption. B) A decrease in the discount rate assumption used may lead to a large gain for a company. C) The actuarially determined service cost of the plan is accrued over the required years of service to participate in the postretirement benefit plan (e.g. 10 years). D) A company which shifts its former salaried employees from its post-65 retiree health plan to spending accounts that allow participants to buy health care from private exchanges creates a reduction in earned benefits referred to as a negative plan amendment.

89)

Which of the following is not a criticism of pension accounting and reporting?

A) Net income immediately includes fund asset gains and losses, as well as projected benefit obligation actuarial gains and losses. B) Management has the discretion with respect to choosing the expected rate of return on plan assets. C) Some argue that operating income is misstated due to the deduction of pension expense. D) Some argue that service cost should be the only component of pension expense.

90) Which of the following statements does not properly represent IFRS guidance on pension costs?

A) Under IFRS past service cost may be recognized immediately. B) IFRS uses the discount rate to compute the expected return on plan asset. C) In recognition that pension costs are related to employee service, all costs are included in operating activities. D) Actuarial gains and losses on the PBO and the actual return (less the expected return on plan assets) are recognized in OCI without subsequent amortization to pension expense.

91)

Under IFRS, pension expense generally consists of:

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A) only the actual payments made to retirees during the fiscal year. B) only current service cost. C) current service cost and past service cost . D) current and past service cost and net interest on the net defined benefit liability or asset.

92) Differences between IFRS and U.S. GAAP in accounting for pensions include all of the following except:

A) Under U. S. GAAP the asset (liability) on the balance sheet differs from the plan’s actual funded status, while under IFRS the asset (liability) on the balance sheet equals the plan’s actual funded status. B) Under IFRS past service costs are recognized immediately as part of pension expense. C) Under IFRS actuarial gains and losses are recognized in OCI without subsequent amortization to pension expense. D) Pension expense computed using U.S. GAAP is likely to be higher because it allows firms to use an expected rate of return that exceeds the discount rate.

93) This type of pension plan requires that employer contributions are made to a legal trust that is separate from the employer.

A) Defined benefit plan B) Defined contribution plan C) Cash balance plan D) All pensions plans require a separate legal trust

94) Who bears the risk associated with underperforming investments of a defined benefit pension plan?

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A) Employees B) Employers C) Employees and Employers share the risk D) The Pension Plan Trustee

95)

When pension-related gains or losses become material, they are recognized as part of:

A) Other comprehensive income B) Wages and salaries payables C) Pension expense D) Pension plan assets

96) A study on the effect of pre-codification Statement of Financial Accounting Standards No. 106 suggested that companies were more likely to reduce OPEB if prior to adoption of the accounting standard their debt-equity ratios were and their OPEB liabilities were .

A) high; low B) low; high C) high; high D) low; low

97) a(n):

A pension plan that requires employers to guarantee a minimum return is referred to as

A) defined contribution plan. B) annuity contract. C) minimum return plan. D) cash balance plan.

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98) Grump Company contributes 6% of employees’ gross compensation to a qualifying pension plan. Grump guarantees that the plan will earn a 7% average annual return. Grump Company sponsors a:

A) cash balance plan. B) traditional defined benefit pension plan. C) life annuity. D) defined contribution plan.

99) Who bears the risk associated with underperforming investments of a cash balance pension plan?

A) Employees B) Employers C) Employees and Employers share the risk D) The Pension Plan Trustee

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 100) Swan Company has provided you with the following data pertaining to its pension plan for the year ended December 31, 20X1:The 20X1 service cost was $175,500.The projected benefit obligation as of January 1, 20X1 was $1,950,000.Plan assets as of January 1, 20X1 totaled $2,020,000.The actual return on plan assets during 20X1 was 10%.Amortization of prior service costs during 20X1 was $9,750.The expected return on plan assets was 8%.The pension plan funding during 20X1 totaled $170,000.The discount rate was 8%.Required:Prepare the journal entry to record pension expense for the year ended December 31,20X1.

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101) The Shelast Corporation adopted a defined benefit pension plan on January 1, 20X1 and has provided the following information:The projected benefit obligation on January 1, 20X1 was $2,160,500.The 20X1 service cost totaled $250,000; the 20X2 service cost totaled $275,000.Annual amortization of prior service costs is $216,050.The discount rate is 10%.The pension plan funding during 20X1 was $200,000; the pension plan funding during 20X2 was $225,000.The actual return on plan assets was $19,000 during 20X2.Required:Determine the projected benefit obligation balance as of December 31, 20X2.

102) The following information pertains to Grumpy Company’s defined benefit pension plan:Pension asset as of 1/01/X1 $ 4,00020X1 service cost $38,00020X1 interest cost $76,00020X1 prior service cost amortization $12,00020X1 expected return on plan assets $44,00020X1 plan asset contributions $80,000Unamortized prior service cost as of 1/01/X1 $48,000Required:Calculate the pension expense for the year ended December 31, 20X1.Prepare the journal entry to record the pension expense for the year ended December 31, 20X1.

103) The Hab Company provided the following information pertaining to its defined benefit pension plan for 20X1:The projected benefit obligation as of January 1, 20X1 was $6,250,000.The discount rate was 8%.The service cost was $300,000.The amortization of prior service cost was $100,000.The expected return on plan assets was 10%.The actual return on plan assets was $800,000.The fair value of plan assets on January 1, 20X1 was $5,000,000.Pension payments to retirees during the year totaled $250,000.Contributions to the pension plan totaled $200,000.Amortization of net actuarial losses totaled $125,000.Required:Determine the pension expense for 20X1.Determine the projected benefit obligation as of December 31, 20X1.Determine the fair value of plan assets as of December 31, 20X1.Determine whether the pension plan is overfunded or underfunded, the amount to be reported on the December 31, 20X1 balance sheet, and determine whether the amount is a pension asset or a pension liability.

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104) Buffalo Company adopted a defined benefit pension plan as of January 1, 20X1. Buffalo has provided the following information pertaining to its pension plan:The projected benefit obligation as of January 1, 20X1 was determined to be $1,050,000.Service cost for 20X1 is $225,000.Amortization of prior service cost will be $52,500 per year.The projected benefit obligation as of December 31, 20X1 was determined to be $1,380,000.The first contribution of $500,000 to the pension plan asset fund was made on December 31, 20X1.The discount rate is 10%.Required:Prepare the journal entry for the adoption of the pension plan at January 1, 20X1.Determine the pension expense for the year ended December 31, 20X1.Prepare one journal entry to record the pension expense and one journal entry to record the pension funding for the year ended December 31, 20X1.Determine the balance of the pension liability at December 31, 20X1.

105)

Krabby, Inc. had the following information at December 31, 20X1:

Balances at December 31, 20X1: Market-related value of plan assets

$ 5,000

Projected benefit obligation

4,200

Funded status: Pension asset

800

AOCI – Prior service cost

300

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AOCI – Actuarial loss

700

The following assumptions are being used for the pension plan in 20X2: Discount rate

Expected rate of return on assets

Average remaining work life

10 years

Remaining amortization period for prior service costs

6 years

You have the following additional information for 20X2: Service cost

442

Cash contributed to the plan at year end

250

Pension benefits paid by the plan at year end

465

Actual return on plan assets

650

New actuarial loss on the projected benefit obligation

Required:Determine the pension expense for 20X2.Determine the balance of the plan assets at December 31, 20X2.Determine the balance of the projected benefit obligation at December 31, 20X2.Determine the balance of AOCI – Actuarial loss at December 31, 20X2.Determine the amount of the pension asset (liability) that will appear on Krabby’s December 31, 20X2 balance sheet.

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106) The Boulder Rock Company has provided the following information pertaining to its defined benefit plan:The projected benefit obligation was $2,100,000 on January 1, 20X1.Recognition of prior service cost during 20X1 was $150,000.Service cost for 20X1 was $300,000.Plan assets on January 1, 20X1 totaled $1,500,000.The expected return on plan assets was 10%.The actual return on plan assets was 8%.The discount rate was 8%.The December 31, 20X1 contribution to the plan asset fund was $450,000.Benefits paid to retirees during 20X1 totaled $225,000.Required:Determine Boulder’s pension expense for 20X1.Determine the projected benefit obligation (PBO) as of December 31, 20X1.Prepare the journal entries to record pension expense and the funding for the year ended December 31, 20X1.Determine the balance of the pension plan assets.Determine what should be reported on the December 31, 20X1 balance sheet with respect to the funded status of the defined benefit pension plan.

107) Describe three differences between the accounting for pensions relative to the accounting for postretirement benefits other than pensions.

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Answer Key Test name: chapter 15 1) FALSE 2) TRUE 3) TRUE 4) TRUE 5) TRUE 6) FALSE 7) TRUE 8) TRUE 9) FALSE 10) TRUE 11) FALSE 12) TRUE 13) TRUE 14) FALSE 15) FALSE 16) B 17) A 18) C 19) C 20) D 21) D 22) B 23) C 24) A 25) C 26) C Version 1

27) C 28) B 29) C 30) A 31) C 32) A 33) A 34) D 35) A 36) A 37) C 38) A 39) C 40) A 41) B 42) B 43) C 44) C 45) B 46) B 47) C 48) C 49) B 50) D 51) A 52) C 53) C 54) D 55) C 56) C Version 1

57) B 58) B 59) B 60) A 61) D 62) B 63) D 64) A 65) B 66) B 67) D 68) C 69) B 70) D 71) C 72) C 73) B 74) A 75) D 76) B 77) D 78) D 79) B 80) B 81) D 82) C 83) A 84) C 85) D 86) D Version 1

87) B 88) B 89) A 90) C 91) D 92) A 93) D 94) B 95) C 96) A 97) D 98) A 99) B 100) Pension expense

179,650*

Cash

170,000

Pension liability

*Pension expense: Service cost

9,650

+ Interest cost

156,000

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(Beginning PBO $1,950,000 × 8%)

9,750

+ Prior service cost amortization − Expected return on plan assets Pension expense

175,500

(161,600 ) (Beginning plan assets $2,020,000 × 8%) $

179,650

101) January 1, 20X1 PBO

$ 2,160,500

20X1 interest cost

216,050

20X1 service cost

250,000

December 31, 20X1 PBO

$ 2,626,550

20X2 interest cost

262,655

20X2 service cost

275,000

December 31, 20X2 PBO

(Beginning PBO $2,160,500 × 10%)

(Beginning PBO $2,626,550 × 10%)

$ 3,164,205

102) 1. Pension expense: Service cost

38,000

+ Interest cost

76,000

+ Prior service cost amortization

12,000

– Expected return on plan assets

(44,000 )

Pension expense

$ 82,000

2. Journal entry: Pension expense

82,000

Pension asset (liability)

10,000

Cash

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80,000

Other comprehensive income

12,000

103) 1. Pension expense Service cost

+ Interest cost

500,000 (Beginning PBO $6,250,000 × 8%) 100,000

+ Prior service cost amortization − Expected return on plan assets + Amortization of net actuarial losses Pension expense

300,000

(500,000 ) (Beginning plan assets $5,000,000 × 10%) 125,000 $

525,000

2. PBO Beginning balance of pension benefit obligation Service cost

$ 6,250,000 300,000

Interest cost

500,000

Benefits paid to retirees

(250,000 )

Ending balance of pension benefit obligation

(Beginning PBO $6,250,000 × 8%)

$ 6,800,000

3. Fair value of plan assets Beginning balance of plan assets

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$ 5,000,000

Actual return on plan assets

800,000

Contributions by employer

200,000

Benefits paid to retirees

(250,000 )

Ending balance of plan assets

$ 5,750,000

4. 12/31/20X1

balance

pension

benefit

obligation

12/31/20X1 balance of plan assets

6,800,000 5,750,000

Difference

$ 1,050,000

The pension plan is underfunded because the 12/31/20X1 PBO is larger than the 12/31/20X1 fair value of plan assets. The balance sheet must report the funded status of the pension plan and therefore reports a pension liability of $1,050,000. 104) 1. Adoption of the pension plan January 1, 20X1 OCI – Prior service cost Pension liability

1,050,000 1,050,000

2. Pension expense: Service cost

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$ 225,000

+ Interest cost

105,000

+ Prior service cost amortization

52,500

Pension expense

$ 382,500

3. Pension expense and funding December 31, 20X1 Pension expense

382,500

Pension liability

330,000

OCI – Prior service cost

52,500

Pension liability

500,000

Cash

500,000

4. Balance of the pension liability Beginning balance of pension liability

Record adoption of pension plan

1,050,000

Record pension expense components

330,000

Contributions by employer

(500,000 )

Ending balance of pension liability

880,000

105) 1. Pension expense

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Service cost

442

Interest cost

210 (Beginning PBO $4,200 × 5%)

Expected return

(400 ) (Beginning plan assets $5,000 × 8%)

Amortization Prior service cost

50 ($300 ÷ 6 years)

Actuarial loss

20 (see below)

Pension expense

322

Amortization of AOCI – Actuarial loss: 1. Calculate corridor at January 1, 20X2: $ 5,000 Market-related value of plan assets Projected benefit obligation 4,200

Choose the larger amount = $5,000 Calculate 10% of $5,000 = $500

2. Calculate amortization for 20X2: AOCI – Actuarial loss at $ 700 1/1/20X2 Corridor (500 ) Amount outside corridor

200

Amortization period

10 years

Amortization

2. Plan assets Version 1

Plan Assets Beginning balance

$ 5,000

Actual return

650

Contribution

250

Benefit payments

(465 )

Ending balance

$ 5,435

3. Projected benefit obligation Projected Benefit Obligation Beginning balance of pension benefit obligation

$ 4,200

Service cost

442

Interest cost

210

New actuarial loss in 20X2

Benefits paid to retirees

(465 )

Ending balance of pension benefit obligation

$ 4,451

4. AOCI – Actuarial loss AOCI – Actuarial loss Beginning balance

700

New Actuarial loss in 20X2

Amortization for 20X2

(20 )

Actual return Less: Expected return Ending balance

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650 (400 )

(250 ) $

494

5. Pension asset (liability) 12/31/20X2

balance

Pension Asset (Liability) of pension benefit obligation

12/31/20X1 balance of plan assets Difference

5,435,000 4,451,000

$ 984,000

The pension plan is underfunded because the 12/31/20X2 PBO is larger than the 12/31/20X2 fair value of plan assets. The balance sheet must report the funded status of the pension plan and therefore reports a pension liability of $984,000. 106) 1. Service cost

300,000

Interest cost

168,000

Recognition of prior service cost Expected return on plan assets

150,000

Pension expense

(Beginning PBO $2,100,000 × 8%)

(150,000 ) (Beginning plan assets $1,500,000 × 10%) $

468,000

2. PBO as of 1/1/20X1 Service cost

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$ 2,100,000 300,000

Interest cost

168,000

Benefit payments

(225,000 )

PBO 12/31/20X1

$ 2,343,000

3. Pension expense

468,000

Pension asset (liability)

318,000

AOCI – Prior service cost

150,000

Pension asset (liability) Cash

450,000 450,000

4. Plan assets at 1/1/20X1

$ 1,500,000

Actual return on plan assets

120,000

Benefit payments

(225,000 )

Contribution to the fund on 12/31/20X1

450,000

Plan assets at 12/31/20X1

$ 1,845,000

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12/31/20X1

balance

pension

12/31/20X1 balance of plan assets Difference

benefit

obligation

2,343,000 1,845,000

$ 498,000

The pension plan is underfunded because the 12/31/20X1 PBO is larger than the 12/31/20X1 fair value of plan assets. The balance sheet must report the funded status of the pension plan and therefore reports a pension liability of $498,000. 107) The interest cost for pension plans is a function of the projected benefit obligation; whereas the interest cost for other postretirement benefits is a function of the accumulated postretirement benefit obligation. The pension asset or liability to be reported on the balance sheet is the difference between the projected benefit obligation and the fair value of plan assets; the asset or liability pertaining to postretirement benefits other than pension plans to be reported on the balance sheet is the difference between the accumulated postretirement benefit obligation and the fair value of plan assets. Current reporting standards require disclosures for postretirement benefit plans other than pensions that differ from the required disclosures for pensions. Pension funding is required and is tax-deductible, whereas the funding of postretirement healthcare benefits is not required and is not tax-deductible.

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CHAPTER 16: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Net income or loss generally arises from transactions with owners who provide net capital to the firm. ⊚ ⊚

true false

If a company purchases treasury stock its earnings per share will increase. ⊚ ⊚

true false

3) A reason prompting a firm to purchase treasury stock is that management believes the stock is undervalued in the marketplace and therefore represents a good investment opportunity. ⊚ ⊚

4) debt.

true false

Corporations that issue preferred stock do so because preferred stock is less risky than

⊚ ⊚

true false

5) Mandatorily redeemable preferred stock dividends are reported as interest expense on the income statement. ⊚ ⊚

true false

6) The Revised Model Business Corporation Act defines solvency as a situation where the fair value of assets exceeds the fair value of liabilities after a distribution to shareholders. ⊚ ⊚

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true false

7) The Revised Model Business Corporation Act would potentially allow a corporation to have negative book value of net assets after an asset distribution occurred. ⊚ ⊚

true false

8) When a loan agreement restricts a company from distributing its entire balance of retained earnings as dividends to shareholders, restricted retained earnings must be reported separately from unrestricted retained earnings on the face of the balance sheet. ⊚ ⊚

true false

9) When a company repurchases its own shares, the transaction may not result in treasury stock being reported on the balance sheet. ⊚ ⊚

true false

10) Under IFRS a company may report either a statement of financial position or a statement of changes in shareholders’ equity but it need not provide both statements. ⊚ ⊚

true false

11) The comparability of earnings per share across firms is influenced by the relative amount of capital raised by the various firms and by the ability of the firms to manage their reported earnings per share. ⊚ ⊚

true false

12) Current GAAP requires that share-based compensation be expensed at the grant date of the stock options award.

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⊚ ⊚

true false

13) Current GAAP requires the allocation of total share-based compensation cost to expense on a straight-line basis over the vesting period. ⊚ ⊚

true false

14) By using the book value method to record the conversion of convertible bonds, managers are able to protect themselves from recording conversion losses. ⊚ ⊚

true false

15) Two companies, Company A and Company B, issue convertible bonds at par. If Company A uses IFRS and Company B follows U.S. GAAP, the amount Company A records for the debt will be greater than the amount Company B records for the debt. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) Which of the following does not accurately describe the "ownership" perspective of the firm?

A) Its focus is on the firm’s net capital deployed. B) It is the prevailing view of GAAP. C) Its focus is on owners’ capital. D) It requires that financing transactions generate income or loss.

17)

Cash dividends paid by a corporation:

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A) are an expense of the corporation that declared the dividend. B) reduce the net income of the corporation that declared the dividend. C) reduce the retained earnings of the corporation that declared the dividend. D) reduce the retained earnings of the corporation that declared the dividend because net income is reduced by the amount of the dividend.

18)

Which item goes not properly describe the par value of common stock?

A) The par value of common stock is set by the state government. B) A stock’s par value does not necessarily have any relationship with a stock’s market value. C) Par value refers to the nominal value or face value of a security. D) Par value is an assigned amount (such as $1 per share) used to compute the dol•lar accounting value of the common shares on the company’s balance sheet.

19) Which of the following statements is correct if treasury stock costing $25,000 was sold for $27,500?

A) Total owners’ equity increases $2,500. B) Total owners’ equity increases $27,500. C) Net income increases $2,500. D) Total owners’ equity increases $25,000.

20)

Treasury stock is reported within the balance sheet as:

A) a long-term investment. B) a short-term investment. C) an account contra to retained earnings. D) an account contra to owners’ equity.

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21) The Vernon Corporation was formed on January 2, 20X1. The company sold 20,000 shares of $8.00 par value stock for $20.00 per share. On July 1, 20X1, Vernon bought back 4,000 shares of stock for $24.00 per share. The treasury stock was resold on September 1, 20X1 for $32.00 per share. Which one of the following is the entry to record the original sale of the stock?

A) DR Cash 400,000 CR Common stock 160,000 CR Paid-in capital in excess of par 240,000 B) DR Cash 400,000 CR Common stock 240,000 CR Paid-in capital in excess of par 160,000 C) DR Common stock 240,000 DR Paid-in capital in excess of par 160,000 CR Cash 400,000 D) DR Common stock 160,000 DR Paid-in capital in excess of par 240,000 CR Cash 400,000

22) The Vernon Corporation was formed on January 2, 20X1. The company sold 20,000 shares of $8.00 par value stock for $20.00 per share. On July 1, 20X1, Vernon bought back 4,000 shares of stock for $24.00 per share. The treasury stock was resold on September 1, 20X1 for $32.00 per share. Which one of the following is the correct entry to record when Vernon acquires its shares to hold as treasury stock?

A) DR Treasury stock 96,000 CR Cash 96,000 B) DR Investments 96,000 CR Cash 96,000 C) DR Common stock 96,000 CR Cash 96,000 D) DR Retained earnings 96,000 CR Cash 96,000

23) The Vernon Corporation was formed on January 2, 20X1. The company sold 20,000 shares of $8.00 par value stock for $20.00 per share. On July 1, 20X1, Vernon bought back 4,000 shares of stock for $24.00 per share. The treasury stock was resold on September 1, 20X1 for $32.00 per share. Which one of the following is the correct entry to record the resale of treasury stock?

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A) DR Cash 128,000 CR Common stock 128,000 B) DR Cash 128,000 CR Treasury stock 96,000 CR Paid-in capital from treasury stock 32,000 C)

DR Cash 128,000 CR Treasury stock 96,000 CR Gain on sale of treasury stock

DR Cash 128,000 CR Treasury stock 96,000 CR Retained earnings 32,000

32,000

24) A corporation reported the following during:Net income $175,250.Sale of 10,000 shares of $5 par value common stock for $8.75 per share.A repurchase of shares as treasury stock, costing $24,750.A resale of treasury stock for $14,695; the shares cost $15,500 when repurchased.A declaration and distribution of a $39,000 cash dividend.A declaration and distribution of a “small” stock dividend of 5,000 shares of $5 par value common stock at a total market value of $50,000.What was the increase in shareholders’ equity during?

A) B) C) D)

$213,695 $188,695 $198,195 $173,195

25) Shareholders who sell their shares back to the company under a share repurchase program are:

A) not taxed. B) taxed at ordinary rates. C) taxed at capital gains rates. D) subject to tax penalties.

26)

Financial analysts should always review stock repurchase plans carefully because:

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A) the plans always produce above-market returns. B) the plans usually produce above-market returns. C) it is important to determine the reasons for the buyback. D) the plans are always beneficial to the shareholders.

27)

Companies with surplus cash will consider the needs of cash for:

A) buying back shares of their company stock. B) acquiring another company. C) issuing a special dividend to shareholders. D) all of these answer choices are considerations for using surplus cash.

28) Which of the following is not typically disclosed in the financial statements regarding share repurchase programs?

A) The dollar amount of the board-approved share buyback. B) The time period the repurchase program will be effective. C) The dollar amount remaining under the share repurchase program. D) The reason for the share repurchase program.

29) A company’s retained earnings on December 31, 20X1 was $2,190,000 and its shareholders’ equity was $8,760,000. During 20X2 the company reported the following:Net income $225,000.A sale of treasury stock costing $75,000 for $79,750.A treasury stock purchase costing $125,700.A cash dividend declaration of $73,200.A 10,000 share “small” common stock ($10 par value) dividend was declared and distributed when the market value was $12.75 per share.What is the retained earnings balance on December 31, 20X2?

A) B) C) D)

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$1,994,050 $2,214,300 $2,219,050 $2,246,550

30) A company’s retained earnings on December 31, 20X1 was $2,190,000 and its shareholders’ equity was $8,760,000. During 20X2 the company reported the following:Net income $225,000.A sale of treasury stock costing $75,000 for $79,750.A treasury stock purchase costing $125,700.A cash dividend declaration of $73,200.A 10,000 share “small” common stock ($10 par value) dividend was declared and distributed when the market value was $12.75 per share.What is the shareholders’ equity balance on December 31, 20X2?

A) B) C) D)

31)

$8,663,350 $8,738,350 $8,865,850 $8,934,300

Which of the following is not a reason why a company would purchase its own stock?

A) The company needs shares in order to meet employee stock option plans. B) The company’s management may have concluded that the company’s stock is undervalued at the prevailing market price. C) The company wants to increase its earnings per share. D) The company wants to manipulate its net income.

32) When a dividend is not declared on preferred stock, and the common share•holders cannot receive a dividend until all past and current dividends are paid to the preferred shareholders, the preferred stock is:

A) cumulative. B) noncumulative. C) participating. D) nonparticipating.

33) Companies with a history of net operating losses are prone to issue which one of the following to raise money?

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A) Debenture bonds B) Serial bonds C) Preferred stock D) Notes payable

34)

Mandatorily redeemable preferred stock is reported on the balance sheet as:

A) a liability. B) an equity item. C) a temporary investment. D) a separate line between liabilities and shareholders’ equity.

35)

Which of the following statements pertaining to preferred stock is not correct?

A) Preferred stock may have an adjustable rate which pays a dividend that is adjusted, usually on a quarterly basis. B) Preferred stock dividends are contractual obligations that must be paid in profitable years. C) Most preferred stock issues are nonparticipating, meaning that the shareholders are entitled to receive only dividends based on the stated dividend rate. D) Preferred shareholders are given preference with respect to both dividend distributions and in liquidation of the company.

36) When a publicly traded company issues both common stock and preferred stock, the SEC requires that:

A) preferred and common stock be combined in the equity section. B) preferred and common stock be clearly differentiated on the balance sheet. C) all preferred stock be shown as a liability. D) mandatorily redeemable preferred stock be shown as a liability.

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37) The Revised Model Business Corporation Act defines solvency as a situation where the fair value of:

A) assets exceeds the book value of liabilities after a distribution to shareholders. B) assets exceeds the fair value of liabilities after a distribution to shareholders. C) liabilities exceeds the fair value of assets. D) liabilities exceeds the fair value of assets after a distribution to shareholders.

38)

As a result of the Revised Model Business Corporation Act, it may be fair to state that:

A) the book value of owners’ equity may not give an accurate picture of potentially legal distributions. B) the book value of owners’ equity gives an accurate picture of potentially legal distributions. C) the book value of owners’ equity never gives an accurate picture of potentially legal distributions. D) the book value of assets gives an accurate picture of potentially legal distributions.

39)

Ace Industries has the following shareholders’ equity accounts at December 31, 20X1:

Preferred stock, $100 par value, 10% dividend, 50,000 $ 5,000,000 shares issued and outstanding Common stock, $6 par value, 1 million shares issued and 6,000,000 outstanding Paid-in capital in excess of par 119,000,000 Unrestricted retained earnings

7,500,000

Retained earnings restricted for plant expansion

2,500,000

Assuming that the preferred stock is cumulative, and that there are no dividends in arrears, what is the maximum dividend that may be distributed to common shareholders at December 31, 20X1? Version 1

A) B) C) D)

40)

$9,500,000 $7,000,000 $7,500,000 $2,000,000

Ace Industries has the following shareholders’ equity accounts at December 31, 20X1:

7,500,000

Retained earnings restricted for plant expansion

2,500,000

On December 15, 20X1 Ace Industries repurchased 200,000 shares of its common stock for $10 per share. Based on its shareholders’ equity accounts, what can be inferred about this purchase?

A) Ace is holding $2,000,000 of treasury stock which is being disclosed in the notes to the financial statements. B) Ace retired the shares by reducing the common stock and paid-in capital accounts. C) Ace is reporting the shares as a $2,000,000 investment on the asset side of the balance sheet. D) Not enough information is provided to determine how Ace recorded the purchase.

41) By examining the statement of shareholders’ equity an investor can determine all of the following except:

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A) shares issued to employees for share-based compensation. B) unrealized losses on available-for-sale securities. C) the amount of convertible bonds issued during the year. D) dividends declared on common stock.

42)

A 3-for-1 stock split will reduce the per share par value and will:

A) decrease the number of shares proportionately. B) decrease earnings per share. C) increase owners’ equity. D) increase the total par value of the common stock.

43)

In discussing book value of common stock, which statement below is not correct?

A) Book value is also referred to as total equity of the firm. B) The terms "issued" and "outstanding" are synonymous when discussing the number of common shares. C) Book value per share is computed by dividing common equity by the number of common shares outstanding. D) If any preferred stock were outstanding, its carrying amount would be deducted from the total equity to obtain the common equity.

44) When a company does not have any convertible securities or options or warrants outstanding, the company has:

A) a complex capital structure. B) a simple capital structure. C) to report only diluted earnings per share. D) to report both basic and diluted EPS.

45)

The denominator used in the calculation of basic earnings per share is the:

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A) number of common shares outstanding at the end of the year. B) number of preferred shares outstanding at the end of the year. C) weighted average number of common shares outstanding during the year. D) weighted average number of common shares and preferred shares outstanding during the year.

46)

Which of the following is not indicative of a complex capital structure?

A) Outstanding convertible bonds. B) Outstanding convertible preferred stock. C) Outstanding cumulative preferred stock. D) Outstanding stock options.

47) Which of the following statements is correct when a company has a complex capital structure?

A) Diluted earnings per share must be shown on the income statement. B) Diluted earnings per share and basic earnings per share must both be shown on the income statement. C) The company might have convertible bonds outstanding. D) The company must have participating preferred stock outstanding.

48) Earnings per share (EPS) data are prominent in corporate annual reports, but EPS suffers as a financial performance measure because EPS ignores the amount of:

A) revenue required to generate reported earnings. B) capital required to generate reported earnings. C) liabilities required to generate reported earnings. D) expenses required to generate reported earnings.

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49) A company that has earnings in Year 2 equal to the earnings of Year 1 can improve its Year 2 reported earnings per share by:

A) selling additional common stock. B) selling additional preferred stock. C) selling shares of treasury stock at a price exceeding what was paid for the treasury stock. D)

purchasing shares of treasury stock.

50) The Heath Corporation reported net income for 20X1 of $177,500. Heath began the year with 100,000 shares of $5 par value common shares outstanding and 2,500 shares of $100 par value 8% preferred shares outstanding. On October 1, Heath sold 10,000 shares of common stock for $6 per share. Heath paid dividends to the common shareholders in December.The weighted average number of common shares used to compute earnings per share for 20X1 is:

A) B) C) D)

100,000. 102,500. 105,000. 110,000.

51) The Heath Corporation reported net income for 20X1 of $177,500. Heath began the year with 100,000 shares of $5 par value common shares outstanding and 2,500 shares of $100 par value 8% preferred shares outstanding. On October 1, Heath sold 10,000 shares of common stock for $6 per share. Heath paid dividends to the common shareholders in December.The basic earnings per share for 20X1 is:

A) $1.43 per share. B) $1.50 per share. C) $1.54 per share. D) $1.73 per share.

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52) The Heath Corporation reported net income for 20X1 of $177,500. Heath began the year with 100,000 shares of $5 par value common shares outstanding and 2,500 shares of $100 par value 8% preferred shares outstanding. On October 1, Heath sold 10,000 shares of common stock for $6 per share. Heath paid dividends to the common shareholders in December.If each share of preferred stock is convertible into 8 shares of common stock, the diluted earnings per share for 20X1 is (rounded):

A) $1.29 per share. B) $1.45 per share. C) $1.54 per share. D) $1.73 per share.

53) Vent, Inc. reported net income of $770,000 for 20X1. Vent sold 15,000 shares of treasury stock acquired in a previous year on July 1 and 15,000 new shares on November 1. At year-end, 180,000 shares were outstanding. Vent had 20,000 shares of $100 par value 7% preferred stock outstanding all year. Vent paid dividends to the preferred shareholders.The weighted average number of common shares used to compute earnings per share for 20X1 is:

A) B) C) D)

150,000. 160,000. 165,000. 180,000.

54) Vent, Inc. reported net income of $770,000 for 20X1. Vent sold 15,000 shares of treasury stock acquired in a previous year on July 1 and 15,000 new shares on November 1. At year-end, 180,000 shares were outstanding. Vent had 20,000 shares of $100 par value 7% preferred stock outstanding all year. Vent paid dividends to the preferred shareholders. The basic earnings per share for 20X1 is (rounded):

A) $3.50 per share. B) $3.94 per share. C) $4.81 per share. D) $6.10 per share.

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55) Vent, Inc. reported net income of $770,000 for 20X1. Vent sold 15,000 shares of treasury stock acquired in a previous year on July 1 and 15,000 new shares on November 1. At year-end, 180,000 shares were outstanding. Vent had 20,000 shares of $100 par value 7% preferred stock outstanding all year. Vent paid dividends to the preferred shareholders. If each share of preferred stock is convertible into 2 shares of common stock, the diluted earnings per share for 20X1 is:

A) $3.85 per share. B) $3.94 per share. C) $4.81 per share. D) $6.10 per share.

56) The following information has been obtained from the Massena Corporation:100,000 shares of common stock were outstanding on January 1, 20X1.30,000 shares of common stock were issued on March 1, 20X1.A 2-for-1 stock split was declared on April 1, 20X1.The 2-for-1 stock split was distributed on May 1, 20X1.10,000 shares of common stock were purchased on October 1, 20X1.What is the weighted average number of shares to be used in the calculation of basic earnings per share for 20X1?

A) B) C) D)

247,500 216,250 230,833 209,167

57) The following information has been obtained from the Brewster Corporation:250,000 shares of common stock were outstanding on January 1, 20X1.30,000 shares of preferred stock were issued on March 1, 20X1.12,000 shares of common stock were purchased on April 1, 20X1.10,000 shares of common stock were issued on October 1, 20X1.What is the weighted average number of shares to be used in the calculation of basic earnings per share for 20X1?

A) B) C) D)

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268,500 243,500 248,000 278,000

58) The following information has been obtained from the Mastic Corporation: 550,000 shares of common stock were outstanding on January 1, 20X1.Bonds convertible into 50,000 shares of common stock were issued on July 1, 20X1; the bonds have been determined to be dilutive. 36,000 shares of common stock were issued on November 1, 20X1.24,000 shares of common stock were purchased on December 1, 20X1.What is the weighted average number of shares to be used in the calculation of diluted earnings per share for 20X1?

A) B) C) D)

612,000 587,000 604,000 579,000

59) The following information has been obtained from the Myers Corporation:300,000 shares of common stock were outstanding on January 1, 20X1.50,000 stock options were outstanding on January 1, 20X1; each option allows the holder to acquire one share of common stock for $20 per share. The average market price of the common stock during 20X1 was $25 per share.48,000 shares of common stock were issued on February 1, 20X1.18,000 shares of common stock were purchased on August 1, 20X1.What is the weighted average number of shares to be used in the calculation of diluted earnings per share for 20X1?

A) B) C) D)

380,000 326,500 346,500 386,500

60) The following information has been provided to you by the Smith Corporation for the year ending December 31, 20X1:The numerator used in the calculation of basic earnings per share was $797,000.Cash dividends were paid to the common shareholders.8% convertible bonds with a par value of $1,000,000 were issued on July 1, 20X1.The corporation’s marginal income tax rate is 40%.6% convertible preferred stock with a par value of $800,000 were outstanding during the entire year.Assuming that both the bonds and preferred stock are dilutive, what is the numerator that should be used in the calculation of diluted earnings per share?

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A) B) C) D)

$893,000 $869,000 $773,000 $821,000

61) The following information has been provided to you by the Rae Corporation for the year ending December 31, 20X1:Net income was $979,000.Cash dividends totaling $120,000 were paid to the common shareholders.6% convertible bonds with a par value of $2,000,000 were issued on February 1, 20X1.The corporation’s marginal income tax rate is 40%.6% convertible preferred stock with a par value of $800,000 was outstanding during the entire year.Assuming that both the bonds and preferred stock are dilutive, what is the numerator that should be used in the calculation of basic earnings per share and diluted earnings per share? Basic EPS

Diluted EPS

811,000

1,051,000

931,000

1,045,000

979,000

1,147,000

931,000

1,099,000

A) Option A B) Option B C) Option C D) Option D

62) Which of the following is not a reason companies use stock options as a form of employee compensation?

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A) As a means of attracting talented employees while attempting to conserve cash. B) To ensure compliance with laws governing executive compensation. C) To align employee’s interests with the interest of the owners. D) To provide tax savings.

63) In the debate regarding whether stock options should be an expense, which of the following was not a reason supporting such an expense?

A) Expensing stock options would yield more accurate earnings measurement and restore investor confidence. B) Expensing stock options would reduce the dilution effect caused by the issuance of excessive grants to top executives. C) Expensing stock options would spur risk-taking and entrepreneurship that are crucial to innovation. D) Expensing stock options would reduce the incentive managers have to pump-up short term earnings for market price gains.

64)

The exercise price for stock option plans on the grant date is:

A) always higher than the market price of the underlying shares. B) always lower than the market price of the underlying shares. C) usually lower than the market price of the underlying shares. D) usually equal to or higher than the market price of the underlying shares.

65) On January 1, 20X1, Waddle Company adopted a compensatory stock option plan and granted its managers 10,000 options to buy shares of common stock; each option can be used to acquire a share of common stock at a price of $25 a share. The fair value of each option was $7.50 on January 1, 20X1. The options can be converted into common stock after July 1, 20X1. The required service period is three years.How much compensation expense will be recorded for the year ending December 31, 20X3 using the fair value approach to accounting for stock options?

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A) $ 75,000 B) $175,000 C) $ 50,000 D) $ 25,000

66) On January 1, 20X1, Waddle Company adopted a compensatory stock option plan and granted its managers 10,000 options to buy shares of common stock; each option can be used to acquire a share of common stock at a price of $25 a share. The fair value of each option was $7.50 on January 1, 20X1. The options can be converted into common stock after July 1, 20X1. The required service period is three years.What is the balance in paid-in capital-stock options as of December 31, 20X2 assuming that the fair value approach to accounting for stock options is used?

A) B) C) D)

$0 $25,000 $50,000 $100,000

67) Which of the following arguments was not used to support the continuation of the accounting for stock-based compensation plans as allowed under APB Opinion No. 25?

A) Stock options do not involve a cash flow; therefore, the recording of an expense would violate appropriate income measurement. B) The Black-Scholes method of valuing stock options has not been widely accepted and is arbitrary. C) The fair value approach could jeopardize compliance with contract terms and conditions. D) The fair value approach would increase expenses and lower net income which would result in lower stock prices.

68) An argument raised by opponents to the FASB’s proposal that employee stock options should be recognized as an expense was that it could:

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A) violate the historical cost principle. B) violate the cost-benefit rule. C) violate materiality concepts. D) jeopardize compliance with contract terms and conditions.

69) SFAS No. 123 was issued as a compromise to the FASB’s original position regarding stock options as it:

A) required companies to continue following the approach used in APB No. 25. B) required companies to measure the fair value of stock options and charge this to expense. C) allowed companies to choose either the APB No. 25 approach or expense the fair value of the options. D) abandoned any reference to recognition of expense for options.

70) Stock options are granted to the employees of Young Company on March 10, 20X1. The employees must wait until March 10, 20X5 to exercise the options. The four-year waiting period is the:

A) expected life of the options. B) grant period. C) vesting period. D) holding period.

71) According to current GAAP, the date when the terms for stock options are mutually agreed-upon and the stock options are awarded to employees is the:

A) vesting date. B) grant date. C) exercise date. D) payment date.

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72)

Current GAAP specifies that the compensation costs for stock options are measured:

A) at the grant date only. B) at the grant date and again at the vesting date. C) at the vesting date only. D) at the grant date and again at the exercise date.

73) Over the vesting period for employee stock options, current GAAP requires that the entire compensation expense be recognized:

A) in the first year of the vesting period. B) in the last year of the vesting period. C) equally in each year of the vesting period. D) only if the options are exercised.

74)

Analysts should expect to see stock option information in:

A) the auditor’s report. B) a note to the financial statements. C) a separate report to the SEC. D) a separate report to shareholders.

75) Which of the following statements does not accurately reflect the financial accounting for compensatory stock option plans?

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A) Compensation expensed is allocated equally over the service (vesting) period. B) The compensation expense is not adjusted for changes in the market value of the stock options during the service (vesting) period. C) The paid-in capital stock options account is credited when compensation expense is recorded each year. D) Total owners’ equity is increased by the par value of the common stock issued when the options are converted.

76)

Which statement below does not represent the taxation of stock option plans?

A) Incentive Stock Options (ISO) provide tax benefits to employees. B) Nonqualified stock option plans provide tax benefits to employers. C) Tax law does not restrict the number of options that an employee can classify as ISOs in a given year. D) Employers do not receive a tax deduction for ISOs.

77)

Which item below is not one of the criteria used to qualify as an ISO?

A) The option is transferable. B) The exercise price cannot be less than the fair value of the stock at the grant date. C) The option is granted within 10 years from the date the plan is adopted. D) The option cannot be exercised after 10 years from the date of the grant.

78)

Accounting for nonqualified stock option plans results in all of the following except:

A) Nonqualified stock option accounting results in a temporary tax difference. B) Nonqualified stock option accounting results in a deferred tax asset based on compensation expense for the year. C) Accounting for nonqualified stock options provides the employer a tax deduction for the intrinsic value of the options at the date of exercise. D) The tax deduction for the options exercised will match the amount of the GAAP compensation expense for those options exercised.

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79) The presentation of the excess tax benefits related to stock options includes all of the following except:

A) Excess tax benefits are shown as a reduction of income tax expense. B) Excess tax benefits are reflected in the cash from financing activities section of the statement of cash flows. C) Excess tax benefits must be shown in both the statement of shareholders’ equity and the statement of cash flows. D) Presentation of excess tax benefits is guided by ASU 2016-09.

80)

Which statement reflects how an employee handles tax on ISOs?

A) Tax is due on the compensation calculated at the grant date. B) Tax is due on the capital gain calculated at the exercise date. C) Tax is due on the capital gain when the employee sells the stock. D) Compensation is taxed on the fair value of the stock as measured at the exercise date.

81) Which item is not an accurate representation of the impact of convertible bonds on the computation of EPS?

A) A convertible bond’s net-of-tax interest expense is added back to net income when determining diluted earnings per share only if the bond is known to be dilutive. B) Convertible bonds that were outstanding during the entire year will not have an impact on the weighted average number of common shares outstanding used in the calculation of basic earnings per share. C) Current GAAP requires that convertible bonds should only be considered as-if converted for diluted earnings per share if the share price is more than the conversion price. D) If the convertible bonds have an antidilutive effect, they are ignored in the computation of diluted EPS.

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82) A bond with a carrying value of $790,000 was converted into 100,000 shares of $5 per share par value common stock at a time when the market value per share was $9.00 per share. Which of the following statements does not accurately describe the financial accounting for the conversion?

A) A loss of $110,000 will be recognized if the market value method of recording the conversion is used. B) Total owners’ equity increases $790,000 if the market value method of recording the conversion is used. C) Total owners’ equity increases $790,000 if the book value method of recording the conversion is used. D) Total owners’ equity increases $900,000 if the market value method of recording the conversion is used.

83)

Convertible bonds are usually:

A) mortgage bonds. B) senior bonds. C) callable. D) participating.

84)

Call provisions on convertible bonds protect the:

A) investor against extreme stock price increases. B) company against extreme stock price increases. C) bank against extreme stock price decreases. D) company against extreme stock price decreases.

85) With the development of modern option pricing methods, prior accounting standards setters would probably have reached the conclusion today that the conversion feature of convertible bonds:

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A) has no value. B) has value. C) has value, but should be ignored. D) does not lend itself to these option pricing models.

86) To record newly issued stock shares upon conversion of debt, managers most often choose the method known as the:

A) market value method. B) book value method. C) Black-Scholes method. D) par value method.

87)

Financial statement users must recognize that interest expense may seriously:

A) overstate the true cost of debt financing when convertible debt is used. B) understate the true cost of debt financing when convertible debt is used. C) impact the dividend rate. D) impact the amount of dividend declared.

88) Which of the following correctly describes U.S. GAAP accounting for convertible bonds and the implication of that requirement?

A) Separation of debt and equity components; interest expense is overstated. B) No separation of debt and equity components; interest expense is understated. C) No separation of debt and equity components; interest expense is overstated. D) Separation of debt and equity components; interest expense is understated.

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89) Cheery Company follows IFRS for its financial reporting. On January 1, 20X1 Cheery issued €250 million of 10-year convertible notes that pay interest at 5% annually. Investors pay €250 million for the notes even though the company’s credit risk at the time implies a 10% interest rate for traditional debt of similar duration. When the cash flows associated with the debt are discounted at 10%, the resulting value is €175 million.How much interest expense will be recorded on Cheery’s December 31, 20X1 income statement?

A) €25 million B) €12.5 million C) €17.5 million D) €8.75 million

90) Cheery Company follows IFRS for its financial reporting. On January 1, 20X1 Cheery issued €250 million of 10-year convertible notes that pay interest at 5% annually. Investors pay €250 million for the notes even though the company’s credit risk at the time implies a 10% interest rate for traditional debt of similar duration. When the cash flows associated with the debt are discounted at 10%, the resulting value is €175 million.How much cash will Cheery pay for interest during 20X1?

A) €25 million B) €12.5 million C) €17.5 million D) €8.75 million

91) Cheery Company follows IFRS for its financial reporting. On January 1, 20X1 Cheery issued €250 million of 10-year convertible notes that pay interest at 5% annually. Investors pay €250 million for the notes even though the company’s credit risk at the time implies a 10% interest rate for traditional debt of similar duration. When the cash flows associated with the debt are discounted at 10%, the resulting value is €175 million.When Cheery records interest expense on December 31, 20X1 the entry will include:

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A) A debit to interest expense for €25 million. B) A credit to Convertible notes payable for €12.5 million. C) A debit to Convertible notes payable for €17.5 million. D) A credit to Convertible notes payable for €5 million

92)

Mandatorily redeemable preferred shares are classified as liabilities consistent with

A) U.S. GAAP. B) IFRS. C) both U.S. GAAP and IFRS. D) neither U.S. GAAP, nor IFRS.

93) Neumann Corporation issues convertible preferred stock that is mandatorily redeemable five years from the date of issuance. During the last two years that the preferred shares are outstanding, investors may convert each one share of preferred stock to two shares of common stock. Prior to conversion or redemption, the preferred shares should be classified on the balance sheet as:

A) shareholders’ equity. B) debt. C) either shareholders’ equity or debt. D) treasury stock.

94)

Dividends on mandatorily redeemable preferred shares should be recognized as a(n):

A) expense. B) reduction of retained earnings. C) reduction of paid-in capital. D) increase in paid-in capital.

95)

Consistent with U.S. GAAP, proceeds from issuing convertible debt are recognized as

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A) a liability. B) shareholders’ equity. C) part liability and part shareholders’ equity. D) a revenue.

96) Alte Inc. issues $5 million face amount convertible bonds; the bonds issue at 101. Similar bonds issued without the conversion right would have been issued at 99. Alte applies U.S. GAAP.At time of issuance, Alte should recognize a bond-related liability in the amount of:

A) $ 0 B) $4.95 million C) $5 million D) $5.05 million

97) Alte Inc. issues $5 million face amount convertible bonds; the bonds issue at 101. Similar bonds issued without the conversion right would have been issued at 99. Alte applies U.S. GAAP.At time of issuance, Alte should recognize shareholders’ equity associated with the issuance of the bonds in the amount of:

A) B) C) D)

$ 0. $ 500,000. $ 1,000,000. $ 5,050,000.

98) Alte Inc. issues $5 million face amount convertible bonds; the bonds issue at 101. Similar bonds issued without the conversion right would have been issued at 99. Alte applies U.S. GAAP.At time of issuance, Alte should recognize the difference between the issue price and the face amount of the bonds as:

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A) B) C) D)

paid-in capital. a premium on bonds payable. a discount on bonds payable. a gain.

99) Neu Inc. issues $5 million face amount convertible bonds; the bonds issue at 101. Similar bonds issued without the conversion right would have been issued at 99. Neu applies IFRS.At time of issuance, Neu should recognize a bond-related liability in the amount of:

A) B) C) D)

$ 0. $4.95 million. $5 million. $5.05 million.

100) Neu Inc. issues $5 million face amount convertible bonds; the bonds issue at 101. Similar bonds issued without the conversion right would have been issued at 99. Neu applies IFRS.At time of issuance, Neu should recognize shareholders’ equity associated with the issuance of the bonds in the amount of:

A) B) C) D)

$ 0. $ 500,000. $ 1,000,000. $ 5,050,000.

101) Neu Inc. issues $5 million face amount convertible bonds; the bonds issue at 101. Similar bonds issued without the conversion right would have been issued at 99. Neu applies IFRS.At time of issuance, Alte should recognize the difference between the issue price and the face amount as the bonds as:

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A) B) C) D)

paid-in capital. a premium on bonds payable. a discount on bonds payable. a gain.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 102) The Squash Company’s shareholders’ equity on January 1, 20X1 was $3,125,500. During 20X1, Squash Company reported the following:Net income of $575,325.Declared cash dividends totaling $125,000; the dividends had not been paid as of December 31, 20X1.Issued 10,000 shares of $5 par value common stock at $9 per share.Purchased 5,000 shares of its common stock for $9.75 per share; the shares are being held as treasury shares.Sold 1,500 shares of treasury stock for $9.25 per share.Required:Prepare the balance of shareholders’ equity as of December 31, 20X1.

103) The Sports Corporation previously issued convertible bonds with a maturity value of $5,000,000; the book value of the bonds as of October 1, 20X1 was $5,250,000. Each $1,000 bond is convertible into 100 shares of $5 par value common stock. On October 1, 20X1, bonds with a maturity value of $2,000,000 were converted into common stock; the common stock’s market value on the conversion date was $12.75 per share.Required: Using the above facts only:1) Prepare the journal entry to record the bond conversion using the book value method.2) Prepare the journal entry to record the bond conversion using the market value method.

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104) Evert Company recently acquired 5,000 shares of its $2 par value common stock for $10 per share. Evert initially issued the stock for $7.50 per share.Required: Assuming the shares were purchased as treasury shares, prepare the necessary journal entry to record the purchase of the 5,000 shares.Continuing with the assumption that the shares were purchased as treasury shares, prepare the journal entry to record the sale of 2,500 shares of the treasury stock for $11.50 per share.Continuing with the assumption that the shares were purchased as treasury shares, prepare the journal entry to record the subsequent sale of 2,000 shares of treasury stock for $9.75 per share. Assuming the shares were purchased and retired, prepare the journal entry to record the retirement of the shares.

105) Penn Company had 10,000,000 shares of common stock outstanding on January 1, 20X1. Penn entered into the following stock transactions during 20X1:2,000,000 shares of common stock were issued on April 1st.600,000 shares of common stock were purchased on May 1st and were being held as treasury stock.500,000 shares of preferred stock were issued on July 1st.400,000 shares of treasury stock were reissued on October 1st.A 2-for-1 common stock split was declared on November 1st.Bonds convertible into 1,200,000 shares of common stock were issued on December 1st; the bonds are considered to be dilutive.Required: Determine the number of shares to be used in the calculation of 1) Basic EPS2) Diluted EPS.

106) The Dunlop Corporation reported basic EPS of $3.50 for the year ended December 31, 20X1; the denominator used in the basic EPS calculation was 360,000 shares. Dunlop’s marginal income tax rate is 40%. Dunlop had the following convertible securities outstanding during the entire year:8% convertible preferred stock with a total par value of $1,000,000; the preferred stock is convertible into 22,000 shares of common stock.10% convertible bonds with a total par value of $6,000,000; the convertible bonds are convertible into 120,000 shares of common stock.Required: Calculate the diluted EPS. (Hint: First test each security separately for dilution.)

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107) The Slazenger Company has provided the following information:Shareholders’ equity on January 1, 20X1 was $2,225,900.Shareholders’ equity on December 31, 20X1 was $2,379,300.Treasury stock costing $71,000 was sold for $62,000; the treasury stock was acquired during 20X0.A property dividend was declared and distributed during 20X1. The property’s book value was $42,325 on the declaration date; the property’s fair value was $54,485 on the declaration date and $57,500 on the distribution date.10,000 shares of $20 par value preferred stock were purchased and retired during 20X1. The shares were initially issued for $25 per share and were purchased for $29 per share.5,000 shares of $5 par value common stock were issued as the result of a small stock dividend. The market value per share was $9 at the declaration date and $9.50 at the distribution date.Cash dividends declared and paid during the year totaled $70,000.Required: What was Slazenger’s 20X1 net income assuming that the only other transactions impacting shareholders’ equity are described above?

108)

Prince Corp. has the following balance sheet information at December 31, 20X1.

Current liabilities Convertible bonds ($1,000 par, 7%) Common stock ($1 par, 100,000 shares issued)

545,000 4,000,000 100,000

Additional paid-in capital

1,000,000

Retained earnings

2,000,000

Treasury stock (9,000 shares)

(360,000 )

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Total liabilities and shareholder’s equity

$ 7,285,000

The convertible bonds were issued at par on April 1, 20X1 and are convertible into Prince’s common stock at a ratio of 25 shares of stock to 1 bond. Prince did not have any treasury stock at December 31, 20X0 and purchased the 9,000 shares evenly throughout 20X1. The average price of the common stock for the year was $40, and the year-end price was $45.Prince Corp. also has 60,000 outstanding and exercisable qualified employee stock options. Employees obtain one share of stock for each option exercised. The exercise price for each option is $21 per share.Prince’s net income for the year ended 20X1 was $292,500. Its tax rate for the year was 35%.Required:Compute basic EPS for the year ended December 31, 20X1. Show all computations.Compute diluted EPS for the year ended December 31, 20X1. Show all computations.

109) McQueen, Inc. grants 200,000 nonqualified stock options to Robert Chalmers, the CEO, on January 1, 20X1. The par value of McQueen’s common stock is $1. The exercise price on the options is $35 per share, and the options are exercisable in two years. The stock price on January 1, 20X1 is $31 per share. This is a fixed option plan. Using the Black-Scholes option pricing model, the value of each option is estimated to be $15.50 at the date of grant. Stock prices are $45, $65, and $50 at December 31, 20X1, 20X2, and 20X3, respectively. Robert exercises his options on April 14, 20X4, when the stock price is $57 per share.Required:Using current GAAP, how much expense will McQueen, Inc. recognize for the year ended December 31, 20X2 related to the options?Prepare the journal entries needed on the date of exercise.

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110) On January 2, 20X1, Cannon Company issued $10,000,000 of convertible debt. The bonds are zero-coupon, and each $1,000 bond is convertible into 10 shares of Cannon Company’s common stock at the bond holder’s option. The bonds mature in 20X5 and were issued at par. Companies with similar credit profiles were issuing non-convertible debt at an effective rate of interest of 8%. The present value factor for $1 for 5 periods at 8% is .68058. For each of the following assumptions, prepare the journal entry to record the issuance of debt and entries for 20X1 and 20X2 to record interest expense. No bonds were converted during 20X1 or 20X2.Required:Cannon Company uses U.S. GAAP to prepare its external financial reporting to shareholders and regulators.Cannon Company uses IFRS to prepare its external financial reporting to shareholders and regulators.

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Answer Key Test name: chapter 16 1) FALSE 2) TRUE 3) TRUE 4) TRUE 5) TRUE 6) TRUE 7) TRUE 8) FALSE 9) TRUE 10) FALSE 11) TRUE 12) FALSE 13) TRUE 14) TRUE 15) FALSE 16) D 17) C 18) A 19) B 20) D 21) A 22) A 23) B 24) A 25) C 26) C Version 1

27) D 28) D 29) B 30) C 31) D 32) A 33) C 34) A 35) B 36) B 37) B 38) A 39) B 40) B 41) C 42) B 43) B 44) B 45) C 46) C 47) C 48) B 49) D 50) B 51) C 52) B 53) B 54) B 55) A 56) A Version 1

57) B 58) D 59) C 60) B 61) B 62) B 63) C 64) D 65) D 66) C 67) B 68) D 69) C 70) C 71) B 72) A 73) C 74) B 75) D 76) C 77) A 78) D 79) B 80) C 81) C 82) D 83) C 84) B 85) B 86) B Version 1

87) B 88) B 89) C 90) B 91) D 92) C 93) B 94) A 95) A 96) D 97) A 98) B 99) B 100) B 101) A 102) Beginning balance, January 1

$ 3,125,500

+ Net income

575,325

− Dividends declared

(125,000 )

+ Shares issued

(10,000 shares × $9 per share) (48,750 ) (5,000 shares × $9.75 per share) 13,875 (1,500 shares × $9.25 per share)

− Treasury stock purchase + Sale of treasury stock Shareholders equity, December 31

90,000

$ 3,630,950

103) (1) Book value method

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Bonds payable

2,000,000

Bond premium

100,000

Common stock

1,000,000

Additional paid-in capital

1,100,000

(2) Market value method Bonds payable

2,000,000

Bond premium

100,000

Loss on bond conversion

450,000

Common stock

1,000,000

Additional paid-in capital

1,550,000

104) 1. Treasury stock Cash

50,000 50,000

2. Cash

28,750

Treasury stock

25,000

Additional paid-in capital-treasury stock

3,750

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3. Cash

19,500

Additional paid-in capital-treasury stock

500

Treasury stock

20,000

4. Common stock

10,000

Additional paid-in capital – common stock

27,500

Retained earnings

12,500

Treasury stock

50,000

105) 1) Basic EPS: January 1 Common shares, effected for stock split April 1

20,000,000

(10,000,000 × 2)

Common shares issued, effected for stock split May 1

3,000,000

(2,000,000 × 2 × 9/12)

Treasury shares purchased, effected for stock split July 1

(800,000 ) (600,000 × 2 × 8/12)

Preferred shares issued

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October 1 Sale of treasury shares

200,000

(400,000 × 2 × 3/12)

December 1 Convertible bonds issued Total shares for basic EPS

0 22,400,000

2) Diluted EPS: January 1 Common shares, effected for stock split April 1

20,000,000

(10,000,000 × 2)

Common shares issued, effected for stock split May 1

3,000,000

(2,000,000 × 2 × 9/12)

Treasury shares purchased, effected for stock split July 1

(800,000 ) (600,000 × 2 × 8/12)

Preferred shares issued

October 1 Sale of treasury shares

200,000

(400,000 × 2 × 3/12)

100,000

(1,200,000 × 1/12)

December 1 Convertible bonds issued Total shares for diluted EPS

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22,500,000

106) Test each separately for dilution. The preferred stock is not dilutive ($80,000/22,000 = $3.64). The bonds are dilutive ($360,000/120,000 = $3.00). Then, Diluted EPS = $3.38 = $1,260,000 ($3.50 × 360,000) + $360,000 ($600,000 × .6) 360,000 + 120,000

107) Shareholders’ equity, January 1

$ 2,225,900

Sale of treasury stock Property dividend at fair

62,000 value when distributed

(57,500 )*

Preferred stock retired

(290,000 )

Stock dividend

Cash dividends

(70,000 )

Subtotal

$ 1,870,400

Shareholders’ equity, December 31

2,379,300

Net income

508,900

* The difference between book value and fair value becomes part of net income. This problem asks for net income so the solution contains the gain on the fair value adjustment of the asset distributed, and retained earnings is reduced for the fair value of the property when distributed. 108) 1. Basic EPS: Net income = Outstanding shares

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$292,500 ((100,000 + (100,000 − 9,000))/2)

$292,500 95,500

$3.06

Net income $292,500 = $3.06 Outstanding shares ((100,000+(100,000-9,000))/2) = 95,500 2. Diluted EPS: Numerator Net income

$ 292,500

Bond interest [.75 × 4,000,000 × .07 × (1 – .35)]

136,500

Numerator

$ 429,000

Denominator Basic shares

95,500

Effect of options Proceeds from exercise

60,000

(60,000 × $21)

$ 1,260,000

Divided by average share price

Shares assumed to be purchased

40 31,500

Increase in shares

28,500

Effect of convertible bonds Average outstanding (.75 × 4,000) Multiplied by conversion ratio

3,000 25

Increase in shares

75,000

Denominator

199,000

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Diluted EPS

$ 2.16

109) 1. ($15.50 × 200,000) ÷ 2 years = $1,550,000 2. Cash (200,000 × $35)

7,000,000

Additional paid-in capital – options

3,100,000 *

Common stock – par

200,000

Additional paid-in capital

9,900,000

* options issued had been fully accounted for by the date of exercise 110) A. January 1, 20X1 Cash Convertible bonds payable

10,000,000 10,000,000

No further entries would be required during 20X1 and 20X2 under U.S. GAAP. Current GAAP allows Cannon Company to avoid interest expense because the zero-coupon convertible debt and structure of the conversion feature allowed the company to sell the bond for par (face) value. Therefore, no interest expense is recorded over the life of the bond.B. January 1, 20X1 Version 1

Cash

10,000,000

Convertible bonds payable

6,805,800

Shareholders’ equity – conversion option

3,194,200

December 31, 20X1 Interest expense

544,464 *

Convertible bonds payable

544,464

*$6,805,800 × 8% December 31, 20X2 Interest expense Convertible bonds payable

588,021 ** 588,021

**$6,805,800 + 544,464 = $7,350,264 × 8%

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CHAPTER 17: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) For an investor each share of common stock and each share of preferred stock owned usually entitles the owner to one vote. ⊚ ⊚

true false

2) The realized gain on a passive investment in equity securities is calculated by comparing the selling price to the original cost. ⊚ ⊚

true false

3) The upward or downward adjustment to reflect fair value of equity investment securities is a direct debit or credit to a fair value adjustment account. ⊚ ⊚

true false

4) An unrealized loss on investment securities results in a deferred tax asset because the loss reduces pre-tax income but has no effect on taxable income. ⊚ ⊚

true false

5) When the ownership percentage of voting stock exceeds 20 percent, GAAP presumes that the investor is able to exert significant influence over the investee company. ⊚ ⊚

true false

6) When the investor pays $100,000 to acquire 40% of a company’s outstanding voting shares at a time when the fair value of the company’s net assets are $175,000, the resulting goodwill amount is $30,000.

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⊚ ⊚

true false

7) When two companies form a joint venture and each company owns exactly 50% of the joint venture, both parents will account for the joint venture using the equity method. ⊚ ⊚

true false

8) Consolidated financial statements must always be prepared when a corporation acquires more than 50% of the voting stock of another corporation. ⊚ ⊚

true false

9) Under purchase method accounting for a business combination, the subsidiary’s assets and liabilities were reported on the consolidated balance sheet at 100 per cent of their fair values at the date of purchase regardless of whether there is a noncontrolling interest. ⊚ ⊚

true false

10) The amount of goodwill recognized on a consolidated balance sheet will always be the same when accounting for a business combination under either the acquisition method or the purchase method. ⊚ ⊚

true false

11) Interest on investments in debt securities intended to be held till maturity is recognized based on the effective interest method, while interest on investments in debt securities expected to be sold prior to maturity is recognized with reference to the stated interest rate. ⊚ ⊚

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true false

12) The fair value adjustment account balance for an investment in bonds classified as Available-for-Sale will have a zero balance at the maturity date of the bonds. ⊚ ⊚

13)

true false

IFRS does not permit use of the fair value option for equity-method investments. ⊚ ⊚

true false

14) While both IFRS and GAAP require companies to consolidate entities they control, IFRS defines control more narrowly than GAAP. ⊚ ⊚

true false

15) When a company has available-for-sale debt securities, the interest income pattern in the income statement is identical to the interest income pattern under the held-to-maturity classification. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) A minority ownership interest generally occurs when an investor owns less than which of the following percentages of the stock of an investee company?

A) B) C) D)

17)

20% 30% 40% 50%

A minority active ownership is represented by:

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A) less than 20% ownership. B) 20% or more but less than 50% ownership. C) more than 50% ownership. D) more than 60% and less than 70% ownership.

18) Investments in debt securities that the investor intends to hold for a short time and that are purchased in an attempt to profit from near-term price changes are classified as:

A) available-for-sale securities. B) trading securities. C) fair value securities. D) adjusted historical cost securities.

19) Investments in debt securities that the investor intends to hold until the funds are needed for a business expansion are classified as:

A) available-for-sale securities. B) trading securities. C) fair value securities. D) adjusted historical cost securities.

20) Under the rules for minority passive investments in equity securities, which of the following statements is not correct?

A) There will be no distinction between trading securities and available-for-sale securities for minority passive equity investments. B) The income statement and balance sheet will be the same as if the equity method had been applied. C) Cash flows from the purchase and sale of equity securities will be classified based on the nature and purpose of the investment. D) An exception will be for investments where fair value is not readily determinable.

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21) Which of the following statements regarding minority passive investments in stock securities is correct?

Unrealized gains or losses will bypass the income statement until the investment is

sold. B) All investments classified as minority passive must be reported at fair value. C) Investments are reported at the lower of cost or net realizable value. D) Investments lacking significant influence are considered minority passive investments.

22)

Investments in debt securities made to generate trading gains are classified as:

A) available-for-sale securities. B) trading securities. C) held to maturity securities. D) minority securities.

23)

Minority active equity investments are accounted for by the:

A) fair value method. B) purchase method. C) equity method. D) cost.

24) In accounting for minority passive equity investments, the unrealized holding gain or loss on equity securities is recorded on:

A) the income statement in the period after the security price change. B) the income statement in the period of the security price change. C) the balance sheet as a deferred charge in the period of the security price change. D) the balance sheet as a separate component of stockholders’ equity.

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25) A company purchased shares of stock of another company for $75,000 during 20X1. The shares’ fair value was $79,000 at the end of 20X1 and $81,000 at the end of 20X2. Which of the following statements correctly describes the investor’s accounting for the investment?

A) A realized gain of $4,000 was recorded during 20X1. B) An unrealized gain of $6,000 was recorded during 20X2. C) An unrealized gain of $2,000 was recorded during 20X2. D) A realized gain of $2,000 was recorded during 20X2.

26) Perry Investments bought 2,000 shares of Able, Inc. common stock on January 1, 20X1, for $20,000 and 2,000 shares of Baker, Inc. common stock on July 1, 20X1 for $24,000. Baker paid $2,400 of previously declared dividends to Perry on December 31, 20X1. At the end of 20X1, the fair value of the Able stock was $18,000 and the fair value of the Baker stock was $28,000. The stocks were purchased for short-term speculation prior to the effective date of the change in accounting rules for equity investments. Perry owns 10% of each company.Perry should record the receipt of the Baker dividend as:

A) DR Cash 240 CR Dividend income 240 B) DR Dividends receivable 2,400 CR Dividend income 2,400 C) DR Cash 2,400 CR Investment in Baker 2,400 D) DR Cash 2,400 CR Dividends receivable 2,400

27) Perry Investments bought 2,000 shares of Able, Inc. common stock on January 1, 20X1, for $20,000 and 2,000 shares of Baker, Inc. common stock on July 1, 20X1 for $24,000. Baker paid $2,400 of previously declared dividends to Perry on December 31, 20X1. At the end of 20X1, the fair value of the Able stock was $18,000 and the fair value of the Baker stock was $28,000. The stocks were purchased for short-term speculation prior to the effective date of the change in accounting rules for equity investments. Perry owns 10% of each company.Perry should record the year-end adjustment as:

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A) DR Fair value adjustment—Trading securities 2,000 CR Unrealized holding gain on Trading securities—Income 2,000 B) DR Unrealized holding gain on equity securities—Income 2,000 CR Fair value adjustment—Trading securities 2,000 C) DR Fair value adjustment—Trading securities 2,000 CR Unrealized holding loss on Trading securities—Income 2,000 D) DR Fair value adjustment—Trading securities 2,000 CR Realized holding gain on Trading securities 2,000

28) Of the following items, which would not be a circumstance that may trigger goodwill impairment?

A) Loss of key personnel B) Unanticipated competition C) Adverse action imposed by a regulator D) Recognition of an inventory loss in the financial statements of the parent

29) Central Investments bought 4,000 shares of Benet Company common stock on January 1, 20X1, for $20,000, and 4,000 shares of Roy Company common on July 1, 20X1, for $24,000. Benet declared dividends on December 31, 20X1 of $3,000. At the end of 20X1, the fair value of Roy was $30,000 and the fair value of Benet was $28,000. At the end of 20X2, the fair value of Roy was $32,000 and the fair value of Benet was $24,000. These investments are reported in the long-term asset section of Central’s balance sheet. Central owns 8% of Benet Company and 12% of Roy Company.Assume that the Roy Company stock was sold during 20X3 for $31,000. The proper accounting recognition at the date of sale was:

A) an unrealized loss $1,000. B) a realized gain of $7,000. C) a realized gain of $6,000. D) a realized loss of $1,000.

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30) Central Investments bought 4,000 shares of Benet Company common stock on January 1, 20X1, for $20,000, and 4,000 shares of Roy Company common on July 1, 20X1, for $24,000. Benet declared dividends on December 31, 20X1 of $3,000. At the end of 20X1, the fair value of Roy was $30,000 and the fair value of Benet was $28,000. At the end of 20X2, the fair value of Roy was $32,000 and the fair value of Benet was $24,000. These investments are reported in the long-term asset section of Central’s balance sheet. Central owns 8% of Benet Company and 12% of Roy Company.The 20X2 year-end adjustment resulted in:

A) a $12,000 reduction of net income. B) a $2,000 reduction of net income. C) a $2,000 increase in stockholders’ equity. D) a realized gain of $2,000.

31) Central Investments bought 4,000 shares of Benet Company common stock on January 1, 20X1, for $20,000, and 4,000 shares of Roy Company common on July 1, 20X1, for $24,000. Benet declared dividends on December 31, 20X1 of $3,000. At the end of 20X1, the fair value of Roy was $30,000 and the fair value of Benet was $28,000. At the end of 20X2, the fair value of Roy was $32,000 and the fair value of Benet was $24,000. These investments are reported in the long-term asset section of Central’s balance sheet. Central owns 8% of Benet Company and 12% of Roy Company.How much income was reported on the 20X1 income statement?

A) B) C) D)

$240 $14,240 $14,000 $0

32) The Shasta Corporation began operations in 20X1. Shasta’s portfolio of minority passive investments reported the following on December 31, 20X1: Equity Investments Cost Fair value

$450,000 $395,000

Which of the following is correct with respect to the accounting for Shasta’s investment portfolio? Version 1

A) Net income was decreased $55,000 during 20X1. B) Net income and total stockholders’ equity were decreased $55,000 as of December 31, 20X1. C) Net income was increased $55,000 during 20X1. D) Net income and total stockholders’ equity were increased $55,000 as of December 31, 20X1.

33) Almond Industries owns an investment that experienced a decline during 20X2 that has been judged to be "other than temporary". The investment is held in Almond’s minority passive equity investment portfolio. It was purchased in March 20X1 at a cost of $460,000. At the end of 20X1, the fair value of the investment was $520,000. At the end of 20X2, the fair value of the investment is $410,000. What amount of loss will Almond Industries report on its income statement for the year ending December 31, 20X2 related to this investment?

A) an unrealized loss of $110,000 B) an unrealized loss of $50,000 C) an unrealized loss of $60,000 D) a realized loss of $50,000

34) Which of the following statements does not properly reflect the accounting rules for accounting for minority equity investment securities, if fair value is not readily determinable?

A) Firms may opt to report at fair value or report at cost. B) If reported at cost, the reported value is to be updated when there is an observable transaction. C) If reported at cost, the reported value is updated when circumstances indicate the asset’s value is impaired. D) If there are changes in carrying value, they are not to be reported in net income.

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35) Palmon Industries owns an investment that experienced a decline during 20X2 that has been judged to be “other than temporary”. The investment is held in Palmon’s available-for-sale debt securities portfolio, and Palmon expects to sell the impaired security before recovery of its amortized cost basis less current-period credit loss. The debt security was purchased in March 20X1 at a cost of $460,000. At the end of 20X1, the fair value of the investment was $520,000 and its amortized cost basis was $454,000. At the end of 20X2, the fair value of the investment is $410,000 and its amortized cost is $448,000. What amount of loss will Palmon Industries report on its income statement for the year ending December 31, 20X2 related to this investment?

A) an unrealized loss $110,000 B) an unrealized loss of $38,000 C) an unrealized loss of $44,000 D) an unrealized loss of $50,000

36) Ralmond Industries owns an investment that experienced a decline during 2019 that has been judged to be “other than temporary”. The investment is held in Ralmond’s available-for-sale debt portfolio, and Ralmond does not expect to sell the security and it is unlikely that Ralmond will be required to sell the security before recovery of its amortized cost basis less any currentperiod credit loss. It was purchased in March 2018 at a cost of $460,000. At the end of 20X1, the fair value of the investment was $520,000 and its amortized cost basis was $454,000. At the end of 2019, the fair value of the investment is $410,000 and its amortized cost is $448,000. At the end of 2019, the present value of expected cash flows associated with the security discounted at the effective interest rate implicit when it was originally acquired is $432,000. What amount of loss will Ralmond Industries report on its income statement for the year ending December 31, 2019 related to this investment?

A) an unrealized loss $16,000 B) an unrealized loss of $38,000 C) an unrealized loss of $44,000 D) an unrealized loss of $22,000

37) When the ownership percentage of stock exceeds 20 percent but is less than 50 percent, GAAP presumes that the investor:

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A) has no influence to exert over the investee company. B) is only investing for a short-term trading position. C) is able to exert influence over the investee company. D) is trying to take over the investee company.

38) When an investor owns less than 20 percent of the investee company, the investor may still be able to exert influence over the investee company if the other stock is:

A) closely held by a few investors. B) widely distributed across a few investors. C) widely distributed across a large number of individual investors. D) controlled a small group of investors.

39) When an investor is capable of influencing the investee company’s dividend policy, the investor is able to augment its own reported income when using:

A) minority passive accounting treatment. B) minority active accounting treatment. C) majority active accounting treatment. D) the equity method.

40)

A minority active investment is accounted for by the:

A) cost method. B) equity method. C) lower of cost or market method. D) speculative investment method.

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41) On January 1, 20X1, Ramsey Company purchased 35% of the outstanding common shares of the Vapor Company for $70,000. At the time of investment, Vapor Company’s net assets were $200,000. During 20X1, Vapor Company earned $80,000 and declared a dividend of $40,000. Ramsey accounted for the investment under the equity method.Ramsey’s share of Vapor’s income for 20X1 is:

A) B) C) D)

$14,000 $28,000 $42,000 $40,000

42) On January 1, 20X1, Ramsey Company purchased 35% of the outstanding common shares of the Vapor Company for $70,000. At the time of investment, Vapor Company’s net assets were $200,000. During 20X1, Vapor Company earned $80,000 and declared a dividend of $40,000. Ramsey accounted for the investment under the equity method.What is the balance in the investment account as of December 31, 20X1?

A) B) C) D)

$70,000 $98,000 $56,000 $84,000

43) On January 1, 20X1, the Regal Company purchased 30% of the outstanding voting stock of the Air Corporation for $300,000; the book value of Air’s net assets at the date of purchase was $900,000. Regal was willing to pay more than the book value of the acquired shares because Air’s depreciable assets with a ten-year remaining life were undervalued. Regal uses straight-line depreciation. During 20X1, Air reported net income of $75,000 and paid dividends of $30,000.The income reported by Regal during 20X1 pertaining to the Air investment was:

A) B) C) D)

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$9,000 $22,500 $31,500 $19,500

44) On January 1, 20X1, the Regal Company purchased 30% of the outstanding voting stock of the Air Corporation for $300,000; the book value of Air’s net assets at the date of purchase was $900,000. Regal was willing to pay more than the book value of the acquired shares because Air’s depreciable assets with a ten-year remaining life were undervalued. Regal uses straight-line depreciation. During 20X1, Air reported net income of $75,000 and paid dividends of $30,000.Regal has elected the fair value option to account for its equity method investments. The fair value of the Air investment as of December 31, 20X1 was $295,000. The income reported by Regal during 20X1 pertaining to the Air investment was:

A) B) C) D)

$9,000 $22,500 $19,500 $4,000

45) On January 1, 20X1, the Regal Company purchased 30% of the outstanding voting stock of the Air Corporation for $300,000; the book value of Air’s net assets at the date of purchase was $900,000. Regal was willing to pay more than the book value of the acquired shares because Air’s depreciable assets with a ten-year remaining life were undervalued. Regal uses straight-line depreciation. During 20X1, Air reported net income of $75,000 and paid dividends of $30,000.Regal has elected the fair value option to account for its equity method investments. The fair value of the Air investment as of December 31, 20X1 was $295,000. The carrying value of the Air investment on December 31, 20X1 was:

A) B) C) D)

$295,000 $300,000 $310,500 $313,500

46) At the acquisition date of an active investment, when the cost of the shares acquired exceeds the underlying book value, the investor is required to amortize any excess that is attributable to separately identifiable assets not having an indefinite life. Which of the following is a separately identifiable asset that might not be recognized on the investee’s balance sheet?

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A) Goodwill B) Land C) Patent D) Inventory

47) On January 1, 20X1, Como Company purchased 45% of the outstanding common shares of the Lite Company for $200,000. The net assets of Lite Company totaled $400,000. The inventory had a book value of $100,000 and a fair value of $120,000. Excess cost attributable to inventory is written off in 20X1. During 20X1, Lite Company earned $200,000 and declared a dividend of $40,000 for the year.The amount of goodwill implicit in Como’s transaction is:

A) B) C) D)

$9,000. $11,000. $20,000. $22,000.

48) On January 1, 20X1, Como Company purchased 45% of the outstanding common shares of the Lite Company for $200,000. The net assets of Lite Company totaled $400,000. The inventory had a book value of $100,000 and a fair value of $120,000. Excess cost attributable to inventory is written off in 20X1. During 20X1, Lite Company earned $200,000 and declared a dividend of $40,000 for the year.The excess amount paid for Lite Company attributable to inventory is:

A) B) C) D)

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$9,000. $11,000. $20,000. $22,000.

49) On January 1, 20X1, Como Company purchased 45% of the outstanding common shares of the Lite Company for $200,000. The net assets of Lite Company totaled $400,000. The inventory had a book value of $100,000 and a fair value of $120,000. Excess cost attributable to inventory is written off in 20X1. During 20X1, Lite Company earned $200,000 and declared a dividend of $40,000 for the year.The amount of the excess cost over book value attributable to inventory written off in 20X1 is:

A) B) C) D)

$3,000. $4,500. $7,500. $9,000.

50) On January 1, 20X1, Como Company purchased 45% of the outstanding common shares of the Lite Company for $200,000. The net assets of Lite Company totaled $400,000. The inventory had a book value of $100,000 and a fair value of $120,000. Excess cost attributable to inventory is written off in 20X1. During 20X1, Lite Company earned $200,000 and declared a dividend of $40,000 for the year.The carrying value of the Lite investment at the end of 20X1 is:

A) B) C) D)

$200,000 $290,000 $272,000 $263,000

51) On January 1, 20X1, Como Company purchased 45% of the outstanding common shares of the Lite Company for $200,000. The net assets of Lite Company totaled $400,000. The inventory had a book value of $100,000 and a fair value of $120,000. Excess cost attributable to inventory is written off in 20X1. During 20X1, Lite Company earned $200,000 and declared a dividend of $40,000 for the year. The fair value of the Lite stock investment at the end of 20X1 was $210,000. Which of the following amounts are correct assuming that Como elected to use the fair value option to account for the Lite investment? 20X1 Income a.

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$ 28,000

December 31, 20X1 carrying value $

210,000

$ 81,000

263,000

$ 91,000

273,000

$ 18,000

210,000

A) Option A B) Option B C) Option C D) Option D

52) Which of the following does not properly describe the accounting for an investment using the equity method when the fair value option has been elected?

A) The carrying value of the investment is the fair value of the investment. B) A retroactive adjustment is required if the investor switches from the fair value method. C) Dividends received by the investor increase net income. D) Unrealized gains and losses resulting from changes in market value are reported in the investor’s income statement.

53) If the parent company owns more than 50% of the subsidiary’s voting stock, and effectively has control of the subsidiary, consolidated financial statements are:

A) optional. B) required. C) not possible. D) required only by the SEC.

54) When two companies form a joint venture and each company owns exactly 50% of the joint venture:

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A) the cost method is used. B) the equity method is used and line-by-line consolidation is required. C) the equity method is used and line-by-line consolidation is not required. D) the company that has more net assets is deemed the parent.

55) A parent company’s investment account would include an element which is representative of :

A) the unrecorded book value of the investor’s assets. B) the recorded current value of the investee’s assets. C) the unrecorded difference between fair value and book value of the investee’s assets. D) the goodwill accrued since the purchase of the investee.

56) Consolidation adjustments that are made to prepare consolidated financial statements of the parent and subsidiary are required in order to:

A) obey the state laws. B) avoid double counting. C) follow tax laws. D) eliminate transactions with third parties.

57) Which of the following statements does not properly describe the accounting for business combinations?

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A) Under the purchase method, the subsidiary’s assets and liabilities are not valued at their full fair values on the consolidated balance sheet when noncontrolling interests are present. B) Under the acquisition method, the subsidiary’s assets and liabilities are valued at their full fair values on the consolidated balance sheet when noncontrolling interests are present. C) The parent company has the option of choosing either the purchase method or the acquisition method to account for the business combination. D) The noncontrolling interest is reported as a component of stockholders’ equity when using the acquisition method.

58) The Parent Company acquired 80% of the Sub Corporation’s voting stock on January 1, 20X1. Which of the following is not an accurate description of the consolidated balance sheet on January 1, 20X1?

A) Consolidated stockholders’ equity does not include the stockholders’ equity of the Sub Corporation. B) Consolidated assets do not include the Investment in Sub account. C) The fair value of both Parent’s and Sub’s assets are included within the consolidated balance sheet. D) Consolidated assets will include goodwill if the imputed total business fair value of Sub is in excess of the fair value of Sub’s identifiable assets.

59) On January 1, 20X1, the Shaw Corporation acquired 70% of the Ward Company’s voting stock for $1,050,000. Ward’s net assets had a book value of $1,200,000; the fair value of Ward’s equipment was $200,000 greater than its book value. The book value of Shaw’s assets immediately after the acquisition of Ward totaled $3,750,000 while Ward’s assets had a book value of $2,150,000. What was the amount of total consolidated assets as of January 1, 20X1?

A) B) C) D)

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$5,150,000 $6,200,000 $5,050,000 $4,850,000

60) On January 1, 20X1, the Knight Corporation acquired 80% of the Red Company’s voting stock for $1,500,000. Red’s net assets had a book value of $1,350,000; the fair value of Red’s land was $325,000 greater than its book value. The book value of Knight’s assets immediately after the acquisition of Red totaled $6,850,000 while Red’s assets had a book value of $1,350,000. What was the amount of goodwill reported on the January 1, 20X1 consolidated balance sheet?

A) B) C) D)

61)

$525,000 $200,000 $160,000 $42,000

Testing for goodwill impairment:

A) requires both qualitative and quantitative tests. B) necessitates determining if the reporting unit itself is impaired after calculatingimplied goodwill. C) may result in an impairment charge defined as the difference between the goodwill reflected for the reporting unit in the consolidated balance sheet and the reporting unit’s implied goodwill. D) requires computing implied goodwill, which is the amount of fair value of the reporting unit less the book value of the separately identifiable net assets of the reporting unit.

62) On January 1, 20X1, the Husky Corporation acquired 90% of the Spartan Company’s voting stock for $2,700,000. Spartan’s net assets had a book value of $2,450,000; the fair value of Spartan’s building was $325,000 greater than its book value. The book value of Husky’s net assets immediately after the acquisition of Spartan totaled $6,850,000. What is total stockholders’ equity on the January 1, 20X1 consolidated balance sheet?

A) B) C) D)

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$9,300,000 $6,850,000 $7,150,000 $7,120,000

63) On January 1, 20X1, the Husky Corporation acquired 90% of the Spartan Company’s voting stock for $2,700,000. Spartan’s net assets had a book value of $2,450,000; the fair value of Spartan’s building was $325,000 greater than its book value. The book value of Husky’s net assets immediately after the acquisition of Spartan totaled $6,850,000. What is the amount of goodwill reported on the January 1, 20X1 consolidated balance sheet?

A) B) C) D)

$495,000 $202,500 $550,000 $225,000

64) Hill Company entered into the following inventory transactions with its investees during 20X1: Sold inventory to Grant Inc. for $150,000. The inventory originally cost Hill $120,000. Grant sold 75% of the inventory during 20X1. Hill owns 15% of the voting stock of Grant and does not use the equity method to account for the Grant investment.Sold inventory to Thornton Inc. for $400,000. The inventory originally cost Hill $320,000. Thornton sold all of this inventory during 20X1. Hill owns 100% of the voting stock of Thornton.Which of the following adjustments is correct with respect to preparing Hill’s 20X1 consolidated financial statements?

A) Sales will be decreased $400,000. B) Cost of goods sold will be decreased $338,000. C) Inventory will be decreased $40,000. D) Gross profit will be decreased $110,000.

65) Which of the following statements does not accurately describe the current accounting standards for goodwill?

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A) If the fair value of the reporting unit is greater than its book value there is not a goodwill impairment. B) Goodwill should not be amortized. C) If the fair value of the reporting unit is less than its book value there will always be a goodwill impairment. D) Goodwill should be tested for impairment on at least an annual basis and in certain conditions between annual dates.

66) When a firm has noncontrolling interests, analysts may compute and review all except which of the following return on equity ratios?

A) Return on total equity where total equity includes common equity, preferred stock, and noncontrolling interests. B) Return on total equity net of non-controlling interests where total equity includes common equity and preferred stock, less noncontrolling interests. C) Return on parent company equity where parent company equity includes both common equity and preferred stock. D) Return on common equity defined as net income attributable to the parent company minus pre•ferred dividends divided by average common equity.

67) The disclosure rules pertaining to GAAP accounting for business combinations complicates financial analysis for which of the following reasons?

A) Comparative financial statements are not retroactively adjusted to include data for the acquired company for periods prior to the acquisition. B) The inclusion of noncontrolling interest in the retroactively adjusted financial statements complicates the analysis. C) The inclusion of acquired goodwill in the retroactively adjusted financial statements complicates the analysis. D) The inclusion of the acquired firm’s equity within the retroactively adjusted financial statements complicates the analysis.

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68) Which of the following criteria is applicable with respect to determining when a variable interest entity (VIE) must be consolidated into the sponsoring firm’s financial statements?

A) A consolidation must occur if the firm has a controlling financial interest and is the VIE’s primary beneficiary. B) A consolidation must occur if the firm is entitled to receive all of the VIE’s residual returns. C) A consolidation must occur regardless of the risk of loss exposure. D) A consolidation must occur if the sponsoring firm owns more than 50% of the VIE’s equity.

69)

Which of the following is not a use of a variable interest entity (VIE)?

A) To set up take-or- pay contracts. B) For any purpose needed by the beneficiary of the VIE. C) To securitize loans or mortgages. D) To sell receivables.

70)

Which of the following does not accurately inform about a variable interest entity (VIE)?

A) A variable interest entity may take many forms including corporations and partnerships. B) In pre-codification literature, a variable interest entity was referred to as a Special Purpose Entity. C) There are 2 criteria for determining if a company has a controlling financial interest in a variable interest entity. D) The power to direct the activities of the VIE that most significantly impact the VIE’s eco•nomic performance is the definition of a controlling financial interest.

71) Financial reporting rules consistent with FASB ASC Topic 810 embrace the concept.

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A) propriety B) economic unit C) shareholders’ D) majority

72) During 20X1, Marten purchased $100,000 face amount bonds at a premium and classifies them as available-for-sale investment. On 12/31/20X1 after recognizing interest income and amortization, the carrying value of the bonds is $101,300 and the market value is $101,900. What additional journal entry related to the bond investment should Marten make on 12/31/20X1?

Fair value adjustment—Available-for-Sale Securities

600

OCI--Unrealized Gain or Loss in Fair Value of Availablefor-Sale Securities

600

Fair value adjustment—Available-for-Sale Securities

1,900

OCI--Unrealized Gain or loss in Fair value of Available-for-Sale

1,900

Fair value adjustment—Available-for-Sale Securities Gain on Available-for-Sale Securities

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600 600

Fair value adjustment—Available-for-Sale Securities

1,900

Gain on Available-for-Sale Securities

1,900

73) Interest income recognized for investments in debt securities classified as available-forsale as compared to being classified as held-to-maturity is:

A) higher for debt securities purchased at a premium. B) higher for debt securities purchased at a discount. C) the same regardless of classification and acquisition price of the investment. D) inversely related to the change in fair value of the investment.

74) Neuman classifies its investment in bonds as available-for-sale investment. The investment was purchased at a discount. Which of the following associated account balance(s) must reach zero by the maturity date?

A) Discount on Bonds Payable B) Discount on Bonds Payable, fair value adjustment C) Discount on Bonds Payable, OCI-unrealized gain or loss D) Discount on Bonds Payable, fair value adjustment, OCI-unrealized gain or loss

75) Proctor sells bonds with a carrying value of $104,800 for $106,200. The bonds were classified as an investment in trading securities. During the past two years, Proctor recognized a net loss of $2,100 related to the investment. On the date of sale, Proctor should:

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A) debit gains for $700. B) credit gains for $1,400. C) credit losses for $2,100. D) debit losses for $700.

76) FASB ASU 2016-03 requires that companies recognize a credit loss for debt investments classified as:

A) trading and available-for-sale securities. B) held-to-maturity and available-for-sale securities. C) held-to-maturity and trading securities. D) available-for-sale, held-to-maturity and trading securities.

77) its:

A credit loss is calculated by comparing the amortized cost basis of a debt security and

A) fair value. B) face amount. C) present value using current interest rates. D) present value using implicit interest rate at acquisition date.

78) Which of the following does not accurately describe the accounting for debt securities under IFRS?

A) Accounting for debt securities is similar to U.S. GAAP. B) IFRS uses a business model classification model. C) The business model classification is determined by observation of the activities the entity undertakes to achieve its business objective. D) The business model classification is determined by individual instruments based on management's intentions.

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79) Which of the following is not correct regarding IFRS with regard to accounting for investments?

A) Minority passive equity investments are accounted for under the Fair Value through Net Income approach unless an option is elected to use Fair value through Other Comprehensive Income. B) Minority active equity investments are accounted for using the equity method with no fair value option. C) The use of Fair Value through Other Comprehensive Income is never available for passive minority investments. D) A firm may elect to use Fair Value through Net Income for any security if doing so eliminates a measurement or recognition inconsistency.

80) Mesquite, Inc. has held-to-maturity debt securities it purchased in 20X1. At December 31, 20X2, the amortized cost basis of the securities is $220,000 and the fair value of the securities is $208,000. The present value of estimated future cash flows discounted at the original effective interest rate is $210,000. Mesquite, Inc. uses IFRS for its external reporting. What amount of loss, if any, will Mesquite, Inc. report related to these securities for 20X2?

A) B) C) D)

$-0$12,000. $10,000. $2,000.

81) The difference between the amortized cost basis of a debt security and the present value of expected cash flows for that security discounted at the effective interest rate implicit in the debt instrument when it was originally acquired is called the:

A) amount representing the credit loss. B) amount related to all other factors. C) other-than-temporary impairment. D) subsequent recovery in fair value.

82)

Other-than-temporary impairments are not an issue for debt investments classified as:

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A) available-for-sale. B) held-to-maturity. C) trading. D) both trading and held-to-maturity.

83) Susqua, Inc. has held-to-maturity debt securities it purchased in 20X1. At December 31, 20X2, Susqua, Inc. reported a $120,000 impairment loss related to these securities. During 20X3, the debtor was successful in registering a new patent which improved the debtor’s operating outlook. This change of events resulted in a reversal of $45,000 of the impairment loss. At December 31, 20X3, the fair value of the debt securities had increased by $68,000 over the impaired value previously recorded. Susqua, Inc. uses IFRS for its external reporting. How much, if any, of this reversal can Susqua, Inc. report in its income for 20X3?

A) B) C) D)

84)

$-0$120,000. $68,000. $45,000.

Which of the following is not true regarding consolidations under IFRS?

A) A parent and a subsidiary are permitted to have different accounting policies. B) While both IFRS and GAAP require a firm to consolidate entities it controls, IFRS defines control more broadly than does GAAP. C) The noncontrolling interest is classified on the balance sheet in the stockholders’ equity section shown separate from the equity of the parent. D) On the income statement, noncontrolling interest is shown as a deduction from total entity (parent + 100% subsidiary) consolidated earnings.

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85) Under IFRS, SPEs are consolidated when evidence indicates that the reporting company “controls” the SPE. Control is presumed if which of the following conditions exist?The reporting entity performs activities on behalf of the SPE.The SPE has decision-making powers over the activities of the reporting entity.The reporting company has exposure, or rights, to variable returns from its involvement with the investee.The reporting company has the ability to use its power over the investee to affect the amount of the firm’s returns.

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

86) If Sun Company acquired Star, Inc. many years ago in a pooling of interests transaction, the entry would have used which one of the following to account for the pooling?

A) fair value of Star’s assets B) book value of Star’s assets C) net present value of Star’s assets D) nuture value of Star’s assets

87) Pooling of interests method for accounting for business combinations was criticized because it tended to allow recording of acquisitions:

A) at artificially high amounts. B) at artificially low amounts. C) at exact amounts. D) at amounts equal to fair value.

88) Financial analysts must be wary of business acquisitions accounted for as pooling of interests because this method tends to inflate the:

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A) current ratio. B) inventory turnover ratio. C) rate of return ratios. D) cash flow ratio.

89) For debt securities, if a firm intends to sell the security or it is more likely than not that the firm will be required to sell the security before recovery of its amortized cost basis less current-period credit loss, then the amount of impairment:

A) is recognized in other comprehensive income equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. B) is separated into two components: the amount representing the credit loss and the amount related to all other factors. C) is separated into two components: the amount recognized in income and the amount deferred until it is realized. D) is recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 90) At December 31, 20X1, a company reported the following minority passive equity investments and related items:Investments in trading securities (at cost): $500,000Investments in available-for-sale securities (at cost): $350,000Accumulated other comprehensive income from investments in AFS securities: Unrealized gain of $30,000Fair value adjustment―Trading securities: Unrealized gain $25,000Required:Prepare the journal entries on 1/1/20X1 to transition to the new rules for minority passive equity investments (ignore income tax).

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91) On April 1, 20X1, GMR Company purchased 30% of the outstanding voting stock of the Victory Corporation for $960,000. Victory’s net assets on April 1, 20X1 totaled $2,500,000. Victory’s equipment was undervalued by $500,000 and its inventory was undervalued by $200,000 as of the date of purchase. The equipment has a ten-year remaining life as of April 1, 20X1; the inventory was sold during 20X1. Victory reported $450,000 of net income during 20X1 and paid dividends of $75,000. Assume that net income was recognized evenly during 20X1 and dividends were declared and paid evenly during 20X1.Required:Prepare a schedule to determine the amount of investment income to be reported by GMR during 20X1 assuming that the equity method of accounting is applicable.Prepare a schedule to determine the balance in the investment account as of December 31, 20X1 assuming that the equity method is applicable.Describe how the financial accounting and reporting would have differed if the equity method was not applicable.Describe how equity method investments are accounted for if GMR uses the fair value option of accounting for its investment.

92) On January 2, 20X1, the Rambler Company purchased 40% of the outstanding common stock of the AMC Corporation for $2,000,000. AMC’s net assets had a book value of $3,900,000 as of January 2, 20X1. AMC’s buildings were undervalued by $350,000, their land was overvalued by $75,000, and their inventory was undervalued by $145,000.Required:Determine the amount of goodwill resulting from the purchase of the AMC stock.

93) Sub Company is a 100% owned subsidiary of Parent Corporation. During 20X1, Parent sold inventory costing $500,000 to Sub for $750,000. Sub Company had sold all of these goods to outsiders as of December 31, 20X1. During 20X1, Parent Company reported sales of $2,250,000 and cost of goods sold of $1,500,000, while Sub Company reported sales of $1,200,000 and cost of goods sold of $1,000,000.Required:Determine the 20X1 consolidated gross profit.

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94) On January 1, 20X1, Pernard Company paid $16,000,000 to acquire 80% of the outstanding common stock of Salzen Incorporated. The book value of Salzen’s net assets was $15,000,000 on the date of acquisition. On the date of acquisition, Salzen’s buildings, with a remaining useful life of ten years, were undervalued by $1,500,000. There are no book-to-fair value differences related to Salzen’s other assets and liabilities. Pernard’s retained earnings balance as of January 1, 20X1 was $5,750,000, while Salzen reported retained earnings of $3,175,000. Pernard’s net income was $1,750,000 during 20X1 and $2,035,000 during 20X2; the 20X1 and 20X2 net income amounts did not include any amounts pertaining to Pernard’s investment in Salzen. Salzen’s retained earnings increased $1,050,000 between January 1, 20X1 and December 31, 20X2; during that period, Salzen declared $225,000 in dividends. Required:Determine the December 31, 20X2 consolidated retained earnings balance.

95) The Collins Company paid $1,050,000 to acquire 70% of Revsine Company’s outstanding common stock on July 1, 20X1. Revsine’s balance sheet on the acquisition date reported net assets totaling $1,200,000. Revsine’s land had a fair value which was $175,000 greater than book value, while the inventory’s fair value exceeded its book value by $67,500. Immediately after the acquisition of the Revsine stock, Collins reported net assets of $5,785,000.Required:Determine the consolidated net assets total as of July 1, 20X1.Determine the amount of noncontrolling interest to be reported on the July 1, 20X1 balance sheet. How is the noncontrolling interest reported within the consolidated balance sheet? Assume that the acquisition method of accounting is applicable.

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96) Ford Corporation paid $10,200,000 for a 47% interest in Allen Corporation on January 1, 20X1 when Allen had the following identifiable assets and liabilities: Book Value

Fair Value

Current assets

3,000,000

$ 3,000,000

Fixed assets (net)

4,000,000

6,800,000

$ 7,000,000

$ 9,800,000

$ 2,000,000

Liabilities

At the time of Ford’s purchase, the fixed assets had a remaining life of 8 years. For the year ended December 31, 20X1, Allen reported sales of $9 million and expenses of $5 million and declared and paid dividends of $1 million. At December 31, 20X1, Allen reported the following balance sheet information: December 31, 20X1 Current assets Fixed assets (net)

$ 4,000,000 5,500,000 9,500,000

Liabilities

$ 1,500,000

Required:Determine the income statement and balance sheet accounts and amounts as they would appear on Ford’s financial statements under the equity method for the year ended December 31, 20X1. Be sure to show calculations.Explain how your answer to requirement 1 would change if Ford determined that it actually controlled Allen and had to consolidate its investment. Determine specific income statement and balance sheet accounts and amounts where possible. Be sure to show calculations. Version 1

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Answer Key Test name: chapter 17 1) FALSE 2) FALSE 3) TRUE 4) TRUE 5) TRUE 6) TRUE 7) TRUE 8) FALSE 9) FALSE 10) FALSE 11) FALSE 12) TRUE 13) TRUE 14) FALSE 15) TRUE 16) D 17) B 18) B 19) A 20) B 21) D 22) B 23) C 24) B 25) C 26) D Version 1

27) A 28) D 29) D 30) B 31) B 32) B 33) A 34) D 35) B 36) A 37) C 38) C 39) B 40) B 41) B 42) D 43) D 44) D 45) A 46) C 47) B 48) A 49) D 50) D 51) A 52) B 53) B 54) C 55) C 56) B Version 1

57) C 58) C 59) A 60) B 61) C 62) C 63) D 64) A 65) C 66) B 67) A 68) A 69) B 70) D 71) B 72) A 73) C 74) D 75) B 76) B 77) D 78) D 79) C 80) C 81) A 82) C 83) D 84) A 85) C 86) B Version 1

87) B 88) C 89) D 90) 1) Reclassify securities categories Investments in equity securities―Fair value

905,000

Investments in trading securities at cost

500,000

Fair value adjustment on trading securities

25,000

Investments in available-for-sale securities

350,000

Fair value adjustment―Available-for-sale securities

30,000

2) Reclassify unrealized gain on available-for-sale securities Accumulated other comprehensive income Retained Earnings

30,000 30,000

91) 1. GMR’s share of Victory’s reported income Adjustment due to the equipment differential Adjustment due to the inventory differential

$ 101,250

20X1 Investment income

($450,000 × 9/12 × 30%)

(11,250 )* (60,000 ) ($200,000 × 30%) 30,000

*($500,000/10 years) × 9/12 × 30%2.

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Initial cost

$ 960,000

20X1 investment income

30,000

20X1 share of dividends

(16,875 ) ($75,000 × 9/12 × 30%)

December 31, 20X1 investment balance

$ 973,125

3. If the equity method was not applicable, the income reported during 20X1 would have been GMR’s share of the declared dividends, and the investment account balance would have been reported on the balance sheet at its fair value with changes in fair value accounted for in net income. 4. Unrealized gains and losses arising from fair value changes are reported in the investor’s income statement; the investor also reports its share of the investee’s declared dividends as income. The investment account is reported on the balance sheet at fair value. 92) Amount paid for the 40% investment $

2,000,000

Book value of net assets acquired

(1,560,000 ) ($3,900,000 × 40%)

Excess of the amount paid Over book value acquired

440,000

Allocation to undervalued buildings Allocation to overvalued land

(140,000 ) ($350,000 × 40%)

Allocation to undervalued inventory

(58,000 ) ($145,000 × 40%)

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30,000

($75,000 × 40%)

Goodwill

272,000

93) Consolidated sales

$ 2,700,000 (1)

Consolidated cost of goods sold

1,750,000 (2)

Consolidated gross profit

950,000

(1) $2,250,000 + $1,200,000 − $750,000 (remove the entire intra-entity sale from Parent)(2) $1,500,000 + $1,000,000 − $750,000 (remove the entire intra-entity cost of goods sold from Sub) 94) Consolidated retained earnings as of January 1, 20X1 Pernard’s net income for 20X1 and 20X2

3,785,000

Pernard’s share of Salzen’s net income for 20X1 and 20X2 Amortization of building differential Consolidated retained earnings as of December 31, 20X2

5,750,000

1,020,000 (1) (240,000) (2) $

10,315,000

(1) Salzen’s net income during the two-year period equals the increase in retained earnings ($1,050,000) plus the dividends declared ($225,000) during the two-year period = $1,275,000; Pernard’s share is $1,275,000 × 0.80 = $1,020,000.(2) $1,500,000/10 years equals $150,000 of amortization per year; two years have passed since the acquisition took place; multiplied by Pernard’s share = $300,000 × 0.80 = $240,000.

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95) 1. Collins Company’s net assets

5,785,000

Revsine Company’s net assets, book value

1,200,000

Investment in Revsine account

(1,050,000 )

Land fair value adjustment

175,000

Inventory fair value adjustment

67,500

Goodwill

57,500 *

Consolidated net assets as of July 1, 20X1

6,235,000

*The implied value of Revsine is $1,500,000 ($1,050,000 ÷ 0.70). The implied value exceeds the $1,200,000 book value by $300,000. The $300,000 differential is partially explained by the land differential of $175,000 and the inventory differential of $75,000; therefore, Goodwill must be $57,500 ($300,000 − $175,000 − $67,500). 2. The noncontrolling interest of $450,000 [($1,050,000/0.70) × 0.30] is reported as a component of stockholders’ equity on the consolidated balance sheet. 96) 1. See following tables. Allocation of acquisition premium Acquisition cost for 47%

$ 10,200,000

Book value purchased Excess

(2,350,000 ) (47% × 5,000,000) $

Less: Amount attributable to fixed assets Amount attributable to goodwill

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7,850,000 (1,316,000 ) (47% × 2,800,000)

6,534,000

Income Statement Effect Share of Allen income

$ 1,880,000

Amortization of difference between cost and book value

(47% × 4,000,000)

(164,500 ) (47% × (2,800,000/8)

Equity investment income

$ 1,715,500

Balance Sheet Effect Balance, 1/1/X1

$ 10,200,000

Share of fiscal year income

1,880,000

Dividends received

(470,000 ) (47% × 1,000,000)

Amortization of difference between cost and book value

(164,500 )

Balance, 12/31/X1

$ 11,445,500

2. Instead of having an investment account, the individual assets and liabilities of Allen will be combined with those of Ford. Instead of an equity investment income account, the individual revenues and expenses will be combined with Ford’s revenue and expenses. Because Ford does not own 100% of Allen, non-controlling interest (minority interest) will be on both the income statement and balance sheet. The specific accounts and effects are provided below. Balance Sheet Current assets Fixed assets Goodwill

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+ 4,000,000 dr + 6,651,500 dr (5,500,000 + 1,316,000 – 164,500) + 6,534,000 dr

Liabilities

+ 1,500,000 cr

Noncontrolling interest

+ 4,240,000 cr (53% × (9,500,000 – 1,500,000))

Income Statement Revenue

+ 9,000,000 cr

Expense Noncontrolling interest

+ 5,164,500 dr (5,000,000 + 164,500) + 2,120,000 dr (4,000,000 × 53%)

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CHAPTER 18: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) U.S. companies that own a majority interest in a foreign subsidiary must convert the subsidiary's financial statement numbers to U.S. Dollars prior to consolidating the financial statements. ⊚ ⊚

true false

The functional currency is determined with reference to the parent company. ⊚ ⊚

true false

3) Accounting rules set forth specific criteria for determining a subsidiary's functional currency. ⊚ ⊚

true false

4) Foreign translation gains or losses arising from the current rate method should be reported as other comprehensive income. ⊚ ⊚

true false

5) For foreign subsidiaries, one of the most critical issues parent companies must consider is whether previously recorded assets or liabilities should be adjusted for subsequent changes in exchange rates. ⊚ ⊚

true false

6) The assets and liabilities of a U.S. consolidated entity must be adjusted for changes in currency rates.

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⊚ ⊚

true false

7) For a U.S. controlled foreign subsidiary operating in a hyperinflationary environment, the functional currency is assumed to be the U.S. dollar. ⊚ ⊚

true false

8) If a foreign subsidiary is operating in a hyperinflationary environment, the controlling entity must apply the current rate method. ⊚ ⊚

true false

9) Investing in a foreign subsidiary always results in a net asset exposure for the parent company. ⊚ ⊚

true false

10) Under the current rate method, the net asset exposure multiplied by the change in the exchange rate approximates the translation adjustment. ⊚ ⊚

11)

true false

Cash, receivables, and inventory are examples of monetary assets. ⊚ ⊚

true false

12) Under the current rate method, the gross margin percentage is the same for the U.S. dollar and the foreign currency based income statements.

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⊚ ⊚

13)

true false

Accounting for foreign currency transactions is similar to the current rate method. ⊚ ⊚

true false

14) A public company's economic segment is reportable if a 10% threshold is met with respect to either sales revenue, net income, or assets. ⊚ ⊚

true false

15) Entities must disclose information related to geographical regions even if they identified only one segment. ⊚ ⊚

true false

16) The results of trend analysis, are the same whether the local (foreign) currency or the U.S. dollar is used. ⊚ ⊚

true false

17) The results of trend analysis, such as associated with revenue trends, are the same whether the local (foreign) currency or the U.S. dollar is used. ⊚ ⊚

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true false

CHECK ALL THE APPLY. Choose all options that best completes the statement or answers the question. 18) Margot Fein, a member of the financial reporting team of Klinger Inc., is reviewing financial statement information for the purpose of determining reportable segments of the company. She is reviewing ASC Topic 280 on segment reporting to determine what characteristics she should consider for combining units with similar characteristics.Required:Consistent with the FASB ASC Topic 280 guidelines, which of the following economic characteristics will provide a basis for combining operating units for segment reporting? (Select all that apply).

A) B) C) D) E) F) G) H)

Products and services Production processes Expenditure patterns Executive decision makers Type or class of customer Vendor for key inputs Product and service distribution methods Regulatory environment

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 19) The financial statements of freestanding foreign companies that are majority-owned by a U.S. company must be to U.S. dollars using the method.

A) translated; temporal B) translated; current rate C) remeasured; temporal D) remeasured; current rate

20) Cramer Company owns 100% of the outstanding shares of its European subsidiaries, which operate under Cramer Company's business model. The subsidiaries' primary objective is to help Cramer Company expand its global market share. In consolidating the subsidiaries' financial statements with those of the U.S. parent, the subsidiaries' financial statement numbers should be:

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A) remeasured using the temporal method. B) remeasured using the current rate method. C) translated using the temporal method. D) translated using the current rate method.

21) Neubart Company owns 100% of the outstanding shares of two European subsidiaries, which operate largely independently and operate in a different industry than Neubart. The subsidiaries' earnings typically are reinvested in their home country. In consolidating the subsidiaries financial statements with those of the U.S. parent, the subsidiaries' financial statement numbers should be:

A) remeasured using the temporal method. B) remeasured using the current rate method. C) translated using the temporal method. D) translated using the current rate method.

22) Margot Company owns a majority interest in Bremmer Company, which is located in Norway. Margot must:

A) not include the results of Bremmer Company in its financial statements. B) must issue separate financial statements for Bremmer Company. C) convert Bremmer financial statements to U.S. dollars and include them in its consolidated statements. D) convert Margot Company's financial statements to the foreign currency for comparison purposes.

23) Which of the following represents an indicator that the functional currency is that of the subsidiary?

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A) Labor and materials for the foreign entity's products or services are primarily purchased from the parent company. B) The subsidiary has an active local sales and distribution market for its products. C) The sales market is mostly in the parent's country and sales contracts are denominated in the parent's currency. D) Cash flows of the subsidiary are readily available for use by the parent company.

24) U.S. GAAP includes these indicators as guidance for determining a subsidiary's functional currency, except for:

A) sources and uses of cash flows. B) sources of expenses. C) location of sales market. D) source of taxation.

25) Limber Company, an IFRS-reporting company, is trying to determine the functional currency of one of its subsidiaries. After considering authoritative guidelines, the results still are mixed. Limber should choose the functional currency:

A) of the economy that determines the pricing of its transactions. B) that results in the lowest translated net asset exposure. C) that results in the highest translated net asset exposure. D) of the economy with the highest proportion of cash flows.

26) Porter Company, a U.S. GAAP reporting company is trying to determine the functional currency of one of its subsidiaries. After considering authoritative guidelines, the results still are mixed. Porter Company should choose the functional currency:

A) based on management judgment. B) that results in the lowest translated net asset exposure. C) that results in the highest translated net asset exposure. D) of the economy with the highest proportion of cash flows.

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27) Sable Inc., a U.S. based company, owns a majority interest in Blau Company, a European subsidiary. Which of the following would be an indicator that Blau's functional currency is the U.S. dollar?

A) Blau purchases the majority of its raw materials from Sable. B) Sales prices for Blau's products are determined by local economic conditions. C) Blau finances its capital expenditures using its local finance markets. D) Blau hires its employees from the local labor market.

28) Norman Company owns a controlling interest in a foreign company that has recently experienced a hyperinflationary economy. Consistent with accounting rules, Norman will switch from the current rate method to the temporal method for converting the foreign currency to Normal Company's local currency. Norman Company also will have to restate prior period financial statements if the company reports consistent with:

A) U.S. GAAP. B) IFRS. C) either U.S. GAAP or IFRS. D) neither U.S. GAAP nor IFRS,

29) The following type of U.S. company is most likely to include in its consolidated financial statements subsidiaries with non-U.S. functional currencies.

A) A conglomerate with foreign investments in many different industries. B) A company with branch offices in Korea C) A manufacturer producing parts in Korea, for later assembly in the U.S. D) U.S. textile company that produces garments produced for the U.S. market primarily in Sri Lanka.

30) Revaluing foreign currency denominated assets and liabilities in response to currency changes always increases or decreases:

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A) net income. B) paid-in capital. C) total assets. D) total stockholders' equity.

31) Assets and liabilities of a foreign subsidiary that are not revaluated in response to exchange rate changes, are reported in the U.S. based consolidated financial statements at:

A) their present value of the related future cash flows. B) their net realizable value. C) historical exchange rates. D) price indexed amounts.

32) The currency used in the market in which a foreign subsidiary effectively operates is referred as the:

A) nominal currency. B) entity currency. C) functional currency. D) direct currency.

33) Foreign Sub, for which the functional currency is the local currency, recognizes a receivable on 11/12/20X1. On December 31, 20X1, Foreign Sub's parent company determines that the exchange rate has changed since the receivable was recognized. In its consolidated financial statements, the parent company should report Foreign Sub's receivable using the exchange rate:

A) in effect on 11/12/20X1. B) that results in the highest reported receivable. C) that results in the lowest reported receivable. D) in effect on 12/31/20X1.

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34) Foreign Sub, for which the functional currency is the local currency, recognizes an accounts payable on 11/19/20X1. On December 31, 20X1, the Foreign Sub's parent company determines that the exchange rate had changed since the payable was recognized. In its consolidated financial statements, the parent company should report Foreign Sub's payable using the exchange rate:

A) in effect on 11/12/20X1. B) in effect on 12/31/20X1. C) that results in the highest reported receivable. D) that results in the lowest reported receivable.

35) Milton Company's unadjusted trial balance on 12/31/20X1 shows an accounts receivable from a non-U.S. customer. The receivable arose from a sale denominated in Euros. Since the receivable was recognized, the Euro value has risen. Milton should:

A) debit "accounts receivable and credit "foreign exchange gain". B) debit "foreign exchange loss" and credit "accounts receivable". C) debit "accounts receivable" and credit "sales revenue". D) debit "sales revenue" and credit "accounts receivable".

36) On January 2, 20X1, when the Euro in terms of U.S. dollars is $1.10, Smith Corporation establishes Neuman AG as a foreign subsidiary by investing $11 million. Neuman immediately incurs long-term debt of 6 million Euros. Smith Corporation has a net asset exposure of:

A) $5 million B) $6 million C) $5.5 million D) $4.4 million

37) Katie analyzes the dollar-based consolidated financial statements of a company that owns a foreign subsidiary. Katie observes that the foreign subsidiary’s sales increased by 24% compared to last year. Katie should be aware that the results

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A) are verifiable using the foreign currency rate in effect at the end of the year. B) may differ if she bases the calculation on the foreign currency. C) will be same if she recalculates the sales trend using the consolidated revenue. D) will be lower if the currency rate increased during the reporting period.

38) Bremmer Company's functional currency is the Euro. On February 1, 20X1, when the exchange rate is $1.20 per Euro, Bremmer purchases 100 units of inventory for a total purchase price of 4,300 Euros. Bremmer sells half of the inventory on March 24 and the other half on April 14. The exchange rate is $1.17 on March 24 and $1.21 on April 14. Bremmer's U.S. based parent company should convert Bremmer's financial statement amount to U.S dollars using the:

A) temporal method. B) current rate method. C) monetary method. D) non-monetary method.

39) Bremmer Company's functional currency is the Euro. On February 1, 20X1, when the exchange rate is $1.20 per Euro, Bremmer purchases 100 units of inventory for a total purchase price of 4,300 Euros. Bremmer sells half of the inventory on March 24 and the other half on April 14. The exchange rate is $1.17 on March 24 and $1.21 on April 14. If Bremmer were to keep records denominated in dollars, it would recognize the sale of inventory on March 24, by crediting cost of goods sold for:

A) B) C) D)

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$2,601.50. $2,580.00. $2,558.50. $2,515.50.

11) Bremmer Company's functional currency is the Euro. On February 1, 20X1, when the exchange rate is $1.20 per Euro, Bremmer purchases 100 units of inventory for a total purchase price of 4,300 Euros. Bremmer sells half of the inventory on March 24 and the other half on April 14. The exchange rate is $1.17 on March 24 and $1.21 on April 14. If Bremmer were to keep records denominated in U.S. dollars, on March 24, the company would record the exchange rate fluctuation with this journal entry:

OCI—Currency Translation

$129

Inventory

$129

Inventory

$129

OCI—Currency Translation

$129

Foreign Currency loss Inventory

$129 $129

D) No journal entry

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12) Bremmer Company's functional currency is the Euro. On February 1, 20X1, when the exchange rate is $1.20 per Euro, Bremmer purchases 100 units of inventory for a total purchase price of 4,300 Euros. Bremmer sells half of the inventory on March 24 and the other half on April 14. The exchange rate is $1.17 on March 24 and $1.21 on April 14. If Bremmer were to keep records denominated in U.S. dollars, the company would recognize the sale of inventory April 14, by crediting cost of goods sold for:

A) B) C) D)

$2,601.50. $2,580.00 $2,558.50 $2,515,50

42) Bremmer Company's functional currency is the Euro. On February 1, 20X1, when the exchange rate is $1.20 per Euro, Bremmer purchases 100 units of inventory for a total purchase price of 4,300 Euros. Bremmer sells half of the inventory on March 24 and the other half on April 14. The exchange rate is $1.17 on March 24 and $1.21 on April 14. Assume that Bremmer's functional currency is the U.S. dollar (instead of the Euro) and that Bremmer keeps records denominated in dollars. On March 24, Bremmer would record the exchange rate fluctuation related to inventory with this journal entry:

OCI—Currency Translation

$129

Inventory

$129

Inventory

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$129

OCI—Currency Translation

$129

Foreign Currency loss

$129

Inventory

$129

D) No journal entry is made.

43)

Under the temporal method, remeasurement exposure is equal to:

A) net monetary assets. B) monetary assets. C) net nonmonetary assets. D) nonmonetary assets.

44) Smith Company, a Subsidiary of Parkins Inc. purchased inventory at the beginning of the year and resold it evenly throughout the first quarter. If the value of the foreign currency increased steadily during the quarter, the gross margin ratio for the first quarter will be highest if the parent company converts Smith Company's financial statement numbers using:

A) the temporal method. B) the current rate method. C) FIFO inventory method. D) LIFO inventory method.

45) Which of the following is not an indication that a foreign subsidiary's function currency is that of the parent company?

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A) There are significant intra-entity transactions between the parent company and the subsidiary. B) The market for the subsidiary's products is primarily is in the parent company's country and currency. C) The subsidiary's cash flows primarily originate in the subsidiary's country and currency. D) The subsidiary's assets are primarily financed through parent company sources.

46) Under the temporal method, income statement items that relate to newly recognized assets and liabilities generally are remeasured using the:

A) average exchange rate. B) current exchange rate. C) historical exchange rate. D) lowest exchange rate for the period.

47) Under the temporal method, income statement items that relate to derecognized assets and liabilities generally are remeasured using the:

A) average exchange rate. B) current exchange rate. C) historical exchange rate. D) lowest exchange rate for the period.

48) One of the key factors that differentiates the temporal method from the current rate method is that currency-related gains and losses are:

A) not recognized. B) reported in the income statement. C) reported as accumulated other comprehensive incomes. D) recognized as adjustments to retained earnings.

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49) One of the key factors that differentiates the temporal method from the current rate method is that under the temporal method, assets and liabilities are reported at:

A) historical exchange rates if they are nonmonetary in nature. B) current exchange rates if they are nonmonetary in nature. C) historical exchange rates if they are monetary in nature. D) current exchange rates if they are monetary in nature.

50) Which method of translating or remeasuring foreign currency denominated amounts may lead to revenue and cost of goods sold being translated/remeasured at different exchange rates?

A) The current rate method. B) The temporal method. C) Both the current rate and the temporal methods. D) Revenue and cost of goods must be translated/remeasured using the same rate.

51) Meadows Limited, a foreign subsidiary of U.S. based Meadows Inc. operates primarily for the benefit of its parent company. When the exchange rate was $1.30 per one British Pound Sterling (£), Meadows Limited purchased Inventory for £2,100 pounds. Meadows resells onethird of the inventory for £900 when the exchange rate was $1.26 per Pound Sterling and another one-third for £900 when the exchange rate was $1.28 per Pound Sterling. The parent company applies the temporal method in its process of consolidating the financial results of its subsidiaries with its own financial results. Meadows Inc. reports cost of goods associated with its subsidiary in the amount of:

A) B) C) D)

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$1,764 $1,778 $1,792 $1,820

52) Meadows Limited, a foreign subsidiary of U.S. based Meadows Inc. operates primarily for the benefit of its parent company. When the exchange rate was $1.30 per one British Pound Sterling (£), Meadows Limited purchased Inventory for £2,100 pounds. Meadows resells onethird of the inventory for £900 when the exchange rate was $1.26 per Pound Sterling and another one-third for £900 when the exchange rate was $1.28 per Pound Sterling. The parent company applies the temporal method in its process of consolidating the financial results of its subsidiaries with its own financial results. Meadows Inc. reports sales revenue associated with its subsidiary in the amount of:

A) B) C) D)

$2,340 $2,304 $2,286 $2,268

53) Meadows Limited, a foreign subsidiary of U.S. based Meadows Inc. operates primarily for the benefit of its parent company. When the exchange rate was $1.30 per one British Pound Sterling (£), Meadows Limited purchased Inventory for £2,100 pounds. Meadows resells onethird of the inventory for £900 when the exchange rate was $1.26 per Pound Sterling and another one-third for £900 when the exchange rate was $1.28 per Pound Sterling. The parent company applies the temporal method in its process of consolidating the financial results of its subsidiaries with its own financial results. Meadows Inc. reports ending inventory associated with its subsidiary in the amount of:

A) B) C) D)

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$910 $896 $889 $882

54) Meadows Limited, a foreign subsidiary of U.S. based Meadows Inc. operates primarily for the benefit of its parent company. When the exchange rate was $1.30 per one British Pound Sterling (£), Meadows Limited purchased Inventory for £2,100 pounds. Meadows resells onethird of the inventory for £900 when the exchange rate was $1.26 per Pound Sterling and another one-third for £900 when the exchange rate was $1.28 per Pound Sterling. The parent company applies the temporal method in its process of consolidating the financial results of its subsidiaries with its own financial results. Meadows Inc. reports gross profit associated with its subsidiary in the amount of:

A) B) C) D)

$466 $508 $526 $576

55) Segment reporting provides information for investor to assess components of a corporation with differing:

A) operating characteristics and risks. B) capital structure. C) revenue inflows. D) product life cycles.

56) Of the 500 companies surveyed by the AICPA in 2012, segment reporting with their annual reports.

A) B) C) D)

57)

percentage included

67%. 74%. 84%. 98%.

The FASB ASC topic addressing segment reporting is topic:

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A) B) C) D)

220. 280. 323. 608.

58) Wiese Limited, a foreign subsidiary of U.S. based Wald Inc. operates primarily economically independent from its parent company. When the exchange rate was $1.30 per one British Pound Sterling (£), Wald Limited purchased Inventory for £2,100 pounds. Wald resells one-third of the inventory for £900 when the exchange rate was $1.26 per Pound Sterling and another one-third for £900 when the exchange rate was $1.28 per Pound Sterling. At the end of the reporting period, the exchange rate is $1.29 per Pound Sterling. The parent company applies the current rate method in its process of consolidating the financial results of its subsidiaries with its own financial results. Wald Inc. reports cost of goods associated with its subsidiary in the amount of:

A) B) C) D)

$1,764. $1,778. $1,792. $1,820.

59) Wiese Limited, a foreign subsidiary of U.S. based Wald Inc. operates primarily economically independent from its parent company. When the exchange rate was $1.30 per one British Pound Sterling (£), Wald Limited purchased Inventory for £2,100 pounds. Wald resells one-third of the inventory for £900 when the exchange rate was $1.26 per Pound Sterling and another one-third for £900 when the exchange rate was $1.28 per Pound Sterling. At the end of the reporting period, the exchange rate is $1.29 per Pound Sterling. The parent company applies the current rate method in its process of consolidating the financial results of its subsidiaries with its own financial results. Wald Inc. reports sales revenue associated with its subsidiary in the amount of:

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A) B) C) D)

$2,340. $2,304. $2,286. $2,268.

60) Wiese Limited, a foreign subsidiary of U.S. based Wald Inc. operates primarily economically independent from its parent company. When the exchange rate was $1.30 per one British Pound Sterling (£), Wald Limited purchased Inventory for £2,100 pounds. Wald resells one-third of the inventory for £900 when the exchange rate was $1.26 per Pound Sterling and another one-third for £900 when the exchange rate was $1.28 per Pound Sterling. At the end of the reporting period, the exchange rate is $1.29 per Pound Sterling. The parent company applies the current rate method in its process of consolidating the financial results of its subsidiaries with its own financial results. Wald Inc. reports ending inventory associated with its subsidiary in the amount of:

A) B) C) D)

$910. $903. $889. $882.

61) Wiese Limited, a foreign subsidiary of U.S. based Wald Inc. operates primarily economically independent from its parent company. When the exchange rate was $1.30 per one British Pound Sterling (£), Wald Limited purchased Inventory for £2,100 pounds. Wald resells one-third of the inventory for £900 when the exchange rate was $1.26 per Pound Sterling and another one-third for £900 when the exchange rate was $1.28 per Pound Sterling. At the end of the reporting period, the exchange rate is $1.29 per Pound Sterling. The parent company applies the current rate method in its process of consolidating the financial results of its subsidiaries with its own financial results. Wald Inc. reports gross profit associated with its subsidiary in the amount of:

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A) B) C) D)

$466. $508. $526. $576.

62) Disaggregating financial information consistent with the internally used approach to assess company performance is referred to as:

A) risk analysis. B) usefulness approach. C) management approach. D) marginal analysis.

63) Consistent with ASC Topic 280 which of the following is a key characteristic defining a separate segment for reporting purposes? The unit:

A) earns revenue within or outside the company. B) produces discrete financial information. C) produces information that is used by chief operating decision makers. D) represents the largest unit of a large corporation.

64) After aggregating segments for reporting purposes, the segments are reportable if a segment meets one of several quantitative thresholds. Which of the following financial statement items is not used for determining quantitative thresholds?

A) sales revenue B) net income C) total assets D) operating income

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65) One of the quantitative thresholds used to determine whether an aggregated segment represents a reportable segment, is related to the absolute value of operating profit or loss. A segment is reportable if the profit or loss exceeds 10% of the greater of the:

A) total segment operating profit for segments with profit or the total operating loss for those segments with losses. B) company's total operating profit or loss. C) company's average operating profits or losses for the past three reporting periods. D) prior year's operating profit or loss for all segments.

66) Reported segments must represent a minimum of income statement.

% of the revenue reported in the

A) 90 B) 85 C) 75 D) 70

67) Reported segments must represent at least 75 % of statement.

reported in the income

A) revenue B) expense C) operating income D) net income

68) The quantitative thresholds for determining reportable segments of a public company relate to the conceptual issue of:

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A) cost/benefit. B) verifiability. C) going concern. D) materiality.

69) An operating segment the company considers important does not meet any of the 10% quantitative thresholds. Which of the following is not correct consistent with GAAP? The company:

A) must not report separate information on that segment. B) may report on the segment if the information meets the objective of the standard. C) may further aggregate operating segments if the majority of aggregative criteria are met. D)

should consider whether reported segments represent at least 75% of total revenue.

70) Philip, an accounting major, is analyzing a multinational company's performance. He is trying to determine the reasons for the company's declining operating profit. The information available includes segment-related disclosures. Philip should consider conducting this type of analysis using segment disclosures:

A) risk and return B) cause of change C) return on investment D) net present value

71) What consideration may discourage executives from disclosing information about many segments of the enterprise?

A) Competitor potential use of proprietary information B) Difficulty generating the needed information C) Limited usefulness of the information to investors D) Limited usefulness of information to internal decision makers

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72)

Segment-related required disclosures include all of the following, except:

A) a complete financial statements for each distinct segment. B) specific selected income statement and balance sheet information. C) information detailing how reporting segments were determined. D) a reconciliation of disclosed segment information with the consolidated financial statements.

73)

U.S. GAAP requires disclosures related to industry and geography locations for:

A) each segment. B) the entire enterprise. C) segments comprising 20% of revenue. D) foreign subsidiaries only.

74) Beyer Company, is a U.S. based multinational that operates in the U.S., Europe, and Asia. The company reports on two distinct product-related segments—manufacturing and financing. Additional disclosures required include:

A) net income by geographic region. B) debt incurred for each segment. C) revenue by geographic region. D) work force distribution by product-related segment and by geographic region.

75) U.S. GAAP requires enterprise-wide disclosures related to industry and geographic locations to enhance:

A) verifiability. B) materiality. C) comparability. D) consistency.

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76) Consistent with GAAP, companies must provide balance sheet related geographic disclosures including information on:

A) long-lived assets. B) long-term receivables. C) debt. D) total shareholders' equity.

77)

Which of the following is not a required entity-wide geographic disclosure?

A) Revenue from external customers derived from entity's country of domicile. B) Revenue from external customers derived from each foreign country, if material. C) Long-lived assets located in country of domicile and in foreign countries, if material. D) Total debt incurred in country of domicile and in foreign countries, if material.

78) On December 1, 20X1 a U.S. company sold merchandise to a foreign company for 750,000 yuan. The payment in yuan is due on January 31, 20X2. The spot rate was as follows: $0.20 per yuan on December 1, 20X1; $0.19 per yuan on December 31, 20X1; and $0.21 per yuan on January 31, 20X2 when the payment was received. Which of the following incorrectly describes the accounting for this foreign currency transaction?

A) The receivable was recorded at $150,000 on December 1, 20X1. B) The receivable was recorded at $142,500 on the December 31, 20X1 balance sheet. C) The foreign currency transaction gain included on the income statement for the year ending December 31, 20X1 was $7,500. D) The foreign currency transaction gain included on the income statement for the year ending December 31, 20X2 was $15,000.

79) On November 1, 20X1, A U.S. company sold merchandise to a foreign company for 375,000 kroner. The payment in krone is due on January 31, 20X2. The spot rate was as follows: $0.20 per krone on November 1, 20X1; $0.21 per krone on December 31, 20X1; and $0.19 per krone on January 31, 20X2 when the payment was received. Which of the following incorrectly describes the accounting for this foreign currency transaction? Version 1

A) The receivable was recorded at $75,000 on November 1, 20X1. B) The receivable was recorded at $78,750 on the December 31, 20X1 balance sheet. C) The foreign currency transaction gain included on the income statement for the year ending December 31, 20X1 was $3,750. D) The foreign currency transaction loss included on the income statement for the year ending December 31, 20X2 was $3,750.

80) Which of the following correctly describes the accounting for assets and liabilities that were created from foreign currency transactions?

A) Foreign currency monetary assets and liabilities are measured using the current rate of exchange as of the date of the initial transaction. B) Foreign currency monetary assets and liabilities are measured using the current rate of exchange as of the balance sheet date. C) Foreign currency nonmonetary assets and liabilities are measured using the current rate of exchange as of the balance sheet date. D) Foreign currency nonmonetary assets and liabilities are measured using the average annual rate of exchange during the year.

81) Which of the following is not correct with regard to the translation of a self-contained foreign subsidiary?

A) The balance sheet ratios are not impacted by the translation to the parent company's currency. B) The effect of changes in exchange rates on future dollar cash flows is uncertain. C) The exchange rate used for translating the balance sheet is the weighted average rate over the statement period. D) For a material transaction, the rate used for translation is the exchange rate in effect on the date the transaction occurred.

82) When accounting for a non-free-standing foreign subsidiary, translation exchange rates are accounted for using the temporal method which involves reporting all cost of goods sold accounts at the:

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A) current rate. B) historical rate. C) rate at time of transaction. D) present value rate.

83) When accounting for self-contained foreign subsidiaries, the parent company uses which one of the following methods for the translation of its financial statements into dollars?

A) Present value rate B) Historical rate C) Future value rate D) Current rate

84) Foreign currency nonmonetary assets and liabilities for non-free-standing subsidiaries are translated using the:

A) historic rate of exchange in effect when the asset or liability was acquired or incurred. B) current rate of exchange on the balance sheet date. C) temporal rate of exchange on the balance sheet date. D) present value rate of exchange when the translation takes place.

85) When accounting for a non-free-standing foreign subsidiary, translation exchange rates are accounted for using the temporal method which involves reporting all revenue accounts at the:

A) current rate. B) historical rate. C) rate at time of transaction. D) present value rate.

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86) Gains and losses arising from rate changes on foreign currency transactions are recognized in:

A) the balance sheet. B) net income. C) the cash flow statement. D) the financial statement notes.

87) Margaret analyzes segment-related information of a multinational company. She is trying to evaluate each segment's effective utilization of its assets. Margot should conduct a:

A) risk analysis. B) geographic analysis. C) return analysis. D) cause-and-effect analysis.

88)

The following information is available for Crammer Company's two segments:

Financial Statement Information Service revenue

Segment A (in Million) $ 100

Segment B (in Million) $ 200

Operating expenses

$ 160

Average Assets

$ 320

Segment A's rate of return on assets is:

A) B) C) D)

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20% 40% 200% 250%

89)

The following information is available for Crammer Company's two segments:

Financial Statement Information Service revenue

Segment A (in Million) $ 100

Segment B (in Million) $ 200

Operating expenses

$ 160

Average Assets

$ 320

Segment B's rate of return on assets is:

A) B) C) D)

12.5% 25.0% 40.0% 50.2%

90) Two segments of a multinational company have identical profit margins and average assets. The revenue of segment B exceeds the revenue of segment A. Which segment has the highest return on assets (ROA)?

A) Segment A B) Segment B C) Segment A and B have the same ROA D) cannot be determined from information given

91) Analysis of a foreign subsidiary's financial statements denominated in Euro, its local currency, shows a growth rate in revenue of 16%. Suppose that during the year, the value of the Euro increased in terms U.S. dollars. The subsidiary's revenue growth rate expressed in U.S. dollars will be:

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A) exactly 16%. B) greater than 16%. C) smaller than 16%. D) unaffected by currency movements.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 92) Peters Inc. a U.S. based company consolidates a subsidiary for which the functional currency is the U.S. Dollar. Required:For each financial statement item listed below, correctly match the currency rate used to convert the foreign currency denominated amounts to the U.S. dollar. Utilize the following code: CR = Current exchange rate HR = Historical exchange rate AR = Average exchange rate for the period Cash Accounts Receivable Inventory Prepaid Rent Property, Plant and Equipment Accounts Payable Notes Payable Common Stock Revenue Cost of Goods Sold

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93) Sally Inc. a U.S. based company consolidates a subsidiary for which the functional currency is the local currency. Required: For each financial statement item listed below, correctly match the currency rate used to convert the foreign currency denominated amounts to the U.S. dollar. Utilize the following code: CR = Current exchange rate HR = Historical exchange rate AR = Average exchange rate for the period Cash Accounts Receivable Inventory Prepaid Rent Property, Plant and Equipment Accounts Payable Notes Payable Common Stock Revenue Cost of Goods Sold

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94) On September 25, 20X1, Dorian Company, a U.S. based firm, establishes a new subsidiary in Norway called Fiorta by investing 4 million Krone in exchange for 100,000 shares of common stock. The exchange rate on September 25, 20X1 is $.10 per Krone. On September 30, 20X1, when the exchange rate is 0.12 per Krone, Fiorta purchases inventory for 2.1 million Krone. On October 24, 201X1, Fiorta sells one third of the inventory for 1.2 million Krone and on December 6, 20X1 another one third of the inventory, also for 1.2 Krone. The exchange rate is $0.09 and $0.10 per Krone on October 24 and December 6, respectively. Dorian and Fiorta issue quarterly and annual financial statements. on December 31, 20X1, the exchange rate is 0.11 per Krone. Required: Assume that Fiorta's functional currency is the Krone. Show the effect of the translations on (1) Fiorta's balance sheet and income statement (2) translate the amount into U.S. dollars under the current rate method using the following format. Local Exchange rate U.S. Dollar Amount Currency (in U.S. Dollar for for Consolidated 1 Krone Krone K) Financial Statements Balance Sheet Cash Inventory Total assets Common Stock Retained Earnings Accumulated other Comprehensive Income Total Liabilities and stockholders' Equity Retained Earnings Beginning Balance Net Income Ending Balance

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Income Statement Sales Cost of goods sold Net Income

95) On September 25, 20X1, Dorian Company, a U.S. based firm, establishes a new subsidiary in Norway called Fiorta by investing 4 million Krone in exchange for 100,000 shares of common stock. The exchange rate on September 25, 20X1 is $.10 per Krone. On September 30, 20X1, when the exchange rate is 0.12 per Krone, Fiorta purchases inventory for 2.1 million Krone. On October 24, 201X1, Fiorta sells one third of the inventory for 1.2 million Krone and on December t, 20X1 another one third of the inventory, also for 1.2 Krone. The exchange rate is $0.09 and $0.10 per Krone on October 24 and December 6, respectively. Dorian and Fiorta issue financial statements quarterly and annually. The exchange rate is 0.11 per Krone on December 31, 20X1. Required:Assume that Fiona's functional currency is the U.S. dollar. What method should be used for translating Fiorta's financial statement result to the U.S. Dollar?Show the effect of the translations on (1) Fiorta's balance sheet and income statement (2) translate the amount into U.S. dollars under the current rate method using the following format.

96)

Concisely describe the two-step approach for determining reportable segments.

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97) Winton Company has several operating segments with the following discrete sales and service revenue involving external customers. Operating Segment A B C D E F G Total all segments

Revenue in Millions 51 44 38 19 17 14 17 200

Review of the segment related information reveals the following: Segments A and C are similar with respect to products, customers, distribution methods, regulatory environment, and production processes. Segments D and F are similar with respect to products, production processes and customers. Segments E and G are not similar. Required: Determine reportable segments using a two-step approach. Explain your reasoning for aggregating or not aggregating segments and proof that the 75% reporting rule is met.

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98) Andersyn Company identified two distinct segments---consumer goods and financing services. Management and the board of directors are concerned about declining sales and operating margin for the consumer goods segment. The following selected information is available for the consumer goods segment.

Sales revenues Operating income

20X2

20X1

$ 1,100,000

$ 1,240,000

198,000

248,000

Revenue growth (decline) Operating income growth (decline) Operating income margin

Required: Complete the table by indicating the growth or decline in revenue and operating income in 20X2 as compared to the prior year; also calculate the operating margins for both years.Conduct a cause-of-change analysis of the operating income; i.e., determine the amount of the change in operating income attributable to (a) change in sales revenue and (b) change in operating income margin.

99) The Kruk Company regularly sells merchandise to German customers. On December 1, 20X1, Kruk sold merchandise to a German customer at a price of three million Euros; the customer is required to pay for the goods on February 1, 20X2. The spot rate was $0.875 per euro on December 1, 20X1, it was $0.8875 per euro on December 31, 20X1, and it was $0.865 per euro on February 1, 20X2. Required: Prepare the journal entries necessary on December 1, 20X1, December 31, 20X1, and on February 1, 20X2.

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100) The financial statements of Berndt Company, a U.K. based company, show the following information: Local Currency Sales

Cost of goods sold Gross profit Gross margin

Current Rate Method

Temporal Method

1,000 800

200 20 %

Assume that the inventory sold during the year was purchased when the exchange rate was $1.30 per £. The average exchange rate during the year was $1.25 per £. Sales occurred evenly throughout the year. Required: Complete the table assuming (1) the current rate method applies and (2) the temporal method applies.

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Answer Key Test name: chapter 18 1) TRUE 2) FALSE 3) FALSE 4) TRUE 5) TRUE 6) FALSE 7) TRUE 8) FALSE 9) FALSE 10) TRUE 11) FALSE 12) TRUE 13) FALSE 14) FALSE 15) TRUE 16) FALSE 17) FALSE 18) [A, B, C, E, G, H] 19) B 20) A 21) D 22) C 23) B 24) D 25) A 26) A Version 1

27) A 28) B 29) A 30) D 31) C 32) C 33) D 34) B 35) A 36) D 37) B 38) B 39) D 40) A 41) A 42) D 43) A 44) A 45) C 46) A 47) C 48) B 49) A 50) B 51) D 52) C 53) A 54) A 55) A 56) C Version 1

57) B 58) B 59) C 60) B 61) A 62) C 63) D 64) B 65) A 66) C 67) A 68) D 69) D 70) B 71) A 72) A 73) B 74) C 75) C 76) A 77) D 78) C 79) D 80) B 81) C 82) B 83) D 84) A 85) C 86) B Version 1

87) C 88) B 89) A 90) B 91) B 92) CR Cash CR Accounts Receivable CR Inventory CR Prepaid Rent CR Property, Plant and Equipment CR Accounts Payable CR Notes Payable HR Common Stock AR Revenue AR Cost of Goods Sold 93) CR Cash CR Accounts Receivable HR Inventory HR Prepaid Rent HR Property, Plant and Equipment CR Accounts Payable CR Notes Payable HR Common Stock AR Revenue HR Cost of Goods Sold 94) Local Currency Exchange U.S. Dollar Amount for (in Krone rate U.S. Consolidated Financial Dollar Statements Requirement K) Requirement 1 for 1 2 Krone Balance Sheet Cash

K 4,300,000

0.11

Inventory

700,000

0.11

Total assets

K 5,000,000

550,000

Common Stock

K 4,000,000

0.10

400,000

Retained Earnings

K 1,000,000

95,000

55,000

550,000

Accumulated Other Comprehensive Income Total Liabilities and stockholders’ Equity Retained Earnings Beginning Balance

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Inferred $ 5,000,000

473,000 77,000

Net Income

K 1,000,000

95,000

Ending Balance

K 1,000,000

95,000

228,000

Income Statement Sales

K 2,400,000

0.095

Cost of goods sold

K 1,400,000

0.095

Net Income

K 1,000,000

133,000 $

95,000

Cash (in Krone): 4 million − 2.1 million + 2.4 million = 4.3 millionInferred AOCI: Total assets = $550,000; CS = $400,000; RE = $95,000;Total assets = CS + RE + AOCI; AOCI = 55,000 95) 1.Dorian Company should use the temporal method to remeasure Fiorta’s financial statement results. 2. Local Exchange U.S. Dollar Amount Currency rate U.S. for Consolidated (in Krone K) Dollar for Financial Statements 1 Krone Balance Sheet Cash

K 4,300,000

0.11

Inventory

0.12

Total assets

K 5,000,000

Common Stock

K 4,000,000

Retained Earnings

K 1,000,000

Total Liabilities and stockholders’ Equity Retained Earnings

K 5,000,000

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700,000

473,000 84,000

557,000

0.10

400,000

Inferred

157,000

558,000

Beginning Balance

Net Income

K 1,000,000

157,000

Ending Balance

K 1,000,000

157,000

228,000

Income Statement Sales

K 2,400,000

0.095

Cost of goods sold

K 1,400,000

0.120

(168,000 )

Foreign exchange gain Net Income

97,000 $

157,000

Total assets = CS + RE; $557,000 = $400,000 + RE; RE = $157,000; Gross profit = ($228,000 − $168,000) = $60,000; thus, foreign currency gain = $97,000 96) Step 1: Aggregate segments based on similar economic characteristics. The characteristics to consider are: (a) products and services, (b) production processes, (c) type or class of customer, (d) product and service distribution methods, and (e) regulatory environment. Segments that meet all five characteristics are aggregated. Step 2: Determine which segments meet the quantitative 10% threshold of either (a) revenue, (b) assets, or (c) the absolute value of operating profit or loss equal or exceeding 10% of the greater of either the total segment operating profit of segments with profit or the total segment operating loss for segments wit losses. If none of the thresholds are met, a segment which management judges to be important in terms of presenting separate information may still be reported if the majority of the five characteristics are met.

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97) Segments A and C: should be combined since they are similar, meeting all of the five aggregation criteria. Both exceed 10% of total revenue. Segments D and F: although the segments do not meet the 10% threshold test, they can be combined because they meet the majority of the aggregation criteria. Reported segments: AC = 89 B = 44 DF = 33 Total segment revenue = 166 Proof that total reported segment revenue is equal to or greater than 75% of the total revenue: $(166/200) = 83%>75%. 98) 1. 20X2

20X1

$ 1,100,000

$ 1,240,000

Operating income

198,000

248,000

Revenue growth (decline)

(11.2903 %)

Operating income growth (decline)

(20.1613 %)

Sales revenues

Operating income margin

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18 %

20 %

Revenue decline: $(1,240,000 − 1,100,000) = $140,000 decline; $140,000/$1,240,000 = 11.2903%Operating income decline: $(248,000 − 198,000) = $50,000; $50,000/$248,000 = 20.1613%Operating income margins: 20X2: $198,000/1,100,000 = 18%; 20X1: $248,000/$1,240,000 = 20% 2. 20X2 Operating Income 20X1 Change in Operating income due to:

248,000

Revenue decline Change in margin Operating Income in 20X2

$ $ $

28,000 22,000 50,000

Cause: revenue decline: 20X1 operating income × % decrease in sales revenue $248,000 × 0.112903 = $28,000 (rounded)Cause: operating profit margin decline: 20X2 revenue × (change in operating income margin) = $1,100,000 × 2% = $22,000 99) December 1, 20X1 Accounts receivable (euros)

2,625,000

Sales

2,625,000

December 31, 20X1 Accounts receivable (euros)

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37500*

Foreign currency transaction gain

37500

*3,000,000 ($0.8875 − $0.875) February 1, 20X2 Cash

2,595,000

Foreign currency transaction loss

67,500*

Accounts receivable (euros)

2,662,500

*3,000,000 ($0.865 − $0.8875) 100) Sales

Local Currency £ 1,000

Cost of goods sold Gross profit Gross margin

Current Rate Method (1) $ 1,250

Temporal Method (2) $ 1,250

1,000

1,040

800 £

200 20 %

250 20 %

210 16.8 %

(1) Current rate method: Revenues and cost of goods sold are translated at the average exchange rate (£1,000 × 1.25) = $1,250; Cost of goods sold: £800 × 1.25 = $1,000; gross profit = $(1,250 − 1,000)/1,250 = 20%(2) Temporal method: Revenues are remeasured at average exchange rate (£1,000 × 1.25) = $1,250; Cost of goods sold is remeasured at the historical exchange rate: £800 × 1.30 = $1,040; gross profit = $(1,250 − 1,040)/1,250 = 16.80%

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CHAPTER 19: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Derivatives have no intrinsic value. ⊚ ⊚

Derivatives always reduce risk. ⊚ ⊚

true false

Derivatives can be net settled by paying cash. ⊚ ⊚

true false

Since futures are based on contracts between two parties, the contracts cannot be traded. ⊚ ⊚

true false

5) When hedging commodity price risk with a futures contract, the value of the contract increases as the selling price of the commodity increases. ⊚ ⊚

true false

6) A lender can effectively convert a fixed-rate debt into a floating-rate debt by using an interest rate swap. ⊚ ⊚

true false

7) A call option contract requires the holder to buy a specific underlying asset at a set price during a specific time period. Version 1

⊚ ⊚

true false

8) Changes in the fair value of all derivatives other than hedges must be recognized in income when they occur. ⊚ ⊚

true false

The value of a call option consists of its intrinsic value and its net realizable value. ⊚ ⊚

true false

10) To be effective, an economic loss on a hedged item is offset by a corresponding gain during the same period. ⊚ ⊚

11)

Derivatives are reported on the balance sheet at net realizable value. ⊚ ⊚

12)

true false

All qualifying hedges are also derivatives. ⊚ ⊚

true false

13) Hedge accounting may be applied only to derivatives that effectively hedge the risk associated with the hedged item. ⊚ ⊚

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true false

14)

The ineffective portion of a hedge must flow directly to income. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 15) All of the following may serve as a source of value for a related derivative, except for a(n):

A) stock exchange index. B) commodity. C) interest rate. D) specific derivative instrument.

16)

Derivative instruments typically require a

initial investment relative to their

A) large; risk B) small; risk C) large; value D) small; value

17)

Which of the following is not an example of a forward contract?

A) A pre-order for a soon to be released smart phone. B) A prepayment for heating oil at a summer special price. C) Purchase of an Amazon $100 gift card. D) Purchase of textbooks for the upcoming semester. Books will be delivered in two weeks.

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18) Minka writes a futures contract for 1,000 bushels of June wheat. If Minka does not personally want to take possession of the wheat, she can consider the following beneficial action:

A) sell the futures contract. B) pay a release of contract fee. C) default on the future contract. D) she cannot avoid accepting delivery of the wheat.

19) a(n):

An interest rate swap converting floating-rate debt to fixed rate debt is an example of

A) cash flow hedge. B) fair value hedge. C) futures contract. D) option.

20) a(n):

An interest rate swap that converts fixed-rate debt into floating-rate debt is an example of

A) cash flow hedge. B) fair value hedge. C) futures contract. D) option.

21)

All of the following is correct regarding the intrinsic value of a call option except:

A) the value is fixed. B) the value is greater than zero. C) can change daily. D) is the difference between spot price and exercise price.

22)

At time of expiration, the present value of a call option is:

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A) above the exercise price. B) equal to the exercise price. C) below the exercise price. D) zero.

23)

Derivatives, such as option contracts, must be reported on the balance sheet at:

A) fair value. B) present value. C) intrinsic value. D) net realizable value.

24) For hedge accounting to be used, U.S. GAAP requires that these criteria must be satisfied, except:

A) The effectiveness of eliminating a specific market risk is documented. B) The derivative is designated as a hedging instrument. C) A net gain results from hedging a specific risk. D) A description of the hedging strategy is provided.

25)

Which of the following may be used as a hedge?

A) an insurance contract B) a real estate contract C) common stock D) an interest rate swap

26)

All of the following may qualify as hedges, except for a(n):

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A) financial guarantee contract. B) future to sell soy beans. C) put option to sell foreign currency. D) forward contract to purchase a foreign currency.

27)

All of the following may qualify as hedges, except for a(n):

A) future to sell copper. B) factored accounts receivable. C) call option to sell Euros. D) forward contract to purchase a Japanese Yen.

28) Assuming 100% hedge effectiveness, if the fair value of a hedged item increases by $1, the derivative fair value will:

A) increase by $1. B) decrease by $1. C) increase by $2. D) decrease by $2.

29) On February 1, 20X1, Hills Company had 10,000 pounds of inventory costing $1.50 per pound; the market value per pound was $1.95 on this date. Hills entered into a futures contract to sell the 10,000 pounds of inventory during May 20X1 at $2.25 per pound. Which of the following statements does not accurately describe the impact of this futures contract?

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A) Hills has foregone the benefit of additional profits (the upside potential) if the price per pound exceeds $2.25 during the month of May. B) Hills has eliminated the risk of reduced profits (the downside potential) if the price per pound is less than $2.25 during the month of May. C) Hills' gross profit in May will be $3,000 regardless of the actual price per pound in May. D) The value of the futures contract decreases as the market price per pound of inventory increases.

30) When two parties agree to the sale of some asset or commodity on some specified future date at a price specified today it is a(n):

A) forward contract. B) swap contract. C) performance contract. D) options contract.

31) A variation of a forward contract that is traded daily in a market with many buyers and sellers and does not have a predetermined settlement date is a/an:

A) futures contract. B) swap contract. C) performance contract. D) options contract.

32)

All of the statements below are true of futures contracts except that futures contracts:

A) result in predictable cash flows. B) eliminate downside risk and upside potential. C) eliminate downside risk while allowing for upside potential. D) result in predictable gross profits.

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33) A derivative instrument that gives the holder the right but not the obligation to do something is a(n):

A) future contract. B) swap contract. C) performance contract. D) options contract.

34)

In order to use hedge accounting, management must do all of the following except:

A) designate the derivative as a hedging instrument. B) describe the hedging strategy. C) get external auditor approval to use hedge accounting. D) document its effectiveness in eliminating a specific market risk for a specific hedged item.

35) On December 1, 20X1 a company bought a call option costing $100,000 as a speculative investment. The call option gave the company the right to purchase 100,000 barrels of oil for $110 per barrel during April 20X2. As of December 31, 20X1 the call option had a value of $125,000. The company liquidated the call option on April 15, 20X2 in exchange for $175,000. Which of the following accurately describes GAAP accounting for this call option?

A) The realized gain applicable to the year ending December 31, 20X1 is $25,000. B) The realized gain recognized on April 15, 20X2 is $75,000. C) The unrealized gain recognized on April 15, 20X2 is $50,000. D) The call option will be reported on the December 31, 20X1 balance sheet at $125,000 and a $25,000 unrealized gain will be reported as a component of income from continuing operations for the year ending December 31, 20X1.

36) Which of the following statements does not properly describe GAAP accounting for derivatives?

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A) Derivatives are reported in the balance sheet at fair value. B) Speculative investments in derivative contracts can increase earnings volatility. C) Changes in the fair value of a derivative must be included in net income when they occur. D) A derivative's unrealized holding gain or loss for a particular year is not a component of that year's income from operations.

37)

A hedged item can be any of the following except:

A) an anticipated (forecasted) transaction. B) an existing asset or liability on the company's books. C) a past transaction. D) a firm commitment.

38)

Which of the following risks may not be accounted for using hedge accounting?

A) foreign currency exchange rates. B) labor strikes. C) commodity prices. D) changes in benchmark interest rates.

39) A hedge of the exposure to changes in the fair value of an existing asset or liability or a firm commitment is a(n):

A) fair value hedge. B) cash flow hedge. C) foreign currency exposure hedge. D) marked-to-market hedge.

40) Which of the following statements does not accurately describe the accounting for derivatives?

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A) The holding gain resulting from a fair value hedge that qualifies for hedge accounting is recognized in net income along with the offsetting loss on the hedged item. B) The holding loss resulting from a cash flow hedge that qualifies for hedge accounting is recognized in net income during the year of the loss. C) Management must be able to describe its hedging strategy in order to meet the GAAP criteria to qualify for hedge accounting. D) Derivatives that fail to meet the GAAP criteria for hedge accounting are accounted for as speculative investments.

41)

All of the following are examples of a fair value hedge, except for a(n):

A) interest rate swap converting a fixed rate to a floating rate. B) interest rate swap converting a floating rate to a fixed rate. C) future contract that "unlocks" a contract to sell soybeans at a specific price in January. D) future contract that "unlocks" a contract to sell silver at a specific price in December.

42)

All of the following are examples of a cash flow hedge, except for a(n):

A) interest rate swap converting a fixed rate to a floating rate. B) interest rate swap converting a floating rate to a fixed rate. C) hedge of a receivable denominated in Euros. D) hedge of a net investment in a foreign subsidiary.

43)

Which of the following is an example of a cash flow hedge?

A) an interest rate swap converting a fixed rate to a floating rate. B) a computer manufacturer's contract to purchase a new chip at a specific price. C) a speculative derivative contract. D) a future contract that unlocks an agreement to sell gold at a specific fixed price.

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44) On September 1, 20X1, Bauer Inc. has 10,000 ounces of silver, with an average cost of $12 per ounce, in inventory. The spot price for silver is $16 per ounce. Bauer decides to retain the inventory until the beginning of January 20X2, hoping that the price increases to $17 per ounce. To hedge its position, Bauer sells future contracts to sell 100,000 ounces of silver at $17 per ounce on January 2, 20X2. The market spot rates and future prices for silver are as follows: Spot Price 16

January 20X2 Future Price $ 17

September 1, 20X1

December 31, 20X1

$ 14.50

15.50

January 2, 20X2

$ 16.80

16.80

What entry does Bauer prepare on September 1, 20X1?

Derivative Future Contract

160,000

Inventory

160,000

Derivative Future Contract Gain on hedge activity

15,000 15,000

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Derivative Future Contract

15,000

Cash

15,000

D) No entry is needed.

45) On September 1, 20X1, Bauer Inc. has 10,000 ounces of silver, with an average cost of $12 per ounce, in inventory. The spot price for silver is $16 per ounce. Bauer decides to retain the inventory until the beginning of January 20X2, hoping that the price increases to $17 per ounce. To hedge its position, Bauer sells future contracts to sell 100,000 ounces of silver at $17 per ounce on January 2, 20X2. The market spot rates and future prices for silver are as follows: Spot Price 16

January 20X2 Future Price $ 17

September 1, 20X1

December 31, 20X1

$ 14.50

15.50

January 2, 20X2

$ 16.80

16.80

What entry does Bauer prepare on December 31, 20X1 to record the change in the fair value of the future contract?

Derivative Future Contract Gain on Hedge Activity

15,000 15,000

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Loss on Hedge Activity

15,000

Derivative Future Contract

15,000

Derivative Future Contract

10,000

Gain on Hedge Activity

10,000

Loss on Hedge Activity

10,000

Derivative Future Contract

10,000

46) On September 1, 20X1, Bauer Inc. has 10,000 ounces of silver, with an average cost of $12 per ounce, in inventory. The spot price for silver is $16 per ounce. Bauer decides to retain the inventory until the beginning of January 20X2, hoping that the price increases to $17 per ounce. To hedge its position, Bauer sells future contracts to sell 100,000 ounces of silver at $17 per ounce on January 2, 20X2. The market spot rates and future prices for silver are as follows: Spot Price September 1, 20X1

December 31, 20X1

$ 14.50

15.50

January 2, 20X2

$ 16.80

16.80

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January 20X2 Future Price $ 17

What entry does Bauer prepare on December 31, 20X1 to adjust the carrying value of the inventory of silver?

Derivative Future Contract

15,000 Inventory—

Silver

15,000

Loss on Hedge Activity

15,000

Derivative Future Contract

15,000

Gain on Hedge Activity

15,000 Inventory—

Silver

15,000

Gain on Hedge Activity Derivative Future Contract

Version 1

10,000 10,000

47) On September 1, 20X1, Bauer Inc. has 10,000 ounces of silver, with an average cost of $12 per ounce, in inventory. The spot price for silver is $16 per ounce. Bauer decides to retain the inventory until the beginning of January 20X2, hoping that the price increases to $17 per ounce. To hedge its position, Bauer sells future contracts to sell 100,000 ounces of silver at $17 per ounce on January 2, 20X2. The market spot rates and future prices for silver are as follows: Spot Price 16

January 20X2 Future Price $ 17

September 1, 20X1

December 31, 20X1

$ 14.50

15.50

January 2, 20X2

$ 16.80

16.80

What is the carrying value of Bauer's inventory of silver on 12/31/20X1?

A) B) C) D)

$120,000 $105,000 $135,000 $145,000

48) On September 1, 20X1, Bauer Inc. has 10,000 ounces of silver, with an average cost of $12 per ounce, in inventory. The spot price for silver is $16 per ounce. Bauer decides to retain the inventory until the beginning of January 20X2, hoping that the price increases to $17 per ounce. To hedge its position, Bauer sells future contracts to sell 100,000 ounces of silver at $17 per ounce on January 2, 20X2. The market spot rates and future prices for silver are as follows: Spot Price 16

January 20X2 Future Price $ 17

September 1, 20X1

December 31, 20X1

$ 14.50

15.50

January 2, 20X2

$ 16.80

16.80

On January 2, 20X2, Bauer sells the silver at the spot rate of $16.80 and cancels the futures contract. Prepare the journal entry Bauer makes on 1/2/X2 to cancel the futures contract. Version 1

Cash

15,000

Gain on Hedge Activity

15,000

Cash

2,000

Gain (Loss) on hedge activity

13,000

Derivative Future Contract

15,000

Derivative Future Contract

10,000

Gain on Hedge Activity

10,000

Loss on Hedge Activity Derivative Future Contract

Version 1

15,000 15,000

49) On September 1, 20X1, Bauer Inc. has 10,000 ounces of silver, with an average cost of $12 per ounce, in inventory. The spot price for silver is $16 per ounce. Bauer decides to retain the inventory until the beginning of January 20X2, hoping that the price increases to $17 per ounce. To hedge its position, Bauer sells future contracts to sell 100,000 ounces of silver at $17 per ounce on January 2, 20X2. The market spot rates and future prices for silver are as follows: Spot Price 16

January 20X2 Future Price $ 17

September 1, 20X1

December 31, 20X1

$ 14.50

15.50

January 2, 20X2

$ 16.80

16.80

On January 2, 20X2, Bauer sells the silver at the spot rate of $16.80 and cancels the futures contract. Prepare the journal entry Bauer makes on 1/2/X2 to adjust the silver inventory to fair value.

Inventory—Silver

13,000

Gain on Hedged activity

13,000

Accounts Receivable

168,000

COGS-Silver

118,000

Sales Revenue

168,000

Inventory—Silver

118,000

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Accounts Receivable

168,000

COGS-Silver

120,000

Sales Revenue

168,000

Inventory—Silver

120,000

Accounts Receivable

170,000

COGS-Silver

115,000

Sales Revenue

168,000

Inventory—Silver

117,000

50) When a company successfully hedges its market risk, any economic loss on the hedged items will be offset by a:

A) gain on the related derivative. B) gain on another hedged item. C) cash flow on a related derivative. D) cash flow on another hedged item.

51)

The objective of hedge accounting under U.S. GAAP is to achieve:

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A) the most conservative financial statement results. B) the lowest reported gain. C) matching of gains and losses between hedged items and related derivatives. D) the highest reported gain or loss in the year the hedged item resolved.

52)

All of the following are potential hedged items, except:

A) an existing receivable or payable denominated in a foreign currency. B) a commitment to purchase 1,000 pounds of silver. C) a need for 1,500 new computer chips in December. D) common stockholders' expectations of quarterly dividends.

53) U.S. GAAP hedge accounting rules permit hedging of these market risks, except for those associated with changes in:

A) fair value of the hedged item. B) future cash flows associated with the hedged item. C) benchmark interest rates. D) insurance rates.

54) U.S. GAAP hedge accounting rules permit hedging of these market risks, except for those associated with changes in:

A) management errors. B) commodity prices. C) foreign currency exchange rates. D) creditworthiness of a security issuer.

55)

Which of the following may not be hedged?

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A) An accounts receivable denominated in Euros. B) The risk of losses from tornados that may impair this years' crops. C) The risk of rising prices for a key component of the company's products. D) Changes in benchmark interest rates.

56) Cassandra Boat Builders builds and sells powerboats with a hull constructed primarily of teak wood. The boat building season is during Spring and Summer. The company begins building each boat only after a firm commitment was made by a specific buyer. Since the price of teak wood tends to fluctuate, Cassandra purchases several future contracts with different due dates during the building season to hedge the risk of fluctuating wood prices. During the 20X1 boat building season, the price of teak wood increased and reduced the Company's gross margin by $250,000. However, due to the increases in the teak wood prices, Cassandra realized a $240,00 gain on the related future contracts. Cassandra designates the futures as a cash flow hedge of an anticipated transaction.At the inception of the future contracts, Cassandra should recognize the purchase price as a(n):

A) asset B) liability C) gain D) loss

57) Cassandra Boat Builders builds and sells powerboats with a hull constructed primarily of teak wood. The boat building season is during Spring and Summer. The company begins building each boat only after a firm commitment was made by a specific buyer. Since the price of teak wood tends to fluctuate, Cassandra purchases several future contracts with different due dates during the building season to hedge the risk of fluctuating wood prices. During the 20X1 boat building season, the price of teak wood increased and reduced the Company's gross margin by $250,000. However, due to the increases in the teak wood prices, Cassandra realized a $240,00 gain on the related future contracts. Cassandra designates the futures as a cash flow hedge of an anticipated transaction.Assume that Cassandra Boat Builders prepares monthly financial statements. At the end of each month, Cassandra should:

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A) adjust the contract to fair value. B) write off contracts that generated a loss. C) cancel the contracts and recognize a gain. D) continue to carry the contracts at original cost.

58) Cassandra Boat Builders builds and sells powerboats with a hull constructed primarily of teak wood. The boat building season is during Spring and Summer. The company begins building each boat only after a firm commitment was made by a specific buyer. Since the price of teak wood tends to fluctuate, Cassandra purchases several future contracts with different due dates during the building season to hedge the risk of fluctuating wood prices. During the 20X1 boat building season, the price of teak wood increased and reduced the Company's gross margin by $250,000. However, due to the increases in the teak wood prices, Cassandra realized a $240,00 gain on the related future contracts. Cassandra designates the futures as a cash flow hedge of an anticipated transaction.Which of the following entries (presented in summary format) should Cassandra Boat Builders make to recognize the gain from the future contracts?

Future contract

240,000

Gain on future contracts--Income

240,000

Future contract Cash

20,000 20,000

Version 1

Cash

240,000

OCI-Unrealized gain on future contracts

240,000

Cash

20,000

OCI-Unrealized gain on future contracts

20,000

59) Cassandra Boat Builders builds and sells powerboats with a hull constructed primarily of teak wood. The boat building season is during Spring and Summer. The company begins building each boat only after a firm commitment was made by a specific buyer. Since the price of teak wood tends to fluctuate, Cassandra purchases several future contracts with different due dates during the building season to hedge the risk of fluctuating wood prices. During the 20X1 boat building season, the price of teak wood increased and reduced the Company's gross margin by $250,000. However, due to the increases in the teak wood prices, Cassandra realized a $240,00 gain on the related future contracts. Cassandra designates the futures as a cash flow hedge of an anticipated transaction.In addition to recognizing revenue and related cost of goods sold on completed boats, the company should also make the following summary entry.

Cash Futures contracts

240,000 240,000

Version 1

Cash

250,000

Futures contracts

250,000

OCI—unrealized gain on futures contract

240,000

Cost of goods sold

240,000

OCI—unrealized gain on futures contract Cost of goods sold

250,000 250,000

60) Cassandra Boat Builders builds and sells powerboats with a hull constructed primarily of teak wood. The boat building season is during Spring and Summer. The company begins building each boat only after a firm commitment was made by a specific buyer. Since the price of teak wood tends to fluctuate, Cassandra purchases several future contracts with different due dates during the building season to hedge the risk of fluctuating wood prices. During the 20X1 boat building season, the price of teak wood increased and reduced the Company's gross margin by $250,000. However, due to the increases in the teak wood prices, Cassandra realized a $240,00 gain on the related future contracts. Cassandra designates the futures as a cash flow hedge of an anticipated transaction.The hedge of the unanticipated cost increase in the price of teak lumber is:

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A) perfectly effective. B) highly effective. C) somewhat effective. D) ineffective.

61)

If a cash flow hedge is not perfectly effective, the difference is recognized:

A) in income. B) as other comprehensive income. C) as a liability. D) as a contra asset.

62) Which of the following is not a required condition for utilizing hedge accounting? The hedge must be:

A) highly effective. B) effective at the inception of the hedge term. C) effective at the end of the hedge term. D) perfectly effective.

63) U.S. GAAP provides guidance that defines hedge effectiveness. To be considered effective, a hedge should offset between % and % of changes in the hedged item's market price.

A) B) C) D)

95; 105 90; 110 80; 115 80; 125

64) Which of the following must be disclosed in the financial statement notes with respect to derivative instruments?

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A) Exact inception dates of futures. B) Number of options held beyond one year. C) Names of issuers of forward contracts. D) Unrealized gains and losses recognized in OCI.

65)

The following must be disclosed related to derivative instruments and contracts, except:

A) the names of each derivative issuer or contract party. B) the types of derivatives held by the entity. C) their effects on other and accumulated other comprehensive income. D) information regarding derivatives not qualifying for hedge accounting.

66)

The following must be disclosed related to derivative instruments and contracts, except:

A) notional amounts and related balance sheet effects. B) the effects of derivatives on net income. C) the types of derivatives held by the entity. D) the effects of derivatives on other and accumulated other comprehensive income. E) management's policy on hedging risk.

67) These accounting rule(s) provide guidance on accounting and reporting of cash flow hedges and fair value hedges.

A) U.S. GAAP only B) IFRS only C) U.S. GAAP and IFRS D) neither U.S. GAAP nor IFRS

68)

The accounting rule(s) that require that derivatives are reported at fair value is/are:

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A) U.S. GAAP only B) IFRS only C) U.S. GAAP and IFRS D) neither U.S. GAAP nor IFRS

69) Consistent with this/these accounting rule(s), hedges must be highly effective in order to utilize hedge accounting.

A) U.S. GAAP only B) IFRS only C) U.S. GAAP and IFRS D) neither U.S. GAAP nor IFRS

70) ASC Topic 2017-12 and revised IFRS 9 permit that a portion of a contract or asset be designated as a hedge, provided that the related risk:

A) is separately identifiable and measurable. B) immaterial. C) can be hedged perfectly. D) does not affect current year income.

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 71) The Hockey Supply Company acquires its inventory from a Canadian supplier. As a result, the company purchases call options in order to hedge its foreign currency risk. On December 1, 20X1, Hockey Supply Company made a commitment to purchase inventory during February 20X2; the payment of one million Canadian dollars is due at the time of the inventory purchase. The company immediately purchased a call option on one million Canadian dollars at a strike price of $.98 per Canadian dollar; the call option cost $5,200. The call option is considered to be a fair value hedge. As of December 31, 20X1, the spot rate was $0.975 U.S. dollars per Canadian dollar, and the fair value of the call option was $1,300. Hockey Supply Company purchased the inventory on February 5, 20X2. The spot rate at the time of purchase was $0.99 U.S. dollars per Canadian dollar and the fair value of the call option was $8,900.Requirement:Prepare the necessary journal entries for December 1, 20X1, December 31, 20X1, and February 5, 20X2.

72) On December 15, 20X1, The International Company received and accepted an order to deliver goods to a foreign customer on February 1, 20X2 in exchange for 3 million euros. International must deliver the goods on February 1, 20X2 and the foreign customer is required to pay for the goods at the time of delivery. On December 15, 20X1, International agreed to a forward contract to deliver 3 million euros to the Speculative Bank on February 1, 20X2 in exchange for $2,730,000. The forward rate as of December 31, 20X1 was $0.915; the spot rate as of February 1, 20X2 was $0.904. Requirement: Prepare the necessary journal entries on December 31, 20X1 and February 1, 20X2 assuming that the forward contract is being used as a fair value hedge.

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73) On January 1, 20X1, Hitchcock Corporation entered into a 5-year interest rate swap agreement. The agreement called for the company to make payments based on an 8% fixed notional amount of $500,000 and to receive interest based on a floating interest rate. The contract called for cash settlement of the net interest amount at the end of each year. The floating rate was to be reset at each cash settlement date. Thus, the floating rate for determining each end of year payment is the rate as of the end of the prior year.Market (LIBOR) interest rates were 8% at January 1, 20X1, 6.5% at December 31, 20X1, and 9% at December 31, 20X2. The fair value of the swap is as follows:

Fair value of interest rate swap

January 1, 20X1 0

December 31, 20X1 ($25,693)

December 31, 20X2 $12,656

Requirements:1. Complete the following table to show the amounts appearing in Hitchcock’s financial statements related to the swap for the years ended December 31, 20X1 and December 31, 20X2. December 31, 20X1 December 31, 20X2 Balance sheet Swap asset (liability) Retained earnings Accumulated other comprehensive income Statement of comprehensive income Net income Other comprehensive income

2. Complete the following table to show the amounts appearing in Hitchcock’s statement of comprehensive income related to the swap and the hedged item for the years ended December 31, 20X1 and December 31, 20X2, assuming that the interest rate swap is being used as a perfectly effective cash flow hedge for a $500,000 variable rate note payable issued by Hitchcock. December 31, 20X1 December 31, 20X2

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Statement of comprehensive income Net income Other comprehensive income

3. Complete the following table to show the amounts appearing in Hitchcock’s statement of comprehensive income related to the swap and the hedged item for the years ended December 31, 20X1 and December 31, 20X2, assuming that the interest rate swap is being used as a perfectly effective fair value hedge for a $500,000 investment in a fixed rate note. The note is classified as an available-for-sale security. December 31, 20X1 December 31, 20X2 Statement of comprehensive income Net income Other comprehensive income

74) Refer to the Year 3 IBM financial statement excerpts, which appear following the requirements listed for this problem. Use the information in the excerpts to answer these questions. All questions relate to fiscal Year 3 unless stated otherwise.Required:1. Explain the risks that IBM is trying to manage with its derivatives.2. Explain how the gains and losses on the fair value hedges affect net income and other comprehensive income during Year 3. Give specific accounts and amounts where possible.3. Explain how the gains and losses on nonhedge/other derivatives affect net income and other comprehensive income during Year 3. Give specific accounts and amounts where possible.4. Explain how the gains and losses on the cash flow hedges affect net income and other comprehensive income during Year 3. Give specific accounts and amounts where possible.5. Was it a good idea for IBM to enter into its cash flow hedges? Excerpt from IBM December 31, Year 3 Financial Statements

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K BORROWINGS SHORT-TERM DEBT (dollars in millions) AT DECEMBER 31: Commercial paper Short-term loans Long-term debt—Current maturities Total

Year 3 $ 2,349 1,124

Year 2 $ 1,302 1,013

3,173

3,716

$ 6,646

$ 6,031

The weighted-average interest rates for commercial paper at December 31, Year 3 and Year 2, were 1.0 percent and 1.7 percent, respectively. The weighted-average interest rate for short-term loans was 2.5 percent at both December 31, Year 3 and Year 2. Pre-Swap Activity (dollars in millions) AT DECEMBER 31:

MATURITIES

Year 3

Year 2

U.S. Dollars: Debentures: 5.875%

Year 32 $

600

6.22%

Year 27

500

6.5%

Year 28

319

700

7.0%

Year 25

600

7.0%

Year 45

150

7.125%

Year 96

850

7.5%

Year 13

550

8.375%

Year 19

750

3.43% convertible notes*

Year 7

309

328

Year 4 Year 13

3,034

2,130

Notes: 5.9% average

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—

Medium-term note program: 3.7% average Other: 4.0% average

Year 4 Year 18

4,690

7,113

Year 4 Year 9

508

610

12,860

14,281

Other currencies (average Interest rate at December 31, Year 3, in parentheses): Euros (5.3%)

Year 4 Year 9

1,174

2,111

Japanese yen (1.1%)

Year 4 Year 15

4,363

4,976

Canadian dollars (5.8%)

Year 4 Year 11

201

445

Swiss francs (4.0%)

Year 3

180

Other (6.0%)

Year 4 Year 14

770

730

19,368

22,723

(1)

806

978

20,159

23,702

3,173

3,716

$ 16,986

$ 19,986

Less: Net unamortized discount/(premium) Add: ASC Topic 815 fair value adjustment**

Less: Current maturities Total

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* On October 1, Year 2, as part of the purchase price consideration for the PwCC acquisition, as addressed in note C, Acquisitions/ Divestitures, on pages 89 to 92, the company issued convertible notes bearing interest at a stated rate of 3.43 percent with a face value of approximately $328 million to certain of the acquired PwCC partners. The notes are convertible into 4,764,543 shares of IBM common stock at the option of the holders at any time after the first anniversary of their issuance based on a fixed conversion price of $68.81 per share of the company's common stock. As of December 31, Year 3, a total of 274,347 shares had been issued under this provision.** In accordance with the requirements of FASB ASC Topic 815, the portion of the company's fixed rate debt obligations that is hedged is reflected in the Consolidated Statement of Financial Position as an amount equal to the sum of the debt s carrying value plus a ASC Topic 815 fair value adjustment representing changes recorded in the fair value of the hedged debt obligations attributable to movements in market interest rates and applicable foreign currency exchange rates.L. DERIVATIVES AND HEDGING TRANSACTIONSThe company operates in approximately 35 functional currencies and is a significant lender and borrower in the global markets. In the normal course of business, the company is exposed to the impact of interest rate changes and foreign currency fluctuations, and to a lesser extent equity price changes and client credit risk. The company limits these risks by following established risk management policies and procedures including the use of derivatives and, where cost-effective, financing with debt in the currencies in which assets are denominated. For interest rate exposures, derivatives are used to align rate movements between the interest rates associated with the company's lease and other financial assets and the interest rates associated with its financing debt. Derivatives are also used to manage the related cost of debt. For foreign currency exposures, derivatives are used to limit the effects of foreign exchange rate fluctuations on financial results.The company does not use derivatives for trading or speculative purposes, nor is it a party to leveraged derivatives. Further, the company has a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors, and maintains strict dollar and term limits that correspond to the institution's credit rating.In its hedging programs, the company employs the use of forward contracts, futures contracts, interest rate and currency swaps, options, caps, floors or a combination thereof depending upon the underlying exposure.A brief description of the major hedging programs follows.DEBT RISK MANAGEMENTThe company issues debt in the global capital markets, principally to fund its financing lease and loan portfolio. Access to cost-effective financing can result in interest rate and/or currency mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company primarily uses interest-rate and currency instruments, principally swaps, to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert specific variable-rate debt and anticipated commercial paper issuances to fixed rate (i.e., cash flow hedges).The resulting cost of funds is lower than that which would have been available if debt with matching characteristics was issued directly. The weighted-average remaining maturity of all swaps in the debt risk management program is approximately four years.A significant portion of the

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company's foreign currency denominated debt portfolio is designated as a hedge of net investment to reduce the volatility in stockholders' equity caused by changes in foreign currency exchange rates in the functional currency of major foreign subsidiaries with respect to the U.S. dollar. The company also uses currencyswaps and foreign exchange forward contracts for this risk management purpose.The currency effects of these hedges (approximately $200 million for the current period, net of tax) are reflected as a loss in the Accumulated gains and (losses)not affecting retained earnings section of the Consolidated Statement of Stockholders Equity, thereby offsetting a portion of the translation of the applicable foreign subsidiaries net assets.ANTICIPATED ROYALTIES AND COST TRANSACTIONSThe company's operations generate significant nonfunctional currency, third party vendor payments and intercompany payments for royalties, and goods and services among the company's non-U.S. subsidiaries and with the parent company. In anticipation of these foreign currency cash flows and in view of the volatility of the currency markets, the company selectively employs foreign exchange forward and option contracts to manage its currency risk. These contracts may have extended maturities beyond one year and from time to time that extend to three years. As of December 31, Year 3, the maximum remaining maturity of these derivative instruments was approximately 18 months, commensurate with the underlying hedged anticipated cash flows.SUBSIDIARY CASH AND FOREIGN CURRENCY ASSET/LIABILITY MANAGEMENTThe company uses its Global Treasury Centers to manage the cash of its subsidiaries. These centers principally use currency swaps to convert cash flows in a cost-effective manner. In addition, the company uses foreign exchange forward contracts to hedge, on a net basis, the foreign currency exposure of a portion of the company's nonfunctional currency assets and liabilities. The terms of these forward and swap contracts are generally less than one year. The changes in fair value from these contracts and from the underlying hedged exposures are generally offsetting and are recorded in Other (income)and expense in the Consolidated Statement of Earnings.EQUITY RISK MANAGEMENTThe company is exposed to certain equity price changes related to certain obligations to employees. These equity exposures are primarily related to market value movements in certain broad equity market indices and in the company's own stock. Changes in the overall value of this employee compensation obligation are recorded in SG&A expense in the Consolidated Statement of Earnings. Although not designated as accounting hedges, the company utilizes equity derivatives, including equity swaps and futures to economically hedge the equity exposures relating to this employee compensation obligation. To match the exposures relating to this employee compensation obligation, these derivatives are linked to the total return of certain broad equity market indices and/or the total return of the company's common stock. These derivatives are recorded at fair value with gains or losses also reported in SG&A expense in the Consolidated Statement of Earnings.OTHER DERIVATIVESThe company holds warrants in connection with certain investments that, although not designated as hedging instruments, are deemed derivatives since they contain net share settlement clauses. During the year, the company recorded the change in the fair value of these warrants in net income.The company is exposed to a potential loss if a client fails to pay amounts due the company under contractual terms (credit

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risk). The company has established policies and procedures for mitigating credit risk on principal transactions, including reviewing and establishing limits for credit exposure, maintaining collateral, and continually assessing the creditworthiness of counterparties. In Year 3, the company began utilizing credit default swaps to economically hedge certain credit exposures. These derivatives have terms of two years. The swaps are not designated as accounting hedges and are recorded at fair value with gains and losses reported in SG&A in the Consolidated Statement of Earnings.The tables on page xx summarize the net fair value of the company's derivative and other risk management instruments at December 31, Year 3 and Year 2 (included in the Consolidated Statement of Financial Position). RISK MANAGEMENT PROGRAM (dollars in millions) Hedge Designation AT DECEMBER 31, Year 3 Fair Cash flow Net Value Investment Derivatives-net asset/(liability): Debt risk management $ 297 $ (23 ) $ —

NonHedge/Other

$ (10 )

Long-term investments in foreign subsidiaries (net investments) Anticipated royalties and cost transactions Subsidiary cash and foreign currency asset/liability management Equity risk management

—

(27 )

—

(643 )

—

(31 )

—

Other derivatives

—

Total derivatives

297 (b)

(666 )(c)

(27 )(d)

—

6 (e)

Debt: Long-term investments in foreign subsidiaries (net investments)

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(2,470 )(a)

—

Total

$ 297

$ (666 )

$ (2,497 )

$ 6

(a) Represents fair value of foreign denominated debt issuances formally designated as a hedge of net investment. (b) Comprises assets of $1,083 million and liabilities of $786 million. (c) Comprises liabilities of $666 million. (d) Comprises liabilities of $27 million. (e) Comprises assets of $73 million and liabilities of $67 million. RISK MANAGEMENT PROGRAM (dollars in millions) Hedge Designation AT DECEMBER 31, Year 3 Fair Cash flow Net Value Investment Derivatives-net asset/(liability): Debt risk management $ 643 $ (7 ) $ — Long-term investments in foreign subsidiaries (net investments) Anticipated royalties and cost transactions Subsidiary cash and foreign currency asset/liability management Equity risk management

NonHedge/Other

—

(469 )

—

(109 )

—

Other derivatives

—

Total derivatives

643 (b)

(476 )(c)

2 (d)

(90 )(e)

—

Debt: Long-term investments in foreign subsidiaries (net investments)

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(2,474 )(a)

—

Total

$ 643

$ (476 )

$ (2,472 )

(90 )

(a) Represents fair value of foreign denominated debt issuances formally designated as a hedge of net investment. (b) Comprises assets of $754 million and liabilities of $111 million. (c) Comprises assets of $2 million and liabilities of $478 million. (d) Comprises assets of $2 million. (e) Comprises assets of $26 million and liabilities of $116 million.ACCUMULATED DERIVATIVE GAINS OR LOSSESAs illustrated above, the company makes extensive use of cash flow hedges, principally in the Anticipated royalties and cost transactions risk management program. In connection with the company's cash flow hedges, it has recorded approximately $454 million of net losses in Accumulated gains and (losses) not affecting retained earnings as of December 31, Year 3, net of tax, of which approximately $405 million is expected to be reclassified to net income within the next year, providing an offsetting economic impact against the underlying anticipated cash flows hedged.The table on page xxx summarizes activity in the Accumulated gains and (losses) not affecting retained earnings section of the Consolidated Statement of Stockholders Equity related to all derivatives classified as cash flow hedges held by the company during the periods January 1, Year 1 (the date of the company's adoption of FASB Topic ASC 815) through December 31, Year 3: (dollars in millions, net of tax) DEBIT/(CREDIT) Cumulative effect of adoption of FASB Topic ASC 815 as $ −219 of January 1, Year 1 Net gains reclassified into earnings from equity 379 during Year 1 Changes in fair value of derivatives in Year 1 −456 December 31, Year 1

−296

Net losses reclassified into earnings from equity during Year 2 Changes in fair value of derivatives in Year 2

664

December 31, Year 2

363

Net losses reclassified into earnings from equity during Year 3 Changes in fair value of derivatives in Year 3

−713

December 31, Year 3

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−5

804 $

454

At December 31, Year 3, there were no significant gains or losses on derivative transactions or portions there of that were either ineffective as hedges, excluded from the assessment of hedge effectiveness, or associated with an underlying exposure that did not occur; nor are there any anticipated in the normal course of business.

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Answer Key Test name: chapter 19 1) TRUE 2) FALSE 3) TRUE 4) FALSE 5) FALSE 6) TRUE 7) FALSE 8) TRUE 9) FALSE 10) TRUE 11) FALSE 12) FALSE 13) TRUE 14) TRUE 15) D 16) B 17) C 18) A 19) A 20) B 21) A 22) D 23) A 24) C 25) D 26) A Version 1

27) A 28) B 29) C 30) A 31) A 32) C 33) D 34) C 35) D 36) D 37) C 38) B 39) A 40) B 41) B 42) A 43) B 44) D 45) A 46) C 47) B 48) B 49) B 50) A 51) C 52) D 53) D 54) A 55) B 56) A Version 1

57) A 58) C 59) C 60) B 61) A 62) D 63) D 64) D 65) A 66) D 67) C 68) C 69) A 70) A 71) December 1, 20X1

Canadian dollar call option

5,200

Cash

December 31, 20X1

Loss on Canadian call option

5,200

3,900

Canadian dollar call option

3,900

(Option cost $5,200 − Fair Value $1,300)

Firm commitment Gain on firm commitment

5,000 5,000

(CDN 1 mill × (strike price $0.98 − spot rate $0.975)

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February 5, 20X2

Canadian dollar call option

7,600

7,600 Gain on Canadian dollar call option (Fair value $8,900 less 12/31 Fair value of $1,300)

Loss on firm commitment

15,000

Firm commitment

15,000

(Spot rate 0.99 − carry value spot 0.975) × $1 million

Canadian dollars

988,900

Cash

980,000

Canadian dollar call option

Inventory

8,900

988,900

Canadian dollars

980,000

The firm commitment balance will be closed to cost of goods sold when the acquired inventory is sold. 72) December 31, 20X1

Forward contract loss

15,000

Forward contract

Firm commitment Firm commitment gain

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15,000

15,000 15,000

February 1, 20X2

Forward contract

33,000

Forward contract gain

33,000

Loss on firm commitment

33,000

Firm commitment

33,000

Euro currency

2,712,000

Sales revenue

2,712,000

Cash

2,730,000

Euro currency

2,712,000

Forward contract

18,000

Firm commitment

18,000

Net income adjustmentexchange rate gain

18,000

73) 1. December 31, 20X1

December 31, 20X2

(25,693) 25,693

12,656 Beginning balance + payment + change in swap value = 25,693 + 7,500 − 38,349 = (5,156) 0

Balance sheet Swap asset (liability) Retained earnings

Accumulated other

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comprehensive income Statement of comprehensive income Net income

25,693

Other comprehensive income

Payment − change in swap value = 7,500 − 38,349 = (30,849) 0

2. Statement of comprehensive income Net income

Other comprehensive income

December 31, 20X1

December 31, 20X2

Interest on note payable: 500,000 × 0.08 = 40,000

Interest: 500,000 × 0.065 = 32,500 Swap payment: 7,500 + 32,500 = 40,000 Change in swap: (12,656 – (25,693)) = (38,349)

Increase in swap: 25,693

3. December 31, 20X1 Statement of comprehensive income Net income Interest from note: 500,000 × 0.08 = (40,000)

Other comprehensive income

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The loss on the derivative is offset by a gain on the available-forsale security. 0

December 31, 20X2

Interest from note: 500,000 × 0.08 = (40,000) Swap payment: 7,500 + (40,000) = (32,500) No gain recognized in net income on swap. 0

74) 1.The first part of note L states that IBM is managing risks associated with interest rates, foreign currency, equity price changes, and client credit risk. These risks and hedging instruments are discussed in subsequent paragraphs.2.In Note L, the risk management program schedule shows the fair value for derivatives designated as fair value hedges of $297 in Year 3 and $643 in Year 2. A reader cannot infer that the entire change in the fair values is due to losses because investments and sales are not disclosed. However, any gains and losses on derivatives during Year 3 would be recognized as part of net income. Gains and losses on the hedged item would also be recognized, resulting in no effect on net income. Note K shows that cumulative derivative gains have been offset by losses on the hedged bonds payable. The carrying value of bonds is increased by $806 million and $978 million in Year 3 and Year 2, respectively. The decline in the liability adjustment of $172 million during Year 3 implies that gains were recognized on the hedged bonds, but losses were recognized on the derivatives designated as fair value hedges. Other comprehensive income is not affected.3.In Note L, the risk management program schedule shows the fair value for derivatives designated as non-hedge/other of $6 in Year 3 and $(90) in Year 2. A reader cannot infer that the entire change in the fair values is due to losses because investments and sales are not disclosed. However, any gains and losses on derivatives during Year 3 would be recognized as part of net income. The first part of Note L states that gains and losses related other derivatives and equity risk management appear in Selling, general, & administrative expenses in the income statement. Gains and losses related to currency swaps related to cash management appear in Other income. IBM says that it does not use hedging for speculation. Therefore, the absence of hedge accounting for these derivatives may indicate ineffective hedge activity. There is no impact on other comprehensive income.4.Gains and losses related to cash flow hedges Version 1

are discussed in Note L below the Risk Management Program schedule. Gains and losses related to cash flow hedges appear in Accumulated gains and (losses) not affecting retained earnings. The change in this account during the year represents the effect on other comprehensive income. At the end on Year 3, IBM has Accumulated losses after tax of $454 million. At the end of Year 2, IBM had Accumulated losses after tax of $363 million. The difference of $91 million represents the amount recognized in other comprehensive income for Year 3. The schedule also indicates that losses of $713 million recognized in other comprehensive income in prior years were transferred from Accumulated gains and (losses) not affecting retained earnings to net income during Year 3. New deferred losses of $804 resulted in the net $91 million effect on other comprehensive income. This schedule informs investors as to whether other comprehensive income is changing because of new activity or recognition of past losses.5.In one sense, it was not a good idea because IBM lost money from Year 1 to Year 3. However, IBM’s strategy may have reduced its overall risk. A reader would probably have to look at more than three years and other parts of the financial statements to ascertain if IBM’s hedging was effective.

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CHAPTER 20: TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Accrual accounting involves subjective judgments that can introduce measurement errors and uncertainty into reported earnings. ⊚ ⊚

true false

2) The statement of cash flows provides relevant information to lenders, investment bankers, and investors to help them analyze a company’s cash flows from its operating, investing, and financing activities. ⊚ ⊚

true false

3) The direct method and the indirect method are two alternative presentations for cash flows from investing activities. ⊚ ⊚

true false

4) A cash collection from a customer pertaining to a sale from the prior year will result in cash flow being reported in this year’s statement of cash flows. ⊚ ⊚

true false

5) Both the direct method and indirect method will arrive at the same amount for cash flow from operating activities. ⊚ ⊚

true false

6) For a firm using the indirect method to prepare cash flows from operating activities, a decrease in a company’s pension liability account should be deducted from net income to arrive at cash flow from operating activities.

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⊚ ⊚

true false

7) An increase in cash flows from financing activities will occur when a company distributes a stock dividend. ⊚ ⊚

true false

8) The FASB addressed simultaneous financing and investing activities by requiring they be ignored with respect to the statement of cash flows. ⊚ ⊚

true false

9) For a firm using the indirect method, changes in inventories due to acquisition of another company are not included as part of the inventory adjustment to accrual-basis income. ⊚ ⊚

true false

10) A significant increase in capital expenditures reported in the investing section of the cash flow statement that coincides with a significant decrease in operating expenses as a percentage of sales may be an indication that the firm is improperly capitalizing costs that should be expensed. ⊚ ⊚

true false

11) If Firm A and Firm B are identical in every sense except that Firm A has a finance lease as defined under ASC 842 and Firm B an operating lease, the operating cash flows for Firm A will be greater than those for Firm B. ⊚ ⊚

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true false

12) Delaying the payment of accrued expenses until a later period is a technique that management can use to manipulate the current year’s cash flow from operating activities. ⊚ ⊚

true false

13) Under IFRS, firms that use bank overdrafts repayable on demand as part of their normal cash management activities must include those overdrafts as part of financing activities. ⊚ ⊚

true false

14) IFRS encourages firms to use the direct method. The result is that firms that follow IFRS rarely use the indirect method of presenting cash flows from operating activities. ⊚ ⊚

true false

15) Under IFRS rules, if a firm uses the direct method, a reconciliation of net income to cash flows from operating activities is not required. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) Accrual accounting net income can differ from operating cash flows for all of the following reasons except:

A) dividend declaration and payment dates. B) useful lives of assets. C) future pension and healthcare benefits. D) estimates of uncollectible accounts.

17)

U.S. GAAP mandates that firms provide a:

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A) working capital statement. B) cash flow statement. C) statement showing inflows and outflows of current assets and current liabilities. D) statement reporting changes in current operations.

18)

Cash flows arising from the purchase or sale of productive assets are cash flows from:

A) investing activities. B) operating activities. C) financing activities. D) research activities.

19) Cash flows arising from the acquisitions and divestitures of other companies are cash flows from:

A) investing activities. B) operating activities. C) financing activities. D) research activities.

20)

Cash flows arising from the payment of dividends are cash flows from:

A) investing activities. B) operating activities. C) financing activities. D) research activities.

21)

Cash flows arising from the issuance of company bonds are cash flows from:

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A) investing activities. B) operating activities. C) financing activities. D) research activities.

22) Which of the following is not correct with respect to the difference between accrual accounting and cash flow reporting?

Accrual accounting uses subjective judgment which can introduce measurement

errors. B) Cash flow reporting uses subjective judgment which can introduce errors and uncertainty. C) Accrual accounting uses subjective judgment which can introduce uncertainty into reported earnings. D) Accrual income can be manipulated by postponing discretionary expenses.

23) The statement of cash flows is used by outside parties in all but which of the following ways?

A) To assess equity values since the firm’s value is dependent on the discounted present value of its expected future cash flows. B) To assess if the proper amount of income taxes is reported and can be paid from current funds. C) To assess credit risk, as cash flows provide the resources for periodic interest and principal repayment. D) To assess whether to underwrite an issue of debt or equity securities, using the firm’s expected operating cash flows in the analysis.

24) Which of the following would be reported in the cash flow from operating activities section of the cash flow statement under the direct method?

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A) Increase in taxes payable. B) Interest and dividends received. C) Issuance of common stock. D) Cash payments made on short-term notes.

25)

The method of preparing the statement of cash flows used by the majority of firms is the:

A) direct method. B) indirect method. C) revenue method. D) dividend method.

26) Which of the following adjustments is commonly made to the cash flow from operating activities under the indirect method because it does not cause cash to increase or decrease?

A) Change in receivables B) Depreciation expense C) Change in fixed assets D) Change in cash

27) Some analysts prefer the indirect method for the preparation of the cash flow statement because the size and direction of the items reconciling net income to net operating cash flow provide a yardstick for measuring the:

A) current ratio. B) return on assets. C) quality of earnings. D) rate of dividends.

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28) The FASB decided that the allocation of income taxes paid to operating, financing, and investing activities would be complex and arbitrary, and relied on which one of the following justifications for its decision?

A) Materiality constraint B) Historical cost C) Cost-benefit constraint D) Revenue recognition principle

29) Under U.S. GAAP, which of the following is not included in net cash flow from operating activities under the direct method?

A) Cash collected from customers (including lessees and licensees) B) Interest and dividends received C) Cash paid for cost of goods sold D) Cash dividends paid

30) Analysts’ preferences regarding use of the direct method or indirect method may be based on all except which of the following reasons?

A) The direct method facilitates cash flow projections. B) The indirect method provides a means to evaluate the quality of earnings. C) The reconciliation between accrual earnings and operating cash flows for firms using the direct method enhances the comparability of operating cash flows to those of firms using the indirect method. D) The indirect method facilitates cash flow projections.

31)

Which of the following is not an accurate description of the direct method?

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A) It is easier to implement because it relies exclusively on data already available in the accrual accounts. B) It requires the presentation of major classes of gross receipts and disbursements. C) It requires a reconciliation of net income to net cash provided by operating activities. D) The guidance provides a list of the minimum specific categories of cash inflows and outflows to include.

32)

The following data is for the Matt Company for 20X1:

Loss on sale of equipment

4,000

Purchase of Ithaca Corp. bonds (face value $400,000)

375,000

Proceeds from sale of machinery

200,000

Dividends paid

25,000

Proceeds from sale of treasury stock

100,000

The amount reported as net cash from investing activities is:

A) B) C) D)

33)

$(175,000). $(150,000). $87,500. $575,000.

The following data is for the Matt Company for 20X1:

Loss on sale of equipment Purchase of Ithaca Corp. bonds (face value $400,000)

Version 1

4,000 375,000

Proceeds from sale of machinery

200,000

Dividends paid

25,000

Proceeds from sale of treasury stock

100,000

The amount reported as net cash from financing activities is:

A) B) C) D)

$(25,000). $30,000. $75,000. $80,000.

34) Bruce Company reported net income for 20X1 of $100,000. The company reported depreciation expense of $17,500 and amortization of $5,000. The company also reported a loss on the sale of equipment of $2,500. Based only on this information, the company would report cash flow from operating activities of:

A) B) C) D)

$117,500. $120,000. $127,500. $125,000.

35) Pipe Corporation reported cost of goods sold of $250,000 for 20X1. It also reported an increase in inventory for the year of $30,000, and an increase in accounts payable of $24,000. Pipe would report cash paid to suppliers in 20X1 under the direct method for cash flows of:

A) B) C) D)

36)

$250,000. $256,000. $280,000. $304,000.

A decrease in accounts receivable of $16,000 for the year:

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A) decreases cash flow from operating activities by $8,000. B) increases cash flow from operating activities by $8,000. C) decreases cash flow from operating activities by $16,000. D) increases cash flow from operating activities by $16,000.

37)

An increase in inventory of $7,000 for the year:

A) decreases cash flow from operating activities by $7,000. B) increases cash from operating activities by $7,000. C) decreases cash flow from operating activities by $14,000. D) increases cash flow from operating activities by $14,000.

38)

A decrease in prepaid expenses of $8,000 for the year:

39)

An increase in accounts receivable of $6,000 for the year:

A) decreases cash flow from operations by $3,000. B) increases cash flow from operations by $3,000. C) decreases cash flow from operations by $6,000. D) increases cash flow from operations by $6,000.

40)

The following data is for the Kris Company for 20X1:

Gain on sale of equipment

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8,000

Purchase of First Corp. bonds (face value $250,000)

275,000

Proceeds from sale of machinery

300,000

Dividends paid

50,000

Proceeds from sale of treasury stock

200,000

The amount reported as net cash provided by investing activities is:

A) B) C) D)

41)

$25,000. $50,000. $275,000. $300,000.

The following data is for the Kris Company for 20X1:

Gain on sale of equipment

8,000

Purchase of First Corp. bonds (face value $250,000)

275,000

Proceeds from sale of machinery

300,000

Dividends paid

50,000

Proceeds from sale of treasury stock

200,000

The amount reported as net cash provided by financing activities is:

A) B) C) D)

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$25,000. $30,000. $150,000. $200,000.

42) Which of the following statements does not correctly describe an adjustment to net income in determining cash flows from operating activities when using the indirect method?

A) A decrease in accounts receivable will be added to net income. B) An increase in inventory will be added to net income. C) An increase in accounts payable will be added to net income. D) Amortization of bond premium will be deducted from net income.

43) For a firm using the indirect method, which of the following statements does not correctly describe an adjustment to net income when determining cash flows from operating activities?

A) An increase in wages payable will be added to net income. B) A decrease in accrued interest payable will be deducted from net income. C) Amortization of bond discount will be added to net income. D) Patent amortization expense will be deducted from net income.

44)

Under the indirect method, the gain on sale of equipment should be:

A) added back to net income to arrive at cash flow from operating activities. B) subtracted from net income to arrive at cash flow from operating activities. C) a source of funds from financing activities. D) a source of funds from investing activities.

45) The cash flow statement of the United Company is in process for 20X2. The United Company is reporting the following balances:

Equipment Loss on sale of equipment

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12/31/X1

12/31/X2

$ 100,000

$ 170,000

10,000

Accumulated depreciation—equipment

75,000

95,000

During 20X2, United sold equipment costing $30,000 for $12,000 and made several purchases of new equipment for cash.Depreciation expense for 20X2 is:

A) B) C) D)

$8,000. $20,000. $18,000. $28,000.

46) The cash flow statement of the United Company is in process for 20X2. The United Company is reporting the following balances:

Equipment Loss on sale of equipment Accumulated depreciation—equipment

12/31/X1

12/31/X2

$ 100,000

$ 170,000

10,000

75,000

95,000

During 20X2, United sold equipment costing $30,000 for $12,000 and made several purchases of new equipment for cash.Equipment purchases in 20X2 were:

A) B) C) D)

$30,000. $70,000. $100,000. $120,000.

47) The cash flow statement of the United Company is in process for 20X2. The United Company is reporting the following balances: 12/31/X1

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12/31/X2

Equipment Loss on sale of equipment Accumulated depreciation—equipment

$ 100,000

$ 170,000

10,000

75,000

95,000

During 20X2, United sold equipment costing $30,000 for $12,000 and made several purchases of new equipment for cash. If these were the only investing activities, the cash flow from investing activities is a net cash:

A) outflow of $12,000. B) inflow of $12,000. C) outflow of $88,000. D) inflow of $88,000.

48)

The following information has been provided to you by your controller:

Net income

$ 100,000

Decrease in accounts payable

38,000

Decrease in inventory

7,500

Increase in accounts receivable

8,000

Decrease in bonds payable

75,000

Amortization of bond discount

9,400

Depreciation expense

20,000

Increase in income taxes payable

6,000

What is the net cash flow from operating activities?

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A) B) C) D)

49)

$96,900 $97,900 $112,900 $94,100

The following information has been provided to you by Watts Corporation:

Net income

$ 175,300

Increase in accounts payable

18,500

Increase in inventory

17,500

Increase in accounts receivable

9,700

Increase in bonds payable

75,000

Amortization of bond premium

5,400

Depreciation expense

21,300

Decrease in income taxes payable

7,300

What is Watts Corporation’s net cash flow from operating activities?

A) B) C) D)

50)

$186,000 $175,200 $138,200 $210,200

Under the indirect method, a loss on the sale of equipment should be:

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A) added back to net income to arrive at cash flow from operating activities. B) subtracted from net income to arrive at cash flow from operating activities. C) a source of funds in the financing activities. D) a source of funds in the investing activities.

51) Changes in the balance sheet accounts at June 30, 20X1 and 20X2 for the Poker Company are presented below: Increase (Decrease) Assets Cash

480,000

Accounts receivable

200,000

Inventory

300,000

Long-term investments

200,000

Equipment

(200,000 )

Accumulated depreciation

(60,000 )

Liabilities and Stockholders’ Equity Accounts payable Dividends payable

(40,000 ) 400,000

Notes payable—Current

(200,000 )

Notes payable—Long-term

400,000

Common stock, $1.00 par

300,000

Additional paid-in capital

100,000

Retained earnings

80,000

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Additional Information for 20X2: Net income was $480,000 and dividends of $400,000 were declared. Common stock was issued for cash. A new long-term investment was acquired for $360,000. A long-term investment was sold for $160,000. Equipment that cost $600,000 was sold for $200,000. The book value of those assets was $150,000.The gain on the sale of equipment for 20X2 is:

A) B) C) D)

$50,000. $70,000. $100,000. $150,000.

52) Changes in the balance sheet accounts at June 30, 20X1 and 20X2 for the Poker Company are presented below: Increase (Decrease) Assets Cash

480,000

Accounts receivable

200,000

Inventory

300,000

Long-term investments

200,000

Equipment

(200,000 )

Accumulated depreciation

(60,000 )

Liabilities and Stockholders’ Equity Accounts payable

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(40,000 )

Dividends payable

400,000

Notes payable—Current

(200,000 )

Notes payable—Long-term

400,000

Common stock, $1.00 par

300,000

Additional paid-in capital

100,000

Retained earnings

80,000

A) B) C) D)

$300,000. $390,000. $400,000. $450,000.

53) Changes in the balance sheet accounts at June 30, 20X1 and 20X2 for the Poker Company are presented below: Increase (Decrease) Assets Cash Accounts receivable

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480,000 200,000

Inventory

300,000

Long-term investments

200,000

Equipment

(200,000 )

Accumulated depreciation

(60,000 )

Liabilities and Stockholders’ Equity Accounts payable Dividends payable

(40,000 ) 400,000

Notes payable—Current

(200,000 )

Notes payable—Long-term

400,000

Common stock, $1.00 par

300,000

Additional paid-in capital

100,000

Retained earnings

80,000

A) B) C) D)

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$200,000 outflow. $280,000 inflow. $280,000 outflow. $400,000 inflow.

54) Changes in the balance sheet accounts at June 30, 20X1 and 20X2 for the Poker Company are presented below: Increase (Decrease) Assets Cash

480,000

Accounts receivable

200,000

Inventory

300,000

Long-term investments

200,000

Equipment

(200,000 )

Accumulated depreciation

(60,000 )

Liabilities and Stockholders’ Equity Accounts payable Dividends payable

(40,000 ) 400,000

Notes payable—Current

(200,000 )

Notes payable—Long-term

400,000

Common stock, $1.00 par

300,000

Additional paid-in capital

100,000

Retained earnings

80,000

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A) B) C) D)

$250,000. $270,000. $300,000. $400,000.

55) Changes in the balance sheet accounts at June 30, 20X1 and 20X2 for the Poker Company are presented below: Increase (Decrease) Assets Cash

480,000

Accounts receivable

200,000

Inventory

300,000

Long-term investments

200,000

Equipment

(200,000 )

Accumulated depreciation

(60,000 )

Liabilities and Stockholders’ Equity Accounts payable Dividends payable

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(40,000 ) 400,000

Notes payable—Current

(200,000 )

Notes payable—Long-term

400,000

Common stock, $1.00 par

300,000

Additional paid-in capital

100,000

Retained earnings

80,000

A) B) C) D)

$200,000 outflow. $400,000 inflow. $400,000 outflow. $600,000 inflow.

56) Changes in the balance sheet accounts at June 30, 20X1 and 20X2 for the Poker Company are presented below: Increase (Decrease) Assets Cash

480,000

Accounts receivable

200,000

Inventory

300,000

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Long-term investments

200,000

Equipment

(200,000 )

Accumulated depreciation

(60,000 )

Liabilities and Stockholders’ Equity Accounts payable Dividends payable

(40,000 ) 400,000

Notes payable—Current

(200,000 )

Notes payable—Long-term

400,000

Common stock, $1.00 par

300,000

Additional paid-in capital

100,000

Retained earnings

80,000

A) B) C) D)

$0. $270,000. $300,000. $400,000.

57) Changes in the balance sheet accounts at June 30, 20X1 and 20X2 for the Poker Company are presented below:

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Increase (Decrease) Assets Cash

480,000

Accounts receivable

200,000

Inventory

300,000

Long-term investments

200,000

Equipment

(200,000 )

Accumulated depreciation

(60,000 )

Liabilities and Stockholders’ Equity Accounts payable Dividends payable

(40,000 ) 400,000

Notes payable—Current

(200,000 )

Notes payable—Long-term

400,000

Common stock, $1.00 par

300,000

Additional paid-in capital

100,000

Retained earnings

80,000

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A) B) C) D)

58)

$200,000 outflow. $400,000 inflow. $600,000 inflow. $700,000 inflow.

The Pulaski Corporation reported the following for the year ended December 31, 20X1: 1/1/X1

12/31/X1

Premium on Bonds Payable

$ 28,500

$ 25,750

Interest Payable

7,350

9,500

Interest Expense $62,250

How much cash did Pulaski pay for interest during 20X1?

A) B) C) D)

$57,350 $62,850 $60,100 $67,150

59) The Keweenaw Sunshine Development Corporation reported the following for the year ended December 31, 20X1: 1/1/X1

12/31/X1

Discount on Bonds Payable

$ 17,500

$ 15,750

Interest Payable

$ 19,500

$ 17,350

Interest Expense $47,750

How much cash did Keweenaw pay for interest during 20X1?

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A) B) C) D)

$51,650 $43,850 $48,150 $46,350

60) Which of the following transactions would not be reported within the financing activities section of the cash flow statement?

A) The payment of a cash dividend. B) An issue of preferred stock in exchange for cash. C) An issue of common stock in order to retire a bond liability. D) The payment of cash to acquire shares of common stock to be held as treasury stock.

61) Which of the following transactions would be reported within the financing activities section of the cash flow statement?

A) An issue of preferred stock in exchange for a parcel of land. B) The accrual of a cash dividend. C) The cash payment of interest associated with bonds payable. D) The sale of treasury stock for cash.

62) Which of the following transactions would be reported within the investing activities section of the cash flow statement?

A) The cash sale of a building at a loss. B) The sale of a building in exchange for a parcel of land. C) The exchange of a stock investment in order to retire a long-term debt. D) The acquisition of treasury stock in exchange for cash.

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63) A building costing $550,000 with accumulated depreciation of $225,000 was sold for $275,000 cash. Which of the following statements is correct with respect to preparing the cash flow statement if the indirect method is being used?

A) $50,000 will be added to net income to determine cash flow from operating activities and $325,000 will be reported as a cash outflow in the investing activities section. B) $50,000 will be deducted from net income to determine cash flow from operating activities and $275,000 will be reported as a cash inflow in the investing activities section. C) $50,000 will be added to net income to determine cash flow from operating activities and $275,000 will be reported as a cash inflow in the investing activities section. D) $275,000 will be added to net income to determine cash flow from operating activities and $325,000 will be reported as a cash outflow in the investing activities section.

64) A company issued 1,000 shares of $10 par value common stock due to a previously declared stock dividend; the market value at both the date of declaration and distribution was $12 per share. Which of the following correctly describes the reporting of this stock issue within the financing activities section of the cash flow statement?

A) A cash outflow of $12,000. B) A cash outflow of $10,000. C) A cash outflow of $2,000. D) There is no cash flow.

65) During 20X1, Lang Corporation reported cost of goods sold of $775,000. During the year inventory decreased $25,000 and accounts payable increased $12,500. How much cash was paid to suppliers during 20X1?

A) B) C) D)

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$737,500 $787,500 $762,500 $812,500

66) During 20X1, Krug Company reported net sales of $1,025,000. During the year net accounts receivable increased $39,750 even though Krug wrote-off $7,150 of receivables as uncollectible; Krug uses the allowance method to account for bad debts. Krug’s bad debt expense during 20X1 was $20,500. How much cash was collected from customers during 20X1?

A) B) C) D)

$964,750 $957,600 $971,900 $1,037,100

67) The Superior Real Estate Corporation reported rental income totaling $175,000 for the year ending December 31, 20X1. The following information was obtained from Superior Corporation’s balance sheets: 1/1/X1

12/31/X1

Unearned Rent

$ 7,500

$ 6,750

Rent Receivable

$ 9,250

$ 6,750

How much cash did Superior collect from its tenants during 20X1?

A) B) C) D)

$175,750 $178,250 $176,750 $171,750

68) Madrid Incorporated’s 20X1 income statement reported income tax expense of $635,375. During 20X1, Madrid’s income taxes payable account increased $19,735 while the deferred tax asset account increased $39,365. How much cash was paid for taxes during 20X1?

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A) B) C) D)

$615,745 $694,475 $655,005 $576,275

69) Treasury stock costing $89,050 was sold for $94,375 cash. Which of the following statements accurately describes the reporting of this transaction within the cash flow statement assuming that the indirect method is used to determine net cash flows from operating activities?

A) A gain of $5,325 is deducted from net income and a $94,375 cash inflow is reported within the investing activities section of the cash flow statement. B) A gain of $5,325 is deducted from net income and a $94,375 cash inflow is reported within the financing activities section of the cash flow statement. C) There is no adjustment necessary to net income but a $94,375 cash inflow is reported within the financing activities section of the cash flow statement. D) There is no adjustment necessary to net income but a $94,375 cash inflow is reported within the investing activities section of the cash flow statement.

70)

Investing transactions that do not directly and immediately affect cash are:

A) included in the cash flow statement. B) included on a supplemental schedule to the cash flow statement. C) reported separately in the cash flow statement. D) reported separately in the retained earnings statement.

71) Which of the following statements does not accurately describe issues pertaining to preparation of the cash flow statement?

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A) The retirement of a fixed asset that is not fully depreciated resulting in a loss equal to the retired asset’s book value creates a discrepancy with respect to changes in the balance sheet relative to what is reported in the investing activities section of the cash flow statement. B) Simultaneous non-cash financing and investing activities such as the purchase of a building by incurring a mortgage do not need to be reported within the investing and financing activities sections of the cash flow statement. C) Changes in working capital accounts and fixed asset accounts will always have to correspond with the changes in these accounts within the statement of cash flows. D) The increase in the fixed asset accounts due only to a translation adjustment resulting from the fall of the dollar will not create an investing cash flow within the investing activities section of the cash flow statement.

72) be:

The FASB addressed simultaneous financing and investing activities by requiring they

A) ignored. B) reported separately on a supplemental schedule to the cash flow statement. C) reported on the retained earnings statement. D) reported separately on the income statement.

73) Which of the following would be included in the statement of cash flows in the financing activities section?

A) Issuing common stock in exchange for a building. B) Issuing a new class of common stock. C) Issuing common stock in exchange for land. D) Issuing common stock in exchange for equipment will create a cash outflow in the investing activities section of the cash flow statement and a cash inflow in the financing activities section of the cash flow statement.

74) Which of the following is not a reason why balance sheet changes do not map directly into the corresponding account changes in the statement of cash flows?

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A) Acquisitions of other companies. B) Simultaneous noncash financing and investing activities. C) The effect of "playing the float" on accounts payable balances. D) Asset write-offs and impairments.

75) Which of the following properly reflects the impact of foreign currency translations on inventory valuations?

A) The change in inventory value presented in the balance sheet and statement of cash flows will map directly. B) Differences in inventory valuation affect only firms using the current rate method of translation. C) Differences in inventory valuation affect only firms using the temporal method. D) Differences in inventory valuation occur under both the current and temporal methods of translation.

76) Changes in balance sheet accounts from one year to the next may not map directly into the corresponding account changes in the statement of cash flows. Which of the following items is not a cause of such mapping differences?

A) Impairment charges B) Retirement of fixed assets C) Reclassification of assets held for sale D) Translation of all company subsidiaries using the temporal method

77) The analyst would most likely understand that the change in the balance sheet account for property, plant, and equipment does not reconcile with the account change included in the statement of cash flows because of a write-off due to impairments which the analyst discovered when examining the:

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A) notes to the financial statements. B) balance sheet. C) capital stock account. D) investments account.

78) When the year-to-year changes in comparative balance sheet accounts do not coincide with the changes implied from amounts reported on the statement of cash flows, the analyst may find useful information for reconciliation in notes to the financial statements and the:

A) operating activities section of the cash flow statement. B) capital stock account. C) balance sheet. D) investments account.

79) Which of the following is not an indicator that operating activities cash flows might be increased through distortion or manipulation?

A) A significantly large increase in accounts payable. B) A significantly large decrease in accounts receivable. C) A significantly large increase in accrued liabilities. D) Increasing the credit period for a customer with an excellent credit history.

80) Which of the following statements does not correctly describe an issue pertaining to the comparability of the cash flow statement across firms?

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A) The proportion of leases treated as operating leases versus finance leases under ASC 842 varies substantially across firms. B) GAAP requires computer software development companies to expense all software development costs until the software reaches technological feasibility. However, GAAP does not have any criteria for determining technological feasibility which therefore allows companies flexibility with respect to this determination. C) Companies selling their accounts receivable at year-end are distorting their cash flows in the current year relative to their competitors that do not sell their receivables at yearend. D) Companies that aggressively manage their working capital can’t easily manage the short-run appearance of their operating cash flows relative to those companies that do not aggressively manage their working capital.

81) Which of the following does not accurately describe the presentation of software development costs on the statement of cash flows?

A) The presentation of software development costs is based upon the determination of technological feasibility. B) GAAP contains bright-line criteria for determining technological feasibility which provides an opportunity for management to distort or manipulate results. C) Reclassifying software development costs from the investing to the operating section of the cash flow statement improves interfirm comparability. D) Reclassifying software development costs undoes the misleading effects for any firm that attempts to improve operating cash flows by low•ering the technological feasibility threshold in the current period relative to prior periods.

82)

Cash flow from operating activities:

A) is very comparable across firms within the same industry. B) is very comparable across all firms reporting under U.S. GAAP. C) is very comparable across all firms within the same industry regardless of whether they report under IFRS or U.S. GAAP. D) may not be comparable across firms.

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83) Which of the following does not represent the impact of the use of stock options when comparing operating cash flows?

A) Firms not using stock options will generally have lower compensation expense and higher net income. B) Stock based compensation is a simultaneous operating and financing transaction and must appear in both sections of the statement of cash flows. C) Stock based compensationexpense is not presented in the statement of cash flows. D) Stock based compensation impacts income taxes and that impact is reflected in the statement of cash flows.

84) Which of the following does not reflect the accounting and impact on the statement of cash flows for the sale or transfer of accounts receivable?

Receivable transfers that are secured borrowings have no effect on operating cash

flows. B) Receivable sales are not reported in the statement of cash flows as they do not represent collections from the end customers and therefore are not part of operating cash flows. C) Receivable sales create an operating cash inflow on the cash flow statement. D) Receivable sales transfer future operating cash flows into the current period.

85) Which of the following statements concerning IFRS and the statement of cash flows is correct?

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A) When large foreign companies that follow IFRS prepare the statement of cash flows they overwhelmingly use the direct method to prepare the cash flow from operating activities section. B) IFRS permits companies to classify interest paid, interest received, and dividends received as part of either investing or operating activities. C) IFRS rules permits companies that use bank overdrafts repayable on demand as part of their normal cash management activities to include those amounts as a component of cash and cash equivalents. D) IFRS rules require companies that use the direct method to also provide a reconciliation of net income to cash flows from operating activities (essentially the indirect method).

86) Autumn Company uses IFRS to prepare its external financial reporting. During 20X1, Autumn Company had the following transactions related to cash flows:

Dividends received

16,000

Interest paid

20,000

Interest received

42,000

With regard to the above information, which of the following is an acceptable classification as part of preparation of the statement of cash flows?

A. B. C. D.

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Cash from operating activities $0 $58,000 $0 ($20,000)

Cash from/(used by) investing activities $42,000 ($20,000) $38,000 $58,000

A) Option A B) Option B C) Option C D) Option D

87) Autumn Company uses IFRS to prepare its external financial reporting. During 20X1, Autumn Company had the following transactions related to cash flows:

Dividends paid

16,000

Interest paid

20,000

Interest received

42,000

With regard to the above information, which of the following is acceptable as part of preparation of the statement of cash flows? Cash from operating activities $0 $26,000 ($20,000) $0

A. B. C. D.

Cash from/(used by) financing activities ($42,000) ($20,000) $26,000 ($46,000)

A) Option A B) Option B C) Option C D) Option D

88)

For nonfinancial firms reporting using IFRS rules, which of the following is correct?

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A) In most cases, cash flows from income taxes must be reported separately as an operating activity. B) Interest and dividends paid may be reported as either operating or investing activities. C) Bank overdrafts repayable on demand used as part of normal cash management activities must include those overdrafts as part of financing activities. D) Firms using the direct method must provide a schedule reconciling net income to cash flows from operating activities.

89) Firms reporting consistent with IFRS may present which of the following as either operating or investing cash flows?

A) Dividends paid B) Interest paid C) Interest and Dividends received D) Income taxes

90)

Firms reporting using IFRS may present which of the following as financing cash flows?

A) Interest and Dividends paid B) Dividends received C) Interest received D) Income taxes

91) Which of the following properly represents the preparation of the statement of cash flows prepared using IFRS rules?

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A) Firms using the direct method are not required to provide a reconciliation of net income to cash flows from operations. B) The presentation of the statement of cash flows differs to those following U.S. GAAP as a result of prescribed classification differences under IFRS. C) The presentation of the statement of cash flows is the same for all companies preparing statements under IFRS. D) The flexibility provided under IFRS guidance for the preparation of the statement of cash flows increases the comparability of results between companies.

92) Yanita Company, an IFRS reporting firm, has three bank accounts. The respective account balances are as follows:Account 1: $50,000; Account 2: $70,000; Account 3: $(10,000).Consistent with IFRS, cash and cash equivalents are equal to:

A) B) C) D)

$55,000. $110,000. $120,000. $130,000.

93) Which of the following adjustments is commonly made to the cash flow from operating activities section under the indirect method because it does not cause cash to increase or decrease?

A) Change in receivables B) Amortization expense C) Change in fixed assets D) Change in cash

94) Which of the following is an acceptable accounting approach for distributions under the equity method?

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A) cumulative investment approach B) net accumulated benefit approach C) nature of distribution approach D) net unrealized appreciation approach

95) Which of the following is an acceptable accounting approach for distributions under the equity method?

A) cumulative earnings approach B) net accumulated benefits approach C) nature of income approach D) net unrealized appreciation approach

96) Smith Company elected to use the cumulative earnings approach for distributions from its equity-method investment purchased at the beginning of 20X1. During 20X1, Smith earned $244,000 on the investment and received $110,000 in dividends. In its statement of cash flows— direct method, Smith should report the dividends as a(n):

A) investing activity. B) financing activity. C) operating activity. D) noncash investing and financing activity.

97) Jones Company elected to use the cumulative earnings approach for distributions from its equity-method investment purchased at the beginning of 20X1. During 20X1, Jones earned $200,000 on the investment and received $210,000 in dividends.In the investing activities section of the statement of cash flows prepared under the direct method, Jones reports dividends of:

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A) B) C) D)

$210,000. $200,000. $10,000. $0.

98) Jones Company elected to use the cumulative earnings approach for distributions from its equity-method investment purchased at the beginning of 20X1. During 20X1, Jones earned $200,000 on the investment and received $210,000 in dividends.In the operating activities section of the statement of cash flows prepared under the direct method, Jones reports dividends of:

A) B) C) D)

$210,000. $200,000. $10,000. $0.

99) Strafford Inc. elected to use the nature of distribution approach for distributions from its equity-method investment purchased at the beginning of 20X1. In the statement of cash flows, Strafford should classify dividends received from its investment:

A) as operating activity. B) as investing activity. C) based on the nature of the earnings generated by the investee company. D) as part operating activity and part investing activity.

100) Debt extinguishments, debt prepayments and settlements should be classified as cash flows.

A) operating. B) financing. C) investing. D) noncash investing or financing.

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 101) The Black Corporation has provided the following information:

Net income

$ 560,000

Increase in prepaid expenses

14,000

Amortization of discount on bonds payable

10,000

Decrease in accounts payable

20,000

Increase in inventory

21,000

Dividends declared

39,000

Dividends paid

36,000

Increase in accounts receivable

30,000

Increase in wages payable

16,000

Increase in deferred tax liability

41,000

Required: Determine the cash flow from operating activities using the indirect method of cash flow statement presentation.

102)

The Bears Corporation has provided you the following information:

Increase in accounts receivable balance

50,000

Net sales

500,000

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Gross profit as a percentage of net sales

40 %

Increase in the inventory account

45,000

Accounts payable balance decreased

17,000

Accounts receivable writeoffs

7,500

Bad debt expense

10,000

Required:Determine the cash collected from customers.Determine the cash paid to suppliers.

103) The Gopher Company’s transactions during 20X1 included the following:Paid cash dividends of $1,200,000 Paid cash toward reducing a long-term note payable $900,000 Issued common stock in exchange for a building $750,000 Paid cash for bond interest $50,000 Bond discount amortization was recorded for $2,250 Issued preferred stock for cash $250,000 Sold a long-term stock investment with a book value of $79,000 for $123,000 cash Sold equipment with a book value of $90,000 for cash. The sale resulted in a $15,000 loss. Issued bonds with a maturity value of $2,000,000 in exchange for $1,950,000 cashRequired:Determine the net cash flow from investing activities for 20X1.Determine the net cash flow from financing activities for 20X1.

104) The Hurricane Company provided the following information for the year ended December 31, 20X1: Version 1

January 1, 20X1

December 31, 20X1

Interest payable

15,500

$ 12,250

Discount on bonds payable

79,900

$ 77,200

Income taxes payable

97,300

$ 99,900

Deferred income taxes payable

17,400

$ 11,150

Income tax expense

$ 157,250

Interest expense

57,770

Required: Determine the cash paid for interest during 20X1.Determine the cash paid for income taxes during 20X1.

105) The Capitals Company has provided you the following information pertaining to the year ending December 31, 20X1: January 1, 20X1

December 31, 20X1

Equipment

$ 575,000

$ 729,000

Accumulated depreciation

$ 165,000

$ 120,500

Equipment costing $25,000 was acquired in exchange for common stock.Equipment with an original cost of $57,500 and a book value of $5,000 was scrapped.Equipment was purchased in exchange for cash.Equipment with a book value of $39,000 was sold resulting in a $14,000 gain. The accumulated depreciation at the time of the sale was $67,000.Required: Determine the cash paid for equipment purchases during 20X1.Determine the depreciation expense for 20X1.

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106) The following information was obtained from the Warrior Corporation’s financial statements for the year ending December 31, 20X1:Bonds with a maturity value of $600,000 were issued for cash.The premium on bonds payable account increased $12,500 during the year.Bond interest expense was $30,500. There was $500 of amortization of premium on newly issued bonds payable.Retained earnings increased $119,300 during the year.A 5% common stock dividend resulted in 5,000 shares of $5 par value common stock being issued at a time when the market price per share was $17.Common stock was sold in exchange for cash.The common stock account increased $70,000 during the year.The additional paid-in capital account increased $210,000 during the year.Net income for the year was $217,400.Required:Determine the cash flow from financing activities for the year ending December 31, 20X1.

107) The following information and financial statements excerpts pertain to Liquidity, Inc.All short term investments (securities available for sale) were purchased on 12/31/X1 and sold during 20X2.The company entered a lease agreement on 12/31/X2.Fixed assets with a net book value of $15 were sold during the year.The company repaid the current portion of long-term debt during the year.Dividend was declared and partially paid. 20X1

20X2

Cash

Short term investments

Accounts receivable

Inventory

Assets

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Prepaid general expenses

Fixed assets under capital lease, net

165

228

422

498

Accounts payable

Wages payable

Tax payable

Dividend payable

Current portion of long term debt

Obligations under capital leases

Long term debt

183

180

Common stock

150

163

Retained earnings

422

498

20X1

20X2

Fixed assets, net

Liabilities and stockowners’ equity

Revenues, net

426

Cost of goods sold

310

Gross margin

116

General expenses

Wages expenses

Depreciation expense

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Interest expense

Loss on sale of fixed assets

Gain on sale of securities available for sale

(12 )

Tax expenses

106

Net income

Required:Prepare the statement of cash flows for the year 20X2 using the direct method.Reconcile net income and net cash flows from operating activities for the year 20X2.

108) The following Income Statement and Operating Cash Flow information pertain to Receivership Inc.’s operations for the year ended December 31, 20X1. Income statement for the year ended December 31, 20X1 Revenues 1,328 Cost of goods sold

587

Rent expenses

152

Wages expenses

136

Insurance expenses

Other SG&A (includes depreciation expenses)

198

Interest expenses

Gain on sale of asset

(5 ) 1,151

Income before tax

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177

Tax

Net income

115

Cash flow provided by operating activities (indirect method), for the year ended December 31, 20X1 Net income

115

Depreciation

Gain on sale of asset

(5 ) 142

Increases/decreases in: Accounts receivable

Inventories

(35 )

Prepaid rent

Accounts payable

Wages payable

(20 )

Tax payable

Interest payable

(2 )

Advances from customers

(3 )

Other accrued SG&A

5 17

Net cash provided by operating activities

159

Required:Prepare the net cash flow from operating activities section of the cash flow statement using the direct method.

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109) Cannon Company has the following information for the year ending December 31, 20X1: Long-term debt of $18,000 was issued for cash.Cash paid for labor during 20X1 amounted to $489,500.During the year, Cannon paid a pension liability in the amount of $14,000.Dividends of $34,000 were received.Cannon’s cash balance at the beginning of 20X1 was $975,000; at the end of 20X1 the cash balance was $839,500.The company made an investment of $310,000 in an affiliate company.A lease payment of $110,000 was made on November 1, 20X1. There is no asset recorded in connection with the lease.During the year, Cannon collected $780,000 cash from customers.Cash paid for income taxes amounted to $56,000 for all of 20X1.During 20X1, Cannon discontinued its consumer electronics division. The business was sold resulting in a $12,000 net cash inflow.Required:Prepare Cannon Company’s statement of cash flows for the year ending December 31, 20X1.

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Answer Key Test name: chapter 20 1) TRUE 2) TRUE 3) FALSE 4) TRUE 5) TRUE 6) TRUE 7) FALSE 8) FALSE 9) TRUE 10) TRUE 11) TRUE 12) TRUE 13) FALSE 14) FALSE 15) TRUE 16) A 17) B 18) A 19) A 20) C 21) C 22) B 23) B 24) B 25) B 26) B Version 1

27) C 28) C 29) D 30) D 31) A 32) A 33) C 34) D 35) B 36) D 37) A 38) B 39) C 40) A 41) C 42) B 43) D 44) B 45) D 46) C 47) C 48) A 49) B 50) A 51) A 52) B 53) B 54) D 55) C 56) A Version 1

57) C 58) B 59) C 60) C 61) D 62) A 63) C 64) D 65) A 66) A 67) C 68) C 69) C 70) B 71) C 72) B 73) B 74) C 75) B 76) D 77) A 78) A 79) D 80) D 81) B 82) D 83) A 84) B 85) C 86) D Version 1

87) B 88) A 89) C 90) A 91) A 92) B 93) B 94) C 95) A 96) C 97) C 98) B 99) C 100) C 101) $542,000 = $560,000 − $14,000 + $10,000 − $20,000 − $21,000 − $30,000 + $16,000 + $41,000. 102) 1. $442,500 = $500,000 − $50,000 − $7,500 2. $362,000 = $300,000 (cost of goods sold: $500,000 × 0.60) + $45,000 + $17,000 103) 1. $198,000 = $123,000 + $75,000 ($90,000 − $15,000) 2. $100,000 = −$1,200,000 − $900,000 + $1,950,000 + $250,000

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104) 1. $58,320 = $57,770 + $3,250 (decrease in interest payable) − $2,700 (amortization of discount on bonds payable) 2. $160,900 = $157,250 − $2,600 (increase in income taxes payable) + $6,250 (decrease in deferred income taxes payable) 105) $154,000 (the increase in the equipment account) = $25,000 − $57,500 − $106,000 (39,000 + 67,000) + X (cash equipment purchases); X = $292,500−$44,500 (the decrease in accumulated depreciation) = −$52,500 − $67,000 + X (20X1 depreciation expense); X = $75,000 106) $794,900 = $613,000 (sale of bonds − cash + premium + amortization of premium) + $195,000 (sale of common stock) − $13,100 (cash dividends) 107) 1. Operating activities Collections from customers Payments to suppliers

426 – 40 =

386

–310 – 23 + 10 =

General expenses

–30 – 4 =

– 323 –34

Wages

–42 – 6 =

–48

Interest Tax

–11 –8 + 2 =

Net cash used by operating activities

–6 36

Investing activities Sale of marketable securities

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95 + 12 =

107

Purchases of fixed assets Sale of fixed assets

–228 + 165 – 15 – = 24 15 – 3 =

Net cash provided by investing activities

– 102 12 17

Financing activities Proceeds from long term debt

(180 + 12) – 183 =

Repayment of long term debt Proceeds from issuance of common stock Dividend paid

9 10

163 – 150 =

4 – (26 + 10 – 30) =

-2

Net cash provided by financing activities

Net decrease in cash

Cash at the beginning of the period

Cash at the end of the period

Supplemental information: Fixed assets acquired under capital lease

Dividend declared and not paid

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2. Reconciliation of net income to net cash flow from operating activities:

Net income

Depreciation

Gain on sale of short term investment

Loss on sale of fixed assets

3 25

Increase in A/R

Increase in inventory

Increase in prepaid expenses

Increase in A/P

Decrease in wages payable

Increase in tax payable

Net cash used by operating activities

108) 1. Collections from customers

1,328 + 26 – 3 = 1,351

Payments to suppliers

–587 – 35 + 28 =

(594 )

Rent payments

–152 + 13 =

(139 )

Wages payments

–136 – 20 =

(156 )

Insurance payments

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(53 )

Interest payments Other SG&A payments Tax payments

–30 – 2 =

(32 )

–198 + 32 + 5 =

(161 )

–62 + 5 =

(57 )

Net cash provided by operating activities

159

109) Cannon Company Statement of Cash Flows For the Year Ended December 31, 20X1 Cash flows from operating activities Cash collected from customers

780,000

Cash paid for labor

(489,500 )

Lease payment

(110,000 )

Pension liability payment

(14,000 )

Dividends received

34,000

Cash paid for current tax expense

(56,000 )

Net cash from operating activities

144,500

Cash flows from investing activities Investment in affiliate

$ (310,000 )

Cash inflow from discontinued operations Net cash from investing activities

12,000 $ (298,000 )

Cash flows from financing activities Issuance of long-term debt

Version 1

18,000

Net cash from financing activities

Change in cash

$ (135,500 )

Beginning cash

975,000

Ending cash

Version 1

18,000

839,500