Intermediate Accounting Principles and Analysis, 2nd Edition Test Bank by Ace Test Banks

Intermediate Accounting Principles and Analysis, 2nd Edition By Warfield, Weygandt, Kieso

CHAPTER 1 FINANCIAL ACCOUNTING AND ACCOUNTING STANDARDS TRUE-FALSE—Conceptual Answer F T T F T T T F F F F F T F T T F F T T T F F F F T T T T F T F T T F

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35.

Description Definition of financial accounting. Purpose of financial statements. Characteristics of accounting. Environment of accounting. Role of accounting. Definition of financial accounting. Capital allocation process. Financial reports. Fair value information. Objectives of financial reporting. Accrual accounting. Responsibility of accounting. Objectives of financial reporting. Generally accepted accounting principles. Generally accepted accounting principles. Users of financial statements. Committee on Accounting Procedure. Passage of FASB standards. Financial Accounting Concepts. Role of the SEC. American Institute of CPAs. Development of accounting standards. Role of the SEC. Major purpose of the APB. Qualifications of FASB members. FASB Interpretations. FASB Technical Bulletins. Role of the AcSEC. Definition of GAAP. FASB Technical Bulletins. Code of Professional Conduct. Accounting standards. International standards. Expectations gap. Ethical issues.

1-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75.

Financial accounting. Users of financial reports. Identify the major financial statements. Financial reporting entity. Managerial accounting. Efficient use of resources. Capital allocation process. Financial statement information. Objectives of financial reporting. Accrual accounting. Objectives of financial reporting. Meaning of “generally accepted.” Common set of standards and procedures. Role of the SEC. Powers of the SEC. SEC enforcement. Creation of FASB. Appointment of FASB members. Purpose of the Financial Accounting Foundation. Characteristics of FASB. FASB and "due process" system. Publications of FASB. Purpose of FASB Technical Bulletins. Purpose of Emerging Issues Task Force. Purpose of GASB. Domain of GASB. Standard setting organizations. Identification of standard setting organizations. Statements of financial accounting concepts. FASB members. FASB statement process. House of GAAP. Hierarchy of GAAP. Nature of GAAP. Body which promulgates GAAP. Authoritative category of GAAP. Publications which are not GAAP. Publications which are not GAAP. Political environment of standard setting. International Accounting Standards Board.

EXERCISES Item

Description

E1-76 E1-77 E1-78 E1-79 E1-80

Objectives of financial reporting. Development of accounting principles. Publications and organizations. FASB. Evolution of a statement of financial accounting standards.

Financial Accounting and Accounting Standards

1-3

CHAPTER LEARNING OBJECTIVES 1. Identify the major financial statements and other means of financial reporting. 2. Explain how accounting assists in the efficient use of scarce resources. 3. Describe some of the challenges facing accounting. 4. Identify the objectives of financial reporting. 5. Explain the need for accounting standards. 6. Identify the major policy-setting bodies and their role in the standard-setting process. 7. Explain the meaning of generally accepted accounting principles. 8. Describe the impact of user groups on the standard-setting process. 9. Understand issues related to ethics and financial accounting.

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

Type

1. 2.

TF TF

3. 36.

TF MC

37. 38.

43.

10. 11.

TF TF

12. 13.

TF TF

44. 45.

14.

16.

17. 18. 19. 20. 21.

TF TF TF TF TF

22. 23. 24. 25. 26.

TF TF TF TF TF

27. 28. 49. 50. 51.

29. 30.

TF TF

31. 67.

TF MC

68. 69.

32.

33.

34.

35.

Note:

TF = True-False

Item

Type

Item

Learning Objective 1 MC 39. MC MC 40. MC Learning Objective 2 TF 7. TF 41. Learning Objective 3 MC Learning Objective 4 MC 46. MC MC 76. E Learning Objective 5 TF 47. MC 48. Learning Objective 6 TF 52. MC 57. TF 53. MC 58. MC 54. MC 59. MC 55. MC 60. MC 56. MC 61. Learning Objective 7 MC 70. MC 72. MC 71. MC 73. Learning Objective 8 TF 74. MC 75. Learning Objective 9

MC = Multiple Choice

Type

Item

Type

42.

77.

MC MC MC MC MC

62. 63. 64. 65. 66.

MC MC MC MC MC

77.

MC MC MC

E = Exercise

Item

Type

77. 78. 79. 80.

E E E E

1-4

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual 1. Financial accounting is the process of identifying, measuring, analyzing, and communicating financial information needed by management to plan, evaluate, and control an organization's operations. 2. Financial statements are the principal means through which financial information is communicated to those outside an enterprise. 3. The essential characteristics of accounting include identification and measurement. 4. The environment of accounting is unaffected by social-economic-political-legal conditions, restraints, and influences that vary from time to time. 5. The principal role of accounting is to furnish investors and lenders information that is useful in assessing the prospective risks and returns associated with an investment. 6. Users of the financial information provided by a company use that information to make capital allocation decisions. 7. An effective process of capital allocation promotes productivity and provides an efficient market for buying and selling securities and obtaining and granting credit. 8. Financial reports in the early 21st century did not provide any information about a company’s soft assets. 9. Accounting standards are now less likely to require the recording or disclosure of fair value information due to its inherent subjectivity. 10. While objectives for financial reporting exist on an informal basis, no formal objectives have been adopted. 11. One weakness of accrual accounting is that it does not provide a good indication of the enterprise's present and continuing ability to generate favorable cash flows. 12. Accounting is responsible for providing standards that ensure accurate financial information that cannot be manipulated or improperly reported. 13. One of the objectives of financial reporting is to provide information that is useful in assessing cash flow prospects of the entity being reported on. 14. The difference between generally accepted accounting principles (GAAP) and specifically accepted accounting principles concerns the degree of authority each possesses. 15. Some generally accepted accounting principles have simply been accepted as appropriate because of their universal application rather than due to the action of an authoritative accounting rule-making body. 16. Users of financial accounting statements have both coinciding and conflicting needs for information of various types.

Financial Accounting and Accounting Standards

1-5

17. The Securities and Exchange Commission appointed the Committee on Accounting Procedure. 18. The passage of a new FASB Standards Statement requires the support of five of the seven board members. 19. Financial Accounting Concepts set forth fundamental objectives and concepts that are used in developing future standards of financial accounting and reporting. 20. The SEC relies on the AICPA and FASB to regulate the accounting profession and develop and enforce accounting standards. 21. The American Institute of Certified Public Accountants (AICPA) is the national professional organization of practicing Certified Public Accountants (CPAs). 22. The SEC has been the principal organization in the development of accounting standards. 23. The Securities and Exchange Commission (SEC) sets accounting standards for companies that do work for the government. 24. The major purpose of the APB during its 13-year existence was to develop a single set of accounting standards useful to all business entities. 25. All those who serve on the FASB must be Certified Public Accountants. 26. FASB Interpretations represent modifications or extensions of existing FASB Standards and have the same authority as Standards. 27. FASB Technical Bulletins are designed to provide guidance on the implementation or application of FASB Statements or Interpretations. 28. A major role of the Accounting Standards Executive Committee (AcSEC) is to inform the FASB of financial reporting problems that are developing in practice. 29. Generally accepted accounting principles (GAAP) are defined, in part, as those principles that have substantial authoritative support. 30. FASB Technical Bulletins are more authoritative than FASB Standards and Interpretations. 31. The AICPA’s Code of Professional Conduct requires that members prepare financial statements in accordance with generally accepted accounting principles. 32. Accounting standards are a product of careful logic or empirical findings and are not influenced by political action. 33. Currently, both U.S. GAAP and the International Financial Reporting Standards are acceptable for international use. 34. The expectations gap is caused by what the public thinks accountants should be doing and what accountants think they can do. 35. Ethical issues in financial accounting are governed by the AICPA.

1-6

Test Bank for Intermediate Accounting, Second Edition

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7.

F T T F T T T

8. 9. 10. 11. 12. 13. 14.

F F F F F T F

15. 16. 17. 18. 19. 20. 21.

T T F F T T T

22. 23. 24. 25. 26. 27. 28.

F F F F T T T

29. 30. 31. 32. 33. 34. 35.

T F T F T T F

MULTIPLE CHOICE—Conceptual 36.

General-purpose financial statements are the product of a. financial accounting. b. managerial accounting. c. both financial and managerial accounting. d. neither financial nor managerial accounting.

37.

Users of financial reports include all of the following except a. creditors. b. government agencies. c. unions. d. All of these are users.

38.

The financial statements most frequently provided include all of the following except the a. balance sheet. b. income statement. c. statement of cash flows. d. statement of retained earnings.

39.

The information provided by financial reporting pertains to a. individual business enterprises, rather than to industries or an economy as a whole or to members of society as consumers. b. business industries, rather than to individual enterprises or an economy as a whole or to members of society as consumers. c. individual business enterprises, industries, and an economy as a whole, rather than to members of society as consumers. d. an economy as a whole and to members of society as consumers, rather than to individual enterprises or industries.

40.

The process of identifying, measuring, analyzing, and communicating financial information needed by management to plan, evaluate, and control an organization’s operations is called a. financial accounting. b. managerial accounting. c. tax accounting. d. auditing.

Financial Accounting and Accounting Standards

1-7

41.

Whether a business is successful and thrives is determined by a. markets. b. free enterprise. c. competition. d. all of these.

42.

An effective capital allocation process a. promotes productivity. b. encourages innovation. c. provides an efficient market for buying and selling securities. d. all of these.

43.

Financial statements in the early 2000s provide information related to a. non-financial measurements. b. forward-looking data. c. hard assets (inventory and plant assets). d. none of these.

44.

Which of the following statements is not an objective of financial reporting? a. Provide information that is useful in investment and credit decisions. b. Provide information about enterprise resources, claims to those resources, and changes to them. c. Provide information on the liquidation value of an enterprise. d. Provide information that is useful in assessing cash flow prospects.

45.

Accrual accounting is used because a. cash flows are considered less important. b. it provides a better indication of ability to generate cash flows than the cash basis. c. it recognizes revenues when cash is received and expenses when cash is paid. d. none of the above.

46.

One objective of financial reporting is to provide a. information about the investors in the business entity. b. information about the liquidation values of the resources held by the enterprise. c. information that is useful in assessing cash flow prospects. d. information that will attract new investors.

47.

Accounting principles are "generally accepted" only when a. an authoritative accounting rule-making body has established it in an official pronouncement. b. it has been accepted as appropriate because of its universal application. c. both a and b. d. neither a nor b.

48.

A common set of accounting standards and procedures are called a. financial accounting standards. b. generally accepted accounting principles. c. objectives of financial reporting. d. statements of financial accounting concepts.

1-8

Test Bank for Intermediate Accounting, Second Edition

49.

The role of the Securities and Exchange Commission in the formulation of accounting principles can be best described as a. consistently primary. b. consistently secondary. c. sometimes primary and sometimes secondary. d. non-existent.

50.

The body that has the power to prescribe the accounting practices and standards to be employed by companies that fall under its jurisdiction is the a. FASB. b. AICPA. c. SEC. d. APB.

51.

Companies that are listed on a stock exchange are required to submit their financial statements to the a. AICPA. b. APB c. FASB. d. SEC.

52.

The Financial Accounting Standards Board (FASB) was proposed by the a. American Institute of Certified Public Accountants. b. Accounting Principles Board. c. Study Group on the Objectives of Financial Statements. d. Special Study Group on establishment of Accounting Principles (Wheat Committee).

53.

The Financial Accounting Standards Board a. has issued a series of pronouncements entitled Statements on Auditing Standards. b. was the forerunner of the current Accounting Principles Board. c. is the arm of the Securities and Exchange Commission responsible for setting financial accounting standards. d. is appointed by the Financial Accounting Foundation.

54.

The Financial Accounting Foundation a. oversees the operations of the FASB. b. oversees the operations of the AICPA. c. provides information to interested parties on financial reporting issues. d. works with the Financial Accounting Standards Advisory Council to provide information to interested parties on financial reporting issues.

55.

The major distinction between the Financial Accounting Standards Board (FASB) and its predecessor, the Accounting Principles Board (APB), is a. the FASB issues exposure drafts of proposed standards. b. all members of the FASB are fully remunerated, serve full time, and are independent of any companies or institutions. c. all members of the FASB possess extensive experience in financial reporting. d. a majority of the members of the FASB are CPAs drawn from public practice.

Financial Accounting and Accounting Standards

1-9

56.

The Financial Accounting Standards Board employs a "due process" system which a. is an efficient system for collecting dues from members. b. enables interested parties to express their views on issues under consideration. c. identifies the accounting issues that are the most important. d. requires that all accountants must receive a copy of financial standards.

57.

Which of the following is not a publication of the FASB? a. Statements of Financial Accounting Concepts b. Accounting Research Bulletins c. Interpretations d. Technical Bulletins

58.

FASB Technical Bulletins a. are similar to FASB Interpretations in that they establish enforceable standards under the AICPA's Code of Professional Ethics. b. are issued monthly by the FASB to deal with current topics. c. are not expected to have a significant impact on financial reporting in general and provide guidance when it does not conflict with any broad fundamental accounting principle. d. were recently discontinued by the FASB because they dealt with specialized topics having little impact on financial reporting in general.

59.

The purpose of the Emerging Issues Task Force is to a. develop a conceptual framework as a frame of reference for the solution of future problems. b. lobby the FASB on issues that affect a particular industry. c. do research on issues that relate to long-term accounting problems. d. issue statements which reflect a consensus on how to account for new and unusual financial transactions that need to be resolved quickly.

60.

The Governmental Accounting Standards Board a. oversees the activities of the SEC. b. is a private-sector body, which addresses state and local governmental reporting issues. c. is a division of the Securities and Exchange Commission, which oversees the corporate accounting in annual reports. d. was terminated when the Financial Accounting Standards Board was created.

61.

The Governmental Accounting Standards Board's main purpose is to develop standards for a. the General Accounting Office. b. the Federal government. c. state and local government. d. the Internal Revenue Service.

62.

Which of the following organizations has not been instrumental in the development of financial accounting standards in the United States? a. AICPA b. FASB c. IASB d. SEC

1 - 10

Test Bank for Intermediate Accounting, Second Edition

63.

An organization that has not published accounting standards is the a. American Institute of Certified Public Accountants. b. Securities and Exchange Commission. c. Financial Accounting Standards Board. d. All of these have published accounting standards.

64.

The purpose of Statements of Financial Accounting Concepts is to a. establish GAAP. b. modify or extend the existing FASB Standards Statement. c. form a conceptual framework for solving existing and emerging problems. d. determine the need for FASB involvement in an emerging issue.

65.

Members of the Financial Accounting Standards Board are a. employed by the American Institute of Certified Public Accountants (AICPA). b. part-time employees. c. required to hold a CPA certificate. d. independent of any other organization.

66.

The following published documents are part of the "due process" system used by the FASB in the evolution of a typical FASB Statement of Financial Accounting Standards: 1. Exposure Draft 2. Statement of Financial Accounting Standards 3. Discussion Memorandum The chronological order in which these items are released is as follows: a. 1, 2, 3. b. 1, 3, 2. c. 2, 3, 1. d. 3, 1, 2.

67.

In the House of GAAP, is the following on the highest level of authoritative status (meaning among the most authoritative)?

a. b. c. d. 68.

FASB Technical Bulletin Yes Yes No No

FASB Statement of Financial Accounting Standards Yes Yes Yes Yes

FASB Interpretation Yes Yes No Yes

FASB Statement of Financial Accounting Concepts Yes No No No

Generally Accepted Accounting Principles include: 1) FASB Technical Bulletins, 2) APB Opinions, and 3) Widely-accepted industry practices. These three items rank from most authoritative to least authoritative as follows: a. 1, 2, 3. b. 1, 3, 2. c. 2, 1, 3. d. 2, 3, 1.

Financial Accounting and Accounting Standards

1 - 11

69.

Generally accepted accounting principles a. include detailed practices and procedures as well as broad guidelines of general application. b. are influenced by pronouncements of the SEC and IRS. c. change over time as the nature of the business environment changes. d. all of these.

70.

The most significant current source of generally accepted accounting principles is the a. AICPA. b. SEC. c. APB. d. FASB.

71.

The most authoritative category of generally accepted accounting principles includes all of the following except a. Accounting Research Bulletins. b. APB Opinions. c. FASB Standards. d. FASB Technical Bulletins.

72.

Which of the following is not a part of generally accepted accounting principles? a. FASB Interpretations b. CAP Accounting Research Bulletins c. APB Opinions d. All of these are part of generally accepted accounting principles.

73.

Which of the following publications does not qualify as a statement of generally accepted accounting principles? a. Statements of financial standards issued by the FASB b. Accounting interpretations issued by the FASB c. APB Opinions d. Accounting research studies issued by the AICPA

74.

Financial accounting standard-setting in the United States a. can be described as a social process which reflects political actions of various interested user groups as well as a product of research and logic. b. is based solely on research and empirical findings. c. is a legalistic process based on rules promulgated by governmental agencies. d. is democratic in the sense that a majority of accountants must agree with a standard before it becomes enforceable.

75.

The purpose of the International Accounting Standards Board is to a. issue enforceable standards which regulate the financial accounting and reporting of multinational corporations. b. develop a uniform currency in which the financial transactions of companies throughout the world would be measured. c. promote uniform accounting standards among countries of the world. d. arbitrate accounting disputes between auditors and international companies.

1 - 12

Test Bank for Intermediate Accounting, Second Edition

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

36. 37. 38. 39. 40. 41.

a d d a b d

42. 43. 44. 45. 46. 47.

d c c b c c

48. 49. 50. 51. 52. 53.

b c c d d d

54. 55. 56. 57. 58. 59.

a b b b c d

60. 61. 62. 63. 64. 65.

b c c d c d

66. 67. 68. 69. 70. 71.

d d c d d d

72. 73. 74. 75.

d d a c

EXERCISES Ex. 1-76—Objectives of financial reporting. What are the objectives of financial reporting by business enterprises?

Solution 1-76 The objectives of financial reporting are to provide information: (a) that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. (b) to help users in assessing the amounts, timing, and uncertainty of prospective cash flows. (c) clearly portraying the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change its resources and obligations.

Ex. 1-77—Development of accounting principles. Presented below are four independent, unrelated statements regarding the formulation of generally accepted accounting principles. Each statement contains some incorrect or debatable statement(s). Statement I The users of financial accounting statements have coinciding and conflicting needs for statements of various types. To meet these needs, and to satisfy the financial reporting responsibility of management, accountants prepare different sets of financial statements for different users. Statement II The FASB should be responsive to the needs and viewpoints of the entire economic community, not just the public accounting profession. The FASB therefore will succeed because it will deal effectively with all interested groups.

Financial Accounting and Accounting Standards

1 - 13

Ex. 1-77 (cont.) Statement III Due to some well-publicized instances of corporate fraud, domestic and foreign bribery, and sudden bankruptcies, the Congress of the United States began in the mid-seventies to inquire into the structure and practices of the accounting profession and the accounting and auditing standard-setting process. As a consequence of these investigations and reports submitted by the committees, the government has now (1) assumed full responsibility through the Securities and Exchange Commission (SEC) for the development and enforcement of financial accounting and reporting standards and (2) assumed full responsibility through the General Accounting Office (GAO) for the development and enforcement of auditing standards. Statement IV The Securities and Exchange Commission is very concerned about financial reporting and has formulated a committee called the Accounting Standards Executive Committee (AcSEC) to provide input to the FASB. In addition, after each FASB Statement is issued, the AcSEC issues Statements of Position stating its position on the FASB statement. Instructions Evaluate each of the independent statements and identify the areas of fallacious reasoning in each. Explain why the reasoning is incorrect. Complete your discussion of each statement before proceeding to the next statement.

Solution 1-77 Statement I It is true that users of financial accounting statements have coinciding and conflicting needs for statements of various types. However, to meet these needs, accountants generally prepare a single set of general-purpose financial statements, rather than a number of different types of financial statements. It may be argued that accountants often do prepare special statements for particular purposes, but in general the accounting profession has relied on general purpose financial statements prepared in conformance with generally accepted accounting principles. Statement II It is true that the FASB should be responsive to the needs of the entire economic community, not just the public accounting profession. However, it is not clear whether the FASB will succeed. The FASB will have the best chance of survival if it deals with problems promptly, sets proper priorities, takes whatever action it thinks is right and in the public interest, and handles pressures responsibly without overreacting to them.

1 - 14

Test Bank for Intermediate Accounting, Second Edition

Solution 1-77 (cont.) Statement III The first sentence of Statement III is correct in that during the mid-seventies Congress, through the Moss and Metcalf Committees, did make inquiries into the accounting profession's practices and the accounting and auditing standard-setting process. In fact, the reports submitted by these committees contained some incorrect conclusions and some very strong remedies, but the government has not assumed responsibility for either accounting or auditing standard-setting or their enforcement. Instead, the accounting profession has taken significant steps to overcome the criticisms which emanated from the congressional inquiries and has retained in the private sector both the accounting and auditing standards-setting functions. At the present time the government appears willing to permit the accounting profession to develop its own standards and to regulate itself with minimal intervention. The AICPA formed the Special Committee on Financial Reporting in 1991. The Committee's charge was to recommend (1) the nature of information that should be made available to others by management and (2) the extent to which auditors should report on the various elements of that information. The Committee's report was made in October 1994. Statement IV The Accounting Standards Executive Committee (AcSEC) was established within the American Institute of Certified Public Accountants, not the Securities and Exchange Commission, to respond to pronouncements of the FASB. The AcSEC does issue Statements of Position, but issues them before the FASB sets standards on the issue.

Ex. 1-78—Publications and organizations. Significant accounting publications are listed below (1-9). Sources or sponsors of accounting publications are identified next by alphabetical character (a-f). Match the publications with their sources. Publications ____ 1. Accounting Research Bulletins (1953-1959) ____ 2. Statements on Auditing Standards ____ 3. Journal of Accountancy ____ 4. Emerging Issues Task Force Statements ____ 5. Opinions (1962-1973) ____ 6. Technical Bulletins ____ 7. Statements of Financial Accounting Standards ____ 8. Statements of Financial Accounting Concepts ____ 9. Statements of Position (SOPs) Sources/Sponsors a. Auditing Standards Board b. Accounting Standards Executive Committee c. The AICPA

d. Committee on Accounting Procedure e. Accounting Principles Board f. Financial Accounting Standards Board

Financial Accounting and Accounting Standards

1 - 15

Solution 1-78 1. d 2. a 3. c

4. f 5. e 6. f

7. f 8. f 9. b

Ex. 1-79—FASB. The Financial Accounting Standards Board was established because many groups interested in financial reporting believed that the Accounting Principles Board was not effective. Discuss the apparent advantages that the FASB should have over its earlier counterpart, the APB.

Solution 1-79 1. Smaller membership. The FASB is composed of seven members, replacing the relatively large 18-member APB. 2. Full-time, remunerated membership. FASB members are well-paid, full-time members, appointed for renewable five-year terms. The APB members were unpaid and part-time. 3. Greater autonomy. The APB was a senior committee of the AICPA, whereas the FASB is not an organ of any single professional organization. It is appointed by and answerable only to the Financial Accounting Foundation. 4. Increased independence. APB members retained their private positions with firms, companies, or institutions. FASB members must sever all such ties. 5. Broader representation. All APB members were required to be CPAs and members of the AICPA. Currently, it is not necessary to be a CPA to be a member of the FASB.

Ex. 1-80—Evolution of a statement of financial accounting standards. In establishing financial accounting standards, two basic premises of the FASB are (1) The FASB should be responsive to the needs and viewpoints of the entire economic community, not just the accounting profession. (2) It should operate in full view of the public through a "due process" system that gives interested persons ample opportunity to make their views known. To ensure achievement of these goals, what are the steps taken in the evolution of an FASB Statement of Financial Accounting Standards?

Solution 1-80 The steps in the evolution of an FASB Statement of Financial Accounting Standards are: a. Topics are identified and placed on the Board's agenda. b. Research and analysis are conducted and a discussion memorandum of pros and cons is issued. c. A public hearing on the proposed standard is held. d. The Board evaluates the research and public response and issues an exposure draft. e. The Board evaluates the responses and changes the exposure draft, if necessary. The final standard is then issued.

CHAPTER 2 CONCEPTUAL FRAMEWORK UNDERLYING FINANCIAL ACCOUNTING TRUE-FALSE—Conceptual Answer

No.

Description

F T F F F F F T F T F T T F F T T F F T T F T T T T T F F T T F F F T

1. 2. 3. 4. 5. 6. 7. 8 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35.

Nature of conceptual framework. Conceptual framework definition. Need for conceptual framework. Use of conceptual framework. Accounting theory. Accounting information. Levels of conceptual framework. International conceptual framework. Statements of Financial Accounting Concepts. Decision usefulness. Financial statement users. Relevance and reliability. Consistency. Relevance. Reliability. Comparable information. Liquidation priorities. Basic elements. Basic elements. Comprehensive income. Going concern assumption. Economic entity assumption. Going concern assumption. Periodicity assumption. Recognition of revenue. Matching principle. Full disclosure principle. Financial statement notes. Matching principle. Realizable revenues. Supplementary information. Materiality factors Conservatism. Reporting immaterial amounts. Industry practices.

2-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84.

GAAP defined. Purpose of conceptual framework. Conceptual framework. Conceptual framework benefits. Objectives of financial reporting. Decision usefulness. Objectives of financial reporting. Financial reporting objectives. Purpose of understandable information. Decision-usefulness criterion. Primary qualities of accounting information. Definition of relevance. Definition of reliability. Relevance and reliability. Timeliness characteristic. Verifiability characteristic. Neutrality characteristic. Neutrality characteristic. Definition of verifiability. Quality of predictive value. Quality of representational faithfulness. Consistency. Consistency characteristic. Comparability and consistency. Comparability. Violation of reliability. Relevance characteristic. Definition of reliability. Consistency principle. Comprehensive income. Elements of financial statements. Distinction between revenues and gains. Definition of a loss. Definition of comprehensive income. Components of comprehensive income. Comprehensive income. Earnings vs. comprehensive income. Reporting financial statement elements. Monetary unit assumption. Periodicity assumption. Monetary unit assumption. Economic entity assumption. Economic entity assumption. Periodicity assumption. Going concern assumption. Going concern assumption. Implications of going concern assumption. Economic entity assumption. Going concern assumption.

Conceptual Framework Underlying Financial Accounting

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

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

85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112.

Definition of economic entity. Historical cost principle. Revenue recognition principle. Matching principle. Matching principle. Full disclosure principle. Historical cost principle. Historical cost principle. Revenue recognition principle. Revenue recognition principle. Revenue recognition principle. Timing of revenue recognition. Realization concept. Definition of realized. Matching principle. Matching principle. Expense recognition. Full-disclosure principle. Constraints to limit the cost of reporting. Cost-benefit constraint. Materiality constraint. Materiality. Pervasive constraints. Conservatism constraint. Conservatism constraint. Trade-offs between characteristics of accounting information. Trade-offs between characteristics of accounting information. Conservatism constraint.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

a b b b a b d d a

113. 114. 115. 116. 117. 118. 119. 120. 121.

Quality of predictive value. Consistency characteristic. Classification of gains and losses. Earnings concept. Components of comprehensive income. Components of comprehensive income. Components of comprehensive income. Components of comprehensive income. Definition of recognition.

2-3

2-4

Test Bank for Intermediate Accounting, Second Edition

EXERCISES Item

Description

E2-122 E2-123 E2-124 E2-125 E2-126 E2-127 E2-128 E2-129 E2-130

Examination of the conceptual framework. Accounting concepts—identification. Accounting concepts—identification. Accounting concepts—matching. Accounting concepts—fill in the blanks. Basic assumptions. Revenue recognition. Historical cost principle. Matching concept.

CHAPTER LEARNING OBJECTIVES 1. Describe the usefulness of a conceptual framework. 2. Describe the FASB’s efforts to construct a conceptual framework. 3. Understand the objectives of financial reporting. 4. Identify the qualitative characteristics of accounting information. 5. Define the basic elements of financial statements. 6. Describe the basic assumptions of accounting. 7. Explain the application of the basic principles of accounting. 8. Describe the impact that constraints have on reporting accounting information.

Conceptual Framework Underlying Financial Accounting

2-5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2.

TF TF

3. 4.

TF TF

36. 37.

10.

11.

41.

12. 13. 14. 15. 16.

TF TF TF TF TF

44. 45. 46. 47. 48.

MC MC MC MC MC

49. 50. 51. 52. 53.

17. 18. 19.

TF TF TF

20. 65. 66.

TF MC MC

67. 68. 69.

21. 22. 23.

TF TF TF

24. 74. 75.

TF MC MC

76. 77. 78.

25. 26. 27. 28. 29.

TF TF TF TF TF

30. 31. 86. 87. 88.

TF TF MC MC MC

89. 90. 91. 92. 93.

32. 33. 34.

TF TF TF

35. 103. 104.

TF MC MC

105. 106. 107.

Note:

TF = True-False MC = Multiple Choice E = Exercise

Type

Item

Type

Item

Learning Objective 1 MC 38. MC 122. MC 39. MC Learning Objective 2 TF 8. TF 9. Learning Objective 3 MC 42. MC 43. Learning Objective 4 MC 54. MC 59. MC 55. MC 60. MC 56. MC 61. MC 57. MC 62. MC 58. MC 63. Learning Objective 5 MC 70. MC 73. MC 71. MC 115. MC 72. MC 116. Learning Objective 6 MC 79. MC 82. MC 80. MC 83. MC 81. MC 84. Learning Objective 7 MC 94. MC 99. MC 95. MC 100. MC 96. MC 101. MC 97. MC 102. MC 98. MC 121. Learning Objective 8 MC 108. MC 111. MC 109. MC 112. MC 110. MC 123.

Type

Item

Type

Item

Type

40.

122.

MC MC MC MC MC

64. 113. 114. 123. 124.

MC MC MC E E

125. 126.

E E

MC MC MC

117. 118. 119.

MC MC MC

120.

MC MC MC

85. 123. 126.

MC E E

127. 128. 129.

E E E

MC MC MC MC MC

123. 124. 125. 126. 128.

E E E E E

129. 130.

E E

MC MC E

124.

2-6

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual 1. The conceptual framework for accounting has been discovered through empirical research. 2. A conceptual framework is a coherent system of interrelated objectives and fundamentals that can lead to consistent standards. 3. A conceptual framework underlying financial accounting is necessary because future accounting practice problems can be solved by reference to the conceptual framework and a formal standard-setting body will not be necessary. 4. Use of a sound conceptual framework in the development of accounting principles will make financial statements of all entities comparable because alternative accounting methods for similar transactions will be eliminated. 5. Accounting theory is developed without consideration of the environment within which it exists. 6. To be reliable, accounting information must be capable of making a difference in a decision. 7. The first level of the conceptual framework identifies the recognition and measurement concepts used in establishing accounting standards. 8. The IASB has issued a conceptual framework that is broadly consistent with that of the United States. 9. Although the FASB intends to develop a conceptual framework, no Statements of Financial Accounting Concepts have been issued to date. 10. Decision usefulness is the underlying theme of the conceptual framework. 11. Users of financial statements are assumed to have no knowledge of business and financial accounting matters by financial statement preparers. 12. Relevance and reliability are the two primary qualities that make accounting information useful for decision making. 13. The idea of consistency does not mean that companies cannot switch from one accounting method to another. 14. Timeliness and neutrality are two ingredients of relevance. 15. Verifiability and predictive value are two ingredients of reliability. 16. Information that has been measured and reported in a similar manner for different enterprises is considered comparable. 17. The fact that equity represents an ownership interest and a residual claim against the net assets of an enterprise means that in the event of liquidation, creditors have a priority over owners in the distribution of assets.

Conceptual Framework Underlying Financial Accounting

2-7

18. The three elements⎯assets, liabilities, and equity⎯describe transactions, events, and circumstances that affect an enterprise during a period of time. 19. Revenues, gains, and distributions to owners all increase equity. 20. Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. 21. The historical cost principle would be of limited usefulness if not for the going concern assumption. 22. The economic entity assumption means that economic activity can be identified with a particular legal entity. 23. The going concern assumption is generally applicable in most business situations unless liquidation appears imminent. 24. The periodicity assumption is a result of the demands of various financial statement user groups for timely reporting of financial information. 25. Recognition of revenue when cash is collected is appropriate only when it is impossible to establish the revenue figure at the time of sale because of the uncertainty of collection. 26. Under the matching principle, it is possible to have an expense reported on the income statement in one period and the cash payment for that expense reported in another period. 27. The full disclosure principle states that information should be provided when it is of sufficient importance to influence the judgment and decisions of an informed user. 28. The notes to financial statements generally summarize the items presented in the main body of the statements. 29. The matching principle states that debits must equal credits in each transaction. 30. Revenues are realizable when assets received or held are readily convertible into cash or claims to cash. 31. Supplementary information may include details or amounts that present a different perspective from that adopted in the financial statements. 32. Companies consider only quantitative factors in determining whether an item is material. 33. Conservatism in accounting means the accountant should attempt to understate assets and income when possible. 34. When an amount is determined by the accountant to be immaterial in relation to other amounts reported in the financial statements, that amount may be deleted from the financial statements. 35. The peculiar nature of some industries and concerns sometimes requires departure from basic theory.

2-8

Test Bank for Intermediate Accounting, Second Edition

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7.

F T F F F F F

8. 9. 10. 11. 12. 13. 14.

T F T F T T F

15. 16. 17. 18. 19. 20. 21.

F T T F F T T

22. 23. 24. 25. 26. 27. 28.

F T T T T T F

29. 30. 31. 32. 33. 34. 35.

F T T F F F T

MULTIPLE CHOICE—Conceptual 36.

Generally accepted accounting principles a. are fundamental truths or axioms that can be derived from laws of nature. b. derive their authority from legal court proceedings. c. derive their credibility and authority from general recognition and acceptance by the accounting profession. d. have been specified in detail in the FASB conceptual framework.

37.

A soundly developed conceptual framework of concepts and objectives should a. increase financial statement users' understanding of and confidence in financial reporting. b. enhance comparability among companies' financial statements. c. allow new and emerging practical problems to be more quickly soluble. d. all of these.

38.

Which of the following (a-c) are not true concerning a conceptual framework in accounting? a. It should be a basis for standard-setting. b. It should allow practical problems to be solved more quickly by reference to it. c. It should be based on fundamental truths that are derived from the laws of nature. d. All of the above (a-c) are true.

39.

Which of the following is not a benefit associated with the FASB Conceptual Framework Project? a. A conceptual framework should increase financial statement users' understanding of and confidence in financial reporting. b. Practical problems should be more quickly solvable by reference to an existing conceptual framework. c. A coherent set of accounting standards and rules should result. d. Business entities will need far less assistance from accountants because the financial reporting process will be quite easy to apply.

40.

In the conceptual framework for financial reporting, what provides "the why"--the goals and purposes of accounting? a. Measurement and recognition concepts such as assumptions, principles, and constraints b. Qualitative characteristics of accounting information c. Elements of financial statements d. Objectives of financial reporting

Conceptual Framework Underlying Financial Accounting

2-9

41.

The underlying theme of the conceptual framework is a. decision usefulness. b. understandability. c. reliability. d. comparability.

42.

Which of the following is not an objective of financial reporting? a. To provide information about economic resources, the claims to those resources, and the changes in them. b. To provide information that is helpful to investors and creditors and other users in assessing the amounts, timing, and uncertainty of future cash flows. c. To provide information that is useful to those making investment and credit decisions. d. All of these are objectives of financial reporting.

43.

The objectives of financial reporting include all of the following except to provide information that a. is useful to the Internal Revenue Service in allocating the tax burden to the business community. b. is useful to those making investment and credit decisions. c. is helpful in assessing future cash flows. d. identifies the economic resources (assets), the claims to those resources (liabilities), and the changes in those resources and claims.

44.

Decision makers vary widely in the types of decisions they make, the methods of decision making they employ, the information they already possess or can obtain from other sources, and their ability to process information. Consequently, for information to be useful there must be a linkage between these users and the decisions they make. This link is a. relevance. b. reliability. c. understandability. d. materiality.

45.

The overriding criterion by which accounting information can be judged is that of a. usefulness for decision making. b. freedom from bias. c. timeliness. d. comparability.

46.

The two primary qualities that make accounting information useful for decision making are a. comparability and consistency. b. materiality and timeliness. c. relevance and reliability. d. reliability and comparability.

47.

Accounting information is considered to be relevant when it a. can be depended on to represent the economic conditions and events that it is intended to represent. b. is capable of making a difference in a decision. c. is understandable by reasonably informed users of accounting information. d. is verifiable and neutral.

2 - 10

Test Bank for Intermediate Accounting, Second Edition

48.

The quality of information that gives assurance that it is reasonably free of error and bias and is a faithful representation is a. relevance. b. reliability. c. verifiability. d. neutrality.

49.

According to Statement of Financial Accounting Concepts No. 2, which of the following relates to both relevance and reliability? a. Materiality b. Understandability c. Usefulness d. All of these

50.

According to Statement of Financial Accounting Concepts No. 2, timeliness is an ingredient of the primary quality of Relevance Reliability a. Yes Yes b. No Yes c. Yes No d. No No

51.

According to Statement of Financial Accounting Concepts No. 2, verifiability is an ingredient of the primary quality of Relevance Reliability a. Yes No b. Yes Yes c. No No d. No Yes

52.

According to Statement of Financial Accounting Concepts No. 2, neutrality is an ingredient of the primary quality of Relevance Reliability a. Yes Yes b. No Yes c. Yes No d. No No

53.

Information is neutral if it a. provides benefits which are at least equal to the costs of its preparation. b. can be compared with similar information about an enterprise at other points in time. c. would have no impact on a decision maker. d. is free from bias toward a predetermined result.

54.

The characteristic that is demonstrated when a high degree of consensus can be secured among independent measurers using the same measurement methods is a. relevance. b. reliability. c. verifiability. d. neutrality.

Conceptual Framework Underlying Financial Accounting

2 - 11

55.

According to Statement of Financial Accounting Concepts No. 2, predictive value is an ingredient of the primary quality of Relevance Reliability a. Yes No b. Yes Yes c. No No d. No Yes

56.

Under Statement of Financial Accounting Concepts No. 2, representational faithfulness is an ingredient of the primary quality of Reliability Relevance a. Yes Yes b. No Yes c. Yes No d. No No

57.

Financial information does not demonstrate consistency when a. firms in the same industry use different accounting methods to account for the same type of transaction. b. a company changes its estimate of the salvage value of a fixed asset. c. a company fails to adjust its financial statements for changes in the value of the measuring unit. d. none of these.

58.

Financial information exhibits the characteristic of consistency when a. expenses are reported as charges against revenue in the period in which they are paid. b. accounting entities give accountable events the same accounting treatment from period to period. c. extraordinary gains and losses are not included on the income statement. d. accounting procedures are adopted which give a consistent rate of net income.

59.

Information about different entities and about different periods of the same entity can be prepared and presented in a similar manner. Comparability and consistency are related to which of these objectives? Comparability Consistency a. Entities Entities b. Entities Periods c. Periods Entities d. Periods Periods

60.

When information about two different enterprises has been prepared and presented in a similar manner, the information exhibits the characteristic of a. relevance. b. reliability. c. consistency. d. none of these.

2 - 12

Test Bank for Intermediate Accounting, Second Edition

61.

Which of the following violates the concept of reliability? a. The management report refers to new discoveries and inventions made, but the financial statements never report the results. b. Financial statements included goodwill with a carrying amount estimated by management. c. Financial statements were issued one year late. d. An interim report is not issued even though it would provide feedback on past performance.

62.

Which of the following is a characteristic describing the primary quality of relevance? a. Materiality b. Predictive value c. Verifiability d. Understandability

63.

If accounting information is verifiable, representationally faithful, and neutral, it can be considered a. relevant. b. timely. c. comparable. d. reliable.

64.

The major objective of the consistency principle is to a. provide timely financial information for statement users. b. promote comparability between financial statements of different accounting periods. c. match the appropriate revenues and expenses in a given accounting period. d. be sure the same information is disclosed in each accounting period.

65.

Comprehensive income as characterized in SFAC No. 6 includes all changes in equity during a period except a. sale of assets other than inventory. b. those resulting from investments by or distribution to owners. c. sales to a particular entity where ultimate payment by the entity is doubtful. d. those resulting from revenue generated by a totally owned subsidiary.

66.

The elements of financial statements include investments by owners. These are increases in an entity's net assets resulting from owners' a. transfers of assets to the entity. b. rendering services to the entity. c. satisfaction of liabilities of the entity. d. all of these.

67.

In classifying the elements of financial statements, the primary distinction between revenues and gains is a. the materiality of the amounts involved. b. the likelihood that the transactions involved will recur in the future. c. the nature of the activities that gave rise to the transactions involved. d. the costs versus the benefits of the alternative methods of disclosing the transactions involved.

Conceptual Framework Underlying Financial Accounting

2 - 13

68.

A decrease in net assets arising from peripheral or incidental transactions is called a(n) a. capital expenditure. b. cost. c. loss. d. expense.

69.

One of the elements of financial statements is comprehensive income. As described in Statement of Financial Accounting Concepts No. 6, "Elements of Financial Statements," comprehensive income is equal to a. revenues minus expenses plus gains minus losses. b. revenues minus expenses plus gains minus losses plus investments by owners minus distributions to owners. c. revenues minus expenses plus gains minus losses plus investments by owners minus distributions to owners plus assets minus liabilities. d. none of these.

70.

Which of the following elements of financial statements is not a component of comprehensive income? a. Revenues b. Distributions to owners c. Losses d. Expenses

71.

Which of the following is false with regard to the element "comprehensive income"? a. It is more inclusive than the traditional notion of net income. b. It includes net income and all other changes in equity exclusive of owners' investments and distributions to owners. c. It can be displayed in any one of three ways. d. This concept is not yet being applied in practice.

72.

According to the FASB conceptual framework, earnings a. are the same as comprehensive income. b. exclude certain gains and losses that are included in comprehensive income. c. include certain gains and losses that are excluded from comprehensive income. d. include certain losses that are excluded from comprehensive income.

73.

According to the FASB Conceptual Framework, the elements⎯assets, liabilities, and equity⎯describe amounts of resources and claims to resources at/during a a. b. c. d.

74.

Moment in Time Yes Yes No No

Period of Time No Yes Yes No

Which of the following basic accounting assumptions is threatened by the existence of severe inflation in the economy? a. Monetary unit assumption b. Periodicity assumption c. Going concern assumption d. Economic entity assumption

2 - 14 75.

Test Bank for Intermediate Accounting, Second Edition During the lifetime of an entity, accountants produce financial statements at artificial points in time in accordance with the concept of a. b. c. d.

Objectivity No Yes No Yes

Periodicity No No Yes Yes

76.

Under current GAAP, inflation is ignored in accounting due to the a. economic entity assumption. b. going concern assumption. c. monetary unit assumption. d. periodicity assumption.

77.

The economic entity assumption a. is inapplicable to unincorporated businesses. b. recognizes the legal aspects of business organizations. c. requires periodic income measurement. d. is applicable to all forms of business organizations.

78.

Preparation of consolidated financial statements when a parent-subsidiary relationship exists is an example of the a. economic entity assumption. b. relevance characteristic. c. comparability characteristic. d. neutrality characteristic.

79.

During the lifetime of an entity, accountants produce financial statements at arbitrary points in time in accordance with which basic accounting concept? a. Cost/benefit constraint b. Periodicity assumption c. Conservatism constraint d. Matching principle

80.

What accounting concept justifies the usage of accruals and deferrals? a. Going concern assumption b. Materiality constraint c. Consistency characteristic d. Monetary unit assumption

81.

The assumption that a business enterprise will not be sold or liquidated in the near future is known as the a. economic entity assumption. b. monetary unit assumption. c. conservatism assumption. d. none of these.

Conceptual Framework Underlying Financial Accounting

2 - 15

82.

Which of the following is an implication of the going concern assumption? a. The historical cost principle is credible. b. Depreciation and amortization policies are justifiable and appropriate. c. The current-noncurrent classification of assets and liabilities is justifiable and signifycant. d. All of these.

83.

The economic entity assumption in accounting is best reflected by which of the following statements? a. When a parent and subsidiary company are merged for accounting and reporting purposes, the economic entity assumption is violated. b. The best way to truly measure the results of enterprise activity is to measure them at the time the enterprise is liquidated. c. The activity of a business enterprise can be kept separate and distinct from its owners and any other business unit. d. A business enterprise is in business to enhance the economic well being of its owners.

84. Continuation of an accounting entity in the absence of evidence to the contrary is an example of the basic concept of a. b. c. d.

Consistency No Yes No Yes

Going Concern No No Yes Yes

85. In accounting, an economic entity may be defined as a. a business enterprise. b. an individual. c. a division within a business enterprise. d. all of the above. 86. Although many objections have been raised about the historical cost principle, it is still widely supported for financial reporting because it a. is an objectively determinable amount. b. is a good measure of current value. c. facilitates comparisons between years. d. takes into account price-level adjusted information. 87. Under the revenue recognition principle, revenue is generally recognized when the earning process is virtually complete and a. an exchange transaction has occurred. b. the merchandise has been ordered. c. all expenses have been identified. d. the accounting process is virtually complete.

2 - 16

Test Bank for Intermediate Accounting, Second Edition

88. Which of the following is an incorrect statement regarding the matching principle? a. Expenses are recognized when they make a contribution to revenue. b. Costs are never charged to the current period as an expense simply because no connection with revenue can be determined. c. In recognizing expenses, accountants attempt to follow the approach of let the expense follow the revenue. d. If no direct connection appears between costs and revenues, but the costs benefit future years, an allocation of cost on some systematic and rational basis might be appropriate. 89. The concept referred to by the matching principle is that a. current liabilities have the same period of existence as the current assets. b. all cash disbursements for a period be matched to cash receipts for the period. c. net income should be reported on a quarterly basis. d. where possible the expenses to be included in the income statement were incurred to produce the revenues. 90. In complying with the full disclosure principle, an accountant must determine the amount of disclosure necessary. How much disclosure is enough? a. Information sufficient for a person without any knowledge of accounting to understand the statements. b. All information that might be of interest to an owner of a business enterprise. c. Information that is of sufficient importance to influence the judgment and decisions of an informed user. d. Information sufficient to permit most persons coming in contact with the statements to reach an accurate decision about the financial condition of the enterprise. 91.

Proponents of historical cost ordinarily maintain that in comparison with all other valuation alternatives for general purpose financial reporting, statements prepared using historical costs are more a. reliable. b. relevant. c. indicative of the entity's purchasing power. d. conservative.

92.

Valuing assets at their liquidation values rather than their cost is inconsistent with the a. periodicity assumption. b. matching principle. c. materiality constraint. d. historical cost principle.

93.

Revenue is generally recognized when realized or realizable and earned. This statement describes the a. consistency characteristic. b. matching principle. c. revenue recognition principle. d. relevance characteristic.

Conceptual Framework Underlying Financial Accounting

2 - 17

94.

Generally, revenue from sales should be recognized at a point when a. management decides it is appropriate to do so. b. the product is available for sale to the ultimate consumer. c. the entire amount receivable has been collected from the customer and there remains no further warranty liability. d. none of these.

95.

Revenue generally should be recognized a. at the end of production. b. at the time of cash collection. c. when realized. d. when realized or realizable and earned.

96.

Which of the following is not a time when revenue may be recognized? a. At time of sale b. At receipt of cash c. During production d. All of these are possible times of revenue recognition.

97.

Under Statement of Financial Accounting Concepts No. 5, which of the following, in the most precise sense, means the process of converting noncash resources and rights into cash or claims to cash? a. Recognition b. Measurement c. Realization d. Allocation

98.

"When products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash" is a definition of a. allocated. b. realized. c. realizable. d. earned.

99.

The allowance for doubtful accounts, which appears as a deduction from accounts receivable on a balance sheet and which is based on an estimate of bad debts, is an application of the a. consistency characteristic. b. matching principle. c. materiality constraint. d. revenue recognition principle.

100.

The accounting principle of matching is best demonstrated by a. not recognizing any expense unless some revenue is realized. b. associating effort (expense) with accomplishment (revenue). c. recognizing prepaid rent received as revenue. d. establishing an Appropriation for Contingencies account.

2 - 18

Test Bank for Intermediate Accounting, Second Edition

101.

Which of the following serves as the justification for the periodic recording of depreciation expense? a. Association of efforts (expense) with accomplishments (revenue) b. Systematic and rational allocation of cost over the periods benefited c. Immediate recognition of an expense d. Minimization of income tax liability

102.

Application of the full disclosure principle a. is theoretically desirable but not practical because the costs of complete disclosure exceed the benefits. b. is violated when important financial information is buried in the notes to the financial statements. c. is demonstrated by the use of supplementary information presenting the effects of changing prices. d. requires that the financial statements be consistent and comparable.

103.

Which of the following statements concerning the cost-benefit relationship is not true? a. Business reporting should exclude information outside of management's expertise. b. Management should not be required to report information that would significantly harm the company's competitive position. c. Management should not be required to provide forecasted financial information. d. If needed by financial statement users, management should gather information not included in the financial statements that would not otherwise be gathered for internal use.

104.

Under Statement of Financial Accounting Concepts No. 2, which of the following relates to both relevance and reliability? a. Cost-benefit constraint b. Predictive value c. Verifiability d. Representational faithfulness

105.

Charging off the cost of a wastebasket with an estimated useful life of 10 years as an expense of the period when purchased is an example of the application of the a. consistency characteristic. b. matching principle. c. materiality constraint. d. historical cost principle.

106.

Which of the following statements about materiality is not correct? a. An item must make a difference or it need not be disclosed. b. Materiality is a matter of relative size or importance. c. An item is material if its inclusion or omission would influence or change the judgment of a reasonable person. d. All of these are correct statements about materiality.

107.

Which of the following are considered pervasive constraints by Statement of Financial Accounting Concepts No. 2? a. Cost-benefit relationship and conservatism b. Timeliness and feedback value c. Conservatism and verifiability d. Materiality and cost-benefit relationship

Conceptual Framework Underlying Financial Accounting

2 - 19

108.

The basic accounting concept that refers to the tendency of accountants to resolve uncertainty in favor of understating assets and revenues and overstating liabilities and expenses is known as the a. conservatism constraint. b. materiality constraint. c. substance over form principle. d. industry practices constraint.

109.

Which of the following best illustrates the accounting concept of conservatism? a. Use of the allowance method to recognize bad debt losses from credit sales b. Use of the lower of cost or market approach in valuing inventories. c. Use of the same accounting method from one period to the next in computing depreciation expense d. Utilization of a policy of deliberate understatement of asset values in order to present a conservative net income figure

110.

Trade-offs between the characteristics that make information useful may be necessary or beneficial. Issuance of interim financial statements is an example of a trade-off between a. relevance and reliability. b. reliability and periodicity. c. timeliness and materiality. d. understandability and timeliness.

111.

Allowing firms to estimate rather than physically count inventory at interim (quarterly) periods is an example of a trade-off between a. verifiability and reliability. b. reliability and comparability. c. timeliness and verifiability. d. neutrality and consistency.

112.

In matters of doubt and great uncertainty, accounting issues should be resolved by choosing the alternative that has the least favorable effect on net income, assets, and owners' equity. This guidance comes from the a. materiality constraint. b. industry practices constraint. c. conservatism constraint. d. full disclosure principle.

2 - 20

Test Bank for Intermediate Accounting, Second Edition

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46.

c d c d d a d a c a c

47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57.

b b d c d b d c a c d

58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68.

b b d b b d b b d c c

69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79.

d b d b a a c c d a b

80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90.

a d d c c d a a b d c

91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101.

a d c d d d c b b b b

102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112.

c d a c d d a b a c c

Solutions to those Multiple Choice questions for which the answer is “none of these.” 57. a company changes its inventory method every few years in order to maximize reported income (other answers are possible). 60. comparability. 69. change in equity of an entity during a period from transactions and other events and circumstances from nonowner sources. 81. going concern assumption. 94. an exchange has taken place and the earnings process is virtually complete.

MULTIPLE CHOICE—CPA Adapted 113.

According to the FASB's conceptual framework, predictive value is an ingredient of Relevance Reliability a. Yes No b. Yes Yes c. No Yes d. No No

114.

According to the FASB's conceptual framework, which of the following relates to both relevance and reliability? Consistency Verifiability a. Yes Yes b. Yes No c. No Yes d. No No

115.

The FASB's conceptual framework classifies gains and losses based on whether they are related to an entity's major ongoing or central operations. These gains or losses may be classified as Nonoperating Operating a. Yes No b. Yes Yes c. No Yes d. No No

Conceptual Framework Underlying Financial Accounting

2 - 21

116.

According to the FASB's conceptual framework, earnings a. is the same as comprehensive income. b. excludes certain gains and losses that are included in comprehensive income. c. includes certain gains and losses that are excluded from comprehensive income. d. includes certain losses that are excluded from comprehensive income.

117.

According to the FASB's conceptual framework, comprehensive income includes which of the following? Operating Income Investments by Owners a. Yes No b. Yes Yes c. No Yes d. No No

118.

According to the FASB's conceptual framework, the calculation of comprehensive income includes which of the following? Income from Distributions Continuing Operations to Owners a. No No b. Yes No c. Yes Yes d. No Yes

119.

According to the FASB's conceptual framework, comprehensive income includes which of the following? Gross Margin Operating Income a. No Yes b. No No c. Yes No d. Yes Yes

120.

Under Statements of Financial Accounting Concepts, comprehensive income includes which of the following? Gains Gross Margin a. No No b. No Yes c. Yes No d. Yes Yes

121.

According to the FASB's conceptual framework, the process of reporting an item in the financial statements of an entity is a. recognition. b. realization. c. allocation. d. matching.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

113. 114.

a b

115. 116.

b b

117. 118.

a b

119. 120.

d d

121.

2 - 22

Test Bank for Intermediate Accounting, Second Edition

EXERCISES Ex. 2-122—Examination of the conceptual framework. At an FASB Concept Framework Symposium, a former member of the FASB discussed his views of a conceptual framework. Some excerpts: Standard Setting in the Private Sector A framework of concepts comprises ideas that coordinate to form the fabric of a system: they determine its bounds. In a system like financial reporting that serves a broad public purpose, the first plank in the framework identifies the public role. The decision of the public sector in the 1930s to look at the private sector for the principal thrust to standard setting was sound and extraordinarily enlightened. The credence given financial reporting will determine whether the private sector's role in standard setting will grow or shrink. An operable conceptual framework will go a long way in providing the necessary level of credibility. Without an operable conceptual framework, continuation of standard setting by the private sector would stand in considerable jeopardy. Essence of the Conceptual Framework The conceptual formulation starts with the broad role of financial reporting in society. It: • •

Identifies its unique competence, that is, its bounds. States the objectives of the reporting.

•

Defines the things admissible to financial statements.

•

Identifies the circumstances triggering admission and qualities to be met for admission to financial statements.

•

Selects useful measurements of things admitted.

•

Furnishes criteria for display.

Those are major pieces of the framework. There are others, of course. The various parts are in a hierarchy ranging from highly abstract to reasonably concrete. They lend guidance—they do not provide simple, no-think answers. They leave open a significant range for hard thinking and deliberation about reporting standards. They furnish the reference point for the thinking. Instructions 1. What are the basic concepts of the conceptual framework? 2. What are your views about the success of the conceptual framework?

Solution 2-122 1. The basic components of the conceptual framework are: a. Objectives—present the goals and purposes of accounting. b. Qualitative characteristics—the characteristics that make accounting information useful. c. Elements—provide the definitions of the broad classifications of items found in financial statements. d. Operational guidelines (recognition and measurement concepts)—recommend concepts to guide decisions concerning the display and disclosure of information about income, cash flows, and financial position. The operational guidelines are composed of three parts:

Conceptual Framework Underlying Financial Accounting

2 - 23

Solution 2-122 (cont.) (1) Basic assumptions. (2) Accounting principles. (3) Constraints. 2. In general, the success of the conceptual framework will be determined by its acceptance in practice. The acceptance in practice will be based in large part upon the FASB's solution of practical problems on a timely basis. It is a matter of opinion and yet to be seen whether or not the conceptual framework will bring about the following benefits. a. The FASB should be able to issue more useful and consistent standards in the future. b. New practice problems should be solved more rapidly by reference to an existing framework. c. Better understanding of and confidence in the financial reporting process by financial statement users should result. d. Enhanced comparability among companies' financial statements should result.

Ex. 2-123—Accounting concepts—identification. State the accounting assumption, principle, information characteristic, or constraint that is most applicable in the following cases. 1. All payments less than $25 are expensed as incurred. (Do not use conservatism.) 2. The company employs the same inventory valuation method from period to period. 3. A patent is capitalized and amortized over the periods benefited. 4. Assuming that dollars today will buy as much as ten years ago. 5. Rent paid in advance is recorded as prepaid rent. 6. Financial statements are prepared each year. 7. All significant post-balance sheet events are reported. 8. Personal transactions of the proprietor are distinguished from business transactions.

Solution 2-123 1. 2. 3. 4. 5. 6. 7. 8.

Materiality constraint. Consistency characteristic. Matching principle or going concern assumption. Monetary unit assumption. Matching principle or going concern assumption. Periodicity assumption. Full disclosure principle. Economic entity assumption.

2 - 24

Test Bank for Intermediate Accounting, Second Edition

Ex. 2-124—Accounting concepts—identification. Presented below are a number of accounting procedures and practices in Sanchez Corp. For each of these items, list the assumption, principle, information characteristic, or modifying convention that is violated. 1. Because the company's income is low this year, a switch from accelerated depreciation to straight-line depreciation is made this year. 2. The president of Sanchez Corp. believes it is foolish to report financial information on a yearly basis. Instead, the president believes that financial information should be disclosed only when significant new information is available related to the company's operations. 3. Sanchez Corp. decides to establish a large loss and related liability this year because of the possibility that it may lose a pending patent infringement lawsuit. The possibility of loss is considered remote by its attorneys. 4. An officer of Sanchez Corp. purchased a new home computer for personal use with company money, charging miscellaneous expense. 5. A machine that cost $40,000 is reported at its current market value of $45,000.

Solution 2-124 1. 2. 3. 4. 5.

Consistency. Periodicity. Matching (also, conservatism). Economic entity. Historical cost (also, revenue recognition)*. *Reporting the asset at FMV of $45,000 implies the following entry: Machine .................................................................................... 5,000 Revenue........................................................................

5,000

Ex. 2-125—Accounting concepts—matching. Listed below are several information characteristics and accounting principles and assumptions. Match the letter of each with the appropriate phrase that states its application. (Items a through k may be used more than once or not at all.) a. b. c. d. e. f.

Economic entity assumption Going concern assumption Monetary unit assumption Periodicity assumption Historical cost principle Revenue recognition principle

g. h. i. j. k.

Matching principle Full disclosure principle Relevance characteristic Reliability characteristic Consistency characteristic

____ 1. Stable-dollar assumption (do not use historical cost principle). ____ 2. Earning process completed and realized or realizable. ____ 3. Presentation of error-free information with representational faithfulness. ____ 4. Yearly financial reports. ____ 5. Accruals and deferrals in adjusting and closing process. (Do not use going concern.)

Conceptual Framework Underlying Financial Accounting

2 - 25

Ex. 2-125 (cont.) ____ 6. Useful standard measuring unit for business transactions. ____ 7. Notes as part of necessary information to a fair presentation. ____ 8. Affairs of the business distinguished from those of its owners. ____ 9. Business enterprise assumed to have a long life. ____ 10. Valuing assets at amounts originally paid for them. ____ 11. Application of the same accounting principles as in the preceding year. ____ 12. Summarizing significant accounting policies. ____ 13. Presentation of timely information with predictive and feedback value.

Solution 2-125 1. c 2. f 3. j

4. d 5. g 6. c

7. h 8. a 9. b

10. e 11. k 12. h

13. i

Ex. 2-126—Accounting concepts—fill in the blanks. Fill in the blanks below with the accounting principle, assumption, or related item that best completes the sentence. 1. ________________________ and _______________________ are the two primary qualities that make accounting information useful for decision making. 2. Information that helps users confirm or correct prior expectations has _________________ ___________________. 3. ________________________ enables users to identify the real similarities and differences in economic phenomena because the information has been measured and reported in a similar manner for different enterprises. 4. Some costs which give rise to future benefits cannot be directly associated with the revenues they generate. Such costs are allocated in a __________________ and _________________ manner to the periods expected to benefit from the cost. 5. _______________________ would allow the expensing of all repair tools when purchased, even though they have an estimated life of 3 years. 6. The ________________________ characteristic requires that the same accounting method be used from one accounting period to the next, unless it becomes evident that an alternative method will bring about a better description of a firm's financial situation. 7. ____________________ guides accountants to select the accounting treatment that is least likely to overstate income and assets.

2 - 26

Test Bank for Intermediate Accounting, Second Edition

Ex. 2-126 (cont.) 8. Parenthetical balance sheet disclosure of the inventory method utilized by a particular company is an application of the _______________________ principle. 9. Corporations must prepare accounting reports at least yearly due to the _______________ assumption. 10. Recording and reporting inflows at the end of production is an allowable exception to the _________________ principle.

Solution 2-126 1. 2. 3. 4. 5.

Relevance; reliability feedback value Comparability rational; systematic The materiality convention

6. 7. 8. 9. 10.

consistency Conservatism full disclosure periodicity revenue recognition

Ex. 2-127—Basic assumptions. Briefly explain the four basic assumptions that underlie financial accounting.

Solution 2-127 1. The economic entity assumption states that economic activity can be identified with a particular unit of accountability. 2. The going concern assumption assumes that a business enterprise will have a long life. 3. The monetary unit assumption means that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis. In addition, the monetary unit remains reasonably stable. 4. The periodicity assumption implies that the economic activities of an enterprise can be divided into artificial time periods.

Ex. 2-128—Revenue recognition. Revenue is generally recognized at the point of sale. There are three exceptions, however. Name the time for each exception, give two qualifications or criteria for the use of each exception, and give an example for each exception.

Solution 2-128 1. During production. The revenue is known (contract) or dependably estimable. Total costs are estimable or other means are available to estimate progress toward completion. Examples are long-term construction contracts and service-type transactions.

Conceptual Framework Underlying Financial Accounting

2 - 27

Solution 2-128 (cont.) 2. At completion. There are quoted prices. Units are interchangeable. There are no significant distribution costs. Unit costs are not determinable. Examples are precious metals or agricultural products. 3. At collection. There is no reasonable basis for estimating the degree of collectibility. Costs of collection, bad debts, and repossessions are not estimable. Examples are installment sales and cost recovery method.

Ex. 2-129—Historical cost principle. Cost as a basis of accounting for assets has been severely criticized. What defense can you build for cost as the basis for financial accounting?

Solution 2-129 Cost is definite and verifiable and not a matter for conjecture or opinion. Once established, cost is fixed as long as the asset remains the property of the party that incurred the cost. Cost is based on fact; that is, it is the result of an arm's length transaction. Cost is also measurable or determinable. Over the years, accountants have found cost to be the most practical basis for record keeping. Financial statements prepared on a cost basis provide business enterprise information having a common, accepted basis from which each reader can make inferences, comparisons, and analyses.

Ex. 2-130—Matching concept. A concept is a group of related ideas. Matching could be considered a concept because it includes ideas related to both revenue recognition and expense recognition. Briefly explain the ideas in (a) revenue recognition and (b) expense recognition.

Solution 2-130 (a) The ideas in revenue recognition include the "three R's" and "earned": 1. Revenues are inflows of net assets from delivering or producing goods or services or other earning activities that are the major operations of an enterprise during a period. 2. Recognition is recording and reporting in the financial statements. 3. Revenues are realized when goods or services are exchanged for cash or claims to cash. 4. Revenues are earned when the earnings process is complete or virtually complete. The revenue recognition principle is that revenue is recognized when it is realized and it is earned. (b) The ideas in expense recognition include "expense" and "matching": 1. Expenses are outflows of net assets during a period from delivering or producing goods or services or other activities that are the major operations of the entity. 2. Expenses are recognized when the goods or services (efforts) make their contribution to revenue.

2 - 28

Test Bank for Intermediate Accounting, Second Edition

Solution 2-130 (cont.) The matching principle is that expenses are matched with revenues. Expenses are matched three ways: 1. When there is an association with revenue, expenses are matched with revenues in the period the revenues are recognized. 2. When no association with revenue is evident, expenses are allocated on some systematic and rational basis. 3. When no association with revenue is evident and no future benefits are expected, expenses are recognized immediately.

CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM TRUE/FALSE Answer

No.

Description

F T F F F T F F T F F T F T T T T F T F F F F T T T F T T F

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. *27. *28. *29. *30.

Recording transactions. Nominal accounts. Real (permanent) accounts. Debits and credits. Internal event example. Double-entry accounting. Liability and stockholders’ equity accounts. Steps in accounting cycle. General journal. General journal vs. special journals. Posting and trial balance. Purpose of trial balance. Adjusting entries. Adjusting entries and accrual accounting. Example of accrued expense. Bad debts and matching principle. Adjusting entries for prepayments. Book value of depreciable assets. Reporting ending retained earnings. Income Summary account. Posting closing entries. Post-closing trial balance. Closing entries and Income Summary. Perpetual inventory system. Periodic inventory system. Cost of goods sold computation. Purpose of reversing entries. Adjusting entries reversed. Worksheet and financial statements. Adjusted trial balance.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

d d d b a d a

31. 32. 33. 34. 35. 36. 37.

Purpose of an accounting system. Necessity of accounting records. Identification of a real account. Identification of a temporary account. Temporary vs. permanent accounts. Book of original entry. Transaction analysis.

3-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

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

38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. *86.

Purpose of an accounting system. Meaning of debit. Double-entry system. Effect on stockholders’ equity. Accounting equation. Accounting process vs. accounting cycle. Criteria for recording events. Identification of a recordable event. Identification of internal events. External events. General journal. Accounting cycle steps. Purpose of trial balance. Limitations of trial balance. Journal entry. Journal entry. Journal entry. Accounting process. Purpose of unadjusted trial balance. Journal entry for unearned revenue. Format of adjusting entry. Example of accrued expense. Classifying unearned rent. Timing of adjustments. Prepaid expense. Expiration of prepaid expenses. Effect of depreciation entry. Unearned revenue relationships. Computation of interest expense for adjusting entry. Purpose of adjusting entries. Matching principle. Prepaid items. Accrued items. Definition of unearned revenue. Definition of accrued expense. Adjusting entry for accrued expense. Factors to consider in estimating depreciation. Adjusting entries. Effect of adjusting entries. Prepaid expense and the matching principle. Accrued revenue and the matching principle. Unearned revenue and the matching principle. Adjusted trial balance. Purpose of closing entries. Closing Income Summary account. Closing entry process. Year-end inventory adjustment. Effect of understanding ending inventory. Purpose of reversing entries.

The Accounting Information System

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

d d b d

*87. *88. *89. *90.

Identification of reversing entries. Identification of reversing entries. Adjusting entries reversed. Reporting inventory on a worksheet.

MULTIPLE CHOICE—Computational Answer

No.

Description

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

91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. *102. 103. 104. 105. *106. *107. *108.

Effect of transactions on owners’ equity. Effect of transactions on owners’ equity. Unearned rent adjustment. Unearned rent adjustment. Unearned rent adjustment. Determine adjusting entry. Determine adjusting entry. Adjusting entry for bad debts. Adjusting entry for bad debts. Adjusting entry for interest receivable. Subsequent period entry for interest. Use of reversing entry. Effect of closing entries. Calculate ending inventory. Calculate sales. Determine adjusting entry. Determine adjusting entry. Unearned rent adjustment.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

c b a c b b a d

109. 110. 111. 112. 113. 114. 115. 116.

Determine accrued interest payable. Determine balance of unearned revenues. Calculate subscriptions revenue. Determine interest receivable. Calculate balance of accrued payable. Calculate accrued salaries. Calculate royalty revenue. Calculate deferred revenue.

* This topic is dealt with in an Appendix to the chapter.

3-3

3-4

Test Bank for Intermediate Accounting, Second Edition

EXERCISES Item

Description

E3-117 E3-118 E3-119 E3-120 E3-121 E3-122

Terminology. Definitions. Accrued and deferred items. Adjusting entries. Adjusting entries. Financial statements.

PROBLEMS Item

Description

P3-123 P3-124 P3-125 *P3-126 P3-127

Adjusting entries and account classifications. Adjusting entries. Adjusting and closing entries. Eight-column work sheet. Accounting cycle.

CHAPTER LEARNING OBJECTIVES 1.

Understand basic accounting terminology.

Explain double-entry rules.

Identify steps in the accounting cycle.

Record transactions in journals, post to ledger accounts, and prepare a trial balance.

Explain the reasons for preparing adjusting entries.

Prepare financial statements from the adjusted trial balance.

Prepare closing entries.

Explain how to adjust inventory accounts at year-end.

*9.

Identify adjusting entries that may be reversed.

*10.

Prepare a 10-column worksheet.

The Accounting Information System

3-5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2.

TF TF

3. 31.

TF MC

32. 33.

4. 5.

TF TF

6. 7.

TF TF

37. 38.

40.

41.

9. 10.

TF TF

11. 12.

TF TF

50. 51.

13. 14. 15. 16. 17. 18. 32. 33.

TF TF TF TF TF TF MC MC

34. 35. 36. 37. 38. 39. 40. 41.

MC MC MC MC MC MC MC MC

42. 43. 44. 45. 46. 47. 48. 50.

19.

80.

122.

20.

21.

22.

24. 25.

TF TF

26. 53.

TF MC

54. 84.

27. 28.

TF TF

58. 59.

MC MC

60. 65.

29.

30.

126.

Note: TF = True/False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 MC 34. MC 36. MC 35. MC 117. Learning Objective 2 MC 39. MC 41. MC 40. MC 42. Learning Objective 3 MC 47. MC 48. Learning Objective 4 MC 61. MC 127. MC 62. MC Learning Objective 5 MC 63. MC 86. MC 64. MC 87. MC 67. MC 88. MC 68. MC 89. MC 69. MC 90. MC 71. MC 91. MC 72. MC 92. MC 85. MC 94. Learning Objective 6 E Learning Objective 7 TF 23. TF 52. Learning Objective 8 MC 104. MC 120. MC 105. MC 123. Learning Objective *9 MC 66. MC 102. MC 73. MC 106. Learning Objective *10 P 127. P E = Exercise P = Problem

Type

Item

Type

Item

Type

MC MC

43.

49.

MC MC MC MC MC MC MC MC

95. 98. 99. 117. 118. 119. 120. 121.

MC MC MC E E E E E

123. 124. 125. 127.

P P P P

74.

121.

E P

125.

MC MC

107. 108.

MC MC

120.

MC E

3-6

Test Bank for Intermediate Accounting, Second Edition

TRUE/FALSE 1.

A ledger is where the company initially records transactions and selected other events.

Nominal (temporary) accounts are revenue, expense, and dividend accounts and are periodically closed.

Real (permanent) accounts are revenue and expense accounts and are periodically closed.

In general, debits refer to increases in account balances, and credits refer to decreases.

An example of an internal event would be a flood that destroyed a portion of an entity's inventory.

Double-entry accounting is the process that leads to the basic equality in accounting expressed by the formula: assets = liabilities + owners' equity.

All liability and stockholders’ equity accounts are increased on the credit side and decreased on the debit side.

The first step in the accounting cycle is the journalizing of transactions and selected other events.

A general journal chronologically lists transactions and other events, expressed in terms of debits and credits to accounts.

10.

A general journal may be used by any entity in recording its transactions, whereas special journals may be used only by entities whose transactions meet certain requirements.

11.

If an entity fails to post one of its journal entries to its general ledger, the trial balance will not show an equal amount of debit and credit balance accounts.

12.

One purpose of a trial balance is to prove that debits and credits of an equal amount are in the general ledger.

13.

Adjusting entries are used to correct errors that occur during the posting process.

14.

Adjusting entries result from compliance with the accrual basis of accounting.

15.

An adjustment for wages expense, earned but unpaid at year end, is an example of an accrued expense.

16.

Proper matching of revenues and expenses requires that bad debts be recorded as an expense of the period in which the sale was made.

17.

Adjusting entries for prepayments record the portion of the prepayment that represents the expense incurred or the revenue earned in the current accounting period.

The Accounting Information System

3-7

18.

The book value of any depreciable asset is the difference between its cost and its salvage value.

19.

The ending retained earnings balance is reported on both the retained earnings statement and the balance sheet.

20.

The Income Summary account used during the closing process is shown in the owners' equity section of the balance sheet.

21.

It is not necessary to post the closing entries to the ledger accounts because new revenue and expense accounts will be opened in the subsequent accounting period.

22.

The post-closing trial balance consists of asset, liability, owners' equity, revenue and expense accounts.

23.

All revenues, expenses, and the dividends account are closed through the Income Summary account.

24.

With a perpetual inventory system, a company records purchases and sales directly in the Inventory account as the purchases and sales occur.

25.

When inventory records are maintained using a periodic inventory system, a purchases account is used and the inventory is unchanged during the period.

26.

The computation of Cost of Goods Sold under a periodic inventory system has the characteristics of both an adjusting entry and a closing entry.

*27.

Reversing entries are made at the end of the accounting cycle to correct errors in the original recording of transactions.

*28.

In general, all adjusting entries for prepaid items for which the original amount was entered in a revenue or expense account and for all accrued items should be reversed.

*29.

The use of a worksheet at the end of each month or quarter permits the preparation of interim financial statements even though the books are closed only at the end of each year.

*30.

An adjusted trial balance that shows equal debit and credit columnar totals proves the accuracy of the adjusting entries.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6.

F T F F F T

7. 8. 9. 10. 11. 12.

F F T F F T

13. 14. 15. 16. 17. 18.

F T T T T F

19. 20. 21. 22. 23. 24.

T F F F F T

25. 26. *27. *28. *29. *30.

T T F T T F

3-8

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual 31.

Factors that shape an accounting information system include the a. nature of the business. b. size of the firm. c. volume of data to be handled. d. all of these.

32.

Maintaining an accounting system that ensures reliable information is reported in the financial statements is a. optional. b. required by the Internal Revenue Service. c. required by the Sarbanes-Oxley Act. d. required by the Internal Revenue Service and the Sarbanes-Oxley Act.

33.

Which of the following is a real (permanent) account? a. Goodwill b. Sales c. Accounts Receivable d. Both Goodwill and Accounts Receivable

34.

Which of the following is a nominal (temporary) account? a. Unearned Revenue b. Salary Expense c. Inventory d. Retained Earnings

35.

Nominal accounts are also called a. temporary accounts. b. permanent accounts. c. real accounts. d. none of these.

36.

An accounting record into which the essential facts and figures in connection with all transactions are initially recorded is called the a. ledger. b. account. c. trial balance. d. none of these.

37.

The debit and credit analysis of a transaction normally takes place a. before an entry is recorded in a journal. b. when the entry is posted to the ledger. c. when the trial balance is prepared. d. at some other point in the accounting cycle.

38.

Debit always means a. right side of an account. b. increase. c. decrease. d. none of these.

The Accounting Information System

3-9

39.

The double-entry accounting system means a. each transaction is recorded with two journal entries. b. each item is recorded in a journal entry, then in a general ledger account. c. the dual effect of each transaction is recorded with a debit and a credit. d. more than one of the above.

40.

When a corporation pays a note payable and interest, a. the account Notes Payable will be increased. b. the account Interest Expense will be decreased. c. it will debit Notes Payable and Interest Expense. d. it will debit Cash.

41.

Stockholders’ equity is not affected by all a. cash receipts. b. dividends. c. revenues. d. expenses.

42.

The accounting equation (A = L + SE) must remain in balance a. throughout each step in the accounting cycle. b. only when journal entries are recorded. c. only at the time the trial balance is prepared. d. only when formal financial statements are prepared.

43.

The difference between the accounting process and the accounting cycle is a. the accounting process results in the preparation of financial statements, whereas the accounting cycle is concerned with recording business transactions. b. the accounting cycle represents the steps taken to accomplish the accounting process. c. the accounting process represents the steps taken to accomplish the accounting cycle. d. merely semantic, because both concepts refer to the same thing.

44.

Which of the following criteria must be met before an event or item should be recorded for accounting purposes? a. The event or item can be measured objectively in financial terms. b. The event or item is relevant and reliable. c. The event or item is an element. d. All of these must be met.

45.

Which of the following is a recordable event or item? a. Changes in managerial policy b. The value of human resources c. Changes in personnel d. None of these

46.

Which of the following is not an internal event? a. Depreciation b. Using raw materials in the production process c. Dividend declaration and subsequent payment d. All of these are internal transactions.

3 - 10

Test Bank for Intermediate Accounting, Second Edition

47.

External events do not include a. interaction between an entity and its environment. b. a change in the price of a good or service that an entity buys or sells, a flood or an earthquake. c. improvement in technology by a competitor. d. using buildings and machinery in operations.

48.

A general journal a. chronologically lists transactions and other events, expressed in terms of debits and credits. b. contains one record for each of the asset, liability, stockholders’ equity, revenue, and expense accounts. c. lists all the increases and decreases in each account in one place. d. contains only adjusting entries.

49.

An optional step in the accounting cycle is preparation of a. adjusting entries. b. closing entries. c. a statement of cash flows. d. a post-closing trial balance.

50.

A trial balance a. proves that debits and credits are equal in the ledger. b. supplies a listing of open accounts and their balances that are used in preparing financial statements. c. is normally prepared three times in the accounting cycle. d. all of these.

51.

A trial balance may prove that debits and credits are equal, but a. an amount could be entered in the wrong account. b. a transaction could have been entered twice. c. a transaction could have been omitted. d. all of these.

52.

A journal entry to record the sale of inventory on account will include a a. debit to Inventory. b. debit to Accounts Receivable. c. debit to Sales. d. credit to Cost of Goods Sold.

53.

A journal entry to record a payment on account will include a a. debit to Accounts Receivable. b. credit to Accounts Receivable. c. debit to Accounts Payable. d. credit to Accounts Payable.

54.

A journal entry to record a receipt of rent revenue in advance will include a a. debit to Rent Revenue. b. credit to Rent Revenue. c. credit to Cash. d. credit to Unearned Rent.

The Accounting Information System

3 - 11

55.

Which of the following statements is not true as it pertains to the accounting process? a. The established system for recording transactions and other events as they occur is referred to as double-entry accounting. b. Events are of two types: (1) external and (2) internal. Accountants record events that affect the financial position of the company. c. Adjustments are necessary to achieve a proper matching of revenues and expenses to determine net income for the current period and to achieve an accurate statement of the assets and equities existing at the end of the period. d. Posting is the initial recording of all transactions in chronological order.

56.

Which of the following is not a principal purpose of an unadjusted trial balance? a. It proves that debits and credits of equal amounts are in the ledger. b. It is the basis for any adjustments to the account balances. c. It supplies a listing of open accounts and their balances. d. It proves that debits and credits were properly entered in the ledger accounts.

57.

Which of the following journal entries is appropriate when a company receives payment in advance for goods or services? a. Debit Cash and credit an expense account b. Credit Cash and debit a revenue account c. Debit Cash and credit a liability account or a revenue account d. Credit Cash and debit a liability or revenue account

58.

An adjusting entry should never include a. a debit to an expense account and a credit to a liability account. b. a debit to an expense account and a credit to revenue account. c. a debit to a liability account and a credit to revenue account. d. a debit to a revenue account and a credit to a liability account.

59.

Which of the following is an example of an accrued expense? a. Office supplies purchased at the beginning of the year and debited to an expense account b. Property taxes incurred during the year, to be paid in the first quarter of the subsequent year c. Depreciation expense d. Rent earned during the period, to be received at the end of the year

60.

Rent collected in advance by a landlord is a(n) a. accrued liability. b. deferred asset. c. accrued revenue. d. unearned revenue.

61.

Adjustments are often prepared a. after the balance sheet date, but dated as of the balance sheet date. b. after the balance sheet date, and dated after the balance sheet date. c. before the balance sheet date, but dated as of the balance sheet date. d. before the balance sheet date, and dated after the balance sheet date.

3 - 12

Test Bank for Intermediate Accounting, Second Edition

62.

At the time a company prepays a cost a. it debits an asset account to show the service or benefit it will receive in the future. b. it debits an expense account to match the expense against revenues earned. c. it credits a liability account to show the obligation to pay for the service in the future. d. more than one of the above.

63.

How do these prepaid expenses expire? a. b. c. d.

Rent With the passage of time With the passage of time Through use and consumption Through use and consumption

Supplies Through use and consumption With the passage of time Through use and consumption With the passage of time

64.

Recording the adjusting entry for depreciation has the same effect as recording the adjusting entry for a. an unearned revenue. b. a prepaid expense. c. an accrued revenue. d. an accrued expense.

65.

Unearned revenue on the books of one company is likely to be a(n) a. prepaid expense on the books of the company that made the advance payment. b. unearned revenue on the books of the company that made the advance payment. c. accrued expense on the books of the company that made the advance payment. d. accrued revenue on the books of the company that made the advance payment.

66.

To compute interest expense for an adjusting entry, the formula is principal × rate × a fraction. The numerator and denominator of the fraction are: a. b. c. d.

67.

Numerator Length of time note has been outstanding Length of note Length of time until note matures Length of time note has been outstanding

Denomintor 12 months 12 months Length of note Length of note

Adjusting entries are necessary to 1. obtain a proper matching of revenue and expense. 2. achieve an accurate statement of assets and equities. 3. adjust assets and liabilities to their fair market value. a. b. c. d.

68.

1 2 3 1 and 2

Why are certain costs of doing business capitalized when incurred and then depreciated or amortized over subsequent accounting cycles? a. To reduce the federal income tax liability b. To aid management in cash flow analysis c. To match the costs of production with revenues as earned d. To adhere to the accounting constraint of conservatism

The Accounting Information System

3 - 13

69.

When an item of expense is paid and recorded in advance, it is normally called a(n) a. prepaid expense. b. accrued expense. c. estimated expense. d. cash expense.

70.

When an item of revenue or expense has been earned or incurred but not yet collected or paid, it is normally called a(n) ____________ revenue or expense. a. prepaid b. adjusted c. estimated d. none of these

71.

When an item of revenue is collected and recorded in advance, it is normally called a(n) ___________ revenue. a. accrued b. prepaid c. unearned d. cash

72.

An accrued expense can best be described as an amount a. paid and currently matched with earnings. b. paid and not currently matched with earnings. c. not paid and not currently matched with earnings. d. not paid and currently matched with earnings.

73.

If, during an accounting period, an expense item has been incurred and consumed but not yet paid for or recorded, then the end-of-period adjusting entry would involve a. a liability account and an asset account. b. an asset or contra asset account and an expense account. c. a liability account and an expense account. d. a receivable account and a revenue account.

74.

Which of the following must be considered in estimating depreciation on an asset for an accounting period? a. The original cost of the asset b. Its useful life c. The decline of its fair market value d. Both the original cost of the asset and its useful life

75.

Which of the following would not be a correct form for an adjusting entry? a. A debit to a revenue account and a credit to a liability account b. A debit to an expense account and a credit to a liability account c. A debit to a liability account and a credit to a revenue account d. A debit to an asset account and a credit to a liability account

76.

Year-end net assets would be overstated and current expenses would be understated as a result of failure to record which of the following adjusting entries? a. Expiration of prepaid insurance b. Depreciation of fixed assets c. Accrued wages payable d. All of these

3 - 14

Test Bank for Intermediate Accounting, Second Edition

77.

A prepaid expense can best be described as an amount a. paid and currently matched with revenues. b. paid and not currently matched with revenues. c. not paid and currently matched with revenues. d. not paid and not currently matched with revenues.

78.

An accrued revenue can best be described as an amount a. collected and currently matched with expenses. b. collected and not currently matched with expenses. c. not collected and currently matched with expenses. d. not collected and not currently matched with expenses.

79.

An unearned revenue can best be described as an amount a. collected and currently matched with expenses. b. collected and not currently matched with expenses. c. not collected and currently matched with expenses. d. not collected and not currently matched with expenses.

80.

An adjusted trial balance a. is prepared after the financial statements are completed. b. proves the equality of the total debit balances and total credit balances of ledger accounts after all adjustments have been made. c. is a required financial statement under generally accepted accounting principles. d. cannot be used to prepare financial statements.

81.

Which of the following statements best describes the purpose of closing entries? a. To facilitate posting and taking a trial balance. b. To determine the amount of net income or net loss for the period. c. To reduce the balances of revenue and expense accounts to zero so that they may be used to accumulate the revenues and expenses of the next period. d. To complete the record of various transactions that were started in a prior period.

82.

If expenses are greater than revenues, the Income Summary account will be closed by a debit to a. Income Summary and a credit to Cash. b. Income Summary and a credit to Retained Earnings. c. Cash and a credit to Income Summary. d. Retained Earnings and a credit to Income Summary.

83.

Which type of account is always debited during the closing process? a. Dividends b. Expense c. Revenue d. Retained earnings

84.

When a company uses a periodic inventory system, the year-end entry to adjust the inventory account will debit and credit inventory as follows: a. b. c. d.

Beginning Inventory Amount Debited Debited Credited Credited

Ending Inventory Amount Credited Debited Debited Credited

The Accounting Information System 85.

If the Inventory account at the end of the year is understated, the effect will be to a. overstate the gross profit on sales. b. understate the net purchases. c. overstate the cost of goods sold. d. overstate the goods available for sale.

*86.

Reversing entries are

3 - 15

1. normally prepared for prepaid, accrued, and estimated items. 2. necessary to achieve a proper matching of revenue and expense. 3. desirable to exercise consistency and establish standardized procedures. a. b. c. d.

1 2 3 1 and 2

*87.

Adjusting entries that should be reversed include those for prepaid or unearned items that a. create an asset or a liability account. b. were originally entered in a revenue or expense account. c. were originally entered in an asset or liability account. d. create an asset or a liability account and were originally entered in a revenue or expense account.

*88.

Adjusting entries that should be reversed include a. all accrued revenues. b. all accrued expenses. c. those that debit an asset account or credit a liability account. d. all of these.

*89.

A reversing entry should never be made for an adjusting entry that a. accrues unrecorded revenue. b. adjusts expired costs from an asset account to an expense account. c. accrues unrecorded expenses. d. adjusts unexpired costs from an expense account to an asset account.

*90.

The worksheet for Sharko Co. consisted of eight pairs of debit and credit columns. The dollar amount of one item appeared in both the credit column of the income statement section and the debit column of the balance sheet section. That item is a. net income for the period. b. beginning inventory. c. cost of goods sold. d. ending inventory.

3 - 16

Test Bank for Intermediate Accounting, Second Edition

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

31. 32. 33. 34. 35. 36. 37. 38. 39.

d d d b a d a d c

40. 41. 42. 43. 44. 45. 46. 47. 48.

c a a b d d c d a

49. 50. 51. 52. 53. 54. 55. 56. 57.

d d d b c d d d c

58. 59. 60. 61. 62. 63. 64. 65. 66.

b b d a a a b a a

67. 68. 69. 70. 71. 72. 73. 74. 75.

d c a d c d d d d

76. 77. 78. 79. 80. 81. 82. 83. 84.

d b c b b c d c c

85. *86. *87. *88. *89. *90.

c d d d b d

Solutions to those Multiple Choice questions for which the answer is “none of these.” 36. journal 38. left or left side 45. Many answers are possible. 70. accrued

MULTIPLE CHOICE—Computational 91.

Maso Company recorded journal entries for the issuance of common stock for $40,000, the payment of $13,000 on accounts payable, and the payment of salaries expense of $21,000. What net effect do these entries have on owners’ equity? a. Increase of $40,000 b. Increase of $27,000 c. Increase of $19,000 d. Increase of $6,000

92.

Mune Company recorded journal entries for the payment of $50,000 of dividends, the $32,000 increase in accounts receivable for services rendered, and the purchase of equipment for $21,000. What net effect do these entries have on owners’ equity? a. Decrease of $71,000 b. Decrease of $39,000 c. Decrease of $18,000 d. Increase of $11,000

93.

Murphy Company sublet a portion of its warehouse for five years at an annual rental of $24,000, beginning on May 1, 2008. The tenant, Sheri Charter, paid one year’s rent in advance, which Murphy recorded as a credit to Unearned Rental Income. Murphy reports on a calendar-year basis. The adjustment on December 31, 2008 for Murphy should be a. No entry b. Unearned Rent Revenue .................................................... 8,000 Rent Revenue ............................................................ 8,000 c. Rent Revenue ..................................................................... 8,000 Unearned Rent Revenue ............................................ 8,000 d. Unearned Rent Revenue .................................................... 16,000 Rent Revenue ............................................................ 16,000

The Accounting Information System

3 - 17

94.

Pappy Corporation received cash of $13,500 on September 1, 2008 for one year’s rent in advance and recorded the transaction with a credit to Unearned Rent. The December 31, 2008 adjusting entry is a. debit Rent Revenue and credit Unearned Rent, $4,500. b. debit Rent Revenue and credit Unearned Rent, $9,000. c. debit Unearned Rent and credit Rent Revenue, $4,500. d. debit Cash and credit Unearned Rent, $9,000.

95.

Panda Corporation paid cash of $18,000 on June 1, 2008 for one year’s rent in advance and recorded the transaction with a debit to Prepaid Rent. The December 31, 2008 adjusting entry is a. debit Prepaid Rent and credit Rent Expense, $7,500. b. debit Prepaid Rent and credit Rent Expense, $10,500. c. debit Rent Expense and credit Prepaid Rent, $10,500. d. debit Prepaid Rent and credit Cash, $7,500.

96.

Tate Company purchased equipment on November 1, 2008 and gave a 3-month, 9% note with a face value of $20,000. The December 31, 2008 adjusting entry is a. debit Interest Expense and credit Interest Payable, $1,800. b. debit Interest Expense and credit Interest Payable, $450. c. debit Interest Expense and credit Cash, $300. d. debit Interest Expense and credit Interest Payable, $300.

97.

During the first year of Wisnewski Co.’s operations, all purchases were recorded as assets. Store supplies in the amount of $6,450 were purchased. Actual year-end store supplies inventory amounted to $2,150. The adjusting entry for store supplies will a. increase net income by $4,390. b. increase expenses by $4,390. c. decrease store supplies by $6,450. d. debit Accounts Payable for $2,150.

98.

Brown Company's account balances at December 31, 2008 for Accounts Receivable and the related Allowance for Doubtful Accounts are $460,000 debit and $700 credit, respectively. From an aging of accounts receivable, it is estimated that $12,500 of the December 31 receivables will be uncollectible. The necessary adjusting entry would include a credit to the allowance account for a. $12,500. b. $13,200. c. $11,800. d. $700.

99.

Chen Company's account balances at December 31, 2008 for Accounts Receivable and the Allowance for Doubtful Accounts are $320,000 debit and $600 credit. Sales during 2008 were $900,000. It is estimated that 1% of sales will be uncollectible. The adjusting entry would include a credit to the allowance account for a. $9,600. b. $9,000. c. $8,400. d. $3,200.

3 - 18 100.

Test Bank for Intermediate Accounting, Second Edition Starr Corporation loaned $90,000 to another corporation on December 1, 2008 and received a 3-month, 8% interest-bearing note with a face value of $90,000. What adjusting entry should Starr make on December 31, 2008? a. Debit Interest Receivable and credit Interest Revenue, $1,800 b. Debit Cash and credit Interest Revenue, $600 c. Debit Interest Receivable and credit Interest Revenue, $600 d. Debit Cash and credit Interest Receivable, $1,800

Use the following information for questions 101 and 102: A company receives interest on a $30,000, 8%, 5-year note receivable each April 1. At December 31, 2007, the following adjusting entry was made to accrue interest receivable: Interest Receivable .................................................................. 1,800 Interest Revenue ............................................................. 1,800 101.

Assuming that the company does not use reversing entries, what entry should be made on April 1, 2008 when the annual interest payment is received? a. Cash ................................................................................... 600 Interest Revenue ..................................................... 600 b. Cash ................................................................................... 1,800 Interest Receivable .................................................. 1,800 c. Cash ................................................................................... 2,400 Interest Receivable .................................................. 1,800 Interest Revenue ..................................................... 600 d. Cash ................................................................................... 2,400 Interest Revenue ..................................................... 2,400

*102. Assuming that the company does use reversing entries, what entry should be made on April 1, 2008 when the annual interest payment is received? a. Cash .................................................................................. 600 Interest Revenue .................................................... 600 b. Cash .................................................................................. 1,800 Interest Receivable ................................................. 1,800 c. Cash .................................................................................. 2,400 Interest Receivable ................................................. 1,800 Interest Revenue .................................................... 600 d. Cash .................................................................................. 2,400 Interest Revenue ..................................................... 2,400 103.

Big-Mouth Frog Corporation had revenues of $200,000, expenses of $120,000, and dividends of $30,000. When Income Summary is closed to Retained Earnings, the amount of the debit or credit to Retained Earnings is a a. debit of $50,000. b. debit of $80,000. c. credit of $50,000. d. credit of $80,000.

The Accounting Information System 104.

3 - 19

The following account balances (normal balances) were taken from the journal entry used to transfer various merchandise accounts under a periodic inventory system into the Cost of Goods Sold account: Cost of Goods Sold $235,000 Inventory (beginning) 62,500 Transportation-In 6,700 Purchase Discounts 4,500 Purchases 214,000 Purchase Allowances 5,700 Based on the above facts, what was ending inventory? a. $21,000 b. $45,600 c. $38,000 d. $37,900

105.

The gross profit of Fordyce Company for 2008 is $75,000, cost of goods manufactured is $320,000, the beginning inventories of goods in process and finished goods are $22,000 and $25,000, respectively, and the ending inventories of goods in process and finished goods are $30,000 and $32,000, respectively. The sales of Fordyce Company for 2008 must have been a. $378,000. b. $385,000. c. $388,000. d. $398,000.

*106. Lopez Company received $6,400 on April 1, 2008 for one year's rent in advance and recorded the transaction with a credit to a nominal account. The December 31, 2008 adjusting entry is a. debit Rent Revenue and credit Unearned Rent, $1,600. b. debit Rent Revenue and credit Unearned Rent, $4,800. c. debit Unearned Rent and credit Rent Revenue, $1,600. d. debit Unearned Rent and credit Rent Revenue, $4,800. *107. Gibson Company paid $3,600 on June 1, 2008 for a two-year insurance policy and recorded the entire amount as Insurance Expense. The December 31, 2008 adjusting entry is a. debit Insurance Expense and credit Prepaid Insurance, $1,050. b. debit Insurance Expense and credit Prepaid Insurance, $2,550. c. debit Prepaid Insurance and credit Insurance Expense, $1,050. d. debit Prepaid Insurance and credit Insurance Expense, $2,550. *108. Garcia Corporation received cash of $18,000 on August 1, 2008 for one year's rent in advance and recorded the transaction with a credit to Rent Revenue. The December 31, 2008 adjusting entry is a. debit Rent Revenue and credit Unearned Rent, $7,500. b. debit Rent Revenue and credit Unearned Rent, $10,500. c. debit Unearned Rent and credit Rent Revenue, $7,500. d. debit Cash and credit Unearned Rent, $10,500.

3 - 20

Test Bank for Intermediate Accounting, Second Edition

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

91. 92. 93. 94.

c c d c

95. 96. 97. 98.

c d b c

99. 100. 101. *102.

b c c d

103. 104. 105. *106.

d c c a

*107. *108.

d b

MULTIPLE CHOICE—CPA Adapted 109.

On September 1, 2007, Lowe Co. issued a note payable to National Bank in the amount of $600,000, bearing interest at 12%, and payable in three equal annual principal payments of $200,000. On this date, the bank's prime rate was 11%. The first payment for interest and principal was made on September 1, 2008. At December 31, 2008, Lowe should record accrued interest payable of a. $24,000. b. $22,000. c. $16,000. d. $14,667.

110.

Eaton Co. sells major household appliance service contracts for cash. The service contracts are for a one-year, two-year, or three-year period. Cash receipts from contracts are credited to Unearned Service Revenues. This account had a balance of $1,800,000 at December 31, 2008 before year-end adjustment. Service contract costs are charged as incurred to the Service Contract Expense account, which had a balance of $450,000 at December 31, 2008. Service contracts still outstanding at December 31, 2008 expire as follows: During 2009 $380,000 During 2010 570,000 During 2011 350,000 What amount should be reported as Unearned Service Revenues in Eaton's December 31, 2008 balance sheet? a. $1,350,000 b. $1,300,000 c. $850,000 d. $500,000

111.

In November and December 2008, Lane Co., a newly organized magazine publisher, received $90,000 for 1,000 three-year subscriptions at $30 per year, starting with the January 2009 issue. Lane included the entire $90,000 in its 2008 income tax return. What amount should Lane report in its 2008 income statement for subscriptions revenue? a. $0 b. $5,000 c. $30,000 d. $90,000

The Accounting Information System

3 - 21

112.

On June 1, 2008, Nott Corp. loaned Horn $400,000 on a 12% note, payable in five annual installments of $80,000 beginning January 2, 2009. In connection with this loan, Horn was required to deposit $5,000 in a noninterest-bearing escrow account. The amount held in escrow is to be returned to Horn after all principal and interest payments have been made. Interest on the note is payable on the first day of each month beginning July 1, 2008. Horn made timely payments through November 1, 2008. On January 2, 2009, Nott received payment of the first principal installment plus all interest due. At December 31, 2008, Nott's interest receivable on the loan to Horn should be a. $0. b. $4,000. c. $8,000. d. $12,000.

113.

Allen Corp.'s liability account balances at June 30, 2008 included a 10% note payable in the amount of $2,400,000. The note is dated October 1, 2006 and is payable in three equal annual payments of $800,000 plus interest. The first interest and principal payment was made on October 1, 2007. In Allen's June 30, 2008 balance sheet, what amount should be reported as accrued interest payable for this note? a. $180,000 b. $120,000 c. $60,000 d. $40,000

114.

Colaw Co. pays all salaried employees on a biweekly basis. Overtime pay, however, is paid in the next biweekly period. Colaw accrues salaries expense only at its December 31 year end. Data relating to salaries earned in December 2008 are as follows: Last payroll was paid on 12/26/08, for the 2-week period ended 12/26/08. Overtime pay earned in the 2-week period ended 12/26/08 was $10,000. Remaining work days in 2008 were December 29, 30, 31, on which days there was no overtime. The recurring biweekly salaries total $180,000. Assuming a five-day work week, Colaw should record a liability at December 31, 2008 for accrued salaries of a. $54,000. b. $64,000. c. $108,000. d. $118,000.

115.

Tolan Corp.'s trademark was licensed to Eddy Co. for royalties of 15% of sales of the trademarked items. Royalties are payable semiannually on March 15 for sales in July through December of the prior year, and on September 15 for sales in January through June of the same year. Tolan received the following royalties from Eddy: March 15 September 15 2007 $5,000 $7,500 2008 6,000 8,500 Eddy estimated that sales of the trademarked items would total $40,000 for July through December 2008. In Tolan's 2008 income statement, the royalty revenue should be a. $14,500. b. $16,000. c. $20,500. d. $22,000.

3 - 22 116.

Test Bank for Intermediate Accounting, Second Edition At December 31, 2008, Sue’s Boutique had 1,000 gift certificates outstanding, which had been sold to customers during 2008 for $50 each. Sue’s operates on a gross margin of 60% of its sales. What amount of revenue pertaining to the 1,000 outstanding gift certificates should be deferred at December 31, 2008? a. $0 b. $20,000 c. $30,000 d. $50,000

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

109. 110.

c b

111. 112.

a c

113. 114.

b b

115. 116.

a d

DERIVATIONS — Computational No.

Answer

Derivation

91.

$40,000 –- $21,000 = $19,000.

92.

$50,000 – $32,000 = $18,000.

93.

$24,000 × 8/12 = $16,000.

94.

$13,500 × 4/12 = $4,500.

95.

$18,000 × 7/12 = $10,500.

96.

2/12 × 9% × $20,000 = $300.

97.

$6,450 – $2,150 = $4,390.

98.

$12,500 – $700 = $11,800.

99.

$900,000 × 1% = $9,000.

100.

1/12 × 8% × $90,000 = $600.

101.

$30,000 × 8% = $2,400.

*102.

103.

$200,000 – $120,000 = $80,000.

104.

($62,500 + $214,000 – $4,500 – $5,700 + $6,700) – $235,000 = $38,000.

105.

($25,000 + $320,000 – $32,000) + $75,000 = $388,000.

The Accounting Information System *106.

3/12 × $6,400 = $1,600.

*107.

17/24 × $3,600 = $2,550.

*108.

7/12 × $18,000 = $10,500.

3 - 23

DERIVATIONS — CPA Adapted No.

Answer

109.

Derivation ($600,000 – $200,000) × 12% × 4/12 = $16,000.

110.

$380,000 + $570,000 + $350,000 = $1,300,000.

111.

$0, none of the $90,000 is earned.

112.

$400,000 × 12% × 2/12 = $8,000.

113.

$1,600,000 × 9/12 × 10% = $120,000.

114.

$10,000 + ($180,000 ÷ 10 × 3) = $64,000.

115.

$8,500 + ($40,000 × 15%) = $14,500.

116.

1,000 × $50 = $50,000.

EXERCISES Ex. 3-117—Terminology. In the space provided at the right, write the word or phrase that is defined or indicated. 1. Revenue and expense accounts.

1. _______________________________________

2. An optional step in the accounting cycle.

2. _______________________________________

3. A revenue collected, but not earned.

3. _______________________________________

4. A revenue earned, but not collected.

4. _______________________________________

5. Asset, liability, and equity accounts.

5. _______________________________________

6. An expense paid, but not incurred.

6. _______________________________________

7. An expense incurred, but not paid.

7. _______________________________________

3 - 24

Test Bank for Intermediate Accounting, Second Edition

Solution 3-117 1. 2. 3. 4.

Nominal (temporary) accounts. Reversing entries. Unearned revenue. Accrued revenue.

5. Real (permanent) accounts. 6. Prepaid expense. 7. Accrued expense.

Ex. 3-118—Definitions. Provide clear, concise answers for the following. 1. What is the accrual basis of accounting? 2. What is an accrued expense? 3. What is accrued revenue? 4. What is a prepaid expense? 5. What is unearned revenue? *6. State the rule that indicates which adjusting entries for prepaid and unearned items should be reversed.

Solution 3-118 1. The accrual basis of accounting recognizes revenue when earned and recognizes expenses in the period incurred. 2. An accrued expense is incurred, but will be paid in the future. 3. Accrued revenue is earned, but will be collected in the future. 4. A prepaid expense is paid, but will be incurred in the future. 5. Unearned revenue is collected, but will be earned in the future. *6. Adjusting entries that create an asset or a liability account should be reversed. This would include prepaid and unearned items originally recorded in a revenue or expense account.

Ex. 3-119—Accrued items and deferred (unearned or prepaid) items. Generally accepted accounting principles require the use of accruals and deferrals in the determination of income. How is income determined under the accrual basis of accounting? Include in your answer what constitutes an accrued item and a deferred (prepaid) item, and give appropriate examples of each.

Solution 3-119 Accrual accounting recognizes and reports the effects of transactions and other events in the time periods to which they relate rather than only when cash is received or paid. Accrual accounting attempts to match revenues and the expenses associated with those revenues in order to determine net income for an accounting period. An accrued item is an item of revenue or expense that has been earned or incurred during the period, but has not yet been collected or paid in cash. An example of an accrued revenue is rent

The Accounting Information System

3 - 25

for the last month of an accounting period that has been earned by a landlord but not yet paid by the tenant. An example of an accrued expense is salaries incurred for the last week of an accounting period that are not payable until the subsequent accounting period. A deferred (unearned or prepaid) item is an item of revenue or expense that has been received or paid in cash, but has not yet been earned or consumed. An example of a deferred revenue is unearned subscription revenue collected in advance of being earned. An example of a deferred expense is an insurance premium paid at the end of an accounting period which will provide insurance coverage for the first six months of the subsequent period.

Ex. 3-120—Adjusting entries. Present, in journal form, the adjustments that would be made on July 31, 2008, the end of the fiscal year, for each of the following. 1. The supplies inventory on August 1, 2007 was $7,350. Supplies costing $20,150 were acquired during the year and charged to the supplies inventory. A count on July 31, 2008 indicated supplies on hand of $8,810. 2. On April 30, a ten-month, 9% note for $20,000 was received from a customer. *3. On March 1, $12,000 was collected as rent for one year and a nominal account was credited.

Solution 3-120 1. Supplies Expense .................................................................... Supplies Inventory ........................................................

18,690

2. Interest Receivable .................................................................. Interest Revenue ..........................................................

450

*3. Rent Revenue .......................................................................... Unearned Revenue.......................................................

7,000

18,690

450

7,000

Ex. 3-121—Adjusting entries. Reed Co. wishes to enter receipts and payments in such a manner that adjustments at the end of the period will not require reversing entries at the beginning of the next period. Record the following transactions in the desired manner and give the adjusting entry on December 31, 2008. (Two entries for each part.) 1. An insurance policy for two years was acquired on April 1, 2008 for $8,000. 2. Rent of $12,000 for six months for a portion of the building was received on November 1, 2008.

3 - 26

Test Bank for Intermediate Accounting, Second Edition

Solution 3-121 1. Prepaid Insurance .................................................................... Cash ............................................................................. Insurance Expense ................................................................... Prepaid Insurance .........................................................

8,000

2. Cash ......................................................................................... Unearned Rent.............................................................. Unearned Rent ......................................................................... Rent Revenue ...............................................................

12,000

8,000 3,000 3,000

12,000 4,000 4,000

Ex. 3-122 The adjusted trial balance of Ryan Financial Planners appears below. Using the information from the adjusted trial balance, you are to prepare for the month ending December 31: 1. an income statement. 2. a statement of retained earnings. 3. a balance sheet. RYAN FINANCIAL PLANNERS Adjusted Trial Balance December 31, 2008

Cash............................................................................................... Accounts Receivable ...................................................................... Office Supplies ............................................................................... Office Equipment ............................................................................ Accumulated Depreciation—Office Equipment ............................... Accounts Payable........................................................................... Unearned Revenue ........................................................................ Common Stock............................................................................... Retained Earnings .......................................................................... Dividends ..................................................................................... Service Revenue ............................................................................ Office Supplies Expense ................................................................ Depreciation Expense .................................................................... Rent Expense.................................................................................

Debit $ 4,400 2,200 1,800 15,000

Credit

$ 4,000 3,800 5,000 10,000 4,400 2,500 3,700 600 2,500 1,900 $30,900

______ $30,900

The Accounting Information System Solution 3-122 1.

(20 min) RYAN FINANCIAL PLANNERS Income Statement For the Month Ended December 31, 2008

Revenues Service revenue ....................................................................... Expenses Depreciation expense............................................................... Rent expense ........................................................................... Office supplies expense ........................................................... Total expenses ...................................................................... Net loss .......................................................................................... 2.

$ 3,700 $2,500 1,900 600 5,000 $(1,300)

RYAN FINANCIAL PLANNERS Statement of Retained Earnings For the Month Ended December 31, 2008

Retained earnings, December 1 ..................................................... Less: Net loss ................................................................................ Dividends ............................................................................. Retained earnings, December 31 ................................................... 3.

3 - 27

$4,400 $1,300 2,500

3,800 $ 600

RYAN FINANCIAL PLANNERS Balance Sheet For the Month Ended December 31, 2008 Assets

Cash .............................................................................................. Accounts receivable ....................................................................... Office supplies ............................................................................... Office equipment ............................................................................ Less: Accumulated depreciation—office equipment ....................... Total assets ..............................................................................

$ 4,400 2,200 1,800 $15,000 4,000

11,000 $19,400

Liabilities and Stockholders’ Equity Liabilities Accounts payable ..................................................................... Unearned revenue ................................................................... Total liabilities ............................................................... Stockholders’ Equity Common stock ......................................................................... Retained earnings .................................................................... Total liabilities and stockholders’ equity ........................

$ 3,800 5,000 $ 8,800 10,000 600

10,600 $19,400

3 - 28

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Pr. 3-123—Adjusting entries and account classification. Selected amounts from Trent Company's trial balance of 12/31/08 appear below: 1. Accounts Payable $160,000 2. Accounts Receivable 150,000 3. Accumulated Depreciation—Equipment 200,000 4. Allowance for Doubtful Accounts 20,000 5. Bonds Payable 500,000 6. Cash 150,000 7. Common Stock 60,000 8. Equipment 840,000 9. Insurance Expense 30,000 10. Interest Expense 10,000 11. Merchandise Inventory 300,000 12. Notes Payable (due 6/1/09) 200,000 13. Prepaid Rent 150,000 14. Retained Earnings 818,000 15. Salaries and Wages Expense 328,000 (All of the above accounts have their standard or normal debit or credit balance.) Part A. a. b. c. d. e.

The equipment has a useful life of 15 years with no salvage value. (Straight-line method being used.) Interest accrued on the bonds payable is $15,000 as of 12/31/08. Expired insurance at 12/31/08 is $20,000. The rent payment of $150,000 covered the six months from November 30, 2007 through May 31, 2009. Salaries and wages earned but unpaid at 12/31/08, $22,000.

Part B.

a. b. c. d. e.

Prepare adjusting journal entries at year end, December 31, 2008, based on the following supplemental information.

Indicate the proper balance sheet classification of each of the 15 numbered accounts in the 12/31/08 trial balance before adjustments by placing appropriate numbers after each of the following classifications. If the account title would appear on the income statement, do not put the number in any of the classifications.

Current assets Property, plant, and equipment Current liabilities Long-term liabilities Stockholders' equity

The Accounting Information System

3 - 29

Solution 3-123 Part A. a. Depreciation Expense—Equipment ($840,000 – 0)  15 ................ Accumulated Depreciation—Equipment..............................

56,000 56,000

b. Interest Expense ............................................................................ Interest Payable ..................................................................

15,000

c. Prepaid Insurance .......................................................................... Insurance Expense ($30,000 – $20,000) ............................

10,000

d. Rent Expense ($150,000  6)......................................................... Prepaid Rent.......................................................................

25,000

e. Salaries and Wages Expense ........................................................ Salaries and Wages Payable ..............................................

22,000

15,000

10,000

25,000

22,000

Part B. a. Current assets—2, 4, 6, 11, 13 b. Property, plant, and equipment—3, 8 c. Current liabilities—1, 12 d. Long-term liabilities—5 e. Stockholders' equity—7, 14

Pr. 3-124—Adjusting entries. Data relating to the balances of various accounts affected by adjusting or closing entries appear below. (The entries which caused the changes in the balances are not given.) You are asked to supply the missing journal entries which would logically account for the changes in the account balances. 1. Interest receivable at 1/1/08 was $1,000. During 2008 cash received from debtors for interest on outstanding notes receivable amounted to $5,000. The 2008 income statement showed interest revenue in the amount of $5,400. You are to provide the missing adjusting entry that must have been made, assuming reversing entries are not made. 2. Unearned rent at 1/1/08 was $5,300 and at 12/31/08 was $8,000. The records indicate cash receipts from rental sources during 2008 amounted to $40,000, all of which was credited to the Unearned Rent Account. You are to prepare the missing adjusting entry. 3. Accumulated depreciation—equipment at 1/1/08 was $230,000. At 12/31/08 the balance of the account was $270,000. During 2008, one piece of equipment was sold. The equipment had an original cost of $40,000 and was 3/4 depreciated when sold. You are to prepare the missing adjusting entry. 4. Allowance for doubtful accounts on 1/1/08 was $50,000. The balance in the allowance account on 12/31/08 after making the annual adjusting entry was $65,000 and during 2008 bad debts written off amounted to $30,000. You are to provide the missing adjusting entry.

3 - 30

Test Bank for Intermediate Accounting, Second Edition

Pr. 3-124 (cont.) 5. Prepaid rent at 1/1/08 was $9,000. During 2008 rent payments of $120,000 were made and charged to "rent expense." The 2008 income statement shows as a general expense the item "rent expense" in the amount of $125,000. You are to prepare the missing adjusting entry that must have been made, assuming reversing entries are not made. 6. Retained earnings at 1/1/08 was $150,000 and at 12/31/08 it was $210,000. During 2008, cash dividends of $50,000 were paid and a stock dividend of $40,000 was issued. Both dividends were properly charged to retained earnings. You are to provide the missing closing entry.

Solution 3-124 1. Interest Receivable ................................................................... Interest Revenue........................................................... Interest revenue per books $5,400 Interest revenue received related to 2008 ($5,000 – $1,000) 4,000 Interest accrued $1,400

1,400

2. Unearned Rent Revenue .......................................................... Rent Revenue ............................................................... Cash receipts $40,000 Beginning balance 5,300 Ending balance (8,000) Rent revenue $37,300

37,300

Depreciation Expense.............................................................. Accumulated Depreciation—Equipment ........................ Ending balance $270,000 Beginning balance 230,000 Difference 40,000 Write-off at time of sale 3/4 × $40,000 30,000 $ 70,000

70,000

4. Bad Debt Expense.................................................................... Allowance for Doubtful Accounts ................................... Ending balance $65,000 Beginning balance 50,000 Difference 15,000 Written off 30,000 $45,000

45,000

5. Rent Expense ........................................................................... Prepaid Rent ................................................................. Rent expense $125,000 Less cash paid 120,000 Reduction in prepaid rent account $ 5,000

5,000

1,400

37,300

70,000

45,000

5,000

The Accounting Information System

3 - 31

Solution 3-124 (cont.) 6. Income Summary ..................................................................... Retained Earnings ........................................................ Ending balance $210,000 Beginning balance 150,000 Difference 60,000 Cash dividends $50,000 Stock dividends 40,000 90,000 $150,000

150,000 150,000

Pr. 3-125—Adjusting and closing entries. The following trial balance was taken from the books of Fisk Corporation on December 31, 2008. Account Cash Accounts Receivable Note Receivable Allowance for Doubtful Accounts Merchandise Inventory Prepaid Insurance Furniture and Equipment Accumulated Depreciation—F. & E. Accounts Payable Common Stock Retained Earnings Sales Cost of Goods Sold Salaries Expense Rent Expense Totals

Debit $ 12,000 40,000 7,000

Credit

$ 1,800 44,000 4,800 125,000 15,000 10,800 44,000 55,000 280,000 111,000 50,000 12,800 $406,600

$406,600

At year end, the following items have not yet been recorded. a. Insurance expired during the year, $2,000. b. Estimated bad debts, 1% of gross sales. c. Depreciation on furniture and equipment, 10% per year. d. Interest at 6% is receivable on the note for one full year. *e. Rent paid in advance at December 31, $5,400 (originally charged to expense). f. Accrued salaries at December 31, $5,800. Instructions (a) Prepare the necessary adjusting entries. (b) Prepare the necessary closing entries.

Solution 3-125 (a) Adjusting Entries a. Insurance Expense ................................................................ Prepaid Insurance ......................................................... b. Bad Debt Expense................................................................. Allowance for Doubtful Accounts...................................

2,000 2,000 2,800 2,800

3 - 32

Test Bank for Intermediate Accounting, Second Edition

Solution 3-125 (cont.) c. Depreciation Expense ............................................................ Accumulated Depreciation—F. & E. .............................. d. Interest Receivable ................................................................ Interest Revenue ........................................................... *e. Prepaid Rent .......................................................................... Rent Expense................................................................ f. Salaries Expense ................................................................... Salaries Payable ........................................................... (b) Closing Entries Sales ............................................................................................. Interest Revenue ........................................................................... Income Summary ................................................................

12,500 12,500 420 420 5,400 5,400 5,800 5,800

280,000 420 280,420

Income Summary .......................................................................... Salaries Expense ................................................................ Rent Expense ..................................................................... Depreciation Expense ......................................................... Bad Debt Expense .............................................................. Insurance Expense ............................................................. Cost of Goods Sold .............................................................

191,500

Income Summary .......................................................................... Retained Earnings ..............................................................

88,920

55,800 7,400 12,500 2,800 2,000 111,000

88,920

*Pr. 3-126—Eight-column worksheet. The trial balance of Winsor Corporation is reproduced on the following page. The information below is relevant to the preparation of adjusting entries needed to both properly match revenues and expenses for the period and reflect the proper balances in the real and nominal accounts. Instructions As the accountant for Winsor Corporation, you are to prepare adjusting entries based on the following data, entering the adjustments on the worksheet and completing the additional columns with respect to the income statement and balance sheet. Carefully key your adjustments and label all items. (Due to time constraints, an adjusted trial balance is not required.) Round all computations to the nearest dollar. (a) Winsor determined that one percent of sales will become uncollectible. (b) Depreciation is computed using the straight-line method, with an eight-year life and $1,000 salvage value. (c) Salesmen are paid commissions of 10% of sales. Commissions on sales for the last week of December have not been paid. (d) The note was issued on October 1, bearing interest at 8%, due Feb. 1, 2009. (e) A physical inventory of supplies indicated $440 of supplies currently in stock.

The Accounting Information System

3 - 33

*Pr. 3-126 (cont.) (f)

Provisions of a lease contract specify payments must be made one month in advance, with monthly payments at $800/mo. This provision has been complied with as of Dec. 31, 2008. Winsor Corporation Worksheet For the Year Ended December 31, 2008

Accounts Cash Trading Sec. Accounts Rec. Allow. for D. A. Mdse. Inventory Supplies Equipment Accum. Depr.-Eq. Accounts Payable Notes Payable Common Stock Ret. Earnings Cost of Goods Sold Office Salaries Exp. Sales Comm. Exp. Rent Expense Misc. Expense Sales Totals

Trial Balance Dr. Cr. 12,400 4,050 50,000 420 16,800 1,040 45,000 9,500 4,400 5,000 40,000 34,690 225,520 20,800 29,000 7,200 2,200 320,000 414,010 414,010

Adjustments Dr. Cr.

Income Statement Dr. Cr.

Balance Sheet Dr. Cr.

3 - 34

Test Bank for Intermediate Accounting, Second Edition

*Solution 3-126 Winsor Corporation Work Sheet For the Year Ended December 31, 2008 Accounts Cash Trading Sec. Accounts Rec. Allow. for D. A. Mdse. Inventory Supplies Equipment Accum. Depr.-Eq. Accounts Payable Notes Payable Common Stock Ret. Earnings Cost of Goods Sold Office Salaries Exp. Sales Comm. Exp. Rent Expense Misc. Expense Sales Totals

Trial Balance Adjustments Dr. Cr. Dr. Cr. 12,400 4,050 50,000 420 (a) 3,200 16,800 1,040 (e) 600 45,000 9,500 (b) 5,500 4,400 5,000 40,000 34,690 225,520 20,800 29,000 (c) 3,000 7,200 (f) 800 2,200 320,000 414,010 414,010

Bad Debt Exp. Depr. Exp. Sales Com. Pay. Interest Expense Interest Payable Supplies Expense Prepaid Rent Totals Net Income Totals

(a) 3,200 (b) 5,500 (d)

100

(e) (f)

600 800 13,200

100

13,200

Income Statement Dr. Cr.

225,520 20,800 32,000 6,400 2,200

Balance Sheet Dr. Cr. 12,400 4,050 50,000 3,620 16,800 440 45,000 15,000 4,400 5,000 40,000 34,690

320,000

3,200 5,500

3,000

100

600 296,320 23,680 320,000

320,000

800 129,490

320,000

129,490

105,810 23,680 129,490

Adjusting entries and explanations (a) Bad Debt Expense ($320,000 x 1%) ............................................... Allowance for Doubtful Accounts .........................................

3,200

(b) Depreciation Expense .................................................................... Accumulated Depreciation—Equipment .............................. ($45,000 – $1,000 is $44,000. One-eighth of $44,000 is $5,500.)

5,500

(c) Sales Commissions ........................................................................ Sales Commissions Payable ............................................... (10% of sales is 10% × $320,000, which is $32,000. The balance in the Sales Commissions account is $29,000 before adjustment, indicating that $3,000 of commissions are accrued but unpaid.)

3,000

3,200 5,500

3,000

The Accounting Information System

3 - 35

*Solution 3-126 (cont.) (d) Interest Expense ............................................................................ Interest Payable .................................................................. ($5,000 × .08 × 3/12 = $100)

100

(e) Supplies Expense .......................................................................... Supplies .............................................................................. (The balance of $1,040 in the Supplies account before adjustment less the correct ending balance of $440 is $600.)

600

(f) Prepaid Rent .................................................................................. Rent Expense ..................................................................... (Since the trial balance contains no account for prepaid rent, the $800 lease payment has apparently been debited to Rent Expense. An account must be set up for the Prepaid Rent.)

800

100

600

800

Pr. 3-127—Accounting Cycle. The post-closing trial balance of Pat Callahan Company at December 31, 2007 is shown below. Account No. 101 102 103 104 105 106 107 108 109 110 200 201 202 203 300 301 400 401 500 501 502 503 504 505 506

Account Cash Investment in Bonds Accounts Receivable Allowance for Doubtful Accounts Interest Receivable Inventory (perpetual) Building (15-year life) Accumulated Depreciation—Building Delivery Truck (5-year life, $3,000 salvage) Accumulated Depreciation—Trucks Accounts Payable Notes Payable Wages Payable Income Taxes Payable Common Par Value $1.00 Retained Earnings Sales Interest Revenue Operating Expenses Wages Expense Depreciation Expense—Building Depreciation Expense—Trucks Bad Debt Expense Cost of Goods Sold Income Tax Expense

Debit $46,000 50,000 28,000

900 *24,000 45,000 12,000 18,000 6,000 18,000 29,000 5,000 85,000 55,100

$211,000 *Ending Inventory (12/31/08) $26,000.

Credit

$211,000

3 - 36

Test Bank for Intermediate Accounting, Second Edition

Pr. 3-127 (cont.) The following transactions took place during 2008. 1. 2. 3. 4. 5.

Collected: Accounts Receivable, $25,000; Interest on Bonds $5,000; Cash Sales, $80,000; (Cost of Goods Sold $14,000). Paid: Accounts Payable, $15,000; Notes Payable, $21,000; Income Taxes Payable, $5,000; Operating Expenses, $37,000. Purchased inventory, $32,000, of which $16,000 was purchased on account. (Assume perpetual inventory.) Made sales on account, $85,000 (Cost of Goods Sold $16,000). On June 30, 2008, purchased a second delivery truck for $15,000, paying cash. The truck has a useful life of 10 years and a salvage value of $3,000.

Instructions a. Journalize each of the above transactions of the Pat Callahan Company. Some items require more than one journal entry. b. Post the entries to appropriate accounts. (You should set up a T-account for each account noted on the trial balance.) c. Prepare a trial balance after posting the journal entries and enter the amounts on a 10column worksheet like the one shown in the text. Enter all of the accounts shown on the original trial balance. *d. Enter the following adjustments on the worksheet: (a) Accrued wages at year end total $700; (b) Bad debt expense is estimated at 1% of credit sales; (c) Record straight-line depreciation on the building and trucks; (d) Accrued interest on the investments in bonds is $1,500; (e) Income tax expense for 2008 is $21,065. The tax is not due until 2009. *e. Complete the income statement and balance sheet columns of the worksheet.

c., d., and e.

No. 101 102 103 104 105 106 107 108 109 110 200 201 202 203 300 301 400 401 500 501 502 503 504 505 506

Account Cash Investment in Bonds Accounts Receivable Allow. For Doubtful Accounts Interest Receivable Inventory Building Accum. Depreciation —Building Delivery Trucks Accum. Depreciation —Trucks Accounts Payable Notes Payable Wags Payable Income Taxes Payable Common Stock Retained Earnings Sales Interest Revenue Operating Expense Wages Expense Deprec. Exp.—Bldg. Deprec. Exp.—Trucks Bad Debts Expense Cost of Goods Sold Income Tax Expense Totals Net Income

Pat Callahan Company Ten-Column Worksheet December 31, 2008 Trial Balance Dr. Cr.

Adjustments Dr. Cr.

Adj. Trial Balance Dr. Cr.

Income Statement Dr. Cr.

Balance Sheet Dr. Cr.

3 - 38

Test Bank for Intermediate Accounting, Second Edition

Solution 3-127 a. Item 1:

Item 2:

Item 3:

Item 4:

Item 5:

Cash ................................................................................ Accounts Receivable ............................................... Cash ................................................................................ Interest Revenue ..................................................... Cash ................................................................................ Sales ....................................................................... Cost of Goods Sold .......................................................... Inventory .................................................................

25,000

Accounts Payable ............................................................ Cash ........................................................................ Notes Payable.................................................................. Cash ........................................................................ Income Taxes Payable ..................................................... Cash ........................................................................ Operating Expenses......................................................... Cash ........................................................................

15,000

Inventory .......................................................................... Cash ........................................................................ Accounts Payable ....................................................

32,000

Accounts Receivable........................................................ Sales ....................................................................... Cost of Goods Sold .......................................................... Inventory .................................................................

85,000

Delivery Truck .................................................................. Cash ........................................................................

15,000

25,000 5,000 5,000 80,000 80,000 14,000 14,000 15,000 21,000 21,000 5,000 5,000 37,000 37,000 16,000 16,000 85,000 16,000 16,000 15,000

b. 46,000 (1) 25,000 (1) 5,000 (1) 80,000

Cash 15,000 (2) 21,000 (2) 5,000 (2) 37,000 (2) 16,000 (3) 15,000 (5)

Investment in Bonds 50,000

47,000 Allowance for Doubtful Accounts 900

Accounts Receivable 28,000 25,000 (1) (4) 85,000

88,000

Interest Receivable

Inventory 24,000 14,000 (1) (3) 32,000 16,000 (4)

26,000

The Accounting Information System

3 - 39

Solution 3-127 (cont.) Building 45,000

Accumulated Depreciation—Building 12,000

Delivery Truck 18,000 (5) 15,000

33,000 Accumulated Depreciation—Trucks 6,000

Accounts Payable (2) 15,000 18,000 16,000 (4)

Notes Payable (2) 21,000 29,000

19,000 Wages Payable

Retained Earnings 55,100

8,000

Income Taxes Payable (2) 5,000 5,000

Sales 80,000 (1) 85,000 (3)

Common Stock 85,000

Interest Revenue 5,000 (1)

165,000

Operating Expenses (2) 37,000

Depreciation Expense—Trucks

Wages Expense

Bad Debts Expense

Depreciation Expense—Building

Cost of Goods Sold (1) 14,000 (4) 16,000

30,000

Income Tax Expense

Solution 3-127 (cont.) c., d., and e.

No. 101 102 103 104 105 106 107 108 109 110 200 201 202 203 300 301 400 401 500 501 502 503 504 505 506

Pat Callahan Company Ten-Column Worksheet December 31, 2008 Trial Balance Dr. Cr. 47,000 50,000 88,000

Account Cash Investment in Bonds Accounts Receivable Allow. For Doubtful Accounts Interest Receivable Inventory 26,000 Building 45,000 Accum. Depreciation —Building Delivery Trucks 33,000 Accum. Depreciation —Trucks Accounts Payable Notes Payable Wages Payable Income Taxes Payable Common Stock Retained Earnings Sales Interest Revenue Operating Expense 37,000 Wages Expense Deprec. Exp.—Bldg. Deprec. Exp.—Trucks Bad Debts Expense Cost of Goods Sold 30,000 Income Tax Expense Totals $356,000 Net Income

900

Adjustments Dr. Cr.

(d) 1,500

(b)

850

12,000

6,000 19,000 8,000

1,500 26,000 45,000 33,000

(a) 700 (c) 21,065

85,000 55,100 165,000 5,000

(d) 1,500 (a) 700 (c) 3,000 (c) 3,600 (b) 850

$356,000

Adj. Trial Balance Dr. Cr. 47,000 50,000 88,000

37,000 700 3,000 3,600 850 30,000 21,065 $30,715 $386,715

Income Statement Dr. Cr.

1,750

1,500 26,000 45,000

15,000 9,600 19,000 8,000 700 21,065 85,000 55,100 165,000 6,500

$386,715

Balance Sheet Dr. Cr. 47,000 50,000 88,000

33,000

37,000 700 3,000 3,600 850 30,000 21,065 96,215 75,285 $171,500

15,000 9,600 19,000 8,000 700 21,065 85,000 55,100

165,000 6,500

171,500 $171,500

1,750

$290,500

215,215 75,285 $290,500

CHAPTER 4 BALANCE SHEET TRUE-FALSE—Conceptual Answer

No.

Description

F T T F T F T F F T T F T F F T F F F T T T T F F

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25.

Liquidity and solvency. Limitations of the balance sheet. Definition of financial flexibility. Balance sheet definition. Items included in balance sheet. Definition of current assets. Classifying restricted cash. Definition of available-for-sale securities. Reporting available-for-sale securities. Definition of current liabilities. Definition of long-term liabilities. Stockholders’ equity accounts. Long-term liability disclosures. Definitions of the balance sheet. Land held for speculation. Balance sheet format. Disclosure of fair values. Disclosure of company operations and estimates. Contingent liability vs. estimated liability. Disclosure of contracts and contingencies. Disclosure of dividends in arrears. Using the term reserve. Disclosure of pertinent information. Use of the term reserve. Adjunct account.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38.

Limitation of the balance sheet. Uses of the balance sheet. Uses of the balance sheet. Criticisms of the balance sheet. Definition of liquidity. Definition of solvency. Primary purpose of balance sheet. Operating cycle concept. Effect of transaction on balance sheet. Identification of current asset. Distinction between current and noncurrent assets. Items included as current assets. Identification of current asset.

4-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

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

39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73.

Prepaid expenses as current assets. Current and long-term liabilities. Identification of current liability. Assets and liabilities comprising working capital. Effect of converting short-term note payable. Computing total stockholders’ equity. Definition of net assets. Current assets presentation. Operating cycle. Operating cycle. Identification of current asset. Identification of current asset. Identification of current asset. Classification of short-term investments. Classification of inventory pledged as security. Identification of long-term investments. Identification of valuation methods. Identification of current liabilities. Definition of working capital. Identification of working capital items. Identification of long-term liabilities. Identification of long-term liabilities. Classification of treasury stock. Disclosures for common stock. Classification of investment in affiliate. Classification of owners' equity. Classification of assets. Identification of contra account. Balance sheet supplementary disclosure. Methods of disclosure. Disclosure of significant accounting policies. Disclosure of depreciation methods used. Required notes to the financial statements. Identification of generally accepted account titles. Use of the term “reserve.”

MULTIPLE CHOICE—Computational Answer

No.

Description

c a b d a b

74. 75. 76. 77. 78. 79.

Classifying investments. Identifying intangible assets Calculate total stockholders’ equity. Classifying investments. Identifying intangible assets. Calculate total stockholders’ equity.

Balance Sheet

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

d d a c b c

80. 81. 82. 83. 84. 85.

Calculate total current assets. Calculate total current assets. Calculate total current liabilities. Calculate retained earnings balance. Calculate current and long-term liabilities. Summary of significant accounting policies.

EXERCISES Item

Description

E4-86 E4-87 E4-88 E4-89 E4-90 E4-91 E4-92 E4-93 E4-94

Balance sheet classification. Definitions. Terminology. Current assets. Account classification. Valuation of balance sheet items. Balance sheet classifications. Balance sheet classifications. Balance sheet classifications.

PROBLEMS Item

Description

P4-95 P4-96 P4-97

Balance sheet format. Balance sheet preparation. Balance sheet preparation.

CHAPTER LEARNING OBJECTIVES 1. Explain the uses and limitations of a balance sheet. 2. Identify the major classifications of the balance sheet. 3. Prepare a classified balance sheet using the report and account formats. 4. Determine which balance sheet information requires supplemental disclosure. 5. Determine the major disclosure techniques for the balance sheet.

4-3

4-4

Test Bank for Intermediate Accounting, Second Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2.

TF TF

3. 4.

TF TF

26. 27.

5. 6. 7. 8. 9. 10. 11. 12. 13. 14.

TF TF TF TF TF TF TF TF TF TF

15. 31. 32. 33. 34. 35. 36. 37. 38. 39.

TF MC MC MC MC MC MC MC MC MC

40. 41. 42. 43. 44. 45. 46. 47. 48. 49.

16.

66.

17. 18.

TF TF

19. 20.

TF TF

21. 67.

22. 23.

TF TF

24. 25.

TF TF

68. 69.

Note: TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 MC 28. MC 30. MC 29. MC Learning Objective 2 MC 50. MC 60. MC 51. MC 61. MC 52. MC 62. MC 53. MC 63. MC 54. MC 64. MC 55. MC 65. MC 56. MC 74. MC 57. MC 75. MC 58. MC 76. MC 59. MC 77. Learning Objective 3 Learning Objective 4 TF 85. MC 87. MC 86. E 88. Learning Objective 5 MC 70. MC 72. MC 71. MC 73. E = Exercise P = Problem

Type

Item

Type

Item

Type

MC MC MC MC MC MC MC MC MC MC

78. 79. 80. 81. 82. 83. 84. 86. 87. 88.

MC MC MC MC MC MC MC E E E

89. 90. 91. 92. 93. 94. 95. 96. 97.

E E E E E E P P P

E E

90. 92.

E E

94. 95.

E P

MC MC

Balance Sheet

4-5

TRUE FALSE—Conceptual 1. Liquidity refers to the ability of an enterprise to pay its debts as they mature. 2. The balance sheet omits many items that are of financial value to the business but cannot be recorded objectively. 3. Financial flexibility measures the ability of an enterprise to take effective actions to alter the amounts and timing of cash flows. 4. The balance sheet reflects a corporation's results of operations for a specified period of time. 5. The three general classes of items included in the balance sheet are assets, liabilities, and equity. 6. Current assets include only assets expected to be sold within one year or the operating cycle, whichever is longer. 7. If cash is restricted for purposes other than the liquidation of current obligations, it should not be classified as a current asset. 8. Available-for-sale investments are debt securities that the enterprise has the positive intent and ability to hold to maturity. 9. Securities classified as available-for-sale should be reported at cost. 10. Current liabilities are the obligations that are reasonably expected to be liquidated either by creation of other current liabilities or through the use of current assets. 11. Long-term liabilities are obligations that are not reasonably expected to be liquidated within one year or the normal operating cycle, whichever is longer. 12. The stockholders' equity accounts used by a corporation are the same as those used in accounting for a partnership or proprietorship. 13. Companies frequently describe the terms of all long-term liability agreements in notes to the financial statements. 14. An asset which is expected to be converted into cash, sold, or consumed within one year of the balance sheet date is always reported as a current asset. 15. Land held for speculation is reported in the property, plant, and equipment section of the balance sheet. 16. The account form and the report form of the balance sheet are both acceptable under GAAP. 17. Because of the historical cost principle, fair values may not be disclosed in the balance sheet.

4-6

Test Bank for Intermediate Accounting, Second Edition

18. Companies have the option of disclosing information about the nature of their operations and the use of estimates in preparing financial statements. 19. A contingent liability and an estimated liability are treated in the same manner for financial statement reporting purposes. 20. Contracts and negotiations of significance, in addition to contingencies, are disclosed in footnotes to the financial statements. 21. Notes are commonly used to disclose the existence and amount of any preferred stock dividends in arrears. 22. The AICPA has recommended that the word "reserve" be used only to describe an appropriation of retained earnings. 23. Companies may use parenthetical explanations, notes, cross references, and supporting schedules to disclose pertinent information. 24. The accounting profession has recommended that companies use the word “reserve” only to describe amounts deducted from assets. 25. On the balance sheet, an adjunct account reduces an asset, a liability, or an owners’ equity account.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5.

F T T F T

6. 7. 8. 9. 10.

F T F F T

11. 12. 13. 14. 15.

T F T F F

16. 17. 18. 19. 20.

T F F F T

21. 22. 23. 24. 25.

T T T F F

MULTIPLE CHOICE—Conceptual 26.

Which of the following is a limitation of the balance sheet? a. Many items that are of financial value are omitted. b. Judgments and estimates are used. c. Current fair value is not reported. d. All of these

27.

The balance sheet is useful for analyzing all of the following except a. liquidity. b. solvency. c. profitability. d. financial flexibility.

Balance Sheet

4-7

28.

The balance sheet contributes to financial reporting by providing a basis for all of the following except a. computing rates of return. b. evaluating the capital structure of the enterprise. c. determining the increase in cash due to operations. d. assessing the liquidity and financial flexibility of the enterprise.

29.

One criticism not normally aimed at a balance sheet prepared using current accounting and reporting standards is a. failure to reflect current value information. b. the extensive use of separate classifications. c. an extensive use of estimates. d. failure to include items of financial value that cannot be recorded objectively.

30.

The amount of time that is expected to elapse until an asset is realized or otherwise converted into cash is referred to as a. solvency. b. financial flexibility. c. liquidity. d. exchangeability.

31.

Solvency refers to the a. ability of an enterprise to pay its debts as they mature. b. amount of time that is expected to elapse until an asset is realized. c. amount of time that is expected to elapse until a liability has to be paid. d. amount of time that is expected to elapse until an asset is converted into cash.

32.

The primary purpose of the balance sheet is to reflect a. the firm's potential for growth in stock values in the stock market. b. items of value, debts, and net worth. c. the value of items owned by the firm. d. the status of the firm's assets in case of forced liquidation of the firm.

33.

For accounting purposes, the operating cycle concept a. has become obsolete. b. affects the income statement but not the balance sheet. c. permits some assets to be classified as current even though they are more than one year removed from becoming cash. d. causes the distinction between current and noncurrent items to depend on whether they will affect cash within one year.

34.

If $1,240 cash and a $4,760 note are given in exchange for a delivery truck to be used in a business, a. assets and liabilities will change by the same amount. b. owners' equity will be increased. c. assets will increase and liabilities decrease. d. assets and liabilities will increase but by different amounts.

4-8

Test Bank for Intermediate Accounting, Second Edition

35.

Which of the following is not a current asset? a. Prepaid property taxes that relate to the next operating period b. The cash surrender value of a life insurance policy carried by a corporation on its president c. Marketable securities purchased as a temporary investment of cash d. Installment notes receivable due over 15 months in accordance with normal trade practices

36.

Of the following statements, which best illustrates the fact that the formal distinction made between current and noncurrent assets is somewhat arbitrary? a. Cash in a checking account is a current asset, while cash in a savings account is more permanent and is normally classified as noncurrent. b. Inventory that may be sold next year, or in the subsequent year as demand dictates may be classified as current or noncurrent. c. Accounts receivable due in less than one year or the operating cycle are classified as current assets, while accounts receivable due in longer than one year or the operating cycle are classified as noncurrent. d. An amount equal to the current depreciation charge on buildings should be placed in the current assets section at the beginning of the year, because it will be consumed in the next operating cycle.

37.

Which of the following items should never be included in the current assets section of the balance sheet? a. Receivable from a customer outstanding for more than a year b. Deferred income taxes resulting from interperiod tax allocation c. Three-year premium for fire insurance on plant and equipment d. A pension fund

38.

Of the following items, the one which should be classified as a current asset is a. trade installment receivables normally collectible in 20 months. b. a deposit on equipment ordered, delivery of which will be made within 7 months. c. cash designated for the redemption of callable bonds. d. cash surrender value of a life insurance policy of which the company is a beneficiary.

39.

Prepaid expenses are included in the current assets section of the balance sheet because a. they will be converted into cash within one year or the operating cycle, whichever is longer. b. if they had not been already paid they would require the use of cash during the next year or operating cycle. c. they were already included in operating expenses on the income statement in the year cash was expended. d. they reflect payments that were made in a prior period that will not be charged to expense in the current period.

40.

One of the main reasons for separating liabilities into current and long-term is to a. provide decision makers with information regarding currently maturing debts. b. separate large and small debts. c. separate capital into its component parts. d. separate total equity into its two basic parts.

Balance Sheet

4-9

41.

A liability to be paid next year would not be included in the current liability section of the balance sheet if the debt is expected to be refinanced through another long-term issue, or a. the operating cycle is less than one year. b. the liability is to be paid with cash that the company expects to earn during the next year. c. if the debt is to be retired out of noncurrent assets. d. the liability is the result of a nonoperating debt instrument due within the next year.

42.

A characteristic of all assets and liabilities comprising working capital is that they are a. monetary. b. marketable. c. current. d. cash equivalents.

43.

If a company converted a short-term note payable into a long-term note payable, this transaction would a. increase both working capital and net income. b. decrease only working capital. c. increase only working capital. d. decrease both working capital and owners' equity.

44.

How are the following items handled in computing the total stockholders' equity section of the balance sheet? a. b. c. d.

Treasury Stock Added Added Subtracted Subtracted

Additional Paid-in Capital Added Subtracted Added Subtracted

45.

The net assets of a business are equal to a. current assets minus current liabilities. b. total assets plus total liabilities. c. total assets minus total stockholders' equity. d. none of these.

46.

The correct order to present current assets is a. cash, accounts receivable, prepaid items, inventories. b. cash, accounts receivable, inventories, prepaid items. c. cash, inventories, accounts receivable, prepaid items. d. cash, inventories, prepaid items, accounts receivable.

47.

The basis for classifying assets as current or noncurrent is conversion to cash within the a. accounting cycle or one year, whichever is shorter. b. operating cycle or one year, whichever is longer. c. accounting cycle or one year, whichever is longer. d. operating cycle or one year, whichever is shorter.

4 - 10

Test Bank for Intermediate Accounting, Second Edition

48.

The basis for classifying assets as current or noncurrent is the period of time normally required by the accounting entity to convert cash invested in a. inventory back into cash, or 12 months, whichever is shorter. b. receivables back into cash, or 12 months, whichever is longer. c. tangible fixed assets back into cash, or 12 months, whichever is longer. d. inventory back into cash, or 12 months, whichever is longer.

49.

The current assets section of the balance sheet should include a. machinery. b. patents. c. goodwill. d. inventory.

50.

Which of the following is a current asset? a. Cash surrender value of a life insurance policy of which the company is the beneficiary. b. Investment in equity securities for the purpose of controlling the issuing company. c. Cash designated for the purchase of tangible fixed assets. d. Trade installment receivables normally collectible in 18 months.

51.

Which of the following should not be considered as a current asset in the balance sheet? a. Installment notes receivable due over 18 months in accordance with normal trade practice. b. Prepaid taxes which cover assessments of the following operating cycle of the business. c. Equity or debt securities purchased with cash available for current operations. d. The cash surrender value of a life insurance policy carried by a corporation, the beneficiary, on its president.

52.

Equity or debt securities held to finance future construction of additional plants should be classified on a balance sheet as a. current assets. b. property, plant, and equipment. c. intangible assets. d. long-term investments.

53.

When a portion of inventories has been pledged as security on a loan, a. the value of the portion pledged should be subtracted from the debt. b. an equal amount of retained earnings should be appropriated. c. the fact should be disclosed but the amount of current assets should not be affected. d. the cost of the pledged inventories should be transferred from current assets to noncurrent assets.

54.

Which of the following is not a long-term investment? a. Cash surrender value of life insurance b. Franchise c. Land held for speculation d. A sinking fund

Balance Sheet 55.

4 - 11

A generally accepted method of valuation is 1. trading securities at market value. 2. accounts receivable at net realizable value. 3. inventories at current cost. a. b. c. d.

1 2 3 1 and 2

56.

Which item below is not a current liability? a. Unearned revenue b. Stock dividends distributable c. The currently maturing portion of long-term debt d. Trade accounts payable

57.

Working capital is a. capital which has been reinvested in the business. b. unappropriated retained earnings. c. cash and receivables less current liabilities. d. none of these.

58.

An example of an item which is not an element of working capital is a. accrued interest on notes receivable. b. goodwill. c. goods in process. d. temporary investments.

59.

Long-term liabilities include a. obligations not expected to be liquidated within the operating cycle. b. obligations payable at some date beyond the operating cycle. c. deferred income taxes and most lease obligations. d. all of these.

60.

Which of the following should be excluded from long-term liabilities? a. Obligations payable at some date beyond the operating cycle b. Most pension obligations c. Long-term liabilities that mature within the operating cycle and will be paid from a sinking fund d. None of these

61.

Treasury stock should be reported as a(n) a. current asset. b. investment. c. other asset. d. reduction of stockholders' equity.

62.

Which of the following should be reported for capital stock? a. The shares authorized b. The shares issued c. The shares outstanding d. All of these

4 - 12

Test Bank for Intermediate Accounting, Second Edition

63.

Which of the following would be classified in a different major section of a balance sheet from the others? a. Capital stock b. Common stock subscribed c. Stock dividend distributable d. Stock investment in affiliate

64.

The stockholders' equity section is usually divided into what three parts? a. Preferred stock, common stock, treasury stock b. Preferred stock, common stock, retained earnings c. Capital stock, additional paid-in capital, retained earnings d. Capital stock, appropriated retained earnings, unappropriated retained earnings

65.

Which of the following is not an acceptable major asset classification? a. Current assets b. Long-term investments c. Property, plant, and equipment d. Deferred charges

66.

Which of the following is a contra account? a. Premium on bonds payable b. Unearned revenue c. Patents d. Accumulated depreciation

67.

Which of the following balance sheet classifications would normally require the greatest amount of supplementary disclosure? a. Current assets b. Current liabilities c. Plant assets d. Long-term liabilities

68.

Which of the following is not a method of disclosing pertinent information? a. Supporting schedules b. Parenthetical explanations c. Cross reference and contra items d. All of these are methods of disclosing pertinent information.

69.

Significant accounting policies may not be a. selected on the basis of judgment. b. selected from existing acceptable alternatives. c. unusual or innovative in application. d. omitted from financial-statement disclosure.

70.

A general description of the depreciation methods applicable to major classes of depreciable assets a. is not a current practice in financial reporting. b. is not essential to a fair presentation of financial position. c. is needed in financial reporting when company policy differs from income tax policy. d. should be included in corporate financial statements or notes thereto.

Balance Sheet

4 - 13

71.

It is mandatory that the essential provisions of which of the following be clearly stated in the notes to the financial statements? a. Stock option plans b. Pension obligations c. Lease contracts d. All of these

72.

A generally accepted account title is a. Prepaid Revenue. b. Appropriation for Contingencies. c Earned Surplus. d. Reserve for Doubtful Accounts.

73.

Which of the following reflects proper use of the term “reserve” in the preparation of financial statements? a. The term used to describe amounts deducted from assets, such as "reserve for depreciation." b. The initial term used in connection with an estimated liability, such as "estimated reserve for product warranty." c. The term used to describe the setting aside of funds for the subsequent payment of an existing liability, such as "reserve for bonds payable." d. The term used to describe an appropriation of retained earnings in the stockholders' equity section of the balance sheet.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

26. 27. 28. 29. 30. 31. 32.

d c c b c a b

33. 34. 35. 36. 37. 38. 39.

c a b d d a b

40. 41. 42. 43. 44. 45. 46.

a c c c c d b

47. 48. 49. 50. 51. 52. 53.

b d d d d d c

54. 55. 56. 57. 58. 59. 60.

b d b d b d d

61. 62. 63. 64. 65. 66. 67.

d d d c d d d

68. 69. 70. 71. 72. 73.

d d d d b d

Solutions to those Multiple Choice questions for which the answer is “none of these.” 45. Total assets minus total liabilities. 57. Current assets less current liabilities. 60. Many answers are possible.

4 - 14

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Computational 74.

Garret Company owns the following investments: Trading securities (fair value) Available-for-sale securities (fair value) Held-to-maturity securities (amortized cost)

$60,000 35,000 47,000

Garret will report investments in its current assets section of a. $0. b. exactly $60,000. c. $60,000 or an amount greater than $60,000, depending on the circumstances. d. exactly $95,000. 75.

For Nicholson Company, the following information is available: Capitalized leases Trademarks Long-term receivables

$200,000 65,000 75,000

In Nicholson’s balance sheet, intangible assets should be reported at a. $65,000. b. $75,000. c. $265,000. d. $275,000. 76.

Sam Hurd Company has the following items: common stock, $720,000; treasury stock, $85,000; deferred taxes, $100,000; retained earnings, $313,000. What total amount should Sam Hurd Company report as stockholders’ equity? a. $848,000 b. $948,000 c. $1,048,000 d. $1,118,000

77.

Horton Company owns the following investments: Trading securities (fair value) Available-for-sale securities (fair value) Held-to-maturity securities (amortized cost)

$60,000 35,000 47,000

Horton will report securities in its long-term investments section of a. exactly $95,000. b. exactly $107,000. c. exactly $142,000. d. $82,000 or an amount less than $82,000, depending on the circumstances. 78.

For Mitchell Company, the following information is available: Capitalized leases Trademarks Long-term receivables

$280,000 90,000 105,000

In Mitchell’s balance sheet, intangible assets should be reported at a. $90,000. b. $105,000. c. $370,000. d. $385,000.

Balance Sheet 79.

4 - 15

Stanton Company has the following items: common stock, $720,000; treasury stock, $85,000; deferred taxes, $100,000; retained earnings, $363,000. What total amount should Stanton Company report as stockholders’ equity? a. $898,000 b. $998,000 c. $1,098,000 d. $1,198,000

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

74. 75.

c a

76. 77.

b d

78. 79.

a b

MULTIPLE CHOICE—CPA Adapted 80.

Reese Corp.'s trial balance reflected the following account balances at December 31, 2008: Accounts receivable (net) $24,000 Trading securities 6,000 Accumulated depreciation on equipment and furniture 15,000 Cash 11,000 Inventory 30,000 Equipment 25,000 Patent 4,000 Prepaid expenses 2,000 Land held for future business site 18,000 In Reese's December 31, 2008 balance sheet, the current assets total is a. $90,000. b. $82,000. c. $77,000. d. $73,000.

Use the following information for questions 81 through 83. The following trial balance of Scott Corp. at December 31, 2008 has been properly adjusted except for the income tax expense adjustment.

4 - 16

Test Bank for Intermediate Accounting, Second Edition Scott Corp. Trial Balance December 31, 2008

Cash Accounts receivable (net) Inventory Property, plant, and equipment (net) Accounts payable and accrued liabilities Income taxes payable Deferred income tax liability Common stock Additional paid-in capital Retained earnings, 1/1/08 Net sales and other revenues Costs and expenses Income tax expenses

Dr. 775,000 2,695,000 2,085,000 7,366,000

Cr.

$ 1,701,000 654,000 85,000 2,350,000 3,680,000 3,450,000 13,360,000 11,180,000 1,179,000 $25,280,000

$25,280,000

Other financial data for the year ended December 31, 2008: •

Included in accounts receivable is $1,200,000 due from a customer and payable in quarterly installments of $150,000. The last payment is due December 29, 2010.

•

The balance in the Deferred Income Tax Liability account pertains to a temporary difference that arose in a prior year, of which $20,000 is classified as a current liability.

•

During the year, estimated tax payments of $525,000 were charged to income tax expense. The current and future tax rate on all types of income is 30%.

In Scott's December 31, 2008 balance sheet, 81.

The current assets total is a. $6,080,000. b. $5,555,000. c. $5,405,000. d. $4,955,000.

82.

The current liabilities total is a. $1,850,000. b. $1,915,000. c. $2,375,000. d. $2,440,000.

83.

The final retained earnings balance is a. $4,451,000. b. $4,536,000. c. $4,976,000. d. $4,905,000.

Balance Sheet

4 - 17

84.

On January 4, 2008, Gregg Co. leased a building to Cole Corp. for a ten-year term at an annual rental of $75,000. At inception of the lease, Gregg received $300,000 covering the first two years' rent of $150,000 and a security deposit of $150,000. This deposit will not be returned to Cole upon expiration of the lease but will be applied to payment of rent for the last two years of the lease. What portion of the $300,000 should be shown as a current and long-term liability in Gregg's December 31, 2008 balance sheet? Current Liability Long-term Liability a. $0 $300,000 b. $75,000 $150,000 c. $150,000 $150,000 d. $150,000 $75,000

85.

Which of the following facts concerning fixed assets should be included in the summary of significant accounting policies? Depreciation Method Composition a. No Yes b. Yes Yes c. Yes No d. No No

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

80. 81.

d d

82. 83.

a c

84. 85.

b c

DERIVATIONS — Computational No.

Answer

74.

75. 76.

a b

77.

78.

79.

Derivation

$720,000 – $85,000 + $313,000 = $948,000.

$720,000 – $85,000 + $363,000 = $998,000.

DERIVATIONS — CPA Adapted No.

Answer

Derivation

80. 81.

d d

$24,000 + $6,000 + $11,000 + $30,000 + $2,000 = $73,000. $775,000 + [$2,695,000 – ($150,000 × 4)] + $2,085,000 = $4,955,000.

82.

$1,701,000 + ($654,000 – $525,000) + $20,000 = $1,850,000.

83.

$3,450,000 + $13,360,000 – $11,180,000 – ($1,179,000 – $525,000) = $4,976,000.

84.

Conceptual.

85.

Conceptual.

4 - 18

Test Bank for Intermediate Accounting, Second Edition

EXERCISES Ex. 4-86—Balance sheet classification. Indicate the most preferred balance sheet classification of each item in Group B by inserting the appropriate letter from Group A in the space provided. Group A

Group B

A. B.

Current assets Property, plant and equipment C. Long-term investments D. Intangible assets E. Other assets F. Current liabilities G. Long-term liabilities H. Capital stock I. Additional paid-in capital J. Unappropriated retained earnings K. Appropriated retained earnings L. Footnote disclosure M. Not shown on balance sheet

_____ 1. _____ 2. _____ 3. _____ 4. _____ 5. _____ 6. _____ 7. _____ 8. _____ 9. _____ 10. _____ 11. _____ 12. _____ 13. _____ 14. _____ 15. _____ 16. _____ 17. _____ 18. _____ 19. _____ 20.

Cash fund for plant expansion Preferred stock Franchise Accrued interest on customers' notes Dividend payable in cash Premium on common stock Non-fund reserve for possible inventory loss Advances to suppliers Accrued employee wages Unexpired insurance Ten-year bonds issued to finance plant acquisition Land Uncertain outcome of a pending lawsuit Undistributed portion of current year's net income Accumulated depreciation Stock dividend distributable Discount on bonds payable Sinking fund for bond retirement Patent Purchase commitment (3 years)

Solution 4-86 1. 2. 3. 4. 5.

C H D A F

6. I 7. K 8. A 9. F 10. A

11. G 12. B 13. L 14. J 15. B

16. H 17. G 18. C 19. D 20. L or M

Ex. 4-87—Definitions. Provide clear, concise answers for the following. 1. What are assets? 2. What are liabilities? 3. What is equity? 4. What are current liabilities? 5. Explain what working capital is and how it is computed. 6. What are intangible assets? 7. What are current assets?

Balance Sheet

4 - 19

Solution 4-87 1. Assets are probable future economic benefits obtained or controlled by an entity as a result of past transactions or events. 2. Liabilities are probable future sacrifices of economic benefits arising from present obligations of an entity as a result of past transactions or events. 3. Equity is the residual interest in the net assets of an entity. 4. Current liabilities are obligations that are expected to be liquidated through the use of current assets or the creation of other current liabilities. 5. Working capital is the net amount of a company’s relatively liquid resources. It is the excess of total current assets over total current liabilities. 6. Intangible assets are economic resources or competitive advantages. They lack physical substance and have a high degree of uncertainty about the future benefits to be received. 7. Current assets are resources (future economic benefits) expected to be converted to cash, sold, or consumed in one year or the operating cycle, whichever is longer.

Ex. 4-88—Terminology. In the space provided at right, write the word or phrase that is defined or indicated. 1. Obligations expected to be liquidated through use of current assets.

1. __________________________________

2. Statement showing financial condition at a point in time.

2. __________________________________

3. Events that depend upon future outcomes.

3. __________________________________

4. Probable future sacrifices of economic benefits.

4. __________________________________

5. Resources expected to be converted to cash in one year or the operating cycle, whichever is longer.

5. __________________________________

6. Resources of a durable nature used in operations.

6. __________________________________

7. Economic rights or competitive advantages which lack physical substance.

7. __________________________________

8. Probable future economic benefits.

8. __________________________________

9. Residual interest in the net assets of an entity.

9. __________________________________

4 - 20

Test Bank for Intermediate Accounting, Second Edition

Solution 4-88 1. 2. 3. 4. 5.

Current liabilities. Balance sheet. Contingencies. Liabilities. Current assets.

6. 7. 8. 9.

Property, plant, and equipment. Intangible assets. Assets. Equity.

Ex. 4-89—Current assets. Define current assets without using the word "asset."

Solution 4-89 Current assets are resources (future economic benefits) expected to be converted to cash, sold, or consumed in one year or the operating cycle, whichever is longer.

Ex. 4-90—Account classification. a. b. c. d. e.

ASSETS Current assets Investments Plant and equipment Intangibles Other assets

LIABILITIES AND STOCKHOLDERS’ EQUITY f. Current liabilities g. Long-term liabilities h. Preferred stock i. Common stock j. Additional paid-in capital k. Retained earnings l. Items excluded from balance sheet

Using the letters above, classify the following accounts according to the preferred and ordinary balance sheet presentation. ____ 1. Bond sinking fund ____ 2. Common stock distributable ____ 3. Appropriation for plant expansion ____ 4. Bank overdraft ____ 5. Bonds payable (due 2010) ____ 6. Premium on common stock ____ 7. Securities owned by another company which are collateral for that company's note ____ 8. Trading securities ____ 9. Inventory ____ 10. Unamortized discount on bonds payable ____ 11. Patents ____ 12. Unearned revenue

Balance Sheet

4 - 21

Solution 4-90 1. 2. 3. 4.

b i k f

5. 6. 7. 8.

g j l a

9. 10. 11. 12.

a g d f

Ex. 4-91—Valuation of Balance Sheet Items. Use the code letters listed below (a – l) to indicate, for each balance sheet item (1 – 13) listed below the usual valuation reported on the balance sheet. ____

1. Common stock

____

8. Long-term bonds payable

____

2. Prepaid expenses

____

9. Land (in use)

____

3. Natural resources

____ 10. Land (future plant site)

____

4. Property, plant, and equipment

____ 11. Patents

____

5. Trade accounts receivable

____ 12. Trading securities

____

6. Copyrights

____ 13. Trade accounts payable

____

7. Merchandise inventory

a. Par value b. Current cost of replacement c. Amount payable when due, less unamortized discount or plus unamortized premium d. Amount payable when due e. Market value at balance sheet date f.

Net realizable value

g. Lower of cost or market h. Original cost less accumulated amortization i.

Original cost less accumulated depletion

Original cost less accumulated depreciation

k. Historical cost l.

Unexpired or unconsumed cost

Solution 4-91 1. 2. 3. 4. 5.

a l i j f

6. 7. 8. 9. 10.

h g c k k

11. 12. 13.

h e d

4 - 22

Test Bank for Intermediate Accounting, Second Edition

Ex. 4-92—Balance sheet classifications. Typical balance sheet classifications are as follows. a. Current Assets g. b. Investments h. c. Plant Assets i. d. Intangible Assets j. e. Other Assets k. f. Current Liabilities l.

Long-Term Liabilities Capital Stock Additional Paid-In Capital Retained Earnings Notes to Financial Statements Not Reported on Balance Sheet

Indicate by use of the above letters how each of the following items would be classified on a balance sheet prepared at December 31, 2008. If a contra account, or any amount that is negative or opposite the normal balance, put parentheses around the letter selected. A letter may be used more than once or not at all. ____ 1. Accrued salaries and wages

____ 16. Natural resource—timberlands

____ 2. Rental revenues for 3 months collected in advance

____ 17. Deficit (no net income earned since beginning of company)

____ 3. Land used as plant site

____ 18. Goodwill

____ 4. Equity securities classified as trading

____ 19. 90-day notes payable

____ 5. Cash

____ 20. Investment in bonds of another company; will be held to 2010 maturity

____ 6. Accrued interest payable due in 30 days

____ 21. Land held for speculation

____ 7. Premium on preferred stock issued

____ 22. Death of company president

____ 8. Dividends in arrears on preferred stock

____ 23. Current maturity of bonds payable

____ 9. Petty cash fund

____ 24. Investment in subsidiary; no plans to sell in near future

____ 10. Unamortized discount on bonds payable due 2010

____ 25. Trade accounts payable ____ 26.

Preferred stock ($10 par)

____ 27.

Prepaid rent for next 12 months

____ 11. Common stock at par value ____ 12. Bond indenture covenants ____ 28. Copyright ____ 13. Unamortized premium on bonds payable due in 2013 ____ 14. Allowance for doubtful accounts ____ 15. Accumulated depreciation

____ 29. Accumulated amortization, patents ____ 30. Earnings not distributed to stockholders

4 - 23

Balance Sheet Solution 4-92 1. 2. 3. 4. 5.

f f c a a

6. 7. 8. 9. 10.

f i k a (g)

11. 12. 13. 14. 15.

h k g (a) (c)

16. 17. 18. 19. 20.

c (j) d f b

21. 22. 23. 24. 25.

b l f b f

26. 27. 28. 29. 30.

h a d (d) j

Ex. 4-93—Balance sheet classifications. The various classifications listed below have been used in the past by Pyle Company on its balance sheet. It asks your professional opinion concerning the appropriate classification of each of the items 1-14 below. a. b. c. d. e.

Current Assets Investments Plant and Equipment Intangible Assets Other Assets

f. g. h. i.

Current Liabilities Long-Term Liabilities Common Stock and Paid-in Capital in Excess of Par Retained Earnings

Indicate by letter how each of the following items should be classified. If an item need not be reported on the balance sheet, use the letter "X." A letter may be used more than once or not at all. If an item can be classified in more than one category, choose the category most favored by the authors of your textbook. ____ 1. Employees' payroll deductions. ____ 2. Cash in sinking fund. ____ 3. Rent revenue collected in advance. ____ 4. Equipment retired from use and held for sale. ____ 5. Patents. ____ 6. Payroll cash fund. ____ 7. Goods held on consignment. ____ 8. Accrued revenue on temporary investments. ____ 9. Advances to salespersons. ____ 10. Premium on bonds payable due two years from date. ____ 11. Bank overdraft. ____ 12. Salaries which company budget shows will be paid to employees within the next year. ____ 13. Work in process. ____ 14. Appropriation for bonded indebtedness.

4 - 24

Test Bank for Intermediate Accounting, Second Edition

Solution 4-93 1. 2. 3. 4.

f b f a or e

5. 6. 7. 8.

d a x a

9. 10. 11. 12.

a g f x

13. 14.

a i

Ex. 4-94—Balance sheet classifications. The various classifications listed below have been used in the past by Lowe Company on its balance sheet. a. b. c. d.

Current Assets Investments Plant and Equipment Intangible Assets

e. f. g. h.

Current Liabilities Long-term Liabilities Common Stock and Paid-in Capital in Excess of Par Retained Earnings

Instructions Indicate by letter how each of the items below should be classified at December 31, 2008. If an item is not reported on the December 31, 2008 balance sheet, use the letter "X" for your answer. If the item is a contra account within the particular classification, place parentheses around the letter. A letter may be used more than once or not at all. Sample question and answer: (a)

Allowance for doubtful accounts.

____ 1. Customers' accounts with credit balances. ____ 2. Bond sinking fund. ____ 3. Salaries which the company's cash budget shows will be paid to employees in 2008. ____ 4. Accumulated depreciation. ____ 5. Appropriation for plant expansion. ____ 6. Amortization of patents for 2008. ____ 7. On December 31, 2008, Lowe signed a purchase commitment to buy all of its raw materials from Delta Company for the next 2 years. ____ 8. Discount on bonds payable due March 31, 2010. ____ 9. Launching of Lowe’s Internet retailing division in February, 2009. ____ 10. Cash dividends declared on December 15, 2008 payable to stockholders on January 15, 2009.

Balance Sheet

4 - 25

Solution 4-94 1. e 2. b 3. x

4. 5. 6.

7. 8. 9.

x (f) x

10.

PROBLEMS Pr. 4-95—Balance sheet format. The following balance sheet has been submitted to you by an inexperienced bookkeeper. List your suggestions for improvements in the format of the balance sheet. Consider both terminology deficiencies as well as classification inaccuracies. Densen Industries, Inc. Balance Sheet For the Period Ended 12/31/08 Assets Fixed Assets—Tangible Equipment $110,000 Less: reserve for depreciation (40,000) $ 70,000 Factory supplies 22,000 Land and buildings 400,000 Less: reserve for depreciation (150,000) 250,000 Plant site held for future use 90,000 $ 432,000 Current Assets Accounts receivable 175,000 Cash 80,000 Inventory 220,000 Treasury stock (at cost) 20,000 495,000 Fixed Assets--Intangible Goodwill 80,000 Notes receivable 40,000 Patents 26,000 146,000 Deferred Charges Advances to salespersons 60,000 Prepaid rent 27,000 Returnable containers 75,000 162,000 TOTAL ASSETS $1,235,000 Liabilities Current Liabilities Accounts payable $140,000 Allowance for doubtful accounts 8,000 Common stock dividend distributable 35,000 Income taxes payable 42,000 Sales taxes payable 17,000 $ 242,000 Long-Term Liabilities, 5% debenture bonds, due 2010 500,000 Reserve for contingencies 150,000 650,000 TOTAL LIABILITIES 892,000

4 - 26

Test Bank for Intermediate Accounting, Second Edition

Pr. 4-95 (cont.) Equity Capital stock, $10.00 par value, issued 12,000 shares with 60 shares held as treasury stock Capital surplus Dividends paid Earned surplus TOTAL EQUITY TOTAL LIABILITIES AND EQUITY

$150,000 90,000 (20,000) 123,000 343,000 $1,235,000

Note 1. The reserve for contingencies has been created by charges to earned surplus and has been established to provide a cushion for future uncertainties. Note 2. The inventory account includes only items physically present at the main plant and warehouse. Items located at the company's branch sales office amounting to $40,000 are excluded since the company has consistently followed this procedure for many years.

Solution 4-95 1. The heading should be as of a specific date rather than for a period of time. 2. Reserve for Depreciation is poor terminology; the title Accumulated Depreciation is more appropriate. 3. Land and buildings should be segregated into two accounts. The Accumulated Depreciation account should only be reported for the buildings. 4. Plant site held for future use should be shown in the Investments section. 5. Current assets should be shown on the balance sheet first in most situations; current assets are listed usually in order of liquidity; factory supplies should be shown as a current asset. 6. Treasury stock is not an asset, but a contra account to stockholders' equity in most situations. 7. Notes receivable should be reported as a current asset or an investment. 8. The deferred charge items should be reclassified as follows in most situations: Advances to salespersons—current asset Prepaid rent—current asset Returnable containers—current asset 9. Allowance for doubtful accounts should be shown as a contra account to accounts receivable. 10. Common stock dividend distributable should be shown in stockholders' equity. 11. 5% debenture bonds should be shown on a separate line. 12. Reserve for Contingencies should be shown as an appropriation of retained earnings. The authors prefer the term "appropriation" to the term "reserve." 13. Capital stock should be shown at the par value of the shares issued, $120,000. Any excess should be included in a paid-in capital account.

Balance Sheet

4 - 27

Solution 4-95 (cont.) 14. Capital surplus and earned surplus are poor terminology. The terms "additional paid-in capital" and "retained earnings" are more appropriate. 15. The dividends paid title is a misnomer. It probably is a dividends declared item that should be closed to retained earnings. 16. No reference in the body of the statement is made to the notes. The order of the notes is wrong. 17. Note 2 indicates that the inventory account is understated by $40,000. 18. Specific identification and description of all significant accounting principles and methods that involve selection from among alternatives and/or those that are peculiar to a given industry should be disclosed in the annual report.

Pr. 4-96—Balance sheet presentation. The following balance sheet was prepared by the bookkeeper for Perry Company as of December 31, 2008. Perry Company Balance Sheet as of December 31, 2008 Cash Accounts receivable (net) Inventories Investments Equipment (net) Patents

$ 80,000 52,200 57,000 76,300 96,000 32,000 $393,500

Accounts payable Long-term liabilities Stockholders' equity

$ 75,000 100,000 218,500

$393,500

The following additional information is provided: 1. Cash includes the cash surrender value of a life insurance policy $9,400, and a bank overdraft of $2,500 has been deducted. 2. The net accounts receivable balance includes: (a) accounts receivable—debit balances $60,000; (b) accounts receivable—credit balances $4,000; (c) allowance for doubtful accounts $3,800. 3. Inventories do not include goods costing $3,000 shipped out on consignment. Receivables of $3,000 were recorded on these goods. 4. Investments include investments in common stock, trading $19,000 and available-for-sale $48,300, and franchises $9,000. 5. Equipment costing $5,000 with accumulated depreciation $4,000 is no longer used and is held for sale. Accumulated depreciation on the other equipment is $40,000. Instructions Prepare a balance sheet in good form (stockholders' equity details can be omitted.)

4 - 28

Test Bank for Intermediate Accounting, Second Edition

Solution 4-96 Perry Company Balance Sheet As of December 31, 2008 Assets Current assets Cash Trading securities Accounts receivable Less: Allowance for doubtful accounts Inventories *Equipment held for sale Total current assets

$ 73,100 19,000 $ 57,000 3,800

Investments Available-for-sale securities Cash surrender value

48,300 9,400

Property, plant, and equipment Equipment Less accumulated depreciation

135,000 40,000

Intangible assets Patents Franchises Total assets

32,000 9,000

(1)

(2) 53,200 60,000 1,000 206,300

(3) (4)

57,700

(5) 95,000

41,000 $400,000

Liabilities and Stockholders' Equity Current liabilities Accounts payable Bank overdraft Total current liabilities

$ 79,000 2,500 81,500

Long-term liabilities Total liabilities

100,000 181,500

Stockholders' equity Total liabilities and stockholders' equity

218,500 $400,000

(1) ($80,000 – $9,400 + $2,500) (2) ($60,000 – $3,000) (3) ($57,000 + $3,000) (4) ($5,000 – $4,000) (5) ($96,000 + $40,000 – $5,000 + $4,000) (6) ($75,000 + $4,000) *An alternative is to show it as an other asset.

(6)

Balance Sheet

4 - 29

Pr. 4-97—Balance sheet preparation. The following accounts appeared on the trial balance of Elbert Company at December 31, 2008. All accounts have normal balances. Notes Payable Accumulated Depreciation—Bldg. Supplies on Hand Accrued Salaries and Wages Investments in Debt Securities* Cash Bonds Payable Due 1/1/12 Allowance for Doubtful Accts. Franchise Notes Receivable Income Taxes Payable Preferred Stock** Appropriated Retained Earnings

$ 64,000 261,000 12,600 11,400 93,800 56,750 400,000 2,600 64,300 46,000 52,000 250,000 98,000

Accounts Receivable $172,800 Prepaid Expenses 18,750 Customers' Deposits 1,250 Common Stock*** 375,000 Unappropriated Retained Earnings ? Inventories (average cost) 526,750 Land at Cost 155,000 Trading Securities**** 24,400 Accrued Interest on Notes Payable 650 Buildings at Cost 642,000 Accounts Payable 136,650 Additional Paid-in Capital 54,600

* The company intends to hold the securities until maturity, which is in ten years. ** 8% cumulative; $10 par value; 25,000 shares authorized and outstanding. *** $1 par value 400,000 shares authorized; 375,000 shares issued and outstanding. **** The company intends to sell the trading securities in the next year. Instructions: Prepare a classified balance sheet for Elbert Company at December 31, 2008.

4 - 30

Test Bank for Intermediate Accounting, Second Edition

Solution 4-97 Elbert Company Balance Sheet December 31, 2008 Assets Current Assets Cash .............................................................................. Trading securities .......................................................... Accounts receivable ...................................................... $172,800 Less allowance for doubtful accounts ..................... 2,600 Notes receivable ............................................................ Inventories at average cost ............................................ Supplies on hand ........................................................... Prepaid expenses .......................................................... Total current assets ................................................ Long-term investments Securities to be held-to-maturity .................................... Property, plant, and equipment Land .............................................................................. Building ......................................................................... 642,000 Less accumulated depreciation ............................... 261,000 Total property, plant, and equipment ................ Intangible assets Franchise ...................................................................... Total assets ............................................................ Liabilities and Stockholders' Equity Current liabilities Notes payable ............................................................... Accounts payable .......................................................... Accrued interest on notes payable ................................. Income tax payable ....................................................... Accrued salaries and wages .......................................... Customers' deposits ...................................................... Total current liabilities ............................................. Long-term debt Bonds payable, due 1/1/12 ............................................ Total liabilities ......................................................... Stockholders' equity Paid-in capital: Preferred stock, 8% cumulative, $10 par value, 25,000 shares authorized and outstanding ............. Common stock, $1 par value, 400,000 shares authorized, 375,000 shares issued and outstanding Additional paid-in-capital................................................ Total Paid-in capital ....................................................... Retained earnings Appropriated ........................................................... $ 98,000 Unappropriated ....................................................... 106,000 Total stockholders' equity ................................. Total liabilities and stockholders' equity............

$ 56,750 24,400 170,200 46,000 526,750 12,600 18,750 $ 855,450 93,800 155,000 381,000 536,000 64,300 $1,549,550

$ 64,000 136,650 650 52,000 11,400 1,250 $ 265,950 400,000 665,950

$250,000 375,000 54,600 679,600

204,000 883,600 $1,549,550

CHAPTER 5 INCOME STATEMENT AND RELATED INFORMATION TRUE-FALSE—Conceptual Answer

No.

Description

T F F T T T T T F F T T F F F F T T T F T F F T F T F F T F F T T F T

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35.

Usefulness of the income statement. Limitations of the income statement. Earnings management. Transaction approach of income measurement. Limitation of the income statement. Advantage of single-step income statement. Single-step income statement. Revenues and gains. Multiple-step vs. single-step income statement. Multiple-step income statement. Multiple-step vs. single-step income statement. Multiple-step income statement. Current operating performance approach. Identification of discontinued operations. Disposal of a business component. Example of extraordinary loss. Unusual gains and losses. Classification of prior period adjustments. Change in accounting principle. Current operating performance approach. Reporting discontinued operations. Reporting extraordinary items. Irregular items. Intraperiod tax allocation. Intraperiod tax allocation. Disclosing earnings per share. Reporting earnings per share. Computation of earnings per share. Prior period adjustments. Retained earnings restrictions. Statement of retained earnings. Definition of prior period adjustment. Reporting comprehensive income. Comprehensive income definition. Reporting other comprehensive income.

5-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80.

Elements of the income statement. Usefulness of the income statement. Limitations of the income statement. Use of an income statement. Income statement reporting. Importance of the income statement to investors/creditors. Single-step income statement. Methods of preparing income statements. Income statement presentation. Event with no income statement effect. Net income effect. Selling expenses. Reporting merchandise inventory. Primary benefit of multiple-step income statement. All-inclusive vs. current operating performance concept. Identification of discontinued operations. Classification of an extraordinary item. Identification of an extraordinary item. Identification of extraordinary item criteria. Identification of an extraordinary item. Difference between revenues and gains. Accounting for change in accounting principle. Identifying a change in accounting principle. All-inclusive concept. Recognizing revenue vs. a gain. Classification of an extraordinary item. Identification of an extraordinary item. Identification of an extraordinary item. Identification of an extraordinary item. Presentation of unusual or infrequent items. Identification of a change in accounting principle. Classification of extraordinary items. EPS disclosures on income statement. Reporting discontinued operations. Reporting unusual or infrequent items. Intraperiod tax allocation. Purpose of intraperiod tax allocation. Earnings per share formula. Earnings per share disclosure. Reporting correction of an error. Retained earnings statement. Prior period adjustment. Identification of a prior period adjustment. Comprehensive income items. Providing information about components of comprehensive income.

Income Statement and Related Information

MULTIPLE CHOICE—Computational Answer

No.

Description

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

81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100.

Single-step income statement. Multiple-step income statement. Calculation of net sales. Presentation of gain on sale of plant assets. Calculate cost of goods sold. Calculate income before extraordinary items. Extraordinary items. Calculate income before extraordinary items. Calculate income before taxes and extraordinary items. Calculate extraordinary loss. Events affecting income from continuing operations. Calculation of events affecting net income. Disposal of a major business component. Tax effect on irregular items. Earnings per share. Retained earnings statement. Retained earnings statement. Retained earnings statement. Calculate balance of retained earnings. Calculate comprehensive income.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

d a a a d c a b a b

101. 102. 103. 104. 105. 106. 107. 108. 109. 110.

Calculate selling expenses. Calculate general and administrative expenses. Calculate selling expenses. Calculate general and administrative expenses. Calculate cost of goods manufactured. Calculate income before extraordinary item. Determine extraordinary loss. Determine infrequent gains not extraordinary. Determine infrequent losses not extraordinary. Identification of prior period adjustment.

EXERCISES Item E5-111 E5-112 E5-113 E5-114 E5-115 E5-116 E5-117 E5-118 E5-119 E5-120

Description Definitions. Terminology. Calculate net income from change in stockholders’ equity. Calculate net income from change in stockholders’ equity. Income statement classifications. Income statement relationships. Multiple-step income statement. Classification of income and retained earnings statement items. Multiple-step income statement. Placement of irregular items.

5-3

5-4

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Item

Description

P5-121 P5-122 P5-123 P5-124 P5-125 P5-126

Multiple-step income statement. Income statement form. Multiple-step income statement. Single-step income statement. Income statement and retained earnings statement. Income statement and retained earnings statement.

CHAPTER LEARNING OBJECTIVES 1.

Understand the uses and limitations of an income statement.

Prepare a single-step income statement.

Prepare a multiple-step income statement.

Explain how to report irregular items.

Explain intraperiod tax allocation.

Identify where to report earnings per share information.

Prepare a retained earnings statement.

Explain how to report other comprehensive income.

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2. 3.

TF TF TF

4. 5. 36.

TF TF MC

37. 38. 39.

9. 10. 11. 12. 43.

TF TF TF TF MC

44. 45. 46. 47. 48.

MC MC MC MC MC

49. 82. 83. 84. 85.

13. 14. 15. 16. 17. 18. 19. 20.

TF TF TF TF TF TF TF TF

21. 22. 23. 50. 51. 52. 53. 54.

TF TF TF MC MC MC MC MC

55. 56. 57. 58. 59. 60. 61. 62.

Type

Item

Type

Item

Learning Objective 1 MC 40. MC 112. MC 41. MC 113. MC 111. E 114. Learning Objective 2 TF 42. MC 81. Learning Objective 3 MC 101. MC 106. MC 102. MC 115. MC 103. MC 116. MC 104. MC 117. MC 105. MC 118. Learning Objective 4 MC 63. MC 86. MC 64. MC 87. MC 65. MC 88. MC 66. MC 89. MC 67. MC 90. MC 68. MC 91. MC 69. MC 92. MC 70. MC 93.

Type

Item

Type

124.

MC E E E E

119. 121. 123. 125. 126.

E P P P P

MC MC MC MC MC MC MC MC

104. 106. 107. 108. 109. 111. 112. 118.

MC MC MC MC MC E E E

Item

Type

120. 121. 122. 123. 124. 125. 126.

E P P P P P P

E E E

Income Statement and Related Information

24. 25.

TF TF

71. 72.

MC MC

94. 112.

26. 27.

TF TF

28. 68.

TF MC

73. 74.

29. 30. 31.

TF TF TF

32. 75. 76.

TF MC MC

77. 78. 96.

33.

34.

35.

Note:

TF = True-False MC = Multiple Choice

Learning Objective 5 MC 121. P 123. E 122. P 124. Learning Objective 6 MC 95. MC 119. MC 111. E 121. Learning Objective 7 MC 97. MC 110. MC 98. MC 111. MC 99. MC 112. Learning Objective 8 TF 79. MC 80.

5-5

P P

125. 126.

P P

E P

123. 124.

P P

125. 126.

P P

MC E E

118. 124. 125.

E P P

126.

100.

E = Exercise P = Problem

TRUE-FALSE—Conceptual 1. The income statement is useful for helping to assess the risk or uncertainty of achieving future cash flows. 2. A strength of the income statement as compared to the balance sheet is that items that cannot be measured reliably can be reported in the income statement. 3. Earnings management generally makes income statement information more useful for predicting future earnings and cash flows. 4. The transaction approach of income measurement focuses on the income-related activities that have occurred during the period. 5. One of the limitations of the income statement is that items that cannot be measured reliably are not reported in the income statement. 6. The primary advantage of the single-step format lies in the simplicity of presentation and the absence of any implication that one type of revenue or expense item has priority over another. 7. Companies frequently report income tax expense as the last item before net income on a single-step income statement. 8. Both revenues and gains increase both net income and owners’ equity. 9. Use of a multiple-step income statement will result in the company reporting a higher net income than if it used a single-step income statement.

5-6

Test Bank for Intermediate Accounting, Second Edition

10. The primary advantage of the multiple-step format lies in the simplicity of presentation and the absence of any implication that one type of revenue or expense item has priority over another. 11. Gross profit and income from operations are reported on a multiple-step but not a singlestep income statement. 12. The multiple-step income statement recognizes a separation of operating transactions from nonoperating transactions and matches costs and expenses with related revenues. 13. The advocates of the current operating performance approach include extraordinary items in the calculation of net income. 14. A manufacturer of computer hardware who sells all computer manufacturing facilities located in foreign countries can record the transaction as a disposal of a business component. 15. Phasing out of a product line or class of service is a disposal of assets that qualifies as a disposal of a component of a business. 16. An example of an extraordinary loss is a large write-down of accounts receivable caused by the unexpected bankruptcy of a major customer. 17. The FASB has specifically prohibited a net-of-tax treatment for gains and losses that are either unusual or nonrecurring but not both. 18. Adjustments that grow out of the use of estimates in accounting are not classified as prior period adjustments. 19. A change in accounting principle is considered appropriate only when it is demonstrated that the newly adopted principle is preferable to the old one. 20. The accounting profession has adopted a current operating performance approach to income reporting. 21. Companies report the results of operations of a component of a business that will be disposed of separately from continuing operations. 22. Gains or losses from exchange or translation of foreign currencies are reported as extraordinary items. 23. Discontinued operations, extraordinary items, and unusual gains and losses are all reported net of tax in the income statement. 24. Intraperiod tax allocation relates the income tax expense of the period to the specific items that give rise to the amount of the tax provision. 25. Intraperiod tax allocation causes a reduction in total income tax expense for the period in which it is used. 26. Because of its importance, earnings per share is required to be disclosed on the face of the income statement.

Income Statement and Related Information

5-7

27. A company that reports a discontinued operation or an extraordinary item has the option of reporting per share amounts for these items. 28. Dividends declared on common and preferred stock are subtracted from net income in the computation of earnings per share. 29. Prior period adjustments can either be added or subtracted in the Retained Earnings Statement. 30. Companies only restrict retained earnings to comply with contractual requirements or current necessity. 31. The statement of retained earnings shows the total change in stockholders' equity for a specified period. 32. A prior period adjustment results from the correction of an error in the financial statements of a prior period discovered subsequent to their issuance. 33. According to the FASB, displaying comprehensive income as a part of the statement of stockholders' equity is one of the acceptable ways of presenting comprehensive income items. 34. Comprehensive income includes all changes in equity during a period except those resulting from distributions to owners. 35. The components of other comprehensive income can be reported in a statement of stockholders’ equity.

True False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7.

T F F T T T T

8. 9. 10. 11. 12. 13. 14.

T F F T T F F

15. 16. 17. 18. 19. 20. 21.

F F T T T F T

22. 23. 24. 25. 26. 27. 28.

F F T F T F F

29. 30. 31. 32. 33. 34. 35.

T F F T T F T

5-8

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual 36.

The major elements of the income statement are a. revenues, cost of goods sold, selling expenses, and general expenses. b. operating section, nonoperating section, discontinued operations, extraordinary items, and cumulative effect. c. revenues, expenses, gains, and losses. d. all of these.

37.

Information in the income statement helps users to a. evaluate the past performance of the enterprise. b. provide a basis for predicting future performance. c. help assess the risk or uncertainty of achieving future cash flows. d. all of these.

38.

Limitations of the income statement include all of the following except a. items that cannot be measured reliably are not reported. b. only actual amounts are reported in determining net income. c. income measurement involves judgment. d. income numbers are affected by the accounting methods employed.

39.

Which of the following would represent the least likely use of an income statement prepared for a business enterprise? a. Use by customers to determine a company's ability to provide needed goods and services b. Use by labor unions to examine earnings closely as a basis for salary discussions c. Use by government agencies to formulate tax and economic policy d. Use by investors interested in the financial position of the entity

40.

The income statement reveals a. resources and equities of a firm at a point in time. b. resources and equities of a firm for a period of time. c. net earnings (net income) of a firm at a point in time. d. net earnings (net income) of a firm for a period of time.

41.

The primary reason the income statement is so important to investors and creditors relates to its ability to provide information helpful in a. determining the honesty of those involved in managing the enterprise. b. assessing the financial position of the entity at a point in time. c. predicting the amount, timing, and uncertainty of future cash flows. d. determining the amount of future income the entity may generate from current operations.

42.

The single-step income statement emphasizes a. the gross profit figure. b. total revenues and total expenses. c. extraordinary items and accounting changes more than these are emphasized in the multiple-step income statement. d. the various components of income from continuing operations.

Income Statement and Related Information

5-9

43.

Which of the following is an acceptable method of presenting the income statement? a. A single-step income statement b. A multiple-step income statement c. A consolidated statement of income d. All of these

44.

Which of the following is not a generally practiced method of presenting the income statement? a. Including prior period adjustments in determining net income b. The single-step income statement c. The consolidated statement of income d. Including gains and losses from discontinued operations of a component of a business in determining net income

45.

The occurrence that most likely would have no effect on 2008 net income (assuming that all amounts involved are material) is the a. sale in 2008 of an office building contributed by a stockholder in 1983. b. collection in 2008 of a receivable from a customer whose account was written off in 2007 by a charge to the allowance account. c. settlement based on litigation in 2008 of previously unrecognized damages from a serious accident which occurred in 2006. d. worthlessness determined in 2008 of stock purchased on a speculative basis in 2004.

46.

The occurrence that most likely would have no effect on 2008 net income is the a. sale in 2008 of an office building contributed by a stockholder in 1962. b. collection in 2008 of a dividend from an investment. c. correction of an error in the financial statements of a prior period discovered subsequent to their issuance. d. stock purchased in 1994 deemed worthless in 2008.

47. Which of the following is not a selling expense? a. Advertising expense b. Office salaries expense c. Freight-out d. Store supplies consumed 48.

The accountant for Orion Sales Company is preparing the income statement for 2008 and the balance sheet at December 31, 2008. The January 1, 2008 merchandise inventory balance will appear a. only as an asset on the balance sheet. b. only in the cost of goods sold section of the income statement. c. as a deduction in the cost of goods sold section of the income statement and as a current asset on the balance sheet. d. as an addition in the cost of goods sold section of the income statement and as a current asset on the balance sheet.

49.

One of the primary benefits of the multiple-step income statement over the single-step income statement is that the multiple-step income statement a. shows gross margin and recognizes different types of costs and expenses. b. shows last year's figures in comparison with the current year. c. discriminates between administrative and selling expenses. d. recognizes no distinction in types of costs or expenses.

5 - 10

Test Bank for Intermediate Accounting, Second Edition

50.

Any gain or loss experienced by a concern, whether directly or indirectly related to operations, contributes to the long-run profitability and should be included in the computation of net income. Those who favor such a philosophy adhere to the Current Operating All-Inclusive Performance Concept Concept a. Yes Yes b. No No c. Yes No d. No Yes

51.

Which of the following asset disposals would qualify as a disposal of a component of a business? a. Phasing out a product line or class of service b. Changes occasioned by a technological improvement c. Sale by an auto parts manufacturer of one of its five parts-manufacturing subsidiaries d. Sale by a transportation company of its bus operations but not its airline operations

52.

To be classified on an income statement as an extraordinary item, the transaction or event must be material in nature and Unusual Occur Infrequently a. Yes Yes b. No Yes c. Yes No d. No No

53.

Which of the following should not be reported on the income statement as an extraordinary item? a. The write-off of major assets as a result of new environmental laws prohibiting their use b. The write-off of a large receivable resulting from a customer's bankruptcy proceedings c. A large loss as a result of an earthquake d. Expropriation of assets by a foreign government

54.

In order to be classified as an extraordinary item in the income statement, an event or transaction should be a. unusual in nature and infrequent, but it need not be material. b. unusual in nature and material, but it need not be infrequent. c. infrequent and material, but it need not be unusual in nature. d. unusual in nature, infrequent, and material.

55.

Which of the following should be reported on the income statement as an extraordinary item? a. The gain on disposal of a component of a business b. The write-down of receivables deemed uncollectible c. The loss from volcanic activity d. The gain from a sale of equipment

56.

In general, the basic difference between the concepts of revenues and gains concerns a. the materiality of the item being considered. b. whether the event giving rise to the item relates to the typical activity of the enterprise. c. whether the item is taxable in the current year. d. the effect on total assets of the enterprise.

Income Statement and Related Information

5 - 11

57.

When a company changes from one accounting principle to another, the income statement for the year of change a. will normally not be affected, as this event is taken directly to Retained Earnings. b. should include only footnote disclosure so readers will be aware of the change. c. should include the cumulative effect, based on a retroactive computation, disclosed as a separate-line item. d. should include the effect of the change related to the current year only and be disclosed as a separate line item.

58.

Changing the basis of inventory pricing from FIFO to average cost is an example of a(n) a. extraordinary item. b. change in accounting principle. c. change in estimate. d. discontinued operation.

The concept that reports extraordinary items in the income statement is called the a. phase-out period concept. b. prior period adjustment concept. c. current operating performance concept. d. all-inclusive concept.

60.

When a manufacturing company sells one of its plant assets at a price in excess of its book value, it should recognize a. b. c. d.

Revenue No No Yes Yes

Gain Yes No No Yes

61.

Classification as an extraordinary item on the income statement would be appropriate for the a. gain or loss on disposal of a component of the business. b. substantial write-off of obsolete inventories. c. loss from a strike. d. none of these.

62.

Which of these is generally an example of an extraordinary item? a. Loss incurred because of a strike by employees b. Write-off of deferred marketing costs believed to have no future benefit c. Gain resulting from the devaluation of the U.S. dollar d. Gain resulting from the state exercising its right of eminent domain on a piece of land used as a parking lot

63.

Under which of the following conditions would material flood damage be considered an extraordinary item for financial reporting purposes? a. Only if floods in the geographical area are unusual in nature and occur infrequently b. Only if the flood damage is material in amount and could have been reduced by prudent management. c. Under any circumstances as an extraordinary item d. Flood damage should never be classified as an extraordinary item

5 - 12

Test Bank for Intermediate Accounting, Second Edition

64.

An item that should be classified as an extraordinary item is a. write-off of goodwill. b. gains from transactions involving foreign currencies. c. losses from moving a plant to another city. d. gains from a company selling the only investment it has ever owned.

65.

How should an unusual event not meeting the criteria for an extraordinary item be disclosed in the financial statements? a. Shown as a separate item in operating revenues or expenses if material and supplemented by a footnote if deemed appropriate. b. Shown in operating revenues or expenses if material but not shown as a separate item. c. Shown net of income tax after ordinary net earnings but before extraordinary items. d. Shown net of income tax after extraordinary items but before net earnings.

66.

Which of the following is a change in accounting principle? a. A change in the estimated service life of machinery b. A change from FIFO to LIFO c. A change from straight-line to double-declining-balance d. A change from FIFO to LIFO and a change from straight-line to double-decliningbalance

67.

Which of the following is never classified as an extraordinary item? a. Losses from a major casualty. b. Losses from an expropriation of assets. c. Gain on a sale of the only security investment a company has ever owned. d. Losses from exchange or translation of foreign currencies.

68.

Which of the following is a required disclosure in the income statement when reporting the disposal of a component of the business? a. The gain or loss on disposal should be reported as an extraordinary item. b. Results of operations of a discontinued component should be disclosed immediately below extraordinary items. c. Earnings per share from both continuing operations and net income should be disclosed on the face of the income statement. d. The gain or loss on disposal should not be segregated, but should be reported together with the results of continuing operations.

69.

When a company discontinues an operation and disposes of the discontinued operation (component), the transaction should be included in the income statement as a gain or loss on disposal reported as a(n) a. prior period adjustment. b. extraordinary item. c. amount after continuing operations and before extraordinary items. d. bulk sale of plant assets included in income from continuing operations.

70.

A material item which is unusual in nature or infrequent in occurrence, but not both should be shown in the income statement Net of Tax Disclosed Separately a. No No b. Yes Yes c. No Yes d. Yes No

Income Statement and Related Information

5 - 13

71.

Income taxes are allocated to a. extraordinary items. b. discontinued operations. c. prior period adjustments. d. all of these.

72.

Which of the following is true about intraperiod tax allocation? a. It arises because certain revenue and expense items appear in the income statement either before or after they are included in the tax return. b. It is required for extraordinary items and cumulative effect of accounting changes but not for prior period adjustments. c. Its purpose is to allocate income tax expense evenly over a number of accounting periods. d. Its purpose is to relate the income tax expense to the items which affect the amount of tax.

73.

Earnings per share is computed by dividing net income a. by the weighted-average common shares outstanding. b. minus total dividends by the weighted-average common shares outstanding. c. minus preferred dividends by the ending common shares outstanding. d. minus preferred dividends by the weighted-average common shares outstanding.

74.

Earnings per share should always be shown separately for a. net income and gross margin. b. net income and pretax income. c. income before extraordinary items. d. extraordinary items and prior period adjustments.

75.

A correction of an error in prior periods' income will be reported a. b. c. d.

In the income statement Yes No Yes No

Net of tax Yes No No Yes

76.

Which of the following items will not appear in the retained earnings statement? a. Net loss b. Prior period adjustment c. Discontinued operations d. Dividends

77.

Which one of the following types of losses is excluded from the determination of net income in income statements? a. Material losses resulting from transactions in the company's investments account. b. Material losses resulting from unusual sales of assets not acquired for resale. c. Material losses resulting from the write-off of intangibles. d. Material losses resulting from correction of errors related to prior periods.

5 - 14

Test Bank for Intermediate Accounting, Second Edition

78.

Shank Corporation made a very large arithmetical error in the preparation of its year-end financial statements by improper placement of a decimal point in the calculation of depreciation. The error caused the net income to be reported at almost double the proper amount. Correction of the error when discovered in the next year should be treated as a. an increase in depreciation expense for the year in which the error is discovered. b. a component of income for the year in which the error is discovered, but separately listed on the income statement and fully explained in a note to the financial statements. c. an extraordinary item for the year in which the error was made. d. a prior period adjustment.

79.

Comprehensive income includes all of the following except a. dividend revenue. b. losses on disposal of assets. c. investments by owners. d. unrealized holding gains.

80.

The approach most companies use to provide information related to the components of other comprehensive income is a a. second separate income statement. b. combined income statement of comprehensive income. c. separate column in the statement of changes in stockholders’ equity. d. footnote disclosure.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

36. 37. 38. 39. 40. 41. 42.

c d b d d c b

43. 44. 45. 46. 47. 48. 49.

d a b c b b a

50. 51. 52. 53. 54. 55. 56.

d d a b d c b

57. 58. 59. 60. 61. 62. 63.

a b d a d d a

64. 65. 66. 67. 68. 69. 70.

d a b d c c c

71. 72. 73. 74. 75. 76. 77.

d d d c d c d

78. 79. 80.

d c c

Solution to Multiple Choice question for which the answer is “none of these.” 61. Many answers are possible.

Income Statement and Related Information

5 - 15

MULTIPLE CHOICE—Computational Use the following in formation for questions 81 and 82. For Garret Wolfe Company, the following information is available: Cost of goods sold Dividend revenue Income tax expense Operating expenses Sales

$ 60,000 2,500 6,000 23,000 100,000

81.

In Garret Wolfe’s single-step income statement, gross profit a. should not be reported. b. should be reported at $13,500. c. should be reported at $40,000. d. should be reported at $42,500.

82.

In Garret Wolfe’s multiple-step income statement, gross profit a. should not be reported b. should be reported at $13,500. c. should be reported at $40,000. d. should be reported at $42,500.

83.

Gross billings for merchandise sold by Otto Company to its customers last year amounted to $15,720,000; sales returns and allowances were $370,000, sales discounts were $175,000, and freight-out was $140,000. Net sales last year for Otto Company were a. $15,720,000. b. $15,350,000. c. $15,175,000. d. $15,035,000.

84.

If plant assets of a manufacturing company are sold at a gain of $820,000 less related taxes of $250,000, and the gain is not considered unusual or infrequent, the income statement for the period would disclose these effects as a. a gain of $820,000 and an increase in income tax expense of $250,000. b. operating income net of applicable taxes, $570,000. c. a prior period adjustment net of applicable taxes, $570,000. d. an extraordinary item net of applicable taxes, $570,000.

85.

During the year 2008, Siska Corporation had the following information available related to its income statement: Disbursements for purchases Increase in trade accounts payable Decrease in merchandise inventory Cost of goods sold for 2008 amounted to a. $735,000. b. $685,000. c. $575,000. d. $525,000.

$630,000 80,000 25,000

5 - 16

Test Bank for Intermediate Accounting, Second Edition

86.

An income statement shows "income before income taxes and extraordinary items" in the amount of $685,000. The income taxes payable for the year are $360,000, including $120,000 that is applicable to an extraordinary gain. Thus, the "income before extraordinary items" is a. $445,000. b. $205,000. c. $465,000. d. $225,000.

87.

Sam Hurd Company has the following items: write-down of inventories, $120,000; loss on disposal of Sports Division, $185,000; and loss due to strike, $113,000. Ignoring income taxes, what total amount should Sam Hurd Company report as extraordinary losses? a. $ -0b. $185,000 c. $233,000 d. $298,000

88.

An income statement shows “income before income taxes and extraordinary items” in the amount of $2,055,000. The income taxes payable for the year are $1,080,000, including $360,000 that is applicable to an extraordinary gain. Thus, the “income before extraordinary items” is a. $1,335,000. b. $615,000. c. $1,395,000. d. $675,000.

89.

Cole Company, with an applicable income tax rate of 30%, reported net income of $210,000. Included in income for the period was an extraordinary loss from flood damage of $30,000 before deducting the related tax effect. The company's income before income taxes and extraordinary items was a. $240,000. b. $300,000. c. $330,000. d. $231,000.

90.

A review of the December 31, 2008, financial statements of Baden Corporation revealed that under the caption "extraordinary losses," Baden reported a total of $515,000. Further analysis revealed that the $515,000 in losses was comprised of the following items: (1) Baden recorded a loss of $150,000 incurred in the abandonment of equipment formerly used in the business. (2) In an unusual and infrequent occurrence, a loss of $250,000 was sustained as a result of hurricane damage to a warehouse. (3) During 2008, several factories were shut down during a major strike by employees, resulting in a loss of $85,000. (4) Uncollectible accounts receivable of $30,000 were written off as uncollectible. Ignoring income taxes, what amount of loss should Baden report as extraordinary on its 2008 income statement? a. $150,000 b. $250,000 c. $400,000 d. $515,000

Income Statement and Related Information

5 - 17

Use the following information for questions 91 and 92. At Hall Company, events and transactions during 2008 included the following. The tax rate for all items is 30%. (1) Depreciation for 2006 was found to be understated by $30,000. (2) A strike by the employees of a supplier resulted in a loss of $25,000. (3) The inventory at December 31, 2006 was overstated by $40,000. (4) A flood destroyed a building that had a book value of $500,000. Floods are very uncommon in that area. 91.

The effect of these events and transactions on 2008 income from continuing operations net of tax would be a. $17,500. b. $38,500. c. $66,500. d. $416,500.

92.

The effect of these events and transactions on 2008 net income net of tax would be a. $17,500. b. $367,500. c. $388,500. d. $416,500.

93.

During 2008, Gomez Corporation disposed of Pine Division, a major component of its business. Gomez realized a gain of $1,200,000, net of taxes, on the sale of Pine's assets. Pine's operating losses, net of taxes, were $1,400,000 in 2008. How should these facts be reported in Gomez's income statement for 2008?

a. b. c. d. 94.

Carpino Corporation has an extraordinary loss of $200,000, an unusual gain of $140,000, and a tax rate of 40%. At what amount should Carpino report each item? a. b. c. d.

95.

Total Amount to be Included in Income from Results of Continuing Operations Discontinued Operations $1,400,000 loss $1,200,000 gain 200,000 loss 0 0 200,000 loss 1,200,000 gain 1,400,000 loss

Extraordinary loss $(200,000) (200,000) (120,000) (120,000)

Unusual gain $140,000 84,000 140,000 84,000

Edmonds Corporation reports the following information: Net income Dividends on common stock Dividends on preferred stock Weighted-average common shares outstanding

$500,000 140,000 60,000 200,000

5 - 18

Test Bank for Intermediate Accounting, Second Edition Edmonds should report earnings per share of a. $1.50. b. $1.80. c. $2.20. d. $2.50.

96.

Simmons Corporation reports the following information: Correction of understatement of depreciation expense in prior years, net of tax $ 430,000 Dividends declared 320,000 Net income 1,000,000 Retained earnings, 1/1/08, as reported 2,000,000 Simmons should report retained earnings, 1/1/08, as adjusted at a. $1,570,000. b. $2,000,000. c. $2,430,000. d. $3,110,000.

97.

Simmons Corporation reports the following information: Correction of understatement of depreciation expense in prior years, net of tax $ 430,000 Dividends declared 320,000 Net income 1,000,000 Retained earnings, 1/1/08, as reported 2,000,000 Simmons should report retained earnings, 12/31/08, as adjusted at a. $1,570,000. b. $2,250,000. c. $2,680,000. d. $3,110,000.

98.

Joe Novak Corporation reports the following information: Correction of overstatement of depreciation expense in prior years, net of tax $ 215,000 Dividends declared 160,000 Net income 500,000 Retained earnings, 1/1/08, as reported 1,000,000 Joe Novak should report retained earnings, 12/31/08, at a. $785,000. b. $1,125,000. c. $1,340,000. d. $1,555,000.

99.

The following information was extracted from the accounts of Boone Corporation at December 31, 2008: CR(DR) Total reported income since incorporation $1,700,000 Total cash dividends paid (800,000) Unrealized holding loss (120,000) Total stock dividends distributed (200,000) Prior period adjustment, recorded January 1, 2008 75,000

Income Statement and Related Information

5 - 19

What should be the balance of retained earnings at December 31, 2008? a. $655,000 b. $700,000 c. $580,000 d. $775,000 100.

Silas Company reported the following information for 2008: Sales revenue Cost of goods sold Operating expenses Unrealized holding gain on available-for-sale securities Cash dividends received on the securities

$500,000 350,000 55,000 20,000 2,000

For 2008, Silas would report comprehensive income of a. $117,000. b. $115,000. c. $97,000. d. $20,000.

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

81. 82. 83. 84.

a c c a

85. 86. 87. 88.

a a a a

89. 90. 91. 92.

c b a b

93. 94. 95. 96.

c c c a

97. 98. 99. 100.

b d d a

MULTIPLE CHOICE—CPA Adapted Use the following information for questions 101 and 102. Meyer Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 2008, included the following expense accounts: Accounting and legal fees Advertising Freight-out Interest Loss on sale of long-term investments Officers' salaries Rent for office space Sales salaries and commissions

$140,000 120,000 75,000 60,000 30,000 180,000 180,000 110,000

One-half of the rented premises is occupied by the sales department.

5 - 20

Test Bank for Intermediate Accounting, Second Edition

101.

How much of the expenses listed above should be included in Meyer's selling expenses for 2008? a. $230,000 b. $305,000 c. $320,000 d. $395,000

102.

How much of the expenses listed above should be included in Meyer's general and administrative expenses for 2008? a. $410,000 b. $440,000 c. $470,000 d. $500,000

103.

Bowen Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 2008 included the following expense and loss accounts: Accounting and legal fees Advertising Freight-out Interest Loss on sale of long-term investment Officers' salaries Rent for office space Sales salaries and commissions

$140,000 180,000 80,000 70,000 30,000 225,000 220,000 170,000

One-half of the rented premises is occupied by the sales department. Bowen's total selling expenses for 2008 are a. $540,000. b. $460,000. c. $430,000. d. $370,000. 104.

The following items were among those that were reported on Nen Co.'s income statement for the year ended December 31, 2008: Legal and audit fees Rent for office space Interest on inventory floor plan Loss on abandoned equipment used in operations

$130,000 180,000 210,000 35,000

The office space is used equally by Nen's sales and accounting departments. What amount of the above-listed items should be classified as general and administrative expenses in Nen's multiple-step income statement? a. $220,000 b. $255,000 c. $310,000 d. $430,000

Income Statement and Related Information

5 - 21

Use the following information for questions 105–107. Hogan Corp.'s trial balance of income statement accounts for the year ended December 31, 2008 included the following: Debit Credit Sales $140,000 Cost of sales $ 50,000 Administrative expenses 25,000 Loss on sale of equipment 9,000 Commissions to salespersons 8,000 Interest revenue 5,000 Freight-out 3,000 Loss due to earthquake damage 12,000 Bad debt expense 3,000 Totals $110,000 $145,000 Other information: Hogan's income tax rate is 30%. Finished goods inventory: January 1, 2008 December 31, 2008

$80,000 70,000

On Hogan's multiple-step income statement for 2008, 105.

Inventory purchases are a. $63,000. b. $60,000. c. $43,000. d. $40,000.

106.

Income before extraordinary item is a. $64,000. b. $47,000. c. $32,900. d. $24,500.

107.

Extraordinary loss is a. $8,400. b. $12,000. c. $14,700. d. $21,000.

108.

Agler Corp. had the following infrequent transactions during 2008: A $150,000 gain from selling the only investment Agler has ever owned. A $210,000 gain on the sale of equipment. A $70,000 loss on the write-down of inventories. In its 2008 income statement, what amount should Agler report as total infrequent net gains that are not considered extraordinary? a. $80,000 b. $140,000 c. $290,000 d. $360,000

5 - 22

Test Bank for Intermediate Accounting, Second Edition

109.

Snead, Inc. incurred the following infrequent losses during 2008: A $70,000 write-down of equipment leased to others. A $40,000 adjustment of accruals on long-term contracts. A $60,000 write-off of obsolete inventory. In its 2008 income statement, what amount should Snead report as total infrequent losses that are not considered extraordinary? a. $170,000 b. $130,000 c. $110,000 d. $100,000

110.

Which of the following should be reported as a prior period adjustment? Change in Estimated Lives of Depreciable Assets a. Yes b. No c. Yes d. No

Change from Unaccepted Principle to Accepted Principle Yes Yes No No

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

101. 102.

d a

103. 104.

a a

105. 106.

d c

107. 108.

a b

109. 110.

a b

DERIVATIONS — Computational No.

Answer

Derivation

81.

82.

$100,000 – $60,000 = $40,000.

83.

$15,720,000 – $370,000 – $175,000 = $15,175,000.

84.

85.

$630,000 + $80,000 + $25,000 = $735,000.

86.

$685,000 – ($360,000 – $120,000) = $445,000.

87.

88.

$2,055,000 – ($1,080,000 – $360,000) = $1,335,000.

89.

$210,000 + ($30,000 × .7) = $231,000 $231,000 ÷ .7 = $330,000.

Income Statement and Related Information

No.

Answer

90.

$515,000 – $150,000 – $85,000 – $30,000 = $250,000.

91.

$25,000 – $7,500 = $17,500.

92.

$17,500 + ($500,000 × .7) = $367,500.

93.

$1,400,000 – $1,200,000 = $200,000.

94.

$200,000 × .60 = $120,000.

95.

($500,000 – $60,000) ÷ 200,000 = $2.20.

96.

$2,000,000 – $430,000 = $1,570,000.

97.

$2,000,000 – $430,000 + $1,000,000 – $320,000 = $2,250,000.

98.

$1,000,000 + $215,000 + $500,000 – $160,000 = $1,555,000.

99.

$1,700,000 – $800,000 – $200,000 + $75,000 = $775,000.

100.

$500,000 – $350,000 – $55,000 + $20,000 + $2,000 = $117,000.

5 - 23

Derivation

DERIVATIONS — CPA Adapted No.

Answer

101.

Derivation $120,000 + $75,000 + $110,000 + $90,000 = $395,000.

102.

$140,000 + $180,000 + $90,000 = $410,000.

103.

$180,000 + $80,000 + $110,000 + $170,000 = $540,000.

104.

$130,000 + $90,000 = $220,000.

105.

$50,000 + $70,000 – $80,000 = $40,000.

106.

$140,000 – $50,000 – $25,000 – $9,000 – $8,000 – $3,000 – $3,000 + $5,000 – $14,100 = $32,900.

107.

$12,000 × 0.7 = $8,400.

108.

$210,000 – $70,000 = $140,000.

109.

$70,000 + $40,000 + $60,000 = $170,000.

110.

Conceptual.

5 - 24

Test Bank for Intermediate Accounting, Second Edition

EXERCISES Ex. 5-111—Definitions. Provide clear, concise answers for the following. 1. What are revenues? 2. What are expenses? 3. What are gains? 4. What are losses? 5. What are the criteria (in addition to materiality) that must be met to classify an event or transaction as extraordinary? 6. When does a discontinued operation occur? 7. Indicate how earnings per share is computed. 8. State the primary category of prior period adjustments and indicate how they are reported in the financial statements.

Solution 5-111 1. Revenues are increases in net assets during a period from delivering goods or services that constitute the entity's major or central operations. 2. Expenses are the using-up of assets or other decreases in net assets during a period from delivering goods or services that constitute the entity's major or central operations. 3. Gains are increases in net assets from peripheral transactions, events, or circumstances affecting the entity except those resulting from revenues or investments by owners. 4. Losses are decreases in net assets from peripheral transactions, events, or circumstances affecting the entity except those resulting from expenses or distributions to owners. 5. Both of the following criteria should be met to classify an item as extraordinary: (1) Unusual nature, considering the environment, and (2) infrequent in occurrence, considering the environment. 6. A discontinued operation occurs when (a) the results of operations and cash flows of a component of a company have been eliminated from the ongoing operations, and (b) there is no significant continuing involvement in that component after the disposal transaction. 7. The computation of earnings per share is: Net income minus preferred dividends divided by the weighted average of common shares outstanding. 8. Prior period adjustments include correction of an error in the financial statements of a prior period. Prior period adjustments (net of tax) should be charged or credited to the opening balance of retained earnings.

Income Statement and Related Information

5 - 25

Ex. 5-112—Terminology. In the space provided, write the word or phrase that is defined or indicated. 1. Net income minus preferred dividends divided by the weighted-average shares outstanding.

1. ________________________________

2. All changes in equity during a period except those resulting from investments by owners and distributions to owners.

2. ________________________________

3. A correction of an error is reported as a

3. ________________________________

4. An event or transaction which is unusual in nature and infrequent in occurrence.

4. ________________________________

5. The income statement category for a disposal of a component of a business.

5. ________________________________

6. Relating tax expense to specific items on the income statement.

6. ________________________________

Solution 5-112 1. 2. 3. 4. 5. 6.

Earnings per share. Comprehensive income. Prior period adjustment. Extraordinary item. Discontinued operations. Intraperiod tax allocation.

Ex. 5-113—Calculation of net income from the change in stockholders' equity. Presented below is certain information pertaining to Juan Company. Assets, January 1 Assets, December 31 Liabilities, January 1 Common stock, December 31 Retained earnings, December 31 Common stock sold during the year Dividends declared during the year Instructions Compute the net income for the year.

$240,000 230,000 150,000 80,000 31,000 10,000 13,000

5 - 26

Test Bank for Intermediate Accounting, Second Edition

Solution 5-113 Assets Liabilities Stockholders' equity Computation of net income: Stockholders' equity December 31 Stockholders' equity January 1 Increase Add: Dividend declared Less: Common stock sold Net income

January 1 $240,000 150,000 $ 90,000

December 31

$111,000*

$111,000 90,000 21,000 13,000 (10,000) $ 24,000

*$80,000 + $31,000

Ex. 5-114—Calculation of net income from the change in stockholders' equity. Presented below are changes in the account balances of Ping Company during the year, except for retained earnings. Increase Increase (Decrease) (Decrease) Cash $29,000 Accounts payable $34,000 Accounts receivable (net) (13,000) Bonds payable (20,000) Inventory 52,000 Common stock 72,000 Plant Assets (net) 37,000 Paid-in capital 16,000 The only entries in Retained Earnings were for net income and a dividend declaration of $12,000. Instructions Compute the net income for the current year.

Solution 5-114 Computation of net income Change in assets ($118,000 – $13,000) Change in liabilities ($34,000 – $20,000) Change in stockholders' equity Add: Dividend declared Less: Investment by stockholders Net income

$105,000 14,000 91,000 12,000 (88,000) $ 15,000

Increase Increase Increase

Income Statement and Related Information

5 - 27

Ex. 5-115—Income statement classifications. Indicate the major section or subsection of a multiple-step income statement in which each of the following items would usually appear: a. Advertising b. Depletion c. Dividend revenue d. Freight-in e. Loss on disposal of a component of the business, net of tax f. Income taxes on income g. Major casualty loss, net of tax h. Purchase discounts i. Sales discounts j. Officers' salaries k. Freight-out l. Sinking fund income

Solution 5-115 a. b. c. d. e. f. g. h. i. j. k. l.

Selling expense. Cost of goods sold. Other revenue. Cost of goods sold as an addition to purchases. Discontinued operations. Income taxes; subtracted from income before income taxes in arriving at net income. Extraordinary items. Cost of goods sold as a subtraction from purchases. Subtracted from gross revenues. Administrative or general expenses. Selling expense. Other revenue.

Ex. 5-116—Income statement relationships. Fill in the appropriate blanks for each of the independent situations below. Company A Company B Sales (a) $_______ $343,400 Beginning inventory 52,600 (d) _______ Net purchases 175,300 255,600 Ending inventory 52,200 108,000 Cost of goods sold (b) _______ (e) _______ Gross profit 85,300 98,000 Operating expenses (c) _______ 50,000 Income before taxes 6,000 (f) _______

Company C $540,000 90,000 (g) _______ 63,000 407,000 (h) _______ 48,000 (i) _______

5 - 28

Test Bank for Intermediate Accounting, Second Edition

Solution 5-116 (a) $261,000 (b) $175,700 (c) $79,300

(d) $97,800 (e) $245,400 (f) $48,000

(g) $380,000 (h) $133,000 (i) $85,000

Ex. 5-117—Multiple-step income statement. Listed below in scrambled order are 13 income statement categories. Use the numerals 1 through 13 to indicate the order in which these categories should appear on a multiple-step income statement. (

)

Discontinued operations.

(

)

Cost of goods sold.

(

)

Other revenues and gains.

(

)

Net income.

(

)

Income taxes.

(

)

Sales.

(

)

Gross profit on sales.

(

)

Income from operations.

(

)

Income from continuing operations before income taxes.

(

)

Operating expenses.

(

)

Extraordinary item.

(

)

Income before extraordinary items.

(

)

Income from continuing operations.

Solution 5-117 10, 2, 6, 13, 8, 1, 3, 5, 7, 4, 12, 11, 9

Income Statement and Related Information

5 - 29

Ex. 5-118—Classification of income statement and retained earnings statement items. For each of the items listed below, indicate how it should be treated in the financial statements. Use the following letter code for your selections: a. Ordinary or unusual (but not extraordinary) item on the income statement b. Discontinued operations c. Extraordinary item on the income statement d. Prior period adjustment _____

The bad debt rate was increased from 1% to 2%, thus increasing bad debt expense.

_____

Obsolete inventory was written off. company's history.

_____

An uninsured casualty loss was incurred by the company. This was the first loss of this type in the company's 50-year history.

_____

Recognition of income earned last year which was inadvertently omitted from last year's income statement.

_____

The company sold one of its warehouses at a loss.

_____

Settlement of litigation with federal government related to income taxes of three years ago. The company is continually involved in various adjustments with the federal government related to its taxes.

_____

A loss incurred from expropriation (the company owned resources in South America which were taken over by a dictator unsympathetic to American business).

_____

The company neglected to record its depreciation in the previous year.

_____

Discontinuance of all production in the United States. The manufacturing operations were relocated in Mexico.

_____ 10.

Loss on sale of investments. The company last sold some of its investments two years ago.

_____ 11.

Loss on the disposal of a component of the business.

Solution 5-118 1. a 2. a 3. c

4. d 5. a 6. a

7. c 8. d 9. a

10. a 11. b

This was the first loss of this type in the

5 - 30

Test Bank for Intermediate Accounting, Second Edition

Ex. 5-119—Multiple-step income statement. Schmitt, Inc., a retail store, has the following data for the year ended December 31, 2008: Sales ...................................................................................................... Extraordinary loss due to hurricane ........................................................ Income tax savings on extraordinary loss ............................................... Cost of goods sold .................................................................................. Interest expense ..................................................................................... Selling expenses .................................................................................... Income tax expense on operations ......................................................... General and administrative expenses ..................................................... Shares of capital stock outstanding, 10,000

$90,000 5,000 (1,100) 55,000 1,000 11,000 4,400 3,000

Instructions Prepare a multiple-step income statement for Schmitt, Inc. for the year ended December 31, 2008.

Solution 5-119 Schmitt Corporation INCOME STATEMENT For the Year Ended December 31, 2008 Sales ................................................................................................. Cost of goods sold............................................................................. Gross profit ............................................................................... Operating expenses Selling expenses ...................................................................... General and administrative expenses ....................................... Total operating expenses .................................................... Income from operations ..................................................................... Other expenses and losses Interest expense ....................................................................... Income before tax.............................................................................. Income tax......................................................................................... Income before extraordinary item ...................................................... Extraordinary item: Loss due to hurricane ............................................................... Less: Income tax savings.......................................................... Net income ........................................................................................ Earnings per share: Income before extraordinary item ($15,600  10,000)............... Extraordinary item ($3,900  10,000) ........................................ Net income ($11,700  10,000).................................................

$90,000 55,000 $35,000 11,000 3,000 14,000 21,000 1,000 20,000 4,400 15,600 5,000 1,100

(3,900) $11,700 $1.56 (.39) $1.17

Income Statement and Related Information

5 - 31

Ex. 5-120—Placement of irregular items. The following items are presented on financial statements: A. Extraordinary items B. Material gains or losses, not considered extraordinary items C. Prior period adjustments D. Changes in estimates E. Changes in accounting principle F. Discontinued operations Instructions For each of the items listed above, describe (a) the criteria used to identify the item and (b) its placement on the financial statements. Assume that each item is material.

Solution 5-120 Item

Criteria

Placement

A. Extraordinary items

Material, unusual recurring.

and

non-

Separate section in the income statement labeled "extraordinary items."

B. Material gains or losses not considered extraordinary

Unusual or infrequent, but not both. Typical of customary business activity.

Separate section in the income statement above income before extraordinary items.

C. Prior period adjustments

Corrections of errors in previously issued financial statement of a prior period.

Direct adjustment to the beginning balance of retained earnings.

D. Changes in estimates

Normal, recurring corrections or adjustments to estimate.

Change in income statement only in the affected account.

E. Changes in accounting principle

Change from one generally accepted accounting principle to another.

Recast prior years’ income statements on the same basis as the newly adopted principle.

F. Discontinued operations

Disposal of a component of a business constituting a separate line of business or a class of customer.

Separate section in the income statement after continuing operations but before extraordinary items.

5 - 32

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Pr. 5-121—Multiple-step income statement. Presented below is information related to Holt Company. Retained earnings, December 31, 2007 Sales Selling and administrative expenses Hurricane loss (pre-tax) on plant (extraordinary item) Cash dividends declared on common stock Cost of goods sold Gain resulting from computation error on depreciation charge in 2006 (pre-tax) Other revenue Other expenses

$ 650,000 1,400,000 240,000 290,000 33,600 780,000 520,000 120,000 100,000

Instructions Prepare in good form a multiple-step income statement for the year 2008. Assume a 30% tax rate and that 80,000 shares of common stock were outstanding during the year.

Solution 5-121 Holt Company INCOME STATEMENT For the Year Ended December 31, 2008 Sales Cost of goods sold Gross profit Selling and administrative expenses Income from operations Other revenue Other expenses Income before taxes Income taxes Income before extraordinary item Extraordinary loss, net of applicable income taxes of $87,000 Net income Per share of common stock— Income before extraordinary item Extraordinary item, net of tax Net income

$3.50 (2.54) $ .96

$1,400,000 780,000 620,000 240,000 380,000 120,000 (100,000) 400,000 (120,000) 280,000 (203,000) $ 77,000

Income Statement and Related Information

5 - 33

Pr. 5-122—Income statement form. Vincent Corporation had income from continuing operations of $800,000 (after taxes) in 2008. In addition, the following information, which has not been considered, is as follows. 1. In 2008, Vincent experienced an uninsured earthquake loss in the amount of $200,000. 2. A machine was sold for $140,000 cash during the year at a time when its book value was $110,000. (Depreciation has been properly recorded.) The company often sells machinery of this type. 3. Vincent decided to discontinue its stereo division in 2008. During the current year, the loss on the disposal of this component of the business was $150,000 less applicable taxes. Instructions Present in good form the income statement of Vincent Corporation for 2008 starting with "income from continuing operations." Assume that Vincent's tax rate is 30% and 200,000 shares of common stock were outstanding during the year.

Solution 5-122 Vincent Corporation PARTIAL INCOME STATEMENT For the Year Ended December 31, 2008 Income from continuing operations Discontinued operations Loss on disposal of a component of a business, $150,000, less applicable income taxes, $45,000 Income before extraordinary item Extraordinary loss, net of applicable income taxes of $60,000 Net income Per share of common stock—Income from cont. operations Discontinued operations, net of tax Income before extraordinary item Extraordinary loss, net of tax Net income *Income from cont. operations (unadjusted) $800,000 Gain on sale of machinery (after tax) 21,000 Income from cont. operations (adjusted) $821,000

$821,000*

(105,000) 716,000 (140,000) $576,000 $4.11 (.53) 3.58 (.70) $2.88

5 - 34

Test Bank for Intermediate Accounting, Second Edition

Pr. 5-123—Multiple-step income statement. Shown below is an income statement for 2008 that was prepared by a poorly trained bookkeeper of Jensen Corporation. Jensen Corporation INCOME STATEMENT December 31, 2008 Sales revenue Investment revenue Cost of merchandise sold Selling expenses Administrative expense Interest expense Income before special items Special items Loss on disposal of a component of the business Major casualty loss (extraordinary item) Net federal income tax liability Net income

$945,000 19,500 (408,500) (145,000) (215,000) (13,000) 183,000 (30,000) (70,000) (24,900) $ 58,100

Instructions Prepare a multiple-step income statement for 2008 for Jensen Corporation that is presented in accordance with generally accepted accounting principles (including format and terminology). Jensen Corporation has 50,000 shares of common stock outstanding and has a 30% federal income tax rate on all tax related items. Round all earnings per share figures to the nearest cent.

Solution 5-123 Jensen Corporation INCOME STATEMENT For the Year Ended December 31, 2008 Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Income from operations Other revenue: Investment revenue

$945,000 408,500 536,500 $145,000 215,000

Other expenses: Interest expense Income from continuing operations before taxes Income taxes Income from continuing operations Loss from discontinued operations, net of applicable income tax of $9,000 Income before extraordinary item Extraordinary casualty loss, net of applicable income tax of $21,000 Net income

360,000 176,500 19,500 196,000 13,000 183,000 54,900 128,100 (21,000) 107,100 (49,000) $ 58,100

Income Statement and Related Information

5 - 35

Solution 5-123 (cont.) Per share of common stock— Income from continuing operations Discontinued operations loss net of tax Income before extraordinary item Extraordinary item, net of tax Net income

$2.56 (.42) 2.14 (.98) $1.16

Pr. 5-124—Single-step income statement. Presented below is an income statement for Morton Company for the year ended December 31, 2008. Morton Company INCOME STATEMENT For the Year Ended December 31, 2008 Net sales Costs and expenses: Cost of goods sold Selling, general, and administrative expenses Other, net Total costs and expenses Income before income taxes Income taxes Net income

$800,000 640,000 70,000 20,000 730,000 70,000 21,000 $ 49,000

Additional information: 1. "Selling, general, and administrative expenses" included a usual but infrequent charge of $7,000 due to a loss on the sale of investments. 2. "Other, net" consisted of interest expense, $10,000, and an extraordinary loss of $10,000 before taxes due to earthquake damage. If the extraordinary loss had not occurred, income taxes for 2008 would have been $24,000 instead of $21,000. 4. Morton had 20,000 shares of common stock outstanding during 2008. Instructions Using the single-step format, prepare a corrected income statement, including the appropriate per share disclosures.

5 - 36

Test Bank for Intermediate Accounting, Second Edition

Solution 5-124 Morton Company INCOME STATEMENT For the Year Ended December 31, 2008 Net sales Costs and expenses: Cost of goods sold Selling, general, and administrative expenses Interest expense Infrequent charge—loss on sale of investments Total costs and expenses Income before taxes and extraordinary item Income taxes Income before extraordinary item Extraordinary loss Earthquake damage Less applicable taxes Net income Per share of common stock— Income before extraordinary item Extraordinary loss, net of tax Net income

$800,000 $640,000 63,000 10,000 7,000 720,000 80,000 24,000 56,000 10,000 3,000

$2.80 (.35) $2.45

(7,000) $ 49,000

Income Statement and Related Information

5 - 37

Pr. 5-125—Income statement and retained earnings statement. Malone Corporation's capital structure consists of 50,000 shares of common stock. At December 31, 2008 an analysis of the accounts and discussions with company officials revealed the following information: Sales Purchase discounts Purchases Earthquake loss (net of tax) (extraordinary item) Selling expenses Cash Accounts receivable Common stock Accumulated depreciation Dividend revenue Inventory, January 1, 2008 Inventory, December 31, 2008 Unearned service revenue Accrued interest payable Land Patents Retained earnings, January 1, 2008 Interest expense General and administrative expenses Dividends declared Allowance for doubtful accounts Notes payable (maturity 7/1/10) Machinery and equipment Materials and supplies Accounts payable

$1,100,000 18,000 642,000 42,000 128,000 60,000 90,000 200,000 180,000 8,000 152,000 125,000 4,400 1,000 370,000 100,000 290,000 17,000 150,000 29,000 5,000 200,000 450,000 40,000 60,000

The amount of income taxes applicable to operating income was $48,600, excluding the tax effect of the earthquake loss which amounted to $18,000. Instructions (a) Prepare a multiple-step income statement. (b) Prepare a retained earnings statement.

5 - 38

Test Bank for Intermediate Accounting, Second Edition

Solution 5-125 Malone Corporation INCOME STATEMENT For the Year Ended December 31, 2008 Sales Cost of goods sold: Merchandise inventory, Jan. 1 Purchases Less purchase discounts Net purchases Merchandise available for sale Less merchandise inv., Dec. 31 Cost of goods sold Gross profit on sales Operating expenses: Selling expenses General and administrative expenses Total operating expenses Operating income Other revenue and expense: Dividend revenue Interest expense Income before taxes Income taxes Income before extraordinary item Extraordinary loss due to earthquake, net of applicable taxes of $18,000 Net income

$1,100,000 $152,000 $642,000 18,000

Per share of common stock— Income before extraordinary item Extraordinary loss, net of tax Net income

624,000 776,000 125,000 651,000 449,000 128,000 150,000 278,000 171,000 8,000 (17,000)

(9,000) 162,000 48,600 113,400

(42,000) 71,400

$2.27 (.84) $1.43

Malone Corporation RETAINED EARNINGS STATEMENT For the Year Ended December 31, 2008 Retained earnings, January 1, 2008 Add: Net income Deduct: Dividends declared Retained earnings, December 31, 2008

$290,000 $71,400 29,000

42,400 $332,400

Income Statement and Related Information

5 - 39

Pr. 5-126—Income statement and retained earnings statement. Presented below is financial information of the Mickey Corporation for 2008. Beginning Retained Earnings, 1/1/08 ............................................................ $ 950,000 Gain on the sale of investments (normal recurring) ....................................... 110,000 Sales for the year .......................................................................................... 30,000,000 Loss due to flood damage (unusual & infrequent).......................................... 125,000* Cost of goods sold......................................................................................... 21,000,000 Loss on disposal of retail division .................................................................. 450,000* Interest revenue ............................................................................................ 70,000 Loss on operations of retail division ............................................................... 460,000* Selling and administrative expenses.............................................................. 5,500,000 Dividends declared on common stock ........................................................... 230,000 Write-off of goodwill ....................................................................................... 520,000 Dividends declared on preferred stock .......................................................... 80,000 Federal income tax on operations for 2008.................................................... 1,600,000 *net of tax Mickey Corporation decided to discontinue its retail operations and to retain its manufacturing operations. On August 15, Mickey sold the retail operations to Schoen Company. During 2008, there were 250,000 shares of common stock outstanding all year. Instructions Prepare a multiple-step income statement and a retained earnings statement for the year 2008.

5 - 40

Test Bank for Intermediate Accounting, Second Edition

Solution 5-126 Mickey Corporation INCOME STATEMENT For The Year Ended December 31, 2008 Sales ...................................................................................... Cost of goods sold.................................................................. Gross profit............................................................................. Less selling and administrative expenses............................... Income from operations .......................................................... Other revenues and gains: Interest revenue................................................................ Gain on sale of investments ............................................. Other expenses and losses: Write-off of goodwill .......................................................... Income from operations before income tax ............................. Income tax.............................................................................. Income from continuing operations ......................................... Discontinued operations Loss from operations, net of tax........................................ Loss from disposition, net of tax ....................................... Income before extraordinary item ........................................... Extraordinary loss from flood, net of tax ................................. Net income .............................................................................

$30,000,000 21,000,000 9,000,000 5,500,000 3,500,000 $ 70,000 110,000

180,000 520,000 3,160,000 1,600,000 1,560,000

460,000 450,000

Earnings per share: Income from continuing operations ................................... Loss from discontinued operations, net of tax ................ Loss from disposition, net of tax..................................... Income before extraordinary item ..................................... Extraordinary loss, net of tax ............................................ Net income .......................................................................

(910,000) 650,000 (125,000) $ 525,000

$5.92a $(1.84) (1.80)

(3.64) 2.28b (.50) $1.78c

Mickey Corporation RETAINED EARNINGS STATEMENT For the Year Ended December 31, 2008 Beginning balance of retained earnings................................. Add Net income ..................................................................... Less dividends: Preferred stock .................................................................... Common stock .................................................................... Ending balance of retained earnings ...................................... a: b: c:

$1,560,000 − $80,000 = $5.92 250,000 shares $650,000 − $80,000 = $2.28 250,000 shares $525,000 − $80,000 = $1.78 250,000 shares

$ 950,000 525,000 1,475,000 $ 80,000 230,000

310,000 $1,165,000

CHAPTER 6 STATEMENT OF CASH FLOWS TRUE-FALSE—Conceptual Answer

No.

Description

F T T F T T T F T F F T T F F T F F F T T F F T F

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25.

Primary purpose of the statement of cash flows. Information provided by statement of cash flows. Classification of operating activities. First step in cash flow statement preparation. Reconciling beginning and ending cash balances. Definition of operating activities. Information provided by statement of cash flows. Definition of financing activities. Classification of sale of property. Information needed to prepare statement of cash flows. Determining net cash provided by operating activities. Preparation of the statement of cash flows. Converting net income to net cash flow from operating activities. FASB’s recommended method. Net income and net cash flow from operating activities. Indirect method adjustments. Indirect method and accrual-basis net income. Adjustment to income for accounts receivable increase. Payment of cash dividends. Adjustment to income for a loss on sale. Decrease in accounts receivable and cash-basis revenues. Decrease in prepaid expenses. Increase in accounts payable. Current cash debt coverage ratio. Free cash flow calculation.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39.

Primary purpose of the statement of cash flows. Answers provided by the statement of cash flows. Cash flow effect of a short-term nontrade note payable. Definition of financing activities. Identification of an investing activity. Identification of an investing activity. First step in cash flow statement preparation. Reporting revenues and expenses on a cash basis. The effect of an inventory increase on cash flows from operating activities. Effect of a change in dividends payable. Definition of indirect method. Cash flow effects of major repairs on machinery. Classifying items as investing activities. Classification of a financing activity.

6-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

b b c a b b d c

40. 41. 42. 43. 44. 45. 46. 47.

Reporting amortization of bond premium. Adjustment to income for inventory increase. Adjustment to net income in determining net cash flow. Adjustment to income for loss and inventory increase. Cash debt coverage ratio. Current cash debt coverage ratio. Liquidity measure. Calculation of free cash flow.

MULTIPLE CHOICE—Computational Answer

No.

Description

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

48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81.

Determine net cash flow from investing activities. Determine net cash flow from financing activities. Determine net cash flow from operating activities. Determine net cash flow from investing activities. Determine net cash flow from financing activities. Determine cash flows from investing activities. Determine cash flows from financing activities. Determine net cash flow from operating activities. Determine net cash flow from investing activities. Determine net cash flow from financing activities. Determine net cash flow from operating activities. Determine net cash flow from operating activities. Compute net cash used in financing activities. Sale of fixed assets at a gain/cash flow effects. Analysis of plant asset account/cash flow presentation. Sale of equipment at a gain/cash flow effects. Determine depreciation expense for the year. Determine depreciation expense for the year. Calculate equipment purchased during the year. Calculate cost of equipment sold. Determine book value of buildings and equipment at end of year. Determine ending balance of accounts payable. Determine ending balance of retained earnings. Determine ending balance of capital stock. Determine the amount of a cash dividend. Reporting a stock dividend. Compute proceeds from issuance of bonds payable. Compute net cash provided by operating activities. Determine net income for period. Compute net cash provided by operating activities. Compute net cash provided by operating activities. Calculation of current cash debt coverage ratio. Calculation of free cash flow. Calculation of cash debt coverage ratio.

Statement of Cash Flows

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

a c c b b b c a a c

82. 83. 84. 85. 86. 87. 88. 89. 90. 91.

Determine cash flow from investing activities. Determine cash flow from financing activities. Determine net cash used in investing activities. Determine net cash used in financing activities. Determine net cash provided by investing activities. Determine net cash provided by financing activities. Determine net cash provided by operating activities. Determine net cash used by investing activities. Determine net cash provided by financing activities. Determine depreciation charged to operations.

EXERCISES Item E6-92 E6-93 E6-94 E6-95 E6-96 E6-97 E6-98 E6-99 E6-100 E6-101 E6-102

Description Classification of cash flows. Classification of cash flows and transactions. Effects of transactions on statement of cash flows. Effects of transactions on statement of cash flows. Effects of transactions on statement of cash flows. Calculations for statement of cash flows. Calculations for statement of cash flows. Cash flows from operating activities (direct/indirect). Statement of cash flows (indirect method). Preparation of statement of cash flows (format provided). Statement of cash flows ratios.

PROBLEMS Item P6-103 P6-104 P6-105

Description Statement of cash flows. Statement of cash flows. A complex statement of cash flows (indirect method).

CHAPTER LEARNING OBJECTIVES 1.

Indicate the primary purpose of the statement of cash flows.

Distinguish among operating, investing, and financing activities.

Identify sources of information for preparing the statement of cash flows.

Differentiate between net income and net cash provided by operating activities.

Determine net cash provided by investing and financing activities.

Prepare a statement of cash flows.

Analyze the statement of cash flows.

6-3

6-4

Test Bank for Intermediate Accounting, Second Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

26.

3. 4.

TF TF

5. 6.

TF TF

7. 8.

10.

11.

12.

15. 16.

TF TF

17. 18.

TF TF

33. 34.

19. 37. 48. 49.

TF MC MC MC

51. 52. 53. 54.

MC MC MC MC

56. 57. 60. 82.

20. 21. 22. 23. 38. 39.

TF TF TF TF MC MC

40. 41. 42. 43. 61. 62.

MC MC MC MC MC MC

63. 64. 65. 66. 67. 68.

24. 25.

TF TF

44. 45.

MC MC

46. 47.

Note: TF = True-False MC = Multiple Choice E = Exercise P = Problem

Type

Item

Type

Item

Learning Objective 1 MC 27. MC Learning Objective 2 TF 9. TF 29. TF 28. MC 30. Learning Objective 3 TF 13. TF 14. Learning Objective 4 MC 35. MC 50. MC 36. MC 55. Learning Objective 5 MC 83. MC 87. MC 84. MC 89. MC 85. MC 90. MC 86. MC 92. Learning Objective 6 MC 69. MC 75. MC 70. MC 76. MC 71. MC 77. MC 72. MC 78. MC 73. MC 88. MC 74. MC 91. Learning Objective 7 MC 79. MC 81. MC 80. MC 102.

Type

Item

Type

MC MC

31.

32.

MC MC

58. 59.

MC MC

MC MC MC E

93. 94. 95. 96.

E E E E

MC MC MC MC MC MC

95. 96. 97. 98. 99. 100.

E E E E E E

MC E

Item

Type

101. 103. 104. 105.

E P P P

Statement of Cash Flows

6-5

TRUE FALSE—Conceptual 1.

The primary purpose of the statement of cash flows is to provide cash-basis information about the company’s operating, investing, and financing activities.

The statement of cash flows provides information to help investors and creditors assess the cash and noncash investing and financing transactions during the period.

Companies classify some cash flows relating to investing or financing activities as operating activities.

The first step in the preparation of the statement of cash flows is to determine the net cash flow from operating activities.

The net increase (decrease) in cash reported on the statement of cash flows should reconcile the beginning and ending cash balances reported in the comparative balance sheets.

Operating activities involve the cash effects of transactions that enter into the determination of net income.

The statement of cash flows provides information not available from other financial statements.

Financing activities include (a) making and collecting loans and (b) acquiring and disposing of investments and productive long-lived assets.

The cash received from the sale of property, plant, and equipment at a gain, although reported in the income statement, is classified as an investing activity.

10.

To prepare the statement of cash flows, only comparative balance sheets and a current income statement are needed.

11.

Determining net cash provided by operating activities involves analysis of the income statement alone as it is the statement that reflects the amount of cash generated from operations as well as the amount of cash used to conduct the operations.

12.

Unlike the other financial statements, the statement of cash flows is not prepared from the adjusted trial balance.

13.

A company can convert net income to net cash flow from operating activities through either the direct method or the indirect method.

14.

The FASB has expressed a preference for the indirect method over the direct method.

15.

Under the accrual basis of accounting, net income is usually the same as net cash flow from operating activities.

16.

The indirect method adjusts net income for items that affected reported net income but did not affect cash.

6-6

Test Bank for Intermediate Accounting, Second Edition

17.

As its name implies, the indirect method is not directly involved with the computation of accrual-basis net income because it results in the presentation of a condensed cash-basis income statement.

18.

When computing net cash provided by operating activities, an increase in accounts receivable (net) during the year must be added to accrual-basis net income because more sales were made than those reflected in the income statement.

19.

Because the payment of cash dividends reduces both cash and retained earnings by a similar amount, this transaction has no effect on the statement of cash flows.

20.

If a company records a loss on the sale of equipment, the amount of the loss must be added back to net income to determine the proper amount of net cash provided by operating activities.

21.

When accounts receivable decrease during a period, cash-basis revenues are higher than revenues reported on an accrual basis.

22.

When prepaid expenses decrease during a period, expenses on an accrual basis are lower than they are on a cash basis.

23.

When accounts payable increase during a period, cost of goods sold on an accrual basis is lower than cost of goods sold on a cash basis.

24.

Free cash flow is net income less capital expenditures and dividends.

25.

Financial statement readers often assess liquidity by using the current cash debt coverage ratio.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5.

F T T F T

6. 7. 8. 9. 10.

T T F T F

11. 12. 13. 14. 15.

F F T F F

16. 17. 18. 19. 20.

T F F F T

21. 22. 23. 24. 25.

T F F F T

Statement of Cash Flows

6-7

MULTIPLE CHOICE—Conceptual 26.

The primary purpose of the statement of cash flows is to provide information a. about the operating, investing, and financing activities of an entity during a period. b. that is useful in assessing cash flow prospects. c. about the cash receipts and cash payments of an entity during a period. d. about the entity's ability to meet its obligations, its ability to pay dividends, and its needs for external financing.

27.

Of the following questions, which one would not be answered by the statement of cash flows? a. Where did the cash come from during the period? b. What was the cash used for during the period? c. Were all the cash expenditures of benefit to the company during the period? d. What was the change in the cash balance during the period?

28.

A company borrows $10,000 and signs a 90-day nontrade note payable. In preparing a statement of cash flows (indirect method), this event would be reflected as a(n) a. addition adjustment to net income in the cash flows from operating activities section. b. cash outflow from investing activities. c. cash inflow from investing activities. d. cash inflow from financing activities.

29.

In general, financing activities as used in the statement of cash flows refer to a. liability and owners' equity items and include (a) obtaining cash from creditors and repaying the amounts borrowed and (b) obtaining capital from owners and providing them with a return on, and a return of, their investment. b. transactions involving long-term assets and include (a) making and collecting loans and (b) acquiring and disposing of investments and productive long-lived assets. c. only debt transactions that result from long-term borrowings from financial institutions. d. the cash effect of transactions that enter into the determination of net income and, thus, help finance the operations of the business through the generation of cash.

30.

Which of the following activities is classified as an investing activity on the statement of cash flows? a. Cash received from the sale of goods and services b. Cash paid to suppliers for inventory c. Cash paid to lenders for interest d. Cash received from the sale of property, plant, and equipment

31.

In a statement of cash flows, the cash flows from investing activities section should report a. the issuance of common stock in exchange for legal services. b. a stock split. c. the collection of a loan. d. a payment of dividends.

32.

The first step in the preparation of the statement of cash flows requires the use of information included in which comparative financial statements? a. Statements of cash flows b. Balance sheets c. Income statements d. Statements of retained earnings

6-8

Test Bank for Intermediate Accounting, Second Edition

33.

To arrive at net cash provided by operating activities, it is necessary to report revenues and expenses on a cash basis. This is done by a. re-recording all income statement transactions that directly affect cash in a separate cash flow journal. b. estimating the percentage of income statement transactions that were originally reported on a cash basis and projecting this amount to the entire array of income statement transactions. c. eliminating the effects of income statement transactions that did not result in a corresponding increase or decrease in cash. d. eliminating all transactions that have no current or future effect on cash, such as depreciation, from the net income computation.

34.

An increase in inventory balance would be reported in a statement of cash flows as a(n) a. addition to net income in arriving at net cash flow from operating activities. b. deduction from net income in arriving at net cash flow from operating activities. c. cash outflow from investing activities. d. cash outflow from financing activities.

35.

When preparing a statement of cash flows, which of the following is not an adjustment to reconcile net income to net cash provided by operating activities? a. A change in interest payable b. A change in dividends payable c. A change in income taxes payable d. All of these are adjustments.

The method used to compute net cash provided by operating activities that adjusts net income for items that affected reported net income but did not affect cash is known as the a. indirect method. b. direct method. c. adjustment method. d. income statement method.

37.

In a statement of cash flows, the cash flows from investing activities section should report a. the issuance of common stock in exchange for a factory building. b. stock dividends received. c. a major repair to machinery charged to accumulated depreciation. d. the assignment of accounts receivable.

38.

Xanthe Corporation had the following transactions occur in the current year: 1. 2. 3. 4. 5. 6.

Cash sale of merchandise inventory. Sale of delivery truck at book value. Sale of Xanthe common stock for cash. Issuance of a note payable to a bank for cash. Sale of a security held as an available-for-sale investment. Collection of loan receivable.

How many of the above items will appear as a cash inflow from investing activities on a statement of cash flows for the current year? a. Five items b. Four items c. Three items d. Two items

Statement of Cash Flows

6-9

39.

Which of the following would be classified as a financing activity on a statement of cash flows? a. Declaration and distribution of a stock dividend b. Deposit to a bond sinking fund c. Sale of a loan receivable d. Payment of interest to a creditor

40.

The amortization of bond premium on long-term debt should be presented in a statement of cash flows as a(n) a. addition to net income. b. deduction from net income. c. investing activity. d. financing activity.

41.

When preparing a statement of cash flows, an increase in ending inventory over beginning inventory will result in an adjustment to reported net earnings because a. cash was increased while cost of goods sold was decreased. b. cost of goods sold on an accrual basis is lower than on a cash basis. c. acquisition of inventory is an investment activity. d. inventory purchased during the period was less than inventory sold resulting in a net cash increase.

42.

In determining net cash flow from operating activities, a decrease in accounts payable during a period a. means that income on an accrual basis is less than income on a cash basis. b. requires an addition adjustment to net income. c. requires a decrease adjustment to net income. d. requires a decrease adjustment to cost of goods sold.

43.

Schroeder Company uses the indirect method in computing net cash provided by operating activities. How would reported net income be adjusted for the following items? a. b. c. d.

Loss on Sale of Machinery Added To Deducted From Added To Deducted From

Increase in Inventories Deducted From Added To Added To Deducted From

44.

The cash debt coverage ratio is computed by dividing net cash provided by operating activities by a. average long-term liabilities. b. average total liabilities. c. ending long-term liabilities. d. ending total liabilities.

45.

The current cash debt coverage ratio is often used to assess a. financial flexibility. b. liquidity. c. profitability. d. solvency.

6 - 10

Test Bank for Intermediate Accounting, Second Edition

46.

A measure of a company’s liquidity is the a. cash debt coverage ratio. b. current cash debt coverage ratio. c. free cash flow. d. cash debt coverage ratio and free cash flow.

47.

Free cash flow is calculated as net cash provided by operating activities less a. capital expenditures. b. dividends. c. capital expenditures and dividends. d. capital expenditures and depreciation.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

26. 27. 28. 29.

c c d a

30. 31. 32. 33.

d c b c

34. 35. 36. 37.

b b a c

38. 39. 40. 41.

c b b b

42. 43. 44. 45.

c a b b

46. 47.

d c

MULTIPLE CHOICE—Computational Use the following information for questions 48 and 49. Lange Co. provided the following information on selected transactions during 2009: Purchase of land by issuing bonds Proceeds from issuing bonds Purchases of inventory Purchases of treasury stock Loans made to affiliated corporations Dividends paid to preferred stockholders Proceeds from issuing preferred stock Proceeds from sale of equipment

$250,000 500,000 950,000 150,000 350,000 100,000 400,000 50,000

48.

The net cash provided (used) by investing activities during 2009 is a. $50,000. b. $(300,000). c. $(550,000). d. $(1,250,000).

49.

The net cash provided by financing activities during 2009 is a. $550,000. b. $650,000. c. $800,000. d. $900,000.

Statement of Cash Flows

6 - 11

Use the following information for questions 50 through 52. The balance sheet data of Naley Company at the end of 2009 and 2008 follow: 2009 Cash $ 50,000 Accounts receivable (net) 120,000 Merchandise inventory 140,000 Prepaid expenses 20,000 Buildings and equipment 180,000 Accumulated depreciation—buildings and equipment (36,000) Land 180,000 Totals $654,000 Accounts payable Accrued expenses Notes payable—bank, long-term Mortgage payable Common stock, $10 par Retained earnings (deficit)

$136,000 24,000 60,000 418,000 16,000 $654,000

2008 $ 70,000 90,000 90,000 50,000 150,000 (16,000) 80,000 $514,000 $110,000 36,000 80,000 318,000 (30,000) $514,000

Land was acquired for $100,000 in exchange for common stock, par $100,000, during the year; all equipment purchased was for cash. Equipment costing $10,000 was sold for $4,000; book value of the equipment was $8,000 and the loss was reported as an ordinary item in net income. Cash dividends of $20,000 were charged to retained earnings and paid during the year; the transfer of net income to retained earnings was the only other entry in the Retained Earnings account. In the statement of cash flows for the year ended December 31, 2009, for Naley Company: 50.

The net cash provided by operating activities was a. $52,000. b. $66,000. c. $56,000. d. $48,000.

51.

The net cash provided (used) by investing activities was a. $26,000. b. $(40,000). c. $(136,000). d. $(36,000).

52.

The net cash provided (used) by financing activities was a. $0. b. $(20,000). c. $(40,000). d. $60,000.

6 - 12 53.

Test Bank for Intermediate Accounting, Second Edition The following information on selected cash transactions for 2009 has been provided by Simpson Company: Proceeds from sale of land Proceeds from long-term borrowings Purchases of plant assets Purchases of inventories Proceeds from sale of Simpson common stock

$160,000 400,000 144,000 680,000 240,000

What is the cash provided (used) by investing activities for the year ended December 31, 2009, as a result of the above information? a. $16,000 b. $256,000 c. $160,000 d. $800,000 54.

Selected information from Adison Company's 2009 accounting records is as follows: Proceeds from issuance of common stock Proceeds from issuance of bonds Cash dividends on common stock paid Cash dividends on preferred stock paid Purchases of treasury stock Sale of stock to officers and employees not included above

$ 400,000 1,200,000 160,000 60,000 120,000 100,000

Adison's statement of cash flows for the year ended December 31, 2009, would show net cash provided (used) by financing activities of a. $60,000. b. $(220,000). c. $160,000. d. $1,360,000. Use the following information for questions 55 through 57. Paxson Mining Co. has recently decided to go public and has hired you as an independent CPA. One statement that the enterprise is anxious to have prepared is a statement of cash flows. Financial statements of Paxson Mining Co. for 2009 and 2008 are provided below. BALANCE SHEETS Cash Accounts receivable Merchandise inventory Property, plant and equipment Less accumulated depreciation

Accounts payable Income taxes payable Bonds payable Common stock Retained earnings

12/31/09 $204,000 180,000 192,000 $304,000 (160,000)

144,000 $720,000 $ 88,000 176,000 180,000 108,000 168,000 $720,000

12/31/08 $ 96,000 108,000 240,000 $480,000 (152,000)

328,000 $772,000 $ 48,000 196,000 300,000 108,000 120,000 $772,000

Statement of Cash Flows

6 - 13

INCOME STATEMENT For the Year Ended December 31, 2009 Sales Cost of sales Gross profit Selling expenses Administrative expenses Income from operations Interest expense Income before taxes Income taxes Net income

$4,200,000 3,576,000 624,000 $300,000 96,000

396,000 228,000 36,000 192,000 48,000 $ 144,000

The following additional data were provided: 1. Dividends for the year 2009 were $96,000. 2. During the year, equipment was sold for $120,000. This equipment cost $176,000 originally and had a book value of $144,000 at the time of sale. The loss on sale was incorrectly charged to cost of sales. 3. All depreciation expense is in the selling expense category. Questions 55 through 57 relate to a statement of cash flows for the year ended December 31, 2009, for Paxson Mining Company. 55.

The net cash provided by operating activities is a. $204,000. b. $144,000. c. $120,000. d. $100,000.

56.

The net cash provided (used) by investing activities is a. $(176,000). b. $24,000. c. $120,000. d. $(144,000).

57.

The net cash provided (used) by financing activities is a. $(120,000). b. $24,000. c. $(216,000). d. $96,000.

58.

During 2008, Greta Company earned net income of $128,000 which included depreciation expense of $26,000. In addition, the company experienced the following changes in the account balances listed below: Increases Accounts payable .................................................................. $15,000 Inventory................................................................................ 12,000 Decreases Accounts receivable .............................................................. Prepaid expenses .................................................................. Accrued liabilities ...................................................................

$ 4,000 11,000 8,000

6 - 14

Test Bank for Intermediate Accounting, Second Edition Based upon this information what amount will be shown for net cash provided by operating activities for 2008? a. $89,000 b. $95,000 c. $155,000 d. $164,000

59.

Cashman Company reported net income after taxes of $85,000 for the year ended 12/31/08. Included in the computation of net income were: depreciation expense, $15,000; amortization of a patent, $8,000; and a gain on sale of investments, $3,000. Cashman also paid a $20,000 dividend during the year. The net cash provided by operating activities would be reported at a. $45,000. b. $85,000. c. $89,000. d. $105,000.

60.

During 2009, Ogden Inc. had the following activities related to its financial operations: Carrying value of convertible preferred stock in Ogden, converted into common shares of Ogden $ 360,000 Payment in 2008 of cash dividend declared in 2008 to preferred shareholders 186,000 Payment for the early retirement of long-term bonds payable (carrying amount $2,220,000) 2,250,000 Proceeds from the sale of treasury stock (on books at cost of $258,000) 300,000 The amount of net cash used in financing activities to appear in Ogden's statement of cash flows for 2009 should be a. $1,590,000. b. $1,776,000. c. $2,136,000. d. $2,148,000.

61.

Tobin Company sold some of its plant assets during 2008. The original cost of the plant assets was $750,000 and the accumulated depreciation at date of sale was $700,000. The proceeds from the sale of the plant assets were $105,000. The information concerning the sale of the plant assets should be shown on Tobin's statement of cash flows for the year ended December 31, 2008, as a(n) a. subtraction from net income of $55,000 and a $50,000 increase in cash flows from financing activities. b. addition to net income of $55,000 and a $105,000 increase in cash flows from investing activities. c. subtraction from net income of $55,000 and a $105,000 increase in cash flows from investing activities. d. addition of $105,000 to net income.

Statement of Cash Flows 62.

6 - 15

An analysis of the machinery accounts of Doonan Company for 2008 is as follows: Machinery, Net of Accumulated Accumulated Machinery Depreciation Depreciation Balance at January 1, 2008 $500,000 $125,000 $375,000 Purchases of new machinery in 2008 for cash 200,000 — 200,000 Depreciation in 2008 — 100,000 (100,000) Balance at Dec. 31, 2008 $700,000 $225,000 $475,000 The information concerning Doonan's machinery accounts should be shown in Doonan's statement of cash flows for the year ended December 31, 2008, as a(n) a. subtraction from net income of $100,000 and a $200,000 decrease in cash flows from financing activities. b. addition to net income of $100,000 and a $200,000 decrease in cash flows from investing activities. c. $100,000 increase in cash flows from financing activities. d. $200,000 decrease in cash flows from investing activities.

63.

Equipment which cost $213,000 and had accumulated depreciation of $114,000 was sold for $111,000. This transaction should be shown on the statement of cash flows as a(n) a. addition to net income of $12,000 and a $111,000 cash inflow from financing activities. b. deduction from net income of $12,000 and a $99,000 cash inflow from investing activities. c. deduction from net income of $12,000 and a $111,000 cash inflow from investing activities. d. addition to net income of $12,000 and a $99,000 cash inflow from financing activities.

64.

During 2009, equipment was sold for $156,000. The equipment cost $252,000 and had a book value of $144,000. Accumulated Depreciation—Equipment was $687,000 at 12/31/08 and $735,000 at 12/31/09. Depreciation expense for 2009 was a. $60,000. b. $96,000. c. $156,000. d. $192,000.

Use the following information for questions 65 and 66. Equipment that cost $300,000 and had a book value of $156,000 was sold for $180,000. Data from the comparative balance sheets are: 12/31/09 12/31/08 Equipment $2,160,000 $1,950,000 Accumulated Depreciation 660,000 570,000 65.

Depreciation expense for 2009 was a. $258,000. b. $234,000. c. $54,000. d. $36,000.

6 - 16 66.

Test Bank for Intermediate Accounting, Second Edition Equipment purchased during 2009 was a. $510,000. b. $300,000. c. $210,000. d. $90,000.

Use the following information for questions 67 through 71. Financial statements for Rogan Company are given below: Rogan Company Balance Sheet January 1, 2008 Assets Cash Accounts receivable Buildings and equipment Accumulated depreciation— buildings and equipment Patents

$ 320,000 288,000 1,200,000 (400,000) 144,000 $1,552,000

Equities Accounts payable

Capital stock Retained earnings

$ 152,000

920,000 480,000 $1,552,000

Rogan Company Statement of Cash Flows For the Year Ended December 31, 2008 Increase (Decrease) in Cash Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable Increase in accounts payable Depreciation—buildings and equipment Gain on sale of equipment Amortization of patents Net cash provided by operating activities Cash flows from investing activities Sale of equipment Purchase of land Purchase of buildings and equipment Net cash used by investing activities Cash flows from financing activities Payment of cash dividend Sale of common stock Net cash provided by financing activities Net increase in cash Cash, January 1, 2008 Cash, December 31, 2008

$400,000

$(128,000) 64,000 120,000 (48,000) 16,000

24,000 424,000

96,000 (200,000) (384,000) (488,000) (120,000) 320,000 200,000 136,000 320,000 $456,000

Total assets on the balance sheet at December 31, 2008 are $2,216,000. Accumulated depreciation on the equipment sold was $112,000.

Statement of Cash Flows

6 - 17

67.

When the equipment was sold, the Buildings and Equipment account received a credit of a. $96,000. b. $208,000. c. $160,000. d. $112,000.

68.

The book value of the buildings and equipment at December 31, 2008 was a. $1,016,000. b. $1,040,000. c. $1,424,000. d. $1,176,000.

69.

The accounts payable at December 31, 2008 were a. $88,000. b. $216,000. c. $64,000. d. $296,000.

70.

The balance in the Retained Earnings account at December 31, 2008 was a. $360,000. b. $880,000. c. $760,000. d. $1,000,000.

71.

Capital stock (plus any additional paid-in capital) at December 31, 2008 was a. $800,000. b. $920,000. c. $520,000. d. $1,240,000.

Use the following information for questions 72 and 73. The balance in retained earnings at December 31, 2008 was $720,000 and at December 31, 2009 was $582,000. Net income for 2009 was $500,000. A stock dividend was declared and distributed which increased common stock $200,000 and paid-in capital $110,000. A cash dividend was declared and paid. 72.

The amount of the cash dividend was a. $248,000. b. $328,000. c. $442,000. d. $638,000.

73.

The stock dividend should be reported on the statement of cash flows as a. an outflow from financing activities of $200,000. b. an outflow from financing activities of $310,000. c. an outflow from investing activities of $310,000. d. Stock dividends are not shown on a statement of cash flows.

6 - 18 74.

Test Bank for Intermediate Accounting, Second Edition The following information was taken from the 2008 financial statements of Sawyer Corporation: Bonds payable, January 1, 2008 Bonds payable, December 31, 2008

$ 500,000 2,000,000

During 2008 • A $450,000 payment was made to retire bonds payable with a face amount of $500,000. • Bonds payable with a face amount of $200,000 were issued in exchange for equipment. In its statement of cash flows for the year ended December 31, 2008, what amount should Sawyer report as proceeds from issuance of bonds payable? a. $1,500,000 b. $1,750,000 c. $1,800,000 d. $2,200,000 75.

Richman Corporation had net income for 2008 of $3,000,000. Additional information is as follows: Depreciation of plant assets Amortization of intangibles Increase in accounts receivable Increase in accounts payable

$1,200,000 240,000 420,000 540,000

Richman's net cash provided by operating activities for 2008 was a. $4,560,000. b. $4,440,000. c. $4,320,000. d. $1,680,000. 76.

Net cash flow from operating activities for 2008 for Fordham Corporation was $300,000. The following items are reported on the financial statements for 2008: Cash dividends paid on common stock Depreciation and amortization Increase in accounts receivables

$20,000 12,000 24,000

Based on the information above, Fordham’s net income for 2008 was a. $312,000. b. $296,000. c. $264,000. d. $256,000. 77.

During 2008, Hogan Company earned net income of $384,000 which included depreciation expense of $78,000. In addition, the company experienced the following changes in the account balances listed below: Increases Accounts payable Inventory

$45,000 36,000

Decreases Accounts receivable Accrued liabilities Prepaid insurance

$12,000 24,000 33,000

Statement of Cash Flows

6 - 19

Based upon this information, what amount will be shown for net cash provided by operating activities for 2008? a. $492,000 b. $465,000 c. $285,000 d. $267,000 78.

Robley Company reported net income of $340,000 for the year ended 12/31/08. Included in the computation of net income were: depreciation expense, $60,000; amortization of a patent, $32,000; and a loss on sale of equipment, $12,000. Robley also paid an $80,000 dividend during the year. The net cash provided by operating activities would be reported at a. $444,000. b. $420,000. c. $236,000. d. $156,000.

Use the following information for questions 79 and 80: Joe Novak Corporation reports the following information: Net cash provided by operating activities Average current liabilities Average long-term liabilities Dividends declared Capital expenditures Payments of debt

$215,000 150,000 100,000 60,000 110,000 35,000

79.

Joe Novak’s current cash debt coverage ratio is a. 0.86. b. 1.43. c. 2.15. d. 4.78.

80.

Joe Novak’s free cash flow is a. $10,000. b. $45,000. c. $105,000. d. $155,000.

81.

Lincoln Corporation reports the following information: Net cash provided by operating activities Average current liabilities Average long-term liabilities Dividends paid Capital expenditures Payments of debt Lincoln’s cash debt coverage ratio is a. 1.02. b. 1.70. c. 2.55. d. 3.00.

$255,000 150,000 100,000 60,000 110,000 35,000

6 - 20

Test Bank for Intermediate Accounting, Second Edition

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

48. 49. 50. 51. 52.

b b c d c

53. 54. 55. 56. 57.

a d a c c

58. 59. 60. 61. 62.

d d c c b

63. 64. 65. 66. 67.

c c b a c

68. 69. 70. 71. 72.

a b c d b

73. 74. 75. 76. 77.

d c a a a

78. 79. 80. 81.

a b b a

MULTIPLE CHOICE—CPA Adapted Use the following information for questions 82 and 83. A company acquired a building, paying a portion of the purchase price in cash and issuing a mortgage note payable to the seller for the balance. 82.

In a statement of cash flows, what amount is included in investing activities for the above transaction? a. Cash payment b. Acquisition price c. Zero d. Mortgage amount

83.

In a statement of cash flows, what amount is included in financing activities for the above transaction? a. Cash payment b. Acquisition price c. Zero d. Mortgage amount

Use the following information for questions 84 and 85. Kerwin Corp.'s transactions for the year ended December 31, 2008 included the following: • Purchased real estate for $550,000 cash which was borrowed from a bank. • Sold available-for-sale securities for $500,000. • Paid dividends of $600,000. • Issued 500 shares of common stock for $250,000. • Purchased machinery and equipment for $125,000 cash. • Paid $450,000 toward a bank loan. • Reduced accounts receivable by $100,000. • Increased accounts payable $200,000.

Statement of Cash Flows 84.

Kerwin's net cash used in investing activities for 2008 was a. $675,000. b. $375,000. c. $175,000. d. $50,000.

85.

Kerwin's net cash used in financing activities for 2008 was a. $50,000. b. $250,000. c. $450,000. d. $500,000.

6 - 21

Use the following information for questions 86 and 87. Miloy Corp.'s transactions for the year ended December 31, 2008 included the following: • • • • • • •

Acquired 50% of Gant Corp.'s common stock for $180,000 cash which was borrowed from a bank. Issued 5,000 shares of its preferred stock for land having a fair value of $320,000. Issued 500 of its 11% debenture bonds, due 2013, for $392,000 cash. Purchased a patent for $220,000 cash. Paid $120,000 toward a bank loan. Sold available-for-sale securities for $796,000. Had a net increase in returnable customer deposits (long-term) of $88,000. 86.

Miloy’s net cash provided by investing activities for 2008 was a. $296,000. b. $396,000. c. $476,000. d. $616,000.

87.

Miloy’s net cash provided by financing activities for 2008 was a. $452,000. b. $540,000. c. $572,000. d. $660,000.

Use the following information for questions 88 through 90. Talbert Corp.'s balance sheet accounts as of December 31, 2009 and 2008 and information relating to 2009 activities are presented below. December 31, 2009 2008 Assets Cash $ 440,000 $ 200,000 Short-term investments 600,000 — Accounts receivable (net) 1,020,000 1,020,000 Inventory 1,380,000 1,200,000 Long-term investments 400,000 600,000 Plant assets 3,400,000 2,000,000 Accumulated depreciation (900,000) (900,000) Patent 180,000 200,000 Total assets $6,520,000 $4,320,000

6 - 22

Test Bank for Intermediate Accounting, Second Edition

Liabilities and Stockholders' Equity Accounts payable and accrued liabilities Notes payable (nontrade) Common stock, $10 par Additional paid-in capital Retained earnings Total liabilities and stockholders' equity

$1,660,000 580,000 1,600,000 800,000 1,880,000 $6,520,000

$1,440,000 — 1,400,000 500,000 980,000 $4,320,000

Information relating to 2009 activities: • Net income for 2009 was $1,500,000. • Cash dividends of $600,000 were declared and paid in 2009. • Equipment costing $1,000,000 and having a carrying amount of $320,000 was sold in 2008 for $360,000. • A long-term investment was sold in 2009 for $320,000. There were no other transactions affecting long-term investments in 2009. • 20,000 shares of common stock were issued in 2008 for $25 a share. • Short-term investments consist of treasury bills maturing on 6/30/10. 88.

Net cash provided by Talbert’s 2009 operating activities was a. $1,500,000. b. $2,120,000. c. $2,080,000. d. $2,160,000.

89.

Net cash used in Talbert’s 2009 investing activities was a. $2,320,000. b. $1,820,000. c. $1,680,000. d. $1,720,000.

90.

Net cash provided by Talbert’s 2009 financing activities was a. $480,000. b. $520,000. c. $1,080,000. d. $1,680,000.

91.

Bell Corp.'s comparative balance sheet at December 31, 2009 and 2008 reported accumulated depreciation balances of $800,000 and $600,000, respectively. Property with a cost of $50,000 and a carrying amount of $38,000 was the only property sold in 2009. Depreciation charged to operations in 2009 was a. $188,000. b. $200,000. c. $212,000. d. $224,000.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

82. 83.

a c

84. 85.

c b

86. 87.

b b

88. 89.

c a

90. 91.

a c

Statement of Cash Flows

6 - 23

DERIVATIONS — Computational No. Answer

Derivation

48.

$50,000 – $350,000 = –$300,000.

49.

$500,000 – $150,000 – $100,000 + $400,000 = $650,000.

50.

$16,000 + $20,000 + $30,000 = $66,000 (NI) ($10,000 – $2,000) – $4,000 = $4,000 (Loss) $36,000 + $2,000 – $16,000 = $22,000 (Depr. exp.) $66,000 – $30,000 – $50,000 + $30,000 + $4,000 + $22,000 + $26,000 – $12,000 = $56,000.

51.

$4,000 – ($180,000 + $10,000 – $150,000) = ($36,000).

52.

($80,000) + $60,000 – $20,000 = ($40,000).

53.

$160,000 – $144,000 = $16,000.

54.

$400,000 + $1,200,000 – $160,000 – $60,000 – $120,000 + $100,000 = $1,360,000.

55.

$144,000 + $24,000 + ($160,000 + $32,000 – $152,000) – $72,000 + $48,000 + $40,000 – $20,000 = $204,000.

56.

$120,000.

57.

($96,000) – ($120,000) = ($216,000).

58.

$128,000 + $26,000 + $15,000 – $12,000 + $4,000 + $11,000 – $8,000 = $164,000.

59.

$85,000 + $15,000 + $8,000 – $3,000 = $105,000.

60.

$300,000 – $186,000 – $2,250,000 = $2,136,000.

61.

$105,000 – ($750,000 – $700,000) = $55,000, $105,000 (proceeds).

62.

Conceptual.

63.

$111,000 – ($213,000 – $114,000) = $12,000, $111,000 (proceeds).

64.

$735,000 – $687,000 + ($252,000 – $144,000) = $156,000.

65.

$660,000 – $570,000 + ($300,000 – $156,000) = $234,000.

66.

$2,160,000 – $1,950,000 + $300,000 = $510,000.

67.

$96,000 – $48,000 = $48,000 (BV); $48,000 + $112,000 = $160,000.

68.

($1,200,000 – $400,000) – $48,000 + $384,000 – $120,000 = $1,016,000.

6 - 24

Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational (cont.) No. Answer

Derivation

69.

$152,000 + $64,000 = $216,000.

70.

$480,000 + $400,000 – $120,000 = $760,000.

71.

$920,000 + $320,000 = $1,240,000.

72.

$720,000 + $500,000 – ($200,000 + $110,000) – X = $582,000 X = $328,000.

73.

Conceptual.

74.

$2,000,000 – $500,000 + $500,000 – $200,000 = $1,800,000.

75.

$3,000,000 + $1,200,000 – $240,000 + $420,000 + $540,000 = $4,560,000.

76.

X + $12,000 – $24,000 = $300,000; X = $312,000.

77.

$384,000 + $78,000 + $45,000 – $36,000 + $12,000 – $24,000 + $33,000 = $492,000.

78.

$340,000 + $60,000 + $32,000 – $48,000 + $12,000 = $396,000.

79.

$215,000 ÷ $150,000 = 1.43.

80.

$215,000 – $60,000 – $110,000 = $45,000.

81.

$255,000 ÷ ($150,000 + $100,000) = 1.02.

DERIVATIONS — CPA Adapted No. Answer

Derivation

82.

Conceptual.

83.

Conceptual.

84.

($550,000) + $500,000 – $125,000 = ($175,000).

85.

$550,000 – $600,000 + $250,000 – $450,000 = ($250,000).

86.

($180,000) – $220,000 + $796,000 = $396,000.

87.

$180,000 + $392,000 – $120,000 + $88,000 = $540,000.

88.

$1,500,000 – $180,000 + ($900,000 – $900,000 + $680,000) + ($360,000 – $320,000) + $20,000 + $220,000 – ($320,000 – $200,000) = $2,080,000.

Statement of Cash Flows

6 - 25

DERIVATIONS — CPA Adapted (cont.) No. Answer

Derivation

89.

$320,000 + $360,000 – ($3,400,000 + $1,000,000 – $2,000,000) – $600,000 = $2,320,000.

90.

20,000 × $25 = $500,000 $500,000 + $580,000 – $600,000 = $480,000.

91.

$800,000 – $600,000 + ($50,000 – $38,000) = $212,000.

EXERCISES Ex. 6-92—Classification of cash flows. Note that X in the following statement of cash flows identifies a dollar amount and the letters (A) through (F) identify specific items which appear in the major sections of the statement. Statement of Cash Flows Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Add Deduct

+X –X

Net cash provided by operating activities

Cash flows from investing activities Inflows Outflows

+X –X

Net cash provided (used) by investing activities Cash flows from financing activities Inflows Outflows

+X –X

(E) (F)

Net cash provided (used) by financing activities

Net increase (decrease) in cash

(A) (B)

6 - 26

Test Bank for Intermediate Accounting, Second Edition

Ex. 6-92 (cont.). Instructions For each of the following items, indicate by letter in the blank spaces below, the section or sections where the effect would be reported. Use the code (A through F) from above. If the item is not required to be reported on the statement of cash flows, write the word "none" in the blank. Assume that generally accepted accounting principles have been followed in determining net income and that there are no short-term securities which are considered cash equivalents. ____

1. After the retirement of an officer, the insurance policy was canceled, and a cash settlement was received by the firm. These proceeds were in excess of the book value of the policy.

____

2. Decrease in Retained Earnings Appropriated for Self-insurance.

____

3. Accrued estimated income taxes for the period. These taxes will be paid next year.

____

4. Trading securities are sold at a loss.

____

5. Two-year notes issued at discount for a patent.

____

6. The book value of trading securities was reduced to fair value.

____

7. Purchase of available-for-sale securities.

____

8. Declaration of stock dividends (not yet issued).

____

9. Issued preferred stock in exchange for equipment.

____ 10. Bad debts (under allowance method) estimated and recorded for the period (receivables classified as current). ____ 11. Gain on disposal of old machinery. ____ 12. Payment of cash dividends (previously declared in a prior period).

Solution 6-92 1. 2. 3. 5.

B and C None A None

6. 7. 8. 10.

A D None A

11. B 12. F

Ex. 6-93—Classification of cash flows and transactions. Give: (a) Three distinct examples of investing activities. (b) Three distinct examples of financing activities. (c) Three distinct examples of significant noncash transactions. (d) Two examples of transactions not shown on a statement of cash flows.

Statement of Cash Flows

6 - 27

Solution 6-93 (a) Investing activities: Purchase or sale of noncurrent assets Purchase or sale of securities of other entities Loans or collection of principal of loans to other entities (b) Financing activities: Issuing or reacquiring stock Issuing or redeeming debt Paying cash dividends to stockholders (c) Significant noncash transactions: Acquiring assets by issuing stock or debt Capital leases Conversion or refinancing of debt Exchanges of nonmonetary assets (d) Not shown on statement of cash flows: Stock dividends Appropriations of retained earnings

Ex. 6-94—Effects of transactions on statement of cash flows. Any given transaction may affect a statement of cash flows in one or more of the following ways: Cash flows from operating activities a. Net income will be increased or adjusted upward. b. Net income will be decreased or adjusted downward. Cash flows from investing activities c. Increase as a result of cash inflows. d. Decrease as a result of cash outflows. Cash flows from financing activities e. Increase as a result of cash inflows. f. Decrease as a result of cash outflows. The statement of cash flows is not affected g. Not required to be reported in the body of the statement. Instructions For each transaction listed below, list the letter or letters from above that describe(s) the effect of the transaction on a statement of cash flows for the year ending December 31, 2008. (Ignore any income tax effects.) ____

1. Preferred stock with a carrying value of $44,000 was redeemed for $50,000 on January 1, 2008.

____

2. Uncollectible accounts receivable in the amount of $3,000 were written off against the allowance for doubtful accounts balance of $12,200 on December 31, 2008.

6 - 28

Test Bank for Intermediate Accounting, Second Edition

Ex. 6-94 (cont.). ____

3. Machinery which originally cost $3,000 and has a book value of $1,800 is sold for $1,400 on December 31, 2008.

____

4. Land is acquired through the issuance of bonds payable on July 1, 2008.

____

5. 1,000 shares of stock, stated value $10 per share, are issued for $25 per share in 2008.

____

6. An appropriation of retained earnings for treasury stock in the amount of $35,000 is established in 2008.

____

7. A cash dividend of $8,000 is paid on December 31, 2008.

____

8. The portfolio of long-term investments (available-for-sale) is at an aggregate market value higher than aggregate cost at December 31, 2008.

Solution 6-94 1. f 2. g

3. a, c 4. g

5. e 6. g

7. f 8. g

Ex. 6-95—Effects of transactions on statement of cash flows. Indicate for each of the following what should be disclosed on a statement of cash flows. If not disclosed, write "Not shown." There may be more than one answer for some items. For an item that is added to net income, write "Add," and for an item that is deducted from net income, write "Deduct." Show financing and investing outflows in parentheses. For example, an answer might be: Deduct $4,700 or Investing ($31,000). If the item is a noncash transaction that should be disclosed separately, write "Noncash." (a)

The deferred tax liability increased $10,000.

(b)

Cash dividends paid, $60,000.

(c)

Issuance of a stock dividend increased common stock $40,000 and paid-in capital $16,000.

(d)

Amortization of patents, $3,000.

(e)

Machinery that cost $100,000 and had accumulated depreciation of $48,000 was sold for $55,000.

(f)

Issued 6,000 shares of common stock ($10 par) with a market value of $15 per share for machinery. (Show the amount, too.)

Solution 6-95 (a) (b) (c) (d)

Add $10,000 Financing ($60,000) Not shown Add $3,000

(e) (f)

Investing $55,000; Deduct $3,000 (gain) Noncash $90,000

Statement of Cash Flows

6 - 29

Ex. 6-96—Effects of transactions on statement of cash flows. Indicate for each of the following what should be disclosed on a statement of cash flows (SCF). If not disclosed, write "Not shown." If an item is a noncash transaction that should be shown separately, write "noncash." If an item is added to net income, write "Add," and if an item is deducted from net income, write "Deduct." Show financing and investing outflows in parentheses. For example, an answer might be: Deduct $4,700 or Investing ($31,000). There is more than one answer for some items. (a)

Issued 3,000 shares of preferred stock, $50 par, with a market value of $110 per share for land. (Show the amount, too.)

(b)

Gain on sale of investments, $1,100.

(c)

The balance in Retained Earnings was $875,000 on December 31, 2008 and $1,310,000 on December 31, 2009. Net income was $1,170,000. A stock dividend was declared and distributed which increased common stock $325,000 and paid-in capital $180,000. (Show calculation of the cash dividend and indicate how it and the stock dividend would be shown on the SCF.)

(d)

Equipment, which cost $115,000 and had accumulated depreciation of $53,000, was sold for $67,000.

(e)

The deferred tax liability increased $18,000.

Solution 6-96 (a) Noncash $330,000. (b) Deduct $1,100. (c) Retained earnings 12/31/09 $1,310,000 (or) Retained earnings 12/31/08 875,000 Increase 435,000 Stock dividend 505,000 940,000 Net income 1,170,000 Cash dividend $ 230,000 Stock dividend—Not shown. Cash dividend—Financing activity ($230,000). (d) Investing activity $67,000. Deduct $5,000 (gain on sale). (e) Add $18,000.

Net income $1,170,000 Increase in retained earnings 435,000 Total dividends 735,000 Stock dividends 505,000 Cash dividend $ 230,000

6 - 30

Test Bank for Intermediate Accounting, Second Edition

Ex. 6-97—Calculations for statement of cash flows. During 2009 equipment was sold for $75,000. This equipment cost $120,000 and had a book value of $70,000. Accumulated depreciation for equipment was $325,000 at 12/31/08 and $310,000 at 12/31/09. Instructions What three items should be shown on a statement of cash flows from this information? Show your calculations.

Solution 6-97 (1) Cash inflow from investing activities

$75,000

(2) Sales price Book value Gain on sale

$75,000 70,000 $ 5,000 Deduct from net income

(3) Cost Book value Accumulated depreciation Deduct decrease in accumulated depreciation Depreciation expense

$120,000 70,000 50,000 (15,000) $ 35,000 Add to net income

Ex. 6-98—Calculations for statement of cash flows. Vinson Co. sold a machine that cost $74,000 and had a book value of $44,000 for $50,000. Data from Vinson's comparative balance sheets are: 12/31/09 12/31/08 Machinery $800,000 $690,000 Accumulated depreciation 190,000 136,000 Instructions What four items should be shown on a statement of cash flows from this information? Show your calculations.

Solution 6-98 (1) Cash inflow from investing activities

$50,000

(2) Sales price Book value Gain on sale

$50,000 44,000 $ 6,000 Deduct from net income

(3) Cost Book value Accumulated depreciation Add increase in accumulated depreciation Depreciation expense

$74,000 44,000 30,000 54,000 $84,000 Add to net income

Statement of Cash Flows

6 - 31

Solution 6-98 (cont.) (4) Cost of machine sold Add increase in machinery Purchase of machinery

$ 74,000 110,000 $184,000 Cash outflow from investing activities

Ex. 6-99—Cash flows from operating activities. Presented below is the income statement of Foley, Inc.: Sales Cost of goods sold Gross profit Operating expenses Income before income taxes Income taxes Net income

$380,000 225,000 $155,000 85,000 70,000 28,000 $ 42,000

In addition, the following information related to net changes in working capital is presented: Cash Trade accounts receivable Inventories Salaries payable (operating expenses) Trade accounts payable Income tax payable

Debit $12,000 15,000

Credit

$19,400 8,000 12,000 3,000

The company also indicates that depreciation expense for the year was $16,700 and that the deferred tax liability account increased $2,600. Instructions Prepare a schedule computing the net cash flow from operating activities that would be shown on a statement of cash flows.

Solution 6-99 Foley, Inc. Statement of Cash Flows (Partial) Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Increase in trade accounts receivable Decrease in inventories Decrease in salaries payable (operating expenses) Increase in trade accounts payable Decrease in income taxes payable Depreciation expense Increase in deferred tax liability Net cash provided by operating activities

$42,000

$(15,000) 19,400 (8,000) 12,000 (3,000) 16,700 2,600

24,700 $66,700

6 - 32

Test Bank for Intermediate Accounting, Second Edition

Ex. 6-100—Statement of cash flows. The following information is taken from Reyser Corporation's financial statements:

Cash Accounts receivable Allowance for doubtful accounts Inventory Prepaid expenses Land Buildings Accumulated depreciation Patents

Accounts payable Accrued liabilities Bonds payable Common stock Retained earnings—appropriated Retained earnings—unappropriated Treasury stock, at cost

Net income Depreciation expense Amortization of patents Cash dividends declared and paid Gain or loss on sale of patents

December 31 2009 2008 $90,000 $ 27,000 92,000 80,000 (4,500) (3,100) 155,000 175,000 7,500 6,800 90,000 60,000 287,000 244,000 (32,000) (13,000) 20,000 35,000 $705,000 $611,700 $ 90,000 54,000 125,000 100,000 80,000 271,000 (15,000) $705,000

$ 84,000 63,000 60,000 100,000 10,000 302,700 (8,000) $611,700

For 2008 Year $58,300 19,000 5,000 20,000 none

Instructions Prepare a statement of cash flows for Reyser Corporation for the year 2009.

Statement of Cash Flows

6 - 33

Solution 6-100 Reyser Corporation Statement of Cash Flows For the Year Ended December 31, 2009 Increase (Decrease) in Cash Cash flows from operating activities Net income Adjust. to reconcile net income to net cash provided by operating activities: Depreciation expense Patent amortization Increase in accounts receivable Decrease in inventory Increase in prepaid expenses Increase in accounts payable Decrease in accrued liabilities

$58,300

$19,000 5,000 (10,600) 20,000 (700) 6,000 (9,000)

Net cash provided by operating activities Cash flows from investing activities Purchase of land Purchase of buildings Sale of patents

88,000

(30,000) (43,000) 10,000

Net cash used by investing activities Cash flows from financing activities Sale of bonds Purchase of treasury stock Payment of cash dividends

29,700

(63,000)

65,000 (7,000) (20,000)

Net cash provided by financing activities

38,000

Net increase in cash Cash, January 1, 2009 Cash, December 31, 2009

$63,000 27,000 $90,000

6 - 34

Test Bank for Intermediate Accounting, Second Edition

Ex. 6-101—Preparation of statement of cash flows (format provided). The balance sheets for Hafner Company showed the following information. Additional information concerning transactions and events during 2009 are presented below. Hafner Company Balance Sheet

Cash Accounts receivable (net) Inventory Long-term investments Property, plant & equipment Accumulated depreciation

Accounts payable Accrued liabilities Long-term notes payable Common stock Retained earnings

December 31 2009 2008 $ 30,900 $ 10,200 43,300 20,300 35,000 42,000 0 15,000 236,500 150,000 (37,700) (25,000) $308,000 $212,500 $ 17,000 21,000 70,000 130,000 70,000 $308,000

$ 26,500 17,000 50,000 90,000 29,000 $212,500

Additional data: 1. Net income for the year 2009, $76,000. 2. Depreciation on plant assets for the year, $12,700. 3. Sold the long-term investments for $28,000 (assume gain or loss is ordinary). 4. Paid dividends of $35,000. 5. Purchased machinery costing $26,500, paid cash. 6. Purchased machinery and gave a $60,000 long-term note payable. 7. Paid a $40,000 long-term note payable by issuing common stock. Instructions Using the format provided on the next page, prepare a statement of cash flows for 2008 for Hafner Company.

Statement of Cash Flows

6 - 35

Ex. 6-101 (cont.) Hafner Company Statement of Cash Flows For the Year Ended December 31, 2009 Increase (Decrease) in Cash Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: __________________________________

$__________

__________________________________

__________

__________________________________

__________

__________________________________

__________

__________________________________

__________

__________________________________

__________

__________________________________

__________

$__________

Net cash provided (used) by operating activities

__________ __________

Cash flows from investing activities ___________________________________

__________

___________________________________

__________

___________________________________

__________

Net cash provided (used) by investing activities

__________

Cash flows from financing activities ___________________________________

__________

___________________________________

__________

___________________________________

__________

Net cash provided (used) by financing activities Net increase (decrease) in cash

__________ $

Cash, January 1, 2009 Cash, December 31, 2009

6 - 36

Test Bank for Intermediate Accounting, Second Edition

Solution 6-101 Hafner Company Statement of Cash Flows For the Year Ended December 31, 2009 Increase (Decrease) in Cash Cash flows from operating activities Net income Adjustment to reconcile net income to net cash provided by operating activities: Depreciation expense Gain on sale of investments Increase in accounts receivable Decrease in inventory Decrease in accounts payable Increase in accrued liabilities

$ 76,000

$ 12,700 (13,000) (23,000) 7,000 (9,500) 4,000 (21,800)

Net cash provided by operating activities Cash flows from investing activities Sale of long-term investments Purchase of machinery

54,200

28,000 (26,500)

Net cash provided by investing activities Cash flows from financing activities Paid dividends

1,500

(35,000)

Net cash used by financing activities

(35,000)

Net increase (decrease) in cash Cash, January 1, 2009 Cash, December 31, 2009

$ 20,700 10,200 $ 30,900

Statement of Cash Flows

6 - 37

Ex. 6-102—Statement of cash flows ratios. Financial statements for Olson Company are presented below: Olson Company Balance Sheet December 31, 2008 Assets Cash Accounts receivable Buildings and equipment Accumulated depreciation— buildings and equipment Patents

$ 40,000 35,000 150,000 (50,000) 20,000 $195,000

Liabilities & Stockholders’ Equity Accounts payable $ 20,000 Bonds payable 50,000

Common stock Retained earnings

65,000 60,000 $195,000

Olson Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable Increase in accounts payable Depreciation—buildings and equipment Gain on sale of equipment Amortization of patents Net cash provided by operating activities

$50,000

$(16,000) 8,000 15,000 (6,000) 2,000

Cash flows from investing activities Sale of equipment Purchase of land Purchase of buildings and equipment Net cash used by investing activities

12,000 (25,000) (48,000)

Cash flows from financing activities Payment of cash dividend Sale of bonds Net cash provided by financing activities

(15,000) 40,000

Net increase in cash Cash, January 1, 2008 Cash, December 31, 2008

3,000 53,000

(61,000)

25,000 17,000 23,000 $40,000

At the beginning of 2008, Accounts Payable amounted to $12,000 and Bonds Payable was $10,000. Instructions Calculate the following for Olson Company: a. Current cash debt coverage ratio b. Cash debt coverage ratio c. Free cash flow

6 - 38

Test Bank for Intermediate Accounting, Second Edition

Solution 6-102 Net cash provided by operating activities a. Current cash debt coverage ratio = —————————————————— Average current liabilities $53,000 $53,000 = ——————————— = ———— = 3.3 : 1 ($12,000 + $20,000) ÷ 2 $16,000 Net cash provided by operating activities b. Cash debt coverage ratio = —————————————————— Average total liabilities $53,000 $53,000 = ——————————— = ———— = 1.2 : 1 ($22,000 + $70,000) ÷ 2 $46,000 c. Free cash flow = Net cash provided by operating activities – capital expenditures and dividends = $53,000 – *$73,000 – $15,000 = $(35,000) *$25,000 + $48,000

Statement of Cash Flows

6 - 39

PROBLEMS Pr. 6-103—Statement of cash flows. The net changes in the balance sheet accounts of Windsor Corporation for the year 2009 are shown below. Account Cash Short-term investments Accounts receivable Allowance for doubtful accounts Inventory Prepaid expenses Plant and equipment Accumulated depreciation Accounts payable Accrued liabilities Deferred tax liability 8% serial bonds Common stock, $10 par Additional paid-in capital Retained earnings—Appropriation for bonded indebtedness Retained earnings—Unappropriated

Debit $ 62,000

Credit $121,000

83,200 13,300 74,200 17,800 210,000 130,000 80,700 21,500 15,500 80,000 90,000 150,000 60,000 38,000 $623,600

$623,600

An analysis of the Retained Earnings—Unappropriated account follows: Retained earnings unappropriated, December 31, 2008 Add: Net income Transfer from appropriation for bonded indebtedness Total Deduct: Cash dividends Stock dividend Retained earnings unappropriated, December 31, 2009

$1,300,000 327,000 60,000 $1,687,000 $185,000 240,000

425,000 $1,262,000

1. On January 2, 2009 short-term investments (classified as available-for-sale) costing $121,000 were sold for $155,000. 2. The company paid a cash dividend on February 1, 2009. 3. Accounts receivable of $16,200 and $19,400 were considered uncollectible and written off in 2009 and 2008, respectively. 4. Major repairs of $33,000 to the equipment were debited to the Accumulated Depreciation account during the year. No assets were retired during 2009. 5. At January 1, 2009, the cash balance was $166,000. Instructions Prepare a statement of cash flows for the year ended December 31, 2009. Windsor Corporation has no securities which are classified as cash equivalents.

6 - 40

Test Bank for Intermediate Accounting, Second Edition

Solution 6-103 Windsor Corporation Statement of Cash Flows For the Year Ended December 31, 2009 Increase (Decrease) in Cash Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Gain on sale of short-term investments Decrease in deferred tax liability Increase in accounts receivable (net) Increase in inventory Decrease in prepaid expenses Decrease in accounts payable Increase in accrued liabilities

$327,000

$163,000 (34,000) (15,500) (69,900) (74,200) 17,800 (80,700) 21,500

Net cash provided by operating activities Cash flows from investing activities Sale of short-term investments Purchase of plant and equipment Major repairs to equipment

255,000

155,000 (210,000) (33,000)

Net cash provided by investing activities Cash flows from financing activities Payment of cash dividend Sale of serial bonds

(72,000)

(88,000)

(185,000) 80,000

Net cash used by financing activities

(105,000)

Net increase in cash Cash, January 1, 2009 Cash, December 31, 2009

62,000 166,000 $228,000

Statement of Cash Flows

6 - 41

Pr. 6-104—Statement of cash flows. Donelly, Inc. has prepared the following comparative balance sheets for 2009 and 2008: Cash Receivables Inventory Prepaid expenses Plant assets Accumulated depreciation Patent

Accounts payable Accrued liabilities Mortgage payable Preferred stock Additional paid-in capital—preferred Common stock Retained earnings

2009 $ 297,000 159,000 150,000 18,000 1,260,000 (450,000) 153,000 $1,587,000

2008 $ 153,000 117,000 180,000 27,000 1,050,000 (375,000) 174,000 $1,326,000

$ 153,000 60,000 — 525,000 120,000 600,000 129,000 $1,587,000

$ 168,000 42,000 450,000 — — 600,000 66,000 $1,326,000

1. The Accumulated Depreciation account has been credited only for the depreciation expense for the period. 2. The Retained Earnings account has been charged for dividends of $138,000 and credited for the net income for the year. The income statement for 2009 is as follows: Sales Cost of sales Gross profit Operating expenses Net income

$1,980,000 1,089,000 891,000 690,000 $ 201,000

Instructions From the information above, prepare a statement of cash flows for Donelly, Inc. for the year ended December 31, 2009.

6 - 42

Test Bank for Intermediate Accounting, Second Edition

Solution 6-104 Donelly, Inc. Statement of Cash Flows For the Year Ended December 31, 2009 Increase (Decrease) in Cash Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Patent amortization Increase in receivables Decrease in inventory Decrease in prepaid expenses Decrease in accounts payable Increase in accrued liabilities

$201,000

$ 75,000 21,000 (42,000) 30,000 9,000 (15,000) 18,000

96,000

Net cash provided by operating activities

297,000

Cash used in investing activities Purchase of plant assets

(210,000)

Cash flows from financing activities Payment of cash dividend Retirement of mortgage payable Sale of preferred stock Net cash provided by financing activities Net increase in cash Cash, January 1, 2009 Cash, December 31, 2009

(138,000) (450,000) 645,000 57,000 144,000 153,000 $297,000

Statement of Cash Flows

6 - 43

Pr. 6-105—A complex statement of cash flows. The net changes in the balance sheet accounts of Lenon, Inc. for the year 2008 are shown below: Account Cash Accounts receivable Allowance for doubtful accounts Inventory Prepaid expenses Long-term investments Land Buildings Machinery Office equipment Accumulated depreciation: Buildings Machinery Office equipment Accounts payable Accrued liabilities Dividends payable Premium on bonds Bonds payable Preferred stock ($50 par) Common stock ($10 par) Additional paid-in capital—common Retained earnings

Debit $ 125,600

Credit $

64,000 14,000

217,200 20,000 144,000 300,000 600,000 100,000 28,000 24,000 20,000 12,000 183,200 72,000 128,000 32,000 800,000 60,000 156,000 223,200 87,200 $1,705,200

$1,705,200

Additional information: 1. Net income for the year was $140,000. 2. Cash dividends of $128,000 were declared December 15, 2008, payable January 15, 2009. A 5% stock dividend was issued March 31, 2008, when the market value was $22 per share. 3. The long-term investments were sold for $140,000. 4. A building and land which cost $480,000 and had a book value of $300,000 were sold for $400,000. The cost of the land, included in the cost and book value above, was $20,000. 5. The following entry was made to record an exchange of an old machine for a new one: Machinery ............................................................................. 160,000 Accumulated Depreciation—Machinery ................................. 40,000 Machinery ................................................................. 60,000 Cash ......................................................................... 140,000 6. A fully depreciated copier machine which cost $28,000 was written off. 7. Preferred stock of $60,000 par value was redeemed for $80,000. 8. The company sold 12,000 shares of its common stock ($10 par) on June 15, 2008 for $25 a share. There were 87,600 shares outstanding on December 31, 2008. 9. Bonds were sold at 104 on December 31, 2008. Instructions Prepare a statement of cash flows. Ignore tax effects.

6 - 44

Test Bank for Intermediate Accounting, Second Edition

Solution 6-105 Lenon, Inc. Statement of Cash Flows For the Year Ended December 31, 2008 Increase (Decrease) in Cash Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense—buildings Depreciation expense—machinery Depreciation expense--office equipment Gain on sale of building and land Loss on sale of long-term investments Decrease in accounts receivable (net) Increase in inventory Increase in prepaid expenses Decrease in accounts payable Increase in accrued liabilities

$ 140,000

$204,000 60,000 16,000 (100,000) 4,000 78,000 (217,200) (20,000) (183,200) 72,000

(1) (2) (3) (4) (5)

Net cash provided by operating activities Cash flows from investing activities Sale of long-term investments Purchase of land Sale of building and land Purchase of building Purchase of machinery

53,600

140,000 (6) (320,000) (7) 400,000 (8) (1,060,000) (9) (140,000) (10)

Net cash used by investing activities Cash flows from financing activities Sale of bonds Retirement of preferred stock Sale of common stock

(86,400)

(980,000)

832,000 (11) (80,000) (12) 300,000 (13)

Net cash provided by financing activities Net increase in cash

1,052,000 $ 125,600

(1)

Net change Debit to accumulated depreciation Depreciation expense

$ 24,000 180,000 $204,000

(2)

Net change Debit to accumulated depreciation Depreciation expense

$20,000 40,000 $60,000

(3)

Net change Write-off Depreciation expense

$(12,000) 28,000 $ 16,000

Statement of Cash Flows Solution 6-105 (cont.) (4)

Sale price of building and land Book value of building and land Gain on sale

$400,000 300,000 $100,000

(5)

Carrying value of long-term investments Sale price of long-term investments Loss on sale

$144,000 140,000 $ 4,000

(6)

Given.

(7)

Net change Land sold (at cost)

(8)

Given.

(9)

Net change Building sold (at cost)

(10)

Given (exchange).

(11)

Bonds Payable Add Premium

(12)

Given.

(13)

12,000 × $25 = $300,000

$300,000 20,000 $320,000

$ 600,000 460,000 $1,060,000

$800,000 32,000 $832,000

Other important reconciliations: Shares outstanding at various times 87,600 December 31, 2008 12,000 Issued June 15, 2008 75,600 Outstanding after stock dividend March 31, 2008 75,600 ÷ 1.05 = 72,000 shares Common Stock Issuance 12,000 × $10 Stock dividend 3,600 × $10

Additional Paid-in Capital Issuance 12,000 × $15 Stock dividend 3,600 × $12

= $120,000 = 36,000 $156,000

= $180,000 = 43,200 $223,200

6 - 45

6 - 46

Test Bank for Intermediate Accounting, Second Edition

Solution 6-105 (cont.) Retained Earnings Net income Dividends (cash) Dividends (stock) Preferred stock redemption

$140,000 (128,000) 12,000 (79,200) (67,200) (20,000) $(87,200)

CHAPTER 7 REVENUE RECOGNITION TRUE-FALSE—Conceptual Answer

No.

Description

F T T F T T F T F T F F T F F F F T T F F T T F T T F T T F T T F T F

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. *27. *28. *29. *30. *31. *32. *33. *34. *35.

Recognition of revenue. Realization of revenue. Delayed recognition of revenue. Recognition of revenue. Recognizing sales when return privilege exists. Definition of trade loading and channel stuffing. Recognizing revenue when right of return exists. Recognizing revenue prior to product completion. Use of percentage-of-completion method. Input measure for contract progress. Conditions when percentage-of-completion method is preferred. Computation of percentage of completion. Principal advantage of completed-contract method. Major disadvantage of completed-contract method. Recognition of revenue under completed-contract method. Principal advantage of percentage of completion method. Recognizing loss on an unprofitable contract. Recognizing current period loss on a profitable contract. Recognizing revenue under completion-of-production basis. Deferring revenue under installment-sales method. Recognizing revenue under cost-recovery method. Recognizing profit under cost-recovery method. Risk of loss in installment sales transactions. Recognizing revenue under the installment-sales method. Difference between realized and deferred gross profit. Recognizing a sale under the deposit method. Reporting Construction in Process and Billings on Construction in Process. Entries under completed-contract and percentage-of-completion methods. Reporting Construction in Process and Billings on Construction in Process. Construction in Process account balance. Deferring gross profit under installment-sales method. Classification of deferred gross profit. Recording repossessed merchandise in a default. Classification of deferred gross profit. Accounting for interest in installment-sales method.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

c b a

36. 37. 38.

Revenue recognition principle. Definition of "realized." Definition of "earned."

7-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

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

39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60.

c b d c a a

61. 62. 63. *64. *65. *66.

c b b c

*67. *68. *69. *70.

Revenue recognition representations. Recognizing revenue at point of sale. Recording sales when right of return exists. Revenue recognition when right of return exists. Revenue recognition when right of return exists. Revenue recognition when right of return exists. Appropriate accounting method for long-term contracts. Percentage-of-completion method. Percentage-of-completion method. Calculation of gross profit using percentage-of-completion. Disadvantage of using percentage-of-completion. Percentage-of-completion input measures. Advantage of completed-contract method Revenue, cost, and gross profit under the completed-contract method. Loss recognition on a long-term contract. Treatment of estimated contract cost increase. Criteria for revenue recognition of completion of production. Completion-of-production basis. Income statement reporting under the completed-contract method. Accounting for long-term contract losses. Use of installment sales method. Recognition of revenues, costs, and gross profit under installment-sales method. Appropriate use of the installment-sales method. Income recognition under the cost-recovery method. Cost recovery basis of revenue recognition. Classification of progress billings and construction in process. Disclosure of earned but unbilled revenues. Reporting construction costs under completed-contract and percentage-ofcompletion. Presentation of deferred gross profit. Valuing repossessed assets. Gross profit deferred under the installment-sales method. Income realization on installment sales.

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE—Computational Answer

No.

Description

c c b d c b c a

71. 72. 73. 74. 75. 76. 77. 78.

Percentage-of-completion method. Percentage-of-completion method. Determine cash collected on long-term construction contract. Determine gross profit using percentage-of-completion. Gross profit to be recognized using percentage-of-completion. Gross profit to be recognized using percentage-of-completion. Profit to be recognized using completed-contract method. Gross profit to be recognized using percentage-of-completion.

Revenue Recognition

MULTIPLE CHOICE—Computational (cont.) Answer

No.

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

79. 80. 81. 82. 83. 84. 85. 86. *87. 88. *89. 90. *91. 92. 93. *94. 95. 96. 97. *98. *99. *100. *101. *102. *103. *104.

Description Profit to be recognized using completed-contract method. Gross profit to be recognized using percentage-of-completion. Gross profit to be recognized using completed-contract method. Computation of construction costs incurred. Revenue recognition using percentage-of-completion method. Loss recognized using percentage-of-completion method. Loss recognized using completed-contract method. Gross profit recognized under percentage-of-completion. Computation of construction in process amount. Computation of income under percentage-of-completion method. Journal entry under percentage-of-completion method. Computation of gross profit under percentage-of-completion method. Calculation of Construction in Process amount. Computation of gross profit rate. Computation of net income from installment sales. Computation of realized and deferred gross profit. Revenue recognized under the cost-recovery method. Calculation of gross profit rate. Computation of net income from installment sales. Computation of realized and deferred gross profit. Gain recognized on repossession—installment sale. Calculate loss on repossessed merchandise. Calculate loss on repossessed merchandise. Interest recognized on installment sales. Calculation of deferred gross profit amount. Computation of loss on repossession.

MULTIPLE CHOICE—CPA Adapted Answer

No.

a b d d b c c c c

105. 106. 107. 108. *109. *110. *111. *112. *113.

Description FASB's definition of "recognition." Determine contract costs incurred during year. Gross profit to be recognized using percentage-of-completion. Profit to be recognized using completed-contract method. Determine balance of installment accounts receivable. Calculate deferred gross profit—installment sales. Calculate deferred gross profit—installment sales. Balance of deferred gross profit—installment sales. Reporting deferred gross profit—installment sales.

EXERCISES Item

Description

E7-114 E7-115 E7-116

Revenue recognition (essay). Revenue recognition (essay). Percentage-of-completion method.

7-3

7-4

Test Bank for Intermediate Accounting, Second Edition

EXERCISES

(cont.)

Item

Description

E7-117 E7-118 E7-119 *E7-120 E7-121 E7-122 *E7-123 *E7-124 *E7-125

Percentage-of-completion method. Percentage-of-completion and completed-contract methods. Long-term contracts (essay). Percentage-of-completion method. Installment sales. Installment sales. Journal entries—percentage-of-completion. Installment sales. Installment sales.

PROBLEMS Item

Description

*P7-126 *P7-127 P7-128 *P7-129 *P7-130

Long-term construction contract. Long-term construction project accounting. Long-term contract accounting—percentage-of-completion. Accounting for long-term construction contracts. Installment sales.

CHAPTER LEARNING OBJECTIVES 1.

Apply the revenue recognition principle.

Describe accounting issues involved with revenue recognition at point of sale.

Apply the percentage-of-completion method for long-term contracts.

Apply the completed-contract method for long-term contracts.

Describe the installment-sales and cost-recovery methods of accounting.

*6.

Prepare the journal entries to record long-term contracts.

*7.

Prepare the journal entries to record installment sales.

Revenue Recognition

7-5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2.

TF TF

3. 4.

TF TF

36. 37.

5. 6.

TF TF

7. 8.

TF TF

9. 40.

10. 11. 12. 45. 46.

TF TF TF MC MC

47. 48. 49. 50. 71.

MC MC MC MC MC

72. 73. 74. 75. 76.

13. 14. 15. 16. 17.

TF TF TF TF TF

18. 19. 20. 21. 22.

TF TF TF TF TF

23. 24. 25. 26. 51.

59. 60.

MC MC

61. 62.

MC MC

63. 92.

27. 28. 29.

TF TF TF

30. 64. 65.

TF MC MC

66. 87. 89.

31. 32. 33. 34.

TF TF TF TF

35. 67. 68. 69.

TF MC MC MC

70. 94. 98. 99.

Note: TF = True-False MC = Multiple Choice E = Exercise P = Problem

Type

Item

Type

Item

Learning Objective 1 MC 38. MC 105. MC 39. MC 114. Learning Objective 2 TF 41. MC 43. MC 42. MC 44. Learning Objective 3 MC 78. MC 86. MC 80. MC 88. MC 82. MC 90. MC 83. MC 106. MC 84. MC 107. Learning Objective 4 TF 52. MC 57. TF 53. MC 58. TF 54. MC 77. TF 55. MC 79. MC 56. MC 81. Learning Objective 5 MC 93. MC 96. MC 95. MC 97. Learning Objective 6* MC 91. MC 126. MC 120. E 127. MC 123. E 129. Learning Objective 7* MC 100. MC 104. MC 101. MC 109. MC 102. MC 110. MC 103. MC 111.

Type

Item

Type

Item

Type

MC E

115.

MC MC

115.

MC MC MC MC MC

116. 117. 118. 119. 120.

E E E E E

126. 127. 128. 129.

P P P P

MC MC MC MC MC

85. 108. 118. 119. 126.

MC MC E E P

127. 129.

P P

MC MC

121. 122.

E E

112. 113. 122. 124.

MC MC E E

125. 130.

E P

P P P MC MC MC MC

7-6

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual 1.

Companies should recognize revenue when it is realized and when cash is received.

Revenues are realized when a company exchanges goods and services for cash or claims to cash.

Delayed recognition of revenue is appropriate if the sale does not represent substantial completion of the earnings process.

The revenue recognition principle adopted by the FASB provides that revenue is recognized when (a) it is collected and (b) the earnings process is complete.

Transactions for which sales recognition is postponed because of a high ratio of returned merchandise should not be recognized as sales until the return privilege has substantially expired.

Trade loading and channel stuffing are management and marketing policy decisions and actions that hype sales, distort operating results, and window dress financial statements.

If a company sells its product but gives the buyer the right to return it, the company should not recognize revenue until the sale is collected.

Companies can recognize revenue prior to completion and delivery of the product under certain circumstances.

Companies must use the percentage-of-completion method when estimates of progress toward completion are reasonably dependable.

10.

The most popular input measure used to determine the progress toward completion is the cost-to-cost basis.

11.

The AICPA indicates that the percentage-of-completion method is preferred in accounting for long-term construction contracts only when estimates of costs to complete and extent of progress toward completion are verified by an independent certified public accountant.

12.

Under the cost-to-cost basis, the percentage of completion is measured by comparing costs incurred to date with the most recent estimate of revenues collected to date.

13.

The principal advantage of the completed-contract method in accounting for long-term construction contracts is that reported income is based on final results rather than on estimates of unperformed work.

14.

The major disadvantage of the completed-contract method as compared with the percentage of-completion method is that total net income over the life of the construction contract is normally smaller under the completed-contract method.

15.

Under the completed-contract method, companies recognize revenue and costs only when the contract is completed.

Revenue Recognition

7-7

16.

The principal advantage of the percentage-of-completion method is that reported revenue reflects final results rather than estimates.

17.

Companies must recognize a loss on an unprofitable contract under the percentage-ofcompletion method but not the completed-contract method.

18.

Companies must recognize the entire expected contract loss in the current period under both the percentage-of-completion and completed-contract methods.

19.

Under the completion-of-production basis, companies recognize revenue when agricultural crops are harvested since the sales price is reasonably assured and no significant costs are involved in product distribution.

20.

Under the installment-sales method, companies defer revenue and income recognition until the period of cash collection.

21.

Under the cost-recovery method, a company recognizes no revenue or profit until the buyer’s cash payments exceed the cost of the merchandise sold.

22.

Companies recognize profit under the cost-recovery method only when cash collections exceed the total cost of the goods sold.

23.

Because payment for a product sold on an installment basis is spread over a relatively long period, the risk of loss resulting from uncollectible accounts is greater in installment sales transactions than in ordinary sales.

24.

Under the installment-sales method, emphasis is placed on collection rather than on sale, and revenue is considered unrealized until the entire sales price has been collected.

25.

The difference between realized gross profit and deferred gross profit on installment sales is based on the cash collections related to the installment sales.

26.

The deposit method postpones recognizing a sale until a determination can be made as to whether a sale has occurred for accounting purposes.

*27.

Under the percentage-of-completion method, the difference between the Construction in Process and the Billings on Construction in Process accounts is reported in the balance sheet as a current asset if a debit, and as a contra asset if a credit.

*28.

The annual entries to record costs of construction, progress billings, and collections from customers under the completed-contract method would be identical to those illustrated under the percentage-of-completion method with the significant exclusion of the recognition of revenue and gross profit.

*29.

If the difference between the Construction in Process and the Billings on Construction in Process account balances is a debit, the difference is reported as a current asset.

*30.

The Construction in Process account includes only construction costs under the percentage-of-completion method.

*31.

The installment-sales method defers only the gross profit instead of both the sales price and cost of goods sold.

7-8

Test Bank for Intermediate Accounting, Second Edition

*32.

Deferred gross profit is generally treated as an unearned revenue and classified as a current liability.

*33.

Repossessed merchandise as a result of a defaulted installment sales contract should be recorded at the best possible estimate of what the item can ultimately be resold for in the second-hand market.

*34.

Deferred gross profit on installment sales is generally treated as consisting entirely of unearned revenue and is classified as a current liability.

*35.

When interest is involved in installment sales, it should be accounted for as an addition to gross profit recognized on the installment sales collections during the period.

True-False Answers—Conceptual Item 1. 2. 3. 4. 5. 6.

Ans. F T T F T T

Item 7. 8. 9. 10. 11. 12.

Ans. F T F T F F

Item 13. 14. 15. 16. 17. 18.

Ans. T F F F F T

Item 19. 20. 21. 22. 23. 24.

Ans. T F F T T F

Item 25. 26. *27. *28. *29. *30.

Ans. T T F T T F

Item *31. *32. *33. *34. *35.

Ans. T T F T F

MULTIPLE CHOICE—Conceptual 36.

The revenue recognition principle provides that revenue is recognized when a. it is realized. b. it is realizable. c. it is realized or realizable and it is earned. d. none of these.

37.

When goods or services are exchanged for cash or claims to cash (receivables), revenues are a. earned. b. realized. c. recognized. d. all of these.

38.

When the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues, revenues are a. earned. b. realized. c. recognized. d. all of these.

Revenue Recognition

7-9

39.

Which of the following is not an accurate representation concerning revenue recognition? a. Companies recognize revenue from selling products at the date of sale, usually interpreted to mean the date of delivery to customers. b. Companies recognize revenue from services rendered when cash is received or when services have been performed. c. Companies recognize revenue from permitting others to use enterprise assets as time passes or as the assets are used. d. Companies recognize revenue from disposing of assets other than products at the date of sale.

40.

Which of the following is not a reason why revenue is recognized at time of sale? a. Realization has occurred. b. The sale is the critical event. c. Title legally passes from seller to buyer. d. All of these are reasons to recognize revenue at time of sale.

41.

An alternative available when the seller is exposed to continued risks of ownership through return of the product is a. recording the sale, and accounting for returns as they occur in future periods. b. not recording a sale until all return privileges have expired. c. recording the sale, but reducing sales by an estimate of future returns. d. all of these.

42.

A sale should not be recognized as revenue by the seller at the time of sale if a. payment was made by check. b. the selling price is less than the normal selling price. c. the buyer has a right to return the product and the amount of future returns cannot be reasonably estimated. d. none of these.

43.

The FASB concluded that if a company sells its product but gives the buyer the right to return the product, revenue from the sales transaction shall be recognized at the time of sale only if all of six conditions have been met. Which of the following is not one of these six conditions? a. The amount of future returns can be reasonably estimated. b. The seller's price is substantially fixed or determinable at time of sale. c. The buyer's obligation to the seller would not be changed in the event of theft or damage of the product. d. The buyer is obligated to pay the seller upon resale of the product.

44.

Which of the following is not a condition that must be present for a company to recognize revenue at the time of sale when the company gives the buyer the right to return the product? a. The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product. b. The present value of the future returns can be reasonably estimated. c. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer. d. The seller's price to the buyer is substantially fixed or determinable at the date of sale.

7 - 10

Test Bank for Intermediate Accounting, Second Edition

45.

In selecting an accounting method for a newly contracted long-term construction project, the principal factor to be considered should be a. the terms of payment in the contract. b. the degree to which a reliable estimate of the costs to complete and extent of progress toward completion is practicable. c. the method commonly used by the contractor to account for other long-term construction contracts. d. the inherent nature of the contractor's technical facilities used in construction.

46.

The percentage-of-completion method must be used when certain conditions exist. Which of the following is not one of those necessary conditions? a. Estimates of progress toward completion, revenues, and costs are reasonably dependable. b. The contractor can be expected to perform the contractual obligation. c. The buyer can be expected to satisfy some of the obligations under the contract. d. The contract clearly specifies the enforceable rights of the parties, the consideration to be exchanged, and the manner and terms of settlement.

47.

When work to be done and costs to be incurred on a long-term contract can be estimated dependably, which of the following methods of revenue recognition is preferable? a. Installment-sales method b. Percentage-of-completion method c. Completed-contract method d. None of these

48.

In accounting for a long-term construction-type contract using the percentage-ofcompletion method, the gross profit recognized during the first year would be the estimated total gross profit from the contract, multiplied by the percentage of the costs incurred during the year to the a. total costs incurred to date. b. total estimated cost. c. unbilled portion of the contract price. d. total contract price.

49.

The principal disadvantage of using the percentage-of-completion method of recognizing revenue from long-term contracts is that it a. is unacceptable for income tax purposes. b. gives results based upon estimates which may be subject to considerable uncertainty. c. is likely to assign a small amount of revenue to a period during which much revenue was actually earned. d. none of these.

50.

One of the more common techniques that companies use to determine the progress toward completion in the percentage-of-completion method is the a. revenue-percentage basis. b. cost-percentage basis. c. progress completion basis. d. cost-to-cost basis.

Revenue Recognition

7 - 11

51.

The principal advantage of the completed-contract method is that a. reported revenue is based on final results rather than estimates of unperformed work. b. it reflects current performance when the period of a contract extends into more than one accounting period. c. it is not necessary to recognize revenue at the point of sale. d. a greater amount of gross profit and net income is reported than is the case when the percentage-of-completion method is used.

52.

Under the completed-contract method a. revenue, cost, and gross profit are recognized during the production cycle. b. revenue and cost are recognized during the production cycle, but gross profit recognition is deferred until the contract is completed. c. revenue, cost, and gross profit are recognized at the time the contract is completed. d. none of these.

53.

Cost estimates on a long-term contract may indicate that a loss will result on completion of the entire contract. In this case, the entire expected loss should be a. recognized in the current period, regardless of whether the percentage-of-completion or completed-contract method is employed. b. recognized in the current period under the percentage-of-completion method, but the completed-contract method should defer recognition of the loss to the time when the contract is completed. c. recognized in the current period under the completed-contract method, but the percentage-of-completion method should defer the loss until the contract is completed. d. deferred and recognized when the contract is completed, regardless of whether the percentage-of-completion or completed-contract method is employed.

54.

When there is a significant increase in the estimated total contract costs but the increase does not eliminate all profit on the contract, which of the following is correct? a. Under both the percentage-of-completion and the completed-contract methods, the estimated cost increase requires a current period adjustment of excess gross profit recognized on the project in prior periods. b. Under the percentage-of-completion method only, the estimated cost increase requires a current period adjustment of excess gross profit recognized on the project in prior periods. c. Under the completed-contract method only, the estimated cost increase requires a current period adjustment of excess gross profit recognized on the project in prior periods. d. No current period adjustment is required.

55.

The criteria for recognition of revenue at the completion of production of precious metals and farm products include a. an established market with quoted prices. b. low additional costs of completion and selling. c. units are interchangeable. d. all of these.

7 - 12

Test Bank for Intermediate Accounting, Second Edition

56.

In certain cases, revenue is recognized at the completion of production even though no sale has been made. Which of the following statements is not true? a. Examples involve precious metals or farm equipment. b. The products possess immediate marketability at quoted prices. c. No significant costs are involved in selling the product. d. All of these statements are true.

57.

Under the completed-contract method of accounting for long-term construction contracts, interim charges and/or credits to the income statement are made for a. b. c. d.

58.

Revenues Yes No No Yes

Costs No No Yes Yes

Gross Profit No No No Yes

The Nathan Company is involved in the construction of an asset under a long-term construction contract. At the end of the third year of the five-year contract, the cost estimates indicate that a loss will result on the completion of the entire contract. In accounting for this contract, the entire expected loss must be recognized in the current period under the

a. b. c. d.

Percentage-ofCompletion Method Yes Yes No No

CompletedContract Method No Yes Yes No

59.

Which of the following methods is used when the collectibility of the receivable is so uncertain that gross profit (or income) is not recognized until cash is received? a. Percentage-of-completion method b. Completed-contract method c. Installment-sales method d. Deposit method

60.

Under the installment-sales accounting method, certain items related to the sale are recognized in the period of the sale and certain items are recognized in the period in which cash is collected. Of the following items, which are recognized in the period of sale and which are recognized in the period in which the cash is collected? a. b. c. d.

61.

Revenues Sale Sale Sale Cash

Cost of Sales Sale Cash Sale Cash

Gross Profit Cash Sale Cash Sale

Other Expenses Cash Cash Sale Cash

The installment-sales method of recognizing profit for accounting purposes is acceptable if a. collections in the year of sale do not exceed 30% of the total sales price. b. an unrealized profit account is credited. c. collection of the sales price is not reasonably assured. d. the method is consistently used for all sales of similar merchandise.

Revenue Recognition

7 - 13

62.

Under the cost-recovery method of revenue recognition, a. income is recognized on a proportionate basis as the cash is received on the sale of the product. b. income is recognized when the cash received from the sale of the product is greater than the cost of the product. c. income is recognized immediately. d. none of these.

63.

Winser, Inc. is engaged in extensive exploration for water in Utah. If, upon discovery of water, Winser does not recognize any revenue from water sales until the sales exceed the costs of exploration, the basis of revenue recognition being employed is the a. production basis. b. cash (or collection) basis. c. sales (or accrual) basis. d. cost recovery basis.

*64.

How should the balances of progress billings and construction in process be shown at reporting dates prior to the completion of a long-term contract? a. Progress billings as deferred income, construction in progress as a deferred expense. b. Progress billings as income, construction in process as inventory. c. Net, as a current asset if debit balance, and current liability if credit balance. d. Net, as income from construction if credit balance, and loss from construction if debit balance.

*65.

How should earned but unbilled revenues at the balance sheet date on a long-term construction contract be disclosed if the percentage-of-completion method of revenue recognition is used? a. As construction in process in the current asset section of the balance sheet. b. As construction in process in the noncurrent asset section of the balance sheet. c. As a receivable in the noncurrent asset section of the balance sheet. d. In a note to the financial statements until the customer is formally billed for the portion of work completed.

*66.

In accounting for long-term construction-type contracts, construction costs are accumulated in an inventory account called Construction in Process under the

a. b. c. d. *67.

Percentage-ofCompletion Method Yes Yes No No

CompletedContract Method Yes No Yes No

Deferred gross profit on installment sales is generally treated as a(n) a. deduction from installment accounts receivable. b. deduction from installment sales. c. unearned revenue and classified as a current liability. d. deduction from gross profit on sales.

7 - 14

Test Bank for Intermediate Accounting, Second Edition

*68.

The method most commonly used to report defaults and repossessions is a. provide no basis for the repossessed asset thereby recognizing a loss. b. record the repossessed merchandise at fair value, recording a gain or loss if appropriate. c. record the repossessed merchandise at book value, recording no gain or loss. d. none of these.

*69.

Under the installment-sales method, a. revenue, costs, and gross profit are recognized proportionate to the cash that is received from the sale of the product. b. gross profit is deferred proportionate to cash uncollected from sale of the product, but total revenues and costs are recognized at the point of sale. c. gross profit is not recognized until the amount of cash received exceeds the cost of the item sold. d. revenues and costs are recognized proportionate to the cash received from the sale of the product, but gross profit is deferred until all cash is received.

*70.

The realization of income on installment sales transactions involves a. recognition of the difference between the cash collected on installment sales and the cash expenses incurred. b. deferring the net income related to installment sales and recognizing the income as cash is collected. c. deferring gross profit while recognizing operating or financial expenses in the period incurred. d. deferring gross profit and all additional expenses related to installment sales until cash is ultimately collected.

Multiple Choice Answers—Conceptual Item 36. 37. 38. 39. 40.

Ans. c b a b d

Item 41. 42. 43. 44. 45.

Ans. d c d b b

Item 46. 47. 48. 49. 50.

Ans. c b b b d

Item 51. 52. 53. 54. 55.

Ans. a c a b d

Item 56. 57. 58. 59. 60.

Ans. a b b c c

Item 61. 62. 63. *64. *65.

Ans. c b d c a

Item *66. *67. *68. *69. *70.

Ans. a c b b c

MULTIPLE CHOICE—Computational 71.

Reese Construction Corporation contracted to construct a building for $1,500,000. Construction began in 2008 and was completed in 2009. Data relating to the contract are summarized below: Year ended December 31 2008 2009 Costs incurred $600,000 $450,000 Estimated costs to complete 400,000 —

Revenue Recognition

7 - 15

Reese uses the percentage-of-completion method as the basis for income recognition. For the years ended December 31, 2008, and 2009, respectively, Reese should report gross profit of a. $270,000 and $180,000. b. $900,000 and $600,000. c. $300,000 and $150,000. d. $0 and $450,000. 72.

Winsor Construction Company uses the percentage-of-completion method of accounting. In 2008, Winsor began work on a contract it had received which provided for a contract price of $15,000,000. Other details follow: 2008 Costs incurred during the year $7,200,000 Estimated costs to complete as of December 31 4,800,000 Billings during the year 6,600,000 Collections during the year 3,900,000 What should be the gross profit recognized in 2008? a. $600,000 b. $7,800,000 c. $1,800,000 d. $3,000,000

Use the following information for questions 73 and 74. In 2008, Crane Corporation began construction work under a three-year contract. The contract price is $2,400,000. Crane uses the percentage-of-completion method for financial accounting purposes. The income to be recognized each year is based on the proportion of costs incurred to total estimated costs for completing the contract. The financial statement presentations relating to this contract at December 31, 2008, follow: Balance Sheet Accounts receivable—construction contract billings Construction in progress Less contract billings Costs and recognized profit in excess of billings

$100,000 $300,000 240,000

Income Statement Income (before tax) on the contract recognized in 2008 73.

How much cash was collected in 2008 on this contract? a. $100,000 b. $140,000 c. $20,000 d. $240,000

74.

What was the initial estimated total income before tax on this contract? a. $300,000 b. $320,000 c. $400,000 d. $480,000

60,000

$60,000

7 - 16 75.

Test Bank for Intermediate Accounting, Second Edition Eaton Construction Co. uses the percentage-of-completion method. In 2008, Eaton began work on a contract for $3,300,000 and it was completed in 2009. Data on the costs are: Year Ended December 31 2008 2009 Costs incurred $1,170,000 $840,000 Estimated costs to complete 780,000 — For the years 2008 and 2009, Eaton should recognize gross profit of a. b. c. d.

2008 $0 $774,000 $810,000 $810,000

2009 $1,290,000 $516,000 $480,000 $1,290,000

Use the following information for questions 76 and 77. Ramos, Inc. began work in 2008 on contract #3814, which provided for a contract price of $7,200,000. Other details follow: 2008 2009 Costs incurred during the year $1,200,000 $3,675,000 Estimated costs to complete, as of December 31 3,600,000 0 Billings during the year 1,350,000 5,400,000 Collections during the year 900,000 5,850,000 76.

Assume that Ramos uses the percentage-of-completion method of accounting. The portion of the total gross profit to be recognized as income in 2008 is a. $450,000. b. $600,000. c. $1,800,000. d. $2,400,000.

77.

Assume that Ramos uses the completed-contract method of accounting. The portion of the total gross profit to be recognized as income in 2009 is a. $900,000. b. $1,350,000. c. $2,325,000. d. $7,200,000.

Use the following information for questions 78 and 79. Miley, Inc. began work in 2008 on a contract for $8,400,000. Other data are as follows: 2008 2009 Costs incurred to date $3,600,000 $5,600,000 Estimated costs to complete 2,400,000 — Billings to date 2,800,000 8,400,000 Collections to date 2,000,000 7,200,000

Revenue Recognition

7 - 17

78.

If Miley uses the percentage-of-completion method, the gross profit to be recognized in 2008 is a. $1,440,000. b. $1,600,000. c. $2,160,000. d. $2,400,000.

79.

If Miley uses the completed-contract method, the gross profit to be recognized in 2009 is a. $1,360,000. b. $2,800,000. c. $1,400,000. d. $5,600,000.

Use the following information for questions 80 and 81. 80.

Parker Construction Co. uses the percentage-of-completion method. In 2008, Parker began work on a contract for $5,500,000; it was completed in 2009. The following cost data pertain to this contract: Year Ended December 31 2008 2009 Cost incurred during the year $1,950,000 $1,400,000 Estimated costs to complete at the end of year 1,300,000 — The amount of gross profit to be recognized on the income statement for the year ended December 31, 2009 is a. $800,000. b. $860,000. c. $900,000. d. $2,150,000.

81.

If the completed-contract method of accounting was used, the amount of gross profit to be recognized for years 2008 and 2009 would be a. b. c. d.

82.

2008 $2,250,000. $2,150,000. $0. $0.

2009 $0. $(100,000). $2,150,000. $2,250,000.

Willingham Construction Company uses the percentage-of-completion method. During 2008, the company entered into a fixed-price contract to construct a building for Richman Company for $30,000,000. The following details pertain to the contract: Percentage of completion Estimated total cost of contract Gross profit recognized to date

At December 31, 2008 25% $22,500,000 1,875,000

The amount of construction costs incurred during 2009 was a. $15,000,000. b. $9,375,000. c. $5,625,000. d. $2,500,000.

At December 31, 2009 60% $25,000,000 3,000,000

7 - 18

Test Bank for Intermediate Accounting, Second Edition

Use the following information for questions 83 and 84. Noonan Construction Co. began operations in 2008. Construction activity for 2008 is shown below. Noonan uses the percentage-of-completion method.

Contract 1 2

Contract Price $1,480,000 1,700,000

Costs to 12/31/08 $250,000 400,000

Estimated Costs to Complete $ 750,000 1,600,000

83.

Which of the following should be shown on the income statement for 2008 related to Contract 1? a. Gross profit, $480,000. b. Gross profit, $160,000. c. Gross profit, $120,000. d. Gross profit, $80,000.

84.

Which of the following should be shown on the income statement for 2008 related to Contract 2? a. Gross profit, $(300,000). b. Gross profit, $(75,000). c. Gross profit, $(60,000). d. Gross profit, $100,000.

85.

Kirby Builders, Inc. is using the completed-contract method for a $5,600,000 contract that will take two years to complete. Data at December 31, 2008, the end of the first year, are as follows: Costs incurred to date Estimated costs to complete Billings to date Collections to date

$2,560,000 3,280,000 2,400,000 2,000,000

The gross profit or loss that should be recognized for 2008 is a. $0. b. a $240,000 loss. c. a $120,000 loss. d. a $105,600 loss. Use the following information for questions 86 and 87. Carter Construction Company had a contract starting April 2008, to construct a $15,000,000 building that is expected to be completed in September 2009, at an estimated cost of $13,750,000. At the end of 2008, the costs to date were $6,325,000 and the estimated total costs to complete had not changed. The progress billings during 2008 were $3,000,000 and the cash collected during 2008 was $2,000,000. Carter uses the percentage-of-completion method. 86.

For the year ended December 31, 2008, Carter would recognize gross profit on the building of a. $0. b. $527,083. c. $575,000. d. $675,000.

Revenue Recognition *87.

7 - 19

At December 31, 2008, Carter would report Construction in Process in the amount of a. $6,900,000. b. $6,325,000. c. $5,900,000. d. $575,000.

Use the following information for questions 88 and 89. Cushing Corporation recently received a long-term contract to construct a luxury liner. The contract will take 3 years to complete at a cost of $3,500,000. The price of the liner is set at $5,000,000. Cost estimates at the end of the first year are in line with original estimates, and $1,050,000 of costs were incurred during the first year. 88.

The amount of income recognized during the first year using the percentage-of-completion method is a. $1,500,000. b $1,050,000. c. $735,000. d. $450,000.

*89.

At the end of the first year which of the following entries would be made to recognize revenue on the contract? a. Accounts Receivable—Construction Contract..................... 1,500,000 Revenue on Long-Term Contract ............................ 1,500,000 b. Construction Expense......................................................... 1,050,000 Revenue on Long-Term Contract ............................ 1,050,000 c. Construction in Process ...................................................... 450,000 Construction Expense......................................................... 1,050,000 Revenue on Long-Term Contract ............................ 1,500,000 d. Construction in Process ...................................................... 1,050,000 Billings on Construction Contract ............................ 1,050,000

Use the following information for questions 90 and 91. Bretts Construction Company had a contract starting April 2008, to construct a $6,000,000 building that is expected to be completed in September 2010, at an estimated cost of $5,500,000. At the end of 2008, the costs to date were $2,530,000 and the estimated total costs to complete had not changed. The progress billings during 2008 were $1,200,000 and the cash collected during 2008 was $800,000. Bretts uses the percentage-of-completion method. 90.

For the year ended December 31, 2008, Bretts would recognize gross profit on the building of a. $210,833. b. $230,000. c. $270,000. d. $0.

*91.

At December 31, 2008, Bretts would report Construction in Process in the amount of a. $230,000. b. $2,530,000. c. $2,760,000. d. $2,360,000.

7 - 20

Test Bank for Intermediate Accounting, Second Edition

Use the following information for questions 92–94. During 2008, Ted Corporation sold merchandise costing $500,000 on an installment basis for $800,000. The cash receipts related to these sales were collected as follows: 2008, $250,000; 2009, $450,000; 2010, $100,000. 92.

What is the rate of gross profit on the installment sales made by Ted Corporation during 2008? a. 37.5% b. 50% c. 60% d. 62.5%

93.

If expenses, other than the cost of the merchandise sold, related to the 2008 installment sales amounted to $60,000, by what amount would Ted's net income for 2008 increase as a result of installment sales? a. $240,000 b. $190,000 c. $71,250 d. $33,750

*94.

What amounts would be shown in the December 31, 2009 financial statements for realized gross profit on 2008 installment sales, and deferred gross profit on 2008 installment sales, respectively? a. $168,750 and $37,500 b. $262,500 and $37,500 c. $131,250 and $50,000 d. $0 and $0

95.

On January 1, 2008, Dole Co. sold land that cost $210,000 for $280,000, receiving a note bearing interest at 10%. The note will be paid in three annual installments of $112,595 starting on December 31, 2008. Because collection of the note is very uncertain, Dole will use the cost-recovery method. How much revenue from this sale should Dole recognize in 2008? a. $0 b. $21,000 c. $28,000 d. $70,000

Use the following information for questions 96–98. During 2008, Steele Corporation sold merchandise costing $1,500,000 on an installment basis for $2,000,000. The cash receipts related to these sales were collected as follows: 2008, $800,000; 2009, $700,000; 2010, $500,000. 96.

What is the rate of gross profit on the installment sales made by Steele Corporation during 2008? a. 75% b. 60% c. 40% d. 25%

Revenue Recognition

7 - 21

97.

If expenses, other than the cost of the merchandise sold, related to the 2008 installment sales amounted to $90,000, by what amount would Steele’s net income for 2008 increase as a result of installment sales? a. $110,000 b. $177,500 c. $200,000 d. $710,000

*98.

What amount would be shown in the December 31, 2009 financial statement for realized gross profit on 2008 installment sales, and deferred gross profit on 2008 installment sales, respectively? a. $175,000 and $375,000 b. $325,000 and $175,000 c. $375,000 and $125,000 d. $175,000 and 125,000

*99.

Harber Co. uses the installment-sales method. When an account had a balance of $8,400, no further collections could be made and the dining room set was repossessed. At that time, it was estimated that the dining room set could be sold for $2,400 as repossessed, or for $3,000 if the company spent $300 reconditioning it. The gross profit rate on this sale was 70%. The gain or loss on repossession was a a. $5,880 loss. b. $6,000 loss. c. $600 gain. d. $180 gain.

*100. Yarbow Corporation has a normal gross profit on installment sales of 30%. A 2007 sale resulted in a default early in 2009. At the date of default, the balance of the installment receivable was $24,000, and the repossessed merchandise had a fair value of $13,500. Assuming the repossessed merchandise is to be recorded at fair value, the gain or loss on repossession should be a. $0. b. a $3,300 loss. c. a $3,300 gain. d. a $7,500 loss. *101. Seeman Furniture uses the installment-sales method. No further collections could be made on an account with a balance of $18,000. It was estimated that the repossessed furniture could be sold as is for $5,400, or for $6,300 if $300 were spent reconditioning it. The gross profit rate on the original sale was 40%. The loss on repossession was a. $4,800. b. $4,500. c. $12,000. d. $12,600. *102. Wagner Company sold some machinery to Granger Company on January 1, 2008. The cash selling price would have been $568,620. Granger entered into an installment sales contract which required annual payments of $150,000, including interest at 10%, over five years. The first payment was due on December 31, 2008. What amount of interest income should be included in Wagner's 2009 income statement (the second year of the contract)?

7 - 22

Test Bank for Intermediate Accounting, Second Edition a. b. c. d.

$15,000 $47,548 $30,000 $41,862

*103. Lamberson Company has used the installment method of accounting since it began operations at the beginning of 2008. The following information pertains to its operations for 2008: Installment sales $1,400,000 Cost of installment sales 980,000 Collections of installment sales 560,000 General and administrative expenses 140,000 The amount to be reported on the December 31, 2008 balance sheet as Deferred Gross Profit should be a. $168,000. b. $252,000. c. $336,000. d. $840,000. *104. Singer Company sells plasma-screen televisions on an installment basis and appropriately uses the installment-sales method of accounting. A customer with an account balance of $5,600 refuses to make any more payments and the merchandise is repossessed. The gross profit rate on the original sale is 40%. Singer estimates that the television can be sold as is for $1,750, or for $2,100 if $140 is spent to refurbish it. The loss on repossession is a. $3,850. b. $2,240. c. $1,610. d. $1,400.

Multiple Choice Answers—Computational Item 71. 72. 73. 74. 75.

Ans. c c b d c

Item 76. 77. 78. 79. 80.

Ans. b c a b a

Item 81. 82. 83. 84. 85.

Ans. c b c a b

Item 86. *87. 88. *89. 90.

Ans. c a d c b

Item *91. 92. 93. *94. 95.

Ans. c a d a a

Item 96. 97. *98. *99. *100.

Ans. d a d d b

Item *101. *102. *103. *104.

Ans. a b b d

Revenue Recognition

7 - 23

MULTIPLE CHOICE—CPA Adapted 105.

According to the FASB's conceptual framework, the process of reporting an item in the financial statements of an entity is a. recognition. b. realization. c. allocation. d. matching.

106.

Flynn Construction Co. has consistently used the percentage-of-completion method of recognizing revenue. During 2008, Flynn entered into a fixed-price contract to construct an office building for $12,000,000. Information relating to the contract is as follows: At December 31 2008 2009 Percentage of completion 15% 45% Estimated total cost at completion $9,000,000 $9,600,000 Gross profit recognized (cumulative) 600,000 1,440,000 Contract costs incurred during 2009 were a. $2,880,000. b. $2,970,000. c. $3,150,000. d. $4,320,000.

107.

Noland Constructors, Inc. has consistently used the percentage-of-completion method of recognizing income. In 2008, Noland started work on a $35,000,000 construction contract that was completed in 2009. The following information was taken from Noland's 2008 accounting records: Progress billings Costs incurred Collections Estimated costs to complete

$11,000,000 10,500,000 7,000,000 21,000,000

What amount of gross profit should Noland have recognized in 2008 on this contract? a. $3,500,000 b. $2,333,334 c. $1,750,000 d. $1,166,667 108.

During 2008, Eaton Corp. started a construction job with a total contract price of $3,500,000. The job was completed on December 15, 2009. Additional data are as follows: Actual costs incurred Estimated remaining costs Billed to customer Received from customer

2008 $1,350,000 1,350,000 1,200,000 1,000,000

2009 $1,525,000 — 2,300,000 2,400,000

Under the completed-contract method, what amount should Eaton recognize as gross profit for 2009? a. $225,000 b. $312,500 c. $475,000 d. $625,000

7 - 24

Test Bank for Intermediate Accounting, Second Edition

*109. Klugg, Inc. appropriately uses the installment-sales method of accounting to recognize income in its financial statements. Some pertinent data relating to this method of accounting include: 2008 2009 Installment sales $750,000 $720,000 Cost of installment sales 570,000 504,000 Gross profit $180,000 $216,000 Rate of gross profit Balance of deferred gross profit at year end: 2008 2009 Total

24%

30%

$108,000

$ 36,000 198,000 $234,000

$108,000

What amount of installment accounts receivable should be presented in Klugg's December 31, 2009 balance sheet? a. $720,000 b. $810,000 c. $780,000 d. $866,666 *110. Neber Co., which began operations on January 1, 2008, appropriately uses the installment-sales method of accounting. The following information pertains to Neber's operations for the year 2008: Installment sales Regular sales Cost of installment sales Cost of regular sales General and administrative expenses Collections on installment sales

$1,200,000 480,000 720,000 300,000 96,000 288,000

The deferred gross profit account in Neber's December 31, 2008 balance sheet should be a. $115,200. b. $192,000. c. $364,800. d. $480,000. *111. On January 1, 2008, Stein Co. sold a used machine to Mays, Inc. for $350,000. On this date, the machine had a depreciated cost of $245,000. Mays paid $50,000 cash on January 1, 2008 and signed a $300,000 note bearing interest at 10%. The note was payable in three annual installments of $100,000 beginning January 1, 2009. Stein appropriately accounted for the sale under the installment method. Mays made a timely payment of the first installment on January 1, 2009 of $130,000, which included interest of $30,000 to date of payment. At December 31, 2009, Stein has deferred gross profit of a. $70,000. b. $66,000. c. $60,000. d. $51,000.

Revenue Recognition

7 - 25

*112. Grant Co. began operations on January 1, 2008 and appropriately uses the installment method of accounting. The following information pertains to Grant's operations for 2008: Installment sales Cost of installment sales General and administrative expenses Collections on installment sales

1,800,000 1,080,000 180,000 825,000

The balance in the deferred gross profit account at December 31, 2008 should be a. $330,000. b. $495,000. c. $390,000. d. $720,000. *113. Lott Co. records all sales using the installment method of accounting. Installment sales contracts call for 36 equal monthly cash payments. According to the FASB's conceptual framework, the amount of deferred gross profit relating to collections 12 months beyond the balance sheet date should be reported in the a. current liabilities section as a deferred revenue. b. noncurrent liabilities section as a deferred revenue. c. current assets section as a contra account. d. noncurrent assets section as a contra account.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

105. 106.

a b

107. 108.

d d

*109. *110.

b c

*111. *112.

c c

*113.

DERIVATIONS — Computational No. 71.

Answer Derivation c

$600,000 —————————— × ($1,500,000 – $1,000,000) = $300,000 $600,000 + $400,000 ($1,500,000 – $1,050,000) – $300,000 = $150,000.

72.

$7,200,000 ——————————— × ($15,000,000 – $12,000,000) = $1,800,000. $7,200,000 + $4,800,000

73.

$240,000 – $100,000 = $140,000.

74.

$300,000 – $60,000 = $240,000 $240,000 ————————— × ($2,400,000 – Total estimated cost) = $60,000 Total estimated cost Total estimated cost = $1,920,000 $2,400,000 – $1,920,000 = $480,000.

7 - 26

Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational (cont.) No. 75.

Answer Derivation c

$1,170,000 —————- × ($3,300,000 – $1,950,000) = $810,000 $1,950,000 ($3,300,000 – $2,010,000) – $810,000 = $480,000.

76.

$1,200,000 ————— × ($7,200,000 – $4,800,000) = $600,000. $4,800,000

77.

$7,200,000 – $4,875,000 = $2,325,000.

78.

$3,600,000 ————— × ($8,400,000 – $6,000,000) = $1,440,000. $6,000,000

79.

$8,400,000 – $5,600,000 = $2,800,000.

80.

[$1,950,000 ÷ ($1,950,000 + $1,300,000)] × $2,250,000 = $1,350,000 ($5,500,000 – $3,350,000) – $1,350,00 = $800,000.

81.

$5,500,000 – $3,350,000 = $2,150,000.

82.

($25,000,000 × .60) – ($22,500,000 × .25) = $9,375,000.

83.

$250,000 ————— × ($1,480,000 – $1,000,000) = $120,000 $1,000,000

84.

$1,700,000 – ($400,000 + $1,600,000) = –$300,000.

85.

$5,600,000 – ($2,560,000 + $3,280,000) = –$240,000.

86.

($6,325,000 ÷ $13,750,000) × $1,250,000 = $575,000.

*87.

($6,325,000 ÷ $13,750,000) × $1,250,000 = $575,000. $6,325,000 + $575,000 = $6,900.000.

88.

($5,000,000 – $3,500,000) × ($1,050,000 ÷ $3,500,000) = $450,000.

*89.

Revenue = ($1,050,000 ÷ $3,500,000) × $5,000,000 = $1,500,000 Construction in Process = $1,500,000 – $1,050,000 = $450,000.

90.

($6,000,000 – $5,500,000) × ($2,530,000 ÷ $5,500,000) = $230,000.

*91.

$2,530,000 + $230,000 = $2,760,000

92.

($800,000 – $500,000) ÷ $800,000 = 37.5%.

93.

($250,000 × .375) – $60,000 = $33,750.

Revenue Recognition

DERIVATIONS — Computational (cont.) No.

Answer Derivation

94.

$450,000 × .375 = $168,750 and $100,000 × .375 = $37,500.

95.

$0.

96.

($2,000,000 – $1,500,000) ÷ $2,000,000 = 25%.

97.

($800,000 × .25) – $90,000 = $110,000.

*98.

$700,000 × .25 = $175,000; $500,000 × .25 = $125,000.

*99.

$8,400 – $5,880 = $2,520 ($3,000 – $300) – $2,520 = $180 gain.

*100.

$24,000 – $7,200 = $16,800 $16,800 – $13,500 = $3,300 loss.

*101.

$18,000 – $7,200 = $10,800 ($6,300 – $300) – $10,800 = $4,800 loss.

*102.

2008: $150,000 – ($568,620 × 10%) = $93,138. 2009: ($568,620 – $93,138) × 10% = $47,548.

*103.

[($1,400,000 – $980,000) ÷ $1,400,000] × $840,000 = $252,000.

*104.

[$5,600 × (1 – .40)] – ($2,100 – $140) = $1,400.

DERIVATIONS — CPA Adapted No.

Answer Derivation

105.

Conceptual.

106.

($9,600,000 × 45%) – ($9,000,000 × 15%) = $2,970,000.

107.

$10,500,000 —————— × ($35,000,000 – $31,500,000) = $1,166,667. $31,500,000

108.

$3,500,000 – $1,350,000 – $1,525,000 = $625,000.

*109.

($36,000 ÷ 24%) + ($198,000 ÷ 30%) = $810,000.

*110.

$1,200,000 – $720,000 = $480,000 gross profit (40% gross profit rate) $480,000 – ($288,000 × .4) = $364,800.

7 - 27

7 - 28

Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — CPA Adapted (cont.) No.

Answer Derivation

*111.

$300,000 + $50,000 = $350,000 $350,000 – $245,000 = $105,000 gross profit (30% gross profit rate) ($300,000 – $100,000) × 30% = $60,000.

*112.

$1,800,000 – $1,080,000 = $720,000 (40% gross profit rate) $720,000 – ($825,000 × 40%) = $390,000.

*113.

Conceptual.

EXERCISES Ex. 7-114— Revenue recognition (essay). The revenue recognition principle provides that revenue is recognized when (1) it is realized or realizable and (2) it is earned. Instructions Explain when revenues are (a) realized, (b) realizable, and (c) earned.

Solution 7-114 (a) Revenues are realized when goods or services are exchanged for cash or claims to cash (receivables). (b) Revenues are realizable when assets received in exchange are readily convertible to known amounts of cash or claims to cash. (c) Revenues are earned when the earnings process is complete or virtually complete.

Ex. 7-115—Revenue recognition (essay). The earning of revenue by a business is recognized for accounting purposes when the transaction is recorded. Revenue is often recognized at time of sale. Instructions At what times, other than at time of sale, may it be appropriate to recognize revenue? Explain and justify each of these times.

Solution 7-115 Revenue is also recognized (1) before delivery and (2) after delivery. (1) Before delivery. The most common situation is the use of the percentage-of-completion method for long-term construction contracts. The point of sale is much less significant than production activity. If the contractor can expect to perform the contractual obligation, the revenue is assured by the contract. To defer recognition until completion of the entire contract misrepresents the efforts (costs) and accomplishments (revenues) of the interim periods. If progress toward completion can be estimated with reasonable accuracy, the percentage-of-completion method should be used.

Revenue Recognition

7 - 29

Solution 7-115 (cont.) (2) After delivery. When collection is highly uncertain and there is no reasonably objective basis for estimating the degree of collectibility, revenue should not be recognized until cash is received. In addition, if collection costs and bad debts are expected to be high and their amount cannot be reasonably estimated, revenue recognition should be deferred.

Ex. 7-116—Percentage-of-completion method. Melanie Construction Company entered into a contract to construct a building for Steve Elbert. The contract called for a flat fee of $900,000, and specified that a progress report be given periodically as to percentage of completion. Construction activities for the first two years are summarized below: 2008: Construction costs incurred during the year amounted to $172,800; estimated cost to complete, $547,200. 2009: Construction costs incurred during the year amounted to $385,450; estimated cost to complete, $166,750. Instructions: Using the percentage-of-completion method, compute the amount of gross profit Melanie Construction Company should recognize in 2008 and 2009 as a result of this contract.

Solution 7-116 2008: Contract price ..................................................................... Less: Cost to date .................................................................. Estimated cost to complete ........................................... Estimated total cost ............................................................ Estimated total gross profit ................................................. Gross profit recognized in 2008: ($172,800  $720,000) × $180,000

$900,000 $172,800 547,200 720,000 $180,000

$43,200

2009: Contract price ..................................................................... Less: Cost to date ($172,800 + $385,450) ............................. Estimated cost to complete ........................................... Estimated total cost ............................................................ Estimated total gross profit ................................................. Gross profit recognized in 2009: ($558,250  $725,000) × $175,000 $134,750 Less 2008 recognized gross profit 43,200 $ 91,550

$900,000 $558,250 166,750 725,000 $175,000

7 - 30

Test Bank for Intermediate Accounting, Second Edition

Ex. 7-117—Percentage-of-completion method. Garnet Construction Co. contracted to build a bridge for $5,000,000. Construction began in 2008 and was completed in 2009. Data relating to the construction are: 2008 $1,650,000 1,350,000

Costs incurred Estimated costs to complete

2009 $1,375,000 —

Garnet uses the percentage-of-completion method. Instructions (a) How much revenue should be reported for 2008? Show your computation. (b) How much gross profit should be reported for 2009? Show your computation.

Solution 7-117 (a)

(b)

$1,650,000 ————— × $5,000,000 = $2,750,000 $3,000,000 Revenue Costs Total gross profit Recognized in 2008 Recognized in 2009 Or Total revenue Recognized in 2008 Recognized in 2009 Costs in 2009 Gross profit in 2009

$5,000,000 3,025,000 1,975,000 (1,100,000) $ 875,000 $5,000,000 (2,750,000) 2,250,000 (1,375,000) $ 875,000

Ex. 7-118—Percentage-of-completion and completed-contract methods. On February 1, 2007, Nance Contractors agreed to construct a building at a contract price of $6,000,000. Nance estimated total construction costs would be $4,000,000 and the project would be finished in 2009. Information relating to the costs and billings for this contract is as follows: Total costs incurred to date Estimated costs to complete Customer billings to date Collections to date

2007 $1,500,000 2,500,000 2,200,000 2,000,000

2008 $2,640,000 1,760,000 4,000,000 3,500,000

2009 $4,600,000 -05,600,000 5,500,000

Instructions Fill in the correct amounts on the following schedule. For percentage-of-completion accounting and for completed-contract accounting, show the gross profit that should be recorded for 2007, 2008, and 2009.

Revenue Recognition Ex. 7-118

7 - 31

(cont.) Percentage-of-Completion Gross Profit

Completed-Contract Gross Profit

2007

__________

2007

__________

2008

__________

2008

__________

2009

__________

2009

__________

2007 2008 2009

Completed-Contract Gross Profit — — $1,400,000d

Solution 7-118

2007 2008 2009

Percentage-of-Completion Gross Profit $750,000a $210,000b $440,000c

a$1,500,000

————— × $2,000,000 = $750,000 $4,000,000

b$2,640,000

————— × $1,600,000 = $960,000 $4,400,000

Less 2007 gross profit 2008 gross profit cTotal revenue

Total costs Total gross profit Recognized to date 2009 gross profit dTotal revenue

Total costs Total gross profit

(750,000) $210,000 $6,000,000 4,600,000 1,400,000 (960,000) $ 440,000 $6,000,000 4,600,000 $1,400,000

Ex. 7-119—Long-term construction contracts (essay). In accounting for long-term construction contracts (those taking longer than one year to complete), the two methods commonly followed are percentage-of-completion and completedcontract. Instructions (a) Discuss how earnings on long-term construction contracts are recognized and computed under these two methods. (b) Under what circumstances should one method be used over the other? *(c) How are job costs and interim billings reflected on the balance sheet under the percentageof-completion method and the completed-contract method?

7 - 32

Test Bank for Intermediate Accounting, Second Edition

Solution 7-119 (a) The revenue recognized on a long-term construction contract under the percentage-ofcompletion method is determined by applying a percentage representing the degree of completion to the total contract price at the end of the accounting period. The percentage may be derived by dividing the costs incurred to date by the total estimated costs of the entire contract based on the most recent information. The revenue so derived is then reduced by the direct contract costs to determine the gross profit recognized in the initial period. In subsequent periods, since the percentage-of-completion method described produces cumulative results, revenue and gross profit recognized in prior periods must be subtracted to obtain current revenue and gross profit to be recognized. Under the completed-contract method, no earnings are recognized until the contract is substantially completed. For the period in which completion occurs, gross revenues include the total contract price. Total job costs incurred are deducted from gross revenues, resulting in recognition of the entire amount of gross profit in the completion period. If it is expected that a loss will occur on the contract, a provision for loss should be recognized immediately under both the completed-contract method and the percentage-of-completion method. (b) The percentage-of-completion method should be used when estimates of the bases upon which progress is measured are reasonably dependable and all the following conditions exist: 1. The contract clearly specifies the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement. 2. The buyer can be expected to satisfy all obligations under the contract. 3. The contractor can be expected to perform the contractual obligation. The completed-contract method should be used when inherent hazards or lack of dependable estimates cause the forecasts to be of doubtful value. *(c) Under the percentage-of-completion method, a schedule is made of the contracts in process, showing the total costs incurred as of the end of a given period, the estimated gross profit recognized based on the degree of completion, and the total billings rendered on each individual contract. If costs incurred plus recognized profits exceed the related billings on a contract, this net figure is shown as a current asset. This treatment shows that the contractor has not fully billed the customer for work performed to date and has a claim against the customer for that portion of work completed but not yet billed. If billings on a contract exceed costs incurred plus estimated profits, this net figure is shown as a current liability, which means that the contractor has overbilled the customer for work done to date and must complete the work represented by the excess billings. Under the completed-contract method, the treatment of excess costs and billings is the same as under the percentage-of-completion method except that estimated profits are not computed because profit recognition is deferred until a contract is completed. The excess of costs over related billings on a contract is a current asset while the excess of billings over related costs on a contract is a current liability.

Revenue Recognition

7 - 33

Ex. 7-120—Percentage-of-completion method. Stiner Builders contracted to build a high-rise for $14,000,000. Construction began in 2008 and is expected to be completed in 2011. Data for 2008 and 2009 are: 2008 $1,800,000 7,200,000

Costs incurred to date Estimated costs to complete

2009 $5,200,000 4,800,000

Stiner uses the percentage-of-completion method. Instructions (a) How much gross profit should be reported for 2008? Show your computation. (b) How much gross profit should be reported for 2009? *(c) Make the journal entry to record the revenue and gross profit for 2009.

Solution 7-120 (a) $1,800,000 ————— × $5,000,000 = $1,000,000 $9,000,000 (b)

$5,200,000 —————— × $4,000,000 = $2,080,000 $10,000,000 Less 2008 gross profit Gross profit in 2009

1,000,000 $1,080,000

*(c) Construction in Process............................................................... 1,080,000 Construction Expenses................................................................ 3,400,000 Revenue from Long-Term Contracts ................................

4,480,000

Ex. 7-121—Installment sales. The following information was taken from the records of Locken Corporation for the years indicated. The company's year end is December 31.

Sales (on installment) Cost of sales Gross profit Cash receipts: 2007 sales 2008 sales 2009 sales

2007 $450,000 342,000 $108,000

2008 $500,000 360,000 $140,000

2009 $620,000 434,000 $186,000

$125,000

$280,000 210,000

$ 45,000 230,000 250,000

Instructions Calculate the amount of realized gross profit on installment sales to be reported in the year-end financial statements of Locken Corporation for the years 2007–2009.

7 - 34

Test Bank for Intermediate Accounting, Second Edition

Solution 7-121 Rate of gross profit on sales ...................................... Realized gross profit 2007 sales ........................................................ 2008 sales ........................................................ 2009 sales ........................................................ Realized gross profit 12-31........................................

2007

2008

2009

24%

28%

30%

$30,000

$ 67,200 58,800

$ 10,800 64,400 75,000 $150,200

_ $30,000

$126,000

Ex. 7-122—Installment sales. Carlin Co. had installment sales of $1,000,000 and cost of installment sales of $700,000 in 2008. A 2008 sale resulted in a default in 2010, at which time the balance of the installment receivable was $30,000. The repossessed merchandise had a fair value of $15,000. Instructions (a) Calculate the rate of gross profit on 2008 installment sales. *(b) Make the entry to record the repossession.

Solution 7-122 (a) $300,000 ÷ $1,000,000 = 30% *(b) Repossessed Merchandise.......................................................... Deferred Gross Profit, 2008 (.30 × $30,000) ................................ Loss on Repossession................................................................. Installment Accounts Receivable, 2008..................................

15,000 9,000 6,000 30,000

*Ex. 7-123—Journal entries—percentage-of-completion. Grant Construction Company was awarded a contract to construct an interchange at the junction of U.S. 94 and Highway 30 at a total contract price of $8,000,000. The estimated total costs to complete the project were $6,000,000. Instructions (a) Make the entry to record construction costs of $3,600,000, on construction in process to date. (b) Make the entry to record progress billings of $2,000,000. (c) Make the entry to recognize the profit that can be recognized to date, on a percentage-ofcompletion basis.

*Solution 7-123 (a)

(b)

Construction in Process ............................................................... 3,600,000 Materials, Cash, Payables, Etc.........................................

3,600,000

Accounts Receivable ................................................................... 2,000,000 Billings on Construction in Process ..................................

2,000,000

Revenue Recognition

7 - 35

*Solution 7-123 (cont.) (c)

Construction Expenses................................................................ 3,600,000 Construction in Process (60% complete) ..................................... 1,200,000 Revenue from Long-Term Contracts ................................

4,800,000

*Ex. 7-124—Installment sales. Tanner Furniture Company concluded its first year of operations in which it made sales of $800,000, all on installment. Collections during the year from down payments and installments totaled $300,000. Purchases for the year totaled $400,000; the cost of merchandise on hand at the end of the year was $80,000. Instructions Using the installment-sales method, make summary entries to record: (a) the installment sales and cash collections; (b) the cost of installment sales; (c) the unrealized gross profit; (d) the realized gross profit.

*Solution 7-124 (a)

(b)

(c)

(d)

Installment Accounts Receivable ................................................. Installment Sales .............................................................

800,000

Cash............................................................................................ Installment Accounts Receivable .....................................

300,000

Cost of Installment Sales ($400,000 – $80,000) .......................... Inventory ..........................................................................

320,000

Installment Sales ......................................................................... Cost of Installment Sales ................................................. Deferred Gross Profit (60%).............................................

800,000

Deferred Gross Profit (60% × $300,000) ..................................... Realized Gross Profit on Installment Sales ......................

180,000

800,000 300,000

320,000

320,000 480,000

180,000

*Ex. 7-125—Installment sales. Gardin Company uses the installment-sales method to account for its installment sales. On January 1, 2008, Gardin Company had an installment account receivable from Silverman Company in the amount of $2,300. Silverman paid a total of $500 on the account during 2008. However, late in 2008 Silverman discontinued payments and the merchandise was repossessed. When the merchandise was repossessed, it had a fair market value of $720. Gardin Company spent an additional $75 to recondition the merchandise. When the repossessed merchandise was originally sold, it was to yield a 45% gross profit rate. Instructions: Prepare the journal entries on Gardin Company’s books to record all transactions with Silverman Company during 2008.

7 - 36

Test Bank for Intermediate Accounting, Second Edition

*Solution 7-125 Cash........................................................................................................ Accounts Receivable ......................................................................

500

Deferred Gross Profit ($500 × 45%) ........................................................ Realized Gross Profit ......................................................................

225

Repossessed Merchandise ..................................................................... Deferred Gross Profit (45% × $1,800) ..................................................... Loss on Repossession ............................................................................ Installment Accounts Receivable ....................................................

720 810 270

Repossessed Merchandise ..................................................................... Cash ...............................................................................................

500

225

1,800

PROBLEMS Ex. 7-126—Long-term construction contract. Meyer Corporation uses the percentage-of-completion method to account for work performed under long-term construction contracts. Meyer began work under contract #7031-21, which provided for a contract price of $3,600,000. Additional data is as follows: Costs incurred during the year Estimated costs to complete, as of December 31 Billings during the year Collections during the year

2008 $ 500,000 1,500,000 580,000 525,000

2009 $1,664,000 -02,875,000 2,670,000

Instructions: (a) What portion of the total contract price would be recognized as revenue in 2008 and in 2009? *(b) Prepare a complete set of journal entries for 2008 under the (1) percentage-of-completion method, and (2) completed-contract method.

Solution 7-126 (a) 2008: 2009:

$500,000 × $3,600,000 = $900,000 $2,000,000 Contract Price Revenue Recognized in 2008 Revenue Recognized in 2009

$3,600,000 900,000 $2,700,000

*(b) (1) Percentage-of-Completion Method - 2008 Construction in Process ...................................................... Materials, Cash, Payable, etc. .................................... Accounts Receivable .......................................................... Billings on Construction in Process ............................

500,000 500,000 580,000 580,000

7 - 37

Revenue Recognition Solution 7-126 (cont.) Cash ................................................................................... Accounts Receivable .................................................

525,000

Construction in Process ...................................................... Construction Expense......................................................... Revenue—Long-Term Contracts (see a) ...................

400,000* 500,000

525,000

900,000

*[$3,600,000 – ($500,000 + $1,500,000)] × [$500,000 ÷ ($500,000 + $1,500,000)] (2) Completed-Contract Method - 2008 Under the completed-contract method, all the above entries are made except for the last entry. No income is recognized until the contract is completed.

Pr. 7-127—Long-term construction project accounting. Benson Construction specializes in the construction of commercial and industrial buildings. The contractor is experienced in bidding long-term construction projects of this type, with the typical project lasting fifteen to twenty-four months. The contractor uses the percentage-of-completion method of revenue recognition since, given the characteristics of the contractor's business and contracts, it is the most appropriate method. Progress toward completion is measured on a cost to cost basis. Benson began work on a lump-sum contract at the beginning of 2008. As bid, the statistics were as follows: Lump-sum price (contract price) Estimated costs Labor Materials and subcontractor Indirect costs

$4,000,000 $ 850,000 1,750,000 400,000

3,000,000 $1,000,000

At the end of the first year, the following was the status of the contract: Billings to date Costs incurred to date Labor Materials and subcontractor Indirect costs

$2,230,000 $ 464,000 1,098,000 193,000

Latest forecast total cost

$3,000,000

1,755,000

It should be noted that included in the above costs incurred to date were standard electrical and mechanical materials stored on the job site, but not yet installed, costing $105,000. These costs should not be considered in the costs incurred to date. Instructions (a) Compute the percentage of completion on the contract at the end of 2008. (b) Indicate the amount of gross profit that would be reported on this contract at the end of 2008. *(c) Make the journal entry to record the income (loss) for 2008 on Benson's books. (d) Assume the latest forecast on total costs at the end of 2008 was $4,050,000. How much income (loss) would Benson report for the year 2008?

7 - 38

Test Bank for Intermediate Accounting, Second Edition

Solution 7-127 (a) Costs to date Less materials on job site

$1,755,000 (105,000) $1,650,000

Costs Incurred to Date —————————— = Percentage of Completion Total Estimated Costs $1,650,000 ————— = 55% $3,000,000 (b) 55% × $4,000,000 = Costs incurred Gross profit

$2,200,000 1,650,000 $ 550,000

*(c) Construction Expense.................................................................. 1,650,000 Construction in Process ............................................................... 550,000 Revenue from Long-Term Project .................................... (d) Total loss reported in 2008 Contract price Estimated cost to complete Amount of loss to be reported

2,200,000

$4,000,000 4,050,000 $ (50,000)

Pr. 7-128—Long-term contract accounting—percentage-of-completion. Sauer Construction, Inc. experienced the following construction activity in 2008, the first year of operations. Cash Cost Estimated Total Billings Collections Incurred Additional Contract through through through Costs to Project Price 12/31/08 12/31/08 12/31/08 Complete X $280,000 $170,000 $155,000 $137,000 $ 63,000 Y 315,000 130,000 130,000 100,000 247,000 Z 396,000 396,000 316,000 252,000 -0$991,000 $696,000 $601,000 $489,000 $310,000 Each of the above contracts is with a different customer, and any work remaining at December 31, 2008 is expected to be completed in 2009. Instructions Determine the amount of income or loss to be reported for each of these projects in 2008. Sauer uses the percentage-of-completion method.

Revenue Recognition

7 - 39

Solution 7-128 Project Contract price Contract costs incurred Additional costs to complete Total cost Total gross profit or (loss) Income (loss) to be reported

X $280,000 137,000 63,000 200,000 $ 80,000 $ 54,800*

Y $315,000 100,000 247,000 347,000 $ (32,000) $ (32,000)

Z $396,000 252,000 -0252,000 $144,000 $144,000

*$80,000 × ($137,000 ÷ $200,000)

Pr. 7-129—Accounting for long-term construction contracts. The board of directors of Dodd Construction Company is meeting to choose between the completed-contract method and the percentage-of-completion method of accounting for long-term contracts in the company's financial statements. You have been engaged to assist Dodd's controller in the preparation of a presentation to be given at the board meeting. The controller provides you with the following information: 1. 2.

Dodd commenced doing business on January 1, 2008. Construction activities for the year ended December 31, 2008, were as follows: Project A B C D E

Project A B C D E

3. 4.

Total Contract Price $ 515,000 690,000 475,000 200,000 480,000 $2,360,000

Billings Through 12/31/08 $ 340,000 210,000 475,000 100,000 400,000 $1,525,000

Contract Costs Incurred Through 12/31/08 $ 424,000 195,000 350,000 123,000 320,000 $1,412,000

Estimated Additional Costs to Complete Contracts $101,000 455,000 -097,000 80,000 $733,000

Cash Collections Through 12/31/08 $ 310,000 210,000 390,000 65,000 400,000 $1,375,000

Each contract is with a different customer. Any work remaining to be done on the contracts is expected to be completed in 2009.

Instructions (a) Prepare a schedule by project, computing the amount of income (or loss) before selling, general, and administrative expenses for the year ended December 31, 2008, which would be reported under: (1) The completed-contract method. (2) The percentage-of-completion method (based on estimated costs). *(b) Prepare the general journal entry(ies) to record revenue and gross profit on project B (second project) for 2008, assuming that the percentage-of-completion method is used.

7 - 40

Test Bank for Intermediate Accounting, Second Edition

Pr. 7-129 (cont.) *(c) Indicate the balances that would appear in the balance sheet at December 31, 2008 for the following accounts for Project D (fourth project), assuming that the percentage-of-completion method is used. Accounts Receivable Billings on Construction in Process Construction in Process (d) How would the balances in the accounts discussed in part (c) change (if at all) for Project D (fourth project), if the completed-contract method is used?

Solution 7-129 (a) (1) and (2) Projects Contract price Contract costs incurred Additional costs to complete Total cost Total gross profit or (loss)

A $515,000 424,000

B $690,000 195,000

C $475,000 350,000

D $200,000 123,000

E $480,000 320,000

101,000 525,000

455,000 650,000

-0350,000

97,000 220,000

80,000 400,000

$ (10,000)

$ 40,000

$125,000

$ (20,000)

$ 80,000

The amount reported as income (loss) under the completed-contract method for 2008 is: Project A B C D E

$ (10,000) -0125,000 (20,000) -0$ 95,000

The amount reported as income (loss) under the percentage-of-completion method for 2008 is: Project A B C D E

$ (10,000) 12,000 125,000 (20,000) 64,000 $171,000

$40,000 × ($195,000 ÷ $650,000)

$80,000 × ($320,000 ÷ $400,000)

*(b) Construction in Process ............................................................... Construction Expenses ................................................................ Revenue from Long-term Contracts ................................. *(c) Billings Cash collections Accounts receivable Billings on Construction in Process

$100,000 65,000 $ 35,000 $100,000

12,000 195,000 207,000

Revenue Recognition

7 - 41

Solution 7-129 (cont.) Costs incurred Loss reported Construction in process (d)

$123,000 (20,000) $103,000

The account balances would be the same.

*Pr. 7-130—Installment sales. Dexter Appliances accounts for all sales of its merchandise on the installment basis. Following is the unadjusted trial balance at 12/31/09. Cash Installment accounts receivable—2007 Installment accounts receivable—2008 Installment accounts receivable—2009 Inventory Repossessed merchandise Accounts payable Deferred gross profit—2007 Deferred gross profit—2008 Common stock Retained earnings Installment sales Cost of installment sales Loss on repossessions Operating expenses

$ 45,000 20,000 50,000 90,000 27,400 4,600 $ 37,600 12,000 26,400 125,000 10,000 120,000 78,000 3,000 13,000 $331,000

$331,000

Additional information: 2007 gross profit rate: 25% Total cash receipts during 2009: $118,000 Merchandise sold in 2008 was repossessed in 2009 and the following entry was prepared: Deferred Gross Profit—2008 .................................................... Repossessed Merchandise ...................................................... Loss on Repossessions ............................................................ Installment Accounts Receivable—2008 .......................

2,400 4,600 3,000 10,000*

Instructions (a) What is the gross profit rate for 2008? Show supporting computations. (b) What is the gross profit rate for 2009? Show supporting computations. (c) Of the total cash receipts in 2009, how much represents collections from installment sales of: (Show supporting computations.) (1) 2007? (2) 2008? (3) 2009? (d) What is the total realized gross profit in 2009? Show supporting computations.

7 - 42

Test Bank for Intermediate Accounting, Second Edition

Solution 7-130 (a)

Determined from the repossession entry: Deferred gross profit Installment accounts receivable

Installment sales Cost of sales Gross profit

$120,000 78,000 $ 42,000

Gross profit

$42,000 ————- = 35% gross profit rate $120,000

Installment sales (c)

(d)

$2,400 ———— = 24% $10,000

2007

Deferred gross profit balance Gross profit rate Beginning accounts receivable Beginning accounts receivable Ending accounts receivable Cash collected

$ 12,000 ÷ 25% $ 48,000 $ 48,000 (20,000) $ 28,000

2008

Deferred gross profit balance Gross profit rate Beginning accounts receivable* Beginning accounts receivable* Ending accounts receivable* Cash collected

$ 26,400 ÷ 24% $110,000 $110,000 (50,000) $ 60,000

2009

Installment sales—2009 Accounts receivable—2009 Cash collected

$120,000 (90,000) $ 30,000

Total realized gross profit in 2009 From 2007 $28,000 × 25% = 2008 $60,000 × 24% = 2009 $30,000 × 35% =

$ 7,000 14,400 10,500 $31,900 *Excluding accounts receivable for repossessed merchandise.

CHAPTER 8 CASH AND RECEIVABLES TRUE-FALSE—Conceptual Answer

No.

Description

T F F F F T F F F T F F F T T T T F F F T T F F F F T T T F T F F T T

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. *33. *34. *35.

Items considered cash. Items considered cash. Items considered cash. Definition of cash. Classification of savings accounts. Classification of bond sinking fund. Bank overdrafts. Cash equivalents definition. Bank overdrafts. Cash equivalents. Classification of receivables. Items considered trade receivables. Accounts receivable and notes receivable. Recognizing sales discounts. Trade discount uses. Sales discounts. Valuation of receivables. Percentage-of-receivables approach. Percentage-of-sales method. Percentage-of-receivables approach. Offsetting assets and liabilities. Reporting notes receivable. Stated interest rate vs. effective rate. Classification of notes receivable. Classification of trade receivable. Definition of factoring. Selling receivables with recourse. Present value of a note. Recourse liability. Buying receivables with recourse. Selling receivables with recourse. Computing receivables turnover. Replenishment of petty cash. Bank reconciliation format. NSF checks and bank reconciliation.

8-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. *68. *69. *70. *71. *72. *73.

Identification of cash items. Identification of cash items. Classification of travel advance. Items included as cash. Identification of cash items. Definition of compensating balance. Cash equivalent definition. Classification of bank overdraft. Classification of compensating balances. Definition of trade receivables. Identification of trade receivables. Presentation of nontrade receivables. Cash discount definition. Trade discount uses. Classification of sales discounts. Valuation of short-term receivables. Bad debt provision and the matching concept. Bad debts as a percentage of sales. Bad debts as a percentage of sales. Bad debts as a percentage of receivables. Bad debt expense and accounts receivable. Accounting for uncollectible accounts receivable. Allowance method vs. direct write-off method. Recognition and valuation of receivables. Financial statement effect of a note recorded incorrectly. Factoring accounts receivable without recourse. Classification of accounts and notes receivable. Transfer of receivables with recourse. Factoring accounts receivable. Assignment of accounts receivable. Accounts receivable turnover ratio. Accounts receivable turnover ratio. Entry to replenish the Petty Cash account. Purpose of Cash Over & Short account. Classification of bank service charges. Treatment of bank credits on bank reconciliation. Preparing a bank reconciliation. Treatment of outstanding checks and deposits on bank reconciliation.

* This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE—Computational Answer

No.

Description

a d b c

74. 75. 76. 77.

Calculate cash balance. Calculate effective interest on loan with required compensatory balance. Reporting cash. Cash and cash equivalents.

Cash and Receivables

MULTIPLE CHOICE—Computational (cont.) Answer

No.

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

78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. *107. *108. *109. *110. *111. *112.

Description Reporting cash. Cash and cash equivalents. Determine effective annual interest rate of sales discount. Calculate balance of accounts receivable. Calculate net realizable value of accounts receivable. Calculate net realizable value of accounts receivable. Calculate bad debt expense using aging of receivables. Calculate bad debt expense using percent of sales. Calculate bad debt expense using percent of receivables. Valuation of accounts receivable. Calculation of bad debt expense. Calculate Allowance for Doubtful Accounts balance. Valuation of accounts receivable. Calculation of bad debt expense. Calculate Allowance for Doubtful Accounts balance. Calculate sales using direct write-off. Calculate decrease in receivable’s net realizable value. Calculate implicit interest rate. Calculate present value of a zero-interest-bearing note. Determine appropriate interest rate for a zero-interest-bearing note. Valuing a note receivable. Calculate cash proceeds from transfer of receivables. Entry to record collection of assigned receivables. Factoring receivables without recourse. Factoring receivables with recourse. Calculate loss on sale of receivables. Calculate loss on sale of receivables. Calculate accounts receivable turnover. Calculate accounts receivable turnover. Entry to replenish the Petty Cash account. Calculate correct balance in bank account. Calculate correct cash balance. Calculate correct cash balance. Calculate correct cash balance. Calculate correct cash balance.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

a d d b c d c c

113. 114. 115. 116. 117. 118. 119. 120.

Determine current net receivables. Calculate adjustment for bad debts. Calculate bad debt expense. Calculate adjustment to write off bad debts. Effect of a write-off under the allowance method. Determine balance in the Allowance for Doubtful Accounts. Determine interest revenue of a zero-interest-bearing note. Determine interest receivable at year end.

8-3

8-4

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—CPA Adapted (cont.) Answer

No.

b a a

121. *122. *123.

Description Assignment and factoring of accounts receivable. Calculate correct cash balance. Calculate the cash balance per books.

EXERCISES Item E8-124 E8-125 E8-126 E8-127 E8-128 E8-129 E8-130

Description Asset classification. Allowance for doubtful accounts. Entries for bad debt expense. Accounting for zero-interest-bearing note. Factoring accounts receivable. Accounts receivable assigned. Bank reconciliation

PROBLEMS Item P8-131 P8-132 P8-133 *P8-134 *P8-135

Description Entries for bad debt expense. Amortization of discount on note. Accounts receivable assigned. Factoring accounts receivable. Bank reconciliation.

CHAPTER LEARNING OBJECTIVES 1.

Identify items considered cash.

Indicate how to report cash and related items.

Define receivables and identify the different types of receivables.

Explain accounting issues related to recognition of accounts receivable.

Explain accounting issues related to valuation of accounts receivable.

Explain accounting issues related to recognition of notes receivable.

Explain accounting issues related to valuation of notes receivable.

Explain accounting issues related to disposition of accounts and notes receivable.

Explain how to report and analyze receivables.

*10.

Explain common techniques employed to control cash.

Cash and Receivables

8-5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2.

TF TF

3. 4.

TF TF

5. 36.

6. 7. 8.

TF TF TF

9. 10. 41.

TF TF MC

42. 43. 44.

11.

12.

13.

14. 15.

TF TF

16. 48.

TF MC

49. 50.

17. 18. 19. 20. 21. 51.

TF TF TF TF TF MC

52. 53. 54. 55. 56. 57.

MC MC MC MC MC MC

58. 59. 81. 82. 83. 84.

22. 23.

TF TF

24. 25.

TF TF

60. 95.

98.

26. 27. 28. 29.

TF TF TF TF

30. 31. 61. 62.

TF TF MC MC

63. 64. 65. 99.

32.

66.

67.

33. 34. 35.

TF TF TF

68. 69. 70.

MC MC MC

71. 72. 73.

Note:

TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 TF 37. MC 39. MC 38. MC 40. Learning Objective 2 MC 75. MC 78. MC 76. MC 79. MC 77. MC 124. Learning Objective 3 TF 45. MC 46. Learning Objective 4 MC 80. MC MC 113. MC Learning Objective 5 MC 85. MC 91. MC 86. MC 92. MC 87. MC 93. MC 88. MC 94. MC 89. MC 114. MC 90. MC 115. Learning Objective 6 MC 96. MC 119. MC 97. MC 120. Learning Objective 7 Learning Objective 8 MC 100. MC 104. MC 101. MC 121. MC 102. MC 128. MC 103. MC 129. Learning Objective 9 MC 105. MC 106. Learning Objective *10 MC 107. MC 110. MC 108. MC 111. MC 109. MC 112. E = Exercise P = Problem

Type

Item

Type

MC MC

74.

47.

MC MC MC MC MC MC

116. 117. 118. 125. 126. 131.

MC MC MC E E P

MC MC

127. 132.

E P

MC MC E E

133. 134.

P P

122. 123. 130.

MC MC E

Item

Type

135.

MC MC E

MC MC MC MC

8-6

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual 1. Savings accounts are usually classified as cash on the balance sheet. 2. Certificates of deposit are usually classified as cash on the balance sheet. 3. Companies include postdated checks and petty cash funds as cash. 4. Cash consists of coin, currency, money market funds, certificates of deposit and other available funds on deposit at the bank. 5. Because the bank has the legal right to demand notice before withdrawal, savings accounts usually are not classified on an entity's balance sheet as cash. 6. Bond sinking fund cash should not be classified as a current asset because its use is restricted. 7. Bank overdrafts occur when a check is written for less than the amount in the cash account. 8. Cash equivalents are investments with original maturities of six months or less. 9. Bank overdrafts are always offset against the cash account in the balance sheet. 10. Short-term, highly liquid investments may be included with cash on the balance sheet. 11. All claims held against customers and others for money, goods, or services are reported as current assets. 12. Trade receivables include notes receivable and advances to officers and employees. 13. Accounts receivable are frequently accepted from customers who need to extend the payment period of an outstanding note receivable. 14. When a sale and the related receivable are initially recorded at the gross amount, sales discounts will be recognized in the accounts only when payment is received within the discount period. 15. Trade discounts are used to avoid frequent changes in catalogs and to alter prices for different quantities purchased. 16. In the gross method, sales discounts are reported as a deduction from sales. 17. The net amount reported for short-term receivables is not affected when a specific account receivable is determined to be uncollectible. 18. The percentage-of-receivables approach of estimating uncollectible accounts emphasizes matching over valuation of accounts receivable. 19. The percentage-of-sales method results in a more accurate valuation of receivables on the balance sheet.

Cash and Receivables

8-7

20. The percentage-of-receivables approach is also referred to as the income statement approach. 21. It is improper to offset assets and liabilities in the balance sheet, except where a right of offset exists. 22. Companies record and report long-term notes receivable at the present value of the cash they expect to collect. 23. When the stated rate of interest exceeds the effective rate, the present value of the note receivable will be less than its face value. 24. Notes receivable are generally reported as noncurrent assets. 25. A trade receivable due two years hence should never be classified as a current asset. 26. Factoring is the term used to describe the pledging of receivables as collateral for a loan. 27. If receivables are sold with recourse, the seller guarantees payment to the purchaser in the event the debtor does not pay. 28. The present value of a note is measured by the fair value of the property, goods, or services exchanged for the note or by an amount that reasonably approximates the market value of the note. 29. Recognition of a recourse liability will make a loss on sale of receivables larger than it would otherwise have been. 30. When buying receivables with recourse, the purchaser assumes the risk of collectibility and absorbs any credit loss. 31. For receivables sold with recourse, the seller guarantees payment to the purchaser if the debtor fails to pay. 32. The receivables turnover ratio is computed by dividing net sales by the ending net receivables. *33. The replenishment of the petty cash fund under an imprest system requires a debit to the Petty Cash account for the amount of the replenishment. *34. Of the two bank reconciliation formats used by a business entity, the more widely used form reconciles both the bank balance and the book balance to a correct cash balance. *35. When preparing a bank reconciliation for the purpose of arriving at a correct cash balance, NSF (not sufficient funds) checks are subtracted from the balance per books.

8-8

Test Bank for Intermediate Accounting, Second Edition

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7.

T F F F F T F

8. 9. 10. 11. 12. 13. 14.

F F T F F F T

15. 16. 17. 18. 19. 20. 21.

T T T F F F T

22. 23. 24. 25. 26. 27. 28.

T F F F F T T

29. 30. 31. 32. *33. *34. *35.

T F T F F T T

MULTIPLE CHOICE—Conceptual 36.

Which of the following is not considered cash for financial reporting purposes? a. Petty cash funds and change funds b. Money orders, certified checks, and personal checks c. Coin, currency, and available funds d. Postdated checks and I.O.U.'s

37.

Which of the following is considered cash? a. Certificates of deposit (CDs) b. Money market checking accounts c. Money market savings certificates d. Postdated checks

38.

Travel advances should be reported as a. supplies. b. cash because they represent the equivalent of money. c. investments. d. none of these.

39.

Which of the following items should not be included in the Cash caption on the balance sheet? a. Coins and currency in the cash register b. Checks from other parties presently in the cash register c. Amounts on deposit in checking account at the bank d. Postage stamps on hand

40.

Which of the following is properly classified as cash? a. Customer's postdated checks on hand b. Certificates of deposit c. Savings accounts d. Bond sinking fund cash

Cash and Receivables

8-9

41.

A compensating balance as defined by the SEC is best reflected by which of the following? a. A savings account maintained at the bank equal to the amount of all outstanding loans. b. An amount of capital stock held in the company's treasury equal to outstanding loan commitments. c. The portion of any demand deposit, time deposit, or certificate of deposit maintained by a corporation which constitutes support for existing borrowing arrangements of the corporation with the lending institution. d. A balance held in a time or demand deposit account that is equal to the interest currently due on a loan.

42.

A cash equivalent is a short-term, highly liquid investment that is readily convertible into known amounts of cash and a. is acceptable as a means to pay current liabilities. b. has a current market value that is greater than its original cost. c. bears an interest rate that is at least equal to the prime rate of interest at the date of liquidation. d. is so near its maturity that it presents insignificant risk of changes in interest rates.

43.

Bank overdrafts, if material, should be a. reported as a deduction from the current asset section. b. reported as a deduction from cash. c. netted against cash and a net cash amount reported. d. reported as a current liability.

44.

Deposits held as compensating balances a. usually do not earn interest. b. if legally restricted and held against short-term credit may be included as cash. c. if legally restricted and held against long-term credit may be included among current assets. d. none of these.

45.

The category "trade receivables" includes a. advances to officers and employees. b. income tax refunds receivable. c. claims against insurance companies for casualties sustained. d. none of these.

46.

Which of the following should be recorded in Accounts Receivable? a. Receivables from officers b. Receivables from subsidiaries c. Dividends receivable d. None of these

47.

What is the preferable presentation of accounts receivable from officers, employees, or affiliated companies on a balance sheet? a. As offsets to capital b. By means of footnotes only c. As assets but separately from other receivables d. As trade notes and accounts receivable if they otherwise qualify as current assets

8 - 10

Test Bank for Intermediate Accounting, Second Edition

48.

When a customer purchases merchandise inventory from a business organization, she may be given a discount which is designed to induce prompt payment. Such a discount is called a(n) a. trade discount. b. nominal discount. c. enhancement discount. d. cash discount.

49.

Trade discounts are a. not recorded in the accounts; rather they are a means of computing a price. b. used to avoid frequent changes in catalogues. c. used to quote different prices for different quantities purchased. d. all of the above.

50.

If a company employs the gross method of recording accounts receivable from customers, then sales discounts taken should be reported as a. a deduction from sales in the income statement. b. an item of "other expense" in the income statement. c. a deduction from accounts receivable in determining the net realizable value of accounts receivable. d. sales discounts forfeited in the cost of goods sold section of the income statement.

51.

Assuming that the ideal measure of short-term receivables in the balance sheet is the discounted value of the cash to be received in the future, failure to follow this practice usually does not make the balance sheet misleading because a. most short-term receivables are not interest-bearing. b. the allowance for uncollectible accounts includes a discount element. c. the amount of the discount is not material. d. most receivables can be sold to a bank or factor.

52.

Which of the following methods of determining bad debt expense does not properly match expense and revenue? a. Charging bad debts with a percentage of sales under the allowance method. b. Charging bad debts with an amount derived from a percentage of accounts receivable under the allowance method. c. Charging bad debts with an amount derived from aging accounts receivable under the allowance method. d. Charging bad debts as accounts are written off as uncollectible.

53.

Which of the following methods of determining annual bad debt expense best achieves the matching concept? a. Percentage of sales b. Percentage of ending accounts receivable c. Percentage of average accounts receivable d. Direct write-off

54.

Which of the following is a generally accepted method of determining the amount of the adjustment to bad debt expense? a. A percentage of sales adjusted for the balance in the allowance b. A percentage of sales not adjusted for the balance in the allowance c. A percentage of accounts receivable not adjusted for the balance in the allowance d. An amount derived from aging accounts receivable and not adjusted for the balance in the allowance

Cash and Receivables

8 - 11

55.

The advantage of relating a company's bad debt expense to its outstanding accounts receivable is that this approach a. gives a reasonably correct statement of receivables in the balance sheet. b. best relates bad debt expense to the period of sale. c. is the only generally accepted method for valuing accounts receivable. d. makes estimates of uncollectible accounts unnecessary.

56.

Green Company wrote off a client’s account receivable of $400 as uncollectible. What will be the effect on net income under the following methods of recognizing bad debt expense? a. b. c. d.

Direct Write-off Decrease None None Decrease

Allowance None Decrease None Decrease

57.

Which of the following statements is not correct regarding uncollectible accounts receivable? a. The direct write-off method records the bad debt in the year that it is determined that a specific receivable cannot be collected. b. The allowance method is based on the assumption that the percentage of receivables that will not be collected can be predicted from past experiences, present market conditions, and an analysis of outstanding balances. c. The direct write-off method will provide for a proper matching of costs with revenues of the period when the average monthly accounts receivable balance is consistent throughout the year. d. An uncollectible account receivable is a loss of revenue that requires⎯through proper entry in the accounts⎯a decrease in the asset accounts receivable and a related decrease in income and stockholders’ equity.

58.

The allowance method is preferable to the direct write-off method because the allowance method a. relies on estimates which are always accurate and stable among years. b. reflects the real facts. c. recognizes the expense of a bad debt in the year in which the account is determined to be uncollectible. d. recognizes the expense of a bad debt in the same period as the sale.

59.

The basic accounting issues for both accounts receivable and notes receivable would center around which of the following? a. b. c. d.

60.

Recognition Yes Yes No No

Valuation No Yes Yes No

At the beginning of 2007, Finney Company received a three-year, zero-interest-bearing $1,000 trade note. The market rate for equivalent notes was 8% at that time. Finney reported this note as a $1,000 trade note receivable on its 2007 year-end statement of financial position and $1,000 as sales revenue for 2007. What effect did this accounting for the note have on Finney's net earnings for 2007, 2008, 2009, and its retained earnings at the end of 2009, respectively?

8 - 12

Test Bank for Intermediate Accounting, Second Edition a. b. c. d.

Overstate, overstate, understate, zero Overstate, understate, understate, understate Overstate, overstate, overstate, overstate None of these

61.

Which of the following is true when accounts receivable are factored without recourse? a. The transaction may be accounted for either as a secured borrowing or as a sale, depending upon the substance of the transaction. b. The receivables are used as collateral for a promissory note issued to the factor by the owner of the receivables. c. The factor assumes the risk of collectibility and absorbs any credit losses in collecting the receivables. d. The financing cost (interest expense) should be recognized ratably over the collection period of the receivables.

62.

Which of the following statements is incorrect regarding the classification of accounts and notes receivable? a. Segregation of the different types of receivables is required if they are material. b. Disclose any loss contingencies that exist on the receivables. c. Any discount or premium resulting from the determination of present value in notes receivable transactions is an asset or liability, respectively. d. Valuation accounts should be appropriately offset against the proper receivable accounts.

63.

Of the following conditions, which is the only one that is not required if the transfer of receivables with recourse is to be accounted for as a sale? a. The transferor is obligated to make a genuine effort to identify those receivables that are uncollectible. b. The transferor surrenders control of the future economic benefits of the receivables. c. The transferee cannot require the transferor to repurchase the receivables. d. The transferor's obligation under the recourse provisions can be reasonably estimated.

64.

Thresher Corporation sold its accounts receivable outright to Kari Company, a financing company which normally buys accounts receivable of other companies without recourse. The accounts receivable have been a. collateralized. b. pledged. c. factored. d. assigned.

65.

In which of the following accounts receivable assignment arrangements do all receivables serve as collateral for the promissory note given by the assignor? a. b. c. d.

General Assignment Yes Yes No No

Specific Assignment Yes No Yes No

Cash and Receivables

8 - 13

66.

The accounts receivable turnover ratio measures the a. number of times the average balance of accounts receivable is collected during the period. b. percentage of accounts receivable turned over to a collection agency during the period. c. percentage of accounts receivable arising during certain seasons. d. number of times the average balance of inventory is sold during the period.

67.

The accounts receivable turnover ratio is computed by dividing a. gross sales by ending net receivables. b. gross sales by average net receivables. c. net sales by ending net receivables. d. net sales by average net receivables.

*68.

Which of the following is not true? a. The imprest petty cash system in effect adheres to the rule of disbursement by check. b. Entries are made to the Petty Cash account only to increase or decrease the size of the fund or to adjust the balance if not replenished at year end. c. The Petty Cash account is debited when the fund is replenished. d. All of these are not true.

*69.

A Cash Over and Short account a. is not generally accepted. b. is debited when the petty cash fund proves out over. c. is debited when the petty cash fund proves out short. d. is a contra account to Cash.

*70.

The journal entries for a bank reconciliation a. are taken from the "balance per bank" section only. b. may include a debit to Office Expense for bank service charges. c. may include a credit to Accounts Receivable for an NSF check. d. may include a debit to Accounts Payable for an NSF check.

*71.

When preparing a bank reconciliation, bank credits are a. added to the bank statement balance. b. deducted from the bank statement balance. c. added to the balance per books. d. deducted from the balance per books.

*72.

When preparing a bank reconciliation for the purpose of arriving at the correct cash balance a. outstanding checks can be added to the balance per books. b. NSF checks should be deducted from the balance per books. c. deposits in transit are deducted from the balance per bank. d. notes collected by the bank should be added to the balance per bank.

8 - 14 *73.

Test Bank for Intermediate Accounting, Second Edition In a bank reconciliation that attempts to reconcile the bank balance to the corrected cash balance, the following items would affect the reconciliation in what way? Outstanding Checks Added Subtracted Added Subtracted

a. b. c. d.

Deposits In Transit Added Added Subtracted Subtracted

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

36. 37. 38. 39. 40. 41.

d b d d c c

42. 43. 44. 45. 46. 47.

d d d d d c

48. 49. 50. 51. 52. 53.

d d a c d a

54. 55. 56. 57. 58. 59.

b a a c d b

60. 61. 62. 63. 64. 65.

d c c a c b

66. 67. *68. *69. *70. *71.

a d c c b c

*72. *73.

b b

Solutions to those Multiple Choice questions for which the answer is “none of these.” 38. As receivables 44. Many answers are possible. 45. Open accounts resulting from short-term extensions of credit to customers 46. Open accounts resulting from short-term extensions of credit to customers 60. Overstate, understate, understate, zero

MULTIPLE CHOICE—Computational 74.

Kari, Inc.'s cash book balance on December 31, 2008, was $5,000. In addition, Kari had the following items on its premises on December 31: Check payable to Kari, Inc., dated January 3, 2009, included in December 31 book balance $ 200 Postage stamps on hand not included in December 31 book balance 100 Cashier's check payable to Kari, Inc., dated December 28, 2008, not included in December 31 book balance 1,300 The proper amount to be shown as Cash on Kari's balance sheet at December 31, 2008, is a. $6,100. b. $6,200. c. $6,300. d. $6,400.

75.

On January 1, 2008, Mann Company borrows $2,000,000 from National Bank at 11% annual interest. In addition, Mann is required to keep a compensatory balance of $200,000 on deposit at National Bank which will earn interest at 5%. The effective interest that Mann pays on its $2,000,000 loan is

Cash and Receivables

a. b. c. d.

8 - 15

10.0%. 11.0%. 11.5%. 11.6%.

76.

Hamilton Company has cash in bank of $10,000, restricted cash in a separate account of $3,000, and a bank overdraft in an account at another bank of $1,000. Hamilton should report cash of a. $9,000. b. $10,000. c. $12,000. d. $13,000.

77.

Horvath Company has the following items at year end: Cash in bank Petty cash Short-term paper with maturity of 2 months Postdated checks

$20,000 300 5,500 1,400

Horvath should report cash and cash equivalents of a. $20,000. b. $20,300. c. $25,800. d. $27,200. 78.

Marshell Company has cash in bank of $15,000, restricted cash in a separate account of $4,000, and a bank overdraft in an account at another bank of $2,000. Marshell should report cash of a. $13,000. b. $15,000. c. $18,000. d. $19,000.

79.

Peterson Company has the following items at year end: Cash in bank Petty cash Short-term paper with maturity of 2 months Postdated checks

$30,000 500 8,200 2,100

Peterson should report cash and cash equivalents of a. $30,000. b. $30,500. c. $38,700. d. $40,800. 80.

If a company purchases merchandise on terms of 1/10, n/30, the cash discount available is equivalent to what effective annual rate of interest (assuming a 360-day year)? a. 1% b. 12% c. 18% d. 30%

8 - 16

Test Bank for Intermediate Accounting, Second Edition

81.

At the close of its first year of operations, December 31, 2008, Linn Company had accounts receivable of $540,000, after deducting the related allowance for doubtful accounts. During 2008, the company had charges to bad debt expense of $90,000 and wrote off, as uncollectible, accounts receivable of $40,000. What should the company report on its balance sheet at December 31, 2008, as accounts receivable before the allowance for doubtful accounts? a. $670,000 b. $590,000 c. $490,000 d. $440,000

82.

Before year-end adjusting entries, Bass Company's account balances at December 31, 2007, for accounts receivable and the related allowance for uncollectible accounts were $600,000 and $45,000, respectively. An aging of accounts receivable indicated that $62,500 of the December 31 receivables are expected to be uncollectible. The net realizable value of accounts receivable after adjustment is a. $582,500. b. $537,500. c. $492,500. d. $555,000.

83.

During the year, Jantz Company made an entry to write off a $4,000 uncollectible account. Before this entry was made, the balance in accounts receivable was $50,000 and the balance in the allowance account was $4,500. The net realizable value of accounts receivable after the write-off entry was a. $50,000. b. $49,500. c. $41,500. d. $45,500.

84.

The following information is available for Reagan Company: Allowance for doubtful accounts at December 31, 2007 Credit sales during 2008 Accounts receivable deemed worthless and written off during 2008

$ 8,000 400,000 9,000

As a result of a review and aging of accounts receivable in early January 2009, however, it has been determined that an allowance for doubtful accounts of $5,500 is needed at December 31, 2008. What amount should Reagan record as "bad debt expense" for the year ended December 31, 2008? a. $4,500 b. $5,500 c. $6,500 d. $13,500 Use the following information for questions 85 and 86. A trial balance before adjustments included the following: Debit Sales Sales returns and allowance Accounts receivable Allowance for doubtful accounts

Credit $425,000

$14,000 43,000 760

Cash and Receivables

8 - 17

85.

If the estimate of uncollectibles is made by taking 2% of net sales, the amount of the adjustment is a. $6,700. b. $8,220. c. $8,500. d. $9,740.

86.

If the estimate of uncollectibles is made by taking 10% of gross account receivables, the amount of the adjustment is a. $3,540. b. $4,300. c. $4,224. d. $5,060.

87.

Simpson Company has the following account balances at year end: Accounts receivable Allowance for doubtful accounts Sales discounts

$60,000 3,600 2,400

Simpson should report accounts receivable at a net amount of a. $54,000. b. $56,400. c. $57,600. d. $60,000. 88.

Holtzman Corporation had a 1/1/08 balance in the Allowance for Doubtful Accounts of $10,000. During 2008, it wrote off $7,200 of accounts and collected $2,100 on accounts previously written off. The balance in Accounts Receivable was $200,000 at 1/1 and $240,000 at 12/31. At 12/31/08, Holtzman estimates that 5% of accounts receivable will prove to be uncollectible. What is Bad Debt Expense for 2008? a. $2,000 b. $7,100 c. $9,200 d. $12,000

89.

Rusch Corporation had a 1/1/08 balance in the Allowance for Doubtful Accounts of $12,000. During 2008, it wrote off $8,640 of accounts and collected $2,520 on accounts previously written off. The balance in Accounts Receivable was $240,000 at 1/1 and $288,000 at 12/31. At 12/31/08, Rusch estimates that 5% of accounts receivable will prove to be uncollectible. What should Rusch report as its Allowance for Doubtful Accounts at 12/31/08? a. $5,760 b. $5,880 c. $8,280 d. $14,400

90.

Sandler Company has the following account balances at year end: Accounts receivable Allowance for doubtful accounts Sales discounts

$80,000 4,800 3,200

8 - 18

Test Bank for Intermediate Accounting, Second Edition Sandler should report accounts receivable at a net amount of a. $72,000. b. $75,200. c. $76,800. d. $80,000.

91.

Delgado Corporation had a 1/1/08 balance in the Allowance for Doubtful Accounts of $20,000. During 2008, it wrote off $14,400 of accounts and collected $4,200 on accounts previously written off. The balance in Accounts Receivable was $400,000 at 1/1 and $480,000 at 12/31. At 12/31/08, Delgado estimates that 5% of accounts receivable will prove to be uncollectible. What is Bad Debt Expense for 2008? a. $4,000 b. $14,200 c. $18,400 d. $24,000

92.

Burnett Corporation had a 1/1/08 balance in the Allowance for Doubtful Accounts of $15,000. During 2008, it wrote off $10,800 of accounts and collected $3,150 on accounts previously written off. The balance in Accounts Receivable was $300,000 at 1/1 and $360,000 at 12/31. At 12/31/08, Burnett estimates that 5% of accounts receivable will prove to be uncollectible. What should Burnett report as its Allowance for Doubtful Accounts at 12/31/08? a. $7,200 b. $7,350 c. $10,350 d. $18,000

93.

For the month of December 2008, the records of White Corporation show the following information: Cash sales $20,000 Cash received on accounts receivable 25,000 Accounts receivable, December 1, 2008 70,000 Accounts receivable, December 31, 2008 64,000 Accounts receivable written off as uncollectible 1,000 White Corporation uses the direct write-off method in accounting for uncollectible accounts receivable. What are the sales for the month of December 31, 2008? a. $39,000 b. $40,000 c. $45,000 d. $52,000

94.

Gardin Corporation uses the allowance method of accounting for uncollectible accounts. During 2008 Gardin had charges to Bad Debts Expense of $20,000 and wrote off as uncollectible, accounts receivable totaling $16,000. These transactions decreased the net receivable’s realizable value by a. $20,000. b. $16,000. c. $4,000. d. $0.

Cash and Receivables

8 - 19

95.

Moluf Corporation receives a 5-year, $20,000 zero-interest-bearing note, the present value of which is $11,348.60. What is the implicit interest rate that equates the total cash to be received to the present value of the future cash flows? a. 8% b. 9% c. 10% d. 12%

96.

On December 31, 2008, Eller Corporation sold for $75,000 an old machine having an original cost of $135,000 and a book value of $60,000. The terms of the sale were as follows: $15,000 down payment $30,000 payable on December 31 for each of the next two years The agreement of sale made no mention of interest; however, 9% would be a fair rate for this type of transaction. What should be the amount of the notes receivable net of the unamortized discount on December 31, 2008 rounded to the nearest dollar? (The present value of an ordinary annuity of 1 at 9% for 2 years is 1.75911.) a. $52,773 b. $67,773 c. $60,000 d. $105,546

97.

Marley Company received a seven-year, zero-interest-bearing note on February 22, 2008, in exchange for property it sold to O’Rear Company. There was no established exchange price for this property and the note has no ready market. The prevailing rate of interest for a note of this type was 7% on February 22, 2008, 7.5% on December 31, 2008, 7.7% on February 22, 2009, and 8% on December 31, 2009. What interest rate should be used to calculate the interest revenue from this transaction for the years ended December 31, 2008 and 2009, respectively? a. 0% and 0% b. 7% and 7% c. 7% and 7.7% d. 7.5% and 8%

98.

Pinkowski sold land to Ewell for $100,000 cash and a zero-interest-bearing note with a face amount of $400,000. The fair value of the land at the date of sale was $450,000. Pinkowski should value the note receivable at a. $450,000. b. $400,000. c. $350,000. d. $500,000.

Use the following information for questions 99 and 100. Henry Co. assigned $400,000 of accounts receivable to Easy Finance Co. as security for a loan of $335,000. Easy charged a 2% commission on the amount of the loan; the interest rate on the note was 10%. During the first month, Henry collected $110,000 on assigned accounts after deducting $380 of discounts. Henry accepted returns worth $1,350 and wrote off assigned accounts totaling $2,980.

8 - 20

Test Bank for Intermediate Accounting, Second Edition

99.

The amount of cash Henry received from Easy at the time of the transfer was a. $301,500. b. $327,000. c. $328,300. d. $335,000.

100.

Entries for Henry during the first month would include a a. debit to Cash of $110,380. b. debit to Bad Debt Expense of $2,980. c. debit to Allowance for Doubtful Accounts of $2,980. d. debit to Accounts Receivable of $114,710.

Use the following information for questions 101 and 102. On February 1, 2008, Norton Company factored receivables with a carrying amount of $300,000 to Koch Company. Koch Company assesses a finance charge of 3% of the receivables and retains 5% of the receivables. Relative to this transaction, you are to determine the amount of loss on sale to be reported in the income statement of Norton Company for February. 101.

Assume that Norton factors the receivables on a without recourse basis. The loss to be reported is a. $0. b. $9,000. c. $15,000. d. $24,000.

102.

Assume that Norton factors the receivables on a with recourse basis. The recourse obligation has a fair value of $1,500. The loss to be reported is a. $9,000. b. $10,500. c. $15,000. d. $25,500.

103.

Joe Novak Corporation factored, with recourse, $100,000 of accounts receivable with Huskie Financing. The finance charge is 3%, and 5% was retained to cover sales discounts, sales returns, and sales allowances. Joe Novak estimates the recourse obligation at $2,400. What amount should Joe Novak report as a loss on sale of receivables? a. $0 b. $3,000 c. $5,400 d. $10,400

104.

Mortonson Corporation factored, with recourse, $300,000 of accounts receivable with Huskie Financing. The finance charge is 3%, and 5% was retained to cover sales discounts, sales returns, and sales allowances. Mortonson estimates the recourse obligation at $7,200. What amount should Mortonson report as a loss on sale of receivables? a. $0 b. $9,000 c. $16,200 d. $31,200

Cash and Receivables

8 - 21

105.

Mike McKinney Corporation had accounts receivable of $100,000 at 1/1. The only transactions affecting accounts receivable were sales of $600,000 and cash collections of $550,000. The accounts receivable turnover is a. 4.0. b. 4.4. c. 4.8. d. 6.0.

106.

Nottingham Corporation had accounts receivable of $100,000 at 1/1. The only transactions affecting accounts receivable were sales of $900,000 and cash collections of $850,000. The accounts receivable turnover is a. 6.0. b. 6.6. c. 7.2. d. 9.0.

*107. If a petty cash fund is established in the amount of $250, and contains $150 in cash and $95 in receipts for disbursements when it is replenished, the journal entry to record replenishment should include credits to the following accounts a. Petty Cash, $75. b. Petty Cash, $100. c. Cash, $95; Cash Over and Short, $5. d. Cash, $100. *108. If the month-end bank statement shows a balance of $36,000, outstanding checks are $12,000, a deposit of $4,000 was in transit at month end, and a check for $500 was erroneously charged by the bank against the account, the correct balance in the bank account at month end is a. $27,500. b. $28,500. c. $20,500. d. $43,500. *109. In preparing its bank reconciliation for the month of April 2008, Gregg, Inc. has available the following information. Balance per bank statement, 4/30/08 NSF check returned with 4/30/08 bank statement Deposits in transit, 4/30/08 Outstanding checks, 4/30/08 Bank service charges for April What should be the correct balance of cash at April 30, 2008? a. $39,370 b. $38,940 c. $38,490 d. $38,470

$39,140 450 5,000 5,200 20

8 - 22

Test Bank for Intermediate Accounting, Second Edition

*110. Tanner, Inc.’s checkbook balance on December 31, 2008 was $21,200. In addition, Tanner held the following items in its safe on December 31. (1) A check for $450 from Peters, Inc. received December 30, 2008, which was not included in the checkbook balance. (2) An NSF check from Garner Company in the amount of $900 that had been deposited at the bank, but was returned for lack of sufficient funds on December 29. The check was to be redeposited on January 3, 2009. The original deposit has been included in the December 31 checkbook balance. (3) Coin and currency on hand amounted to $1,450. The proper amount to be reported on Tanner's balance sheet for cash at December 31, 2008 is a. $21,300. b. $20,400. c. $22,200. d. $21,750. *111. The cash account shows a balance of $45,000 before reconciliation. The bank statement does not include a deposit of $2,300 made on the last day of the month. The bank statement shows a collection by the bank of $940 and a customer's check for $320 was returned because it was NSF. A customer's check for $450 was recorded on the books as $540, and a check written for $79 was recorded as $97. The correct balance in the cash account was a. $45,512. b. $45,548. c. $45,728. d. $47,848. *112. In preparing its May 31, 2008 bank reconciliation, Dogg Co. has the following information available: Balance per bank statement, 5/31/08 $30,000 Deposit in transit, 5/31/08 5,400 Outstanding checks, 5/31/08 4,900 Note collected by bank in May 1,250 The correct balance of cash at May 31, 2008 is a. $35,400. b. $29,250. c. $30,500. d. $31,750.

Cash and Receivables

8 - 23

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

74. 75. 76. 77. 78. 79.

a d b c b c

80. 81. 82. 83. 84. 85.

c b b d c b

86. 87. 88. 89. 90. 91.

a b b d b b

92. 93. 94. 95. 96. 97.

d b a d a b

98. 99. 100. 101. 102. 103.

c c c b b c

104. 105. 106. *107. *108. *109.

c c c d b b

*110. *111. *112.

c b c

MULTIPLE CHOICE—CPA Adapted 113.

On the December 31, 2008 balance sheet of Yount Co., the current receivables consisted of the following: Trade accounts receivable Allowance for uncollectible accounts Claim against shipper for goods lost in transit (November 2008) Selling price of unsold goods sent by Yount on consignment at 130% of cost (not included in Yount 's ending inventory) Security deposit on lease of warehouse used for storing some inventories Total

$ 75,000 (2,000) 3,000 26,000 30,000 $132,000

At December 31, 2008, the correct total of Yount 's current net receivables was a. $76,000. b. $102,000. c. $106,000. d. $132,000. 114.

May Co. prepared an aging of its accounts receivable at December 31, 2008 and determined that the net realizable value of the receivables was $300,000. Additional information is available as follows: Allowance for uncollectible accounts at 1/1/08—credit balance Accounts written off as uncollectible during 2008 Accounts receivable at 12/31/08 Uncollectible accounts recovered during 2008

$ 29,000 23,000 320,000 5,000

For the year ended December 31, 2008, May's uncollectible accounts expense would be a. $25,000. b. $23,000. c. $16,000. d. $9,000. 115.

For the year ended December 31, 2008, Colt Co. estimated its allowance for uncollectible accounts using the year-end aging of accounts receivable. The following data are available: Allowance for uncollectible accounts, 1/1/08 Provision for uncollectible accounts during 2008 (2% on credit sales of $2,000,000) Uncollectible accounts written off, 11/30/08 Estimated uncollectible accounts per aging, 12/31/08

$56,000 40,000 46,000 69,000

8 - 24

Test Bank for Intermediate Accounting, Second Edition After year-end adjustment, the uncollectible accounts expense for 2008 should be a. $46,000. b. $62,000. c. $69,000. d. $59,000.

116.

King Co.'s allowance for uncollectible accounts was $95,000 at the end of 2008 and $90,000 at the end of 2007. For the year ended December 31, 2008, King reported bad debt expense of $13,000 in its income statement. What amount did King debit to the appropriate account in 2008 to write off actual bad debts? a. $5,000 b. $8,000 c. $13,000 d. $18,000

117.

Under the allowance method of recognizing uncollectible accounts, the entry to write off an uncollectible account a. increases the allowance for uncollectible accounts. b. has no effect on the allowance for uncollectible accounts. c. has no effect on net income. d. decreases net income.

118.

The following accounts were abstracted from Todd Co.'s unadjusted trial balance at December 31, 2008: Debit Credit Accounts receivable $750,000 Allowance for uncollectible accounts 8,000 Net credit sales $3,000,000 Todd estimates that 2% of the gross accounts receivable will become uncollectible. After adjustment at December 31, 2008, the allowance for uncollectible accounts should have a credit balance of a. $60,000. b. $52,000. c. $23,000. d. $15,000.

119.

On January 1, 2007, Marr Co. exchanged equipment for a $400,000, zero-interest-bearing note due on January 1, 2010. The prevailing rate of interest for a note of this type at January 1, 2007 was 10%. The present value of $1 at 10% for three periods is 0.75. What amount of interest revenue should be included in Marr's 2008 income statement? a. $0 b. $30,000 c. $33,000 d. $40,000

Cash and Receivables

8 - 25

120.

On June 1, 2008, Watt Corp. loaned Hall $300,000 on a 12% note, payable in five annual installments of $60,000 beginning January 2, 2009. In connection with this loan, Hall was required to deposit $3,000 in a zero-interest-bearing escrow account. The amount held in escrow is to be returned to Hall after all principal and interest payments have been made. Interest on the note is payable on the first day of each month beginning July 1, 2008. Hall made timely payments through November 1, 2008. On January 2, 2009, Watt received payment of the first principal installment plus all interest due. At December 31, 2008, Watt's interest receivable on the loan to Hall should be a. $0. b. $3,000. c. $6,000. d. $9,000.

121.

Which of the following is a method to generate cash from accounts receivable? a. b. c. d.

Assignment Yes Yes No No

Factoring No Yes Yes No

*122. In preparing its August 31, 2008 bank reconciliation, Adel Corp. has available the following information: Balance per bank statement, 8/31/08 Deposit in transit, 8/31/08 Return of customer's check for insufficient funds, 8/30/08 Outstanding checks, 8/31/08 Bank service charges for August

$21,650 3,900 600 2,750 100

At August 31, 2008, Adel's correct cash balance is a. $22,800. b. $22,200. c. $22,100. d. $20,500. *123. Sandy, Inc. had the following bank reconciliation at March 31, 2008: Balance per bank statement, 3/31/08 Add: Deposit in transit Less: Outstanding checks Balance per books, 3/31/08 Data per bank for the month of April 2008 follow: Deposits Disbursements

$37,200 10,300 47,500 12,600 $34,900 $46,700 49,700

All reconciling items at March 31, 2008 cleared the bank in April. Outstanding checks at April 30, 2008 totaled $6,000. There were no deposits in transit at April 30, 2008. What is the cash balance per books at April 30, 2008? a. $28,200 b. $31,900 c. $34,200 d. $38,500

8 - 26

Test Bank for Intermediate Accounting, Second Edition

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

113. 114.

a d

115. 116.

d b

117. 118.

c d

119. 120.

c c

121. *122.

b a

*123.

DERIVATIONS — Computational No.

Answer

Derivation

74.

$5,000 – $200 + $1,300 = $6,100.

75.

$2,000,000 × .11 = $200,000 × (.11 – .05) = Interest

$220,000 12,000 $232,000

$232,000 ÷ $2,000,000 = .116 = 11.6%. 76.

77.

78.

79.

$30,000 + $500 + $8,200 = $38,700.

80.

.01 × 360 ÷ 20 = 18%.

81.

$540,000 + ($90,000 – $40,000) = $590,000.

82.

$600,000 – $62,500 = $537,500.

83.

($50,000 – $4,000) – ($4,500 – $4,000) = $45,500.

84.

$8,000 – $9,000 + X = $5,500; X = $6,500

85.

($425,000 – $14,000) × .02 = $8,220.

86.

($43,000 × .10) – $760 = $3,540.

87.

$60,000 – $3,600 = $56,400.

88.

($24,000 × .05) – [$10,000 – ($7,200 – $2,100)] = $7,100.

89.

$288,000 × .05 = $14,400.

90.

$80,000 – $44,800 = $75,200.

91.

$480,000 × .05 – [$20,000 – ($14,400 – $4,200)] = $14,200

$20,000 + $300 + $5,500 = $25,800.

Cash and Receivables

DERIVATIONS — Computational (cont.) No.

Answer

Derivation

92.

$360,000 × .05 = $18,000.

93.

$64,000 – ($70,000 – $25,000 – $1,000) + $20,000 = $40,000.

94.

$20,000 – $16,000 + $16,000 = $20,000.

95.

$11,348.60 ÷ $20,000 = .56743; .56743 = PV factor for 12%.

96.

$30,000 × 1.75911 = $52,773.

97.

7% and 7%.

98.

$450,000 – $100,000 = $350,000.

99.

$335,000 – $6,700 = $328,300.

100.

101.

$300,000 × .03 = $9,000.

102.

($300,000 × .03) + $1,500 = $10,500.

103.

($100,000 × .03) + $2,400 = $5,400.

104.

($300,000 × .03) + $7,200 = $16,200.

105.

$600,000 ÷ [($100,000 + $150,000) ÷ 2] = 4.8

106.

$900,000 ÷ [($100,000 + $150,000) ÷ 2] = 7.21

*107.

$250 – $150 = $100.

*108.

$36,000 – $12,000 + $4,000 + $500 = $28,500.

*109.

$39,140 + $5,000 – $5,200 = $38,940.

*110.

$21,200 + $450 – $900 + $1,450 = $22,200.

*111.

$45,000 + $940 – $320 – $90 + $18 = $45,548.

*112.

$30,000 + $5,400 – $4,900 = $30,500.

8 - 27

8 - 28

Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — CPA Adapted No.

Answer

Derivation

113.

$75,000 – $2,000 + $3,000 = $76,000.

114.

Allowance for Doubtful Acct. balance $34,000 + $5,000 – $23,000 = $16,000 (before bad debt expense) $325,000 – $300,000 – $16,000 = $9,000 (bad debt expense).

115.

$69,000 – $56,000 + $46,000 = $59,000.

116.

$90,000 + $14,000 – $95,000 = $8,000.

117.

Conceptual.

118.

$750,000 × .02 = $15,000.

119.

$400,000 × .75 = $300,000 present value $300,000 × .10 = $30,000 (2007 interest) ($300,000 + $30,000) × .10 = $33,000 (2008 interest).

120.

$300,000 × 12% × 2 ÷ 12 = $6,000.

121.

Conceptual.

*122.

$21,650 + $3,900 – $2,750 = $22,800.

*123.

$37,200 + $46,700 – $49,700 = $34,200 (4/30 balance per bank) $34,200 – $6,000 = $28,200.

Cash and Receivables

8 - 29

EXERCISES Ex. 8-124—Asset classification. Below is a list of items. Classify each into one of the following balance sheet categories: a. Cash b. Receivables

c. Short-term Investments d. Other

___

1. Compensating balances held in long-term borrowing arrangements

___

2. Savings account

___

3. Trust fund

___

4. Checking account

___

5. Postage stamps

___

6. Treasury bills maturing in six months

___

7. Post-dated checks from customers

___

8. Certificate of deposit maturing in five years

___

9. Common stock of another company (to be sold by December 31, this year)

___ 10. Change fund

Solution 8-124 1. 2.

d a

3. 4.

d a

5. 6.

d c

7. 8.

b d

9. 10.

c a

Ex. 8-125—Allowance for doubtful accounts. When a company has a policy of making sales for which credit is extended, it is reasonable to expect a portion of those sales to be uncollectible. As a result of this, a company must recognize bad debt expense. There are basically two methods of recognizing bad debt expense: (1) direct write-off method, and (2) allowance method. Instructions (a) Describe fully both the direct write-off method and the allowance method of recognizing bad debt expense. (b) Discuss the reasons why one of the above methods is preferable to the other and the reasons why the other method is not usually in accordance with generally accepted accounting principles.

8 - 30

Test Bank for Intermediate Accounting, Second Edition

Solution 8-125 (a) There are basically two methods of recognizing bad debt expense: (1) direct write-off and (2) allowance. The direct write-off method requires the identification of specific balances that are deemed to be uncollectible before any bad debt expense is recognized. At the time a specific account is deemed uncollectible, the account is removed from accounts receivable and a corresponding amount of bad debt expense is recognized. The allowance method requires an estimate of bad debt expense for a period of time by reference to the composition of the accounts receivable balance at a specific point in time (aging) or to the overall experience with credit sales over a period of time. Thus, total bad debt expense expected to arise as a result of operations for a specific period is estimated, the valuation account (allowance for doubtful accounts) is appropriately adjusted, and a corresponding amount of bad debt expense is recognized. As specific accounts are identified as uncollectible, the account is written off. It is removed from accounts receivable and a corresponding amount is removed from the valuation account (allowance for doubtful accounts). Net accounts receivable do not change, and there is no charge to bad debt expense when specific accounts are identified as uncollectible and written off using the allowance method. (b) The allowance method is preferable because it matches the cost of making a credit sale with the revenues generated by the sale in the same period and achieves a proper carrying value for accounts receivable at the end of a period. Since the direct write-off method does not recognize the bad debt expense until a specific amount is deemed uncollectible, which may be in a subsequent period, it does not comply with the matching principle and does not achieve a proper carrying value for accounts receivable at the end of a period.

Ex. 8-126—Entries for bad debt expense. A trial balance before adjustment included the following: Accounts receivable Allowance for doubtful accounts Sales Sales returns and allowances

Debit $80,000

Credit 730 $340,000

8,000

Give journal entries assuming that the estimate of uncollectibles is determined by taking (1) 5% of gross accounts receivable and (2) 1% of net sales.

Solution 8-126 (1)

Bad Debt Expense ............................................................. Allowance for Doubtful Accounts ............................ Gross receivables $80,000 Rate 5% Total allowance needed 4,000 Present allowance (730) Adjustment needed $ 3,270

3,270 3,270

Cash and Receivables

8 - 31

Solution 8-126 (cont.) (2)

Bad Debt Expense ............................................................. Allowance for Doubtful Accounts ............................ Sales $340,000 Sales returns and allowances 8,000 Net sales 332,000 Rate 1% Bad debt expense $ 3,320

3,320 3,320

Ex. 8-127—Accounting for zero-interest-bearing note. DeFilippo Company agreed to loan Morreale Glass Corporation $400,000. Morreale Glass Corporation gave a zero-interest-bearing note due in 4 years and also promised to provide DeFilippo Company with glass products at a special discount price. (A 12% interest rate is an appropriate rate for both companies.) Instructions (a) Prepare the journal entry DeFilippo Company would make to record this transaction. (b) Prepare an amortization schedule for the note using the effective-interest method.

Solution 8-127 (a) Deferred Charge (Future Sales Discount) ................................. Notes Receivable...................................................................... Cash ................................................................................ Discount on Notes Receivable ......................................... Calculation of discount: Amount of loan ................................................................. Face amount of note ........................................................ P.V.* of 1 at 12%, 4 years ................................................ Present value of the note ................................................. Discount ...........................................................................

145,792 400,000 400,000 145,792

$400,000 $400,000 × .63552

*Present value.

(b) Year

Cash Received

Interest Revenue

Discount Amortized

$0 0 0 0

$ 30,505 34,166 38,265 42,856 $145,792

1 2 3 4 *Rounded by $1.

Carrying Amount of Note $254,208 284,713 318,879 357,144 400,000*

254,208 $145,792

8 - 32

Test Bank for Intermediate Accounting, Second Edition

Ex. 8-128—Factoring accounts receivable. Ehrlich Company factors $175,000 of accounts receivable with Vegas Finance Corporation on a without recourse basis on July 1, 2008. All the records related to the receivables are transferred to Vegas Finance as it will receive the collections. Vegas Finance assesses a finance charge of 2% of the amount of accounts receivable and retains an amount equal to 5% of accounts receivable to cover sales discounts, returns, and allowances. Instructions (a) Prepare the journal entry that Ehrlich Company would make to record the sale of these receivables on July 1, 2008. (b). Prepare the journal entry that Vegas Finance Corporation would make to record the purchase of the receivables on July 1, 2008.

Solution 8-128 (a) Cash ............................................................................................ Due from Factor........................................................................... Loss on Sale of Receivables........................................................ Accounts Receivable........................................................

162,750 8,750 3,500 175,000

(Finance Charge: $175,000 × .02 = $3,500) (Due from Factor: $175,000 × .05 = $8,750) (b)

Accounts Receivable ................................................................... Due to Ehrlich Company .................................................. Financing Revenue .......................................................... Cash ................................................................................

175,000 8,750 3,500 162,750

Ex. 8-129—Accounts receivable assigned. Accounts receivable in the amount of $250,000 were assigned to the Fast Finance Company by Nance, Inc., as security for a loan of $200,000. The finance company charged a 4% commission on the face amount of the loan, and the note bears interest at 9% per year. During the first month, Nance collected $130,000 on assigned accounts. This amount was remitted to the finance company along with one month's interest on the note. Instructions Make all the entries for Nance Inc. associated with the transfer of the accounts receivable, the loan, and the remittance to the finance company.

Solution 8-129 Cash............................................................................................... Finance Charge .............................................................................. Notes Payable ....................................................................

192,000 8,000

Cash............................................................................................... Accounts Receivable ..........................................................

130,000

200,000

130,000

Cash and Receivables

8 - 33

Solution 8-129 (cont.) Notes Payable................................................................................ Interest Expense ............................................................................ Cash ...................................................................................

130,000 1,500 131,500

*Ex. 8-130—Bank reconciliation. You are asked to prepare a bank reconciliation for Malikowski Company as of October 31, 2008. By placing the appropriate letter in the space provided, indicate whether the following items should be: A. added to the balance per bank statement. B. deducted from the balance per bank statement. C. added to the balance per books. D. deducted from the balance per books. E. omitted from the bank reconciliation because the bank amount and the book amount are already in agreement with respect to this item. _____1. Outstanding checks of Malikowski Company as of October 31, 2008; the checks were written in October 2008. _____2. Outstanding checks of Malikowski Company as of October 31, 2008; the checks were written in September 2008. _____3. A check of Mankowski Company had been charged by the bank against the account of Malikowski Company. _____4. A certified check by Malikowski Company, dated October 10, 2008, is outstanding as of October 31. _____5. Bank service charges for October. _____6. Discovered that check No. 101 (one of the cancelled checks included with the bank statement) had been made out to Blue Company (a creditor) for $100. Malikowski Company had recorded the check in its Cash Payments Journal in the amount of $1,000. _____7. Malikowski Company understated the amount of a customer's check in its Cash Receipts Journal. The check was received and deposited by Malikowski in October.

*Solution 8-130 1. 2. 3. 4.

B B A E

5. D 6. C 7. C

8 - 34

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Pr. 8-131—Entries for bad debt expense. The trial balance before adjustment of Pratt Company reports the following balances:

Accounts receivable Allowance for doubtful accounts Sales (all on credit) Sales returns and allowances

Dr. $100,000

Cr. $ 2,500 750,000

40,000

Instructions (a) Prepare the entries for estimated bad debts assuming that doubtful accounts are estimated to be (1) 6% of gross accounts receivable and (2) 1% of net sales. (b) Assume that all the information above is the same, except that the Allowance for Doubtful Accounts has a debit balance of $2,500 instead of a credit balance. How will this difference affect the journal entries in part (a)?

Solution 8-131 (a)

(1)

(2)

(b)

Bad Debt Expense ........................................................ Allowance for Doubtful Accounts ....................... Gross receivables $100,000 Rate 6% Total allowance needed 6,000 Present allowance (2,500) Bad debt expense $ 3,500

3,500

Bad Debt Expense ........................................................ Allowance for Doubtful Accounts ....................... Sales $750,000 Sales returns and allowances (40,000) Net sales 710,000 Rate 1% Bad debt expense $ 7,100

7,100

3,500

7,100

The percentage of receivables approach would be affected as follows: Gross receivables $100,000 Rate 6% Total allowance needed 6,000 Present allowance 2,500 Additional amount required $ 8,500

The journal entry is therefore as follows: Bad Debt Expense ........................................................ Allowance for Doubtful Accounts ....................... The entry would not change under the percentage of sales method.

8,500 8,500

Cash and Receivables

8 - 35

Pr. 8-132—Amortization of discount on note. On December 31, 2008, Brown Company finished consultation services and accepted in exchange a promissory note with a face value of $400,000, a due date of December 31, 2011, and a stated rate of 5%, with interest receivable at the end of each year. The fair value of the services is not readily determinable and the note is not readily marketable. Under the circumstances, the note is considered to have an appropriate imputed rate of interest of 10%. The following interest factors are provided: Interest Rate 5% 10% 1.15763 1.33100 .86384 .75132 3.15250 3.31000 2.72325 2.48685

Table Factors For Three Periods Future Value of 1 Present Value of 1 Future Value of Ordinary Annuity of 1 Present Value of Ordinary Annuity of 1

Instructions (a) Determine the present value of the note. (b) Prepare a Schedule of Note Discount Amortization for Brown Company under the effectiveinterest method. (Round to whole dollars.)

Solution 8-132 (a) Present value of interest Present value of maturity value

(b)

Date 12/31/08 12/31/09 12/31/10 12/31/11

= =

$20,000 × 2.48685 $400,000 × .75132

= =

$ 49,737 300,528 $350,265

Brown Company Schedule of Note Discount Amortization Effective-Interest Method 5% Note Discounted at 10% (Imputed) Cash Interest (5%)

Effective Interest (10%)

Discount Amortized

$20,000 20,000 20,000 $60,000

$ 35,027 36,529 38,179* $109,735

$15,027 16,529 18,179 $49,735

*$3 adjustment to compensate for rounding.

Unamortized Discount Balance $49,735 34,708 18,179 0

Carrying Value of Note $350,265 365,292 381,821 400,000

8 - 36

Test Bank for Intermediate Accounting, Second Edition

Pr. 8-133—Accounts receivable assigned. Prepare journal entries for Lott Co. for: (a) Accounts receivable in the amount of $500,000 were assigned to Vance Finance Co. by Lott as security for a loan of $425,000. Vance charged a 3% commission on the accounts; the interest rate on the note is 12%. (b) During the first month, Lott collected $200,000 on assigned accounts after deducting $450 of discounts. Lott wrote off a $530 assigned account. (c) Lott paid to Vance the amount collected plus one month's interest on the note.

Solution 8-133 (a) Cash ....................................................................................... Finance Charge ($500,000 × .03) ........................................... Notes Payable...............................................................

410,000 15,000

(b) Cash ....................................................................................... Sales Discounts ...................................................................... Allowance for Doubtful Accounts ............................................. Accounts Receivable.....................................................

200,000 450 530

(c) Notes Payable......................................................................... Interest Expense ($425,000 × .12 × 1/12) ............................... Cash .............................................................................

200,000 4,250

425,000

200,980

204,250

Pr. 8-134—Factoring Accounts Receivable. On May 1, Carter, Inc. factored $800,000 of accounts receivable with Rapid Finance on a without recourse basis. Under the arrangement, Carter was to handle disputes concerning service, and Rapid Finance was to make the collections, handle the sales discounts, and absorb the credit losses. Rapid Finance assessed a finance charge of 6% of the total accounts receivable factored and retained an amount equal to 2% of the total receivables to cover sales discounts. Instructions (a) Prepare the journal entry required on Carter 's books on May 1. (b) Prepare the journal entry required on Rapid Finance’s books on May 1. (c) Assume Carter factors the $800,000 of accounts receivable with Rapid Finance on a with recourse basis instead. The recourse provision has a fair value of $14,000. Prepare the journal entry required on Carter’s books on May 1.

Solution 8-134 (a) Cash ............................................................................................. Due from Factor (2% × $800,000) ................................................. Loss on Sale of Receivables (6% × $800,000) .............................. Accounts Receivable .....................................................

736,000 16,000 48,000 800,000

Cash and Receivables

8 - 37

Solution 8-134 (cont.) (b) Accounts Receivable .................................................................... Due to Carter ...................................................................... Financing Revenue ............................................................. Cash ...................................................................................

800,000

(c) Cash ............................................................................................. Due from Factor ............................................................................ Loss on Sale of Receivables ......................................................... Accounts Receivable .......................................................... Recourse Liability ...............................................................

736,000 16,000 62,000

16,000 48,000 736,000

800,000 14,000

*Pr. 8-135—Bank reconciliation. Adcock Plastics Company deposits all receipts and makes all payments by check. The following information is available from the cash records: MARCH 31 BANK RECONCILIATION Balance per bank Add: Deposits in transit Deduct: Outstanding checks Balance per books

$26,746 2,100 (3,800) $25,046

Month of April Results Balance April 30 April deposits April checks April note collected (not included in April deposits) April bank service charge April NSF check of a customer returned by the bank (recorded by bank as a charge)

Per Bank $27,995 10,784 11,600 3,000 35 900

Instructions (a) Calculate the amount of the April 30: 1. Deposits in transit 2. Outstanding checks (b) What is the April 30 adjusted cash balance? Show all work.

*Solution 8-135 (a) 1. Deposits in transit, $5,205 [$13,889 – ($10,784 – $2,100)] 2. Outstanding checks, $2,280 [$10,080 – ($11,600 – $3,800)] (b) Adjusted cash balance at April 30, $30,920 ($27,995 + $5,205 – $2,280) OR

($28,855 + $3,000 – $35 – $900)

Per Books $28,855 13,889 10,080 -0-0-0-

CHAPTER 9 ACCOUNTING FOR INVENTORIES TRUE-FALSE—Conceptual Answer

No.

Description

T F F F T F F F F T F T F T F T F F T T T T F F T T T F T T F F T F T T F T F T

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. *36. *37. *38. *39. *40.

Work-in-process inventory. Merchandising and manufacturing inventory accounts. Perpetual inventory system. Determining when title passes. Perpetual inventory system and physical inventory. Goods shipped f.o.b. shipping point. Goods on consignment. Period and product costs. Period vs. product costs. Reporting Purchase Discounts Lost. Cost flow assumption. FIFO periodic vs. perpetual system. Argument in favor of FIFO method. Using LIFO for tax purposes. LIFO vs. FIFO and current costs. Purchase commitments. Using LIFO for reporting purposes. LIFO liquidation. LIFO liquidations. LIFO liquidation problems. Dollar-value LIFO layers. Dollar-value LIFO. Dollar-value LIFO method. LIFO-FIFO comparison. LIFO conformity rule. Rising prices and LIFO. Writing inventory down to market. Definition of net realizable value. Cost basis after inventory write-down. When to use lower-of-cost-or-market. Lower-of-cost-or-market and conservatism. Purpose of the “floor” in LCM. Lower-of-cost-or-market and consistency. Computing inventory turnover ratio. Average days to sell inventory. Gross profit method. Gross profit as a percentage. Disadvantage of gross profit method. Gross profit as a percentage. Gross profit method.

9-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88.

Entries under perpetual inventory system. Classification of goods in transit. Classification of goods in transit. Identify inventory ownership. Classification of goods on consignment. Valuation of inventories. Classification of beginning inventory. F.o.b. destination / f.o.b. shipping point Identification of product costs. Interest capitalization in manufacturing inventory. Method approximating current cost. Weighted-average inventory method. Nature of FIFO valuation of inventory. Flow of costs in a manufacturing situation. FIFO and decreasing prices. FIFO and increasing prices. FIFO and increasing prices. FIFO and LIFO inventory assumptions. LIFO and increasing prices. Knowledge of inventory valuation methods. Periodic and perpetual inventory methods. Stating inventory at replacement cost. LIFO and perpetual inventory system. Argument against specific identification method. Departure from historical cost basis. LIFO vs. FIFO and rising prices. Traditional LIFO approach disadvantage. Identifying trend of inventory prices. LIFO reserve account classification. Dollar-value LIFO method. Dollar-value LIFO method advantage. Dollar-value LIFO method. Identifying advantages of LIFO. LIFO for tax purposes and external reporting. LIFO advantages. FIFO periodic and FIFO perpetual. Justification for using LCM. Replacement cost as designated market value. Valuation of inventory under LCM. Replacement cost as market under LCM. Knowledge of lower-of-cost-or-market valuations. Appropriate use of LCM valuation. Definition of “market” under LCM. Definition of “ceiling.” Definition of “designated market value.” Application of lower-of-cost-or-market valuation. Effect of inventory write-down. Net realizable value under LCM.

Valuation of Inventories

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

d a a c d d b

89. 90. 91. 92. *93. *94. *95.

Definition of “net realizable value.” Valuation of inventory at net realizable value. Computing average days to sell inventory. Inventory turnover ratio. Gross profit method assumptions. Appropriate use of gross profit method. Appropriate use of gross profit method.

MULTIPLE CHOICE—Computational Answer

No.

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

96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123. *124. *125. *126. *127. *128. *129. *130.

Description Classification as inventory. Determining inventory value. Comparison of FIFO and LIFO income before taxes. Calculate ending inventory using weighted-average. Calculate ending inventory using moving average. Calculate ending inventory using LIFO. Calculate cost of goods sold using FIFO. Effect of using LIFO or FIFO. Perpetual inventory—LIFO valuation. Perpetual inventory—LIFO valuation. Perpetual inventory—FIFO valuation. Perpetual inventory—average cost valuation. Cost flow assumptions. LIFO reserve. LIFO liquidation. Dollar-value LIFO. Dollar-value LIFO. Calculate ending inventory using dollar-value LIFO. Calculate ending inventory using dollar-value LIFO. Calculate ending inventory using dollar-value LIFO. Calculate ending inventory using dollar-value LIFO. Value inventory under LCM. Lower-of-cost-or-market. Lower-of-cost-or-market. Value inventory under LCM. Inventory value under LCM. Average days to sell inventory. Calculate inventory turnover ratio. Estimate ending inventory using gross profit method. Calculate total sales from cost information. Estimate ending inventory using gross profit method. Calculate ending inventory using gross profit method. Calculate ending inventory using gross profit method. Estimate cost of inventory destroyed by fire. Estimate cost of inventory destroyed by fire.

* This topic is dealt with in an Appendix to the chapter.

9-3

9-4

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—CPA Adapted Answer

No.

a c a c c b d b b a

131. 132. 133. 134. 135. 136. 137. 138. 139. *140.

Description Calculate Accounts Payable at year end. Calculate unit cost using moving-average method. Periodic and perpetual inventory methods. FIFO and LIFO with increasing prices. Calculate ending inventory using LIFO. Calculate ending inventory using dollar-value LIFO. Recognizing a loss due to LCM. Appropriate use of replacement costs in LCM. Identification of the designated market value. Estimate cost of inventory lost by theft.

EXERCISES Item

Description

E9-141 E9-142 E9-143 E9-144 E9-145 E9-146 E9-147 E9-148 *E9-149 *E9-150

FIFO and LIFO inventory methods. FIFO and LIFO inventory methods. Perpetual LIFO. Perpetual LIFO and periodic FIFO. Dollar-value LIFO. Lower-of-cost-or-market Lower-of-cost-or-market Lower-of-cost-or-market Gross profit method. Gross profit method.

PROBLEMS Item

Description

P9-151 P9-152 P9-153 P9-154 *P9-155

Inventory cut-off. Inventory methods. Dollar-value LIFO. Dollar-value LIFO. Gross profit method.

CHAPTER LEARNING OBJECTIVES 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. *11.

Identify major classifications of inventory. Distinguish between perpetual and periodic inventory systems. Understand the items to include as inventory cost. Describe and compare the cost flow assumptions used to account for inventories. Explain the significance and use of a LIFO reserve. Understand the effect of LIFO liquidations. Explain the dollar-value LIFO method. Identify the major advantages and disadvantages of LIFO. Describe and apply the lower-of-cost-or-market rule. Explain how to report and analyze inventory. Determine ending inventory by applying the gross profit method.

Valuation of Inventories

9-5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

95.

3. 4. 5.

TF TF TF

6. 7. 41.

TF TF MC

42. 43. 44.

10.

11. 12. 13. 14. 15. 51.

TF TF TF TF TF MC

52. 53. 54. 55. 56. 57.

MC MC MC MC MC MC

58. 59. 60. 61. 62. 63.

16.

17.

69.

18.

19.

20.

21. 22. 23.

TF TF TF

70. 71. 72.

MC MC MC

111. 112. 113.

24.

25.

26.

27. 28. 29. 30. 31.

TF TF TF TF TF

32. 33. 77. 78. 79.

TF TF MC MC MC

80. 81. 82. 83. 84.

34.

35.

91.

36. 37. 38.

TF TF TF

39. 40. 93.

TF TF MC

94. 95. 124.

Note: TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 MC Learning Objective 2 MC 45. MC 96. MC 46. MC 131. MC 47. MC 151. Learning Objective 3 TF 49. MC 50. Learning Objective 4 MC 64. MC 100. MC 65. MC 101. MC 66. MC 102. MC 67. MC 103. MC 68. MC 104. MC 99. MC 105. Learning Objective 5 MC 109. MC Learning Objective 6 TF 110. MC Learning Objective 7 MC 114. MC 136. MC 115. MC 145. MC 116. MC 153. Learning Objective 8 TF 73. MC 74. Learning Objective 9 MC 85. MC 90. MC 86. MC 117. MC 87. MC 118. MC 88. MC 119. MC 89. MC 120. Learning Objective 10 MC 92. MC 122. Learning Objective *11 MC 125. MC 128. MC 126. MC 129. MC 127. MC 130. E = Exercise P = Problem

Type

Item

Type

Item

Type

MC MC MC MC MC MC

106. 107. 108. 132. 133. 134.

MC MC MC MC MC MC

141. 142. 143. 144. 152.

E E E E P

MC E P

154.

75.

76.

MC MC MC MC MC

121. 137. 138. 139. 146.

MC MC MC MC E

147. 148.

E E

123.

MC MC MC

140. 149. 150.

MC E E

155.

MC MC P MC

9-6

Test Bank for Intermediate Accounting, Second Edition

TRUE FALSE—Conceptual 1.

A manufacturing concern would report the cost of units only partially processed as inventory in the balance sheet.

Both merchandising and manufacturing companies normally have multiple inventory accounts.

When using a perpetual inventory system, freight charges on goods purchased are debited to Freight-In.

If a supplier ships goods f.o.b. destination, title passes to the buyer when the supplier delivers the goods to the common carrier.

A physical inventory should be taken at least annually, even when a perpetual inventory system is used.

When goods are shipped f.o.b. shipping point, title passes only when the seller receives full payment for the merchandise.

Goods held on consignment should be included in the consignee's inventory reported on the balance sheet.

Period costs and product costs are both inventoriable costs that relate to manufactured rather than purchased inventory.

Freight charges on goods purchased are considered a period cost and therefore are not part of the cost of the inventory.

10.

Purchase Discounts Lost is a financial expense and is reported in the “other expenses and losses” section of the income statement.

11.

The cost flow assumption adopted must be consistent with the physical movement of the goods.

12.

In all cases when FIFO is used, the cost of goods sold would be the same whether a perpetual or periodic system is used.

13.

A major argument in favor of the FIFO method of inventory costing is that current costs are matched against current revenues.

14.

If LIFO is used for tax purposes, it must also be used for financial reporting purposes.

15.

LIFO comes closer than FIFO to stating inventory on the balance sheet at current costs.

16.

The change in the LIFO Reserve from one period to the next is recorded as an adjustment to Cost of Goods Sold.

17.

Many companies use LIFO for both tax and internal reporting purposes.

18.

LIFO liquidation often distorts net income, but usually leads to substantial tax savings.

Valuation of Inventories

9-7

19.

LIFO liquidations can occur frequently when using a specific-goods approach.

20.

To alleviate the LIFO liquidation problems and to simplify the accounting, goods can be combined into pools.

21.

Under dollar-value LIFO, there will never be a layer for a particular year unless the quantity of inventory increased during that year.

22.

Dollar-value LIFO techniques help protect LIFO layers from erosion.

23.

The dollar-value LIFO method measures any increases and decreases in a pool in terms of total dollar value and physical quantity of the goods.

24.

A disadvantage of LIFO is that it does not match more recent costs against current revenues as well as FIFO.

25.

The LIFO conformity rule requires that if a company uses LIFO for tax purposes, it must also use LIFO for financial accounting purposes.

26.

In a period of rising prices, LIFO yields a larger cost of goods sold than does FIFO.

27.

Inventory should be written down to market when its revenue-producing ability is no longer as great as its cost.

28.

Net realizable value is the estimated selling price in the normal course of business less the normal profit margin.

29.

When inventory is written down to market, this new basis is considered to be the cost basis for future periods.

30.

A company should abandon the historical cost principle when the future utility of the inventory item falls below its original cost.

31.

The lower-of-cost-or-market method is used for inventory despite being less conservative than valuing inventory at market value.

32.

The purpose of the “floor” in lower-of-cost-or-market considerations is to avoid overstating inventory.

33.

Application of the lower-of-cost-or-market rule results in inconsistency because a company may value inventory at cost in one year and at market in the next year.

34.

The inventory turnover ratio is computed by dividing the cost of goods sold by the ending inventory on hand.

35.

The average days to sell inventory represents the average number of days’ sales for which a company has inventory on hand.

*36.

The gross profit method can be used to approximate the dollar amount of inventory on hand.

*37.

In most situations, the gross profit percentage is stated as a percentage of cost.

9-8

Test Bank for Intermediate Accounting, Second Edition

*38.

A disadvantage of the gross profit method is that it uses past percentages in determining the markup.

*39.

The gross profit expressed as a percentage of cost is normally less than the gross profit expressed as a percentage of sales.

*40.

The use of the gross profit method for interim reports does not preclude the need for a physical inventory to be taken at least annually.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7.

T F F F T F F

8. 9. 10. 11. 12. 13. 14.

F F T F T F T

15. 16. 17. 18. 19. 20. 21.

F T F F T T T

22. 23. 24. 25. 26. 27. 28.

T F F T T T F

29. 30. 31. 32. 33. 34. 35.

T T F F T F T

*36. *37. *38. *39. *40.

T F T F T

MULTIPLE CHOICE—Conceptual 41.

When using a perpetual inventory system, a. no Purchases account is used. b. a Cost of Goods Sold account is used. c. two entries are required to record a sale. d. all of these.

42.

Goods in transit which are shipped f.o.b. shipping point should be a. included in the inventory of the seller. b. included in the inventory of the buyer. c. included in the inventory of the shipping company. d. none of these.

43.

Goods in transit which are shipped f.o.b. destination should be a. included in the inventory of the seller. b. included in the inventory of the buyer. c. included in the inventory of the shipping company. d. none of these.

44.

Which of the following items should be included in a company's inventory at the balance sheet date? a. Goods in transit which were purchased f.o.b. destination. b. Goods received from another company for sale on consignment. c. Goods sold to a customer which are being held for the customer to call for at his or her convenience. d. None of these.

Valuation of Inventories

9-9

45.

Goods on consignment are a. included in the consignee's inventory. b. recorded in a Consignment Out account which is an inventory account. c. recorded in a Consignment In account which is an inventory account. d. all of these.

46.

Valuation of inventories requires the determination of all of the following except a. the costs to be included in inventory. b. the physical goods to be included in inventory. c. the cost of goods held on consignment from other companies. d. the cost flow assumption to be adopted.

47.

The accountant for the Orion Sales Company is preparing the income statement for 2008 and the balance sheet at December 31, 2008. Orion uses the periodic inventory system. The January 1, 2008 merchandise inventory balance will appear a. only as an asset on the balance sheet. b. only in the cost of goods sold section of the income statement. c. as a deduction in the cost of goods sold section of the income statement and as a current asset on the balance sheet. d. as an addition in the cost of goods sold section of the income statement and as a current asset on the balance sheet.

48.

Goods in transit at the balance sheet date should be included in the purchaser's inventory if they are shipped: F.O.B Destination F.O.B. Shipping Point a. No No b. No Yes c. Yes No d. Yes Yes

49.

Which of the following is correct? a. Selling costs are product costs. b. Manufacturing overhead costs are product costs. c. Interest costs for routine inventories are product costs. d. All of these.

Which of the following types of interest cost incurred in connection with the purchase or manufacture of inventory should be capitalized as a product cost? a. Interest associated with getting inventories ready for sale b. Interest incurred during the production of discrete projects such as ships or real estate projects c. Interest incurred on notes payable to vendors for routine purchases made on a repetitive basis d. All of these should be capitalized.

51.

Which inventory costing method most closely approximates current cost for each of the following: Ending Inventory Cost of Goods Sold a. FIFO FIFO b. FIFO LIFO c. LIFO FIFO d. LIFO LIFO

9 - 10

Test Bank for Intermediate Accounting, Second Edition

52.

The pricing of issues from inventory must be deferred until the end of the accounting period under which method of inventory valuation? a. Moving average b. Weighted-average c. LIFO perpetual d. FIFO

53.

An inventory pricing procedure in which the oldest costs incurred rarely have an effect on the ending inventory valuation is a. FIFO. b. LIFO. c. base stock. d. weighted-average.

54.

Which method of inventory pricing best approximates specific identification of the actual flow of costs and units in most manufacturing situations? a. Average cost b. First-in, first-out c. Last-in, first-out d. Base stock

55.

Assuming no beginning inventory, what can be said about the trend of inventory prices if cost of goods sold computed when inventory is valued using the FIFO method exceeds cost of goods sold when inventory is valued using the LIFO method? a. Prices decreased. b. Prices remained unchanged. c. Prices increased. d. Price trend cannot be determined from information given.

56.

In a period of rising prices, the inventory method which tends to give the highest reported net income is a. base stock. b. first-in, first-out. c. last-in, first-out. d. weighted-average.

57.

In a period of rising prices, the inventory method which tends to give the highest reported inventory is a. FIFO. b. moving average. c. LIFO. d. weighted-average.

58.

Quayle Corporation's inventory cost on its balance sheet was lower using first-in, first-out than it would have been using last-in, first-out. Assuming no beginning inventory, in what direction did the cost of purchases move during the period? a. Up b. Down c. Steady d. Cannot be determined

Valuation of Inventories

9 - 11

59.

In a period of rising prices, the inventory method which tends to give the highest reported cost of goods sold is a. FIFO. b. average cost. c. LIFO. d. none of these.

60.

Which of the following statements is not valid as it applies to inventory costing methods? a. If inventory quantities are to be maintained, part of the earnings must be invested (plowed back) in inventories when FIFO is used during a period of rising prices. b. LIFO tends to smooth out the net income pattern by matching current cost of goods sold with current revenue, when inventories remain at constant quantities. c. When a firm using the LIFO method fails to maintain its usual inventory position (reduces stock on hand below customary levels), there may be a matching of old costs with current revenue. d. The use of FIFO permits some control by management over the amount of net income for a period through controlled purchases, which is not true with LIFO.

61.

The acquisition cost of a certain raw material changes frequently. The book value of the inventory of this material at year end will be the same if perpetual records are kept as it would be under a periodic inventory method only if the book value is computed under the a. weighted-average method. b. moving average method. c. LIFO method. d. FIFO method.

62.

Which of the following inventory methods comes closest to stating ending inventory at replacement cost? a. FIFO b. LIFO c. Weighted-average d. Dollar-value LIFO

63.

The use of LIFO under a perpetual inventory system (units and costs) a. may yield a higher inventory valuation than LIFO under a periodic inventory system when prices are steadily falling. b. may yield a higher inventory valuation than LIFO under a periodic inventory system when prices are steadily rising. c. always yields the same inventory valuation as LIFO under a periodic inventory system. d. can never yield the same inventory valuation as LIFO under a periodic inventory system.

64. One argument against the use of the specific identification inventory method is a. actual costs are matched against actual revenues. b. estimated costs are matched against actual revenues. c. the potential for the manipulation of net income by selecting costs to match against revenues. d. that it is difficult to understand.

9 - 12

Test Bank for Intermediate Accounting, Second Edition

65.

Which of the following represents a departure from the historical cost basis of valuing inventories? a. Dollar-value LIFO b. Specific identification c. Replacement cost d. Average cost

66.

In periods of rising prices, use of LIFO rather than the FIFO inventory method will most likely have what effect on the following items? a. b. c. d.

Net Income Higher Lower Higher Lower

Cost of Goods Sold Lower Higher Higher Higher

Working Capital Lower Lower Higher Higher

67.

The traditional LIFO approach which tends to emphasize specific goods in costing LIFO inventories is often unrealistic because a. it does not result in a proper matching of costs and revenues in a particular period. b. cash flows are often distorted and can be delayed for one or two subsequent periods. c. future price declines will adversely affect the ability to accurately report future earnings. d. erosion of the LIFO inventory can easily occur which often leads to distortions of net income and large tax payments.

68.

Assuming no beginning inventory, what can be said about the trend of inventory prices if cost of goods sold computed when inventory is valued using the FIFO method exceeds cost of goods sold when inventory is valued using the LIFO method? a. Prices increased. b. Prices decreased. c. Prices remained unchanged. d. Price trend cannot be determined from the information given.

69.

When a company uses LIFO for external reporting purposes and FIFO for internal reporting purposes, an Allowance to Reduce Inventory to LIFO account is used. This account should be reported a. on the income statement in the Other Revenues and Gains section. b. on the income statement in the Cost of Goods Sold section. c. on the income statement in the Other Expenses and Losses section. d. on the balance sheet in the Current Assets section.

70.

Which of the following statements is not true as it relates to the dollar-value LIFO inventory method? a. It is easier to erode LIFO layers using dollar-value LIFO techniques than it is with specific goods pooled LIFO. b. Under the dollar-value LIFO method, it is possible to have the entire inventory in only one pool. c. Several pools are commonly employed in using the dollar-value LIFO inventory method. d. Under dollar-value LIFO, increases and decreases in a pool are determined and measured in terms of total dollar value, not physical quantity.

Valuation of Inventories

9 - 13

71.

The dollar-value inventory method is an improvement over the traditional LIFO pool approach because a. the mathematical computations are greatly simplified. b. it is easier to apply where few inventory items are employed and little change in product mix is anticipated. c. increases and decreases in a pool are determined and measured in terms of total dollar value rather than the physical quantity of the goods in the inventory pool. d. dissimilar items of inventory can be grouped to form pools under the dollar-value LIFO method.

72.

Estimates of price-level changes for specific inventories are required for which of the following inventory methods? a. Weighted-average cost b. FIFO c. LIFO d. Dollar-value LIFO

73.

Which of the following is not considered an advantage of LIFO when prices are rising? a. The inventory will be overstated. b. The more recent costs are matched against current revenues. c. There will be a deferral of income tax. d. A company's future reported earnings will not be affected substantially by future price declines.

74.

Which of the following is true regarding the use of LIFO for inventory valuation? a. If LIFO is used for external financial reporting, then it must also be used for internal reports. b. For purposes of external financial reporting, LIFO may not be used with the lower of cost or market approach. c. If LIFO is used for external financial reporting, then it cannot be used for tax purposes. d. None of these.

75.

If inventory levels are stable or increasing, an argument which is not an advantage of the LIFO method as compared to FIFO is a. income taxes tend to be reduced in periods of rising prices. b. cost of goods sold tends to be stated at approximately current cost on the income statement. c. cost assignments typically parallel the physical flow of goods. d. income tends to be smoothed as prices change over time.

76.

The acquisition cost of a heavily used raw material changes frequently. The inventory amount of this material at year end will be the same if perpetual records (units and costs) are kept as it would be under a periodic inventory method only if the inventory amount is computed under the a. weighted-average method. b. first-in, first-out method. c. last-in, first-out method. d. direct costing method.

9 - 14

Test Bank for Intermediate Accounting, Second Edition

77.

Which of the following represents the best justification for the departure from the historical cost principle that results when lower-of-cost-or-market is used? a. It is easier to keep track of market value than it is to keep track of cost as market value is available from any supplier. b. Cost loses its relevance for the determination of cost of goods sold if the cost of inventory has been incurred in an earlier accounting period. c. The balance sheet valuation of inventory is the most important consideration in the preparation of financial statements. d. The loss in utility that results from a decline in the market value of inventory should be charged against revenues in the period in which it occurs.

78.

Replacement cost is the designated market value used to compare to cost in determining lower-of-cost-or-market when its relationship to the items shown below is a. b. c. d.

Net Realizable Value Lower Higher Higher Lower

NRV less Normal Profit Higher Higher Lower Lower

79.

If a unit of inventory has declined in value below original cost, and the market value is less than the net realizable value less a normal profit margin, the amount to be used for purposes of inventory valuation is a. original cost. b. market value. c. net realizable value. d. net realizable value less a normal profit margin.

80.

Under the lower-of-cost-or-market rule, market will be replacement cost except when replacement cost is a. higher than cost. b. less than net realizable value. c. less than net realizable value less a normal profit margin. d. less than cost.

81.

Which of the following is true about lower-of-cost-or-market? a. It is inconsistent because losses are recognized but not gains. b. It usually understates assets. c. It can increase future income. d. All of these.

82.

The primary basis of accounting for inventories is cost. A departure from the cost basis of pricing the inventory is required where there is evidence that when the goods are sold in the ordinary course of business their a. selling price will be less than their replacement cost. b. replacement cost will be more than their net realizable value. c. cost will be less than their replacement cost. d. future utility will be less than their cost.

Valuation of Inventories

9 - 15

83.

When valuing raw materials inventory at lower-of-cost-or-market, what is the meaning of the term "market"? a. Net realizable value b. Net realizable value less a normal profit margin c. Current replacement cost d. Discounted present value

84.

In no case can "market" in the lower-of-cost-or-market rule be more than a. estimated selling price in the ordinary course of business. b. estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal. c. estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal and an allowance for an approximately normal profit margin. d. estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal, an allowance for an approximately normal profit margin, and an adequate reserve for possible future losses.

85.

Designated market value a. is always the middle value of replacement cost, net realizable value, and net realizable value less a normal profit margin. b. should always be equal to net realizable value. c. may sometimes exceed net realizable value. d. should always be equal to net realizable value less a normal profit margin.

86.

Lower-of-cost-or-market a. is most conservative if applied to the total inventory. b. is most conservative if applied to major categories of inventory. c. is most conservative if applied to individual items of inventory. d. must be applied to major categories for taxes.

87.

An item of inventory purchased this period for $15.00 has been incorrectly written down to its current replacement cost of $10.00. It sells during the following period for $30.00, its normal selling price, with disposal costs of $3.00 and normal profit of $12.00. Which of the following statements is not true? a. The cost of sales of the following year will be understated. b. The current year's income is understated. c. The closing inventory of the current year is understated. d. Income of the following year will be understated.

88.

When inventory declines in value below original (historical) cost, and this decline is considered other than temporary, what is the maximum amount that the inventory can be valued at? a. Sales price b. Net realizable value c. Historical cost d. Net realizable value reduced by a normal profit margin

9 - 16

Test Bank for Intermediate Accounting, Second Edition

89.

Net realizable value is a. acquisition cost plus costs to complete and sell. b. selling price. c. selling price plus costs to complete and sell. d. selling price less costs to complete and sell.

90.

If a unit of inventory has declined in value below original cost, but the market value exceeds net realizable value, the amount to be used for purposes of inventory valuation is a. net realizable value. b. original cost. c. market value. d. net realizable value less a normal profit margin.

91.

The average days to sell inventory is computed by dividing a. 365 days by the inventory turnover ratio. b. the inventory turnover ratio by 365 days. c. net sales by the inventory turnover ratio. d. 365 days by cost of goods sold.

92.

The inventory turnover ratio is computed by dividing the cost of goods sold by a. beginning inventory. b. ending inventory. c. average inventory. d. number of days in the year.

*93.

Which of the following is not a basic assumption of the gross profit method? a. The beginning inventory plus the purchases equal total goods to be accounted for. b. Goods not sold must be on hand. c. If the sales, reduced to the cost basis, are deducted from the sum of the opening inventory plus purchases, the result is the amount of inventory on hand. d. The total amount of purchases and the total amount of sales remain relatively unchanged from the comparable previous period.

*94.

The gross profit method of inventory valuation is invalid when a. a portion of the inventory is destroyed. b. there is a substantial increase in inventory during the year. c. there is no beginning inventory because it is the first year of operation. d. none of these.

*95.

Which statement is not true about the gross profit method of inventory valuation? a. It may be used to estimate inventories for interim statements. b. It may be used to estimate inventories for annual statements. c. It may be used by auditors. d. None of these.

Valuation of Inventories

9 - 17

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

41. 42. 43. 44. 45. 46. 47. 48.

d b a d b c b b

49. 50. 51. 52. 53. 54. 55. 56.

b b b b a b a b

57. 58. 59. 60. 61. 62. 63. 64.

a b c d d a b c

65. 66. 67. 68. 69. 70. 71. 72.

c b d b d a c d

73. 74. 75. 76. 77. 78. 79. 80.

a d c b d a d c

81. 82. 83. 84. 85. 86. 87. 88.

d d c b a c d b

89. 90. 91. 92. *93. *94. *95.

d a a c d d b

Solutions to those Multiple Choice questions for which the answer is “none of these.” 44. Goods in transit which were purchased f.o.b. shipping point. 74. If LIFO is used for tax purposes, then it must also be used for external financial reporting. *94. The gross profit percentage applicable to the goods in ending inventory is different from the percentage applicable to the goods sold during the period.

MULTIPLE CHOICE—Computational 96.

TJones Manufacturing Company has the following account balances at year end: Office supplies Raw materials Work-in-process Finished goods Prepaid insurance

$ 4,000 27,000 59,000 72,000 6,000

What amount should TJones report as inventories in its balance sheet? a. $72,000 b. $76,000 c. $158,000 d. $162,000 97.

The following items were included in Voigt Corporation's inventory account at December 31, 2008: Goods held on consignment by Voigt Merchandise out on consignment, at sales price, including 30% mark-up on selling price Goods purchased, in transit, shipped f.o.b. shipping point

$ 7,000 12,000 9,000

Voigt's inventory account at December 31, 2008, should be reduced by a. $10,600. b. $12,600. c. $16,000. d. $28,000.

9 - 18 98.

Test Bank for Intermediate Accounting, Second Edition Slowe Company has been using the LIFO cost method of inventory valuation for 8 years. Its 2008 ending inventory was $135,000 but it would have been $180,000 if FIFO had been used. Thus, if FIFO had been used, Slowe's net income before income taxes would have been a. $45,000 less in 2008. b. $45,000 more in 2008. c. $45,000 greater over the 8-year period. d. $45,000 less over the 8-year period.

Use the following information for questions 99 and 100. The following information was available from the inventory records of Neer Company for January: Balance at January 1 Purchases: January 6 January 26 Sales: January 7 January 31 Balance at January 31

Units 3,000

Unit Cost $9.77

Total Cost $29,310

2,000 2,700

10.30 10.71

20,600 28,917

(2,500) (4,000) 1,200

99.

Assuming that Neer does not maintain perpetual inventory records, what should be the inventory at January 31, using the weighted-average inventory method, rounded to the nearest dollar? a. $12,606 b. $12,284 c. $12,312 d. $12,432

100.

Assuming that Neer maintains perpetual inventory records, what should be the inventory at January 31, using the moving-average inventory method, rounded to the nearest dollar? a. $12,606 b. $12,284 c. $12,312 d. $12,432

Use the following information for questions 101 and 102. Kiner Co. has the following data related to an item of inventory: Inventory, March 1 100 units @ $4.20 Purchase, March 7 350 units @ $4.40 Purchase, March 16 70 units @ $4.50 Inventory, March 31 130 units 101.

The value assigned to ending inventory if Kiner uses LIFO is a. $579. b. $552. c. $546. d. $585.

Valuation of Inventories

9 - 19

102.

The value assigned to cost of goods sold if Kiner uses FIFO is a. $579. b. $552. c. $1,723. d. $1,696.

103.

Baker Company has been using the LIFO method of inventory valuation for 10 years, since it began operations. Its 2008 ending inventory was $40,000, but it would have been $60,000 if FIFO had been used. Thus, if FIFO had been used, Baker's income before income taxes would have been a. $20,000 greater over the 10-year period. b. $20,000 less over the 10-year period. c. $20,000 greater in 2008. d. $20,000 less in 2008.

Use the following information for questions 104 through 107. Transactions for the month of June were: Purchases June 1 (balance) 800 @ $3.20 3 2,200 @ 3.10 7 1,200 @ 3.30 15 1,800 @ 3.40 22 500 @ 3.50

June 2 6 9 10 18 25

Sales 600 @ $5.50 1,600 @ 5.50 1,000 @ 5.50 400 @ 6.00 1,400 @ 6.00 200 @ 6.00

104.

Assuming that perpetual inventory records are kept in units only, the ending inventory on a LIFO basis is a. $4,110. b. $4,160. c. $4,290. d. $4,470.

105.

Assuming that perpetual inventory records are kept in dollars, the ending inventory on a LIFO basis is a. $4,110. b. $4,160. c. $4,290. d. $4,470.

106.

Assuming that perpetual inventory records are kept in dollars, the ending inventory on a FIFO basis is a. $4,110. b. $4,160. c. $4,290. d. $4,470.

107.

Assuming that perpetual inventory records are kept in units only, the ending inventory on an average-cost basis, rounded to the nearest dollar, is a. $4,096. b. $4,238. c. $4,290. d. $4,322.

9 - 20

Test Bank for Intermediate Accounting, Second Edition

108.

Kingman Company had 500 units of “Dink” in its inventory at a cost of $5 each. It purchased, for $2,400, 300 more units of “Dink”. Kingman then sold 600 units at a selling price of $10 each, resulting in a gross profit of $2,100. The cost flow assumption used by Kingman a. is FIFO. b. is LIFO. c. is weighted average. d. cannot be determined from the information given.

109.

Green Corporation uses the FIFO method for internal reporting purposes and LIFO for external reporting purposes. The balance in the LIFO Reserve account at the end of 2007 was $80,000. The balance in the same account at the end of 2008 is $120,000. Green’s Cost of Goods Sold account has a balance of $600,000 from sales transactions recorded during the year. What amount should Green report as Cost of Goods Sold in the 2008 income statement? a. $560,000 b. $600,000 c. $640,000 d. $720,000

110.

Johnson Company had 400 units of “Tank” in its inventory at a cost of $4 each. It purchased 600 more units of “Tank” at a cost of $6 each. Johnson then sold 700 units at a selling price of $10 each. The LIFO liquidation overstated normal gross profit by a. $0. b. $200. c. $400. d. $600.

Use the following information for 111 and 112. AJ Company had January 1 inventory of $100,000 when it adopted dollar-value LIFO. During the year, purchases were $600,000 and sales were $1,000,000. December 31 inventory at year-end prices was $143,360, and the price index was 112. 111.

What is AJ Company’s ending inventory? a. $100,000 b. $128,000 c. $131,360 d. $143,360

112.

What is AJ Company’s gross profit? a. $428,000 b. $431,360 c. $443,460 d. $868,640

Valuation of Inventories

9 - 21

Use the following information for questions 113 through 115. Dolan Corporation adopted the dollar-value LIFO method of inventory valuation on December 31, 2006. Its inventory at that date was $220,000 and the relevant price index was 100. Information regarding inventory for subsequent years is as follows: Date December 31, 2007 December 31, 2008 December 31, 2009

Inventory at Current Prices $256,800 290,000 325,000

Current Price Index 107 125 130

113.

What is the cost of the ending inventory at December 31, 2007 under dollar-value LIFO? a. $240,000 b. $256,800 c. $241,400 d. $235,400

114.

What is the cost of the ending inventory at December 31, 2008 under dollar-value LIFO? a. $232,000 b. $231,400 c. $232,840 d. $240,000

115.

What is the cost of the ending inventory at December 31, 2009 under dollar-value LIFO? a. $256,240 b. $254,800 c. $250,000 d. $263,400

116.

Amidei Company adopts dollar-value LIFO inventory on 12/31/07 when its inventory at current price is $45,000. The inventory value on 12/31/08 at current 2008 prices is $65,000. If prices increased by 30% during 2008, what is the dollar-value LIFO inventory at 12/31/08? a. $65,000 b. $58,000 c. $51,500 d. $48,700

117.

Marr Corporation has two products in its ending inventory, each accounted for at the lower-of-cost-or-market. A profit margin of 30% on selling price is considered normal for each product. Specific data with respect to each product follows: Product #1 Product #2 Historical cost $40.00 $ 70.00 Replacement cost 45.00 54.00 Estimated cost to dispose 10.00 26.00 Estimated selling price 80.00 130.00 In pricing its ending inventory using the lower-of-cost-or-market, what unit values should Marr use for products #1 and #2, respectively? a. $40.00 and $65.00 b. $46.00 and $65.00 c. $46.00 and $60.00 d. $45.00 and $54.00

9 - 22

Test Bank for Intermediate Accounting, Second Edition

118.

Paul Konerko Company sells product 2005WSC for $20 per unit. The cost of one unit of 2005WSC is $18, and the replacement cost is $17. The estimated cost to dispose of a unit is $4, and the normal profit is 40%. At what amount per unit should product 2005WSC be reported, applying lower-of-cost-or-market? a. $8 b. $16 c. $17 d. $18

119.

Remington Company sells product 1976NLC for $40 per unit. The cost of one unit of 1976NLC is $36, and the replacement cost is $34. The estimated cost to dispose of a unit is $8, and the normal profit is 40%. At what amount per unit should product 1976NLC be reported, applying lower-of-cost-or-market? a. $16 b. $32 c. $34 d. $36

120.

A dudad has an original cost of $15 and a replacement cost of $12. The cost of completion and disposal is $2. If the dudad has a net realizable value of $16 and a normal profit margin of $5, its inventory value should be a. $15. b. $12. c. $16. d. $14.

121.

Martinez Corporation has two products in its ending inventory. A profit margin of 30% on selling price is considered normal for each product. Specific data with respect to each product follows: Product A Product B Historical cost $22.00 $ 55.00 Replacement cost 20.00 56.00 Estimated cost to dispose 7.00 31.00 Estimated selling price 35.00 110.00 In pricing its ending inventory using the lower-of-cost-or-market method, what unit values should Martinez use for products A and B, respectively? a. $17.50 and $55.00 b. $20.00 and $46.00 c. $20.00 and $55.00 d. $28.00 and $56.00

122.

Ace Corporation’s computation of cost of goods sold is: Beginning inventory Add: Cost of goods purchased Cost of goods available for sale Ending inventory Cost of goods sold

$ 60,000 405,000 465,000 80,000 $385,000

Valuation of Inventories

9 - 23

The average days to sell inventory for Ace are a. 56.9 days. b. 63.1 days. c. 66.4 days. d. 75.8 days. 123.

The 2008 financial statements of Wert Company reported a beginning inventory of $80,000, an ending inventory of $120,000, and cost of goods sold of $600,000 for the year. Wert’s inventory turnover ratio for 2008 is a. 7.5 times. b. 6.0 times. c. 5.0 times. d. 4.3 times.

*124. The following information is available for October for Jordan Company. Beginning inventory Net purchases Net sales Percentage markup on cost

$ 50,000 150,000 300,000 66.67%

A fire destroyed Jordan’s October 31 inventory, leaving undamaged inventory with a cost of $3,000. Using the gross profit method, the estimated ending inventory destroyed by fire is a. $17,000. b. $77,000. c. $80,000. d. $100,000. *125. Gomez Company had a gross profit of $360,000, total purchases of $420,000, and an ending inventory of $240,000 in its first year of operations as a retailer. Gomez’s sales in its first year must have been a. $540,000. b. $660,000. c. $180,000. d. $600,000. *126. Miller, Inc. estimates the cost of its physical inventory at March 31 for use in an interim financial statement. The rate of markup on cost is 25%. The following account balances are available: Inventory, March 1 Purchases Purchase returns Sales during March

$220,000 172,000 8,000 300,000

The estimate of the cost of inventory at March 31 would be a. $84,000. b. $144,000. c. $159,000. d. $112,000.

9 - 24

Test Bank for Intermediate Accounting, Second Edition

*127. On January 1, 2008, the merchandise inventory of Colaw, Inc. was $800,000. During 2008 Colaw purchased $1,600,000 of merchandise and recorded sales of $2,000,000. The gross profit rate on these sales was 25%. What is the merchandise inventory of Colaw at December 31, 2008? a. $400,000 b. $500,000 c. $900,000 d. $1,500,000 *128. For 2008, cost of goods available for sale for Vale Corporation was $900,000. The gross profit rate was 20%. Sales for the year were $800,000. What was the amount of the ending inventory? a. $0 b. $260,000 c. $180,000 d. $160,000 *129. On April 15 of the current year, a fire destroyed the entire uninsured inventory of a retail store. The following data are available: Sales, January 1 through April 15 Inventory, January 1 Purchases, January 1 through April 15 Markup on cost

$300,000 50,000 250,000 25%

The amount of the inventory loss is estimated to be a. $60,000. b. $30,000. c. $75,000. d. $50,000. *130

On January 31, fire destroyed the entire inventory of Mojares Company. The following data are available: Sales for January Inventory, January 1 Purchases for January Markup on cost

$60,000 10,000 55,000 25%

The amount of the inventory loss is estimated to be a. $17,000. b. $20,000. c. $15,000. d. $16,250.

Valuation of Inventories

9 - 25

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

96. 97. 98. 99. 100.

c a c b d

101. 102. 103. 104. 105.

b d a a c

106. 107. 108. 109. 110.

d b b c b

111. 112. 113. 114. 115.

c b c c a

116. 117. 118. 119. 120.

c a b b b

121. 122. 123. *124. *125.

c c b a a

*126. *127. *128. *129. *130.

b c b a a

MULTIPLE CHOICE—CPA Adapted 131

Gear Co.'s accounts payable balance at December 31, 2008 was $1,500,000 before considering the following transactions: •

Goods were in transit from a vendor to Gear on December 31, 2008. The invoice price was $70,000, and the goods were shipped f.o.b. shipping point on December 29, 2008. The goods were received on January 4, 2009.

•

Goods shipped to Gear, f.o.b. shipping point on December 20, 2008, from a vendor were lost in transit. The invoice price was $50,000. On January 5, 2009, Gear filed a $50,000 claim against the common carrier.

In its December 31, 2008 balance sheet, Gear should report accounts payable of a. $1,620,000. b. $1,570,000. c. $1,550,000. d. $1,500,000. 132.

Dark Co. recorded the following data pertaining to raw material X during January 2008: Units Date Received Cost Issued On Hand 1/1/08 Inventory $8.00 3,200 1/11/08 Issue 1,600 1,600 1/22/08 Purchase 4,000 $9.40 5,600 The moving-average unit cost of X inventory at January 31, 2008 is a. $8.70. b. $8.85. c. $9.00. d. $9.40.

133.

During periods of rising prices, a perpetual inventory system would result in the same dollar amount of ending inventory as a periodic inventory system under which of the following inventory cost flow methods? FIFO LIFO a. Yes No b. Yes Yes c. No Yes d. No No

9 - 26

Test Bank for Intermediate Accounting, Second Edition

134.

Earl Co. was formed on January 2, 2008, to sell a single product. Over a two-year period, Earl's acquisition costs have increased steadily. Physical quantities held in inventory were equal to three months' sales at December 31, 2008, and zero at December 31, 2009. Assuming the periodic inventory system, the inventory cost method which reports the highest amount of each of the following is Inventory Cost of Sales December 31, 2008 2009 a. LIFO FIFO b. LIFO LIFO c. FIFO FIFO d. FIFO LIFO

135.

Noll Co. had 450 units of product A on hand at January 1, 2008, costing $42 each. Purchases of product A during January were as follows: Date Units Unit Cost Jan. 10 600 $44 18 750 46 28 300 48 A physical count on January 31, 2008 shows 600 units of product A on hand. The cost of the inventory at January 31, 2008 under the LIFO method is a. $28,200. b. $26,700. c. $25,500. d. $24,600.

136.

Carr Co. adopted the dollar-value LIFO inventory method on December 31, 2008. Carr's entire inventory constitutes a single pool. On December 31, 2008, the inventory was $320,000 under the dollar-value LIFO method. Inventory data for 2009 are as follows: 12/31/09 inventory at year-end prices Relevant price index at year end (base year 2008)

$440,000 110

Using dollar value LIFO, Carr's inventory at December 31, 2009 is a. $352,000. b. $408,000. c. $400,000. d. $440,000. 137.

Teel Distribution Co. has determined its December 31, 2008 inventory on a FIFO basis at $250,000. Information pertaining to that inventory follows: Estimated selling price Estimated cost of disposal Normal profit margin Current replacement cost

$255,000 10,000 30,000 225,000

Teel records losses that result from applying the lower-of-cost-or-market rule. At December 31, 2008, the loss that Teel should recognize is a. $0. b. $5,000. c. $20,000. d. $25,000.

Valuation of Inventories

9 - 27

138.

Under the lower-of-cost-or-market method, the replacement cost of an inventory item would be used as the designated market value a. when it is below the net realizable value less the normal profit margin. b. when it is below the net realizable value and above the net realizable value less the normal profit margin. c. when it is above the net realizable value. d. regardless of net realizable value.

139.

The original cost of an inventory item is above the replacement cost and the net realizable value. The replacement cost is below the net realizable value less the normal profit margin. As a result, under the lower-of-cost-or-market method, the inventory item should be reported at the a. net realizable value. b. net realizable value less the normal profit margin. c. replacement cost. d. original cost.

*140. Gore Company's accounting records indicated the following information: Inventory, 1/1/08 Purchases during 2008 Sales during 2008

$ 600,000 3,000,000 3,800,000

A physical inventory taken on December 31, 2008, resulted in an ending inventory of $700,000. Gore's gross profit on sales has remained constant at 25% in recent years. Gore suspects some inventory may have been taken by a new employee. At December 31, 2008, what is the estimated cost of missing inventory? a. $50,000 b. $150,000 c. $200,000 d. $250,000

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

131. 132.

a c

133. 134.

a c

135. 136.

c b

137. 138.

d b

139. *140.

b a

DERIVATIONS — Computational No.

Answer

96.

Derivation $27,000 + $59,000 + $72,000 = $158,000.

97.

$7,000 + ($12,000 × .30) = $10,600.

98.

$180,000 – $135,000 = $45,000.

99.

($29,310 + $20,600 + $28,917) ÷ (3,000 + 2,000 + 2,700) = $10.237/unit $10.237 × 1,200 = $12,284.

9 - 28

Test Bank for Intermediate Accounting, Second Edition

No.

Answer

100.

Avg. on 1/6 $49,910 ÷ 5,000 = $9.982/unit 1/26 $53,872 ÷ 5,200 = $10.36/unit $10.36 × 1,200 = $12,432.

101.

(100 × $4.20) + (30 × $4.40) = $552.

102.

100 + 350 + 70 – 130 = 390 units (100 × $4.20) + (290 × $4.40) = $1,696.

103.

($60,000 – $40,000) = $20,000.

104.

Available (purchases) = 6,500 units Sales = 5,200 units EI = 6,500 – 5,200 = 1,300 units (800 × $3.20) + (500 × $3.10) = $4,110.

105.

(200 × $3.2) + (400 × $3.1) + (400 × $3.4) + (300 × $3.5) = $4,290.

Date 6/1 6/2 6/3

Derivation

Purchase (800 @ 3.2) 2,560

Sold (600 @ 3.2)

1,920

(1,600 @ 3.1)

4,960

6/9

(1,000 @ 3.3)

3,300

6/10

(200 @ 3.3) (200 @ 3.1)

1,280

(2,200 @ 3.1)

6,820

6/6 6/7

6/15

(1,200 @ 3.3)

(1,800 @ 3.4)

3,960

6,120

6/18

6/22 6/25

(1,400 @ 3.4) 4,760

(500 @ 3.5)

1,750 (200 @ 3.5)

700

106.

(500 × $3.5) + (800 × $3.4) = $4,470.

107.

$21,210 ÷ 6,500 units = $3.26 $3.26 × 1,300 = $4,238.

Balance (800 @ 3.2) 2,560 (200 @ 3.2) 640 (200 @ 3.2) (2,200 @ 3.1) 7,460 (200 @ 3.2) (600 @ 3.1) 2,500 (200 @ 3.2) (600 @ 3.1) 6,460 (1,200 @ 3.3) (200 @ 3.2) (600 @ 3.1) 3,160 (200 @ 3.3) (200 @ 3.2) (400 @ 3.1) 1,880 (200 @ 3.2) (400 @ 3.1) 8,000 (1,800 @ 3.4) (200 @ 3.2) (400 @ 3.1) 3,240 (400 @ 3.4) (500 @ 3.5) 4,990 (200 @ 3.2) (400 @ 3.1) (400 @ 3.4) 4,290 (300 @ 3.5)

Valuation of Inventories

No.

Answer

108.

(600 × $10) – $2,100 = $3,900 COGS [(500 × $5) + $2,400] – $3,900 = $1,000 E.I. 200 × $5 = $1,000 E.I. under LIFO.

109.

$600,000 + ($120,000 – $80,000) = $640,000.

110.

[(700 – 600) × ($6 – $4)] = $200.

111.

$143,360 ÷ 1.12 = $128,000 – $100,000 = $28,000. $100,000 + ($28,000 × 1.12) = $131,360.

112.

$100,000 + $600,000 – $131,360 = $568,640 COGS $1,000,000 – $568,640 = $431,360.

113.

$256,800 ÷ 1.07 = $240,000 $220,000 + [(240,000 – $220,000) × 1.07] = $241,400.

114.

$290,000 ÷ 1.25 = $232,000 ($220,000 × 1) + ($12,000 × 1.07) = $232,840.

115.

$325,000 ÷ 1.30 = $250,000 ($220,000 × 1) + ($12,000 × 1.07) + ($18,000 × 1.3) = $256,240.

116.

$65,000 – ($65,000 ÷ 1.30) = 15,000 [($50,000 – $45,000) × 1.30] + $45,000 = $51,500.

117.

Product 1:

9 - 29

Derivation

Product 2:

RC = $45, NRV = $80 – $10 = $70 NRV – PM = $70 – ($80 × .3) = $46, cost = $40. RC = $54, NRV = $130 – $26 = $104 NRV – PM = $104 – ($130 × .3) = $65, cost = $70.

118.

NRV = $20 – $4 = $16, RC = $17 NRV – PM = $16 – ($20 × .40) = $8, cost = $18.

119.

NRV = $40 – $8 = $32, RC = $34 NRV – PM = $32 – ($40 × .40) = $16, cost = $36.

120.

NRV – PM = $16 – $5 = $11; MV = $12; $12 < $15 cost.

121.

Product A: NRV = $35 – $7 = $28; Floor = $28 – ($35 × .30) = $17.50 MV = $20, LCM = $20 Product B: NRV = $110 – $31 = $79; Floor = $79 – ($110 × .30) = $46 MV = $56, LCM = $55.

122.

$385,000 ÷ [($60,000 + $80,000) ÷ 2] = 5.5; 365 ÷ 5.5 = 66.4.

123.

$600,000 ÷ [($80,000 + $120,000) ÷ 2] = 6 times

*124.

($50,000 + $150,000) – ($300,000 ÷ 5/3) – $3,000 = $17,000.

9 - 30

Test Bank for Intermediate Accounting, Second Edition

No.

Answer

*125.

Derivation $360,000 + ($420,000 – $240,000) = $540,000.

*126.

COGS = $300,000 ÷ 1.25 = $240,000 ($220,000 + $172,000 – $8,000) – $240,000 = $144,000.

*127.

COGS = $2,000,000 × .75 = $1,500,000 $800,000 + $1,600,000 – $1,500,000 = $900,000.

*128.

$900,000 – ($800,000 × .80) = $260,000.

*129.

$300,000 $50,000 + $250,000 – ————— = $60,000. 1.25

*130.

($10,000 + $55,000) – ($60,000 ÷ 1.25) = $17,000.

DERIVATIONS — CPA Adapted No.

Answer

131.

Derivation $1,500,000 + $70,000 + $50,000 = $1,620,000.

132.

[(1,600 × $8.00) + (4,000 × $9.40)] ÷ 5,600 = $9.00.

133.

Conceptual.

134.

Conceptual.

135.

(450 × $42) + (150 × $44) = $25,500.

136.

$440,000 ÷ 1.1 = $400,000 $320,000 + ($80,000 × 1.1) = $408,000.

137

$250,000 – $225,000 (RC) = $25,000.

138.

Conceptual.

139.

Conceptual.

*140.

$3,800,000 × .75 = $2,850,000 (COGS) $600,000 + $3,000,000 – $2,850,000 – $700,000 = $50,000.

Valuation of Inventories

9 - 31

EXERCISES Ex. 9-141—FIFO and LIFO inventory methods. During June, the following changes in inventory item 27 took place: June 1 14 24 8 10 29

Balance Purchased Purchased Sold Sold Sold

1,400 units @ $24 800 units @ $36 700 units @ $30 400 units @ $50 1,000 units @ $40 500 units @ $44

Perpetual inventories are maintained. Instructions What is the cost of the ending inventory for item 27 under the following methods? (Show calculations.) (a) FIFO. (b) LIFO.

Solution 9-141 (a) 700 @ $30 = $21,000 300 @ $36 = 10,800 $31,800

(b) 800 @ $36 = 200 @ $30 =

$28,800 6,000 $34,800

Ex. 9-142—FIFO and LIFO inventory methods. The Pine Shop shows the following data related to an item of inventory: Inventory, January 1 100 units @ $5.00 Purchase, January 9 300 units @ $5.40 Purchase, January 19 70 units @ $6.00 Inventory, January 31 120 units Instructions (a) What value should be assigned to the ending inventory using FIFO? (b) What value should be assigned to cost of goods sold using LIFO?

Solution 9-142 (a) 70 @ $6.00 = $420 50 @ $5.40 = 270 $690

(b)

70 @ $6.00 = $ 420 280 @ $5.40 = 1,512 $1,932

9 - 32

Test Bank for Intermediate Accounting, Second Edition

Ex. 9-143—Perpetual LIFO. A record of transactions for the month of May was as follows: Purchases May 1 (balance) 400 @ $4.20 May 3 4 1,300 @ $4.10 6 8 800 @ $4.30 12 14 700 @ $4.40 18 22 1,200 @ $4.50 25 29 500 @ $4.55

Sales 300 @ $7.00 1,000 @ 7.00 900 @ 7.50 400 @ 7.50 1,400 @ 8.00

Assuming that perpetual inventory records are kept in dollars, determine the inventory using LIFO.

Solution 9-143 100 @ $4.20 = $ 420 200 @ $4.10 = 820 100 @ $4.40 = 440 500 @ $4.55 = 2,275 $3,955

Ex. 9-144—Perpetual LIFO and Periodic FIFO. Seitzer Corporation sells item A as part of its product line. Information as to balances on hand, purchases, and sales of item A are given in the following table for the first six months of 2008. Quantities Date January 11 January 24 February 8 March 16 June 11

Purchased — 1,300 — — 600

Sold — — 300 560 —

Balance 400 1,700 1,400 840 1,440

Unit Price of Purchase $2.50 $2.60 — — $2.75

Instructions (a) Compute the ending inventory at June 30 under the perpetual LIFO inventory pricing method. (b) Compute the cost of goods sold for the first six months under the periodic FIFO inventory pricing method.

Solution 9-144 (a)

400 @ $2.50 = 440 @ $2.60 = 600 @ $2.75 = 1,440

$1,000 1,144 1,650 $3,794

(b)

400 @ $2.50 = $1,000 460 @ $2.60 = 1,196 860 $2,196

Valuation of Inventories

9 - 33

Ex. 9-145—Dollar-value LIFO method. Part A.

Gant Company has a beginning inventory in year one of $300,000 and an ending inventory of $363,000. The price level has increased from 100 at the beginning of the year to 110 at the end of year one. Calculate the ending inventory under the dollarvalue LIFO method.

Part B.

At the end of year two, Gant's inventory is $437,000 in terms of a price level of 115 which exists at the end of year two. Calculate the inventory at the end of year two continuing the use of the dollar-value LIFO method.

Solution 9-145 Part A. Computation of Ending Inventory, Year One Ending Inventory Layers at at Base-Year Price Base-Year Prices Price Index $363,000 ÷ 1.10 = $330,000 $300,000 × 1.00 = $30,000 × 1.10 =

Ending Inventory at Dollar-Value LIFO $300,000 33,000 $333,000

Part B. Computation of Ending Inventory, Year Two Ending Inventory Layers at at Base-Year Price Base-Year Prices Price Index $437,000 ÷ 1.15 = $380,000 $300,000 × 1.00 = $30,000 × 1.10 = $50,000 × 1.15 =

Ending Inventory at Dollar-Value LIFO $300,000 33,000 57,500 $390,500

Ex. 9-146—Lower-of-cost-or-market. Determine the proper unit inventory price in the following independent cases by applying the lower of cost or market rule. Circle your choice. 1 2 3 4 5 Cost $8.00 $10.50 $12.00 $6.00 $7.20 Net realizable value 8.85 10.00 12.20 4.25 6.90 Net realizable value less normal profit 8.15 9.00 11.40 3.75 6.00 Market replacement cost 7.90 10.10 12.50 4.00 5.40

Solution 9-146 Case 1 Case 2 Case 3

$ 8.00 $10.00 $12.00

Case 4 Case 5

$4.00 $6.00

9 - 34

Test Bank for Intermediate Accounting, Second Edition

Ex. 9-147—Lower-of-cost-or-market. Assume in each case that the selling expenses are $8 per unit and that the normal profit is $5 per unit. Calculate the limits for each case. Then enter the amount that should be used for lower-ofcost-or-market. Selling Price

Upper Limit

Replacement Cost

Lower Limit

Cost

LCM

(a)

$54

$______

$38

$______

$43

$______

(b)

______

(c)

______

(d)

______

Lower Limit $41 34 43 34

LCM $41 36 40 39

Solution 9-147 (a) (b) (c) (d)

Upper Limit $46 39 48 39

Ex. 9-148—Lower-of-cost-or-market. The December 31, 2008 inventory of Dwyer Company consisted of four products, for which certain information is provided below. Product A B C D

Original Cost $25.00 $42.00 $120.00 $18.00

Replacement Cost $22.00 $40.00 $115.00 $15.80

Estimated Disposal Cost $6.50 $12.00 $25.00 $3.00

Expected Selling Price $40.00 $48.00 $190.00 $26.00

Normal Profit on Sales 20% 25% 30% 10%

Instructions Using the lower-of-cost-or-market approach applied on an individual-item basis, compute the inventory valuation that should be reported for each product on December 31, 2008.

Solution 9-148 Product A B C D

Designated Market

Cost

Lower-of Costor-Market

$25.50

$25.00

Ceiling $40.00 – $6.50 = $33.50

Floor $33.50 – $8.00 = $25.50

$48.00 – $12.00 = $36.00

$36.00 – $12.00 = $24.00

$36.00

$42.00

$36.00

$190.00 – $25.00 = $165.00

$165.00 – $57.00 = $108.00

$115.00

$120.00

$115.00

$26.00 – $3.00 = $23.00

$23.00 – $2.60 = $20.40

$20.40

$18.00

Valuation of Inventories

9 - 35

*Ex. 9-149—Gross profit method. On January 1, a store had inventory of $48,000. January purchases were $46,000 and January sales were $90,000. On February 1 a fire destroyed most of the inventory. The rate of gross profit was 25% of cost. Merchandise with a selling price of $5,000 remained undamaged after the fire. Compute the amount of the fire loss, assuming the store had no insurance coverage. Label all figures.

*Solution 9-149 Beginning Inventory Purchases Goods available Cost of sale ($90,000 ÷ 125%) Estimated ending inventory Cost of undamaged inventory ($5,000 ÷ 125%) Estimated fire loss

$ 48,000 46,000 94,000 (72,000) 22,000 (4,000) $18,000

*Ex. 9-150—Gross profit method. Reese Co. prepares monthly income statements. Inventory is counted only at year end; thus, month-end inventories must be estimated. All sales are made on account. The rate of mark-up on cost is 20%. The following information relates to the month of May. Accounts receivable, May 1 Accounts receivable, May 31 Collections of accounts during May Inventory, May 1 Purchases during May

$21,000 27,000 90,000 45,000 58,000

Instructions Calculate the estimated cost of the inventory on May 31.

*Solution 9-150 Collections of accounts Add accounts receivable, May 31 Deduct accounts receivable, May 1 Sales during May

$ 90,000 27,000 (21,000) $ 96,000

Inventory, May 1 Purchases during May Goods available Cost of sales ($96,000 ÷ 120%) Estimated cost of inventory, May 31

$ 45,000 58,000 103,000 (80,000) $ 23,000

9 - 36

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Pr. 9-151—Inventory cut-off. Slone Company sells TVs. The perpetual inventory was stated as $28,500 on the books at December 31, 2008. At the close of the year, a new approach for compiling inventory was used and apparently a satisfactory cut-off for preparation of financial statements was not made. Some events that occurred are as follows. 1. TVs shipped to a customer January 2, 2009, costing $5,000 were included in inventory at December 31, 2008. The sale was recorded in 2009. 2. TVs costing $12,000 received December 30, 2008, were recorded as received on January 2, 2009. 3. TVs received during 2008 costing $4,600 were recorded twice in the inventory account. 4. TVs shipped to a customer December 28, 2008, f.o.b. shipping point, which cost $10,000, were not received by the customer until January, 2009. The TVs were included in the ending inventory. 5. TVs on hand that cost $6,100 were never recorded on the books. Instructions Compute the correct inventory at December 31, 2008.

Solution 9-151 Inventory per books Add: Shipment received 12/30/08 TVs on hand

Deduct:

TVs recorded twice TVs shipped 12/28/08 Correct inventory 12/31/08

$28,500 $12,000 6,100

4,600 10,000

18,100 46,600

14,600 $32,000

Pr. 9-152—Inventory methods. Flynt Company was formed on December 1, 2007. The following information is available from Flynt 's inventory record for Product X. Units Unit Cost January 1, 2008 (beginning inventory) 1,600 $18.00 Purchases: January 5, 2008 2,600 $20.00 January 25, 2008 2,400 $21.00 February 16, 2008 1,000 $22.00 March 15, 2008 1,800 $23.00 A physical inventory on March 31, 2008, shows 2,500 units on hand.

Valuation of Inventories

9 - 37

Pr. 9-152 (cont.) Instructions Prepare schedules to compute the ending inventory at March 31, 2008, under each of the following inventory methods: (a) FIFO. (b) LIFO. (c) Weighted-average. Show supporting computations in good form.

Solution 9-152 (a)

Flynt Company COMPUTATION OF INVENTORY FOR PRODUCT X UNDER FIFO INVENTORY METHOD March 31, 2008

March 15, 2008 February 16, 2008 March 31, 2008, inventory

(b)

Unit Cost $23.00 22.00

Total Cost $41,400 15,400 $56,800

Flynt Company COMPUTATION OF INVENTORY FOR PRODUCT X UNDER LIFO INVENTORY METHOD March 31, 2008

Beginning inventory January 5, 2008 (portion) March 31, 2008, inventory (c)

Units 1,800 700 2,500

Units 1,600 900 2,500

Unit Cost $18.00 20.00

Total Cost $28,800 18,000 $46,800

Flynt Company COMPUTATION OF INVENTORY FOR PRODUCT X UNDER WEIGHTED-AVERAGE INVENTORY METHOD March 31, 2008 Beginning inventory January 5, 2008 January 25, 2008 February 16, 2008 March 15, 2008

Units 1,600 2,600 2,400 1,000 1,800 9,400

Weighted average cost ($194,600 ÷ 9,400) March 31, 2008, inventory

Unit Cost $18.00 20.00 21.00 22.00 23.00

Total Cost $ 28,800 52,000 50,400 22,000 41,400 $194,600

$20.70 2,500

$20.70

$51,750

9 - 38

Test Bank for Intermediate Accounting, Second Edition

Pr. 9-153—Dollar-value LIFO. Dent Company manufactures one product. On December 31, 2006, Dent adopted the dollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO inventory method was $180,000. Inventory data are as follows: Inventory at year-end prices $252,000 368,000 387,500

Year 2007 2008 2009

Price index (base year 2006) 1.05 1.15 1.25

Instructions Compute the inventory at December 31, 2007, 2008, and 2009, using the dollar-value LIFO method for each year.

Solution 9-153 Dent Company Dollar-Value LIFO Computations At December 31, 2007, 2008, and 2009

At 12/31, 2007:

Ending Inventory at Base-Year Price $252,000 ÷ 1.05 = $240,000

Layers at Base-Year Prices $180,000 $60,000

× ×

At 12/31, 2008:

$368,000 ÷ 1.15 = $320,000

$180,000 $60,000 $80,000

× × ×

1.00 1.05 1.15

= = =

$180,000 63,000 92,000 $335,000

At 12/31, 2009:

$387,500 ÷ 1.25 = $310,000

$180,000 $60,000 $70,000

× × ×

1.00 1.05 1.15

= = =

$180,000 63,000 80,500 $323,500

Price Index 1.00 = 1.05 =

Ending Inventory Dollar-Value LIFO $180,000 63,000 $243,000

Pr. 9-154—Dollar-value LIFO. Perry Company manufactures a single product. On December 31, 2007, Perry adopted the dollarvalue LIFO inventory method. The inventory on that date using the dollar-value LIFO inventory method was $50,000. Inventory data are as follows: Year 2007 2008 2009

Inventory at Respective Year-End Cost Prices $50,000 73,500 71,500

Price Index at Year End 100 105 110

Instructions Compute the inventory at December 31, 2008 and 2009 using the dollar-value LIFO method.

Valuation of Inventories

9 - 39

Solution 9-154 December 31, 2008 inventory at 2008 prices ........................................................... December 31, 2008, inventory at base-year prices ($73,500  1.05) ....................... January 1, 2008 inventory at base-year prices ......................................................... 2008 inventory increase at base-year prices ............................................................ 2008 inventory increase at 2008 prices ($20,000 × 1.05) .........................................

$73,500 70,000 50,000 20,000 21,000

December 31, 2008 inventory: Layer 2007 2008

Base-Year Prices $50,000 20,000 $70,000

Price Index 100 105

Dollar-Value LIFO $50,000 21,000 $71,000

December 31, 2009 inventory at 2009 prices ........................................................... December 31, 2009 inventory at base-year prices ($71,500  1.10) ........................ January 1, 2008 inventory at base-year prices ......................................................... 2009 inventory decrease at base-year prices ........................................................... 2009 inventory decreases at prices in existence when most recent layer was added (2008) $5,000 × 1.05 ...................................................................

$71,500 65,000 70,000 5,000 5,250

December 31, 2008 inventory: Layer 2007 2008

Base-Year Prices $50,000 15,000 $65,000

Price Index 100 105

Dollar-Value LIFO $50,000 15,750 $65,750

*Pr. 9-155—Gross profit method. On December 31, 2008 Carr Company's inventory burned. Sales and purchases for the year had been $1,400,000 and $980,000, respectively. The beginning inventory (Jan. 1, 2008) was $170,000; in the past Carr's gross profit has averaged 40% of selling price. Instructions Compute the estimated cost of inventory burned, and give entries as of December 31, 2008 to close merchandise accounts.

*Solution 9-155 Beginning inventory Add: Purchases Cost of goods available Sales Less 40% Estimated inventory lost

$ 170,000 980,000 1,150,000 $1,400,000 (560,000)

840,000 $ 310,000

9 - 40

Test Bank for Intermediate Accounting, Second Edition

*Solution 9-155 (cont.) Sales .............................................................................................. 1,400 000 Income Summary................................................................ Cost of Goods Sold ........................................................................ Fire Loss ........................................................................................ Inventory ............................................................................. Purchases...........................................................................

1,400,000

840,000 310,000 170,000 980,000

CHAPTER 10 ACCOUNTING FOR PROPERTY, PLANT, AND EQUIPMENT TRUE-FALSE—Conceptual Answer

No.

Description

F T F T F F T F F F T F T T T T F F T T F F F F T F F T T F F T T T T F T F F F F

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41.

Nature of property, plant, and equipment. Nature of property, plant, and equipment. Cost of removing old building. Insurance on equipment purchased. Accounting for special assessments. Classification of a building. Valuing property, plant, and equipment. Accounting for excavation costs. Capitalization of interest costs. Interest capitalization. Interest capitalization on land purchase. Valuing an asset in noncash transaction. Accounting for capital expenditure. Costs subsequent to acquisition. Definition of improvements. Nature of depreciation. Nature of depreciation. Concept of depreciation. Definition of depreciable base. Physical factors affecting service life. Effect of maintenance on service life. Definition of depreciation base. Factors involved in depreciation process. Definition of inadequacy. Objection to straight-line method. Units-of-production approach. Accelerated depreciation method. Declining-balance method. Accounting for changes in estimates. Productivity and declining-balance method. Straight-line depreciation method. Declining-balance method and salvage value. Reporting changes in estimate. Nonmonetary exchange with commercial substance. Computation of gain/loss in nonmonetary exchange. Recognizing gain in nonmonetary exchange. Accounting for nonmonetary exchanges. Nonmonetary exchanges. Recognizing losses on nonmonetary exchanges. Involuntary conversion gains/losses. Computing asset turnover ratio.

10 - 2

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual (cont.) Answer

No.

Description

T F F T

42. *43. *44. *45.

Profit margin on sales ratio. Determining amount of interest to capitalize. Qualifying assets for interest capitalization. Avoidable interest.

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83.

Definition of plant assets. Characteristics of plant assets. Characteristics of plant assets. Composition of land cost. Composition of land cost. Determination of land cost. Determine cost of land used as a parking lot. Determine cost of machinery. Classification of fences and parking lots. Recording plant assets at historical cost. Characteristics of plant assets. Classification of interest earned on securities purchased with borrowed funds. Capitalization of interest on constructed assets. Plant asset acquired by issuance of stock. Valuation of nonmonetary exchanges. Valuation of donated assets. Identify conditions for capital expenditures. Capital expenditure. Identification of a capital expenditure. Identification of a capital expenditure. Accounting for capital expenditures. Knowledge of depreciation accounting. Conceptual rationale for depreciation accounting. Depreciation and retaining funds. Definition of depreciation. Service life vs. physical life. Economic factors affecting service life. Activity method of depreciation. Units-of-production method of depreciation. Units-of-production method of depreciation. Knowledge of double-declining balance method. Components of sum-of-the-years'-digits method. Graphic depiction of straight-line and sum-of-the-years'-digits methods. Disadvantage of using straight-line method. Partial-year depreciation computation. Change in estimated life of depreciable asset. Reporting a change in estimate. Straight-line method assumption.

Accounting for Property, Plant, and Equipment

10 - 3

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

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

84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. *98. *99. *100. *101. *102. *103. *104.

Description Straight-line depreciation assumption. Depreciable base and salvage value. Partial-year depreciation computation. Nonmonetary exchanges and culmination of earning process. Recognizing gains/losses in exchange having commercial substance. Valuation of nonmonetary asset. Gain recognition on plant asset exchange. Gain recognition on a nonmonetary exchange. Gain recognition on a nonmonetary exchange. Gain or loss on plant asset disposal. Determine loss on sale of depreciable asset. Required disclosures for depreciation. Disclosure of depreciation policy. Asset turnover ratio. Assets which qualify for interest capitalization. Assets which qualify for interest capitalization. Definition of "avoidable interest." Period of time over which interest may be capitalized. Maximum amount of annual interest that may be capitalized. Write-off of capitalized interest costs. Conditions for interest capitalization.

MULTIPLE CHOICE—Computational Answer

No.

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

105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123. 124. 125. 126. 127.

Description Determine cost of land. Determine cost of building. Calculate cost of land and building. Calculate cost of equipment. Calculate cost of land acquired. Calculate cost of delivery van purchased. Allocation of cost of a lump sum purchase. Acquisition of equipment by exchange of stock held as an investment. Factors involved in depreciation. Calculate depreciation using activity method. Calculate depreciation using double-declining balance method. Calculate depreciation using double-declining balance method. Calculate depreciation using double-declining balance method. Calculate depreciation using double-declining balance method. Calculate depreciation using double-declining balance method. Sum-of-the-years’-digits method. Calculate depreciation using sum-of-the-years’-digits method. Calculate depreciation using sum-of-the-years’-digits method. Calculate depreciation using sum-of-the-years’-digits method. Determine acquisition cost from sum-of-the-years’-digits method. Determine acquisition cost from sum-of-the-years’-digits method. Calculate gain on sale of machinery. Determine depreciation expense from change in Accumulated Depreciation account.

10 - 4

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Computational (cont.) Answer

No.

128.

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

129. 130. 131. 132. 133. 134. 135. 136. 137. 138. 139. 140. 141. 142. 143. 144. 145. 146. 147. 148. 149. 150. 151. 152. 153. *154. *155. *156. *157. *158. *159. *160.

Description Determine depreciation expense from change in Accumulated Depreciation account. Depreciation and partial periods. Change in estimated useful life. Change in estimated life of equipment. Determine depreciation expense after major overhaul. Determine depreciation expense after major overhaul. Determine loss on sale of machine. Calculate sum-of-the-years’-digits depreciation. Exchange lacking commercial substance. Exchange lacking commercial substance/gain. Exchange lacking commercial substance/gain. Valuation of a nonmonetary exchange. Exchange lacking commercial substance/gain. Valuation of a nonmonetary exchange. Gain recognition of a nonmonetary exchange. Valuation of a nonmonetary exchange. Valuation of a nonmonetary exchange. Valuation of a nonmonetary exchange. Calculate gain on exchange lacking commercial substance. Calculate cash received from sale of machinery. Calculate cash received from sale of machinery. Calculate loss on sale of machine. Calculate gain on sale of equipment. Calculate asset turnover ratio. Calculate return on total assets. Calculate asset turnover rate. Calculate depreciation expense using the straight-line method. Calculate average accumulated expenditures. Calculate amount of interest to be capitalized. Calculate weighted-average accumulated expenditures. Calculate actual interest cost incurred during year. Calculate amount of interest to be capitalized. Calculate amount of interest to be capitalized.

MULTIPLE CHOICE—CPA Adapted Answer

No.

c b b d a c b b a d

161. 162. 163. 164. 165. 166. 167. 168. 169. 170.

Description Determine cost of land. Classification of sale of building. Accounting for donated assets. Capitalizing renovation costs. Valuation of replacement equipment. Calculate depreciation using 150% declining balance method. Double-declining balance method. Determine accumulated depreciation using sum-of-the-years’-digits. Calculate depreciation expense using sum-of-the-years’-digits. Effect of salvage value on accumulated depreciation.

Accounting for Property, Plant, and Equipment

10 - 5

MULTIPLE CHOICE—CPA Adapted (cont.) Answer

No.

b b a a b

171. 172. 173. 174. *175.

Description Effect of including salvage value in depreciation base Effect of decreasing charge methods on sale of asset. Exchange lacking commercial substance. Exchange lacking commercial substance. Determine interest cost to be capitalized.

EXERCISES Item E10-176 E10-177 E10-178 E10-179 E10-180 E10-181 E10-182 E10-183 R10-184 E10-185 E10-186 *E10-187 *E10-188

Description Plant asset accounting. Donated assets. Capitalizing vs. expensing. Definitions. True or False. Depreciation methods. Calculate depreciation. Calculate depreciation. Asset depreciation and disposition. Nonmonetary exchange. Nonmonetary exchange. Weighted-average accumulated expenditures. Capitalization of interest.

PROBLEMS Item P10-189 P10-190 P10-191 P10-192 P10-193 P10-194 P10-195 P10-196 *P10-197 *P10-198

Description Capitalizing acquisition costs. Depreciation methods. Adjustment of depreciable base. Nonmonetary exchange. Nonmonetary exchange. Nonmonetary exchange. Nonmonetary exchange. Nonmonetary exchange. Capitalization of interest. Capitalization of interest.

CHAPTER LEARNING OBJECTIVES 1. 2. 3. 4. 5. 6. 7. 8. 9. *10.

Describe property, plant, and equipment and costs to include in its initial valuation. Describe the accounting problems associated with interest capitalization. Understand accounting issues related to acquiring and valuing plant assets. Describe the accounting treatment for costs subsequent to acquisition. Explain the concept of depreciation. Identify the factors involved in the depreciation process. Compare activity, straight-line, and decreasing-charge methods of depreciation. Describe the accounting treatment for the disposal of property, plant, and equipment. Explain how to report and analyze property, plant, and equipment. Understand the procedures for determining capitalized interest methods.

10 - 6

Test Bank for Intermediate Accounting, Second Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2. 3. 4.

TF TF TF TF

5. 6. 7. 8.

TF TF TF TF

46. 47. 48. 49.

10.

11.

12. 59.

TF MC

60. 61.

MC MC

109. 110.

13. 14.

TF TF

15. 62.

TF MC

63. 64.

16. 17.

TF TF

18. 67.

TF MC

68. 69.

19. 20.

TF TF

21. 22.

TF TF

23. 24.

25. 26. 27. 28. 29. 30. 31. 32.

TF TF TF TF TF TF TF TF

33. 73. 74. 75. 76. 77. 78. 79.

TF MC MC MC MC MC MC MC

114. 115. 116. 117. 118. 119. 120. 121.

34. 35. 36. 37. 38.

TF TF TF TF TF

39. 40. 91. 92. 93.

TF TF MC MC MC

94. 136. 137. 138. 139.

41. 42.

TF TF

95. 96.

MC MC

97. 151.

43. 44. 45. 98.

TF TF TF MC

99. 100. 101. 102.

MC MC MC MC

103. 104. 154. 155.

Note:

TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 MC 50. MC 54. MC 51. MC 55. MC 52. MC 56. MC 53. MC 105. Learning Objective 2 TF 57. MC 58. Learning Objective 3 MC 111. MC 163. MC 112. MC 176. Learning Objective 4 MC 65. MC 164. MC 66. MC 165. Learning Objective 5 MC 70. MC MC 179. E Learning Objective 6 TF 71. MC 113. TF 72. MC 180. Learning Objective 7 MC 122. MC 130. MC 123. MC 131. MC 124. MC 132. MC 125. MC 133. MC 126. MC 134. MC 127. MC 135. MC 128. MC 166. MC 129. MC 167. Learning Objective 8 MC 140. MC 145. MC 141. MC 146. MC 142. MC 147. MC 143. MC 148. MC 144. MC 149. Learning Objective 9 MC 152. MC MC 153. MC Learning Objective *10 MC 156. MC 160. MC 157. MC 175. MC 158. MC 187. MC 159. MC 188. P = Problem E = Exercise

Type

Item

Type

Item

Type

MC MC MC MC

106. 107. 108. 161.

MC MC MC MC

162. 176. 178. 189.

MC E E P

176.

178.

MC E

177. 178.

E E

MC MC

176. 178.

E E

MC MC MC MC MC MC MC MC

168. 169. 170. 171. 172. 180. 181. 182.

MC MC MC MC MC E E E

183. 184. 190. 191.

E E P P

MC MC MC MC MC

150. 173. 174. 185. 186.

MC MC MC E E

192. 193. 194. 195. 196.

P P P P P

MC MC E E

197. 198.

P P

MC E

Accounting for Property, Plant, and Equipment

10 - 7

TRUE-FALSE—Conceptual 1. Assets classified as Property, Plant, and Equipment can be either acquired for use in operations, or acquired for resale. 2. Assets classified as Property, Plant, and Equipment must be both long-term in nature and possess physical substance. 3. When land with an old building is purchased as a future building site, the cost of removing the old building is part of the cost of the new building. 4. Insurance on equipment purchased, while the equipment is in transit, is part of the cost of the equipment. 5. Special assessments for local improvements such as street lights and sewers should be accounted for as land improvements. 6. A building owned by a corporation is always classified as property, plant and equipment. 7. The cash or cash equivalent price of items classified as property, plant and equipment best measures the value of the asset on the date of acquisition. 8. When land has been purchased for the purpose of constructing a new building, all costs incurred in connection with preparing the land for excavation are considered building costs. 9. The interest costs on funds used to acquire an asset should not be capitalized even if a significant period of time is required to bring the asset to a condition or location necessary for its intended use. 10. When capitalizing interest during construction of an asset, an imputed interest cost on stock financing must be included. 11. When a company purchases land with the intention of developing it for a particular use, interest costs associated with those expenditures qualify for interest capitalization. 12. An asset should be recorded at the fair market value of the consideration given up to acquire it or at its fair market value, whichever is higher. 13. If a capital expenditure related to a machine increases the useful life but does not improve its quality, the expenditure may be debited to accumulated depreciation rather than to the asset account. 14. Costs incurred subsequent to the acquisition of an asset are capitalized if they provide future benefits. 15. Improvements are often referred to as betterments and involve the substitution of a better asset for the one currently used. 16. Depreciation is a means of cost allocation, not a matter of valuation.

10 - 8

Test Bank for Intermediate Accounting, Second Edition

17. Depreciation is based on the decline in the fair market value of the asset. 18. The accounting concept of depreciation reflects the decline in value associated with a plant asset. 19. An asset's cost less its salvage value is referred to as the depreciable base. 20.

Physical factors such as wear and tear set the outside limit for the service life of an asset.

21. Whenever the economic nature of the asset is the primary determinant of service life, maintenance plays an extremely vital role in prolonging service life. 22. The book value of an asset less its salvage value is its depreciation base. 23. The three factors involved in the depreciation process are the depreciation base, the useful life, and the risk of obsolescence. 24. Inadequacy is the replacement of one asset with another more efficient and economical asset. 25. The major objection to the straight-line method is that it assumes the asset’s economic usefulness and repair expense is the same each year. 26. The units-of-production approach to depreciation is appropriate when depreciation is a function of time instead of activity. 27. An accelerated depreciation method is appropriate when the asset’s economic usefulness is the same each year. 28. The declining-balance method does not deduct the salvage value in computing the depreciation base. 29. Changes in estimates are handled prospectively by dividing the asset’s book value less any salvage value by the remaining estimated life. 30. Companies that desire low depreciation during periods of low productivity and high depreciation during high productivity either adopt or switch to a declining-balance method. 31. The straight-line depreciation method is used most often in actual practice because the assumptions upon which it is based apply to most plant assets. 32. Under the declining-balance depreciation method, salvage value is considered only in computing the amount of depreciation for the final year(s) of an asset's service life. 33. If one of the estimates used in computing depreciation is subsequently found to require adjustments, no change in prior years' financial statements is required. 34. If an exchange of nonmonetary assets occurs and the exchange has commercial substance, it is presumed that the earnings process related to these assets is completed. 35. Gains and losses on the exchange of nonmonetary assets are computed by comparing the book value of the asset given up with the fair value of the asset given up.

Accounting for Property, Plant, and Equipment

10 - 9

36. When an exchange of nonmonetary assets with no commercial substance results in a gain and insignificant boot is included as a part of the transaction, the gain to be recognized is limited to the amount of the boot received. 37. Companies account for the exchange of nonmonetary assets on the basis of the fair value of the asset given up or the fair value of the asset received. 38. If a nonmonetary exchange lacks commercial substance and cash is received, a partial gain or loss is recognized. 39. When a company exchanges nonmonetary assets and a loss results, the company recognizes the loss only if the exchange has commercial substance. 40. Companies always treat gains or losses from an involuntary conversion as extraordinary items. 41. The asset turnover ratio is computed by dividing net sales by ending total assets. 42. The profit margin on sales ratio is a measure for analyzing the use of property, plant, and equipment. *43. The amount of interest to be capitalized is the higher of actual interest cost incurred during the period or avoidable interest. *44. Assets under construction for a company’s own use do not qualify for interest cost capitalization. *45. Avoidable interest is the amount of interest cost that a company could theoretically avoid if it had not made expenditures for the asset.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7. 8.

F T F T F F T F

9. 10. 11. 12. 13. 14. 15. 16.

F F T F T T T T

17. 18. 19. 20. 21. 22. 23. 24.

F F T T F F F F

25. 26. 27. 28. 29. 30. 31. 32.

T F F T T F F T

33. 34. 35. 36. 37. 38. 39. 40.

T T T F T F F F

41. 42. *43. *44. *45.

F T F F T

10 - 10 Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual 46.

Plant assets may properly include a. deposits on machinery not yet received. b. idle equipment awaiting sale. c. land held for possible use as a future plant site. d. none of these.

47.

Which of the following is not a major characteristic of a plant asset? a. Possesses physical substance b. Acquired for resale c. Acquired for use in operations d. Yields services over a number of years

48.

Which of these is not a major characteristic of a plant asset? a. Possesses physical substance b. Acquired for use in operations c. Yields services over a number of years d. All of these are major characteristics of a plant asset.

49.

Cotton Hotel Corporation recently purchased Holiday Hotel and the land on which it is located with a plan to tear down the Holiday Hotel and build a new luxury hotel on the site. The cost of the Holiday Hotel should be a. depreciated over the period from acquisition to the date the hotel is scheduled to be torn down. b. written off as an extraordinary loss in the year the hotel is torn down. c. capitalized as part of the cost of the land. d. capitalized as part of the cost of the new hotel.

50.

The cost of land does not include a. costs of grading, filling, draining, and clearing. b. costs of removing old buildings. c. costs of improvements with limited lives. d. special assessments.

51.

The cost of land typically includes the purchase price and all of the following costs except a. grading, filling, draining, and clearing costs. b. street lights, sewers, and drainage systems costs. c. private driveways and parking lots. d. assumption of any liens or mortgages on the property.

52.

If a corporation purchases a lot and building and subsequently tears down the building and uses the property as a parking lot, the proper accounting treatment of the cost of the building would depend on the a. significance of the cost allocated to the building in relation to the combined cost of the lot and building. b. length of time for which the building was held prior to its demolition. c. contemplated future use of the parking lot. d. intention of management for the property when the building was acquired.

Accounting for Property, Plant, and Equipment

10 - 11

53.

The debit for a sales tax properly levied and paid on the purchase of machinery preferably would be a charge to a. the machinery account. b. a separate deferred charge account. c. miscellaneous tax expense (which includes all taxes other than those on income). d. accumulated depreciation—machinery.

54.

Fences and parking lots are reported on the balance sheet as a. current assets. b. land improvements. c. land. d. property and equipment.

55.

Historical cost is the basis advocated for recording the acquisition of property, plant, and equipment for all of the following reasons except a. at the date of acquisition, cost reflects fair market value. b. property, plant, and equipment items are always acquired at their original historical cost. c. historical cost involves actual transactions and, as such, is the most reliable basis. d. gains and losses should not be anticipated but should be recognized when the asset is sold.

56.

Which of the following is not a necessary characteristic for an item to be classified as property, plant, and equipment? a. Usually subject to depreciation b. Characterized by physical substance c. Can be used in operations for at least 5 years d. Not acquired for resale

57.

When funds are borrowed to pay for construction of assets that qualify for capitalization of interest, the excess funds not needed to pay for construction may be temporarily invested in interest-bearing securities. Interest earned on these temporary investments should be a. offset against interest cost incurred during construction. b. used to reduce the cost of assets being constructed. c. multiplied by an appropriate interest rate to determine the amount of interest to be capitalized. d. recognized as revenue of the period.

58.

Which of the following is the recommended approach to handling interest incurred in financing the construction of property, plant, and equipment? a. Capitalize only the actual interest costs incurred during construction. b. Charge construction with all costs of funds employed, whether identifiable or not. c. Capitalize no interest during construction. d. Capitalize interest costs equal to the prime interest rate times the estimated cost of the asset being constructed.

59.

When a plant asset is acquired by issuance of common stock, the cost of the plant asset is properly measured by the a. par value of the stock. b. stated value of the stock. c. book value of the stock. d. market value of the stock.

10 - 12 Test Bank for Intermediate Accounting, Second Edition 60.

When a closely held corporation issues preferred stock for land, the land should be recorded at the a. total par value of the stock issued. b. total book value of the stock issued. c. total liquidating value of the stock issued. d. fair market value of the land.

61.

A plant site donated by a township to a manufacturer that plans to open a new factory should be recorded on the manufacturer's books at a. the nominal cost of taking title to it. b. its market value. c. one dollar (since the site cost nothing but should be included in the balance sheet). d. the value assigned to it by the company's directors.

62.

In order for a cost to be capitalized (capital expenditure), the following must be present: a. The useful life of an asset must be increased. b. The quantity of assets must be increased. c. The quality of assets must be increased. d. Any one of these.

63.

An improvement made to a machine increased its fair market value and its production capacity by 25% without extending the machine's useful life. The cost of the improvement should be a. expensed. b. debited to accumulated depreciation. c. capitalized in the machine account. d. allocated between accumulated depreciation and the machine account.

64.

Which of the following is a capital expenditure? a. Payment of an account payable b. Retirement of bonds payable c. Payment of Federal income taxes d. None of these

65.

Which of the following is not a capital expenditure? a. Repairs that maintain an asset in operating condition b. An addition c. A betterment d. A replacement

66.

An expenditure made in connection with a machine being used by an enterprise should be a. expensed immediately if it merely extends the useful life but does not improve the quality. b. expensed immediately if it merely improves the quality but does not extend the useful life. c. capitalized if it maintains the machine in normal operating condition. d. capitalized if it increases the quantity of units produced by the machine.

67.

The following is true of depreciation accounting. a. It is not a matter of valuation. b. It is part of the matching of revenues and expenses. c. It retains funds by reducing income taxes and dividends. d. All of these.

Accounting for Property, Plant, and Equipment

10 - 13

68.

Which of the following principles best describes the conceptual rationale for the methods of matching depreciation expense with revenues? a. Associating cause and effect b. Systematic and rational allocation c. Immediate recognition d. Partial recognition

69.

Depreciation accounting a. provides funds. b. funds replacements. c. retains funds. d. all of these.

70.

Which of the following most accurately reflects the concept of depreciation as used in accounting? a. The process of charging the decline in value of an economic resource to income in the period in which the benefit occurred. b. The process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset. c. A method of allocating asset cost to an expense account in a manner which closely matches the physical deterioration of the tangible asset involved. d. An accounting concept that allocates the portion of an asset used up during the year to the contra asset account for the purpose of properly recording the fair market value of tangible assets.

71.

The major difference between the service life of an asset and its physical life is that a. service life refers to the time an asset will be used by a company and physical life refers to how long the asset will last. b. physical life is the life of an asset without consideration of salvage value and service life requires the use of salvage value. c. physical life is always longer than service life. d. service life refers to the length of time an asset is of use to its original owner, while physical life refers to how long the asset will be used by all owners.

72.

Economic factors that shorten the service life of an asset include a. obsolescence. b. supersession. c. inadequacy. d. all of these.

73.

The activity method of depreciation a. is a variable charge approach. b. assumes that depreciation is a function of the passage of time. c. conceptually associates cost in terms of input measures. d. all of these.

74.

For income statement purposes, depreciation is a variable expense if the depreciation method used is a. units-of-production. b. straight-line. c. sum-of-the-years'-digits. d. declining-balance.

10 - 14 Test Bank for Intermediate Accounting, Second Edition 75.

If an industrial firm uses the units-of-production method for computing depreciation on its only plant asset, factory machinery, the credit to accumulated depreciation from period to period during the life of the firm will a. be constant. b. vary with unit sales. c. vary with sales revenue. d. vary with production.

76.

Use of the double-declining balance method a. results in a decreasing charge to depreciation expense. b. means salvage value is not deducted in computing the depreciation base. c. means the book value should not be reduced below salvage value. d. all of these.

77.

Use of the sum-of-the-years'-digits method a. results in salvage value being ignored. b. means the denominator is the years remaining at the beginning of the year. c. means the book value should not be reduced below salvage value. d. all of these.

78.

A graph is set up with "yearly depreciation expense" on the vertical axis and "time" on the horizontal axis. Assuming linear relationships, how would the graphs for straight-line and sum-of-the-years'-digits depreciation, respectively, be drawn? a. Vertically and sloping down to the right b. Vertically and sloping up to the right c. Horizontally and sloping down to the right d. Horizontally and sloping up to the right

79.

A principal objection to the straight-line method of depreciation is that it a. provides for the declining productivity of an aging asset. b. ignores variations in the rate of asset use. c. tends to result in a constant rate of return on a diminishing investment base. d. gives smaller periodic write-offs than decreasing charge methods.

80.

Depreciation is normally computed on the basis of the nearest a. full month and to the nearest cent. b. full month and to the nearest dollar. c. day and to the nearest cent. d. day and to the nearest dollar.

81.

Quayle Company acquired machinery on January 1, 2003 which it depreciated under the straight-line method with an estimated life of fifteen years and no salvage value. On January 1, 2008, Quayle estimated that the remaining life of this machinery was six years with no salvage value. How should this change be accounted for by Quayle? a. As a prior period adjustment b. As the cumulative effect of a change in accounting principle in 2008 c. By setting future annual depreciation equal to one-sixth of the book value on January 1, 2008 d. By continuing to depreciate the machinery over the original fifteen year life

Accounting for Property, Plant, and Equipment

10 - 15

82.

A change in estimate should a. result in restatement of prior period statements. b. be handled in current and future periods. c. be handled in future periods only. d. be handled retroactively.

83.

Which of the following is a realistic assumption of the straight-line method of depreciation? a. The asset's economic usefulness is the same each year. b. The repair and maintenance expense is essentially the same each period. c. The rate of return analysis is enhanced using the straight-line method. d. Depreciation is a function of time rather than a function of usage.

84.

Which of the following statements is the assumption on which straight-line depreciation is based? a. The operating efficiency of the asset decreases in later years. b. Service value declines as a function of time rather than use. c. Service value declines as a function of obsolescence rather than time. d. Physical wear and tear are more important than economic obsolescence.

85.

Which of the following depreciation methods does not consider salvage value in computing the depreciable base of the asset? a. Straight-line b. Sum-of-the-years'-digits c. Declining-balance d. Activity or production

86.

When depreciation is computed for partial periods under a decreasing charge depreciation method, it is necessary to a. charge a full year's depreciation to the year of acquisition. b. determine depreciation expense for the full year and then prorate the expense between the two periods involved. c. use the straight-line method for the year in which the asset is sold or otherwise disposed of. d. use a salvage value equal to the first year's partial depreciation charge.

87.

Which of the following nonmonetary exchange transactions represents a culmination of the earning process? a. Exchange of assets with no difference in future cash flows. b. Exchange of products by companies in the same line of business with no difference in future cash flows. c. Exchange of assets with a difference in future cash flows.. d. Exchange of an equivalent interest in similar productive assets that causes the companies involved to remain in essentially the same economic position.

88.

When boot is involved in an exchange having commercial substance a. gains or losses are recognized in their entirety. b. a gain or loss is computed by comparing the fair value of the asset received with the fair value of the asset given up. c. only gains should be recognized. d. only losses should be recognized.

10 - 16 Test Bank for Intermediate Accounting, Second Edition 89.

The cost of a nonmonetary asset acquired in exchange for another nonmonetary asset and the exchange has commercial substance is usually recorded at a. the fair value of the asset given up, and a loss is recognized. b. the book value of the asset given up, and a loss may be recognized. c. the fair value of the asset received if it is equally reliable as the fair value of the asset given up. d. either the fair value of the asset given up or the asset received, whichever one results in the largest gain (smallest loss) to the company.

90.

The King-Kong Corporation exchanges one plant asset for another plant asset and gives cash in the exchange. The exchange is not expected to cause a material change in the future cash flows for either entity. If a gain on the disposal of the old asset is indicated, the gain will a. be reported in the Other Revenues and Gains section of the income statement. b. effectively reduce the amount to be recorded as the cost of the new asset. c. effectively increase the amount to be recorded as the cost of the new asset. d. be credited directly to the owner's capital account.

91.

Accounting recognition should be given to some or all of the gain realized on a nonmonetary exchange of plant assets except when the exchange has a. no commercial substance and additional cash is paid. b. no commercial substance and additional cash is received. c. commercial substance and additional cash is paid. d. commercial substance and additional cash is received.

92.

For a nonmonetary exchange of plant assets, accounting recognition should not be given to a. a loss when the exchange has no commercial substance. b. a gain when the exchange has commercial substance. c. part of a gain when the exchange has no commercial substance and cash is paid. d. part of a gain when the exchange has no commercial substance and cash is received.

93.

When a plant asset is disposed of, a gain or loss may result. The gain or loss would be classified as an extraordinary item on the income statement if it resulted from a. an involuntary conversion and the conditions of the disposition are unusual and infrequent in nature. b. a sale prior to the completion of the estimated useful life of the asset. c. the sale of a fully depreciated asset. d. an abandonment of the asset.

94.

The sale of a depreciable asset resulting in a loss indicates that the proceeds from the sale were a. less than current market value. b. greater than cost. c. greater than book value. d. less than book value.

95.

Which of the following disclosures is not required in the financial statements regarding depreciation? a. Accumulated depreciation, either by major classes of depreciable assets or in total. b. Details demonstrating how depreciation was calculated. c. Depreciation expense for the period. d. Balances of major classes of depreciable assets, by nature and function.

Accounting for Property, Plant, and Equipment

10 - 17

96.

97.

The asset turnover ratio is computed by dividing a. net income by ending total assets. b. net income by average total assets. c. net sales by ending total assets. d. net sales by average total assets.

*98.

Which of the following assets do not qualify for capitalization of interest costs incurred during construction of the assets? a. Assets under construction for an enterprise's own use. b. Assets intended for sale or lease that are produced as discrete projects. c. Assets financed through the issuance of long-term debt. d. Assets not currently undergoing the activities necessary to prepare them for their intended use.

*99.

Assets that qualify for interest cost capitalization include a. assets under construction for a company's own use. b. assets that are ready for their intended use in the earnings of the company. c. assets that are not currently being used because of excess capacity. d. All of these assets qualify for interest cost capitalization.

*100. When computing the amount of interest cost to be capitalized, the concept of "avoidable interest" refers to a. the total interest cost actually incurred. b. a cost of capital charge for stockholders' equity. c. that portion of total interest cost which would not have been incurred if expenditures for asset construction had not been made. d. that portion of average accumulated expenditures on which no interest cost was incurred. *101. The period of time during which interest must be capitalized ends when a. the asset is substantially complete and ready for its intended use. b. no further interest cost is being incurred. c. the asset is abandoned, sold, or fully depreciated. d. the activities that are necessary to get the asset ready for its intended use have begun.

10 - 18 Test Bank for Intermediate Accounting, Second Edition *102. Which of the following statements is true regarding capitalization of interest? a. Interest cost capitalized in connection with the purchase of land to be used as a building site should be debited to the land account and not to the building account. b. The amount of interest cost capitalized during the period should not exceed the actual interest cost incurred. c. When excess borrowed funds not immediately needed for construction are temporarily invested, any interest earned should be offset against interest cost incurred when determining the amount of interest cost to be capitalized. d. The minimum amount of interest to be capitalized is determined by multiplying a weighted average interest rate by the amount of average accumulated expenditures on qualifying assets during the period. *103. Interest cost that is capitalized should a. be written off over the remaining term of the debt. b. be accumulated in a separate deferred charge account and written off equally over a 40-year period. c. not be written off until the related asset is fully depreciated or disposed of. d. none of these. *104. Which of the following is not a condition that must be satisfied before interest capitalization can begin on a qualifying asset? a. Interest cost is being incurred. b. Expenditures for the assets have been made. c. The interest rate is equal to or greater than the company's cost of capital. d. Activities that are necessary to get the asset ready for its intended use are in progress.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

46. 47. 48. 49. 50. 51. 52. 53. 54.

d b d c c c d a b

55. 56. 57. 58. 59. 60. 61. 62. 63.

b c d a d d b d c

64. 65. 66. 67. 68. 69. 70. 71. 72.

d a d d b c b a d

73. 74. 75. 76. 77. 78. 79. 80. 81.

a a d d c c b b c

82. 83. 84. 85. 86. 87. 88. 89. 90.

b d b c b c a a b

91. 92. 93. 94. 95. 96. 97. *98. *99.

a c a d b d d d a

*100. *101. *102. *103. *104.

c a b d c

Solutions to those Multiple Choice questions for which the answer is “none of these.” 46. Long-lived tangible assets used in the enterprise’s operations. 64. Capital expenditures include additions, betterments, improvements, and extraordinary repairs. *103. Capitalized interest is depreciated over the related asset’s useful life.

Accounting for Property, Plant, and Equipment

10 - 19

MULTIPLE CHOICE—Computational Use the following information for questions 105 and 106. Seiler Co. purchased land as a factory site for $600,000. Seiler paid $60,000 to tear down two buildings on the land. Salvage was sold for $5,400. Legal fees of $3,480 were paid for title investigation and making the purchase. Architect's fees were $31,200. Title insurance cost $2,400, and liability insurance during construction cost $2,600. Excavation cost $10,440. The contractor was paid $2,200,000. An assessment made by the city for pavement was $6,400. Interest costs during construction were $170,000. 105.

The cost of the land that should be recorded by Seiler Co. is a. $660,480. b. $666,880. c. $669,880. d. $676,280.

106.

The cost of the building that should be recorded by Seiler Co. is a. $2,403,800. b. $2,404,840. c. $2,413,200. d. $2,414,240.

107.

On February 1, 2008, Morgan Corporation purchased a parcel of land as a factory site for $200,000. An old building on the property was demolished, and construction began on a new building which was completed on November 1, 2008. Costs incurred during this period are listed below: Demolition of old building $ 20,000 Architect's fees 35,000 Legal fees for title investigation and purchase contract 5,000 Construction costs 1,090,000 (Salvaged materials resulting from demolition were sold for $10,000.) Morgan should record the cost of the land and new building, respectively, as a. $225,000 and $1,115,000. b. $210,000 and $1,130,000. c. $210,000 and $1,125,000. d. $215,000 and $1,125,000.

108.

Tyson Chandler Company purchased equipment for $10,000. Sales tax on the purchase was $500. Other costs incurred were freight charges of $200, repairs of $350 for damage during installation, and installation costs of $225. What is the cost of the equipment? a. $10,000 b. $10,500 c. $10,925 d. $11,275

10 - 20 Test Bank for Intermediate Accounting, Second Edition 109.

On December 1, Wynne Corporation exchanged 2,000 shares of its $25 par value common stock held in treasury for a parcel of land to be held for a future plant site. The treasury shares were acquired by Wynne at a cost of $40 per share, and on the exchange date the common shares of Wynne had a fair market value of $50 per share. Wynne received $6,000 for selling scrap when an existing building on the property was removed from the site. Based on these facts, the land should be capitalized at a. $74,000. b. $80,000. c. $94,000. d. $100,000.

110.

Taylor Company buys a delivery van with a list price of $30,000. The dealer grants a 15% reduction in list price and an additional 2% cash discount on the net price if payment is made in 30 days. Sales taxes amount to $400 and the company paid an extra $300 to have a special horn installed. What should be the recorded cost of the van? a. $24,990. b. $25,645. c. $25,690. d. $25,390.

111.

On April 1, Renner Corporation purchased for $855,000 a tract of land on which was located a warehouse and office building. The following data were collected concerning the property: Current Assessed Valuation Vendor’s Original Cost Land $300,000 $280,000 Warehouse 200,000 180,000 Office building 400,000 340,000 $900,000 $800,000 What are the appropriate amounts that Renner should record for the land, warehouse, and office building, respectively? a. Land, $280,000; warehouse, $180,000; office building, $340,000. b. Land, $300,000; warehouse, $200,000; office building, $400,000. c. Land, $299,250; warehouse, $192,375; office building, $363,375. d. Land, $285,000; warehouse, $190,000; office building, $380,000.

112.

Herman Company exchanged 400 shares of Daily Company common stock, which Herman was holding as an investment, for equipment from West Company. The Daily Company common stock, which had been purchased by Herman for $50 per share, had a quoted market value of $58 per share at the date of exchange. The equipment had a recorded amount on West's books of $21,000. What journal entry should Herman make to record this exchange? a. Equipment .......................................................................... 20,000 Investment in Daily Co. Common Stock .................... 20,000 b. Equipment .......................................................................... 21,000 Investment in Daily Co. Common Stock .................... 20,000 Gain on Disposal of Investment ................................. 1,000 c. Equipment .......................................................................... 21,000 Loss on Disposal of Investment ......................................... 2,200 Investment in Daily Co. Common Stock .................... 23,200 d. Equipment .......................................................................... 23,200 Investment in Daily Co. Common Stock .................... 20,000 Gain on Disposal of Investment ................................. 3,200

Accounting for Property, Plant, and Equipment

10 - 21

113.

Harrison Company purchased a depreciable asset for $100,000. The estimated salvage value is $10,000, and the estimated useful life is 10 years. The straight-line method will be used for depreciation. What is the depreciation base of this asset? a. $9,000 b. $10,000 c. $90,000 d. $100,000

114.

Lennon Company purchased a depreciable asset for $200,000. The estimated salvage value is $10,000, and the estimated useful life is 10,000 hours. Lennon used the asset for 1,100 hours in the current year. The activity method will be used for depreciation. What is the depreciation expense on this asset? a. $19,000 b. $20,900 c. $22,000 d. $190,000

115.

Starr Company purchased a depreciable asset for $150,000. The estimated salvage value is $10,000, and the estimated useful life is 8 years. The double-declining balance method will be used for depreciation. What is the depreciation expense for the second year on this asset? a. $17,500 b. $26,250 c. $28,125 d. $37,500

116.

On July 1, 2007, Rodriguez Corporation purchased factory equipment for $150,000. Salvage value was estimated to be $4,000. The equipment will be depreciated over ten years using the double-declining balance method. Counting the year of acquisition as onehalf year, Gonzalez should record depreciation expense for 2008 on this equipment of a. $30,000. b. $27,000. c. $26,280. d. $24,000.

117.

Norris Corporation purchased factory equipment that was installed and put into service January 2, 2007, at a total cost of $60,000. Salvage value was estimated at $4,000. The equipment is being depreciated over four years using the double-declining balance method. For the year 2008, Norris should record depreciation expense on this equipment of a. $14,000. b. $15,000. c. $28,000. d. $30,000.

118.

On April 13, 2007, Foley Co. purchased machinery for $120,000. Salvage value was estimated to be $5,000. The machinery will be depreciated over ten years using the double-declining balance method. If depreciation is computed on the basis of the nearest full month, Foley should record depreciation expense for 2008 on this machinery of a. $20,800. b. $20,400. c. $20,550. d. $20,933.

10 - 22 Test Bank for Intermediate Accounting, Second Edition 119.

Vinson Co. purchased machinery that was installed and ready for use on January 3, 2007, at a total cost of $69,000. Salvage value was estimated at $9,000. The machinery will be depreciated over five years using the double-declining balance method. For the year 2008, Vinson should record depreciation expense on this machinery of a. $14,400. b. $16,560. c. $18,000. d. $27,600.

120.

A plant asset has a cost of $24,000 and a salvage value of $6,000. The asset has a threeyear life. If depreciation in the third year amounted to $3,000, which depreciation method was used? a. Straight-line b. Declining-balance c. Sum-of-the-years'-digits d. Cannot tell from information given

121.

On January 1, 2007, Carson Company purchased a new machine for $2,100,000. The new machine has an estimated useful life of nine years and the salvage value was estimated to be $75,000. Depreciation was computed on the sum-of-the-years'-digits method. What amount should be shown in Carson's balance sheet at December 31, 2008, net of accumulated depreciation, for this machine? a. $1,695,000 b. $1,335,000 c. $1,306,666 d. $1,244,250

122.

On January 1, 2001, Barnes Company purchased equipment at a cost of $50,000. The equipment was estimated to have a salvage value of $5,000 and it is being depreciated over eight years under the sum-of-the-years'-digits method. What should be the charge for depreciation of this equipment for the year ended December 31, 2008? a. $1,250 b. $1,389 c. $2,500 d. $5,625

123.

On September 19, 2007, Rosen Co. purchased machinery for $190,000. Salvage value was estimated to be $10,000. The machinery will be depreciated over eight years using the sumof-the-years'-digits method. If depreciation is computed on the basis of the nearest full month, Rosen should record depreciation expense for 2008 on this machinery of a. $40,903. b. $38,845. c. $38,750. d. $35,000.

124.

On January 3, 2006, Lopez Co. purchased machinery. The machinery has an estimated useful life of eight years and an estimated salvage value of $30,000. The depreciation applicable to this machinery was $65,000 for 2008, computed by the sum-of-the-years'digits method. The acquisition cost of the machinery was

Accounting for Property, Plant, and Equipment a. b. c. d.

10 - 23

$360,000. $390,000. $420,000. $468,000.

125.

On January 2, 2005, Payne Company acquired equipment to be used in its manufacturing operations. The equipment has an estimated useful life of 10 years and an estimated salvage value of $15,000. The depreciation applicable to this equipment was $70,000 for 2008, computed under the sum-of-the-years'-digits method. What was the acquisition cost of the equipment? a. $535,000 b. $565,000 c. $550,000 d. $541,667

126.

Sears Corporation, which has a calendar year accounting period, purchased a new machine for $40,000 on April 1, 2003. At that time Sears expected to use the machine for nine years and then sell it for $4,000. The machine was sold for $22,000 on Sept. 30, 2008. Assuming straight-line depreciation, no depreciation in the year of acquisition, and a full year of depreciation in the year of retirement, the gain to be recognized at the time of sale would be a. $4,000. b. $3,000. c. $2,000. d. $0.

127.

On January 1, 2008, the Accumulated Depreciation—Machinery account of a particular company showed a balance of $370,000. At the end of 2008, after the adjusting entries were posted, it showed a balance of $395,000. During 2008, one of the machines which cost $125,000 was sold for $60,500 cash. This resulted in a loss of $4,000. Assuming that no other assets were disposed of during the year, how much was depreciation expense for 2008? a. $85,500 b. $93,500 c. $25,000 d. $60,500

128.

During 2008, Geiger Co. sold equipment that had cost $98,000 for $58,800. This resulted in a gain of $4,300. The balance in Accumulated Depreciation—Equipment was $325,000 on January 1, 2008, and $310,000 on December 31. No other equipment was disposed of during 2008. Depreciation expense for 2008 was a. $15,000. b. $19,300. c. $28,500. d. $58,500.

129.

McCartney Company purchased a depreciable asset for $250,000 on April 1, 2005. The estimated salvage value is $25,000, and the estimated useful life is 5 years. The straightline method is used for depreciation. What is the balance in accumulated depreciation on May 1, 2008 when the asset is sold?

10 - 24 Test Bank for Intermediate Accounting, Second Edition a. b. c. d.

$90,000 $105,000 $123,750 $138,750

130.

George Martin Corporation purchased a depreciable asset for $300,000 on January 1, 2005. The estimated salvage value is $30,000, and the estimated useful life is 9 years. The straight-line method is used for depreciation. In 2008, George Martin changed its estimates to a total useful life of 5 years with a salvage value of $50,000. What is 2008 depreciation expense? a. $30,000 b. $50,000 c. $80,000 d. $90,000

131.

Jantz Corporation purchased a machine on July 1, 2005, for $750,000. The machine was estimated to have a useful life of 10 years with an estimated salvage value of $42,000. During 2008, it became apparent that the machine would become uneconomical after December 31, 2012, and that the machine would have no scrap value. Accumulated depreciation on this machine as of December 31, 2007, was $177,000. What should be the charge for depreciation in 2008 under generally accepted accounting principles? a. $106,200 b. $114,600 c. $123,000 d. $143,250

132.

Weston Company purchased a tooling machine on January 3, 2001 for $500,000. The machine was being depreciated on the straight-line method over an estimated useful life of 10 years, with no salvage value. At the beginning of 2008, the company paid $125,000 to overhaul the machine. As a result of this improvement, the company estimated that the useful life of the machine would be extended an additional 5 years (15 years total). What should be the depreciation expense recorded for the machine in 2008? a. $34,375 b. $41,667 c. $50,000 d. $55,000

133.

Klein Co. purchased machinery on January 2, 2002, for $440,000. The straight-line method is used and useful life is estimated to be 10 years, with a $40,000 salvage value. At the beginning of 2008 Klein spent $96,000 to overhaul the machinery. After the overhaul, Klein estimated that the useful life would be extended 4 years (14 years total), and the salvage value would be $20,000. The depreciation expense for 2008 should be a. $28,250. b. $34,500. c. $40,000. d. $37,000.

134.

Thucydides Company purchased a new machine on May 1, 1999, for $25,000. At the time of acquisition, the machine was estimated to have a useful life of 10 years and an estimated salvage value of $1,000. The company has recorded monthly depreciation using the straight-line method. On March 1, 2008, the machine was sold for $800. What should be the loss recognized from the sale of the machine?

Accounting for Property, Plant, and Equipment a. b. c. d.

10 - 25

$0 $2,000 $3,000 $3,400

135.

Plato Corporation purchased a machine with a cost of $165,000 and a salvage value of $9,000 on April 1, 2008. The machine will be depreciated over a 12-year useful life using the sum-of-the-years'-digits method. The amount of depreciation Plato Corporation would record for the year ended 12/31/09 would be a. $22,000. b. $24,000. c. $16,500. d. $22,500.

136.

On January 2, 2008, Quick Delivery Company traded in an old delivery truck for a newer model. The exchange lacked commercial substance. Data relative to the old and new trucks follow: Old Truck Original cost $24,000 Accumulated depreciation as of January 2, 2008 16,000 Average published retail value 7,000 New Truck List price $40,000 Cash price without trade-in 36,000 Cash paid with trade-in 30,000 What should be the cost of the new truck for financial accounting purposes? a. $30,000 b. $36,000 c. $38,000 d. $40,000

137.

On December 1, 2008, Fiene Company acquired a new delivery truck in exchange for an old delivery truck that it had acquired in 2005. The old truck was purchased for $35,000 and had a book value of $13,300. On the date of the exchange, the old truck had a market value of $14,000. In addition, Fiene paid $45,500 cash for the new truck, which had a list price of $63,000. The exchange lacked commercial substance. At what amount should Fiene record the new truck for financial accounting purposes? a. $45,500 b. $58,800 c. $59,500 d. $63,000

Use the following information for questions 138 and 139. A machine cost $120,000, has annual depreciation of $20,000, and has accumulated depreciation of $90,000 on December 31, 2007. On April 1, 2008, when the machine has a market value of $27,500, it is exchanged for a machine with a fair value of $135,000 and the proper amount of cash is paid. The exchange lacked commercial substance.

10 - 26 Test Bank for Intermediate Accounting, Second Edition 138.

The gain to be recorded on the exchange is a. $0. b. $2,500 gain. c. $5,000 gain. d. $15,000 gain.

139.

The new machine should be recorded at a. $107,500. b. $122,500. c. $132,500. d. $135,000.

Use the following information for questions 140 and 141. Equipment that cost $66,000 and has accumulated depreciation of $30,000 is exchanged for equipment with a fair value of $48,000 and $12,000 cash is received. The exchange lacked commercial substance. 140.

The gain to be recognized from the exchange is a. $4,800 gain. b. $6,000 gain. c. $18,000 gain. d. $24,000 gain.

141.

The new equipment should be recorded at a. $48,000. b. $36,000. c. $30,000. d. $28,800.

Use the following information for questions 142 and 143. Two independent companies, Mintz Co. and Pine Co., are in the home building business. Each owns a tract of land held for development, but each would prefer to build on the other's land. They agree to exchange their land. An appraiser was hired, and from her report and the companies' records, the following information was obtained: Mintz's Land Pine's Land Cost and book value $192,000 $120,000 Fair value based upon appraisal 240,000 210,000 The exchange was made, and based on the difference in appraised fair values, Pine paid $30,000 to Mintz. The exchange lacked commercial substance. 142.

For financial reporting purposes, Mintz should recognize a pre-tax gain on this exchange of a. $0. b. $6,000. c. $30,000. d. $48,000.

Accounting for Property, Plant, and Equipment 143.

10 - 27

The new land should be recorded on Mintz's books at a. $168,000. b. $192,000. c. $210,000. d. $240,000.

Use the following information for questions 144 and 145. Glen Inc. and Armstrong Co. have an exchange with no commercial substance. The asset given up by Glen Inc. has a book value of $12,000 and a fair market value of $15,000. The asset given up by Armstrong Co. has a book value of $20,000 and a fair market value of $19,000. Boot of $4,000 is received by Armstrong Co. 144.

What amount should Glen Inc. record for the asset received? a. $15,000 b. $16,000 c. $19,000 d. $20,000

145.

What amount should Armstrong Co. record for the asset received? a. $15,000 b. $16,000 c. $19,000 d. $20,000

146.

Hardin Company received $40,000 in cash and a used computer with a fair value of $120,000 from Page Corporation for Hardin Company's existing computer having a fair value of $160,000 and an undepreciated cost of $150,000 recorded on its books. The transaction has no commercial substance. How much gain should Hardin recognize on this exchange, and at what amount should the acquired computer be recorded, respectively? a. $0 and $110,000 b. $769 and $110,769 c. $10,000 and $120,000 d. $40,000 and $150,000

147.

Bobby Jenks Company purchased machinery for $160,000 on January 1, 2004. Straightline depreciation has been recorded based on a $10,000 salvage value and a 5-year useful life. The machinery was sold on May 1, 2008 at a gain of $3,000. How much cash did Bobby Jenks receive from the sale of the machinery? a. $23,000 b. $27,000 c. $33,000 d. $43,000

148.

Morganstern Company purchased machinery for $320,000 on January 1, 2004. Straightline depreciation has been recorded based on a $20,000 salvage value and a 5-year useful life. The machinery was sold on May 1, 2008 at a gain of $6,000. How much cash did Morganstern receive from the sale of the machinery? a. $46,000 b. $54,000 c. $66,000 d. $86,000

10 - 28 Test Bank for Intermediate Accounting, Second Edition 149.

Jeter Company purchased a new machine on May 1, 2000 for $176,000. At the time of acquisition, the machine was estimated to have a useful life of ten years and an estimated salvage value of $8,000. The company has recorded monthly depreciation using the straight-line method. On March 1, 2009, the machine was sold for $24,000. What should be the loss recognized from the sale of the machine? a. $0 b. $3,600 c. $8,000 d. $11,600

150.

On January 1, 2000, Hite Corporation purchased for $152,000, equipment having a useful life of ten years and an estimated salvage value of $8,000. Hite has recorded monthly depreciation of the equipment on the straight-line method. On December 31, 2008, the equipment was sold for $28,000. As a result of this sale, Hite should recognize a gain of a. $0. b. $5,600. c. $13,600. d. $28,000.

Use the following information for questions 151 and 152: For 2008, Colaw Company reports beginning of the year total assets of $900,000, end of the year total assets of $1,100,000, net sales of $1,250,000, and net income of $250,000. 151.

Colaw’s 2008 asset turnover ratio is a. .23 times. b. .25 times. c. 1.14 times. d. 1.25 times.

152.

The rate of return on assets for Colaw in 2008 is a. 20.0%. b. 22.7%. c. 25.0%. d. 27.8%.

153.

Rubber Soul Company reported the following data: Sales Net Income Assets at year end Liabilities at year end

2008 $2,000,000 300,000 1,800,000 1,100,000

What is Rubber Soul’s asset turnover for 2009? a. 1.04 b. 1.07 c. 1.21 d. 1.44

2009 $2,600,000 400,000 2,500,000 1,500,000

Accounting for Property, Plant, and Equipment

10 - 29

*154. Wheeler Corporation constructed a building at a cost of $20,000,000. Average accumulated expenditures were $8,000,000, actual interest was $1,200,000, and avoidable interest was $600,000. If the salvage value is $1,600,000, and the useful life is 40 years, depreciation expense for the first full year using the straight-line method is a. $475,000. b. $490,000. c. $515,000. d. $675,000. *155. Hackleman Company is constructing a building. Construction began in 2008 and the building was completed 12/31/08. Hackleman made payments to the construction company of $1,500,000 on 7/1, $3,300,000 on 9/1, and $3,000,000 on 12/31. Average accumulated expenditures were a. $1,575,000. b. $1,850,000. c. $4,800,000. d. $7,800,000. *156. During 2008, Gannon Co. incurred average accumulated expenditures of $400,000 during construction of assets that qualified for capitalization of interest. The only debt outstanding during 2008 was a $500,000, 10%, 5-year note payable dated January 1, 2006. What is the amount of interest that should be capitalized by Gannon during 2008? a. $0 b. $10,000 c. $40,000 d. $50,000 *157. On March 1, Bakken Co. began construction of a small building. Payments of $180,000 were made monthly for four months beginning March 1. The building was completed and ready for occupancy on June 1. In determining the amount of interest cost to be capitalized, the weighted-average accumulated expenditures are a. $90,000. b. $180,000. c. $360,000. d. $720,000. Use the following information for questions 158 and 159. On March 1, 2008, Dennis Company purchased land for an office site by paying $540,000 cash. Dennis began construction on the office building on March 1. The following expenditures were incurred for construction: Date Expenditures March 1, 2008 $ 360,000 April 1, 2008 504,000 May 1, 2008 900,000 June 1, 2008 1,440,000 The office was completed and ready for occupancy on July 1. To help pay for construction, $720,000 was borrowed on March 1, 2008 on a 9%, 3-year note payable. Other than the construction note, the only debt outstanding during 2008 was a $300,000, 12%, 6-year note payable dated January 1, 2008.

10 - 30 Test Bank for Intermediate Accounting, Second Edition *158. The actual interest cost incurred during 2008 was a. $90,000. b. $100,800. c. $50,400. d. $84,000. *159. Assume the weighted-average accumulated expenditures for the construction project are $870,000. The amount of interest cost to be capitalized during 2008 is a. $78,300. b. $82,800. c. $90,000. d. $100,800. *160. During 2008, Aber Corporation constructed assets costing $1,000,000. The weightedaverage accumulated expenditures on these assets during 2008 was $600,000. To help pay for construction, $440,000 was borrowed at 10% on January 1, 2008, and funds not needed for construction were temporarily invested in short-term securities, yielding $9,000 in interest revenue. Other than the construction funds borrowed, the only other debt outstanding during the year was a $500,000, 10-year, 9% note payable dated January 1, 2002. What is the amount of interest that should be capitalized by Aber during 2008? a. $60,000 b. $30,000 c. $58,400 d. $94,400

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

105. 106. 107. 108. 109. 110. 111. 112.

b d d c c c d d

113. 114. 115. 116. 117. 118. 119. 120.

c b c b b b b c

121. 122. 123. 124. 125. 126. 127. 128.

b a c c b c a c

129. 130. 131. 132. 133. 134. 135. 136.

d c b a b c d b

137. 138. 139. 140. 141. 142. 143. 144.

b a c a d b a b

145. 146. 147. 148. 149. 150. 151. 152.

a c c c b b d c

153. *154. *155. *156. *157. *158. *159. *160.

c a b c a a b c

Accounting for Property, Plant, and Equipment

10 - 31

MULTIPLE CHOICE—CPA Adapted 161.

On December 1, 2008, Logan Co. purchased a tract of land as a factory site for $800,000. The old building on the property was razed, and salvaged materials resulting from demolition were sold. Additional costs incurred and salvage proceeds realized during December 2008 were as follows: Cost to raze old building Legal fees for purchase contract and to record ownership Title guarantee insurance Proceeds from sale of salvaged materials

$70,000 10,000 16,000 8,000

In Logan 's December 31, 2008 balance sheet, what amount should be reported as land? a. $826,000 b. $862,000 c. $888,000 d. $896,000 162.

Land was purchased to be used as the site for the construction of a plant. A building on the property was sold and removed by the buyer so that construction on the plant could begin. The proceeds from the sale of the building should be a. classified as other income. b. deducted from the cost of the land. c. netted against the costs to clear the land and expensed as incurred. d. netted against the costs to clear the land and amortized over the life of the plant.

163.

Petty County owned an idle parcel of real estate consisting of land and a factory building. Petty gave title to this realty to Larson Co. as an incentive for Larson to establish manufacturing operations in Petty County. Larson paid nothing for this realty, which had a fair market value of $250,000 at the date of the grant. Larson should record this nonmonetary transaction as a a. memo entry only. b. credit to Contribution Revenue for $250,000. c. credit to extraordinary income for $250,000. d. credit to Donated Capital for $250,000.

164.

On September 10, 2008, Flint Co. incurred the following costs for one of its printing presses: Purchase of attachment $55,000 Installation of attachment 5,000 Replacement parts for renovation of press 18,000 Labor and overhead in connection with renovation of press 7,000 Neither the attachment nor the renovation increased the estimated useful life of the press. However, the renovation resulted in significantly increased productivity. What amount of the costs should be capitalized? a. $0 b. $67,000 c. $78,000 d. $85,000

10 - 32 Test Bank for Intermediate Accounting, Second Edition 165.

On January 2, 2008, Renn Corp. replaced its boiler with a more efficient one. The following information was available on that date: Purchase price of new boiler Carrying amount of old boiler Fair value of old boiler Installation cost of new boiler

$150,000 10,000 4,000 20,000

The old boiler was sold for $4,000. What amount should Renn capitalize as the cost of the new boiler? a. $170,000 b. $166,000 c. $160,000 d. $150,000 166.

Gant Co. purchased a machine on July 1, 2008, for $400,000. The machine has an estimated useful life of five years and a salvage value of $80,000. The machine is being depreciated from the date of acquisition by the 150% declining-balance method. For the year ended December 31, 2008, Gant should record depreciation expense on this machine of a. $120,000. b. $80,000. c. $60,000. d. $48,000.

167.

A machine with a five-year estimated useful life and an estimated 10% salvage value was acquired on January 1, 2006. The depreciation expense for 2008 using the doubledeclining balance method would be original cost multiplied by a. 90% × 40% × 40%. b. 60% × 60% × 40%. c. 90% × 60% × 40%. d. 40% × 40%.

168.

On April 1, 2006, Reiley Co. purchased new machinery for $240,000. The machinery has an estimated useful life of five years, and depreciation is computed by the sum-of-theyears'-digits method. The accumulated depreciation on this machinery at March 31, 2008, should be a. $160,000. b. $144,000. c. $96,000. d. $80,000.

169.

Mack Co. takes a full year's depreciation expense in the year of an asset's acquisition and no depreciation expense in the year of disposition. Data relating to one of Mack's depreciable assets at December 31, 2008 are as follows: Acquisition year Cost Residual value Accumulated depreciation Estimated useful life

2006 $140,000 20,000 96,000 5 years

Using the same depreciation method as used in 2006, 2007, and 2008, how much depreciation expense should Mack record in 2009 for this asset?

Accounting for Property, Plant, and Equipment a. b. c. d. 170.

Straight-line Yes Yes No No

Productive Output No Yes Yes No

Net income is understated if, in the first year, estimated salvage value is excluded from the depreciation computation when using the

a. b. c. d. 172.

$16,000 $24,000 $28,000 $32,000

A depreciable asset has an estimated 15% salvage value. At the end of its estimated useful life, the accumulated depreciation would equal the original cost of the asset under which of the following depreciation methods? a. b. c. d.

171.

10 - 33

Straight-line Method Yes Yes No No

Production or Use Method No Yes No Yes

A plant asset with a five-year estimated useful life and no residual value is sold at the end of the second year of its useful life. How would using the sum-of-the-years'-digits method of depreciation instead of the double-declining balance method of depreciation affect a gain or loss on the sale of the plant asset? a. b. c. d.

Gain Decrease Decrease Increase Increase

Loss Decrease Increase Decrease Increase

173.

Gray Football Co. had a player contract with Vance that is recorded in its books at $3,600,000 on July 1, 2008. Day Football Co. had a player contract with Simms that is recorded in its books at $4,500,000 on July 1, 2008. On this date, Gray traded Vance to Day for Simms and paid a cash difference of $450,000. The fair value of the Simms contract was $5,400,000 on the exchange date. The exchange had no commercial substance. After the exchange, the Simms contract should be recorded in Gray's books at a. $4,050,000. b. $4,500,000. c. $4,950,000. d. $5,400,000.

174.

Reed Co. exchanged nonmonetary assets with Wilton Co. No cash was exchanged and the exchange had no commercial substance. The carrying amount of the asset surrendered by Reed exceeded both the fair value of the asset received and Wilton's carrying amount of that asset. Reed should recognize the difference between the carrying amount of the asset it surrendered and

10 - 34 Test Bank for Intermediate Accounting, Second Edition a. b. c. d. 175.

the fair value of the asset it received as a loss. the fair value of the asset it received as a gain. Wilton's carrying amount of the asset it received as a loss. Wilton's carrying amount of the asset it received as a gain.

A company is constructing an asset for its own use. Construction began in 2007. The asset is being financed entirely with a specific new borrowing. Construction expenditures were made in 2007 and 2008 at the end of each quarter. The total amount of interest cost capitalized in 2008 should be determined by applying the interest rate on the specific new borrowing to the a. total accumulated expenditures for the asset in 2007 and 2008. b. average accumulated expenditures for the asset in 2007 and 2008. c. average expenditures for the asset in 2008. d. total expenditures for the asset in 2008.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

161. 162. 163.

c b b

164. 165. 166.

d a c

167. 168. 169.

b b a

170. 171. 172.

d b b

173. 174. *175.

a a b

DERIVATIONS — Computational No.

Answer Derivation

105.

$600,000 + $60,000 – $5,400 + $3,480 + $2,400 + $6,400 = $666,880.

106.

$31,200 + $2,600 + $10,440 + $2,200,000 + $170,000 = $2,414,240.

107.

Land: $200,000 + $20,000 + $5,000 – $10,000 = $215,000. Building: $35,000 + $1,090,000 = $1,125,000.

108.

$10,000 + $500 + $200 + $225 = $10,925.

109.

(2,000 × $50) – $6,000 = $94,000.

110.

($30,000 × .85 × .98) + $400 + $300 = $25,690.

111.

Land: 30/90 × $855,000 = $285,000. Warehouse: 20/90 × $855,000 = $190,000. Office Building: 40/90 × $855,000 = $380,000.

112.

$23,200 – $20,000 = $3,200 (gain).

113.

$100,000 – $10,000 = $90,000.

114.

[$200,000 – $10,000) ÷ 10,000] × 1,100 = $20,900.

115.

$150,000 × [(1 ÷ 8) × 2] = $37,500 ($150,000 – $37,500) × [(1 ÷ 8) × 2] = $28,125.

Accounting for Property, Plant, and Equipment

DERIVATIONS — Computational (cont.) No.

Answer Derivation

116.

[$150,000 – ($150,000 × 0.1)] × 0.2 = $27,000.

117.

[$60,000 × (1 – 0.5)] × 0.5 = $15,000.

118.

[$120,000 – ($120,000 × 0.2 × 0.75)] × 0.2 = $20,400.

119.

[$69,000 – ($69,000 × 0.4)] × 0.4 = $16,560.

120.

($24,000 – $6,000) × 1/6 = $3,000.

121.

$2,100,000 – [($2,100,000 – $75,000) × (9/45 + 8/45)] = $1,335,000.

122.

($50,000 – $5,000) × 1/36 = $1,250.

123.

($180,000 × 8/36 × 9/12) + ($180,000 × 7/36 × 3/12) = $38,750.

124.

(AC – $30,000) × 6/36 = $65,000 AC = $420,000.

125.

(AC – $15,000) × 7/55 = $70,000 AC = $565,000.

126.

$40,000 – [($40,000 – $4,000) ÷ 9 × 5] = $20,000 (BV) $22,000 – $20,000 = $2,000 (gain).

127.

($395,000 – $370,000) + [$125,000 – ($60,500 + $4,000)] = $85,500.

128.

$310,000 – {$325,000 – [$98,000 – ($58,800 – $4,300)]} = $28,500.

129.

[($250,000 – $25,000) ÷ 5] × 3 1/12 = $138,750.

130.

$300,000 – [($300,000 – $30,000) × 3/9] = $210,000 ($210,000 – $50,000) ÷ (5 – 3) = $80,000.

131.

($750,000 – $177,000) ÷ 5 = $114,600.

132.

[($500,000 ÷ 10) × 7] – $125,000 = $225,000 new (AD) $500,000 – $225,000 = $275,000; $275,000 ÷ 8 = $34,375 per year.

133.

[($400,000  10) × 6] – $96,000 = $144,000 new (AD) $440,000 – $144,000 = $296,000 (BV) ($296,000 – $20,000) ÷ 8 = $34,500 per year.

134.

[($25,000 – $1,000) × 106/120] = $21,200 [$800 – ($25,000 – $21,200)] = $3,000 loss.

135.

[($165,000 – $9,000) × 11.25/78] = $22,500.

10 - 35

10 - 36 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational (cont.) No.

Answer Derivation

136.

Fair market value of new truck = $36,000. Loss: ($36,000 – $30,000) – $4,000 = $2,000. New Machine: $8,000 + $30,000 – $2,000 = $36,000.

137.

$13,300 + $45,500 = $58,800.

138.

$0, gain on exchange of similar asset when cash is paid.

139.

$120,000 – $95,000 = $25,000; $27,500 – $25,000 = $2,500 $135,000 – $2,500 = $132,500.

140.

$12,000 ————————— × $24,000 = $4,800. $12,000 + $48,000

141.

$48,000 – ($24,000 – $4,800) = $28,800.

142.

$30,000 ————————— × $48,000 = $6,000. $30,000 + $210,000

143.

$210,000 – ($48,000 – $6,000) = $168,000 or $30,000 $192,000 – ————— × $192,000 = $168,000. $240,000

(

)

144.

145.

146.

($40,000 + $120,000) – $150,000 = $10,000 gain.

147.

[($160,000 – $10,000) ÷ 5] × 4 1/3 = $130,000 ($160,000 – $130,000) + $3,000 = $33,000.

148.

[($320,000 – $20,000) ÷ 5] × 4 1/3 = $260,000 ($320,000 – $260,000) + $6,000 = $66,000.

149.

($176,000 – $8,000) ÷ (10 × 12) = $1,400 per month $24,000 – [$176,000 – ($1,400 × 106 mo.)] = –$3,600.

150.

($152,000 – $8,000) ÷ (10 × 12) = $1,200/mo.; $28,000 – [$152,000 – ($1,200 × 108)] = $5,600.

151.

$1,250,000 ÷ [($900,000 + $1,100,000) ÷ 2] = 1.25

152.

$250,000 ÷ [($900,000 + $1,100,000) ÷ 2] = 25%

153.

$2,600,000 ÷ [($1,800,000 – $2,500,000) ÷ 2] = 1.21

Accounting for Property, Plant, and Equipment

DERIVATIONS — Computational (cont.) No.

Answer Derivation

*154.

[($20,000,000 + $600,000) – $1,600,000] ÷ 40 = $475,000.

*155.

($1,500,000 × 6/12) + ($3,300,000 × 4/12) = $1,850,000.

*156.

$400,000 × .10 = $40,000.

*157.

$180,000 × (3/12 + 2/12 + 1/12) = $90,000.

*158.

($720,000 × 9% × 10/12) + ($300,000 × 12%) = $90,000.

*159.

($720,000 × .09) + ($150,000 × .12) = $82,800.

*160.

($440,000 × .1) + ($160,000 × .09) = $58,400.

DERIVATIONS — CPA Adapted No.

Answer Derivation

161.

$800,000 + $70,000 + $10,000 + $16,000 – $8,000 = $888,000.

162.

Conceptual.

163.

Conceptual.

164.

$55,000 + $5,000 + $18,000 + $7,000 = $85,000.

165.

$150,000 + $20,000 = $170,000.

166.

$400,000 × 0.3 × 0.5 = $60,000.

167.

Conceptual.

168.

$240,000 × (5/15 + 4/15) = $144,000.

169.

2/15 × ($140,000 – $20,000) = $16,000.

170.

Conceptual.

171.

Conceptual.

172.

Conceptual.

173.

($5,400,000 – $450,000) – $3,600,000 = $1,350,000 (deferred gain) $5,400,000 – $1,350,000 = $4,050,000 (Basis).

174.

Conceptual.

*175.

Conceptual.

10 - 37

10 - 38 Test Bank for Intermediate Accounting, Second Edition

EXERCISES Ex. 10-176—Plant asset accounting. During 2008 and 2009, Gorman Corporation experienced several transactions involving plant assets. A number of errors were made in recording some of these transactions. For each item listed below, indicate the effect of the error (if any) in the blanks provided by using the following codes: O = Overstate; U = Understate; NE = No Effect If no error was made, write NE in each of the four columns.

Transaction

2008 Net Book Value of Plant 2008 Assets at Net 12/31/08 Income

1. The cost of installing a new computer system in 2008 was not recorded in 2008. _______ It was charged to expense in 2009.

2009 Net Book Value of Plant 2009 Assets at Net 12/31/09 Income

______

_______

______

_______

______

_______

______

_______

______

_______

______

2. In 2009 clerical workers were trained to use the new computer system at a cost of $15,000, which was erroneously capitalized. The cost is to be written off over the expected life of the new computer system. 3. A major overhaul of factory machinery in 2008, which extended its useful life by 5 years, was charged to accumulated depreciation in 2008. 4. Interest cost qualifying for capitalization in 2008 was charged to interest expense in 2008. 5. In 2008 land was bought for an employee parking lot. The $2,000 title search fee was charged to expense in 2008. 6. The cost of moving several manufacturing facilities from metropolitan locations to suburban areas in 2008 was capitalized. The cost was written off over a 10-year period beginning in 2008.

Accounting for Property, Plant, and Equipment

10 - 39

Solution 10-176 Net Book Value of Plant Assets at 12/31/08 U NE NE U U NE

1. 2. 3. 4. 5. 6.

2008 Net Income O NE NE U U NE

Net Book Value of Plant Assets at 12/31/09 U O NE U U NE

2009 Net Income U O NE O NE NE

Ex. 10-177—Donated assets. Perez Company has recently decided to accept a proposal from the City of Bel Aire that publicly owned property with a large warehouse located on it will be donated to Perez if Perez will build a branch plant in Bel Aire. The appraised value of the property is $490,000 and of the warehouse is $980,000. Instructions Prepare the entry by Perez for the receipt of the properties.

Solution 10-177 Building (Warehouse)..................................................................... Land............................................................................................... Contribution Revenue .........................................................

980,000 490,000 1,470,000

Ex. 10-178—Capitalizing vs. Expensing. Consider each of the items below. Place the proper letter in the blank space provided to indicate the nature of the account or accounts to be debited when recording each transaction using the preferred accounting treatment. Prepayments should be recorded in balance sheet accounts. Disregard income tax considerations unless instructed otherwise. a. b. c. d. e.

asset(s) only accumulated depreciation only expense only asset(s) and expense some other account or combination of accounts

____ 1. A motor in one of Grant Company’s trucks was overhauled at a cost of $600. It is expected that this will extend the life of the truck for two years. ____ 2. Machinery which had originally cost $130,000 was rearranged at a cost of $450, including installation, in order to improve production.

10 - 40 Test Bank for Intermediate Accounting, Second Edition Ex. 10-178 (cont.) ____ 3. Long Bike Company recently purchased land and two buildings for a total cost of $35,000, and entered the purchase on the books. The $1,200 cost of razing the smaller building, which has an appraisal value of $6,200, is recorded. ____ 4. Sanders Company traded its old machine with a net book value of $3,000 plus cash of $7,000 for a new one which had a fair market value of $9,000. ____ 5. Ken Ellis and Barb Potter, maintenance repair workers, spent five days in unloading and setting up a new $6,000 precision machine in the plant. The wages earned in this five-day period, $480, are recorded. ____ 6. On June 1, the Colter Hotel installed a sprinkler system throughout the building at a cost of $13,000. As a result the insurance rate was decreased by 40%. ____ 7. An improvement, which extended the life but not the usefulness of the asset, cost $6,000. ____ 8. The attic of the administration building was finished at a cost of $3,000 to provide an additional office. ____ 9. In March, the Iola Theatre bought projection equipment on the installment basis. The contract price was $23,610, payable $5,610 down, and $2,250 a month for the next eight months. The cash price for this equipment was $22,530. ____ 10. Tinsley Company recorded the first year’s interest on 6%, $100,000, ten-year bonds sold a year ago at 94. The bonds were sold in order to finance the construction of a hydroelectric plant. Six months after the sale of the bonds, the construction of the hydroelectric plant was completed and operations were begun. (Only cash interest, and not discount amortization, is to be considered.)

Solution 10-178 1. 2. 3. 4. 5.

b a or c a e a

6. 7. 8. 9. 10.

a b a e d

Ex. 10-179—Definitions. Provide clear, concise answers for the following. 1. Define depreciation. 2. Define depreciation accounting. 3. Does depreciation accounting provide funds? If not, what does provide funds? What does depreciation accounting do related to funds?

Accounting for Property, Plant, and Equipment

10 - 41

Solution 10-179 1. Depreciation is the decline in service potentials or in future benefits of a plant asset due to physical or economic factors. 2. Depreciation accounting is the systematic and rational allocation of the cost of plant assets to the periods benefited from the use of the assets. 3. Depreciation accounting does not provide funds. Revenues provide funds. Depreciation accounting retains funds by reducing income taxes and dividends.

Ex. 10-180—True or False. Place T or F in front of each of the following statements. ____ 1. The straight-line method of depreciation is based on the assumption that depreciation expense can be regarded as a constant function of time. ____ 2. Plant assets should be written down (below cost) when their market value has declined temporarily. ____ 3. The accounting profession has developed specifically recommended procedures for recording appraisal increases with respect to plant assets. ____ 4. An asset's cost minus its accumulated depreciation equals its book value. ____ 5. The sum-of-the-years'-digits method of depreciation ignores salvage value in the computation of an asset's depreciable base. ____ 6. When using the double-declining balance method of determining depreciation, a declining percentage is applied to a constant book value. ____ 7. The book value of plant assets declines more rapidly under decreasing-charge methods than under the straight-line method. ____ 8. Accounting depreciation is computed by determining the change in the market value of a company's plant assets during the period under review. ____ 9. The methods of depreciation based upon output assume that obsolescence will not significantly affect the usefulness of the asset. ____ 10. The correction of prior periods' depreciation estimates would be disclosed on the retained earnings statement.

Solution 10-180 1. 2.

T F

3. 4.

F T

5. 6.

F F

7. 8.

T F

9. 10.

T F

10 - 42 Test Bank for Intermediate Accounting, Second Edition Ex. 10-181—Depreciation methods. Each of the statements appearing below is descriptive of one or more of the following depreciation methods. In the spaces below, place the letter(s) belonging to the method(s) to which the statement best applies. a. Declining-balance b. Straight-line c. Sum-of-the-years'-digits

d. Units of output e. Working hours

____ 1. The depreciation charged by this method decreases by the same amount each year. ____ 2. Once the depreciable base, scrap value, and life of a plant asset are determined, the annual charges to operations under this method will be the same. ____ 3. These methods allocate larger shares of the cost of a plant asset to expense during the years in which the greatest use is made of the asset. ____ 4. These methods always allocate larger shares of the cost of a plant asset to expense during the earlier years of its life.

Solution 10-181 1. c 2. b

3. d, e 4. a, c

Ex. 10-182—Calculate depreciation. A machine which cost $200,000 is acquired on October 1, 2008. Its estimated salvage value is $20,000 and its expected life is eight years. Instructions Calculate depreciation expense for 2008 and 2009 by each of the following methods, showing the figures used. (a) Double-declining balance (b) Sum-of-the-years'-digits

Solution 10-182 (a) 2008: 25% × $200,000 × ¼

$12,500

2009: 25% × $187,500

$46,875

(b) 2008: 8/36 × $180,000 × ¼

$10,000

2009: 8/36 × $180,000 × ¾ 7/36 × $180,000 × ¼

= =

$30,000 8,750 $38,750

Accounting for Property, Plant, and Equipment

10 - 43

Ex. 10-183—Calculate depreciation. A machine cost $500,000 on April 1, 2008. Its estimated salvage value is $50,000 and its expected life is eight years. Instructions Calculate the depreciation expense (to the nearest dollar) by each of the following methods, showing the figures used. (a) Straight-line for 2008 (b) Double-declining balance for 2009 (c) Sum-of-the-years'-digits for 2009

Solution 10-183 (a) 1/8 × $450,000 × ¾

$42,188

(b) 2009: 25% × $406,250

= $101,563

= =

$25,000 65,625 $90,625

Ex. 10-184—Asset depreciation and disposition. Answer each of the following questions. 1. A plant asset purchased for $150,000 has an estimated life of 10 years and a residual value of $12,000. Depreciation for the second year of use, determined by the declining-balance method at twice the straight-line rate is $_____________. 2. A plant asset purchased for $200,000 at the beginning of the year has an estimated life of 5 years and a residual value of $20,000. Depreciation for the second year, determined by the sum-of-the-years'-digits method is $______________. 3. A plant asset with a cost of $160,000 and accumulated depreciation of $45,000, is given together with cash of $60,000 in exchange for a similar asset worth $165,000. The gain or loss recognized on the disposal (indicate by "G" or "L") is $______________. 4. A plant asset with a cost of $216,000, estimated life of 5 years, and residual value of $36,000, is depreciated by the straight-line method. This asset is sold for $160,000 at the end of the second year of use. The gain or loss on the disposal (indicate by "G" or "L") is $___________.

Solution 10-184 1. 2. 3. 4.

$24,000 $48,000 $10,000 L $16,000 G

10 - 44 Test Bank for Intermediate Accounting, Second Edition Ex. 10-185—Nonmonetary exchange. A machine cost $80,000, has annual depreciation expense of $16,000, and has accumulated depreciation of $40,000 on December 31, 2008. On April 1, 2009, when the machine has a fair value of $32,000, it is exchanged for a similar machine with a fair value of $96,000 and the proper amount of cash is paid. The exchange lacked commercial substance. Instructions Prepare all entries that are necessary at April 1, 2009.

Solution 10-185 Depreciation Expense ($16,000 × 3/12) ......................................... Accumulated Depreciation .................................................

4,000

Accumulated Depreciation ............................................................. Machinery ...................................................................................... Loss on Disposal ............................................................................ Machinery .......................................................................... Cash ($96,000 – $32,000) .................................................

44,000 96,000 4,000

4,000

80,000 64,000

Ex. 10-186—Nonmonetary exchange. Equipment that cost $80,000 and has accumulated depreciation of $63,000 is exchanged for similar equipment with a fair value of $35,000 and $15,000 cash is received. The exchange lacked commercial substance. Instructions (a) Show the calculation of the gain to be recognized from the exchange. (b) Prepare the entry for the exchange. Show a check of the amount recorded for the new equipment.

Solution 10-186 (a) Cost Accumulated depreciation Book value Fair value ($35,000 + $15,000) Gain Gain recognized (15/50 × $33,000)

$80,000 (63,000) 17,000 50,000 $33,000 $ 9,900

(b) Accumulated Depreciation ...................................................... Equipment ............................................................................... Cash ....................................................................................... Equipment ................................................................... Gain on Disposal .........................................................

63,000 11,900 15,000 80,000 9,900

Accounting for Property, Plant, and Equipment

10 - 45

Solution 10-186 (cont.) Check: Fair value Less deferred gain Basis of new equipment

$35,000 (23,100) $11,900

*Ex. 10-187—Weighted-Average Accumulated Expenditures. On April 1, Tyler Co. began construction of a small building. Payments of $120,000 were made monthly for four months beginning on April 1. The building was completed and ready for occupancy on August 1. For the purpose of determining the amount of interest cost to be capitalized, calculate the weighted-average accumulated expenditures on the building by completing the schedule below: Date

Expenditures

Capitalization Period

Weighted-Average Expenditures

Expenditures $120,000 120,000 120,000 120,000

Capitalization Period 4/12 3/12 2/12 1/12

Weighted-Average Expenditures $ 40,000 30,000 20,000 10,000 $100,000

*Solution 10-187 Date April 1 May 1 June 1 July 1

*Ex. 10-188—Capitalization of interest. On March 1, Gatt Co. began construction of a small building. The following expenditures were incurred for construction: March 1 May 1 July 1

$ 75,000 180,000 100,000

April 1 June 1

$ 74,000 270,000

The building was completed and occupied on July 1. To help pay for construction $50,000 was borrowed on March 1 on a 12%, three-year note payable. The only other debt outstanding during the year was a $500,000, 10% note issued two years ago. Instructions (a) Calculate the weighted-average accumulated expenditures. (b) Calculate avoidable interest. *Solution 10-188 (a) Date March 1 April 1 May 1 June 1 July 1

Expenditures $ 75,000 74,000 180,000 270,000 100,000

Capitalization Period 4/12 3/12 2/12 1/12 0

Weighted-Average Accum. Expend. $25,000 18,500 30,000 22,500 0 $96,000

10 - 46 Test Bank for Intermediate Accounting, Second Edition *Solution 10-188 (cont.) (b)

Weighted-Average Accum. Expend. $50,000 46,000 $96,000

Avoidable Interest $ 6,000 4,600 $10,600

Rate .12 .10

PROBLEMS Pr. 10-189—Capitalizing acquisition costs. Myers Manufacturing Co. was incorporated on 1/2/08 but was unable to begin manufacturing activities until 8/1/08 because new factory facilities were not completed until that date. The Land and Building account at 12/31/08 per the books was as follows: Date 1/31/08 2/28/08 4/1/08 5/1/08 5/1/08 5/1/08 8/1/08 8/1/08 12/31/08

Item Land and dilapidated building Cost of removing building Legal fees Fire insurance premium payment Special tax assessment for streets Partial payment of new building construction Final payment on building construction General expenses Asset write-up

Amount $200,000 4,000 6,000 5,400 4,500 150,000 150,000 30,000 75,000 $624,900

Additional information: 1. To acquire the land and building on 1/31/08, the company paid $100,000 cash and 1,000 shares of its common stock (par value = $100/share) which is very actively traded and had a market value per share of $170. 2. When the old building was removed, Myers paid Kwik Demolition Co. $4,000, but also received $1,500 from the sale of salvaged material. 3. Legal fees covered the following: Cost of organization Examination of title covering purchase of land Legal work in connection with the building construction

$2,500 2,000 1,500 $6,000

4. The fire insurance premium covered premiums for a three-year term beginning May 1, 2008. 5. General expenses covered the following for the period 1/2/08 to 8/1/08. President's salary Plant superintendent covering supervision of new building

$20,000 10,000 $30,000

6. Because of the rising land costs, the president was sure that the land was worth at least $75,000 more than what it cost the company.

Accounting for Property, Plant, and Equipment

10 - 47

Pr. 10-189 (cont.) Instructions Determine the proper balances as of 12/31/08 for a separate land account and a separate building account. Use separate T-accounts (one for land and one for building) labeling all the relevant amounts and disclosing all computations.

Solution 10-189 Land Land and old building ($100,000 plus $170,000) Removal of old building ($4,000 – $1,500) Legal fees Special assessment Balance

270,000 2,500 2,000 4,500 279,000

Building Legal Fees Partial payment Insurance (3 months) Final payment Superintendent's salary Balance

1,500 150,000 450 150,000 10,000 311,950

Pr. 10-190—Depreciation methods. On July 1, 2008, Nyland Company purchased for $2,160,000 snow-making equipment having an estimated useful life of 5 years with an estimated salvage value of $90,000. Depreciation is taken for the portion of the year the asset is used. Instructions (a) Complete the form below by determining the depreciation expense and year-end book values for 2008 and 2009 using the 1. sum-of-the-years'-digits method. 2. double-declining balance method. Sum-of-the-Years'-Digits Method Equipment Less: Accumulated Depreciation Year-End Book Value Depreciation Expense for the Year

2008 $2,160,000 ______ ______ ______

2009 $2,160,000 _______ _______ _______

Double-Declining Balance Method Equipment Less: Accumulated Depreciation Year-End Book Value Depreciation Expense for the Year

$2,160,000 ______ ______ ______

$2,160,000 _______ _______ _______

10 - 48 Test Bank for Intermediate Accounting, Second Edition Pr. 10-190 (cont.) (b) Assume the company had used straight-line depreciation during 2008 and 2009. During 2010, the company determined that the equipment would be useful to the company for only one more year beyond 2010. Salvage value is estimated at $120,000. Compute the amount of depreciation expense for the 2010 income statement.

Solution 10-190 (a) Sum-of-the-Years'-Digits Accumulated Depreciation Book Value Depreciation Expense

2008 $ 345,000 1,815,000 345,000

2009 $ 966,000 1,194,000 621,000

Double-Declining Balance Accumulated Depreciation Book Value Depreciation Expense

$ 432,000 1,728,000 432,000

$1,123,200 1,036,800 691,200

(b) Cost Depreciation Salvage

$2,160,000 (621,000) (120,000) $1,419,000 × 1/2 = $709,500, 2010 depreciation

Pr. 10-191—Adjustment of Depreciable Base. A truck was acquired on July 1, 2005, at a cost of $216,000. The truck had a six-year useful life and an estimated salvage value of $24,000. The straight-line method of depreciation was used. On January 1, 2008, the truck was overhauled at a cost of $20,000, which extended the useful life of the truck for an additional two years beyond that originally estimated (salvage value is still estimated at $24,000). In computing depreciation for annual adjustment purposes, expense is calculated for each month the asset is owned. Instructions Prepare the appropriate entries for January 1, 2008 and December 31, 2008.

Solution 10-191 Cost Less salvage value Depreciable base, July 1, 2005 Less depreciation to date [($192,000 ÷ 6) × 2 1/2] Depreciable base, Jan. 1, 2008 (unadjusted) Overhaul Depreciable base, Jan. 1, 2008 (adjusted)

$216,000 24,000 192,000 80,000 112,000 20,000 $132,000

January 1, 2008 Accumulated Depreciation.............................................................. Cash ...................................................................................

20,000 20,000

Accounting for Property, Plant, and Equipment

10 - 49

Solution 10-191 (cont.) December 31, 2008 Depreciation Expense .................................................................... Accumulated Depreciation ($132,000 ÷ 5.5 yrs) .................

24,000 24,000

Pr. 10-192—Nonmonetary exchange. Ferry Corporation follows a policy of a 10% depreciation charge per year on all machinery and a 5% depreciation charge per year on buildings. The following transactions occurred in 2008: March 31, 2008— Negotiations which began in 2007 were completed and a warehouse purchased 1/1/99 (depreciation has been properly charged through December 31, 2007) at a cost of $3,200,000 with a fair market value of $2,000,000 was exchanged for a second warehouse which also had a fair market value of $2,000,000. The exchange had no commercial substance. Both parcels of land on which the warehouses were located were equal in value, and had a fair value equal to book value. June 30, 2008— Machinery with a cost of $240,000 and accumulated depreciation through January 1 of $180,000 was exchanged with $150,000 cash for a parcel of land with a fair market value of $230,000. Instructions Prepare all appropriate journal entries for Ferry Corporation for the above dates.

Solution 10-192 3/31/08 Depreciation Expense...................................................... Accumulated Depreciation—Warehouse .......... ($3,200,000 × 5% × 1/4)

40,000 40,000

Warehouse ...................................................................... 1,720,000 Accumulated Depreciation—Warehouse ......................... 1,480,000 Warehouse........................................................ ($3,200,000 × 5% × 9 1/4 = $1,480,000) 6/30/08 Depreciation Expense...................................................... Accumulated Depreciation—Machinery............. ($240,000 × 10% × 1/2)

3,200,000

12,000

Land ................................................................................ 230,000 Accumulated Depreciation—Machinery ........................... 192,000 Gain on Exchange............................................. Machinery ......................................................... Cash ................................................................. [$80,000 – ($240,000 – $192,000)] = $32,000

12,000

32,000 240,000 150,000

10 - 50 Test Bank for Intermediate Accounting, Second Edition Pr. 10-193—Nonmonetary exchange. Gorman Co. had a sheet metal cutter that cost $96,000 on January 5, 2004. This old cutter had an estimated life of ten years and a salvage value of $16,000. On April 3, 2009, the old cutter is exchanged for a new cutter with a market value of $48,000. The exchange lacked commercial substance. Gorman also received $12,000 cash. Assume that the last fiscal period ended on December 31, 2008, and that straight-line depreciation is used. Instructions (a) Show the calculation of the amount of the gain or loss to be recognized by Gorman Co. (b) Prepare all entries that are necessary on April 3, 2009. Show a check of the amount recorded for the new cutter.

Solution 10-193 (a)

(b)

Cost Accumulated depreciation (5 1/4 × $8,000) Book value Fair value ($48,000 + $12,000) Gain

$96,000 (42,000) 54,000 60,000 $ 6,000

Gain recognized (12/60 × $6,000)

$ 1,200

Depreciation Expense ......................................................... Accumulated Depreciation.......................................

2,000

Accumulated Depreciation .................................................. Machinery ........................................................................... Cash ................................................................................... Machinery .............................................................. Gain on Disposal .................................................... Check: Fair value $48,000 Less deferred gain (4,800) Basis of new machinery $43,200

42,000 43,200 12,000

2,000

96,000 1,200

Pr. 10-194—Nonmonetary exchange. Pratt Co. has a machine that cost $255,000 on March 20, 2004. This old machine had an estimated life of ten years and a salvage value of $15,000. On December 23, 2008, the old machine is exchanged for a new machine with a market value of $162,000. The exchange lacked commercial substance. Pratt also received $18,000 cash. Assume that the last fiscal period ended on December 31, 2007, and that straight-line depreciation is used. Instructions (a) Show the calculation of the amount of gain or loss to be recognized by Pratt Co. from the exchange. (Round to the nearest dollar.) (b) Prepare all entries that are necessary on December 23, 2008. Show a check of the amount recorded for the new machine.

Accounting for Property, Plant, and Equipment

10 - 51

Solution 10-194 (a)

(b)

Cost Accumulated depreciation (4 3/4 × $24,000) Book value Fair value ($162,000 + $18,000) Gain

$255,000 (114,000) 141,000 180,000 $ 39,000

Gain recognized (18/180 × $39,000)

Depreciation Expense ........................................................ Accumulated Depreciation ......................................

3,900 24,000

Accumulated Depreciation .................................................. 114,000 Machine.............................................................................. 126,900 Cash ................................................................................... 18,000 Machine .................................................................. Gain on Disposal..................................................... Check: Fair value $162,000 Deferred gain (35,100) Basis of new machine $126,900

24,000

255,000 3,900

Pr. 10-195—Nonmonetary exchange. Silas Co. exchanged Building 24 which has an appraised value of $3,200,000, a cost of $5,060,000, and accumulated depreciation of $2,400,000 for Building M belonging to Mock Co. Building M has an appraised value of $3,008,000, a cost of $6,020,000, and accumulated depreciation of $3,168,000. The correct amount of cash was also paid. Assume depreciation has already been updated. Instructions Prepare the entries on both companies' books assuming the exchange had no commercial substance. Show a check of the amount recorded for Building M on Silas's books. (Round to the nearest dollar.)

Solution 10-195 Silas Co.: Cost Accumulated depreciation Book value Fair value Gain

$5,060,000 2,400,000 2,660,000 3,200,000 $ 540,000

Gain recognized (192/3,200 × $540,000)

$32,400

Accumulated Depreciation .................................................. 2,400,000 Building M .......................................................................... 2,500,400 Cash ................................................................................... 192,000 Building 24 .............................................................. Gain on Disposal.....................................................

5,060,000 32,400

10 - 52 Test Bank for Intermediate Accounting, Second Edition Solution 10-195 (cont.) Check: Fair value Deferred gain Basis for Building M Mock Co.: Cost Accumulated Depreciation Book value Fair value Gain

$3,008,000 (507,600) $2,500,400 $6,020,000 3,168,000 2,852,000 3,008,000 $ 156,000

Accumulated Depreciation .................................................. 3,168,000 Building 24 .......................................................................... 3,044,000 Building M ............................................................... Cash .......................................................................

6,020,000 192,000

Pr. 10-196—Nonmonetary exchange. Edmond Company exchanged machinery with an appraised value of $1,755,000, a recorded cost of $2,700,000 and Accumulated Depreciation of $1,350,000 with Rosen Corporation for machinery Rosen owns. The machinery has an appraised value of $1,695,000, a recorded cost of $3,240,000, and Accumulated Depreciation of $1,782,000. Rosen also gave Edmond $60,000 in the exchange. Assume depreciation has already been updated. Instructions (a) Prepare the entries on both companies' books assuming that the exchange had commercial substance. (Round all computations to the nearest dollar.) (b) Prepare the entries on both companies' books assuming that the exchange lacked commercial substance. (Round all computations to the nearest dollar.)

Solution 10-196 (a)

Dissimilar Assets Edmond Machinery ...................................... 1,695,000 Cash .............................................. 60,000 Accumulated Depreciation— Machinery ................................. 1,350,000 Gain on Exchange of Plant Assets ................. 405,000 Machinery ....................... 2,700,000 Rosen Machinery ...................................... 1,755,000 Accumulated Depreciation— Machinery ................................. 1,782,000 Gain on Exchange of Plant Assets ................. 237,000 Machinery ....................... 3,240,000 Cash ............................... 60,000

Cost A/D BV FV Gain

$2,700,000 1,350,000 1,350,000 1,755,000 $ 405,000

Cost A/D BV FV Gain

$3,240,000 1,782,000 1,458,000 1,695,000 $ 237,000

Accounting for Property, Plant, and Equipment

10 - 53

Solution 10-196 (b)

Similar Assets Edmond Machinery................................................................................... 1,303,846 Cash........................................................................................... 60,000 Accumulated Deprecation—Machinery....................................... 1,350,000 Gain on Exchange ....................................................... Machinery ....................................................................

13,846 2,700,000

$60,000 ÷ ($60,000 + $1,695,000) × $405,000 = $13,846 Rosen Machinery................................................................................... 1,518,000 Accumulated Depreciation—Machinery ...................................... 1,782,000 Machinery .................................................................... Cash ............................................................................

3,240,000 60,000

*Pr. 10-197—Capitalization of interest. During 2008, Naylor Building Company constructed various assets at a total cost of $8,400,000. The weighted average accumulated expenditures on assets qualifying for capitalization of interest during 2008 were $5,600,000. The company had the following debt outstanding at December 31, 2008: 1. 10%, 5-year note to finance construction of various assets, dated January 1, 2008, with interest payable annually on January 1

$3,600,000

2. 12%, ten-year bonds issued at par on December 31, 2002, with interest payable annually on December 31

4,000,000

3. 9%, 3-year note payable, dated January 1, 2007, with interest payable annually on January 1

2,000,000

Instructions Compute the amounts of each of the following (show computations). 1. Avoidable interest. 2. Total interest to be capitalized during 2008.

*Solution 10-197 1.

Weighted Average Accumulated Expenditures $3,600,000 2,000,000 $5,600,000

Applicable Interest Rate .10 .11*

Avoidable Interest $360,000 220,000 $580,000 = Avoidable Interest

10 - 54 Test Bank for Intermediate Accounting, Second Edition *Solution 10-197 (cont.) *Computation of weighted average interest rate: Principal 12% ten-year bonds $4,000,000 9% 3-year note 2,000,000 $6,000,000

Interest $480,000 180,000 $660,000

Weighted average interest rate = $660,000 ÷ $6,000,000 = 11%. 2. Actual interest cost during 2008: Construction note, $3,600,000 × .10 12% ten-year bonds, $4,000,000 × .12 9% three-year note, $2,000,000 × .09

$ 360,000 480,000 180,000 $1,020,000

The interest cost to be capitalized is $580,000 (the lesser of the $580,000 avoidable interest and the $1,020,000 actual interest).

*Pr. 10-198—Capitalization of interest. Early in 2008, Maley Corporation engaged Reese, Inc. to design and construct a complete modernization of Maley's manufacturing facility. Construction was begun on June 1, 2008 and was completed on December 31, 2008. Maley made the following payments to Reese, Inc. during 2008: Date Payment June 1, 2008 $3,600,000 August 31, 2008 5,400,000 December 31, 2008 4,500,000 In order to help finance the construction, Maley issued the following during 2008: 1. $3,200,000 of 10-year, 9% bonds payable, issued at par on May 31, 2008, with interest payable annually on May 31. 2. 1,000,000 shares of no-par common stock, issued at $10 per share on October 1, 2008. In addition to the 9% bonds payable, the only debt outstanding during 2008 was a $750,000, 12% note payable dated January 1, 2004 and due January 1, 2014, with interest payable annually on January 1. Instructions Compute the amounts of each of the following (show computations): 1. Weighted-average accumulated expenditures qualifying for capitalization of interest cost. 2. Avoidable interest incurred during 2008. 3. Total amount of interest cost to be capitalized during 2008.

Accounting for Property, Plant, and Equipment

10 - 55

*Solution 10-198 1. Date June 1 August 31 December 31

Weighted-Average Accumulated Expenditures $3,000,000 900,000 $3,900,000

Capitalization Expenditures $3,600,000 5,400,000 4,500,000

Period 7/12 4/12 0

Appropriate Interest Rate .09 .12

Actual interest incurred during 2008: 9% bonds payable, $3,200,000 × .09 × 7/12 12% note payable, $750,000 × .12

Weighted-Average Accumulated Expenditures $2,100,000 1,800,000 0 $3,900,000

Avoidable Interest $270,000 108,000 $378,000

$168,000 90,000 $258,000

The interest cost to be capitalized is $258,000 (the lesser of the $378,000 avoidable interest and the $258,000 actual interest cost).

CHAPTER 11 INTANGIBLE ASSETS TRUE-FALSE—Conceptual Answer

No.

Description

F F F F F F T T T T F F T F T T T F F F T F T T T F F T F T T F T F T

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35.

Characteristics of intangible assets. Intangible assets’ characteristics. Accounting for internally incurred costs. Internally created intangibles. Recording internally generated intangibles. Amortization of limited-life intangible assets. Amortization of intangible assets. Amortizing limited-life intangibles. Amortizing intangible assets. Life of a trademark. Legal life of a copyright. Legal fees and patents. Accounting for a customer list. Amortization of patents. Modification of an existing patent. Basic concept of goodwill. Internally generated goodwill. Recording internally generated goodwill. Definition of goodwill. Goodwill as master valuation account. Concept of “badwill.” Impairment of indefinite-life intangibles. Impairment of goodwill. Impairment of intangibles. Recognition of impairment loss. Recovery of impairment loss. Impairment of intangibles. Example of research and development costs. Capitalizing research and development costs. Accounting for R & D costs. Expensing R & D costs. Accounting for start-up costs. Recording research and development costs. Reporting intangible assets. Disclosure of R & D costs.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

c b d d

36. 37. 38. 39.

Accounting for internally-created intangibles. Amortization methods for intangible assets. Cost of intangible asset. Factors in determining useful life.

11 - 2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

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

40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71.

Classifying intangible assets. Intangible asset useful life. Capitalizing trademark costs. Accounting for trademark cost. Patent amortization. Patent amortization. Legal fees associated with patent infringement. Identification of intangible assets. Amortization of intangible assets. Entry to record patent amortization. Accounting for goodwill. Goodwill as master valuation account. Reporting of "negative goodwill." Accounting for goodwill. Recording goodwill. Amortization of goodwill. Write-off of goodwill. Accounting for negative goodwill. Impairment of property, plant, and equipment. Recording an asset impairment. Impairment of intangible asset. Impairment test for indefinite-life intangibles. Accounting for organization costs. Capitalization of certain R & D costs. Accounting principle for R & D expenditures. Accounting for R & D costs. Costs excluded from R & D expense. Depreciation of laboratory building used in R & D. Operating losses during start-up period. Accounting for organization costs. Classification of R & D expense. Reporting patent amortization.

MULTIPLE CHOICE—Computational Answer

No.

Description

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

72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83.

Valuation of patent. Valuation of patent. Intangible asset amortization. Intangible asset amortization. Computing amortization expense and franchise loss. Computing franchise amortization expense. Computing patent amortization expense. Computing patent amortization expense. Calculate total intangible assets. Determine amount of worthless patent to be written off. Calculate patent amortization. Calculate trademark amortization.

Intangible Assets

MULTIPLE CHOICE—Computational (cont.) Answer

No.

Description

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

84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104.

Exchange of similar intangible assets. Calculate patent amortization. Calculate goodwill amount. Calculate goodwill amount. Calculate amount of goodwill. Proper accounting when fair value of net assets acquired exceeds cost. Calculate goodwill impairment. Calculate impairment loss. Calculate patent carrying value. Calculate patent carrying value. Calculate loss on impairment of goodwill. Calculate loss on impairment of goodwill. Recording impairment loss. Calculate impairment loss. Recognizing loss on impairment. Recognizing loss on impairment. Accounting for start-up costs. Calculate R & D expense. Calculate R & D expense. Calculate R & D expense. Calculate R & D expense.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

a c d d c d c a c a

105. 106. 107. 108. 109. 110. 111. 112. 113. 114.

Determine capitalized patent costs. Valuation of patent exchanged for common stock. Valuation of patent exchanged for treasury stock. Valuation and amortization of a patent. Amortization of a patent. Amortization of a copyright. Capitalization of legal fees. Amortization of goodwill. Calculate R & D expense. Determine R & D expense for the year.

EXERCISES Item E11-115 E11-116 E11-117 E11-118 E11-119 E11-120 E11-121 E11-122

Description Short essay questions. Intangible assets questions. Intangible assets theory. Accounting for patent. Carrying value of patent. Accounting for patent. Impairment of copyrights. Acquisition of tangible and intangible assets.

11 - 3

11 - 4

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Item P11-123 P11-124

Description Intangible assets. Goodwill, impairment.

CHAPTER LEARNING OBJECTIVES 1.

Describe the characteristics of intangible assets.

Identify the costs to include in the initial valuation of intangible assets.

Explain the procedure for amortizing intangible assets.

Describe the types of intangible assets.

Explain the conceptual issues related to goodwill.

Describe the accounting procedures for recording goodwill.

Explain the accounting issues related to impairments.

Identify the conceptual issues related to research and development costs.

Describe the accounting for research and development and similar costs.

10.

Indicate the presentation of intangible assets and related items.

Intangible Assets

11 - 5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

110.

6. 7. 8.

TF TF TF

9. 10. 37.

TF TF MC

38. 39. 40.

11. 12. 13. 14. 15.

TF TF TF TF TF

42. 43. 44. 45. 46.

MC MC MC MC MC

47. 48. 78. 79. 80.

16.

49.

50.

17. 18. 19.

TF TF TF

20. 21. 51.

TF TF MC

52. 53. 54.

22. 23. 24. 25.

TF TF TF TF

26. 27. 58. 59.

TF TF MC MC

60. 61. 90. 91.

28. 29.

TF TF

30. 62.

TF MC

63. 64.

31. 32. 33.

TF TF TF

66. 67. 68.

MC MC MC

69. 70. 101.

34.

35.

71.

Note: TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 E 115. E Learning Objective 2 TF 36. MC 72. Learning Objective 3 MC 41. MC 76. MC 74. MC 77. MC 75. MC 115. Learning Objective 4 MC 81. MC 105. MC 82. MC 106. MC 83. MC 107. MC 84. MC 108. MC 85. MC 109. Learning Objective 5 MC 112. MC 115. Learning Objective 6 MC 55. MC 86. MC 56. MC 87. MC 57. MC 88. Learning Objective 7 MC 92. MC 96. MC 93. MC 97. MC 94. MC 98. MC 95. MC 99. Learning Objective 8 MC 65. MC MC 100. MC Learning Objective 9 MC 102. MC 105. MC 103. MC 113. MC 104. MC 114. Learning Objective 10 MC E = Exercise P = Problem

Type

Item

Type

Item

Type

73.

MC MC E

116. 117. 118.

E E E

MC MC MC MC MC

110. 111. 116. 118. 119.

MC MC E E E

120. 121. 123.

E E P

116.

124.

MC MC MC

89. 116. 122.

MC E E

MC MC MC MC

120. 121. 124.

E E P

MC MC MC

123.

11 - 6

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual 1.

Intangible assets derive their value from the right (claim) to receive cash in the future.

Lack of physical substance is the only characteristic of intangible assets that distinguishes them from all other assets reported on the balance sheet.

Costs incurred internally to create intangibles are generally the basis for recording intangible assets, which are then amortized over the estimated life of the intangible asset.

Internally created intangibles are recorded at cost.

Internally generated intangible assets are initially recorded at fair value.

Amortization of limited-life intangible assets should not be impacted by expected residual values.

Some intangible assets are not required to be amortized every year.

Limited-life intangibles are amortized by systematic charges to expense over their useful life.

Intangible assets are amortized over their useful lives unless the intangible can remain in existence indefinitely.

10.

A trademark may properly be considered to have an indefinite life.

11.

A copyright is granted for the life of the creator or 50 years, whichever is longer.

12.

Legal fees and other costs incurred in successfully defending a patent suit are expensed as incurred.

13.

The cost of acquiring a customer list from another company is recorded as an intangible asset.

14.

The cost of purchased patents should be amortized over the remaining legal life of the patent.

15.

If a new patent is acquired through modification of an existing patent, the remaining book value of the original patent may be amortized over the life of the new patent.

16.

In a business combination, a company assigns the cost, where possible, to the identifiable tangible and intangible assets, with the remainder recorded as goodwill.

17.

Internally generated goodwill should not be capitalized in the accounts.

18.

Internally generated goodwill associated with a business may be recorded as an asset when a firm offer to purchase that business unit has been received.

19.

Goodwill is often identified on the balance sheet as the excess of the fair value over the cost of the net assets acquired.

Intangible Assets

11 - 7

20.

Use of the master valuation approach to measure goodwill requires an estimate of a firm's excess earning power.

21.

Badwill arises when the fair market value of the asset acquired is higher than the purchase price of the asset.

22.

For indefinite-life intangibles, a recoverability test is used to determine whether an impairment has occurred.

23.

When determining the impairment, if any, of goodwill, the fair value of the reporting unit should be compared to its carrying amount including goodwill.

24.

All intangibles are subject to periodic consideration of impairment with corresponding potential write-downs.

25.

If the fair value of an unlimited-life intangible other than goodwill is less than its book value, an impairment loss must be recognized.

26.

If market value of an impaired asset recovers after an impairment has been recognized, the impairment may be reversed in a subsequent period.

27.

The same recoverability test that is used for impairments of property, plant, and equipment is used for impairments of indefinite-life intangibles.

28.

Periodic alterations to existing products are an example of research and development costs.

29.

Research and development costs that result in patents may be capitalized to the extent of the fair value of the patent.

30.

As a result of FASB Statement No. 2, all research and development (R & D) costs should normally be charged to expense when incurred.

31.

The costs of services performed by others in connection with the reporting company's R & D should be expensed as incurred.

32.

Start-up costs are usually charged to an account called Start-Up Costs and may be carried as an asset on the balance sheet.

33.

Research and development costs are recorded as an intangible asset if it is felt they will provide economic benefits in future years.

34.

Contra accounts must be reported for intangible assets in a manner similar to accumulated depreciation and property, plant, and equipment.

35.

Acceptable accounting practice requires that disclosure be made in the financial statements of the total R & D costs charged to expense each period for which an income statement is presented.

11 - 8

Test Bank for Intermediate Accounting, Second Edition

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7.

F F F F F F T

8. 9. 10. 11. 12. 13. 14.

T T T F F T F

15. 16. 17. 18. 19. 20. 21.

T T T F F F T

22. 23. 24. 25. 26. 27. 28.

F T T T F F T

29. 30. 31. 32. 33. 34. 35.

F T T F T F T

MULTIPLE CHOICE—Conceptual 36.

Costs incurred internally to create intangibles are a. capitalized. b. capitalized if they have an indefinite life. c. expensed as incurred. d. expensed only if they have a limited life.

37.

Which of the following methods of amortization is normally used for intangible assets? a. Sum-of-the-years'-digits b. Straight-line c. Units of production d. Double-declining-balance

38.

The cost of an intangible asset includes all of the following except a. purchase price. b. legal fees. c. other incidental expenses. d. all of these are included.

39.

Factors considered in determining an intangible asset’s useful life include all of the following except a. the expected use of the asset. b. any legal or contractual provisions that may limit the useful life. c. any provisions for renewal or extension of the asset’s legal life. d. the amortization method used.

40.

Under current accounting practice, intangible assets are classified as a. amortizable or unamortizable. b. limited-life or indefinite-life. c. specifically identifiable or goodwill-type. d. legally restricted or goodwill-type.

41.

One factor that is not considered in determining the useful life of an intangible asset is a. legal life. b. expected actions of competitors. c. salvage value. d. provisions for renewal or extension.

Intangible Assets

11 - 9

42.

When a company develops a trademark or trade name, the costs directly related to securing it should generally be capitalized. Which of the following costs associated with a trademark or trade name would not be allowed to be capitalized? a. Attorney fees b. Consulting fees c. Research and development fees d. Design costs

43.

A large publicly held company has developed and registered a trademark during 2008. How should the cost of developing and registering the trademark be accounted for if it is considered to have a limited life? a. Charged to an asset account that should not be amortized b. Amortized over 10 years regardless of its useful life c. Expensed as incurred d. Amortized over its useful life

44.

The cost of purchasing patent rights for a product that might otherwise have seriously competed with one of the purchaser's patented products should be a. charged off in the current period. b. amortized over the legal life of the purchased patent. c. added to factory overhead and allocated to production of the purchaser's product. d. amortized over the remaining estimated life of the original patent covering the product whose market would have been impaired by competition from the newly patented product.

45.

Riser Corporation was granted a patent on a product on January 1, 1998. To protect its patent, the corporation purchased on January 1, 2007 a patent on a competing product which was originally issued on January 10, 2003. Because of its unique plant, Riser Corporation does not feel the competing patent can be used in producing a product. The cost of the competing patent should be a. amortized over a maximum period of 20 years. b. amortized over a maximum period of 16 years. c. amortized over a maximum period of 11 years. d. expensed in 2007.

46.

Wriglee, Inc. went to court this year and successfully defended its patent from infringement by a competitor. The cost of this defense should be charged to a. patents and amortized over the legal life of the patent. b. legal fees and amortized over 5 years or less. c. expenses of the period. d. patents and amortized over the remaining useful life of the patent.

47.

Which of the following is not an intangible asset? a. Trade name b. Research and development costs c. Franchise d. Copyright

11 - 10 Test Bank for Intermediate Accounting, Second Edition 48.

Which of the following intangible assets should not be amortized? a. Copyrights b. Customer lists c. Perpetual franchises d. All of these intangible assets should be amortized.

49.

When a patent is amortized, the credit is usually made to a. the Patent account. b. an Accumulated Amortization account. c. a Deferred Credit account. d. an expense account.

50.

Goodwill a. generated internally should not be capitalized unless it is measured by an individual independent of the enterprise involved. b. is easily computed by assigning a value to the individual attributes that comprise its existence. c. represents a unique asset in that its value can be identified only with the business as a whole. d. exists in any company that has earnings that differ from those of a competitor.

51.

The reason goodwill is sometimes referred to as a master valuation account is because a. it represents the purchase price of a business that is about to be sold. b. it is the difference between the fair market value of the net tangible and identifiable intangible assets as compared with the purchase price of the acquired business. c. the value of a business is computed without consideration of goodwill and then goodwill is added to arrive at a master valuation. d. it is the only account in the financial statements that is based on value, all other accounts are recorded at an amount other than their value.

52.

Easton Company and Lofton Company were combined in a purchase transaction. Easton was able to acquire Lofton at a bargain price. The sum of the market or appraised values of identifiable assets acquired less the fair value of liabilities assumed exceeded the cost to Easton. After revaluing noncurrent assets to zero, there was still some "negative goodwill." Proper accounting treatment by Easton is to report the amount as a. an extraordinary gain. b. part of current income in the year of combination. c. a deferred credit and amortize it. d. paid-in capital.

53.

Purchased goodwill should a. be written off as soon as possible against retained earnings. b. be written off as soon as possible as an extraordinary item. c. be written off by systematic charges as a regular operating expense over the period benefited. d. not be amortized.

54.

The intangible asset goodwill may be a. capitalized only when purchased. b. capitalized either when purchased or created internally. c. capitalized only when created internally. d. written off directly to retained earnings.

Intangible Assets

11 - 11

55.

The amortization of goodwill a. is dependent upon the number of years a company expects to use the benefits it provides. b. does not happen as it is deemed to have an indefinite life. c. represents as acceptable an accounting practice as does the immediate write-off method. d. should be computed using the straight-line method unless another method is deemed more appropriate.

56.

The accounting profession does not allow the immediate write-off of goodwill. The best reason for this requirement seems to be that a. goodwill has a useful life like all assets and should be charged as an expense at a normal rate. b. to write off goodwill immediately would lead to the incorrect conclusion that goodwill has no future service potential. c. the immediate write-off would cause net income to be much lower than it had been for the company in recent years and comparability would be distorted. d. because the amortization of goodwill is tax deductible, an immediate write-off serves no useful purpose.

57.

When the fair market value of the assets acquired in a business purchase exceed the purchase price, negative goodwill (also called badwill) arises. When negative goodwill arises, GAAP requires that it be allocated to a. an extraordinary gain. b. all periods benefited on an equitable basis. c. reduce proportionately the values assigned to noncurrent assets. d. reduce proportionately the values assigned to both current and noncurrent assets.

58.

Jo Jo Chong, Inc. needs to determine if its property, plant, and equipment has been impaired and should be reduced or written off on its balance sheet. The impairment test(s) to be used is (are): a. b. c. d.

Recoverability Test Yes Yes No No

Fair Value Test Yes No Yes No

59.

White Printing Company determines that a printing press used in its operations has suffered a permanent impairment in value because of technological changes. An entry to record the impairment should a. recognize an extraordinary loss for the period. b. include a credit to the equipment accumulated depreciation account. c. include a credit to the equipment account. d. not be made if the equipment is still being used.

60.

A loss on impairment of an intangible asset is the difference between the asset’s a. carrying amount and the expected future net cash flows. b. carrying amount and its fair value. c. fair value and the expected future net cash flows. d. book value and its fair value.

11 - 12 Test Bank for Intermediate Accounting, Second Edition 61.

Weaver Boxing Company needs to determine if its indefinite-life intangibles other than goodwill have been impaired and should be reduced or written off on its balance sheet. The impairment test(s) to be used is (are) a. b. c d.

Recoverability Test Yes Yes No No

Fair Value Test Yes No Yes No

62.

The carrying amount of an intangible is a. the fair market value of the asset at a balance sheet date. b. the asset's acquisition cost less the total related amortization recorded to date. c. equal to the balance of the related accumulated amortization account. d. the assessed value of the asset for intangible tax purposes.

63.

Which of the following research and development related costs should be capitalized and amortized over current and future periods? a. Research and development general laboratory building which can be put to alternative uses in the future b. Inventory used for a specific research project c. Administrative salaries allocated to research and development d. Research findings purchased from another company to aid a particular research project currently in process

64.

Which of the following principles best describes the current method of accounting for research and development costs? a. Associating cause and effect b. Systematic and rational allocation c. Income tax minimization d. Immediate recognition as an expense

65.

How should research and development costs be accounted for, according to a Financial Accounting Standards Board Statement? a. Must be capitalized when incurred and then amortized over their estimated useful lives b. Must be expensed in the period incurred c. May be either capitalized or expensed when incurred, depending upon the materiality of the amounts involved d. Must be expensed in the period incurred unless it can be clearly demonstrated that the expenditure will have alternative future uses or unless contractually reimbursable

66.

Which of the following costs should be excluded from research and development expense? a. Modification of the design of a product b. Acquisition of R & D equipment for use on a current project only c. Cost of marketing research for a new product d. Engineering activity required to advance the design of a product to the manufacturing stage

Intangible Assets

11 - 13

67.

If a company constructs a laboratory building to be used as a research and development facility, the cost of the laboratory building is matched against earnings as a. research and development expense in the period(s) of construction. b. depreciation deducted as part of research and development costs. c. depreciation or immediate write-off depending on company policy. d. an expense at such time as productive research and development has been obtained from the facility.

68.

Operating losses incurred during the start-up years of a new business should be a. accounted for and reported like the operating losses of any other business. b. written off directly against retained earnings. c. capitalized as a deferred charge and amortized over five years. d. capitalized as an intangible asset and amortized over a period not to exceed 20 years.

69. The costs of organizing a corporation include legal fees, fees paid to the state of incorporation, fees paid to promoters, and the costs of meetings for organizing the promoters. These costs are said to benefit the corporation for the entity's entire life. These costs should be a. capitalized and never amortized. b. capitalized and amortized over 40 years. c. capitalized and amortized over 5 years. d. expensed as incurred. 70. Which of the following would not be considered an R & D activity? a. Adaptation of an existing capability to a particular requirement or customer's need b. Searching for applications of new research findings c. Laboratory research aimed at discovery of new knowledge d. Conceptual formulation and design of possible product or process alternatives 71. The total amount of patent cost amortized to date is usually a. shown in a separate Accumulated Patent Amortization account which is shown contra to the Patent account. b. shown in the current income statement. c. reflected as credits in the Patent account. d. reflected as a contra property, plant and equipment item.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

36. 37. 38. 39. 40. 41.

c b d d b c

42. 43. 44. 45. 46. 47.

c d d c d b

48. 49. 50. 51. 52. 53.

c a c b a d

54. 55. 56. 57. 58. 59.

a b b a a b

60. 61. 62. 63. 64. 65.

b c b a d d

66. 67. 68. 69. 70. 71.

c b a d a c

11 - 14 Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Computational 72. Lynne Corporation acquired a patent on May 1, 2008. Lynne paid cash of $20,000 to the seller. Legal fees of $800 were paid related to the acquisition. What amount should be debited to the patent account? a. $800 b. $19,200 c. $20,000 d. $20,800 73. Maris Corporation acquired a patent on May 1, 2008. Maris paid cash of $25,000 to the seller. Legal fees of $1,000 were paid related to the acquisition. What amount should be debited to the patent account? a. $1,000 b. $24,000 c. $25,000 d. $26,000 74. Jeff Corporation purchased a limited-life intangible asset for $120,000 on May 1, 2006. It has a useful life of 10 years. What total amount of amortization expense should have been recorded on the intangible asset by December 31, 2008? a. $0 b. $24,000 c. $32,000 d. $36,000 75. Rich Corporation purchased a limited-life intangible asset for $180,000 on May 1, 2006. It has a useful life of 10 years. What total amount of amortization expense should have been recorded on the intangible asset by December 31, 2008? a. $0 b. $36,000 c. $48,000 d. $54,000 76. Hooker Corporation acquired a franchise to operate a Good Pet Dog Kennel in January, 2003. The cost of the franchise was $125,000 and was estimated to have a limited life of 40 years. Early in the year 2009, the franchise was deemed worthless due to significant law suits that caused the franchisor to go out of business. What amount of cost or expense should be charged to the income statement of Hooker Corporation for the years noted below? a. b. c. d.

2003 $5,000 $3,125 $0 $3,125

2009 $5,000 $3,125 $125,000 $106,250

Intangible Assets 77.

11 - 15

Smith Co. bought a window franchise from Paine, Inc., on January 2, 2008, for $100,000. A highly regarded independent research company estimated that the remaining useful life of the franchise was 50 years. Its unamortized cost on Paine's books at January 1, 2008, was $15,000. Smith has decided to write off the franchise over the longest possible period. How much should be amortized by Smith Co. for the year ended December 31, 2008? a. $375 b. $2,000 c. $2,500 d. $15,000

78. ELO Corporation purchased a patent for $180,000 on September 1, 2006. It had a useful life of 10 years. On January 1, 2008, ELO spent $44,000 to successfully defend the patent in a lawsuit. ELO feels that as of that date, the remaining useful life is 5 years. What amount should be reported for patent amortization expense for 2008? a. $41,200 b. $40,000 c. $37,600 d. $31,200 79. LRF Corporation purchased a patent for $450,000 on September 1, 2006. It had a useful life of 10 years. On January 1, 2008, LRF spent $110,000 to successfully defend the patent in a lawsuit. LRF feels that as of that date, the remaining useful life is 5 years. What amount should be reported for patent amortization expense for 2008? a. $103,000 b. $100,000 c. $94,000 d. $78,000 80.

The general ledger of Vance Corporation as of December 31, 2008, includes the following accounts: Copyrights Deposits with advertising agency (will be used to promote goodwill) Discount on bonds payable Excess of cost over fair value of identifiable net assets of acquired subsidiary Trademarks

$ 20,000 27,000 67,500 390,000 90,000

In the preparation of Vance's balance sheet as of December 31, 2008, what should be reported as total intangible assets? a. $594,500 b. $527,000 c. $500,000 d. $460,000 81.

In January, 2003, Findley Corporation purchased a patent for a new consumer product for $720,000. At the time of purchase, the patent was valid for fifteen years. Due to the competitive nature of the product, however, the patent was estimated to have a useful life of only ten years. During 2008, the product was permanently removed from the market under governmental order because of a potential health hazard present in the product. What amount should Findley charge to expense during 2008, assuming amortization is recorded at the end of each year?

11 - 16 Test Bank for Intermediate Accounting, Second Edition a. b. c. d.

$480,000 $360,000 $72,000 $48,000

82.

Kerr Company purchased a patent on January 1, 2006 for $180,000. The patent had a remaining useful life of 10 years at that date. In January of 2007, Kerr successfully defends the patent at a cost of $81,000, extending the patent’s life to 12/31/18. What amount of amortization expense would Kerr record in 2007? a. $18,000 b. $20,250 c. $21,750 d. $27,000

83.

On January 2, 2007, Klein Co. bought a trademark from Royce, Inc. for $500,000. An independent research company estimated that the remaining useful life of the trademark was 10 years. Its unamortized cost on Royce’s books was $400,000. In Klein’s 2007 income statement, what amount should be reported as amortization expense? a. $50,000 b. $40,000 c. $25,000 d. $20,000

84.

Wildcat Baseball Company had a player contract with Carter that was recorded in its accounting records at $5,800,000. Aggie Baseball Company had a player contract with Jeter that was recorded in its accounting records at $5,600,000. Wildcat traded Carter to Aggie for Jeter by exchanging each player's contract. The fair value of each contract was $6,000,000. What amount should be shown in the accounting records after the exchange of player contracts? a. b. c. d.

Wildcat $5,600,000 $5,600,000 $5,800,000 $6,000,000

Aggie $5,600,000 $5,800,000 $5,600,000 $6,000,000

85. A company acquires a patent for a drug with a remaining legal and useful life of six years on January 1, 2005 for $1,200,000. The company uses straight-line amortization for patents. On January 2, 2007, a new patent is received for a timed-release version of the same drug. The new patent has a legal and useful life of twenty years. The least amount of amortization that could be recorded in 2007 is a. $200,000. b. $40,000. c. $54,545. d. $60,000. 86. Blue Sky Company’s 12/31/08 balance sheet reports assets of $5,000,000 and liabilities of $2,000,000. All of Blue Sky’s assets’ book values approximate their fair value, except for land, which has a fair value that is $300,000 greater than its book value. On 12/31/08, Horace Wimp Corporation paid $5,100,000 to acquire Blue Sky. What amount of goodwill should Horace Wimp record as a result of this purchase?

Intangible Assets a. b. c. d.

11 - 17

$0 $100,000 $1,800,000 $2,100,000

87. Turner Company’s 12/31/08 balance sheet reports assets of $6,000,000 and liabilities of $2,500,000. All of Turner’s assets’ book values approximate their fair value, except for land, which has a fair value that is $400,000 greater than its book value. On 12/31/08, Benedict Corporation paid $6,100,000 to acquire Turner. What amount of goodwill should Benedict record as a result of this purchase? a. $0 b. $100,000 c. $2,200,000 d. $2,600,000 88. Distributor Company purchases Supplier Company for $800,000 cash on January 1, 2009. The book value of Supplier Company’s net assets, as reflected on its December 31, 2008 balance sheet is $620,000. An analysis by Distributor on December 31, 2008 indicates that the fair value of Supplier’s tangible assets exceeded the book value by $60,000, and the fair value of identifiable intangible assets exceeded book value by $45,000. How much goodwill should be recognized by Distributor Company when recording the purchase of Supplier Company? a. $0 b. $180,000 c. $120,000 d. $75,000 89.

During 2008, Bond Company purchased the net assets of May Corporation for $950,000. On the date of the transaction, May had $300,000 of liabilities. The fair value of May's assets when acquired were as follows: Current assets Noncurrent assets

$ 540,000 1,260,000 $1,800,000

How should the $550,000 difference between the fair value of the net assets acquired ($1,500,000) and the cost ($950,000) be accounted for by Bond? a. The $550,000 difference should be credited to retained earnings. b. The $550,000 difference should be recognized as an extraordinary gain. c. The current assets should be recorded at $375,000 and the noncurrent assets should be recorded at $875,000. d. A deferred credit of $550,000 should be set up and then amortized to income over a period not to exceed forty years. 90. General Products Company bought Special Products Division in 2007 and appropriately booked $250,000 of goodwill related to the purchase. On December 31, 2008, the fair value of Special Products Division is $2,000,000 and it is carried on General Product’s books for a total of $1,700,000, including the goodwill. An analysis of Special Products Division’s assets indicates that goodwill of $200,000 exists on December 31, 2008. What goodwill impairment should be recognized by General Products in 2008?

11 - 18 Test Bank for Intermediate Accounting, Second Edition a. b. c. d. 91.

$0 $200,000 $50,000 $300,000

The following information is available for Barkley Company’s patents: Cost Carrying amount Expected future net cash flows Fair value

$1,720,000 860,000 800,000 640,000

Barkley would record a loss on impairment of a. $1,080,000. b. $220,000. c. $160,000. d. $60,000. 92. Mining Company acquired a patent on an oil extraction technique on January 1, 2007 for $5,000,000. It was expected to have a 10 year life and no residual value. Mining uses straight-line amortization for patents. On December 31, 2008, the expected future cash flows expected from the patent were expected to be $600,000 per year for the next eight years. The present value of these cash flows, discounted at Mining’s market interest rate, is $2,800,000. At what amount should the patent be carried on the December 31, 2008 balance sheet? a. $5,000,000 b. $4,800,000 c. $4,000,000 d. $2,800,000 93. Malrom Manufacturing Company acquired a patent on a manufacturing process on January 1, 2007 for $10,000,000. It was expected to have a 10 year life and no residual value. Malrom uses straight-line amortization for patents. On December 31, 2008, the expected future cash flows expected from the patent were expected to be $800,000 per year for the next eight years. The present value of these cash flows, discounted at Malrom’s market interest rate, is $4,800,000. At what amount should the patent be carried on the December 31, 2008 balance sheet? a. $10,000,000 b. $8,000,000 c. $6,400,000 d. $4,800,000 94. Twilight Corporation acquired End-of-the-World Products on January 1, 2008 for $2,000,000, and recorded goodwill of $375,000 as a result of that purchase. At December 31, 2008, the End-of-the-World Products Division had a fair value of $1,700,000. The net identifiable assets of the Division (excluding goodwill) had a fair value of $1,450,000 at that time. What amount of loss on impairment of goodwill should Twilight record in 2008? a. $0 b. $125,000 c. $175,000 d. $300,000

Intangible Assets

11 - 19

95. Fleming Corporation acquired Out-of-Sight Products on January 1, 2008 for $4,000,000, and recorded goodwill of $750,000 as a result of that purchase. At December 31, 2008, the Out-of-Sight Products Division had a fair value of $3,400,000. The net identifiable assets of the Division (excluding goodwill) had a fair value of $2,900,000 at that time. What amount of loss on impairment of goodwill should Fleming record in 2008? a. $0 b. $250,000 c. $350,000 d. $600,000 96.

In 2005, Hume, Inc. purchased Rousseau Metals for $3 million. At December 31, 2008, the Rousseau division reported net assets of $3,300,000 (including $1,700,000 of goodwill). Hume reviewed the Rousseau division and determined that expected net future cash flows equal $2,500,000 and the fair value is estimated to be only $1,800,000. What entry should Hume record concerning the Rousseau division on December 31, 2008? a. No entry is needed. b. Loss on impairment ......................................................... 1,500,000 Goodwill .................................................................. 1,500,000 c. Loss on impairment ......................................................... 1,200,000 Goodwill .................................................................. 1,200,000 d. Loss on impairment ......................................................... 1,500,000 Prorata deduction of all assets ................................ 1,500,000

97.

Isa Company has equipment that, due to changes in use, is reviewed for possible impairment. The asset’s carrying amount is $400,000 ($500,000 cost less $100,000 accumulated depreciation). The expected future net cash flows (undiscounted) from the use of the asset and its eventual disposition are determined to be $380,000 and it has a current market value of $350,000. What is the amount of the impairment, if any, that should be recorded by Isa Company? a. $0 b. $20,000 c. $50,000 d. $400,000

98.

Peppers Corporation owns machinery with a book value of $190,000. It is estimated that the machinery will generate future cash flows of $200,000. The machinery has a fair value of $140,000. Peppers should recognize a loss on impairment of a. $0. b. $10,000. c. $50,000. d. $60,000.

99.

Dillman Corporation owns machinery with a book value of $190,000. It is estimated that the machinery will generate future cash flows of $175,000. The machinery has a fair value of $140,000. Dillman should recognize a loss on impairment of a. $0. b. $15,000. c. $50,000. d. $35,000.

11 - 20 Test Bank for Intermediate Accounting, Second Edition 100.

Calvin Company incurred the following costs related to the start-up of the business: Attorney's fee Underwriter's fee State incorporation fee

$10,000 15,000 7,000 $32,000

The company wishes to amortize these costs over the maximum period allowed under generally accepted accounting principles. Assuming that Calvin Company began operation on January 1, 2008, what amount of the start-up costs should be amortized in 2009? a. $4,400 b. $2,200 c. $800 d. $0 101.

In 2008, Edwards Corporation incurred research and development costs as follows: Materials and equipment Personnel Indirect costs

$ 80,000 120,000 150,000 $350,000

These costs relate to a product that will be marketed in 2009. It is estimated that these costs will be recouped by December 31, 2011. The equipment has no alternative future use. What is the amount of research and development costs that should be expensed in 2008? a. $0 b. $200,000 c. $270,000 d. $350,000 102.

Hall Co. incurred research and development costs in 2008 as follows: Materials used in research and development projects $ 450,000 Equipment acquired that will have alternate future uses in future research and development projects 3,000,000 Depreciation for 2008 on above equipment 300,000 Personnel costs of persons involved in research and development projects 750,000 Consulting fees paid to outsiders for research and development projects 150,000 Indirect costs reasonably allocable to research and development projects 225,000 $4,875,000 The amount of research and development costs charged to Hall's 2008 income statement should be a. $1,500,000. b. $1,650,000. c. $1,875,000. d. $4,050,000.

11 - 21

Intangible Assets 103.

Martin Inc. incurred the following costs during the year ended December 31, 2008: Laboratory research aimed at discovery of new knowledge Costs of testing prototype and design modifications Quality control during commercial production, including routine testing of products Construction of research facilities having an estimated useful life of 6 years but no alternative future use

$180,000 45,000 270,000 360,000

The total amount to be classified and expensed as research and development in 2008 is a. $555,000. b. $855,000. c. $585,000. d. $285,000. 104. MaBelle Corporation incurred the following costs in 2008: Acquisition of R&D equipment with a useful life of 4 years in R&D projects Start-up costs incurred when opening a new plant Advertising expense to introduce a new product Engineering costs incurred to advance a product to full production stage

$600,000 140,000 700,000 350,000

What amount should MaBelle record as research & development expense in 2008? a. $500,000 b. $640,000 c. $950,000 d. $1,340,000

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

72. 73. 74. 75. 76.

d d c c d

77. 78. 79. 80. 81.

b b b c b

82. 83. 84. 85. 86.

b a c b c

87. 88. 89. 90. 91.

c d b a b

92. 93. 94. 95. 96.

c d b b b

97. 98. 99. 100. 101.

c a c d d

102. 103. 104.

c c a

MULTIPLE CHOICE—CPA Adapted 105.

Lopez Corp. incurred $420,000 of research and development costs to develop a product for which a patent was granted on January 2, 2003. Legal fees and other costs associated with registration of the patent totaled $80,000. On March 31, 2008, Lopez paid $120,000 for legal fees in a successful defense of the patent. The total amount capitalized for the patent through March 31, 2008 should be a. $200,000. b. $500,000. c. $540,000. d. $620,000.

11 - 22 Test Bank for Intermediate Accounting, Second Edition 106.

On June 30, 2008, Cey, Inc. exchanged 2,000 shares of Seely Corp. $30 par value common stock for a patent owned by Gore Co. The Seely stock was acquired in 2008 at a cost of $55,000. At the exchange date, Seely common stock had a fair value of $45 per share, and the patent had a net carrying value of $110,000 on Gore's books. Cey should record the patent at a. $55,000. b. $60,000. c. $90,000. d. $110,000.

107.

On May 5, 2008, Flynn Corp. exchanged 2,000 shares of its $25 par value treasury common stock for a patent owned by Denson Co. The treasury shares were acquired in 2006 for $45,000. At May 5, 2008, Flynn's common stock was quoted at $32 per share, and the patent had a carrying value of $55,000 on Denson's books. Flynn should record the patent at a. $45,000. b. $50,000. c. $55,000. d. $64,000.

108.

Ely Co. bought a patent from Baden Corp. on January 1, 2008, for $300,000. An independent consultant retained by Ely estimated that the remaining useful life is 30 years. Its unamortized cost on Baden 's accounting records was $150,000; the patent had been amortized for 5 years by Baden. How much should be amortized for the year ended December 31, 2008? a. $0 b. $5,000 c. $10,000 d. $20,000

109.

On January 2, 2005, Koll, Inc. purchased a patent for a new consumer product for $180,000. At the time of purchase, the patent was valid for 15 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, 2008, the product was permanently withdrawn from sale under governmental order because of a potential health hazard in the product. What amount should Koll charge against income during 2008, assuming amortization is recorded at the end of each year? a. $18,000 b. $108,000 c. $126,000 d. $144,000

110.

On January 1, 2004, Unruh Company purchased a copyright for $800,000, having an estimated useful life of 16 years. In January 2008, Unruh paid $120,000 for legal fees in a successful defense of the copyright. Copyright amortization expense for the year ended December 31, 2008, should be a. $0. b. $50,000. c. $57,500. d. $60,000.

Intangible Assets 111.

11 - 23

Which of the following legal fees should be capitalized? Legal fees to obtain a copyright a. No b. No c. Yes d. Yes

Legal fees to successfully defend a trademark No Yes Yes No

112.

Which of the following costs of goodwill should be amortized over their estimated useful lives? Costs of goodwill from a business combination Costs of developing accounted for as a purchase goodwill internally a. No No b. No Yes c. Yes Yes d. Yes No

113.

During 2008, Leon Co. incurred the following costs: Testing in search for process alternatives Costs of marketing research for new product Modification of the formulation of a process Research and development services performed by Beck Corp. for Leon

$350,000 250,000 510,000 325,000

In Leon's 2008 income statement, research and development expense should be a. $510,000. b. $835,000. c. $1,185,000. d. $1,435,000. 114.

Riley Co. incurred the following costs during 2008: Modification to the formulation of a chemical product Trouble-shooting in connection with breakdowns during commercial production Costs of marketing research for new product Seasonal or other periodic design changes to existing products Laboratory research aimed at discovery of new technology

$160,000 150,000 200,000 185,000 215,000

In its income statement for the year ended December 31, 2008, Riley should report research and development expense of a. $575,000. b. $725,000. c. $415,000. d. $335,000.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

105. 106.

a c

107. 108.

d d

109. 110.

c d

111. 112.

c a

113. 114.

c a

11 - 24 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational No.

Answer Derivation

72.

$20,000 + $800 = $20,800.

73.

$25,000 + $1,000 = $26,000.

74.

($120,000 ÷ 10) × 2 2/3 = $32,000.

75.

($180,000 ÷ 10) × 2 2/3 = $48,000.

76.

$125,000 ÷ 40 = $3,125; $125,000 – ($3,125 × 6) = $106,250.

77.

$100,000 ÷ 50 = $2,000.

78.

$180,000 – [($180,000 ÷ 10) × 1 1/3] = $156,000 ($156,000 + $44,000) ÷ 5 = $40,000.

79.

$450,000 – [($450,000 ÷ 10) × 1 1/3] = $390,000 ($390,000 + $110,000) ÷ 5 = $100,000.

80.

$20,000 + $390,000 + $90,000 = $500,000.

81.

($720,000 ÷ 10) × 5 = $360,000.

82.

[($180,000 – $18,000) + $81,000] ÷ 12 = $20,250.

83.

$500,000 ÷ 10 = $50,000.

84.

Wildcat: $6,000,000 – $200,000 (deferred gain) = $5,800,000. Aggie: $6,000,000 – $400,000 (deferred gain) = $5,600,000.

85.

$1,200,000 – [($1,200,000 ÷ 6) × 2] = $800,000 $800,000 ÷ 20 = $40,000.

86.

($5,000,000 + $300,000) – $2,000,000 = $3,300,000 $5,100,000 – $3,300,000 = $1,800,000.

87.

($6,000,000 + $400,000) – $2,500,000 = $3,900,000 $6,100,000 – $3,900,000 = $2,200,000.

88.

$620,000 + $60,000 + $45,000 = $725,000 $800,000 – $725,000 = $75,000.

89.

$1,500,000 – $950,000 = $550,000 extraordinary gain.

90.

Since $2,000,000 > $1,700,000, $0 impairment.

91.

$860,000 – $640,000 = $220,000.

92.

$5,000,000 – [($5,000,000 ÷ 10) × 2] = $4,000,000.

Intangible Assets

11 - 25

DERIVATIONS — Computational (cont.) No.

Answer Derivation

93.

$10,000,000 – [($10,000,000 ÷ 10) × 2] = $8,000,000. Since $8,000,000 > ($800,000 × 8), patent is reported at $4,800,000 (present value of cash flows.

94.

$1,700,000 – $1,450,000 = $250,000 $375,000 – $250,000 = $125,000.

95.

$3,400,000 – $2,900,000 = $500,000 $750,000 – $500,000 = $250,000.

96.

$3,300,000 – $1,800,000 = $1,500,000.

97.

$400,000 – $350,000 = $50,000.

98.

$200,000 > $190,000; No loss recognized.

99.

$175,000 < $190,000; $140,000 – $190,000 = ($50,000).

100.

All $32,000 of costs were expensed in 2008.

101.

Expense total of $350,000.

102.

$4,875,000 – $3,000,000 = $1,875,000.

103.

$180,000 + $45,000 + $360,000 = $585,000.

104.

($600,000 ÷ 4) + $350,000 = $500,000.

DERIVATIONS — CPA Adapted No.

Answer Derivation

105.

$80,000 + $120,000 = $200,000.

106.

$2,000 × $45 = $90,000.

107.

$2,000 × $32 = $64,000.

108.

$300,000 ÷ (20 – 5) = $20,000.

109.

$180,000 – [($180,000 ÷ 10) × 3] = $126,000.

110.

($800,000 – [($800,000 ÷ 16) × 4] = $600,000 ($600,000 + $120,000) ÷ 12 = $60,000.

111.

Conceptual.

112.

Conceptual.

113.

$350,000 + $510,000 + $325,000 = $1,185,000.

114.

$160,000 + $200,000 + $215,000 = $575,000.

11 - 26 Test Bank for Intermediate Accounting, Second Edition

EXERCISES Ex. 11-115—Short essay questions. 1. 2.

What are intangible assets? How are limited-life intangibles accounted for subsequent to acquisition?

Solution 11-115 1. Intangible assets are assets that derive their value from the rights and privileges granted to the company using them. They provide services over a period of years and are normally classified as long-term assets. Examples are patents, copyrights, franchises, goodwill, trademarks, and trade names. 2. Limited-life intangibles are amortized by systematic charges to expense over their useful life. In addition, they are reviewed for impairment each year. Impairment occurs when the future net cash flows are less than the carrying amount of the intangible asset. The intangible asset is reduced for the amount by which its carrying value exceeds its fair value at year end.

Ex. 11-116—Intangible assets questions. Indicate the best answer by circling the proper letter. 1. Copyrights should be amortized over a. their legal life. b. the life of the creator plus fifty years. c. twenty years. d. their useful life or legal life, whichever is shorter. 2. A patent should be amortized over a. twenty years. b. its useful life. c. its useful life or twenty years, whichever is longer. d. its useful life or twenty years, whichever is shorter. 3. The major problem of accounting for intangibles is determining a. fair market value. b. separability. c. salvage value. d. useful life. 4. Limited-life intangibles are reported at their a. replacement cost. b. carrying amount unless impaired. c. acquisition cost. d. liquidation value.

Intangible Assets

11 - 27

Ex. 11-116 (cont.) 5. Negative goodwill arises when the ______________ of the net assets acquired is higher than the purchase price of the assets. a. useful life b. carrying value c. fair market value d. excess earnings

Solution 11-116 1. d

2. d

3. d

4. b

5. c

Ex. 11-117—Intangible assets theory. It has been argued on the grounds of conservatism that all intangible assets should be written off immediately after acquisition. Discuss the accounting arguments against this treatment.

Solution 11-117 Intangible assets provide revenues over a period of years. Limited-life intangibles are therefore capitalized and amortized by systematic charges to expense over their useful life. This treatment is in accordance with the matching principle—deducting expenses in the same period(s) that revenues are reported.

Ex. 11-118—Accounting for patent. A patent was acquired by Grotius Corporation on January 1, 2000, at a cost of $72,000. The useful life of the patent was estimated to be 10 years. At the beginning of 2004, Grotius spent $9,000 in successfully prosecuting an attempted infringement of the patent. At the beginning of 2005, Grotius purchased a patent for $25,000 that was expected to prolong the life of its original patent for 5 additional years. On July 1, 2008, a competitor obtained rights to a patent that made the company's patent obsolete. Grotius records amortization expense directly with a credit to the Patent account. Instructions Calculate the following amounts for Grotius Corporation. (a) Amortization expense for 2000. (b) The balance in the Patent account at the beginning of 2004, immediately after the infringement suit. (c) Amortization expense for 2004. (d) The balance in the Patent account at the beginning of 2005, after purchase of the additional patent. (e) Amortization expense for 2005. (f) The amount of loss recorded at July 1, 2008.

11 - 28 Test Bank for Intermediate Accounting, Second Edition Solution 11-118 PATENT ACCOUNT

Infringement Suit (b) Balance Patent Purchased (d) Balance

1-1-00

$72,000

1-04 1-04

9,000 $52,200 25,000 $68,500

1-05

_______ $44,525 (a) (c) (e)

$ 7,200 7,200 7,200 7,200 ______ 8,700 ______ 6,850 6,850 6,850 3,425 $44,525

Amortization 12-31-00 (a) Amortization 12-31-01 Amortization 12-31-02 Amortization 12-31-03 Amortization 12-31-04 (c) Amortization 12-31-05 (e) Amortization 12-31-06 Amortization 12-31-07 Amortization 7-1-08 Loss on 7-1-08 (f)

$72,000  10 =$7,200 $52,200 6 = $8,700 $68,500  10 =$6,850

Ex. 11-119—Carrying value of patent. Fehr Co. purchased a patent from Wells Co. for $180,000 on July 1, 2005. Expenditures of $51,000 for successful litigation in defense of the patent were paid on July 1, 2008. Fehr estimates that the useful life of the patent will be 20 years from the date of acquisition. Instructions Prepare a computation of the carrying value of the patent at December 31, 2008.

Solution 11-119 Cost of patent Amortization 7/1/05 to 7/1/08 [($180,000 ÷ 20) × 3] Carrying value at 7/1/08 Cost of successful defense Carrying value Amortization 7/1/08 to 12/31/08 [$204,000 × 1/(20 – 3) × 1/2] Carrying value at 12/31/08

$180,000 (27,000) 153,000 51,000 204,000 (6,000) $198,000

Ex. 11-120—Accounting for patent. In early January 2007, Lerner Corporation applied for a patent, incurring legal costs of $50,000. In January 2008, Lerner incurred $9,000 of legal fees in a successful defense of its patent. Instructions (a) Compute 2007 amortization, 12/31/07 carrying value, 2008 amortization, and 12/31/08 carrying value if the company amortizes the patent over 10 years.

Intangible Assets

11 - 29

Ex. 11-120 (cont.) (b) Compute the 2009 amortization and the 12/31/09 carrying value, assuming that at the beginning of 2009, based on new market research, Lerner determines that the fair value of the patent is $44,000. Estimated future cash flows from the patent are $45,000 on January 3, 2009.

Solution 11-120 (a) 2007 amortization: $50,000 ÷ 10 yrs. = $5,000 12/31/07 carrying value: $50,000 – $5,000 = $45,000 2008 amortization: ($45,000 + $9,000) ÷ 9 yrs. = $6,000 12/31/08 carrying value: ($45,000 + $9,000) – $6,000 = $48,000 (b) Since the expected future cash flows ($45,000) are less than the carrying value ($48,000), an impairment loss must be computed. Loss on impairment: $48,000 carrying value – $44,000 fair value = $4,000 2009 amortization: $44,000 ÷ 8 yrs. = $5,500 12/31/09 carrying value: $44,000 – $5,500 = $38,500

Ex. 11-121—Impairment of copyrights. Presented below is information related to copyrights owned by Wamser Corporation at December 31, 2008. Cost $2,700,000 Carrying amount 2,400,000 Expected future net cash flows 2,100,000 Fair value 1,400,000 Assume Wamser will continue to use this asset in the future. As of December 31, 2008, the copyrights have a remaining useful life of 5 years. Instructions (a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2008. (b) Prepare the journal entry to record amortization expense for 2009. (c) The fair value of the copyright at December 31, 2009 is $1,500,000. Prepare the journal entry (if any) necessary to record this increase in fair value.

Solution 11-121 (a)

December 31, 2008 Loss on Impairment ................................................................... Copyrights ....................................................................... Carrying amount Fair value Loss on impairment

$2,400,000 1,400,000 $1,000,000

1,000,000 1,000,000

11 - 30 Test Bank for Intermediate Accounting, Second Edition Solution 11-121 (cont.) (b)

December 31, 2009 Amortization Expense ................................................................ Copyrights........................................................................ New carrying amount Useful life Amortization

280,000 280,000

$1,400,000 ÷ 5 years $ 280,000

Ex. 11-122—Acquisition of tangible and intangible assets. Fowler Manufacturing Company decided to expand further by purchasing Abel Company. The balance sheet of Abel Company as of December 31, 2008 was as follows: Abel Company Balance Sheet December 31, 2008 Assets Cash Receivables Inventory Plant assets (net) Total assets

$ 210,000 450,000 275,000 1,025,000 $1,960,000

Equities Accounts payable Common stock Retained earnings

$ 325,000 800,000 835,000

Total equities

$1,960,000

An appraisal, agreed to by the parties, indicated that the fair market value of the inventory was $350,000 and that the fair market value of the plant assets was $1,225,000. The fair market value of the receivables is equal to the amount reported on the balance sheet. The agreed purchase price was $2,100,000, and this amount was paid in cash to the previous owners of Abel Company. Instructions Determine the amount of goodwill (if any) implied in the purchase price of $2,100,000. Show calculations.

Solution 11-122 Purchase price Less tangible net assets acquired: Book value Appraisal increment—inventory Appraisal increment—plant assets Total fair market value of tangible net assets acquired Goodwill

$2,100,000 $1,635,000 75,000 200,000 1,910,000 $ 190,000

Intangible Assets

11 - 31

PROBLEMS Pr. 11-123—Intangible assets. The following transactions involving intangible assets of Minton Corporation occurred on or near December 31, 2007. Complete the chart below by writing the journal entry(ies) needed at that date to record the transaction and at December 31, 2008 to record any resultant amortization. If no entry is required at a particular date, write "none needed." On Date of Transaction

On December 31, 2008

1. Minton paid Grand Company $250,000 for the exclusive right to market a particular product, using the Grand name and logo in promotional material. The franchise runs for as long as Minton is in business. 2. Minton spent $300,000 developing a new manufacturing process. It has applied for a patent, and it believes that its application will be successful. 3. In January, 2008, Minton's application for a patent (#2 above) was granted. Legal and registration costs incurred were $60,000. The patent runs for 20 years. The manufacturing process will be useful to Minton for 10 years. 4. Minton incurred $96,000 in successfully defending one of its patents in an infringement suit. The patent expires during December, 2011. 5. Minton incurred $240,000 in an unsuccessful patent defense. As a result of the adverse verdict, the patent, with a remaining unamortized cost of $126,000, is deemed worthless. 6. Minton paid Sneed Laboratories $52,000 for research and development work performed by Sneed under contract for Minton. The benefits are expected to last six years.

Solution 11-123 On Date of Transaction 1. Franchise ............ Cash .............. 2. Research and Devel. Expense ... Cash ..............

On December 31, 2008 1. “None needed.”

250,000 250,000

2. "None needed." 300,000 300,000

11 - 32 Test Bank for Intermediate Accounting, Second Edition Solution 11-123 (cont.) 3. Patents ................ Cash ..............

4. Patents ................ Cash ..............

60,000 60,000

96,000 96,000

5. Legal Fees Exp.... Cash ..............

240,000

Patent Expense ... Patents ..........

126,000

6. Research and Devel. Expense ... Cash ..............

3. Patent Amortization Expense ................... Patents ...............

6,000 6,000

4. Patent Amortization Expense ................... 24,000 Patents ...............

24,000

5. “None needed.” 240,000 126,000 6. "None needed."

52,000 52,000

Pr. 11-124—Goodwill, impairment. On May 31, 2008, Porter Company paid $3,200,000 to acquire all of the common stock of Eaton Corporation, which became a division of Porter. Eaton reported the following balance sheet at the time of the acquisition: Current assets Noncurrent assets

$ 800,000 2,700,000

Total assets

$3,500,000

Current liabilities Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity

$ 600,000 500,000 2,400,000 $3,500,000

It was determined at the date of the purchase that the fair value of the identifiable net assets of Eaton was $2,700,000. At December 31, 2008, Eaton reports the following balance sheet information: Current assets Noncurrent assets (including goodwill recognized in purchase) Current liabilities Long-term liabilities Net assets

$ 600,000 2,400,000 (700,000) (500,000) $1,800,000

It is determined that the fair market value of the Eaton division is $1,900,000. The recorded amount for Eaton’s net assets (excluding goodwill) is the same as fair value, except for property, plant, and equipment, which has a fair value of $200,000 above the carrying value. Instructions (a) Compute the amount of goodwill recognized, if any, on May 31, 2008. (b) Determine the impairment loss, if any, to be recorded on December 31, 2008. (c) Assume that the fair value of the Eaton division is $1,700,000 instead of $1,900,000. Prepare the journal entry to record the impairment loss, if any, on December 31, 2008.

Intangible Assets

11 - 33

Solution 11-124 (a) Goodwill = Fair value of the division less the fair value of the identifiable assets. $3,200,000 – $2,700,000 = $500,000. (b) No impairment loss is recorded, because the fair value of Eaton ($1,900,000) is greater than the carrying value ($1,800,000) of the new assets. (c) Computation of impairment loss: Implied fair value of goodwill = Fair value of division less the carrying value of the division (adjusted for fair value changes), net of goodwill: Fair value of Eaton division Carrying value of division Increase in fair value of PP&E Less goodwill

$1,700,000 $1,800,000 200,000 (500,000) (1,500,000) 200,000 (500,000) $ (300,000)

Implied value of goodwill Carrying amount of goodwill Loss on impairment Loss on Impairment ................................................................ Goodwill........................................................................

300,000 300,000

CHAPTER 12 ACCOUNTING FOR LIABILITIES TRUE-FALSE—Conceptual Answer

No.

Description

F F T T F F T F F F F T T F T F F T T T F F T F T T F T F T T F T F F T F F T T F F F

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. *43.

Zero-interest-bearing note payable. Dividends in arrears. Examples of unearned revenues. Reporting discount on Notes Payable. Currently maturing long-term debt. Current liability classification requirement. Classifying currently maturing bond. Preferred dividends in arrears. Classifying stock dividend distributable. Long-term debt covenants. Definition of revenue bonds. Bonds as borrowing process. Bond interest payments. Debenture bonds. Definition of serial bonds. Market rate vs. coupon rate. Definition of stated interest rate. Stated rate and coupon rate. Accounting for bond issue costs. Reporting bond discount. Reporting bond-issue costs. Computing loss from extinguishment. Refunding of bond issue. Accruing estimated loss contingency. Disclosing gain contingencies. Recording a loss contingency. Recording a liability for litigation. Reporting a loss from litigation. Sales-type warranty profit. Fair value of asset retirement obligation. Reporting a litigation liability. Expense warranty approach. Off-balance-sheet financing. Off-balance-sheet financing. Measuring amount of liabilities. Reporting maturing long-term debt. Acid-test ratio components. Affect on current ratio. Reporting current liabilities. Debt to total assets ratio. Refinancing long-term debt. Times interest earned ratio. Amortization of premium and discount.

12 - 2

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual (cont.) Answer

No.

Description

F F

*44. *45.

Interest paid vs. interest expense. Computing interest expense.

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86.

Definition of a liability. Nature of current liabilities. Classification of discounts on notes payable. Bonds reported as current liability. Identify item which is not a current liability. Dividends reported as current liability. Identify item which is not a current liability. Essential characteristics of a liability. Recording zero-interest-bearing note. Classifying currently maturing long-term debt. Definition of a debenture bond. Definition of collateral trust bonds. Bond terms. Definition of "debenture bonds." Definition of income bonds. Interest rate of the bond indenture. Rate of interest earned by the bondholders. Calculate the selling price of bonds. Calculate the selling price of bonds. Premium and interest rates on bonds. Reporting a bond premium. Accounting for bond-issue costs. Early extinguishment of debt. Classification of bond issuance costs. Bond issuance costs. Early extinguishment of bonds payable. Gain or loss on extinguishment of debt. Disclosure of a gain contingency. Disclosure of contingencies. Accrual of loss contingency. Litigation and loss contingencies. Accrual of a contingent liability. Source of a contingent liability. Definition of a contingency. Accrual of loss contingency. Accounting for a loss contingency. Recording an environmental liability. Asset retirement obligation. Asset retirement obligation. Classification of warranty liability. Liability accrual due to governmental action.

Accounting for Liabilities

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

a b d d d c d d d c c. c d d a a d d

87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. *101. *102. *103. *104.

Description Accrual of product warranties. Determining loss amount to report. Reporting lawsuit loss and liability. Accrual method for warranty costs. Off-balance-sheet financing. Off-balance-sheet financing. Long-term debt maturing within one year. Required bond disclosures. Long-term debt disclosures. Times interest earned ratio. Debt to total assets ratio. Presentation of current liabilities. Disclosure of accrued liabilities. Acid-test ratio elements. Effective-interest vs. straight-line method. Interest and discount amortization. Effective-interest amortization method. Impact of effective-interest method.

MULTIPLE CHOICE—Computational Answer

No.

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

105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123. 124. 125. *126. *127. *128. *129. *130. *131.

Description Adjusting entry involving discount on short-term note payable. Calculate the present value of bond interest. Determine the issue price of bonds. Proceeds from bond issuance. Recording issuance of bonds. Calculate gain on retirement of bonds. Calculate gain on retirement of bonds. Calculate loss on retirement of bonds. Bond retirement with call premium. Calculate rebate expense and liability. Asset retirement obligation. Calculate insurance expense and loss. Calculate warranty liability. Calculate liability for premiums. Determine premiums expense for the year. Calculate estimated liability for premiums. Determine amount to accrue as a loss contingency. Calculate warranty liability. Determine amount to accrue as a gain contingency. Calculate the quick (acid-test) ratio. Calculate times interest earned ratio. Effective-interest method interest expense. Effective-interest method carrying value. Straight-line method carrying value. Straight-line amortization/interest expense. Interest expense using effective-interest method. Interest expense using effective-interest method.

12 - 3

12 - 4

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—CPA Adapted Answer

No.

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

132. 133. 134. 135. 136. 137. 138. 139. 140. *141. *142. *143.

Description Determine current and long-term portions of debt. Determine accrued interest payable. Calculate loss on retirement of bonds. Determine carrying value of bonds to be retired. Carrying value of bonds with call provision. Calculate unearned service contract revenue. Determine range of loss accrual. Calculate the estimated warranty liability. Disclosure of a casualty claim. Determine unamortized bond premium. Determine unamortized bond discount. Calculate bond interest expense.

EXERCISES Item E12-144 E12-145 E12-146 E12-147 E12-148 E12-149 *E12-150

Description Terms related to long-term debt. Bond issue price and premium amortization. Entries for bonds payable. Retirement of bonds. Contingent liabilities. Warranties. Amortization of discount or premium.

PROBLEMS Item P12-151 P12-152 P12-153 *P12-154 *P12-155 *P12-156

Description Accounts and notes payable. Accounting for bonds. Warranties. Bond discount amortization. Bond interest and discount amortization. Entries for bonds payable.

CHAPTER LEARNING OBJECTIVES 1.

Describe the nature, type, and valuation of current liabilities.

Identify various types of bond issues.

Describe the accounting valuation for bonds at date of issuance.

Describe the accounting procedures for the extinguishment of debt.

Identify the criteria used to account for and disclose gain and loss contingencies.

Explain the accounting for different types of loss contingencies.

Explain the reporting of off-balance-sheet financing arrangements.

Indicate how to present and analyze liabilities and contingencies.

*9.

Compute amortization of bond discount and premium using the effective-interest method.

Accounting for Liabilities

12 - 5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2. 3. 4.

TF TF TF TF

5. 6. 7. 8.

TF TF TF TF

9. 46. 47. 48.

10. 11.

TF TF

12. 13.

TF TF

14. 15.

16. 17. 18.

TF TF TF

19. 20. 21.

TF TF TF

61. 62. 63.

22. 23. 68.

TF TF MC

69. 70. 71.

MC MC MC

72. 110. 111.

24. 25.

TF TF

26. 73.

TF MC

74. 75.

27. 28. 29. 30. 31.

TF TF TF TF TF

32. 81. 82. 83. 84.

TF MC MC MC MC

85. 86. 87. 88. 89.

33.

34.

91.

35. 36. 37.

TF TF TF

38. 39. 40.

TF TF TF

41. 42. 93.

43. 44. 45.

TF TF TF

101. 102. 103.

MC MC MC

104. 126. 127.

Note: TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 TF 49. MC 53. MC 50. MC 54. MC 51. MC 55. MC 52. MC 56. Learning Objective 2 TF 57. MC 59. TF 58. MC 60. Learning Objective 3 MC 64. MC 67. MC 65. MC 106. MC 66. MC 107. Learning Objective 4 MC 112. MC 135. MC 113. MC 136. MC 134. MC 144. Learning Objective 5 MC 76. MC 78. MC 77. MC 79. Learning Objective 6 MC 90. MC 118. MC 114. MC 119. MC 115. MC 120. MC 116. MC 121. MC 117. MC 122. Learning Objective 7 MC 92. MC Learning Objective 8 TF 94. MC 97. TF 95. MC 98. MC 96. MC 99. Learning Objective *9 MC 128. MC 131. MC 129. MC 141. MC 130. MC 142. E = Exercise P = Problem

Type

Item

Type

Item

Type

MC MC MC MC

105. 132. 133. 151.

MC MC MC P

MC MC MC

108. 109. 144.

MC MC E

145. 152.

E P

MC MC E

146. 147.

E E

MC MC

80. 148.

MC E

MC MC MC MC MC

123. 137. 138. 139. 140.

MC MC MC MC MC

149. 153.

E P

MC MC MC

100. 124. 125.

MC MC MC

151.

MC MC MC

143. 150. 152.

MC E P

154. 155. 156.

P P P

MC MC

12 - 6

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual 1. A zero-interest-bearing note payable that is issued at a discount will not result in any interest expense being recognized. 2. Dividends in arrears on cumulative preferred stock should be recorded as a current liability. 3. Magazine subscriptions and airline ticket sales both result in unearned revenues. 4. Discount on Notes Payable is a contra account to Notes Payable on the balance sheet. 5. All long-term debt maturing within the next year must be classified as a current liability on the balance sheet. 6. The only requirement for an obligation to be classified as a current liability is that it be liquidated within the operating cycle or one year, whichever is longer. 7. The currently maturing portion of a serial bond should not be classified as a current liability if it will be paid out of a long-term asset such as a sinking fund. 8. Preferred dividends in arrears should be recognized as a liability in the balance sheet. 9. A stock dividend distributable is classified as a long-term liability because it will not be liquidated using current assets. 10. Generally, long-term debt, in whatever form, is issued subject to various covenants or restrictions for the protection of corporate stockholders. 11. Revenue bonds are bonds whose interest rate is a function of the revenue earned by the company issuing the bonds. 12. Bonds issued by a corporation represent a means of borrowing funds from the general public or institutional investors on a long-term basis. 13. Companies usually make bond interest payments semiannually, although the interest rate is generally expressed as an annual rate. 14. A mortgage bond is referred to as a debenture bond. 15. Bond issues that mature in installments are called serial bonds. 16. If the market rate is greater than the coupon rate, bonds will be sold at a premium. 17. The interest rate written in the terms of the bond indenture is called the effective yield or market rate. 18. The stated rate is the same as the coupon rate. 19. Bond issue costs are capitalized as a deferred charge and amortized to expense over the life of the debt.

Accounting for Liabilities

12 - 7

20. Bond discount should be reported in the balance sheet as a direct deduction from the face amount of the bond. 21. The expenses associated with the issuance of bonds should be added to the bond discount or subtracted from the bond premium on the date the bonds are issued. 22. Any excess of the net carrying amount over the reacquisition price is a loss from extinguishment. 23. The replacement of an existing bond issue with a new one is called refunding. 24. Companies should accrue an estimated loss from a loss contingency if information available prior to the issuance of financial statements indicates that it is probable that a liability has been incurred. 25. A company discloses gain contingencies in the notes only when a high probability exists for realizing them. 26. If a loss contingency is likely to occur and its amount can be reasonably estimated, it should be recorded in the accounts. 27. One factor to consider in determining whether a liability should be recorded with respect to threatened litigation is the effect such a liability will have on a reported financial condition. 28. To report a loss and a liability in the financial statements, the cause for litigation must have occurred on or before the date of the financial statements. 29. The expected profit from a sales type warranty that covers several years should all be recognized in the period the warranty is sold. 30. The fair value of an asset retirement obligation is recorded as both an increase to the related asset and a liability. 31. The cause for litigation must have occurred on or before the date of the financial statements to report a liability in the financial statements. 32. Under the expense warranty approach, companies charge warranty costs only to the period in which they comply with the warranty. 33. Off-balance-sheet financing is an attempt to borrow monies in such a way to minimize the reporting of debt on the balance sheet. 34. Off-balance-sheet financing is an attempt to borrow monies in such a way that the obligations are recorded in the retained earnings statement. 35. Liabilities are generally measured by the present value of the future outlay of cash required to liquidate them. 36. Long-term debt that matures within one year should be reported as a current liability, unless retirement is to be accomplished with other than current assets.

12 - 8

Test Bank for Intermediate Accounting, Second Edition

37. Prepaid insurance should be included in the numerator when computing the acid-test (quick) ratio. 38. Paying a current liability with cash will always reduce the current ratio. 39. Current liabilities are usually recorded and reported in financial statements at their full maturity value. 40. The debt to total assets ratio will go up if an equal amount of assets and liabilities are added to the balance sheet. 41. If a company plans to refinance long-term debt or retire it from a bond retirement fund, it should report the debt as current. 42. The times interest earned ratio is computed by dividing income before interest expense by interest expense. *43. Amortization of a premium increases bond interest expense, while amortization of a discount decreases bond interest expense. *44. The cash paid for interest will always be greater than interest expense when using effectiveinterest amortization for a bond. *45. Under the effective-interest method, semiannual interest expense is computed by multiplying the effective-interest rate times a constant carrying value of the bonds.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7. 8.

F F T T F F T F

9. 10. 11. 12. 13. 14. 15. 16.

F F F T T F T F

17. 18. 19. 20. 21. 22. 23. 24.

F T T T F F T F

25. 26. 27. 28. 29. 30. 31. 32.

T T F T F T T F

33. 34. 35. 36. 37. 38. 39. 40.

T F F T F F T T

41. 42. *43. *44. *45.

F F F F F

Accounting for Liabilities

12 - 9

MULTIPLE CHOICE—Conceptual 46.

Liabilities are a. any accounts having credit balances after closing entries are made. b. deferred credits that are recognized and measured in conformity with generally accepted accounting principles. c. obligations to transfer ownership shares to other entities in the future. d. obligations arising from past transactions and payable in assets or services in the future.

47.

Which of the following is a current liability? a. A long-term debt maturing currently, which is to be paid with cash in a sinking fund b. A long-term debt maturing currently, which is to be retired with proceeds from a new debt issue c. A long-term debt maturing currently, which is to be converted into common stock d. None of these

48.

Which of the following is not true about the discount on short-term notes payable? a. The Discount on Notes Payable account has a debit balance. b. The Discount on Notes Payable account should be reported as an asset on the balance sheet. c. When there is a discount on a note payable, the effective interest rate is higher than the stated discount rate. d. All of these are true.

49.

Which of the following items is a current liability? a. Bonds (for which there is an adequate sinking fund properly classified as a long-term investment) due in three months. b. Bonds due in three years. c. Bonds (for which there is an adequate appropriation of retained earnings) due in eleven months. d. Bonds to be refunded when due in eight months, there being no doubt about the marketability of the refunding issue.

50.

Which of the following should not be included in the current liabilities section of the balance sheet? a. Trade notes payable b. Short-term zero-interest-bearing notes payable c. The discount on short-term notes payable d. All of these are included

51.

Which of the following is a current liability? a. Preferred dividends in arrears b. A dividend payable in the form of additional shares of stock c. A cash dividend payable to preferred stockholders d. All of these

52.

Of the following items, the only one which should not be classified as a current liability is a. current maturities of long-term debt. b. sales taxes payable. c. short-term obligations expected to be refinanced. d. unearned revenues.

12 - 10 Test Bank for Intermediate Accounting, Second Edition 53.

A liability has three essential characteristics. Which of the following is not one of them? a. It is a present obligation that entails settlement by probable future transfer or use of cash, goods, or services. b. The obligation must be liquidated using cash, goods, or services that were earned by the entity in the performance of its normal business operation. c. The liability must be an unavoidable obligation. d. The transaction or other event creating the obligation must have already occurred.

54.

Diana Co. issues a $208,000 6-month, zero-interest-bearing note to Tang National Bank. The present value of the note is $200,000. The entry to record this transaction by Diana Co. would include a a. credit to Notes Payable of $200,000. b. debit to Discount on Notes Payable of $8,000. c. credit to Discount on Notes Payable of $8,000. d. debit to Cash of $208,000.

55.

The currently maturing portion of long-term debt should be classified as a current liability if a. the debt is to be converted into capital stock. b. the debt is to be refinanced on a long-term basis. c. the funds used to liquidate it are currently classified as a long-term investment on the balance sheet. d. the portion so classified will be liquidated within one year using current assets.

56.

If a corporation issues a debenture bond, it means the bond a. is secured by stocks and bonds of other corporations. b. matures in installments. c. is unsecured. d. may be converted into other securities of the corporation for a specified time after issuance.

57.

Bonds that are secured by stocks and bonds of other corporations are called a. collateral trust bonds. b. registered bonds. c. serial bonds. d. treasury bonds.

58.

The covenants and other terms of the agreement between the issuer of bonds and the lender are set forth in the a. bond indenture. b. bond debenture. c. registered bond. d. bond coupon.

59.

The term used for bonds that are unsecured as to principal is a. junk bonds. b. debenture bonds. c. indebenture bonds. d. callable bonds.

Accounting for Liabilities 60.

Bonds that pay no interest unless the issuing company is profitable are called a. collateral trust bonds. b. debenture bonds. c. revenue bonds. d. income bonds.

61.

The interest rate written in the terms of the bond indenture is known as the a. coupon rate. b. nominal rate. c. stated rate. d. coupon rate, nominal rate, or stated rate.

62.

The rate of interest actually earned by bondholders is called the a. stated rate. b. yield rate. c. effective rate. d. effective yield or market rate.

12 - 11

Use the following information for questions 63 and 64. Cox Co. issued $100,000 of ten-year, 10% bonds that pay interest semiannually. The bonds are sold to yield 8%. 63.

One step in calculating the selling price of the bonds is to multiply the principal by the table value for a. 10 periods and 10% from the present value of 1 table. b. 20 periods and 5% from the present value of 1 table. c. 10 periods and 8% from the present value of 1 table. d. 20 periods and 4% from the present value of 1 table.

64.

Another step in calculating the selling price of the bonds is to a. multiply $10,000 by the table value for 10 periods and 10% from the present value of an annuity table. b. multiply $10,000 by the table value for 20 periods and 5% from the present value of an annuity table. c. multiply $10,000 by the table value for 20 periods and 4% from the present value of an annuity table. d. none of these.

65.

Stone, Inc. issued bonds with a maturity amount of $200,000 and a maturity ten years from date of issue. If the bonds were issued at a premium, this indicates that a. the effective yield or market rate of interest exceeded the stated (nominal) rate. b. the nominal rate of interest exceeded the market rate. c. the market and nominal rates coincided. d. no necessary relationship exists between the two rates.

66.

A bond premium should be reported in the balance sheet a. at the present value of the future reduction in bond interest expense due to the premium. b. as a deferred credit. c. along with other premium accounts such as those resulting from stock transactions. d. as a direct addition to the face amount of the bond.

12 - 12 Test Bank for Intermediate Accounting, Second Edition 67.

Bond issue costs, such as printing costs, legal fees, commissions, etc. are most appropriately accounted for by a. charging them to an expense account in the year the bonds are actually sold so there is revenue to charge them against on the income statement. b. debiting them to Unamortized Bond-Issue Costs and amortizing them in a manner similar to bond discount over the life of the bond. c. charging them to an expense account in the year the bonds are originally dated, whether or not they are sold in that year. d. adding them to any discount on bonds or subtracting them from any premium on bonds when the bonds are sold.

68.

When debt is extinguished before its maturity date, any difference between the reacquisition price of outstanding debt and its net carrying amount per books should be a. amortized over the remaining original life of the extinguished issue. b. amortized over the life of the new issue. c. recognized currently in income as a loss or gain. d. treated as a prior period adjustment.

69.

Theoretically, the costs of issuing bonds could be a. expensed when incurred. b. reported as a reduction of the bond liability. c. debited to a deferred charge account and amortized over the life of the bonds. d. any of these.

70.

The printing costs and legal fees associated with the issuance of bonds should a. be expensed when incurred. b. be reported as a deduction from the face amount of bonds payable. c. be accumulated in a deferred charge account and amortized over the life of the bonds. d. not be reported as an expense until the period the bonds mature or are retired.

71.

An early extinguishment of bonds payable, which were originally issued at a premium, is made by purchase of the bonds between interest dates. At the time of reacquisition a. any costs of issuing the bonds must be amortized up to the purchase date. b. the premium must be amortized up to the purchase date. c. interest must be accrued from the last interest date to the purchase date. d. all of these.

72.

The generally accepted method of accounting for gains or losses from the early extinguishment of debt treats any gain or loss as a(n) a. adjustment to the cost basis of the asset obtained by the debt issue. b. amount that should be considered a cash adjustment to the cost of any other debt issued over the remaining life of the old debt instrument. c. amount received or paid to obtain a new debt instrument and, as such, should be amortized over the life of the new debt. d. difference between the reacquisition price and the net carrying amount of the debt which should be recognized in the period of redemption.

Accounting for Liabilities

12 - 13

73.

Which of the following is the proper way to report a gain contingency? a. As an accrued amount. b. As deferred revenue. c. As an account receivable with additional disclosure explaining the nature of the contingency. d. As a disclosure only.

74.

Which of the following contingencies need not be disclosed in the financial statements or the notes thereto? a. Probable losses not reasonably estimable b. Environmental liabilities that cannot be reasonably estimated c. Guarantees of indebtedness of others d. All of these must be disclosed.

75.

Which of the following sets of conditions would give rise to the accrual of a contingency under current generally accepted accounting principles? a. Amount of loss is reasonably estimable and event occurs infrequently. b. Amount of loss is reasonably estimable and occurrence of event is probable. c. Event is unusual in nature and occurrence of event is probable. d. Event is unusual in nature and event occurs infrequently.

76.

Mark Ward is a farmer who owns land which borders on the right-of-way of Northern Railroad. On August 10, 2008, due to Northern’s admitted negligence, hay on the farm was set on fire and burned. Ward had had a dispute with the railroad for several years concerning the ownership of a small parcel of land. The representative of the railroad has offered to assign any rights which the railroad may have in the land to Ward in exchange for a release of his right to reimbursement for the loss he has sustained from the fire. Ward appears inclined to accept the railroad's offer. Northern Railroad's 2008 financial statements should include the following related to the incident: a. recognition of a loss and creation of a liability for the value of the land. b. recognition of a loss only. c. creation of a liability only. d. disclosure in note form only.

77.

A contingency can be accrued when a. it is certain that funds are available to settle the disputed amount. b. an asset may have been impaired. c. the amount of the loss can be reasonably estimated and it is probable that an asset has been impaired or a liability incurred. d. it is probable that an asset has been impaired or a liability incurred even though the amount of the loss cannot be reasonably estimated.

78.

A contingent liability a. definitely exists as a liability but its amount and due date are indeterminable. b. is accrued even though not reasonably estimated. c. is not disclosed in the financial statements. d. is the result of a loss contingency.

12 - 14 Test Bank for Intermediate Accounting, Second Edition 79.

A contingency is defined by FASB Statement No. 5 as an a. existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. b. existing condition, situation, or set of circumstances involving uncertainty as to a possible loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. c. event that will result in the requirement to record a liability if it can be shown that an asset is in danger of being lost to the enterprise and the company has no ability to avoid the loss. d. uncertain event that must have a reasonable chance of occurrence and the amount must be reasonably determinable by the company.

80.

Which of the following loss contingencies is normally accrued? a. Pending or threatened litigation b. General or unspecified business risk c. Obligations related to product warranties d. Risk of property loss due to fire

81.

If a loss is either probable or estimable, but not both, and if there is at least a reasonable possibility that a liability may have been incurred, the proper accounting treatment would be reflected by which of the following? a. Record the loss and the related liability, but at an amount that is significantly conservative. b. Record the loss and the related liability, but indicate in a footnote to the financial statements that this loss may not occur because one of the criteria may not be met. c. Disclose in the footnotes to the financial statements (1) the nature of the contingency, and (2) an estimate of the possible loss or range of loss or a statement that an estimate cannot be made. d. Do not record the contingency or make mention of it in the financial statements because it lacks meeting the required criteria.

82.

Wilson Company is involved in a litigation suit concerning the clean-up of old underground oil storage tanks on property it sold to a housing development company five years ago. The attorneys for Wilson Company cannot give a best estimate for the probable liability; however, the attorneys state that the liability to Wilson Company will probably fall within a range of $2 million to $10 million. According to the SEC, what should Wilson Company record with regards to this environmental liability? a. No entry is required. b. A loss and liability of $10 million. c. A loss and liability of $6 million. d. A loss and liability of $2 million.

83.

To record an asset retirement obligation (ARO), the cost associated with the ARO is a. expensed. b. included in the carrying amount of the related long-lived asset. c. included in a separate account. d. none of these.

Accounting for Liabilities

12 - 15

84.

A company is legally obligated for the costs associated with the retirement of a long-lived asset a. only when it hires another party to perform the retirement activities. b. only if it performs the activities with its own workforce and equipment. c. whether it hires another party to perform the retirement activities or performs the activities itself. d. when it is probable the asset will be retired.

85.

Assume that a manufacturing corporation has (1) good quality control, (2) a one-year operating cycle, (3) a relatively stable pattern of annual sales, and (4) a continuing policy of guaranteeing new products against defects for three years that has resulted in material but rather stable warranty repair and replacement costs. Any liability for the warranty a. should be reported as long-term. b. should be reported as current. c. should be reported as part current and part long-term. d. need not be disclosed.

86.

Lopez Corporation, a manufacturer of household paints, is preparing annual financial statements at December 31, 2008. Because of a recently proven health hazard in one of its paints, the government has clearly indicated its intention of having Lopez recall all cans of this paint sold in the last six months. The management of Lopez estimates that this recall would cost $800,000. What accounting recognition, if any, should be accorded this situation? a. No recognition b. Note disclosure only c. Operating expense of $800,000 and liability of $800,000 d. Appropriation of retained earnings of $800,000

87.

Information available prior to the issuance of the financial statements indicates that it is probable that, at the date of the financial statements, a liability has been incurred for obligations related to product warranties. The amount of the loss involved can be reasonably estimated. Based on the above facts, an estimated loss contingency should be a. accrued. b. disclosed but not accrued. c. neither accrued nor disclosed. d. classified as an appropriation of retained earnings.

88.

Mayberry Co. has a loss contingency to accrue. The loss amount can only be reasonably estimated within a range of outcomes. No single amount within the range is a better estimate than any other amount. The amount of loss accrual should be a. zero. b. the minimum of the range. c. the mean of the range. d. the maximum of the range.

12 - 16 Test Bank for Intermediate Accounting, Second Edition 89.

Marx Company becomes aware of a lawsuit after the date of the financial statements, but before they are issued. A loss and related liability should be reported in the financial statements if the amount can be reasonably estimated, an unfavorable outcome is highly probable, and a. Marx Company admits guilt. b. the court will decide the case within one year. c. the damages appear to be material. d. the cause for action occurred during the accounting period covered by the financial statements.

90.

Use of the accrual method in accounting for product warranty costs a. is required for federal income tax purposes. b. is frequently justified on the basis of expediency when warranty costs are immaterial. c. finds the expense account being charged when the seller performs in compliance with the warranty. d. represents accepted practice and should be used whenever the warranty is an integral and inseparable part of the sale.

91.

Which of the following is an example of "off-balance-sheet financing"? 1. Non-consolidated subsidiary 2. Special purpose entity 3. Operating leases a. 1 b. 2 c. 3 d. All of these are examples of "off-balance-sheet financing."

92.

When a business enterprise enters into what is referred to as off-balance-sheet financing, the company a. is attempting to conceal the debt from shareholders by having no information about the debt included in the balance sheet. b. wishes to confine all information related to the debt to the income statement and the statement of cash flows. c. can enhance the quality of its financial position and perhaps permit credit to be obtained more readily and at less cost. d. is in violation of generally accepted accounting principles.

93.

Long-term debt that matures within one year and is to be converted into stock should be reported a. as a current liability. b. in a special section between liabilities and stockholders’ equity. c. as noncurrent. d. as noncurrent and accompanied with a note explaining the method to be used in its liquidation.

Accounting for Liabilities

12 - 17

94.

Which of the following must be disclosed relative to long-term debt maturities and sinking fund requirements? a. The present value of future payments for sinking fund requirements and long-term debt maturities during each of the next five years. b. The present value of scheduled interest payments on long-term debt during each of the next five years. c. The amount of scheduled interest payments on long-term debt during each of the next five years. d. The amount of future payments for sinking fund requirements and long-term debt maturities during each of the next five years.

95.

Note disclosures for long-term debt generally include all of the following except a. assets pledged as security. b. call provisions and conversion privileges. c. restrictions imposed by the creditor. d. names of specific creditors.

96.

The times interest earned ratio is computed by dividing a. net income by interest expense. b. income before taxes by interest expense. c. income before income taxes and interest expense by interest expense. d. net income and interest expense by interest expense.

97.

The debt to total assets ratio is computed by dividing a. current liabilities by total assets. b. long-term liabilities by total assets. c. total liabilities by total assets. d. total assets by total liabilities.

98.

Which of the following is not acceptable treatment for the presentation of current liabilities? a. Listing current liabilities in order of maturity b. Listing current liabilities according to amount c. Offsetting current liabilities against assets that are to be applied to their liquidation d. Showing current liabilities immediately below current assets to obtain a presentation of working capital

99.

Accrued liabilities are disclosed in financial statements by a. a footnote to the statements. b. showing the amount among the liabilities but not extending it to the liability total. c. an appropriation of retained earnings. d. appropriately classifying them as regular liabilities in the balance sheet.

100.

The numerator of the acid-test ratio consists of a. total current assets. b. cash and marketable securities. c. cash and net receivables. d. cash, marketable securities, and net receivables.

12 - 18 Test Bank for Intermediate Accounting, Second Edition *101. If bonds are issued initially at a premium and the effective-interest method of amortization is used, interest expense in the earlier years will be a. greater than if the straight-line method were used. b. greater than the amount of the interest payments. c the same as if the straight-line method were used. d. less than if the straight-line method were used. *102. If bonds are initially sold at a discount and the straight-line method of amortization is used, interest expense in the earlier years will a. exceed what it would have been had the effective-interest method of amortization been used. b. be less than what it would have been had the effective-interest method of amortization been used. c. be the same as what it would have been had the effective-interest method of amortization been used. d. be less than the stated (nominal) rate of interest. *103. Under the effective-interest method of bond discount or premium amortization, the periodic interest expense is equal to a. the stated (nominal) rate of interest multiplied by the face value of the bonds. b. the market rate of interest multiplied by the face value of the bonds. c. the stated rate multiplied by the beginning-of-period carrying amount of the bonds. d. the market rate multiplied by the beginning-of-period carrying amount of the bonds. *104. When the effective-interest method is used to amortize bond premium or discount, the periodic amortization will a. increase if the bonds were issued at a discount. b. decrease if the bonds were issued at a premium. c. increase if the bonds were issued at a premium. d. increase if the bonds were issued at either a discount or a premium.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

46. 47. 48. 49. 50. 51. 52. 53. 54.

d d b c d c c b b

55. 56. 57. 58. 59. 60. 61. 62. 63.

d c a a b d d d d

64. 65. 66. 67. 68. 69. 70. 71. 72.

d b d b c d c d d

73. 74. 75. 76. 77. 78. 79. 80. 81.

d d b a c d a c c

82. 83. 84. 85. 86. 87. 88. 89. 90.

d b c c c a b d d

91. 92. 93. 94. 95. 96. 97. 98. 99.

d c d d d c c c d

100. *101. *102. *103. *104.

d a a d d

Solutions to those Multiple Choice questions for which the answer is “none of these.” 47. A long-term debt maturing currently to be paid with current assets is a current liability. 64. multiply $5,000 by the table value for 20 periods and 4% from the present value of an annuity table.

Accounting for Liabilities

12 - 19

MULTIPLE CHOICE—Computational 105.

Edson Corp. signed a three-month, zero-interest-bearing note on November 1, 2008 for the purchase of $150,000 of inventory. The face value of the note was $152,205. Assuming Edson used a “Discount on Note Payable” account to initially record the note and that the discount will be amortized equally over the 3-month period, the adjusting entry made at December 31, 2008 will include a a. debit to Discount on Note Payable for $735. b. debit to Interest Expense for $1,470. c. credit to Discount on Note Payable for $735. d. credit to Interest Expense for $1,470.

Use the following information for questions 106 and 107. On January 1, 2008, Bleeker Co. issued eight-year bonds with a face value of $1,000,000 and a stated interest rate of 6%, payable semiannually on June 30 and December 31. The bonds were sold to yield 8%. Table values are: Present value of 1 for 8 periods at 6% ......................................... Present value of 1 for 8 periods at 8% ......................................... Present value of 1 for 16 periods at 3% ....................................... Present value of 1 for 16 periods at 4% ....................................... Present value of annuity for 8 periods at 6%................................ Present value of annuity for 8 periods at 8%................................ Present value of annuity for 16 periods at 3%.............................. Present value of annuity for 16 periods at 4%..............................

.627 .540 .623 .534 6.210 5.747 12.561 11.652

106.

The present value of the interest is a. $344,820. b. $349,560. c. $372,600. d. $376,830.

107.

The issue price of the bonds is a. $883,560. b. $884,820. c. $889,560. d. $999,600.

108.

Limeway Company issues $5,000,000, 6%, 5-year bonds dated January 1, 2008 on January 1, 2008. The bonds pay interest semiannually on June 30 and December 31. The bonds are issued to yield 5%. What are the proceeds from the bond issue? Present value of a single sum for 5 periods Present value of a single sum for 10 periods Present value of an annuity for 5 periods Present value of an annuity for 10 periods a. b. c. d.

$5,000,000 $5,216,494 $5,218,809 $5,217,308

2.5% .88385 .78120 4.64583 8.75206

3.0% .86261 .74409 4.57971 8.53020

5.0% 6.0% .78353 .74726 .61391 .55839 4.32948 4.21236 7.72173 7.36009

12 - 20 Test Bank for Intermediate Accounting, Second Edition 109.

On October 1, 2008, Sinatra Corporation issued 5%, 10-year bonds with a par value of $300,000 at 104. Interest is paid on October 1 and April 1. The entry to record the issuance of the bonds would include a a. credit of $7,500 to Accrued Interest Payable. b. credit of $12,000 to Premium on Bonds Payable. b. credit of $288,000 to Bonds Payable. c. debit of $12,000 to Discount on Bonds Payable.

110.

The December 31, 2008, balance sheet of Eddy Corporation includes the following items: 9% bonds payable due December 31, 2017 Unamortized premium on bonds payable

$3,500,000 94,500

The bonds were issued on December 31, 2007, at 103, with interest payable on July 1 and December 31 of each year. On January 2, 2009, Eddy retired $1,400,000 of these bonds at 98. What should Eddy record as a gain on retirement of these bonds? Ignore taxes. a. $28,000 b. $37,800 c. $65,800 d. $70,000 111.

On January 1, 2002, Gonzalez Corporation issued $4,500,000 of 10%, ten-year bonds at 103. The bonds are callable at the option of Gonzalez at 105. On December 31, 2008, when the fair market value of the bonds was 96, Gonzalez repurchased $1,000,000 of the bonds in the open market at 96. The unamortized total premium at the date of repurchase was $40,500. Gonzalez has recorded interest and amortization for 2008. Ignoring income taxes and assuming that the gain is material, Gonzalez should report this reacquisition as a. a loss of $49,000. b. a gain of $49,000. c. a loss of $61,000. d. a gain of $61,000.

112.

The 10% bonds payable of Klein Company had a net carrying amount of $570,000 on December 31, 2007. The bonds, which had a face value of $600,000, were issued at a discount to yield 12%. Interest was paid on January 1 and July 1 of each year. On July 2, 2008, several years before their maturity, Klein retired the bonds at 102. The interest payment on July 1, 2008 was made as scheduled and $4,200 of the discount was amortized. What is the loss that Klein should record on the early retirement of the bonds on July 2, 2008? Ignore taxes. a. $12,000 b. $37,800 c. $33,600 d. $42,000

Accounting for Liabilities

12 - 21

113.

A corporation called an outstanding bond obligation four years before maturity. At that time there was an unamortized discount of $300,000. To extinguish this debt, the company had to pay a call premium of $100,000. Ignoring income tax considerations, how should these amounts be treated for accounting purposes? a. Amortize $400,000 over four years. b. Charge $400,000 to a loss in the year of extinguishment. c. Charge $100,000 to a loss in the year of extinguishment and amortize $300,000 over four years. d. Either amortize $400,000 over four years or charge $400,000 to a loss immediately, whichever management selects.

114.

A company offers a cash rebate of $1 on each $4 package of light bulbs sold during 2008. Historically, 10% of customers mail in the rebate form. During 2008, 4,000,000 packages of light bulbs are sold, and 140,000 $1 rebates are mailed to customers. What is the rebate expense and liability, respectively, shown on the 2008 financial statements dated December 31? a. $400,000; $400,000 b. $400,000; $260,000 c. $260,000; $260,000 d. $140,000; $260,000

115.

A company buys an oil rig for $1,000,000 on January 1, 2008. The life of the rig is 10 years and the expected cost to dismantle the rig at the end of 10 years is $200,000 (present value at 10% is $77,110). 10% is an appropriate interest rate for this company. What expense should be recorded for 2008 as a result of these events? a. Depreciation expense of $120,000 b. Depreciation expense of $100,000 and interest expense of $7,711 c. Depreciation expense of $100,000 and interest expense of $20,000 d. Depreciation expense of $107,710 and interest expense of $7,711

116.

Wellman Company self insures its property for fire and storm damage. If the company were to obtain insurance on the property, it would cost them $1,000,000 per year. The company estimates that on average it will incur losses of $800,000 per year. During 2008, $350,000 worth of losses were sustained. How much total expense and/or loss should be recognized by Wellman Company for 2008? a. $350,000 in losses and no insurance expense b. $350,000 in losses and $450,000 in insurance expense c. $0 in losses and $800,000 in insurance expense d. $0 in losses and $1,000,000 in insurance expense

117.

During 2007, Younger Co. introduced a new line of machines that carry a three-year warranty against manufacturer’s defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 4% in the year after sale, and 6% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows: 2007 2008 2009

Sales $ 600,000 1,500,000 2,100,000 $4,200,000

Actual Warranty Expenditures $ 9,000 45,000 135,000 $189,000

What amount should Younger report as a liability at December 31, 2009?

12 - 22 Test Bank for Intermediate Accounting, Second Edition a. b. c. d. 118.

$0 $15,000 $204,000 $315,000

Milner Frosted Flakes Company offers its customers a pottery cereal bowl if they send in 3 box tops from Milner Frosted Flakes boxes and $1.00. The company estimates that 60% of the box tops will be redeemed. In 2008, the company sold 675,000 boxes of Frosted Flakes and customers redeemed 330,000 box tops receiving 110,000 bowls. If the bowls cost Milner Company $2.50 each, how much liability for outstanding premiums should be recorded at the end of 2008? a. $25,000 b. $37,500 c. $62,500 d. $87,500

Use the following information for questions 119 and 120. Kent Co. includes one coupon in each bag of dog food it sells. In return for eight coupons, customers receive a leash. The leashes cost Kent $2.00 each. Kent estimates that 40 percent of the coupons will be redeemed. Data for 2008 and 2009 are as follows: Bags of dog food sold Leashes purchased Coupons redeemed

2008 500,000 18,000 120,000

2009 600,000 22,000 150,000

119.

The premium expense for 2008 is a. $25,000. b. $30,000. c. $35,000. d. $50,000.

120.

The estimated liability for premiums at December 31, 2008 is a. $7,500. b. $10,000. c. $17,500. d. $20,000.

121.

Vernon Co. is being sued for illness caused to local residents as a result of negligence on the company's part in permitting the local residents to be exposed to highly toxic chemicals from its plant. Vernon's lawyer states that it is probable that Vernon will lose the suit and be found liable for a judgment costing Vernon anywhere from $1,200,000 to $6,000,000. However, the lawyer states that the most probable cost is $3,600,000. As a result of the above facts, Vernon should accrue a. a loss contingency of $1,200,000 and disclose an additional contingency of up to $4,800,000. b. a loss contingency of $3,600,000 and disclose an additional contingency of up to $2,400,000. c. a loss contingency of $3,600,000 but not disclose any additional contingency. d. no loss contingency but disclose a contingency of $1,200,000 to $6,000,000.

Accounting for Liabilities 122.

12 - 23

In 2008, Slimon Corporation began selling a new line of products that carry a two-year warranty against defects. Based upon past experience with other products, the estimated warranty costs related to dollar sales are as follows: First year of warranty 2% Second year of warranty 5% Sales and actual warranty expenditures for 2008 and 2009 are presented below: 2008 2009 Sales $300,000 $400,000 Actual warranty expenditures 10,000 20,000 What is the estimated warranty liability at the end of 2009? a. $19,000 b. $29,000 c. $49,000 d. $8,000

123.

On January 3, 2008, Alton Corp. owned a machine that had cost $200,000. The accumulated depreciation was $120,000, estimated salvage value was $12,000, and fair market value was $320,000. On January 4, 2008, this machine was irreparably damaged by Reed Corp. and became worthless. In October 2008, a court awarded damages of $320,000 against Reed in favor of Alton. At December 31, 2008, the final outcome of this case was awaiting appeal and was, therefore, uncertain. However, in the opinion of Alton’s attorney, Reed’s appeal will be denied. At December 31, 2008, what amount should Alton accrue for this gain contingency? a. $320,000 b. $260,000 c. $200,000 d. $0

124.

Presented below is information available for Norton Company. Current Assets Cash Short-term investments Accounts receivable Inventories Prepaid expenses Total current assets

4,000 75,000 61,000 110,000 30,000 $280,000

Total current liabilities are $120,000. The acid-test ratio for Norton is a. 2.33 to 1. b. 2.08 to 1. c. 1.17 to 1. d. .54 to 1. 125.

Nyland Company’s 2008 financial statements contain the following selected data: Income taxes Interest expense Net income Nyland’s times interest earned for 2008 is

$40,000 20,000 60,000

12 - 24 Test Bank for Intermediate Accounting, Second Edition a. b. c. d.

3 times 4 times. 5 times. 6 times.

*126. A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2008. Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. Using effective-interest amortization, how much interest expense will be recognized in 2008? a. $780,000 b. $1,560,000 c. $1,568,498 d. $1,568,332 *127. A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2008. Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. Using effective-interest amortization, what will the carrying value of the bonds be on the December 31, 2008 balance sheet? a. $19,612,643 b. $20,000,000 c. $19,625,125 d. $19,608,310 *128. A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2006. Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. Using straight-line amortization, what is the carrying value of the bonds on December 31, 2008? a. $19,670,231 b. $19,940,622 c. $19,633,834 d. $19,663,523 *129. A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007. Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. What is interest expense for 2008, using straight-line amortization? a. $1,540,207 b. $1,560,000 c. $1,569,192 d. $1,579,793 *130. On January 1, 2008, Foley Co. sold 12% bonds with a face value of $600,000. The bonds mature in five years, and interest is paid semiannually on June 30 and December 31. The bonds were sold for $646,200 to yield 10%. Using the effective-interest method of amortization, interest expense for 2008 is a. $60,000. b. $64,436. c. $64,620. d. $72,000.

Accounting for Liabilities

12 - 25

*131. On January 2, 2008, a calendar-year corporation sold 8% bonds with a face value of $600,000. These bonds mature in five years, and interest is paid semiannually on June 30 and December 31. The bonds were sold for $553,600 to yield 10%. Using the effectiveinterest method of computing interest, how much should be charged to interest expense in 2008? a. $48,000 b. $55,360 c. $55,544 d. $60,000

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

105. 106. 107. 108.

b b a c

109. 110. 111. 112.

b c b b

113. 114. 115. 116.

b b d a

117. 118. 119. 120.

d b d d

121. 122. 123. 124.

b a d c

125. *126. *127. *128.

d c a d

*129. *130. *131.

d b c

MULTIPLE CHOICE—CPA Adapted 132.

On January 1, 2008, Didde Co. leased a building to Ellis Corp. for a ten-year term at an annual rental of $80,000. At inception of the lease, Didde received $320,000 covering the first two years' rent of $160,000 and a security deposit of $160,000. This deposit will not be returned to Ellis upon expiration of the lease but will be applied to payment of rent for the last two years of the lease. What portion of the $320,000 should be shown as a current and long-term liability, respectively, in Didde's December 31, 2008 balance sheet? Current Liability Long-term Liability a. $0 $320,000 b. $80,000 $160,000 c. $160,000 $160,000 d. $160,000 $80,000

133.

On September 1, 2007, Looper Co. issued a note payable to National Bank in the amount of $1,200,000, bearing interest at 12%, and payable in three equal annual principal payments of $400,000. On this date, the bank's prime rate was 11%. The first payment for interest and principal was made on September 1, 2008. At December 31, 2008, Looper should record accrued interest payable of a. $48,000. b. $44,000. c. $32,000. d. $29,334.

134.

On its December 31, 2007 balance sheet, Lane Corp. reported bonds payable of $6,000,000 and related unamortized bond issue costs of $320,000. The bonds had been issued at par. On January 2, 2008, Lane retired $3,000,000 of the outstanding bonds at par plus a call premium of $70,000. What amount should Lane report in its 2008 income statement as loss on extinguishment of debt (ignore taxes)?

12 - 26 Test Bank for Intermediate Accounting, Second Edition a. b. c. d.

$0 $70,000 $160,000 $230,000

135.

On June 30, 2008, Rosen Co. had outstanding 8%, $3,000,000 face amount, 15-year bonds maturing on June 30, 2018. Interest is payable on June 30 and December 31. The unamortized balances in the bond discount and deferred bond issue costs accounts on June 30, 2008 were $105,000 and $30,000, respectively. On June 30, 2008, Rosen acquired all of these bonds at 94 and retired them. What net carrying amount should be used in computing gain or loss on this early extinguishment of debt? a. $2,970,000 b. $2,895,000 c. $2,865,000 d. $2,820,000

136.

A ten-year bond was issued in 2005 at a discount with a call provision to retire the bonds. When the bond issuer exercised the call provision on an interest date in 2007, the carrying amount of the bond was less than the call price. The amount of bond liability removed from the accounts in 2007 should have equaled the a. call price. b. call price less unamortized discount. c. face amount less unamortized discount. d. face amount plus unamortized discount.

137.

Dexter Co. sells major household appliance service contracts for cash. The service contracts are for a one-year, two-year, or three-year period. Cash receipts from contracts are credited to unearned service contract revenues. This account had a balance of $480,000 at December 31, 2008 before year-end adjustment. Service contract costs are charged as incurred to the service contract expense account, which had a balance of $120,000 at December 31, 2008. Outstanding service contracts at December 31, 2008 expire as follows: During 2009 $100,000

During 2010 $160,000

During 2011 $70,000

What amount should be reported as unearned service contract revenues in Dexter's December 31, 2008 balance sheet? a. $360,000 b. $330,000 c. $240,000 d. $220,000 138.

Lett Co. has a probable loss that can only be reasonably estimated within a range of outcomes. No single amount within the range is a better estimate than any other amount. The loss accrual should be a. zero. b. the maximum of the range. c. the mean of the range. d. the minimum of the range.

Accounting for Liabilities 139.

12 - 27

During 2008, Blass Co. introduced a new product carrying a two-year warranty against defects. The estimated warranty costs related to dollar sales are 2% within 12 months following sale and 4% in the second 12 months following sale. Sales and actual warranty expenditures for the years ended December 31, 2008 and 2009 are as follows:

2008 2009

Sales $ 800,000 1,000,000 $1,800,000

Actual Warranty Expenditures $12,000 30,000 $42,000

At December 31, 2009, Blass should report an estimated warranty liability of a. $0. b. $10,000. c. $30,000. d. $66,000. 140.

In March 2008, an explosion occurred at Howe Co.'s plant, causing damage to area properties. By May 2008, no claims had yet been asserted against Howe. However, Howe's management and legal counsel concluded that it was reasonably possible that Howe would be held responsible for negligence, and that $4,000,000 would be a reasonable estimate of the damages. Howe's $5,000,000 comprehensive public liability policy contains a $400,000 deductible clause. In Howe's December 31, 2007 financial statements, for which the auditor's fieldwork was completed in April 2008, how should this casualty be reported? a. As a note disclosing a possible liability of $4,000,000. b. As an accrued liability of $400,000. c. As a note disclosing a possible liability of $400,000. d. No note disclosure of accrual is required for 2007 because the event occurred in 2008.

*141. On January 1, 2008, Gomez Co. issued its 10% bonds in the face amount of $3,000,000, which mature on January 1, 2018. The bonds were issued for $3,405,000 to yield 8%, resulting in bond premium of $405,000. Gomez uses the effective-interest method of amortizing bond premium. Interest is payable annually on December 31. At December 31, 2008, Gomez's adjusted unamortized bond premium should be a. $405,000. b. $377,400. c. $364,500. d. $304,500. *142. On July 1, 2006, Kitel, Inc. issued 9% bonds in the face amount of $5,000,000, which mature on July 1, 2016. The bonds were issued for $4,695,000 to yield 10%, resulting in a bond discount of $305,000. Kitel uses the effective-interest method of amortizing bond discount. Interest is payable annually on June 30. At June 30, 2008, Kitel's unamortized bond discount should be a. $264,050. b. $255,000. c. $244,000. d. $215,000.

12 - 28 Test Bank for Intermediate Accounting, Second Edition *143. On January 1, 2008, Nott Co. sold $1,000,000 of its 10% bonds for $885,296 to yield 12%. Interest is payable semiannually on January 1 and July 1. What amount should Nott report as interest expense for the six months ended June 30, 2008? a. $44,266 b. $50,000 c. $53,118 d. $60,000

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

132. 133.

b c

134. 135.

d c

136. 137.

c b

138. 139.

d d

140. *141.

c b

*142. *143.

a c

DERIVATIONS — Computational No.

Answer

Derivation

105.

$152,205 – $150,000 = $2,205 $2,205 × 2/3 = $1,470.

106.

($1,000,000 × .03) × 11.652 = $349,560.

107.

$534,000 + $349,560 = $883,560.

108.

($5,000,000 × .78120) + ($150,000 × 8.75206) = $5,218,809.

109.

($300,000 × 1.04) – $300,000 = $12,000.

110.

$3,594,500 × .4 = $1,437,800 (CV of retired bonds) $1,437,800 – ($1,400,000 × .98) = $65,800.

111.

$4,540,500 × $1,000,000/$4,500,000 = $1,009,000 (CV of retired bonds) $1,009,000 – ($1,000,000  .96) = $49,000.

112.

$570,000 + $4,200 = $574,200 (CV of bonds) $574,200 – ($600,000 × 1.02) = $37,800.

113.

$300,000 + $100,000 = $400,000.

114.

4,000,000 × .10 × $1 = $400,000; $400,000 – $140,000 = $260,000.

115.

($1.000,000 + $77,110) ÷ 10 = $107,710; $77,110 × .10 = $7,711.

116.

117.

($4,200,000 × .12) – $189,000 = $315,000.

118.

{[(675,000 × .60) – 330,000] ÷ 3} × $1.50 = $37,500.

Accounting for Liabilities

DERIVATIONS — Computational (cont.) No.

Answer

Derivation

119.

[(500,000 × .4) ÷ 8] × $2 = $50,000.

120.

[(200,000 – 120,000) ÷ 8] × $2 = $20,000.

121.

$3,600,000 and $2,400,000.

122.

[($300,000 + $400,000) × .07] – $30,000 = $19,000.

123.

$0, gain contingencies are not accrued.

124.

$4,000 + $75,000 + $61,000 ————————————— = 1.17 to 1. $120,000

125.

$60,000 + $40,000 + $20,000 ————————————— = 6 times. $20,000

*126.

($19,604,145 × .04) + ($19,608,310 × .04) = $1,568,498.

*127.

$19,604,145 + [($19,604,145 × .04) – $780,000] + [$19,608,310 × .04) – $780,000] = $19,612,643.

*128.

$19,604,145 + ($395,855 × 3/20) = $19,663,523.

*129.

($20,000,000 × .078) + ($395,855 ÷ 20) = $1,579,793.

*130.

$646,200 × .05 = $32,310 [$646,200 – ($36,000 – $32,310)] × .05 = 32,126 $64,436

*131.

$553,600 × .05 = $27,680 [$553,600 + ($27,680 – $24,000)] × .05 = 27,864 $55,544

DERIVATIONS — CPA Adapted No.

Answer

Derivation

132.

$80,000 and $160,000.

133.

4 $800,000 × .12 × — = $32,000. 12

134.

($3,000,000 + $70,000) – [($6,000,000 – $320,000) × 1/2] = $230,000.

135.

$3,000,000 – ($105,000 + $30,000) = $2,865,000.

12 - 29

12 - 30 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — CPA Adapted (cont.) No.

Answer

Derivation

136.

Conceptual.

137.

$100,000 + $160,000 + $70,000 = $330,000.

138.

Conceptual.

139.

($1,800,000 × .06) – $42,000 = $66,000.

140.

Conceptual.

*141.

$405,000 – [($3,000,000 × .10) – ($3,405,000 × .08)] = $377,400.

*142.

2006-2007: $4,695,000 + [($4,695,000 × .1) – ($5,000,000 × .09)] = $4,714,500. 2007-2008: $4,714,500 + ($471,450 – $450,000) = $4,735,950 $5,000,000 – $4,735,950 = $264,050.

*143.

$885,296 × .06 = $53,118.

Accounting for Liabilities

12 - 31

EXERCISES Ex. 12-144—Terms related to long-term debt. Place the letter of the best matching phrase before each word. ____ 1. Bond Indenture

___ 6. Times Interest Earned Ratio

____ 2. Serial Bonds

___ 7. Extinguishment of Debt

____ 3. Bonds Issued at Par

___ 8. Premium on Bonds

____ 4. Carrying Value

___ 9. Reacquisition Price

____ 5. Nominal Rate

___ 10. Market Rate

a. Requires that bond discount be reported in the balance sheet as a direct deduction from the face of the bond. b. Rate set by party issuing the bonds which appears on the bond instrument. c. The interest paid each period is the effective interest at date of issuance. d. Rate of interest actually earned by the bondholders. e. Results when bonds are sold below par. f. Results when bonds are sold above par. g. Bond issues that mature in installments. h. Price paid by issuing corporation for its own bonds. i.

Book value of bonds at any given date.

Ratio of current assets to current liabilities.

k. The bond contract or agreement. l.

Indicates the company’s ability to meet interest payments as they come due.

m. Ratio of debt to equity. n. Exclusive right to manufacture a product. o. The payment of debt.

Solution 12-144 1. k 2. g

3. 4.

c i

5. 6

b l

7. 8

o f

9. 10.

h d

12 - 32 Test Bank for Intermediate Accounting, Second Edition Ex. 12-145—Bond issue price and premium amortization. On January 1, 2008, Lowry Co. issued ten-year bonds with a face value of $1,000,000 and a stated interest rate of 10%, payable semiannually on June 30 and December 31. The bonds were sold to yield 12%. Table values are: Present value of 1 for 10 periods at 10% ................................. .386 Present value of 1 for 10 periods at 12% ................................. .322 Present value of 1 for 20 periods at 5% ................................... .377 Present value of 1 for 20 periods at 6% ................................... .312 Present value of annuity for 10 periods at 10% ........................ 6.145 Present value of annuity for 10 periods at 12% ........................ 5.650 Present value of annuity for 20 periods at 5% .......................... 12.462 Present value of annuity for 20 periods at 6% .......................... 11.470 Instructions (a) Calculate the issue price of the bonds. *(b) Without prejudice to your solution in part (a), assume that the issue price was $884,000. Prepare the amortization table for 2008, assuming that amortization is recorded on interest payment dates.

Solution 12-145 (a) .312 × $1,000,000 = $312,000 11.470 × $50,000 = 573,500 $885,500 *(b)

Date 1/1/08 6/30/08 12/31/08

Cash

Expense

Amortization

$50,000 50,000

$53,040 53,222

3,040 3,222

Carrying Amount $884,000 887,040 890,262

Ex. 12-146—Entries for Bonds Payable. Prepare journal entries to record the following transactions related to long-term bonds of Starr Co. (a) On January 1, 2008, Starr issued $500,000, 9% bonds for $530,000. The bonds were sold to yield 8%. Interest is payable annually on January 1, and the bonds mature on January 1, 2018. *(b) On July 1, 2008 Starr retired $150,000 of the bonds at 102 plus accrued interest. Starr uses effective-interest amortization.

Accounting for Liabilities

12 - 33

Solution 12-146 (a) Cash ............................................................................................. Bonds Payable ................................................................... Premium on Bonds Payable ...............................................

530,000

*(b) Interest Expense ($530,000 × .08 × 6/12) × .30 ............................ Premium on Bonds Payable.......................................................... Cash ($150,000 × 9% × 6/12) .............................................

6,360 390

Bonds Payable ............................................................................. Premium on Bonds Payable ($30,000 × .3) – $390 ....................... Cash ................................................................................... Gain on Redemption of Bonds ............................................

150,000 8,610

500,000 30,000

6,750

153,000 5,610

Ex. 12-147—Retirement of bonds. Prepare the journal entry to record the following retirement. The December 31, 2008 balance sheet of Marin Co. included the following items: 7.5% bonds payable due December 31, 2016 Unamortized discount on bonds payable

$1,200,000 48,000

The bonds were issued on December 31, 2006 at 95, with interest payable on June 30 and December 31. On January 2, 2009, Marin retired $240,000 of these bonds at 101 plus accrued interest.

Solution 12-147 Bonds Payable ............................................................................... Loss on Redemption of Bonds ....................................................... Discount on Bonds Payable (1/5 × $48,000) ....................... Cash ...................................................................................

240,000 12,000 9,600 242,400

Ex. 12-148—Contingent liabilities. Below are three independent situations. 1. In August, 2008 a worker was injured in the factory in an accident partially the result of his own negligence. The worker has sued Rooney Co. for $800,000. Counsel believes it is reasonably possible that the outcome of the suit will be unfavorable and that the settlement would cost the company from $250,000 to $500,000. 2. A suit for breach of contract seeking damages of $2,400,000 was filed by an author against Early Co. on October 4, 2008. Early's legal counsel believes that an unfavorable outcome is probable. A reasonable estimate of the award to the plaintiff is between $600,000 and $1,800,000. No amount within this range is a better estimate of potential damages than any other amount.

12 - 34 Test Bank for Intermediate Accounting, Second Edition Ex. 12-148 (cont.) 3. Peete is involved in a pending court case. Peete’s lawyers believe it is probable that Peete will be awarded damages of $1,000,000. Instructions Discuss the proper accounting treatment, including any required disclosures, for each situation. Give the rationale for your answers.

Solution 12-148 1.

Rooney Co. should disclose in the notes to the financial statements the existence of a possible contingent liability related to the law suit. The note should indicate the range of the possible loss. The contingent liability should not be accrued because the loss is not probable.

2. The probable award should be accrued by a charge to an estimated loss and a credit to an estimated liability of $600,000. Early Co. should disclose the following in the notes to the financial statements: the amount of the suit, the nature of the contingency, the reason for the accrual, and the range of the possible loss. The accrual is made because it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The lowest amount of the range of possible losses is used when no amount is a better estimate than any other amount. 3.

Peete should not record the gain contingency until it’s realized. Usually, gain contingencies are neither accrued nor disclosed. The $1,000,000 gain contingency should be disclosed only if the probability that it will be realized is very high.

Ex. 12-149—Warranties. Herren Corporation manufactures CB radios. Each radio is sold with a two-year unconditional warranty against defects. During 2008, 280 radios were sold for $150 each. The company estimates that the warranty cost will average $20 per unit. The actual warranty costs incurred in 2008 amounted to $2,350. Instructions Prepare the journal entries for the sale of CBs, the estimated warranty cost, and the actual warranty cost incurred.

Solution 12-149 Sale of CBs (280 × $150): Cash or Accounts Receivable .................................................... Sales .................................................................................... Estimated warranty cost (280 × $20): Warranty Expense...................................................................... Estimated Liability under Warranties .................................... Actual warranty cost: Estimated Liability under Warranties .......................................... Cash.....................................................................................

42,000 42,000 5,600 5,600 2,350 2,350

Accounting for Liabilities

12 - 35

*Ex. 12-150—Amortization of discount or premium. Benson Industries, Inc. issued $6,000,000 of 8% debentures on May 1, 2008 and received cash totaling $5,323,577. The bonds pay interest semiannually on May 1 and November 1. The maturity date on these bonds is November 1, 2016. The firm uses the effective-interest method of amortizing discounts and premiums. The bonds were sold to yield an effective-interest rate of 10%. Instructions Calculate the total dollar amount of discount or premium amortization during the first year (5/1/08 through 4/30/09) these bonds were outstanding. (Show computations and round to the nearest dollar.)

*Solution 12-150 Date 5/1/08 11/1/08 5/1/09

Interest Expense

Cash Interest

Discount Amortized

$266,179 267,488

$240,000 240,000

$26,179 27,488 $53,667

Total

Carrying Value of Bonds $5,323,577 5,349,756 5,377,244

PROBLEMS Pr. 12-151—Accounts and Notes Payable. Described below are certain transactions of Carson Company for 2008: 1.

On June 1, the company purchased equipment for $60,000 from Nolan Company, paying $20,000 in cash and giving a one-year, 9% note for the balance.

On September 30, the company discounted at 10% its $120,000, one-year zero-interestbearing note at First State Bank.

Instructions (a) Prepare the journal entries necessary to record the transactions above using appropriate dates. (b) Prepare the adjusting entries necessary at December 31, 2008 in order to properly report interest expense related to the above transactions. Assume straight-line amortization of discounts. (c) Indicate the manner in which the above transactions should be reflected in the Current Liabilities section of Carson Company's December 31, 2008 balance sheet.

Solution 12-151 (a) June 1, 2008 Equipment ................................................................................ Cash ............................................................................. Notes Payable ..............................................................

60,000 20,000 40,000

12 - 36 Test Bank for Intermediate Accounting, Second Edition Solution 12-151 (cont.) September 30, 2008 Cash ......................................................................................... Discount on Notes Payable ...................................................... Notes Payable...............................................................

108,000 12,000 120,000

(b) Interest Expense....................................................................... Interest Payable ($40,000 × .09 × 7/12) ........................

2,100

Interest Expense....................................................................... Discount on Notes Payable ($12,000 × 3/12) ................

3,000

2,100

3,000

$ $120,000 9,000

2,100 40,000

111,000 $153,100

Pr. 12-152—Accounting for bonds. The following information relates to a $200,000, 4-year, 6% bond issue by Garfunkel Co. The bonds, issued on 1-1-08, are due on 1-1-12 and pay interest on January 1 and July 1. The bonds are sold to yield 5%. Instructions (a) Calculate the selling price of the Garfunkel Co. bonds by filling in the missing amounts below. Present value of the principal Present value of the interest Proceeds from sale of bonds *(b) Prepare a partial amortization schedule for Garfunkel Co. using the effective-interest method. Schedule of Interest Expense and Bond Premium Amortization Effective-Interest Method 6% Bonds Sold to Yield 5%

Date

Credit Cash

Debit Interest Expense

Debit Bond Premium

1-1-08 7-1-08 1-1-09 7-1-09

Carrying Value of Bonds $

Accounting for Liabilities

12 - 37

Solution 12-152 (a) Present value of $200,000 due in 8 years at 2 1/2% semiannual interest (Table A-2) ($200,000 × .82075) Present value of $6,000 interest payable semiannually for 8 periods at 2 1/2% (Table A-4) ($6,000 × 7.17014) Proceeds from sale of bonds *(b)

$164,150 43,021 $207,171

Schedule of Interest Expense and Bond Premium Amortization Effective-Interest Method 6% Bonds Sold to Yield 5%

Date 1-1-08 7-1-08 1-1-09 7-1-09

Credit Cash

Debit Interest Expense

Debit Bond Premium

$6,000 (a) 6,000 6,000

$5,179 (b) 5,159 5,138

$821 (c) 841 862

Carrying Value of Bonds $207,171 206,350 (d) 205,509 204,647

(d) $207,171 – $821

(a) $200,000 × .03

(b) $207,171 × .025

Pr. 12-153—Warranties. James Equipment Company sells computers for $1,500 each and also gives each customer a 2year warranty that requires the company to perform periodic services and to replace defective parts. During 2008, the company sold 700 computers. Based on past experience, the company has estimated the total 2-year warranty costs as $30 for parts and $60 for labor. (Assume sales all occur at December 31, 2008.) In 2009, James incurred actual warranty costs relative to 2008 computer sales of $10,000 for parts and $18,000 for labor. Instructions (a) Under the expense warranty treatment, give the entries to reflect the above transactions (accrual method) for 2008 and 2009. (b) Under the cash basis method, what are the Warranty Expense balances for 2008 and 2009? (c) The transactions of part (a) create what balance under current liabilities in the 2008 balance sheet?

Solution 12-153 (a)

2008 Accounts Receivable ...................................................................... 1,050,000 Sales .................................................................................. Warranty Expense .......................................................................... Estimated Liability Under Warranties .................................. 2009 Estimated Liability Under Warranties .............................................. Parts Inventory ................................................................... Accrued Payroll ..................................................................

1,050,000

63,000 63,000 28,000 10,000 18,000

12 - 38 Test Bank for Intermediate Accounting, Second Edition Solution 12-153 (cont.) (b)

2008 2009

$0. $28,000.

(c)

2008

Current Liabilities—Estimated Liability Under Warranties $31,500. (The remainder of the $63,000 liability is a long-term liability.)

*Pr. 12-154—Bond discount amortization. On June 1, 2007, Janson Bottle Company sold $400,000 in long-term bonds for $351,040. The bonds will mature in 10 years and have a stated interest rate of 8% and a yield rate of 10%. The bonds pay interest annually on May 31 of each year. The bonds are to be accounted for under the effective-interest method. Instructions (a) Construct a bond amortization table for this problem to indicate the amount of interest expense and discount amortization at each May 31. Include only the first two years. Make sure all columns and rows are properly labeled. (Round to the nearest dollar.) (b) Assuming that interest and discount amortization are recorded each May 31, prepare the adjusting entry to be made on December 31, 2009. (Round to the nearest dollar.)

*Solution 12-154 (a) Date 6/1/07 5/31/08 5/31/09 (b)

Credit Cash

Debit Interest Expense

Credit Bond Discount

$32,000 32,000

$35,104 35,414

$3,104 3,414

Interest Expense.......................................................................... Interest Payable ............................................................... Discount on Bonds Payable .............................................

Carrying Amount of Bonds $351,040 354,144 357,558 20,858* 18,667** 2,191

*7/12  $35,756 (from Table) = $20,858 **7/12  8%  $400,000 = $18,667

*Pr. 12-155—Bond interest and discount amortization. Logan Corporation issued $800,000 of 8% bonds on October 1, 2008, due on October 1, 2013. The interest is to be paid twice a year on April 1 and October 1. The bonds were sold to yield 10% effective annual interest. Logan Corporation closes its books annually on December 31. Instructions (a) Complete the following amortization schedule for the dates indicated. (Round all answers to the nearest dollar.) Use the effective-interest method.

Accounting for Liabilities

12 - 39

*Pr. 12-155 (cont.) Credit Cash

Debit Interest Expense

Credit Bond Discount

October 1, 2008 April 1, 2009 October 1, 2009

Carrying Amount of Bonds $738,224

(b) Prepare the adjusting entry for December 31, 2009. Use the effective-interest method. (c) Compute the interest expense to be reported in the income statement for the year ended December 31, 2009.

*Solution 12-155 (a) October 1, 2008 April 1, 2009 October 1, 2009

Credit Cash

Debit Interest Expense

$32,000 32,000

$36,911 37,157

Credit Bond Discount $4,911 5,157

(b) Interest Expense ($748,292 × 10% × 3/12) ................................... Interest Payable (1/2 × $32,000) ........................................ Discount on Bonds Payable ($18,707 – $16,000) .............. (c)

$18,456 37,157 18,707 $74,320

Carrying Amount of Bonds $738,224 743,135 748,292

18,707 16,000 2,707

(1/2 of $36,911)

*Pr. 12-156—Entries for bonds payable. Prepare the necessary journal entries to record the following transactions relating to the long-term issuance of bonds by Titus Co.: January 1 Issued $600,000 face value, 8%, 5-year bonds for $651,000, a 6% yield. Interest is payable semiannually on January 1 and July 1. The bonds are callable at 102. July 1 Paid semiannual interest on the bonds. Use effective-interest amortization of any discount/premium. December 31 Accrued semiannual interest on the bonds.

12 - 40 Test Bank for Intermediate Accounting, Second Edition *Solution 12-156 Jan. 1: Cash ................................................................................... Bonds Payable ........................................................ Premium on Bonds Payable ....................................

651,000

July 1: Interest Expense ($651,000 × .06 × 6/12) ........................... Premium on Bonds Payable ................................................ Cash ........................................................................

19,530 4,470

Dec. 31: Interest Expense ($651,000 – $4,470) × .06 × 6/12 ........... Premium on Bonds Payable ................................................ Interest Payable ......................................................

19,396 4,604

600,000 51,000

24,000

CHAPTER 13 STOCKHOLDERS’ EQUITY TRUE-FALSE—Conceptual Answer

No.

Description

T F T T F T F T F T F T T T F F F T F T F F T T T F F T F T T T F T F T F F T T F T T F T

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. *40. *41. *42. *43. *44. *45.

State a corporation incorporates in. Definition of preemptive right. Common stock as residual interest. Meaning of preemptive right. Earned capital definition. Reporting true no-par stock. Allocating proceeds in lump sum sales. Accounting for stock issued for noncash consideration Par value of stock. Sources of corporate equity. Capital stock issued for noncash assets. Expensing stock issue costs. Reason for purchasing outstanding stock. Classification of treasury stock. Gain on sale of treasury stock. Definition of treasury stock. Reporting treasury stock under cost method. Selling treasury stock below cost. Participating preferred stock. Callable preferred stock. Classification of dividends in arrears. Convertible preferred stock. Dividend payment amounts. Cash dividend declaration consideration. Restricting legal capital. Disclosing dividend policy. Affect of dividends on total stockholders’ equity. Property dividends definition. Classification of declared cash dividend. Definition of property dividend. Liquidating dividend. Effect of stock dividend on stockholders’ equity. Amount transferred from retained earnings in small stock dividend. Large stock dividend. Computing rate of return on common stock equity. Accounting for small stock dividend. Stock splits and large stock dividends. Computing rate of return on common stock equity. Computing payout ratio. Accounting for convertible bond issue. Reporting gain/loss on convertible debt retirement. Reporting additional payment to encourage conversion. Allocating proceeds between debt and detachable warrants. Allocating proceeds from nondetachable warrants. Allocating proceeds between debt and detachable warrants.

13 - 2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93.

Nature of stockholders' interest. Preemptive right. Preemptive right. Nature of stockholders' equity. Sources of stockholders' equity. Classification of stockholders' equity. Allocation methods for a lump sum issuance. Capital stock issued in payment of services. Costs of issuing capital stock. Creation of "secret reserves." Authorized shares. Par value stock. Meaning of “capital.” Shareholders contingent liability. Recording sale of common stock. Stock issued for services or noncash assets. Treasury stock classification. Acquisition of treasury shares. Treasury shares definition. Purchase of treasury stock at greater than par value. Sale of treasury stock. Reissued treasury stock at less than acquisition cost. Reissued treasury stock at greater than acquisition cost. Effect of treasury stock transactions. Preferred stock—debt features. Cumulative feature of preferred stock. Reporting redeemable stock. Reporting dividends in arrears. Identifying common preference of preferred stock. Effects of a cash dividend. Accounting for a property dividend. Issued vs. outstanding common stock. Timing of entry to record dividends. Shares entitled to receive a cash dividend. Accounting for a property dividend. Distribution of a property dividend. Liquidating dividend. Entry to record a liquidating dividend. Effects of a stock dividend. Effects of a stock dividend. Effect of a large stock dividend. Large stock dividend. Small stock dividend. Small stock dividend. Classification of stock dividends distributable. Effect of stock splits and stock dividends. Effect of a stock split. Effect of stock dividends and stock splits.

Stockholders’ Equity

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

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

94. 95. 96. 97. 98. 99. *100. *101. *102. *103. *104. *105.

Description Effect of a stock dividend/stock split on total stockholders’ equity. Reason for recording a stock dividend. Disclosures in the balance sheet. Return on common stock equity calculation. Payout ratio calculation. Book value per share. Recording conversion of bonds. Reasons for issuing convertible debt. Reporting gain/loss on conversion of bonds. Bonds issued with detachable stock warrants. Debt equity features of debt issued with stock warrants. Bonds issued with detachable stock warrants.

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE—Computational Answer

No.

Description

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

106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123. 124. 125. 126. 127. 128. 129. 130. 131. 132. 133. 134.

Composition of stockholders' equity. Calculation of total paid-in capital. Allocating proceeds in lump sum sale. Allocating proceeds in lump sum sale. Computing total paid-in capital. Allocating proceeds in lump sum sale. Recording purchase of treasury stock. Recording purchase of treasury stock. Reissue treasury stock—above acquisition cost. Reissue treasury stock—cost method. Additional paid-in capital with treasury stock transactions. Calculation of additional paid-in capital. Calculation of additional paid-in capital. Total stockholders' equity with treasury stock transactions. Total stockholders' equity with treasury stock exchange. Reduction in retained earnings caused by a property dividend. Reduction in retained earnings from property dividends. Reduction in retained earnings from property dividends. Computation of reduction in retained earnings from property dividend. Determine retained earnings available for dividends. Computation of decrease in retained earnings. Decrease in retained earnings from cash and stock dividends. Calculation of a large stock dividend. Calculation of a small stock dividend. Calculation of a small stock dividend. Small stock dividend's effect on retained earnings. Balance of retained earnings after a small stock dividend. Calculate dividends paid to common stockholders. Rate of return on common stock equity.

13 - 3

13 - 4

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Computational Answer

No.

c a b b a b b c c b b

135. 136. 137. 138. *139. *140. *141. *142. *143. *144. *145.

Description Determine the rate of return on common stock equity. Determine book value per share. Computation of payout ratio. Computation of book value per share. Conversion of convertible bonds. Conversion of convertible bonds. Bonds issued with detachable stock warrants. Bonds issued with detachable stock warrants. Recording paid-in capital from stock warrants. Bonds issued with detachable stock warrants. Bonds issued with detachable stock warrants.

MULTIPLE CHOICE—CPA Adapted Answer

No.

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

146. 147. 148. 149. 150. 151. 152. 153. 154. 155. *156. *157.

Description Capital stock issued in payment of services. Proceeds from preferred stock in lump sum issue. Determine paid-in capital from treasury stock. Reissue treasury stock—cost method. Effect of the reissuance of treasury stock. Entry to record property dividends declared. Effect of a liquidating dividend. Effect of a stock dividend. Stock dividend when market price exceeds par value. Balance of retained earnings following stock dividend. Cash proceeds from issuance of convertible bonds. Bonds issued with detachable stock warrants.

EXERCISES Item E13-158 E13-159 E13-160 E13-161 E13-162 E13-163 E13-164 E13-165 E13-166 E13-167 E13-168 *E13-169 *E13-170

Description Lump sum issuance of stock. Treasury stock. Treasury stock. Treasury stock. Treasury stock. Stockholders’ equity. Property dividends. Stock dividends. Stock dividends. Stock dividends and stock splits. Computation of selected financial ratios. Convertible bonds. Convertible debt and debt with warrants (essay).

Stockholders’ Equity

13 - 5

PROBLEMS Item P13-171 P13-172 P13-173 P13-174 *P13-175

Description Equity transactions. Treasury stock transactions. Stock dividends. Equity transactions. Convertible bonds and stock warrants.

CHAPTER LEARNING OBJECTIVES 1.

Discuss the characteristics of the corporate form of organization.

Identify the key components of stockholders' equity.

Explain the accounting procedures for issuing shares of stock.

Describe the accounting for treasury stock.

Explain the accounting for and reporting of preferred stock.

Describe the policies used in distributing dividends.

Identify the various forms of dividend distributions.

Explain the accounting for small and large stock dividends, and for stock splits.

Indicate how to present and analyze stockholders’ equity.

*10.

Understand the accounting issues related to financial instruments with both debt and equity characteristics.

13 - 6

Test Bank for Intermediate Accounting, Second Edition

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

49.

50.

6. 7. 8. 9.

TF TF TF TF

10. 52. 53. 54.

TF MC MC MC

55. 56. 57. 58.

11. 12. 13. 14. 15.

TF TF TF TF TF

16. 17. 18. 62. 63.

TF TF TF MC MC

64. 65. 66. 67. 68.

19. 20.

TF TF

21. 22.

TF TF

70. 71.

23.

24.

25.

27. 28. 29. 30.

TF TF TF TF

31. 32. 75. 76.

TF TF MC MC

77. 78. 79. 80.

33. 34. 35. 36. 37.

TF TF TF TF TF

86. 87. 88. 89. 90.

MC MC MC MC MC

91. 92. 93. 94. 95.

38. 39.

TF TF

96. 97.

MC MC

98. 99.

40. 41. 42. 43.

TF TF TF TF

44. 45. 100. 101.

TF TF MC MC

102. 103. 104. 105.

Note:

TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 TF 4. TF 46. Learning Objective 2 MC 51. MC Learning Objective 3 MC 59. MC 107. MC 60. MC 108. MC 61. MC 109. MC 106. MC 110. Learning Objective 4 MC 69. MC 116. MC 112. MC 117. MC 113. MC 118. MC 114. MC 119. MC 115. MC 120. Learning Objective 5 MC 72. MC 74. MC 73. MC Learning Objective 6 TF 26. TF Learning Objective 7 MC 81. MC 85. MC 82. MC 121. MC 83. MC 122. MC 84. MC 123. Learning Objective 8 MC 125. MC 130. MC 126. MC 131. MC 127. MC 132. MC 128. MC 153. MC 129. MC 154. Learning Objective 9 MC 133. MC 135. MC 134. MC 136. Learning Objective *10 MC 139. MC 143. MC 140. MC 144. MC 141. MC 145. MC 142. MC 156. E = Exercise P = Problem

Type

Item

Type

Item

Type

47.

48.

MC MC MC MC

111. 146. 147. 158.

MC MC MC E

171.

MC MC MC MC MC

148. 149. 150. 159. 160.

MC MC MC E E

161. 162. 172.

E E P

MC MC MC MC

124. 151. 152. 163.

MC MC MC E

164. 173. 174.

E P P

MC MC MC MC MC

155. 165. 166. 167. 173.

MC E E E P

174.

MC MC

137. 138.

MC MC

168.

MC MC MC MC

157. 169. 170. 175.

MC E E P

Stockholders’ Equity

13 - 7

TRUE-FALSE—Conceptual 1.

A corporation is incorporated in only one state regardless of the number of states in which it operates.

The preemptive right allows stockholders the right to vote for directors of the company.

Common stock is the residual corporate interest that bears the ultimate risks of loss.

The preemptive right protects an existing stockholder from involuntary dilution of ownership interest.

Earned capital consists of additional paid-in capital and retained earnings.

True no-par stock should be carried in the accounts at issue price without any additional paid-in capital reported.

Companies allocate the proceeds received from a lump-sum sale of securities based on the securities’ par values.

Companies should record stock issued for services or noncash property at either the fair value of the stock issued or the fair value of the consideration received.

The par value of a share of common stock usually is a good indication of what the stock is worth on the market.

10.

Contributions by shareholders (paid-in capital) and income retained by the corporation represent the two primary sources from which corporate equity is derived.

11.

When capital stock is issued for noncash assets, the assets received should be recorded at the par value of the stock issued.

12.

Management salaries and other indirect costs related to a stock issue should be expensed as incurred.

13.

A company might purchase its outstanding stock to provide tax efficient distributions of excess cash to shareholders.

14.

Treasury shares represent a reduction in the number of outstanding shares but not in the number of issued shares.

15.

The gain on the sale of treasury stock should be included in income before extraordinary items on the income statement.

16.

Treasury stock is a company’s own stock that has been reacquired and retired.

17.

The cost method records all transactions in treasury shares at their cost and reports the treasury stock as a deduction from capital stock.

18.

When a corporation sells treasury stock below its cost, it usually debits the difference between cost and selling price to Paid-in Capital from Treasury Stock.

13 - 8

Test Bank for Intermediate Accounting, Second Edition

19.

Participating preferred stock requires that if a company fails to pay a dividend in any year, it must make it up in a later year before paying any common dividends.

20.

Callable preferred stock permits the corporation at its option to redeem the outstanding preferred shares at stipulated prices.

21.

Dividends in arrears on preferred stock should be classified on the balance sheet as a liability.

22.

A convertible preferred stock issue normally will sell for a lower price than the same issue would without the conversion feature.

23.

Very few companies pay dividends in amounts equal to their retained earnings legally available for dividends.

24.

The current cash position of a corporation is a prime consideration in deciding whether a cash dividend should be declared.

25.

The laws of some states require that corporations restrict their legal capital from distribution to stockholders.

26.

The SEC requires companies to disclose their dividend policy in their annual report.

27.

All dividends, except for liquidating dividends, reduce the total stockholders’ equity of a corporation.

28.

Dividends payable in assets of the corporation other than cash are called property dividends or dividends in kind.

29.

A declared cash dividend is not a liability because the board of directors can simply undeclare the dividend.

30.

A property dividend is a nonreciprocal transfer of nonmonetary assets between an enterprise and its owners.

31.

Any dividend not based on profits must be a reduction of corporate capital, and to that extent, it is a liquidating dividend.

32.

A stock dividend results in a capitalization of retained earnings with no corresponding decrease in total stockholders' equity.

33.

When a stock dividend is less than 20-25% of the common shares outstanding at the time of the dividend declaration, the par value of the stock issued should be transferred from retained earnings.

34.

If a stock dividend is large (more than 20-25%), the distribution should be referred to as a stock split.

35.

The rate of return on common stock equity is computed by dividing sales by average common stockholders' equity.

Stockholders’ Equity

13 - 9

36.

When a stock dividend is less than 20-25 percent of the common stock outstanding, a company is required to transfer the fair market value of the stock issued from retained earnings.

37.

Stock splits and large stock dividends have the same effect on a company’s retained earnings and total stockholders’ equity.

38.

The rate of return on common stock equity is computed by dividing net income by the average common stockholders’ equity.

39.

The payout ratio is determined by dividing cash dividends paid to common stockholders by net income available to common stockholders.

*40.

The recording of convertible bonds at the date of issue is the same as the recording of straight debt issues.

*41.

Companies recognize the gain or loss on retiring convertible debt as an extraordinary item.

*42.

The FASB states that when an issuer makes an additional payment to encourage conversion, the payment should be reported as an expense.

*43.

A company should allocate the proceeds from the sale of debt with detachable stock warrants between the two securities based on their market values.

*44.

Nondetachable warrants, as with detachable warrants, require an allocation of the proceeds between the bonds and the warrants.

*45.

The proceeds from the sale of debt with detachable warrants should be allocated between the debt and the warrants.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7. 8.

T F T T F T F T

9. 10. 11. 12. 13. 14. 15. 16.

F T F T T T F F

17. 18. 19. 20. 21. 22. 23. 24.

F T F T F F T T

25. 26. 27. 28. 29. 30. 31. 32.

T F F T F T T T

33. 34. 35. 36. 37. 38. 39. *40.

F T F T F F T T

*41. *42. *43. *44. *45.

F T T F T

13 - 10 Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual 46.

The residual interest in a corporation belongs to the a. management. b. creditors. c. common stockholders. d. preferred stockholders.

47.

The preemptive right of a common stockholder is the right to a. share proportionately in corporate assets upon liquidation. b. share proportionately in any new issues of stock of the same class. c. receive cash dividends before they are distributed to preferred stockholders. d. exclude preferred stockholders from voting rights.

48.

The preemptive right enables a stockholder to a. share proportionately in any new issues of stock of the same class. b. receive cash dividends before other classes of stock without the preemptive right. c. sell capital stock back to the corporation at the option of the stockholder. d. receive the same amount of dividends on a percentage basis as the preferred stockholders.

49.

Total stockholders' equity represents a. a claim to specific assets contributed by the owners. b. the maximum amount that can be borrowed by the enterprise. c. a claim against a portion of the total assets of an enterprise. d. only the amount of earnings that have been retained in the business.

50.

A primary source of stockholders' equity is a. income retained by the corporation. b. appropriated retained earnings. c. contributions by stockholders. d. both income retained by the corporation and contributions by stockholders.

51.

Stockholders' equity is generally classified into two major categories: a. contributed capital and appropriated capital. b. appropriated capital and retained earnings. c. retained earnings and unappropriated capital. d. earned capital and contributed capital.

52.

The accounting problem in a lump sum issuance is the allocation of proceeds between the classes of securities. An acceptable method of allocation is the a. pro forma method. b. proportional method. c. incremental method. d. either the proportional method or the incremental method.

53.

When a corporation issues its capital stock in payment for services, the least appropriate basis for recording the transaction is the a. market value of the services received. b. par value of the shares issued. c. market value of the shares issued. d. Any of these provides an appropriate basis for recording the transaction.

Stockholders’ Equity 54.

13 - 11

Direct costs incurred to sell stock such as underwriting costs should be accounted for as 1. a reduction of additional paid-in capital. 2. an expense of the period in which the stock is issued. 3. an intangible asset. a. b. c. d.

1 2 3 1 or 3

55.

A "secret reserve" will be created if a. inadequate depreciation is charged to income. b. a capital expenditure is charged to expense. c. liabilities are understated. d. stockholders' equity is overstated.

56.

Which of the following represents the total number of shares that a corporation may issue under the terms of its charter? a. Authorized shares b. Issued shares c. Unissued shares d. Outstanding shares

57.

Stock that has a fixed per-share amount printed on each stock certificate is called a. stated value stock. b. fixed value stock. c. uniform value stock. d. par value stock.

58.

When accountants refer to capital of a corporate organization, they mean a. the cash held by the organization at the point in time when the reference to capital is made. b. the assets of a business organization that are durable and last a long period of time. c. money borrowed to finance the operations of the organization. d. stockholders' equity or owners' equity.

59.

When stock is purchased by shareholders at a price below par value, a. a liability should be recorded in the financial statements, classified as long-term, and payable upon dissolution of the company to creditors not fully reimbursed. b. a contingent liability exists that is an obligation to the corporation's creditors. c. a contingent liability exists that is an obligation to the corporation. d. the difference between purchase price and par value must be paid by the original shareholder to the corporation before they may sell the stock to another party.

60.

When common stock is sold by a corporation, a journal entry is prepared which includes a debit to cash and a credit to the common stock account. If the debit to cash is greater than the credit to the common stock account, then it can be assumed that a. the common stock is worth more than its current market value. b. a gain on the sale of stock is a part of the transaction. c. the common stock was sold at a discount d. the stated value of the common stock is less than the per share price investors were willing to pay.

13 - 12 Test Bank for Intermediate Accounting, Second Edition 61.

The general rule to be applied when stock is issued for services or property other than cash is that the property or services be recorded at a. the fair market value of the stock issued. b. the fair market value of the noncash consideration received. c. either the fair market value of the stock issued or the fair market value of the noncash consideration received, whichever is more clearly determinable. d. a value that clearly reflects the intentions of the parties entering into the transaction and provides a relevant basis for recording.

62.

Treasury stock is a. canceled as soon as it is acquired. b. a current asset. c. the same as unissued stock. d. included in issued shares.

63.

In January 2008, Castro Corporation, a newly formed company, issued 10,000 shares of its $10 par common stock for $15 per share. On July 1, 2008, Castro Corporation reacquired 1,000 shares of its outstanding stock for $12 per share. The acquisition of these treasury shares a. decreased total stockholders' equity. b. increased total stockholders' equity. c. did not change total stockholders' equity. d. decreased the number of issued shares.

64.

Treasury shares are a. shares held as an investment by the treasurer of the corporation. b. shares held as an investment of the corporation. c. issued and outstanding shares. d. issued but not outstanding shares.

65.

When treasury stock is purchased for more than the par value of the stock and the cost method is used to account for treasury stock, what account(s) should be debited? a. Treasury stock for the par value and paid-in capital in excess of par for the excess of the purchase price over the par value. b. Paid-in capital in excess of par for the purchase price. c. Treasury stock for the purchase price. d. Treasury stock for the par value and retained earnings for the excess of the purchase price over the par value.

66.

“Gains" on sales of treasury stock (using the cost method) should be credited to a. paid-in capital from treasury stock. b. capital stock. c. retained earnings. d. other income.

67.

Wilson Corp. purchased its own par value stock on January 1, 2008 for $20,000 and debited the treasury stock account for the purchase price. The stock was subsequently sold for $12,000. The $8,000 difference between the cost and sales price should be recorded as a deduction from

Stockholders’ Equity

13 - 13

a. additional paid-in capital to the extent that previous net "gains" from sales of the same class of stock are included therein; otherwise, from retained earnings. b. additional paid-in capital without regard as to whether or not there have been previous net "gains" from sales of the same class of stock included therein. c. retained earnings. d. net income. 68.

How should a "gain" from the sale of treasury stock be reflected when using the cost method of recording treasury stock transactions? a. As ordinary earnings shown on the income statement. b. As paid-in capital from treasury stock transactions. c. As an increase in the amount shown for common stock. d. As an extraordinary item shown on the income statement.

69.

Which of the following best describes a possible result of treasury stock transactions by a corporation? a. May increase but not decrease retained earnings. b. May increase net income if the cost method is used. c. May decrease but not increase retained earnings. d. May decrease but not increase net income.

70.

Which of the following features of preferred stock makes the security more like debt than an equity instrument? a. Participating b. Voting c. Redeemable d. Noncumulative

71.

The cumulative feature of preferred stock a. limits the amount of cumulative dividends to the par value of the preferred stock. b. requires that dividends not paid in any year must be made up in a later year before dividends are distributed to common shareholders. c. means that the shareholder can accumulate preferred stock until it is equal to the par value of common stock at which time it can be converted into common stock. d. enables a preferred stockholder to accumulate dividends until they equal the par value of the stock and receive the stock in place of the cash dividends.

72.

According to the FASB, redeemable preferred stock should be a. included with common stock. b. included as a liability. c. excluded from the stockholders’ equity heading. d. included as a contra item in stockholders' equity.

73.

Cumulative preferred dividends in arrears should be shown in a corporation's balance sheet as a. an increase in current liabilities. b. an increase in stockholders' equity. c. a footnote. d. an increase in current liabilities for the current portion and long-term liabilities for the long-term portion.

13 - 14 Test Bank for Intermediate Accounting, Second Edition 74.

While the preferences given to preferred stock may vary in many situations, the most common preference is a. they are assured a dividend, usually at a stated rate, before any amount may be distributed to common shareholders. b. preferred shareholders receive a larger dividend than do common shareholders because they have given up the right to vote. c. receipt of dividends every time a common stock dividend is declared. d. the right to convert shares of preferred for shares of common on a basis determined in the preferred stock indenture.

75.

How does the declaration of a cash dividend affect the following account balances? a. b. c. d.

Retained Earnings Decrease Increase Decrease Decrease

Current Liabilities No Effect Decrease Increase No Effect

Cash Account Decrease No Effect No Effect Increase

76.

When a corporation declares a property dividend, the corporation should a. divide the property equally among all stockholders. b. record the dividend by debiting retained earnings for an amount equal to the fair value of the property to be distributed. c. record the dividend by debiting retained earnings for an amount equal to the book value of the property to be distributed. d. record the dividend on its books at the carrying value of the property distributed and inform stockholders as to the fair value of the property so they may individually recognize a gain or loss.

77.

At the date of the financial statements, common stock shares issued would exceed common stock shares outstanding as a result of the a. declaration of a stock split. b. declaration of a stock dividend. c. purchase of treasury stock. d. payment in full of subscribed stock.

78.

An entry is not made on the a. date of declaration. b. date of record. c. date of payment. d. An entry is made on all of these dates.

79.

Cash dividends are paid on the basis of the number of shares a. authorized. b. issued. c. outstanding. d. outstanding less the number of treasury shares.

80.

Which of the following statements about property dividends is not true? a. A property dividend is usually in the form of securities of other companies. b. A property dividend is also called a dividend in kind. c. The accounting for a property dividend should be based on the carrying value (book value) of the nonmonetary assets transferred. d. All of these statements are true.

Stockholders’ Equity

13 - 15

81.

Farmer Corporation owns 4,000,000 shares of stock in Baha Corporation. On December 31, 2008, Farmer distributed these shares of stock as a dividend to its stockholders. This is an example of a a. property dividend. b. stock dividend. c. liquidating dividend. d. cash dividend.

82.

A dividend which is a return to stockholders of a portion of their original investments is a a. liquidating dividend. b. property dividend. c. liability dividend. d. participating dividend.

83.

A mining company declared a liquidating dividend. The journal entry to record the declaration must include a debit to a. Retained Earnings. b. a paid-in capital account. c. Accumulated Depletion. d. Accumulated Depreciation.

84.

If management wishes to "capitalize" part of the earnings, it may issue a a. cash dividend. b. stock dividend. c. property dividend. d. liquidating dividend.

85.

Which dividends do not reduce stockholders' equity? a. Cash dividends b. Stock dividends c. Property dividends d. Liquidating dividends

86.

The declaration and issuance of a stock dividend larger than 25% of the shares previously outstanding a. increases common stock outstanding and increases total stockholders' equity. b. decreases retained earnings but does not change total stockholders' equity. c. may increase or decrease paid-in capital in excess of par but does not change total stockholders' equity. d. increases retained earnings and increases total stockholders' equity.

87.

Pryor Corporation issued a 100% stock dividend of its common stock which had a par value of $10 before and after the dividend. At what amount should retained earnings be capitalized for the additional shares issued? a. There should be no capitalization of retained earnings. b. Par value c. Market value on the declaration date d. Market value on the payment date

13 - 16 Test Bank for Intermediate Accounting, Second Edition 88.

The issuer of a 5% common stock dividend to common stockholders preferably should transfer from retained earnings to contributed capital an amount equal to the a. market value of the shares issued. b. book value of the shares issued. c. minimum legal requirements. d. par or stated value of the shares issued.

89.

At the date of declaration of a small common stock dividend, the entry should not include a. a credit to Common Stock Dividend Payable. b. a credit to Paid-in Capital in Excess of Par. c. a debit to Retained Earnings. d. All of these are acceptable.

90.

The balance in Common Stock Dividend Distributable should be reported as a(n) a. deduction from common stock issued. b. addition to capital stock. c. current liability. d. contra current asset.

91.

A feature common to both stock splits and stock dividends is a. a transfer to earned capital of a corporation. b. that there is no effect on total stockholders' equity. c. an increase in total liabilities of a corporation. d. a reduction in the contributed capital of a corporation.

92.

What effect does the issuance of a 2-for-1 stock split have on each of the following? a. b. c. d.

Par Value per Share No effect Increase Decrease Decrease

Retained Earnings No effect No effect No effect Decrease

93.

A feature common to both stock dividends and stock splits is a a. reduction in total stockholders' equity of a corporation. b. transfer from retained earnings to additional paid-in capital. c. reduction in par value. d. change in the number of shares of stock outstanding.

94.

Total stockholders' equity will increase as a result of a a. b. c. d.

95.

Stock Dividend Yes No Yes No

Stock Split Yes No No Yes

Unlike a stock split, a stock dividend requires a formal journal entry in the financial accounting records because a. stock dividends are payable on the date they are declared. b. stock dividends represent a transfer from retained earnings to paid-in capital. c. stock dividends increase the relative book value of an individual's stock holdings. d. stock splits increase the relative book value of an individual's stock holdings.

Stockholders’ Equity

13 - 17

96.

Which one of the following disclosures should be made in the equity section of the balance sheet, rather than in the notes to the financial statements? a. Dividend preferences b. Liquidation preferences c. Call prices d. Conversion or exercise prices

97.

The rate of return on common stock equity is calculated by dividing a. net income less preferred dividends by average common stockholders’ equity. b. net income by average common stockholders’ equity. c. net income less preferred dividends by ending common stockholders’ equity. d. net income by ending common stockholders’ equity.

98.

The payout ratio can be calculated by dividing a. dividends per share by earnings per share. b. cash dividends by net income less preferred dividends. c. cash dividends by market price per share. d. dividends per share by earnings per share and dividing cash dividends by net income less preferred dividends.

99.

Windsor Company has outstanding both common stock and nonparticipating, noncumulative preferred stock. The liquidation value of the preferred is equal to its par value. The book value per share of the common stock is unaffected by a. the declaration of a stock dividend on preferred payable in preferred stock when the market price of the preferred is equal to its par value. b. the declaration of a stock dividend on common stock payable in common stock when the market price of the common is equal to its par value. c. the payment of a previously declared cash dividend on the common stock. d. a 2-for-1 split of the common stock.

*100. The conversion of bonds is most commonly recorded by the a. incremental method. b. proportional method. c. market value method. d. book value method. *101. Corporations issue convertible debt for two main reasons. One is the desire to raise equity capital that, assuming conversion, will arise when the original debt is converted. The other is a. the ease with which convertible debt is sold even if the company has a poor credit rating. b. the fact that equity capital has issue costs that convertible debt does not. c. that many corporations can obtain financing at lower rates. d. that convertible bonds will always sell at a premium. *102. When convertible debt is retired by the issuer, any material difference between the cash acquisition price and the carrying amount of the debt should be a. reflected currently in income, but not as an extraordinary item. b. reflected currently in income as an extraordinary item. c. treated as a prior period adjustment. d. treated as an adjustment of additional paid-in capital.

13 - 18 Test Bank for Intermediate Accounting, Second Edition *103. When the cash proceeds from a bond issued with detachable stock warrants exceed the sum of the par value of the bonds and the fair market value of the warrants, the excess should be credited to a. additional paid-in capital from stock warrants. b. retained earnings. c. a liability account. d. premium on bonds payable. *104. Proceeds from an issue of debt securities having stock warrants should not be allocated between debt and equity features when a. the market value of the warrants is not readily available. b. exercise of the warrants within the next few fiscal periods seems remote. c. the allocation would result in a discount on the debt security. d. the warrants issued with the debt securities are nondetachable. *105. A corporation issues bonds with detachable warrants. The amount to be recorded as paidin capital is preferably a. zero. b. calculated by the excess of the proceeds over the face amount of the bonds. c. equal to the market value of the warrants. d. based on the relative market values of the two securities involved.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

46. 47. 48. 49. 50. 51. 52. 53. 54.

c b a c d d d b a

55. 56. 57. 58. 59. 60. 61. 62. 63.

b a d d b d c d a

64. 65. 66. 67. 68. 69. 70. 71. 72.

d c a a b c c b b

73. 74. 75. 76. 77. 78. 79. 80. 81.

c a c b c b c c a

82. 83. 84. 85. 86. 87. 88. 89. 90.

a b b b b b a a b

91. 92. 93. 94. 95. 96. 97. 98. 99.

b c d b b b a b c

*100. *101. *102. *103. *104. *105.

d c a d d d

Stockholders’ Equity

13 - 19

MULTIPLE CHOICE—Computational Use the following information for questions 106 and 107. Presented below is information related to Edis Corporation: Common Stock, $1 par Paid-in Capital in Excess of Par—Common Stock Preferred 8 1/2% Stock, $50 par Paid-in Capital in Excess of Par—Preferred Stock Retained Earnings Treasury Common Stock (at cost)

$4,300,000 550,000 2,000,000 400,000 1,500,000 150,000

106.

The total stockholders' equity of Edis Corporation is a. $8,600,000. b. $8,750,000. c. $7,100,000. d. $7,250,000.

107.

The total paid-in capital (cash collected) related to the common stock is a. $4,300,000. b. $4,850,000. c. $5,250,000. d. $4,700,000.

108.

Bleeker Company issued 10,000 shares of its $5 par value common stock having a market value of $25 per share and 15,000 shares of its $15 par value preferred stock having a market value of $20 per share for a lump sum of $480,000. How much of the proceeds would be allocated to the common stock? a. $50,000 b. $218,182 c. $250,000 d. $255,000

109.

Mouser Company issues 4,000 shares of its $5 par value common stock having a market value of $25 per share and 6,000 shares of its $15 par value preferred stock having a market value of $20 per share for a lump sum of $192,000. What amount of the proceeds should be allocated to the preferred stock? a. $172,000 b. $120,000 c. $104,727 d. $90,000

110.

Adler Corporation has 50,000 shares of $10 par common stock authorized. The following transactions took place during 2008, the first year of the corporation’s existence: Sold 5,000 shares of common stock for $18 per share. Issued 5,000 shares of common stock in exchange for a patent valued at $100,000. At the end of Adler’s first year, total paid-in capital amounted to a. $40,000. b. $90,000. c. $100,000. d. $190,000.

13 - 20 Test Bank for Intermediate Accounting, Second Edition 111.

Aguirre Company issues 500 shares of its $5 par value common stock having a market value of $25 per share and 750 shares of its $15 par value preferred stock having a market value of $20 per share for a lump sum of $24,000. How would the proceeds be allocated between the common and preferred stock? a. b. c. d.

Common Stock $2,500 $10,909 $12,500 $12,750

Preferred Stock $21,500 $13,091 $15,000 $11,250

112.

On February l, 2008, Martin Company reacquired 8,000 shares of its $30 par value common stock for $32 per share. Martin uses the cost method to account for treasury stock. The journal entry Martin should make to record the acquisition of treasury stock would include debits to a. Treasury Stock for $240,000 and Additional Paid-in capital for $16,000. b. Treasury Stock for $240,000 and Retained Earnings for $16,000. c. Retained Earnings for $256,000. d. Treasury Stock for $256,000.

113.

On September 1, 2008, Zelner Company reacquired 12,000 shares of its $10 par value common stock for $15 per share. Zelner uses the cost method to account for treasury stock. The journal entry to record the reacquisition of the stock should debit a. Treasury Stock for $120,000. b. Common Stock for $120,000. c. Common Stock for $120,000 and Paid-in Capital in Excess of Par for $60,000. d. Treasury Stock for $180,000.

114.

Gannon Company acquired 6,000 shares of its own common stock at $20 per share on February 5, 2007, and sold 3,000 of these shares at $27 per share on August 9, 2008. The market value of Gannon's common stock was $24 per share at December 31, 2007, and $25 per share at December 31, 2008. The cost method is used to record treasury stock transactions. What account(s) should Gannon credit in 2008 to record the sale of 3,000 shares? a. Treasury Stock for $81,000 b. Treasury Stock for $60,000 and Paid-in Capital from Treasury Stock for $21,000 c. Treasury Stock for $60,000 and Retained Earnings for $21,000 d. Treasury Stock for $72,000 and Retained Earnings for $9,000

115.

King Co. issued 100,000 shares of $10 par common stock for $1,200,000. King acquired 8,000 shares of its own common stock at $15 per share. Three months later King sold 4,000 of these shares at $19 per share. If the cost method is used to record treasury stock transactions, to record the sale of the 4,000 treasury shares King should credit a. Treasury Stock for $76,000. b. Treasury Stock for $40,000 and Paid-in Capital from Treasury Stock for $36,000. c. Treasury Stock for $60,000 and Paid-in Capital from Treasury Stock for $16,000. d. Treasury Stock for $60,000 and Paid-in Capital in Excess of Par for $16,000.

Stockholders’ Equity 116.

13 - 21

An analysis of stockholders' equity of Jinn Corporation as of January 1, 2008, is as follows: Common stock, par value $20; authorized 100,000 shares; issued and outstanding 90,000 shares $1,800,000 Paid-in capital in excess of par 900,000 Retained earnings 760,000 Total $3,460,000 Jinn uses the cost method of accounting for treasury stock and during 2008 entered into the following transactions: Acquired 2,500 shares of its stock for $75,000. Sold 2,000 treasury shares at $35 per share. Sold the remaining treasury shares at $20 per share. Assuming no other equity transactions occurred during 2008, what should Jinn report at December 31, 2008, as total additional paid-in capital? a. $895,000 b. $900,000 c. $905,000 d. $915,000

117.

Trent Corporation was organized on January 1, 2008, with an authorization of 1,200,000 shares of common stock with a par value of $6 per share. During 2008, the corporation had the following capital transactions: January 5 issued 675,000 shares @ $10 per share July 28 purchased 90,000 shares @ $11 per share December 31 sold the 90,000 shares held in treasury @ $18 per share Trent used the cost method to record the purchase and reissuance of the treasury shares. What is the total amount of additional paid-in capital as of December 31, 2008? a. $0 b. $2,070,000 c. $2,700,000 d. $3,330,000

118.

Watt Co.'s stockholders' equity at January 1, 2008 is as follows: Common stock, $10 par value; authorized 300,000 shares; outstanding 225,000 shares Paid-in capital in excess of par Retained earnings Total

$2,250,000 900,000 2,190,000 $5,340,000

During 2008, Watt had the following stock transactions: Acquired 6,000 shares of its stock for $270,000. Sold 3,600 treasury shares at $50 a share. Sold the remaining treasury shares at $41 per share. No other stock transactions occurred during 2008. Assuming Watt uses the cost method to record treasury stock transactions, the total amount of all additional paid-in capital accounts at December 31, 2008 is a. $891,600. b. $870,000. c. $908,400. d. $927,600.

13 - 22 Test Bank for Intermediate Accounting, Second Edition 119.

Presented below is the stockholders' equity section of Mead Corporation at December 31, 2007: Common stock, par value $20; authorized 75,000 shares; issued and outstanding 45,000 shares $ 900,000 Paid-in capital in excess of par value 250,000 Retained earnings 500,000 $1,650,000 During 2008, the following transactions occurred relating to stockholders' equity: 3,000 shares were reacquired at $28 per share. 3,000 shares were reacquired at $35 per share. 1,800 shares of treasury stock were sold at $30 per share. For the year ended December 31, 2008, Mead reported net income of $450,000. Assuming Mead accounts for treasury stock under the cost method, what should it report as total stockholders' equity on its December 31, 2008, balance sheet? a. $1,965,000 b. $1,961,400 c. $1,957,800 d. $1,515,000

120.

On December 1, 2008, Lynn Corporation exchanged 20,000 shares of its $10 par value common stock held in treasury for a used machine. The treasury shares were acquired by Lynn at a cost of $40 per share, and are accounted for under the cost method. On the date of the exchange, the common stock had a market value of $55 per share (the shares were originally issued at $30 per share). As a result of this exchange, Lynn's total stockholders' equity will increase by a. $200,000. b. $800,000. c. $1,100,000. d. $900,000.

121.

Vittly Corporation owned 900,000 shares of Nixon Corporation stock. On December 31, 2008, when Vittly's account "Investment in Common Stock of Nixon Corporation" had a carrying value of $5 per share, Vittly distributed these shares to its stockholders as a dividend. Vittly originally paid $8 for each share. Nixon has 3,000,000 shares issued and outstanding, which are traded on a national stock exchange. The quoted market price for a Nixon share was $7 on the declaration date and $9 on the distribution date. What would be the reduction in Vittly's stockholders' equity as a result of the above transactions? a. $3,600,000 b. $4,500,000 c. $7,200,000 d. $8,100,000

122.

Baden Corporation owned 20,000 shares of Terney Corporation’s $5 par value common stock. These shares were purchased in 2004 for $180,000. On September 15, 2008, Baden declared a property dividend of one share of Terney for every ten shares of Baden held by a stockholder. On that date, when the market price of Terney was $14 per share, there were 180,000 shares of Baden outstanding. What NET reduction in retained earnings would result from this property dividend?

Stockholders’ Equity a. b. c. d.

13 - 23

$90,000 $252,000 $72,000 $162,000

123.

Diamond’s Corporation has an investment in 5,000 shares of Sigmond Company common stock with a cost of $218,000. These shares are used in a property dividend to stockholders of Diamond’s. The property dividend is declared on May 25 and scheduled to be distributed on July 31 to stockholders of record on June 15. The market value per share of Sigmond stock is $63 on May 25, $66 on June 15, and $68 on July 31. The net effect of this property dividend on retained earnings is a reduction of a. $340,000. b. $330,000. c. $315,000. d. $218,000.

124.

Mildred Corporation owned 2,000 shares of Lester Corporation. These shares were purchased in 2004 for $18,000. On October 15, 2008, Mildred declared a property dividend of one share of Lester for every ten shares of Mildred held by a stockholder. On that date, when the market price of Lester was $14 per share, there were 18,000 shares of Mildred outstanding. What gain and net reduction in retained earnings would result from this property dividend?

a. b. c. d.

Gain $0 $0 $9,000 $9,000

Net Reduction in Retained Earnings $16,200 $25,200 $7,200 $16,200

125.

At the beginning of 2008, M.R. Magoo Company had retained earnings of $100,000. During the year, M.R. Magoo reported net income of $50,000, sold treasury stock at a gain of $18,000, declared a cash dividend of $30,000, and declared and issued a small stock dividend of 1,500 shares ($10 par value) when the market value of the stock was $20 per share. The amount of retained earnings available for dividends at the end of 2008 was a. $90,000. b. $105,000. c. $108,000. d. $123,000.

126.

M. Wauboosie Company has 280,000 shares of $10 par value common stock outstanding. During the year, M. Wauboosie declared a 5% stock dividend when the market price of the stock was $24 per share. Two months later M. Wauboosie declared a $.60 per share cash dividend. As a result of the dividends declared during the year, retained earnings decreased by a. $168,000. b. $176,400. c. $336,000. d. $512,400.

13 - 24 Test Bank for Intermediate Accounting, Second Edition 127.

Gonzalez Company has 350,000 shares of $10 par value common stock outstanding. During the year, Gonzalez declared a 10% stock dividend when the market price of the stock was $30 per share. Four months later Gonzalez declared a $.50 per share cash dividend. As a result of the dividends declared during the year, retained earnings decreased by a. $1,242,500. b. $525,000. c. $192,500. d. $175,000.

128.

On June 30, 2008, when Vietti Co.'s stock was selling at $65 per share, its capital accounts were as follows: Capital stock (par value $50; 60,000 shares issued) Premium on capital stock Retained earnings

$3,000,000 600,000 4,200,000

If a 100% stock dividend were declared and distributed, capital stock would be a. $3,000,000. b. $3,600,000. c. $6,000,000. d. $7,800,000. 129.

The stockholders' equity section of Lawton Corporation as of December 31, 2007, was as follows: Common stock, par value $2; authorized 20,000 shares; issued and outstanding 10,000 shares $ 20,000 Paid-in capital in excess of par 30,000 Retained earnings 75,000 $125,000 On March 1, 2008, the board of directors declared a 15% stock dividend, and accordingly 1,500 additional shares were issued. On March 1, 2008, the fair market value of the stock was $6 per share. For the two months ended February 28, 2008, Lawton sustained a net loss of $10,000. What amount should Lawton report as retained earnings as of March 1, 2008? a. $56,000 b. $62,000 c. $66,000 d. $72,000

130.

The stockholders' equity of Benton Company at July 31, 2008 is presented below: Common stock, par value $20, authorized 400,000 shares; issued and outstanding 160,000 shares Paid-in capital in excess of par Retained earnings

$3,200,000 160,000 950,000 $4,310,000

On August 1, 2008, the board of directors of Benton declared a 15% stock dividend on common stock, to be distributed on September 15th. The market price of Benton's common stock was $35 on August 1, 2008, and $38 on September 15, 2008. What is the amount of the debit to retained earnings as a result of the declaration and distribution of this stock dividend?

Stockholders’ Equity a. b. c. d. 131.

13 - 25

$800,000 $840,000 $912,000 $600,000

On January 1, 2008, Carl, Inc., declared a 10% stock dividend on its common stock when the market value of the common stock was $20 per share. Stockholders' equity before the stock dividend was declared consisted of: Common stock, $10 par value, authorized 200,000 shares; issued and outstanding 120,000 shares Additional paid-in capital on common stock Retained earnings Total stockholders' equity

$1,200,000 150,000 700,000 $2,050,000

What was the effect on Carl’s retained earnings as a result of the above transaction? a. $120,000 decrease b. $240,000 decrease c. $400,000 decrease d. $200,000 decrease 132.

On January 1, 2008, Golden Corporation had 110,000 shares of its $5 par value common stock outstanding. On June 1, the corporation acquired 10,000 shares of stock to be held in the treasury. On December 1, when the market price of the stock was $8, the corporation declared a 10% stock dividend to be issued to stockholders of record on December 16, 2008. What was the impact of the 10% stock dividend on the balance of the retained earnings account? a. $50,000 decrease b. $80,000 decrease c. $88,000 decrease d. No effect

133.

Kimm, Inc. had net income for 2008 of $2,120,000 and earnings per share on common stock of $5. Included in the net income was $300,000 of bond interest expense related to its long-term debt. The income tax rate for 2008 was 30%. Dividends on preferred stock were $400,000. The payout ratio on common stock was 25%. What were the dividends on common stock in 2008? a. $430,000 b. $530,000 c. $482,500 d. $645,000

134.

Presented below is information related to Sampson, Inc.:

Common stock 4% Preferred stock Retained earnings (includes net income for current year) Net income for year

December 31, 2008 2007 $ 75,000 $ 60,000 350,000 350,000 90,000 75,000 30,000 32,000

What is Sampson’s rate of return on common stock equity for 2008?

13 - 26 Test Bank for Intermediate Accounting, Second Edition a. b. c. d.

20.0% 10.7% 18.2% 21.3%

Use the following information for questions 135 and 136. The following data are provided: December 31, 2008 2007 $100,000 $100,000 120,000 90,000 80,000 65,000 240,000 215,000 90,000

10% Cumulative preferred stock, $50 par Common stock, $10 par Additional paid-in capital Retained earnings (includes current year net income) Net income

Additional information: On May 1, 2008, 3,000 shares of common stock were issued. The preferred dividends were not declared during 2008. The market price of the common stock was $50 at December 31, 2008. 135.

The rate of return on common stock equity for 2008 is a. 90 ÷ 400. b. 90 ÷ 440. c. 80 ÷ 400. d. 80 ÷ 440.

136.

The book value per share of common stock at 12/31/08 is a. 430 ÷ 12. b. 200 ÷ 12. c. 330 ÷ 12. d. 440 ÷ 11.

Use the following information for questions 137 and 138. Winger Corporation had the following information in its financial statements for the year ended 2007 and 2008: Cash dividends for the year 2008 Net income for the year ended 2008 Market price of stock, 12/31/08 Common stockholders’ equity, 12/31/07 Common stockholders’ equity, 12/31/08 Outstanding shares, 12/31/08 Preferred dividends for the year ended 2008 137.

$ 15,000 124,000 24 2,200,000 2,400,000 120,000 30,000

What is the payout ratio for Winger Corporation for the year ended 2008? a. 12.1% b. 16.0% c. 36.3% d. 41.3%

Stockholders’ Equity 138.

13 - 27

What is the book value per share for Winger Corporation for the year ended 2008? a. $19.17 b. $20.00 c. $10.43 d. $24.00

*139. Jenks Co.has $2,500,000 of 8% convertible bonds outstanding. Each $1,000 bond is convertible into 30 shares of $30 par value common stock. The bonds pay interest on January 31 and July 31. On July 31, 2008, the holders of $800,000 bonds exercised the conversion privilege. On that date the market price of the bonds was 105 and the market price of the common stock was $36. The total unamortized bond premium at the date of conversion was $175,000. Jenks should record, as a result of this conversion, a a. credit of $136,000 to Paid-in Capital in Excess of Par. b. credit of $120,000 to Paid-in Capital in Excess of Par. c. credit of $56,000 to Premium on Bonds Payable. d. loss of $8,000. *140. On July 1, 2008, an interest payment date, $60,000 of Risen Co. bonds were converted into 1,200 shares of Risen Co. common stock each having a par value of $45 and a market value of $54. There is $2,400 unamortized discount on the bonds. Using the book value method, Risen would record a. no change in paid-in capital in excess of par. b. a $3,600 increase in paid-in capital in excess of par. c. a $7,200 increase in paid-in capital in excess of par. d. a $4,800 increase in paid-in capital in excess of par. *141

On December 1, 2008, Howell Company issued at 103, two hundred of its 9%, $1,000 bonds. Attached to each bond was one detachable stock warrant entitling the holder to purchase 10 shares of Howell's common stock. On December 1, 2008, the market value of the bonds, without the stock warrants, was 95, and the market value of each stock purchase warrant was $50. The amount of the proceeds from the issuance that should be accounted for as the initial carrying value of the bonds payable would be a. $193,640. b. $195,700. c. $200,000. d. $206,000.

*142. During 2008, Cartel Company issued at 104 three hundred, $1,000 bonds due in ten years. One detachable stock warrant entitling the holder to purchase 15 shares of Cartel’s common stock was attached to each bond. At the date of issuance, the market value of the bonds, without the stock warrants, was quoted at 96. The market value of each detachable warrant was quoted at $40. What amount, if any, of the proceeds from the issuance should be accounted for as part of Cartel’s stockholders' equity? a. $0 b. $12,000 c. $12,480 d. $11,856

13 - 28 Test Bank for Intermediate Accounting, Second Edition Use the following information for questions *143 and *144. On May 1, 2008, Logan Co. issued $300,000 of 7% bonds at 103, which are due on April 30, 2018. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Logan’s common stock, $15 par value, were attached to each $1,000 bond. The bonds without the warrants would sell at 96. On May 1, 2008, the fair value of Logan’s common stock was $35 per share and of the warrants was $2. *143. On May 1, 2008, Logan should credit Paid-in Capital from Stock Warrants for a. $11,520. b. $12,000. c. $12,360. d. $21,000. *144. On May 1, 2008, Logan should record the bonds with a a. discount of $12,000. b. discount of $3,360. c. discount of $3,000. d. premium of $9,000. *145. Sloane Corporation offered detachable 5-year warrants to buy one share of common stock (par value $5) at $20 (at a time when the stock was selling for $32). The price paid for 2,000, $1,000 bonds with the warrants attached was $205,000. The market price of the Sloane bonds without the warrants was $180,000, and the market price of the warrants without the bonds was $20,000. What amount should be allocated to the warrants? a. $20,000 b. $20,500 c. $24,000 d. $25,000

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

106. 107. 108. 109. 110. 111.

a b b c d b

112. 113. 114. 115. 116. 117.

d d b c c d

118. 119. 120. 121. 122. 123.

c a c b d d

124. 125. 126. 127. 128. 129.

d a d a c a

130. 131. 132. 133. 134. 135.

b b b a b c

136. 137. 138. *139. *140. *141.

a b b a b b

*142. *143. *144. *145.

c c b b

Stockholders’ Equity

13 - 29

MULTIPLE CHOICE—CPA Adapted 146.

A corporation was organized in January 2008 with authorized capital of $10 par value common stock. On February 1, 2008, shares were issued at par for cash. On March 1, 2008, the corporation's attorney accepted 7,000 shares of common stock in settlement for legal services with a fair value of $90,000. Additional paid-in capital would increase on February 1, 2008 March 1, 2008 a. Yes No b. Yes Yes c. No No d. No Yes

147.

On July 1, 2008, Cole Co. issued 2,500 shares of its $10 par common stock and 5,000 shares of its $10 par convertible preferred stock for a lump sum of $125,000. At this date Cole's common stock was selling for $24 per share and the convertible preferred stock for $18 per share. The amount of the proceeds allocated to Cole's preferred stock should be a. $62,500. b. $75,000. c. $90,000. d. $68,750.

148.

Norton Co. was organized on January 2, 2008, with 500,000 authorized shares of $10 par value common stock. During 2008, Norton had the following capital transactions: January 5—issued 375,000 shares at $14 per share. July 27—purchased 25,000 shares at $11 per share. November 25—sold 15,000 shares of treasury stock at $13 per share. Norton used the cost method to record the purchase of the treasury shares. What would be the balance in the Paid-in Capital from Treasury Stock account at December 31, 2008? a. $0 b. $15,000 c. $30,000 d. $45,000

149.

In 2007, Marly Corp. acquired 9,000 shares of its own $1 par value common stock at $18 per share. In 2008, Marly issued 4,000 of these shares at $25 per share. Marly uses the cost method to account for its treasury stock transactions. What accounts and what amounts should Marly credit in 2008 to record the issuance of the 4,000 shares?

a. b. c. d. 150.

Treasury Stock $72,000 $72,000

Additional Paid-in Capital $28,000 $96,000 $68,000

Retained Earnings $70,000

$28,000

Common Stock

$4,000 $4,000

At its date of incorporation, Wilson, Inc. issued 100,000 shares of its $10 par common stock at $11 per share. During the current year, Wilson acquired 20,000 shares of its common stock at a price of $16 per share and accounted for them by the cost method. Subsequently, these shares were reissued at a price of $12 per share. There have been no other issuances or acquisitions of its own common stock. What effect does the reissuance of the stock have on the following accounts?

13 - 30 Test Bank for Intermediate Accounting, Second Edition

a. b. c. d.

Retained Earnings Decrease No effect Decrease No effect

Additional Paid-in Capital Decrease Decrease No effect No effect

151.

Palmer Corp. owned 20,000 shares of Dixon Corp. purchased in 2003 for $240,000. On December 15, 2007, Palmer declared a property dividend of all of its Dixon Corp. shares on the basis of one share of Dixon for every 10 shares of Palmer common stock held by its stockholders. The property dividend was distributed on January 15, 2008. On the declaration date, the aggregate market price of the Dixon shares held by Palmer was $400,000. The entry to record the declaration of the dividend would include a debit to Retained Earnings of a. $0. b. $160,000. c. $240,000. d. $400,000.

152.

A corporation declared a dividend, a portion of which was liquidating. How would this distribution affect each of the following?

a. b. c. d.

Additional Paid-in Capital Decrease Decrease No effect No effect

Retained Earnings No effect Decrease Decrease No effect

153.

On May 1, 2008, Kent Corp. declared and issued a 10% common stock dividend. Prior to this dividend, Kent had 100,000 shares of $1 par value common stock issued and outstanding. The fair value of Kent 's common stock was $20 per share on May 1, 2008. As a result of this stock dividend, Kent's total stockholders' equity a. increased by $200,000. b. decreased by $200,000. c. decreased by $10,000. d. did not change.

154.

How would the declaration and subsequent issuance of a 10% stock dividend by the issuer affect each of the following when the market value of the shares exceeds the par value of the stock? Additional Common Stock Paid-in Capital a. No effect No effect b. No effect Increase c. Increase No effect d. Increase Increase

Stockholders’ Equity 155.

13 - 31

On December 31, 2007, the stockholders' equity section of Clark, Inc., was as follows: Common stock, par value $10; authorized 30,000 shares; issued and outstanding 9,000 shares Additional paid-in capital Retained earnings Total stockholders' equity

$ 90,000 116,000 174,000 $380,000

On March 31, 2008, Clark declared a 10% stock dividend, and accordingly 900 additional shares were issued, when the fair market value of the stock was $18 per share. For the three months ended March 31, 2008, Clark sustained a net loss of $32,000. The balance of Clark’s retained earnings as of March 31, 2008, should be a. $125,800. b. $133,000. c. $134,800. d. $142,000.

MULTIPLE CHOICE—Dilutive Securities, CPA Adapted *156. On January 2, 2008, Carr Co. issued 10-year convertible bonds at 105. During 2010, these bonds were converted into common stock having an aggregate par value equal to the total face amount of the bonds. At conversion, the market price of Carr’s common stock was 50 percent above its par value. On January 2, 2008, cash proceeds from the issuance of the convertible bonds should be reported as a. paid-in capital for the entire proceeds. b. paid-in capital for the portion of the proceeds attributable to the conversion feature and as a liability for the balance. c. a liability for the face amount of the bonds and paid-in capital for the premium over the face amount. d. a liability for the entire proceeds. *157. Kane Co. issued bonds with detachable common stock warrants. Only the warrants had a known market value. The sum of the fair value of the warrants and the face amount of the bonds exceeds the cash proceeds. This excess is reported as a. Discount on Bonds Payable. b. Premium on Bonds Payable. c. Common Stock Subscribed. d. Paid-in Capital in Excess of Par—Stock Warrants.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

146. 147.

d b

148. 149.

c b

150. 151.

c d

152. 153.

b d

154. 155.

d a

*156. *157.

d a

13 - 32 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational No. Answer Derivation 106.

$4,300,000 + $400,000 + $550,000 + $2,000,000 + $1,500,000 – $150,000 = $8,600,000.

107.

$4,300,000 + $550,000 = $4,850,000.

108.

(10,000 × $25) + (15,000 × $20) = $550,000 ($250,000 ÷ $550,000) × $480,000 = $218,182.

109.

(4,000 × $25) + (6,000 × $20) = $220,000 ($120,000 ÷ $220,000) × $192,000 = $104,727.

110.

(5,000 × $18) + $100,000 = $190,000.

111.

(500 × $25) + (750 × $20) = $27,500; $12,500 ÷ $27,500 × $24,000 = $10,909.

112.

8,000 × $32 = $256,000.

113.

12,000 × $15 = $180,000.

114.

3,000 × $20 = $60,000; 3,000 × $7 = $21,000.

115.

4,000 × $15 = $60,000; 4,000 × $4 = $16,000.

116.

$900,000 + (2,000 × $5) – (500 × $10) = $905,000.

117.

(675,000 × $4) + (90,000 × $7) = $3,330,000.

118.

$900,000 + (3,600 × $5) – (2,400 × $4) = $908,400.

119.

$1,650,000 – (3,000 × $28) – (3,000 × $35) + (1,800 × $30) + $450,000 = $1,965,000.

120.

20,000 × $55 = $1,100,000.

121.

(900,000 × $7) – [($7 – $5) × 900,000] = $4,500,000.

122.

(180,000 ÷ 10) × $14 = $252,000 $252,000 – [$252,000 – (180,000 × 18/20)] = $162,000.

123.

(5,000 × $63) = $315,000 $315,000 – ($315,000 – $218,000) = $218,000.

124.

[(18,000 ÷ 10) × $14] – [($14 – $9) × 1,800] = $16,200.

125.

$100,000 + $50,000 – $30,000 – (1,500 × $20) = $90,000

126.

(280,000 × .05 × $24) + [(280,000 × 1.05) × .60] = $512,400.

Stockholders’ Equity

13 - 33

DERIVATIONS — Computational (cont.) No. Answer Derivation 127.

350,000 × .10 × $30 = $1,050,000 $1,050,000 + (350,000 × 1.10 × $.50) = $1,242,500.

128.

(60,000 × $50) + $3,000,000 = $6,000,000.

129.

$75,000 – $10,000 – (1,500 × $6) = $56,000.

130.

160,000 × .15 × $35 = $840,000.

131.

120,000 × .10 × $20 = $240,000.

132.

100,000 × .10 × $8 = $80,000.

133.

X ——————————— = .25, X = $430,000. ($2,120,000 – $400,000)

134.

$30,000 – (.04 × $350,000) —————————————————————— = .107 = 10.7%. [($60,000 + $75,000) + ($75,000 + $90,000)] ÷ 2

135.

$90,000 – ($100,000 × .10) —————————————————————————————————— [($120,000 + $80,000 + $240,000 – $10,000) + ($90,000 + $65,000 + $215,000)] ÷ 2 = $80 ÷ 400.

136.

$120,000 + $80,000 + (240,000 – $10,000) ——————————————————— = $430 ÷ 12. 12,000

137.

$15,000 ÷ ($124,000 – $30,000) = 16.0%.

138.

$2,400,000 ÷ 120,000 = $20.00.

139.

$800,000 + ($175,000 × .32) – (800 × 30 × $30) = $136,000.

140.

$60,000 – (1,200 × $45) – $2,400 = $3,600.

141.

($200,000 × .95) + (200 × $50) = $200,000; $200,000 × 1.03 = $206,000 $190,000 ———— × $206,000 = $195,700. $200,000

142.

($300,000 × .96) + (300 × $40) = $300,000; $300,000 × 1.04 = $312,000 $12,000 ———— × $312,000 = $12,480. $300,000

13 - 34 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational (cont.) No. 143.

Answer Derivation c

($300,000 × .96) + (6,000 × $2) = $300,000; $300,000 × 1.03 = $309,000 $12,000 ———— × $309,000 = $12,360. $300,000

(

) = $3,360.

144.

$288,000 $300,000 – ————— × $309,000 $300,000

145.

[$20,000 ÷ ($20,000 + $180,000)] × $205,000 = $20,500.

DERIVATIONS — CPA Adapted No.

Answer Derivation

146.

Conceptual.

147.

($24 × 2,500) + ($18 × 5,000) = $150,000. $90,000 ————— × $125,000 = $75,000. $150,000

148.

15,000 × $2 = $30,000.

149.

(4,000 × $18) = $72,000; (4,000 × $7) = $28,000.

150.

Conceptual.

151.

$400,000 (market value).

152.

Conceptual.

153.

Conceptual.

154.

Conceptual.

155.

$174,000 – $32,000 – (900 × $18) = $125,800.

*156.

Conceptual

*157.

Conceptual

Stockholders’ Equity

13 - 35

EXERCISES Ex. 13-158—Lump sum issuance of stock. Landon Corporation has issued 2,000 shares of common stock and 400 shares of preferred stock for a lump sum of $72,000 cash. Instructions (a) Give the entry for the issuance assuming the par value of the common was $5 and the market value $30, and the par value of the preferred was $40 and the market value $50. (Each valuation is on a per share basis and there are ready markets for each stock.) (b) Give the entry for the issuance assuming the same facts as (a) above except the preferred stock has no ready market and the common stock has a market value of $25 per share.

Solution 13-158 (a) Cash ............................................................................................. Common Stock ............................................................... Paid-in Capital in Excess of Par—Common ..................... Preferred Stock ............................................................... Paid-in Capital in Excess of Par—Preferred .................... (common $30 × 2,000 $60,000 preferred $50 × 400 20,000 $80,000 market value 60/80 × $72,000 = 20/80 × $72,000 =

72,000 10,000 44,000 16,000 2,000

$54,000 common 18,000 preferred $72,000)

(b) Cash ............................................................................................. Common Stock.................................................................. Paid-in Capital in Excess of Par—Common ...................... Preferred Stock ................................................................. Paid-in Capital in Excess of Par—Preferred ......................

72,000 10,000 40,000 16,000 6,000

Ex. 13-159—Treasury stock. For numerous reasons, a corporation may reacquire shares of its own capital stock. When a company purchases treasury stock, it usually accounts for the stock using the cost method. Instructions Explain how a company would account for each of the following: 1. Purchase of shares at a price less than par value. 2. Subsequent resale of treasury shares at a price less than purchase price, but more than par value. 3. Subsequent resale of treasury shares at a price greater than both purchase price and par value. 4. Effect on net income.

13 - 36 Test Bank for Intermediate Accounting, Second Edition Solution 13-159 1. Treasury stock is debited for the purchase price of the shares even though the purchase price is less than par value. 2. Treasury stock is credited for the original cost (purchase price) of the shares, and the excess of the original cost (purchase price) over the sales price first is debited to paid-in capital from treasury stock from earlier sales of treasury stock and any remainder then is debited to retained earnings. 3. Treasury stock is credited for the original cost (purchase price) of the shares, and the excess of the sales price over the original cost (purchase price) is credited to paid-in capital from treasury stock. 4. There is no effect on net income as a result of treasury stock transactions.

Ex. 15-160—Treasury stock. Camby Corporation's balance sheet reported the following: Capital stock outstanding, 5,000 shares, par $30 per share Paid-in capital in excess of par Retained earnings

$150,000 80,000 100,000

The following transactions occurred this year: (a) Purchased 120 shares of capital stock to be held as treasury stock, paying $60 per share. (b) Sold 90 of the shares of treasury stock at $65 per share. (c) Sold the remaining shares of treasury stock at $50 per share. Instructions Prepare the journal entry for these transactions under the cost method of accounting for treasury stock.

Solution 13-160 (a) Treasury Stock ............................................................................... Cash ......................................................................................

7,200

(b) Cash .............................................................................................. Treasury Stock....................................................................... Paid-in Capital from Treasury Stock .......................................

5,850

(c) Cash ............................................................................................... Paid-in Capital from Treasury Stock ............................................... Treasury Stock.......................................................................

1,500 300

7,200

5,400 450

1,800

Stockholders’ Equity

13 - 37

Ex. 15-161—Treasury stock. Gagne Company's balance sheet shows: Common stock, $20 par Paid-in capital in excess of par Retained earnings

$3,000,000 1,050,000 750,000

Instructions Record the following transactions by the cost method. (a) Bought 5,000 shares of its common stock at $29 a share. (b) Sold 2,500 treasury shares at $30 a share. (c) Sold 1,000 shares of treasury stock at $26 a share.

Solution 13-161 (a) (b)

(c)

Treasury Stock ............................................................................ Cash ................................................................................

145,000

Cash............................................................................................ Treasury Stock................................................................. Paid-in Capital from Treasury Stock.................................

75,000

Cash............................................................................................ Paid-in Capital from Treasury Stock ............................................ Retained Earnings ....................................................................... Treasury Stock.................................................................

26,000 2,500 500

145,000 72,500 2,500

29,000

Ex. 13-162—Treasury stock. In 2007, Robison Co. issued 200,000 of its 500,000 authorized shares of $10 par value common stock at $35 per share. In January, 2008, Robison repurchased 15,000 shares at $30 per share. Assume these are the only stock transactions the company has ever had. Instructions (a) What are the two methods of accounting for treasury stock? (b) Prepare the journal entry to record the purchase of treasury stock by the cost method. (c) 5,000 shares of treasury stock are reissued at $33 per share. Prepare the journal entry to record the reissuance by the cost method.

Solution 13-162 (a)

The two methods of accounting for treasury stock are the cost method and the par value method.

(b)

Treasury Stock ............................................................................ Cash ................................................................................

450,000

Cash............................................................................................ Paid-in Capital from Treasury Stock................................. Treasury Stock.................................................................

165,000

(c)

450,000

15,000 150,000

13 - 38 Test Bank for Intermediate Accounting, Second Edition Ex. 13-163—Stockholders’ Equity. Indicate the effect of each of the following transactions on total stockholders' equity by placing an "X" in the appropriate column. Increase Decrease No Effect 1. Treasury stock is resold at more than cost.

________

2. Operating loss for the period.

________

3. Retirement of bonds payable at more than book value.

________

4. Declaration of a stock dividend.

________

5. Acquisition of machinery for common stock.

________

6. Conversion of bonds payable into common stock.

________

7. Not declaring a dividend on cumulative preferred stock.

________

8. Declaration of cash dividend.

________

9. Payment of cash dividend.

________

Increase

Decrease

No Effect

Solution 13-163

1. Treasury stock is resold at more than cost.

2. Operating loss for the period.

3. Retirement of bonds payable at more than book value.

4. Declaration of a stock dividend.

5. Acquisition of machinery for common stock.

6. Conversion of bonds payable into common stock.

7. Not declaring a dividend on cumulative preferred stock. 8. Declaration of cash dividend. 9. Payment of cash dividend.

X X X

Stockholders’ Equity

13 - 39

Ex. 13-164—Property dividends. Cole Corporation has 100,000 shares of common stock outstanding. The corporation also owns 100,000 shares of William Company common stock purchased 5 years ago at $10 per share. Cole decided to distribute the William Company stock as a property dividend on the basis of one share of William stock for each share of Cole stock owned. The William stock has a current market value of $25 per share and has been accounted for using the cost method since the date of acquisition. Instructions Prepare the journal entries Cole Corporation would make for the declaration and payment of the dividend.

Solution 13-164 Declaration of Dividend: Investment in Securities ..................................................... Gain on Appreciation of Securities .......................... Retained Earnings .............................................................. Property Dividend Payable ...................................... Payment of Dividend: Property Dividend Payable ................................................. Investment in Securities ..........................................

1,500,000 1,500,000 2,500,000 2,500,000

2,500,000 2,500,000

Ex. 13-165—Stock dividends. Courtney Corporation has the following accounts in its stockholders' equity section at the beginning of 2008: Preferred Stock, $100 par value, 7% cumulative and nonparticipating, 5,000 shares authorized, 4,000 shares issued and outstanding (one year's dividends in arrears) ........ Common Stock, $5 par value, 35,000 shares authorized, 15,000 shares issued and outstanding ....................................................................... Paid-in Capital in Excess of Par⎯Common ................................................ Retained Earnings .......................................................................................

$ 400,000 75,000 300,000 1,080,000

During 2008, Courtney Corporation declared and distributed the following dividends in the order shown: 1. The arrears dividend and the current dividend on preferred and a $3 per share common dividend. 2. A 15% stock dividend on common stock, current market price is $28 per share. 3. A $2 per share dividend on common stock outstanding. Instructions: (a) Prepare journal entries for the declaration and distribution of each dividend. (Assume each dividend is distributed prior to the declaration of the subsequent dividend.) (b) By what amount did these transactions change (increase or decrease) the total stockholders' equity section of Courtney Corporation?

13 - 40 Test Bank for Intermediate Accounting, Second Edition Solution 13-165 (a) 1. Retained Earnings .............................................................. Dividend Payable—Preferred................................. Dividend Payable—Common .................................

101,000 56,000a 45,000

(400,000 × .07 × 2 = $56,000)

Dividend Payable—Preferred ........................................ Dividend Payable—Common ........................................ Cash ......................................................................

56,000 45,000

2. Retained Earnings .............................................................. Stock Dividend Distributable—Common ................ Paid-in Capital in Excess of Par—Common ...........

63,000

101,000 11,250b 51,750

(15,000 × .15 × $5 = $11,250)

Stock Dividend Distributable—Common........................ Common Stock ......................................................

11,250

3. Retained Earnings .............................................................. Dividend Payable—Common .................................

34,500

11,250 34,500c

(15,000 + 2,250 × $2 = $34,500)

Dividend Payable—Common ........................................ Cash ......................................................................

34,500 34,500

(b) Decrease: $135,500 ($101,000 + $34,500 = $135,500) A stock dividend has no effect on total stockholders' equity.

Ex. 13-166—Stock dividends. Describe the journal entry for a stock dividend on common stock (which has a par value).

Solution 13-166 A stock dividend results in the transfer from retained earnings to paid-in capital of an amount equal to the market value of each share, if the dividend is less than 20-25%, or par value of each share, if the dividend is greater than 20-25%. Retained Earnings is debited for the total amount transferred, Common Stock Dividend Distributable is credited for the total par value of the shares, and, for a small stock dividend, the excess of market value over par value is credited to Paid-in Capital in Excess of Par.

Stockholders’ Equity

13 - 41

Ex. 13-167—Stock dividends and stock splits. Indicate the principal effects of a stock dividend versus a stock split as they affect the issuing corporation. Respond in the spaces as follows: "C" for change; "NC" for no change. Stock Dividend

Stock Split

Number of Shares Outstanding

________

Par Value per Share

________

Total Par Outstanding

________

Retained Earnings

________

Total Stockholders' Equity

________

Composition of Stockholders' Equity

________

Stock Dividend C NC C C NC C

Stock Split C C NC NC NC NC

Solution 15-167 Number of Shares Outstanding Par Value per Share Total Par Outstanding Retained Earnings Total Stockholders' Equity Composition of Stockholders' Equity

Ex. 13-168—Computation of selected financial ratios. The following information pertains to Nyland Co.: Preferred stock, cumulative: Par per share Dividend rate Shares outstanding Dividends in arrears Common stock: Par per share Shares issued Dividends paid per share Market price per share Additional paid-in capital Unappropriated retained earnings (after closing) Retained earnings appropriated for contingencies Common treasury stock: Number of shares Total cost Net income

$100 8% 5,000 none $10 60,000 $2.70 $48.00 $200,000 $135,000 $150,000 5,000 $125,000 $370,000

13 - 42 Test Bank for Intermediate Accounting, Second Edition Ex. 13-168

(cont.)

Instructions Compute (assume no changes in balances during the past year): (a) Total amount of stockholders’ equity in the balance sheet (b) Earnings per share of common stock (c) Book value per share of common stock (d) Payout ratio of common stock (e) Return on common stock equity

Solution 13-168 (a)

(5,000 × $100) + (60,000 × $10) + $200,000 + $135,000 + $150,000 – $125,000 = $1,460,000.

(b)

[$370,000 – (5,000 × $100 × 8%)] ÷ (60,000 – 5,000) = 330,000 ÷ 55,000 = $6.00 per share.

(c)

($1,460,000 – $500,000) ÷ (60,000 – 5,000) = $960,000 ÷ 55,000 = $17.45 per share.

(d)

$2.70 ÷ $6 = 45% or [($2.70 × 55,000) ÷ ($370,000 – $40,000)].

(e)

($370,000 – $40,000) ÷ ($1,460,000 – $500,000) = 34.4%.

*Ex. 13-169—Convertible Bonds. Linn Co. sold convertible bonds at a premium. Interest is paid on May 31 and November 30. On May 31, after interest was paid, 100, $1,000 bonds are tendered for conversion into 3,000 shares of $10 par value common stock that had a market price of $40 per share. How should Linn Co. account for the conversion of the bonds into common stock under the book value method? Discuss the rationale for this method.

*Solution 13-169 To account for the conversion of bonds under the book value method, Bonds Payable should be debited for the face value, Premium on Bonds Payable should be debited, and Common Stock should be credited at par for the shares issued. Using the book value method, no gain (loss) on conversion is recorded. The amount to be recorded for the stock is equal to the book (carrying) value (face value plus unamortized premium) of the bonds. Paid-in Capital in Excess of Par would be credited for the difference between the book value of the bonds and the par value of the stock issued. The rationale for the book value method is that the conversion is the completion of the transaction initiated when the bonds were issued. Since this is viewed as a transaction with stockholders, no gain (loss) should be recognized.

Stockholders’ Equity

13 - 43

*Ex. 13-170—Convertible Debt and Debt with Warrants (Essay). What accounting treatment is required for convertible debt? Why? What accounting treatment is required for debt issued with stock warrants? Why?

*Solution 16-170 Convertible debt is treated solely as debt. One reason is that the debt and conversion option are inseparable. The holder cannot sell one and retain the other. The two choices are mutually exclusive. Another reason is that the valuation of the conversion option or the debt security without the conversion option is subjective because these values are not established separately in the marketplace. When debt is issued with stock warrants, the warrants are given separate recognition. After issue, the debt and the detachable warrants trade separately. The proceeds may be allocated to the two elements based on the relative fair values of the debt security without the warrants and the warrants at the time of issuance. The proceeds allocated to the warrants should be accounted for as paid-in capital.

PROBLEMS Pr. 13-171—Equity transactions. Presented below is information related to Rollins Company: 1. The company is granted a charter that authorizes issuance of 15,000 shares of $100 par value preferred stock and 40,000 shares of no-par common stock. 2. 8,000 shares of common stock are issued to the founders of the corporation for land valued by the board of directors at $300,000. The board establishes a stated value of $5 a share for the common stock. 3. 5,000 shares of preferred stock are sold for cash at $120 per share. 4. The company issues 100 shares of common stock to its attorneys for costs associated with starting the company. At that time, the common stock was selling at $60 per share. Instructions Prepare the general journal entries necessary to record these transactions.

13 - 44 Test Bank for Intermediate Accounting, Second Edition Solution 13-171 1. No entry necessary. 2. Land ............................................................................................... Common Stock ................................................................... Paid-in Capital in Excess of Stated Value ...........................

300,000

3. Cash ............................................................................................... Preferred Stock ................................................................... Paid-in Capital in Excess of Par—Preferred Stock ..............

600,000

4. Organization Expense .................................................................... Common Stock ................................................................... Paid-in Capital in Excess of Stated Value ...........................

6,000

40,000 260,000 500,000 100,000 500 5,500

Pr. 13-172—Treasury stock transactions. The original sale of the $50 par value common shares of Eddy Company was recorded as follows: Cash ......................................................................................... 290,000 Common Stock.............................................................. 250,000 Paid-in Capital in Excess of Par .................................... 40,000 Instructions Record the treasury stock transactions (given below) under the cost method: Transactions: (a) Bought 300 shares of common stock as treasury shares at $62. (b) Sold 80 shares of treasury stock at $60. (c) Sold 40 treasury shares at $68.

Solution 13-172 (a)

(b)

(c)

Treasury Stock .................................................................................. Cash .........................................................................................

18,600

Cash .................................................................................................. Retained Earnings ............................................................................. Treasury Stock ..........................................................................

4,800 160

Cash .................................................................................................. Paid-in Capital from Treasury Stock .......................................... Treasury Stock ..........................................................................

2,720

18,600

4,960

240 2,480

Stockholders’ Equity

13 - 45

Pr. 13-173—Stock dividends. The stockholders' equity section of Reston Corporation's balance sheet as of December 31, 2007 is as follows: Stockholders' Equity Common stock, $5 par value; authorized, 2,000,000 shares; issued, 400,000 shares $2,000,000 Paid-in capital in excess of par 850,000 Retained earnings 3,000,000 $5,850,000 The following events occurred during 2008: 1. Jan. 5

10,000 shares of authorized and unissued common stock were sold for $8 per share.

2. Jan. 16

Declared a cash dividend of 20 cents per share, payable February 15 to stockholders of record on February 5.

3. Feb. 10

20,000 shares of authorized and unissued common stock were sold for $12 per share.

4. March 1

A 30% stock dividend was declared and issued. Market value per share is currently $15.

5. April 1

A two-for-one split was carried out. The par value of the stock was to be reduced to $2.50 per share. Market value on March 31 was $18 per share.

6. July 1

A 15% stock dividend was declared and issued. Market value is currently $10 per share.

7. Aug. 1

A cash dividend of 20 cents per share was declared, payable September 1 to stockholders of record on August 21.

Instructions Enter the above events into the following work sheet showing how each event affects the column. Event No. 1 will serve as an example. Common Stock No. of Total Paid-in Capital in Item Shares Issued Par Value Excess of Par Retained Earnings Beginning Balance—1/1/08 400,000 $2,000,000 $850,000 $3,000,000 Event #1—Jan. 5 10,000 50,000 30,000 -0Balance 410,000 $2,050,000 $880,000 $3,000,000 Event # 2—Jan. 16 (and events 3 through 7)

13 - 46 Test Bank for Intermediate Accounting, Second Edition Solution 13-173 Event #2—Jan. 16 -0-0-0(82,000) ——————————————————————————————————————————— Balance 410,000 $2,050,000 $880,000 $2,918,000 #3—Feb. 10 20,000 100,000 140,000 -0——————————————————————————————————————————— Balance 430,000 $2,150,000 $1,020,000 $2,918,000 #4—March 1 129,000 645,000 -0(645,000) ——————————————————————————————————————————— Balance 559,000 $2,795,000 $1,020,000 $2,273,000 #5—April 1 559,000 -0-0-0——————————————————————————————————————————— Balance 1,118,000 $2,795,000 $1,020,000 $2,273,000 #6—July 1 167,700 419,250 1,257,750 (1,677,000) ——————————————————————————————————————————— Balance 1,285,700 $3,214,250 $2,277,750 $596,000 #7—Aug. 1 -0-0-0(257,140) ——————————————————————————————————————————— Balance 1,285,700 $3,214,250 $2,277,750 $338,860

Pr. 13-174—Equity transactions. Sands Corporation has the following capital structure at the beginning of the year: 6% Preferred stock, $50 par value, 20,000 shares authorized, 6,000 shares issued and outstanding Common stock, $10 par value, 60,000 shares authorized, 40,000 shares issued and outstanding Paid-in capital in excess of par Total paid-in capital Retained earnings Total stockholders' equity

300,000 400,000 110,000

810,000 440,000 $1,250,000

Instructions Record the following transactions which occurred consecutively (show all calculations). 1. A total cash dividend of $90,000 was declared and payable to stockholders of record. Record dividends payable on common and preferred stock in separate accounts. 2. A 10% common stock dividend was declared. The average market value of the common stock is $18 a share. 3. Assume that net income for the year was $150,000 (record the closing entry) and the board of directors appropriated $70,000 of retained earnings for plant expansion.

Stockholders’ Equity

13 - 47

Solution 13-174 1. Retained Earnings ....................................................................... Dividends Payable—Preferred ($300,000 × .06) .......... Dividends Payable—Common ..................................... 2.

90,000 18,000 72,000

40,000 shares × 10% 4,000 shares as stock dividend × $18 $72,000 total dividend Retained Earnings ....................................................................... Common Stock Dividend Distributable................................... Paid-in Capital in Excess of Par.............................................

72,000

3. Income Summary ........................................................................ Retained Earnings .................................................................

150,000

Retained Earnings ....................................................................... Retained Earnings Appropriated for Plant Expansion ............

70,000

40,000 32,000

150,000

70,000

*Pr. 13-175—Convertible bonds and stock warrants. For each of the unrelated transactions described below, present the entry(ies) required to record the bond transactions. 1. On August 1, 2008, Ryan Corporation called its 10% convertible bonds for conversion. The $8,000,000 par bonds were converted into 320,000 shares of $20 par common stock. On August 1, there was $700,000 of unamortized premium applicable to the bonds. The fair market value of the common stock was $20 per share. Ignore all interest payments. 2. Lopez Company issues $5,000,000 of bonds with a coupon rate of 8%. To help the sale, detachable stock warrants are issued at the rate of ten warrants for each $1,000 bond sold. It is estimated that the value of the bonds without the warrants is $4,935,000 and the value of the warrants is $315,000. The bonds with the warrants sold at 101.

*Solution 13-175 1. Bonds Payable ............................................................................... 8,000,000 Premium on Bonds Payable ........................................................... 700,000 Common Stock ................................................................... Paid-in Capital in Excess of Par .......................................... 2. Cash .............................................................................................. 5,050,000 Discount on Bonds Payable ........................................................... 253,000 Bonds Payable ................................................................... Paid-in Capital—Stock Warrants......................................... ($315,000 ÷ $5,250,000 × $5,050,000 = $303,000)

6,400,000 2,300,000

5,000,000 303,000

CHAPTER 14 INVESTMENTS TRUE-FALSE—Conceptual Answer

No.

Description

F T F T F F F T T F F T F T F T T F F T T T T F T F T F T T T F T F T

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35.

Examples of debt securities. Definition of trading securities. Available-for-sale unrealized gains/losses. Definition of held-to-maturity securities. Definition of available-for-sale securities. Classifying debt and equity securities. Valuing held-to-maturity securities. Reporting trading securities. Available-for-sale debt securities. Trading debt securities. Classifying held-to-maturity securities. Fair value changes in AFS securities. Securities Fair Value Adjustment account. Accounting for trading securities. Definition of significant influence. Reporting Unrealized Holding Gain/Loss—Equity account. Examples of significant influence. Definition of controlling interest. Fair value method. Reporting unrealized gains and losses. Significant influence and equity method. Changes in net assets under equity method. Permanent decline and cost basis. Use of equity method. Effect of dividends on investment under equity. Reporting revenue under fair value method. Definition of controlling interest. Classifying trading securities and AFS securities. Reclassification adjustment for AFS securities. Classification of held-to-maturity securities. Impairment test for debt securities. Temporary declines and write downs. Impaired available-for-sale securities. Transfer of held-to-maturity securities. Transfers from trading to available-for-sale.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

c b c c

36. 37. 38. 39.

Debt securities. Valuation of debt securities. Held-to-maturity securities. Unrealized gain/loss recognition for securities.

14 - 2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

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

40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72.

Accounting for accrued interest. Identifying securities accounted for at amortized cost. Accounting for available-for-sale securities. Definition of trading securities. Held-to-maturity securities. Using effective-interest method of amortization. Identifying available-for-sale securities. Classification as held-to-maturity. Reporting held-to-maturity securities. Acquisition of held-to-maturity securities. Accounting for trading securities. Accounting for trading debt securities. Recording investments in debt securities. Calculating the issue price of bonds. Valuation of investments in debt securities. Recording amortization of bond discount. Amortization of premium/discount on investment in a debt security. Effective-interest rate method. Debt securities purchased between interest dates. Sale of debt security prior to maturity. Passive interest investment. Identifying significant level of influence. Accounting for long-term investment. Fair value vs. equity method. Fair value vs. equity method. Conditions for using the equity method. Ownership interest required for using the equity method. Recording of dividends received under the equity method. Recognition of earnings of investee using the equity method. Classification of unrealized loss on available-for-sale securities. Reclassification adjustment in comprehensive income. Reclassification of securities. Reclassification of securities.

MULTIPLE CHOICE—Computational Answer

No.

Description

c d b a c a b c a b b

73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83.

Recording the purchase of debt securities. Calculation of discount amortization. Calculation of revenue from HTM securities. Computation of other comprehensive income. Computation of gain/loss on sale of bonds. Acquisition of held-to-maturity securities. Carrying value of held-to-maturity securities. Carrying value of available-for-sale debt securities. Calculation of income from available-for-sale debt securities. Calculation of income from HTM securities. Determine gain on sale of debt securities.

Investments

MULTIPLE CHOICE—Computational (cont.) Answer

No.

Description

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

84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105.

Recording unrealized gain/loss on trading securities. Accounting for investment without significant influence. Fair value for trading securities. Unrealized gain on available-for-sale securities. Calculation of gain on sale of equity security. Determination of unrealized loss on AFS securities. Calculation of unrealized loss included in comprehensive income. Computation of revenue from investment. Computation of investment account balance. Calculation of investment revenue. Accounting for stock investments/fair value method. Accounting for stock investments/equity method. Accounting for stock investments/fair value method. Equity method of accounting. Fair value method of accounting for stock investment. Equity method of accounting for stock investment. Balance of investment account using the equity method. Investment income recognized under the equity method. Balance of investment account using the equity method. Balance of investment account using the equity method. Investment income recognized under the equity method. Other comprehensive income.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

d d c d c b c a b

106. 107. 108. 109. 110. 111. 112. 113. 114.

Carrying value of AFS debt securities. Unrealized loss on trading and AFS securities. Unrealized loss on trading and AFS securities. Classification of an equity security. Investment income recognized under the equity method. Balance of investment account using the equity method. Sale of stock investment. Calculate the acquisition price of a stock investment. Transfer of securities from trading to AFS.

EXERCISES Item

Description

E14-115 E14-116 E14-117 E14-118 E14-119 E14-120 E14-121 E14-122

Investment in debt securities at a premium. Investment in debt securities at a discount. Available-for-sale securities. Investments in equity securities (essay). Investment in equity securities. Fair value and equity methods (essay). Fair value and equity methods. Comprehensive income calculation.

14 - 3

14 - 4

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Item

Description

P14-123 P14-124 P14-125

Trading equity securities. Trading securities. Available-for-sale securities.

CHAPTER LEARNING OBJECTIVES 1.

Identify the three categories of debt securities and describe the accounting and reporting treatment for each category.

Understand the procedures for discount and premium amortization on bond investments.

Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

Explain the equity method of accounting and compare it to the fair value method for equity securities.

Describe the disclosure requirements for investments in debt and equity securities.

Discuss the accounting for impairments of debt and equity investments.

Describe the accounting for transfer of investment securities between categories.

Investments

14 - 5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2. 3.

TF TF TF

4. 5. 6.

TF TF TF

7. 8. 36.

9. 10. 11. 12. 13. 14.

TF TF TF TF TF TF

45. 46. 47. 48. 49. 50.

MC MC MC MC MC MC

51. 52. 53. 54. 55. 56.

15. 16. 17.

TF TF TF

18. 19. 20.

TF TF TF

60. 61. 85.

21. 22. 23. 24. 25.

TF TF TF TF TF

26. 27. 62. 63. 64.

TF TF MC MC MC

65. 66. 67. 68. 91.

28.

29.

30.

31.

32.

33.

34. 35.

TF MC

71. 72.

MC MC

114. 118.

Note: TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 TF 37. MC 40. TF 38. MC 41. MC 39. MC 42. Learning Objective 2 MC 57. MC 77. MC 58. MC 78. MC 59. MC 79. MC 74. MC 80. MC 75. MC 81. MC 76. MC 82. Learning Objective 3 MC 86. MC 89. MC 87. MC 90. MC 88. MC 107. Learning Objective 4 MC 92. MC 97. MC 93. MC 98. MC 94. MC 99. MC 95. MC 100. MC 96. MC 101. Learning Objective 5 TF 69. MC 70. Learning Objective 6 TF 118. E 124. Learning Objective 7 MC 123. P E 124. P E = Exercise P = Problem

Type

Item

Type

MC MC MC

43. 44. 73.

MC MC MC

MC MC MC MC MC MC

83. 84. 106. 115. 116. 117.

MC MC MC E E E

MC MC MC

108. 109. 118.

MC MC MC MC MC MC P

Item

Type

MC MC E

123. 124. 125.

P P P

102. 103. 104. 110. 111.

MC MC MC MC MC

112. 113. 119. 120. 121.

MC MC E E E

105.

122.

14 - 6

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual 1.

Debt securities include corporate bonds and convertible debt, but not U.S. government securities.

Trading securities are securities bought and held primarily for sale in the near term to generate income on short-term price differences.

Unrealized holding gains and losses are recognized in net income for available-for-sale debt securities.

Held-to-maturity securities are securities that the enterprise has the positive intent and ability to hold to maturity.

Available-for-sale securities are securities that are bought and held primarily for sale in the near term to generate income on short-term price differences.

Both debt securities and equity securities can be classified as held-to-maturity.

Held-to-maturity securities are accounted for at fair value.

Trading securities are reported at fair value, with unrealized holding gains and losses reported as part of net income.

Amortization of discount or premium on available-for-sale debt securities is debited or credited to the Available-for-Sale Securities account.

10. Amortization of discount or premium on trading debt securities is debited or credited to the Securities Fair Value Adjustment (Trading) account. 11. A company can classify a debt security as held-to-maturity if it has the positive intent to hold the securities to maturity. 12. Companies do not report changes in the fair value of available-for-sale debt securities as income until the security is sold. 13. The Securities Fair Value Adjustment account has a normal credit balance. 14. Companies report trading securities at fair value, with unrealized holding gains and losses reported in net income. 15. Equity security holdings between 20 and 50 percent indicates that the investor has a controlling interest over the investee. 16. The Unrealized Holding Gain/Loss—Equity account is reported as a part of other comprehensive income. 17. Significant influence over an investee may be indicated by material intercompany transactions and interchange of managerial personnel.

Investments

14 - 7

18. The accounting profession has concluded that an investment of more than 50 percent of the voting stock of an investee should lead to a presumption of significant influence over an investee. 19. The fair value method requires that companies classify equity securities at acquisition as held-to-maturity securities or available-for-sale securities. 20. When an investor has holdings of less than 20% in an investee and the securities are classified as trading securities, unrealized holding gains or losses are reported as part of net income. 21. In instances of "significant influence" (generally an investment of 20% or more), the investor is required to account for the investment using the equity method. 22. The equity method gives recognition to the fact that investee earnings increase investee net assets that underlie the investment and investee losses and dividends decrease the net assets. 23. If the decline in value of securities is judged to be other than temporary, the cost basis of the individual security is written down to a new cost basis. 24. Once the equity method is adopted by an investor, the method must continue in use until the investment to which it has been applied is sold or liquidated by some other means. 25. All dividends received by an investor from the investee decrease the investment’s carrying value under the equity method. 26. Under the fair value method, the investor reports as revenue its share of the net income reported by the investee. 27. A controlling interest occurs when one corporation acquires a voting interest of more than 50 percent in another corporation. 28. Trading securities and available-for-sale securities are classified as current or noncurrent assets depending on the circumstances. 29. When a company sells available-for-sale securities, a reclassification adjustment is necessary to avoid counting gains and losses twice. 30. Held-to-maturity securities should be classified as current or noncurrent, based on the maturity date of the individual securities. 31. For debt securities, the impairment test is to determine whether "it is probable that the investor will be unable to collect all amounts due according to the contractual terms." 32. If a decline in a security’s value is judged to be temporary, a company needs to write down the cost basis of the individual security to a new cost basis. 33. Subsequent increases and decreases in the fair value of impaired available-for-sale securities are included in other comprehensive income.

14 - 8

Test Bank for Intermediate Accounting, Second Edition

34. If a company transfers held-to-maturity securities to available-for-sale securities, the unrealized gain or loss is recognized in income. 35. The transfer of securities from trading to available-for-sale and from available-for-sale to trading has the same impact on stockholders’ equity and net income.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6.

F T F T F F

7. 8. 9. 10. 11. 12.

F T T F F T

13. 14. 15. 16. 17. 18.

F T F T T F

19. 20. 21. 22. 23. 24.

F T T T T F

25. 26. 27. 28. 29. 30.

T F T F T T

31. 32. 33. 34. 35.

T F T F T

MULTIPLE CHOICE—Conceptual 36.

Which of the following is not a debt security? a. Convertible bonds b. Commercial paper c. Loans receivable d. All of these are debt securities.

37.

A correct valuation is a. available-for-sale at amortized cost. b. held-to-maturity at amortized cost. c. held-to-maturity at fair value. d. none of these.

38.

Securities which could be classified as held-to-maturity are a. redeemable preferred stock. b. warrants. c. municipal bonds. d. treasury stock.

39.

Unrealized holding gains or losses which are recognized in income are from securities classified as a. held-to-maturity. b. available-for-sale. c. trading. d. none of these.

Investments

14 - 9

40. When an investor's accounting period ends on a date that does not coincide with an interest receipt date for bonds held as an investment, the investor must a. make an adjusting entry to debit Interest Receivable and to credit Interest Revenue for the amount of interest accrued since the last interest receipt date. b. notify the issuer and request that a special payment be made for the appropriate portion of the interest period. c. make an adjusting entry to debit Interest Receivable and to credit Interest Revenue for the total amount of interest to be received at the next interest receipt date. d. do nothing special and ignore the fact that the accounting period does not coincide with the bond's interest period. 41. Debt securities that are accounted for at amortized cost, not fair value, are a. held-to-maturity debt securities. b. trading debt securities. c. available-for-sale debt securities. d. never-sell debt securities. 42. Debt securities acquired by a corporation which are accounted for by recognizing unrealized holding gains or losses and are included as other comprehensive income and as a separate component of stockholders' equity are a. held-to-maturity debt securities. b. trading debt securities. c. available-for-sale debt securities. d. never-sell debt securities. 43. Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences are a. held-to-maturity debt securities. b. trading debt securities. c. available-for-sale debt securities. d. never-sell debt securities. 44. Debt securities from which there is no recognized unrealized holding gains or losses in net income nor included as other comprehensive income are a. held-to-maturity debt securities. b. trading debt securities. c. available-for-sale debt securities. d. never-sell debt securities. 45. Use of the effective-interest method in amortizing bond premiums and discounts results in a. a greater amount of interest income over the life of the bond issue than would result from use of the straight-line method. b. a varying amount being recorded as interest income from period to period. c. a variable rate of return on the book value of the investment. d. a smaller amount of interest income over the life of the bond issue than would result from use of the straight-line method.

14 - 10 Test Bank for Intermediate Accounting, Second Edition 46. Equity securities acquired by a corporation which are accounted for by recognizing unrealized holding gains or losses as other comprehensive income and as a separate component of stockholders' equity are a. available-for-sale securities where a company has holdings of less than 20%. b. trading securities where a company has holdings of less than 20%. c securities where a company has holdings of between 20% and 50%. d. securities where a company has holdings of more than 50%. 47.

A requirement for a security to be classified as held-to-maturity is a. ability to hold the security to maturity. b. positive intent. c. the security must be a debt security. d. All of these are required.

48.

Held-to-maturity securities are reported at a. acquisition cost. b. acquisition cost plus amortization of a discount. c. acquisition cost plus amortization of a premium. d. fair value.

49.

Solo Co. purchased $300,000 of bonds for $315,000. If Solo intends to hold the securities to maturity, the entry to record the investment includes a. a debit to Held-to-Maturity Securities at $300,000. b. a credit to Premium on Investments of $15,000. c. a debit to Held-to-Maturity Securities at $315,000. d. none of these.

50.

Which of the following is not correct in regard to trading securities? a. They are held with the intention of selling them in a short period of time. b. Unrealized holding gains and losses are reported as part of net income. c. Any discount or premium is not amortized. d. All of these are correct.

51.

In accounting for investments in debt securities that are classified as trading securities, a. a discount is reported separately. b. a premium is reported separately. c. any discount or premium is not amortized. d. none of these.

52.

Investments in debt securities are generally recorded at a. cost including accrued interest. b. maturity value. c. cost including brokerage and other fees. d. maturity value with a separate discount or premium account.

53.

Pippen Co. purchased ten-year, 10% bonds that pay interest semiannually. The bonds are sold to yield 8%. One step in calculating the issue price of the bonds is to multiply the principal by the table value for a. 10 periods and 10% from the present value of 1 table. b. 10 periods and 8% from the present value of 1 table. c. 20 periods and 5% from the present value of 1 table. d. 20 periods and 4% from the present value of 1 table.

Investments

14 - 11

54.

Investments in debt securities should be recorded on the date of acquisition at a. lower of cost or market. b. market value. c. market value plus brokerage fees and other costs incident to the purchase. d. face value plus brokerage fees and other costs incident to the purchase.

55.

An available-for-sale debt security is purchased at a discount. The entry to record the amortization of the discount includes a a. debit to Available-for-Sale Securities. b. debit to the discount account. c. debit to Interest Revenue. d. none of these.

56.

APB Opinion No. 21 specifies that, regarding the amortization of a premium or discount on a debt security, the a. effective-interest method of allocation must be used. b. straight-line method of allocation must be used. c. effective-interest method of allocation should be used but other methods can be applied if there is no material difference in the results obtained. d. par value method must be used and therefore no allocation is necessary.

57.

Which of the following is correct about the effective-interest method of amortization? a. The effective-interest method applied to investments in debt securities is different from that applied to bonds payable. b. Amortization of a discount decreases from period to period. c. Amortization of a premium decreases from period to period. d. The effective-interest method produces a constant rate of return on the book value of the investment from period to period.

58.

When investments in debt securities are purchased between interest payment dates, preferably the a. securities account should include accrued interest. b. accrued interest is debited to Interest Expense. c. accrued interest is debited to Interest Revenue. d. accrued interest is debited to Interest Receivable.

59. Which of the following is not generally correct about recording a sale of a debt security before maturity date? a. Accrued interest will be received by the seller even though it is not an interest payment date. b. An entry must be made to amortize a discount to the date of sale. c. The entry to amortize a premium to the date of sale includes a credit to the Premium on Investments in Debt Securities. d. A gain or loss on the sale is not extraordinary. 60. When a company has acquired a "passive interest" in another corporation, the acquiring company should account for the investment by a. using the equity method. b. using the fair value method. c. using the effective-interest method. d. consolidation.

14 - 12 Test Bank for Intermediate Accounting, Second Edition 61. If a company has acquired a 20% to 50% interest in another corporation, this generally results in a(n) a. insignificant level of influence. b passive level of influence. c. significant level of influence. d. controlling level of influence. 62. McCoy Corporation purchased 7,400 shares of Chudzick Company's common stock. The purchase price was $362,600, which is equal to 50% of Chudzick Company's retained earnings balance. Chudzick Company's 46,000 shares of common stock are actively traded, and each share has a par value of $10. McCoy Corporation should account for this long-term investment using the a. fair value method. b. equity method. c. consolidation method. d. amortized cost method. 63. Bista Corporation declares and distributes a cash dividend that is a result of current earnings. How will the receipt of those dividends affect the investment account of the investor under each of the following accounting methods? a. b. c. d.

Fair Value Method No Effect Increase No Effect Decrease

Equity Method Decrease Decrease No Effect No Effect

64. An investor has a long-term investment in stocks. Regular cash dividends received by the investor are recorded as Fair Value Method a. Income b. A reduction of the investment c. Income d. A reduction of the investment

Equity Method Income A reduction of the investment A reduction of the investment Income

65.

When a company holds between 20% and 50% of the outstanding stock of an investee, which of the following statements applies? a. The investor should always use the equity method to account for its investment. b. The investor should use the equity method to account for its investment unless circumstances indicate that it is unable to exercise "significant influence" over the investee. c. The investor must use the fair value method unless it can clearly demonstrate the ability to exercise "significant influence" over the investee. d. The investor should always use the fair value method to account for its investment.

66.

If the parent company owns 90% of the subsidiary company's outstanding common stock, the company should generally account for the income of the subsidiary under the a. cost method. b. fair value method. c. divesture method. d. equity method.

Investments

14 - 13

67.

Byner Corporation accounts for its investment in the common stock of Yount Company under the equity method. Byner Corporation should ordinarily record a cash dividend received from Yount as a. a reduction of the carrying value of the investment. b. additional paid-in capital. c. an addition to the carrying value of the investment. d. dividend income.

68.

Under the equity method of accounting for investments, an investor recognizes its share of the earnings in the period in which the a. investor sells the investment. b. investee declares a dividend. c. investee pays a dividend. d. earnings are reported by the investee in its financial statements.

69.

An unrealized holding loss on a company's available-for-sale securities should be reflected in the current financial statements as a. an extraordinary item shown as a direct reduction from retained earnings. b. a current loss resulting from holding securities. c. a note or parenthetical disclosure only. d. other comprehensive income and deducted in the equity section of the balance sheet.

70.

A reclassification adjustment is reported in the a. income statement as an Other Revenue or Expense. b. stockholders’ equity section of the balance sheet. c. statement of comprehensive income as other comprehensive income. d. statement of stockholders’ equity.

71.

When an investment in a held-to-maturity security is transferred to an available-for-sale security, the carrying value assigned to the available-for-sale security should be a. its original cost. b. its fair value at the date of the transfer. c. the lower of its original cost or its fair value at the date of the transfer. d. the higher of its original cost or its fair value at the date of the transfer.

72.

When an investment in an available-for-sale security is transferred to trading because the company anticipates selling the stock in the near future, the carrying value assigned to the investment upon entering it in the trading portfolio should be a. its original cost. b. its fair value at the date of the transfer. c. the higher of its original cost or its fair value at the date of the transfer. d. the lower of its original cost or its fair value at the date of the transfer.

14 - 14 Test Bank for Intermediate Accounting, Second Edition

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

36. 37. 38. 39. 40. 41.

c b c c a a

42. 43. 44. 45. 46. 47.

c b a b a d

48. 49. 50. 51. 52. 53.

b c d c c d

54. 55. 56. 57. 58. 59.

c a c d c c

60. 61. 62. 63. 64. 65.

b c a a c b

66. 67. 68. 69. 70. 71.

d a d d c b

72.

MULTIPLE CHOICE—Computational 73.

On August 1, 2008, Witten Co. acquired 200, $1,000, 9% bonds at 97 plus accrued interest. The bonds were dated May 1, 2008, and mature on April 30, 2014, with interest paid each October 31 and April 30. The bonds will be added to Witten’s available-for-sale portfolio. The preferred entry to record the purchase of the bonds on August 1, 2008 is a. Available-for-Sale Securities ............................................... 198,500 Cash ........................................................................ 198,500 b. Available-for-Sale Securities ............................................... Interest Receivable ............................................................. Cash ........................................................................

194,000 4,500

c. Available-for-Sale Securities ............................................... Interest Revenue................................................................. Cash ........................................................................

194,000 4,500

d. Available-for-Sale Securities ............................................... Interest Revenue................................................................. Discount on Debt Securities .................................... Cash .......................................................................

200,000 4,500

198,500

6,000 198,500

Use the following information for questions 74 and 75. Oliver Company purchased $400,000 of 10% bonds of McGee Co. on January 1, 2008, paying $376,100. The bonds mature January 1, 2018; interest is payable each July 1 and January 1. The discount of $23,900 provides an effective yield of 11%. Oliver Company uses the effectiveinterest method and plans to hold these bonds to maturity. 74. On July 1, 2008, Oliver Company should increase its Held-to-Maturity Debt Securities account for the McGee Co. bonds by a. $2,392. b. $1,371. c. $1,196. d. $686. 75. For the year ended December 31, 2008, Oliver Company should report interest revenue from the McGee Co. bonds of a. $42,392. b. $41,409. c. $41,368. d. $40,000.

Investments

14 - 15

Use the following information for questions 76 and 77. Marten Co. purchased $500,000 of 8%, 5-year bonds from Duggan, Inc. on January 1, 2008, with interest payable on July 1 and January 1. The bonds sold for $520,790 at an effective interest rate of 7%. Using the effective-interest method, Marten Co. decreased the Available-for-Sale Debt Securities account for the Duggan, Inc. bonds on July 1, 2008 and December 31, 2008 by the amortized premiums of $1,770 and $1,830, respectively. 76. At December 31, 2008, the fair value of the Duggan, Inc. bonds was $530,000. What should Marten Co. report as other comprehensive income and as a separate component of stockholders' equity? a. $12,810 b. $9,210 c. $3,600 d. No entry should be made. 77. At April 1, 2009, Marten Co. sold the Duggan bonds for $515,000. After accruing for interest, the carrying value of the Duggan bonds on April 1, 2009 was $516,875. Assuming Marten Co. has a portfolio of Available-for-Sale Debt Securities, what should Marten Co. report as a gain or loss on the bonds? a. ($14,685) b. ($10,935) c. ($1,875) d. $0 78.

79.

On August 1, 2008, Bettis Company acquired $200,000 face value 10% bonds of Hanson Corporation at 104 plus accrued interest. The bonds were dated May 1, 2007, and mature on April 30, 2013, with interest payable each October 31 and April 30. The bonds will be held to maturity. What entry should Bettis make to record the purchase of the bonds on August 1, 2008? a. Held-to-Maturity Securities.................................................. 208,000 Interest Revenue ................................................................ 5,000 Cash ....................................................................... 213,000 b. Held-to-Maturity Securities.................................................. Cash .......................................................................

213,000

c. Held-to-Maturity Securities.................................................. Interest Revenue ..................................................... Cash .......................................................................

213,000

d. Held-to-Maturity Securities.................................................. Premium on Bonds ............................................................. Cash .......................................................................

200,000 13,000

213,000 5,000 208,000

213,000

On October 1, 2008, Porter Co. purchased to hold to maturity, 1,000, $1,000, 9% bonds for $990,000 which includes $15,000 accrued interest. The bonds, which mature on February 1, 2017, pay interest semiannually on February 1 and August 1. Porter uses the straight-line method of amortization. The bonds should be reported in the December 31, 2008 balance sheet at a carrying value of a. $975,000. b. $975,750. c. $990,000. d. $990,250.

14 - 16 Test Bank for Intermediate Accounting, Second Edition 80.

On November 1, 2008, Little Company purchased 600 of the $1,000 face value, 9% bonds of Player, Incorporated, for $632,000, which includes accrued interest of $9,000. The bonds, which mature on January 1, 2013, pay interest semiannually on March 1 and September 1. Assuming that Little uses the straight-line method of amortization and that the bonds are appropriately classified as available-for-sale, the net carrying value of the bonds should be shown on Little's December 31, 2008, balance sheet at a. $600,000. b. $623,000. c. $622,080. d. $632,000.

81.

On November 1, 2008, Morton Co. purchased Gomez, Inc., 10-year, 9% bonds with a face value of $250,000, for $225,000. An additional $7,500 was paid for the accrued interest. Interest is payable semiannually on January 1 and July 1. The bonds mature on July 1, 2015. Morton uses the straight-line method of amortization. Ignoring income taxes, the amount reported in Morton's 2008 income statement as a result of Morton's availablefor-sale investment in Gomez was a. $4,375. b. $4,167. c. $3,750. d. $3,333.

82.

On October 1, 2008, Lyman Co. purchased to hold to maturity, 200, $1,000, 9% bonds for $208,000. An additional $6,000 was paid for accrued interest. Interest is paid semiannually on December 1 and June 1 and the bonds mature on December 1, 2012. Lyman uses straight-line amortization. Ignoring income taxes, the amount reported in Lyman's 2008 income statement from this investment should be a. $4,500. b. $4,020. c. $4,980. d. $5,460.

83.

During 2006, Plano Co. purchased 2,000, $1,000, 9% bonds. The carrying value of the bonds at December 31, 2008 was $1,960,000. The bonds mature on March 1, 2013, and pay interest on March 1 and September 1. Plano sells 1,000 bonds on September 1, 2009, for $988,000, after the interest has been received. Plano uses straight-line amortization. The gain on the sale is a. $0. b. $4,800. c. $8,000. d. $11,200.

84.

On January 1, 2008, Alton Co. purchased $100,000 of 10%, Olson, Inc. bonds with interest payable on July 1 and January 1 for $107,000. On February 1, 2008, Alton purchased $100,000 of 12%, Ehrlich Co. bonds with interest payable on August 1 and February 1 for $95,000. Alton classifies the Olson and Ehrlich bonds as trading debt securities. On December 31, 2008, the fair value of the Olson and Ehrlich bonds are $110,000 and $94,000, respectively. At December, 2008, what adjusting entry should be made by Alton?

Investments a. No entry should be made. b. Securities Fair Value Adjustment (Trading) ......................... Unrealized Holding Gain or Loss—Income................. c. Securities Fair Value Adjustment (Trading) ......................... Unrealized Holding Gain or Loss—Income................. d. Unrealized Holding Gain or Loss—Income ......................... Securities Fair Value Adjustment (Trading) ................

14 - 17

3,000 3,000 2,000 2,000 1,000 1,000

85.

On January 3, 2008, Slezak Company purchased 22% of Urban Corporation's common stock for $250,000. Shortly after the purchase, Slezak Company executives tried to obtain representation on Urban Corporation's board of directors and failed. During 2008, Urban reported net income of $150,000 and paid cash dividends of $80,000 on the common stock. The balance in Slezak Company's Investment in Urban Corporation account at December 31, 2008, should be a. $265,400. b. $234,600. c. $250,000. d. $300,600.

86.

Redman Company's trading securities portfolio which is appropriately included in current assets is as follows: December 31, 2008 Cost Fair Value Unrealized Gain (Loss) Arlington Corp. $250,000 $200,000 $(50,000) Downs, Inc. 245,000 265,000 20,000 $495,000 $465,000 $(30,000) Ignoring income taxes, what amount should be reported as a charge against income in Redman's 2008 income statement if 2008 is Redman's first year of operation? a. $0 b. $20,000 c. $30,000 d. $50,000

87.

On its December 31, 2007, balance sheet, Quinn Co. reported its investment in availablefor-sale securities, which had cost $600,000, at fair value of $550,000. At December 31, 2008, the fair value of the securities was $585,000. What should Quinn report on its 2008 income statement as a result of the increase in fair value of the investments in 2008? a. $0 b. Unrealized loss of $15,000 c. Realized gain of $35,000 d. Unrealized gain of $35,000

88. During 2007, Ellis Company purchased 20,000 shares of Hiller Corp. common stock for $315,000 as an available-for-sale investment. The fair value of these shares was $300,000 at December 31, 2007. Ellis sold all of the Hiller stock for $17 per share on December 3, 2008, incurring $14,000 in brokerage commissions. Ellis Company should report a realized gain on the sale of stock in 2008 of a. $11,000. b. $25,000. c. $26,000. d. $40,000.

14 - 18 Test Bank for Intermediate Accounting, Second Edition Use the following information for questions 89 and 90. On its December 31, 2007 balance sheet, Klugman Company appropriately reported a $10,000 debit balance in its Securities Fair Value Adjustment (Available-for-Sale) account. There was no change during 2008 in the composition of Klugman’s portfolio of marketable equity securities held as available-for-sale securities. The following information pertains to that portfolio: Security X Y Z

Cost $125,000 100,000 175,000 $400,000

Fair value at 12/31/08 $160,000 95,000 125,000 $380,000

89. What amount of unrealized loss on these securities should be included in Klugman's stockholders' equity section of the balance sheet at December 31, 2008? a. $30,000 b. $20,000 c. $10,000 d. $0 90. The amount of unrealized loss to appear as a component of comprehensive income for the year ending December 31, 2008 is a. $30,000. b. $20,000. c. $10,000. d. $0. 91. Kennett Corporation purchased 25,000 shares of common stock of the Swenson Corporation for $40 per share on January 2, 2008. Swenson Corporation had 100,000 shares of common stock outstanding during 2008, paid cash dividends of $60,000 during 2008, and reported net income of $200,000 for 2008. Kennett Corporation should report revenue from investment for 2008 in the amount of a. $15,000. b. $35,000. c. $50,000. d. $55,000. Use the following information for questions 92 and 93. Garrison Co. owns 20,000 of the 50,000 outstanding shares of Steele, Inc. common stock. During 2008, Steele earns $800,000 and pays cash dividends of $640,000. 92. If the beginning balance in the investment account was $500,000, the balance at December 31, 2008 should be a. $820,000. b. $660,000. c. $564,000. d. $500,000.

Investments

14 - 19

93. Garrison should report investment revenue for 2008 of a. $320,000. b. $256,000. c. $64,000. d. $0. Use the following information for questions 94 through 97. The summarized balance sheets of Elston Company and Alley Company as of December 31, 2008 are as follows: Elston Company Balance Sheet December 31, 2008 Assets $1,200,000 Liabilities Capital stock Retained earnings Total equities

$ 150,000 600,000 450,000 $1,200,000 Alley Company Balance Sheet December 31, 2008

Assets

$900,000

Liabilities Capital stock Retained earnings Total equities

$225,000 555,000 120,000 $900,000

94.

If Elston Company acquired a 20% interest in Alley Company on December 31, 2008 for $195,000 and the fair value method of accounting for the investment were used, the amount of the debit to Investment in Alley Company Stock would have been a. $135,000. b. $111,000. c. $195,000. d. $180,000.

95.

If Elston Company acquired a 30% interest in Alley Company on December 31, 2008 for $225,000 and the equity method of accounting for the investment were used, the amount of the debit to Investment in Alley Company Stock would have been a. $285,000. b. $225,000. c. $180,000. d. $202,500.

96.

If Elston Company acquired a 20% interest in Alley Company on December 31, 2008 for $135,000 and during 2009 Alley Company had net income of $75,000 and paid a cash dividend of $30,000, applying the fair value method would give a debit balance in the Investment in Alley Company Stock account at the end of 2009 of a. $111,000. b. $135,000. c. $150,000. d. $144,000.

14 - 20 Test Bank for Intermediate Accounting, Second Edition 97.

If Elston Company acquired a 30% interest in Alley Company on December 31, 2008 for $202,500 and during 2009 Alley Company had net income of $75,000 and paid a cash dividend of $30,000, applying the equity method would give a debit balance in the Investment in Alley Company Stock account at the end of 2009 of a. $202,500. b. $216,000. c. $225,000. d. $217,500.

Use the following information for questions 98 and 99. Karter Company purchased 200 of the 1,000 outstanding shares of Flynn Company's common stock for $300,000 on January 2, 2008. During 2008, Flynn Company declared dividends of $50,000 and reported earnings for the year of $200,000. 98.

If Karter Company used the fair value method of accounting for its investment in Flynn Company, its Investment in Flynn Company account on December 31, 2008 should be a. $290,000. b. $330,000. c. $300,000. d. $340,000.

99.

If Karter Company uses the equity method of accounting for its investment in Flynn Company, its Investment in Flynn Company account at December 31, 2008 should be a. $290,000. b. $300,000. c. $330,000. d. $340,000.

Use the following information for questions 100 and 101. Barry Corporation earns $240,000 and pays cash dividends of $80,000 during 2008. Glenon Corporation owns 3,000 of the 10,000 outstanding shares of Barry. 100.

What amount should Glenon show in the investment account at December 31, 2008 if the beginning of the year balance in the account was $320,000? a. $392,000 b. $320,000 c. $368,000 d. $480,000

101.

How much investment income should Glenon report in 2008? a. $80,000 b. $72,000 c. $48,000 d. $240,000

Investments 102.

14 - 21

Young Co. acquired a 60% interest in Tomlin Corp. on December 31, 2007 for $945,000. During 2008, Tomlin had net income of $600,000 and paid cash dividends of $150,000. At December 31, 2008, the balance in the investment account should be a. $945,000. b. $1,305,000. c. $1,215,000. d. $1,395,000.

Use the following information for questions 103 and 104. Stone Co. owns 4,000 of the 10,000 outstanding shares of Maye Corp. common stock. During 2008, Maye earns $120,000 and pays cash dividends of $40,000. 103.

If the beginning balance in the investment account was $240,000, the balance at December 31, 2008 should be a. $240,000. b. $272,000. c. $288,000. d. $320,000.

104.

Stone should report investment revenue for 2008 of a. $16,000. b. $32,000. c. $40,000. d. $48,000.

105.

The following information relates to Vernon Company for 2008: Realized gain on sale of available-for-sale securities Unrealized holding gains arising during the period on available-for-sale securities Reclassification adjustment for gains included in net income

$15,000 35,000 10,000

Vernon’s 2008 other comprehensive income is a. $25,000. b. $40,000. c. $50,000. d. $60,000.

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

73. 74. 75. 76. 77.

c d b a c

78. 79. 80. 81. 82.

a b c a b

83. 84. 85. 86. 87.

b c c c a

88. 89. 90. 91. 92.

a b a c c

93. 94. 95. 96. 97.

a c b b b

98. 99. 100. 101. 102.

c c c b c

103. 104. 105.

b d b

14 - 22 Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—CPA Adapted 106.

On October 1, 2007, Ming Co. purchased 600 of the $1,000 face value, 8% bonds of Loy, Inc., for $702,000, including accrued interest of $12,000. The bonds, which mature on January 1, 2014, pay interest semiannually on January 1 and July 1. Ming used the straight-line method of amortization and appropriately recorded the bonds as available-forsale. On Ming's December 31, 2008 balance sheet, the carrying value of the bonds is a. $690,000. b. $684,000. c. $681,600. d. $672,000.

107.

Unruh Corp. began operations in 2008. An analysis of Unruh’s equity securities portfolio acquired in 2008 shows the following totals at December 31, 2008 for trading and available-for-sale securities: Trading Available-for-Sale Securities Securities Aggregate cost $90,000 $110,000 Aggregate fair value 65,000 95,000 What amount should Unruh report in its 2008 income statement for unrealized holding loss? a. $40,000 b. $10,000 c. $15,000 d. $25,000

108.

At December 31, 2008, Malle Corp. had the following equity securities that were purchased during 2008, its first year of operation: Fair Unrealized Cost Value Gain (Loss) Trading Securities: Security A $ 90,000 $ 60,000 $(30,000) B 15,000 20,000 5,000 Totals $105,000 $ 80,000 $(25,000) Available-for-Sale Securities: Security Y Z Totals

$ 70,000 85,000 $155,000

$ 80,000 55,000 $135,000

$ 10,000 (30,000) $(20,000)

All market declines are considered temporary. Fair value adjustments at December 31, 2008 should be established with a corresponding charge against Income Stockholders’ Equity a. $45,000 $ 0 b. $30,000 $30,000 c. $25,000 $20,000 d. $25,000 $ 0

Investments 109.

14 - 23

On December 29, 2009, Greer Co. sold an equity security that had been purchased on January 4, 2008. Greer owned no other equity securities. An unrealized holding loss was reported in the 2008 income statement. A realized gain was reported in the 2009 income statement. Was the equity security classified as available-for-sale and did its 2008 market price decline exceed its 2009 market price recovery? 2008 Market Price Decline Exceeded 2009 Available-for-Sale Market Price Recovery a. Yes Yes b. Yes No c. No Yes d. No No

Use the following information for questions 110 through 112. Kimm, Inc. acquired 30% of Carne Corp.'s voting stock on January 1, 2008 for $400,000. During 2008, Carne earned $160,000 and paid dividends of $100,000. Kimm's 30% interest in Carne gives Kimm the ability to exercise significant influence over Carne's operating and financial policies. During 2009, Carne earned $200,000 and paid dividends of $60,000 on April 1 and $60,000 on October 1. On July 1, 2009, Kimm sold half of its stock in Carne for $264,000 cash. 110.

Before income taxes, what amount should Kimm include in its 2008 income statement as a result of the investment? a. $160,000 b. $100,000 c. $48,000 d. $30,000

111.

The carrying amount of this investment in Kimm's December 31, 2008 balance sheet should be a. $400,000. b. $418,000. c. $448,000. d. $460,000.

112.

What should be the gain on sale of this investment in Kimm's 2009 income statement? a. $64,000 b. $55,000 c. $49,000 d. $40,000

113.

On January 1, 2008, Sloane Co. purchased 25% of Orr Corp.'s common stock; no goodwill resulted from the purchase. Sloane appropriately carries this investment at equity and the balance in Sloane’s investment account was $720,000 at December 31, 2008. Orr reported net income of $450,000 for the year ended December 31, 2008, and paid common stock dividends totaling $180,000 during 2008. How much did Sloane pay for its 25% interest in Orr? a. $652,500 b. $765,000 c. $787,500 d. $877,500

14 - 24 Test Bank for Intermediate Accounting, Second Edition 114.

On December 31, 2007, Nance Co. purchased equity securities as trading securities. Pertinent data are as follows: Fair Value Security Cost At 12/31/08 A $132,000 $117,000 B 168,000 186,000 C 288,000 258,000 On December 31, 2008, Nance transferred its investment in security C from trading to available-for-sale because Nance intends to retain security C as a long-term investment. What total amount of gain or loss on its securities should be included in Nance's income statement for the year ended December 31, 2008? a. $3,000 gain b. $27,000 loss c. $30,000 loss d. $45,000 loss

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

106. 107.

d d

108. 109.

c d

110. 111.

c b

112. 113.

c a

114.

DERIVATIONS — Computational No.

Answer Derivation

73.

Dr. Available-for-Sale Securities: 200 × $1,000 × .97 = $194,000 Dr. Interest Revenue: $200,000 × .045 × 3/6 = $4,500 Cr. Cash: $194,000 + $4,500 = $198,500.

74.

($376,100 × .055) – ($400,000 × .05) = $686.

75.

$376,100 × .055 = $20,686 ($376,100 + $686) × .055 - $20,723; $20,686 + $20,723 = $41,409.

76.

$530,000 – ($520,790 – $1,770 – $1,830) = $12,810.

77.

$516,875 – $515,000 = $1,875.

78.

Dr. Held-to-Maturity Securities: $200,000 × 1.04 = $208,000 Dr. Interest Revenue: $200,000 × .05 × 3/6 = $5,000 Cr. Cash: $208,000 + $5,000 = $213,000.

79.

$975,000 + ($25,000 × 3/100) = $975,750.

80.

$632,000 – $9,000 = $623,000 $623,000 – ($23,000 × 2/50) = $622,080.

81.

($250,000 × .045) + ($25,000 × 2/80) – $7,500 = $4,375.

Investments

14 - 25

DERIVATIONS — Computational (cont.) No.

Answer Derivation

82.

($200,000 × .09 × 3/12) – ($8,000 × 3/50) = $4,020.

83.

Discount amortization: $40,000 × 8/50 = $6,400 ($1,960,000 + $6,400) ÷ 2 = $983,200; $988,000 – $983,200 = $4,800 gain.

84.

($110,000 + $94,000) – ($107,000 + $95,000) = $2,000.

85.

No significant influence.

86.

$30,000 (unrealized loss).

87.

$0 (available-for-sale securities).

88.

[(20,000 × $17) – $14,000] – $315,000 = $11,000.

89.

($400,000 – $380,000) = $20,000.

90.

$10,000 + $20,000 = $30,000.

91.

$200,000 × (25,000 ÷ 100,000) = $50,000.

92.

$500,000 + [($800,000 – $640,000) × (20,000 ÷ 50,000)] = $564,000.

93.

$800,000 × (20,000 ÷ 50,000) = $320,000.

94.

$195,000, acquisition cost.

95.

$225,000, acquisition cost.

96.

$135,000, acquisition cost.

97.

$202,500 + ($75,000 × .3) – ($30,000 × .3) = $216,000.

98.

$300,000, acquisition cost.

99.

$300,000 + ($200,000 × .2) – ($50,000 × .2) = $330,000.

100.

$320,000 + ($240,000 × .3) – ($80,000 × .3) = $368,000.

101.

$240,000 × .3 = $72,000.

102.

$945,000 + ($600,000 × .6) – ($150,000 × .6) = $1,215,000.

103.

$240,000 + ($120,000 × .4) – ($40,000 × .4) = $272,000.

104.

$120,000 × .4 = $48,000.

105.

$15,000 + $35,000 – $10,000 = $40,000.

14 - 26 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — CPA Adapted No. 106.

Answer Derivation d

$702,000 – $12,000 = $690,000 15 $690,000 – $90,000 × — 75

(

) = $672,000.

$90,000 – $65,000 = $25,000.

107.

108.

109.

Conceptual.

110.

$160,000 × 30% = $48,000.

111.

$400,000 + $48,000 – ($100,000 × 30%) = $418,000.

112.

$418,000 – ($60,000 × 30%) + ($200,000 × 50% × 30%) = $430,000. $264,000 – ($430,000 ÷ 2) = $49,000.

113.

$720,000 – ($450,000 × 25%) + ($180,000 × 25%) = $652,500.

114.

$18,000 – $15,000 – $30,000 = $27,000 loss.

EXERCISES Ex. 14-115—Investment in debt securities at premium. On April 1, 2008, Sean Co. purchased $160,000 of 6% bonds for $166,300 plus accrued interest as an available-for-sale security. Interest is paid on July 1 and January 1 and the bonds mature on July 1, 2013. Instructions (a) Prepare the journal entry on April 1, 2008. (b) The bonds are sold on November 1, 2009 at 103 plus accrued interest. Amortization was recorded when interest was received by the straight-line method (by months and round to the nearest dollar). Prepare all entries required to properly record the sale.

Solution 14-115 (a) Available-for-Sale Securities ......................................................... Interest Revenue ($160,000 × .06 × 1/4) ....................................... Cash ................................................................................

166,300 2,400

(b) Interest Revenue ($6,300 × 4 ÷ 63) ............................................... Available-for-Sale Securities ............................................

400

168,700

400

Investments

14 - 27

Solution 14-115 (cont.) Cash ($160,000 × .06 × 1/3) ......................................................... Interest Revenue .............................................................

3,200

Cash ............................................................................................. Gain on Sale of Securities ............................................... Available-for-Sale Securities ........................................... $166,300 – [($6,300 ÷ 63) × 19]

164,800

3,200

400 164,400

Ex. 14-116—Investment in debt securities at a discount. On May 1, 2008, Gipson Corp. purchased $450,000 of 12% bonds, interest payable on January 1 and July 1, for $422,800 plus accrued interest. The bonds mature on January 1, 2014. Amortization is recorded when interest is received by the straight-line method (by months and round to the nearest dollar). (Assume bonds are available for sale.) Instructions (a) Prepare the entry for May 1, 2008. (b) The bonds are sold on August 1, 2009 for $425,000 plus accrued interest. Prepare all entries required to properly record the sale.

Solution 14-116 (a)

(b)

Available-for-Sale Securities ....................................................... Interest Revenue ($450,000 × .12 × 4/12) ................................... Cash ................................................................................

422,800 18,000

Available-for-Sale Securities ($27,200 ÷ 68 × 1) .......................... Interest Revenue .............................................................

400

Cash ($450,000 × .12 × 1/12) ...................................................... Interest Revenue .............................................................

4,500

Cash............................................................................................ Loss on Sale of Securities ........................................................... Available-for-Sale Securities ............................................ $422,800 + [($27,200 ÷ 68)  15]

425,000 3,800

440,800

400

4,500

428,800

Ex. 14-117—Available-for-sale securities. Funk Company has the following securities in its investment portfolio on December 31, 2007 (all securities were purchased in 2007): (1) 5,000 shares of Beem Co. common stock which cost $55,000, (2) 30,000 shares of Lenard Co. common stock which cost $150,000, and (3) 4,000 shares of Taylor Co. common stock which cost $120,000. The Securities Fair Value Adjustment account shows a credit of $8,500 at the end of 2007.

14 - 28 Test Bank for Intermediate Accounting, Second Edition Ex. 14-117 (cont.) In 2008 Funk completed the following securities transactions: (a) On March 15, sold 2,000 shares of Beem’s common stock at $10 per share less fees of $150. (b) On June 1, purchased 10,000 shares of Chong Co. common stock at $12 per share plus fees of $200. On December 31, 2008, the market values per share of these securities were: Beem $8, Lenard $10, Taylor $28, and Chong $15. In addition, the Treasurer of Funk told you that, even though all these securities have readily determinable fair values, Funk will not actively trade these securities because the company plans to hold them for more than one year. Instructions (a) Prepare the entry for the security sale on March 15, 2008. (b) Prepare the journal entry to record the security purchase on June 1, 2008. (c) Compute the unrealized gains or losses and prepare the adjusting entry for Beem on December 31, 2008.

Solution 14-117 (a) March 15, 2008 Cash [($2,000 × $10) – $150]..................................................... Loss on Sale of Stock ................................................................ Available-for-Sale Securities (2,000 × $11) .....................

19,850 2,150

June 1, 2008 Available-for-Sale Securities ...................................................... Cash [(10,000 × $12) + $200] ..........................................

120,200

22,000

(b)

(c)

Investments Beem Co. Lenard Co. Taylor Co. Chong Co. Total of portfolio

120,200

Funk Company Available-for-Sale Equity Security Portfolio December 31, 2008 Cost $ 33,000 150,000 120,000 120,200 423,200

Fair Value $ 24,000 300,000 112,000 150,000 586,000

Unrealized Gain (Loss) $ (9,000) 150,000 (8,000) 29,800 162,800

Previous securities fair value adjustment balance Securities fair value adjustment December 31, 2008 Securities Fair Value Adjustment (Available-for-Sale) .......................... Unrealized Holding Gain or Loss—Equity .................................

8,500 $171,300

171,300 171,300

Investments

14 - 29

Ex. 14-118—Investments in equity securities. Presented below are unrelated cases involving investments in equity securities. Case I. The fair value of the trading securities at the end of last year was 30% below original cost, and this was properly reflected in the accounts. At the end of the current year, the fair value has increased to 20% above cost. Case II. The fair value of an available-for-sale security has declined to less than forty percent of the original cost. The decline in value is considered to be other than temporary. Case III. An equity security, whose fair value is now less than cost, is classified as trading but is reclassified as available-for-sale. Instructions Indicate the accounting required for each case separately. Solution 14-118 Case I. At the end of last year, the company would have recognized an unrealized holding loss and recorded a Securities Fair Value Adjustment (Trading). At the end of the current year, the company would record an unrealized holding gain that would be reported in the other revenue and gains section. The adjustment account would now have a debit balance. Case II. When the decline in value is considered to be other than temporary, the loss should be recognized as if it were realized and earnings will be reduced. The fair value becomes a new cost basis. Case III. The security is transferred at fair value, which is the new cost basis of the security. The Available-for-Sale Securities account is recorded at fair value, and the Unrealized Holding Loss— Income account is debited for the unrealized loss. The Trading Securities account is credited for cost.

Ex. 14-119—Investment in equity securities. Watt Corp. acquired a 25% interest in Sauer Co. on January 1, 2008, for $500,000. At that time, Sauer had 1,000,000 shares of its $1 par common stock issued and outstanding. During 2008, Sauer paid cash dividends of $160,000 and thereafter declared and issued a 5% common stock dividend when the market value was $2 per share. Sauer's net income for 2008 was $360,000. What is the balance in Watt’s investment account at the end of 2008?

Solution 14-119 Cost Share of net income (.25 × $360,000) Share of dividends (.25 × $160,000) Balance in investment account

$500,000 90,000 (40,000) $550,000

14 - 30 Test Bank for Intermediate Accounting, Second Edition Ex. 14-120—Fair value and equity methods. (Essay) Compare the fair value and equity methods of accounting for investments in stocks subsequent to acquisition.

Solution 14-120 Under the fair value method, investments are originally recorded at cost and are reported at fair value. Dividends are reported as other revenues and gains. Under the equity method, investments are originally recorded at cost. Subsequently, the investment account is adjusted for the investor's share of the investee's net income or loss and this amount is recognized in the income of the investor. Dividends received from the investee are reductions in the investment account.

Ex. 14-121—Fair value and equity methods. Fill in the dollar changes caused in the Investment account and Dividend Revenue or Investment Revenue account by each of the following transactions, assuming Maxey Company uses (a) the fair value method and (b) the equity method for accounting for its investments in Linden Company. (a) Fair Value Method (b) Equity Method Investment Dividend Investment Investment Transaction Account Revenue Account Revenue ——————————————————————————————————————————— 1. At the beginning of Year 1, Maxey bought 30% of Linden's common stock at its book value. Total book value of all Linden's common stock was $800,000 on this date. ——————————————————————————————————————————— 2. During Year 1, Linden reported $60,000 of net income and paid $30,000 of dividends. ——————————————————————————————————————————— 3. During Year 2, Linden reported $30,000 of net income and paid $40,000 of dividends. ——————————————————————————————————————————— 4. During Year 3, Linden reported a net loss of $10,000 and paid $5,000 of dividends. ——————————————————————————————————————————— 5. Indicate the Year 3 ending balance in the Investment account, and cumulative totals for Years 1, 2, and 3 for dividend revenue and investment revenue. ———————————————————————————————————————————

Investments

14 - 31

Solution 14-121

Transaction

(a) Fair Value Method (b) Equity Method Investment Dividend Investment Investment Account Revenue Account Revenue

———————————————————————————————————————————————

240,000

———————————————————————————————————————————————

2. 9,000

18,000 (9,000)

18,000

———————————————————————————————————————————————

3. 12,000

9,000 (12,000)

9,000

———————————————————————————————————————————————

4. 1,500

(3,000) (1,500)

(3,000)

———————————————————————————————————————————————

240,000

22,500

241,500

24,000

———————————————————————————————————————————————

Ex. 14-122—Comprehensive income calculation. The following information is available for Griner Company for 2008: Net Income Realized gain on sale of available-for-sale securities Unrealized holding gain arising during the period on available-for-sale securities Reclassification adjustment for gains included in net income

$120,000 10,000 24,000 8,000

Instructions (1) Determine other comprehensive income for 2008. (2) Compute comprehensive income for 2008.

Solution 14-122 (1) 2008 other comprehensive income = $26,000 ($10,000 realized gain + $24,000 unrealized holding gain – $8,000 reclassification adjustment). (2) 2008 comprehensive income = $146,000 ($120,000 + $26,000).

14 - 32 Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Pr. 14-123—Trading equity securities. Gordon Company has the following securities in its portfolio of trading equity securities on December 31, 2008: Cost Fair Value 5,000 shares of Milner Corp., Common $155,000 $139,000 10,000 shares of Eddy, Common 182,000 190,000 $337,000 $329,000 All of the securities had been purchased in 2008. In 2009, Gordon completed the following securities transactions: March 1 April 1

Sold 5,000 shares of Milner Corp., Common @ $31 less fees of $1,500. Bought 600 shares of Yount Stores, Common @ $45 plus fees of $550.

The Gordon Company portfolio of trading equity securities appeared as follows on December 31, 2009: Cost Fair Value 10,000 shares of Eddy, Common $182,000 $195,500 600 shares of Yount Stores, Common 27,550 25,500 $209,550 $221,000 Instructions Prepare the general journal entries for Gordon Company for: (a) the 2008 adjusting entry. (b) the sale of the Milner Corp. stock. (c) the purchase of the Yount Stores' stock. (d) the 2009 adjusting entry.

Solution 14-123 (a)

(b)

(c)

(d)

12-31-08 Unrealized Holding Gain or Loss—Income .................................. Securities Fair Value Adjustment (Trading) ...................... ($337,000 – $329,000)

8,000 8,000

3-1-09 Cash [(5,000  $31) – $1,500] ..................................................... Loss on Sale of Securities ........................................................... Trading Securities ............................................................

153,500 1,500

4-1-09 Trading Securities ........................................................................ Cash [(600  $45) + $550] ...............................................

27,550

12-31-09 Securities Fair Value Adjustment (Trading) .................................. Unrealized Holding Gain or Loss—Income .......................

19,450

155,000

27,550

19,450

Investments

14 - 33

Pr. 14-124—Trading equity securities. Lopez Company began operations in 2006. Since then, it has reported the following gains and losses for its investments in trading securities on the income statement:

Gains (losses) from sale of trading securities Unrealized holding losses on valuation of trading securities Unrealized holding gain on valuation of trading securities

2006 $ 15,000 (25,000) —

2007 $(20,000) — 10,000

2008 $ 14,000 (30,000) —

At January 1, 2009, Lopez owned the following trading securities: AGH Common (15,000 shares) DEL Preferred (2,000 shares) Pratt Convertible bonds (100 bonds)

Cost $450,000 210,000 115,000

During 2009, the following events occurred: 1. Sold 5,000 shares of AGH for $170,000. 2. Acquired 1,000 shares of Norton Common for $40 per share. Brokerage commissions totaled $1,000. At 12/31/09, the fair values for Lopez's trading securities were: AGH Common, $28 per share DEL Preferred, $110 per share Pratt Bonds, $1,020 per bond Norton Common, $42 per share Instructions (a) Prepare a schedule which shows the balance in the Securities Fair Value Adjustment (Trading) at December 31, 2008 (after the adjusting entry for 2008 is made). (b) Prepare a schedule which shows the aggregate cost and fair values for Lopez's trading securities portfolio at 12/31/09. (c) Prepare the necessary adjusting entry based upon your analysis in (b) above.

Solution 14-124 (a)

Balance 12/31/06 (result of that year's adjusting entry) Deduct unrealized gain for 2007 Add: Unrealized loss for 2008 Balance at 12/31/08

(b)

Aggregate cost and fair value for trading securities at 12/31/09: AGH Common 10,000 shares DEL Preferred 2,000 shares Norton Common, 1,000 shares Pratt Bonds, 100 bonds Total

$(25,000) 10,000 (30,000) $(45,000)

Cost $300,000 210,000 41,000 115,000 $666,000

Fair Value $280,000 220,000 42,000 102,000 $644,000

14 - 34 Test Bank for Intermediate Accounting, Second Edition Solution 14-124 (cont.) (c)

Adjusting entry at 12/31/09: Securities Fair Value Adjustment (Trading) .................................. Unrealized Holding Gain or Loss—Income ....................... (Balance at 1/1/09 $45,000 Balance needed at 12/31/09 22,000 Recovery $23,000)

23,000 23,000

Pr. 14-125—Available-for-sale equity securities. During the course of your examination of the financial statements of Simpson Corporation for the year ended December 31, 2008, you found a new account, "Investments." Your examination revealed that during 2008, Simpson began a program of investments, and all investment-related transactions were entered in this account. Your analysis of this account for 2008 follows: Simpson Corporation Analysis of Investments For the Year Ended December 31, 2008 Date—2008

Debit

(a) Pinson Company Common Stock Feb. 14 Purchased 4,000 shares @ $55 per share. $220,000 July 26 Received 400 shares of Pinson Company common stock as a stock dividend. (Memorandum entry in general ledger.) Sept. 28 Sold the 400 shares of Pinson Company common stock received July 26 @ $70 per share.

Credit

$28,000

(b) Debit Apr. Oct.

Watts Inc., Common Stock 30 Purchased 20,000 shares @ $40 per share. 28 Received dividend of $1.20 per share.

Credit

$800,000

Additional information: 1. The fair value for each security as of the 2008 date of each transaction follow: Security Feb. 14 Apr. 30 July 26 Sept. 28 Pinson Co. $55 $62 $70 Watts Inc. $40 Simpson Corp. 25 28 30 33

$24,000

Dec. 31 $74 32 35

2. All of Simpson’s investments are nominal in respect to percentage of ownership (5% or less). 3. Each investment is considered by Simpson’s management to be available-for-sale. Instructions (1) Prepare any necessary correcting journal entries related to investments (a) and (b). (2) Prepare the entry, if necessary, to record the proper valuation of the available-for-sale equity security portfolio as of December 31, 2008.

Investments

14 - 35

Solution 14-125 (1) (a) Pinson — original purchase stock dividend total holding

4,000 shares 400 shares 4,400 shares

Total cost of $220,000 ÷ Total shares of 4,400 = $50 cost per share Sold 100 shares Correct entry: Cash (400 × $70)...................................................................... Available-for-Sale Securities ......................................... Gain on Sale of Securities.............................................

28,000

Entry made: Cash ......................................................................................... Available-for-Sale Securities .........................................

28,000

Correction: Available-for-Sale Securities..................................................... Gain on Sale of Securities.............................................

8,000

20,000 8,000

28,000

8,000

(b) Watts—should record cash dividend as dividend income. Correct entry: Cash ......................................................................................... Dividend Revenue.........................................................

24,000

Entry made: Cash ......................................................................................... Available-for-Sale Securities .........................................

24,000

Correction: Available-for-Sale Securities..................................................... Dividend Revenue......................................................... (To properly record dividends under fair value method)

24,000

24,000 24,000

(2) Valuation at End of Year:

Pinson Watts

Quantity 4,000 shares 20,000 shares

Cost $ 200,000 800,000 $1,000,000

Increase (Decrease) $ 96,000 (160,000) $ 64,000

Fair Value $296,000 640,000 $936,000

Year-end Adjustment: Securities Fair Value Adjustment (Available-for-Sale) .................... Unrealized Holding Gain or Loss—Equity ........................

64,000 64,000

CHAPTER 15 ACCOUNTING FOR INCOME TAXES TRUE-FALSE—Conceptual Answer

No.

Description

F F T T F T F T F F T F T T F T F T F T F F T T F F T T F F T T F F F

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35.

Taxable income. Use of pretax financial income. Taxable amounts. Deferred tax liability. Future tax effects on taxable income. Definition of a deferred tax liability. Identification of deferred tax expense. Objective of accounting for income taxes. Definition of a deferred tax asset. Deductible amounts. Deferred tax asset. Need for valuation allowance account. Positive and negative evidence. Information considered in determining valuation allowance account. Computation of income tax expense. Taxable temporary differences. Taxable temporary difference examples. Permanent differences. Definition of an originating temporary difference. Identification of a reversing difference. Definition of permanent difference. Effective tax rate vs. statutory rate. Computing deferred income taxes with new tax rate. Applying tax rates to temporary differences. Change in tax rates. Accounting for a loss carryback. Tax effect of a loss carryforward. Possible source of taxable income. Recognizing tax benefits of loss carryforwards. Recognizing tax loss carryforward in current year. Classifying deferred taxes on balance sheet. Classification of deferred tax assets and liabilities. Classification of deferred tax accounts. Method used for accounting for income taxes. Asset-liability approach of accounting for income taxes.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

b c a b

36. 37. 38. 39.

Differences between taxable and accounting income. Differences between taxable and accounting income. Determination of income tax expense. Determination of deferred tax expense.

15 - 2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

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

40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71.

Rationale for interperiod tax allocation. Causes of a deferred tax liability. Situation requiring interperiod tax allocation. Permanent differences and interperiod tax allocation. Permanent differences. Differences arising from depreciation methods. Temporary difference and a revenue item. Definition of a deferred tax liability. Effect of future taxable amount. Causes of a deferred tax liability. Distinction between temporary and permanent differences. Identification of deductible temporary difference. Identification of taxable temporary difference. Identification of future taxable amounts. Identify a permanent difference. Identification of permanent differences. Identification of temporary differences. Difference due to the equity method of investment accounting. Difference due to unrealized loss on marketable securities. Accelerated depreciation vs. straight-line depreciation Identification of permanent differences. Accounting for change in tax rate. Appropriate tax rate for deferred tax amounts. Recognition of tax benefit of a loss carryforward. Accounting for net operating losses. Reasons for disclosure of deferred income tax information. Classification of deferred income tax on the balance sheet. Classification of deferred income tax on the balance sheet. Basis for classification as current or noncurrent. Income statement presentation of a tax benefit from NOL carryforward. Classification of a deferred tax liability. Procedures for computing deferred income taxes.

MULTIPLE CHOICE—Computational Answer

No.

Description

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

72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84.

Computation of income tax payable. Computation of net income. Calculate current/noncurrent portions of deferred tax liability. Calculate income tax expense for the year. Calculate amount of deferred tax asset to be recognized. Calculate current deferred tax liability. Determine income taxes payable for the year. Calculate amount of deferred tax asset to be recognized. Calculate current/noncurrent portions of deferred tax liability. Calculate amount deducted for depreciation on the tax return. Calculate amount of deferred tax asset to be recognized. Calculate deferred tax asset with temporary and permanent differences. Entry for recording reduction in DTA.

Accounting for Income Taxes

15 - 3

MULTIPLE CHOICE—Computational (cont.) Answer

No.

Description

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

85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104.

Calculate deferred portion of income tax expense. Computation of total income tax expense. Calculate installment accounts receivable. Computation of pretax financial income. Calculate deferred tax liability amount. Calculate income tax expense for the year. Calculate income tax expense for the year. Computation of income tax expense. Computation of income tax expense. Computation of warranty claims paid. Computation of temporary differences. Computation of deferred tax liability amount. Computation of deferred tax liability increase. Determine change in deferred tax liability. Calculate deferred tax liability with changing tax rates. Calculate loss to be reported after NOL carryback. Calculate loss to be reported after NOL carryback. Calculate loss to be reported after NOL carryforward. Determine income tax refund following an NOL carryback. Calculate income tax benefit from an NOL carryback.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

a a c d d b a a c c

105. 106. 107. 108. 109. 110. 111. 112. 113. 114.

Determine current income tax liability. Determine current income tax liability. Deferred tax liability arising from depreciation methods. Deferred tax liability when using equity method of investment accounting. Calculate deferred tax liability and income taxes currently payable. Determine current income tax expense. Deferred income tax liability from temporary and permanent differences. Deferred tax liability arising from installment method. Differences arising from depreciation and warranty expenses. Deferred tax asset arising from warranty expenses.

EXERCISES Item E15-115 E15-116 E15-117 E15-118 E15-119 E15-120 E15-121 E15-122 E15-123

Description Computation of taxable income. Future taxable and deductible amounts (essay). Deferred income taxes. Deferred income taxes. Recognition of deferred tax asset. Permanent and temporary differences. Permanent and temporary differences. Temporary differences. Operating loss carryforward.

15 - 4

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Item P15-124 P15-125 P15-126 P15-127

Description Differences between accounting and taxable income and the effect on deferred taxes. Multiple temporary differences. Deferred tax asset. Interperiod tax allocation with change in enacted tax rates.

CHAPTER LEARNING OBJECTIVES 1.

Identify differences between pretax financial income and taxable income.

Describe a temporary difference that results in future taxable amounts.

Describe a temporary difference that results in future deductible amounts.

Explain the purpose of a deferred tax asset valuation allowance.

Describe the presentation of income tax expense in the income statement.

Describe various temporary and permanent differences.

Explain the effect of various tax rates and tax rate changes on deferred income taxes.

Apply accounting procedures for a loss carryback and a loss carryforward.

Describe the presentation of deferred income taxes in financial statements.

10.

Indicate the basic principles of the asset-liability method.

Accounting for Income Taxes

15 - 5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2.

TF TF

36. 37.

MC MC

38. 39.

3. 4. 5. 6.

TF TF TF TF

7. 40. 41. 42.

TF MC MC MC

43. 44. 45. 46.

8. 9. 10.

TF TF TF

11. 76. 79.

TF MC MC

81. 82. 83.

12.

13.

14.

15.

48.

85.

16. 17. 18. 19. 20.

TF TF TF TF TF

21. 49. 50. 51. 52.

TF MC MC MC MC

53. 54. 55. 56. 57.

22. 23.

TF TF

24. 25.

TF TF

61. 62.

26. 27.

TF TF

28. 29.

TF TF

30. 63.

31. 32. 33.

TF TF TF

65. 66. 67.

MC MC MC

68. 69. 70.

34.

35.

71.

Note:

TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 MC 72. MC 105. MC 73. MC 106. Learning Objective 2 MC 47. MC 107. MC 74. MC 108. MC 75. MC 116. MC 78. MC 117. Learning Objective 3 MC 116. E 119. MC 117. E 123. MC 118. E 124. Learning Objective 4 TF 84. MC Learning Objective 5 MC 86. MC 109. Learning Objective 6 MC 58. MC 89. MC 59. MC 90. MC 60. MC 91. MC 87. MC 92. MC 88. MC 93. Learning Objective 7 MC 97. MC 99. MC 98. MC 127. Learning Objective 8 TF 64. MC 101. MC 100. MC 102. Learning Objective 9 MC 77. MC 111. MC 80. MC 112. MC 110. MC 113. Learning Objective 10 MC E = Exercise P = Problem

Type

Item

Type

Item

Type

MC MC

115. 124.

E P

125. 126.

P P

MC MC E E

118. 124. 125. 126.

E P P P

E E P

125. 126.

P P

110.

123.

MC MC MC MC MC

94. 95. 96. 120. 121.

MC MC MC E E

122. 124. 126.

E P P

MC MC

103. 104.

MC MC

123.

MC MC MC

114. 126.

MC P

15 - 6

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual 1.

Taxable income is a tax accounting term and is also referred to as income before taxes.

Pretax financial income is the amount used to compute income tax payable.

Taxable amounts increase taxable income in future years.

A deferred tax liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year.

When the book amount of an asset or liability differs from the tax basis as a result of a temporary difference, the future tax effects on taxable income must be reported solely in the future financial statement that the difference affects.

A deferred tax liability is the amount of deferred tax consequences attributable to existing temporary differences that will result in net taxable amounts in future years.

Deferred tax expense is the decrease in the deferred tax liability balance from the beginning to the end of the accounting period.

An objective of accounting for income taxes is to recognize deferred tax liabilities and assets for the future tax consequences of events that have already been recognized in the financial statements.

A deferred tax asset represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year.

10.

Deductible amounts cause taxable income to be greater than pretax financial income in the future as a result of existing temporary differences.

11.

A deferred tax asset represents the increase in taxes refundable in future years as a result of deductible temporary differences existing at the end of the current year.

12.

A company reduces a deferred tax asset by a valuation allowance if it is probable that it will not realize some portion of the deferred tax asset.

13.

Companies should consider both positive and negative evidence to determine whether it needs to record a valuation allowance to reduce a deferred tax asset.

14.

All positive and negative information should be considered in determining whether a valuation allowance is needed.

15.

A company should add a decrease in a deferred tax liability to income tax payable in computing income tax expense.

16.

Taxable temporary differences will result in taxable amounts in future years when the related assets are recovered.

17.

Examples of taxable temporary differences are subscriptions received in advance and advance rental receipts.

Accounting for Income Taxes

15 - 7

18.

Permanent differences do not give rise to future taxable or deductible amounts.

19.

An originating temporary difference is the initial difference that occurs when the book basis of an asset exceeds, but is not exceeded by, the tax basis of a liability.

20.

A reversing difference occurs when a temporary difference that originated in prior periods is eliminated and the related tax effect is removed from the deferred tax account.

21.

A permanent difference results when the tax laws cause an item reported on the income statement to be different from that same item reported on the balance sheet.

22.

A corporation that has tax-free income has an effective tax rate that is less than the statutory (regular) tax rate.

23.

In computing deferred income taxes, a new tax rate should be used if (a) it is probable that a future tax rate change will occur, and (b) the rate is reasonably estimable.

24.

Companies must consider presently enacted changes in the tax rate that become effective in future years when determining the tax rate to apply to existing temporary differences.

25.

When a change in the tax rate is enacted, the effect is reported as an adjustment to income tax payable in the period of the change.

26.

Under the loss carryback approach, companies must apply a current year loss to the most recent year first and then to an earlier year.

27.

The tax effect of a loss carryforward represents future tax savings and results in the recognition of a deferred tax asset.

28.

A possible source of taxable income that may be available to realize a tax benefit for loss carryforwards is future reversals of existing taxable temporary differences.

29.

In general, the tax benefits of loss carryforwards should not be recognized in the loss year when the benefits arise, but rather in the year they are realized.

30.

The only way a tax loss carryforward can be recognized in the current year is when an entity has incurred net losses during the past three calendar years and has no ability to carry any of the loss back.

31.

In classifying deferred taxes on the balance sheet, an entity should net the current deferred tax asset and liability amount and net the noncurrent deferred tax asset and liability amount thus reporting only one current and one noncurrent deferred tax amount.

32.

An individual deferred tax asset or liability is classified as current or noncurrent based on the classification of the related asset/liability for financial reporting purposes.

33.

Companies should classify the balances in the deferred tax accounts on the balance sheet as noncurrent assets and noncurrent liabilities.

34.

The FASB believes that the deferred tax method is the most consistent method for accounting for income taxes.

15 - 8 35.

Test Bank for Intermediate Accounting, Second Edition The asset-liability approach to accounting for income taxes requires a journal entry at the end of each year which either increases an asset or decreases a liability.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6.

F F T T F T

7. 8. 9. 10. 11. 12.

F T F F T F

13. 14. 15. 16. 17. 18.

T T F T F T

19. 20. 21. 22. 23. 24.

F T F F T T

25. 26. 27. 28. 29. 30.

F F T T F F

31. 32. 33. 34. 35.

T T F F F

MULTIPLE CHOICE—Conceptual 36.

Taxable income of a corporation a. differs from accounting income due to differences in intraperiod allocation between the two methods of income determination. b. differs from accounting income due to differences in interperiod allocation and permanent differences between the two methods of income determination. c. is based on generally accepted accounting principles. d. is reported on the corporation's income statement.

Taxable income of a corporation differs from pretax financial income because of

a. b. c. d. 38.

Permanent Differences No No Yes Yes

Temporary Differences No Yes Yes No

Interperiod income tax allocation causes a. tax expense shown on the income statement to equal the amount of income taxes payable for the current year plus or minus the change in the deferred tax asset or liability balances for the year. b. tax expense shown in the income statement to bear a normal relation to the tax liability. c. tax liability shown in the balance sheet to bear a normal relation to the income before tax reported in the income statement. d. tax expense in the income statement to be presented with the specific revenues causing the tax.

Accounting for Income Taxes

15 - 9

39.

The deferred tax expense is the a. increase in balance of deferred tax asset minus the increase in balance of deferred tax liability. b. increase in balance of deferred tax liability minus the increase in balance of deferred tax asset. c. increase in balance of deferred tax asset plus the increase in balance of deferred tax liability. d. decrease in balance of deferred tax asset minus the increase in balance of deferred tax liability.

40.

The rationale for interperiod income tax allocation is to a. recognize a tax asset or liability for the tax consequences of temporary differences that exist at the balance sheet date. b. recognize a distribution of earnings to the taxing agency. c. reconcile the tax consequences of permanent and temporary differences appearing on the current year's financial statements. d. adjust income tax expense on the income statement to be in agreement with income taxes payable on the balance sheet.

41.

Interperiod tax allocation results in a deferred tax liability from a. an income item partially recognized for financial purposes but fully recognized for tax purposes in any one year. b. the amount of deferred tax consequences attributed to temporary differences that result in net deductible amounts in future years. c. an income item fully recognized for tax and financial purposes in any one year. d. the amount of deferred tax consequences attributed to temporary differences that result in net taxable amounts in future years.

42.

Which of the following situations would require interperiod income tax allocation procedures? a. An excess of percentage depletion over cost depletion b. Interest received on municipal bonds c. A temporary difference exists at the balance sheet date because the tax basis of an asset or liability and its reported amount in the financial statements differ d. Proceeds from a life insurance policy on an officer

43.

Interperiod income tax allocation procedures are appropriate when a. an extraordinary loss will cause the amount of income tax expense to be less than the tax on ordinary net income. b. an extraordinary gain will cause the amount of income tax expense to be greater than the tax on ordinary net income. c. differences between net income for tax purposes and financial reporting occur because tax laws and financial accounting principles do not concur on the items to be recognized as revenue and expense. d. differences between net income for tax purposes and financial reporting occur because, even though financial accounting principles and tax laws concur on the item to be recognized as revenues and expenses, they don't concur on the timing of the recognition.

15 - 10 Test Bank for Intermediate Accounting, Second Edition 44.

Interperiod tax allocation would not be required when a. costs are written off in the year of the expenditure for tax purposes but capitalized for accounting purposes. b. statutory (or percentage) depletion exceeds cost depletion for the period. c. different methods of revenue recognition arise for tax purposes and accounting purposes. d. different depreciable lives are used for machinery for tax and accounting purposes.

45.

Machinery was acquired at the beginning of the year. Depreciation recorded during the life of the machinery could result in Future Taxable Amounts Yes Yes No No

a. b. c. d.

Future Deductible Amounts Yes No Yes No

46.

A temporary difference arises when a revenue item is reported for tax purposes in a period After it is reported Before it is reported in financial income in financial income a. Yes Yes b. Yes No c. No Yes d. No No

47.

In terms of FASB Statement of Financial Accounting Concepts No. 6, a deferred tax liability Results from Is a Represents a Past Present Future Transaction Obligation Sacrifice a. Yes No Yes b. Yes Yes No c. Yes Yes Yes d. No No No

48. At the December 31, 2007 balance sheet date, Garth Brooks Corporation reports an accrued receivable for financial reporting purposes but not for tax purposes. When this asset is recovered in 2008, a future taxable amount will occur and a. pretax financial income will exceed taxable income in 2008. b. Garth will record a decrease in a deferred tax liability in 2008. c. total income tax expense for 2008 will exceed current tax expense for 2008. d. Garth will record an increase in a deferred tax asset in 2008. 49.

Assuming a 40% statutory tax rate applies to all years involved, which of the following situations will give rise to reporting a deferred tax liability on the balance sheet? I. II. III. IV.

A revenue is deferred for financial reporting purposes but not for tax purposes. A revenue is deferred for tax purposes but not for financial reporting purposes. An expense is deferred for financial reporting purposes but not for tax purposes. An expense is deferred for tax purposes but not for financial reporting purposes.

Accounting for Income Taxes a. b. c. d.

15 - 11

item II only items I and II only items II and III only items I and IV only

50.

A major distinction between temporary and permanent differences is a. permanent differences are not representative of acceptable accounting practice. b. temporary differences occur frequently, whereas permanent differences occur only once. c. once an item is determined to be a temporary difference, it maintains that status; however, a permanent difference can change in status with the passage of time. d. temporary differences reverse themselves in subsequent accounting periods, whereas permanent differences do not reverse.

51.

Which of the following are temporary differences that are normally classified as expenses or losses that are deductible after they are recognized in financial income? a. Advance rental receipts b. Product warranty liabilities c. Depreciable property d. Fines and expenses resulting from a violation of law

52.

Which of the following is a temporary difference classified as a revenue or gain that is taxable after it is recognized in financial income? a. Subscriptions received in advance. b. Prepaid royalty received in advance. c. An installment sale accounted for on the accrual basis for financial reporting purposes and on the installment (cash) basis for tax purposes. d. Interest received on a municipal obligation.

53.

Which of the following differences would result in future taxable amounts? a. Expenses or losses that are tax deductible after they are recognized in financial income. b. Revenues or gains that are taxable before they are recognized in financial income. c. Revenues or gains that are recognized in financial income but are never included in taxable income. d. Expenses or losses that are tax deductible before they are recognized in financial income.

54.

Renner Corporation's taxable income differed from its accounting income computed for this past year. An item that would create a permanent difference in accounting and taxable incomes for Renner would be a. a balance in the Unearned Rent account at year end. b. using accelerated depreciation for tax purposes and straight-line depreciation for book purposes. c. a fine resulting from violations of OSHA regulations. d. making installment sales during the year.

55.

An example of a permanent difference is a. proceeds from life insurance on officers. b. interest expense on money borrowed to invest in municipal bonds. c. insurance expense for a life insurance policy on officers. d. all of these.

15 - 12 Test Bank for Intermediate Accounting, Second Edition 56.

Which of the following will not result in a temporary difference? a. Product warranty liabilities b. Advance rental receipts c. Installment sales d. All of these will result in a temporary difference.

57.

A company uses the equity method to account for an investment. This would result in what type of difference and in what type of deferred income tax? a. b. c. d.

58.

Type of Difference Permanent Permanent Temporary Temporary

Deferred Tax Asset Liability Asset Liability

A company records an unrealized loss on short-term securities. This would result in what type of difference and in what type of deferred income tax? a. b. c. d.

Type of Difference Temporary Temporary Permanent Permanent

Deferred Tax Liability Asset Liability Asset

59.

The use of accelerated depreciation for tax purposes and straight-line depreciation for accounting purposes results in a. a larger amount of depreciation expense shown on the tax return than on the income statement, over the asset's useful life. b. the asset being fully depreciated for tax purposes in half the time it takes to become fully depreciated for accounting purposes. c. a larger amount of depreciation expense shown on the income statement than on the tax return in the last year of the asset's useful life. d. a loss on the sale of the asset in question if it is sold for its book value before its useful life expires.

60.

Which of the following is a permanent difference that is recognized for tax purposes but not for financial reporting purposes? a. The deduction for dividends received from U.S. corporations. b. Interest received on state and municipal bonds. c. Compensation expense associated with certain employee stock options. d. A litigation accrual.

61.

When a change in the tax rate is enacted into law, its effect on existing deferred income tax accounts should be a. handled retroactively in accordance with the guidance related to changes in accounting principles. b. considered, but it should only be recorded in the accounts if it reduces a deferred tax liability or increases a deferred tax asset. c. reported as an adjustment to tax expense in the period of change. d. applied to all temporary or permanent differences that arise prior to the date of the enactment of the tax rate change, but not subsequent to the date of the change.

Accounting for Income Taxes

15 - 13

62.

Tax rates other than the current tax rate may be used to calculate the deferred income tax amount on the balance sheet if a. it is probable that a future tax rate change will occur. b. it appears likely that a future tax rate will be greater than the current tax rate. c. the future tax rates have been enacted into law. d. it appears likely that a future tax rate will be less than the current tax rate.

63.

Recognition of tax benefits in the loss year due to a loss carryforward requires a. the establishment of a deferred tax liability. b. the establishment of a deferred tax asset. c. the establishment of an income tax refund receivable. d. only a note to the financial statements.

64.

A net operating loss occurs for tax purposes in a year when tax-deductible expenses exceed taxable revenues. Under certain circumstances the federal tax laws permit taxpayers to use the losses of one year to offset the profits of other years. For what period of time can net operating losses be offset against prior or future years' profits? a. b. c. d.

Loss Carryback 10 years 2 years 2 years 20 years

Loss Carryforward 10 years 20 years 10 years 3 years

65.

Major reasons for disclosure of deferred income tax information is (are) a. better assessment of quality of earnings. b. better predictions of future cash flows. c. that it may be helpful in setting government policy. d. all of these.

66.

Accounting for income taxes can result in the reporting of deferred taxes as any of the following except a. a current or long-term asset. b. a current or long-term liability. c. a contra-asset account. d. All of these are acceptable methods of reporting deferred taxes.

67.

Deferred taxes should be presented on the balance sheet a. as one net debit or credit amount. b. in two amounts: one for the net current amount and one for the net noncurrent amount. c. in two amounts: one for the net debit amount and one for the net credit amount. d. as reductions of the related asset or liability accounts.

68.

Deferred tax amounts that are related to specific assets or liabilities should be classified as current or noncurrent based on a. their expected reversal dates. b. their debit or credit balance. c. the length of time the deferred tax amounts will generate future tax deferral benefits. d. the classification of the related asset or liability.

15 - 14 Test Bank for Intermediate Accounting, Second Edition 69.

Tanner, Inc. incurred a financial and taxable loss for 2007. Tanner therefore decided to use the carryback provisions as it had been profitable up to this year. How should the amounts related to the carryback be reported in the 2007 financial statements? a. The reduction of the loss should be reported as a prior period adjustment. b. The refund claimed should be reported as a deferred charge and amortized over five years. c. The refund claimed should be reported as revenue in the current year. d. The refund claimed should be shown as a reduction of the loss in 2007.

70.

A deferred tax liability is classified on the balance sheet as either a current or a noncurrent liability. The current amount of a deferred tax liability should generally be a. the net deferred tax consequences of temporary differences that will result in net taxable amounts during the next year. b. totally eliminated from the financial statements if the amount is related to a noncurrent asset. c. based on the classification of the related asset or liability for financial reporting purposes. d. the total of all deferred tax consequences that are not expected to reverse in the operating period or one year, whichever is greater.

71.

All of the following are procedures for the computation of deferred income taxes except to a. identify the types and amounts of existing temporary differences. b. measure the total deferred tax liability for taxable temporary differences. c. measure the total deferred tax asset for deductible temporary differences and operating loss carrybacks. d. All of these are procedures in computing deferred income taxes.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

36. 37. 38. 39. 40. 41.

b c a b a d

42. 43. 44. 45. 46. 47.

c d b a a c

48. 49. 50. 51. 52. 53.

b c d b c d

54. 55. 56. 57. 58. 59.

c d d d b c

60. 61. 62. 63. 64. 65.

a c c b b d

66. 67. 68. 69. 70. 71.

c b d d c c

MULTIPLE CHOICE—Computational 72.

In 2008, Delaney Company had revenues of $180,000 for book purposes and $150,000 for tax purposes. Delaney also had expenses of $100,000 for both book and tax purposes. If Delaney has a 35% tax rate, what is Delaney's income tax payable for 2008? a. $10,500 b. $17,500 c. $28,000 d. $35,000

Accounting for Income Taxes

15 - 15

73.

Maureen Corporation reports income before taxes of $500,000 in its income statement, but because of temporary differences taxable income is only $200,000. If the tax rate is 45%, what amount of net income should the corporation report? a. $337,500 b. $275,000 c. $225,000 d. $90,000

74.

Smiley Corporation purchased a machine on January 2, 2007, for $2,000,000. The machine has an estimated 5-year life with no salvage value. The straight-line method of depreciation is being used for financial statement purposes and the following MACRS amounts will be deducted for tax purposes: 2007 2008 2009

$400,000 640,000 384,000

2010 2011 2012

$230,000 230,000 116,000

Assuming an income tax rate of 30% for all years, the net deferred tax liability that should be reflected on Smiley's balance sheet at December 31, 2008, should be

a. b. c. d.

Deferred Tax Liability Current Noncurrent $0 $72,000 $4,800 $67,200 $67,200 $4,800 $72,000 $0

Use the following information for questions 75 through 77. Hefner Co. at the end of 2008, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 500,000 Estimated litigation expense 1,250,000 Installment sales (1,000,000) Taxable income $ 750,000 The estimated litigation expense of $1,250,000 will be deductible in 2010 when it is expected to be paid. The gross profit from the installment sales will be realized in the amount of $500,000 in each of the next two years. The estimated liability for litigation is classified as noncurrent and the installment accounts receivable are classified as $500,000 current and $500,000 noncurrent. The income tax rate is 30% for all years. 75.

The income tax expense is a. $150,000. b. $225,000. c. $250,000. d. $500,000.

76.

The deferred tax asset to be recognized is a. $0. b. $75,000 current. c. $375,000 current. d. $375,000 noncurrent.

15 - 16 Test Bank for Intermediate Accounting, Second Edition 77.

The deferred tax liability—current to be recognized is a. $75,000. b. $225,000. c. $150,000. d. $300,000.

Use the following information for questions 78 through 80. Frizell Co. at the end of 2007, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income Estimated litigation expense Extra depreciation for taxes Taxable income

$ 750,000 1,000,000 (1,500,000) $ 250,000

The estimated litigation expense of $1,000,000 will be deductible in 2008 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $500,000 in each of the next three years. The income tax rate is 30% for all years. 78.

Income tax payable is a. $0. b. $75,000. c. $150,000. d. $225,000.

79.

The deferred tax asset to be recognized is a. $75,000 current. b. $150,000 current. c. $225,000 current. d. $300,000 current.

80.

The deferred tax liability to be recognized is Current Noncurrent a. $150,000 $300,000 b. $150,000 $225,000 c. $0 $450,000 d. $0 $375,000

81.

Markes Corporation's partial income statement after its first year of operations is as follows: Income before income taxes Income tax expense Current Deferred Net income

$3,750,000 $1,035,000 90,000

1,125,000 $2,625,000

Markes uses the straight-line method of depreciation for financial reporting purposes and accelerated depreciation for tax purposes. The amount charged to depreciation expense on its books this year was $1,500,000. No other differences existed between book income and taxable income except for the amount of depreciation. Assuming a 30% tax rate, what amount was deducted for depreciation on the corporation's tax return for the current year?

Accounting for Income Taxes a. b. c. d. 82.

15 - 17

$1,200,000 $1,425,000 $1,500,000 $1,800,000

Dwyer Company reported the following results for the year ended December 31, 2008, its first year of operations: 2008 Income (per books before income taxes) $ 750,000 Taxable income 1,200,000 The disparity between book income and taxable income is attributable to a temporary difference which will reverse in 2009. What should Dwyer record as a net deferred tax asset or liability for the year ended December 31, 2008, assuming that the enacted tax rates in effect are 40% in 2008 and 35% in 2009? a. $180,000 deferred tax liability b. $157,500 deferred tax asset c. $180,000 deferred tax asset d. $157,500 deferred tax liability

83.

In 2008, Admire Company accrued, for financial statement reporting, estimated losses on disposal of unused plant facilities of $1,500,000. The facilities were sold in March 2009 and a $1,500,000 loss was recognized for tax purposes. Also in 2008, Admire paid $100,000 in premiums for a two-year life insurance policy in which the company was the beneficiary. Assuming that the enacted tax rate is 30% in both 2008 and 2009, and that Admire paid $780,000 in income taxes in 2008, the amount reported as net deferred income taxes on Admire's balance sheet at December 31, 2008, should be a a. $420,000 asset. b. $360,000 asset. c. $360,000 liability. d. $450,000 asset.

84.

Gleim Inc. has a deductible temporary difference of $100,000 at the end of its first year of operations. Its tax rate is 40%. Income taxes payable are $90,000. Gleim properly recorded a deferred tax asset. Later, after careful review of all available evidence, it is determined that it is more likely than not that $15,000 of the deferred tax asset will not be realized. What entry should Gleim make to record the reduction in asset value? a. Income Tax Expense .......................................................... 15,000 Deferred Tax Asset ................................................. 15,000 b. Income Tax Payable ........................................................... 15,000 Income Tax Expense .............................................. 15,000 c. Allowance to Reduce Deferred Tax Asset to Expected Realizable Value .............................................. 15,000 Income Tax Expense .............................................. 15,000 d. Income Tax Expense .......................................................... 15,000 Allowance to Reduce Deferred Tax Asset to Expected Realizable Value................................... 15,000

15 - 18 Test Bank for Intermediate Accounting, Second Edition Use the following information for questions 85 and 86. O’Malley Corporation prepared the following reconciliation for its first year of operations: Pretax financial income for 2008 Tax exempt interest Originating temporary difference Taxable income

$ 900,000 (75,000) (225,000) $600,000

The temporary difference will reverse evenly over the next two years at an enacted tax rate of 40%. The enacted tax rate for 2008 is 35%. 85.

What amount should be reported in its 2008 income statement as the deferred portion of the provision for income taxes? a. $90,000 debit b. $120,000 debit c. $90,000 credit d. $105,000 credit

86.

In O’Malley’s 2008 income statement, what amount should be reported for total income tax expense? a. $330,000 b. $315,000 c. $300,000 d. $210,000

87.

Jesse Company sells household furniture. Customers who purchase furniture on the installment basis make payments in equal monthly installments over a two-year period, with no down payment required. Jesse's gross profit on installment sales equals 40% of the selling price of the furniture. For financial accounting purposes, sales revenue is recognized at the time the sale is made. For income tax purposes, however, the installment method is used. There are no other book and income tax accounting differences, and Jesse's income tax rate is 30%. If Jesse's December 31, 2008, balance sheet includes a deferred tax liability of $300,000 arising from the difference between book and tax treatment of the installment sales, it should also include installment accounts receivable of a. $2,500,000. b. $1,000,000. c. $750,000. d. $300,000.

88.

Cromwell Company has the following cumulative taxable temporary differences: 12/31/08 $1,350,000

12/31/07 $960,000

The tax rate enacted for 2008 is 40%, while the tax rate enacted for future years is 30%. Taxable income for 2008 is $2,400,000 and there are no permanent differences. Cromwell's pretax financial income for 2008 is a. $3,750,000. b. $2,790,000. c. $2,010,000. d. $1,050,000.

Accounting for Income Taxes

15 - 19

Use the following information for questions 89 through 91. McGee Company deducts insurance expense of $84,000 for tax purposes in 2008, but the expense is not yet recognized for accounting purposes. In 2009, 2010, and 2011, no insurance expense will be deducted for tax purposes, but $28,000 of insurance expense will be reported for accounting purposes in each of these years. McGee Company has a tax rate of 40% and income taxes payable of $72,000 at the end of 2008. There were no deferred taxes at the beginning of 2008. 89.

What is the amount of the deferred tax liability at the end of 2008? a. $33,600 b. $28,800 c. $12,000 d. $0

90.

What is the amount of income tax expense for 2008? a. $105,600 b. $100,800 c. $84,000 d. $72,000

91.

Assuming that income tax payable for 2009 is $96,000, the income tax expense for 2009 would be what amount? a. $129,600 b. $107,200 c. $96,000 d. $84,800

Use the following information for questions 92 and 93. Tyler Company made the following journal entry in late 2008 for rent on property it leases to Danford Corporation. Cash

60,000 Unearned Rent

60,000

The payment represents rent for the years 2009 and 2010, the period covered by the lease. Tyler Company is a cash basis taxpayer. Tyler has income tax payable of $92,000 at the end of 2008, and its tax rate is 35%. 92.

What amount of income tax expense should Tyler Company report at the end of 2008? a. $53,000 b. $71,000 c. $81,500 d. $113,000

93.

Assuming the taxes payable at the end of 2009 is $102,000, what amount of income tax expense would Tyler Company record for 2009? a. $81,000 b. $91,500 c. $112,500 d. $123,000

15 - 20 Test Bank for Intermediate Accounting, Second Edition 94.

The following information is available for Nielsen Company after its first year of operations: Income before taxes Federal income tax payable Deferred income tax Income tax expense Net income

$250,000 $104,000 (4,000) 100,000 $150,000

Nielsen estimates its annual warranty expense as a percentage of sales. The amount charged to warranty expense on its books was $95,000. Assuming a 40% income tax rate, what amount was actually paid this year for warranty claims? a. $105,000 b. $100,000 c. $95,000 d. $85,000 95.

Kubitz Company reported the following items on its income statement for the year ended December 31, 2008. Interest received on municipal bonds Fines from a violation of law

$16,000 11,000

For Kubitz Company the amount of temporary differences used to measure deferred income taxes amount to a. $0. b. $11,000. c. $16,000. d. $27,000. 96.

Nolan Company sells its product on an installment basis, earning a $450 pretax gross profit on each installment sale. For accounting purposes the entire $450 is recognized in the year of sale, but for income tax purposes the installment method of accounting is used. Assume Nolan makes one sale in 2007, another sale in 2008, and a third sale in 2009. In each case, one-third of the gross sales price is collected in the year of sale, onethird in the next year, and the final installment in the third year. If the tax rate is 50%, what amount of deferred tax liability should Nolan Company show on its December 31, 2009 balance sheet? a. $150 b. $225 c. $300 d. $450

97.

Fesmire Co. had a deferred tax liability balance due to a temporary difference at the beginning of 2007 related to $200,000 of excess depreciation. In December of 2007, a new income tax act is signed into law that raises the corporate rate from 35% to 40%, effective January 1, 2009. If taxable amounts related to the temporary difference are scheduled to be reversed by $100,000 for both 2008 and 2009, Fesmire should increase or decrease deferred tax liability by what amount? a. Decrease by $10,000 b. Decrease by $5,000 c. Increase by $5,000 d. Increase by $10,000

Accounting for Income Taxes

15 - 21

98.

Meyers Co. had a deferred tax liability balance due to a temporary difference at the beginning of 2007 related to $600,000 of excess depreciation. In December of 2007, a new income tax act is signed into law that lowers the corporate rate from 40% to 35%, effective January 1, 2009. If taxable amounts related to the temporary difference are scheduled to be reversed by $300,000 for both 2008 and 2009, Meyers should increase or decrease deferred tax liability by what amount? a. Decrease by $30,000 b. Decrease by $15,000 c. Increase by $15,000 d. Increase by $30,000

99.

A reconciliation of Reaker Company's pretax accounting income with its taxable income for 2008, its first year of operations, is as follows: Pretax accounting income Excess tax depreciation Taxable income

$3,000,000 (90,000) $2,910,000

The excess tax depreciation will result in equal net taxable amounts in each of the next three years. Enacted tax rates are 40% in 2008, 35% in 2009 and 2010, and 30% in 2011. The total deferred tax liability to be reported on Reaker's balance sheet at December 31, 2008, is a. $36,000. b. $30,000. c. $31,500. d. $27,000. 100.

Mast, Inc. reports a taxable and financial loss of $650,000 for 2009. Its pretax financial income for the last two years was as follows: 2007 2008

$300,000 400,000

The amount that Mast, Inc. reports as a net loss for financial reporting purposes in 2009, assuming that it uses the carryback provisions, and that the tax rate is 30% for all periods affected, is a. $650,000 loss. b. $0. c. $195,000 loss. d. $455,000 loss. Use the following information for questions 101 and 102. Neasha Corporation reported the following results for its first three years of operation: 2007 income (before income taxes) 2008 loss (before income taxes) 2009 income (before income taxes)

$ 100,000 (900,000) 1,000,000

There were no permanent or temporary differences during these three years. Assume a corporate tax rate of 30% for 2007 and 2008, and 40% for 2009.

15 - 22 Test Bank for Intermediate Accounting, Second Edition 101.

Assuming that Neasha elects to use the carryback provision, what income (loss) is reported in 2008? (Assume that any deferred tax asset recognized is more likely than not to be realized.) a. $(900,000) b. $0 c. $(870,000) d. $(550,000)

102.

Assuming that Neasha elects to use the carryforward provision and not the carryback provision, what income (loss) is reported in 2008? a. $(900,000) b. $(540,000) c. $0 d. $(870,000)

103.

Peck Co. reports a taxable and pretax financial loss of $400,000 for 2009. Peck's taxable and pretax financial income and tax rates for the last two years were: 2007 2008

$400,000 400,000

30% 35%

The amount that Peck should report as an income tax refund receivable in 2009, assuming that it uses the carryback provisions and that the tax rate is 40% in 2009, is a. $120,000. b. $140,000. c. $160,000. d. $180,000. 104.

Bennington Corporation began operations in 2004. There have been no permanent or temporary differences to account for since the inception of the business. The following data are available: Year Enacted Tax Rate Taxable Income Taxes Paid 2006 45% $750,000 $337,500 2007 40% 900,000 360,000 2008 35% 2009 30% In 2008, Bennington had an operating loss of $930,000. What amount of income tax benefits should be reported on the 2008 income statement due to this loss? a. $409,500 b. $373,500 c. $372,000 d. $279,000

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

72. 73. 74. 75. 76.

b b a a d

77. 78. 79. 80. 81.

c b d c d

82. 83. 84. 85. 86.

b d d a c

87. 88. 89. 90. 91.

a b a a d

92. 93. 94. 95. 96.

b c d a b

97. 98. 99. 100. 101.

c b b d d

102. 103. 104.

b a a

Accounting for Income Taxes

15 - 23

MULTIPLE CHOICE—CPA Adapted 105.

Ramos Corp.'s books showed pretax financial income of $1,500,000 for the year ended December 31, 2008. In the computation of federal income taxes, the following data were considered: Gain on an involuntary conversion $650,000 (Ramos has elected to replace the property within the statutory period using total proceeds.) Depreciation deducted for tax purposes in excess of depreciation deducted for book purposes 100,000 Federal estimated tax payments, 2008 125,000 Enacted federal tax rate, 2008 30% What amount should Ramos report as its current federal income tax liability on its December 31, 2008 balance sheet? a. $100,000 b. $130,000 c. $225,000 d. $255,000

106.

Eddy Corp.'s 2008 income statement showed pretax accounting income of $750,000. To compute the federal income tax liability, the following 2008 data are provided: Income from exempt municipal bonds $ 30,000 Depreciation deducted for tax purposes in excess of depreciation deducted for financial statement purposes 60,000 Estimated federal income tax payments made 150,000 Enacted corporate income tax rate 30% What amount of current federal income tax liability should be included in Eddy's December 31, 2008 balance sheet? a. $48,000 b. $66,000 c. $75,000 d. $198,000

107.

On January 1, 2008, Lebo, Inc. purchased a machine for $720,000 which will be depreciated $72,000 per year for financial statement reporting purposes. For income tax reporting, Lebo elected to expense $80,000 and to use straight-line depreciation which will allow a cost recovery deduction of $64,000 for 2008. Assume a present and future enacted income tax rate of 30%. What amount should be added to Lebo's deferred income tax liability for this temporary difference at December 31, 2008? a. $43,200 b. $24,000 c. $21,600 d. $19,200

15 - 24 Test Bank for Intermediate Accounting, Second Edition 108.

On January 1, 2008, Magee Corp. purchased 40% of the voting common stock of Reed, Inc. and appropriately accounts for its investment by the equity method. During 2008, Reed reported earnings of $360,000 and paid dividends of $120,000. Magee assumes that all of Reed's undistributed earnings will be distributed as dividends in future periods when the enacted tax rate will be 30%. Ignore the dividend-received deduction. Magee's current enacted income tax rate is 25%. The increase in Magee's deferred income tax liability for this temporary difference is a. $72,000. b. $60,000. c. $43,200. d. $28,800.

109.

Brock Corp.'s 2008 income statement had pretax financial income of $250,000 in its first year of operations. Brock uses an accelerated cost recovery method on its tax return and straight-line depreciation for financial reporting. The differences between the book and tax deductions for depreciation over the five-year life of the assets acquired in 2008, and the enacted tax rates for 2008 to 2012 are as follows: 2008 2009 2010 2011 2012

Book Over (Under) Tax $(50,000) (65,000) (15,000) 60,000 70,000

Tax Rates 35% 30% 30% 30% 30%

There are no other temporary differences. In Brock's December 31, 2008 balance sheet, the noncurrent deferred income tax liability and the income taxes currently payable should be Noncurrent Deferred Income Taxes Income Tax Liability Currently Payable a. $39,000 $50,000 b. $39,000 $70,000 c. $15,000 $60,000 d. $15,000 $70,000 110.

Foyle Corp. prepared the following reconciliation of income per books with income per tax return for the year ended December 31, 2008: Book income before income taxes $1,200,000 Add temporary difference Construction contract revenue which will reverse in 2009 160,000 Deduct temporary difference Depreciation expense which will reverse in equal amounts in each of the next four years (640,000) Taxable income $720,000 Foyle's effective income tax rate is 34% for 2008. What amount should Foyle report in its 2008 income statement as the current provision for income taxes? a. $54,400 b. $244,800 c. $408,000 d. $462,400

Accounting for Income Taxes

15 - 25

111.

In its 2007 income statement, Hertz Corp. reported depreciation of $1,110,000 and interest revenue on municipal obligations of $210,000. Hertz reported depreciation of $1,650,000 on its 2007 income tax return. The difference in depreciation is the only temporary difference, and it will reverse equally over the next three years. Hertz's enacted income tax rates are 35% for 2007, 30% for 2008, and 25% for 2009 and 2010. What amount should be included in the deferred income tax liability in Hertz's December 31, 2007 balance sheet? a. $144,000 b. $186,000 c. $225,000 d. $262,500

112.

Karr, Inc. uses the accrual method of accounting for financial reporting purposes and appropriately uses the installment method of accounting for income tax purposes. Installment income of $900,000 will be collected in the following years when the enacted tax rates are: Collection of Income Enacted Tax Rates 2007 $ 90,000 35% 2008 180,000 30% 2009 270,000 30% 2010 360,000 25% The installment income is Karr's only temporary difference. What amount should be included in the deferred income tax liability in Karr's December 31, 2007 balance sheet? a. $225,000 b. $256,500 c. $283,500 d. $315,000

113.

For calendar year 2007, Neer Corp. reported depreciation of $1,200,000 in its income statement. On its 2007 income tax return, Neer reported depreciation of $1,800,000. Neer's income statement also included $225,000 accrued warranty expense that will be deducted for tax purposes when paid. Neer's enacted tax rates are 30% for 2007 and 2008, and 24% for 2009 and 2010. The depreciation difference and warranty expense will reverse over the next three years as follows: Depreciation Difference Warranty Expense 2008 $240,000 $ 45,000 2009 210,000 75,000 2010 150,000 105,000 $600,000 $225,000 These were Neer's only temporary differences. In Neer's 2007 income statement, the deferred portion of its provision for income taxes should be a. $200,700. b. $112,500. c. $101,700. d. $109,800.

15 - 26 Test Bank for Intermediate Accounting, Second Edition 114.

Nevitt Co., organized on January 2, 2007, had pretax accounting income of $880,000 and taxable income of $1,600,000 for the year ended December 31, 2007. The only temporary difference is accrued product warranty costs which are expected to be paid as follows: 2008 2009 2010 2011

$240,000 120,000 120,000 240,000

The enacted income tax rates are 35% for 2007, 30% for 2008 through 2010, and 25% for 2011. If Nevitt expects taxable income in future years, the deferred tax asset in Nevitt's December 31, 2007 balance sheet should be a. $144,000. b. $168,000. c. $204,000. d. $252,000.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

105. 106.

a a

107. 108.

c d

109. 110.

d b

111. 112.

a a

113. 114.

c c

DERIVATIONS — Computational No.

Answer Derivation

72.

($150,000 – $100,000) × 35% = $17,500.

73.

$500,000 – ($500,000 × 45%) = $275,000.

74.

($640,000 – $400,000) × 30% = $72,000.

75.

Income tax payable = ($750,000 × 30%) = $225,000 Change in deferred tax liability = ($1,000,000 × 30%) = $300,000 Change in deferred tax asset = ($1,250,000 × 30%) = $375,000 $225,000 + $300,000 – $375,000 = $150,000.

76.

($1,250,000 × 30%) = $375,000.

77.

($500,000 × 30%) = $150,000.

78.

($250,000 × 30%) = $75,000.

79.

($1,000,000 × 30%) = $300,000.

80.

($1,500,000 × 30%) = $450,000.

81.

(30% × Temporary Difference) = $90,000; Temporary Difference = ($90,000 ÷ 30%) = $300,000; $1,500,000 + $300,000 = $1,800,000.

Accounting for Income Taxes

DERIVATIONS — Computational (cont.) No.

Answer Derivation

82.

($1,200,000 – $750,000) × 35% = $157,500.

83.

($1,500,000 × 30%) = $450,000.

84.

Asset value reduced by Allowance account.

85.

$225,000 × .40 = $90,000 debit.

86.

($600,000 × .35) + ($225,000 × .40) = $300,000.

87.

$300,000 ÷ 30% = $1,000,000 temporary difference $1,000,000 ÷ 40% = $2,500,000.

88.

$2,400,000 + ($1,350,000 – $960,000) = $2,790,000.

89.

$84,000 × .40 = $33,600.

90.

$72,000 + ($84,000 × .40) = $105,600.

91.

$96,000 – ($28,000 × .40) = $84,800.

92.

$92,000 – ($60,000 × .35) = $71,000.

93.

$102,000 + ($30,000 × .35) = $112,500.

94.

$95,000 – ($4,000 ÷ .40) = $85,000.

95.

Neither item is a temporary difference.

96.

[($450 × 3) – ($150 + $300 + $450)] × 50% = $225.

97.

(40% – 35%) × $100,000 = $5,000.

98.

$300,000 × (.35 – .40) = $15,000 decrease.

99.

($30,000 × 35%) + ($30,000 × 35%) + ($30,000 × 30%) = $30,000.

100.

$650,000 – (30% × $650,000) = $455,000.

101.

($100,000 × 30%) = $30,000; $800,000 × 40% = $320,000; ($900,000 – $30,000 – $320,000) = $550,000.

102.

($900,000 × 40%) = $360,000; $900,000 – $360,000 = $540,000.

103.

($400,000 × 30%) = $120,000.

104.

($750,000 × .45) + [($930,000 – $750,000) × .40] = $409,500.

15 - 27

15 - 28 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — CPA Adapted No.

Answer Derivation

105.

($1,500,000 – $650,000 – $100,000) × 30% = $225,000; $225,000 – $125,000 = $100,000.

106.

($750,000 – $30,000 – $60,000) × 30% = $198,000; $198,000 – $150,000 = $48,000.

107.

($80,000 + $64,000 – $72,000) × 30% = $21,600.

108.

($360,000 – $120,000) × 40% = $96,000; $96,000 × 30% = $28,800.

109.

($50,000 × 30%) = $15,000; ($250,000 – $50,000) × 35% = $70,000.

110.

($720,000 × 34%) = $244,800.

111.

($180,000 × 30%) + ($180,000 × 25%) + ($180,000 × 25%) = $144,000.

112.

($180,000 × 30%) + ($270,000 × 30%) + ($360,000 × 25%) = $225,000.

113.

($240,000 – $45,000) × 30% = $58,500; ($210,000 – $75,000) × 24% = $32,400; ($150,000 – $105,000) × 24% = $10,800; $58,500 + $32,400 + $10,800 = $101,700.

114.

($240,000 + $120,000 + $120,000) × 30% = $144,000; $240,000 × 25% = $60,000; $144,000 + $60,000 = $204,000.

EXERCISES Ex. 15-115—Computation of taxable income. The records for Orkin Co. show this data for 2008: •

Gross profit on installment sales recorded on the books was $360,000. Gross profit from collections of installment receivables was $270,000.

•

Life insurance on officers was $3,800.

•

Machinery was acquired in January for $300,000. Straight-line depreciation over a ten-year life (no salvage value) is used. For tax purposes, MACRS depreciation is used and Orkin may deduct 14% for 2008.

•

Interest received on tax exempt Iowa State bonds was $9,000.

•

The estimated warranty liability related to 2008 sales was $19,600. Repair costs under warranties during 2008 were $13,600. The remainder will be incurred in 2009.

•

Pretax financial income is $600,000. The tax rate is 30%.

Accounting for Income Taxes

15 - 29

Ex. 15-115 (cont.) Instructions (a) Prepare a schedule starting with pretax financial income and compute taxable income. (b) Prepare the journal entry to record income taxes for 2008.

Solution 15-115 (a)

(b)

Pretax financial income Permanent differences Life insurance Tax-exempt interest Temporary differences Installment sales ($360,000 – $270,000) Extra depreciation ($42,000 – $30,000) Warranties ($19,600 – $13,600) Taxable income

$600,000 3,800 (9,000) (90,000) (12,000) 6,000 $498,800

Income Tax Expense [$149,640 + ($30,600 – $1,800)] ............... Deferred Tax Asset (30% × $6,000) ............................................ Deferred Tax Liability (30% × $102,000) .......................... Income Tax Payable (30% × $498,800) ...........................

178,440 1,800 30,600 149,640

Ex. 15-116—Future taxable and deductible amounts. Define temporary differences, future taxable amounts, and future deductible amounts.

Solution 15-116 Temporary differences are differences between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable amounts or deductible amounts in future years. Future taxable amounts increase taxable income in future years and cause a deferred tax liability to be recorded. Future deductible amounts decrease taxable income in future years and cause a deferred tax asset to be recorded.

Ex. 15-117—Deferred income taxes. Nott Co. at the end of 2008, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income Extra depreciation taken for tax purposes Estimated expenses deductible for taxes when paid Taxable income

$ 420,000 (1,050,000) 840,000 $ 210,000

15 - 30 Test Bank for Intermediate Accounting, Second Edition Ex. 15-117 (cont.) Use of the depreciable assets will result in taxable amounts of $350,000 in each of the next three years. The estimated litigation expenses of $840,000 will be deductible in 2011 when settlement is expected. Instructions (a) Prepare a schedule of future taxable and deductible amounts. (b) Prepare the journal entry to record income tax expense, deferred taxes, and income taxes payable for 2008, assuming a tax rate of 40% for all years.

Solution 15-117 (a) Future taxable (deductible) amounts Extra depreciation Litigation (b)

2009

2010

$350,000

Income Tax Expense ($84,000 + $420,000 – $336,000) ............. Deferred Tax Asset ($840,000 × 40%) ........................................ Deferred Tax Liability ($1,050,000 × 40%) ...................... Income Tax Payable ($210,000 × 40%) ..........................

2011

Total

$350,000 $1,050,000 (840,000) (840,000) 168,000 336,000 420,000 84,000

Ex. 15-118—Deferred income taxes. Earl Co. at the end of 2008, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 750,000 Estimated expenses deductible for taxes when paid 1,200,000 Extra depreciation (1,350,000) Taxable income $ 600,000 Estimated warranty expense of $800,000 will be deductible in 2009, $300,000 in 2010, and $100,000 in 2011. The use of the depreciable assets will result in taxable amounts of $450,000 in each of the next three years. Instructions (a) Prepare a table of future taxable and deductible amounts. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2008, assuming an income tax rate of 40% for all years.

Solution 15-118 (a)

2009 Future taxable (deductible) amounts Warranties $(800,000) Excess depreciation 450,000

2010

2011

Total

$(300,000) $(100,000) $(1,200,000) 450,000 450,000 1,350,000

Accounting for Income Taxes

15 - 31

Solution 15-118 (cont.) (b)

Income Tax Expense [$240,000 + ($540,000 – $480,000)] ......... Deferred Tax Asset ($1,200,000 × 40%) ..................................... Deferred Tax Liability ($1,350,000 × 40%) ...................... Income Tax Payable ($600,000 × 40%) ..........................

300,000 480,000 540,000 240,000

Ex. 15-119—Recognition of deferred tax asset. (a) (b)

Describe a deferred tax asset. When should a deferred tax asset be reduced by a valuation allowance?

Solution 15-119 (a)

A deferred tax asset is the deferred tax consequences attributable to deductible temporary differences and operating loss carryforwards.

(b)

A deferred tax asset should be reduced by a valuation allowance if, based on all available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. More likely than not means a level of likelihood that is at least slightly more than 50%.

Ex. 15-120—Permanent and temporary differences. Listed below are items that are treated differently for accounting purposes than they are for tax purposes. Indicate whether the items are permanent differences or temporary differences. For temporary differences, indicate whether they will create deferred tax assets or deferred tax liabilities. 1.

Investments accounted for by the equity method.

Advance rental receipts.

Fine for polluting.

Estimated future warranty costs.

Excess of contributions over pension expense.

Expenses incurred in obtaining tax-exempt revenue.

Installment sales.

Excess tax depreciation over accounting depreciation.

Long-term construction contracts.

10.

Premiums paid on life insurance of officers (company is the beneficiary).

15 - 32 Test Bank for Intermediate Accounting, Second Edition Solution 15-120 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Temporary difference, deferred tax liability. Temporary difference, deferred tax asset. Permanent difference. Temporary difference, deferred tax asset. Temporary difference, deferred tax liability. Permanent difference. Temporary difference, deferred tax liability. Temporary difference, deferred tax liability. Temporary difference, deferred tax liability. Permanent difference.

Ex. 15-121—Permanent and temporary differences. Indicate and explain whether each of the following independent situations should be treated as a temporary difference or a permanent difference. (a)

For accounting purposes, a company reports revenue from installment sales on the accrual basis. For income tax purposes, it reports the revenues by the installment method, deferring recognition of gross profit until cash is collected.

(b)

Pretax accounting income and taxable income differ because 80% of dividends received from U.S. corporations was deducted from taxable income, while 100% of the dividends received was reported for financial statement purposes.

(c)

Estimated warranty costs (covering a three-year warranty) are expensed for accounting purposes at the time of sale but deducted for income tax purposes when paid.

Solution 15-121 (a)

(b)

(c)

Temporary difference. This difference in the timing of revenue recognition for pretax financial income and taxable income will initially increase pretax financial income, but will increase taxable income by the amount of deferred gross profits as cash is collected in subsequent years. Assuming the estimate as to collectibility of installment receivables is valid, the total amounts reported as gross profits for accounting purposes and for tax purposes will be equal over the life of a group of installment receivables. The time lag between the accrual for accounting purposes and the recognition for tax purposes will result in credit entries to a company's deferred tax liability as long as installment sales are level or increasing. The credit entries related to particular installment receivables will be "drawn down," or reversed, however, when the receivables are collected. Permanent difference. This difference in pretax financial income and taxable income will never reverse because present tax laws allow a company that owns stock in another U.S. corporation to deduct 80% of the dividends it receives from that company. Taxes will not be paid on the dividends deducted and there are no tax consequences for those dividends, even though they are recognized as income for book purposes. Temporary difference. The full estimated three years of warranty expenses reduce the current year's pretax financial income, but will reduce taxable income in varying amounts each year as paid. Assuming the estimate for each warranty is valid, the total amounts deducted for accounting and for tax purposes will be equal over the three-year period for each warranty. This is an example of an expense that, in the first period, reduces pretax financial income more than taxable income and, in later years, reverses and reduces taxable income without affecting pretax financial income.

Accounting for Income Taxes

15 - 33

Ex. 15-122—Temporary differences. There are four types of temporary differences. For each type: (1) indicate the cause of the difference, (2) give an example, and (3) indicate whether it will create a taxable or deductible amount in the future.

Solution 15-122 (a)

Revenues or gains are taxable after they are recognized in pretax financial income. Examples are installment sales, long-term construction contracts, and the equity method of accounting for investments. They result in future taxable amounts.

(b)

Revenues or gains are taxable before they are recognized in pretax financial income. Examples are subscriptions received in advance and rents received in advance. They result in future deductible amounts.

(c)

Expenses or losses are deductible before they are recognized in pretax financial income. Examples are extra depreciation, prepaid expenses, and pension funding in excess of pension expense. They result in future taxable amounts.

(d)

Expenses or losses are deductible after they are recognized in pretax financial income. Examples are warranty expenses, estimated litigation losses, and unrealized loss on marketable securities. They result in future deductible amounts.

Ex. 15-123—Operating loss carryforward. In 2007, its first year of operations, Penner Corp. has a $900,000 net operating loss when the tax rate is 30%. In 2008, Penner has $360,000 taxable income and the tax rate remains 30%. Instructions Assume the management of Penner Corp. thinks that it is more likely than not that the loss carryforward will not be realized in the near future because it is a new company (this is before results of 2008 operations are known). (a)

What are the entries in 2007 to record the tax loss carryforward?

(b)

What entries would be made in 2008 to record the current and deferred income taxes and to recognize the loss carryforward? (Assume that at the end of 2008 it is more likely than not that the deferred tax asset will be realized.)

Solution 15-123 (a)

Deferred Tax Asset ($900,000 × 30%) ........................................ Benefit Due to Loss Carryforward ....................................

270,000

Benefit Due to Loss Carryforward................................................ Allowance to Reduce Deferred Tax Asset to Expected Realizable Value ..........................................

270,000

15 - 34 Test Bank for Intermediate Accounting, Second Edition Solution 15-123 (cont.) (b)

Income Tax Expense ($360,000 × 30%) ...................................... Deferred Tax Asset .......................................................... Allowance to Reduce Deferred Tax Asset to Expected Realizable Value ..................................................................... Benefit Due to Loss Carryforward ....................................

108,000 108,000

PROBLEMS Pr. 15-124— Differences between accounting and taxable income and the effect on deferred taxes. The following differences enter into the reconciliation of financial income and taxable income of Hatley Company for the year ended December 31, 2007, its first year of operations. The enacted income tax rate is 30% for all years. Pretax accounting income Excess tax depreciation Litigation accrual Unearned rent revenue deferred on the books but appropriately recognized in taxable income Interest income from New York municipal bonds Taxable income 1. 2. 3. 4.

$700,000 (320,000) 70,000 50,000 (20,000) $480,000

Excess tax depreciation will reverse equally over a four-year period, 2008-2011. It is estimated that the litigation liability will be paid in 2011. Rent revenue will be recognized during the last year of the lease, 2011. Interest revenue from the New York bonds is expected to be $20,000 each year until their maturity at the end of 2011.

Instructions (a) Prepare a schedule of future taxable and (deductible) amounts. (b) Prepare a schedule of the deferred tax (asset) and liability. (c) Since this is the first year of operations, there is no beginning deferred tax asset or liability. Compute the net deferred tax expense (benefit). (d) Prepare the journal entry to record income tax expense, deferred taxes, and the income taxes payable for 2007.

Solution 15-124 (a)

2008 Future taxable (deductible) amounts: Depreciation $80,000 Litigation Unearned rent

2009

2010

$80,000

2011

Total

$80,000 $320,000 (70,000) (70,000) (50,000) (50,000)

Accounting for Income Taxes

15 - 35

Solution 15-124 (cont.) (b) Temporary Differences Depreciation Litigation Unearned rent Totals

Future Taxable (Deductible) Amounts $320,000 (70,000) (50,000) $200,000

Tax Rate 30% 30% 30%

Deferred Tax (Asset) Liability $96,000 $(21,000) (15,000) $(36,000) $96,000

(c)

Deferred tax expense Deferred tax benefit Net deferred tax expense

$96,000 (36,000) $60,000

(d)

Income Tax Expense ($144,000 + $60,000) ................................ Deferred Tax Asset .................................................................... Deferred Tax Liability ...................................................... Income Tax Payable ($480,000 × 30%) ..........................

204,000 36,000 96,000 144,000

Pr. 15-125—Multiple temporary differences. The following information is available for the first three years of operations for Taylor Company: 1. Year 2007 2008 2009

Taxable Income $500,000 330,000 400,000

2. On January 2, 2007, heavy equipment costing $600,000 was purchased. The equipment had a life of 5 years and no salvage value. The straight-line method of depreciation is used for book purposes and the tax depreciation taken each year is listed below: 2007 $198,000

2008 $270,000

Tax Depreciation 2009 2010 $90,000 $42,000

Total $600,000

3. On January 2, 2008, $240,000 was collected in advance for rental of a building for a threeyear period. The entire $240,000 was reported as taxable income in 2008, but $160,000 of the $240,000 was reported as unearned revenue at December 31, 2008 for book purposes. 4. The enacted tax rates are 40% for all years. Instructions (a) Prepare a schedule comparing depreciation for financial reporting and tax purposes. (b) Determine the deferred tax (asset) or liability at the end of 2007. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2008. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2008. (e) Compute the net deferred tax expense (benefit) for 2008. (f) Prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2008.

15 - 36 Test Bank for Intermediate Accounting, Second Edition Solution 15-125 (a) Year 2007 2008 2009 2010 2011

(b)

Depreciation for Financial Reporting Purposes $120,000 120,000 120,000 120,000 120,000 $600,000

Depreciation for Tax Purposes $198,000 270,000 90,000 42,000 -0$600,000

2008 Future taxable (deductible) amounts: Depreciation $(150,000)

Temporary Difference $ (78,000) (150,000) 30,000 78,000 120,000 $ -0-

2009

2010

2011

Total

$30,000

$78,000

$120,000

$78,000

Deferred tax liability: $78,000 × 40% = $31,200 at the end of 2007. (c) Future taxable (deductible) amounts: Depreciation Rent

2009

2010

2011

Total

$30,000 (80,000)

$78,000 (80,000)

$120,000

$228,000 (160,000)

(d) Temporary Differences Depreciation Rent Totals (e)

(f)

Future Taxable (Deductible) Amounts $228,000 (160,000) $ 68,000

Tax Rate 40% 40%

Deferred Tax (Asset) Liability $91,200 $(64,000) $(64,000) $91,200

Deferred tax asset at end of 2008 Deferred tax asset at beginning of 2008 Deferred tax (benefit)

$(64,000) -0$(64,000)

Deferred tax liability at end of 2008 Deferred tax liability at beginning of 2008 Deferred tax expense

$91,200 31,200 $60,000

Deferred tax (benefit) Deferred tax expense Net deferred tax benefit for 2008

$(64,000) 60,000 $ (4,000)

Income Tax Expense ($132,000 – $4,000) .................................. Deferred Tax Asset ...................................................................... Deferred Tax Liability ....................................................... Income Tax Payable ($330,000 × 40%) ...........................

128,000 64,000 60,000 132,000

Accounting for Income Taxes

15 - 37

Pr. 15-126—Deferred tax asset. Yarman Inc. began business on January 1, 2008. Its pretax financial income for the first 2 years was as follows: 2008 2009

$240,000 560,000

The following items caused the only differences between pretax financial income and taxable income. 1. In 2008, the company collected $180,000 of rent; of this amount, $60,000 was earned in 2008; the other $120,000 will be earned equally over the 2009-2010 period. The full $180,000 was included in taxable income in 2008. 2. The company pays $10,000 a year for life insurance on officers. 3. In 2009, the company terminated a top executive and agreed to $90,000 of severance pay. The amount will be paid $30,000 per year for 2009-2011. The 2009 payment was made. The $90,000 was expensed in 2009. For tax purposes, the severance pay is deductible as it is paid. The enacted tax rates existing at December 31, 2008 are: 2008 2009

30% 35%

2010 2011

40% 40%

Instructions (a) Determine taxable income for 2008 and 2009. (b) Determine the deferred income taxes at the end of 2008, and prepare the journal entry to record income taxes for 2008. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2009. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2009. (e) Compute the net deferred tax expense (benefit) for 2009. (f) Prepare the journal entry to record income taxes for 2009. (g) Show how the deferred income taxes should be reported on the balance sheet at December 31, 2009.

Solution 15-126 (a) Pretax financial income Permanent differences: Life insurance Temporary differences: Rent Severance pay Taxable income

2008 $240,000

2009 $560,000

10,000 250,000

10,000 570,000

120,000 -0$370,000

(60,000) 60,000 $570,000

15 - 38 Test Bank for Intermediate Accounting, Second Edition Solution 15-126 (cont.) (b)

2009

2010

Total

$(60,000) 35% $(21,000)

$(60,000) 40% $(24,000)

$(120,000)

Income Tax Expense ($111,000 – $45,000) ................................ Deferred Tax Asset ...................................................................... Income Tax Payable ($370,000 × 30%) .........................

66,000 45,000

Future taxable (deductible) amounts: Rent Tax rate Deferred tax (asset) liability

111,000

2010

2011

Total

$(60,000) (30,000)

$(30,000)

$(60,000) (60,000)

Future Taxable (Deductible) Amounts $ (60,000) (60,000) $(120,000)

Tax Rate 40% 40%

(e)

Deferred tax asset at end of 2009 Deferred tax asset at beginning of 2009 Net deferred tax (expense) for 2009

(f)

Income Tax Expense ($199,500 – $3,000) .................................. Deferred Tax Asset ...................................................................... Income Tax Payable ($570,000 × 35%) ...........................

(g)

$(45,000) at end of 2008

Deferred Tax (Asset) Liability $(24,000) (24,000) $(48,000)

$(48,000) (45,000) $ (3,000) 196,500 3,000 199,500

The deferred income taxes should be reported on the December 31, 2009 balance sheet as follows: Current assets Deferred tax asset ($90,000* × 40%) $36,000 Other assets Deferred tax asset ($30,000 × 40%)

$12,000

*$60,000 + $30,000

Pr. 15-127—Interperiod tax allocation with change in enacted tax rates. Norway Company purchased equipment for $180,000 on January 2, 2007, its first day of operations. For book purposes, the equipment will be depreciated using the straight-line method over three years with no salvage value. Pretax financial income and taxable income are as follows: 2007 2008 2009 Pretax financial income $224,000 $260,000 $300,000 Taxable income 200,000 260,000 324,000

Accounting for Income Taxes

15 - 39

Pr. 15-127 (cont.) The temporary difference between pretax financial income and taxable income is due to the use of accelerated depreciation for tax purposes. Instructions (a) Prepare the journal entries to record income taxes for all three years (expense, deferrals, and liabilities) assuming that the enacted tax rate applicable to all three years is 30%. (b)

Prepare the journal entries to record income taxes for all three years (expense, deferrals, and liabilities) assuming that the enacted tax rate as of 2007 is 30% but that in the middle of 2008, Congress raises the income tax rate to 35% retroactive to the beginning of 2008.

Solution 15-127 (a) Book depreciation Tax depreciation Temporary difference 2007

2008

2009

(b)

2007

2008

2009

2007 $ 60,000 84,000 $(24,000)

2008 $60,000 60,000 $ -0-

2009 $60,000 36,000 $24,000

Total $180,000 180,000 $ -0-

Income Tax Expense ....................................................... Deferred Tax Liability ($24,000 × .30) .................. Income Tax Payable ($200,000 × .30)..................

67,200

Income Tax Expense ....................................................... Income Tax Payable ($260,000 × .30)..................

78,000

Income Tax Expense ....................................................... Deferred Tax Liability ....................................................... Income Tax Payable ($324,000 × .30)..................

90,000 7,200

Income Tax Expense ....................................................... Deferred Tax Liability ($24,000 × .30) .................. Income Tax Payable ($200,000 × .30)..................

67,200

Income Tax Expense ....................................................... Deferred Tax Liability ........................................... Income Tax Payable ($260,000 × .35)..................

92,200

105,000 8,400

*Future taxable amount Deferred tax @ 30% Deferred tax @ 35% Adjustment

2009 $24,000 7,200 8,400 $ 1,200

7,200 60,000

78,000

97,200

7,200 60,000

1,200* 91,000

113,400

CHAPTER 16 ACCOUNTING FOR COMPENSATION TRUE-FALSE—Conceptual Answer

No.

Description

F T F T F T T T F T F F F T F T T F T F T F F F T F T F F T

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

Accounting for sick pay. Social security taxes as liabilities. Definition of accumulation rights. Recognizing compensated absences expense. Definition of vested rights. Accounting for sick pay benefits. Computation of compensation expense. Compensation cost under intrinsic method. Compensation expense in fair value method. Service period in stock option plans. Accounting for nonexercise of stock options. Accounting for stock option forfeiture. Defined-benefit plan liability. Defined-benefit plans. Beneficiaries of defined benefit/contribution trust. Interest on projected benefit obligation. Selection of interest rate for pension expense. Definition of service cost. Definition of interest cost. Recognizing accumulated benefit obligation. Pension Asset/Liability balance. Identifying interest rate to use. Plan amendment and projected benefit obligation increase. Years-of-service amortization method. Expected return and actual return. Unexpected gains and losses. Recording prior service cost. Reporting accumulated OCI (PSC) on the balance sheet. Other comprehensive income (PSC) and net income. Reconciliation of PBO and fair value of plan assets.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

b d d c d c a c a

31. 32. 33. 34. 35. 36. 37. 38. 39.

Vested rights vs. accumulated rights. Employer’s payroll tax expense. Accrual of a liability for compensated absences. Accrual of a liability for compensated absences. Accrual of a liability for compensated absences. Characteristics of noncompensatory stock option plan. Measurement of compensation in stock option. Recognition of compensation expense in a stock option plan. Compensation expense in a stock option plan.

16 - 2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

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

40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60.

Characteristics of noncompensatory stock purchase plan. Nature of a defined-contribution plan. Nature of a defined-benefit plan. Defined-contribution plan characteristics. Accounting for a defined-benefit plan. Pension funding and pension expense recognition. Components of pension expense. Service cost calculated using future compensation levels. Settlement interest rates. Nature of plan assets. Definition of actual return on plan assets. Pension asset/liability. Recording of a pension liability. Recognition of prior service costs. Amortization of prior service costs. Amortization methods for prior service costs. Reporting a pension liability. Identification of a balance sheet account. Disclosures of pension plan information. Disclosures of postretirement benefits. Postretirement benefits.

MULTIPLE CHOICE—Computational Answer

No.

Description

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

61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80.

Federal/state unemployment taxes. Vacation liability accrual. Calculate payroll tax expense. Calculate vacation expense to be recognized. Calculate accrued liability to be recognized. Net income effect in stock option plan. Determine compensation expense in a stock option plan. Impact of stock options on stockholders’ equity. Determine compensation expense ins a stock option plan. Determine compensation expense ins a stock option plan. Calculate pension expense. Calculate pension expense. Calculate pension expense. Determine pension expense. Calculate pension liability to be reported. Calculate other comprehensive loss amortization. Calculate pension expense. Calculate pension expense. Calculate actual return on plan assets. Calculate unexpected gain on plan assets.

Accounting for Compensation

MULTIPLE CHOICE—Computational Answer

No.

Description

b c c b c c c d c b

81. 82. 83. 84. 85. 86. 87. 88. 89. 90.

Calculate projected benefit obligation balance. Calculate fair value of plan assets. Calculate interest cost. Determine actual return on plan assets. Calculate the unexpected gain on plan assets. Calculate pension asset/liability recognized in the balance sheet. Calculate pension liability. Calculate pension liability. Calculate pension liability. Calculate amount of pension liability.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

d c d b c d c b

91. 92. 93. 94. 95. 96. 97. 98.

Accrual of payroll taxes. Compensation expense in a stock option plan. Determine the projected benefit obligation. Nature of interest cost. Determine the pension asset/liability. Determine the pension asset/liability. Determine liability of a defined-benefit plan. Determine the amount of pension liability to be reported.

EXERCISES Item E16-99 E16-100 E16-101 E16-102 E16-103 E16-104 E16-105 E16-106

Description Payroll entries. Compensated absences. Stock options. Pension accounting terminology. Measuring and recording pension expense. Measuring and recording pension expense. Pension asset/liability. Pension plan calculation and entries.

PROBLEMS Item P16-107 P16-108 P16-109 P16-110

Description Issuance, exercise, and termination of stock options. Measuring, recording, and reporting pension expense and liability. Measuring and recording pension expense. Preparing a pension worksheet.

16 - 3

16 - 4

Test Bank for Intermediate Accounting, Second Edition

CHAPTER LEARNING OBJECTIVES 1.

Explain the accounting for salary and bonuses.

Describe the accounting for stock compensation plans under generally accepted accounting principles.

Discuss the controversy surrounding stock compensation plans.

Identify types of pension plans and their characteristics

List the components of pension expense.

Utilize a worksheet for an employer's pension plan entries.

Explain the accounting for prior service cost and gains and losses.

Describe the reporting requirements for pension plans in financial statements.

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2. 3.

TF TF TF

4. 5. 6.

TF TF TF

31. 32. 33.

7. 8. 9.

TF TF TF

10. 11. 12.

TF TF TF

36. 37. 38.

13.

14.

15.

16. 17. 18. 19.

TF TF TF TF

45. 46. 47. 48.

MC MC MC MC

49. 50. 71. 72.

20. 21.

TF TF

22. 51.

TF MC

52. 81.

23. 24.

TF TF

25. 26.

TF TF

27. 53.

28. 29.

TF TF

30. 59.

TF MC

60. 75.

Note:

TF =True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 MC 34. MC 62. MC 35. MC 63. MC 61. MC 64. Learning Objective 2 MC 39. MC 67. MC 40. MC 68. MC 66. MC 69. Learning Objective 4 TF 41. MC 42. Learning Objective 5 MC 73. MC 79. MC 74. MC 80. MC 77. MC 83. MC 78. MC 84. Learning Objective 6 MC 82. MC 87. MC 86. MC 88. Learning Objective 7 TF 54. MC 56. MC 55. MC 57. Learning Objective 8 MC 96. MC 98. MC 97. MC 105. E = Exercise P = Problem

Type

Item

Type

Item

Type

MC MC MC

65. 91. 99.

MC MC E

100.

MC MC MC

70. 92. 101.

MC MC E

107.

43.

44.

MC MC MC MC

85. 93. 94. 102.

MC MC MC E

103. 104. 108. 109.

E E P P

MC MC

89. 90.

MC MC

95. 110.

MC P

MC MC

58. 76.

MC MC

108. 109.

P P

MC E

106

Accounting for Compensation

16 - 5

TRUE-FALSE—Conceptual 1.

A company must accrue a liability for sick pay that accumulates but does not vest.

Companies report the amount of social security taxes withheld from employees as well as the companies’ matching portion as current liabilities until they are remitted.

Accumulated rights exist when an employer has an obligation to make payment to an employee even after terminating his employment.

Companies should recognize the expense and related liability for compensated absences in the year earned by employees.

Vested rights exist when an employer has an obligation to make payment to an employee but not if the employee is terminated.

If sick pay benefits accumulate but do not vest, accrual is permitted but not required.

Using the fair value method, total compensation expense is computed based on the fair value of the options expected to vest on the date the options are granted to the employees.

Under the intrinsic value method, total compensation cost is computed as the excess of the market price of the stock over the option price on the measurement date.

Under the fair value method, companies compute total compensation expense based on the fair value of options on the date of exercise.

10.

The service period in stock option plans is the time between the grant date and the vesting date.

11.

If an employee fails to exercise a stock option before its expiration date, the company should decrease compensation expense.

12.

If an employee forfeits a stock option because of failure to satisfy a service requirement, the company should record paid-in capital from expired options.

13.

An employer does not have to report a liability on its balance sheet in a defined-benefit plan.

14.

Employers are at risk with defined-benefit plans because they must contribute enough to meet the cost of benefits that the plan defines.

15.

The employees are the beneficiaries of a defined benefit trust, but the employer is the beneficiary of a defined contribution trust.

16.

Interest on the liability (or interest expense) is the interest for the period on the projected benefit obligation outstanding during the period.

17.

When considering the interest rate component used in the determination of pension cost, the FASB concluded that the rate selected should reflect conservatism.

16 - 6

Test Bank for Intermediate Accounting, Second Edition

18.

Service cost is the expense caused by the increase in the accumulated benefit obligation because of employees’ service during the current year.

19.

The interest component of pension expense in the current period is computed by multiplying the settlement rate by the beginning balance of the projected benefit obligation.

20.

Companies recognize the accumulated benefit obligation in their accounts and in their financial statements.

21.

The Pension Asset/Liability account balance equals the difference between the projected benefit obligation and the fair value of pension plan assets.

22.

The interest rate used to compute the projected benefit obligation should also be used as the rate of return on plan assets.

23.

Companies should recognize the entire increase in projected benefit obligation due to a plan initiation or amendment as pension expense in the year of amendment.

24.

The FASB allows only the years-of-service method for amortization of prior service cost.

25.

The difference between the expected return and the actual return is referred to as the unexpected gain or loss.

26.

The unexpected gains and losses from changes in the projected benefit obligation are called asset gains and losses.

27.

When a company amends its defined benefit plan and recognizes prior service, the projected benefit obligation is increased to recognize this additional liability.

28.

Companies report Accumulated Other Comprehensive Income (PSC) as a liability on the balance sheet.

29.

Other Comprehensive Income (PSC) is reported as part of net income.

30.

Companies must disclose a reconciliation of how the projected benefit obligation and the fair value of plan assets changed during the year either in their financial statements or in the notes.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5.

F T F T F

6. 7. 8. 9. 10.

T T T F T

11. 12. 13. 14. 15.

F F F T F

16. 17. 18. 19. 20.

T T F T F

21. 22. 23. 24. 25.

T F F F T

26. 27. 28. 29. 30.

F T F F T

Accounting for Compensation

16 - 7

MULTIPLE CHOICE—Conceptual 31.

In accounting for compensated absences, the difference between vested rights and accumulated rights is a. vested rights are normally for a longer period of employment than are accumulated rights. b. vested rights are not contingent upon an employee's future service. c. vested rights are a legal and binding obligation on the company, whereas accumulated rights expire at the end of the accounting period in which they arose. d. vested rights carry a stipulated dollar amount that is owed to the employee; a

32.

Which of these is not included in an employer's payroll tax expense? a. F.I.C.A. (social security) taxes b. Federal unemployment taxes c. State unemployment taxes d. Federal income taxes

33.

Which of the following is a condition for accruing a liability for the cost of compensation for future absences? a. The obligation relates to the rights that vest or accumulate. b. Payment of the compensation is probable. c. The obligation is attributable to employee services already performed. d. All of these are conditions for the accrual.

34.

A liability for compensated absences such as vacations, for which it is expected that employees will be paid, should a. be accrued during the period when the compensated time is expected to be used by employees. b. be accrued during the period following vesting. c. be accrued during the period when earned. d. not be accrued unless a written contractual obligation exists.

35.

The amount of the liability for compensated absences should be based on 1. the current rates of pay in effect when employees earn the right to compensated absences. 2. the future rates of pay expected to be paid when employees use compensated time. 3. the present value of the amount expected to be paid in future periods. a. b. c. d.

36.

1. 2. 3. Either 1 or 2 is acceptable.

Which of the following is not a characteristic of a noncompensatory stock option plan? a. Substantially all full-time employees may participate on an equitable basis. b. The plan offers no substantive option feature. c. Unlimited time period permitted for exercise of an option as long as the holder is still employed by the company. d. Discount from the market price of the stock no greater than would be reasonable in an offer of stock to stockholders or others.

16 - 8

Test Bank for Intermediate Accounting, Second Edition

37.

The date on which to measure the compensation element in a stock option granted to a corporate employee ordinarily is the date on which the employee a. is granted the option. b. has performed all conditions precedent to exercising the option. c. may first exercise the option. d. exercises the option.

38.

Compensation expense resulting from a compensatory stock option plan is generally a. recognized in the period of exercise. b. recognized in the period of the grant. c. allocated to the periods benefited by the employee's required service. d. allocated over the periods of the employee's service life to retirement.

39.

The date on which total compensation expense is computed in a stock option plan is the date a. of grant. b. of exercise. c. that the market price coincides with the option price. c. that the market price exceeds the option price.

40.

Which of the following is not a characteristic of a noncompensatory stock purchase plan? a. It is open to almost all full-time employees. b. The discount from market price is small. c. The plan offers no substantive option feature. d. All of these are characteristics.

41.

In a defined-contribution plan, a formula is used that a. defines the benefits that the employee will receive at the time of retirement. b. ensures that pension expense and the cash funding amount will be different. c. requires an employer to contribute a certain sum each period based on the formula. d. ensures that employers are at risk to make sure funds are available at retirement.

42.

In a defined-benefit plan, a formula is used that a. requires that the benefit of gain or the risk of loss from the assets contributed to the pension plan be borne by the employee. b. defines the benefits that the employee will receive at the time of retirement. c. requires that pension expense and the cash funding amount be the same. d. defines the contribution the employer is to make; no promise is made concerning the ultimate benefits to be paid out to the employees.

43.

Which of the following is not a characteristic of a defined-contribution pension plan? a. The employer's contribution each period is based on a formula. b. The benefits to be received by employees are usually determined by an employee’s three highest years of salary. c. The accounting for a defined-contribution plan is straightforward and uncomplicated. d. The benefit of gain or the risk of loss from the assets contributed to the pension fund are borne by the employee.

Accounting for Compensation

16 - 9

44.

In accounting for a defined-benefit pension plan a. an appropriate funding pattern must be established to ensure that enough monies will be available at retirement to meet the benefits promised. b. the employer's responsibility is simply to make a contribution each year based on the formula established in the plan. c. the expense recognized each period is equal to the cash contribution. d. the liability is determined based upon known variables that reflect future salary levels promised to employees.

45.

The relationship between the amount funded and the amount reported for pension expense is as follows: a. pension expense must equal the amount funded. b. pension expense will be less than the amount funded. c. pension expense will be more than the amount funded. d. pension expense may be greater than, equal to, or less than the amount funded.

46.

The computation of pension expense includes all the following except a. service cost component measured using current salary levels. b. interest on projected benefit obligation. c. expected return on plan assets. d. All of these are included in the computation.

47.

In computing the service cost component of pension expense, the FASB concluded that a. the accumulated benefit obligation provides a more realistic measure of the pension obligation on a going concern basis. b. a company should employ an actuarial funding method to report pension expense that best reflects the cost of benefits to employees. c. the projected benefit obligation using future compensation levels provides a realistic measure of present pension obligation and expense. d. all of these.

48.

The interest on the projected benefit obligation component of pension expense a. reflects the incremental borrowing rate of the employer. b. reflects the rates at which pension benefits could be effectively settled. c. is the same as the expected return on plan assets. d. may be stated implicitly or explicitly when reported.

49.

One component of pension expense is expected return on plan assets. Plan assets include a. contributions made by the employer and contributions made by the employee when a contributory plan of some type is involved. b. plan assets still under the control of the company. c. only assets reported on the balance sheet of the employer as prepaid pension cost. d. none of these.

50.

The actual return on plan assets a. is equal to the change in the fair value of the plan assets during the year. b. includes interest, dividends, and changes in the market value of the fund assets. c. is equal to the expected rate of return times the fair value of the plan assets at the beginning of the period. d. all of these.

16 - 10 Test Bank for Intermediate Accounting, Second Edition 51.

In accounting for a pension plan, any difference between the pension cost charged to expense and the payments into the fund should be reported as a. an offset to the liability for prior service cost. b. pension asset/liability. c. other comprehensive income (G/L). d. accumulated other comprehensive income (PSC).

52.

A corporation has a defined-benefit plan. A pension liability will be recorded at the end of the first year if the a. projected benefit obligation exceeds the fair value of the plan assets. b. fair value of the plan assets exceeds the projected benefit obligation. c. amount of employer contributions exceeds the pension expense. d. amount of pension expense exceeds the amount of employer contributions.

53.

When a company adopts a pension plan, prior service cost should be charged to a. accumulated other comprehensive income (PSC). b. operations of prior periods. c. other comprehensive income (PSC). d. retained earnings.

54.

When a company amends a pension plan, for accounting purposes, prior service cost should be a. treated as a prior period adjustment because no future periods are benefited. b. amortized in accordance with procedures used for income tax purposes. c. recorded in other comprehensive income (PSC). d. reported as an expense of the period the plan is amended.

55.

Prior service cost is amortized on a a. straight-line basis over the expected future years of service. b. years-of-service method over the average remaining service life of active employees. c. straight-line basis over 15 years. d. straight-line basis over the average remaining service life of active employees or 15 years, whichever is longer.

56.

A pension liability is reported when a. the projected benefit obligation exceeds the fair value of pension plan assets. b. the accumulated benefit obligation is less than the fair value of pension plan assets. c. the pension expense reported for the period is greater than the funding amount for the same period. d. accumulated other comprehensive income exceeds the fair value of pension plan assets.

57.

Which of the following statements is correct? a. There is an account titled Pension Asset/Liability. b. There is an account titled Accumulated Benefit Obligation. c. Accumulated other comprehensive income should be reported in the liability section of the balance sheet. d. Other comprehensive income (PSC) should be included in net income.

Accounting for Compensation

16 - 11

58.

Which of the following disclosures of pension plan information would not normally be required? a. The major components of pension expense b. The amount of prior service cost charged or credited in previous years. c. The funded status of the plan and the amounts recognized in the financial statements d. The rates used in measuring the benefit amounts

59.

Which of the following disclosures of postretirement benefits would not be required by professional pronouncements? a. Postretirement expense for the period b. A schedule showing changes in postretirement benefits and plan assets during the year c. The amount of the EPBO d. The assumptions and rates used in computing the EPBO and APBO

60.

Postretirement benefits may include all of the following except a. severance pay to laid-off employees. b. dental care. c. legal and tax services. d. tuition assistance.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

31. 32. 33. 34. 35.

b d d c d

36. 37. 38. 39. 40.

c a c a d

41. 42. 43. 44. 45.

c b b a d

46. 47. 48. 49. 50.

a c b a b

51. 52. 53. 54. 55.

b d a c b

56. 57. 58. 59. 60.

c a b c a

MULTIPLE CHOICE—Computational 61.

Unruh Co., which has a taxable payroll of $400,000, is subject to FUTA tax of 6.2% and a state contribution rate of 5.4%. However, because of stable employment experience, the company’s state rate has been reduced to 2%. What is the total amount of federal and state unemployment tax for Unruh Co.? a. $46,800 b. $32,800 c. $16,000 d. $11,200

62.

A company gives each of its 50 employees (assume they were all employed continuously through 2007 and 2008) 12 days of vacation a year if they are employed at the end of the year. The vacation accumulates and may be taken starting January 1 of the next year. The employees work 8 hours per day. In 2007, they made $14 per hour and in 2008 they made $16 per hour. During 2008, they took an average of 9 days of vacation each. The company’s policy is to record the liability existing at the end of each year at the wage rate for that year. What amount of vacation liability would be reflected on the 2007 and 2008 balance sheets, respectively?

16 - 12 Test Bank for Intermediate Accounting, Second Edition a. b. c. d. 63.

$67,200; $93,600 $76,800; $96,000 $67,200; $96,000 $76,800; $93,600

The total payroll of Waters Company for the month of October, 2008 was $360,000, of which $90,000 represented amounts paid in excess of $90,000 to certain employees. $300,000 represented amounts paid to employees in excess of the $7,000 maximum subject to unemployment taxes. $90,000 of federal income taxes and $9,000 of union dues were withheld. The state unemployment tax is 1%, the federal unemployment tax is .8%, and the current F.I.C.A. tax is 7.65% on an employee’s wages to $90,000 and 1.45% in excess of $90,000. What amount should Waters record as payroll tax expense? a. $118,620 b. $113,040 c. $23,040 d. $28,440

Use the following information for questions 64 and 65. Simson Company has 35 employees who work 8-hour days and are paid hourly. On January 1, 2007, the company began a program of granting its employees 10 days of paid vacation each year. Vacation days earned in 2007 may first be taken on January 1, 2008. Information relative to these employees is as follows: Year 2007 2008 2009

Hourly Wages $25.80 27.00 28.50

Vacation Days Earned by Each Employee 10 10 10

Vacation Days Used by Each Employee 0 8 10

Simson has chosen to accrue the liability for compensated absences at the current rates of pay in effect when the compensated time is earned. 64.

What is the amount of expense relative to compensated absences that should be reported on Simson’s income statement for 2007? a. $0 b. $68,880 c. $75,600 d. $72,240

65.

What is the amount of the accrued liability for compensated absences that should be reported at December 31, 2009? a. $94,920 b. $90,720 c. $79,800 d. $95,760

66.

On December 31, 2007, Filmore Company granted some of its executives options to purchase 50,000 shares of the company's $10 par common stock at an option price of $50 per share. The options become exercisable on January 1, 2008, and represent compensation for executives' services over a three-year period beginning January 1, 2008. The Black-Scholes option pricing model determines total compensation expense to be $300,000. At December 31, 2008, none of the executives had exercised their options.

Accounting for Compensation

16 - 13

What is the impact on Filmore's net income for the year ended December 31, 2008 as a result of this transaction under the fair value method? a. $100,000 increase b. $0 c. $100,000 decrease d. $300,000 decrease 67.

Yunger Corp. on January 1, 2004, granted stock options for 40,000 shares of its $10 par value common stock to its key employees. The market price of the common stock on that date was $23 per share and the option price was $20. The Black-Scholes option pricing model determines total compensation expense to be $240,000. The options are exercisable beginning January 1, 2007, provided those key employees are still in Yunger’s employ at the time the options are exercised. The options expire on January 1, 2008. On January 1, 2007, when the market price of the stock was $29 per share, all 40,000 options were exercised. The amount of compensation expense Yunger should record for 2006 under the fair value method is a. $0. b. $40,000. c. $80,000. d. $120,000.

68.

On December 31, 2007, Jansen Company granted some of its executives options to purchase 45,000 shares of the company's $50 par common stock at an option price of $60 per share. The Black-Scholes option pricing model determines total compensation expense to be $900,000. The options become exercisable on January 1, 2008, and represent compensation for executives' past and future services over a three-year period beginning January 1, 2008. What is the impact on Jansen's total stockholders' equity for the year ended December 31, 2007, as a result of this transaction under the fair value method? a. $900,000 decrease b. $300,000 decrease c. $0 d. $300,000 increase

69.

On June 30, 2004, Sealey Corporation granted compensatory stock options for 30,000 shares of its $20 par value common stock to certain of its key employees. The market price of the common stock on that date was $36 per share and the option price was $30. The Black-Scholes option pricing model determines total compensation expense to be $360,000. The options are exercisable beginning January 1, 2007, provided those key employees are still in Sealey’s employ at the time the options are exercised. The options expire on June 30, 2008. On January 4, 2007, when the market price of the stock was $42 per share, all 30,000 options were exercised. What should be the amount of compensation expense recorded by Sealey Corporation for the calendar year 2006 using the fair value method? a. $0 b. $144,000 c. $180,000 d. $360,000

16 - 14 Test Bank for Intermediate Accounting, Second Edition 70.

In order to retain certain key executives, Tanner Corporation granted them incentive stock options on December 31, 2006. 50,000 options were granted at an option price of $35 per share. Market prices of the stock were as follows: December 31, 2007 December 31, 2008

$46 per share 51 per share

The options were granted as compensation for executives' services to be rendered over a two-year period beginning January 1, 2007. The Black-Scholes option pricing model determines total compensation expense to be $500,000. What amount of compensation expense should Tanner recognize as a result of this plan for the year ended December 31, 2007 under the fair value method? a. $250,000 b. $500,000 c. $550,000 d. $1,750,000 71.

Presented below is pension information related to Tyler, Inc. for the year 2008: Service cost $72,000 Interest on projected benefit obligation 54,000 Interest on vested benefits 24,000 Amortization of prior service cost due to increase in benefits 12,000 Expected return on plan assets 18,000 The amount of pension expense to be reported for 2008 is a. $108,000. b. $144,000. c. $162,000. d. $120,000.

72.

Koble, Inc. sponsors a defined-benefit pension plan. The following data relates to the operation of the plan for the year 2008. Service cost $ 200,000 Contributions to the plan 220,000 Actual return on plan assets 180,000 Projected benefit obligation (beginning of year) 2,400,000 Market-related and fair value of plan assets (beginning of year) 1,600,000 The expected return on plan assets and the settlement rate were both 10%. The amount of pension expense reported for 2008 is a. $200,000. b. $260,000. c. $280,000. d. $440,000.

73.

Randel, Inc. received the following information from its pension plan trustee concerning the operation of the company's defined-benefit pension plan for the year ended December 31, 2008. January 1, 2008 December 31, 2008 Fair value of pension plan assets $4,200,000 $4,500,000 Projected benefit obligation 4,800,000 5,160,000 Accumulated benefit obligation 840,000 1,020,000 Accumulated OCI—(Gains/Losses) -0(90,000)

Accounting for Compensation

16 - 15

The service cost component of pension expense for 2008 is $360,000 and the amortization of prior service cost due to an increase in benefits is $60,000. The settlement rate is 10% and the expected rate of return is 9%. What is the amount of pension expense for 2008? a. $360,000 b. $522,000 c. $531,000 d. $432,000 Use the following information for questions 74 through 76. The following information for Monroe Enterprises is given below: December 31, 2008 Assets and obligations Plan assets (at fair value) Accumulated benefit obligation Projected benefit obligation Other Items Pension asset/liability, January 1, 2008 Contributions Accumulated other comprehensive loss

$100,000 185,000 200,000

5,000 60,000 83,950

There were no actuarial gains or losses at January 1, 2008. The average remaining service life of employees is 10 years. 74.

What is the pension expense that Monroe Enterprises should report for 2008? a. $86,050 b. $110,000 c. $60,000 d. $83,950

75.

What is the amount that Monroe Enterprises should report as its pension liability on its balance sheet as of December 31, 2008? a. $100,000 b. $15,000 c. $185,000 d. $200,000

76.

The amortization of Other Comprehensive Loss for 2009 is a. $0. b. $6,395. c. $11,500. d. $8,395.

77.

Presented below is pension information for Welch Company for the year 2008: Actual return on plan assets Service cost Interest on projected benefit obligation Amortization of prior service cost due to increase in benefits

$24,000 30,000 21,000 18,000

16 - 16 Test Bank for Intermediate Accounting, Second Edition The amount of pension expense to be reported for 2008 is a. $93,000. b. $69,000. c. $60,000. d. $45,000. 78.

Downing, Inc. received the following information from its pension plan trustee concerning the operation of the company's defined-benefit pension plan for the year ended December 31, 2008. 1/1/08 12/31/08 Projected benefit obligation $11,400,000 $11,760,000 Pension assets (at fair value) 6,000,000 6,900,000 Accumulated benefit obligation 2,400,000 2,760,000 Net (gains) and losses -0240,000 The service cost component of pension expense for 2008 is $840,000 and the amortization of unrecognized prior service cost is $180,000. The settlement rate is 10% and the expected rate of return is 8%. What is the amount of pension expense for 2008? a. $1,716,000 b. $1,680,000 c. $1,608,000 d. $1,440,000

Use the following information for questions 79 and 80. The following data are for the pension plan for the employees of Nickels Company. Accumulated benefit obligation Projected benefit obligation Plan assets (at fair value) AOCL-net loss Settlement rate (for year) Expected rate of return (for year)

1/1/07 $7,500,000 8,100,000 6,900,000 -0-

12/31/07 $7,800,000 8,400,000 9,000,000 1,440,000 10% 8%

12/31/08 $10,200,000 11,100,000 9,900,000 1,500,000 9% 7%

Nickels’ contribution was $1,260,000 in 2008 and benefits paid were $1,125,000. Nickels estimates that the average remaining service life is 15 years. 79.

The actual return on plan assets in 2008 was a. $900,000. b. $765,000. c. $600,000. d. $465,000.

80.

Assume that the actual return on plan assets in 2008 was $765,000. The unexpected gain on plan assets in 2008 was a. $156,000. b. $135,000. c. $114,000. d. $72,000.

Accounting for Compensation

16 - 17

Use the following information for questions 81 and 82. On January 1, 2008, Kinder Co. has the following balances: Projected benefit obligation Fair value of plan assets

$2,100,000 1,800,000

The settlement rate is 10%. Other data related to the pension plan for 2008 are: Service cost Amortization of prior service cost due to increase in benefits Contributions Benefits paid Actual return on plan assets Amortization of net gain

$180,000 60,000 300,000 105,000 237,000 18,000

81.

The balance of the projected benefit obligation at December 31, 2008 is a. $2,685,000. b. $2,385,000. c. $2,355,000. d. $2,337,000.

82.

The fair value of plan assets at December 31, 2008 is a. $2,430,000. b. $2,250,000. c. $2,232,000. d. $2,214,000.

Use the following information for questions 83 through 85. The following information relates to the pension plan for the employees of Polzin Co.: Accum. benefit obligation Projected benefit obligation Fair value of plan assets AOCI-net (gain) or loss Settlement rate (for year) Expected rate of return (for year)

1/1/07 $5,280,000 5,580,000 5,100,000 -0-

12/31/07 $5,520,000 5,976,000 6,240,000 (864,000) 11% 8%

12/31/08 $7,200,000 8,004,000 6,888,000 (960,000) 11% 7%

Polzin estimates that the average remaining service life is 16 years. Polzin's contribution was $756,000 in 2008 and benefits paid were $564,000. 83.

The interest cost for 2008 is a. $537,840. b. $607,200. c. $657,360. d. $880,440.

84.

The actual return on plan assets in 2008 is a. $408,000. b. $456,000. c. $588,000. d. $648,000.

16 - 18 Test Bank for Intermediate Accounting, Second Edition 85.

The unexpected gain or loss on plan assets in 2008 is a. $39,360 loss. b. $22,560 gain. c. $19,200 gain. d. $214,560 gain.

86.

Presented below is information related to Bitner Manufacturing Company as of December 31, 2008: Projected benefit obligation in excess of plan assets Accumulated OCI—net gain Accumulated OCI (PSC)

$900,000 300,000 405,000

The amount for the prior service cost is related to a decrease in benefits. The fair value of the pension plan assets is $600,000. The pension asset/liability reported on the balance sheet at December 31, 2008 is a pension liability of a. $300,000. b. $600,000. c. $900,000. d. $1,305,000. Use the following information for questions 87 and 88. Barkley Corporation received the following report from its actuary at the end of the year: December 31, 2007 December 31, 2008 Projected benefit obligation $1,600,000 $1,800,000 Market-related asset value 1,400,000 1,420,000 Accumulated benefit obligation 1,300,000 1,480,000 Fair value of pension plan assets 1,380,000 1,440,000 87.

The amount reported as the pension liability at December 31, 2007 is a. $0. b. $200,000. c. $220,000. d. $300,000.

88.

The amount reported as the pension liability at December 31, 2008 is a. $1,800,000. b. $1,480,000. c. $380,000. d. $360,000.

Accounting for Compensation

16 - 19

Use the following information for questions 89 and 90. The following information relates to Haywood, Inc.: For the Year Ended December 31, 2007 2008 $1,260,000 $1,824,000 570,000 450,000 1,620,000 1,884,000 600,000 450,000 480,000 420,000

Plan assets (at fair value) Pension expense Projected benefit obligation Annual contribution to plan Accumulated OCI (PSC) 89.

The amount reported as the liability for pensions on the December 31, 2007 balance sheet is a. $0. b. $30,000. c. $360,000. d. $390,000.

90.

The amount reported as the liability for pensions on the December 31, 2008 balance sheet is a. $0. b. $60,000. c. $1,884,000. d. $520,000.

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

61. 62. 63. 64. 65.

d c c d a

66. 67. 68. 69. 70.

c c c b a

71. 72. 73. 74. 75.

d c b a a

76. 77. 78. 79. 80.

b d b b b

81. 82. 83. 84. 85.

b c c b c

86. 87. 88. 89. 90.

c c d c b

MULTIPLE CHOICE—CPA Adapted 91.

Quirk Corp.'s payroll for the pay period ended October 31, 2008 is summarized as follows: Department Total Payroll Wages Factory $ 75,000 Sales 22,000 Office 18,000 $115,000

Federal Income Tax Withheld $ 9,000 3,000 2,000 $14,000

Assume the following payroll tax rates: F.I.C.A. for employer and employee Unemployment

Amount of Wages Subject to Payroll Taxes F.I.C.A. Unemployment $70,000 $22,000 16,000 2,000 8,000 — $94,000 $24,000 7% each 3%

16 - 20 Test Bank for Intermediate Accounting, Second Edition What amount should Quirk accrue as its share of payroll taxes in its October 31, 2008 balance sheet? a. $21,300 b. $14,720 c. $13,880 d. $7,300 92.

On January 1, 2007, Doane Corp. granted an employee an option to purchase 6,000 shares of Doane's $5 par value common stock at $20 per share. The Black-Scholes option pricing model determines total compensation expense to be $140,000. The option became exercisable on December 31, 2008, after the employee completed two years of service. The market prices of Doane's stock were as follows: January 1, 2007 December 31, 2008

$30 50

For 2008, Doane should recognize compensation expense under the fair value method of a. $90,000. b. $30,000. c. $70,000. d. $0. 93.

The following information pertains to Mellon Co.'s pension plan: Actuarial estimate of projected benefit obligation at 1/1/08 Assumed discount rate Service costs for 2008 Pension benefits paid during 2008

$72,000 10% $18,000 $15,000

If no change in actuarial estimates occurred during 2008, Mellon's projected benefit obligation at December 31, 2008 was a. $64,200. b. $75,000. c. $79,200. d. $82,200. 94.

Interest cost included in the pension expense recognized for a period by an employer sponsoring a defined-benefit pension plan represents the a. shortage between the expected and actual returns on plan assets. b. increase in the projected benefit obligation due to the passage of time. c. increase in the fair value of plan assets due to the passage of time. d. amortization of the discount on accumulated OCI (PSC).

95.

Reser Corp., a company whose stock is publicly traded, provides a noncontributory defined-benefit pension plan for its employees. The company's actuary has provided the following information for the year ended December 31, 2008: Projected benefit obligation $600,000 Accumulated benefit obligation 525,000 Fair value of plan assets 825,000 Service cost 240,000 Interest on projected benefit obligation 24,000 Amortization of prior service cost 60,000 Expected and actual return on plan assets 82,500

Accounting for Compensation

16 - 21

The market-related asset value equals the fair value of plan assets. No contributions have been made for 2008 pension cost. In its December 31, 2008 balance sheet, Reser should report a(n) a. $600,000 pension liability. b. $824,000 pension asset. c. $225,000 pension asset. d. $525,000 pension liability. 96.

Yeager Co. maintains a defined-benefit pension plan for its employees. At each balance sheet date, Yeager should report a pension asset/liability equal to the a. accumulated benefit obligation. b. projected benefit obligation. c. unfunded accumulated benefit obligation. d. funded status relative to the projected benefit obligation.

97.

Ohlman, Inc. maintains a defined-benefit pension plan for its employees. As of December 31, 2008, the market value of the plan assets is less than the accumulated benefit obligation. The projected benefit obligation exceeds the accumulated benefit obligation. In its balance sheet as of December 31, 2008, Ohlman should report a minimum liability in the amount of the a. excess of the projected benefit obligation over the fair value of the plan assets. b. excess of the accumulated benefit obligation over the fair value of the plan assets. c. projected benefit obligation. d. accumulated benefit obligation.

98.

At December 31, 2008, the following information was provided by the Nilges Corp. pension plan administrator: Fair value of plan assets $4,500,000 Accumulated benefit obligation 5,580,000 Projected benefit obligation 7,200,000 What is the amount of the pension liability that should be shown on Nilges' December 31, 2008 balance sheet? a. $7,200,000 b. $2,700,000 c. $1,620,000 d. $1,080,000

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

91. 92.

d c

93. 94.

d b

95. 96.

c d

97. 98.

c b

16 - 22 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational No.

Answer Derivation

61.

[(.062 – .054) + .02] × $400,000 = $11,200.

62.

50 × 12 × 8 × $14 = $67,200; 50 × 15 × 8 × $16 = $96,000.

63.

($270,000 × 7.65%) + ($90,000 × 1.45%) + ($60,000 × 1.8%) = $23,040.

64.

$25.80 × 8 × 10 × 35 = $72,240.

65.

($28.50 × 8 × 10 × 35) + ($27.00 × 8 × 2 × 35) = $94,920.

66.

$300,000 ÷ 3 = $100,000.

67.

$240,000 ÷ 3 = $80,000/year.

68.

69.

12 $360,000 × —- = $144,000. 30

70.

$500,000 ÷ 2 = $250,000.

71.

$72,000 + $54,000 + $12,000 – $18,000 = $120,000.

72.

$200,000 + ($2,400,000 × .10) – ($1,600,000 × .10) = $280,000.

73.

$360,000 + $60,000 + ($4,800,000 × .10) – ($4,200,000 × .09) = $522,000.

74.

$100,000 + $60,000 – $83,950 = $86,050.

75.

$200,000 – $100,000 = $100,000.

76.

($83,950 – $20,000) ÷ 10 = $6,395.

77.

$30,000 + $21,000 + $18,000 – $24,000 = $45,000.

78.

$840,000 + ($11,400,000 × .10) – ($6,000,000 × .08) + $180,000 = $1,680,000.

79.

($9,900,000 – $9,000,000) – $1,260,000 + $1,125,000 = $765,000.

80.

$765,000 – ($9,000,000 × .07) = $135,000.

81.

$2,100,000 + $180,000 + ($2,100,000 × .10) – $105,000 = $2,385,000.

82.

$1,800,000 + $237,000 + $300,000 – $105,000 = $2,232,000.

2 $900,000 – ($900,000 × — ) = $300,000 increase (from the credit to Paid-in 3 Capital—Stock Options). Offset by $300,000 decrease (from the debit to Compensation Expense).

Accounting for Compensation

DERIVATIONS — Computational (cont.) No.

Answer Derivation

83.

$5,976,000 × .11 = $657,360.

84.

($6,888,000 – $6,240,000) – ($756,000 – $564,000) = $456,000.

85.

$456,000 – ($6,240,000 × .07) = $19,200.

86.

$900,000.

87.

$1,600,000 – $1,380,000 = $220,000.

88.

$1,800,000 – $1,440,000 = $360,000.

89.

$1,620,000 – $1,260,000 = $360,000.

90.

$1,884,000 – $1,824,000 = $60,000.

DERIVATIONS — CPA Adapted No.

Answer Derivation

91.

($94,000 × .07) + ($24,000 × .03) = $7,300

92.

$140,000 ÷ 2 = $70,000.

93.

$72,000 + $18,000 + ($72,000 × .10) – $15,000 = $82,200.

94.

Conceptual.

95.

$825,000 – $600,000 = $225,000.

96.

Conceptual.

97.

Conceptual.

98.

$7,200,000 – $4,500,000 = $2,700,000.

16 - 23

16 - 24 Test Bank for Intermediate Accounting, Second Edition

EXERCISES Ex. 16-99—Payroll entries. Total payroll of Thames Co. was $920,000, of which $160,000 represented amounts paid in excess of $90,000 to certain employees. The amount paid to employees in excess of $7,000 was $720,000. Income taxes withheld were $225,000. The state unemployment tax is 1.2%, the federal unemployment tax is .8%, and the F.I.C.A. tax is 7.65% on an employee’s wages to $90,000 and 1.45% in excess of $90,000. Instructions (a) Prepare the journal entry for the wages and salaries paid. (b) Prepare the entry to record the employer payroll taxes.

Solution 16-99 (a) Wages and Salaries Expense ................................................... Withholding Taxes Payable ........................................... FICA Taxes Payable ..................................................... Cash ............................................................................. * [($920,000 – $160,000) × 7.65%] + ($160,000 × 1.45%)

920,000

(b) Payroll Tax Expense .............................................................. FICA Taxes Payable ($760,000 × 7.65%) + ($160,000 × 1.45%).............. Federal Unemployment Tax Payable [($920,000 – $720,000) × .8%] ............................... State Unemployment Tax Payable ($200,000 × 1.2%) .

64,460

225,000 60,460* 634,540

60,460 1,600 2,400

Ex. 16-100—Compensated absences. Wolff Co. began operations on January 2, 2007. It employs 15 people who work 8-hour days. Each employee earns 10 paid vacation days annually. Vacation days may be taken after January 10 of the year following the year in which they are earned. The average hourly wage rate was $24.00 in 2007 and $25.50 in 2008. The average vacation days used by each employee in 2008 was 9. Wolff Co. accrues the cost of compensated absences at rates of pay in effect when earned. Instructions Prepare journal entries to record the transactions related to paid vacation days during 2007 and 2008.

Solution 16-100 2007

Wages Expense.................................................................. 28,800 (1) Vacation Wages Payable ........................................ (1) 15 × 8 × $24.00 = $2,880; $2,880 × 10 = $28,800.

28,800

Accounting for Compensation

16 - 25

Solution 16-100 (cont.) 2008

Wages Expense ................................................................. 1,620 Vacation Wages Payable.................................................... 25,920 (2) Cash .......................................................................

27,540 (3)

Wages Expense ................................................................. 30,600 (4) Vacation Wages Payable ........................................

30,600

(2) $2,880 × 9 = $25,920. (3) 15  8  $25.50 = $3,060; $3,060  9 = $27,540. (4) $3,060  10 = $30,600.

Ex. 16-101—Stock options. Prepare the necessary entries from 1/1/07-2/1/09 for the following events using the fair value method. If no entry is needed, write "No Entry Necessary." 1. On 1/1/07, the stockholders adopted a stock option plan for top executives whereby each might receive rights to purchase up to 12,000 shares of common stock at $40 per share. The par value is $10 per share. 2. On 2/1/07, options were granted to each of five executives to purchase 12,000 shares. The options were non-transferable and the executive had to remain an employee of the company to exercise the option. The options expire on 2/1/09. It is assumed that the options were for services performed equally in 2007 and 2008. The Black-Scholes option pricing model determines total compensation expense to be $1,300,000. 3. At 2/1/09, four executives exercised their options. The fifth executive chose not to exercise his options, which therefore were forfeited.

Solution 16-101 1.

1/1/07 No entry necessary.

2/1/07 No entry necessary. 12/31/07 Compensation Expense .............................................................. Paid-in Capital—Stock Options ........................................ 12/31/08 Compensation Expense .............................................................. Paid-in Capital—Stock Options ........................................

650,000 650,000 650,000 650,000

16 - 26 Test Bank for Intermediate Accounting, Second Edition Solution 16-101 (cont.) 3.

2/1/09 Cash (4 × 12,000 × $40) ............................................................. 1,920,000 Paid-in Capital—Stock Options ($1,300,000 × 4/5) ..................... 1,040,000 Common Stock ................................................................ Paid-in Capital in Excess of Par ....................................... Paid-in Capital—Stock Options .................................................... Paid-in Capital from Expired Stock Options ......................

480,000 2,480,000

260,000 260,000

Ex. 16-102—Pension accounting terminology. Briefly explain the following terms: (a) Service cost (b) Interest cost (c) Prior service cost

Solution 16-102 (a)

The service cost component of pension expense is the actuarial present value of benefits attributed by the pension benefit formula to employee service during the current period.

(b)

The interest cost component of pension expense is the interest for the period on the projected benefit obligation outstanding during the period. To simplify the calculation, the amount of interest is computed by applying a single rate to the beginning balance of the projected benefit obligation.

(c)

When a defined-benefit plan is initiated or amended, credit that is given to employees for service provided before the date of initiation or amendment results in prior service cost. The amount of prior service cost is computed by an actuary.

Ex. 16-103—Measuring and recording pension expense. Gregory, Inc. received the following information from its pension plan trustee concerning the operation of the company's defined-benefit pension plan for the year ended December 31, 2008: January 1, 2008 December 31, 2008 Projected benefit obligation $2,500,000 $2,850,000 Market-related asset value 1,250,000 1,600,000 Accumulated OCI-(PSC) 540,000 300,000 The service cost component for 2008 is $150,000 and the amortization of prior service cost is $240,000. The company's actual funding of the plan in 2008 amounted to $510,000. The expected return on plan assets and the settlement rate were both 8%. Instructions (a) Determine the pension expense to be reported in 2008. (b) Prepare the journal entry to record pension expense and the employers' contribution to the pension plan in 2008.

Accounting for Compensation

16 - 27

Solution 16-103 (a)

Service cost Interest on projected benefit obligation ($2,500,000 × 8%) Expected return on plan assets ($1,250,000 × 8%) Amortization of prior service cost Pension expense—2008

(b)

Pension Expense ........................................................................ Pension Asset/Liability................................................................. Cash ................................................................................ Other Comprehensive Income (PSC) ...............................

$150,000 200,000 (100,000) 240,000 $490,000 490,000 260,000 510,000 240,000

Ex. 16-104—Measuring and recording pension expense. Presented below is information related to Major Department Stores, Inc. pension plan for 2008. Accumulated benefit obligation (at year-end) $600,000 Service cost 520,000 Funding contribution for 2008 500,000 Settlement rate used in actuarial computation 10% Expected return on plan assets 9% Amortization of PSC (due to benefit increase) 100,000 Amortization of net gains 48,000 Projected benefit obligation (at beginning of period) 480,000 Market-related and fair value of plan assets (at beginning of period) 360,000 Instructions (a) Compute the amount of pension expense to be reported for 2008. (Show computations.) (b) Prepare the journal entry to record pension expense and the employer's contribution for 2008.

Solution 16-104 (a)

Service cost Interest on projected benefit obligation ($480,000 × 10%) Expected return on plan assets ($360,000 × 9%) Amortization of PSC Amortization of net gains Pension expense—2008

(b)

Other Comprehensive Income (G/L) ............................................ Pension Expense ........................................................................ Pension Asset/Liability ..................................................... Cash ................................................................................ Other Comprehensive Income (PSC) ...............................

$520,000 48,000 (32,400) 100,000 (48,000) $587,600 48,000 587,600 35,600 500,000 100,000

16 - 28 Test Bank for Intermediate Accounting, Second Edition Ex. 16-105—Pension asset/liability. Reese Co. had the following selected balances at December 31, 2008: Projected benefit obligation Accumulated benefit obligation Fair value of plan assets Accumulated OCI (PSC)

$4,700,000 4,550,000 4,340,000 170,000

Instructions Calculate the pension asset/liability to be recorded at December 31, 2008.

Solution 16-105 Projected benefit obligation Fair value of plan assets Pension asset/liability

$(4,700,000) 4,340,000 $ (360,000)

Ex. 16-106—Pension plan calculations and journal entry. On January 1, 2008, Stine Co. had the following balances: Projected benefit obligation Fair value of plan assets

$7,200,000 7,200,000

Other data related to the pension plan for 2008: Service cost Contributions to the plan Benefits paid Actual return on plan assets Settlement rate Expected rate of return

315,000 459,000 450,000 432,000 9% 6%

Instructions (a) Determine the projected benefit obligation at December 31, 2008. There are no net gains or losses. (b) Determine the fair value of plan assets at December 31, 2008. (c) Calculate pension expense for 2008. (d) Prepare the journal entry to record pension expense and the contributions for 2008.

Solution 16-106 (a)

Projected benefit obligation, January 1 Service cost Interest cost (9% × $7,200,000) Benefits paid Projected benefit obligation, December 31

$7,200,000 315,000 648,000 (450,000) $7,713,000

Accounting for Compensation

16 - 29

Solution 16-106 (cont.) (b)

Fair value of plan assets, January 1 Actual return Contributions Benefits paid Fair value of plan assets, December 31

$7,200,000 432,000 459,000 (450,000) $7,641,000

(c)

Service cost Interest cost (9% × $7,200,000) Actual return on plan assets Pension expense

(d)

Pension Expense ........................................................................ Pension Asset/Liability ..................................................... Cash ................................................................................

$315,000 648,000 (432,000) $531,000 531,000 72,000 459,000

PROBLEMS Pr. 16-107—Issuance, exercise, and termination of stock options. On January 1, 2007, Titania Inc. granted stock options to officers and key employees for the purchase of 30,000 shares of the company’s $10 par common stock at $25 per share. The options were exercisable within a 5-year period beginning January 1, 2009, by grantees still in the employ of the company, and expiring December 31, 2013. The service period for this award is 2 years. Assume that the fair value option pricing model determines total compensation expense to be $480,000. On April 1, 2008, 3,000 option shares were terminated when the employees resigned from the company. The market value of the common stock was $35 per share on this date. On March 31, 2009, 18,000 option shares were exercised when the market value of the common stock was $40 per share. Instructions Prepare journal entries using the fair value method to record issuance of the stock options, termination of the stock options, exercise of the stock options, and charges to compensation expense, for the years ended December 31, 2007, 2008, and 2009.

Solution 16-107 1/1/07

No entry

12/31/07 Compensation Expense ........................................................ Paid-in Capital—Stock Options .................................... ($480,000 × ½)

240,000

4/1/08

48,000

Paid-in Capital—Stock Options ............................................. Compensation Expense ............................................... ($480,000 × 3,000/30,000)

240,000

48,000

16 - 30 Test Bank for Intermediate Accounting, Second Edition Solution 16-107 (cont.) 12/31/08 Compensation Expense ....................................................... Paid-in Capital—Stock Options ................................... ($480,000 × ½)

240,000

3/31/09

450,000 288,000

Cash (18,000 × $25) ............................................................ Paid-in Capital—Stock Options ($480,000 × 18,000/30,000) Common Stock ............................................................ Paid-in Capital in Excess of Par ..................................

240,000

180,000 558,000

Pr. 16-108—Measuring, recording, and reporting pension expense and liability. Eckert, Inc. on January 1, 2008 initiated a noncontributory, defined-benefit pension plan that grants benefits to its employees for services rendered in years prior to the adoption of the pension plan. An actuarial consulting firm has indicated that the present value of the projected benefit obligation on January 1, 2008 was $5,040,000. Eckert estimates that the average remaining service period is 12 years. On December 31, 2008, the following information was provided concerning the pension plan's operations for its first year. Employer's contribution at end of year $1,600,000 Service cost 600,000 Projected benefit obligation 6,000,000 Plan assets (at fair value) 1,600,000 Expected return on plan assets 9% Settlement rate 8% Instructions (a) Compute the pension expense recognized in 2008. (b) Prepare the journal entries to reflect accounting for the company's pension plan for the year ended December 31, 2008.

Solution 16-108 (a)

Service cost Interest on projected benefit obligation ($5,040,000 × 8%) Amortization of prior service cost ($5,040,000 ÷ 12) Pension expense—2008

$ 600,000 403,200 420,000 $1,423,200

(b)

Pension Expense......................................................................... 1,423,200 Pension Asset/Liability ................................................................. 596,800 Cash ................................................................................ OCI-PSC ..........................................................................

1,600,000 420,000

Accounting for Compensation

16 - 31

Pr. 16-109—Measuring and recording pension expense. Presented below is information related to the pension plan of Vector Inc. for the year 2008. 1. The service cost of pension expense is $240,000 using the projected benefits approach. 2. The projected benefit obligation at the beginning of the year is $300,000. Plan assets at the beginning of the year were $280,000. The expected return on plan assets is 9% and the settlement rate is 10% 3. The accumulates OCI-prior service cost at the beginning of the year is $140,000. The company estimates that the average remaining service life is 10 years. 4. The contribution made to the pension fund in 2008 was $231,000. Instructions (a) Determine the pension expense to be reported on the income statement for 2008. (Round all computations to nearest dollar.) (b) Prepare the journal entry to record pension expense for 2008.

Solution 16-109 (a)

Service cost (projected benefits approach) Interest on projected benefit obligation (10% × $300,000) Expected return on plan assets (9% × $280,000) Amortization of prior service cost ($140,000 ÷ 10) Pension expense

(b)

Pension Expense ........................................................................ Pension Asset/Liability ........................................................ Cash ................................................................................... OCI-PSC ............................................................................

$240,000 30,000 (25,200) 14,000 $258,800 258,800 13,800 231,000 14,000

Pr. 16-110—Preparing a pension work sheet. The accountant for Jarvis Corporation has developed the following information for the company's defined-benefit pension plan for 2008: Service cost $500,000 Actual return on plan assets 260,000 Annual contribution to the plan 900,000 Amortization of prior service cost 105,000 Benefits paid to retirees 60,000 Settlement rate 10% Expected rate of return on plan assets 8% The accumulated benefit obligation at December 31, 2008, amounted to $4,250,000. Instructions (a) Using the above information for Jarvis Corporation, complete the pension worksheet for 2008. Indicate (credit) entries by parentheses. Calculated amounts should be supported. (b) Prepare the journal entries to reflect the accounting for the company's pension plan for the year ending December 31, 2008.

Pr. 16-110 (cont.) Jarvis Corporation Pension Worksheet—2008 —————————————————————————————————————————————————————————— General Journal Entries Memo Entries —————————————————————————————————————————————————————————— Annual OCI Projected Pension Pension Benefit Plan Expense Cash PSC Gain/Loss Asset/Liability Obligation Assets —————————————————————————————————————————————————————————— Bal., Dec. 31, 2007 625,000 (3,750,000) 2,750,000 —————————————————————————————————————————————————————————— Service Cost —————————————————————————————————————————————————————————— Interest Cost —————————————————————————————————————————————————————————— Actual return —————————————————————————————————————————————————————————— Unexpected gain/loss —————————————————————————————————————————————————————————— Amortization of PSC —————————————————————————————————————————————————————————— Contributions —————————————————————————————————————————————————————————— Benefits —————————————————————————————————————————————————————————— Journal entry for 2008 Balance, Dec. 31, 2008

Solution 16-110

ASOCI, 12/31/07

625,000

-0-

Balance, Dec. 31, 2008

520,000

(40,000)

(715,000)

(4,565,000)

3,850,000

Accounting for Compensation

Jarvis Corporation Pension Worksheet—2008 —————————————————————————————————————————————————————————— General Journal Entries Memo Entries —————————————————————————————————————————————————————————— Annual OCI Projected Pension Pension Benefit Plan Expense Cash PSC Gain/Loss Asset/Liability Obligation Assets —————————————————————————————————————————————————————————— Bal., Dec. 31, 2007 625,000 (1,000,000) (3,750,000) 2,750,000 —————————————————————————————————————————————————————————— Service Cost 500,000 (500,000) —————————————————————————————————————————————————————————— Interest Cost (1) 375,000 (375,000) —————————————————————————————————————————————————————————— Actual return (260,000) 260,000 —————————————————————————————————————————————————————————— Unexpected gain/loss (2) 40,000 (40,000) —————————————————————————————————————————————————————————— Amortization of PSC 105,000 (105,000) —————————————————————————————————————————————————————————— Contributions (900,000) 900,000 —————————————————————————————————————————————————————————— Benefits 60,000 (60,000) —————————————————————————————————————————————————————————— Journal entry for 2008 760,000 (900,000) (105,000) (40,000) 285,000

16 - 34 Test Bank for Intermediate Accounting, Second Edition Solution 16-110 (cont.)

(b)

(1)

$3,750,000 × 10% = $375,000

(2)

$260,000 – ($2,750,000 × 8%) = $40,000

Pension Expense......................................................................... Pension Asset/Liability ................................................................. Cash ................................................................................ Other Comprehensive Income (PSC) ............................... Other Comprehensive Income (G/L).................................

760,000 285,000 900,000 105,000 40,000

CHAPTER 17 ACCOUNTING FOR LEASES TRUE-FALSE—Conceptual Answer

No.

Description

T F F T F T T T F F T F T F F T F F F F F T F T F T F T T T

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

Benefits of leasing. Accounting for long-term leases. Definition of a lease. Element of a lease agreement. Definition of an operating lease. Lease with a bargain purchase option. Lessee’s accounting for an operating lease. Lessee’s accounting for a capital lease. Recording a capital lease at fair market value. Lessor’s treatment of guaranteed residual value. Lessee’s treatment of guaranteed residual value. Classifying lease containing purchase option. Accounting for executory costs. Depreciating a capitalized asset. Lessee recording of interest expense. Benefit of leasing to lessor. Distinction between operating lease and capital lease. Sales-type lease and lessor’s classification. Classification of capital leases by lessor. Distinction between direct-financing and sales-type leases. Lessors’ classification of leases. Direct-financing leases. Accounting for operating lease. Reporting interest revenue in direct-financing lease. Recognizing income when using sales-type leases. Difference between direct-financing and sales-type leases. Gross profit in sales-type lease. FASB required lease disclosures. Reporting capital leases on lessee’s balance sheet. Lessor disclosure requirements.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

d d b c a c c d d

31. 32. 33. 34. 35. 36. 37. 38. 39.

Advantages of leasing. Advantages of leasing. Basic principle of lease accounting. Conceptual support for treating all leases as a sale/purchase. Essential element of a lease. Advantages of leasing. Principal and interest in lease payments. Identification of an operating lease. Capital lease based on lease term criterion.

17 - 2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

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

40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62.

Computation of minimum lease payments. Operating lease and rent expense. Bargain purchase option and minimum lease payments. Cost amount for a capital lease. Lease accounting by lessee. Knowledge of the capitalization criteria. Components of minimum lease payments. Identification of executory costs. Discount rate used by lessee. Depreciation of a leased asset by lessee. Effect of a capital lease on lessee's debt. Depreciation of a capital lease. Effect of capital lease on balance sheet items. Criteria for capital lease to lessor. Identification of lease type for lessor. Elements of lease receivable by lessor. Recognition of unearned lease income. Direct-financing lease receivable. Difference between direct financing and sales-type lease. Amount of revenue in sales-type lease. Accounting for a sales-type lease. Disclosing obligations under capital leases. Treatment of guaranteed vs. unguaranteed residual value.

MULTIPLE CHOICE—Computational Answer

No.

Description

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

63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84.

Operating lease expense for year. Calculate interest expense and depreciation expense for lessee. Calculate minimum annual lease payment. Calculate total annual lease payment. Identification of lease type for lessor. Identification of lease type for lessee. Calculate depreciation expense for lessee. Identification of lease type for lessee. Calculate leased asset amount. Calculate total lease obligation. Compute interest expense for year. Compute interest expense for year. Calculate lease liability amount. Compute interest expense and depreciation expense for year. Compute interest expense and depreciation expense for year. Compute depreciation expense for lease with transfer of title. Identification of lease type for lessee. Expense recorded by lessee/operating lease. Calculate reduction of lease obligation for lessee. Identification of lease type for lessor. Calculate lease receivable. Revenues and expenses recorded by lessor/operating lease.

Accounting for Leases

MULTIPLE CHOICE—Computational (cont.) Answer

No.

Description

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

85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98.

Operating lease expense for year. Calculate expense of an operating lease. Calculate income from operating lease. Calculate lease payments. Calculate loss on guaranteed residual value lease. Calculate interest revenue in sales-type lease. Determine gross profit and interest revenue. Calculate interest expense and depreciation expense for lessee. Calculate profit and interest revenue for lessor/sales-type lease. Calculate profit on sales-type lease and interest revenue. Identification of lease type for lessor. Determine discount rate implicit in lease payments. Lease-related expenses recognized by lessee. Determine long-term lease obligation for lessee.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

c a d a d d c a

99. 100. 101. 102. 103. 104. 105. 106.

Identification of lease type for lessee. Calculate the lease liability of a lessee. Calculate the lease liability of a lessee. Determine reduction of lease obligation for lessee. Calculate interest expense for lessee. Calculate depreciation expense for lessee. Recognition of interest revenue in a sales-type lease. Calculate income realized by lessor/sales-type lease.

EXERCISES Item E17-107 E17-108 E17-109 E17-110 E17-111 E17-112

Description Capital lease (essay). Capital lease amortization and journal entries. Operating lease. Lease criteria for classification by lessor. Direct-financing lease (essay). Lessor accounting—sales-type lease.

PROBLEMS Item P17-113 P17-114 P17-115 P17-116

Description Lessee accounting—capital lease. Lessee accounting—capital lease. Lessor accounting—direct-financing lease. Lessor accounting—sales-type lease.

17 - 3

17 - 4

Test Bank for Intermediate Accounting, Second Edition

CHAPTER LEARNING OBJECTIVES 1.

Explain the nature, economic substance, and advantages of lease transactions.

Describe the accounting criteria and procedures for capitalizing leases by the lessee.

Contrast the operating and capitalization methods of recording leases.

Identify the classifications of leases for the lessor.

Describe the lessor's accounting for direct-financing leases.

Describe the lessor's accounting for sales-type leases.

List the disclosure requirements for leases.

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2.

TF TF

3. 4.

TF TF

31. 32.

5. 6. 7. 8. 9. 10. 11. 12.

TF TF TF TF TF TF TF TF

13. 14. 37. 38. 39. 40. 41. 42.

TF TF MC MC MC MC MC MC

43. 44. 45. 46. 47. 48. 49. 63.

15. 16.

TF TF

17. 50.

TF MC

51. 52.

18. 19.

TF TF

20. 21.

TF TF

53. 54.

22. 23.

TF TF

24. 56.

TF MC

57. 83.

25. 26. 27.

TF TF TF

58. 59. 60.

MC MC MC

90. 91. 93.

28.

29.

30.

Note:

TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 MC 33. MC 35. MC 34. MC 36. Learning Objective 2 MC 64. MC 73. MC 65. MC 74. MC 66. MC 75. MC 68. MC 76. MC 69. MC 77. MC 70. MC 78. MC 71. MC 79. MC 72. MC 80. Learning Objective 3 MC 85. MC 109. MC 86. MC Learning Objective 4 MC 55. MC 82. MC 67. MC 87. Learning Objective 5 MC 84. MC 110. MC 96. MC 111. Learning Objective 6 MC 94. MC 106. MC 104. MC 110. MC 105. MC 112. Learning Objective 7 TF 61. MC 62. E = Exercise P = Problem

Type

Item

Type

Item

Type

81. 88. 89. 92. 97. 98. 99. 100.

MC MC MC MC MC MC MC MC

101. 102. 103. 104. 107. 108. 113. 114.

MC MC MC MC E E P P

MC MC

95.

E E

115.

MC E E

116.

MC MC MC MC MC MC MC MC MC MC E

Accounting for Leases

17 - 5

TRUE-FALSE—Conceptual 1.

Leasing equipment reduces the risk of obsolescence to the lessee, and passes the risk of residual value to the lessor.

The FASB agrees with the capitalization approach and requires companies to capitalize all long-term leases.

A lease is a contractual agreement conveying ownership of certain property from one party to another party.

An essential element of the lease agreement is that the lessor conveys less than the total interest in the property.

An operating lease refers to a lease agreement for property used in the operations of the lessee's business.

If a lease is noncancelable and contains a bargain purchase option, the lessee shall classify and account for the arrangement as a capital lease.

Under the operating method, the lessee assigns rent to the periods benefiting from the use of the asset and does not record the commitment to make future payments.

Under the capital lease method, the lessee treats the lease transaction as if an asset were being purchased on an installment payment basis.

The lessee records a capital lease as an asset, using the fair market value of the leased asset on the date of the lease as the asset's cost.

10.

When the lessor accounts for minimum lease payments, the basis for capitalization includes the guaranteed residual value but excludes the unguaranteed residual value.

11.

A lessee would treat guaranteed residual value as an additional lease payment that will be paid in property or cash, or both, at the end of the lease term.

12.

A lease that contains a purchase option must be capitalized by the lessee.

13.

Executory costs should be excluded by the lessee in computing the present value of the minimum lease payments.

14.

A capitalized leased asset is always depreciated over the term of the lease by the lessee.

15.

A lessee records interest expense in both a capital lease and an operating lease.

16.

A benefit of leasing to the lessor is the return of the leased property at the end of the lease term.

17.

One of the major distinctions between an operating lease and a capital lease is the fact that annual rental payments under a capital lease are higher than rental payments under an operating lease.

17 - 6

Test Bank for Intermediate Accounting, Second Edition

18.

A lessor must be a manufacturer or dealer to realize a profit (or loss) at the inception of a lease that requires application of sales-type lease accounting.

19.

All leases that do not qualify as direct financing or sales-type leases are classified and accounted for by the lessors as capital leases.

20.

The distinction between a direct-financing lease and a sales-type lease is the presence or absence of a transfer of title.

21.

Lessors classify and account for all leases that don’t qualify as sales-type leases as operating leases.

22.

Direct-financing leases are in substance the financing of an asset purchase by the lessee.

23.

Under the operating method, the lessor records each rental receipt as part interest revenue and part rental revenue.

24.

The interest revenue related to a lease transaction accounted for under the direct financing method should be reported as income over the lease term by use of the effective interest method.

25.

Companies that use sales-type leases recognize income later than if a direct-financing lease is used.

26.

The primary difference between a direct-financing lease and a sales-type lease is the manufacturer’s or dealer’s gross profit.

27.

The gross profit amount in a sales-type lease is greater when a guaranteed residual value exists.

28.

The FASB requires lessees and lessors to disclose certain information about leases in their financial statements or in the notes.

29.

During the term of the lease, assets recorded under capital leases are separately identified in the lessee's balance sheet.

30.

Lease disclosure requirements on the part of the lessor apply only to lessors whose predominant business activity is leasing.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5.

T F F T F

6. 7. 8. 9. 10.

T T T F F

11. 12. 13. 14. 15.

T F T F F

16. 17. 18. 19. 20.

T F F F F

21. 22. 23. 24. 25.

F T F T F

26. 27. 28. 29. 30.

T F T T T

Accounting for Leases

17 - 7

MULTIPLE CHOICE—Conceptual 31.

Major reasons why a company may become involved in leasing to other companies is(are) a. interest revenue. b. high residual values. c. tax incentives. d. all of these.

32.

Which of the following is an advantage of leasing? a. Off-balance-sheet financing b. Less costly financing c. 100% financing at fixed rates d. All of these

33.

Which of the following best describes current practice in accounting for leases? a. Leases are not capitalized. b. Leases similar to installment purchases are capitalized. c. All long-term leases are capitalized. d. All leases are capitalized.

34.

While only certain leases are currently accounted for as a sale or purchase, there is theoretic justification for considering all leases to be sales or purchases. The principal reason that supports this idea is that a. all leases are generally for the economic life of the property and the residual value of the property at the end of the lease is minimal. b. at the end of the lease the property usually can be purchased by the lessee. c. a lease reflects the purchase or sale of a quantifiable right to the use of property. d. during the life of the lease the lessee can effectively treat the property as if it were owned by the lessee.

35.

An essential element of a lease conveyance is that the a. lessor conveys less than his or her total interest in the property. b. lessee provides a sinking fund equal to one year's lease payments. c. property that is the subject of the lease agreement must be held for sale by the lessor prior to the drafting of the lease agreement. d. term of the lease is substantially equal to the economic life of the leased property.

36.

Which of the following is not one of the commonly discussed advantages of leasing? a. Leasing permits 100% financing versus 60 to 80% when purchasing an asset. b. Leasing permits rapid changes in equipment, thus reducing the risk of obsolescence. c. Leasing improves financial ratios by increasing assets without a corresponding increase in debt. d. Leasing permits write-off of the full cost of the asset.

37.

The accounting principles used in lease accounting attempt to provide symmetry between the lessee and lessor. With respect to lease rental payments in a capital lease, they are considered to consist of both interest and principal by the Lessee Lessor a. Yes No b. No Yes c. Yes Yes d. No No

17 - 8

Test Bank for Intermediate Accounting, Second Edition

38.

Which of the following lease arrangements would most likely be accounted for as an operating lease by the lessee? a. The lease agreement runs for 15 years and the economic life of the leased property is 20 years. b. The present value of the minimum lease payments is $55,600 and the fair value of the leased property is $60,000. c. The lease agreement allows the lessee the right to purchase the leased asset for $1.00 when half of the asset's economic useful life has expired. d. The lessee may renew the two-year lease for an additional two years at the same rental.

39.

If the lease term is equal to 75% or more of the estimated economic life of the leased property, the asset should be capitalized by the lessee. The one exception to this rule is when the a. lease term is for 5 years or less. b. lessee does not intend to exercise its option to purchase the asset at the conclusion of the lease term. c. lessor refuses to offer a bargain purchase option and the leased property will revert to the lessor at the end of the lease term. d. inception of the lease occurs during the last 25% of the life of the asset.

40.

Minimum lease payments are payments the lessee is obligated to make or can be expected to make in connection with the leased property. In computing minimum lease payments, all of the following would be included except the a. present value of the cost of the leased asset. b. penalty for failure to renew or extend the lease. c. bargain purchase option. d. minimum rental payments.

41.

Under an operating lease, a rent expense accrues day by day to the lessee as the property is used. This amount of rent expense is a. capitalized in an asset account and charged against income as the asset depreciates. b. capitalized in an asset account and netted against the corresponding lease liability each time a balance sheet is prepared. c. charged against income in the periods benefiting from the use of the asset. d. charged against income at the same rate as the reduction in the corresponding lease liability.

42.

What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee? a. No impact as the option does not enter into the transaction until the end of the lease term. b. The lessee must increase the present value of the minimum lease payments by the present value of the option price. c. The lessee must decrease the present value of the minimum lease payments by the present value of the option price. d. The minimum lease payments would be increased by the present value of the option price if, at the time of the lease agreement, it appeared certain that the lessee would exercise the option at the end of the lease and purchase the asset at the option price.

Accounting for Leases

17 - 9

43.

The amount to be recorded as the cost of an asset under capital lease is equal to the a. present value of the minimum lease payments. b. present value of the minimum lease payments or the fair value of the asset, whichever is lower. c. present value of the minimum lease payments plus the present value of any unguaranteed residual value. d. carrying value of the asset on the lessor's books.

44.

The methods of accounting for a lease by the lessee are a. operating and capital lease methods. b. operating, sales, and capital lease methods. c. operating and leveraged lease methods. d. none of these.

45.

Which of the following is a correct statement of one of the capitalization criteria? a. The lease transfers ownership of the property to the lessor. b. The lease contains a purchase option. c. The lease term is equal to or more than 75% of the estimated economic life of the leased property. d. The minimum lease payments (excluding executory costs) equal or exceed 90% of the fair value of the leased property.

46.

Minimum lease payments may include a a. penalty for failure to renew. b. bargain purchase option. c. guaranteed residual value. d. any of these.

47.

Executory costs include a. maintenance. b. property taxes. c. insurance. d. all of these.

48.

In computing the present value of the minimum lease payments, the lessee should a. use its incremental borrowing rate in all cases. b. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is higher, assuming that the implicit rate is known to the lessee. c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee. d. none of these.

49.

In computing depreciation of a leased asset, the lessee should subtract a. a guaranteed residual value and depreciate over the term of the lease. b. an unguaranteed residual value and depreciate over the term of the lease. c. a guaranteed residual value and depreciate over the life of the asset. d. an unguaranteed residual value and depreciate over the life of the asset.

17 - 10 Test Bank for Intermediate Accounting, Second Edition 50.

In the earlier years of a lease, from the lessee's perspective, the use of the a. capital method will enable the lessee to report higher income, compared to the operating method. b. capital method will cause debt to increase, compared to the operating method. c. operating method will cause income to decrease, compared to the capital method. d. operating method will cause debt to increase, compared to the capital method.

51.

A lessee with a capital lease containing a bargain purchase option should depreciate the leased asset over the a. asset's remaining economic life. b. term of the lease. c. life of the asset or the term of the lease, whichever is shorter. d. life of the asset or the term of the lease, whichever is longer.

52.

If a lease transaction is accorded capital lease treatment rather than operating lease treatment, it would have what impact on the following financial items of the lessee? Return on Reported Debt Total Assets Total Assets a. Increase Increase Increase b. Increase Increase Decrease c. Decrease Increase Increase d. Increase Increase No Effect

53.

In addition to the four criteria that a lessee must assess in deciding whether to classify a lease transaction as a capital lease, a lessor must meet two additional criteria. These include (1) the collectibility of the payments required from the lessee is reasonably predictable, and (2) a. the lease includes an element of manufacturer or dealer profit. b. the lessee has the ability to meet the requirements of the guaranteed residual value. c. executory costs are provided for in a manner which makes their ultimate payment virtually a certainty. d. no important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease.

54.

Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct-financing lease of a lessor? Transfers Ownership Contains Bargain Collectibility of Lease Any Important By End Of Lease? Purchase Option? Payments Assured? Uncertainties? a. No Yes Yes No b. Yes No No No c. Yes No No Yes d. No Yes Yes Yes

55.

Which of the following would not be included in the Lease Receivable account? a. Guaranteed residual value b. Unguaranteed residual value c. A bargain purchase option d. All would be included

Accounting for Leases

17 - 11

56.

In a lease that is appropriately recorded as a direct-financing lease by the lessor, income revenue a. should be recognized over the period of the lease using the interest method. b. should be recognized over the period of the lease using the straight-line method. c. does not arise. d. should be recognized at the lease's expiration.

57.

In order to properly record a direct-financing lease, the lessor needs to know how to calculate the lease receivable. The lease receivable in a direct-financing lease is best defined as a. the amount of funds the lessor has tied up in the asset which is the subject of the direct-financing lease. b. the difference between the lease payments receivable and the fair market value of the leased property. c. the present value of minimum lease payments. d. the total book value of the asset less any accumulated depreciation recorded by the lessor prior to the lease agreement.

58.

The primary difference between a direct-financing lease and a sales-type lease is the a. manner in which rental receipts are recorded as rental income. b. amount of the depreciation recorded each year by the lessor. c. recognition of the manufacturer's or dealer's profit at the inception of the lease. d. allocation of executory costs by the lessor to periods benefited by the lease arrangements.

59.

A lessor with a sales-type lease involving an unguaranteed residual value available to the lessor at the end of the lease term will report sales revenue in the period of inception of the lease at which of the following amounts? a. The minimum lease payments plus the unguaranteed residual value. b. The present value of the minimum lease payments. c. The cost of the asset to the lessor, less the present value of any unguaranteed residual value. d. The present value of the minimum lease payments plus the present value of the unguaranteed residual value.

60.

For a sales-type lease, a. the sales price includes the present value of the unguaranteed residual value. b. the present value of the guaranteed residual value is deducted to determine the cost of goods sold. c. the gross profit will be the same whether the residual value is guaranteed or unguaranteed. d. none of these.

61.

The Lease Liability account should be disclosed as a. all current liabilities. b. all noncurrent liabilities. c. current portions in current liabilities and the remainder in noncurrent liabilities. d. deferred credits.

17 - 12 Test Bank for Intermediate Accounting, Second Edition 62.

With respect to the computation of minimum lease payments by the lessee, how are the following items handled in the computation? Guaranteed Unguaranteed Residual Value Residual Value a. Included Excluded b. Included Included c. Excluded Included d. Excluded Excluded

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

31. 32. 33. 34. 35.

d d b c a

36. 37. 38. 39. 40.

c c d d a

41. 42. 43. 44. 45.

c b b a c

46. 47. 48. 49. 50.

d d c a b

51. 52. 53. 54. 55.

a b d a d

56. 57. 58. 59. 60.

a c c b c

61. 62.

c a

MULTIPLE CHOICE—Computational 63.

On December 1, 2008, Perez Corporation leased office space for 10 years at a monthly rental of $90,000. On that date Perez paid the landlord the following amounts: Rent deposit First month's rent Last month's rent Installation of new walls and offices

$ 90,000 90,000 90,000 495,000 $765,000

The entire amount of $765,000 was charged to rent expense in 2008. What amount should Perez have charged to expense for the year ended December 31, 2008? a. $90,000 b. $94,125 c. $184,125 d. $495,000 64.

On January 1, 2008, Penn Corporation signed a ten-year noncancelable lease for certain machinery. The terms of the lease called for Penn to make annual payments of $100,000 at the end of each year for ten years with title to pass to Penn at the end of this period. The machinery has an estimated useful life of 15 years and no salvage value. Penn uses the straight-line method of depreciation for all of its fixed assets. Penn accordingly accounted for this lease transaction as a capital lease. The lease payments were determined to have a present value of $671,008 at an effective interest rate of 8%. With respect to this capitalized lease, Penn should record for 2008 a. lease expense of $100,000. b. interest expense of $44,734 and depreciation expense of $38,068. c. interest expense of $53,681 and depreciation expense of $44,734. d. interest expense of $45,681 and depreciation expense of $67,101.

Accounting for Leases

17 - 13

Use the following information for questions 65 through 70. (Annuity tables on page 20-21.) On January 1, 2008, Dexter, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Garr Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the end of each year. (b) The fair value of the building on January 1, 2008 is $3,000,000; however, the book value to Garr is $2,500,000. (c) The building has an estimated economic life of 10 years, with no residual value. Dexter depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Dexter's incremental borrowing rate is 11% per year. Garr Warehouse Co. set the annual rental to ensure a 10% rate of return. The implicit rate of the lessor is known by Dexter, Inc. (f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property. 65.

What is the amount of the minimum annual lease payment? (Rounded to the nearest dollar.) a. $188,237 b. $478,236 c. $488,236 d. $498,236

66.

What is the amount of the total annual lease payment? a. $188,237 b. $478,237 c. $488,237 d. $498,237

67.

From the lessor's viewpoint, what type of lease is involved? a. Sales-type lease b. Sale-leaseback c. Direct-financing lease d. Operating lease

68.

From the lessee's viewpoint, what type of lease exists in this case? a. Sales-type lease b. Sale-leaseback c. Capital lease d. Operating lease

69.

Dexter, Inc. would record depreciation expense on this storage building in 2008 of (Rounded to the nearest dollar.) a. $0. b. $250,000. c. $300,000. d. $488,237.

17 - 14 Test Bank for Intermediate Accounting, Second Edition 70.

If the lease were nonrenewable, there was no purchase option, title to the building does not pass to the lessee at termination of the lease and the lease were only for eight years, what type of lease would this be for the lessee? a. Sales-type lease b. Direct-financing lease c. Operating lease d. Capital lease

71.

Huffman Company leases a machine from Lincoln Corp. under an agreement which meets the criteria to be a capital lease for Huffman. The six-year lease requires payment of $102,000 at the beginning of each year, including $15,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor's implicit rate is 8% and is known by the lessee. The present value of an annuity due of 1 for six years at 10% is 4.79079. The present value of an annuity due of 1 for six years at 8% is 4.99271. Huffman should record the leased asset at a. $509,256. b. $488,661. c. $434,366. d. $416,799.

72.

On December 31, 2007, Pool Corporation leased a ship from Renn Company for an eightyear period expiring December 30, 2015. Equal annual payments of $200,000 are due on December 31 of each year, beginning with December 31, 2007. The lease is properly classified as a capital lease on Pool's books. The present value at December 31, 2007 of the eight lease payments over the lease term discounted at 10% is $1,173,685. Assuming all payments are made on time, the amount that should be reported by Pool Corporation as the total obligation under capital leases on its December 31, 2008 balance sheet is a. $1,091,054. b. $1,000,159. c. $871,054. d. $1,200,000.

Use the following information for questions 73 and 74. On January 1, 2008, Dalton Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Dalton to make annual payments of $50,000 at the beginning of each year for five years with title to pass to Dalton at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Dalton uses the straight-line method of depreciation for all of its fixed assets. Dalton accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $208,493 at an effective interest rate of 10%. 73.

In 2008, Dalton should record interest expense of a. $15,849. b. $29,151. c. $20,849. d. $34,151.

74.

In 2009, Dalton should record interest expense of a. $10,849. b. $12,434. c. $15,849. d. $17,434.

Accounting for Leases 75.

17 - 15

On December 31, 2008, Dodd Corporation leased a plane from Aero Company for an eight-year period expiring December 30, 2016. Equal annual payments of $150,000 are due on December 31 of each year, beginning with December 31, 2008. The lease is properly classified as a capital lease on Dodd’s books. The present value at December 31, 2008 of the eight lease payments over the lease term discounted at 10% is $880,264. Assuming the first payment is made on time, the amount that should be reported by Dodd Corporation as the lease liability on its December 31, 2008 balance sheet is a. $880,264. b. $818,290. c. $792,238. d. $730,264.

Use the following information for questions 76 and 77. On January 1, 2008, Carley Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Carley to make annual payments of $60,000 at the end of each year for five years with title to pass to Carley at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Carley uses the straight-line method of depreciation for all of its fixed assets. Carley accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $227,448 at an effective interest rate of 10%. 76.

With respect to this capitalized lease, for 2008 Carley should record a. rent expense of $60,000. b. interest expense of $22,745 and depreciation expense of $45,489. c. interest expense of $22,745 and depreciation expense of $32,493. d. interest expense of $30,000 and depreciation expense of $45,489.

77.

With respect to this capitalized lease, for 2009 Carley should record a. interest expense of $22,745 and depreciation expense of $32,493. b. interest expense of $20,469 and depreciation expense of $32,493. c. interest expense of $19,019 and depreciation expense of $32,493. d. interest expense of $14,469 and depreciation expense of $32,493.

78.

Barkley Corporation is a lessee with a capital lease. The asset is recorded at $450,000 and has an economic life of 8 years. The lease term is 5 years. The asset is expected to have a market value of $150,000 at the end of 5 years, and a market value of $50,000 at the end of 8 years. The lease agreement provides for the transfer of title of the asset to the lessee at the end of the lease term. What amount of depreciation expense would the lessee record for the first year of the lease? a. $90,000 b. $80,000 c. $60,000 d. $50,000

17 - 16 Test Bank for Intermediate Accounting, Second Edition Use the following information for questions 79 through 84. (Annuity tables on pages 17-20 and 17-21.) Hay Corporation enters into an agreement with Marly Rentals Co. on January 1, 2008 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $155,213 are due on December 31 of each year. (b) The fair value of the machine on January 1, 2008, is $400,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Hay depreciates all machinery it owns on a straight-line basis. (d) Hay's incremental borrowing rate is 10% per year. Hay does not have knowledge of the 8% implicit rate used by Marly. (e) Immediately after signing the lease, Marly finds out that Hay Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful. 79.

What type of lease is this from Hay Corporation's viewpoint? a. Operating lease b. Capital lease c. Sales-type lease d. Direct-financing lease

80.

If Hay accounts for the lease as an operating lease, what expenses will be recorded as a consequence of the lease during the fiscal year ended December 31, 2008? a. Depreciation Expense b. Rent Expense c. Interest Expense d. Depreciation Expense and Interest Expense

81.

If the present value of the future lease payments is $400,000 at January 1, 2008, what is the amount of the reduction in the lease liability for Hay Corp. in the second full year of the lease if Hay Corp. accounts for the lease as a capital lease? (Rounded to the nearest dollar.) a. $115,213 b. $123,213 c. $126,734 d. $133,070

82.

From the viewpoint of Marly, what type of lease agreement exists? a. Operating lease b. Capital lease c. Sales-type lease d. Direct-financing lease

83.

If Marly records this lease as a direct-financing lease, what amount would be recorded as Lease Receivable at the inception of the lease? a. $155,213 b. $385,991 c. $400,000 d. $465,638

Accounting for Leases

17 - 17

84.

Which of the following lease-related revenue and expense items would be recorded by Marly if the lease is accounted for as an operating lease? a. Rental Revenue b. Interest Revenue c. Depreciation Expense d. Rental Revenue and Depreciation Expense

85.

Sele Company leased equipment to Snead Company on July 1, 2007, for a one-year period expiring June 30, 2008, for $60,000 a month. On July 1, 2008, Sele leased this piece of equipment to Quirk Company for a three-year period expiring June 30, 2011, for $75,000 a month. The original cost of the equipment was $4,800,000. The equipment, which has been continually on lease since July 1, 2003, is being depreciated on a straightline basis over an eight-year period with no salvage value. Assuming that both the lease to Snead and the lease to Quirk are appropriately recorded as operating leases for accounting purposes, what is the amount of income (expense) before income taxes that each would record as a result of the above facts for the year ended December 31, 2008? Sele Snead Quirk a. $210,000 $(360,000) $(450,000) b. $210,000 $(360,000) $(750,000) c. $810,000 $(60,000) $(150,000) d. $810,000 $(660,000) $(450,000)

Use the following information for questions 86 and 87. Eddy leased equipment to Hoyle Company on May 1, 2008. At that time the collectibility of the minimum lease payments was not reasonably predictable. The lease expires on May 1, 2009. Hoyle could have bought the equipment from Eddy for $3,200,000 instead of leasing it. Eddy's accounting records showed a book value for the equipment on May 1, 2008, of $2,800,000. Eddy's depreciation on the equipment in 2008 was $360,000. During 2008, Hoyle paid $720,000 in rentals to Eddy for the 8-month period. Eddy incurred maintenance and other related costs under the terms of the lease of $64,000 in 2008. After the lease with Hoyle expires, Eddy will lease the equipment to another company for two years. 86.

Ignoring income taxes, the amount of expense incurred by Hoyle from this lease for the year ended December 31, 2008, should be a. $296,000. b. $360,000. c. $656,000. d. $720,000.

87.

The income before income taxes derived by Eddy from this lease for the year ended December 31, 2008, should be a. $296,000. b. $360,000. c. $656,000. d. $720,000.

88.

Hite Company has a machine with a cost of $400,000 which also is its fair market value on the date the machine is leased to Rich Company. The lease is for 6 years and the machine is estimated to have an unguaranteed residual value of $40,000. If the lessor's interest rate implicit in the lease is 12%, the six beginning-of-the-year lease payments would be

17 - 18 Test Bank for Intermediate Accounting, Second Edition a. b. c. d. 89.

$92,361. $82,465. $78,180. $66,667.

Estes Co. leased a machine to Dains Co. Assume the lease payments were made on the basis that the residual value was guaranteed and Estes gets to recognize all the profits, and at the end of the lease term, before the lessee transfers the asset to the lessor, the leased asset and obligation accounts have the following balances: Leased equipment under capital lease Less accumulated depreciation--capital lease

$400,000 384,000 $ 16,000

Interest payable Obligations under capital leases

$ 1,520 14,480 $16,000

If, at the end of the lease, the fair market value of the residual value is $8,800, what gain or loss should Estes record? a. $6,480 gain b. $7,120 loss c. $7,200 loss d. $8,800 gain 90.

Durham Company leased machinery to Santi Company on July 1, 2008, for a ten-year period expiring June 30, 2018. Equal annual payments under the lease are $75,000 and are due on July 1 of each year. The first payment was made on July 1, 2008. The rate of interest used by Durham and Santi is 9%. The cash selling price of the machinery is $525,000 and the cost of the machinery on Durham's accounting records was $465,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Durham, what amount of interest revenue would Durham record for the year ended December 31, 2008? a. $47,250 b. $40,500 c. $20,250 d. $0

91.

Eby Company leased equipment to the Mills Company on July 1, 2008, for a ten-year period expiring June 30, 2018. Equal annual payments under the lease are $80,000 and are due on July 1 of each year. The first payment was made on July 1, 2008. The rate of interest contemplated by Eby and Mills is 9%. The cash selling price of the equipment is $560,000 and the cost of the equipment on Eby's accounting records was $496,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Eby, what is the amount of profit on the sale and the interest revenue that Eby would record for the year ended December 31, 2008? a. $64,000 and $50,400 b. $64,000 and $43,200 c. $64,000 and $21,600 d. $0 and $0

Accounting for Leases

17 - 19

Use the following information for questions 92 and 93. Risen Company, a dealer in machinery and equipment, leased equipment to Foran, Inc., on July 1, 2008. The lease is appropriately accounted for as a sale by Risen and as a purchase by Foran. The lease is for a 10-year period (the useful life of the asset) expiring June 30, 2018. The first of 10 equal annual payments of $621,000 was made on July 1, 2008. Risen had purchased the equipment for $3,900,000 on January 1, 2008, and established a list selling price of $5,400,000 on the equipment. Assume that the present value at July 1, 2008, of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $4,500,000. 92.

Assuming that Foran, Inc. uses straight-line depreciation, what is the amount of depreciation and interest expense that Foran should record for the year ended December 31, 2008? a. $225,000 and $155,160 b. $225,000 and $180,000 c. $270,000 and $155,160 d. $270,000 and $180,000

93.

What is the amount of profit on the sale and the amount of interest income that Risen should record for the year ended December 31, 2008? a. $0 and $155,160 b. $600,000 and $155,160 c. $600,000 and $180,000 d. $900,000 and $360,000

94.

Mayer Company leased equipment from Lennon Company on July 1, 2008, for an eightyear period expiring June 30, 2016. Equal annual payments under the lease are $300,000 and are due on July 1 of each year. The first payment was made on July 1, 2008. The rate of interest contemplated by Mayer and Lennon is 8%. The cash selling price of the equipment is $1,861,875 and the cost of the equipment on Lennon's accounting records was $1,650,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Lennon, what is the amount of profit on the sale and the interest income that Lennon would record for the year ended December 31, 2008? a. $0 and $0 b. $0 and $62,475 c. $211,875 and $62,475 d. $211,875 and $74,475

Use the following information for questions 95 through 98. Bohl Co. purchases land and constructs a service station and car wash for a total of $360,000. At January 2, 2007, when construction is completed, the facility and land on which it was constructed are sold to a major oil company for $400,000 and immediately leased from the oil company by Bohl. Fair value of the land at time of the sale was $40,000. The lease is a 10-year, noncancelable lease. Bohl uses straight-line depreciation for its other various business holdings. The economic life of the facility is 15 years with zero salvage value. Title to the facility and land will pass to Bohl at termination of the lease. A partial amortization schedule for this lease is as follows: Payments Interest Amortization Balance Jan. 2, 2007 $400,000 Dec. 31, 2007 $65,098 $40,000 $25,098 374,901 Dec. 31, 2008 65,098 37,490 27,607 347,293 Dec. 31, 2009 65,098 34,729 30,368 316,925

17 - 20 Test Bank for Intermediate Accounting, Second Edition 95.

From the viewpoint of the lessor, what type of lease is involved above? a. Sales-type lease b. Operating lease c. Direct-financing lease d. None of these

96.

What is the discount rate implicit in the amortization schedule presented above? a. 12% b. 10% c. 8% d. 6%

97.

The total lease-related expenses recognized by the lessee during 2008 is which of the following? (Rounded to the nearest dollar.) a. $64,000 b. $65,098 c. $73,490 d. $61,490

98.

What is the amount of the lessee's liability to the lessor after the December 31, 2009 payment? (Rounded to the nearest dollar.) a. $400,000 b. $374,902 c. $347,294 d. $316,925

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

63. 64. 65. 66. 67. 68.

b c c d a c

69. 70. 71. 72. 73. 74.

c d c c a b

75. 76. 77. 78. 79. 80.

d c c d b b

81. 82. 83. 84. 85. 86.

c a c d a d

87. 88. 89. 90. 91. 92.

a b c c c a

93. 94. 95. 96. 97. 98.

b c c b d d

Future Value of Ordinary Annuity of 1 Period 1 2 3 4 5 6 7 8 9 10

5% 1.00000 2.05000 3.15250 4.31013 5.52563 6.80191 8.14201 9.54911 11.02656 12.57789

6% 1.00000 2.06000 3.18360 4.37462 5.63709 6.97532 8.39384 9.89747 11.49132 13.18079

8% 1.00000 2.08000 3.24640 4.50611 5.86660 7.33592 8.92280 10.63663 12.48756 14.48656

10% 1.00000 2.10000 3.31000 4.64100 6.10510 7.71561 9.48717 11.43589 13.57948 15.93743

12% 1.00000 2.12000 3.37440 4.77933 6.35285 8.11519 10.08901 12.29969 14.77566 17.54874

Accounting for Leases

17 - 21

Present Value of an Ordinary Annuity of 1 Period 1 2 3 4 5 6 7 8 9 10

5% .95238 1.85941 2.72325 3.54595 4.32948 5.07569 5.78637 6.46321 7.10782 7.72173

6% .94340 1.83339 2.67301 3.46511 4.21236 4.91732 5.58238 6.20979 6.80169 7.36009

8% .92593 1.78326 2.57710 3.31213 3.99271 4.62288 5.20637 5.74664 6.24689 6.71008

10% .90909 1.73554 2.48685 3.16986 3.79079 4.35526 4.86842 5.33493 5.75902 6.14457

12% .89286 1.69005 2.40183 3.03735 3.60478 4.11141 4.56376 4.96764 5.32825 5.65022

MULTIPLE CHOICE—CPA Adapted 99.

Lease A does not contain a bargain purchase option, but the lease term is equal to 90 percent of the estimated economic life of the leased property. Lease B does not transfer ownership of the property to the lessee by the end of the lease term, but the lease term is equal to 75 percent of the estimated economic life of the leased property. How should the lessee classify these leases? Lease A Lease B a. Operating lease Capital lease b. Operating lease Operating lease c. Capital lease Capital lease d. Capital lease Operating lease

100.

On December 31, 2008, Mendez, Inc. leased machinery with a fair value of $840,000 from Cey Rentals Co. The agreement is a six-year noncancelable lease requiring annual payments of $160,000 beginning December 31, 2008. The lease is appropriately accounted for by Mendez as a capital lease. Mendez's incremental borrowing rate is 11%. Mendez knows the interest rate implicit in the lease payments is 10%. The present value of an annuity due of 1 for 6 years at 10% is 4.7908. The present value of an annuity due of 1 for 6 years at 11% is 4.6959. In its December 31, 2008 balance sheet, Mendez should report a lease liability of a. $606,528. b. $680,000. c. $751,344. d. $766,528.

101.

On December 31, 2007, Patten Co. leased a machine from Bass, Inc. for a five-year period. Equal annual payments under the lease are $630,000 (including $30,000 annual executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2007, and the second payment was made on December 31, 2008. The five lease payments are discounted at 10% over the lease term. The present value of minimum lease payments at the inception of the lease and before the first annual payment was $2,502,000. The lease is appropriately accounted for as a capital lease by Patten. In its December 31, 2008 balance sheet, Patten should report a lease liability of

17 - 22 Test Bank for Intermediate Accounting, Second Edition a. b. c. d. 102.

$1,902,000. $1,872,000. $1,711,800. $1,492,200.

A lessee had a ten-year capital lease requiring equal annual payments. The reduction of the lease liability in year 2 should equal a. the current liability shown for the lease at the end of year 1. b. the current liability shown for the lease at the end of year 2. c. the reduction of the lease liability in year 1. d. one-tenth of the original lease liability.

Use the following information for questions 103 and 104. On January 2, 2008, Martinez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $150,000 starting at the end of the first year, with title passing to Martinez at the expiration of the lease. Martinez treated this transaction as a capital lease. The drill press has an estimated useful life of 15 years, with no salvage value. Martinez uses straight-line depreciation for all of its plant assets. Aggregate lease payments were determined to have a present value of $900,000, based on implicit interest of 10%. 103.

In its 2008 income statement, what amount of interest expense should Martinez report from this lease transaction? a. $0 b. $56,250 c. $75,000 d. $90,000

104.

In its 2008 income statement, what amount of depreciation expense should Martinez report from this lease transaction? a. $150,000 b. $100,000 c. $90,000 d. $60,000

105.

In a lease that is recorded as a sales-type lease by the lessor, interest revenue a. should be recognized in full as revenue at the lease's inception. b. should be recognized over the period of the lease using the straight-line method. c. should be recognized over the period of the lease using the effective interest method. d. does not arise.

106.

Castro Co. manufactures equipment that is sold or leased. On December 31, 2008, Castro leased equipment to Ermler for a five-year period ending December 31, 2013, at which date ownership of the leased asset will be transferred to Ermler. Equal payments under the lease are $220,000 (including $20,000 executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2008. Collectibility of the remaining lease payments is reasonably assured, and Castro has no material cost uncertainties. The normal sales price of the equipment is $770,000, and cost is $600,000. For the year ended December 31, 2008, what amount of income should Castro realize from the lease transaction?

Accounting for Leases a. b. c. d.

$170,000 $220,000 $230,000 $330,000

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

99. 100.

c a

101. 102.

d a

103. 104.

d d

105. 106.

c a

DERIVATIONS — Computational No.

Answer Derivation $495,000 1 (———— × —) = $94,125. 10 12

63.

$90,000 +

64.

$671,008 × .08 = $53,681, $671,008 ÷ 15 = $44,734.

65.

$3,000,000 ÷ 6.14457 = $488,236 (PV of Ordinary Annuity Table).

66.

$488,236 + $10,000 = $498,237.

67.

Conceptual, FV exceeds cost.

68.

Conceptual.

69.

$3,000,000 ÷ 10 = $300,000.

70.

8/10 = .8 > 75% of economic life.

71.

($102,000 - $15,000) × 4.99271 = $434,366.

72.

$1,173,685 – $200,000 = $973,685 × .10 = $97,369 $973,685 – ($200,000 – $97,369) = $871,054.

73.

($208,493 – $50,000) × .10 = $15,849.

74.

[$158,493 – ($50,000 - $15,849)] × .10 = $12,434.

75.

$880,264 – $150,000 = $730,264.

76.

$227,448 × .10 = $22,745; ($227,448 – 0) ÷ 7 = $32,493.

77.

[$227,448 – ($60,000 – $22,745)] × .10 = $19,019.

78.

($450,000 – $50,000) ÷ 8 = $50,000.

17 - 23

17 - 24 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational (cont.) No. 79.

Answer Derivation b

$155,213 × 2.48685 = $385,991; $385,991 ———— = 96% > 90%. $400,000

80.

Conceptual.

81.

$400,000 – [$155,213 – ($400,000 × .1)] = $284,787. $155,213 – ($284,787 ×.1) = $126,734.

82.

Fails to meet Group II requirements.

83.

Fair value = $400,000.

84.

Conceptual.

85.

Sele: Snead: Quirk:

86.

$720,000.

87.

$720,000 – $64,000 – $360,000 = $296,000.

88.

[$400,000 – ($40,000 × .50663)] ÷ 4.60478 = $82,465.

89.

$8,800 – $16,000 = ($7,200).

90.

($525,000 – $75,000) × .09 × 6/12 = $20,250.

91.

$560,000 – $496,000 = $64,000; ($560,000 – $80,000) × .09 × 6/12 = $21,600.

92.

$4,500,000 1 ————— × — = $225,000. 10 2

($60,000 × 6) + ($75,000  6) – (4,800,000 ÷ 8) = $210,000 ($60,000) × 6 = $(360,000) ($75,000) × 6 = $(450,000).

($4,500,000 – $621,000) × .04 = $155,160. 93.

$4,500,000 – $3,900,000 = $600,000. ($4,500,000 – $621,000) × .04 = $155,160.

94.

$1,861,875 – $1,650,000 = $211,875. ($1,861,875 – $300,000) × .04 = $62,475.

95.

Conceptual.

96.

$40,000 $400,000 ———— = 10% or ————— = 6.1446* $400,000 $65,098.13 *6.1446 = PV factor of ordinary annuity of $1 for 10 years at 10%.

Accounting for Leases

17 - 25

DERIVATIONS — Computational (cont.) No.

Answer Derivation

97.

[($400,000 – $40,000) ÷ 15] + $37,490 = $61,490.

98.

$316,925 (See amortization table.)

DERIVATIONS — CPA Adapted No.

Answer Derivation

99.

Conceptual.

100.

($160,000 × 4.7908) – $160,000 = $606,528.

101.

$2,502,000 – $630,000 + $30,000 = $1,902,000 (2007). $1,902,000 – [$600,000 – ($1,902,000 × .10)] = $1,492,200 (2008).

102.

Conceptual.

103.

$900,000 × .10 = $90,000.

104.

$900,000 ÷ 15 = $60,000.

105.

Conceptual.

106.

$770,000 – $600,000 = $170,000.

EXERCISES Ex. 17-107—Capital lease (Essay). Explain the procedures used by the lessee to account for a capital lease.

Solution 17-107 When the capital lease method is used, the lessee treats the lease transactions as if the asset were being purchased. The asset and liability are recorded at the lower of (1) the present value of the minimum lease payments (excluding executory costs) or (2) the fair value of the asset at the inception of the lease. The present value of the lease payments is computed using the lessee's incremental borrowing rate, unless the implicit rate used by the lessor is lower and the lessee has knowledge of it. The effective-interest method is used to allocate each lease payment between interest expense and a reduction of the lease liability. If the lease transfers ownership or contains a bargain purchase option, the asset is amortized in a manner consistent with the lessee's normal depreciation policy on assets owned, over the economic life of the asset and allowing for residual value. If the lease does not transfer ownership or contain a bargain purchase option, the leased asset is amortized over the lease term.

17 - 26 Test Bank for Intermediate Accounting, Second Edition Ex. 17-108—Capital lease amortization and journal entries. Windom Co. as lessee records a capital lease of machinery on January 1, 2008. The seven annual lease payments of $350,000 are made at the end of each year. The present value of the lease payments at 10% is $1,704,000. Windom uses the effective-interest method of amortization and sum-of-the-years'-digits depreciation (no residual value). Instructions (Round to the nearest dollar.) (a) Prepare an amortization table for 2008 and 2009. (b) Prepare all of Windom 's journal entries for 2008.

Solution 17-108 (a) Date 1/1/08 12/31/08 12/31/09 (b)

Annual Payments

10% Interest

Reduction Of Liability

$350,000 350,000

$170,400 152,440

$179,600 197,560

Lease Liability $1,704,000 1,524,400 1,326,840

Leased Machinery ....................................................................... 1,704,000 Lease Liability .................................................................. Interest Expense.......................................................................... Lease Liability .............................................................................. Cash ................................................................................

170,400 179,600

Depreciation Expense (7/28 × $1,704,000) .................................. Accumulated Depreciation ..............................................

426,000

1,704,000

350,000

426,000

Ex. 17-109—Operating lease. Kirby Co. purchased a machine on January 1, 2008, for $1,000,000 for the express purpose of leasing it. The machine is expected to have a five-year life, no salvage value, and be depreciated on a straight-line monthly basis. On April 1, 2008, under a cancelable lease, Kirby leased the machine to Harley Company for $300,000 a year for a four-year period ending March 31, 2012. Kirby incurred total maintenance and other related costs under the provisions of the lease of $15,000 relating to the year ended December 31, 2008. Harley paid $300,000 to Kirby on April 1, 2008. Instructions [Assume the operating method is appropriate for parts (a) and (b).] (a) Under the operating method, what should be the income before income taxes derived by Kirby Co. from this lease for the year ended December 31, 2008? (b) What should be the amount of rent expense incurred by Harley from this lease for the year ended December 31, 2008?

Accounting for Leases

17 - 27

Solution 17-109 (a)

(b)

Revenue 4/1/08—12/31/08 ($300,000 × 9/12) Expenses: Depreciation ($200,000 × 9/12) Maintenance, etc. Income before taxes

$225,000 $150,000 15,000

165,000 $ 60,000

Rent expense, 4/1/08—12/31/08 ($300,000 × 9/12) = $225,000.

Ex. 17-110—Lease criteria for classification by lessor. What are the criteria that must be satisfied for a lessor to classify a lease as a direct-financing or sales-type lease?

Solution 17-110 In order for a lessor to classify a lease as a direct-financing or a sales-type lease, the lease at the date of inception must satisfy one or more of the following Group I criteria (a, b, c, and d) and both of the following Group II criteria (a and b): Group I (a) The lease transfers ownership of the property to the lessee. (b) The lease contains a bargain purchase option. (c) The lease term is equal to 75% or more of the estimated economic life of the leased property. (d) The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90% of the fair value of the leased property. Group II (a) Collectibility of the payments required from the lessee is reasonably predictable. (b) No important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease.

Ex. 17-111—Direct-financing lease (essay). Explain the procedures used to account for a direct-financing lease.

Solution 17-111 The lessor records the present value of the minimum lease payments (excluding executory costs) plus the present value of the unguaranteed residual value (a guaranteed residual value is included in the minimum lease payments) as Lease Receivable and removes the asset from the books. The lessor records payments received as a reduction in Lease Receivable and Interest Revenue. Interest revenue is recognized by using the effective-interest method. The implicit interest rate is applied to the declining balance of the Lease Receivable balance. The implicit rate is the rate of interest that will discount the minimum lease payments (excluding executory costs) and the unguaranteed residual value to the fair value of the asset at the inception of the lease.

17 - 28 Test Bank for Intermediate Accounting, Second Edition Ex. 17-112—Lessor accounting—sales-type lease. Piper Corp. is a manufacturer of truck trailers. On January 1, 2008, Piper Corp. leases ten trailers to Runyan Company under a six-year noncancelable lease agreement. The following information about the lease and the trailers is provided: 1.

Equal annual payments that are due on December 31 each year provide Piper Corp. with an 8% return on net investment (present value factor for 6 periods at 8% is 4.62288).

Titles to the trailers pass to Runyan at the end of the lease.

The fair value of each trailer is $50,000. The cost of each trailer to Piper Corp. is $45,000. Each trailer has an expected useful life of nine years.

Collectibility of the lease payments is reasonably predictable and there are no important uncertainties surrounding the amount of costs yet to be incurred by Piper Corp.

Instructions (a) What type of lease is this for the lessor? Discuss. (b) Calculate the annual lease payment. (Round to nearest dollar.) (c) Prepare a lease amortization schedule for Piper Corp. for the first three years. (d) Prepare the journal entries for the lessor for 2008 and 2009 to record the lease agreement, the receipt of the lease rentals, and the recognition of income (assume the use of a perpetual inventory method and round all amounts to the nearest dollar).

Solution 17-112 (a)

It is a sales-type lease to the lessor, Piper Corp. Piper's (the manufacturer) profit upon sale is $50,000, which is recognized in the year of sale (2008). It is not an operating lease because title to the assets passes to the lessee, the present value ($500,000) of the minimum lease payments equals or exceeds 90% ($450,000) of the fair value of the leased trailers, collectibility is reasonably assured, and no important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor. The remaining accounting treatment is similar to that accorded a direct-financing lease.

(b)

($50,000 × 10) ÷ 4.62288 = $108,158.

(c)

Lease Amortization Schedule (Lessor)

Date 1/1/08 12/31/08 12/31/09 12/31/10 (d)

Annual Lease Rental

Interest on Lease Receivable

Lease Receivable Recovery

$108,158 108,158 108,158

$40,000 34,547 28,658

$68,158 73,611 79,500

January 1, 2008 Lease Receivable ........................................................................ Cost of Goods Sold...................................................................... Sales Revenue ................................................................. Inventory ..........................................................................

Lease Receivable $500,000 431,842 358,231 278,731

500,000 450,000 500,000 450,000

Accounting for Leases

17 - 29

Solution 17-112 (cont.) December 31, 2008 Cash............................................................................................ Lease Receivable ............................................................ Interest Revenue ............................................................. December 31, 2009 Cash............................................................................................ Lease Receivable ............................................................ Interest Revenue .............................................................

108,158 68,158 40,000 108,158 73,611 34,547

PROBLEMS Pr. 17-113—Lessee accounting—capital lease. Horton Company, as lessee, enters into a lease agreement on July 1, 2008, for equipment. The following data are relevant to the lease agreement: 1. The term of the noncancelable lease is 4 years, with no renewal option. Payments of $422,689 are due on June 30 of each year. 2. The fair value of the equipment on July 1, 2008 is $1,400,000. The equipment has an economic life of 6 years with no salvage value. 3. Horton depreciates similar machinery it owns on the sum-of-the-years'-digits basis. 4. The lessee pays all executory costs. 5. Horton's incremental borrowing rate is 10% per year. The lessee is aware that the lessor used an implicit rate of 8% in computing the lease payments (present value factor for 4 periods at 8%, 3.31213; at 10%, 3.16986. Instructions (a) Indicate the type of lease Horton Company has entered into and what accounting treatment is applicable. (b) Prepare the journal entries on Horton's books that relate to the lease agreement for the following dates: (Round all amounts to the nearest dollar. Include a partial amortization schedule.) 1. July 1, 2008. 2. December 31, 2008. 3. June 30, 2009. 4. December 31, 2009.

Solution 17-113 (a)

Capitalized amount: $422,689 × PV of an ordinary annuity for 4 periods at 8% $422,689 × 3.31213 = $1,400,000 Because the present value of the lease payments ($1,400,000) equals the fair value, $1,400,000, of the leased property, it is a capital lease and must be accounted for under the capital lease method.

17 - 30 Test Bank for Intermediate Accounting, Second Edition Solution 17-113 (cont.) (b)

July 1, 2008 Leased Equipment Under Capital Leases .............................. 1,400,000 Lease Liability ............................................................ December 31, 2008 Depreciation Expense ............................................................ Accumulated Depreciation—Capital Leases [($1,400,000 × 4/10) × 6/12] ...................................

1,400,000

280,000 280,000

Interest Expense ($112,000 × 6/12) ....................................... Interest Payable .........................................................

56,000 56,000

Lease Amortization Schedule Date 7/1/08 6/30/09 6/30/10 3.

Annual Lease Payment

Interest on Unpaid Obligation

Reduction of Lease Obligation

$422,689 422,689

$112,000 87,145

$310,689 335,544

June 30, 2009 Interest Expense ..................................................................... Lease Liability ......................................................................... Cash ............................................................................. (Interest payable entry assumed to have been reversed 1/1/09) December 31, 2009 Depreciation Expense ............................................................. Accumulated Depreciation—Capital Leases .................. [($1,400,000 × 4/10) × 6/12 plus ($1,400,000 × 3/10) × 6/12] Interest Expense ($87,145 × 6/12) .......................................... Interest Payable ............................................................

Balance of Lease Obligation $1,400,000 1,089,311 753,767

112,000 310,689 422,689

490,000 490,000

43,573 43,573

Pr. 17-114—Lessee accounting—capital lease. Forbes Company on January 1, 2008, enters into a five-year noncancelable lease, with four renewal options of one year each, for equipment having an estimated useful life of 10 years and a fair value to the lessor, Holt Corp., at the inception of the lease of $3,000,000. Forbes's incremental borrowing rate is 8%. Forbes uses the straight-line method to depreciate its assets. The lease contains the following provisions: 1. Rental payments of $219,000 including $19,000 for property taxes, payable at the beginning of each six-month period. 2. A termination penalty assuring renewal of the lease for a period of four years after expiration of the initial lease term. 3. An option allowing the lessor to extend the lease one year beyond the last renewal exercised by the lessee. 4. A guarantee by Forbes Company that Holt Corp. will realize $100,000 from selling the asset at the expiration of the lease. However, the actual residual value is expected to be $60,000.

Accounting for Leases

17 - 31

Pr. 17-114 (cont.) Instructions (a) What kind of lease is this to Forbes Company? (b) What should be considered the lease term? (c) What are the minimum lease payments? (d) What is the present value of the minimum lease payments? (PV factor for annuity due of 20 semi-annual payments at 8% annual rate, 14.13394; PV factor for amount due in 20 interest periods at 8% annual rate, .45639.) (Round to nearest dollar.) (e) What journal entries would Forbes record during the first year of the lease? (Include an amortization schedule through 1/1/09 and round to the nearest dollar.)

Solution 17-114 (a)

This lease is a capital lease to Forbes Company because its term (10 years—see computation in b below) exceeds 75% of the equipment's estimated useful life. In addition, the present value (see computation in d below) of the minimum lease payments (see computation in c below) exceeds 90% of the fair value of the equipment ($3,000,000).

(b)

The lease term is: Noncancelable period Additional period for which termination penalty assures renewal Period covered by lessor extension option

(c)

The minimum lease payments are: Semi-annual rental payments Executory costs

Residual guarantee Minimum lease payments

(e)

years years year years

$ 219,000 (19,000) 200,000 × 20 4,000,000 100,000 $4,100,000

Number of payments over lease term

(d)

5 4 1 10

The present value of the minimum lease payments is: Factor for present value of an annuity due, 20 periods, 4% Semi-annual payments, net of executory costs

14.13394 $ 200,000 2,826,788

Factor for present value of $1 due in 20 interest periods at 4% .45639 Residual guarantee × 100,000 Present value of lease payments

45,639 $2,872,427

January 1, 2008 Leased Equipment Under Capital Leases.................................... 2,872,427 Lease Liability ..................................................................

2,872,427

January 1, 2008 Leases Liability ............................................................................ Property Taxes ............................................................................ Cash ................................................................................

200,000 19,000 219,000

17 - 32 Test Bank for Intermediate Accounting, Second Edition Solution 17-114 (cont.) July 1, 2008 Lease Liability .............................................................................. Property Taxes ........................................................................... Interest Expense ......................................................................... Cash ................................................................................

Date Initial PV 1/1/08 7/1/08 1/1/09

93,103 19,000 106,897 219,000

Lease Amortization Schedule Semi-Annual Interest Reduction of Lease Payment 4% Lease Obligation $200,000 200,000 200,000

— 106,897 103,173

$200,000 93,103 96,827

December 31, 2008 Depreciation Expense.................................................................. Accumulated Depreciation—Capital Leases..................... Interest Expense.......................................................................... Interest Payable .............................................................. *($2,872,427 – $60,000) ÷ 10 = $281,243.

Balance $2,872,427 2,672,427 2,579,324 2,482,497

281,243* 281,243 103,173 103,173

Pr. 17-115—Lessor accounting—direct-financing lease. Jenks, Inc. enters into a lease agreement as lessor on January 1, 2008, to lease an airplane to National Airlines. The term of the noncancelable lease is eight years and payments are required at the end of each year. The following information relates to this agreement: 1. National Airlines has the option to purchase the airplane for $9,000,000 when the lease expires at which time the fair value is expected to be $15,000,000. 2. The airplane has a cost of $38,000,000 to Jenks, an estimated useful life of fourteen years, and a salvage value of zero at the end of that time (due to technological obsolescence). 3. National Airlines will pay all executory costs related to the leased airplane. 4. Annual year-end lease payments of $5,766,425 allow Jenks to earn an 8% return on its investment. 5. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by Jenks. Instructions (a) What type of lease is this? Discuss. (b) Prepare a lease amortization schedule for the lessor for the first two years (2008-2009). (Round all amounts to nearest dollar.) (c) Prepare the journal entries on the books of the lessor to record the lease agreement, to reflect payments received under the lease, and to recognize income, for the years 2008 and 2009.

Accounting for Leases

17 - 33

Solution 17-115 (a)

The lease is a direct-financing type lease from the lessor's point of view or a capital lease from the lessee's point of view. The lease contains a bargain purchase option which satisfies one of the criteria for classification as a direct-financing lease. The option to buy for $9,000,000 at the termination of the lease when the asset is expected to have a fair value of $15,000,000 constitutes a bargain purchase option. Additionally, the payments are collectible, and there are no uncertainties as to future lessor costs.

(b)

Lessor's Lease Amortization Schedule Date 1/1/08 12/31/08 12/31/09

Annual Lease Rental

Interest on Lease Receivable

$5,766,425* 5,766,425

$3,040,000 2,821,886

Lease Receivable Recovery Lease Receivable $38,000,000 $2,726,425 35,273,575 2,944,539 32,329,036

*[$38,000,000 – ($9,000,000 × .54027)] ÷ 5.74664 = $5,766,425.

(c)

January 1, 2008 Lease Receivable ....................................................................... 38,000,000 Airplanes......................................................................... 38,000,000 December 31, 2008 Cash........................................................................................... 5,766,425 Lease Receivable ........................................................... Interest Revenue ............................................................

2,726,425 3,040,000

December 31, 2009 Cash........................................................................................... 5,766,425 Lease Receivable ........................................................... Interest Revenue ............................................................

2,944,539 2,821,886

Pr. 17-116—Lessor accounting—sales-type lease. Hom Leasing Company agrees to lease equipment to Golden Corporation on January 1, 2008. The following information relates to the lease agreement. 1. The term of the lease is seven years with no renewal option and the equipment has an estimated economic life of seven years. 2. The cost of the equipment is $210,000, and the fair value of the asset on 1/1/08 is also $280,000. 3. At the end of the lease term the asset reverts to the lessor. At the end of the lease term the asset is expected to have a residual value of $52,000, all of which is guaranteed by the lessee. 4. Golden Corporation assumes responsibility for all executory costs. 5. The lease agreements requires equal annual rental payments, beginning on January 1, 2008. 6. The collectibility of the lease payments is reasonably predictable and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor.

17 - 34 Test Bank for Intermediate Accounting, Second Edition Pr. 17-116 (cont.) Instructions (a) Assuming the lessor desires a 12% rate of return on its investment, calculate the amount of the annual rental payment required. Round to the nearest dollar. (b) Prepare an amortization schedule for the lessor for the lease term. (c) Prepare the journal entries the lessor would make in 2008 and 2009 related to the lease arrangement. Assume that Hom Leasing Company has a December 31 year end.

Solution 17-116 (a) Fair market value of leased asset Less: Present value of guaranteed residual value of $52,000 × .45235 (present value of 1 at 12% for 7 periods) Amount to be recovered through lease payments Seven periodic lease payments: $256,478 ÷ 5.11141* = $50,178 *(Present value of annuity due of 1 for 7 periods at 12%) (b)

$280,000 23,522 $256,478

Hom Leasing Company Lease Amortization Schedule

Date 1/1/08 1/1/08 1/1/09 1/1/10 1/1/11 1/1/12 1/1/13 1/1/14 12/31/14

Annual Lease Payment Plus GRV

Interest on Lease Receivable

Lease Receivable Recovery

$ 50,178 50,178 50,178 50,178 50,178 50,178 50,178 52,000 $403,246

$ 27,579 24,867 21,829 18,428 14,618 10,350 5,575* $123,246

$ 50,178 22,599 25,311 28,349 31,750 35,560 39,828 46,425 $280,000

Lease Receivable $280,000 229,822 207,223 181,912 153,563 121,813 86,253 46,425 -0-

*($4 rounding error) c.

January 1, 2008 Cost of Goods Sold ....................................................................... Lease Receivable ......................................................................... Inventory ............................................................................. Sales ................................................................................... Cash ............................................................................................. Lease Payments Receivable ............................................... December 31, 2008 Interest Receivable ....................................................................... Interest Revenue................................................................. January 1, 2009 Cash ............................................................................................. Lease Receivable ............................................................... Interest Receivable ............................................................. December 31, 2009 Interest Receivable ....................................................................... Interest Revenue.................................................................

210,000 280,000 210,000 280,000 50,178 50,178 27,579 27,579 50,178 22,599 27,579 24,867 24,867

CHAPTER 18 ADDITIONAL REPORTING ISSUES TRUE-FALSE—Conceptual Answer

No.

Description

F T F T F T F F T F F T T T T F T F T F T F F T T T F T F T F F T F T T T T F. F

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40.

Change in accounting estimate. Errors in financial statements. Adoption of a new principle. Accounting alternatives and comparability. Identify change in accounting principle. Definition of change in accounting principle. Change from unacceptable to acceptable accounting principle. FASB requirements for changes in accounting principles. Reporting accounting principle change under retrospective approach. Change in accounting principle. Indirect effects of change in accounting principle. Retrospective application of accounting principle. Disclosure requirements for a change in principle. Indirect effect of an accounting change. Retrospective application impracticality. Retrospective application and its effects. Retrospective application impracticality. Reporting a change in estimate. Change in principle or change in estimate. Reporting changes in accounting estimates. Change in principle vs. change in estimate. Accounting for change in depreciation method. Accounting error vs. change in estimate. Accounting for corrections of errors. New principle created by FASB standard. Accounting for change from unacceptable accounting principle. FASB 16 and reporting corrections of errors. Cumulative preferred stock and EPS. Restating shares for stock dividends and stock splits. Stock dividend and weighted-average shares outstanding. Preferred dividends and income before extraordinary items. Identify simple capital structure. Stock dividend and weighted-average shares. Definition of antidilutive securities. Antidilutive securities and diluted EPS. Treasure stock method and stock options. Earnings per share disclosures. Reporting EPS in a complex capital structure. Dilutive stock options. Reporting EPS for income from continuing operations.

18 - 2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60.

Identify changes in accounting principle. Identify a change in accounting principle. Change in accounting principle. Reporting changes retrospectively in financial statements. Reporting changes in an accounting principle. Identify direct effect of change in accounting principle. Identify a non-retrospective change. Entry to record a change in depreciation methods. Disclosures required for a change in depreciation methods. Change from percentage-of-completion to completed-contracts. Disclosures required for a change from LIFO to FIFO. Change from FIFO to LIFO. Identify a condition when retrospective application is not impracticable. Current and prospective approach. Change in accounting estimate. Change in accounting estimate. Identify a change in accounting estimate. Change in accounting estimate. Identify a change in accounting estimate. Identify a correction of an error.

MULTIPLE CHOICE—Earnings Per Share, Conceptual Answer

No.

Description

c d d d b a d a b d

61. 62. 63. 64. 65. 66. 67. 68. 69. 70.

Simple capital structure. Computing EPS for a simple capital structure. Computation of weighted-average shares outstanding. Diluted EPS. Dilutive convertible securities. Cumulative convertible preferred stock income adjustment. Treasury stock method. Treasury stock method. Treasury stock method. Antidilutive securities.

MULTIPLE CHOICE—Computational Answer

No.

Description

b b c d a d b c b d a

71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81.

Calculate effect of a change in depreciation method. Calculate effect of a change in depreciation method. Calculate net income with change in accounting principle with tax effects. Calculate effect of accounting change. Calculate depreciation expense after change in accounting principle. Calculate cumulative effect of a change on retained earnings. Calculate effect of a change on retained earnings. Compute depreciation expense after a change in depreciation methods. Calculate cumulative effect of a change in inventory methods. Calculate deferred tax liability amount. Calculate deferred tax liability amount.

Additional Reporting Issues

18 - 3

MULTIPLE CHOICE—Computational (cont.) Answer

No.

Description

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

82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114.

Calculate net income after a change to LIFO method. Calculate net income with change from FIFO to LIFO. Calculate depreciation after a change in estimate. Calculate net income with change in an accounting estimate. Determine depreciation expense after a change in estimated life. Compute effect of errors on income before taxes. Compute effect of errors on retained earnings. Calculate effect of error on net income. Compute effect of error on retained earnings. Weighted average number of common shares outstanding. Weighted average number of common shares outstanding. Weighted average number of common shares outstanding. Weighted average number of shares outstanding. Determination of shares used in computing EPS. Computation of earnings per share. Number of shares in computing diluted EPS. Diluted EPS. Diluted EPS with convertible bonds. Diluted EPS with convertible bonds. Diluted EPS with convertible bonds. Diluted EPS. Basic EPS with convertible bonds and convertible preferred stock. Diluted EPS. Denominator in computing basic EPS and DEPS with convertible bonds. Shares outstanding for basic EPS and DEPS. Basic EPS with convertible preferred stock. Basic EPS with convertible preferred stock. Diluted EPS with convertible bonds. Basic EPS and DEPS with convertible bonds issued during year. Basic EPS with convertible preferred stock and convertible bonds. DEPS with convertible preferred stock and convertible bonds. DEPS and the treasury stock method. DEPS using the treasury stock method.

Answer

No.

Description

b c a a b b

115. 116. 117. 118. 119. 120.

Identify a change in accounting principle. Cumulative effect of a change from weighted-average to LIFO. Reporting a change to FIFO from LIFO. Balance of accumulated depreciation after a change in estimate. Determine carrying value of a patent with a change in estimate. Depreciation expense to be recorded following an error.

MULTIPLE CHOICE—CPA Adapted

18 - 4

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Earnings Per Share, CPA Adapted Answer

No.

Description

b b d b b d

121. 122. 123. 124. 125. 126.

Determine earnings per common share. Determine earnings per common share. Determine diluted EPS. Number of shares to calculate diluted EPS. DEPS with convertible securities. Effect of dividends on nonconvertible preferred stock.

EXERCISES Item

Description

E18-127 E18-128 E18-129 E18-130 E18-131 E18-132 E18-133 E18-134 E18-135 E18-136 E18-137

Matching accounting changes to situations. How changes or corrections are recognized. Matching disclosures to situations. Change in accounting principle. Change in estimate, change in entity, corrections of errors. Changes in depreciation methods, estimates. Noncounterbalancing error. Weighted average shares outstanding. Earnings per share (essay). Earnings per share. Diluted earnings per share.

PROBLEMS Item

Description

P18-138 P18-139 P18-140 P18-141

Accounting for changes and error corrections. Earnings per share. Basic and diluted earnings per share. Basic and diluted earnings per share.

CHAPTER LEARNING OBJECTIVES 1.

Identify the types of accounting changes.

Understand how to account for retrospective accounting changes.

Understand how to account for impracticable changes.

Describe the accounting for changes in estimates.

Describe the accounting for correction of errors.

Compute earnings per share in a simple capital structure.

Compute earnings per share in a complex capital structure.

Additional Reporting Issues

18 - 5

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 2.

TF TF

3. 4.

TF TF

5. 6.

8. 9. 10. 11. 12.

TF TF TF TF TF

13. 14. 44. 45. 46.

TF TF MC MC MC

47. 48. 49. 71. 72.

15. 16.

TF TF

17. 50.

TF MC

51. 52.

18. 19. 20. 21.

TF TF TF TF

22. 54. 55. 56.

TF MC MC MC

57. 58. 59. 84.

23. 24. 25.

TF TF TF

26. 27. 60.

TF TF MC

87. 88. 89.

28. 29. 30. 31.

TF TF TF TF

32. 33. 61. 62.

TF TF MC MC

63. 91. 92. 93.

34. 35. 36. 37. 38. 39.

TF TF TF TF TF TF

40. 64. 65. 66. 67. 68.

TF MC MC MC MC MC

69. 70. 97. 98. 99. 100.

Note: TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 TF 7. TF 42. TF 41. MC 43. Learning Objective 2 MC 73. MC 78. MC 74. MC 79. MC 75. MC 80. MC 76. MC 81. MC 77. MC 115. Learning Objective 3 MC 53. MC 83. MC 82. MC 117. Learning Objective 4 MC 85. MC 127. MC 86. MC 128. MC 118. MC 129. MC 119. MC 131. Learning Objective 5 MC 90. MC 128. MC 120. MC 129. MC 127. E 131. Learning Objective 6 MC 94. MC 121. MC 95. MC 122. MC 96. MC 123. MC 108. MC 134. Learning Objective 7 MC 101. MC 107. MC 102. MC 109. MC 103. MC 110. MC 104. MC 111. MC 105. MC 112. MC 106. MC 113. E = Exercise P = Problem

Type

Item

Type

Item

Type

MC MC MC MC MC

116. 127. 128. 129. 130.

MC E E E E

138.

MC MC

128. 129.

E E

130. 138.

E P

E E E E

132. 138.

E P

E E E

133. 138.

E P

MC MC MC E

135. 140. 141.

E P P

MC MC MC MC MC MC

114. 124. 125. 126. 135. 136.

MC MC MC MC E E

137. 139. 140. 141.

E P P P

MC MC

18 - 6

Test Bank for Intermediate Accounting, Second Edition

TRUE-FALSE—Conceptual 1.

A change in accounting principle is a change that occurs as the result of new information or additional experience.

Errors in financial statements result from mathematical mistakes or oversight or misuse of facts that existed when preparing the financial statements.

Adoption of a new principle in recognition of events that have occurred for the first time is treated as an accounting change.

Accounting alternatives diminish the comparability of financial information between periods and between companies.

A change in accounting principle results when a company adopts a new principle in recognition of events that were previously immaterial.

A change in accounting principle results when a company changes from one generally accepted accounting principle to another.

If the previously used accounting principle was not acceptable, a change to a generally accepted accounting principle is considered a change in principle.

The FASB requires companies to use the prospective (in the future) approach for reporting changes in accounting principles.

When a company changes an accounting principle under the retrospective approach, it adjusts its financial statements for each prior period presented.

10.

When a company changes an accounting principle, it should not adjust any assets or liabilities.

11.

The FASB takes the position that companies should retrospectively apply the indirect effects of a change in accounting principle.

12.

Retrospective application refers to the application of a different accounting principle to recast previously issued financial statements—as if the new principle had always been used.

13.

One of the disclosure requirements for a change in accounting principle is to show the cumulative effect of the change on retained earnings as of the beginning of the earliest period presented.

14.

An indirect effect of an accounting change is any change to current or future cash flows of a company that result from making a change in accounting principle that is applied retrospectively.

15.

Retrospective application is considered impracticable if a company cannot determine the prior period effects using every reasonable effort to do so.

Additional Reporting Issues

18 - 7

16.

Companies should use retrospective application if the company cannot determine the effects of the retrospective application.

17.

If it becomes impracticable to use retrospective application for a change in accounting principle, a company should prospectively apply the new accounting principle.

18.

If a change in an accounting estimate affects current net income by an amount equal to or greater than 1% of net income, the change should be handled retroactively.

19.

Whenever it is impossible to determine whether a change in principle or a change in estimate has occurred, the change should be considered a change in estimate.

20.

Companies report changes in accounting estimates retrospectively.

21.

When it is impossible to determine whether a change in principle or change in estimate has occurred, the change is considered a change in estimate.

22.

Companies account for a change in depreciation methods as a change in accounting principle.

23.

Accounting errors include changes in estimates that occur because a company acquires more experience, or as it obtains additional information.

24.

Companies record corrections of errors from prior periods as an adjustment to the beginning balance of retained earnings in the current period.

25.

If an FASB standard creates a new principle, expresses preference for, or rejects a specific accounting principle, the change is considered clearly acceptable.

26.

A change from an accounting principle that is not generally accepted to an accounting principle that is acceptable should be treated as an accounting error.

27.

FASB Statement No. 16 requires that corrections of errors be handled prospectively and shown in the current operating section of the income statement in the year the correction is made.

28.

If preferred stock is cumulative and no dividends are declared, the company subtracts the current year preferred dividend in computing earnings per share.

29.

When stock dividends or stock splits occur, companies must restate the shares outstanding after the stock dividend or split, in order to compute the weighted-average number of shares.

30.

If a stock dividend occurs after year end, but before issuing the financial statements, a company must restate the weighted-average number of shares outstanding for the year.

31.

Preferred dividends are subtracted from net income but not income before extraordinary items in computing earnings per share.

32.

A corporation's capital structure is simple if it includes securities that could have a dilutive effect on earnings per common share.

18 - 8

Test Bank for Intermediate Accounting, Second Edition

33.

When stock dividends or stock splits occur, computation of the weighted-average number of shares requires restatement of the shares outstanding before the stock dividend or split.

34.

Antidilutive securities are securities which upon their conversion or exercise decrease earnings per share (or increase the loss per share).

35.

Antidilutive securities should be ignored in all calculations and should not be considered in computing diluted earnings per share.

36.

The treasury stock method will increase the number of shares outstanding whenever the exercise price of an option or warrant is below the market price of the common stock.

37.

Earnings per share data are required for each of the following: (a) income from continuing operations, (b) income before extraordinary items, and (c) net income.

38.

When a company has a complex capital structure, it must report both basic and diluted earnings per share.

39.

In computing diluted earnings per share, stock options are considered dilutive when their option price is greater than the market price.

40.

A company should report per share amounts for income before extraordinary items, but not for income from continuing operations.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4. 5. 6. 7.

F T F T F T F

8. 9. 10. 11. 12. 13. 14.

F T F F T T T

15. 16. 17. 18. 19. 20. 21.

T F T F T F T

22. 23. 24. 25. 26. 27. 28.

F F T T T F T

29. 30. 31. 32. 33. 34. 35.

F T F F T F T

36. 37. 38. 39. 40.

T T T F F

Additional Reporting Issues

18 - 9

MULTIPLE CHOICE—Conceptual 41.

Which of the following is not treated as a change in accounting principle? a. A change from LIFO to FIFO for inventory valuation b. A change to a different method of depreciation for newly acquired plant assets c. A change from full-cost to successful efforts in the extractive industry d. A change from completed-contract to percentage-of-completion

42.

Which of the following is accounted for as a change in accounting principle? a. A change in the estimated useful life of plant assets. b. A change from the cash basis of accounting to the accrual basis of accounting. c. A change from expensing immaterial expenditures to deferring and amortizing them as they become material. d. A change in inventory valuation from average cost to FIFO.

43.

A change in accounting principle is evidenced by a. a change from the historical cost principle to current value accounting. b. adopting the allowance method in estimating bad debts expense when a credit sales policy is instituted. c. changing the basis of inventory pricing from weighted-average cost to LIFO. d. a change from current value accounting to the historical cost principle.

44.

A company that reports changes retrospectively would a. report the cumulative effect in the current year’s income statement as an irregular item. b. not change any prior-year financial statements. c. make changes prospectively. d. show any cumulative effect of the change as an adjustment to beginning retained earnings of the earliest year presented.

45.

According to the FASB, which approach is required for reporting changes in an accounting principle? a. Currently b. Retrospectively c. Prospectively d. Futuristically

46.

Which of the following is not considered a direct effect of a change in accounting principle? a. An employee profit-sharing plan based on net income when a company uses the percentage-of-completion method. b. The inventory balance as a result of a change in the inventory valuation method. c. An impairment adjustment resulting from applying the lower-of-cost-or-market-test to the adjusted inventory balance. d. Deferred income tax effects of an impairment adjustment resulting from applying the lower-of-cost-or-market test to the adjusted inventory balance.

18 - 10 Test Bank for Intermediate Accounting, Second Edition 47.

Which of the following is not a retrospective-type accounting change? a. Completed-contract method to the percentage-of-completion method for long-term contracts b. LIFO method to the FIFO method for inventory valuation c. Sum-of-the-years'-digits method to the straight-line method d. "Full cost" method to another method in the extractive industry

48.

A company changes from straight-line to an accelerated method of calculating depreciation, which will be similar to the method used for tax purposes. The entry to record this change should include a a. credit to Accumulated Depreciation. b. debit to Retained Earnings in the amount of the difference on prior years. c. debit to Deferred Tax Asset. d. credit to Deferred Tax Liability.

49.

Which of the following disclosures is required for a change from sum-of-the-years-digits to straight-line? a. The cumulative effect on prior years, net of tax, in the current retained earnings statement b. Restatement of prior years’ income statements c. Recomputation of current and future years’ depreciation d. All of these are required.

50.

A company changes from percentage-of-completion to completed-contract, which is the method used for tax purposes. The entry to record this change should include a a. debit to Construction in Process. b. debit to Loss on Long-term Contracts in the amount of the difference on prior years, net of tax. c. debit to Retained Earnings in the amount of the difference on prior years, net of tax. d. credit to Deferred Tax Liability.

51.

Which of the following disclosures is required for a change from LIFO to FIFO? a. The cumulative effect on prior years, net of tax, in the current retained earnings statement b. The justification for the change c. Restated prior year income statements d. All of these are required.

52.

Stone Company changed its method of pricing inventories from FIFO to LIFO. What type of accounting change does this represent? a. A change in accounting estimate for which the financial statements for prior periods included for comparative purposes should be presented as previously reported. b. A change in accounting principle for which the financial statements for prior periods included for comparative purposes should be presented as previously reported. c. A change in accounting estimate for which the financial statements for prior periods included for comparative purposes should be restated. d. A change in accounting principle for which the financial statements for prior periods included for comparative purposes should be restated.

Additional Reporting Issues

18 - 11

53.

Which of the following is a condition in which retrospective application is not impracticable? a. The company cannot determine the effects of retrospective application. b. Retrospective application requires assumptions about management’s intent in a prior period. c. The company has changed auditors. d. Retrospective application requires significant estimates for a prior period, and the company cannot objectively verify the necessary information to develop these estimates.

54.

Which of the following is not a part of applying the current and prospective approach in accounting for a change in an estimate? a. Report current and future financial statements on a new basis. b. Restate prior period financial statements. c. Disclose in the year of change the effect on net income and earnings per share data for that period only. d. Make no adjustments to current period opening balances for purposes of catch-up.

55.

Which type of accounting change should always be accounted for in current and future periods? a. Change in accounting principle b. Change in reporting entity c. Change in accounting estimate d. Correction of an error

56.

Which of the following is (are) the proper time period(s) to record the effects of a change in accounting estimate? a. Current period and prospectively b. Current period and retrospectively c. Retrospectively only d. Current period only

57.

When a company decides to switch from the double-declining balance method to the straight-line method, this change should be handled as a a. change in accounting principle. b. change in accounting estimate. c. prior period adjustment. d. correction of an error.

58.

The estimated life of a building that has been depreciated 30 years of an originally estimated life of 50 years has been revised to a remaining life of 10 years. Based on this information, the accountant should a. continue to depreciate the building over the original 50-year life. b. depreciate the remaining book value over the remaining life of the asset. c. adjust accumulated depreciation to its appropriate balance, through net income, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years. d. adjust accumulated depreciation to its appropriate balance through retained earnings, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years.

18 - 12 Test Bank for Intermediate Accounting, Second Edition 59.

Which of the following statements is correct? a. Changes in accounting principle are always handled in the current or prospective period. b. Prior statements should be restated for changes in accounting estimates. c. A change from expensing certain costs to capitalizing these costs due to a change in the period benefited, should be handled as a change in accounting estimate. d. Correction of an error related to a prior period should be considered as an adjustment to current year net income.

60.

An example of a correction of an error in previously issued financial statements is a change a. from the FIFO method of inventory valuation to the LIFO method. b. in the service life of plant assets, based on changes in the economic environment. c. from the cash basis of accounting to the accrual basis of accounting. d. in the tax assessment related to a prior period.

61.

With respect to the computation of earnings per share, which of the following would be most indicative of a simple capital structure? a. Common stock, preferred stock, and convertible securities outstanding in lots of even thousands b. Earnings derived from one primary line of business c. Ownership interest consisting solely of common stock d. None of these

62.

In computing earnings per share for a simple capital structure, if the preferred stock is cumulative, the amount that should be deducted as an adjustment to the numerator (earnings) is the a. preferred dividends in arrears. b. preferred dividends in arrears times (one minus the income tax rate). c. annual preferred dividend times (one minus the income tax rate). d. none of these.

63.

In computations of weighted average of shares outstanding, when a stock dividend or stock split occurs, the additional shares are a. weighted by the number of days outstanding. b. weighted by the number of months outstanding. c. considered outstanding at the beginning of the year. d. considered outstanding at the beginning of the earliest year reported.

64.

When computing diluted earnings per share, convertible bonds are a. ignored. b. assumed converted whether they are dilutive or antidilutive. c. assumed converted only if they are antidilutive. d. assumed converted only if they are dilutive.

65.

Dilutive convertible securities must be used in the computation of a. basic earnings per share only. b. diluted earnings per share only. c. diluted and basic earnings per share. d. none of these.

Additional Reporting Issues

18 - 13

66.

In computing earnings per share, the equivalent number of shares of convertible preferred stock are added as an adjustment to the denominator (number of shares outstanding). If the preferred stock is cumulative, which amount should then be added as an adjustment to the numerator (net earnings)? a. Annual preferred dividend b. Annual preferred dividend times (one minus the income tax rate) c. Annual preferred dividend times the income tax rate d. Annual preferred dividend divided by the income tax rate

67.

In the diluted earnings per share computation, the treasury stock method is used for options and warrants to reflect assumed reacquisition of common stock at the average market price during the period. If the exercise price of the options or warrants exceeds the average market price, the computation would a. fairly present diluted earnings per share on a prospective basis. b. fairly present the maximum potential dilution of diluted earnings per share on a prospective basis. c. reflect the excess of the number of shares assumed issued over the number of shares assumed reacquired as the potential dilution of earnings per share. d. be antidilutive.

68.

In applying the treasury stock method to determine the dilutive effect of stock options and warrants, the proceeds assumed to be received upon exercise of the options and warrants a. are used to calculate the number of common shares repurchased at the average market price, when computing diluted earnings per share. b. are added, net of tax, to the numerator of the calculation for diluted earnings per share. c. are disregarded in the computation of earnings per share if the exercise price of the options and warrants is less than the ending market price of common stock. d. none of these.

69.

When applying the treasury stock method for diluted earnings per share, the market price of the common stock used for the repurchase is the a. price at the end of the year. b. average market price. c. price at the beginning of the year. d. none of these.

70.

Antidilutive securities a. should be included in the computation of diluted earnings per share but not basic earnings per share. b. are those whose inclusion in earnings per share computations would cause basic earnings per share to exceed diluted earnings per share. c. include stock options and warrants whose exercise price is less than the average market price of common stock. d. should be ignored in all earnings per share calculations.

18 - 14 Test Bank for Intermediate Accounting, Second Edition

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

41. 42. 43. 44. 45.

b d c d b

46. 47. 48. 49. 50.

a c a c c

51. 52. 53. 54. 55.

d b c b c

56. 57. 58. 59. 60.

a b b c c

61. 62. 63. 64. 65.

c d d d b

66. 67. 68. 69. 70.

a d a b d

Solution to Multiple Choice question for which the answer is “none of these.” 62.

annual preferred dividend.

MULTIPLE CHOICE—Computational 71.

On January 1, 2006, Lynn Corporation acquired equipment at a cost of $600,000. Lynn adopted the double-declining balance method of depreciation for this equipment and had been recording depreciation over an estimated life of eight years, with no residual value. At the beginning of 2009, a decision was made to change to the straight-line method of depreciation for this equipment. Assuming a 30% tax rate, the cumulative effect of this accounting change on beginning retained earnings, net of tax, is a. $121,875. b. $0. c. $78,750. d. $77,109.

72.

On January 1, 2006, Foley Corporation acquired machinery at a cost of $250,000. Foley adopted the double-declining balance method of depreciation for this machinery and had been recording depreciation over an estimated useful life of ten years, with no residual value. At the beginning of 2009, a decision was made to change to the straight-line method of depreciation for the machinery. The depreciation expense to be recorded for the machinery in 2009 is (round to the nearest dollar) a. $25,600. b. $18,286. c. $22,857. d. $25,000.

73.

On January 1, 2006, Baden Co., purchased a machine (its only depreciable asset) for $300,000. The machine has a five-year life, and no salvage value. Sum-of-the-years'digits depreciation has been used for financial statement reporting and the elective straight-line method for income tax reporting. Effective January 1, 2009, for financial statement reporting, Baden decided to change to the straight-line method for depreciation of the machine. Assume that Baden can justify the change. Baden's income before depreciation, before income taxes, and before the cumulative effect of the accounting change (if any), for the year ended December 31, 2009, is $250,000. The income tax rate for 2009, as well as for the years 2006-2008, is 30%. What amount should Baden report as net income for the year ended December 31, 2009? a. $60,000 b. $91,000 c. $154,000 d. $175,000

Additional Reporting Issues

18 - 15

Use the following information for questions 74 and 75. Waeglein Corporation purchased machinery on January 1, 2007 for $630,000. The company used the straight-line method and no salvage value to depreciate the asset for the first two years of its estimated six-year life. In 2009, Waeglein changed to the sum-of-the-years’-digits depreciation method for this asset. The following facts pertain: 2007 2008 Straight-line $105,000 $105,000 Sum-of-the-years’-digits 180,000 150,000 74.

Waeglein is subject to a 40% tax rate. The cumulative effect of this accounting change on beginning retained earnings is a. $135,000. b. $120,000. c. $72,000. d. $0.

75.

The amount that Waeglein should report for depreciation expense on its 2009 income statement is a. $168,000. b. $105,000. c. $75,000. d. none of the above.

76.

During 2008, a construction company changed from the completed-contract method to the percentage-of-completion method for accounting purposes but not for tax purposes. Gross profit figures under both methods for the past three years appear below: 2006 2007 2008

Completed-Contract $ 475,000 625,000 700,000 $1,800,000

Percentage-of-Completion $ 800,000 950,000 1,050,000 $2,800,000

Assuming an income tax rate of 40% for all years, the affect of this accounting change on prior periods should be reported by a credit of a. $600,000 on the 2008 income statement. b. $390,000 on the 2008 income statement. c. $600,000 on the 2008 retained earnings statement. d. $390,000 on the 2008 retained earnings statement. Use the following information for questions 77 and 78. On January 1, 2005, Wintz Corporation acquired machinery at a cost of $600,000. Wintz adopted the straight-line method of depreciation for this machine and had been recording depreciation over an estimated life of ten years, with no residual value. At the beginning of 2008, a decision was made to change to the double-declining balance method of depreciation for this machine. 77.

Assuming a 30% tax rate, the cumulative effect of this accounting change on beginning retained earnings, is a. $67,200. b. $0. c. $78,960. d. $112,800.

18 - 16 Test Bank for Intermediate Accounting, Second Edition 78.

The amount that Wintz should record as depreciation expense for 2008 is a. $60,000. b. $84,000. c. $120,000. d. none of the above.

79.

On December 31, 2009 Kean Company changed its method of accounting for inventory from weighted average cost method to the FIFO method. This change caused the 2009 beginning inventory to increase by $420,000. The cumulative effect of this accounting change to be reported for the year ended 12/31/09, assuming a 40% tax rate, is a. $420,000. b. $252,000. c. $168,000. d. $0.

80.

Weaver Company changes from the LIFO method to the FIFO method in 2009. The increase in pre-tax income as a result of the difference in the two methods prior to 2007 is $100,000, for the year 2007 is $40,000, and for the year 2008 is $30,000. The estimated tax effect is 40%. The entry to record the change at the beginning of 2008 should include a a. debit to Deferred Tax Liability of $68,000. b. credit to Deferred Tax Liability of $68,000. c. debit to Deferred Tax Liability of $56,000. d. credit to Deferred Tax Liability of $56,000.

81.

In 2008, Flynn Company has changed from the percentage-of-completion method to the completed-contract method for long-term construction contracts. The difference in pre-tax income prior to 2008 is a decrease of $60,000 and for 2008 is a decrease of $20,000. The estimated tax effect is 40%. The journal entry made by Flynn Company should include a a. debit to Deferred Tax Liability of $24,000. b. credit to Deferred Tax Liability of $32,000. c. debit to Deferred Tax Liability of $32,000. d. credit to Deferred Tax Liability of $24,000.

82.

Eaton Company began operations on January 1, 2008, and uses the FIFO method in costing its raw materials inventory. Management is contemplating a change to the LIFO method and is interested in determining what effect such a change will have on net income. Accordingly, the following information has been developed: Final Inventory FIFO LIFO Net Income (computed under the FIFO method)

2008 $640,000 560,000 980,000

2009 $ 712,000 636,000 1,080,000

Based on the above information, a change to the LIFO method in 2009 would result in net income for 2009 of a. $1,120,000. b. $1,080,000. c. $1,004,000. d. $1,000,000.

Additional Reporting Issues 83.

18 - 17

Hannah Company began operations on January 1, 2008, and uses the FIFO method in costing its raw materials inventory. Management is contemplating a change to the LIFO method and is interested in determining what effect such a change will have on net income. Accordingly, the following information has been developed: Final Inventory 2008 2009 FIFO $320,000 $360,000 LIFO 240,000 300,000 Net Income (computed under the FIFO method) 500,000 600,000 Based upon the above information, a change to the LIFO method in 2009 would result in net income for 2009 of a. $540,000. b. $600,000. c. $620,000. d. $660,000.

84.

Equipment was purchased at the beginning of 2006 for $204,000. At the time of its purchase, the equipment was estimated to have a useful life of six years and a salvage value of $24,000. The equipment was depreciated using the straight-line method of depreciation through 2009. At the beginning of 2009, the estimate of useful life was revised to a total life of eight years and the expected salvage value was changed to $15,000. The amount to be recorded for depreciation for 2009, reflecting these changes in estimates, is a. $12,375. b. $19,800. c. $22,800. d. $23,625.

Use the following information for questions 85 and 86. Carey Company purchased a machine on January 1, 2006, for $300,000. At the date of acquisition, the machine had an estimated useful life of six years with no salvage. The machine is being depreciated on a straight-line basis. On January 1, 2009, Carey determined, as a result of additional information, that the machine had an estimated useful life of eight years from the date of acquisition with no salvage. An accounting change was made in 2009 to reflect this additional information. 85.

Assume that the direct effects of this change are limited to the effect on depreciation and the related tax provision, and that the income tax rate was 30% in 2006, 2007, 2008, and 2009. What should be reported in Carey's income statement for the year ended December 31, 2009, as the cumulative effect on prior years of changing the estimated useful life of the machine? a. $0 b. $20,000 c. $30,000 d. $105,000

86.

What is the amount of depreciation expense on this machine that should be charged in Carey's income statement for the year ended December 31, 2009? a. $30,000 b. $37,500 c. $60,000 d. $75,000

18 - 18 Test Bank for Intermediate Accounting, Second Edition Use the following information for questions 87 and 88. Washington Inc. is a calendar-year corporation. Its financial statements for the years ended 12/31/08 and 12/31/09 contained the following errors:

Ending inventory Depreciation expense

2008 $15,000 overstatement 6,000 understatement

2009 $24,000 understatement 12,000 overstatement

87.

Assume that the 2008 errors were not corrected and that no errors occurred in 2007. By what amount will 2008 income before income taxes be overstated or understated? a. $21,000 overstatement b. $9,000 overstatement c. $21,000 understatement d. $9,000 understatement

88.

Assume that no correcting entries were made at 12/31/08, or 12/31/09. Ignoring income taxes, by how much will retained earnings at 12/31/09 be overstated or understated? a. $24,000 overstatement b. $21,000 overstatement c. $30,000 understatement d. $9,000 understatement

Use the following information for questions 89 and 90. Handy Company purchased equipment that cost $750,000 on January 1, 2006. The entire cost was recorded as an expense. The equipment had a nine-year life and a $30,000 residual value. Handy uses the straight-line method to account for depreciation expense. The error was discovered on December 10, 2008. Handy is subject to a 40% tax rate. 89.

Handy’s net income for the year ended December 31, 2006, was understated by a. $402,000. b. $450,000. c. $670,000. d. $750,000.

90.

Before the correction was made and before the books were closed on December 31, 2008, retained earnings was understated by a. $332,000. b. $336,000. c. $354,000. d. $450,000.

91.

Jett Corp. had 600,000 shares of common stock outstanding on January 1, issued 900,000 shares on July 1, and had income applicable to common stock of $1,050,000 for the year ending December 31, 2008. Earnings per share of common stock for 2008 would be a. $1.75. b. $.83. c. $1.00. d. $1.17.

Additional Reporting Issues

18 - 19

92.

At December 31, 2008, Norbett Company had 500,000 shares of common stock issued and outstanding, 400,000 of which had been issued and outstanding throughout the year and 100,000 of which were issued on October 1, 2008. Net income for the year ended December 31, 2008, was $1,020,000. What should be Norbett's 2008 earnings per common share, rounded to the nearest penny? a. $2.02 b. $2.55 c. $2.40 d. $2.27

93.

Loeb Co. had 600,000 shares of common stock outstanding on January 1, issued 126,000 shares on May 1, purchased 63,000 shares of treasury stock on September 1, and issued 54,000 shares on November 1. The weighted average shares outstanding for the year is a. 651,000. b. 672,000. c. 693,000. d. 714,000.

94.

On January 1, 2008, Dingler Corporation had 125,000 shares of its $2 par value common stock outstanding. On March 1, Dingler sold an additional 250,000 shares on the open market at $20 per share. Dingler issued a 20% stock dividend on May 1. On August 1, Dingler purchased 140,000 shares and immediately retired the stock. On November 1, 200,000 shares were sold for $25 per share. What is the weighted-average number of shares outstanding for 2008? a. 510,000 b. 375,000 c. 358,333 d. 258,333

95.

The following information is available for Alley Corporation: January 1, 2008 April 1, 2008 July 1, 2008 October 1, 2008

Shares outstanding Shares issued Treasury shares purchased Shares issued in a 100% stock dividend

1,250,000 200,000 75,000 1,375,000

The number of shares to be used in computing earnings per common share for 2008 is a. 2,825,500. b. 2,737,500. c. 2,725,000. d. 1,706,250. 96.

At December 31, 2007 Polk Company had 300,000 shares of common stock and 10,000 shares of 5%, $100 par value cumulative preferred stock outstanding. No dividends were declared on either the preferred or common stock in 2007 or 2008. On January 30, 2009, prior to the issuance of its financial statements for the year ended December 31, 2008, Polk declared a 100% stock dividend on its common stock. Net income for 2008 was $950,000. In its 2008 financial statements, Polk's 2008 earnings per common share should be a. $1.50. b. $1.58. c. $3.00. d. $3.17.

18 - 20 Test Bank for Intermediate Accounting, Second Edition 97.

Caruso Company had 500,000 shares of common stock issued and outstanding at December 31, 2007. On July 1, 2008, an additional 500,000 shares were issued for cash. Caruso also had stock options outstanding at the beginning and end of 2008 which allow the holders to purchase 150,000 shares of common stock at $20 per share. The average market price of Caruso's common stock was $25 during 2008. What is the number of shares that should be used in computing diluted earnings per share for the year ended December 31, 2008? a. 1,030,000 b. 870,000 c. 787,500 d. 780,000

98.

Hoffman Corporation had net income for the year of $480,000 and a weighted-average number of common shares outstanding during the period of 200,000 shares. The company has a convertible bond issue outstanding. The bonds were issued four years ago at par ($2,000,000), carry a 7% interest rate, and are convertible into 40,000 shares of common stock. The company has a 40% tax rate. Diluted earnings per share are a. $1.65. b. $2.23. c. $2.35. d. $2.58.

99.

On January 2, 2008, Ramos Co. issued at par $10,000 of 6% bonds convertible in total into 1,000 shares of Ramos's common stock. No bonds were converted during 2008. Throughout 2008, Ramos had 1,000 shares of common stock outstanding. Ramos's 2008 net income was $3,000, and its income tax rate is 30%. No potentially dilutive securities other than the convertible bonds were outstanding during 2008. Ramos's diluted earnings per share for 2008 would be (rounded to the nearest penny) a. $1.50. b. $1.71. c. $1.80. d. $3.42.

100.

At December 31, 2007, Pratt Company had 500,000 shares of common stock outstanding. On October 1, 2008, an additional 100,000 shares of common stock were issued. In addition, Pratt had $10,000,000 of 6% convertible bonds outstanding at December 31, 2007, which are convertible into 225,000 shares of common stock. No bonds were converted into common stock in 2008. The net income for the year ended December 31, 2008, was $3,000,000. Assuming the income tax rate was 30%, the diluted earnings per share for the year ended December 31, 2008, should be (rounded to the nearest penny) a. $6.52. b. $4.80. c. $4.56. d. $4.00.

101.

On January 2, 2008, Dino Co. issued at par $300,000 of 9% convertible bonds. Each $1,000 bond is convertible into 30 shares. No bonds were converted during 2008. Dino had 50,000 shares of common stock outstanding during 2008. Dino's 2008 net income was $160,000 and the income tax rate was 30%. Dino's diluted earnings per share for 2008 would be (rounded to the nearest penny)

Additional Reporting Issues a. b. c. d. 102.

18 - 21

$2.71. $3.03. $3.20. $3.58.

At December 31, 2007, Kegan Co. had 1,200,000 shares of common stock outstanding. In addition, Kegan had 450,000 shares of preferred stock which were convertible into 750,000 shares of common stock. During 2008, Kegan paid $600,000 cash dividends on the common stock and $400,000 cash dividends on the preferred stock. Net income for 2008 was $3,400,000 and the income tax rate was 40%. The diluted earnings per share for 2008 is (rounded to the nearest penny) a. $1.24. b. $1.74. c. $2.51. d. $2.84.

Use the following information for questions 103 and 104. Gilley Co. had 200,000 shares of common stock, 20,000 shares of convertible preferred stock, and $1,000,000 of 10% convertible bonds outstanding during 2008. The preferred stock is convertible into 40,000 shares of common stock. During 2008, Gilley paid dividends of $.90 per share on the common stock and $3.00 per share on the preferred stock. Each $1,000 bond is convertible into 45 shares of common stock. The net income for 2008 was $600,000 and the income tax rate was 30%. 103.

Basic earnings per share for 2008 is (rounded to the nearest penny) a. $2.21. b. $2.42. c. $2.51. d. $2.70.

104.

Diluted earnings per share for 2008 is (rounded to the nearest penny) a. $2.14. b. $2.25. c. $2.35. d. $2.46.

105.

Werth, Incorporated, has 3,200,000 shares of common stock outstanding on December 31, 2007. An additional 800,000 shares of common stock were issued on April 1, 2008, and 400,000 more on July 1, 2008. On October 1, 2008, Werth issued 20,000, $1,000 face value, 8% convertible bonds. Each bond is convertible into 20 shares of common stock. No bonds were converted into common stock in 2008. What is the number of shares to be used in computing basic earnings per share and diluted earnings per share, respectively? a. 4,000,000 and 4,000,000 b. 4,000,000 and 4,100,000 c. 4,000,000 and 4,400,000 d. 4,400,000 and 5,200,000

18 - 22 Test Bank for Intermediate Accounting, Second Edition 106.

Lemke Co. has 4,000,000 shares of common stock outstanding on December 31, 2007. An additional 200,000 shares are issued on April 1, 2008, and 480,000 more on September 1. On October 1, Lemke issued $6,000,000 of 9% convertible bonds. Each $1,000 bond is convertible into 40 shares of common stock. No bonds have been converted. The number of shares to be used in computing basic earnings per share and diluted earnings per share on December 31, 2008 is a. 4,310,000 and 4,310,000. b. 4,310,000 and 4,370,000. c. 4,310,000 and 4,550,000. d. 5,080,000 and 5,320,000.

107.

At December 31, 2007, Quirk Company had 2,000,000 shares of common stock outstanding. On January 1, 2008, Quirk issued 500,000 shares of preferred stock which were convertible into 1,000,000 shares of common stock. During 2008, Quirk declared and paid $1,500,000 cash dividends on the common stock and $500,000 cash dividends on the preferred stock. Net income for the year ended December 31, 2008, was $5,000,000. Assuming an income tax rate of 30%, what should be diluted earnings per share for the year ended December 31, 2008? (Round to the nearest penny.) a. $1.50 b. $1.67 c. $2.50 d. $2.08

108.

Colaw Company had 300,000 shares of common stock issued and outstanding at December 31, 2007. During 2008, no additional common stock was issued. On January 1, 2008, Colaw issued 400,000 shares of nonconvertible preferred stock. During 2008, Colaw declared and paid $180,000 cash dividends on the common stock and $150,000 on the nonconvertible preferred stock. Net income for the year ended December 31, 2008, was $960,000. What should be Colaw's 2008 earnings per common share, rounded to the nearest penny? a. $1.16 b. $2.10 c. $2.70 d. $3.20

109.

At December 31, 2007, Agler Company had 1,200,000 shares of common stock outstanding. On September 1, 2008, an additional 400,000 shares of common stock were issued. In addition, Agler had $12,000,000 of 6% convertible bonds outstanding at December 31, 2007, which are convertible into 800,000 shares of common stock. No bonds were converted into common stock in 2008. The net income for the year ended December 31, 2008, was $4,500,000. Assuming the income tax rate was 30%, what should be the diluted earnings per share for the year ended December 31, 2008, rounded to the nearest penny? a. $2.11 b. $3.38 c. $2.35 d. $2.45

Additional Reporting Issues 110.

18 - 23

Foley Company has 1,800,000 shares of common stock outstanding on December 31, 2007. An additional 150,000 shares of common stock were issued on July 1, 2008, and 300,000 more on October 1, 2008. On April 1, 2008, Foley issued 6,000, $1,000 face value, 8% convertible bonds. Each bond is convertible into 40 shares of common stock. No bonds were converted into common stock in 2008. What is the number of shares to be used in computing basic earnings per share and diluted earnings per share, respectively, for the year ended December 31, 2008? a. 1,950,000 and 2,130,000 b. 1,950,000 and 1,950,000 c. 1,950,000 and 2,190,000 d. 2,250,000 and 2,430,000

Use the following information for questions 111 and 112. Information concerning the capital structure of Simot Corporation is as follows: December 31, 2008 2007 Common stock 150,000 shares 150,000 shares Convertible preferred stock 15,000 shares 15,000 shares 9% convertible bonds $2,400,000 $2,400,000 During 2008, Simot paid dividends of $1.20 per share on its common stock and $3.00 per share on its preferred stock. The preferred stock is convertible into 30,000 shares of common stock. The 9% convertible bonds are convertible into 75,000 shares of common stock. The net income for the year ended December 31, 2008, was $600,000. Assume that the income tax rate was 30%. 111.

What should be the basic earnings per share for the year ended December 31, 2008, rounded to the nearest penny? a. $2.66 b. $2.92 c. $3.70 d. $4.00

112.

What should be the diluted earnings per share for the year ended December 31, 2008, rounded to the nearest penny? a. $3.20 b. $2.95 c. $2.83 d. $2.35

113.

Warrants exercisable at $20 each to obtain 30,000 shares of common stock were outstanding during a period when the average market price of the common stock was $25. Application of the treasury stock method for the assumed exercise of these warrants in computing diluted earnings per share will increase the weighted-average number of outstanding shares by a. 30,000. b. 24,000. c. 6,000. d. 7,500.

18 - 24 Test Bank for Intermediate Accounting, Second Edition 114.

Ferry Corporation had 300,000 shares of common stock outstanding at December 31, 2008. In addition, it had 90,000 stock options outstanding, which had been granted to certain executives, and which gave them the right to purchase shares of Ferry's stock at an option price of $37 per share. The average market price of Ferry's common stock for 2008 was $50. What is the number of shares that should be used in computing diluted earnings per share for the year ended December 31, 2008? a. 300,000 b. 331,622 c. 366,600 d. 323,400

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

71. 72. 73. 74. 75. 76. 77.

b b c d a d b

78. 79. 80. 81. 82. 83. 84.

c b d a c a b

85. 86. 87. 88. 89. 90. 91.

a a a c a c c

92. 93. 94. 95. 96. 97. 98.

c b b c a d c

99. 100. 101. 102. 103. 104. 105.

b c b b d c b

106. 107. 108. 109. 110. 111. 112.

b b c c a c b

113. 114.

c d

MULTIPLE CHOICE—CPA Adapted 115.

Which of the following should be reported as a prior period adjustment? Change in Change from Estimated Lives Unaccepted Principle of Depreciable Assets to Accepted Principle a. Yes Yes b. No Yes c. Yes No d. No No

116.

On December 31, 2008, Ellworth, Inc. appropriately changed its inventory valuation method to FIFO cost from weighted-average cost for financial statement and income tax purposes. The change will result in a $1,500,000 increase in the beginning inventory at January 1, 2008. Assume a 30% income tax rate. The cumulative effect of this accounting change on beginning retained earnings is a. $0. b. $450,000. c. $1,050,000. d. $1,500,000.

Additional Reporting Issues

18 - 25

117.

On January 1, 2008, Bosco Corp. changed its inventory method to FIFO from LIFO for both financial and income tax reporting purposes. The change resulted in an $800,000 increase in the January 1, 2008 inventory. Assume that the income tax rate for all years is 30%. The cumulative effect of the accounting change should be reported by Bosco in its 2008 a. retained earnings statement as a $560,000 addition to the beginning balance. b. income statement as a $560,000 cumulative effect of accounting change. c. retained earnings statement as an $800,000 addition to the beginning balance. d. income statement as an $800,000 cumulative effect of accounting change.

118.

On January 1, 2005, Dent Co. purchased a machine for $792,000 and depreciated it by the straight-line method using an estimated useful life of eight years with no salvage value. On January 1, 2008, Dent determined that the machine had a useful life of six years from the date of acquisition and will have a salvage value of $72,000. An accounting change was made in 2008 to reflect these additional data. The accumulated depreciation for this machine should have a balance at December 31, 2008 of a. $438,000. b. $462,000. c. $480,000. d. $528,000.

119.

On January 1, 2005, Neer Co. purchased a patent for $595,000. The patent is being amortized over its remaining legal life of 15 years expiring on January 1, 2020. During 2008, Neer determined that the economic benefits of the patent would not last longer than ten years from the date of acquisition. What amount should be reported in the balance sheet for the patent, net of accumulated amortization, at December 31, 2008? a. $357,000 b. $408,000 c. $420,000 d. $436,375

120.

On January 1, 2007, Gregg Corp. acquired a machine at a cost of $500,000. It is to be depreciated on the straight-line method over a five-year period with no residual value. Because of a bookkeeping error, no depreciation was recognized in Gregg's 2007 financial statements. The oversight was discovered during the preparation of Gregg's 2008 financial statements. Depreciation expense on this machine for 2008 should be a. $0. b. $100,000. c. $125,000. d. $200,000.

121.

Peine Co. had 300,000 shares of common stock issued and outstanding at December 31, 2007. No common stock was issued during 2007. On January 1, 2008, Peine issued 200,000 shares of nonconvertible preferred stock. During 2008, Peine declared and paid $100,000 cash dividends on the common stock and $80,000 on the preferred stock. Net income for the year ended December 31, 2008 was $620,000. What should be Peine's 2008 earnings per common share? a. $2.07 b. $1.80 c. $1.73 d. $1.47

18 - 26 Test Bank for Intermediate Accounting, Second Edition 122.

At December 31, 2008 and 2007, Glass Corp. had 180,000 shares of common stock and 10,000 shares of 5%, $100 par value cumulative preferred stock outstanding. No dividends were declared on either the preferred or common stock in 2008 or 2007. Net income for 2008 was $400,000. For 2008, earnings per common share amounted to a. $2.22. b. $1.94. c. $1.67. d. $1.11.

123.

Royce Co. had 2,400,000 shares of common stock outstanding on January 1 and December 31, 2007. In connection with the acquisition of a subsidiary company in June 2006, Royce is required to issue 100,000 additional shares of its common stock on July 1, 2008, to the former owners of the subsidiary. Royce paid $200,000 in preferred stock dividends in 2007, and reported net income of $3,400,000 for the year. Royce's diluted earnings per share for 2007 should be a. $1.42. b. $1.36. c. $1.33. d. $1.28.

124.

Eller, Inc., had 560,000 shares of common stock issued and outstanding at December 31, 2006. On July 1, 2007, an additional 40,000 shares of common stock were issued for cash. Eller also had unexercised stock options to purchase 32,000 shares of common stock at $15 per share outstanding at the beginning and end of 2007. The average market price of Eller's common stock was $20 during 2007. What is the number of shares that should be used in computing diluted earnings per share for the year ended December 31, 2007? a. 580,000 b. 588,000 c. 608,000 d. 612,000

125.

When computing diluted earnings per share, convertible securities are a. ignored. b. recognized only if they are dilutive. c. recognized only if they are antidilutive. d. recognized whether they are dilutive or antidilutive.

126.

In determining diluted earnings per share, dividends on nonconvertible cumulative preferred stock should be a. disregarded. b. added back to net income whether declared or not. c. deducted from net income only if declared. d. deducted from net income whether declared or not.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

115. 116.

b c

117. 118.

a a

119. 120.

b b

121. 122.

b b

123. 124.

d b

125. 126.

b d

Additional Reporting Issues

18 - 27

DERIVATIONS — Computational No. Answer

Derivation

71.

$0, No cumulative effect; handle prospectively.

72.

$250,000 – [($250,000 × .2) + ($200,000 × .2) + ($160,000 × .2)] = $128,000 $128,000 ÷ 7 = $18,286.

73.

[(5/15 + 4/15 + 3/15) × $300,000] = $240,000 (AD) ($300,000 – $240,000) = $60,000 (BV) [$250,000 – ($60,000 ÷ 2)] × (1 – .3) = $154,000.

74.

$0, No cumulative effect; handle prospectively.

75.

[$630,000 – ($105,000 + $105,000)] = $420,000. $420,000 × 4/10 = $168,000.

76.

[($800,000 + $950,000) – ($475,000 + $625,000)] × (1 – .40) = $390,000.

77.

$0, No cumulative effect; handle prospectively.

78.

{($600,000 – [($600,000 ÷ 10) × 3]} ÷ 7 × 2 = $120,000.

79.

$420,000 × (1 – .40) = $252,000.

80.

($100,000 + $40,000) × .40 = $56,000.

81.

$60,000 × .40 = $24,000.

82.

$1,080,000 – ($712,000 – $636,000) = $1,004,000.

83.

$600,000 – ($360,000 – $300,000) = $540,000.

84.

$204,000 – {[($204,000 – $24,000) ÷ 6] × 3} = $114,000 ($114,000 – $15,000) ÷ (8 – 3) = $19,800.

85.

$0, no cumulative effect, handle prospectively (change in estimate).

86.

($300,000 ÷ 6) × 3 = $150,000 A/D ($300,000 – $150,000) ÷ 5 = $30,000.

87.

$15,000 + $6,000 = $21,000 overstatement.

88.

$24,000 + $6,000 = $30,000 understatement.

89.

($750,000 – [($750,000 – $30,000) ÷ 9]) × (1 – .40) = $402,000.

90.

$750,000 – [($750,000 – $30,000) ÷ 9 × 2] = $590,000. $590,000 × (1 – .40) = $354,000.

18 - 28 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational (cont.) No. Answer

Derivation $1,050,000 ———————————— = $1.00. 6 600,000 + (900,000 × — ) 12

91.

92.

93.

600,000 + (126,000 × 8/12) – (63,000 × 4/12) + (54,000 × 2/12) = 672,000.

94.

[(125,000 × 2 × 1.20) + (375,000 × 2 × 1.20) + (450,000 × 3) + (310,000 × 3) + (510,000 × 2)] ÷ 12 = 375,000.

95.

[(1,250,000 × 3 × 2) + (1,450,000 × 3 × 2) + (1,375,000 × 3 × 2) + (2,750,000 × 3)] ÷ 12 = 2,725,000.

96.

[$950,000 – (10,000 × $100 × .05)] ÷ (300,000 × 2) = $1.50.

97.

500,000 + (500,000 × 6/12) + [(25 – 20)/25 × 150,000] = 780,000.

98.

[$480,000 + ($2,000,000 × .07 × .60)] ÷ (200,000 + 40,000) = $2.35.

99.

$3,000 + ($10,000 × .06 × .70) —————————————— = $1.71. 1,000 + 1,000

100.

101.

$160,000 + ($300,000 × .09 × .7) ————————————————— = $3.03. 50,000 + [($300,000 ÷ $1,000) × 30)]

102.

$3,400,000 —————————— = $1.74. 1,200,000 + 750,000

103.

$600,000 – (20,000 × $3) ——————————— = $2.70. 200,000

104.

$600,000 + ($1,000,000 × .10 × .7) ———————————————— = $2.35. 200,000 + 45,000 + 40,000

105.

3,200,000 + (800,000 × 9/12) + (400,000 × 6/12) = 4,000,000 (BEPS) 4,000,000 + (20,000 × 20 × 3/12) = 4,100,000 (DEPS).

106.

4,000,000 + (200,000 × 9/12) + (480,000 × 4/12) = 4,310,000. 4,310,000 + [($6,000,000 ÷ $1,000) × 40 × 3/12] = 4,370,000.

$1,020,000 ———————————— = $2.40. 3 400,000 + (100,000 × —- ) 12

$3,000,000 + ($10,000,000 × .06 × .7) ————————————————— = $4.56. 3 500,000 + (100,000 × —- ) + 225,000 12

Additional Reporting Issues

DERIVATIONS — Computational (cont.) No. Answer

Derivation

107.

$5,000,000 —————————— = $1.67. 2,000,000 + 1,000,000

108.

$960,000 – $150,000 —————————— = $2.70. 300,000

109.

$4,500,000 + ($12,000,000 × .06 × .7) —————————————————— = $2.35. 1,200,000 + (400,000  4/12) + 800,000

110.

111.

$600,000 – (15,000 × $3.00) ————————————— = $3.70. 150,000

112.

$600,000 + ($2,400,000 × .09 × .7) ———————————————— = $2.95. 150,000 + 75,000 + 30,000

113.

30,000 × $20 ÷ $25 = 24,000 30,000 – 24,000 = 6,000.

114.

90,000 – (90,000 × $37 ÷ $50) = 23,400 300,000 + 23,400 = 323,400.

1,800,000 + (150,000 × 6/12) + (300,000 × 3/12) = 1,950,000 1,950,000 + (6,000 × 40 × 9/12) = 2,130,000.

DERIVATIONS — CPA Adapted No. Answer

Derivation

115.

Conceptual.

116.

$1,500,000 × (1 – .3) = $1,050,000.

117.

$800,000 × (1 – .3) = $560,000.

118.

$792,000 × 3/8 = $297,000 $297,000 + [($792,000 – $297,000 – $72,000) × 1/3] = $438,000.

119.

$595,000 × 3/15 = $119,000 $595,000 – $119,000 – [($595,000 – $119,000) × 1/7] = $408,000.

120.

$500,000 ÷ 5 = $100,000.

121

$620,000 – $80,000 ————————— = $1.80. 300,000

18 - 29

18 - 30 Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — CPA Adapted (cont.) No. Answer

Derivation

122.

$400,000 – (10,000 × $100 × .05) ——————————————— = $1.94. 180,000

123.

$3,400,000 – $200,000 ——————————– = $1.28. 2,400,000 + 100,000

124.

560,000 + (40,000 × 6/12) + [32,000 – (32,000 × $15 ÷ $20)] = 588,000.

125.

Conceptual.

126.

Conceptual.

EXERCISES Ex. 18-127—Matching accounting changes to situations. The four types of accounting changes, including error correction, are: Code a. Change in accounting principle. b. Change in accounting estimate. c. Change in reporting entity. d. Error correction. Instructions Following are a series of situations. You are to enter a code letter to the left to indicate the type of change. ____

Change in expected recovery of an account receivable.

____

Change due to charging a new asset directly to an expense account.

____

Change from expensing to capitalizing certain costs, due to a change in periods benefited.

____

Change from FIFO to LIFO inventory procedures.

____

Change due to failure to recognize an accrued (uncollected) revenue.

____

Change in amortization period for an intangible asset.

____

Changing the subsidiaries included in consolidated financial statements.

____

Change in the loss rate on warranty costs.

____

Change due to failure to recognize and accrue income.

____ 10.

Change in residual value of a depreciable plant asset.

____ 11.

Change from an unacceptable to an acceptable accounting principle.

Additional Reporting Issues

18 - 31

Ex. 18-127 (cont.) ____ 12.

Change in both estimate and acceptable accounting principles.

____ 13.

Change due to failure to recognize a prepaid asset.

____ 14.

Change from straight-line to sum-of-the-years'-digits method of depreciation.

____ 15.

Change in life of a depreciable plant asset.

____ 16.

Change from one acceptable principle to another acceptable principle.

____ 17.

Change due to understatement of inventory.

Solution 18-127 1. b 2. d 3. b

4. a 5. d 6. b

7. c 8. b 9. d

10. b 11. d 12. b

13. d 14. b 15. b

16. a 17. d

Ex. 18-128—How changes or corrections are recognized. For each of the following items, indicate the type of accounting change and how each is recognized in the accounting records in the current year. (a)

Change from straight-line method of depreciation to sum-of-the-years'-digits

(b)

Change from the cash basis to accrual basis of accounting

(c)

Change from FIFO to LIFO method for inventory valuation purposes

(d)

Change in the realizability of certain receivables

(e)

Change due to failure to record depreciation in a previous period

(f)

Change from LIFO to FIFO method for inventory valuation purposes

Solution 18-128 (a)

Change in accounting estimate; currently and prospectively.

(b)

Correction of an error; restatement of financial statements of all prior periods presented; adjustment of beginning retained earnings of the current period.

(c)

Change in accounting principle; no restatement; base inventory is the opening inventory of the period of change.

(d)

Change in accounting estimate; currently and prospectively.

(e)

Correction of an error; restatement of financial statements of the period affected; prior period adjustment; adjustment of beginning retained earnings of the first period after the error.

(f)

Change in accounting principle; retrospective restatement of all affected prior financial statements; adjustment of beginning retained earnings of the current period.

18 - 32 Test Bank for Intermediate Accounting, Second Edition Ex. 18-129—Matching disclosures to situations. In the blank to the left of each question, fill in the letter from the following list which best describes the presentation of the item on the financial statements of Gorden Corporation for 2008. a. b. c. d.

Change in estimate Prior period adjustment (not due to change in principle) Retrospective type accounting change with note disclosure None of the above

____

In 2008, the company changed its method of recognizing income from the completed-contract method to the percentage-of-completion method.

____

At the end of 2008, an audit revealed that the corporation's allowance for doubtful accounts was too large and should be reduced to 2%. When the audit was made in 2007, the allowance seemed appropriate.

____

Depreciation on a truck, acquired in 2005, was understated because the service life had been overestimated. The understatement had been made in order to show higher net income in 2006 and 2007.

____

The company switched from a LIFO to a FIFO inventory valuation method during the current year.

____

In the current year, the company decides to change from expensing certain costs to capitalizing these costs, due to a change in the period benefited.

____

During 2008, a long-term bond with a carrying value of $3,600,000 was retired at a cost of $4,100,000.

____

After negotiations with the IRS, income taxes for 2006 were established at $42,900. They were originally estimated to be $28,600.

____

In 2008, the company incurred interest expense of $29,000 on a 20-year bond issue.

____

In computing the depreciation in 2006 for equipment, an error was made which overstated income in that year $75,000. The error was discovered in 2008.

____ 10.

In 2008, the company changed its method of depreciating plant assets from the double-declining balance method to the straight-line method.

Solution 18-129 1. 2.

c a

3. 4.

b c

5. 6.

a d

7. 8.

a d

9. 10.

b a

Additional Reporting Issues

18 - 33

Ex. 18-130—Change in accounting principle. In 2008, Maxwell Corporation changed its method of inventory pricing from LIFO to FIFO. Net income computed on a LIFO as compared to a FIFO basis for the four years involved is: (Ignore income taxes.) LIFO FIFO 2005 $78,200 $83,700 2006 84,500 88,100 2007 87,000 91,400 2008 92,500 94,700 Instructions (a) Indicate the net income that would be shown on comparative financial statements issued at 12/31/08 for each of the four years, assuming that the company changed to the FIFO method in 2008. (b)

Assume that the company had switched from the average cost method to the FIFO method with net income on an average cost basis for the four years as follows: 2005, $80,400; 2006, $86,120; 2007, $90,300; and 2008, $93,600. Indicate the net income that would be shown on comparative financial statements issued at 12/31/08 for each of the four years under these conditions.

(c)

Assuming that the company switched from the FIFO to the LIFO method, what would be the net income reported on comparative financial statements issued at 12/31/08 for 2005, 2006, and 2007?

Solution 18-130 (a)

2005, $83,700; 2006, $88,100; 2007, $91,400; 2008, $94,700, (Retrospective restatement).

(b)

2005, $83,700; 2006, $88,100; 2007, $91,400; 2008, $94,700, (Retrospective restatement).

(c)

2005, $83,700; 2006, $88,100; 2007, $91,400.

Ex. 18-131—Change in estimate, change in entity, correction of errors. Discuss the accounting procedures for and illustrate the following: (a) Change in estimate (b) Correction of an error

Solution 18-131 (a)

Accounting estimates will change as new events occur, as more experience is acquired, or new information is obtained. Examples of changes in estimate are: (a) collectibility of receivables, (b) inventory obsolescence, (c) estimated lives or residual values, and (d) warranty costs. Changes in estimates are handled prospectively; that is, in current and future periods. No restatement of previous financial statements is made.

18 - 34 Test Bank for Intermediate Accounting, Second Edition Solution 22-131 (cont.) (b)

Examples of accounting errors are: (a) a change from an accounting principle that is not generally accepted to an accounting principle that is accepted, (b) mathematical mistakes, (c) changes in estimates that occur because the estimates are not made in good faith, (d) an oversight, (e) a misuse of facts, and (f) misclassification of an asset as an expense or vice versa. Corrections of errors are recorded in the year discovered, are treated as prior period adjustments, and the beginning balance of retained earnings is adjusted. Prior financial statements are restated.

Ex. 18-132—Changes in depreciation methods, estimates. On January 1, 2003, Sauder Company purchased a building and machinery that have the following useful lives, salvage value, and costs. Building, 25-year estimated useful life, $4,000,000 cost, $400,000 salvage value Machinery, 10-year estimated useful life, $500,000 cost, no salvage value The building has been depreciated under the straight-line method through 2007. In 2008, the company decided to switch to the double-declining balance method of depreciation for the building. Sauder also decided to change the total useful life of the machinery to 8 years, with a salvage value of $25,000 at the end of that time. The machinery is depreciated using the straightline method. Instructions (a) Prepare the journal entry necessary to record the depreciation expense on the building in 2008. (b) Compute depreciation expense on the machinery for 2008.

Solution 18-132 Computation of 2008 depreciation expense on the building: Cost of building Accumulated depreciation [($4,000,000 – $400,000) ÷ 25] × 5 years Book value, 1/1/08

$4,000,000 720,000 $3,280,000

2008 Depreciation expense: $3,280,000 × 10% = $328,000 Depreciation Expense .................................................................... Accumulated Depreciation—Building ..................................... Computation of 2008 depreciation expense on machinery: Cost of machinery Accumulated depreciation [($500,000 – $0) ÷ 10] × 5 years Book value, 1/1/08

328,000 328,000

$500,000 250,000 $250,000

2008 Depreciation expense: ($250,000 – $25,000) ÷ (8 – 5) = $225,000 ÷ 3 = $75,000

Additional Reporting Issues

18 - 35

Ex. 18-133—Noncounterbalancing error. Stevens Co. bought a machine on January 1, 2006 for $875,000. It had a $75,000 estimated residual value and a ten-year life. An expense account was debited on the purchase date. Stevens uses straight-line depreciation. This was discovered in 2008. Instructions Prepare the entry or entries related to the machine for 2008.

Solution 18-133 Machine ............................................................................................... Retained Earnings .................................................................... Accumulated Depreciation (2 × $80,000) ..................................

875,000

Depreciation Expense .......................................................................... Accumulated Depreciation ........................................................

80,000

715,000 160,000

80,000

Ex. 18-134—Weighted average shares outstanding. On January 1, 2008, Yarrow Corporation had 1,000,000 shares of common stock outstanding. On March 1, the corporation issued 150,000 new shares to raise additional capital. On July 1, the corporation declared and issued a 2-for-1 stock split. On October 1, the corporation purchased on the market 600,000 of its own outstanding shares and retired them. Instructions Compute the weighted-average number of shares to be used in computing earnings per share for 2008.

Solution 18-134

Jan. 1 March 1 July 1 Oct. 1

Increase (Decrease) — 150,000 1,150,000 (600,000)

Outstanding 1,000,000 1,150,000 2,300,000 1,700,000

Months Outstanding 2 4 3 3 12 (25,200,000 ÷ 12)

Ex. 18-135—Earnings Per Share. (Essay) Define the following: (a) The computation of earnings per common share (b) Complex capital structure (c) Basic earnings per share (d) Diluted earnings per share

2/1 2/1

Share Months 4,000,000 9,200,000 6,900,000 5,100,000 25,200,000 2,100,000

18 - 36 Test Bank for Intermediate Accounting, Second Edition Solution 18-135 (a) Earnings per common share is computed by dividing net income less preferred dividends by the weighted average of common shares outstanding. (b) A complex capital structure exists when a corporation has convertible securities, options, warrants, or other rights that upon conversion or exercise could dilute earnings per share. (c) Basic earnings per share is earnings per share computed based on the common shares outstanding during the period. (d) Diluted earnings per share is earnings per share computed based on common stock and all potentially dilutive common shares that were outstanding during the period.

Ex. 18-136—Earnings per share. Ramirez Corporation has 400,000 shares of common stock outstanding throughout 2008. In addition, the corporation has 5,000, 20-year, 7% bonds issued at par in 2005. Each $1,000 bond is convertible into 20 shares of common stock after 9/23/09. During the year 2008, the corporation earned $600,000 after deducting all expenses. The tax rate was 30%. Instructions Compute the proper earnings per share for 2008.

Solution 18-136 Net income $600,000 Earnings per share: ————————— = ———— = $1.50 Outstanding shares 400,000 Net income + Interest after taxes Earnings per share assuming bond conversion: ——————————————— Assumed outstanding shares $600,000 + $245,000 ($350,000 × .7 = $245,000); —————————— = $1.69 400,000 + 100,000 Therefore the bonds are antidilutive, and earnings per common share outstanding of $1.50 should be reported. Note that the convertible security is antidilutive: Bond interest after taxes $245,000 ————————————— = ———— = $2.45 Assumed incremental shares 100,000

Additional Reporting Issues

18 - 37

Ex. 18-137—Diluted earnings per share. Brewer Company had 400,000 shares of common stock outstanding during the year 2008. In addition, at December 31, 2008, 90,000 shares were issuable upon exercise of executive stock options which require a $40 cash payment upon exercise (options granted in 2006). The average market price during 2008 was $50. Instructions Compute the number of shares to be used in determining diluted earnings per share for 2008.

Solution 18-137 Shares outstanding Add: Assumed issuance Deduct: Proceeds/Average market price ($3,600,000 ÷ $50) Number of shares

400,000 90,000 490,000 (72,000) 418,000

PROBLEMS Pr. 18-138—Accounting for changes and error corrections. Pack Company's net incomes for the past three years are presented below: 2009 2008 2007 $480,000 $450,000 $360,000 During the 2009 year-end audit, the following items come to your attention: 1. Pack bought a truck on January 1, 2006 for $196,000 with a $16,000 estimated salvage value and a six-year life. The company debited an expense account and credited cash on the purchase date for the entire cost of the asset. (Straight-line method) 2. During 2009, Pack changed from the straight-line method of depreciating its cement plant to the double-declining balance method. The following computations present depreciation on both bases: 2009 2008 2007 Straight-line 36,000 36,000 36,000 Double-declining 46,080 57,600 72,000 The net income for 2009 was computed using the double-declining balance method, on the January 1, 2009 book value, over the useful life remaining at that time. The depreciation recorded in 2009 was $72,000. 3. Pack, in reviewing its provision for uncollectibles during 2009, has determined that 1% is the appropriate amount of bad debt expense to be charged to operations. The company had used 1/2 of 1% as its rate in 2008 and 2009 when the expense had been $18,000 and $12,000, respectively. The company recorded bad debt expense under the new rate for 2009. The company would have recorded $6,000 less of bad debt expense on December 31, 2009 under the old rate.

18 - 38 Test Bank for Intermediate Accounting, Second Edition Pr. 18-138 (cont.) Instructions (a) Prepare in general journal form the entry necessary to correct the books for the transaction in part 1 of this problem, assuming that the books have not been closed for the current year. (b)

Compute the net income to be reported each year 2007 through 2009.

(c)

Assume that the beginning retained earnings balance (unadjusted) for 2007 was $1,260,000. At what adjusted amount should this beginning retained earnings balance for 2007 be stated, assuming that comparative financial statements were prepared?

(d)

Assume that the beginning retained earnings balance (unadjusted) for 2009 is $1,800,000 and that non-comparative financial statements are prepared. At what adjusted amount should this beginning retained earnings balance be stated?

Solution 18-138 (a)

Equipment ................................................................................... Depreciation Expense.................................................................. Accumulated Depreciation (4 years, 06-09)...................... Retained Earnings............................................................

(b)

2007: $360,000 – $30,000 = $330,000. 2008: $450,000 – $30,000 = $420,000. 2009: $480,000 – $30,000 = $450,000.

(c)

Retained earnings (unadjusted) Correction of 2006 error ($196,000 – $30,000) Retained earnings (adjusted)

$1,260,000 166,000 $1,426,000

(d)

Retained earnings (unadjusted) Correction of error ($196,000 – $90,000) Retained earnings (adjusted)

$1,800,000 106,000 $1,906,000

196,000 30,000 120,000 106,000

Pr. 18-139—Earnings per share. Adcock Corp. had $500,000 net income in 2008. On January 1, 2008 there were 200,000 shares of common stock outstanding. On April 1, 20,000 shares were issued and on September 1, Adcock bought 30,000 shares of treasury stock. There are 30,000 options to buy common stock at $40 a share outstanding. The market price of the common stock averaged $50 during 2008. The tax rate is 40%. During 2008, there were 40,000 shares of convertible preferred stock outstanding. The preferred is $100 par, pays $3.50 a year dividend, and is convertible into three shares of common stock. Adcock issued $2,000,000 of 8% convertible bonds at face value during 2007. Each $1,000 bond is convertible into 30 shares of common stock.

Additional Reporting Issues

18 - 39

Pr. 18-139 (cont.) Instructions Compute diluted earnings per share for 2008. Complete the schedule and show all computations.

Security

Net Income

Adjustment

Adjusted Net Income

Adjustment

Adjusted Shares

EPS

Adjusted Net Income

Adjustment

Adjusted Shares

EPS

$360,000

200,000

5,000a

205,000

$1.76

360,000

205,000

6,000b

211,000

1.71

456,000

211,000

60,000

271,000

1.68

596,000

271,000

120,000

391,000

1.52

Solution 18-139 Security Com. Stock

Net Income $500,000

Adjustment $(140,000)

Options Bonds

360,000

96,000c

Preferred

456,000

140,000

20,000 × 3/4 = 30,000 × 1/3 =

15,000 (10,000) 5,000 SA

30,000 $1,200,000 ÷ $50 = (24,000) 6,000 SA

(or) [(50 – 40) ÷ 50] × 30,000 = 6,000 SA

$96,000 ———— = $1.60 60,000

$2,000,000 × .08 × .6 = $96,000

$140,000 ———— = $1.17 120,000

Pr. 18-140—Basic and diluted EPS. Assume that the following data relative to Eddy Company for 2008 is available: Net Income Transactions in Common Shares Jan. 1, 2008, Beginning number Mar. 1, 2008, Purchase of treasury shares June 1, 2008, Stock split 2-1 Nov. 1, 2008, Issuance of shares

$2,100,000 Change (60,000) 640,000 120,000

Cumulative 700,000 640,000 1,280,000 1,400,000

8% Cumulative Convertible Preferred Stock Sold at par, convertible into 200,000 shares of common (adjusted for split).

$1,000,000

Stock Options Exercisable at the option price of $25 per share. Average market price in 2008, $30 (market price and option price adjusted for split).

60,000 shares

18 - 40 Test Bank for Intermediate Accounting, Second Edition Pr. 18-140 (cont.) Instructions (a) Compute the basic earnings per share for 2008. (Round to the nearest penny.) (b) Compute the diluted earnings per share for 2008. (Round to the nearest penny.)

Solution 18-140 Computation of weighted average shares outstanding during the year: January 1 March 1

Outstanding Repurchase (5/6 × 60,000)

June 1 November 1

2-for-1 split Issued (1/6 × 120,000)

700,000 (50,000) 650,000 1,300,000 20,000 1,320,000

Additional shares for purposes of diluted earnings per share: Potentially dilutive securities 8% convertible preferred stock Stock options Proceeds from exercise of 60,000 options (60,000 × $25) Shares issued upon exercise of options Less: treasury stock purchasable with proceeds ($1,500,000 ÷ $30) Dilutive securities—additional shares

200,000 $1,500,000 60,000 50,000

10,000 210,000

$2,100,000 – $80,000 (a) Basic earnings per share: —————————— = $1.53 1,320,000 (b) Diluted earnings per share:

$2,100,000 ———–—————— = $1.37 1,320,000 + 210,000

Pr. 18-141—Basic and diluted EPS. The following information was taken from the books and records of Simonic, Inc.: 1. Net income

$ 280,000

2. Capital structure: a. Convertible 6% bonds. Each of the 300, $1,000 bonds is convertible into 50 shares of common stock at the present date and for the next 10 years.

300,000

b. $10 par common stock, 200,000 shares issued and outstanding during the entire year.

2,000,000

c. Stock warrants outstanding to buy 16,000 shares of common stock at $20 per share.

Additional Reporting Issues

18 - 41

Pr. 18-141 (cont.) 3. Other information: a. Bonds converted during the year b. Income tax rate c. Convertible debt was outstanding the entire year d. Average market price per share of common stock during the year e. Warrants were outstanding the entire year f. Warrants exercised during the year

None 30% $32 None

Instructions Compute basic and diluted earnings per share.

Solution 18-141 Basic EPS = $280,000 ÷ 200,000 sh. = $1.40 Security

Net Income

Adjustment

Adjusted Net Income

Adjustment

Adjusted Shares

Diluted EPS

Com. Stock

$280,000

—

$280,000

200,000

—

200,000

$1.40

280,000

—

280,000

200,000

6,0001

206,000

1.36

280,000

$12,6002

292,600

206,000

15,000

221,000

1.32

Warrants Conv. Bonds

16,000 320,000 ———— = (10,000) 32 6,000

$300,000  .06  .7 = $12,600

$12,600 ———— = $.84 15,000

COMPREHENSIVE EXAMINATION A PART 1

(Chapters 1–5)

Problem

Topic

A-I A-II A-III A-IV A-V

Multiple Choice (Various Topics). Adjusting and Reversing Entries.* Key Conceptual Terms. Balance Sheet Form. Balance Sheet and Income Statement Classifications.

*Topic dealt with in Appendix 3A.

Approximate Time 15 min. 30 min. 10 min. 20 min. 15 min. 90 min.

A-2

Test Bank for Intermediate Accounting, Second Edition

Problem A-I — Multiple Choice. Choose the best answer for each of the following questions and enter the identifying letter in the space provided. ____ 1. How does failure to record accrued revenue distort the financial reports? a. It understates revenue, net income, and current assets. b. It understates net income, stockholders’ equity, and current liabilities. c. It overstates revenue, stockholders’ equity, and current liabilities. d. It understates current assets and overstates stockholders’ equity. ____ 2. A contingent liability which is normally accrued is a. notes receivable discounted. b. accommodation endorsements on customer notes. c. additional compensation that may be payable on a dispute now being arbitrated. d. estimated claims under a service warranty on new products sold. ____ 3. Which of the following items is a current liability? a. Bonds due in three months (for which there is an adequate sinking fund classified as a long-term investment). b. Bonds due in three years. c. Bonds (for which there is an adequate appropriation of retained earnings) due in eleven months. d. Bonds to be refunded when due in eight months, there being no doubt about the marketability of the refunding issue. ____ 4. On June 15, 2008 Greer Corporation accepted delivery of merchandise which it purchased on account. As of June 30 Greer had not recorded the transaction or included the merchandise in its inventory. The effect of this error on its balance sheet for June 30, 2008 would be a. assets and stockholders’ equity were overstated but liabilities were not affected. b. stockholders’ equity was the only item affected by the omission. c. assets and liabilities were understated but stockholders’ equity was not affected. d. assets and stockholders’ equity were understated but liabilities were not affected. ____ *5. Reversing entries are most commonly used in relation to year-end adjusting entries that a. allocate the expired portion of a depreciable asset to expense. b. amortize intangible assets. c. provide for bad debts expense. d. accrue interest revenue on notes receivable. ____ 6. Of the following adjusting entries, which one would cause an increase in assets at the end of the period? a. The entry to record the earned portion of rent received in advance. b. The entry to accrue unrecorded interest expense. c. The entry to accrue unrecorded interest revenue. d. The entry to record expiration of prepaid insurance.

Comprehensive Examination A

A-3

____ 7. Why is it necessary to make adjusting entries? a. The accountant has made errors in recording external transactions. b. Certain facts about the affairs of the business are not included in the ledger as built up from external transactions. c. The accountant wants to show the largest possible net income for the period. d. The accountant wants to show the net cash flow for the year. ____ 8. Notes to financial statements should not be used to a. describe the nature and effect of a change in accounting principles. b. identify substantial differences between book and tax income. c. correct an improper financial statement presentation. d. indicate basis for asset valuation. ____ 9. The characteristic of consistency is best demonstrated when a. expenses are reported as charges against the period in which incurred. b. the effect of changes in accounting procedure is properly disclosed. c. extraordinary gains and losses are not reported on the income statement. d. accounting procedures are adopted which give a consistent rate of net income. ____ 10. The current asset section of a balance sheet should never include a. a receivable from a customer not collectible for over one year. b. premium paid on temporary bond investment. c. goodwill arising from the purchase of a going business. d. customers' accounts with credit balances. Problem A-II — Adjusting and Reversing Entries. The following list of accounts and their balances represents the unadjusted trial balance of Bly Company at December 31, 2008: Cash Short-term Investment Accounts Receivable Allowance for Doubtful Accounts Merchandise Inventory Prepaid Rent Plant and Equipment Accumulated Depreciation Accounts Payable Bonds Payable Common Stock Retained Earnings Sales Cost of Goods Sold Transportation-Out Salaries and Wages Expense Interest Expense Rent Revenue Miscellaneous Expense Insurance Expense

$ 30,890 60,000 69,000 $

500

54,720 36,000 160,000 14,740 11,370 90,000 170,000 97,180 214,800 154,400 11,000 32,000 2,040 21,600 890 9,250 $620,190

$620,190

A-4

Test Bank for Intermediate Accounting, Second Edition

Problem A-II — (cont.) Additional Data: 1. The balance in the Insurance Expense account contains the premium costs of three policies: Policy 1, remaining cost of $2,550, 1-yr. term, taken out on May 1, 2007; Policy 2, original cost of $5,400, 3-yr. term, taken out on Oct. 1, 2008; Policy 3, original cost of $1,300, 1-yr. term, taken out on Jan. 1, 2008. 2. On September 30, 2008, Bly received $21,600 rent from its lessee for an eighteen-month lease beginning on that date. 3. The regular rate of depreciation is 10% per year. Acquisitions and retirements during a year are depreciated at half this rate. There were no purchases during the year. On December 31, 2008, the balance of the Plant and Equipment account was $260,000. 4. On December 28, 2008, the bookkeeper incorrectly credited sales for a receipt on account in the amount of $10,000. 5. At December 31, 2008, salaries accrued but unpaid were $4,200. 6. Bly estimates that 2% of sales will become uncollectible. 7. On August 1, 2008, Bly purchased, as a temporary investment, 70 $1,000, 9% bonds of Allen Corp. at par. The bonds mature on August 1, 2009. Interest payment dates are July 31 and January 31. 8. On April 30, 2008, Bly rented a warehouse for $3,000 per month, paying $36,000 in advance.

Instructions (a) Record the necessary correcting and adjusting entries. (b) Indicate which of the adjusting entries may be reversed at the beginning of the next accounting period.

Comprehensive Examination A

A-5

Problem A-III — Key Conceptual Terms. Various accounting assumptions, principles, constraints, and characteristics are listed below. Select those which best justify the following accounting procedures and indicate the corresponding letter(s) in the space(s) provided. A letter may be used more than once or not at all. a. b. c. d. e.

Historical cost Relevance Monetary unit Going concern Consistency

f. g. h. i. j.

Economic entity Materiality Conservatism Periodicity Matching

k. Revenue recognition l. Full disclosure m. Substance over form n. Industry practices o. Reliability

____

1. Using the lower of cost or market approach in valuing inventories.

____

2. Describing the depreciation methods used in the financial statements.

____

3. Applying the same accounting treatment to similar accounting events.

____

4. The quality which helps users make predictions about present, past, and future events.

____

5. Recording a transaction when goods or services are exchanged for cash or claims to cash.

____

6. Preparing consolidated statements.

____

7. Expensing, when acquired, metal office wastebaskets having a life of ten years.

____

8. Provides the figure at which to record a liability.

____

9. The preparation of timely reports on continuing operations.

____ 10. Accrual accounting (do not use "going concern"). ____ 11. Reporting those items which are significant enough to affect decisions. Select two (11 and 12). ____ 12. See item 11 above. ____ 13. Ignoring the phenomenon of general price-level change (do not use "historical cost"). ____ 14. Not reporting assets at liquidation prices (do not use "historical cost"). ____ 15. Reporting information which is faithfully representative of economic events. ____ 16. Establishment of an allowance for doubtful accounts. ____ 17. Additivity of financial statement figures relating to different time periods. ____ 18. Carrying inventories at sales price less distribution costs. ____ 19. Use of estimating procedures for amortization policies. "periodicity") (19 and 20). ____ 20. See item 19 above.

Select two (do not use

A-6

Test Bank for Intermediate Accounting, Second Edition

Problem A-IV — Balance Sheet Form. List the corrections needed to present in good form the balance sheet below. Errors include misclassifications, lack of adequate disclosure, and poor terminology. Do not concern yourself with the arithmetic. If an item can be classified in more than one category, select the category most favored by the authors of your textbook. Norton Corporation Balance Sheet For the year ended December 31, 2008 Assets Current Assets: Cash Trading securities (fair value, $32,000) Accounts receivable Merchandise inventory Supplies inventory Stock investment in subsidiary company Investments: Treasury stock Tangible Fixed Assets: Buildings and land Less: Reserve for depreciation

$ 18,000 27,000 75,000 60,000 3,000 60,000

$243,000 78,000

213,000 60,000

Deferred Charges: Unamortized discount on bonds payable Other Assets: Cash surrender value of life insurance

153,000

3,000 54,000 $531,000

Liabilities and Capital Current Liabilities: Accounts payable Reserve for income taxes Customer's accounts with credit balances

$ 45,000 42,000 3

Long-Term Liabilities: Bonds payable Total Liabilities Capital Stock: Capital stock Earned surplus Cash dividends declared

$ 87,003

120,000 207,003

225,000 74,997 24,000

323,997 $531,000

Comprehensive Examination A

A-7

Problem A-V — Balance Sheet and Income Statement Classifications. Specify, to the left of each account, the letter of the financial statement classification the account would appear in. Use only the classifications shown. Balance Sheet a. Current Assets b. Investments c. Property, Plant, and Equipment d. Intangible Assets e. Other Assets f. Current Liabilities g. Long-term Debt h. Capital Stock i. Retained Earnings

Income and Retained Earnings Statement j. Sales Revenue k. Cost of Goods Sold l. Operating Expenses m. Other Revenues and Gains n. Other Expenses and Losses o. Extraordinary Item p. Retained Earnings Section q. Not on the Statements

Account balances taken from the ledger of Morin Company on December 31, 2009 follow: ____

1. Capital Stock, $10 par

_____ 16. Merchandise Inventory

____

2. Loss on Sale of Equipment

_____ 17. Salaries and Wages Expense

____

3. Buildings

_____ 18. Merchandise on order with supplier

____

4. Office Expense

_____ 19. Interest Revenue

____

5. Allowance for Doubtful Accounts

_____ 20. Selling Expense

____

6. Notes Payable—Short Term

_____ 21. Interest Expense

____

7. Accum. Depreciation—Buildings

_____ 22. Taxes Payable

____

8. Mortgage Payable due 2011

_____ 23. Insurance Expense

____

9. Depletion Expense

_____ 24. Advertising Expense

____ 10. Freight-Out

_____ 25. Long-Term Investments

____ 11. Sales

_____ 26. Accounts Receivable

____ 12. Dividends Declared

_____ 27. Land

____ 13. Retained Earnings Dec. 31, 2008

_____ 28. Accounts Payable

____ 14. Cash ____ 15. Sales Discounts

_____ 29. Error made in computing 2007 depreciation expense _____ 30. Gain from early extinguishment of debt

A-8

Test Bank for Intermediate Accounting, Second Edition

Solutions — Comprehensive Examination A Problem A-I — Solution. 1. a 2. d 3. c

4. c 5. d 6. c

7. b 8. c 9. b

10. c

Problem A-II — Solution. (a) 1. Prepaid Insurance .................................................................... 4,950 Insurance Expense ....................................................... (Both Policies 1 and 3 have expired and their costs belong in Insurance Expense. The monthly premium on Policy 2 is $5,400 ÷ 36 = $150. At 12/31/08, 33 mos. of insurance, or $4,950, remains unexpired) 2. Rent Revenue .......................................................................... Unearned Rent ............................................................. (Monthly rent is $21,600 ÷ 18 = $1,200. At 12/31/08, 15 mos. of rent, or $18,000, remains unearned)

18,000

3. Depreciation Expense .............................................................. Accumulated Depreciation ............................................ [(Equipment retired during 2008 = $260,000 – $160,000 = $100,000) 10% of $160,000 = $16,000 5% of $100,000 = 5,000 Total depreciation = $21,000]

21,000

4. Sales ........................................................................................ Accounts Receivable .................................................... (To correct the entry made in error)

10,000

5. Salaries and Wages Expense ................................................... Salaries and Wages Payable ........................................

4,200

6. Bad Debts Expense .................................................................. Allowance for Doubtful Accounts ................................... (Corrected Sales balance is $214,800 – $10,000 = $204,800. 2% of $204,800 is $4,096.)

4,096

7. Interest Receivable ................................................................... Interest Revenue .......................................................... (Monthly interest is $60,000 × .09 × 1/12 = $450. 5 months' accrued interest is $2,250)

2,250

8. Rent Expense ........................................................................... Prepaid Rent ................................................................. (To record 8 months' of rent expired at $3,000 per month)

24,000

4,950

18,000

21,000

10,000

4,200

4,096

2,250

24,000

Comprehensive Examination A

A-9

(b) 1, 2, 5, and 7. Items No. 1 and No. 2 represent prepaid items that were initially recorded in nominal accounts. Items No. 5 and No. 7 represent accrued items. Problem A-III — Solution. 1. 2. 3. 4. 5.

h l e b k

6. 7. 8. 9. 10.

f g a i j or k

11. 12. 13. 14. 15.

l g or b c d o

16. 17. 18. 19. 20.

j c n d j

Problem A-IV — Solution. 1.

"For the year ended" in the title should be deleted.

Trading securities should be reported at their fair value.

The amount of Allowance for Doubtful Accounts should be disclosed and deducted from Accounts Receivable.

The inventory costing method (cost, lower of cost or market) and the basis for pricing the inventory (LIFO, FIFO, etc.) should be disclosed.

Stock Investment in Subsidiary should be classified as an investment.

Treasury Stock is misclassified under Investments. It should appear as a deduction from the Stockholders' Equity section.

Buildings and Land should be separated.

"Reserve for" Depreciation should be either "Allowance for" or "Accumulated" Depreciation.

Unamortized Discount on Bonds Payable should be classified with and deducted from Bonds Payable.

10.

Cash Surrender Value of Life Insurance should be classified among Investments.

11.

"Reserve" for Income Taxes should be titled Income Taxes Payable.

12.

The small balance of $3 for customer's accounts with credit balances, while not erroneously classified, might be offset against and buried in the Accounts Receivable account because it is so small in amount.

13.

The maturity date and the interest rate should be disclosed for the Bonds Payable.

14.

"Capital Stock" listed as title should be "Stockholders' Equity;" "Capital stock" listed as account should be “Common stock.”

A - 10 Test Bank for Intermediate Accounting, Second Edition 15.

More information relative to the capital stock, such as par value and the number of shares authorized, issued, and outstanding should be disclosed.

16.

"Earned surplus" should not be used; Retained Earnings is the preferred title.

17.

Cash dividends declared is actually Dividends Payable and should be classified as a current liability.

Problem A-V — Solution. 1. 2. 3. 4. 5. 6.

h n c l a f

7. 8. 9. 10. 11. 12.

c g k l j p

13. 14. 15. 16. 17. 18.

p a j a l q

19. 20. 21. 22. 23. 24.

m l n f l l

25. 26. 27. 28. 29. 30.

b a c f p m

COMPREHENSIVE EXAMINATION B PART 2

(Chapters 6–9)

Problem

Topic

B-I B-II B-III B-IV B-V B-VI B-VII

Multiple Choice. Lower of Cost or Market. Notes Receivable. FIFO vs. LIFO. Statement of Cash Flows. Long-Term Contracts. Installment Sales Method.

Approximate Time 15 min. 10 min. 15 min. 10 min. 25 min. 10 min. 15 min. 100 min.

B-2

Test Bank for Intermediate Accounting, Second Edition

Problem B-I — Multiple Choice — Cash and Receivables. Choose the best answer for each of the following questions and enter the identifying letter in the space provided. ____ 1. When should the loss on an uncollectible account receivable be recorded as an expense for accrual accounting purposes? a. When it is determined that an account cannot be collected. b. In the same period in which the sale on account occurs. c. When the balance is past due for more than 3 months. d. When a lawyer indicates that collection efforts would cost more than the account is worth. ____ 2. Which of the following methods of accounting for uncollectible accounts does not properly match costs with revenues? a. Percentage of sales b. Percentage of receivables c. Direct write-off d. Aging schedule ____ 3. Oswald Company's account balances at December 31 for Accounts Receivable and the related Allowance for Doubtful Accounts are $600,000 and $13,000, respectively. From an analysis of accounts receivable, it is estimated that $28,000 of the December 31 receivables will be uncollectible. After adjustment for the above facts, the net realizable value of accounts receivable would be a. $600,000. b. $587,000. c. $559,000. d. $572,000. ____ 4. Which group of items listed below should be included in the cash account? a. Silver coins, postage stamps, demand deposits, personal checks. b. Promissory notes, demand deposits, money orders, silver coins. c. Money orders, postdated checks, personal checks, time deposits. d. Silver coins, money orders, demand deposits, personal checks. ____ 5. On December 31, 2008, Dorr Company, which sells only one product, adopted the periodic last-in, first-out method of inventory valuation. The inventory was valued at $30,000 on the December 31, 2008 balance sheet. The number of items in its inventory remained constant during 2009. The December 31, 2009 inventory valuation would be a. less than $30,000 if prices were steadily decreasing. b. less than $30,000 if prices were steadily increasing. c. greater than $30,000 if prices were steadily increasing. d. $30,000 regardless of any price changes.

Comprehensive Examination B

B-3

____ 6. A company has been using the FIFO cost method of inventory valuation since it was started 10 years ago. Its 2008 ending inventory was $90,000, but it would have been $70,000 if LIFO had been used. Thus, if LIFO had been used, this company's income before taxes would have been a. $20,000 less in 2008. b. $20,000 less over the 10-year period. c. $20,000 greater over the 10-year period. d. $20,000 greater in 2008. ____ 7. Most methods of pricing inventories are in accord with generally accepted accounting principles and generally are permissible for income tax purposes. The method that must be used for financial reporting purposes if used for tax purposes is a. moving average. b. weighted average. c. LIFO. d. FIFO. ____ *8. Pine Company estimates the cost of its physical inventory at March 31 for use in an interim financial statement. The rate of markup on cost is 25%. The following account balances are available: Inventory, March 1 Purchases during March Purchase returns Sales during March

$1,160,000 500,000 26,000 1,000,000

The estimate of the cost of inventory at March 31 would be a. $750,000. b. $800,000. c. $834,000. d. $884,000.

B-4

Test Bank for Intermediate Accounting, Second Edition

Problem B-II — Lower of Cost or Market Presented below is data relative to the 12/31/08 inventory of Kidd Company: Item A B C D E Total

Item

Number Units In Inventory 3,000 3,000 3,000 3,000 3,000 15,000

Upper Limit ("Ceiling")

Original Cost Per Unit $1.09 1.30 1.50 1.60 1.80

Lower Limit ("Floor")

Total Original Cost $3,270 3,900 4,500 4,800 5,400 $21,870

Designated Market

Current Replacement Cost $1.08 1.15 1.05 1.65 1.70

Appropriate Inventory Valuation (Totals)

A B C D E Total Additional Data: Selling price is $2.00/unit for all items. Disposal costs amount to 10% of selling price and a "normal" profit is 35% of selling price. Instructions Complete the four columns above for each item.

Comprehensive Examination B

B-5

Problem B-III — Notes Receivable. On December 31, 2007 Long Corporation sold some of its product to Doane Company, accepting a 3%, four-year promissory note having a maturity value of $900,000 (interest payable annually on December 31). Doane Company pays 8% for its borrowed funds. Instructions (a) Prepare the journal entries to record the transaction on the books of Long Corporation at December 31, 2007. (Assume that the effective interest method is used. Use the interest tables below and round to the nearest dollar.) (b) Make all appropriate entries for 2008 on the books of Long Corporation. (c) Make all appropriate entries for 2009 on the books of Long Corporation.

For Use on Problem B-III Table 1 Present Value of 1 Periods 1 2 3 4 5

2% 0.98039 0.96117 0.94232 0.92385 0.90573

3% 0.97087 0.94260 0.91514 0.88849 0.86261

4% 0.96154 0.92456 0.88900 0.85480 0.82193

6% 0.94340 0.89000 0.83962 0.79209 0.74726

8% 0.92593 0.85734 0.79383 0.73503 0.68058

Table 2 Present Value of Ordinary Annuity of 1 Periodic Rents 1 2 3 4 5

2% 0.98039 1.94156 2.88388 3.80773 4.71346

3% 0.97087 1.91347 2.82861 3.71710 4.57971

4% 0.96154 1.88609 2.77509 3.62990 4.45182

6% 0.94340 1.83339 2.67301 3.46511 4.21236

8% 0.92593 1.78326 2.57710 3.31213 3.99271

B-6

Test Bank for Intermediate Accounting, Second Edition

Problem B-IV — FIFO vs. LIFO. In comparing and contrasting FIFO vs. LIFO inventory procedures, the following listing was developed. You are to complete the tabulation with an answer of "YES" or "NO" as demonstrated by the first item. Any combination of yes-no answers is possible in each situation. FIFO

LIFO

0. Usually matches the actual physical flow of goods.

Yes_

No _

1. Emphasizes the income statement in that it matches the more recent costs with revenue.

_____

2. Defers tax payments in times of rising prices.

_____

3. Possibility of liquidating the base may be a significant negative aspect.

_____

4. Will probably not be adopted if prices are expected to decline.

_____

5. Emphasizes the balance sheet in that the more recent costs are contained in the inventory account.

_____

6. Can use price indexes to cost layers.

_____

7. Switching to this method could cause problems in the equity markets, with loan covenants, etc.

_____

8. Income figure more accurately reflects cash available for dividends, investments, etc.

_____

9. Tends to smooth income in periods of fluctuating prices.

_____

10. Income figure is more "real" in that it doesn't contain "paper profits."

_____

11. A change to this method must be justified (i.e., to the auditor) other than solely on the basis of the tax effect.

_____

12. Perpetual inventory results may be different from periodic inventory results.

_____

13. Is acceptable to the IRS (i.e., for income tax purposes).

_____

14. Gives lower profits when prices rise.

_____

15. In a period of rising prices has an adverse effect on assets, working capital, and stockholders' equity.

_____

16. Quick inventory turnover may have somewhat of a mitigating effect on some of the method's claimed disadvantages.

_____

Comprehensive Examination B

B-7

FIFO

LIFO

17. Improves cash flow in periods of rising prices.

_____

18. If used for tax purposes, it must be used for financial reporting purposes.

_____

19. Somewhat opens door for profit manipulation and may cause poor purchase decisions.

_____

20. Is a current value, rather than a historical cost, valuation method.

_____

Problem B-V — Statement of Cash Flows. Cedar Company Comparative Balance Sheet

Cash Accounts receivable, net Inventory Land Building Accumulated depreciation Equipment Accumulated depreciation

Accounts payable Bonds payable Capital stock, $10 par Retained earnings

December 31 2008 2007 $ 64,000 $ 36,000 53,000 57,000 171,000 123,000 180,000 285,000 300,000 300,000 (75,000) (60,000) 1,545,000 900,000 (177,000) (141,000) $2,061,000 $1,500,000 $ 172,000 480,000 1,125,000 284,000 $2,061,000

$ 150,000 -01,125,000 225,000 $1,500,000

Additional Data: 1.

Net income for the year amounted to $104,000.

Cash dividends were paid amounting to 4% of par value.

Land was sold for $120,000.

Cedar sold equipment, which cost $225,000 and had accumulated depreciation of $90,000, for $105,000.

Instructions Prepare a statement of cash flows using the indirect method.

B-8

Test Bank for Intermediate Accounting, Second Edition

Problem B-VI — Long-Term Contracts. Turner Company contracted on 4/1/07 to construct a building for $2,700,000. The project was completed in 2009. Additional data follow:

Costs incurred to date Estimated cost to complete Billings to date Collections to date

2007 $ 600,000 1,000,000 500,000 400,000

2008 $1,200,000 600,000 1,860,000 1,400,000

2009 $1,900,000 — 2,700,000 2,550,000

Instructions Calculate the income recognized by Turner under the percentage-of-completion method of accounting in each of the years 2007, 2008, and 2009.

Problem B-VII — Installment Sales Method. Ruxton, Inc. accounts for all sales of its merchandise on the installment basis. Following is the unadjusted trial balance at 12/31/08: Cash Installment Accounts Receivable—2007 Installment Accounts Receivable—2008 Inventory, 1/1/08 Accounts Payable Deferred Gross Profit—2007 Capital Stock Retained Earnings Installment Sales Cost of Installment Sales Operating Expenses

45,000 200,000 360,000 140,000 $ 110,000 91,000 300,000 199,000 500,000

335,000 120,000 $1,200,000

The gross profit rate on sales for 2007 was 35%. Instructions (a) Determine collections during 2008 on Installment A/R for 2007 and 2008. (b) Compute the gross profit realized in 2008 based on requirement (a).

$1,200,000

Comprehensive Examination B

B-9

Solutions — Comprehensive Examination B Problem B-I — Solution. 1. b 2. c 3. d

4. d 5. d 6. b

7. c *8. c

Solutions to computational multiple choice questions. 3. $600,000 – $28,000 = $572,000. *8. $1,634,000 – (80% × $1,000,000) = $834,000. Problem B-II — Solution.

Item A B C D E

Upper Limit ("Ceiling") $1.80 1.80 1.80 1.80 1.80

Lower Limit ("Floor") $1.10 1.10 1.10 1.10 1.10

Designated Market $1.10 1.15 1.10 1.65 1.70

Appropriate Inventory Valuation (Totals) $ 3,270 3,450 3,300 4,800 5,100 $19,920

Problem B-III — Solution. (a)

12/31/07 Notes Receivable ........................................................................ Discount on Notes Receivable ......................................... Sales ............................................................................... Computation of Present Value of Note: $900,000 × .73503 = 27,000 × 3.31213 = Present value of note Face value of note Amount of discount

(b)

(c)

900,000 149,045 750,955

$661,527 89,428 750,955 900,000 $149,045

12/31/08 Cash............................................................................................ Discount on Notes Receivable..................................................... Interest Revenue ............................................................. ($750,955 × .08 = $60,076 – $27,000) 12/31/09 Cash............................................................................................ Discount on Notes Receivable..................................................... Interest Revenue ............................................................. [($750,955 + $33,076) × .08 = $62,722 – $27,000]

27,000 33,076 60,076

27,000 35,722 62,722

B - 10 Test Bank for Intermediate Accounting, Second Edition Problem B-IV — Solution. 1. 2. 3. 4. 5. 6.

No-Yes No-Yes No-Yes No-Yes Yes-No No-Yes

7. 8. 9. 10. 11. 12.

No-Yes No-Yes No-Yes No-Yes Yes-Yes No-Yes

13. 14. 15. 16. 17. 18.

Yes-Yes No-Yes No-Yes Yes-No No-Yes No-Yes

19. No-Yes 20. No-No

Problem B-V — Solution. Cedar Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable Increase in inventory Increase in accounts payable Gain on sale of land Loss on sale of equipment Depreciation expense—building Depreciation expense—equipment Net cash provided by operating activities

$104,000

4,000 (48,000) 22,000 (15,000) 30,000 15,000 126,000

Cash flows from investing activities Sale of land Sale of equipment Purchase of equipment Net cash used by investing activities

120,000 105,000 (870,000)

Cash flows from financing activities Payment of cash dividends Issuance of bonds Net cash provided by financing activities

(45,000) 480,000

134,000 238,000

(645,000)

Net increase in cash Cash, January 1, 2008 Cash, December 31, 2008

435,000 28,000 36,000 $ 64,000

Problem B-VI — Solution. 2007 income = ($600,000 ÷ $1,600,000) × ($2,700,000 – $1,600,000) = $412,500 2008 income = [($1,200,000 ÷ $1,800,000) × ($2,700,000 – $1,800,000)] – $412,500 = $187,500 2009 income = ($2,700,000 – $1,900,000) – $600,000 = $200,000

Comprehensive Examination B Problem B-VII — Solution. (a)

(b)

Collections in 2008 on installment accounts receivable: 2007

$91,000 ÷ ($200,000 + collections) = 35% Collections equal $60,000

2008

Installment Sales — Installment Accounts Receivable = Collections $500,000 – $360,000 = $140,000

Gross profit realized in 2008: 2007 sales: $ 60,000 × .35 = $21,000 2008 sales: 140,000 × .33* = 46,200 $67,200 * ($500,000 – $335,000) ÷ $500,000

B - 11

COMPREHENSIVE EXAMINATION C PART 3

(Chapters 10–12)

Problem

Topic

C-I C-II C-III C-IV C-V C-VI

Multiple Choice—Tangible and Intangible Assets. Assignment of Costs. Research and Development. Exchange of Assets. Long-Term Debt. Depreciation Methods.

Approximate Time 30 min. 6 min. 10 min. 20 min. 30 min. 20 min. 116 min.

C-2

Test Bank for Intermediate Accounting, Second Edition

Problem C-I — Multiple Choice — Tangible and Intangible Assets. Choose the best answer for each of the following questions and enter the identifying letter in the space provided. ____ 1. When the sum-of-the-years'-digits method is used, depreciation expense for a given asset will a. decline by a constant amount each year. b. be the same each year. c. decrease rapidly and then slowly over the life of the asset. d. vary from year to year in relation to changes in output. ____ 2. Newton Corporation acquired land, buildings, and equipment from a bankrupt company at a lump-sum price of $275,000. At the time of acquisition, Newton paid $25,000 to have the assets appraised. The appraisal disclosed the following values: Land Buildings Equipment

$160,000 128,000 32,000

What cost should be assigned to the land, buildings, and equipment, respectively? a. $200,000, $160,000, and $40,000 b. $137,500, $110,000, and $27,500 c. $150,000, $120,000, and $30,000 d. $100,000, $100,000, and $100,000 ____ 3. In accordance with GAAP, the maximum period over which a patent can be amortized is a. 20 years. b. 28 years. c. 40 years. d. 50 years. ____ 4. Purchased goodwill represents a. excess of price paid over fair market value of net assets obtained in a combination. b. excess of price paid over the book value of the net assets obtained in a combination. c. the difference in the aggregate amount of the market prices of the stock of the combining companies. d. a tangible asset. Use the following data for questions 5 through 9: Utley Company purchased a new piece of equipment on July 1, 2007 at a cost of $900,000. The equipment has an estimated useful life of 5 years and an estimated salvage value of $75,000. The current year end is 12/31/08. Utley records depreciation to the nearest month. ____ 5. What is straight-line depreciation for 2008? a. $82,500 b. $90,000 c. $165,000 d. $180,000

Comprehensive Examination C

C-3

____ 6. What is sum-of-the-years'-digits depreciation for 2008? a. $219,999 b. $247,500 c. $270,000 d. $275,000 ____ 7. What is double-declining-balance depreciation for 2008? a. $216,000 b. $288,000 c. $330,000 d. $360,000 ____ 8. If Utley expensed the total cost of the equipment at 7/1/07, what was the effect on 2007 and 2008 income before taxes, assuming Utley uses straight-line depreciation? a. $735,000 understated and $165,000 overstated b. $810,000 understated and $90,000 overstated c. $817,500 understated and $165,000 overstated d. $900,000 understated and $90,000 overstated ____ 9. If, at the end of 2009, Utley Company decides the equipment still has five more years of life beyond 12/31/09, with a salvage value of $75,000, what is straight-line depreciation for 2009? (Assume straight-line used in all years.) a. $90,000 b. $96,250 c. $108,750 d. $165,000

Use the following data for questions 10 through 17. Eidman Corporation has a machine (Machine A) that it acquired on 1/1/08 for $240,000. On 12/31/08 such machines have a selling price and fair market value of $276,000. When used in production, such machines have an estimated useful life of 10 years with no salvage value. Use the straight-line method. Dryer Corporation has a machine (Machine B) that it acquired on 1/1/08 for $324,000. On 12/31/08 such machines have a selling price and fair market value of $240,000. When used in production, such machines have an estimated useful life of 10 years with no salvage value. Use the straight-line method. On 12/31/08 Dryer gave Machine B plus $36,000 cash to Eidman in return for Machine A. ____ 10. Assume that both Eidman and Dryer are new machine dealers and that the machines are still new. Also assume that the exchange lacks commercial substance. At what amount will Machine A be recorded on Dryer’s books? a. $324,000 b. $276,000 c. $360,000 d. $240,000

C-4

Test Bank for Intermediate Accounting, Second Edition

____ 11. Given the assumptions in 10 above, at what amount will Machine B be recorded in Eidman’s books? a. $208,696 b. $324,000 c. $240,000 d. $280,696 ____ 12. Assume that instead of dealers, both Eidman and Dryer are machine manufacturers and use the machines in production. Assume that the exchange lacks commercial substance. At what amount will Dryer record Machine A? a. $240,000 b. $276,000 c. $324,000 d. $360,000 ____ 13. Given the assumption in 12 above, at what amount will Eidman record Machine B? a. $247,826 b. $180,000 c. $223,824 d. $187,826 ____ 14. Given the assumption in 12 above except that the fair market values of Machines A and B are $336,000 and $300,000, respectively, at what amount will Dryer record Machine A? a. $291,600 b. $336,000 c. $300,000 d. $327,600 ____ 15. Return to the original problem. Assume that Eidman is a dealer selling new machines and that Dryer is a manufacturer. Assume that the exchange has commercial substance. For this transaction, at what amount will Eidman record Machine B? a. $240,000 b. $327,600 c. $276,000 d. $291,600 ____ 16. Given the assumptions in 15 above, at what amount will Dryer record Machine A? a. $240,000 b. $276,000 c. $270,000 d. $243,000 ____ 17. Given the assumptions in 15 above except that the selling prices and fair market values of A and B are $336,000 and $300,000, respectively, at what amount will Dryer record Machine A? a. $291,600 b. $270,000 c. $336,000 d. $300,000

Comprehensive Examination C

C-5

For the following two questions, indicate the nature of the account or accounts to be debited when recording each transaction. ____ 18. A replacement, which extended the life but did not increase the quality of units produced by the asset, cost $15,000. a. Asset(s) only. b. One of these: Accumulated amortization, depletion, or depreciation. c. Expense only. d. Asset(s) and expense. ____ 19. Jim Trane and Matt Sloan, maintenance repairmen, spent five days in unloading and setting up a new $30,000 precision machine in the plant. Their wages earned in this five-day period totaled $800. a. Asset(s) only. b. One of these: Accumulated amortization, depletion, or depreciation. c. Expense only. d. Asset(s) and expense.

Problem C-II — Assignment of Costs. Match the following cost items with these appropriate accounts: a. Land b. Buildings

c. Land Improvements d. Other

____

1. Interest cost incurred during building construction.

____

2. Back taxes on purchased plot of land to be used for building site.

____

3. Assessment by city for drainage system.

____

4. Building permits.

____

5. Landscaping shrubs planted after building has been constructed.

____

6. Demolition costs of building on land bought for plant site.

____

7. Interest cost incurred after completion of building construction.

____

8. Recording fees for land.

____

9. Architect's fees.

____ 10. Grading and filling building site. ____ 11. Parking lots. ____ 12. Fences.

C-6

Test Bank for Intermediate Accounting, Second Edition

Problem C-III — Research and Development. Identify (in accordance with FASB Statement No. 2) each of the following activities as: a. Research and development b. Not research and development ____

1. Testing in search for, or evaluation of, product or process alternatives.

____

2. Cost of marketing research to promote new product.

____

3. Adaptation of an existing capability to a particular requirement or customer's need.

____

4. Design, construction, and testing of pre-production prototypes and models.

____

5. Routine, on-going efforts to refine, enrich, or improve the qualities of an existing product.

____

6. Engineering activity required to advance the design of a product to the manufacturing stage.

____

7. Searching for applications of new research findings.

____

8. Laboratory research aimed at discovery of a new knowledge.

____

9. Conceptual formulation and design of possible product or process alternatives.

____ 10. Trouble-shooting break-downs during production. ____ 11. Periodic design changes to existing products. ____ 12. Modification of the design of a product or process. ____ 13. Costs of testing prototype and design modifications. ____ 14. Engineering follow-through in an early phase of production. ____ 15. Design, construction, and operation of a pilot plant not useful for commercial production. ____ 16. Activity, including design and construction engineering related to the construction, relocation, rearrangement, or start-up of facilities or equipment. ____ 17. Quality control during commercial production including routine testing. ____ 18. Legal work on patent applications, sale, licensing, or litigation.

Comprehensive Examination C

C-7

Problem C-IV — Exchange of Assets. Assume that the following cases are independent and rely on the following data. Make entries on the books of both companies. Cowher Co. Hinson Co. Equipment (cost) $450,000 $825,000 Accumulated depreciation 145,000 450,000 Fair market value of equipment 350,000 350,000 1. Cowher Co. and Hinson Co. traded the above equipment. The exchange has commercial substance. Cowher Co.'s Books:

Hinson Co.'s Books:

2. Cowher Co. and Hinson Co. traded the above equipment. The exchange lacks commercial substance. Cowher Co.'s Books:

Hinson Co.'s Books:

Assume that the following case is independent and relies on the following data. Make entries on the books of both companies. Cowher Co. Hinson Co. Equipment (cost) $450,000 $825,000 Accumulated depreciation 145,000 525,000 Fair market value of equipment 280,000 350,000 Cash received (paid) (70,000) 70,000 3. Cowher Co. and Hinson Co. traded the above equipment. The exchange has commercial substance. Cowher Co.'s Books:

Hinson Co.'s Books:

4. Cowher Co. and Hinson Co. traded the above equipment. The exchange lacks commercial substance. Cowher Co.'s Books:

Hinson Co.'s Books:

C-8

Test Bank for Intermediate Accounting, Second Edition

Problem C-V — Long-Term Debt. 1. On July 1, 2008, Notson Company issued $600,000 par value, 10%, 10-year bonds dated July 1, 2008, with interest payable semiannually on January 1 and July 1. The bonds are issued at $681,300 (to yield 8%). The effective interest method is used. (a) Prepare the journal entry at the date the bonds are issued.

*(b) Prepare the adjusting entry at December 31, 2008, the end of the fiscal year.

(d) Prepare the entry to record the retirement of ½ of the bonds on January 2, 2009 @ 105.

*2. On January 1 of the current year, Elston Corporation issued $1,000,000 of 10% debenture bonds on a basis to yield 9%, receiving $1,044,860. Interest is payable annually on December 31 and the bonds mature in 6 years. The effective-interest method is used. (a) What is the interest expense for the first year?

(b) What is the interest expense for the second year?

Comprehensive Examination C

C-9

Problem C-VI — Depreciation Methods. A high-speed multiple-bit drill press costing $240,000 has an estimated salvage value of $20,000 and a life of ten years. What is the annual depreciation for each of the first two full years under the following depreciation methods? 1. Double-declining-balance method: a. Year one, $______________. b. Year two, $______________.

2. Units of production (activity) method (lifetime output is estimated at 110,000 units; the press produced 12,000 units in year one and 18,000 in year two): a. Year one, $______________. b. Year two, $______________.

3. Sum-of-the-years'-digits method: a. Year one, $______________. b. Year two, $______________.

4. Straight-line depreciation method: a. Year one, $______________. b. Year two, $______________.

C - 10 Test Bank for Intermediate Accounting, Second Edition

Solutions — Comprehensive Examination C Problem C-I — Solution. 1. 2. 3. 4. 5. 6.

a c a a c b

7. 8. 9. 10. 11. 12.

b c b b a b

13. 14. 15 16. 17. 18.

d d a b c b

19.

Solutions to selected computational multiple choice questions. 6. ($825,000 × 5/15 × ½) + ($825,000 × 4/15 × ½) = $247,500. 7. $900,000 × .4 × ½ = $180,000; ($900,000 – $180,000) × .4 = $288,000. 9. ($900,000 – $247,500 – $75,000) × 1/6 = $96,250. 11. $240,000 – (240/276 × $36,000) = $208,696. 13. $240,000 – (240/276 × $60,000) = $187,826. Problem C-II — Solution. 1. 2. 3. 4. 5.

b a a b a

6. 7. 8. 9. 10.

a d a b a

11. 12.

c c

13. 14. 15. 16. 17. 18.

a b a b b b

Problem C-III — Solution. 1. 2. 3. 4. 5. 6.

a b b a b a

7. 8. 9. 10. 11. 12.

a a a b b a

Problem C-IV — Solution. 1.

Cowher Co.'s Books

Hinson Co.'s Books

Equipment Accum. Depreciation Gain on Exchange Equipment

350,000 145,000

2. Equipment Accum. Depreciation Equipment

305,000 145,000

45,000 450,000

Equipment Accum. Depreciation Loss on Exchange Equipment Same as 1.

450,000

350,000 450,000 25,000 825,000

Comprehensive Examination C 3. Equipment Accum. Depreciation Loss on Exchange Equipment Cash

350,000 145,000 25,000 450,000 70,000

4. Same as 3.

Equipment Accum. Depreciation Cash Gain on Exchange Equipment

C - 11

280,000 525,000 70,000 50,000 825,000

Equipment 240,000 Accum. Depreciation 525,000 Cash 70,000 Gain on Exchange 10,000 Equipment 825,000 [$70,000 ÷ ($70,000 + $280,000) × $50,000 = $10,000 gain]

Problem C-V — Solution. 1. (a) Cash ......................................................................................... Bonds Payable .............................................................. Premium on Bonds Payable ..........................................

681,300

*(b) Interest Expense ...................................................................... Premium on Bonds Payable ..................................................... Interest Payable ($600,000 × .10 × 6/12) ...................... (Interest expense: $681,300 × .08 × 6/12 = $27,252)

27,252 2,748

(c) Interest Payable ....................................................................... Cash .............................................................................

30,000

(d) Bonds Payable ......................................................................... Premium on Bonds Payable ($81,300 – $2,748) × ½ .............. Cash ($300,000 × 1.05) ................................................ Gain on Retirement of Bonds ........................................

300,000 39,276

600,000 81,300

30,000

315,000 24,276

2. (a) First year interest expense: $1,044,860 × .09 = $94,037 (b) Second year interest expense: $100,000 – $94,037 = $5,963 Premium amortization (First year). $1,044,860 – $5,963 = $1,038,897 Book value of bonds at the beginning of the second year. $1,038,897 × .09 = $93,501 Interest expense.

Problem C-VI -— Solution. 1. a. $240,000 × .20 = $48,000. b. ($240,000 – $48,000) × .20 = $38,400. 2. a. [($240,000 – $20,000) ÷ 110,000] × 12,000 = $24,000. b. [($240,000 – $20,000) ÷ 110,000] × 18,000 = $36,000.

C - 12 Test Bank for Intermediate Accounting, Second Edition 3. a. ($240,000 – $20,000) × 10/55 = $40,000. b. ($240,000 – $20,000) × 9/55 = $36,000. 4. a. ($240,000 – $20,000) ÷ 10 = $22,000. b. $22,000

COMPREHENSIVE EXAMINATION D PART 4

(Chapters 13–15)

Problem D-I D-II D-III D-IV D-V D-VI

Topic Treasury Stock. Cash Dividends. Stock Dividends and Stock Splits. Deferred Income Taxes. Available-for-Sale Equity Securities. Trading Securities.

Approximate Time 15 min. 10 min. 10 min. 25 min. 15 min. 30 min. 105 min.

D-2

Test Bank for Intermediate Accounting, Second Edition

Problem D-I — Treasury Stock The stockholders' equity section of Tresh Co.'s balance sheet at December 31, 2007, was as follows: Common stock--$10 par (authorized 1,000,000 shares, issued and outstanding 600,000 shares) Paid-in capital in excess of par Retained earnings

$ 6,000,000 1,500,000 3,250,000 $10,750,000

Instructions Prepare journal entries to reflect the following treasury stock transactions showing how each is accounted for under the cost method. (Show computations.) 1. On January 4, 2008, having idle cash, Tresh Co. repurchased 25,000 shares of its outstanding stock for $500,000. 2. On March 4, Tresh sold 5,000 of these reacquired shares at $22 per share. 3. Show the proper disclosures in the stockholders' equity section of the balance sheet issued at the end of the first quarter, March 31, 2008. Assume net income of $100,000 during the first quarter. 4. On June 30, 2008, the firm sold 15,000 of the reacquired shares for $18 per share.

Problem D-II — Cash Dividends Randall Company has stock outstanding as follows: Common, $10 par value per share, 140,000 shares; Preferred, 6%; $100 par value per share, 6,000 shares. The Preferred is cumulative and two years’ dividends are in arrears (not including the current year). The total amount of cash dividends declared for both classes of stock is $290,000. Instructions Prepare the entry for the dividend declaration, separating the dividend into the common and preferred portions. Show computations.

Comprehensive Examination D

D-3

Problem D-III — Stock Dividends and Stock Splits Stock dividends and stock splits are common forms of corporate stock distribution to stockholders. Consider each of the numbered statements. You are to decide whether it: A. Applies to both stock dividends and stock splits. B. Applies to neither. C. Applies to stock splits only. D. Applies to stock dividends only. E. Applies to stock splits effected in the form of a dividend only. F. Applies to both stock splits effected in the form of a dividend and a stock dividend. (In each instance, the issuing company has only one class of stock.) Instructions Print next to the number of each statement below, the single capital letter of the description which applies to the statement. Statements ____ 1. There is no transfer between retained earnings and capital stock accounts, other than to the extent occasioned by legal requirements. ____ 2. There is no change in the total stockholders' equity of the issuing corporation. ____ 3. The retained earnings available for dividends are increased. ____ 4. The par (or stated value) of the stock is unchanged. ____ 5. Subsequent per-share earnings, if any, are decreased. ____ 6. Retained earnings in the amount of the distribution are transferred to capital stock, in some instances in an amount in excess of that required by the laws of the state of incorporation. ____ 7. The individual stockholder's share of net assets is increased. ____ 8. The total number of shares outstanding is increased. ____ 9. The distribution is a multiple as contrasted to a fraction of the number of shares previously outstanding.

D-4

Test Bank for Intermediate Accounting, Second Edition

Problem D-IV — Deferred Income Taxes. In 2008, the initial year of its existence, Hyland Company's accountant, in preparing both the income statement and the tax return, developed the following list of items causing differences between accounting and taxable income: 1. The company sells its merchandise on an installment contract basis. In 2008, Hyland elected, for tax purposes, to report the gross profit from these sales in the years the receivables are collected. However, for financial statement purposes, the company recognized all the gross profit in 2008. These procedures created a $300,000 difference between book and taxable incomes. The future collection of the installment contracts receivables are expected to result in taxable amounts of $150,000 in each of the next two years. (Note: the company treats installment contracts receivable as a current asset on its balance sheet.) 2. The company has also chosen to depreciate all of its depreciable assets on an accelerated basis for tax purposes but on a straight-line basis for accounting purposes. These procedures resulted in $60,000 excess depreciation for tax purposes over accounting depreciation. The temporary difference due to excess tax depreciation will reverse equally over the three year period from 2009-2011. 3. Hyland leased some of its property to Simms Company on July 1, 2008. The lease was to expire on July 1, 2010 and the monthly rentals were to be $40,000. Simms, however, paid the first year's rent in advance and Hyland reported this entire amount on its tax return. These procedures resulted in a $240,000 difference between book and taxable incomes. (Note: this lease was an operating lease and Hyland classified the unearned rent as a current liability on its balance sheet.) 4. Hyland owns $200,000 of bonds issued by the State of Ohio upon which 5% interest is paid annually. In 2008, Hyland showed $10,000 of income from the bonds on its income statement but did not show any of this amount on its tax return. (Note: these bonds are classified as long-term investments on Hyland's balance sheet.) 5. In 2008, Hyland insured the lives of its chief executives. The premiums paid amounted to $12,000 and this amount was shown as an expense on the income statement. However, this amount was not deducted on the tax return. The company is the beneficiary. Instructions Assuming that the income statement of Hyland Company showed "Income before income taxes" of $1,200,000; that the enacted tax rates are 40% for all years; and that no other differences between book and taxable incomes existed, except for those mentioned above: (a)

Compute the income tax payable.

(b)

Prepare a schedule of future taxable and (deductible) amounts at the end of 2008.

(c)

Prepare a schedule of deferred tax (asset) and liability at the end of 2008.

(d)

Compute the net deferred tax expense (benefit) for 2008.

(e)

Make the journal entry recording income tax expense, income tax payable, and deferred income taxes for 2008.

(f)

Indicate how income tax expense and any deferred income taxes should be disclosed on the financial statements under generally accepted accounting principles. Show the amounts for these items and indicate specifically where they would be disclosed.

Comprehensive Examination D

D-5

Problem D-V — Available-for-Sale Securities On January 2, 2008, Lilly Company purchased 1,000 shares of Grey Company common stock for $35,000. The stock has a par value of $10 and is part of the total stock outstanding of 20,000 shares of Grey Company. Lilly Company intends the stock to be an available-for-sale security. Total stockholders' equity of Grey Company on January 2, 2008 was $600,000. Instructions Prepare necessary journal entries in accordance with generally accepted accounting principles on the books of Lilly Company for the following transactions. If no entry is required, write "none" in the space provided. (a)

January 2, 2008: Lilly purchases the shares described above.

(b)

December 31, 2008: Lilly receives a $.75 per share dividend from Grey, and Grey announces a net income for 2008 of $250,000.

(c)

December 31, 2008: According to The Wall Street Journal, Grey common is selling for $30 per share. Lilly's management views this decline as being only temporary in nature. Grey's common is Lilly's only available-for-sale security.

(d)

February 15, 2009: Lilly sells 500 of the shares purchased in (a) for $36 per share.

Problem D-VI — Trading Securities The information below relates to Dryer Company's trading securities in 2008 and 2009. (a)

Prepare the journal entries for the following transactions.

May 1, 2008

Purchased $250,000 par value of Cole Company bonds at 97 plus accrued interest. The bonds pay interest annually at 9% each December 31. Broker's commission was $2,500.

September 1, 2008

Sold $125,000 par value of Cole Company bonds at 94 plus accrued interest. Broker's commission, taxes, and fees were $1,250.

September 5, 2008

Purchased 5,000 shares of Ott, Inc. common stock for $25 per share. The broker's commission on the purchase amounted to $2,000.

December 31, 2008

Make the appropriate entry for the Cole Company bonds.

December 31, 2008

The market prices of the trading securities at December 31 were: Ott, Inc. common stock, $26 per share; and Cole Company bonds, 99. Make the appropriate entry.

July 1, 2009

Dryer sold 1/2 of the Ott, Inc. common stock at $27 per share. Broker's commission, taxes, and fees were $1,000.

December 1, 2009

Dryer purchased 600 shares of Ely, Inc. common stock at $40 per share. Broker's commission was $500.

D-6

Test Bank for Intermediate Accounting, Second Edition

Problem D-VI (cont.) December 31, 2009

Make the appropriate entry for the Cole Company bonds.

December 31, 2009

The market prices of the trading securities at December 31 were: Ott, Inc. common stock, $28 per share; Cole Company bonds, 98; and Ely, Inc. common stock, $42 per share. Make the appropriate entry.

(b)

Present the financial statement disclosure (balance sheet and income statement) of Dryer Company's transactions in trading securities for each of the years 2008 and 2009. Appropriate financial statement subheadings must be disclosed.

Comprehensive Examination D

D-7

Solutions — Comprehensive Examination D Problem D-I — Solution. 1. Treasury Stock ............................................................................... Cash ...................................................................................

500,000

2. Cash .............................................................................................. Treasury Stock ................................................................... Paid-in Capital from Treasury Stock ...................................

110,000

3. Stockholders' equity: Common stock, $10 par, 1,000,000 shares authorized, 600,000 shares issued, 580,000 shares outstanding Paid-in capital in excess of par value Paid-in capital from treasury stock Retained earnings Less: Cost of 20,000 shares held in treasury Total stockholders' equity 4. Cash .............................................................................................. Paid-in Capital from Treasury Stock ............................................... Retained Earnings .......................................................................... Treasury Stock ...................................................................

500,000

100,000 10,000

$ 6,000,000 1,500,000 10,000 3,350,000 10,860,000 (400,000) $10,460,000 270,000 10,000 20,000 300,000

Problem D-II — Solution. Retained Earnings ............................................................................... Dividends Payable, Preferred ................................................... Dividends Payable, Common ...................................................

290,000 108,000 182,000

Computations: Arrears—$600,000 × 6% × 2 Preferred—$600,000 × 6% Common—($290,000 – $72,000 – $36,000)

Preferred $ 72,000 36,000 $108,000

Problem D-III — Solution. 1. E 2. A 3. B

4. F 5. A 6. F

7. B 8. A 9. C

Common

$182,000 $182,000

Total $ 72,000 36,000 182,000 $290,000

D-8

Test Bank for Intermediate Accounting, Second Edition

Problem D-IV — Solution. (a)

The computation of income tax payable is as follows: Pretax financial income Permanent differences: State of Ohio bonds Executive insurance premiums Temporary differences: Installment contracts Excess tax depreciation Lease rental Taxable income Tax rate Income tax payable

(b) Future taxable (deductible) amounts: Installment sales Depreciation Unearned rent (c) Temporary Differences Installment Sales Depreciation Rent Totals (d)

(e)

(f)

$1,200,000 (10,000) 12,000 (300,000) (60,000) 2450,000 1,082,000 40% $ 432,800

2009

2010

2011

Total

$150,000 20,000 (240,000)

$150,000 20,000

$20,000

$300,000 60,000 (240,000)

Future Taxable (Deductible) Amounts $300,000 60,000 (240,000) $120,000

Tax Rate 40% 40 40

Deferred Tax (Asset) Liability $120,000 24,000 $(96,000) $(96,000) $144,000

Deferred tax asset at end of 2008 Deferred tax asset at beginning of 2008 Deferred tax (benefit)

$(96,000) -0$(96,000)

Deferred tax liability at end of 2008 Deferred tax liability at beginning of 2008 Deferred tax expense

$144,000 -0$144,000

Deferred tax expense Deferred tax (benefit) Net deferred tax expense for 2008

$144,000 (96,000) $ 48,000

Income Tax Expense ($432,800 + $48,000) ................................ Deferred Tax Asset ...................................................................... Deferred Tax Liability ...................................................... Income Tax Payable ....................................................... Income statement Income before income taxes Income tax expense: Current Deferred Net income

480,800 96,000 144,000 432,800

$1,200,000 $432,800 48,000

480,800 $ 719,200

Comprehensive Examination D

D-9

Problem D-IV — Solution (cont.) Balance sheet Current liabilities: Deferred tax liability ($120,000 – $100,000)

$20,000

Long-term liabilities: Deferred tax liability

$24,000

Problem D-V — Solution. (a)

(b)

Available-for-Sale Securities ....................................................... Cash ................................................................................

35,000

Cash............................................................................................ Dividend Revenue ...........................................................

750

35,000

750

No entry to accrue investee profits because fair value, not equity, method is being used. (c)

(d)

Unrealized Holding Gain or Loss—Equity .................................... Securities Fair Value Adjustment (Available-for-Sale) ......

5,000

Cash (500 × $36) ........................................................................ Gain on Sale of Securities ............................................... Available-for-Sale Securities (500 × $35) .........................

18,000

5,000

500 17,500

Problem D-VI — Solution. May 1, 2008* Trading Securities ................................................................................ Interest Revenue.................................................................................. Cash ......................................................................................... September 1, 2008 Cash ($117,500 + $7,500 – $1,250) ..................................................... Loss on Sale of Securities .................................................................... Trading Securities .................................................................... Interest Revenue ......................................................................

245,000 7,500 252,500

123,750 6,250 122,500 7,500

September 5, 2008 Trading Securities ................................................................................ Cash .........................................................................................

127,000

December 31, 2008* Cash .................................................................................................... Interest Revenue ......................................................................

11,250

127,000

11,250

D - 10 Test Bank for Intermediate Accounting, Second Edition Problem D-VI — Solution (cont.). December 31, 2008 Securities Fair Value Adjustment (Trading) .......................................... 4,250 Unrealized Holding Gain or Loss—Income ($253,750 – $249,500)

4,250

*If Interest Receivable is debited for $7,500 on May 1, then the December 31, entry is: Cash..................................................................................................... Interest Receivable ................................................................... Interest Revenue ...................................................................... July 1, 2009 Cash ($67,500 – $1,000) ...................................................................... Gain on Sale of Securities ........................................................ Trading Securities .....................................................................

11,250 7,500 3,750

66,500 3,000 63,500

December 1, 2009 Trading Securities ................................................................................ Cash .........................................................................................

24,500

December 31, 2009 Cash..................................................................................................... Interest Revenue ......................................................................

11,250

24,500

11,250

December 31, 2009 Unrealized Holding Gain or Loss—Income .......................................... Securities Fair Value Adjustment (Trading) .............................. $4,250 + ($210,500 – $207,800)

6,950 6,950

December 31, Balance Sheet Current assets: Trading securities, at fair value Income Statement Other revenue and gains: Unrealized holding gain on trading securities Interest Revenue Gain on sale of securities Other expenses and losses: Loss on sale of securities Unrealized holding loss on trading securities

2008

2009

$253,750

$207,800

$ 4,250 11,250

$11,250 3,000

6,250 6,950

COMPREHENSIVE EXAMINATION E PART 5

(Chapters 16–18)

Problem E-I E-II E-III E-IV

Topic Pensions. Basic and Diluted Earnings per Share. Accounting Changes and Error Corrections. Leases.

Approximate Time 15 min. 20 min. 30 min. 25 min. 90 min.

E-2

Test Bank for Intermediate Accounting, Second Edition

Problem E-I — Pensions. Presented below is information related to Stage Department Stores, Inc. pension plan for 2008. Service cost Funding contribution for 2008 Settlement rate used in actuarial computation Expected return on plan assets Amortization of PSC (due to benefit increase) Amortization of unrecognized net gains Projected benefit obligation (at beginning of period) Market-related (and fair) value of plan assets (at beginning of period)

$520,000 500,000 10% 9% 80,000 48,000 480,000 360,000

Instructions (a) Compute the amount of pension expense to be reported for 2008. (Show computations.) (b) Prepare the journal entry to record pension expense and the employer's contribution for 2008.

Problem E-II — Basic and Diluted Earnings Per Share. Assume that the following data relate to Bass, Inc. for the year 2008: Net income (30% tax rate) Average common shares outstanding 2008 10% cumulative convertible preferred stock: Convertible into 80,000 shares of common 8% convertible bonds; convertible into 70,000 shares of common Stock options: Exercisable at the option price of $25 per share; average market price in 2008, $30

$3,500,000 1,000,000

$1,600,000 $2,500,000

60,000

Instructions Compute (a) basic earnings per share, and (b) diluted earnings per share.

Comprehensive Examination E

E-3

Problem E-III — Accounting Changes and Error Corrections. Saluki Company’s reported net incomes for 2009 and the previous two years are presented below. 2009 2008 2007 $105,000 $95,000 $70,000 2009’s net income was properly determined after giving effect to the following accounting changes, error corrections, etc. which took place during the year. The incomes for 2007 and 2008 do not take these items into account and are stated at the amounts determined in those years. Ignore income taxes. Instructions (a)

For each of the six accounting changes, errors, or prior period adjustment situations described below, give the journal entry or entries Saluki Company made to record them during 2009. If no entry is required, write “none.”

(b)

After recording the situation in part (a) above, give the year-end adjusting entry for December 31, 2009. If no entry, write “none.”

Early in 2009, Saluki determined that equipment purchased in January, 2007 at a cost of $430,000, with an estimated life of 5 years and salvage value of $30,000 is now estimated to continue in use until December 31, 2013 and will have a $10,000 salvage value. Saluki recorded its 2009 depreciation at the end of 2009.

(a)

(b)

Saluki determined that it had understated its depreciation by $20,000 in 2008 owing to the fact that an adjusting entry did not get recorded.

(a)

(b)

(a)

(b)

Saluki bought a truck January 1, 2006 for $40,000 with a $4,000 estimated salvage value and a six-year life. The company debited an expense account and credited cash on the purchase date. The truck is expected to be traded at the end of 2011. Saluki uses straightline depreciation for its trucks.

E-4

Test Bank for Intermediate Accounting, Second Edition

Problem E-III (cont.). 4.

During 2009, Saluki changed from the straight-line method of depreciating its cement plant to the double-declining balance method. The following calculations present depreciation on both bases. (Ignore income taxes.)

Straight-line Double-declining

2009 $96,000 $128,000

2008 $96,000 $160,000

2007 $96,000 $200,500

(a)

(b)

Saluki, in reviewing its provision for uncollectibles during 2009, had determined that ½ of 1% is the appropriate amount of bad debt expense to be charged to operations. The company had used 1% as its rate in 2008 and 2007 when the expense had been $20,000 and $14,000, respectively. The company would have recorded $30,000 of bad debt expense on December 31, 2009 under the old rate.

(a)

(b)

During 2009, Saluki decided to change from the LIFO method of valuing inventories to average cost. The net incomes involved under each method were as follows:

LIFO Average cost

2009 $51,000 $63,000

2008 $59,000 $69,000

2007 $42,000 $48,000

Assume no difference between LIFO and average cost inventory values in years prior to 2007. (a)

(b)

Comprehensive Examination E

E-5

Problem E-IV — Leases. On January 1, 2008, Garnett Company (as lessor) entered into a noncancelable lease agreement with Rush Company for machinery which was carried on the accounting records of Garnett at $4,530,000 and had a market value of $5,000,000. Minimum lease payments under the lease agreement which expires on December 31, 2017, total $7,100,000. Payments of $710,000 are due each January 1. The first payment was made on January 1, 2008 when the lease agreement was finalized. The interest rate of 10% which was stipulated in the lease agreement is the implicit rate set by the lessor. The effective-interest method of amortization is being used. Rush expects the machine to have a ten-year life with no salvage value, and be depreciated on a straight-line basis. Collectibility of the rentals is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. Instructions (a) From the lessee's viewpoint, what kind of lease is the above agreement? From the lessor's viewpoint, what kind of lease is the above agreement? (b)

What should be the income before income taxes derived by Garnett from the lease for the year ended December 31, 2008?

(c)

Ignoring income taxes, what should be the expenses incurred by Rush from this lease for the year ended December 31, 2008?

(d)

What journal entries should be recorded by Rush Company on January 1, 2008?

(e)

What journal entries should be recorded by Garnett Company on January 1, 2008?

E-6

Test Bank for Intermediate Accounting, Second Edition

Solutions — Comprehensive Examination E Problem E-I — Solution. (a)

Service cost Interest on projected benefit obligation ($480,000 × 10%) Expected return on plan assets ($360,000 × 9%) Amortization of PSC Amortization of net gains Pension expense—2008

(b)

Pension Expense......................................................................... Other Comprehensive Income (G/L) ............................................ Cash ................................................................................ Other Comprehensive Income (PSC) ............................... Pension Asset/Liability .....................................................

$520,000 48,000 (32,400) 80,000 (48,000) $567,600 567,600 48,000 500,000 80,000 35,600

Problem E-II — Solution. (a)

$3,000,000 – $160,000 Basic EPS = ——————————— = $2.84 1,000,000

(b) Start Convertible preferred Convertible bonds Options

Shares 1,000,000 80,000 70,000 10,000** 1,160,000

Earnings $3,000,000 0 140,000* 0 $3,140,000

*($2,500,000 × .08) × (1 – .30) **[($30 – $25) ÷ $30] × 60,000 $3,140,000 ÷ 1,160,000 = $2.71 DEPS

Problem E-III — Solution. 1. (a) (b)

2. (a)

(b)

None Depreciation Expense ............................................................ Accumulated Depreciation............................................. [($430,000 – $160,000 – $10,000) ÷ 5]

52,000

Retained Earnings ................................................................. Accumulated Depreciation.............................................

20,000

None

52,000

20,000

Comprehensive Examination E

E-7

Problem E-III — Solution (cont.) 3. (a)

(b)

4. (a)

(b)

5. (a) (b)

6. (a)

(b)

Truck ..................................................................................... Accumulated Depreciation ............................................ Retained Earnings ........................................................

40,000

Depreciation Expense............................................................ Accumulated Depreciation ............................................

6,000

Retained Earnings ................................................................. Accumulated Depreciation ............................................

168,500

Depreciation Expense............................................................ Accumulated Depreciation ............................................

128,000

18,000 22,000

6,000

168,500

128,000

None Bad Debt Expense................................................................. Allowance for Doubtful Accounts...................................

15,000

Inventory (Beginning)............................................................. Retained Earnings ........................................................

16,000

15,000

16,000

None

Problem E-IV — Solution. (a)

From the viewpoint of the lessee (Rush Company), the lease is a capital lease because the present value of the minimum lease payments ($4,800,000) exceeds 90% of the fair market value of the leased property. The lease term also is in excess of 75% of the property's estimated economic life. For those same reasons and because of the predictable collectibility, absence of uncertainties surrounding costs yet to be incurred by the lessor, and presence of a dealer's profit, the lease is a sales-type lease to the lessor, Garnett Company.

(b)

Profit on sale Interest on outstanding balance ($4,800,000 – $710,000) × .10 Income of lessor in 2008

(c)

(d)

Interest on outstanding balance ($4,800,000 – $710,000) × .10 Depreciation ($4,800,000 ÷ 10) Expenses incurred by lessee in 2008

$470,000 409,000 $879,000

$409,000 480,000 $889,000

Machinery Under Capital Leases................................................ Lease Liability .................................................................

4,800,000

Lease Liability ............................................................................ Cash ...............................................................................

710,000

4,800,000

710,000

E-8

Test Bank for Intermediate Accounting, Second Edition

Problem E-IV — Solution (cont.) (e)

Lease Receivable ...................................................................... Cost of Goods Sold.................................................................... Sales Revenue ............................................................... Inventory ........................................................................

4,800,000 4,530,000

Cash .......................................................................................... Lease Receivable...........................................................

710,000

4,800,000 4,530,000

710,000

APPENDIX A ACCOUNTING AND THE TIME VALUE OF MONEY TRUE-FALSE—Conceptual Answer

No.

Description

F T F T T F F T T T F F F T T T F T F T

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

Time value of money. Definition of interest expense. Simple interest. Compound interest. Compound interest. Future value of an ordinary annuity. Present value of an annuity due. Compounding period interest rate. Definition of present value. Future value of a single sum. Determining present value. Present value of a single sum. Annuity due and interest. Annuity due and ordinary annuity. Annuity due and ordinary annuity. Number of compounding periods. Future value of an annuity due factor. Present value of an ordinary annuity. Future value of a deferred annuity. Determining present value of bonds.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

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

21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36.

Appropriate use of an annuity due table. Understanding compound interest tables. Identification of correct compound interest table. Identification of correct compound interest table. Identification of correct compound interest table. Identification of correct compound interest table. Identification of correct compound interest table. Identification of present value of 1 table. Identification of correct compound interest table. Identification of correct compound interest table. Present value of an annuity due table. Definition of an annuity due. Identification of compound interest concept. Identification of compound interest concept. Identification of number of compounding periods. Adjust the interest rate for time periods.

A-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual (cont.) Answer

No.

Description

d c c c b c b b b d

37. 38. 39. 40. 41. 42. 43. 44. 45. 46.

Definition of present value. Compound interest concepts. Future value of an annuity due factor. Determine the timing of rents of an annuity due. Factors of an ordinary annuity and an annuity due. Determine present value of an ordinary annuity. Identification of a future value of an ordinary annuity of 1. Present value of an ordinary annuity and an annuity due. Difference between an ordinary annuity and an annuity due. Definition of deferred annuities.

MULTIPLE CHOICE—Computational Answer

No.

Description

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

47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79.

Interest compounded quarterly. Calculate present value of a future amount. Calculate a future value. Calculate a future value of an annuity due. Calculate a future value. Calculate a future value. Calculate present value of a future amount. Calculate present value of a future amount. Calculate present value of an annuity due. Calculate the future value of 1. Present value of a single sum. Present value of a single sum, unknown number of periods. Future value of a single sum. Present value of a single sum. Present value of a single sum, unknown number of periods. Future value of a single sum. Present value of an ordinary annuity. Present value of an annuity due. Future value of an ordinary annuity. Future value of a annuity due. Present value of an ordinary annuity. Present value of an annuity due. Future value of an ordinary annuity. Future value of an annuity due. Calculate future value of an annuity due. Calculate future value of an ordinary annuity. Calculate future value of an annuity due. Calculate annual deposit for annuity due. Calculate cost of machine purchased on installment. Calculate present value of an ordinary annuity. Calculate present value of an annuity due. Calculate cost of machine purchased on installment. Calculate cost of machine purchased on installment.

Accounting and the Time Value of Money

MULTIPLE CHOICE—Computational (cont.) Answer

No.

Description

a b b b

80. 81. 82. 83.

Calculate the annual rents of leased equipment. Calculate present value of an investment in equipment. Calculate proceeds from issuance of bonds. Calculate proceeds from issuance of bonds.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

c d c a b a a d b

84. 85. 86. 87. 88. 89. 90. 91. 92.

Calculate interest expense of bonds. Identification of correct compound interest table. Calculate interest revenue of a noninterest-bearing note. Appropriate use of an ordinary annuity table. Calculate annual deposit of annuity due. Calculate the present value of a note. Calculate the present value of a note. Determine the issue price of a bond. Determine the acquisition cost of a franchise.

EXERCISES Item EA-93 EA-94 EA-95 EA-96 EA-97 EA-98 EA-99 EA-100

Description Present and future value concepts. Compute estimated goodwill. Present value of an investment in equipment. Future value of an annuity due. Present value of an annuity due. Compute the annual rent. Calculate the market price of a bond. Calculate the market price of a bond.

PROBLEMS Item PA-101 PA-102 PA-103 PA-104 PA-105 PA-106

Description Present value and future value computations. Annuity with change in interest rate. Present value of ordinary annuity and annuity due. Finding the implied interest rate. Calculation of unknown rent and interest. Deferred annuity.

A-3

A-4

Test Bank for Intermediate Accounting, Second Edition

CHAPTER LEARNING OBJECTIVES 1. 2. 3. 4. 5. 6. 7. 8.

Identify accounting topics where the time value of money is relevant. Distinguish between simple and compound interest. Use appropriate compound interest tables. Identify variables fundamental to solving interest problems. Solve future and present value of 1 problems. Solve future value of ordinary and annuity due problems. Solve present value of ordinary and annuity due problems. Solve present value problems related to deferred annuities and bonds.

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

21.

6. 7. 8.

TF TF TF

22. 23. 24.

MC MC MC

25. 26. 27.

33.

34.

10. 11. 12. 37.

TF TF TF MC

38. 48. 49. 51.

MC MC MC MC

52. 53. 54. 56.

13. 14. 16.

TF TF TF

17. 39. 40.

TF MC NC

41. 50. 63.

15. 18. 41. 42. 43.

TF TF MC MC MC

44. 45. 55. 74. 75.

MC MC MC MC MC

76. 77. 78. 79. 80.

19.

20.

46.

Note: TF = True-False MC = Multiple Choice

Type

Item

Type

Item

Learning Objective 1 MC Learning Objective 2 TF 84. MC Learning Objective 3 MC 28. MC 31. MC 29. MC 32. MC 30. MC 47. Learning Objective 4 MC 35. MC 36. Learning Objective 5 MC 57. MC 61. MC 58. MC 62. MC 59. MC 84. MC 60. MC 86. Learning Objective 6 MC 64. MC 67. MC 65. MC 68. MC 66. MC 69. Learning Objective 7 MC 81. MC 89. MC 82. MC 90. MC 83. MC 91. MC 87. MC 92. MC 88. MC 97. Learning Objective 8 MC 106. P E = Exercise P = Problem

Type

Item

Type

Item

Type

MC MC MC

85.

MC MC MC MC

93. 94. 95. 101.

E E E P

MC MC MC

70. 71. 72.

MC MC MC

73. 96. 102.

MC E P

MC MC MC MC E

98. 99. 100. 101. 103.

E E E P P

104. 105.

P P

Accounting and the Time Value of Money

A-5

TRUE-FALSE—Conceptual 1. The time value of money refers to the fact that a dollar received today is worth less than a dollar promised at some time in the future. 2. Interest is the excess cash received or repaid over and above the amount lent or borrowed. 3. Simple interest is computed on principal and on any interest earned that has not been withdrawn. 4. Compound interest, rather than simple interest, must be used to properly evaluate longterm investment proposals. 5. Compound interest uses the accumulated balance at each year end to compute interest in the succeeding year. 6. The future value of an ordinary annuity table is used when payments are invested at the beginning of each period. 7. The present value of an annuity due table is used when payments are made at the end of each period. 8. If the compounding period is less than one year, the annual interest rate must be converted to the compounding period interest rate by dividing the annual rate by the number of compounding periods per year. 9. Present value is the value now of a future sum or sums discounted assuming compound interest. 10. The future value of a single sum is determined by multiplying the future value factor by its present value. 11. In determining present value, a company moves backward in time using a process of accumulation. 12. The unknown present value is always a larger amount than the known future value because dollars received currently are worth more than dollars to be received in the future. 13. The rents that comprise an annuity due earn no interest during the period in which they are originally deposited. 14. If two annuities have the same number of rents with the same dollar amount, but one is an annuity due and one is an ordinary annuity, the future value of the annuity due will be greater than the future value of the ordinary annuity. 15. If two annuities have the same number of rents with the same dollar amount, but one is an annuity due and one is an ordinary annuity, the present value of the annuity due will be greater than the present value of the ordinary annuity. 16. The number of compounding periods will always be one less than the number of rents when computing the future value of an ordinary annuity.

A-6

Test Bank for Intermediate Accounting, Second Edition

17. The future value of an annuity due factor is found by multiplying the future value of an ordinary annuity factor by 1 minus the interest rate. 18. The present value of an ordinary annuity is the present value of a series of equal rents withdrawn at equal intervals. 19. The future value of a deferred annuity is less than the future value of an annuity not deferred. 20. At the date of issue, bond buyers determine the present value of the bonds’ cash flows using the market interest rate.

True-False Answers—Conceptual Item

Type

Item

Type

Item

Type

Item

Type

1. 2. 3. 4. 5.

F T F T T

6. 7. 8. 9. 10.

F F T T T

11. 12. 13. 14. 15.

F F F T T

16. 17. 18. 19. 20.

T F T F T

MULTIPLE CHOICE—Conceptual 21.

Which of the following transactions would require the use of the present value of an annuity due concept in order to calculate the present value of the asset obtained or liability owed at the date of incurrence? a. A capital lease is entered into with the initial lease payment due upon the signing of the lease agreement. b. A capital lease is entered into with the initial lease payment due one month subsequent to the signing of the lease agreement. c. A ten-year 8% bond is issued on January 2 with interest payable semiannually on July 1 and January 1 yielding 7%. d. A ten-year 8% bond is issued on January 2 with interest payable semiannually on July 1 and January 1 yielding 9%.

22.

Which of the following tables would show the smallest value for an interest rate of 5% for six periods? a. Future value of 1 b. Present value of 1 c. Future value of an ordinary annuity of 1 d. Present value of an ordinary annuity of 1

23.

Which table would you use to determine how much you would need to have deposited three years ago at 10% compounded annually in order to have $1,000 today? a. Future value of 1 or present value of 1 b. Future value of an annuity due of 1 c. Future value of an ordinary annuity of 1 d. Present value of an ordinary annuity of 1

Accounting and the Time Value of Money

A-7

24.

Which table would you use to determine how much must be deposited now in order to provide for 5 annual withdrawals at the beginning of each year, starting one year hence? a. Future value of an ordinary annuity of 1 b. Future value of an annuity due of 1 c. Present value of an annuity due of 1 d. None of these

25.

Which table has a factor of 1.00000 for 1 period at every interest rate? a. Future value of 1 b. Present value of 1 c. Future value of an ordinary annuity of 1 d. Present value of an ordinary annuity of 1

26.

Which table would show the largest factor for an interest rate of 8% for five periods? a. Future value of an ordinary annuity of 1 b. Present value of an ordinary annuity of 1 c. Future value of an annuity due of 1 d. Present value of an annuity due of 1

27.

Which of the following tables would show the smallest factor for an interest rate of 10% for six periods? a. Future value of an ordinary annuity of 1 b. Present value of an ordinary annuity of 1 c. Future value of an annuity due of 1 d. Present value of an annuity due of 1

28.

The figure .94232 is taken from the column marked 2% and the row marked three periods in a certain interest table. From what interest table is this figure taken? a. Future value of 1 b. Future value of annuity of 1 c. Present value of 1 d. Present value of annuity of 1

29.

Which of the following tables would show the largest value for an interest rate of 10% for 8 periods? a. Future amount of 1 table. b. Present value of 1 table. c. Future amount of an ordinary annuity of 1 table. d. Present value of an ordinary annuity of 1 table.

30.

On June 1, 2008, Walsh Company sold some equipment to Fischer Company. The two companies entered into an installment sales contract at a rate of 8%. The contract required 8 equal annual payments with the first payment due on June 1, 2008. What type of compound interest table is appropriate for this situation? a. Present value of an annuity due of 1 table. b. Present value of an ordinary annuity of 1 table. c. Future amount of an ordinary annuity of 1 table. d. Future amount of 1 table.

A-8

Test Bank for Intermediate Accounting, Second Edition

31.

Which of the following transactions would best use the present value of an annuity due of 1 table? a. Diamond Bar, Inc. rents a truck for 5 years with annual rental payments of $20,000 to be made at the beginning of each year. b. Michener Co. rents a warehouse for 7 years with annual rental payments of $120,000 to be made at the end of each year. c. Durant, Inc. borrows $20,000 and has agreed to pay back the principal plus interest in three years. d. Babbitt, Inc. wants to deposit a lump sum to accumulate $50,000 for the construction of a new parking lot in 4 years.

32.

A series of equal receipts at equal intervals of time when each receipt is received at the beginning of each time period is called an a. ordinary annuity. b. annuity in arrears. c. annuity due. d. unearned receipt.

33.

In the time diagram below, which concept is being depicted?

1 $1

2 $1

3 $1

4 $1

PV a. b. c. d.

Present value of an ordinary annuity Present value of an annuity due Future value of an ordinary annuity Future value of an annuity due

34.

On December 1, 2008, Michael Hess Company sold some machinery to Shawn Keling Company. The two companies entered into an installment sales contract at a predetermined interest rate. The contract required four equal annual payments with the first payment due on December 1, 2008, the date of the sale. What present value concept is appropriate for this situation? a. Future amount of an annuity of 1 for four periods b. Future amount of 1 for four periods c. Present value of an ordinary annuity of 1 for four periods d. Present value of an annuity due of 1 for four periods.

35.

An amount is deposited for eight years at 8%. If compounding occurs quarterly, then the table value is found at a. 8% for eight periods. b. 2% for eight periods. c. 8% for 32 periods. d. 2% for 32 periods.

Accounting and the Time Value of Money

A-9

36.

If the number of periods is known, the interest rate is determined by a. dividing the future value by the present value and looking for the quotient in the future value of 1 table. b. dividing the future value by the present value and looking for the quotient in the present value of 1 table. c. dividing the present value by the future value and looking for the quotient in the future value of 1 table. d. multiplying the present value by the future value and looking for the product in the present value of 1 table.

37.

Present value is a. the value now of a future amount. b. the amount that must be invested now to produce a known future value. c. always smaller than the future value. d. all of these.

38.

Which of the following statements is true? a. The higher the discount rate, the higher the present value. b. The process of accumulating interest on interest is referred to as discounting. c. If money is worth 10% compounded annually, $1,100 due one year from today is equivalent to $1,000 today. d. If a single sum is due on December 31, 2010, the present value of that sum decreases as the date draws closer to December 31, 2010.

If the interest rate is 10%, the factor for the future value of annuity due of 1 for n = 5, i = 10% is equal to the factor for the future value of an ordinary annuity of 1 for n = 5, i = 10% a. plus 1.10. b. minus 1.10. c. multiplied by 1.10. d. divided by 1.10.

40.

Which of the following is true? a. Rents occur at the beginning of each period of an ordinary annuity. b. Rents occur at the end of each period of an annuity due. c. Rents occur at the beginning of each period of an annuity due. d. None of these.

41.

Which statement is false? a. The factor for the future value of an annuity due is found by multiplying the ordinary annuity table value by one plus the interest rate. b. The factor for the present value of an annuity due is found by multiplying the ordinary annuity table value by one minus the interest rate. c. The factor for the future value of an annuity due is found by subtracting 1.00000 from the ordinary annuity table value for one more period. d. The factor for the present value of an annuity due is found by adding 1.00000 to the ordinary annuity table value for one less period.

42.

Ed Sloan wants to withdraw $20,000 (including principal) from an investment fund at the end of each year for five years. How should he compute his required initial investment at the beginning of the first year if the fund earns 10% compounded annually?

A - 10

Test Bank for Intermediate Accounting, Second Edition a. b. c. d.

$20,000 times the future value of a 5-year, 10% ordinary annuity of 1. $20,000 divided by the future value of a 5-year, 10% ordinary annuity of 1. $20,000 times the present value of a 5-year, 10% ordinary annuity of 1. $20,000 divided by the present value of a 5-year, 10% ordinary annuity of 1.

43.

Ann Ruth wants to invest a certain sum of money at the end of each year for five years. The investment will earn 6% compounded annually. At the end of five years, she will need a total of $40,000 accumulated. How should she compute her required annual investment? a. $40,000 times the future value of a 5-year, 6% ordinary annuity of 1. b. $40,000 divided by the future value of a 5-year, 6% ordinary annuity of 1. c. $40,000 times the present value of a 5-year, 6% ordinary annuity of 1. d. $40,000 divided by the present value of a 5-year, 6% ordinary annuity of 1.

44.

An accountant wishes to find the present value of an annuity of $1 payable at the beginning of each period at 10% for eight periods. The accountant has only one present value table which shows the present value of an annuity of $1 payable at the end of each period. To compute the present value, the accountant would use the present value factor in the 10% column for a. seven periods. b. eight periods and multiply by (1 + .10). c. eight periods. d. nine periods and multiply by (1 – .10).

45.

If an annuity due and an ordinary annuity have the same number of equal payments and the same interest rates, then a. the present value of the annuity due is less than the present value of the ordinary annuity. b. the present value of the annuity due is greater than the present value of the ordinary annuity. c. the future value of the annuity due is equal to the future value of the ordinary annuity. d. the future value of the annuity due is less than the future value of the ordinary annuity.

46.

Which of the following is false? a. The future value of a deferred annuity is the same as the future value of an annuity not deferred. b. A deferred annuity is an annuity in which the rents begin after a specified number of periods. c. To compute the present value of a deferred annuity, we compute the present value of an ordinary annuity of 1 for the entire period and subtract the present value of the rents which were not received during the deferral period. d. If the first rent is received at the end of the sixth period, it means the ordinary annuity is deferred for six periods.

Accounting and the Time Value of Money

A - 11

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

21. 22. 23. 24.

a b a d

25. 26. 27. 28.

c c b c

29. 30. 31. 32.

c a a c

33. 34. 35. 36.

a d d a

37. 38. 39. 40.

d c c c

41. 42. 43. 44.

b c b b

45. 46.

b d

Solution to Multiple Choice question for which the answer is “none of these.” 24. Present value of an Ordinary Annuity of 1.

MULTIPLE CHOICE—Computational 47.

If a savings account pays interest at 4% compounded quarterly, then the amount of $1 left on deposit for 8 years would be found in a table using a. 8 periods at 4%. b. 8 periods at 1%. c. 32 periods at 4%. d. 32 periods at 1%.

Items 48 through 51 apply to the appropriate use of interest tables. Given below are the future value factors for 1 at 8% for one to five periods. Each of the items 48 to 51 is based on 8% interest compounded annually. Periods 1 2 3 4 5

Future Value of 1 at 8% 1.080 1.166 1.260 1.360 1.469

48.

What amount should be deposited in a bank account today to grow to $10,000 three years from today? a. $10,000 × 1.260 b. $10,000 × 1.260 × 3 c. $10,000 ÷ 1.260 d. $10,000 ÷ 1.080 × 3

49.

If $3,000 is put in a savings account today, what amount will be available three years from today? a. $3,000 ÷ 1.260 b. $3,000 × 1.260 c. $3,000 × 1.080 × 3 d. ($3,000 × 1.080) + ($3,000 × 1.166) + ($3,000 × 1.260)

50.

What amount will be in a bank account three years from now if $6,000 is invested each year for four years with the first investment to be made today? a. ($6,000 × 1.260) + ($6,000 × 1.166) + ($6,000 × 1.080) + $6,000 b. $6,000 × 1.360 × 4 c. ($6,000 × 1.080) + ($6,000 × 1.166) + ($6,000 × 1.260) + ($6,000 × 1.360) d. $6,000 × 1.080 × 4

A - 12 51.

Test Bank for Intermediate Accounting, Second Edition If $4,000 is put in a savings account today, what amount will be available six years from now? a. $4,000 × 1.080 × 6 b. $4,000 × 1.080 × 1.469 c. $4,000 × 1.166 × 3 d. $4,000 × 1.260 × 2

Items 52 through 55 apply to the appropriate use of present value tables. Given below are the present value factors for $1.00 discounted at 10% for one to five periods. Each of the items 52 to 55 is based on 10% interest compounded annually. Present Value of $1 Periods Discounted at 10% per Period 1 0.909 2 0.826 3 0.751 4 0.683 5 0.621 52.

If an individual put $4,000 in a savings account today, what amount of cash would be available two years from today? a. $4,000 × 0.826 b. $4,000 × 0.826 × 2 c. $4,000 ÷ 0.826 d. $4,000 ÷ 0.909 × 2

53.

What is the present value today of $6,000 to be received six years from today? a. $6,000 × 0.909 × 6 b. $6,000 × 0.751 × 2 c. $6,000 × 0.621 × 0.909 d. $6,000 × 0.683 × 3

54.

What amount should be deposited in a bank today to grow to $3,000 three years from today? a. $3,000 ÷ 0.751 b. $3,000 × 0.909 × 3 c. ($3,000 × 0.909) + ($3,000 × 0.826) + ($3,000 × 0.751) d. $3,000 × 0.751

55.

What amount should an individual have in a bank account today before withdrawal if $5,000 is needed each year for four years with the first withdrawal to be made today and each subsequent withdrawal at one-year intervals? (The balance in the bank account should be zero after the fourth withdrawal.) a. $5,000 + ($5,000 × 0.909) + ($5,000 × 0.826) + ($5,000 × 0.751) b. $5,000 ÷ 0.683 × 4 c. ($5,000 × 0.909) + ($5,000 × 0.826) + ($5,000 × 0.751) + ($5,000 × 0.683) d. $5,000 ÷ 0.909 × 4

Accounting and the Time Value of Money

A - 13

56.

At the end of two years, what will be the balance in a savings account paying 6% annually if $5,000 is deposited today? The future value of one at 6% for one period is 1.06. a. $5,000 b. $5,300 c. $5,600 d. $5,618

57.

Windsor Company will receive $100,000 in 7 years. If the appropriate interest rate is 10%, the present value of the $100,000 receipt is a. $51,000. b. $51,316. c. $151,000. d. $194,872.

58.

Sheeley Company will receive $100,000 in a future year. If the future receipt is discounted at an interest rate of 10%, its present value is $51,316. In how many years is the $100,000 received? a. 5 years b. 6 years c. 7 years d. 8 years

59.

Jensen Company will invest $200,000 today. The investment will earn 6% for 5 years, with no funds withdrawn. In 5 years, the amount in the investment fund is a. $200,000. b. $260,000. c. $267,646. d. $268,058.

60.

Finley Company will receive $500,000 in 7 years. If the appropriate interest rate is 10%, the present value of the $500,000 receipt is a. $255,000. b. $256,580. c. $755,000. d. $974,360.

61.

Swanson Company will receive $100,000 in a future year. If the future receipt is discounted at an interest rate of 8%, its present value is $63,017. In how many years is the $100,000 received? a. 5 years b. 6 years c. 7 years d. 8 years

62.

Jasper Company will invest $300,000 today. The investment will earn 6% for 5 years, with no funds withdrawn. In 5 years, the amount in the investment fund is a. $300,000. b. $390,000. c. $401,469. d. $402,087.

A - 14

Test Bank for Intermediate Accounting, Second Edition

63.

Quincey Corporation makes an investment today (January 1, 2008). They will receive $10,000 every December 31st for the next six years (2008 – 2013). If Quincey wants to earn 12% on the investment, what is the most they should invest on January 1, 2008? a. $41,114 b. $46,048 c. $81,152 d. $90,890

64.

Craig Rusch Corporation will receive $10,000 today (January 1, 2008), and also on each January 1st for the next five years (2009 – 2013). What is the present value of the six $10,000 receipts, assuming a 12% interest rate? a. $41,114 b. $46,048 c. $81,152 d. $90,890

65.

Schmitt Corporation will invest $10,000 every December 31st for the next six years (2008 – 2013). If Schmitt will earn 12% on the investment, what amount will be in the investment fund on December 31, 2013? a. $41,114 b. $46,048 c. $81,152 d. $90,890

66.

Linton Corporation will invest $10,000 every January 1st for the next six years (2008 – 2013). If Linton will earn 12% on the investment, what amount will be in the investment fund on December 31, 2013? a. $41,114 b. $46,048 c. $81,152 d. $90,890

67.

Gorman Corporation makes an investment today (January 1, 2008). They will receive $20,000 every December 31st for the next six years (2008 – 2013). If Gorman wants to earn 12% on the investment, what is the most they should invest on January 1, 2008? a. $82,228 b. $92,096 c. $162,304 d. $181,780

68.

Renfro Corporation will receive $20,000 today (January 1, 2008), and also on each January 1st for the next five years (2009 – 2013). What is the present value of the six $20,000 receipts, assuming a 12% interest rate? a. $82,228 b. $92,096 c. $162,304 d. $181,780

69.

Pedigo Corporation will invest $30,000 every December 31st for the next six years (2008 – 2013). If Pedigo will earn 12% on the investment, what amount will be in the investment fund on December 31, 2013?

Accounting and the Time Value of Money a. b. c. d.

A - 15

$123,342 $138,144 $243,456 $272,670

70.

Wagner Corporation will invest $25,000 every January 1st for the next six years (2008 – 2013). If Wagner will earn 12% on the investment, what amount will be in the investment fund on December 31, 2013? a. $102,785 b. $115,120 c. $202,880 d. $227,225

71.

On January 1, 2007, Carly Company decided to begin accumulating a fund for asset replacement five years later. The company plans to make five annual deposits of $50,000 at 9% each January 1 beginning in 2007. What will be the balance in the fund, within $10, on January 1, 2012 (one year after the last deposit)? The following 9% interest factors may be used. Present Value of Future Value of Ordinary Annuity Ordinary Annuity 4 periods 3.2397 4.5731 5 periods 3.8897 5.9847 6 periods 4.4859 7.5233 a. b. c. d.

$326,166 $299,235 $272,500 $250,000

Use the following 8% interest factors for questions 72 through 75.

7 periods 8 periods 9 periods

Present Value of Ordinary Annuity 5.2064 5.7466 6.2469

Future Value of Ordinary Annuity 8.92280 10.63663 12.48756

72.

What will be the balance on September 1, 2013 in a fund which is accumulated by making $8,000 annual deposits each September 1 beginning in 2006, with the last deposit being made on September 1, 2013? The fund pays interest at 8% compounded annually. a. $85,093 b. $71,383 c. $60,480 d. $45,973

73.

If $5,000 is deposited annually starting on January 1, 2007 and it earns 8%, what will the balance be on December 31, 2014? a. $44,614 b. $48,183 c. $53,183 d. $57,438

A - 16

Test Bank for Intermediate Accounting, Second Edition

74.

Henson Company wishes to accumulate $300,000 by May 1, 2015 by making 8 equal annual deposits beginning May 1, 2007 to a fund paying 8% interest compounded annually. What is the required amount of each deposit? a. $52,205 b. $28,204 c. $26,115 d. $30,234

75.

What amount should be recorded as the cost of a machine purchased December 31, 2007, which is to be financed by making 8 annual payments of $6,000 each beginning December 31, 2008? The applicable interest rate is 8%. a. $42,000 b. $37,481 c. $63,820 d. $34,480

76.

How much must be deposited on January 1, 2007 in a savings account paying 6% annually in order to make annual withdrawals of $20,000 at the end of the years 2007 and 2008? The present value of one at 6% for one period is .9434. a. $36,668 b. $37,740 c. $40,000 d. $17,800

77.

How much must be invested now to receive $10,000 for 15 years if the first $10,000 is received today and the rate is 9%? Present Value of Periods Ordinary Annuity at 9% 14 7.78615 15 8.06069 16 8.31256 a. $80,607 b. $87,862 c. $150,000 d. $73,125

78.

Foley Company financed the purchase of a machine by making payments of $18,000 at the end of each of five years. The appropriate rate of interest was 8%. The future value of one for five periods at 8% is 1.46933. The future value of an ordinary annuity for five periods at 8% is 5.8666. The present value of an ordinary annuity for five periods at 8% is 3.99271. What was the cost of the machine to Foley? a. $26,448 b. $71,869 c. $90,000 d. $105,600

79.

A machine is purchased by making payments of $5,000 at the beginning of each of the next five years. The interest rate was 10%. The future value of an ordinary annuity of 1 for five periods is 6.10510. The present value of an ordinary annuity of 1 for five periods is 3.79079. What was the cost of the machine?

Accounting and the Time Value of Money a. b. c. d.

A - 17

$33,578 $30,526 $20,849 $18,954

80.

Catt Co. has a machine that cost $200,000. It is to be leased for 20 years with rent received at the beginning of each year. Catt wants a return of 10%. Calculate the amount of the annual rent. Present Value of Period Ordinary Annuity 19 8.36492 20 8.51356 21 8.64869 a. $21,356 b. $23,909 c. $29,728 d. $23,492

81.

Find the present value of an investment in plant and equipment if it is expected to provide annual earnings of $21,000 for 15 years and to have a resale value of $40,000 at the end of that period. Assume a 10% rate and earnings at year end. The present value of 1 at 10% for 15 periods is .23939. The present value of an ordinary annuity at 10% for 15 periods is 7.60608. The future value of 1 at 10% for 15 periods is 4.17725. a. $159,728 b. $169,303 c. $185,276 d. $324,576

82.

On January 2, 2008, Yenn Corporation wishes to issue $2,000,000 (par value) of its 8%, 10-year bonds. The bonds pay interest annually on January 1. The current yield rate on such bonds is 10%. Using the interest factors below, compute the amount that Yenn will realize from the sale (issuance) of the bonds. Present value of 1 at 8% for 10 periods Present value of 1 at 10% for 10 periods Present value of an ordinary annuity at 8% for 10 periods Present value of an ordinary annuity at 10% for 10 periods a. b. c. d.

0.4632 0.3855 6.7101 6.1446

$2,000,000 $1,754,136 $2,000,012 $2,212,052

Note: Students must be given interest tables for question 83. 83.

The market price of a $200,000, ten-year, 12% (pays interest semiannually) bond issue sold to yield an effective rate of 10% is a. $224,578. b. $224,925. c. $226,654. d. $374,472.

A - 18

Test Bank for Intermediate Accounting, Second Edition

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

47. 48. 49. 50. 51. 52.

d c b a b c

53. 54. 55. 56. 57. 58.

c d a d b c

59. 60. 61. 62. 63. 64.

c b b c a b

65. 66. 67. 68. 69. 70.

c d a b c d

71. 72. 73. 74. 75. 76.

a a d c d a

77. 78. 79. 80. 81. 82.

b b c a b b

83.

MULTIPLE CHOICE—CPA Adapted 84.

On January 1, 2008, Nott Co. sold to Day Corp. $400,000 of its 10% bonds for $354,118 to yield 12%. Interest is payable semiannually on January 1 and July 1. What amount should Nott report as interest expense for the six months ended June 30, 2008? a. $17,706 b. $20,000 c. $21,247 d. $24,000

85.

On May 1, 2007, a company purchased a new machine which it does not have to pay for until May 1, 2009. The total payment on May 1, 2009 will include both principal and interest. Assuming interest at a 10% rate, the cost of the machine would be the total payment multiplied by what time value of money factor? a. Future value of annuity of 1 b. Future value of 1 c. Present value of annuity of 1 d. Present value of 1

86.

On January 1, 2007, Abel Co. exchanged equipment for a $160,000 noninterest-bearing note due on January 1, 2010. The prevailing rate of interest for a note of this type at January 1, 2007 was 10%. The present value of $1 at 10% for three periods is 0.75. What amount of interest revenue should be included in Abel's 2008 income statement? a. $0 b. $12,000 c. $13,200 d. $16,000

87.

For which of the following transactions would the use of the present value of an ordinary annuity concept be appropriate in calculating the present value of the asset obtained or the liability owed at the date of incurrence? a. A capital lease is entered into with the initial lease payment due one month subsequent to the signing of the lease agreement. b. A capital lease is entered into with the initial lease payment due upon the signing of the lease agreement. c. A ten-year 8% bond is issued on January 2 with interest payable semiannually on January 2 and July 1 yielding 7%. d. A ten-year 8% bond is issued on January 2 with interest payable semiannually on January 2 and July 1 yielding 9%.

Accounting and the Time Value of Money 88.

A - 19

On January 15, 2008, Flynn Corp. adopted a plan to accumulate funds for environmental improvements beginning July 1, 2012, at an estimated cost of $4,000,000. Flynn plans to make four equal annual deposits in a fund that will earn interest at 10% compounded annually. The first deposit was made on July 1, 2008. Future value factors are as follows: Future value of 1 at 10% for 5 periods Future value of ordinary annuity of 1 at 10% for 4 periods Future value of annuity due of 1 at 10% for 4 periods

1.61 4.64 5.11

Flynn should make four annual deposits of a. $711,618. b. $782,779. c. $862,069. d. $1,000,000. 89.

On December 30, 2008, Cey, Inc. purchased a machine from Frank Corp. in exchange for a noninterest-bearing note requiring eight payments of $50,000. The first payment was made on December 30, 2008, and the others are due annually on December 30. At date of issuance, the prevailing rate of interest for this type of note was 11%. Present value factors are as follows: Present Value of Ordinary Present Value of Period Annuity of 1 at 11% Annuity Due of 1 at 11% 7 4.712 5.231 8 5.146 5.712 On Cey's December 31, 2008 balance sheet, the net note payable to Frank is a. $235,600. b. $257,300. c. $261,775. d. $285,600.

90.

On January 1, 2008, Lex Co. sold goods to Eaton Company. Eaton signed a noninterestbearing note requiring payment of $80,000 annually for seven years. The first payment was made on January 1, 2008. The prevailing rate of interest for this type of note at date of issuance was 10%. Information on present value factors is as follows: Period 6 7

Present Value of 1 at 10% .5645 .5132

Present Value of Ordinary Annuity of 1 at 10% 4.3553 4.8684

Lex should record sales revenue in January 2008 of a. $428,419. b. $389,472. c. $348,424. d. $285,600. 91.

On January 1, 2008, Grant Co. issued ten-year bonds with a face amount of $2,000,000 and a stated interest rate of 8% payable annually on January 1. The bonds were priced to yield 10%. Present value factors are as follows: At 8% At 10% Present value of 1 for 10 periods 0.463 0.386 Present value of an ordinary annuity of 1 for 10 periods 6.710 6.145

A - 20

Test Bank for Intermediate Accounting, Second Edition The total issue price of the bonds was a. $2,000,000. b. $1,960,000. c. $1,840,000. d. $1,755,200.

92.

On July 1, 2008, Ed Vance signed an agreement to operate as a franchisee of Kwik Foods, Inc., for an initial franchise fee of $180,000. Of this amount, $60,000 was paid when the agreement was signed and the balance is payable in four equal annual payments of $30,000 beginning July 1, 2009. The agreement provides that the down payment is not refundable and no future services are required of the franchisor. Vance's credit rating indicates that he can borrow money at 14% for a loan of this type. Information on present and future value factors is as follows: Present value of 1 at 14% for 4 periods Future value of 1 at 14% for 4 periods Present value of an ordinary annuity of 1 at 14% for 4 periods

0.59 1.69 2.91

Vance should record the acquisition cost of the franchise on July 1, 2008 at a. $130,800. b. $147,300. c. $180,000. d. $202,800.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

84. 85.

c d

86. 87.

c a

88. 89.

b a

90. 91.

a d

92.

DERIVATIONS — Computational No.

Answer

47.

Derivation 4 × 8 = 32 periods; 4% ÷ 4 = 1%.

48.

1.260 × PV = $10,000; PV = $10,000 ÷ 1.260.

49.

1.260 × $3,000.

50.

($6,000 × 1.260) + ($6,000 × 1.166) + ($6,000 × 1.080) + $6,000.

51.

$4,000 × (1.080)6 or $4,000 × 1.469 × 1.080.

52.

0.826 × PV = $4,000; PV = $4,000 ÷ 0.826.

53.

$6,000 × 0.621 × 0.909.

54.

$3,000 × 0.751.

55.

$5,000 + ($5,000 × 0.909) + ($5,000 × 0.826) + ($5,000 × 0.751).

Accounting and the Time Value of Money

A - 21

No.

Answer

56.

Derivation $5,000 × (1.06)2 = $5,618.

57.

$100,000 × 0.51316 = $51,316.

58.

$51,316 ÷ $100,000 = 0.51316; 0,51316 is PV factor for 7 years.

59.

$200,000 × 1.33823 = $267,646.

60.

$500,000 × 0.51316 = $256,580.

61.

$63,017 ÷ $100,000 = 0.63017; 0.63017 is PV factor for 6 years.

62.

$300,000 × 1.33823 = $401,469.

63.

$10,000 × 4.11141 = $41,114.

64.

$10,000 × 4.60478 = $46,048.

65.

$10,000 × 8.11519 = $81,152.

66.

$10,000 × 8.11519 × 1.12 = $90,890.

67.

$20,000 × 4.11141 = $82,228.

68.

$20,000 × 4.60478 = $92,096.

69.

$30,000 × 8.11519 = $243,456.

70.

$25,000 × 8.11519 × 1.12 = $227,225.

71.

$50,000 × (7.5233 – 1) = $326,166 or $50,000 × 5.9847 × 1.09.

72.

$8,000 × 10.63663 = $85,093.

73.

$5,000 × (12.48756 – 1) = $57,438 or $5,000 × 10.63663 × 1.08.

74.

(10.63663 × 1.08) × R = $300,000; R = $300,000 ÷ 11.48756 = $26,115.

75.

$6,000 × 5.7466 = $34,480.

76.

($20,000 × 0.9434) + [$20,000 × (0.9434)2] = $36,668.

77.

$10,000 × (7.78615 + 1) = $87,862 or $10,000 × 8.06069 × 1.09.

78.

$18,000 × 3.99271 = $71,869.

79.

$5,000 × (3.79079 × 1.10) = $5,000 × 4.16987 = $20,849.

80.

$200,000 = R × (8.51356 × 1.10); R = $200,000 ÷ 9.36492 = $21,356.

A - 22

Test Bank for Intermediate Accounting, Second Edition

No.

Answer

81.

Derivation ($21,000 × 7.60608) + ($40,000 × .23939) = $169,303.

82.

$2,000,000 × .08 = $160,000 (annual interest payment) ($160,000 × 6.1446) + ($2,000,000 × 0.3855) = $1,754,136.

83.

$200,000 × .06 = $12,000 (semiannual interest payment) ($12,000 × 12.46221) + ($200,000 × .37689) = $224,925.

DERIVATIONS — CPA Adapted No.

Answer

84.

Derivation $354,118 × .06 = $21,247.

85.

Conceptual.

86.

$160,000 × .75 = $120,000 (present value of note) $120,000 × 1.10 = $132,000; $132,000 × 0.10 = $13,200.

87.

Conceptual.

88.

5.11 × R = $4,000,000; R = $4,000,000 ÷ 5.11 = $782,779.

89.

$50,000 × 4.712 = $235,600 or ($50,000 × 5.712) – $50,000 = $235,600.

90.

$80,000 × (4.8684 × 1.1) = $428,419.

91.

$2,000,000 × .08 = $160,000 ($160,000 × 6.145) + ($2,000,000 × 0.386) = $1,755,200.

92.

($30,000 × 2.91) + $60,000 = $147,300.

Accounting and the Time Value of Money

A - 23

EXERCISES Ex. A-93—Present and future value concepts. On the right are six diagrams representing six different present and future value concepts stated on the left. Identify the diagrams with the concepts by writing the identifying letter of the diagram on the blank line at the left. Assume n = 4 and i = 8%. Concept _____ 1.

Diagram of Concept

Future value of 1.

? a.

_____ 2.

Present value of 1.

_____ 3.

Future value of an annuity due of 1.

_____ 4.

Future value of an ordinary annuity of 1.

_____ 5.

Present value of an ordinary annuity of 1.

_____ 6.

Present value of an annuity

due of 1.

? $1

|- - - - |

? $1

|- - - - |

$1 e.

Solution A-93 1. e

2. a

3. f

4. b

5. d

6. c

Ex. A-94—Compute estimated goodwill. (Tables needed.) Compute estimated goodwill if it is found by discounting excess earnings at 12% compounded quarterly. Excess annual earnings of $12,000 are expected for 8 years.

Solution A-94 Present value of $3,000 for 32 periods at 3% ($3,000 × 20.38877) = $61,166.

A - 24

Test Bank for Intermediate Accounting, Second Edition

Ex. A-95—Present value of an investment in equipment. (Tables needed.) Find the present value of an investment in equipment if it is expected to provide annual savings of $10,000 for 10 years and to have a resale value of $25,000 at the end of that period. Assume an interest rate of 9% and that savings are realized at year end.

Solution A-95 Present value of $10,000 for 10 periods at 9% (6.41766 × $10,000) = Present value of $25,000 discounted for 10 periods at 9% (.42241 × $25,000) = Present value of investment in equipment

$64,177 10,560 $74,737

Ex. A-96—Future value of an annuity due. (Tables needed.) If $4,000 is deposited annually starting on January 1, 2007 and it earns 9%, how much will accumulate by December 31, 2016?

Solution 6-96 Future value of an annuity due of $4,000 for 10 periods at 9% ($4,000 × 15.19293 × 1.09) = $66,241.

Ex. A-97—Present value of an annuity due. (Tables needed.) How much must be invested now to receive $20,000 for ten years if the first $20,000 is received today and the rate is 8%?

Solution A-97 Present value of an annuity due of $20,000 for ten periods at 8% ($20,000 × 7.24689) = $144,938.

Ex. A-98—Compute the annual rent. (Tables needed.) Aaron Co. has machinery that cost $80,000. It is to be leased for 15 years with rent received at the beginning of each year. Aaron wants a return of 10%. Compute the amount of the annual rent.

Solution A-98 Present value factor for an annuity due for 15 periods at 10% (1.10  7.60608) = 8.36669 $80,000 ÷ 8.36669 = $9,562.

Ex. A-99—Calculate market price of a bond. (Tables needed.) Determine the market price of a $200,000, ten-year, 10% (pays interest semiannually) bond issue sold to yield an effective rate of 12%.

Accounting and the Time Value of Money

A - 25

Solution A-99 Present value of $10,000 for 20 periods at 6% ($10,000 × 11.46992) = Present value of $200,000 discounted for 20 periods at 6% ($200,000 × .31180) = Market price of the bond issue

$114,699 62,360 $177,059

Ex. A-100—Calculate market price of a bond. On January 1, 2008 Kiner Co. issued five-year bonds with a face value of $400,000 and a stated interest rate of 12% payable semiannually on July 1 and January 1. The bonds were sold to yield 10%. Present value table factors are: Present value of 1 for 5 periods at 10% .62092 Present value of 1 for 5 periods at 12% .56743 Present value of 1 for 10 periods at 5% .61391 Present value of 1 for 10 periods at 6% .55839 Present value of an ordinary annuity of 1 for 5 periods at 10% 3.79079 Present value of an ordinary annuity of 1 for 5 periods at 12% 3.60478 Present value of an ordinary annuity of 1 for 10 periods at 5% 7.72173 Present value of an ordinary annuity of 1 for 10 periods at 6% 7.36009 Calculate the issue price of the bonds.

Solution A-100 Present value of $400,000 discounted for 10 periods at 5% ($400,000 × .61391) = Present value of $24,000 for 10 periods at 5% ($24,000 × 7.72173) = Issue price of the bonds

$245,564 185,322 $430,886

PROBLEMS Pr. A-101—Present value and future value computations. Part (a) Compute the amount that a $20,000 investment today would accumulate at 10% (compound interest) by the end of 6 years. Part (b) Don wants to retire at the end of this year (2008). His life expectancy is 20 years from his retirement. Don has come to you, his CPA, to learn how much he should deposit on December 31, 2008 to be able to withdraw $40,000 at the end of each year for the next 20 years, assuming the amount on deposit will earn 8% interest annually. Part (c) Mary Houser has a $1,200 overdue debt for medical books and supplies at Ken's Bookstore. She has only $400 in her checking account and doesn't want her parents to know about this debt. Ken's tells her that she may settle the account in one of two ways since she can't pay it all now: 1. Pay $400 now and $1,000 when she completes her residency, two years from today. 2. Pay $1,600 one year after completion of residency, three years from today. Assuming that the cost of money is the only factor in Mary's decision and that the cost of money to her is 8%, which alternative should she choose? Your answer must be supported with calculations.

A - 26

Test Bank for Intermediate Accounting, Second Edition

Solution A-101 Part (a) Future value of $20,000 compounded @ 10% for 6 years ($20,000 × 1.77156) = $35,431. Part (b) Present value of a $40,000 ordinary annuity discounted @ 8% for 20 years ($40,000 × 9.81815) = $392,726. Part (c) Alternative 1 Present value of $1,000 discounted @ 8% for 2 years ($1,000 × .85734) = Present value of $1,000 now = Present value of $400 now = Present value of Alternative 1

$ 857 400 $1,257

Alternative 2 Present value of $1,600 discounted @ 8% for 3 years ($1,600 × .79383)

$1,270

On the present value basis, Alternative 1 is preferable.

Pr. A-102—Annuity with change in interest rate. Meg Sloan established a savings account for her son's college education by making annual deposits of $6,000 at the beginning of each of six years to a savings account paying 8%. At the end of the sixth year, the account balance was transferred to a bank paying 10%, and annual deposits of $6,000 were made at the end of each year from the seventh through the tenth years. What was the account balance at the end of the tenth year?

Solution A-102 Years 1-6:

Future value of annuity due of $6,000 for 6 periods at 8%: (7.33592 × 1.08) × $6,000 = $47,537

Years 7-10: Future value of $47,537 for 4 periods at 10%: 1.4641 × $47,537 = $69,599 Future value of ordinary annuity of $6,000 for 4 periods at 10%: 4.6410 × $6,000 = $27,846 Sum in bank at end of tenth year: $27,846 + $69,599 = $97,445

Pr. A-103—Present value of an ordinary annuity due. Jill Norris is presently leasing a small business computer from Darby Office Equipment Company. The lease requires 10 annual payments of $4,000 at the end of each year and provides the lessor (Darby) with an 8% return on its investment. You may use the following 8% interest factors: Future Value of 1 Present Value of 1 Future Value of Ordinary Annuity of 1 Present Value of Ordinary Annuity of 1 Present Value of Annuity Due of 1

9 Periods 1.99900 .50025 12.48756 6.24689 6.74664

10 Periods 2.15892 .46319 14.48656 6.71008 7.24689

11 Periods 2.33164 .42888 16.64549 7.13896 7.71008

Accounting and the Time Value of Money

A - 27

Pr. A-103 (cont.) Instructions (a) Assuming the computer has a ten-year life and will have no salvage value at the expiration of the lease, what was the original cost of the computer to Darby? (b) What amount would each payment be if the ten annual payments are to be made at the beginning of each period?

Solution A-103 (a) Present value of an ordinary annuity of $4,000 at 8% for 10 years is 6.71008 × $4,000 =

$26,840

(b) Present value factor for an annuity due of $4,000 at 8% for 10 years is 7.24689; $26,840 ÷ 7.24689 =

$3,704

Pr. A-104—Finding the implied interest rate. Cline Company has entered into two lease agreements. In each case the cash equivalent purchase price of the asset acquired is known and you wish to find the interest rate which is applicable to the lease payments. Instructions Calculate the implied interest rate for the lease payments. Lease A — Lease A covers office equipment which could be purchased for $36,048. Cline Company has, however, chosen to lease the equipment for $10,000 per year, payable at the end of each of the next 5 years. Lease B — Lease B applies to a machine which can be purchased for $57,489. Cline Company has chosen to lease the machine for $12,000 per year on a 6-year lease. Payments are due at the start of each year.

Solution A-104 Lease A — Calculation of the Implied Interest Rate: $10,000 × (factor for Present Value of Ordinary Annuity for 5 yrs.) = $36,048 Factor for Present Value of Ordinary Annuity for 5 yrs. = $36,048 ÷ $10,000 = 3.6048 The 3.6048 factor implies a 12% interest rate. Lease B — Calculation of the Implied Interest Rate: $12,000 × (factor for Present Value of Annuity Due for 6 yrs.) = $57,489 Factor for Present Value of Annuity Due for 6 yrs. = $57,489 ÷ $12,000 = 4.79075 The 4.79075 factor implies a 10% interest rate (present value of an annuity due table).

A - 28

Test Bank for Intermediate Accounting, Second Edition

Pr. A-105—Calculation of unknown rent and interest. Rice Leasing Company purchased specialized equipment from Wayne Company on December 31, 2007 for $400,000. On the same date, it leased this equipment to Sears Company for 5 years, the useful life of the equipment. The lease payments begin January 1, 2008 and are made every 6 months until July 1, 2012. Rice Leasing wants to earn 10% annually on its investment. Various Factors at 10% Periods or Rents 9 10 11

Periods or Rents 9 10 11

Future Value of $1 2.35795 2.59374 2.85312

Present Value of $1 .42410 .38554 .35049

Future Value of an Ordinary Annuity 13.57948 15.93743 18.53117

Present Value of an Ordinary Annuity 5.75902 6.14457 6.49506

Future Value of $1 1.55133 1.62889 1.71034

Various Factors at 5% Present Future Value of an Value of $1 Ordinary Annuity .64461 11.02656 .61391 12.57789 .58468 14.20679

Present Value of an Ordinary Annuity 7.10782 7.72173 8.30641

Instructions (a) Calculate the amount of each rent. (b) How much interest revenue will Rice earn in 2008?

Solution A-105 (a) Calculation of rent: 7.72173  1.05 = 8.10782 (present value of a 10-rent annuity due at 5%.) $400,000  8.10782 = $49,335. (b) Interest Revenue during 2008:

Rent No. 1 2 None

Cash Received $49,335 49,335 None

Date 1/1/08 7/1/08 12/31/08 Total

Interest Revenue $ -017,533 15,943 (Accrual) $33,476

Lease Receivable $350,665 318,863

Pr. A-106—Deferred annuity. Baker Company owns a plot of land on which buried toxic wastes have been discovered. Since it will require several years and a considerable sum of money before the property is fully detoxified and capable of generating revenues, Baker wishes to sell the land now. It has located two potential buyers: Buyer A, who is willing to pay $320,000 for the land now, and Buyer B, who is willing to make 20 annual payments of $50,000 each, with the first payment to be made 5 years from today. Assuming that the appropriate rate of interest is 9%, to whom should Baker sell the land? Show calculations.

Accounting and the Time Value of Money

A - 29

Solution A-106 Buyer A. The present value of the purchase price is $320,000. Buyer B. The present value of the purchase price is: Present value of ordinary annuity of $50,000 for 24 periods at 9% Less present value of ordinary annuity of $50,000 for 4 periods (deferred) at 9% Difference Multiplied by annual payments Present value of payments Conclusion: Baker should sell to Buyer B.

9.70661 3.23972 6.46689 × $50,000 $323,345

APPENDIX B REPORTING CASH FLOWS TRUE-FALSE—Conceptual Answer

No.

Description

F T F T T T T F F F T F F T F

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

Effect of writedowns and amortization charges on cash. Reporting loss on sale of equipment. Increase in accounts payable and cost of goods sold. Purchases and sales of trading securities. Disclosing noncash investing and financing activities. Changes in working capital. Reporting cash flows from extraordinary transactions. Net income and net cash flow from operating activities. Reporting cash receipts/disbursements in direct method. FASB’s recommended method. Decrease in accounts receivable and cash-basis revenues. Decrease in prepaid expenses. Income from equity method investment. Computing cash receipts from customers. Computing cash payments for operating expenses.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

b c c a a b b c d a

16. 17. 18. 19. 20. 21. 22. 23. 24. 25.

Adjustment to income for inventory increase. Adjustment under the direct and indirect methods. Adjustment to cost of goods sold under the direct method. Adjustment for an increase in accounts payable. Adjustment for a decrease in prepaid insurance. Direct method vs. indirect method. Reporting amortization of bond premium. Converting accrual based expense to cash basis. Adjustment for equity method investment income. Reporting extraordinary transactions.

MULTIPLE CHOICE—Computational Answer

No.

Description

a c b d c d a c

26. 27. 28. 29. 30. 31. 32. 33.

Determine net cash flow from operating activities. Determine net cash flow from investing activities. Determine cash received from customers (direct method). Determine cash paid to suppliers (direct method). Determine net cash flow from financing activities. Compute net cash provided by investing activities. Compute net cash provided by financing activities. Determine cash collected from accounts receivable.

B-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Computational (cont.) Answer

No.

Description

b b a c b c

34. 35. 36. 37. 38. 39.

Determine cash paid on accounts payable to suppliers. Determine net income for period. Adjust net income for bad debt provision. Reporting insurance proceeds from a flood loss. Reporting a flood loss. Determine net cash flow from operating activities.

EXERCISES Item

Description

EB-40 EB-41 EB-42

Cash flows from operating activities (direct method). Direct and indirect methods (essay). Statement of cash flows (direct method).

PROBLEMS Item

Description

PB-43 PB-44

Statement of cash flows (direct method). Statement of cash flows (direct method).

CHAPTER LEARNING OBJECTIVES 1.

Identify sources of information for a statement of cash flows.

Prepare a statement of cash flows.

Discuss special problems in preparing a statement of cash flows.

Understand the direct method of calculating net cash flow from operating activities.

Reporting Cash Flows

B-3

SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item

Type

Item

Type

Item

1. 16.

TF MC

17. 18.

MC MC

19. 20.

2. 3.

TF TF

22. 23.

MC MC

26. 27.

4. 5.

TF TF

6. 7.

TF TF

24. 25.

8. 9. 10.

TF TF TF

11. 12. 13.

TF TF TF

14. 15. 28.

Note: TF = True-False MC = Multiple Choice E = Exercise P = Problem

Type

Item

Type

Item

Learning Objective 1 MC 21. MC 105. MC 103. E Learning Objective 2 MC 30. TF 32. MC 31. MC Learning Objective 3 MC 35. MC 37. MC 36. MC 38. Learning Objective 4 TF 29. MC 41. TF 33. MC 42. MC 34. MC 44.

Type

Item

Type

Item

Type

39. 40.

MC E

43.

MC MC E E P

B-4

Test Bank for Intermediate Accounting, Second Edition

TRUE FALSE—Conceptual 1.

Writedowns, amortization charges, and similar book entries have no effect on cash or net income.

A loss on the sale of equipment must be added back to net income to arrive at net cash provided by operating activities.

When accounts payable increase during the year, cost of goods sold and expenses on a cash basis are higher than they are on an accrual basis.

Companies report the cash flows from purchases and sales of trading securities as cash flows from operating activities.

Noncash investing and financing activities are disclosed either in a separate schedule or in a separate note to the financial statements.

Some changes in working capital, although they affect cash, do not affect net income.

Cash flows from extraordinary transactions and other events whose effects are included in net income, but which are not related to operations, should be reported either as investing activities or as financing activities.

When the direct method is used in determining cash provided by operating activities, users of the statement of cash flows are unable to reconcile the net income to the net cash provided by operations because this is only provided when the indirect method is used.

The direct method, also called the reconciliation method, reports cash receipts and cash disbursements from operating activities.

10.

The FASB encourages the use of the indirect method over the direct method.

11.

When accounts receivable decrease during a period, cash-basis revenues are higher than revenues reported on an accrual basis.

12.

When prepaid expenses decrease during a period, expenses on an accrual basis are lower than they are on a cash basis.

13.

Income from an investment in common stock using the equity method is added to net income in computing net cash provided from operating activities.

14.

Cash receipts from customers are computed by adding a decrease in accounts receivable to revenue from sales.

15.

Cash payments for operating expenses are computed by subtracting an increase in prepaid expenses and a decrease in accrued expenses payable from operating expenses.

Reporting Cash Flows

B-5

True-False Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

1. 2. 3. 4.

F T F T

5. 6. 7. 8.

T T T F

9. 10. 11. 12.

F F T F

13. 14. 15.

F T F

MULTIPLE CHOICE—Conceptual 16.

When preparing a statement of cash flows (indirect method), an increase in ending inventory over beginning inventory will result in an adjustment to reported net earnings because a. cash was increased while cost of goods sold was decreased. b. cost of goods sold on an accrual basis is lower than on a cash basis. c. acquisition of inventory is an investment activity. d. inventory purchased during the period was less than inventory sold resulting in a net cash increase.

17.

When preparing a statement of cash flows, a decrease in accounts receivable during a period would cause which one of the following adjustments in determining cash flow from operating activities? a. b. c. d.

Direct Method Increase Decrease Increase Decrease

Indirect Method Decrease Increase Increase Decrease

18.

In determining net cash flow from operating activities, a decrease in accounts payable during a period a. means that income on an accrual basis is less than income on a cash basis. b. requires an addition adjustment to net income under the indirect method. c. requires an increase adjustment to cost of goods sold under the direct method. d. requires a decrease adjustment to cost of goods sold under the direct method.

19.

When preparing a statement of cash flows, an increase in accounts payable during a period would require which of the following adjustments in determining cash flows from operating activities? a. b. c. d.

20.

Indirect Method Increase Decrease Increase Decrease

Direct Method Decrease Increase Increase Decrease

When preparing a statement of cash flows, a decrease in prepaid insurance during a period would require which of the following adjustments in determining cash flows from operating activities?

B-6

Test Bank for Intermediate Accounting, Second Edition

a. b. c. d. 21.

Indirect Method Increase Decrease Increase Decrease

Direct Method Decrease Increase Increase Decrease

When preparing a statement of cash flows, the following are used for which method in determining cash flows from operating activities? a. b. c. d.

Gross Accounts Receivable Indirect Direct Direct Neither

Net Accounts Receivable Direct Indirect Direct Indirect

22.

The amortization of bond premium on long-term debt should be presented in a statement of cash flows (using the indirect method for operating activities) as a(n) a. addition to net income. b. deduction from net income. c. investing activity. d. financing activity.

23.

Crabbe Company reported $80,000 of selling and administrative expenses on its income statement for the past year. The company had depreciation expense and an increase in prepaid expenses associated with the selling and administrative expenses for the year. Assuming use of the direct method, how would these items be handled in converting the accrual based selling and administrative expenses to the cash basis?

a. b. c. d.

Depreciation Deducted From Added To Deducted From Added To

Increase in Prepaid Expenses Deducted From Added To Added To Deducted From

24.

Riley Company reports its income from investments under the equity method and recognized income of $25,000 from its investment in Wood Co. during the current year, even though no dividends were declared or paid by Wood during the year. On Riley's statement of cash flows (indirect method), the $25,000 should a. not be shown. b. be shown as cash inflow from investing activities. c. be shown as cash outflow from financing activities. d. be shown as a deduction from net income in the cash flows from operating activities section.

25.

In reporting extraordinary transactions on a statement of cash flows (indirect method), the a. gross amount of an extraordinary gain should be deducted from net income. b. net of tax amount of an extraordinary gain should be added to net income. c. net of tax amount of an extraordinary gain should be deducted from net income. d. gross amount of an extraordinary gain should be added to net income.

Reporting Cash Flows

B-7

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

16. 17.

b c

18. 19.

c a

20. 21.

a b

22. 23.

b c

24. 25.

d a

MULTIPLE CHOICE—Computational Use the following information for questions 26 through 30. Paxson Mining Co. has recently decided to go public and has hired you as an independent CPA. One statement that the enterprise is anxious to have prepared is a statement of cash flows. Financial statements of Paxson Mining Co. for 2008 and 2007 are provided below. BALANCE SHEETS Cash Accounts receivable Merchandise inventory Property, plant and equipment Less accumulated depreciation

Accounts payable Income taxes payable Bonds payable Common stock Retained earnings

12/31/08 $204,000 180,000 192,000 $304,000 (160,000)

144,000 $720,000

12/31/07 $ 96,000 108,000 240,000 $480,000 (152,000)

$ 88,000 176,000 180,000 108,000 168,000 $720,000

328,000 $772,000 $ 48,000 196,000 300,000 108,000 120,000 $772,000

INCOME STATEMENT For the Year Ended December 31, 2008 Sales Cost of sales Gross profit Selling expenses Administrative expenses Income from operations Interest expense Income before taxes Income taxes Net income

$4,200,000 3,576,000 624,000 $300,000 96,000

396,000 228,000 36,000 192,000 48,000 $ 144,000

The following additional data were provided: 1. Dividends for the year 2008 were $96,000. 2. During the year, equipment was sold for $120,000. This equipment cost $176,000 originally and had a book value of $144,000 at the time of sale. The loss on sale was included in administrative expenses. 3. All depreciation expense is in the selling expense category.

B-8

Test Bank for Intermediate Accounting, Second Edition

Questions 26 through 30 relate to a statement of cash flows (direct method) for the year ended December 31, 2008, for Paxson Mining Company. 26.

The net cash provided by operating activities is a. $204,000. b. $144,000. c. $120,000. d. $100,000.

27.

The net cash provided (used) by investing activities is a. $(176,000). b. $24,000. c. $120,000. d. $(144,000).

28.

Under the direct method, the cash received from customers is a. $4,272,000. b. $4,128,000. c. $4,200,000. d. $4,220,000.

29.

Under the direct method, the cash paid to suppliers is a. $3,768,000. b. $3,568,000. c. $3,528,000. d. $3,488,000.

30.

The net cash provided (used) by financing activities is a. $(120,000). b. $24,000. c. $(216,000). d. $96,000.

Reporting Cash Flows

B-9

Questions 31 through 34 are based on the data shown below related to the statement of cash flows for Litwin, Inc.: Litwin, Inc. Comparative Balance Sheets December 31, 2008 2007 Assets: Current Assets: Cash Accounts Receivable (net) Merchandise Inventory Prepaid Expenses Total Current Assets Long-Term Investments Plant Assets: Property, Plant & Equipment Accumulated Depreciation Total Plant Assets Total Assets Equities: Current Liabilities: Accounts Payable Accrued Expenses Dividends Payable Total Current Liabilities Long-Term Notes Payable Stockholders' Equity: Common Stock Retained Earnings Total Equities

$ 690,000 1,560,000 1,950,000 351,000 4,551,000 225,000

$ 540,000 1,080,000 1,260,000 315,000 3,195,000

2,190,000 (450,000) 1,740,000 $6,516,000

1,440,000 (270,000) 1,170,000 $4,365,000

$1,275,000 309,000 201,000 1,785,000 825,000

$1,095,000 282,000

3,000,000 906,000 $6,516,000

2,400,000 588,000 $4,365,000

1,377,000

Litwin, Inc. Comparative Income Statements

Net Credit Sales Cost of Goods Sold Gross Profit Expenses (including Income Tax) Net Income

December 31, 2008 2007 $7,020,000 $3,753,000 3,915,000 1,881,000 3,105,000 1,872,000 2,586,000 1,374,000 $ 519,000 $ 498,000

Additional Information: a. Accounts receivable and accounts payable relate to merchandise held for sale in the normal course of business. The allowance for bad debts was the same at the end of 2008 and 2007, and no receivables were charged against the allowance. Accounts payable are recorded net of any discount and are always paid within the discount period. b. The proceeds from the note payable were used to finance the acquisition of property, plant, and equipment. Capital stock was sold to provide additional working capital.

B - 10

Test Bank for Intermediate Accounting, Second Edition

31.

The amount to be shown on the cash flow statement as net cash provided by investing activities would total what amount? a. $225,000 b. $750,000 c. $795,000 d. $975,000

32.

The amount to be shown on the cash flow statement as net cash provided by financing activities would total what amount? a. $1,425,000 b. $825,000 c. $600,000 d. $408,000

33.

What amount of cash was collected from 2008 accounts receivable? a. $7,500,000 b. $7,020,000 c. $6,540,000 d. $3,270,000

34.

What amount of cash was paid on accounts payable to suppliers during 2008? a. $4,605,000 b. $4,425,000 c. $4,095,000 d. $3,735,000

35.

The net cash provided by operating activities in Otto Company's statement of cash flows for 2008 was $115,000. For 2008, depreciation on plant assets was $45,000, amortization of patent was $8,000, and cash dividends paid on common stock was $54,000. Based only on the information given above, Otto’s net income for 2008 was a. $115,000. b. $62,000. c. $8,000. d. $116,000.

36.

During 2008, Garber Corporation, which uses the allowance method of accounting for doubtful accounts, recorded a provision for bad debt expense of $25,000 and in addition it wrote off, as uncollectible, accounts receivable of $10,000. As a result of these transactions, net cash flows from operating activities would be calculated (indirect method) by adjusting net income with a a. $25,000 increase. b. $10,000 increase. c. $15,000 increase. d. $15,000 decrease.

Use the following information for questions 37 and 38. A flood damaged a building and its contents. Floods are unusual and infrequent in this area. The receipts from insurance companies totaled $300,000, which was $90,000 less than the book values. The tax rate is 30%.

Reporting Cash Flows

B - 11

37.

On the statement of cash flows (indirect method), the receipts from insurance companies should a. be shown as an addition to net income of $210,000. b. be shown as an inflow from investing activities of $210,000. c. be shown as an inflow from investing activities of $300,000. d. not be shown.

38.

On the statement of cash flows (indirect method), the flood loss should a. be shown as an addition to net income of $63,000. b. be shown as an addition to net income of $90,000. c. be shown as an inflow from investing activities of $63,000. d. not be shown.

39.

Snow Incorporated, had net income for 2008 of $5,000,000. Additional information is as follows: Amortization of patents Depreciation on plant assets Long-term debt: Bond premium amortization Interest paid Provision for doubtful accounts: Current receivables Long-term nontrade receivables

$ 45,000 1,650,000 65,000 900,000 80,000 30,000

What should be the net cash provided by operating activities in the statement of cash flows for the year ended December 31, 2008, based solely on the above information? a. $6,820,000. b. $6,870,000. c. $6,740,000. d. $6,840,000.

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

26. 27.

a c

28. 29.

b d

30. 31.

c d

32. 33.

a c

34. 35.

b b

36. 37.

a c

38. 39.

b c

B - 12

Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational No. Answer

Derivation

26.

$144,000 + $24,000 + ($160,000 + $32,000 – $152,000) – $72,000 + $48,000 + $40,000 – $20,000 = $204,000.

27.

$120,000.

28.

$108,000 + $4,200,000 – $180,000 = $4,128,000.

29.

$3,576,000 + $192,000 – $240,000 = $3,528,000. $3,528,000 + $48,000 – $88,000 = $3,488,000.

30.

($96,000) + ($120,000) = ($216,000).

31.

$225,000 + ($2,190,000 – $1,440,000) = $975,000.

32.

$825,000 + ($3,000,000 – $2,400,000) = $1,425,000.

33.

$1,080,000 + $7,020,000 – $1,560,000 = $6,540,000.

34.

$1,095,000 + ($3,915,000 + $1,950,000 – $1,260,000) – $1,275,000 = $4,425,000.

35.

$115,000 – $45,000 – $8,000 = $62,000.

36.

$25,000.

37.

Conceptual, $300,000 (proceeds), (extraordinary item).

38.

Conceptual, $390,000 – $300,000 = $90,000.

39.

$5,000,000 + $45,000 + $1,650,000 – $65,000 + $80,000 + $30,000 = $6,740,000.

Reporting Cash Flows

B - 13

EXERCISES Ex. B-40—Cash flows from operating activities (direct method). Presented below is the income statement of Foley, Inc.: Sales Cost of goods sold Gross profit Operating expenses Income before income taxes Income taxes Net income

$380,000 225,000 $155,000 85,000 70,000 28,000 $ 42,000

Debit $12,000 15,000

Credit

$19,400 8,000 12,000 3,000

Solution B-40 Foley, Inc. Statement of Cash Flows (Partial) (Direct Method) Cash flows from operating activities Cash received from customers ($380,000 – $15,000) Cash paid to suppliers ($225,000 – $19,400 – $12,000) Operating expenses paid ($85,000 + $8,000 – $16,700) Taxes paid ($28,000 + $3,000 – $2,600) Net cash provided by operating activities

$365,000 $193,600 76,300 28,400

Ex. B-41—Direct and indirect methods. Compare the direct method and the indirect method by explaining each one.

298,300 $ 66,700

B - 14

Test Bank for Intermediate Accounting, Second Edition

Solution B-41 The direct method adjusts revenues and expenses to a cash basis. The difference between cash revenues and cash expenses is cash net income, which is equal to net cash flow from operating activities. The indirect method involves adjusting accrual net income to a cash basis. This is done by starting with accrual net income and adding or subtracting noncash items included in net income. Examples of adjustments include depreciation, amortization, other noncash expenses and revenues, gains and losses, and changes in the balances of current assets and current liabilities during the year.

Ex. B-42—Statement of cash flows (direct method). Comparative balance sheets at December 31, 2007 and 2008 for Morse Company are shown below. Morse Company Comparative Balance Sheets

Cash Accounts receivable Inventory Prepaid expenses Land Plant assets Accumulated depreciation Franchise Total assets

December 31 2008 2007 $ 98,000 $ 62,000 79,000 74,000 124,000 118,000 6,000 5,000 86,000 -0279,000 224,000 (80,000) (86,000) 24,000 32,000 $616,000 $429,000

Accounts payable Notes payable Bonds payable Common stock Additional paid-in capital Retained earnings Total equities

$ 53,000 58,000 129,000 275,000 56,000 45,000 $616,000

$ 41,000 63,000 -0250,000 46,000 29,000 $429,000

Additional information: 1. A fully depreciated plant asset, which originally cost $20,000 and had no salvage value, was sold for $1,000. 2. Bonds payable were issued at par value. Two-thirds of the bonds were exchanged for land; the remaining one-third was issued for cash. 3. Common stock was sold for cash. 4. The only entries in the Retained Earnings account are for dividends paid in the amount of $10,000 and for the net income for the year. 5. Normal depreciation expense was recorded during the year and the franchise was amortized. 6. The income statement for 2008 is as follows:

Reporting Cash Flows

B - 15

Ex. B-42 (cont.) Morse Company Income Statement Sales Cost of sales Gross profit Operating expenses Income from operations Gain on sale of plant assets Net income

$186,000 102,000 84,000 59,000 25,000 1,000 $ 26,000

Instructions Prepare a statement of cash flows for Morse Company using the direct method.

Solution B-42 Morse Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash received from customers (a) Cash paid to suppliers (b) Cash paid for operating expenses (c) Net cash provided by operating activities Cash flows from investing activities Sale of plant assets Purchase of plant assets Net cash provided (used) by investing activities Cash flows from financing activities Sale of common stock Sale of bonds ($129,000 × 1/3) Payment of dividends Payment of note payable Net cash used by financing activities Net increase in cash Cash, January 1, 2008 Cash, December 31, 2008

$181,000 $96,000 38,000

134,000 47,000

1,000 (75,000) (74,000)

35,000 43,000 (10,000) (5,000) 63,000 36,000 62,000 $ 98,000

(a) $186,000 – $5,000 = $181,000 (b) $102,000 + $6,000 – $12,000 = $96,000 (c) $59,000 – $14,000 – $8,000 + $1,000 = $38,000 Noncash inventory and financing activities: Purchase of land for bonds

$86,000

B - 16

Test Bank for Intermediate Accounting, Second Edition

Pr. B-43—Statement of cash flows (direct method). Donelly, Inc. has prepared the following comparative balance sheets for 2007 and 2008: Cash Receivables Inventory Prepaid expenses Plant assets Accumulated depreciation Patent

Accounts payable Accrued liabilities Mortgage payable Preferred stock Additional paid-in capital—preferred Common stock Retained earnings

2008 $ 297,000 159,000 150,000 18,000 1,260,000 (450,000) 153,000 $1,587,000

2007 $ 153,000 117,000 180,000 27,000 1,050,000 (375,000) 174,000 $1,326,000

$ 153,000 60,000 — 525,000 120,000 600,000 129,000 $1,587,000

$ 168,000 42,000 450,000 — — 600,000 66,000 $1,326,000

1. The Accumulated Depreciation account has been credited only for the depreciation expense for the period. 2. The Retained Earnings account has been charged for dividends of $138,000 and credited for the net income for the year. The income statement for 2008 is as follows: Sales Cost of sales Gross profit Operating expenses Net income

$1,980,000 1,089,000 891,000 690,000 $ 201,000

Instructions From the information above, prepare a statement of cash flows using the direct method for Donelly, Inc. for the year ended December 31, 2008.

Reporting Cash Flows

B - 17

Solution B-43 Donelly, Inc. Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash received from customers (1) Cash paid to suppliers (2) Operating expenses paid (3) Net cash provided by operating activities

$1,938,000 $1,074,000 567,000

Cash used in investing activities Purchase of plant assets Cash flows from financing activities Payment of cash dividend Retirement of mortgage payable Sale of preferred stock Net cash provided by financing activities Net increase in cash Cash, January 1, 2008 Cash, December 31, 2008

(1) (2) (3)

$1,980,000 – $42,000 $1,089,000 – $30,000 + $15,000 $690,000 – $75,000 – $21,000 – $9,000 – $18,000

1,641,000 297,000

(210,000)

(138,000) (450,000) 645,000 57,000 144,000 153,000 $ 297,000

B - 18

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Pr. B-44—Statement of cash flows (direct method). Comparative balance sheet accounts of Sullivan Company are presented below: Sullivan Company Comparative Balance Sheet Accounts December 31, 2007 and 2008 Debit Balances Cash Accounts receivable Merchandise inventory Long-term investments Equipment Buildings Land Totals

2008 $ 50,000 72,500 35,000 27,250 35,000 72,500 12,500 $304,750

2007 $ 38,750 65,000 29,000 42,500 23,750 61,250 12,500 $272,500

Credit balances Allowance for doubtful accounts Accumulated depreciation—equipment Accumulated depreciation—building Accounts payable Accrued wages Long-term notes payable Common stock Retained earnings Totals

4,750 10,625 18,500 35,000 5,875 31,000 155,000 44,000 $304,750

4,000 7,250 14,000 29,750 5,125 35,000 130,000 47,625 $272,750

Additional data (ignore taxes): 1. Net income for the year is $69,000. 2. Cash dividends declared during the year were $47,625. 3. A stock dividend was declared during the year. This resulted in retained earnings of $25,000 being capitalized. 4. Investments that cost $17,250 were sold for $26,000. 5. Equipment that cost $5,000, and was one-fourth depreciated, was sold for $2,000. Sullivan’s 2008 income statement is as follows (ignore taxes): Sales Less cost of goods sold Gross profit Less operating expenses Income from operations Other: Gain on sale of investments Loss on sale of equipment Net income

$630,000 398,500 231,500 169,500* 62,000 $8,750 (1,750)

*(includes $9,125 of depreciation and $1,000 of bad debts expense)

7,000 $ 69,000

Reporting Cash Flows

B - 19

Instructions Prepare a statement of cash flows using the direct method.

Solution B-44 Sullivan Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash receipts from customers (1) Cash payments to suppliers (2) Cash payment for operating expenses (3) Net cash provided by operating activities Cash flows from investing activities Purchase of investments Purchase of equipment Addition to building Sale of investment Sale of equipment Net cash provided by investing activities Cash flows from financing activities Reduction in long-term notes Cash dividend paid Net cash used by financing activities Net increase in cash Cash balance, January 1, 2008 Cash balance, December 31, 2008

$622,250 $399,250 158,625

557,875 64,375

(2,000) (16,250) (11,250) 26,000 2,000 (1,500)

(4,000) (47,625) (51,625) 11,250 38,750 $ 50,000

(1) (Sales) less (Increase in Receivables) less (Receivable write-off) $630,000 – $7,500 – $250 = $622,250 (2) (Cost of goods sold) plus (Increase in inventory) less (increase in accounts payable) $398,500 + $6,000 – $5,250 = $399,250 (3) (Operating expenses) less (Depreciation expense) less (Increase in accrued wages) less (Bad debts expense) $169,500 – $9,125 – $750 – $1,000 = $158,625

APPENDIX D RETAIL INVENTORY METHOD MULTIPLE CHOICE—Conceptual Answer

No.

Description

d a d b a

1. 2. 3. 4. 5.

Advantage of retail inventory method. Assumptions of the retail inventory method. Appropriate use of the retail inventory method. Markdowns and the conventional retail method. Markups and the conventional retail method.

MULTIPLE CHOICE—Computational Answer

No.

Description

b b a d d a

6. 7. 8. 9. 10. 11.

Calculate cost of retail ratio to approximate LCM. Calculate ending inventory at retail. Calculate cost to retail ratio approximating LCM. Determine cost to retail ratio to approximate LCM. Calculate ending inventory at retail. Calculate ending inventory using conventional retail.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

a d

12. 13.

Determine cost of ending inventory using retail method. Determine cost of ending inventory using retail method.

EXERCISE Item

Description

ED-14

Conventional retail method.

PROBLEM Item

Description

PD-15

Conventional retail method.

D-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual 1.

A major advantage of the retail inventory method is that it a. provides reliable results in cases where the distribution of items in the inventory is different from that of items sold during the period. b. hides costs from competitors and customers. c. gives a more accurate statement of inventory costs than other methods. d. provides a method for inventory control and facilitates determination of the periodic inventory for certain types of companies.

The retail inventory method is based on the assumption that the a. final inventory and the total of goods available for sale contain the same proportion of high-cost and low-cost ratio goods. b. ratio of gross margin to sales is approximately the same each period. c. ratio of cost to retail changes at a constant rate. d. proportions of markups and markdowns to selling price are the same.

Which statement is true about the retail inventory method? a. It may not be used to estimate inventories for interim statements. b. It may not be used to estimate inventories for annual statements. c. It may not be used by auditors. d. None of these.

When the conventional retail inventory method is used, markdowns are commonly ignored in the computation of the cost to retail ratio because a. there may be no markdowns in a given year. b. this tends to give a better approximation of the lower-of-cost-or-market. c. markups are also ignored. d. this tends to result in the showing of a normal profit margin in a period when no markdown goods have been sold.

To produce an inventory valuation which approximates the lower-of-cost-or-market using the conventional retail inventory method, the computation of the ratio of cost to retail should a. include markups but not markdowns. b. include markups and markdowns. c. ignore both markups and markdowns. d. include markdowns but not markups.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Solutions to those Multiple Choice questions for which the answer is “none of these.” 3.

Many answers are possible.

Retail Inventory Method

D-3

MULTIPLE CHOICE—Computational 6.

Flynn Sales Company uses the retail inventory method to value its merchandise inventory. The following information is available for the current year: Beginning inventory Purchases Freight-in Net markups Net markdowns Employee discounts Sales

Cost $ 30,000 145,000 2,500 — — — —

Retail $ 50,000 200,000 — 8,500 10,000 1,000 205,000

If the ending inventory is to be valued at the lower-of-cost–or-market, what is the cost to retail ratio? a. $177,500 ÷ $250,000 b. $177,500 ÷ $258,500 c. $175,000 ÷ $260,000 d. $177,500 ÷ $248,500 Use the following information for questions 7 and 8. The following data concerning the retail inventory method are taken from the financial records of Stone Company. Cost Retail Beginning inventory $ 49,000 $ 70,000 Purchases 224,000 320,000 Freight-in 6,000 — Net markups — 20,000 Net markdowns — 14,000 Sales — 336,000 7.

The ending inventory at retail should be a. $74,000. b. $60,000. c. $64,000. d. $42,000.

If the ending inventory is to be valued at approximately the lower-of-cost-or-market, the calculation of the cost to retail ratio should be based on goods available for sale at (1) cost and (2) retail, respectively of a. $279,000 and $410,000. b. $279,000 and $396,000. c. $279,000 and $390,000. d. $273,000 and $390,000.

D-4

Test Bank for Intermediate Accounting, Second Edition

Use the following information for questions 9 through 11. Trent Co. uses the retail inventory method. The following information is available for the current year. Cost Retail Beginning inventory $ 78,000 $122,000 Purchases 295,000 415,000 Freight-in 5,000 — Employee discounts — 2,000 Net markups — 15,000 Net markdowns — 20,000 Sales — 390,000 9.

If the ending inventory is to be valued at approximately lower of average cost or market, the calculation of the cost ratio should be based on cost and retail of a. $300,000 and $430,000. b. $300,000 and $428,000. c. $373,000 and $550,000. d. $378,000 and $552,000.

10.

The ending inventory at retail should be a. $160,000. b. $150,000. c. $144,000. d. $140,000.

11.

The approximate cost of the ending inventory by the conventional retail method is a. $95,900. b. $94,920. c. $98,000. d. $102,480.

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

10.

11.

Retail Inventory Method

D-5

MULTIPLE CHOICE—CPA Adapted 12.

Eaton Co. uses the retail inventory method to estimate its inventory for interim statement purposes. Data relating to the computation of the inventory at July 31, 2008, are as follows: Cost Retail Inventory, 2/1/08 $ 200,000 $ 250,000 Purchases 1,000,000 1,575,000 Markups, net 175,000 Sales 1,750,000 Estimated normal shoplifting losses 20,000 Markdowns, net 110,000 Under the lower-of-cost-or-market method, Eaton's estimated inventory at July 31, 2008 is a. $72,000. b. $84,000. c. $96,000. d. $120,000.

13.

At December 31, 2008, the following information was available from Goff Co.'s accounting records: Cost Retail Inventory, 1/1/08 $147,000 $ 203,000 Purchases 833,000 1,155,000 Additional markups 42,000 Goods available for sale $980,000 $1,400,000 Sales for the year totaled $1,050,000. Markdowns amounted to $10,000. Under the lowerof-cost-or-market method, Goff's inventory at December 31, 2008 was a. $294,000. b. $245,000. c. $252,000. d. $238,000.

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

12.

13.

D-6

Test Bank for Intermediate Accounting, Second Edition

DERIVATIONS — Computational No.

Answer Derivation

Cost: Retail:

$30,000 + $145,000 + $2,500 = $177,500. $50,000 + $200,000 + $8,500 = $258,500.

$70,000 + $320,000 + $20,000 – $14,000 – $336,000 = $60,000.

Cost: Retail:

$49,000 + $224,000 + $6,000 = $279,000. $70,000 + $320,000 + $20,000 = $410,000.

Cost: Retail:

$78,000 + $295,000 + $5,000 = $378,000. $122,000 + $415,000 + $15,000 = $552,000.

10.

$122,000 + $415,000 – $2,000 + $15,000 – $20,000 – $390,000 = $140,000.

11.

$140,000 × .685 = $95,900.

DERIVATIONS — CPA Adapted No.

Answer Derivation

12.

($200,000 + $1,000,000) ÷ ($250,000 + $1,575,000 + $175,000) = 0.6 ($250,000 + $1,575,000 + $175,000 – $20,000 – $110,000 – $1,750,000) × 0.6 = $72,000.

13.

$980,000 ÷ $1,400,000 = 0.7 ($1,400,000 – $10,000 – $1,050,000) × 0.7 = $238,000.

Retail Inventory Method

D-7

EXERCISE Ex. C-14—Conventional retail method. When you undertook the preparation of the financial statements for Vancey Company at January 31, 2009, the following data were available: At Cost At Retail Inventory, February 1, 2008 $ 70,800 $ 98,500 Markdowns 35,000 Markups 63,000 Markdown cancellations 20,000 Markup cancellations 10,000 Purchases 219,500 294,000 Sales 345,000 Purchases returns and allowances 4,300 5,500 Sales returns and allowances 10,000 Instructions Compute the ending inventory at cost as of January 31, 2009, using the retail method which approximates lower of cost or market. Your solution should be in good form with amounts clearly labeled.

Solution C-14 At Cost $ 70,800 $219,500 4,300 215,200 $286,000

Beginning inventory, 2/1/08 Purchases Less purchase returns Totals Add markups (net) Totals Deduct markdowns (net) Sales price of goods available Sales less sales returns Ending inventory, 1/31/09 at retail Ending inventory at cost: Ratio of cost to retail = $286,000 ÷ $440,000 = 65%; $90,000 × 65% = $58,500

$ 58,500

At Retail $ 98,500 $294,000 5,500 288,500 387,000 53,000 440,000 15,000 425,000 335,000 $ 90,000

D-8

Test Bank for Intermediate Accounting, Second Edition

PROBLEM Problem D-15 — Conventional Retail Method. The following data is for the University Book Store, which uses the conventional retail method. Cost $ 36,100 359,400 9,000 7,000

Inventory 1/1/08 Purchases Purchase Returns Purchase Discounts Sales (Gross) Sales Returns Employee Discounts Freight-in Freight-out Markups Markup Cancellations Markdowns Markdown Cancellations

Retail $ 50,000 600,000 20,000 605,000 20,000 5,000

23,500 50,000 38,000 18,000 18,500 8,500

Instructions Prepare a neat, labeled schedule showing the computation of the cost of inventory on hand at 12/31/08.

Solution D-15 Beginning Inventory Purchases Purchase Returns Purchase Discounts Freight-In Markups Markup Cancellations Goods Available Cost Ratio = 62% Sales Sales Returns Employee Discounts Markdowns Markdown Cancellations Ending Inventory @ Retail Est. Ending Inventory @ Cost (62% × $50,000)

Cost $ 36,100 359,400 (9,000) (7,000) 23,500

$403,000 $605,000 (20,000)

Retail $ 50,000 600,000 (20,000)

38,000 (18,000) 650,000

(585,000) (5,000)

18,500 (8,500)

(10,000) $ 50,000 $ 31,000

APPENDIX E ACCOUNTING FOR NATURAL RESOURCES MULTIPLE CHOICE—Conceptual Answer

No.

Description

a d d

1. 2. 3.

Classification of depletion expense. Units-of-production depletion expense. Reserve recognition accounting.

MULTIPLE CHOICE—Computational Answer

No.

Description

c c b d b

4. 5. 6. 7. 8.

Calculate units-of-production depletion expense. Calculate units-of-production depletion expense. Calculate units-of-production depletion expense. Calculate units-of-production depletion expense. Capitalization of exploration costs and discovery values.

MULTIPLE CHOICE—CPA Adapted Answer

No.

Description

b c

9. 10.

Units-of-production depletion expense. Calculate depletion expense for the year.

EXERCISE Item

Description

EE-11

Depletion allowance.

E-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual 1.

Depletion expense a. is usually part of cost of goods sold. b. includes tangible equipment costs in the depletion base. c. excludes intangible development costs from the depletion base. d. excludes restoration costs from the depletion base.

The most common method of recording depletion for accounting purposes is the a. percentage depletion method. b. decreasing charge method. c. straight-line method. d. units-of-production method.

Reserve recognition accounting a. is presently the generally accepted accounting method for financial reporting of oil and gas reserves. b. is a historical cost method similar to the full cost approach and the successful efforts approach. c. is used for reporting of oil and gas reserves for federal income tax purposes. d. requires estimates of future production costs, the appropriate discount rate, and the expected selling price of oil and gas reserves.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

MULTIPLE CHOICE—Computational 4.

Seymor Resources Company acquired a tract of land containing an extractable natural resource. Seymor is required by its purchase contract to restore the land to a condition suitable for recreational use after it has extracted the natural resource. Geological surveys estimate that the recoverable reserves will be 2,000,000 tons, and that the land will have a value of $1,200,000 after restoration. Relevant cost information follows: Land Estimated restoration costs

$9,000,000 1,800,000

If Seymor maintains no inventories of extracted material, what should be the charge to depletion expense per ton of extracted material? a. $3.90 b. $4.50 c. $4.80 d. $5.40

Accounting for Natural Resources

E-3

In January, 2008, Pratt Corporation purchased a mineral mine for $3,400,000 with removable ore estimated by geological surveys at 2,000,000 tons. The property has an estimated value of $200,000 after the ore has been extracted. The company incurred $1,000,000 of development costs preparing the mine for production. During 2008, 500,000 tons were removed and 400,000 tons were sold. What is the amount of depletion that Pratt should expense for 2008? a. $640,000 b. $800,000 c. $840,000 d. $1,120,000

During 2008, Bolton Corporation acquired a mineral mine for $1,500,000 of which $200,000 was ascribed to land value after the mineral has been removed. Geological surveys have indicated that 10 million units of the mineral could be extracted. During 2008, 1,500,000 units were extracted and 1,200,000 units were sold. What is the amount of depletion expensed for 2008? a. $130,000 b. $156,000 c. $180,000 d. $195,000

In March, 2008, Sauder Mines Co. purchased a coal mine for $6,000,000. Removable coal is estimated at 1,500,000 tons. Sauder is required to restore the land at an estimated cost of $720,000, and the land should have a value of $630,000. The company incurred $1,500,000 of development costs preparing the mine for production. During 2008, 450,000 tons were removed and 300,000 tons were sold. The total amount of depletion that Sauder should record for 2008 is a. $1,374,000. b. $1,518,000. c. $2,061,000. d. $2,277,000.

In 2000, Minton Company purchased a tract of land as a possible future plant site. In January, 2008, valuable sulphur deposits were discovered on adjoining property and Minton Company immediately began explorations on its property. In December, 2008, after incurring $400,000 in exploration costs, which were accumulated in an expense account, Minton discovered sulphur deposits appraised at $2,250,000 more than the value of the land. To record the discovery of the deposits, Minton should a. make no entry. b. debit $400,000 to an asset account. c. debit $2,250,000 to an asset account. d. debit $2,650,000 to an asset account.

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

E-4

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—CPA Adapted 9.

Lane Company acquired a tract of land containing an extractable natural resource. Lane is required by the purchase contract to restore the land to a condition suitable for recreational use after it has extracted the natural resource. Geological surveys estimate that the recoverable reserves will be 5,000,000 tons, and that the land will have a value of $1,000,000 after restoration. Relevant cost information follows: Land Estimated restoration costs

$7,000,000 1,500,000

If Lane maintains no inventories of extracted material, what should be the charge to depletion expense per ton of extracted material? a. $1.70 b. $1.50 c. $1.40 d. $1.20 10.

In January 2008, Jenks Mining Corporation purchased a mineral mine for $4,200,000 with removable ore estimated by geological surveys at 2,500,000 tons. The property has an estimated value of $400,000 after the ore has been extracted. Jenks incurred $1,150,000 of development costs preparing the property for the extraction of ore. During 2008, 340,000 tons were removed and 300,000 tons were sold. For the year ended December 31, 2008, Jenks should include what amount of depletion in its cost of goods sold? a. $516,800 b. $456,000 c. $594,000 d. $673,200

Multiple Choice Answers—CPA Adapted Item

Ans.

Item

Ans.

10.

Accounting for Natural Resources

E-5

DERIVATIONS — Computational No.

Answer Derivation

($9,000,000 + $1,800,000 – $1,200,000) ÷ 2,000,000 = $4.80.

[($3,400,000 – $200,000 + $1,000,000) ÷ 2,000,000] × 400,000 = $840,000.

[($1,500,000 – $200,000) ÷ 10,000,000] × 1,200,000 = $156,000.

[($6,000,000 + $720,000 – $630,000 + $1,500,000) ÷ 1,500,000] × 450,000 = $2,277,000.

Discovery value is generally not recognized.

DERIVATIONS — CPA Adapted No.

Answer Derivation

($7,000,000 + $1,500,000 – $1,000,000) ÷ 5,000,000 = $1.50.

10.

[($4,200,000 – $400,000 + $1,150,000) ÷ 2,500,000] × 300,000 = $594,000.

EXERCISE Ex. E-11—Depletion allowance. Oates Company purchased for $5,600,000 a mine estimated to contain 2 million tons of ore. When the ore is completely extracted, it is expected that the land will be worth $200,000. A building and equipment costing $2,800,000 were constructed on the mine site, and they will be completely used up and have no salvage value when the ore is exhausted. During the first year, 750,000 tons of ore were mined, and $450,000 was spent for labor and other operating costs. Instructions Compute the total cost per ton of ore mined in the first year. (Show computations by setting up a schedule giving cost per ton.)

Solution E-11 Item Ore Building and Equipment Labor and Operating Expenses Total Cost

Base $5,400,000 2,800,000 450,000

Tons 2,000,000 2,000,000 750,000

Per Ton $2.70 1.40 .60 $4.70

APPENDIX G ACCOUNTING FOR TROUBLED DEBT MULTIPLE CHOICE—Conceptual Answer

No.

Description

c d b b c

1. 2. 3. 4. 5.

Modification of terms in debt restructure. Gain/loss on troubled debt restructuring. Gain/loss on troubled debt restructuring. Interest and troubled debt restructuring. Creditor's calculations for modification of terms.

MULTIPLE CHOICE—Computational Answer

No.

Description

b d a

6. 7. 8.

Transfer of equipment in debt settlement. Recognizing gain on debt restructure. Interest and troubled debt restructuring.

EXERCISES Item

Description

EG-9 EG-10 EG-11

Accounting for a troubled debt settlement. Accounting for troubled debt restructuring. Accounting for troubled debt.

PROBLEM Item

Description

PG-12

Accounting for a troubled debt settlement.

G-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual 1.

In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows, a. a loss should be recognized by the debtor. b. a gain should be recognized by the debtor. c. a new effective-interest rate must be computed. d. no interest expense of revenue should be recognized in the future.

A troubled debt restructuring will generally result in a a. loss by the debtor and a gain by the creditor. b. loss by both the debtor and the creditor. c. gain by both the debtor and the creditor. d. gain by the debtor and a loss by the creditor.

In a troubled debt restructuring in which the debt is settled by a transfer of assets with a fair market value less the carrying amount of the debt, the debtor would recognize a. no gain or loss on the settlement. b. a gain on the settlement. c. a loss on the settlement. d. none of these.

In a troubled debt restructuring in which the debt is continued with modified terms, a gain should be recognized at the date of restructure, but no interest expense should be recognized over the remaining life of the debt, whenever the a. carrying amount of the pre-restructure debt is less than the total future cash flows. b. carrying amount of the pre-restructure debt is greater than the total future cash flows. c. present value of the pre-restructure debt is less than the present value of the future cash flows. d. present value of the pre-restructure debt is greater than the present value of the future cash flows.

In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows, the creditor should a. compute a new effective-interest rate. b. not recognize a loss. c. calculate its loss using the historical effective rate of the loan. d. calculate its loss using the current effective rate of the loan.

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Accounting for Troubled Debt

G-3

MULTIPLE CHOICE—Computational Use the following information for questions 6 through 8: On December 31, 2006, Pace Co. is in financial difficulty and cannot pay a note due that day. It is a $600,000 note with $60,000 accrued interest payable to Stevens, Inc. Stevens agrees to accept from Pace equipment that has a fair value of $290,000, an original cost of $480,000, and accumulated depreciation of $230,000. Stevens also forgives the accrued interest, extends the maturity date to December 31, 2009, reduces the face amount of the note to $250,000, and reduces the interest rate to 6%, with interest payable at the end of each year. 6.

Pace should recognize a gain or loss on the transfer of the equipment of a. $0. b. $40,000 gain. c. $60,000 gain. d. $190,000 loss.

Pace should recognize a gain on the partial settlement and restructure of the debt of a. $0. b. $15,000. c. $55,000. d. $75,000.

Pace should record interest expense for 2009 of a. $0. b. $15,000. c. $30,000. d. $45,000.

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

Item

Ans.

DERIVATIONS — Computational No.

Answer Derivation

$290,000 – ($480,000 – $230,000) = $40,000.

($600,000 + $60,000) – [$290,000 + $250,000 + ($250,000 × 06 × 3)] = $75,000.

0. The effective interest rate is 0%.

G-4

Test Bank for Intermediate Accounting, Second Edition

EXERCISES Ex. G-9—Accounting for a troubled debt settlement. Craft, Inc., which owes Flood Co. $600,000 in notes payable with accrued interest of $54,000, is in financial difficulty. To settle the debt, Flood agrees to accept from Craft equipment with a fair value of $570,000, an original cost of $840,000, and accumulated depreciation of $195,000. Instructions (a) Compute the gain or loss to Craft on the settlement of the debt. (b) Compute the gain or loss to Craft on the transfer of the equipment. (c) Prepare the journal entry on Craft's books to record the settlement of the debt. (d) Prepare the journal entry on Flood's books to record the settlement of the receivable.

Solution G-9 (a) Note payable Interest payable Carrying amount of debt Fair value of equipment Gain on settlement of debt

$600,000 54,000 654,000 570,000 $ 84,000

(b) Cost Accumulated depreciation Book value Fair value of plant assets Loss on disposal of equipment

$840,000 195,000 645,000 570,000 $ 75,000

(c) Notes Payable............................................................................... Interest Payable ............................................................................ Accumulated Depreciation ............................................................ Loss on Disposal of Equipment ..................................................... Equipment ........................................................................ Gain on Settlement of Debt ..............................................

600,000 54,000 195,000 75,000

(d) Equipment ..................................................................................... Allowance for Doubtful Accounts ................................................... Notes Receivable .............................................................. Interest Receivable ............................................................

570,000 84,000

840,000 84,000

600,000 54,000

Accounting for Troubled Debt

G-5

Ex. G-10—Accounting for a troubled debt restructuring. On December 31, 2007, Rose Co. is in financial difficulty and cannot pay a note due that day. It is a $500,000 note with $50,000 accrued interest payable to Clark, Inc. Clark agrees to forgive the accrued interest, extend the maturity date to December 31, 2009, and reduce the interest rate to 4%. The present value of the restructured cash flows is $428,000. Instructions Prepare entries for the following: (a) The restructure on Rose's books. (b) The payment of interest on December 31, 2008. (c) The restructure on Clark’s books.

Solution G-10 (a) Interest Payable ............................................................................ Notes Payable ($500,000 × 4% × 2).................................. Gain on Restructuring .......................................................

50,000

(b) Notes Payable .............................................................................. Cash .................................................................................

20,000

(c) Allowance for Doubtful Accounts .................................................. Notes Receivable .............................................................. Interest Receivable ...........................................................

122,000

40,000 10,000

20,000

72,000 50,000

Ex. G-11—Accounting for troubled debt. (a) What are the general rules for measuring and recognizing a gain or loss by the debtor on a settlement of troubled debt which includes the transfer of noncash assets? (b) What are the general rules for measuring and recognizing a gain and for recording future payments by the debtor in a troubled debt restructuring?

Solution G-11 (a) If the settlement of debt includes the transfer of noncash assets, a gain is measured by the debtor as the difference between the fair value of the assets transferred and the carrying amount of the debt, including accrued interest. The debtor also recognizes a gain or loss on the disposal of assets as the difference between the fair value of the assets transferred and their book value. (b) If the carrying amount of the payable is greater than the undiscounted total future cash flows, the gain is measured by the debtor as the difference between the carrying amount and the future cash flows. Future payments reduce the principal; no interest expense is recorded by the debtor. If the carrying amount of the payable is less than the future cash flows, no restructuring gain is recognized by the debtor. A new effective-interest rate is calculated that equates the present value of the future cash flows with the carrying amount of the debt. A part of the future cash flows is recorded as interest expense by the debtor.

G-6

Test Bank for Intermediate Accounting, Second Edition

PROBLEM Pr. G-12—Accounting for a troubled debt settlement. Dunn, Inc., which owes Cabell Co. $800,000 in notes payable, is in financial difficulty. To eliminate the debt, Cabell agrees to accept from Dunn land having a fair market value of $610,000 and a recorded cost of $450,000. Instructions (a) Compute the amount of gain or loss to Dunn, Inc. on the transfer (disposition) of the land. (b) Compute the amount of gain or loss to Dunn, Inc. on the settlement of the debt. (c) Prepare the journal entry on Dunn's books to record the settlement of this debt. (d) Compute the gain or loss to Cabell Co. from settlement of its receivable from Dunn. (e) Prepare the journal entry on Cabell's books to record the settlement of this receivable.

Solution G-12 (a)

Fair market value of the land Cost of the land to Dunn, Inc. Gain on disposition of land

$610,000 450,000 $160,000

(b)

Carrying amount of debt Fair market value of the land given Extraordinary gain on settlement of debt

$800,000 610,000 $190,000

(c)

Notes Payable ............................................................................. Land ................................................................................. Gain on Disposition of Land ............................................. Gain on Settlement of Debt ..............................................

(d)

Carrying amount of receivable Land received in settlement Loss on settled debt

(e)

Land ............................................................................................ Allowance for Doubtful Accounts ................................................. Notes Receivable .............................................................

800,000 450,000 160,000 190,000

$800,000 610,000 $190,000 610,000 190,000 800,000

APPENDIX H ACCOUNTING FOR DERIVATIVE INSTRUMENTS MULTIPLE CHOICE—Conceptual Answer

No.

Description

c b a c b a c

1. 2. 3. 4. 5. 6. 7.

Accounting for derivatives. Characteristics of a derivative instrument. Identifying companies that are arbitrageurs. Accounting for fair value hedges. Gains/losses on cash flow hedges. Identifying an embedded derivative. Requirements for financial instrument disclosures.

EXERCISES Item

Description

EH-8 EH-9

Fair value hedge. Cash flow hedge.

PROBLEMS Item

Description

EH-10 EH-11

Derivative financial instrument. Free-standing derivative.

H-2

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Conceptual 1.

All of the following statements regarding accounting for derivatives are correct except that a. they should be recognized in the financial statements as assets and liabilities. b. they should be reported at fair value. c. gains and losses resulting from speculation should be deferred. d. gains and losses resulting from hedge transactions are reported in different ways, depending upon the type of hedge.

All of the following are characteristics of a derivative financial instrument except the instrument a. has one or more underlyings and an identified payment provision. b. requires a large investment at the inception of the contract. c. requires or permits net settlement. d. all of these are characteristics.

Companies that attempt to exploit inefficiencies in various derivative markets by attempting to lock in profits by simultaneously entering into transactions in two or more markets are called a. arbitrageurs. b. gamblers. c. hedgers. d. speculators.

The accounting for fair value hedges records the derivative at its a. amortized cost. b. carrying value. c. fair value. d. historical cost.

Gains or losses on cash flow hedges are a. ignored completely. b. recorded in equity, as part of other comprehensive income. c. reported directly in net income. d. reported directly in retained earnings.

An option to convert a convertible bond into shares of common stock is a(n) a. embedded derivative. b. host security. c. hybrid security. d. fair value hedge.

All of the following are requirements for disclosures related to financial instruments except a. disclosing the fair value and related carrying value of the instruments. b. distinguishing between financial instruments held or issued for purposes other than trading. c. combining or netting the fair value of separate financial instruments. d. displaying as a separate classification of other comprehensive income the net gain/loss on derivative instruments designated in cash flow hedges.

H-3

Accounting for Derivative Instruments

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

Item

Ans.

EXERCISES Ex. H-8—Fair value hedge. On January 2, 2008, Nolan Co. issued a 4-year, $500,000 note at 6% fixed interest, interest payable semiannually. Nolan now wants to change the note to a variable rate note. As a result, on January 2, 2008, Nolan Co. enters into an interest rate swap where it agrees to receive 6% fixed and pay LIBOR of 5.6% for the first 6 months on $500,000. At each 6-month period, the variable interest rate will be reset. The variable rate is reset to 6.6% on June 30, 2008. Instructions (a) Compute the net interest expense to be reported for this note and related swap transaction as of June 30, 2008. (b) Compute the net interest expense to be reported for this note and related swap transaction as of December 31, 2008.

Solution H-8 (a) and (b) Fixed-rate debt Fixed rate (6% ÷ 2) Semiannual debt payment Swap fixed receipt Net income effect Swap variable rate 5.6% × ½ × $500,000 6.6% × ½ × $500,000 Net interest expense

6/30/08 $500,000 3% $ 15,000 15,000 $ 0

12/31/08 $500,000 3% $ 15,000 15,000 $ 0

$ 14,000 0 $ 14,000

$ 16,500 $ 16,500

H-4

Test Bank for Intermediate Accounting, Second Edition

Ex. H-9—Cash flow hedge. On January 2, 2008, Reese Company issued a 5-year, $8,000,000 note at LIBOR with interest paid annually. The variable rate is reset at the end of each year. The LIBOR rate for the first year is 6.8% Reese Company decides it prefers fixed-rate financing and wants to lock in a rate of 6%. As a result, Reese enters into an interest rate swap to pay 7% fixed and receive LIBOR based on $8 million. The variable rate is reset to 7.4% on January 2, 2009. Instructions (a) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2008. (b) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2009.

Solution H-9 (a) and (b) Variable-rate debt Variable rate Debt payment

12/31/08 $8,000,000 6.8% $ 544,000

12/31/09 $8,000,000 7.4% $ 592,000

Debt payment Swap receive variable Net income effect Swap payable—fixed Net interest expense

$ 544,000 (544,000) $ 0 560,000 $ 560,000

$ 592,000 (592,000) $ 0 560,000 $ 560,000

Accounting for Derivative Instruments

H-5

PROBLEMS Pr. H-10—Derivative financial instrument. Kelley Co. purchased a put option on Flynn common shares on July 7, 2008, for $100. The put option is for 200 shares, and the strike price is $30. The option expires on January 31, 2009. The following data are available with respect to the put option: Date September 30, 2008 December 31, 2008 January 31, 2009

Market Price of Flynn Shares $32 per share $31 per share $33 per share

Time Value of Put Option $53 21 0

Instructions Prepare the journal entries for Kelley Co. for the following dates: (a)

July 7, 2008—Investment in put option on Flynn shares.

(b)

September 30, 2008—Kelley prepares financial statements.

(c)

December 31, 2008—Kelley prepares financial statements.

(d)

January 31, 2009—Put option expires.

Solution H-10 (a)

(b)

(c)

(d)

July 7, 2008 Put Option ................................................................................... Cash ................................................................................

100

September 30, 2008 Unrealized Holding Gain or Loss—Income .................................. Put Option ($100 – $53)...................................................

December 31, 2008 Unrealized Holding Gain or Loss—Income .................................. Put Option ($53 – $21).....................................................

January 31, 2009 Loss on Settlement of Put Option ................................................ Put Option ($21 – $0).......................................................

100

H-6

Test Bank for Intermediate Accounting, Second Edition

Pr. H-11—Free-standing derivative. Yates Co. purchased a put option on Dixon common shares on July 7, 2008, for $215. The put option is for 300 shares, and the strike price is $51. The option expires on July 31, 2008. The following data are available with respect to the put option: Date March 31, 2008 June 30, 2008 July 6, 2008

Market Price of Dixon Shares $48 per share $50 per share $46 per share

Time Value of Put Option $120 54 16

Instructions Prepare the journal entries for Yates Co. for the following dates: (a)

January 7, 2008—Investment in put option on Dixon shares.

(b)

March 31, 2008—Yates prepares financial statements.

(c)

June 30, 2008—Yates prepares financial statements.

(d)

July 6, 2008—Yates settles the call option on the Dixon shares.

Solution H-11 (a)

(b)

January 7, 2008 Put Option ................................................................................... Cash ................................................................................

215

March 31, 2008 Put Option ................................................................................... Unrealized Holding Gain or Loss—Income ($3 × 300)......

900

Unrealized Holding Gain or Loss—Income .................................. Put Option ($215 – $120) .................................................

(c)

June 30, 2008 Unrealized Holding Gain or Loss—Income .................................. Put Option ($2 × 300) ....................................................... Unrealized Holding Gain or Loss—Income .................................. Put Option ($120 – $54) ...................................................

(d)

July 6, 2008 Unrealized Holding Gain or Loss—Income .................................. Put Option ($54 – $16) ..................................................... Cash (300 × $5) ........................................................................... Gain on Settlement of Put Option ..................................... Put Option*.......................................................................

215

900 95 95

600 600 66 66

38 38 1,500 1,184 316

Accounting for Derivative Instruments *Value of Put Option settlement: Put Option 215 900

316

95 600 66 38

H-7

APPENDIX I ERROR ANALYSIS TRUE-FALSE—Conceptual Answer

No.

Description

F T F T T

1. 2. 3. 4. 5.

Understatement of ending inventory. Noncounterbalancing errors. Counterbalancing errors. Inventory errors. Overstatement of purchases and ending inventory.

MULTIPLE CHOICE—Conceptual Answer

No.

Description

b d b a a d a

6. 7. 8. 9. 10. 11. 12.

Effect of beginning inventory overstated. Effect of understating purchases. Effect of recording merchandise on consignment. Effect of ending inventory overvaluation. Effect of inventory errors on income. Effect of understating purchases and ending inventory. Effect of ending inventory understated.

MULTIPLE CHOICE—Computational Answer

No.

Description

d a a

13. 14. 15.

Effect of inventory and depreciation errors on income. Effect of inventory and depreciation errors on retained earnings. Effect of inventory errors on working capital.

EXERCISES No.

Description

EI-16

Error Analysis.

PROBLEMS No.

Description

PI-17

Analysis of Errors.

I-2

Test Bank for Intermediate Accounting, Second Edition

TRUE FALSE—Conceptual 1.

An understatement of the ending inventory will cause cost of goods sold to be understated and net income to be overstated for that period.

Noncounterbalancing errors are those that take longer than two periods to correct themselves.

Counterbalancing errors are those that are not offset in the next accounting period.

If ending inventory is understated, then net income is understated.

If both purchases and ending inventory are overstated by the same amount, net income is not affected.

True-False Answers—Conceptual Item

Ans.

Item

Ans.

1. 2. 3.

F T F

4. 5.

T T

MULTIPLE CHOICE—Conceptual 6.

If the beginning inventory for 2008 is overstated, the effects of this error on cost of goods sold for 2008, net income for 2008, and assets at December 31, 2009, respectively, are a. overstatement, understatement, overstatement. b. overstatement, understatement, no effect. c. understatement, overstatement, overstatement. d. understatement, overstatement, no effect.

The failure to record a purchase of merchandise on account even though the goods are properly included in the physical inventory results in a. an overstatement of assets and net income. b. an understatement of assets and net income. c. an understatement of cost of goods sold and liabilities and an overstatement of assets. d. an understatement of liabilities and an overstatement of owners' equity.

Belle Co. received merchandise on consignment. As of March 31, Belle had recorded the transaction as a purchase and included the goods in inventory. The effect of this on its financial statements for March 31 would be a. no effect. b. net income was correct and current assets and current liabilities were overstated. c. net income, current assets, and current liabilities were overstated. d. net income and current liabilities were overstated.

Error Analysis

I-3

Eller Co. received merchandise on consignment. As of January 31, Eller included the goods in inventory, but did not record the transaction. The effect of this on its financial statements for January 31 would be a. net income, current assets, and retained earnings were overstated. b. net income was correct and current assets were understated. c. net income and current assets were overstated and current liabilities were understated. d. net income, current assets, and retained earnings were understated.

10.

Cross Co. accepted delivery of merchandise which it purchased on account. As of December 31, Cross had recorded the transaction, but did not include the merchandise in its inventory. The effect of this on its financial statements for December 31 would be a. net income, current assets, and retained earnings were understated. b. net income was correct and current assets were understated. c. net income was understated and current liabilities were overstated. d. net income was overstated and current assets were understated.

11.

On June 15, 2008, Tolon Corporation accepted delivery of merchandise which it purchased on account. As of June 30, Tolon had not recorded the transaction or included the merchandise in its inventory. The effect of this on its balance sheet for June 30, 2008 would be a. assets and stockholders' equity were overstated but liabilities were not affected. b. stockholders' equity was the only item affected by the omission. c. assets, liabilities, and stockholders' equity were understated. d. none of these.

12.

The ending inventory of Bonie Company is understated in year one by $20,000. This error is not corrected in year one or in year two. What impact will this error have on total net income for years one and two combined? a. No effect on total net income for the two years b. Overstate total net income by $20,000 c. Understate total net income by $20,000 d. Overstate net income for year one by $20,000 and year two by $20,000 for a total overstatement of $40,000

Multiple Choice Answers—Conceptual Item

Ans.

Item

Ans.

6. 7. 8. 9.

b d b a

10. 11. 12.

a d a

I-4

Test Bank for Intermediate Accounting, Second Edition

MULTIPLE CHOICE—Computational Use the following information for questions 13 through 15. Dexter, Inc. is a calendar-year corporation. Its financial statements for the years 2008 and 2007 contained errors as follows: 2008 2007 Ending inventory $3,000 overstated $8,000 overstated Depreciation expense $2,000 understated $6,000 overstated 13.

Assume that the proper correcting entries were made at December 31, 2007. By how much will 2008 income before taxes be overstated or understated? a. $1,000 understated b. $1,000 overstated c. $2,000 overstated d. $5,000 overstated

14.

Assume that no correcting entries were made at December 31, 2007. Ignoring income taxes, by how much will retained earnings at December 31, 2008 be overstated or understated? a. $1,000 understated b. $5,000 overstated c. $5,000 understated d. $9,000 understated

15.

Assume that no correcting entries were made at December 31, 2007, or December 31, 2008 and that no additional errors occurred in 2009. Ignoring income taxes, by how much will working capital at December 31, 2009 be overstated or understated? a. $0 b. $2,000 overstated c. $2,000 understated d. $5,000 understated

Multiple Choice Answers—Computational Item

Ans.

Item

Ans.

13. 14.

d a

15.

DERIVATIONS — Computational No.

Answer

Derivation

13.

$3,000 + $2,000 = $5,000.

14.

$6,000 – ($3,000 + $2,000) = $1,000.

15.

The effect of the errors in ending inventories reverse themselves in the following year.

Error Analysis

I-5

EXERCISES Ex. I-16—Error analysis. An examination of the records of Moran Company revealed that goods costing $1,000 were received on December 31, 2008. The purchase invoice for these goods was not received until January 4, 2009, at which time the purchase and related liability were recorded. Moran Company incorrectly excluded the cost of the goods from its December 31, 2008 inventory. Indicate whether the following financial statement items were understated (U), overstated (O), or not misstated (N) for the years 2008 and 2009. 2008

2009

Purchases

________

Inventory, December 31

________

Cost of goods sold

________

Net income

________

Assets

________

Liabilities

________

Retained earnings

________

2008

2009

Purchases

Inventory, December 31

Cost of goods sold

Net income

Assets

Liabilities

Retained earnings

Solution I-16

I-6

Test Bank for Intermediate Accounting, Second Edition

PROBLEMS Pr. I-17—Analysis of errors. (All sales and purchases are on credit.) Indicate in each of the spaces provided the effect of the described errors on the various elements of a company's financial statements. Use the following codes: O = amount is overstated; U = amount is understated; NE = no effect. Assume a periodic inventory system. Accounts Receivable

Inventory

Accounts Payable Sales

Cost of Goods Sold

EXAMPLE: Excluded goods in rented warehouse from inventory NE U NE NE O count. ____________________________________________________________________________ 1. Goods in transit shipped "f.o.b. destination" by supplier were recorded as a purchase but were excluded from ending inventory. ____________________________________________________________________________ 2. Goods held on consignment were included in inventory count and recorded as a purchase. ____________________________________________________________________________ 3. Goods in transit shipped "f.o.b. shipping point" were not recorded as a sale and were included in ending inventory. ____________________________________________________________________________ 4. Goods were shipped and appropriately excluded from ending inventory but sale was not recorded. ____________________________________________________________________________

Solution I-17 1. 2. 3. 4.

NE NE U U

NE O O NE

O O NE NE

NE NE U U

O NE U NE