Intermediate Accounting, 14th Edition By Kieso, Weygandt, Warfield
Email: richard@qwconsultancy.com
CHAPTER 1 FINANCIAL ACCOUNTING AND ACCOUNTING STANDARDS IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer F T T T F T T F F T T F T F T T F F F F
No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
Description Definition of financial accounting. Purpose of financial statements. Definition of financial accounting. Capital allocation process. Objective of financial reporting. Decision-Usefulness approach. Users of financial statements. Committee on Accounting Procedure. Passage of FASB standards. Financial Accounting Concepts. Creation of Accounting Principles Board. FASB Codification. Code of Professional Conduct. GAAP and political action. Public Company Accounting Oversight Board. Expectations gap. Financial reports. Fair value information. International Financial Reporting Standards. Ethical issues.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
a d d a d b b a d d c c c d c
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35.
Financial accounting. Users of financial reports. Identify the major financial statements. Financial reporting entity. Differences between financial and managerial accounting. Financial reporting communication. Managerial accounting. Capital allocation process. Efficient use of resources. Capital allocation process. Financial statement information. Accounting profession challenge. Financial reporting objective. Financial statements primary users. Investor’s decision making.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
b c c b a c d d b b a c d c b a c c d d d a b b b c d b b c d c d d d d d d b c c 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. P 68. P 69. 70. 71. 72. 73. 74. 75. 76. 77. 78.
Accrual accounting. Objective of financial reporting perspective. Meaning of “generally accepted.” Common set of standards and procedures. Limitation of general purpose financial statements. Securities and Exchange Commission and accounting standard setting. Due process in FASB standard setting. Organizations responsible for setting accounting standards. Reason for Accounting Principles Board creation Organization issuing Accounting Research Bulletins. Characteristic of GAAP. Characteristics of GAAP. FASB accounting standards. FASB standard passage. Purpose of Emerging Issues Task Force. AICPA role in standard setting. Role of 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. Role of the AICPA. Pronouncement issued by the APB. Standard setting organizations. Identification of standard setting organizations. Statements of financial accounting concepts. FASB members. FASB statement process. Nature of GAAP. Body which promulgates GAAP. Publications which are not GAAP. Publications which are not GAAP. Code for Professional Conduct Rule 203. Purpose of FASB staff position. Components of GAAP. Political environment of standard setting. International Accounting Standards Board.
Financial Accounting and Accounting Standards
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MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
d a c b d a
79. 80. 81. 82. 83. 84.
Standard setting process pressure. Danger of politics in standard setting Definition of "expectation gap". Reason accounting standards differ across countries. Advantage of countries adopting same accounting standards. Ethical concern of accountants.
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Note: these questions also appear in the Problem-Solving Survival Guide.
EXERCISES Item
Description
E1-85 E1-86 E1-87 E1-88 E1-89
Objectives of financial reporting. Development of accounting principles. Publications and organizations. FASB. Evolution of a statement of financial accounting standards.
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. Identify the objectives of financial reporting. 4. Explain the need for accounting standards. 5. Identify the major policy-setting bodies and their role in the standard-setting process. 6. Explain the meaning of generally accepted accounting principles (GAAP) and the role of the Codification for GAAP. 7. Describe the impact of user groups on the rule-making process. 8. Describe some of the challenges facing financial reporting. 9. Understand issues related to ethics and financial accounting.
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SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2.
TF TF
21. 22.
MC MC
23. 24.
3.
TF
4.
TF
28.
5. 6.
TF TF
33. 34.
MC MC
35. 36.
7.
TF
38.
MC
39.
8. 9. 10. 11. 41. 42.
TF TF TF TF MC MC
43. 44. 45. 46. 47. 48.
MC MC MC MC MC MC
49. 50. 51. 52. 53. 54.
12. 13.
TF TF
70. 71.
MC MC
72. 73.
14. 15.
TF TF
16. 62.
TF MC
77. 78.
17.
TF
18.
TF
19.
20.
TF
84.
MC
Note:
TF = True-False MC = Multiple Choice E = Exercise
Type
Item
Type
Item
Type
Learning Objective 1 P MC 25. MC 27. MC MC 26. MC Learning Objective 2 MC 29. MC 30. MC Learning Objective 3 MC 37. MC MC 85. E Learning Objective 4 MC 40. MC 86. E Learning Objective 5 MC 55. MC 61. MC MC 56. MC 62. MC MC 57. MC 63. MC MC 58. MC 64. MC MC 59. MC 65. MC MC 60. MC 66. MC Learning Objective 6 MC 74. MC 76. MC MC 75. MC Learning Objective 7 MC 79. MC 81. MC 80. MC 82. Learning Objective 8 TF 31. MC 32. Learning Objective 9
MC MC MC
Item
Type
Item
Type
67. 68. P 69. P 86. 87. 88.
MC MC MC E E E
89.
E
83.
E
P
Financial Accounting and Accounting Standards
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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 a company’s operations. 2. Financial statements are the principal means through which a company communicates its financial information to those outside it. 3. Users of financial reports provided by a company use that information to make their capital allocation decisions. 4. An effective process of capital allocation promotes productivity and provides an efficient market for buying and selling securities and obtaining and granting credit. 5. The objective of financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, but not to users who are not investors. 6. Investors are interested in financial reporting because it provides information that is useful for making decisions (decision-usefulness approach). 7. Users of financial accounting statements have both coinciding and conflicting needs for information of various types. 8. The Securities and Exchange Commission appointed the Committee on Accounting Procedure. 9. The passage of a new FASB Standards Statement requires the support of five of the seven board members. 10. Financial Accounting Concepts set forth fundamental objectives and concepts that are used in developing future standards of financial accounting and reporting. 11. The AICPA created the Accounting Principles Board in 1959. 12. The FASB’s Codification integrates existing GAAP, and creates new GAAP. 13. The AICPA’s Code of Professional Conduct requires that members prepare financial statements in accordance with generally accepted accounting principles. 14. GAAP is a product of careful logic or empirical findings and are not influenced by political action. 15. The Public Company Accounting Oversight Board has oversight and enforcement authority and establishes auditing and independence standards and rules. 16. The expectations gap is caused by what the public thinks accountants should do and what accountants think they can do.
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Test Bank for Intermediate Accounting, Fourteenth Edition
17. Financial reports in the early 21st century did not provide any information about a company’s soft assets (intangibles). 18. Accounting standards are now less likely to require the recording or disclosure of fair value information. 19. U.S. companies that list overseas are required to use International Financial Reporting Standards, issued by the International Accounting Standards Board. 20. Ethical issues in financial accounting are governed by the AICPA.
True-False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F T T T F
Item 6. 7. 8. 9. 10.
Ans. T T F F T
Item 11. 12. 13. 14. 15.
Ans. T F T F T
Item 16. 17. 18. 19. 20.
Ans. T F F F F
MULTIPLE CHOICE—Conceptual 21.
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.
22.
Users of financial reports include all of the following except a. creditors. b. government agencies. c. unions. d. All of these are users.
23.
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.
24.
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.
Financial Accounting and Accounting Standards
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25.
All the following are differences between financial and managerial accounting in how accounting information is used except to a. plan and control company's operations. b. decide whether to invest in the company. c. evaluate borrowing capacity to determine the extent of a loan to grant. d. All the above.
26.
Which of the following represents a form of communication through financial reporting but not through financial statements? a. Balance sheet. b. President's letter. c. Income statement. d. Notes to financial statements.
27.
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.
28.
How does accounting help the capital allocation process attract investment capital? a. Provides timely, relevant information. b. Encourages innovation. c. Promotes productivity. d. a and b above.
29.
Whether a business is successful and thrives is determined by a. markets. b. free enterprise. c. competition. d. all of these.
30.
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.
31.
Financial statements in the early 2000s provide information related to a. nonfinancial measurements. b. forward-looking data. c. hard assets (inventory and plant assets). d. none of these.
32.
Which of the following is not a major challenge facing the accounting profession? a. Nonfinancial measurements. b. Timeliness. c. Accounting for hard assets. d. Forward-looking information.
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Test Bank for Intermediate Accounting, Fourteenth Edition
33.
What is the objective of financial reporting? a. Provide information that is useful to management in making decisions. b. Provide information that clearly portray nonfinancial transactions. c. Provide information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors. d. Provide information that excludes claims to the resources.
34.
Primary users for general-purpose financial statements include a. creditors. b. employees. c. investors. d. both creditors and investors.
35.
When making decisions, investors are interested in assessing a. the company’s ability to generate net cash inflows. b. management’s ability to protect and enhance the capital providers’ investments. c. Both a and b. d. the company’s ability to generate net income.
36.
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.
37.
Which perspective is adopted as part of the objective of general-purpose financial reporting? a. Decision-usefulness perspective. b. Proprietary perspective. c. Entity perspective. d. Financial reporting perspective.
38.
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.
39.
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.
Financial Accounting and Accounting Standards
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40.
Which of the following is a general limitation of "general purpose financial statements"? a. General purpose financial statements may not be the most informative for a specific enterprise. b. General purpose financial statements are comparable. c. General purpose financial statements are assumed to present fairly the company's financial operations. d. None of the above.
41.
What is the relationship between the Securities and Exchange Commission and accounting standard setting in the United States? a. The SEC requires all companies listed on an exchange to submit their financial statements to the SEC. b. The SEC coordinates with the AICPA in establishing accounting standards. c. The SEC has a mandate to establish accounting standards for enterprises under its jurisdiction. d. The SEC reviews financial statements for compliance.
42.
What is due process in the context of standard setting at the FASB? a. FASB operates in full view of the public. b. Public hearings are held on proposed accounting standards. c. Interested parties can make their views known. d. All of the above.
43.
Which of the following organizations has been responsible for setting U.S. accounting standards? a. Accounting Principles Board. b. Committee on Accounting Procedure. c. Financial Accounting Standards Board. d. All of the above.
44.
Why did the AICPA create the Accounting Principles Board? a. The SEC disbanded the previous standard setting organization. b. The previous standard setting organization did not provide a structured set of accounting principles. c. No such organization existed in the past. d. None of the above.
45.
Which organization was responsible for issuing Accounting Research Bulletins? a. Accounting Principles Board. b. Committee on Accounting Procedure. c. The SEC. d. AICPA.
46.
A characteristic of generally accepted accounting principles include the following: a. common set of standards and principles. b. standards and principles are based federal statutes. c. acceptance requires an affirmative vote of Certified Public Accountants. d. practices that become accepted for at least a year by all industry members.
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Test Bank for Intermediate Accounting, Fourteenth Edition
47.
Characteristics of generally accepted accounting principles include all of the following except a. authoritative accounting the rule-making body established a principle of reporting. b. standards are considered useful by the profession. c. each principle is approved by the SEC. d. practice has become universally accepted over time.
48.
Why was it believed that accounting standards that were issued by the Financial Accounting Standards Board would carry more weight? a. Smaller membership. b. FASB board members are well-paid. c. FASB board members must be CPAs. d. Due process.
49.
The passage of a new FASB Standards Statement requires the support of a. all Board members. b. three Board members. c. four Board members. d. five Board members.
50.
What is the purpose of Emerging Issues Task Force? a. Provide interpretation of existing standards. b. Provide a consensus on how to account for new and unusual financial transactions. c. Provide interpretive guidance. d. Provide timely guidance on select issues.
51.
Which organization is responsible for issuing Emerging Issues Task Force Statements? a. FASB b. CAP c. APB d. SEC
52.
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.
53.
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.
Financial Accounting and Accounting Standards
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54.
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.
55.
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).
56.
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.
57.
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.
58.
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.
59.
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.
60.
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
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Test Bank for Intermediate Accounting, Fourteenth Edition
61.
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.
62.
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.
63.
The American Institute of Certified Public Accountants (AICPA) continues to be involved in all of the following except a. developing and enforcing professional ethics. b. developing auditing standards. c. providing professional education programs. d. all of the above.
64.
Which of the following pronouncements were issued by the Accounting Principles Board? a. Accounting Research Bulletins b. Opinions c. Statements of Position d. Statements of Financial Accounting Concepts
65.
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
66.
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.
67.
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.
Financial Accounting and Accounting Standards
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P
68.
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.
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69.
The following 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. Preliminary Views 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.
70.
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.
71.
The most significant current source of generally accepted accounting principles is the a. AICPA. b. SEC. c. APB. d. FASB.
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.
Rule 203 of the Code of Professional Conduct addresses: a. ethical requirements. b. financial statements should be based on generally accepted accounting principles. c. advertising to obtained clients. d. auditing financial statements.
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Test Bank for Intermediate Accounting, Fourteenth Edition
75.
What is the purpose of a FASB Staff Position? a. Provide interpretation of existing standards. b. Provide a consensus on how to account for new and unusual financial transactions. c. Provide interpretive guidance. d. Provide timely guidance on select issues.
76.
Which of the following is not considered a component of generally accepted accounting principles? a. FASB Implementation Guides. b. Widely recognized industry practices. c. Articles published in CPA journals. d. AICPA Accounting Interpretations.
77.
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.
78.
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.
79.
What is not a source of pressure that may influence the accounting standard setting process? a. Congress. b. Lobbyist. c. CPA firms. d. None of the above.
80.
What is a possible danger if politics plays too big a role in accounting standard setting? a. Accounting standards that are not truly generally accepted. b. Individuals may influence the standards. c. User groups become active. d. The FASB delegates its authority to elected officials.
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81.
What is "expectation gap"? a. The difference between what the public thinks the accountant is not doing and what the accountant knows they don't do. b. The difference between what the public thinks the accountant is doing and what Congress says the accountant is doing. c. The difference between what the public thinks the accountant is doing and what the accountant thinks they can do. d. The difference between what the accountant is doing and what the Courts say the accountant should be doing.
82.
What is not a reason that accounting standards may differ across countries? a. Governments. b. Language. c. Culture. d. Past Practice.
83.
What would be an advantage of having all countries adopt and follow the same accounting standards? a. Consistency. b. Comparability. c. Lower preparation costs. d. b and c
84.
Which of the following is an ethical concern of accountants? a. Earnings manipulation. b. Conservative accounting. c. Industry practices. d. None of the above.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27. 28. 29. 30.
a d d a d b b a d d
31. 32. 33. 34. 35. 36. 37. 38. 39. 40.
c c c d c b c c b a
41. 42. 43. 44. 45. 46. 47. 48. 49. 50.
c d d b b a c d c b
51. 52. 53. 54. 55. 56. 57. 58. 59. 60.
a c c d d d a b b b
61. 62. 63. 64. 65. 66. 67. 68. 69. 70.
c d b b c d c d d d
71. 72. 73. 74. 75. 76. 77. 78. 79. 80.
d d d b c c a c d a
81. 82. 83. 84.
c b d a
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Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Ex. 1-85—Objective of financial reporting. What is the objective of financial reporting? How do general-purpose financial statements help meet this objective.
Solution 1-85 The objective of financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in decisions about providing resources to the entity. General-purpose financial statements provide financial reporting information to a wide variety of users. They help shareholders, creditors, employees, and regulators to better understand a company’s financial position and related performance.
Ex. 1-86—Development of accounting principles. Presented below are three 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.
Statement III 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.
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Solution 1-86 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. Statement III 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. 1-87—Publications and organizations. Significant accounting publications are listed below (1-8). 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. Statements of Position (SOPs) ____ 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 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
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Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 1-87 1. d 2. a 3. b
4. f 5. e 6. f
7. f 8. f
Ex. 1-88—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 1-88 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 part 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. 1-89—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 1-89 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 preliminary views of pros and cons are 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.
Financial Accounting and Accounting Standards
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IFRS QUESTIONS True/False: 1. IFRS includes both International Financial Reporting Standards and International Accounting Standards. 2. International Financial Reporting Standards preceded International Accounting Standards 3. The standard-setting structure used by the International Accounting Standards Board is very similar to that used by the Financial Accounting Standards Board. 4. The rules-based standards of IFRS are more detailed than the simpler, principles-based standards of U.S. GAAP. 5. The International Accounting Standards Board issues International Financial Reporting Standards. 6. International Accounting Standards are no longer considered part of IFRS because they have been replaced by International Financial Reporting Standards.
Answers to True/False questions: 1. True 2. False 3. True 4. False 5. True 6. False
Multiple Choice: 1. Authoritative standards for IFRS include: a. International Financial Reporting Standards only. b. International Financial Reporting Standards and International Accounting Standards only. c. International Financial Reporting Standards, International Accounting Standards and U.S. GAAP only. d. International Financial Reporting Standards, International Accounting Standards and any GAAP standard recognized by an organized stock exchange.
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Test Bank for Intermediate Accounting, Fourteenth Edition
2. Which of these statements regarding the IFRS and U.S. GAAP is correct? a. U.S. GAAP is considered to be "principles-based" and more detailed than IFRS. b. U.S. GAAP is considered to be "rules-based" and less detailed than IFRS. c. IFRS is considered to be "principles-based" and less detailed than U.S. GAAP d. Both U.S. GAAP and IFRS are considered to be "rules-based", but U.S. GAAP tends to be more complex. 3. The IASB's standard-setting structure includes all of the following except a. Standing Interpretations Committee b. Standards Advisory Council c. Standards Comparison Committee d. Trustees
Answers to Multiple Choice: 1. b 2. c 3. c
Short Answer: 1. Why would it be advantageous for U.S. GAAP and International GAAP to be the same? 1. Relevant and reliable financial information is a necessity for viable capital markets. Unfortunately, financial statements from companies outside the United States are often prepared using different principles than U.S. GAAP. As a result, international companies have to develop financial information in different ways. Beyond the additional costs these companies incur, users of financial statements are often forced to understand at least two sets of GAAP. It is not surprising that there is a growing demand for one set of high quality international standards. 2. What is the difference between principles-based and rules-based accounting rules? Is IFRS more principles-based than U.S. GAAP? Explain. 2. Principles-based rules are considered to be based on accounting principles to result in financial statements that are presented. Rules-based standards are generally quite detailed, and in many instances follow a “check-box” mentality that some contend may shield auditors and companies from legal liability. Because IFRS tends to be simpler and less stringent in its accounting and disclosure requirements, it is generally considered more principles-based than U.S. GAAP.
CHAPTER 2 CONCEPTUAL FRAMEWORK UNDERLYING FINANCIAL ACCOUNTING IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F T F T F T F T T F F F T T F F T T F F
1. 2. 3. 4 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
Nature of conceptual framework. Conceptual framework definition. Levels of conceptual framework. International conceptual framework. Statements of Financial Accounting Concepts. Decision usefulness.Objective of financial reporting. Financial statement users. Relevance and reliabilityfaithful representation. Consistency. Relevance. Faithful representation.Reliability. Basic elements. Comprehensive income. Going concern assumption. Economic entity assumption. Expense recognition principle. Realizable revenues. Supplementary information. Materiality factorsCost benefit trade-off. Conservatism.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
c d c d d d a d a a a b c c a
21. 22. 23. 24. S 25. 26. 27. 28. P 29. 30. 31. 32. 33. 34. 35.
GAAP defined. Purpose of conceptual framework. Conceptual framework. Conceptual framework purpose. Conceptual framework benefits. Objectives of financial reporting. Decision usefulness. Objectives of financial reporting. Financial reporting objectives. Primary objective of financial reporting. Primary objective of financial reporting. Characteristic of accounting information. Characteristic of accounting information. Meaning of comparability. Meaning of consistency.
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MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
d c a b d a c a c b b d c d b d c a c d b b d d c c d b d b a b a d c d c b b a c c d a b a d d a
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. P 64. S 65. S 66. 67 68. 69. 70. 71. 72. 73 74. S 75. S 76. 77. 78. 79. 80. 81. 82. 83. 84.
Ingredient of relevance. Ingredient of reliability. Consistency characteristic. Primary quality of accounting information. Quality of relevance. Quality of reliability. Purpose of understandable informationConsistency quality. Decision-usefulness criterion. Primary qualities of accounting information. Definition of relevance. Definition of reliability. Relevance and reliabilityquality. Timeliness Materiality characteristic. Verifiability Completeness characteristic. Neutrality characteristic. Neutrality characteristic. Definition of verifiability. Quality of predictive value. Quality of representational faithfulnessfree from error. Consistency. Consistency characteristic. Comparability and consistency. Comparability. 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. Basic element of financial statements. Basic element of financial statements. Basic element of financial statements. Definition of gains. Historical cost assumption. Periodicity assumption. Going concern assumption. Periodicity assumption. 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. Historical cost principle.
Conceptual Framework Underlying Financial Accounting
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
d c d d d c b b b b c a d b c a d c a d c a d c a c d c b a 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. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123. P 124.
Description Historical cost principle. Revenue recognition principle. Revenue recognition principle. Revenue recognition principle. Timing of revenue recognition. Realization concept. Definition of realized. Expense recognition principle. Expense recognition principle. Expense recognition. Full-disclosure principle. Argument against historical cost. Recognition of revenue. Revenue recognition principle. Deviation from revenue recognition principle. Required components of financial statements. Recognition of expenses. Historical cost principle. Expense recognition principle example. Recording expenditure as asset. Historical cost principle violation. Full disclosure principle violation. Full disclosure principle. Historical cost principle violation. Materiality Industry practice constraint. Costs of providing financial information. Benefits of providing financial information. Use of materiality. Definition of prudence/conservation. Example of materiality constraint. Constraints to limit the cost of reporting. Cost-benefit constraint. Materiality constraintcharacteristic. Materiality. Pervasive constraints. Prudence or Conservatism conservatismconstraint. Conservatism Industry practices constraint. Trade-offs between characteristics of accounting information. Trade-offs between characteristics of accounting information. Prudence or cConservatism constraint.
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MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
a b b b a b d d a
125. 126. 127. 128. 129. 130. 131. 132. 133.
Quality of predictive value. Consistency characteristicRelevance and faithful representation. 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.
P S
Note: these questions also appear in the Problem-Solving Survival Guide. Note: these questions also appear in the Study Guide.
EXERCISES Item
Description
E2-134 E2-135 E2-136 E2-137 E2-138 E2-139 E2-140 E2-141 E2-142
Examination of the conceptual frameworkQualitative characteristics. 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
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SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2.
TF TF
21. 22.
MC MC
23. 24.
3.
TF
4.
TF
5.
6. 7.
TF TF
27. 28.
MC MC
8. 9. 10. 11. 32. 33.
TF TF TF TF MC MC
34. 35. 36. 37. 38. 39.
MC MC MC MC MC MC
12. 13. 59.
TF TF MC
60. 61. 62.
MC MC MC
14. 15. 71.
TF TF MC
72. 73. 74.
MC MC MC
16. 17. 18. 84. 85. 86.
TF TF TF MC MC MC
87. 88. 89. 90. 91. 92.
MC MC MC MC MC MC
93. 94. 95. 96. 97. 98.
19. 20. 109.
TF TF MC
110. 111. 112.
MC MC MC
113. 114. 115.
Note:
TF = True-False MC = Multiple Choice E = Exercise
P
29. 30. 40. 41. 42. 43. 44. 45.
63. 64. S 65. P
S S
75. 76. 77.
Type
Item
Type
Item
Learning Objective 1 S MC 25. MC MC 134. E Learning Objective 2 TF 26. MC 94. Learning Objective 3 MC 31. MC MC 134. E Learning Objective 4 MC 46. MC 52. MC 47. MC 53. MC 48. MC 54. MC 49. MC 55. MC 50. MC 56. MC 51. MC 57. Learning Objective 5 S MC 66. MC 69. MC 67. MC 70. MC 68. MC 127. Learning Objective 6 MC 78. MC 81. MC 79. MC 82. MC 80. MC 83. Learning Objective 7 MC 99. MC 105. MC 100. MC 106. MC 101. MC 107. MC 102. MC 108. MC 103. MC 133. MC 104. MC 135. Learning Objective 8 MC 116. MC 119. MC 117. MC 120. MC 118. MC 121.
Item
Typ e
Item
Typ e
MC MC MC MC MC MC
58. 125. 126. 135. 136. 137.
MC MC MC E E E
138.
E
MC MC MC
128. 129. 130.
MC MC MC
131. 132.
MC MC
MC MC MC
135. 138. 139.
E E E
140. 141.
E E
MC MC MC MC MC E
136. 137. 138. 140. 141. 142.
E E E E E E
MC MC MC
122. 123. P 124.
MC MC MC
135. 136.
E E
Type
E
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Test Bank for Intermediate Accounting, FourThirteenth Edition
TRUE-FALSE—Conceptual 1. The A soundly developed conceptual framework for accounting has been discovered through empirical researchenables the FASB to issue more useful and consistent pronouncements over time. 2. A conceptual framework is a coherent system of concepts of interrelated objectives and fundamentals that can lead to consistent standardsthat flow from an objective. 3. The first level of the conceptual framework identifies the recognition, and measurement, and disclosure concepts used in establishing accounting standards. 4. The IASB has also issued a conceptual framework that is broadly consistent with that of the United Statesand the FASB and the IASB have agreed to develop a common conceptual framework. 5. Although the FASB intends hasto developed a conceptual framework, no Statements of Financial Accounting Concepts have been issued to date. 6. Decision usefulness is the underlying theme of the conceptual frameworkThe objective of financial reporting is the foundation of the conceptual framework. 7. Users of financial statements are assumed to have need no knowledge of business and financial accounting matters by financial statement preparersto understand information contained in financial statements. 8. Relevance and reliability faithful representation are the two primary qualities that make accounting information useful for decision making. 9. The idea of consistency does not mean that companies cannot switch from one accounting method to another. 10. Timeliness and neutrality are two ingredients of relevance. 11. Verifiability and predictive value are two ingredients of reliabilityfaithful representation. 12. Revenues, gains, and distributions to owners all increase equity. 13. Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. 14. The historical cost principle would be of limited usefulness if not for the going concern assumption. 15. The economic entity assumption means that economic activity can be identified with a particular legal entity. 16. The expense recognition principle states that debits must equal credits in each transaction. 17. Revenues are realizable when assets received or held are readily convertible into cash or claims to cash.
Conceptual Framework Underlying Financial Accounting
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18. Supplementary information may include details or amounts that present a different perspective from that adopted in the financial statements. 19. Companies consider only quantitative factors in determining whether an item is materialIn order to justify reguiring a particular measurement or disclosure, the benefits to be derived from it must equal the costs associated with it. 20. Prudence or Conservatism conservatism in accounting means the accountant should attempt to understate assets and income when possiblemeans when in doubt, choose the solution that will be least likely to overstate liabilities or expenses.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. FT T F T F
Item 6. 7. 8. 9. 10.
Ans. T F T T F
Item 11. 12. 13. 14. 15.
Ans. F F T T F
Item 16. 17. 18. 19. 20.
Ans. F T T F F
MULTIPLE CHOICE—Conceptual 21.
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.
22.
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 solved. d. all of these.
23.
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.
24.
What is a purpose of having a conceptual framework? a. To enable the profession to more quickly solve emerging practical problems. b. To provide a foundation from which to build more useful standards. c. Neither a nor b. d. Both a and b.
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25.
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.
26.
In the conceptual framework for financial reporting, what provides "the why"--the goals and purposes of accounting? a. Recognition, Measurement measurement,an, and d disclosure recognition concepts such as assumptions, principles, and constraints b. Qualitative characteristics of accounting information c. Elements of financial statements d. Objectives of financial reporting
27.
The underlying theme of the conceptual framework is a. decision usefulness. b. understandability. c. faithful representationreliability. d. comparability.
28.
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.
29.
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.
30.
What is a primary objective of financial reporting as indicated in the conceptual framework? a. provide information that is useful to those making investing and credit decisions. b. provide information that is useful to management. c. provide information about those investing in the entity. d. All of the above.
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P
Conceptual Framework Underlying Financial Accounting 31.
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What is a primary objective of financial reporting as indicated in the conceptual framework? a. Provide information that is helpful to present and potential investors, creditors, and other users in assessing the amounts, timing, and uncertainty of future cash flows. b. Provide information that is helpful to present investors, creditors, and other users in assessing the amounts, timing, and uncertainty of future cash flows. c. Provide information that is helpful to potential investors, creditors, and other users in assessing the amounts, timing, and uncertainty of future cash flows. d. None of the above.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
32.
Which of the following is a primary fundamental characteristic of useful accounting information? a. Comparability. b. Relevance. c. ConsistencyNeutrality. d. Materiality.
33.
Which of the following is a primary characteristic of useful accounting information? a. Conservatism. b. Comparability. c. ReliabilityFaithful representation. d. Consistency.
34.
What is meant by comparability when discussing financial accounting information? a. Information has predictive or feedback confirmatory value. b. Information is reasonably free from error. c. Information that is measured and reported in a similar fashion across companies. d. Information is timely.
35.
What is meant by consistency when discussing financial accounting information? a. Information that is measured and reported in a similar fashion across points in time. b. Information is timely. c. Information is measured similarly across the industry. d. Information is verifiable.
36.
Which of the following is an ingredient of relevance? a. Verifiability. b. Representational faithfulnessNeutrality. c. NeutralityTimeliness. d. TimelinessMateriality.
37.
Which of the following is an ingredient of reliabilityfaithful representation? a. Predictive value. b. MaterialityTimeliness. c. Neutrality. d. Feedback Confirmatory value.
38.
Changing the method of inventory valuation should be reported in the financial statements under what qualitative characteristic of accounting information? a. Consistency. b. Verifiability. c. Timeliness. d. Comparability.
39.
Company A issuing its annual financial reports within one month of the end of the year is an example of which ingredient of primary fundamental quality of accounting information? a. Neutrality. b. Timeliness. c. Predictive value. d. Representational faithfulnessCompleteness.
Conceptual Framework Underlying Financial Accounting
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40.
What is the quality of information that enables users to better forecast future operations? a. ReliabilityFaithful representation. b. Materiality. c. ComparabilityTimeliness. d. Relevance.
41.
Neutrality Representational faithfulness is an ingredient of which primary fundamental quality of information? a. Faithful representationReliability. b. Comparability. c. Relevance. d. ConsistencyUnderstandability.
42.
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 isIf the FIFO inventory method was used last period, it should be used for the current and following periods because of a. relevance. b. reliabilityneutrality. c. understandability. d. materialityconsistency.
43.
The overriding pervasive criterion by which accounting information can be judged is that of a. decision usefulness for decision making. b. freedom from bias. c. timeliness. d. comparability.
44.
The two primary fundamental qualities that make accounting information useful for decision making are a. comparability and consistencytimeliness. b. materiality and timelinessneutrality. c. relevance and reliabilityfaithful representation. d. reliability and comparabilityfaithful representation and comparability.
45.
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.
46.
The quality of information that means the numbers and descriptions match what really existed or happened isgives assurance that it is reasonably free of error and bias and is a faithful representation is a. relevance. b. faithful representationreliability. c. verifiabilitycompleteness. d. neutrality.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
47.
According to Statement of Financial Accounting Concepts No. 2, which Which of the following does not relates relate to both relevance and reliability? a. Materiality b. UnderstandabilityPredictive value c. UsefulnessConfirmatory value d. All of these
48.
According to Statement of Financial Accounting Concepts No. 2, timeliness materiality is an ingredient of the primary fundamental quality of
a. b. c. d. 49.
50.
RelevanceReliabilityFaithful Representation Yes Yes No Yes Yes No No No
According to Statement of Financial Accounting Concepts No. 2, verifiability completeness is an ingredient of the fundamentalprimary quality of RelevanceFaithful RepresentationReliability a. Yes No b. Yes Yes c. No No d. No Yes According to Statement of Financial Accounting Concepts No. 2, neutrality is an ingredient of the fundamentalprimary quality of Relevance Faithful RepresentationReliability a. Yes Yes b. No Yes c. Yes No d. No No
51.
Information is neutral if itNeutrality means that information 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 resultcannot favor one set of interested parties over another.
52.
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. faithful representationreliability. c. verifiability. d. neutrality.
53.
According to Statement of Financial Accounting Concepts No. 2, predictive value is an ingredient of the fundamentalprimary quality of RelevanceFaithful RepresentationReliability a. Yes No b. Yes Yes c. No No
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Conceptual Framework Underlying Financial Accounting d. 54.
No
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Yes
Under Statement of Financial Accounting Concepts No. 2, representational faithfulnessfree from error is an ingredient of the fundamentalprimary quality of Faithful RepresentationReliabilityRelevance a. Yes Yes b. No Yes c. Yes No d. No No
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55.
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.
56.
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 eventscompanies apply the same accounting treatment to similar events, 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.
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57.
Information about different companiesentities and about different periods of the same companyentity can be prepared and presented in a similar manner. Comparability and consistency are related to which of these objectives? Comparability Consistency a.companiesEntities companiesEntities b.companiesEntities Periods c. Periods companiesEntities d. Periods Periods
58.
When information about two different enterprises has been prepared and presented in a similar manner, the information exhibits the characteristic of a. relevance. b. reliabilityfaithful representation. c. consistency. d. none of these.
59.
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.
60.
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.
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Test Bank for Intermediate Accounting, FourThirteenth Edition d. the costs versus the benefits of the alternative methods of disclosing the transactions involved.
61.
A decrease in net assets arising from peripheral or incidental transactions is called a(n) a. capital expenditure. b. cost. c. loss. d. expense.
62.
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.
63.
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
P
64.
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. This concept is not yet being applied in practice. d. It excludes prior period adjustments (transactions that relate to previous periods, such as corrections of errors).
S
65.
According to the FASB conceptual framework, earningswhich of the following elements describes transactions or events that affect a company during a period of time? a. are the same as comprehensive incomeAssets. b. exclude certain gains and losses that are included in comprehensive incomeExpenses. c. include certain gains and losses that are excluded from comprehensive incomeEquity. d. include certain losses that are excluded from comprehensive incomeLiabilities.
S
66.
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.
67.
Moment in Time Yes Yes No No
Period of Time No Yes Yes No
Which of the following is not a basic element of financial statements?
Conceptual Framework Underlying Financial Accounting a. b. c. d.
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Assets. Balance sheet. Losses. Revenue.
68.
Which of the following basic elements of financial statements is more associated with the balance sheet than the income statement? a. Equity. b. Revenue. c. Gains. d. Expenses.
69.
Issuance of common stock for cash affects which basic element of financial statements? a. Revenues. b. Losses. c. Liabilities. d. Equity.
70.
Which basic element of financial statements arises from peripheral or incidental transactions? a. Assets. b. Liabilities. c. Gains. d. Expenses.
71.
Which of the following is not a basic assumption underlying the financial accounting structure? a. Economic entity assumption. b. Going concern assumption. c. Periodicity assumption. d. Historical cost assumption.
72.
Which basic assumption is illustrated when a firm reports financial results on an annual basis? a. Economic entity assumption. b. Going concern assumption. c. Periodicity assumption. d. Monetary unit assumption.
73.
Which basic assumption may not be followed when a firm in bankruptcy reports financial results? a. Economic entity assumption. b. Going concern assumption. c. Periodicity assumption. d. Monetary unit assumption.
74.
Which accounting assumption or principle is being violated if a company provides financial reports in connection with a new product introduction? a. Economic entity. b. Periodicity. c. Revenue recognition. d. Full disclosure.
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Conceptual Framework Underlying Financial Accounting S
75.
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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.
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76.
Test Bank for Intermediate Accounting, FourThirteenth Edition During the lifetime of an entity accountants produce financial statements at artificial points in time in accordance with the concept of ObjectivityRelevance Periodicity a. No No b. Yes No c. No Yes d. Yes Yes
77.
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.
78.
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.
79.
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.
80.
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 Expense recognition principle
81.
What accounting concept justifies the usage of accruals and deferralsdepreciation and amortization policies? a. Going concern assumption b. Materiality constraintFair value principle c. Full disclosure principleConsistency characteristic d. Monetary unit assumption
Conceptual Framework Underlying Financial Accounting 82.
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The assumption that a business enterprisecompany will not be sold or liquidated in the near future is known as the a. economic entity assumption. b. monetary unit assumption. c. conservatism periodicity assumption. d. none of these.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
83.
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.
84.
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. reliablefaithfully representative. b. relevant. c. indicative of the entity's purchasing power. d. conservative.
85.
Valuing assets at their liquidation values rather than their cost is inconsistent with the a. periodicity assumption. b. expense recognitionmatching principle. c. materiality constraint. d. historical cost principle.
86.
Revenue is generally recognized when realized or realizable and earned. This statement describes the a. consistency characteristic. b. expense recognitionmatching principle. c. revenue recognition principle. d. relevance characteristic.
87.
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.
88.
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.
Conceptual Framework Underlying Financial Accounting 89.
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.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
90.
Under Statement of Financial Accounting Concepts No. 5, Wwhich of the following, in the most precise sense, meansis the process of converting noncash resources and rightsassets received or held into cash or claims to cash? a. Recognition b. Measurement c. Realization d. Allocation
91.
"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.
92.
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. expense recognitionmatching principle. c. materiality constraint. d. revenue recognition principle.
93.
The accounting principle of expense recognitionmatching 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.
94.
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
95.
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.
Conceptual Framework Underlying Financial Accounting 96.
Which of the following is an argument against using historical cost in accounting? a. Fair values are more relevant. b. Historical costs are based on an exchange transaction. c. Historical costs are reliable. d. Fair values are subjective.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
97.
When is revenue generally recognized? a. When cash is received. b. When the warranty expires. c. When production is completed. d. When the sale occurs.
98.
Which of the following are the two components of the revenue recognition principle? a. Cash is received and the amount is material. b. Recognition occurs when earned and earned realized or realizable. c. Production is complete and there is an active market for the product. d. Cash is realized or realizable and production is complete.
99.
Which of the following practices may not be an acceptable deviation from recognizing revenue at the point of sale? a. Upon receipt of cash. b. During production. c. Upon receipt of order. d. End of production.
100.
Which of the following is not a required component of financial statements prepared in accordance with generally accepted accounting principles? a. President's letter to shareholders. b. Balance sheet. c. Income statement. d. Notes to financial statements.
101.
What is the general approach as to when product costs are recognized as expenses? a. In the period when the expenses are paid. b. In the period when the expenses are incurred. c. In the period when the vendor invoice is received. d. In the period when the related revenue is recognized.
102.
Not adjusting the amounts reported in the financial statements for inflation is an example of which basic principle of accounting? a. Economic entity. b. Going concern. c. Historical cost. d. Full disclosure.
103.
Recognition of expense related to amortization of an intangible asset illustrates which principle of accounting? a. Expense recognition. b. Full disclosure. c. Revenue recognition. d. Historical cost.
104.
When should an expenditure be recorded as an asset rather than an expense? a. Never. b. Always. c. If the amount is material. d. When future benefit exits.
Conceptual Framework Underlying Financial Accounting
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105.
Which accounting assumption or principle is being violated if a company reports its corporate headquarter building at its fair value on the balance sheet? a. Going concern. b. Monetary unit. c. Historical cost. d. Full disclosure.
106.
Which accounting assumption or principle is being violated if a company is a party to major litigation that it may lose and decides not to include the information in the financial statements because it may have a negative impact on the company's stock price? a. Full disclosure. b. Going concern. c. Historical cost. d. MatchingExpense recognition.
107.
Which assumption or principle requires that all information significant enough to affect a decision of reasonably informed users should be reported in the financial statements? a. Matching. b. Going concern. c. Historical cost. d. Full disclosure.
108.
A company has a factory building that originally cost the company $250,000. The current fair value of the factory building is $3 million. The president would like to report the difference as a gain. The write-up would represent a violation of which accounting assumption or principle? a. Revenue recognition. b. Going concern. c. Historical cost. d. Monetary unit.
109.
Which of the following is a constraint in presenting financial information? a. MaterialityIndustry practice. b. Full disclosure. c. Relevance. d. Consistency.
110.
All of the following represent costs of providing financial information except a. preparing. b. disseminating. c. accessing capital. d. auditing.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
111.
Which of the following are benefits of providing financial information? a. Potential litigation. b. Auditing. c. Disclosure to competition. d. Improved allocation of resources.
Conceptual Framework Underlying Financial Accounting
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112.
Where is materiality not used in providing financial information? a. Applying the revenue recognition principle. b. Determining what items to include in the financial statements. c. Applying the going concern assumption. d. Determining the level of disclosure.
113.
What is prudence or conservatism? a. Understating assets and net income. b. When in doubt, recognizing the option that is least likely to overstate assets and income. c. Recognizing the option that is least likely to overstate assets and income. d. Recognizing revenue when earned and realized.
114.
Expensing the cost of copy paper when the paper is acquired is an example of which constraint? a. Materiality. b. Cost-benefit. c. Conservatism. d. Industry practices.
115.
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.
116.
Under Statement of Financial Accounting Concepts No. 2, wWhich of the following relates to both relevance and faithful representationreliability? a. Cost-benefit constraint b. Predictive value c. Verifiability d. Representational faithfulnessNeutrality
117.
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 expense recognition principle. c. materiality constraintcharacteristic. d. historical cost principle.
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Test Bank for Intermediate Accounting, FourThirteenth Edition 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.
Conceptual Framework Underlying Financial Accounting
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119.
Which of the following are considered pervasive constraints by Statement of Financial Accounting Concepts No. 2? a. Cost-benefit constraint relationship and conservatism b. Timeliness and feedback value c. Conservatism and verifiability d. Materiality and cost-constraintbenefit relationship
120.
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. prudence or conservatism constraint. b. the materiality constraint. c. the substance over form principle. d. the industry practices constraint.
121.
Which of the Ffollowing best illustrates the accounting concept of conservatism? the peculiar nature of some business concerns, which sometimes requires departure from basic theory is known as a. Use of the allowance method to recognize bad debt losses from credit salesthe economic entity assumption. b. Use of the lower of cost or market approach in valuing inventories.industry practices. c. Use of the same accounting method from one period to the next in computing depreciation expensethe cost constraint. d. Utilization of a policy of deliberate understatement of asset values in order to present a conservative net income figurethe going concern assumption.
122.
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 faithful representationreliability. b. faithful representationreliability and periodicity. c. timeliness and materiality. d. understandability and timeliness.
123.
Allowing firms to estimate rather than physically count inventory at interim (quarterly) periods is an example of a trade-off between a. verifiability and reliabilityfaithful representation. b. faithful representationreliability and comparability. c. timeliness and verifiability. d. neutrality and consistency.
P
124. 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 the cost constraint. b. the industry practices constraint. c. prudence or conservatism constraint. d. the full disclosure principle.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36.
c d c d d d a d a a a b c c a d
37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52.
c a b d a c a c b b d c d b d c
53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68.
a c d b b d d c c d b d b a b a
69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84.
d c d c b b a c c d a b a d d a
85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100.
d c d d d c b b b b c a d b c a
101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116.
d c a d c a d c a c d c b a d a
117. 118. 119. 120. 121. 122. 123. 124.
c d d a b a c c
Solutions to those Multiple Choice questions for which the answer is “none of these.” 55. a company changes its inventory method every few years in order to maximize reported income (other answers are possible). 58. comparability. 62. change in equity of an entity during a period from transactions and other events and circumstances from nonowner sources. 82. going concern assumption. 87. an exchange has taken place and the earnings process is virtually complete.
MULTIPLE CHOICE—CPA Adapted 125.
126.
According to the FASB's conceptual framework, predictive value is an ingredient of Relevance Faithful RepresentationReliability a. Yes No b. Yes Yes c. No Yes d. No No According to the FASB's conceptual framework, which of the following relates to both relevance and faithful representationreliability? ConsistencyComparabilityVerifiabilityNeutrality a. Yes Yes b. Yes No c. No Yes d. No No
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127.
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
128.
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.
129.
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
130.
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
131.
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
132.
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
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Test Bank for Intermediate Accounting, FourThirteenth Edition 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.
125. 126.
a b
127. 128.
b b
129. 130.
a b
131. 132.
d d
133.
a
EXERCISES Ex. 2-134—Qualitative Characteristics.Ex. frameworkQualitative Characteristics
2-134—Examination
of
the
conceptual
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Accounting information provides useful information about business transactions and events. Those who provide and use financial reports must often select and evaluate accounting alternatives. The FASB statement on qualitative characteristics of accounting information examines the characteristics of accounting information that make it useful for decision-making. It also points out that various limitations inherent in the measurement and reporting process may necessitate trade-offs or sacrifices among the characteristics of useful information. Instructions. (a) Describe briefly the following chaaracteristics of useful accounting information. (1) Relevance (2) Faithful representation
(4) Comparability (5) Consistency
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(3) Understandability
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(ba) For each of the following pairs of information characteristics, give an example of a situation int which one of the characteristics may be sacrificed in return for a gain in the other. (1) Relevance and faithful representation.
(3) Comparability and consistency.
(2) Relevance and consistency.
(4) Relevance and understandability.
(c) What criterion should be used to evaluate trade-offs between information characteristics?
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Solution 2-134. (a) (1) Relevance is one of the two primary decision-specific characteristics of useful accounting information. Relevant information is capable of making a difference in a decision. Relevant information helps users to make predictions about the outcomes of past, present, and future events, or to confirm or correct prior expectations. Information must also be timely in order to be considered relevant.
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(2) Faithful representation is one of the two primary decision-specific characteristics of useful accounting information. Reliable information can be depended upon to represent the conditions and events that it is intended to represent. Representational faithfulness is corresspondence or agreement between accounting inofrformation and the economic phenomena it is intended to represent steamming from completeness, neutrality, and free from error.
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(3) Understandability is a user-specific characteristic of information. Information is understandable when it permits reasonably informed users to perceive its significance. Understandability is a link between users, who vary widely in their capacity to comprehend or utilize the information, and the decision-specific qualities of information.
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(4) Comparability means that information about enterprises has been prepared and presented in a similar manner. Comparability enhances comparisons between information about two different enterprises at a particular point in time. (5) Consistency means that unchanging policies and procedures have been used by an enterprise from one period to another. Consistency enhances comparisons between information about the same enterprise at two different points in time. (b) (Note to instructor: There are a multitude of answers possible here. The suggestions below are intended to serve as examples). (1) Forecasts of future operating results and projections of future cash flows may be highly relevant to some decision makers. However, they would not be as free from error as historical cost information about past transactions.
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(2) Proposed new accounting methods may be more relevant to many decision makers than existing methods. However, if adopted, they would impair consistency and make trend comparisons of an enterprise's results over time difficult or impossible.
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(3) There presently exists much diversity among acceptable accounting methods and procedures. In order to facilitate comparability between enterprises, the use of only one accepted accounting method for a particular type of transaction could be required. However, consistency would be impaired for those firms changing to the new required methods.
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(4) Occasionally, releavant information is exceedingly complex. Judgement is required in determining the optimum trade-off between relevance and understandability. Information about the impact of general and specific price changes may be highly relevant but not understandable by all users.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
(c) Although trade-offs result in the esacrifice of some desirable quality of information, the overall result should be information that is more useful for decision making.
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At an FASB Concept Framework Symposium, a former member of the FASB discussed his views of a conceptual framework. Some excerpts:
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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.
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Conceptual Framework Underlying Financial Accounting
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Instructions 1. What are the basic components of the conceptual framework? 2. What are your views about the success of the conceptual framework?
Solution 2-134 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: (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. 2-135—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.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
Solution 2-135 1. 2. 3. 4. 5. 6. 7. 8.
Materiality constraint. Consistency characteristic. Expense recognitionMatching principle or going concern assumption. Monetary unit assumption. Expense recognitionMatching principle or going concern assumption. Periodicity assumption. Full disclosure principle. Economic entity assumption.
Ex. 2-136—Accounting concepts—identification. Presented below are a number of accounting procedures and practices in Ramirez 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 Ramirez 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. Ramirez 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 Ramirez 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.
Conceptual Framework Underlying Financial Accounting
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Solution 2-136 1. 2. 3. 4. 5.
Consistency. Periodicity. Matching Expense recognition (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
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Ex. 2-137—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. Economic entity assumption b. Going concern assumption c. Monetary unit assumption Ex. 2-137 (cont.)
g. Expense recognitionMatching principle h. Full disclosure principle i. Relevance characteristic
d. Periodicity assumption characteristic e. Historical cost principle f. Revenue recognition principle
j.
Reliability Faithful representation
k. 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 faithfulnessNumbers and descriptions match what really existed or happened. ____ 4. Yearly financial reports. ____ 5. Accruals and deferrals in adjusting and closing process. (Do not use going concern.) ____ 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 enterpriseCompany 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 2-137 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
Conceptual Framework Underlying Financial Accounting
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Ex. 2-138—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 fundamental qualities that make accounting information useful for decision making. 2. Information that helps users confirm or correct prior expectations has _________________ ___________________. Ex. 2-138 (cont.) 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 enterprisesevents between companies. 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 costis the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Ex. 2-138 (cont.) 5. Information is _______________________ would allow the expensing of all repair tools when purchased, even though they have an estimated life of 3 yearsif omitting it or misstating it could influence decisions that users make on the basis of the reported financial information. 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 treatmentmeans when in doubt, choose the solution that iswill be least likely to overstate income and assets. 8. Parenthetical balance sheet disclosure of the inventory method utilized by a particular company is an application of theroviding information that is of sufficient importance to influence the judgement and decisions of an informed user is referred to as _______________________ 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 _________________ principlegenerally occurs when realized or realizable and when earned.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
Solution 2-138 1. 2. 3. 4. 5.
Relevance; reliabilityfaithful representation 6. consistency feedback confirmatory value 7. Prudence or cConservatism Comparability 8. full disclosure rational; systematicFair value 9. periodicity The materiality convention 10. Rrevenue recognition
Conceptual Framework Underlying Financial Accounting
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Ex. 2-139—Basic assumptions. Briefly explain the four basic assumptions that underlie financial accounting.
Solution 2-139 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 enterprisecompany 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 a company can divided itsthe economic activities of an enterprise can be divided into artificial time periods.
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Test Bank for Intermediate Accounting, FourThirteenth Edition
Ex. 2-140—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 2-140 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. 2. At completion. There are quoted prices. Units are interchangeable. There are no significant distribution costs. 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. 2-141—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 2-141 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. 2-142—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 2-142 (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.
Conceptual Framework Underlying Financial Accounting
2 - 43
Solution 2-142 (cont.) 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. The expense recognition 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.
2 - 44
Test Bank for Intermediate Accounting, FourThirteenth Edition
IFRS QUESTIONS True / False 1. The conceptual framework underlying U.S. GAAP is similar to that underlying iGAAPIFRS. 2. The FASB conceptual framework specifically identifies accrual basis accounting as one of its fundamental assumptions. 3. One of two assumptions made by the IASB conceptual framework is that the reporting entity is a going concern. 4. One of the challenges in developing a common conceptual framework will be to agree on how the framework should be organized since the FASB and IASB conceptual frameworks are organized in very different ways. 5. One issue that the IASB and FASB must resolve in developing a common conceptual framework is how control should be defined with regard to the definition of an asset. Answers to True / False questions: 1. True 2. False 3. True 4. False 5. True
Conceptual Framework Underlying Financial Accounting
2 - 45
Multiple Choice Questions: 1.
Which of the following statements regarding the IASB and FASB conceptual frameworks is not correct? a. The existing IASB and FASB conceptual frameworks are organized in similar ways. b. The two assumptions of the IASB framework are that the financial statements are prepared on an accrual basis and that the reporting entity is a going concern. c. The FASB and IASB agree that the sole objective of financial reporting is to provide users with information that is useful for decision-making. d. The FASB conceptual framework discusses the concept of accrual basis accounting in detail, but does not specifically identity it as an assumption.
2.
The issues which the FASB and IASB must address in developing a common conceptual framework include all of the following except: a. Should the common framework lead to standards that are principles-based or rulesbased? b. Should the role of financial reporting focus on stewardship as well as providing information to assist users in decision making? c. Should the characteristic of reliability be traded-off in favor of information that is verifiable? d. Should a single measurement method such as historical cost be used?
Answers to Multiple Choice: 1. c 2. a
Short Answer: 1. What two assumptions are central to the IFRSiGAAP conceptual framework? 1. The IASB framework makes two assumptions. One assumption is that financial statements are prepared on an accrual basis; the other is that the reporting entity is a going concern. The FASB discuss accrual accounting extensively but does not identify it as an assumption. The going concern concept is only briefly discussed. The going concern concept will undoubtedly be debated as to its place in the conceptual framework. 2. Do the iGAAP IFRS and U.S. GAAP conceptual frameworks differ in terms of the role of financial reporting? Explain. 2. While there is some agreement that the role of financial reporting is to assist users in decision-making, the IASB framework has had more of a focus on the objective of providing information on management’s performance—often referred to as stewardship. It is likely that there will be much debate regarding the role of stewardship in the conceptual framework.
CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM IFRS questions are available at the end of this chapter.
TRUE/FALSE Answer
No.
Description
F T F F F F F T T F T T F T F F F F F F
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. *18. *19. *20.
Recording transactions. Nominal accounts. Real (permanent) accounts. Internal event example. Liability and stockholders’ equity accounts. Debits and credits. Steps in accounting cycle. Purpose of trial balance. General journal. Posting and trial balance. Adjusting entries for prepayments. Example of accrued expense. Book value of depreciable assets. Reporting ending retained earnings. Post-closing trial balance. Closing entries and Income Summary. Posting closing entries. Accrual basis accounting. Purpose of reversing entries. Adjusted trial balance.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
d d d d d d b a c c a a a b
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34.
Purpose of an accounting system. Necessity of accounting records. Purpose of an accounting system. Book of original entry. Purpose of trial balance. Identification of a real account. Identification of a temporary account. Temporary vs. permanent accounts. Meaning of debit. Double-entry system. Effect on stockholders’ equity. Transaction analysis. Accounting equation. Accounting process vs. accounting cycle.
3-2
Test Bank for Intermediate Accounting, Fourteenth Edition d d d c d d a b c d d d b b d c a b d a a a a b a a d c a d c d c d d d b c b b c c d d c c c d d b d
35. 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. *85.
Accounting cycle steps. Criteria for recording events. Identification of a recordable event. Identification of internal events. External events. Limitations of trial balance. General journal. Journal entry. Journal entry. Journal entry. Imbalance in a trial balance. Purpose of unadjusted trial balance. Format of adjusting entry. Example of accrued expense. Accrual basis of accounting. Accrued expense adjusting entry. Effect of not recording accrued expense. Description of a deferral. Effect of not recording accrued revenue. Effect of not recording depreciation expense. 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. Closing entry process. Purpose of closing entries. Cash collections vs. revenue earned. Cash basis revenue. Convert cash receipts to service revenue. Convert cash paid for operating expenses. Purpose of reversing entries. Identification of reversing entries. Identification of reversing entries. Adjusting entries reversed. Reporting inventory on a worksheet.
The Accounting Information System
MULTIPLE CHOICE—Computational Answer No.
Description
c c c c d c b c c d d b d b b d c c c d c b a d
Effect of transactions on owners’ equity. Effect of transactions on owners’ equity. Unearned rent adjustment. Unearned rent adjustment. 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. Adjusting entry for unearned rent. Adjusting entry for supplies. Effect of closing entries. Calculate cash received for interest. Calculate cash paid for salaries. Calculate cash paid for insurance. Calculate insurance expense. Calculate interest revenue. Calculate salary expense. Adjusting entry for supplies. Reversing entries. Unearned rent adjustment. Determine adjusting entry. Determine adjusting entry.
86. 87. 88. 89. 90. 91. 92. 93. 94. *95. 96. 97. 98. *99. *100. *101. *102. *103. *104. *105. *106. *107. *108. *109.
MULTIPLE CHOICE—CPA Adapted Answer c b a c b b a d b c b a
No. 110. 111. 112. 113. 114. 115. 116. 117. *118. *119. *120. *121.
Description 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. Difference between cash basis and accrual method. Determine cash basis revenue. Determine accrual basis revenue. Calculate cost of goods sold.
*This topic is dealt with in an Appendix to the chapter.
3-3
3-4
Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Item
Description
E3-122 E3-123 E3-124 E3-125 E3-126 E3-127 *E3-128 *E3-129 *E3-130 *E3-131 *E3-132
Definitions. Terminology. Accrued and deferred items. Adjusting entries. Adjusting entries. Financial statements. Cash basis vs. accrual basis accounting. Accrual basis. Accrual basis. Accrual basis. Cash basis.
PROBLEMS Item
Description
P3-133 P3-134 P3-135 *P3-136 *P3-137 *P3-138 *P3-139
Adjusting entries and account classifications. Adjusting entries. Adjusting and closing entries. Cash to accrual accounting. Accrual accounting. Accrual accounting. Eight-column work sheet.
CHAPTER LEARNING OBJECTIVES 1.
Understand basic accounting terminology.
2.
Explain double-entry rules.
3.
Identify steps in the accounting cycle.
4.
Record transactions in journals, post to ledger accounts, and prepare a trial balance.
5.
Explain the reasons for preparing adjusting entries.
6.
Prepare financial statements from the adjusted trial balance.
7.
Prepare closing entries.
*8.
Differentiate the cash basis of accounting from the accrual basis of accounting.
*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. TF 21. MC
22. 23.
4. 5.
TF TF
6. 29.
TF MC
30. 31.
7.
TF
35.
MC
36.
8. 9.
TF TF
10. 25.
TF MC
40. 41.
11. 12. 13. 45. 46. 47. 48. 49. 50.
TF TF TF MC MC MC MC MC MC
51. 52. 53. 54. 55. 56. 57. 58. 59.
MC MC MC MC MC MC MC MC MC
60. 61. 62. 63. 64. 65. 66. 67. 68.
14.
TF
74.
MC
127.
15.
TF
16.
TF
17.
18. 77. 78. 79.
TF MC MC MC
80. 99. 100. 101.
MC MC MC MC
102. 103. 104. 118.
19. 81.
TF MC
82. 83.
MC MC
84. 95.
20.
TF
85.
MC
139.
Note:
TF = True/False MC = Multiple Choice
Type
Item
Type
Item
Learning Objective 1 MC 24. MC 26. MC 25. MC 27. Learning Objective 2 MC 32. MC 34. MC 33. MC Learning Objective 3 MC 37. MC 38. Learning Objective 4 MC 42. MC 44. MC 43. MC 86. Learning Objective 5 MC 69. MC 92. MC 70. MC 93. MC 71. MC 94. MC 72. MC 96. MC 73. MC 97. MC 88. MC 110. MC 89. MC 111. MC 90. MC 112. MC 91. MC 113. Learning Objective 6 E Learning Objective 7 TF 75. MC 76. Learning Objective *8 MC 119. MC 129. MC 120. MC 130. MC 121. MC 131. MC 128. E 132. Learning Objective *9 MC 105. MC 108. MC 106. MC 109. Learning Objective *10 P
E = Exercise P = Problem
Type
Item
Type
Item
Type
MC MC
28. 123.
MC E
MC
39.
MC
MC MC
87.
MC
MC MC MC MC MC MC MC MC MC
114. 115. 116. 117. 122. 123. 124. 125. 126.
MC MC MC MC E E E E E
133. 134. 135.
P P P
MC
98.
MC
135.
P
E E E E
136. 137. 138.
P P P
MC Mc
126.
E
MC
3-6
Test Bank for Intermediate Accounting, Fourteenth Edition
TRUE/FALSE 1.
A ledger is where the company initially records transactions and selected other events.
2.
Nominal (temporary) accounts are revenue, expense, and dividend accounts and are periodically closed.
3.
Real (permanent) accounts are revenue, expense, and dividend accounts and are periodically closed.
4.
An example of an internal event would be a flood that destroyed a portion of a company's inventory.
5.
All liability and stockholders’ equity accounts are increased on the credit side and decreased on the debit side.
6.
In general, debits refer to increases in account balances, and credits refer to decreases.
7.
The first step in the accounting cycle is the journalizing of transactions and selected other events.
8.
One purpose of a trial balance is to prove that debits and credits of an equal amount are in the general ledger.
9.
A general journal chronologically lists transactions and other events, expressed in terms of debits and credits to accounts.
10.
If a company 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.
11.
Adjusting entries for prepayments record the portion of the prepayment that represents the expense incurred or the revenue earned in the current accounting period.
12.
An adjustment for wages expense, earned but unpaid at year end, is an example of an accrued expense.
13.
The book value of any depreciable asset is the difference between its cost and its salvage value.
14.
The ending retained earnings balance is reported on both the retained earnings statement and the balance sheet.
15.
The post-closing trial balance consists of asset, liability, owners' equity, revenue and expense accounts.
16.
All revenues, expenses, and the dividends account are closed through the Income Summary account.
17.
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.
The Accounting Information System
3-7
*18.
The accrual basis recognizes revenue when earned and expenses in the period when cash is paid.
*19.
Reversing entries are made at the end of the accounting cycle to correct errors in the original recording of transactions.
*20.
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.
F T F F
5. 6. 7. 8.
F F F T
9. 10. 11. 12.
T F T T
13. 14. 15. 16.
F T F F
17. *18. *19. *20.
F F F F
MULTIPLE CHOICE—Conceptual 21.
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.
22.
Maintaining a set of accounting records is a. optional. b. required by the Internal Revenue Service. c. required by the Foreign Corrupt Practices Act. d. required by the Internal Revenue Service and the Foreign Corrupt Practices Act.
23.
Debit always means a. right side of an account. b. increase. c. decrease. d. none of these.
24.
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.
3-8
Test Bank for Intermediate Accounting, Fourteenth Edition
25.
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.
26.
Which of the following is a real (permanent) account? a. Goodwill b. Sales c. Accounts Receivable d. Both Goodwill and Accounts Receivable
27.
Which of the following is a nominal (temporary) account? a. Unearned Revenue b. Salary Expense c. Inventory d. Retained Earnings
28.
Nominal accounts are also called a. temporary accounts. b. permanent accounts. c. real accounts. d. none of these.
29.
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.
30.
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. they will debit notes payable and interest expense. d. they will debit cash.
31.
Stockholders’ equity is not affected by all a. cash receipts. b. dividends. c. revenues. d. expenses.
32.
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.
The Accounting Information System
3-9
33.
The accounting equation 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.
34.
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.
35.
An optional step in the accounting cycle is the preparation of a. adjusting entries. b. closing entries. c. a statement of cash flows. d. a post-closing trial balance.
36.
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.
37.
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
38.
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.
39.
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 earthquake. c. improvement in technology by a competitor. d. using buildings and machinery in operations.
40.
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.
3 - 10
Test Bank for Intermediate Accounting, Fourteenth Edition
41.
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.
42.
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.
43.
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.
44.
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.
45.
Which of the following errors will cause an imbalance in the trial balance? a. Omission of a transaction in the journal. b. Posting an entire journal entry twice to the ledger. c. Posting a credit of $720 to Accounts Payable as a credit of $720 to Accounts Receivable. d. Listing the balance of an account with a debit balance in the credit column of the trial balance.
S
46.
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.
S
47.
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 a 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.
48.
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
The Accounting Information System
3 - 11
P
49.
Which of the following statements is associated with the accrual basis of accounting? a. The timing of cash receipts and disbursements is emphasized. b. A minimum amount of record keeping is required. c. This method is used less frequently by businesses than the cash method of accounting. d. Revenues are recognized in the period they are earned, regardless of the time period the cash is received.
P
50.
An adjusting entry to record an accrued expense involves a debit to a(an): a. expense account and a credit to a prepaid account. b. expense account and a credit to Cash. c. expense account and a credit to a liability account. d. liability account and a credit to an expense account.
P
51.
The failure to properly record an adjusting entry to accrue an expense will result in an: a. understatement of expenses and an understatement of liabilities. b. understatement of expenses and an overstatement of liabilities. c. understatement of expenses and an overstatement of assets. d. overstatement of expenses and an understatement of assets.
P
52.
Which of the following properly describes a deferral? a. Cash is received after revenue is earned. b. Cash is received before revenue is earned. c. Cash is paid after expense is incurred. d. Cash is paid in the same time period that an expense is incurred.
P
53.
The failure to properly record an adjusting entry to accrue a revenue item will result in an: a. understatement of revenues and an understatement of liabilities. b. overstatement of revenues and an overstatement of liabilities. c. overstatement of revenues and an overstatement of assets. d. understatement of revenues and an understatement of assets.
P
54.
The omission of the adjusting entry to record depreciation expense will result in an: a. overstatement of assets and an overstatement of owners' equity. b. understatement of assets and an understatement of owner's equity. c. overstatement of assets and an overstatement of liabilities. d. overstatement of liabilities and an understatement of owners' equity.
55.
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.
56.
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. its credits a liability account to show the obligation to pay for the service in the future. d. more than one of the above.
3 - 12 57.
Test Bank for Intermediate Accounting, Fourteenth Edition How do these prepaid expenses expire? Rent a. With the passage of time b. With the passage of time c. Through use and consumption d. Through use and consumption
Supplies Through use and consumption With the passage of time Through use and consumption With the passage of time
58.
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.
59.
Unearned revenue on the books of one company is likely to be a. a prepaid expense on the books of the company that made the advance payment. b. an unearned revenue on the books of the company that made the advance payment. c. an accrued expense on the books of the company that made the advance payment. d. an accrued revenue on the books of the company that made the advance payment.
60.
To compute interest expense for an adjusting entry, the formula is (principal X annual rate X a fraction). The numerator and denominator of the fraction are: Numerator Denominator a. Length of time note has been outstanding 12 months b. Length of note 12 months c. Length of time until note matures Length of note d. Length of time note has been outstanding Length of note
61.
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. 1 b. 2 c. 3 d. 1 and 2
62.
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
63.
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.
The Accounting Information System
3 - 13
64.
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
65.
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
66.
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.
67.
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.
68.
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.
69.
Which of the following would not be a correct form for an adjusting entry? a. A debit to a revenue and a credit to a liability b. A debit to an expense and a credit to a liability c. A debit to a liability and a credit to a revenue d. A debit to an asset and a credit to a liability
70.
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
71.
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.
3 - 14
Test Bank for Intermediate Accounting, Fourteenth Edition
72.
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.
73.
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.
74.
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.
75.
Which type of account is always debited during the closing process? a. Dividends. b. Expense. c. Revenue. d. Retained earnings.
S
76.
Which of the following statements best describes the purpose of closing entries? a. To faciliate 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.
P
77.
If ending accounts receivable exceeds the beginning accounts receivable: a. cash collections during the period exceed the amount of revenue earned. b. net income for the period is less than the amount of cash basis income. c. no cash was collected during the period. d. cash collections during the year are less than the amount of revenue earned.
*78.
Under the cash basis of accounting, revenues are recorded a. when they are earned and realized. b. when they are earned and realizable. c. when they are earned. d. when they are realized.
*79.
When converting from cash basis to accrual-basis accounting, which of the following adjustments should be made to cash receipts from customers to determine accrual basis service revenue? a. Subtract ending accounts receivable. b. Subtract beginning unearned service revenue. c. Add ending accounts receivable. d. Add cash sales.
The Accounting Information System
3 - 15
*80.
When converting from cash basis to accrual basis accounting, which of the following adjustments should be made to cash paid for operating expenses to determine accrual basis operating expenses? a. Add beginning accrued liabilities. b. Add beginning prepaid expense. c. Subtract ending prepaid expense. d. Subtract interest expense.
*81.
Reversing entries are 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. 1 b. 2 c. 3 d. 1 and 2
*82.
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.
*83.
Adjusting entries that should be reversed include a. all accrued revenues. b. all accrued expenses. c. those that debit an asset or credit a liability. d. all of these.
S
*84.
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.
S
*85.
The worksheet for Sharko Co. consisted of five 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. Net loss for the period.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31.
d d d d d d b a c c a
32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42.
a a b d d d c d d a b
43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53.
c d d d b b d c a b d
54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64.
a a a a b a a d c a d
65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75.
c d c d d d b c b b c
76. 77. *78. *79. *80. *81. *82. *83. *84. *85.
c d d c c c d d b d
Solutions to those Multiple Choice questions for which the answer is “none of these.” 23. left or left-side. 24. journal. 37. Many answers are possible. 64. accrued.
MULTIPLE CHOICE—Computational 86.
Maso Company recorded journal entries for the issuance of common stock for $80,000, the payment of $26,000 on accounts payable, and the payment of salaries expense of $42,000. What net effect do these entries have on owners’ equity? a. Increase of $80,000. b. Increase of $54,000. c. Increase of $38,000. d. Increase of $12,000.
87.
Mune Company recorded journal entries for the declaration of $100,000 of dividends, the $64,000 increase in accounts receivable for services rendered, and the purchase of equipment for $42,000. What net effect do these entries have on owners’ equity? a. Decrease of $142,000. b. Decrease of $78,000. c. Decrease of $36,000. d. Increase of $22,000.
88.
Pappy Corporation received cash of $18,000 on September 1, 2012 for one year’s rent in advance and recorded the transaction with a credit to Unearned Rent Revenue. The December 31, 2012 adjusting entry is a. debit Rent Revenue and credit Unearned Rent Revenue, $6,000. b. debit Rent Revenue and credit Unearned Rent Revenue, $12,000. c. debit Unearned Rent Revenue and credit Rent Revenue, $6,000. d. debit Cash and credit Unearned Rent Revenue, $12,000.
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89.
Panda Corporation paid cash of $30,000 on June 1, 2012 for one year’s rent in advance and recorded the transaction with a debit to Prepaid Rent. The December 31, 2012 adjusting entry is a. debit Prepaid Rent and credit Rent Expense, $12,500. b. debit Prepaid Rent and credit Rent Expense, $17,500. c. debit Rent Expense and credit Prepaid Rent, $17,500. d. debit Prepaid Rent and credit Cash, $12,500.
90.
Tate Company purchased equipment on November 1, 2012 and gave a 3-month, 9% note with a face value of $40,000. The December 31, 2012 adjusting entry is a. debit Interest Expense and credit Interest Payable, $3,600. b. debit Interest Expense and credit Interest Payable, $900. c. debit Interest Expense and credit Cash, $600. d. debit Interest Expense and credit Interest Payable, $600.
91.
Brown Company's account balances at December 31, 2012 for Accounts Receivable and the related Allowance for Doubtful Accounts are $920,000 debit and $1,400 credit, respectively. From an aging of accounts receivable, it is estimated that $25,000 of the December 31 receivables will be uncollectible. The necessary adjusting entry would include a credit to the allowance account for a. $25,000. b. $26,400. c. $23,600. d. $1,400.
92.
Chen Company's account balances at December 31, 2012 for Accounts Receivable and the Allowance for Doubtful Accounts are $480,000 debit and $900 credit. Sales during 2012 were $1,350,000. It is estimated that 1% of sales will be uncollectible. The adjusting entry would include a credit to the allowance account for a. $14,400. b. $13,500. c. $12,600. d. $4,800.
93.
Starr Corporation loaned $150,000 to another corporation on December 1, 2012 and received a 3-month, 8% interest-bearing note with a face value of $150,000. What adjusting entry should Starr make on December 31, 2012? a. Debit Interest Receivable and credit Interest Revenue, $3,000. b. Debit Cash and credit Interest Revenue, $1,000. c. Debit Interest Receivable and credit Interest Revenue, $1,000. d. Debit Cash and credit Interest Receivable, $3,000.
94.
A company receives interest on a $40,000, 8%, 5-year note receivable each April 1. At December 31, 2012, the following adjusting entry was made to accrue interest receivable: Interest Receivable ............................................................ 2,400 Interest Revenue .................................................... 2,400
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Test Bank for Intermediate Accounting, Fourteenth Edition Assuming that the company does not use reversing entries, what entry should be made on April 1, 2013 when the annual interest payment is received? a. Cash .................................................................................. 800 Interest Revenue .................................................... 800 b. Cash .................................................................................. 2,400 Interest Receivable ................................................. 2,400 c. Cash .................................................................................. 3,200 Interest Receivable ................................................. 2,400 Interest Revenue .................................................... 800 d. Cash .................................................................................. 3,200 Interest Revenue .................................................... 3,200
*95.
A company receives interest on a $40,000, 8%, 5-year note receivable each April 1. At December 31, 2012, the following adjusting entry was made to accrue interest receivable: Interest Receivable ............................................................ 2,400 Interest Revenue .................................................... 2,400 Assuming that the company does use reversing entries, what entry should be made on April 1, 2013 when the annual interest payment is received? a. Cash .................................................................................. 800 Interest Revenue .................................................... 800 b. Cash .................................................................................. 2,400 Interest Receivable ................................................. 2,400 c. Cash ................................................................................. 3,200 Interest Receivable ................................................. 2,400 Interest Revenue .................................................... 800 d. Cash .................................................................................. 3,200 Interest Revenue ..................................................... 3,200
96.
Murphy Company sublet a portion of its warehouse for five years at an annual rental of $30,000, beginning on May 1, 2012. The tenant, Sheri Charter, paid one year's rent in advance, which Murphy recorded as a credit to Unearned Rent Revenue. Murphy reports on a calendar-year basis. The adjustment on December 31, 2012 for Murphy should be a. No entry b. Unearned Rent Revenue ................................................... 10,000 Rent Revenue ........................................................ 10,000 c. Rent Revenue .................................................................... 10,000 Unearned Rent Revenue ........................................ 10,000 d. Unearned Rent Revenue ................................................... 20,000 Revenue Revenue................................................... 20,000
97.
During the first year of Wilkinson Co.'s operations, all purchases were recorded as assets. Supplies in the amount of $25,800 were purchased. Actual year-end supplies amounted to $8,600. The adjusting entry for store supplies will a. increase net income by $17,200. b. increase expenses by $17,200. c. decrease supplies by $8,600. d. debit Accounts Payable for $8,600.
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98.
Big-Mouth Frog Corporation had revenues of $300,000, expenses of $180,000, and dividends of $45,000. When Income Summary is closed to Retained Earnings, the amount of the debit or credit to Retained Earnings is a a. debit of $75,000. b. debit of $120,000. c. credit of $75,000. d. credit of $120,000.
*99.
The income statement of Dolan Corporation for 2012 included the following items: Interest revenue $131,000 Salaries and wages expense 170,000 Insurance expense 15,200
The following balances have been excerpted from Dolan Corporation's balance sheets: December 31, 2012 December 31, 2011 Interest receivable $18,200 $15,000 Salaries and wages payable 17,800 8,400 Prepaid insurance 2,200 3,000 The cash received for interest during 2012 was a. $112,800. b. $127,800. c. $131,000. d. $134,200. *100. The income statement of Dolan Corporation for 2012 included the following items: Interest revenue $131,000 Salaries and wages expense 170,000 Insurance expense 15,200 The following balances have been excerpted from Dolan Corporation's balance sheets: December 31, 2012 December 31, 2011 Interest receivable $18,200 $15,000 Salaries and wages payable 17,800 8,400 Prepaid insurance 2,200 3,000 The cash paid for salaries during 2012 was a. $179,400. b. $160,600. c. $161,600. d. $187,800. *101. The income statement of Dolan Corporation for 2012 included the following items: Interest revenue $131,000 Salaries and wages expense 170,000 Insurance expense 15,200
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Test Bank for Intermediate Accounting, Fourteenth Edition
The following balances have been excerpted from Dolan Corporation's balance sheets: December 31, 2012 December 31, 2011 Interest receivable $18,200 $15,000 Salaries and wages payable 17,800 8,400 Prepaid insurance 2,200 3,000 The cash paid for insurance premiums during 2012 was a. $13,000. b. $12,200. c. $16,000. d. $14,400. *102. Olsen Company paid or collected during 2012 the following items: Insurance premiums paid $ 20,800 Interest collected 67,800 Salaries paid 240,400 The following balances have been excerpted from Olsen's balance sheets: December 31, 2012 December 31, 2011 Prepaid insurance $ 2,400 $ 3,000 Interest receivable 7,400 5,800 Salaries and wages payable 24,600 21,200 The insurance expense on the income statement for 2012 was a. $15,400. b. $20,200. c. $21,400. d. $26,200. *103. Olsen Company paid or collected during 2012 the following items: Insurance premiums paid $ 20,800 Interest collected 67,800 Salaries paid 240,400 The following balances have been excerpted from Olsen's balance sheets: December 31, 2012 December 31, 2011 Prepaid insurance $ 2,400 $ 3,000 Interest receivable 7,400 5,800 Salaries and wages payable 24,600 21,200 The interest revenue on the income statement for 2012 was a. $54,600. b. $66,200. c. $69,400. d. $81,000.
The Accounting Information System
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*104. Olsen Company paid or collected during 2012 the following items: Insurance premiums paid $ 20,800 Interest collected 67,800 Salaries paid 240,400 The following balances have been excerpted from Olsen's balance sheets: December 31, 2012 December 31, 2011 Prepaid insurance $ 2,400 $ 3,000 Interest receivable 7,400 5,800 Salaries and wages payable 24,600 21,200 Salaries expense on the income statement for 2012 was a. $194,600. b. $237,000. c. $243,800. d. $286,200. *105. The Supplies account had a balance at the beginning of year 3 of $8,000 (before the reversing entry). Payments for purchases of supplies during year 3 amounted to $50,000 and were recorded as expense. A physical count at the end of year 3 revealed supplies costing $9,500 were on hand. Reversing entries are used by this company. The required adjusting entry at the end of year 3 will include a debit to: a. Supplies Expense for $1,500. b. Supplies for $1,500. c. Supplies Expense for $48,500. d. Supplies for $9,500. *106. At the end of 2012, Drew Company made four adjusting entries for the following items: 1. Depreciation expense, $25,000. 2. Expired insurance, $2,200 (originally recorded as prepaid insurance.) 3. Interest payable, $6,000. 4. Rent receivable, $10,000. In the normal situation, to facilitate subsequent entries, the adjusting entry or entries that may be reversed is (are) a. Entry No. 3. b. Entry No. 4. c. Entry No. 3 and No. 4. d. Entry No. 2, No. 3 and No. 4. *107. Garcia Corporation received cash of $24,000 on August 1, 2012 for one year's rent in advance and recorded the transaction with a credit to Rent Revenue. The December 31, 2012 adjusting entry is a. debit Rent Revenue and credit Unearned Rent Revenue, $10,000. b. debit Rent Revenue and credit Unearned Rent Revenue, $14,000. c. debit Unearned Rent Revenue and credit Rent Revenue, $10,000. d. debit Cash and credit Unearned Rent Revenue, $14,000.
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Test Bank for Intermediate Accounting, Fourteenth Edition
*108. Lopez Company received $9,600 on April 1, 2012 for one year's rent in advance and recorded the transaction with a credit to a nominal account. The December 31, 2012 adjusting entry is a. debit Rent Revenue and credit Unearned Rent Revenue, $2,400. b. debit Rent Revenue and credit Unearned Rent Revenue, $7,200. c. debit Unearned Rent Revenue and credit Rent Revenue, $2,400. d. debit Unearned Rent Revenue and credit Rent Revenue, $7,200. *109. Gibson Company paid $6,000 on June 1, 2012 for a two-year insurance policy and recorded the entire amount as Insurance Expense. The December 31, 2012 adjusting entry is a. debit Insurance Expense and credit Prepaid Insurance, $1,750. b. debit Insurance Expense and credit Prepaid Insurance, $4,250. c. debit Prepaid Insurance and credit Insurance Expense, $1,750 d. debit Prepaid Insurance and credit Insurance Expense, $4,250.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans
Item
Ans
Item
Ans.
86. 87. 88. 89.
c c c c
90. 91. 92. 93.
d c b c
94. 95. 96. 97.
c d d b
98. *99. *100. *101.
d. b b d
*102. *103. *104. *105.
c. c c d
*106. *107. *108. *109.
c b a d
MULTIPLE CHOICE—CPA Adapted 110.
On September 1, 2012, Lowe Co. issued a note payable to National Bank in the amount of $900,000, bearing interest at 12%, and payable in three equal annual principal payments of $300,000. On this date, the bank's prime rate was 11%. The first payment for interest and principal was made on September 1, 2013. At December 31, 2013, Lowe should record accrued interest payable of a. $36,000. b. $33,000. c. $24,000. d. $22,000.
111.
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 Revenue. This account had a balance of $3,600,000 at December 31, 2012 before year-end adjustment. Service contract costs are charged as incurred to the Service Contract Expense account, which had a balance of $900,000 at December 31, 2012. Service contracts still outstanding at December 31, 2012 expire as follows: During 2013 $760,000 During 2014 1,140,000 During 2015 700,000
The Accounting Information System
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What amount should be reported as Unearned Service Revenue in Eaton's December 31, 2012 balance sheet? a. $2,700,000. b. $2,600,000. c. $1,700,000. d. $1,000,000. 112.
In November and December 2012, Lane Co., a newly organized magazine publisher, received $75,000 for 1,000 three-year subscriptions at $25 per year, starting with the January 2013 issue. Lane included the entire $75,000 in its 2012 income tax return. What amount should Lane report in its 2012 income statement for subscriptions revenue? a. $0. b. $4,167. c. $25,000. d. $75,000.
113.
On June 1, 2012, Nott Corp. loaned Horn $600,000 on a 12% note, payable in five annual installments of $120,000 beginning January 2, 2013. 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, 2012. Horn made timely payments through November 1, 2012. On January 2, 2013, Nott received payment of the first principal installment plus all interest due. At December 31, 2012, Nott's interest receivable on the loan to Horn should be a. $0. b. $6,000. c. $12,000. d. $18,000.
114.
Allen Corp.'s liability account balances at June 30, 2013 included a 10% note payable in the amount of $3,000,000. The note is dated October 1, 2011 and is payable in three equal annual payments of $1,000,000 plus interest. The first interest and principal payment was made on October 1, 2012. In Allen's June 30, 2013 balance sheet, what amount should be reported as accrued interest payable for this note? a. $225,000. b. $150,000. c. $75,000. d. $50,000.
115.
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 2012 are as follows: Last payroll was paid on 12/26/12, for the 2-week period ended 12/26/12. Overtime pay earned in the 2-week period ended 12/26/12 was $15,000. Remaining work days in 2012 were December 29, 30, 31, on which days there was no overtime. The recurring biweekly salaries total $270,000.
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Test Bank for Intermediate Accounting, Fourteenth Edition Assuming a five-day work week, Colaw should record a liability at December 31, 2012 for accrued salaries of a. $81,000. b. $96,000. c. $162,000. d. $177,000.
116.
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 2011 $5,000 $7,500 2012 6,000 8,500 Eddy estimated that sales of the trademarked items would total $30,000 for July through December 2012. In Tolan's 2012 income statement, the royalty revenue should be a. $13,000. b. $14,500. c. $19,000. d. $20,500.
117.
At December 31, 2012, Sue’s Boutique had 1,000 gift certificates outstanding, which had been sold to customers during 2012 for $75 each. Sue’s operates on a gross profit of 60% of its sales. What amount of revenue pertaining to the 1,000 outstanding gift certificates should be deferred at December 31, 2012? a. $0. b. $30,000. c. $45,000. d. $75,000.
*118. Compared to the accrual basis of accounting, the cash basis of accounting overstates income by the net increase during the accounting period of the a. b. c. d.
Accounts Receivable No No Yes Yes
Accrued Expenses Payable No Yes No Yes
*119. Gregg Corp. reported revenue of $1,250,000 in its accrual basis income statement for the year ended June 30, 2013. Additional information was as follows: Accounts receivable June 30, 2012 $400,000 Accounts receivable June 30, 2013 530,000 Uncollectible accounts written off during the fiscal year 15,000 Under the cash basis, Gregg should report revenue of a. $835,000. b. $850,000. c. $1,105,000. d. $1,135,000.
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*120. Jim Yount, M.D., keeps his accounting records on the cash basis. During 2013, Dr. Yount collected $300,000 from his patients. At December 31, 2012, Dr. Yount had accounts receivable of $40,000. At December 31, 2013, Dr. Yount had accounts receivable of $70,000 and unearned revenue of $10,000. On the accrual basis, how much was Dr. Yount's patient service revenue for 2013? a. $260,000. b. $320,000. c. $330,000. d. $340,000. *121. The following information is available for Ace Company for 2012: Disbursements for purchases Increase in trade accounts payable Decrease in merchandise inventory
$1,160,000 100,000 40,000
Cost of goods sold for 2012 was a. $1,300,000. b. $1,220,000. c. $1,100,000. d. $1,020,000.
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans
Item
Ans.
110. 111.
c b
112. 113.
a c
114. 115.
b b
116. 117.
a d
*118. *119.
b. c
*120. *121.
b a
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Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational No.
Answer
Derivation
86.
c
$80,000 - $42,000 = $38,000.
87.
c
$100,000 - $64,000 = $36,000.
88.
c
$18,000 x 4/12 = $6,000.
89.
c
$30,000 x 7/12 = $17,500.
90.
d
2/12 x 9% x $40,000 = $600.
91.
c
$25,000 – $1,400 = $23,600.
92.
b
$1,350,000 x 1% = $13,500.
93.
c
1/12 x 8% x $150,000 = $1,000.
94.
c
$40,000 x 8% = $3,200; $3,200 - $2,400 = $800 int. rev.
*95.
d
*96.
d
$30,000 x 8/12 = $20,000.
*97.
b
$25,800 – $8,600 = $17,200.
*98.
d
$300,000 - $180,000 = $120,000.
*99.
b
$15,000 + $131,000 - $18,200 = $127,800.
*100.
b
$8,400 + $170,000 - $17,800 = $160,600.
*101.
d
$15,200 – $3,000 + $2,200 = $14,400.
*102.
c
$20,800 + $600 = $21,400.
*103.
c
$67,800 – $5,800 + $7,400 = $69,400.
*104.
c
$240,400 – $21,200 + $24,600 = $243,800.
*105.
d
$9,500 + $8,000 – $8,000 = $9,500.
*106.
c
*107. *108.
b a
7/12 x $24,000 = $14,000. 3/12 x $9,600 = $2,400.
*109.
d
17/24 x $6,000 = $4,250.
The Accounting Information System
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DERIVATIONS — CPA Adapted No.
Answer
Derivation
110.
c
($900,000 – $300,000) × 12% × 4/12 = $24,000.
111.
b
$760,000 + $1,140,000 + $700,000 = $2,600,000.
112.
a
$0, none of the $75,000 is earned.
113.
c
$600,000 × 12% × 2/12 = $12,000.
114.
b
$2,000,000 × 9/12 × 10% = $150,000.
115.
b
$15,000 + ($270,000 ÷ 10 × 3) = $96,000.
116.
a
$8,500 + ($30,000 × 15%) = $13,000.
117.
d
1,000 × $75 = $75,000.
*118.
b
Conceptual.
*119.
c
$1,250,000 + $400,000 – $530,000 – $15,000 = $1,105,000.
*120.
b
$300,000 – $40,000 + $70,000 – $10,000 = $320,000.
*121.
a
$1,160,000 + $100,000 + $40,000 = $1,300,000.
EXERCISES Ex. 3-122—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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 3-122 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. 3-123—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. _______________________________________
Solution 3-123 1. 2. 3. 4.
Nominal (temporary) accounts. Reversing entries. Unearned revenue. Accrued revenue.
5. Real (permanent) accounts. 6. Prepaid expense. 7. Accrued expense.
Ex. 3-124—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.
The Accounting Information System
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Solution 3-124 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 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. 3-125—Adjusting entries. Present, in journal form, the adjustments that would be made on July 31, 2013, the end of the fiscal year, for each of the following. 1. The supplies inventory on August 1, 2012 was $7,350. Supplies costing $22,150 were acquired during the year and charged to the supplies inventory. A count on July 31, 2013 indicated supplies on hand of $8,810. 2. On April 30, a ten-month, 6% 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 3-125 1. Supplies Expense .................................................................. Supplies .......................................................................
20,690
2. Interest Receivable ................................................................. Interest Revenue .........................................................
300
*3. Rent Revenue ........................................................................ Unearned Rent Revenue .............................................
7,000
20,690
300
7,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 3-126—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, 2012. (Two entries for each part.) 1. An insurance policy for two years was acquired on April 1, 2012 for $12,000. 2. Rent of $15,000 for six months for a portion of the building was received on November 1, 2012.
Solution 3-126 1. Prepaid Insurance ................................................................... Cash ............................................................................ Insurance Expense .................................................................. Prepaid Insurance ........................................................
12,000
2. Cash
15,000
..................................................................................... Unearned Rent Revenue .............................................. Unearned Rent Revenue .......................................................... Rent Revenue ..............................................................
12,000 4,500 4,500
15,000 5,000 5,000
Ex. 3-127 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. 2. 3.
an income statement. a retained earnings statement. a balance sheet. RYAN FINANCIAL PLANNERS Adjusted Trial Balance December 31, 2012
Cash .............................................................................................. Accounts Receivable ...................................................................... Supplies ..................................................................................... Equipment ..................................................................................... Accumulated Depreciation—Equipment ......................................... Accounts Payable........................................................................... Unearned Service Revenue ........................................................... Common Stock............................................................................... Retained Earnings .......................................................................... Dividends ..................................................................................... Service Revenue ............................................................................ Supplies Expense........................................................................... Depreciation Expense .................................................................... Rent Expense.................................................................................
Debit $ 3,900 2,200 1,800 15,000
Credit
$ 4,000 3,800 5,000 10,000 4,400 2,000 3,700 600 2,500 2,900 $30,900
______ $30,900
The Accounting Information System Solution 3-127 1.
(20 min) RYAN FINANCIAL PLANNERS Income Statement For the Month Ended December 31, 2012
Revenues Service revenue ....................................................................... Expenses Rent expense ........................................................................... Depreciation expense............................................................... Supplies expense ..................................................................... Total expenses ...................................................................... Net loss ..........................................................................................
2.
$ 3,700 $2,900 2,500 600 6,000 $(2,300)
RYAN FINANCIAL PLANNERS Retained Earnings Statement For the Month Ended December 31, 2012
Retained earnings, December 1 ..................................................... Less: Net loss ................................................................................ Dividends ............................................................................. Retained earnings, December 31 ...................................................
3.
3 - 31
$ 4,400 $2,300 2,000
4,300 $ 100
RYAN FINANCIAL PLANNERS Balance Sheet December 31, 2012 Assets
Cash .............................................................................................. Accounts receivable ....................................................................... Supplies ..................................................................................... Equipment ..................................................................................... Less: Accumulated depreciation—equipment ................................ Total assets.............................................................................
$ 3,900 2,200 1,800 $15,000 4,000
11,000 $18,900
Liabilities and Stockholders’ Equity Liabilities Accounts payable ..................................................................... Unearned service revenue ....................................................... Total liabilities ............................................................... Stockholders’ Equity Common stock ......................................................................... Retained earnings .................................................................... Total liabilities and stockholders’ equity ........................
$ 3,800 5,000 $ 8,800 10,000 100
10,100 $18,900
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Test Bank for Intermediate Accounting, Fourteenth Edition
*Ex. 3-128—Cash basis vs. accrual basis of accounting. Contrast the cash basis of accounting with the accrual basis of accounting. *Solution 3-128 The essential difference between the cash basis and the accrual basis of accounting relates to the timing of the recognition of revenues and expenses. Under the cash basis of accounting, the effects of transactions and other events are recognized and reported only when cash is received or paid. Under the accrual basis of accounting, these effects are recognized and reported in the time periods to which they relate, regardless of the time of the receipt or payment of cash. Because no attempt is made under the cash basis of accounting to match revenues and the expenses associated with those revenues, cash basis financial statements are not in accordance with generally accepted accounting principles.
*Ex. 3-129—Accrual basis. Sales salaries paid during 2012 were $75,000. Advances to salesmen were $1,100 on January 1, 2012, and $800 on December 31, 2012. Sales salaries accrued were $1,360 on January 1, 2012, and $1,880 on December 31, 2012. Show the computation of sales salaries on an accrual basis for 2012.
*Solution 3-129 $75,000 + $1,100 – $800 – $1,360 + $1,880 = $75,820.
*Ex. 3-130—Accrual basis. The records for Todd Inc. showed the following for 2012: Accrued expenses Prepaid expenses Cash paid during the year for expenses, $37,500
Jan. 1 $1,300 720
Dec. 31 $2,150 870
Show the computation of the amount of expense that should be reported on the income statement.
*Solution 3-130 $37,500 – $1,300 + $2,150 + $720 – $870 = $38,200.
The Accounting Information System *Ex. 3-131—Accrual basis. The records for Kiley Company showed the following for 2012: Jan. 1 Unearned revenue $1,100 Accrued revenue 1,260 Cash collected during the year for revenue, $55,000
3 - 33
Dec. 31 $2,160 920
Show the computation of the amount of revenue that should be reported on the income statement. *Solution 3-131 $55,000 + $1,100 – $2,160 – $1,260 + $920 = $53,600.
*Ex. 3-132—Cash basis. Revenue on the income statement was $145,800. Accounts receivable were $3,500 on January 1 and $3,540 on December 31. Unearned revenue was $1,050 on January 1 and $1,670 on December 31. Show the computation of revenue for the year on a cash basis. *Solution 3-132 $145,800 + $3,500 – $3,540 – $1,050 + $1,670 = $146,380.
PROBLEMS Pr. 3-133—Adjusting entries and account classification. Selected amounts from Trent Company's trial balance of 12/31/12 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 900,000 9. Insurance Expense 30,000 10. Interest Expense 10,000 11. Inventory 300,000 12. Notes Payable (due 6/1/13) 200,000 13. Prepaid Rent 180,000 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.)
3 - 34 Part A.
Test Bank for Intermediate Accounting, Fourteenth Edition Prepare adjusting journal entries at year end, December 31, 2012, based on the following supplemental information.
a. The equipment has a useful life of 15 years with no salvage value. (Straight-line method being used.) b. Interest accrued on the bonds payable is $15,000 as of 12/31/12. c. Expired insurance at 12/31/12 is $25,000. d. The rent payment of $180,000 covered the six months from November 30, 2012 through May 31, 2013. e. Salaries and wages earned but unpaid at 12/31/12, $22,000.
Part B.
a. b. c. d. e.
Indicate the proper balance sheet classification of each of the 15 numbered accounts in the 12/31/12 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
Solution 3-133 Part A. a. Depreciation Expense ($900,000 – 0) 15 .................................... Accumulated Depreciation—Equipment .............................
60,000 60,000
b. Interest Expense ............................................................................ Interest Payable .................................................................
15,000
c. Prepaid Insurance ......................................................................... Insurance Expense ($30,000 - $25,000) ............................
5,000
d. Rent Expense ($180,000 6) ......................................................... Prepaid Rent ......................................................................
30,000
e. Salaries and Wages Expense ........................................................ Salaries and Wages Payable .............................................
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
15,000
5,000
30,000
22,000
The Accounting Information System
3 - 35
Pr. 3-134—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 1/1/12 was $1,000. During 2012 cash received from debtors for interest on outstanding notes receivable amounted to $5,000. The 2012 income statement showed interest revenue in the amount of $7,400. You are to provide the missing adjusting entry that must have been made, assuming reversing entries are not made. 2. Unearned rent at 1/1/12 was $5,300 and at 12/31/12 was $8,000. The records indicate cash receipts from rental sources during 2012 amounted to $55,000, all of which was credited to the Unearned Rent Revenue Account. You are to prepare the missing adjusting entry. 3. Accumulated depreciation—equipment at 1/1/12 was $230,000. At 12/31/12 the balance of the account was $290,000. During 2012, 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 1/1/12 was $50,000. The balance in the allowance account on 12/31/12 after making the annual adjusting entry was $65,000 and during 2012 bad debts written off amounted to $30,000. You are to provide the missing adjusting entry. 5. Prepaid rent at 1/1/12 was $9,000. During 2012 rent payments of $120,000 were made and charged to "rent expense." The 2012 income statement shows as a general expense the item "rent expense" in the amount of $135,000. You are to prepare the missing adjusting entry that must have been made, assuming reversing entries are not made. 6. Retained earnings at 1/1/12 was $130,000 and at 12/31/12 it was $210,000. During 2012, 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 3-134 1. Interest Receivable .................................................................. Interest Revenue ......................................................... Interest revenue per books $7,400 Interest revenue received related to 2012 ($5,000 – $1,000) 4,000 Interest accrued $3,400
3,400
2. Unearned Rent Revenue ......................................................... Rent Revenue .............................................................. Cash receipts $55,000 Beginning balance 5,300 Ending balance (8,000) Rent revenue $52,300
52,300
3,400
52,300
3 - 36
Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 3-134 (cont.) 3.
Depreciation Expense ............................................................. Accumulated Depreciation—Equipment ....................... Ending balance $290,000 Beginning balance 230,000 Difference 60,000 Write-off at time of sale 3/4 × $40,000 30,000 $ 90,000
90,000
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 $135,000 Less cash paid 120,000 Reduction in prepaid rent account $ 15,000
15,000
6. Income Summary .................................................................... Retained Earnings ....................................................... Ending balance $210,000 Beginning balance 130,000 Difference 80,000 Cash dividends $50,000 Stock dividends 40,000 90,000 $170,000
170,000
90,000
45,000
15,000
170,000
Pr. 3-135—Adjusting and closing entries. The following trial balance was taken from the books of Fisk Corporation on December 31, 2012. Account Cash Accounts Receivable Notes Receivable Allowance for Doubtful Accounts Inventory Prepaid Insurance Equipment Accumulated Depreciation--Equip. Accounts Payable Common Stock Retained Earnings Sales Revenue Cost of Goods Sold Salaries and wages Expense Rent Expense Totals
Debit $ 9,000 40,000 10,000
Credit
$ 1,800 44,000 4,800 110,000 15,000 10,800 44,000 75,000 260,000 126,000 50,000 12,800 $406,600
$406,600
The Accounting Information System
3 - 37
Pr. 3-135 (cont.) 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 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 and wages at December 31, $5,800. Instructions (a) Prepare the necessary adjusting entries. (b) Prepare the necessary closing entries. Solution 3-135 (a) Adjusting Entries a. Insurance Expense ............................................................... Prepaid Insurance ........................................................ b. Bad Debt Expense ................................................................ Allowance for Doubtful Accounts .................................. c. Depreciation Expense ........................................................... Accumulated Depreciation--Equip. ............................... d. Interest Receivable ............................................................... Interest Revenue .......................................................... *e. Prepaid Rent ........................................................................ Rent Expense .............................................................. f. Salaries and Wages Expense ............................................... Salaries and Wages Payable ....................................... (b) Closing Entries Sales ........................................................................................... Interest Revenue ......................................................................... Income Summary ...............................................................
2,000 2,000 2,600 2,600 11,000 11,000 600 600 5,400 5,400 5,800 5,800
260,000 600 260,600
Income Summary ......................................................................... Salaries and Wages Expense ............................................ Rent Expense .................................................................... Depreciation Expense ........................................................ Bad Debt Expense ............................................................. Insurance Expense ............................................................ Cost of Goods Sold ............................................................
204,800
Income Summary ......................................................................... Retained Earnings .............................................................
55,200
55,800 7,400 11,000 2,600 2,000 126,000
55,200
3 - 38
Test Bank for Intermediate Accounting, Fourteenth Edition
*Pr. 3-136—Cash to accrual accounting. The following information is available for Renn Corporation's first year of operations: Payment for merchandise purchases $315,000 Ending merchandise inventory 135,000 Accounts payable (balance at end of year) 60,000 Collections from customers 280,000 The balance in accounts payable relates only to merchandise purchases. All merchandise items were marked to sell at 40% above cost. What should be the ending balance in accounts receivable, assuming all accounts are deemed collectible?
*Solution 3-136 Since this is the first year of operations and there were $280,000 of accounts receivable collected, one must compute total sales to determine the ending balance in accounts receivable. Cost of goods sold is $240,000 assuming the accounts payable are for inventory (the $315,000 constitutes only payments made for purchases). Since the markup is 40% on cost, the sales are $336,000 ($240,000 × 140%). Sales of $336,000 less collections of $280,000 results in an ending accounts receivable balance of $56,000 as calculated below. Cash purchases A/P balance Total purchases Ending inventory Cost of goods sold Sales Less collections Ending A/R
$315,000 60,000 375,000 135,000 240,000 × 140% 336,000 280,000 $56,000
*Pr. 3-137—Accrual accounting. Yates Company's records provide the following information concerning certain account balances and changes in these account balances during the current year. Transaction information is missing from each item below. Instructions Prepare the entry to record the missing information for each account. (Consider each independently.) 1. Accounts Receivable: Jan. 1, balance $41,000, Dec. 31, balance $65,000, uncollectible accounts written off during the year, $6,000; accounts receivable collected during the year, $139,000. Prepare the entry to record sales revenue. 2. Allowance for Doubtful Accounts: Jan. 1, balance $4,000, Dec. 31, balance $7,500, uncollectible accounts written off during the year, $20,000. Prepare the entry to record bad debt expense. 3. Accounts Payable: Jan. 1, balance $25,000, Dec. 31, balance $44,000, purchases on account for the year, $120,000. Prepare the entry to record payments on account. 4. Interest Receivable: Jan. 1 accrued, $3,000, Dec. 31 accrued, $2,100, earned for the year, $35,000. Prepare the entry to record cash interest received.
The Accounting Information System
3 - 39
*Solution 3-137 1. Ending balance Beginning balance Difference Uncollectible accounts Receivables collected Sales revenue for period
$ 65,000 41,000 24,000 6,000 139,000 $169,000
Ending balance Plus: Rec. collected Write-offs OR Less: Beginning balance Sales revenue for period
Accounts Receivable ..................................................................... Sales Revenue ................................................................... 2. Ending balance Beginning balance Difference Write-off Adjusting entry
$ 7,500 4,000 3,500 20,000 $23,500
3. Ending balance Beginning balance Difference Purchases Payments
$ 44,000 25,000 19,000 120,000 $101,000
$35,000 (2,100) 3,000 $35,900
169,000 $ 7,500 20,000 27,500 4,000 $23,500
OR Beginning balance Adjusting entry 23,500
23,500
Beginning balance Plus purchases
$ 25,000 120,000 145,000 44,000 $101,000
OR Less ending balance Payments
Accounts Payable .......................................................................... Cash .................................................................................. 4. Revenue Earned Less: Dec. 31 accrual Plus: Jan. 1 accrual Cash received
169,000
Ending balance Write-off
Bad Debt Expense ........................................................................ Allowance for Doubtful Accounts .......................................
101,000 101,000
Beginning balance Plus revenue earned
$ 3,000 35,000 38,000 2,100 $35,900
OR Less ending balance Cash received
Cash .............................................................................................. Interest Receivable ............................................................. (This entry assumes that the $35,000 interest earned was first recorded as a receivable.)
$ 65,000 139,000 6,000 210,000 41,000 $169,000
35,900 35,900
3 - 40
Test Bank for Intermediate Accounting, Fourteenth Edition
*Pr. 3-138—Accrual basis. Grier & Associates maintains its records on the cash basis. You have been engaged to convert its cash basis income statement to the accrual basis. The cash basis income statement, along with additional information, follows: Grier & Associates Income Statement (Cash Basis) For the Year Ended December 31, 2012 Cash receipts from customers Cash payments: Salaries and wages Income taxes Insurance Interest Net income
$450,000 $150,000 65,000 40,000 25,000
280,000 $170,000
Additional information: Balances at 12/31 2012 2011 $60,000 $30,000 10,000 20,000 24,000 19,000 8,000 4,000 95,000 75,000 3,000 9,000
Accounts receivable Salaries and wages payable Income taxes payable Prepaid insurance Accumulated depreciation Interest payable No plant assets were sold during 2012.
*Solution 3-138 Grier & Associates Income Statement (Accrual Basis) For the Year Ended December 31, 2012 Revenue ($450,000 + $60,000 – $30,000) Expenses Salaries and wages ($150,000 + $10,000 – $20,000) Income taxes ($65,000 + $24,000 – $19,000) Insurance ($40,000 + $4,000 – $8,000) Depreciation ($95,000 – $75,000) Interest ($25,000 + $3,000 – $9,000) Total expenses Net Income
$480,000 $140,000 70,000 36,000 20,000 19,000 285,000 $195,000
The Accounting Information System
3 - 41
*Pr. 3-139—Eight-column work sheet. 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 work sheet 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, 2013. (e) A physical inventory of supplies indicated $340 of supplies currently in stock. (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, 2012. Winsor Corporation Work Sheet For the Year Ended December 31, 2012
Trial Balance Accounts Dr. Cr. Cash 12,400 Equity Invest. 4,050 Accounts Rec. 50,000 Allow. for D. A. 420 Inventory 16,800 Supplies 1,040 Equipment 65,000 Accum. Depr.-Equip. 9,500 Accounts Payable 4,400 Notes Payable 10,000 Common Stock 40,000 Ret. Earnings 29,690 Cost of Goods Sold 225,520 Salaries and wagesExp. 20,800 Sales Comm. Exp. 29,000 Rent Expense 7,200 Misc. Expense 2,200 Sales Revenue 340,000 Totals 434,010 434,010
Adjustments Dr. Cr.
Income Statement Dr. Cr.
Balance Sheet Dr. Cr.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 3-139 Winsor Corporation Work Sheet For the Year Ended December 31, 2012 Accounts Cash Equity Invest. Accounts Rec. Allow. for D. A. Inventory Supplies Equipment Accum. Depr.-Eq. Accounts Payable Notes Payable Common Stock Ret. Earnings Cost of Goods Sold Salaries and wages Exp. Sales Comm. Exp. Rent Expense Misc. Expense Sales Revenue Totals
Trial Balance Dr. Cr. 12,400 4,050 50,000 420 16,800 1,040 65,000 9,500 4,400 10,000 40,000 29,690 225,520 20,800 29,000 7,200 2,200 434,010
Adjustments Dr. Cr.
Balance Sheet Dr. Cr. 12,400 4,050 50,000 3,820 16,800 340 65,000 17,500 4,400 10,000 40,000 29,690
(a) 3,400 (e)
700
(b) 8,000
225,520 (c) 5,000 (f)
800
340,000 434,010
Bad Debt Exp. Depr. Exp. Sales Com. Exp Pay. Interest Expense Interest Payable Supplies Expense Prepaid Rent Totals Net Income Totals
Income Statement Dr. Cr.
(a) 3,400 (b) 8,000 (d)
200
(e) (f)
700 800 18,100
(c) 5,000 (d)
200
18,100
20,800 34,000 6,400 2,200
340,000
3,400 8,000
5,000
200
200
700 301,220 38,780 340,000
340,000
800 149,390
340,000
149,390
110,610 38,780 149,390
Adjusting entries and explanations (a) Bad Debt Expense ($340,000 x 1%) .............................................. Allowance for Doubtful Accounts ........................................
3,400
(b) Depreciation Expense .................................................................... Accumulated Depreciation—Equipment ............................. ($65,000 – $1,000 is $64,000. One-eighth of $64,000 is $8,000.)
8,000
3,400
8,000
The Accounting Information System
3 - 43
Solution 3-139 (cont.) (c) Sales Commission Expense .......................................................... 5,000 Sales Commission Expense Payable ................................. (10% of sales is 10% × $340,000, which is $34,000. The balance in the Sales Commission Expense account is $29,000 before adjustment, indicating that $5,000 of commissions are accrued but unpaid.) (d) Interest Expense ........................................................................... Interest Payable ................................................................. ($10,000 × .08 × 3/12 = $200)
200
(e) Supplies Expense ......................................................................... Supplies ............................................................................. (The balance of $1,040 in the Supplies account before adjustment less the correct ending balance of $340 is $700.)
700
(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
5,000
200
700
800
3 - 44
Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS Short Answer: 1. Are all international companies subject to the same internal control standards? Explain. 1. No, all international companies are not subject to the same internal control standards. All public companies that list their securitites on U.S. stock exchanges are subject to the internal control testing and assurance provisions of the Sarbanes-Oxley Act of 2002. International companies that list their securities on non-U.S. exchanges are not subject to these rules and there is debate as to whether they should have to comply. 2. What are some of the consequences of international differences in internal control standards? 2. There is concern that the cost of complying with higher internal control provisions is making U.S. markets less competitive as a place to list securities. This in turn could give U.S. investors less investment oppurtunties. On the other hand, some argue that the enhanced internal control requirements in the U.S. increase the perceived reliability of companies’ financial statements and helps reduce their cost of capital. Furthermore, the decline in public listings in the U.S. are more likely due to other factors, such as growth in non-U.S. markets and general globalization. Thus, the jury is still out on the net cost/benefit of Sarbanes-Oxley and its impact on international competitiveness.
CHAPTER 4 INCOME STATEMENT AND RELATED INFORMATION IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
T F F T T T F F T F T F F T F 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.
Usefulness of the income statement. Limitations of the income statement. Earnings management. Transaction approach of income measurement. 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. Current operating performance approach. Reporting discontinued operations. Reporting extraordinary items. Irregular items. Intraperiod tax allocation. Reporting earnings per share. Computation of earnings per share. Prior period adjustments. Retained earnings restrictions. Comprehensive income definition. Reporting other comprehensive income.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
c d b d d c b c b a d b d a b c
21. 22. 23. S 24. S 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. S 36.
Elements of the income statement. Usefulness of the income statement. Limitations of the income statement. Use of an income statement. Income statement reporting. Income statement information. Example of managing earnings down. Example of managing earnings up. Improving current net income. Decreasing current net income. Single-step income statement advantage. Single-step income statement. Methods of preparing income statements. Income statement presentation. Event with no income statement effect. Net income effect.
4-2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer b b a d d a d a d d c c c d d c d d c d d c d c d d b c b a d c c
No.
Description
P
Selling expenses. Reporting merchandise inventory. Definition of an extraordinary item. 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. Intraperiod tax allocation. Reporting items net of tax. Reporting items at gross amount. Earnings per share disclosure. EPS disclosures on income statement. EPS disclosures on income statement. Earnings per share disclosure. Reporting correction of an error. Retained earnings statement. Prior period adjustment. Identification of a prior period adjustment. Reporting EPS amounts. Reporting EPS on financial statements. Comprehensive income inclusion. Displaying comprehensive income. Comprehensive income disclosure method. Comprehensive income items. Providing information about components of comprehensive income.
37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. S 49. 50. 51. 52. 53. 54. 55. 56. 57. S 58. P 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. P
MULTIPLE CHOICE—Computational Answer
No.
Description
a c a c c c a a a a c
70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80.
Calculate total revenues. Calculate total expenses. Single-step income statement. Multiple-step income statement. Multiple-step income statement. Calculation of net sales. Presentation of gain on sale of plant assets. Extraordinary items. Extraordinary items. Calculate income before extraordinary items. Calculate income before taxes and extraordinary items.
Income Statement and Related Information
MULTIPLE CHOICE—Computational (cont.) b a b c c c b a a b d d c c a b c d d d a c c a P S
81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104.
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. Tax effect on irregular items. Calculate income tax expense. Calculate income tax expense. Calculate income tax expense. Calculate earnings per share. Calculate EPS for extraordinary loss. Calculate earnings per share. Earnings per share. Earnings per share. Retained earnings statement. Retained earnings statement. Retained earnings statement. Retained earnings statement. Calculate balance of retained earnings. Calculate other comprehensive income. Calculate comprehensive income. Calculate ending Accumulated Other Comprehensive Income. Calculate ending Retained Earnings balance. Calculate total stockholders' equity.
Note: these questions also appear in the Problem-Solving Survival Guide. Note: these questions also appear in the Study Guide.
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
d a a a d c a b a b
105. 106. 107. 108. 109. 110. 111. 112. 113. 114.
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.
4-3
4-4
Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Item
Description
E4-115 E4-116 E4-117 E4-118 E4-119 E4-120 E4-121 E4-122 E4-123
Definitions. Terminology. Income statement disclosures. 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.
PROBLEMS Item
Description
P4-124 P4-125 P4-126 P4-127 P4-128 P4-129
Multiple-step income statement. Income statement form. Multiple-step income statement. Single-step income statement. Income statement and retained earnings statement. Irregular items and financial statements.
CHAPTER LEARNING OBJECTIVES 1.
Understand the uses and limitations of an income statement.
2.
Prepare a single-step income statement.
3.
Prepare a multiple-step income statement.
4.
Explain how to report irregular items.
5.
Explain intraperiod tax allocation.
6.
Identify where to report earnings per share information.
7.
Prepare a retained earnings statement.
8.
Explain how to report other comprehensive income.
Income Statement and Related Information
4-5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2. 3.
TF TF TF
4. 21. 22.
TF MC MC
5. 6.
TF TF
31. 32.
MC MC
7. 8. 9. 33.
TF TF TF MC
34. 35. S 36. P 37.
MC MC MC MC
P
10. 11. 12. 13. 39. 40.
TF TF TF TF MC MC
41. 42. 43. 44. 45. 46.
MC MC MC MC MC MC
47. 48. S 49. 77. 78. 79.
14. 50. 51.
TF MC MC
52. 53. 54.
MC MC MC
85. 86. 87.
15. 16. 47.
TF TF MC
55. 56. 57.
MC MC MC
17. 18. P 59.
TF TF MC
60. 61. 62.
MC MC MC
63. 64. 95.
19. 20.
TF TF
65. 66.
MC MC
67. 68.
Note:
23. 24. S 25. S
70. 71.
S
TF = True-False MC = Multiple Choice
38. 73. 74. 75.
58. 90. 91.
Type
Item
Type
Item
Learning Objective 1 MC 26. MC 29. MC 27. MC 30. MC 28. MC 115. Learning Objective 2 MC 72. MC MC 127. P Learning Objective 3 MC 76. MC 108. MC 105. MC 109. MC 106. MC 110. MC 107. MC 120. Learning Objective 4 MC 80. MC 110. MC 81. MC 111. MC 82. MC 112. MC 83. MC 113. MC 84. MC 115. MC 108. MC 116. Learning Objective 5 MC 88. MC 124. MC 89. MC 125. MC 116. E 126. Learning Objective 6 MC 92. MC 115. MC 93. MC 124. MC 94. MC 126. Learning Objective 7 MC 96. MC 99. MC 97. MC 114. MC 98. MC 115. Learning Objective 8 MC 69. MC 101. MC 100. MC 102.
E = Exercise P = Problem
Type
Item
Type
Item
Type
MC MC E
116. 117. 118.
E E E
119.
E
MC MC MC E
121. 122. 123. 124.
E E E P
126. 128.
P P
MC MC MC MC E E
123. 124. 125. 126. 127. 128.
E P P P P P
P P P
127. 128.
P P
E P P
127. 128.
P P
MC MC E
116. 123. 127.
E E P
128.
P
MC MC
103. 104.
MC MC
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Test Bank for Intermediate Accounting, Fourteenth Edition
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. Companies frequently report income tax expense as the last item before net income on a single-step income statement. 6. Both revenues and gains increase both net income and owners’ equity. 7. Use of a multiple-step income statement will result in the company reporting a higher net income than if they used a single-step income statement. 8. 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. 9. Gross profit and income from operations are reported on a multiple-step but not a singlestep income statement. 10. The accounting profession has adopted a current operating performance approach to income reporting. 11. Companies report the results of operations of a component of a business that will be disposed of separately from continuing operations. 12. Gains or losses from exchange or translation of foreign currencies are reported as extraordinary items. 13. Discontinued operations, extraordinary items, and unusual gains and losses are all reported net of tax in the income statement. 14. 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. 15. A company that reports a discontinued operation or an extraordinary item has the option of reporting per share amounts for these items. 16. Dividends declared on common and preferred stock are subtracted from net income in the computation of earnings per share.
Income Statement and Related Information
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17. Prior period adjustments can either be added or subtracted in the Retained Earnings Statement. 18. Companies only restrict retained earnings to comply with contractual requirements or current necessity. 19. Comprehensive income includes all changes in equity during a period except those resulting from distributions to owners. 20. The components of other comprehensive income can be reported in a statement of stockholders’ equity.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. T F F T T
Item 6. 7. 8. 9. 10.
Ans. T F F T F
Item 11. 12. 13. 14. 15.
Ans. T F F T F
Item 16. 17. 18. 19. 20.
Ans. F T F F T
MULTIPLE CHOICE—Conceptual
S
21.
The major elements of the income statement are a. revenue, cost of goods sold, selling expenses, and general expense. b. operating section, nonoperating section, discontinued operations, extraordinary items, and cumulative effect. c. revenues, expenses, gains, and losses. d. all of these.
22.
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.
23.
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.
24.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
25.
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.
26.
The income statement information would help in which of the following tasks? a. Evaluate the liquidity of a company. b. Evaluate the solvency of a company c. Estimate future cash flows d. Estimate future financial flexibility
27.
Which of the following is an example of managing earnings down? a. Changing estimated bad debts from 3 percent to 2.5 percent of sales. b. Revising the estimated life of equipment from 10 years to 8 years. c. Not writing off obsolete inventory. d. Reducing research and development expenditures.
28.
Which of the following is an example of managing earnings up? a. Decreasing estimated salvage value of equipment. b. Writing off obsolete inventory. c. Underestimating warranty claims. d. Accruing a contingent liability for an ongoing lawsuit.
29.
What might a manager do during the last quarter of a fiscal year if she wanted to improve current annual net income? a. Increase research and development activities. b. Relax credit policies for customers. c. Delay shipments to customers until after the end of the fiscal year. d. Delay purchases from suppliers until after the end of the fiscal year.
30.
What might a manager do during the last quarter of a fiscal year if she wanted to decrease current annual net income? a. Delay shipments to customers until after the end of the fiscal year. b. Relax credit policies for customers. c. Pay suppliers all amounts owed. d. Delay purchases from suppliers until after the end of the fiscal year.
31.
Which of the following is an advantage of the single-step income statement over the multiple-step income statement? a. It reports gross profit for the year. b. Expenses are classified by function. c. It matches costs and expenses with related revenues. d. It does not imply that one type of revenue or expense has priority over another.
32.
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
S
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33.
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
34.
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
35.
The occurrence which most likely would have no effect on 2012 net income (assuming that all amounts involved are material) is the a. sale in 2012 of an office building contributed by a stockholder in 1983. b. collection in 2012 of a receivable from a customer whose account was written off in 2011 by a charge to the allowance account. c. settlement based on litigation in 2012 of previously unrecognized damages from a serious accident which occurred in 2010. d. worthlessness determined in 2012 of stock purchased on a speculative basis in 2008.
36.
The occurrence that most likely would have no effect on 2012 net income is the a. sale in 2012 of an office building contributed by a stockholder in 1961. b. collection in 2012 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 1996 deemed worthless in 2012.
P
37. Which of the following is not a selling expense? a. Advertising expense b. Office salaries expense c. Freight-out d. Store supplies consumed
P
38.
The accountant for the Lintz Sales Company is preparing the income statement for 2012 and the balance sheet at December 31, 2012. The January 1, 2012 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.
39.
In order to be classified as an extraordinary item in the income statement, an event or transaction should be a. unusual in nature, infrequent, and material in amount. b. unusual in nature and infrequent, but it need not be material. c. infrequent and material in amount, but it need not be unusual in nature. d. unusual in nature and material, but it need not be infrequent.
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Test Bank for Intermediate Accounting, Fourteenth Edition
40.
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.
41.
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.
42.
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.
43.
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.
44.
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.
45.
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
46.
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.
Income Statement and Related Information
S
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47.
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.
48.
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. a prior period adjustment. b. an extraordinary item. c. an amount after continuing operations and before extraordinary items. d. a bulk sale of plant assets included in income from continuing operations.
49.
A material item which is unusual in nature or infrequent in occurrence, but not both should be shown in the income statement a. b. c. d.
Net of Tax No Yes No Yes
Disclosed Separately No Yes Yes No
50.
Income taxes are allocated to a. extraordinary items. b. discontinued operations. c. prior period adjustments. d. all of these.
51.
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.
52.
Companies use intraperiod tax allocation for all of the following items except a. Discontinued operations. b. Extraordinary items. c. Changes in accounting estimates. d. Income from continuing operations.
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Test Bank for Intermediate Accounting, Fourteenth Edition
53.
Which of the following items would be reported net of tax on the face of the income statement? a. Prior period adjustment b. Unusual gain c. Cumulative effect of a change in an accounting principle d. Discontinued operations
54.
Which of the following items would be reported at its gross amount on the face of the income statement? a. Extraordinary loss b. Prior period adjustment c. Cumulative effect of a change in an accounting principle d. Unusual gain
55.
Where must earnings per share be disclosed in the financial statements to satisfy generally accepted accounting principles? a. On the face of the statement of retained earnings (or, statement of stockholders' equity.) b. In the footnotes to the financial statements. c. On the face of the income statement. d. Either (a) or (c).
56.
Which of the following earnings per share figures must be disclosed on the face of the income statement? a. EPS on income from continuing operations. b. The effect on EPS from operations of a discontinued division, net of taxes. c. The effect on EPS from an extraordinary item, net of taxes. d. All of the above.
57.
Which of the following earnings per share figures must be disclosed on the face of the income statement? a. EPS for income before taxes. b. The effect on EPS from unusual items. c. EPS for gross profit. d. EPS for income from continuing operations.
S
58.
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.
P
59.
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
Income Statement and Related Information
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60.
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
61.
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.
62.
Watts 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.
63.
A company is not required to report a per share amount on the face of the income statement for which of the following items? a. Net income b. Prior period adjustment c. Extraordinary item d. Discontinued operations
64.
Earnings per share data are required on the face of which of the following financial statements? a. Statement of retained earnings b. Statement of stockholders' equity c. Income statement d. Balance sheet
65.
Which of the following is included in comprehensive income? a. Investments by owners. b. Unrealized gains on available-for-sale securities. c. Distributions to owners. d. Changes in accounting principles.
66.
Which of the following is not an acceptable way of displaying the components of other comprehensive income? a. Combined statement of retained earnings b. Second income statement c. Combined statement of comprehensive income d. As part of the statement of stockholders' equity
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Test Bank for Intermediate Accounting, Fourteenth Edition
67.
Which disclosure method do most companies use to display the components of other comprehensive income? a. Combined statement of retained earnings b. Second income statement c. Combined statement of comprehensive income d. As part of the statement of stockholders' equity
68.
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.
69.
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.
21. 22. 23. 24. 25. 26. 27.
c d d d d c b
28. 29. 30. 31. 32. 33. 34.
c b a d b d a
35. 36. 37. 38. 39. 40. 41.
b c b b a d d
42. 43. 44. 45. 46. 47. 48.
a d a d d c c
49. 50. 51. 52. 53. 54. 55.
c d d c d d c
56. 57. 58. 59. 60. 61. 62.
d d c d c d d
63. 64. 65. 66. 67. 68. 69.
b c b a d c c
Solution to Multiple Choice question for which the answer is “none of these.” 40. Many answers are possible.
Income Statement and Related Information
MULTIPLE CHOICE—Computational 70.
Ortiz Co. had the following account balances: Sales revenue $ 180,000 Cost of goods sold 90,000 Salaries and wages expense 15,000 Depreciation expense 30,000 Dividend revenue 6,000 Utilities expense 12,000 Rent revenue 30,000 Interest expense 18,000 Sales returns and allow. 16,500 Advertising expense 19,500 What would Ortiz report as total revenues in a single-step income statement? a. b. c. d.
71.
$199,500 $ 15,000 $216,000 $180,000
Ortiz Co. had the following account balances: Sales revenue $ 180,000 Cost of goods sold 90,000 Salaries and wages expense 15,000 Depreciation expense 30,000 Dividend revenue 6,000 Utilities expense 12,000 Rent revenue 30,000 Interest expense 18,000 Sales returns and allow. 16,500 Advertising expense 19,500 What would Ortiz report as total expenses in a single-step income statement? a. b. c. d.
72.
$190,500 $201,000 $184,500 $ 94,500
For Mortenson Company, the following information is available: Cost of goods sold Dividend revenue Income tax expense Operating expenses Sales revenue
$120,000 5,000 12,000 46,000 200,000
In Mortenson’s single-step income statement, gross profit a. should not be reported. b. should be reported at $27,000. c. should be reported at $80,000. d. should be reported at $85,000.
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4 - 16 73.
Test Bank for Intermediate Accounting, Fourteenth Edition For Mortenson Company, the following information is available: Cost of goods sold Dividend revenue Income tax expense Operating expenses Sales revenue
$120,000 5,000 12,000 46,000 200,000
In Mortenson’s multiple-step income statement, gross profit a. should not be reported b. should be reported at $27,000. c. should be reported at $80,000. d. should be reported at $85,000. 74.
For Rondelli Company, the following information is available: Cost of goods sold Dividend revenue Income tax expense Operating expenses Sales revenue
$270,000 12,000 27,000 105,000 450,000
In Rondelli's multiple-step income statement, gross profit a. should not be reported b. should be reported at $60,000. c. should be reported at $180,000. d. should be reported at $192,000. 75.
Gross billings for merchandise sold by Lang Company to its customers last year amounted to $12,720,000; sales returns and allowances were $370,000, sales discounts were $175,000, and freight-out was $140,000. Net sales last year for Lang Company were a. $12,720,000. b. $12,350,000. c. $12,175,000. d. $12,035,000.
76.
If plant assets of a manufacturing company are sold at a gain of $1,640,000 less related taxes of $500,000, and the gain is not considered unusual or infrequent, the income statement for the period would disclose these effects as a. a gain of $1,640,000 and an increase in income tax expense of $500,000. b. operating income net of applicable taxes, $1,140,000. c. a prior period adjustment net of applicable taxes, $1,140,000. d. an extraordinary item net of applicable taxes, $1,140,000.
77.
Manning Company has the following items: write-down of inventories, $360,000; loss on disposal of Sports Division, $555,000; and loss due to strike, $339,000. Ignoring income taxes, what total amount should Manning Company report as extraordinary losses? a. $ -0-. b. $555,000. c. $699,000. d. $894,000.
Income Statement and Related Information
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78.
Garwood Company has the following items: write-down of inventories, $360,000; loss on disposal of Sports Division, $555,000; and loss due to an expropriation, $339,000. Ignoring income taxes, what total amount should Garwood Company report as extraordinary losses? a. $339,000 b. $555,000. c. $699,000. d. $894,000.
79.
An income statement shows “income before income taxes and extraordinary items” in the amount of $2,740,000. The income taxes payable for the year are $1,440,000, including $480,000 that is applicable to an extraordinary gain. Thus, the “income before extraordinary items” is a. $1,780,000. b. $820,000. c. $1,860,000. d. $900,000.
80.
Dole Company, with an applicable income tax rate of 30%, reported net income of $350,000. Included in income for the period was an extraordinary loss from flood damage of $50,000 before deducting the related tax effect. The company's income before income taxes and extraordinary items was a. $400,000. b. $500,000. c. $550,000. d. $385,000.
81.
A review of the December 31, 2012, financial statements of Somer Corporation revealed that under the caption "extraordinary losses," Somer reported a total of $1,030,000. Further analysis revealed that the $1,030,000 in losses was comprised of the following items: (1) Somer recorded a loss of $300,000 incurred in the abandonment of equipment formerly used in the business. (2) In an unusual and infrequent occurrence, a loss of $500,000 was sustained as a result of hurricane damage to a warehouse. (3) During 2012, several factories were shut down during a major strike by employees, resulting in a loss of $170,000. (4) Uncollectible accounts receivable of $60,000 were written off as uncollectible. Ignoring income taxes, what amount of loss should Somer report as extraordinary on its 2012 income statement? a. $300,000. b. $500,000. c. $800,000. d. $1,030,000.
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Test Bank for Intermediate Accounting, Fourteenth Edition
82. At Ruth Company, events and transactions during 2012 included the following. The tax rate for all items is 30%. (1) Depreciation for 2010 was found to be understated by $60,000. (2) A strike by the employees of a supplier resulted in a loss of $50,000. (3) The inventory at December 31, 2010 was overstated by $80,000. (4) A flood destroyed a building that had a book value of $1,000,000. Floods are very uncommon in that area. The effect of these events and transactions on 2012 income from continuing operations net of tax would be a. ($35,000). b. ($77,000). c. ($133,000). d. ($833,000). 83. At Ruth Company, events and transactions during 2012 included the following. The tax rate for all items is 30%. (1) Depreciation for 2010 was found to be understated by $60,000. (2) A strike by the employees of a supplier resulted in a loss of $50,000. (3) The inventory at December 31, 2010 was overstated by $80,000. (4) A flood destroyed a building that had a book value of $1,000,000. Floods are very uncommon in that area. The effect of these events and transactions on 2012 net income net of tax would be a. ($35,000). b. ($735,000). c. ($777,000). d. ($833,000). 84.
During 2012, Lopez Corporation disposed of Pine Division, a major component of its business. Lopez realized a gain of $1,800,000, net of taxes, on the sale of Pine's assets. Pine's operating losses, net of taxes, were $2,100,000 in 2012. How should these facts be reported in Lopez's income statement for 2012?
a. b. c. d. 85.
Total Amount to be Included in Income from Results of Continuing Operations Discontinued Operations $2,100,000 loss $1,800,000 gain 300,000 loss 0 0 300,000 loss 1,800,000 gain 2,100,000 loss
Sandstrom Corporation has an extraordinary loss of $150,000, an unusual gain of $105,000, and a tax rate of 40%. At what amount should Sandstrom report each item? Extraordinary loss a. $(150,000) b. (150,000) c. (90,000) d. (90,000)
Unusual gain $105,000 63,000 105,000 63,000
Income Statement and Related Information 86.
Prophet Corporation has an extraordinary loss of $600,000, an unusual gain of $420,000, and a tax rate of 40%. At what amount should Prophet report each item? a. b. c. d.
87.
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Extraordinary loss $(600,000) (600,000) (360,000) (360,000)
Unusual gain $420,000 252,000 420,000 252,000
Arreaga Corp. has a tax rate of 40 percent and income before non-operating items of $464,000. It also has the following items (gross amounts). Unusual loss Extraordinary loss Gain on disposal of equipment Change in accounting principle increasing prior year's income
$ 74,000 202,000 16,000 106,000
What is the amount of income tax expense Arreaga would report on its income statement? a. $185,600 b. $162,400 c. $198,400 d. $124,000 88.
Palomo Corp has a tax rate of 30 percent and income before non-operating items of $714,000. It also has the following items (gross amounts). Unusual gain Loss from discontinued operations Dividend revenue Income increasing prior period adjustment
$ 46,000 366,000 12,000 148,000
What is the amount of income tax expense Palomo would report on its income statement? a. $231,600 b. $121,800 c. $166,200 d. $217,800 89.
Lantos Company had a 40 percent tax rate. Given the following pre-tax amounts, what would be the income tax expense reported on the face of the income statement? Sales revenue $ 300,000 Cost of goods sold 180,000 Salaries and wages expense 24,000 Depreciation expense 33,000 Dividend revenue 27,000 Utilities expense 3,000 Extraordinary loss 30,000 Interest expense 6,000 a. b. c. d.
$32,400 $20,400 $21,600 $ 9,600
4 - 20 90.
Test Bank for Intermediate Accounting, Fourteenth Edition In 2012, Esther Corporation reported net income of $600,000. It declared and paid preferred stock dividends of $150,000 and common stock dividends of $60,000. During 2012, Esther had a weighted average of 200,000 common shares outstanding. Compute Esther's 2012 earnings per share. a. b. c. d.
91.
In 2012, Linz Corporation reported an extraordinary loss of $1,000,000, net of tax. It declared and paid preferred stock dividends of $100,000 and common stock dividends of $300,000. During 2012, Linz had a weighted average of 400,000 common shares outstanding. Compute the effect of the extraordinary loss, net of tax, on earnings per share. a. b. c. d.
92.
$1.50 $1.75 $2.25 $2.50
In 2012, Benfer Corporation reported net income of $280,000. It declared and paid common stock dividends of $32,000 and had a weighted average of 70,000 common shares outstanding. Compute the earnings per share to the nearest cent. a. b. c. d.
93.
$1.95 $2.25 $3.00 $3.75
$3.54 $2.80 $3.60 $4.00
Benedict Corporation reports the following information: Net income Dividends on common stock Dividends on preferred stock Weighted average common shares outstanding
$750,000 210,000 90,000 100,000
Benedict should report earnings per share of a. $4.50. b. $5.40 c. $6.60. d. $7.50. 94.
Norling Corporation reports the following information: Net income Dividends on common stock Dividends on preferred stock Weighted average common shares outstanding Norling should report earnings per share of a. $2.25. b. $2.70 c. $3.30. d. $3.75.
$750,000 210,000 90,000 200,000
Income Statement and Related Information 95.
Moorman Corporation reports the following information: Correction of understatement of depreciation expense in prior years, net of tax $ 645,000 Dividends declared 480,000 Net income 1,500,000 Retained earnings, 1/1/12, as reported 3,000,000 Moorman should report retained earnings, 1/1/12, as adjusted at a. $2,355,000. b. $3,000,000. c. $3,645,000. d. $4,665,000.
96.
Moorman Corporation reports the following information: Correction of understatement of depreciation expense in prior years, net of tax $ 645,000 Dividends declared 480,000 Net income 1,500,000 Retained earnings, 1/1/12, as reported 3,000,000 Moorman should report retained earnings, 12/31/12, as adjusted at a. $2,355,000. b. $3,375,000. c. $4,020,000. d. $4,665,000.
97.
Leonard 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, 1/1/12, as reported 2,000,000 Leonard should report retained earnings, 1/1/12, as adjusted at a. $1,785,000. b. $2,000,000. c. $2,215,000. d. $2,555,000.
98.
Leonard 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, 1/1/12, as reported 2,000,000 Leonard should report retained earnings, 12/31/12, at a. $1,785,000. b. $2,125,000. c. $2,340,000. d. $2,555,000.
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4 - 22 99.
Test Bank for Intermediate Accounting, Fourteenth Edition The following information was extracted from the accounts of Essex Corporation at December 31, 2012: CR(DR) Total reported income since incorporation $3,400,000 Total cash dividends paid (1,600,000) Unrealized holding loss (240,000) Total stock dividends distributed (400,000) Prior period adjustment, recorded January 1, 2012 150,000 What should be the balance of retained earnings at December 31, 2012? a. $1,310,000. b. $1,400,000. c. $1,160,000. d. $1,550,000.
100.
Madsen Company reported the following information for 2012: Sales revenue Cost of goods sold Operating expenses Unrealized holding gain on available-for-sale securities Cash dividends received on the securities
$1,530,000 1,050,000 165,000 120,000 6,000
For 2012, Madsen would report other comprehensive income of a. $411,000. b. $405,000. c. $126,000. d. $120,000. 101.
Korte Company reported the following information for 2012: Sales revenue Cost of goods sold Operating expenses Unrealized holding gain on available-for-sale securities Cash dividends received on the securities For 2012, Korte would report comprehensive income of a. $351,000. b. $345,000. c. $291,000. d. $60,000.
$1,500,000 1,050,000 165,000 60,000 6,000
Income Statement and Related Information 102.
For the year ended December 31, 2012, Transformers Inc. reported the following: Net income Preferred dividends declared Common dividend declared Unrealized holding loss, net of tax Retained earnings Common stock Accumulated Other Comprehensive Income, Beginning Balance
$120,000 20,000 4,000 2,000 160,000 80,000 10,000
What would Transformers report as its ending balance of Accumulated Other Comprehensive Income? a. b. c. d. 103.
$12,000 $10,000 $8,000 $2,000
For the year ended December 31, 2012, Transformers Inc. reported the following: Net income $120,000 Preferred dividends declared 20,000 Common dividend declared 4,000 Unrealized holding loss, net of tax 2,000 Retained earnings, beginning balance 160,000 Common stock 80,000 Accumulated Other Comprehensive Income, Beginning Balance 10,000 What would Transformers report as the ending balance of Retained Earnings? a. b. c. d.
104.
$278,000 $266,000 $256,000 $254,000
For the year ended December 31, 2012, Transformers Inc. reported the following: Net income $120,000 Preferred dividends declared 20,000 Common dividend declared 4,000 Unrealized holding loss, net of tax 2,000 Retained earnings, beginning balance 160,000 Common stock 80,000 Accumulated Other Comprehensive Income, Beginning Balance 10,000 What would Transformers report as total stockholders' equity? a. b. c. d.
$344,000 $336,000 $256,000 $240,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
70. 71. 72. 73. 74. 75.
a c a c c c
76. 77. 78. 79. 80. 81.
a a a a c b
82. 83. 84. 85. 86. 87.
a b c c c b
88. 89. 90. 91. 92. 93.
a a b d d c
94. 95. 96. 97. 98. 99.
c a b c d d
100. 101 102 103 104
d a c c a
MULTIPLE CHOICE—CPA Adapted 105. Perry Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 2012, 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
$280,000 240,000 150,000 120,000 60,000 360,000 360,000 220,000
One-half of the rented premises is occupied by the sales department. How much of the expenses listed above should be included in Perry's selling expenses for 2012? a. $460,000. b. $610,000. c. $640,000. d. $790,000. 106. Perry Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 2012, 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
$280,000 240,000 150,000 120,000 60,000 360,000 360,000 220,000
One-half of the rented premises is occupied by the sales department.
Income Statement and Related Information
4 - 25
How much of the expenses listed above should be included in Perry's general and administrative expenses for 2012? a. $820,000. b. $880,000. c. $940,000. d. $1,000,000. 107.
Didde Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 2012 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
$210,000 270,000 120,000 105,000 45,000 335,000 330,000 255,000
One-half of the rented premises is occupied by the sales department. Didde's total selling expenses for 2012 are a. $810,000. b. $690,000. c. $645,000. d. $555,000. 108.
The following items were among those that were reported on Dye Co.'s income statement for the year ended December 31, 2012: Legal and audit fees $390,000 Rent for office space 540,000 Interest on inventory floor plan 630,000 Loss on abandoned equipment used in operations 105,000 The office space is used equally by Dye's sales and accounting departments. What amount of the above-listed items should be classified as general and administrative expenses in Dye's multiple-step income statement? a. $660,000. b. $765,000. c. $930,000. d. $1,290,000.
109. Logan Corp.'s trial balance of income statement accounts for the year ended December 31, 2012 included the following: Debit Credit Sales revenue $280,000 Cost of goods sold $100,000 Administrative expenses 50,000 Loss on disposal of equipment 18,000 Sales commission expense 16,000 Interest revenue 10,000 Freight-out 6,000
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Test Bank for Intermediate Accounting, Fourteenth Edition Loss due to earthquake damage Bad debt expense Totals
24,000 6,000 $220,000
$290,000
Other information: Logan's income tax rate is 30%. Finished goods inventory: January 1, 2012 $160,000 December 31, 2012 140,000 On Logan's multiple-step income statement for 2012, Cost of goods manufactured is a. $126,000. b. $120,000. c. $86,000. d. $80,000. 110. Logan Corp.'s trial balance of income statement accounts for the year ended December 31, 2012 included the following: Debit Credit Sales revenue $280,000 Cost of good sold $100,000 Administrative expenses 50,000 Loss on disposal of equipment 18,000 Sales commission expense 16,000 Interest revenue 10,000 Freight-out 6,000 Loss due to earthquake damage 24,000 Bad debt expense 6,000 Totals $220,000 $290,000 Other information: Logan's income tax rate is 30%. Finished goods inventory: January 1, 2012 $160,000 December 31, 2012 140,000 On Logan's multiple-step income statement for 2012, Income before extraordinary item is a. $128,000. b. $94,000. c. $65,800. d. $49,000.
Income Statement and Related Information
4 - 27
111. Logan Corp.'s trial balance of income statement accounts for the year ended December 31, 2012 included the following: Debit Credit Sales $280,000 Cost of sales $100,000 Administrative expenses 50,000 Loss on sale of equipment 18,000 Commissions to salespersons 16,000 Interest revenue 10,000 Freight-out 6,000 Loss due to earthquake damage 24,000 Bad debt expense 6,000 Totals $220,000 $290,000 Other information: Logan's income tax rate is 30%. Finished goods inventory: January 1, 2012 $160,000 December 31, 2012 140,000 On Logan's multiple-step income statement for 2012, Extraordinary loss is a. $16,800. b. $24,000. c. $29,400. d. $42,000. 112.
Chase Corp. had the following infrequent transactions during 2012: A $225,000 gain from selling the only investment Chase has ever owned. A $315,000 gain on the sale of equipment. A $105,000 loss on the write-down of inventories. In its 2012 income statement, what amount should Chase report as total infrequent net gains that are not considered extraordinary? a. $120,000. b. $210,000. c. $435,000. d. $540,000.
113.
James, Inc. incurred the following infrequent losses during 2012: A $140,000 write-down of equipment leased to others. A $80,000 adjustment of accruals on long-term contracts. A $120,000 write-off of obsolete inventory. In its 2012 income statement, what amount should James report as total infrequent losses that are not considered extraordinary? a. $340,000. b. $260,000. c. $220,000. d. $200,000.
4 - 28 114.
Test Bank for Intermediate Accounting, Fourteenth Edition 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.
105. 106.
d a
107. 108.
a a
109. 110.
d c
111. 112.
a b
113. 114.
a b
DERIVATIONS — Computational No.
Answer
70.
a
Derivation $180,000 + $6,000 + $30,000 – $16,500 = $199,500.
71
c
$90,000 + $15,000 + $30,000 + $12,000 + $18,000 + $19,500 = $184,500.
72.
a
73.
c
$200,000 – $120,000 = $80,000.
74.
c
$450,000 – $270,000 = $180,000.
75.
c
$12,720,000 – $370,000 – $175,000 = $12,175,000.
76.
a
77.
a
78.
a
79.
a.
$2,740,000 – ($1,440,000 – $480,000) = $1,780,000.
80.
c
81.
b
$350,000 + ($50,000 × .7) = $385,000 $385,000 ÷ .7 = $550,000. $1,030,000 – $300,000 – $170,000 – $60,000 = $500,000.
82.
a
$50,000 – $15,000 = $35,000.
83.
b
$35,000 + ($1,000,000 × .7) = $735,000.
84.
c
$2,100,000 – $1,800,000 = $300,000.
Income Statement and Related Information
4 - 29
No.
Answer
85.
c
Derivation $150,000 × .60 = $90,000.
86.
c
$600,000 × .60 = $360,000.
87.
b
($464,000 – $74,000 + $16,000) × .40 = $162,400.
88.
a
($714,000 + $46,000 + $12,000) × .30 = $231,600.
89.
a
($300,000 – $180,000 – $24,000 – $33,000 + $27,000 – $3,000 – $6,000) x .40 = $32,400.
90.
b
($600,000 – $150,000) ÷ 200,000 sh. = $2.25.
91.
d
$1,000,000 ÷ 400,000 sh. = $2.50.
92.
d
($280,000) ÷ 70,000 sh. = $4.00.
93.
c
($750,000 – $90,000) ÷ 100,000 = $6.60.
94.
c
($750,000 – $90,000) ÷ 200,000 = $3.30.
95.
a
$3,000,000 – $645,000 = $2,355,000.
96.
b
$3,000,000 – $645,000 + $1,500,000 – $480,000 = $3,375,000.
97.
c
$2,000,000 + $215,000 = $2,215,000.
98.
d
$2,000,000 + $215,000 + $500,000 – $160,000 = $2,555,000.
99.
d
$3,400,000 – $1,600,000 – $400,000 + $150,000 = $1,550,000.
100.
d
Other comprehensive income = $120,000.
101.
a
$1,500,000 – $1,050,000 – $165,000 + $60,000 + $6,000 = $351,000.
102.
c
$10,000 – $2,000 = $8,000.
103.
c
$160,000 + $120,000 - $20,000 – $4,000 = $256,000.
104.
a
($160,000 + $120,000 – $20,000 – $4,000) + $80,000 + ($10,000 –$2,000) = $344,000.
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Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — CPA Adapted No.
Answer
Derivation
105.
d
$240,000 + $150,000 + $220,000 + $180,000 = $790,000.
106.
a
$280,000 + $360,000 + $180,000 = $820,000.
107.
a
$270,000 + $120,000 + $165,000 + $255,000 = $810,000.
108.
a
$390,000 + $270,000 = $660,000.
109.
d
$100,000 + $140,000 – $160,000 = $80,000.
110.
c
$280,000 – $100,000 – $50,000 – $18,000 – $16,000 – $6,000 – $6,000 + $10,000 – $28,200 = $65,800.
111.
a
$24,000 × 0.7 = $16,800.
112.
b
$315,000 – $105,000 = $210,000.
113.
a
$140,000 + $80,000 + $120,000 = $340,000.
114.
b
Conceptual.
Income Statement and Related Information
4 - 31
EXERCISES Ex. 4-115—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 4-115 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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 4-116—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 of 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 4-116 1. 2. 3. 4. 5. 6.
Earnings per share. Comprehensive income. Prior period adjustment. Extraordinary item. Discontinued operations. Intraperiod tax allocation.
Ex. 4-117—Income statement disclosures. What is disclosed in an income statement? Be specific.
Solution 4-117 An income statement discloses revenues, expenses, gains, and losses. It discloses the net income (loss) for a period and earnings per share data. The income statement may also include discontinued operations (net of tax) and extraordinary items (net of tax).
Income Statement and Related Information
4 - 33
Ex. 4-118—Calculation of net income from the change in stockholders' equity. Presented below is certain information pertaining to Edson 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
$250,000 230,000 150,000 80,000 31,000 10,000 13,000
Compute the net income for the year.
Solution 4-118 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 $250,000 150,000 $100,000
December 31
$111,000*
$111,000 100,000 11,000 13,000 (10,000) $ 14,000
*$80,000 + $31,000
Ex. 4-119—Calculation of net income from the change in stockholders' equity. Presented below are changes in the account balances of Wenn 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 62,000 Plant assets (net) 47,000 Paid-in capital 16,000 The only entries in Retained Earnings were for net income and a dividend declaration of $12,000. Compute the net income for the current year.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 4-119 Computation of net income Change in assets ($128,000 – $13,000) Change in liabilities ($34,000 – $20,000) Change in stockholders' equity Add: Dividend declared Less: Investment by stockholders Net income
$115,000 14,000 101,000 12,000 (78,000) $ 35,000
Increase Increase Increase
Ex. 4-120—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. Interest income
Solution 4-120 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.
Income Statement and Related Information
4 - 35
Ex. 4-121—Income statement relationships. Fill in the appropriate blanks for each of the independent situations below. Company A Company B Sales revenue (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 75,300 108,000 Operating expenses (c) _______ 50,000 Income before taxes 6,000 (f) _______
Company C $540,000 90,000 (g) _______ 63,000 417,000 (h) _______ 48,000 (i) _______
Solution 4-121 (a) $251,000 (b) $175,700 (c) $69,300
(d) $87,800 (e) $235,400 (f) $58,000
(g) $390,000 (h) $123,000 (i) $75,000
Ex. 4-122—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 revenue.
(
)
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 4-122 10, 2, 6, 13, 8, 1, 3, 5, 7, 4, 12, 11, 9
4 - 36
Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 4-123—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 _____
1.
The bad debt rate was increased from 1% to 2%, thus increasing bad debt expense.
_____
2.
Obsolete inventory was written off. This was the first loss of this type in the company's history.
_____
3.
An uninsured casualty loss was incurred by the company. This was the first loss of this type in the company's 50-year history.
_____
4.
Recognition of income earned last year which was inadvertently omitted from last year's income statement.
_____
5.
The company sold one of its warehouses at a loss.
_____
6.
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.
_____
7.
A loss incurred from expropriation (the company owned resources in South America which were taken over by a dictator unsympathetic to American business).
_____
8.
The company neglected to record its depreciation in the previous year.
_____
9.
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 4-123 1. a 2. a 3. c
4. d 5. a 6. a
7. c 8. d 9. a
10. a 11. b
Income Statement and Related Information
4 - 37
PROBLEMS Pr. 4-124—Multiple-step income statement. Presented below is information related to Farr Company. Retained earnings, December 31, 2012 Sales revenue 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 2011 (pre-tax) Other revenue Other expenses
$ 650,000 1,400,000 240,000 270,000 33,600 830,000 520,000 120,000 100,000
Instructions Prepare in good form a multiple-step income statement for the year 2013. Assume a 30% tax rate and that 80,000 shares of common stock were outstanding during the year.
Solution 4-124 Farr Company INCOME STATEMENT For the Year Ended December 31, 2013 Sales revenue 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 $81,000 Net income Per share of common stock— Income before extraordinary item Extraordinary item, net of tax Net income
$3.06 (2.36) $ .70
$1,400,000 830,000 570,000 240,000 330,000 120,000 (100,000) 350,000 105,000 245,000 (189,000) $ 56,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 4-125—Income statement form. Wilcox Corporation had income from continuing operations of $750,000 (after taxes) in 2012. In addition, the following information, which has not been considered, is as follows. 1. In 2012, Wilcox experienced an uninsured earthquake loss in the amount of $240,000. 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. Wilcox decided to discontinue its stereo division in 2012. 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 Wilcox Corporation for 2012 starting with "income from continuing operations." Assume that Wilcox's tax rate is 30% and 200,000 shares of common stock were outstanding during the year.
Solution 4-125 Wilcox Corporation Partial Income Statement For the Year Ended December 31, 2012 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 $72,000 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) $750,000 Gain on sale of machinery (after tax) 21,000 Income from cont. operations (adjusted) $771,000
$771,000*
(105,000) 666,000 (168,000) $498,000 $3.86 (.53) 3.33 (.84) $2.49
Income Statement and Related Information
4 - 39
Pr. 4-126—Multiple-step income statement. Shown below is an income statement for 2012 that was prepared by a poorly trained bookkeeper of Howell Corporation. Howell Corporation INCOME STATEMENT December 31, 2012 Sales revenue Investment revenue Cost of merchandise sold Selling expenses Administrative expenses 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
$ 915,000 19,500 (408,500) (145,000) (215,000) (13,000) 153,000 (30,000) (60,000) (27,900) $ 35,100
Instructions Prepare a multiple-step income statement for 2012 for Howell Corporation that is presented in accordance with generally accepted accounting principles (including format and terminology). Howell 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 4-126 Howell Corporation INCOME STATEMENT For the Year Ended December 31, 2012 Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Income from operations Other revenue: Investment revenue
$915,000 408,500 506,500 $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 $18,000 Net income
360,000 146,500 19,500 166,000 13,000 153,000 54,900 98,100 21,000 77,100 42,000 $ 35,100
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Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 4-126 (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
$1.96 (.42) 1.54 (.84) $ .70
Pr. 4-127—Single-step income statement. Presented below is an income statement for Kinder Company for the year ended December 31, 2012. Kinder Company Income Statement For the Year Ended December 31, 2012 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
$800,000 560,000 70,000 20,000 650,000 150,000 45,000 $105,000
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 2012 would have been $24,000 instead of $21,000. 4. Kinder had 20,000 shares of common stock outstanding during 2012. Instructions Using the single-step format, prepare a corrected income statement, including the appropriate per share disclosures.
Income Statement and Related Information
4 - 41
Solution 4-127 Kinder Company Income Statement For the Year Ended December 31, 2012 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 $560,000 63,000 10,000 7,000 640,000 160,000 48,000 112,000 10,000 3,000
$5.60 (.35) $5.25
(7,000) $105,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 4-128—Income statement and retained earnings statement. Porter Corporation's capital structure consists of 50,000 shares of common stock. At December 31, 2012 an analysis of the accounts and discussions with company officials revealed the following information: Sales revenue Purchase discounts Purchases Earthquake loss (net of tax) (extraordinary item) Selling expenses Cash Accounts receivable Common stock Accumulated depreciation-machinery Dividend revenue Inventory, January 1, 2012 Inventory, December 31, 2012 Unearned service revenue Interest payable Land Patents Retained earnings, January 1, 2012 Interest expense Administrative expenses Dividends declared Allowance for doubtful accounts Notes payable (maturity 7/1/15) Machinery Materials Accounts payable
$1,100,000 18,000 692,000 35,000 128,000 60,000 90,000 200,000 180,000 8,000 152,000 125,000 4,400 1,000 370,000 100,000 290,000 17,000 170,000 24,000 5,000 200,000 450,000 40,000 60,000
The amount of income taxes applicable to ordinary income was $27,600, excluding the tax effect of the earthquake loss which amounted to $15,000. Instructions (a) Prepare a multiple-step income statement. (b) Prepare a retained earnings statement.
Income Statement and Related Information
4 - 43
Solution 4-128 Porter Corporation INCOME STATEMENT For the Year Ended December 31, 2012 Sales Cost of goods sold: Inventory, Jan. 1 Purchases Less purchase discounts Net purchases Cost of goods available for sale Less inventory., Dec. 31 Cost of goods sold Gross profit Operating expenses: Selling expenses 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 $15,000 Net income
$1,100,000 $152,000 $692,000 18,000
Per share of common stock— Income before extraordinary item Extraordinary loss, net of tax Net income
674,000 826,000 125,000 701,000 399,000 128,000 170,000 298,000 101,000 8,000 (17,000)
(9,000) 92,000 27,600 64,400
$
(35,000) 29,400
$1.29 (.70) $ .59
Porter Corporation RETAINED EARNINGS STATEMENT For the Year Ended December 31, 2012 Retained earnings, January 1, 2012 Add: Net income Deduct: Dividends declared Retained earnings, December 31, 2012
$290,000 $29,400 24,000
5,400 $295,400
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Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 4-129—Irregular items and financial statements. The accountant preparing the income statement for Bakersfield, Inc. had some doubts about the appropriate accounting treatment of the seven items listed below during the fiscal year ending December 31, 2012. Assume a tax rate of 40 percent. 1.
The corporation experienced an uninsured flood loss of $70,000 before taxes. While this loss meets the criteria of an extraordinary item, it has not been recorded.
2.
The corporation disposed of its sporting goods division during 2012. This disposal meets the criteria for discontinued operations. The division correctly calculated income from operating this division of $110,000 before taxes and a loss of $12,000 before taxes on the disposal of the division. All of these events occurred in 2012 and have not been recorded.
3.
The company recorded advances of $10,000 to employees made December 31, 2012 as Salaries and wages Expense.
4.
Dividends of $10,000 during 2012 were recorded as an operating expense.
5.
In 2012, Bakersfield changed its method of accounting for inventory from the first-in-firstout method to the average cost method. Inventory in 2012 was correctly recorded using the average cost method. The new inventory method would have resulted in an additional $115,000 of cost of goods sold (before taxes) being reported on prior years' income statement.
6.
Office equipment purchased January 1, 2012 for $45,000 was incorrectly charged to Supplies Expense at the time of purchase. The office equipment has an estimated threeyear service life with no expected salvage value. Bakersfield uses the straight-line method to depreciate office equipment for financial reporting purposes. This error has not been recorded.
7.
On January 1, 2008, Bakersfield bought a building that cost $85,000, had an estimated useful life of ten years, and had a salvage value of $5,000. Bakersfield uses the straight-line depreciation method to depreciate the building. In 2012, it was estimated that the remaining useful life was eight years and the salvage value was zero. Depreciation expense reported on the 2012 income statement was correctly calculated based on the new estimates. No adjustment for prior years' depreciation estimates was made. Part A. For each item, record corrections to income from continuing operations before taxes, if any. Denote any negative numbers by using brackets < >.
Income Statement and Related Information
4 - 45
Solution 4-129 Number Item
Description
Increase <Decrease> to Income from Continuing Operations
1
Extraordinary items reported after Income from Continuing Operations (ICO)
No Effect
2
Discontinued Items reported after ICO
No Effect
3
Correct with Dr: Prepaid Salary
$10,000
Cr: Salaries/ wages Expense 4
Dividends are not reported on the Income Statement; should be on R/E Statement.
$10,000
5
Change in inventory method: Current year reported correctly on income statement, need to adjust beginning R/E.
No Effect
6
To correct, need to put back all $45,000 of equipment into Equipment account and take out of Supplies Expense account. Also take depreciation of $15,000 for the year. Net effect is to increase income by $30,000.
$30,000
7
Current year is correct. Change in estimate does not need retroactive action.
No Effect
4 - 46
Test Bank for Intermediate Accounting, Fourteenth Edition Part B. At January 1, 2010, Bakersfield, Inc.'s retained earnings balance was $200,000. Assume that income from continuing operations (before taxes) and after correctly considering any of the seven additional items was $1,200,000. Prepare the income statement and retained earnings statement. Denote negative numbers by using brackets < >. Do not disclose earnings per share data. Bakersfield Incorporated Partial Income Statement For the Year Ending December 31, 2012 Income from continuing operations before income taxes
1,200,000
Less: Income tax expense ($1,200,000 × 40%)
<480,000>
Income from continuing operations
720,000
Discontinued operations Add: Income from discontinued operations, net of tax ($110,000 × .6)
66,000
Less: Loss on disposal of discontinued operations, net of tax ($12,000 × .6)
<7,200>
Income before extraordinary item Less: Loss due to extraordinary item, net of tax
778,800 <42,000>
($70,000 × .6) Net income
736,800
Bakersfield Incorporated Retained Earnings Statement For the Year Ending December 31, 2012 Beginning Retained earnings as of January 1, 2012
200,000
Adjustment for change in inventory method
<69,000>
($115,000 × .6) Beginning Retained earnings adjusted
131,000
Add: Net Income
736,800
Less: Dividends
<10,000>
Ending Retained earnings
857,800
Income Statement and Related Information
4 - 47
IFRS QUESTIONS True/False 1. Both U.S. GAAP and IFRS discuss income statement presentation using either a single-step or multi-step approach. 2. IFRS does not allow gains or losses to be classified as extraordinary items. 3. IFRS allows for revaluation of long-term tangible and intangible assets with the differences impacting equity but not net income. 4. Both IFRS and U.S. GAAP allow for comprehensive income to be reported in either a Statement of Stockholders' Equity or a Statement of Recognized Income and Expense. 5. Under IFRS, a company may classify expenses by function, but must also disclose the classification of expenses by nature. Answers to True/False: 1. 2. 3. 4. 5.
False True True False True
Multiple Choice: 1. The IFRS income statement classification of expenses by nature results in descriptions which include all of the following except a. salaries b. depreciation c. distribution d. utilities 2. U.S. GAAP allows all of the following statement formats to be used for reporting comprehensive income except a. Statement of Recognized Income and Expense b. Single Income Statement c. Combined Income Statement of Comprehensive Income d. Statement of Stockholders' Equity 3. An IFRS SoRIE statement might include all of the following except a. net income or loss b. unrealized gains or losses on the revaluation of long-term assets c. cumulative effect of a change in accounting principle d. extraordinary gain or loss Answers to Multiple Choice: 1. c 2. a 3. d
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Test Bank for Intermediate Accounting, Fourteenth Edition
Short Answer: 1. What are the IFRS requirements with respect to expense classification? 1. Under IFRS expenses must be classified by either nature or function. Classification by nature leads to descriptions such as the following: salaries, depreciation expense, utilities expense and so on. Classification by function leads to descriptions like administration, distribution, and manufacturing. Disclosure by nature is required in the notes to the financial statements if the functional expense method is used on the income statement. There is no U.S. GAAP in this area, except the SEC does require public companies to report their expenses by function. 2. Bradshaw Company experienced a loss that was deemed to be both unusual in nature and infrequent in occurrence. How should Bradshaw report this item in accordance with IFRS? 2. Bradshaw should report this item similar to other unusual gains and losses. While under U.S. GAAP, companies are required to report an item as extraordinary if it is unusual in nature and infrequent in occurrence, extraordinary item reporting is prohibited under IFRS.
CHAPTER 5 BALANCE SHEET AND STATEMENT OF CASH FLOWS IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F T T T F F T F F T T T F T F F F T F F
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
Liquidity and solvency. Limitations of the balance sheet. Definition of financial flexibility. Long-term liability disclosures. Definitions of the balance sheet. Land held for speculation. Balance sheet format. Purpose of statement of cash flows. Statement of cash flows reporting. Financial flexibility. Collection of a loan. Determining cash provided by operating activities. Reporting significant financing and investing activities. Current cash debt coverage ratio. Reporting other comprehensive income. Disclosure of fair values. Disclosure of company operations and estimates. Disclosure of pertinent information. Use of the term reserve. Adjunct account.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
d c b d d c b c d b b d d d d d
21. 22. 23. 24. 25. S 26. S 27. P 28. 29. 30. 31. 32. 33. 34. 35. 36.
Limitation of the balance sheet. Uses of the balance sheet. Use of balance sheet information. Use of balance sheet information. Limitation of the balance sheet. Uses of the balance sheet. Criticisms of the balance sheet. Definition of liquidity. 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.
5-2
Test Bank for Intermediate Accounting, Fourteenth Edition c
37.
Classification of inventory pledged as security.
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
b d b d b d d d d d c d d d d b c d d d d d d b c c c b d d b b c a d b b d c b b
38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. P 50. S 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. S 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. S 77. P 78.
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. Long-term liabilities' disclosure. Balance sheet supplementary disclosure. Disclosure of contractual situations. Disclosure of accounting policies. Contingency reported in financial statement notes. 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. Purpose of the statement of cash flows. Statement of cash flows answers. Statement of cash flows reporting. Statement of cash flows objective. Reporting issuance of stock for machine. Identify a financing activity. Classification of cash receipts. Identify a financing activity. Cash flow from operating activities. Identify an investing activity. Preparing the statement of cash flows. Cash debt coverage ratio. Current cash debt coverage ratio. Financial flexibility measure. Calculation of free cash flow. Description of financial flexibility. Cash debt coverage ratio.
P S
Note: these questions also appear in the Problem-Solving Survival Guide. Note: these questions also appear in the Study Guide.
Balance Sheet and Statement of Cash Flows
MULTIPLE CHOICE—Computational Answer
No.
Description
c a b d a b c c d b b a c c a b a b
79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96.
Classifying investments. Identifying intangible assets Calculate total stockholders’ equity. Classifying investments. Identifying intangible assets. Calculate total stockholders’ equity. Calculate beginning stockholders’ equity. Calculate ending stockholders’ equity. Calculate net income. Calculate ending cash balance. Calculate ending cash balance. Calculate cash provided by operating activities. Cash provided by operating activities. Cash provided by operating activities. Cash debt coverage ratio. Free cash flow. Cash debt coverage ratio. Free cash flow.
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
d d a c b c a d b c
97. 98. 99. 100. 101. 102. 103. 104. 105. 106.
Calculate total current assets. Calculate total current assets. Calculate total current liabilities. Calculate retained earnings balance. Calculate current and long-term liabilities. Classification of investing activity. Classification of operating activity. Classification of financing activity. Classification of investing activity. Summary of significant accounting policies.
EXERCISES Item
Description
E5-107 E5-108 E5-109 E5-110 E5-111 E5-112 E5-113 E5-114 E5-115 E5-116
Definitions. Terminology. Current assets. Account classification. Valuation of balance sheet items. Balance sheet classifications. Balance sheet classifications. Balance sheet classifications. Statement of cash flows. Statement of cash flows ratios.
5-3
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Test Bank for Intermediate Accounting, Fourteenth Edition
PROBLEMS Item
Description
P5-117 P5-118 P5-119 P5-120 P5-121
Balance sheet format. Balance sheet preparation. Balance sheet presentation. Statement of cash flows preparation. Statement of cash flows 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. Indicate the purpose of the statement of cash flows. 5. Identify the content of the statement of cash flows. 6. Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet.
Balance Sheet and Statement of Cash Flows
5-5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2.
TF TF
3. 21.
TF MC
22. 23.
4. 5. 6. 29. 30. 31. 32.
TF TF TF MC MC MC MC
33. 34. 35. 36. 37. 38. 39.
MC MC MC MC MC MC MC
40. 41. 42. 43. 44. 45. 46.
7.
TF
50.
MC
85.
8.
TF
9.
TF
51.
10. 11. 55.
TF TF MC
56. 57. 58.
MC MC MC
59. 60. 88.
12.
TF
13.
TF
61.
14. 15.
TF TF
62. 63.
MC MC
64. 65.
16. 17. S 68.
TF TF MC
69. 70. 71.
MC MC MC
72. 73. 106.
18. 19.
TF TF
20. 74.
TF MC
75. 76.
Note:
P
TF = True-False MC = Multiple Choice
Type
Item
Type
Item
Learning Objective 1 S MC 24. MC 26. S MC 25. MC 27. Learning Objective 2 MC 47. MC 83. MC 48. MC 84. MC 49. MC 97. MC 79. MC 98. MC 80. MC 99. MC 81. MC 100. MC 82. MC 101. Learning Objective 3 MC 86. MC 87. Learning Objective 4 S MC 52. MC 53. Learning Objective 5 MC 89. MC 103. MC 90. MC 104. MC 102. MC 105. Learning Objective 6 MC 91. MC 92. Learning Objective 7 S MC 66. MC 93. S MC 67. MC 94. Learning Objective 8 MC 107. E 112. MC 108. E 114. MC 110. E 117. Learning Objective 9 MC 77. MC MC 78. MC E = Exercise P = Problem
Type
Item
Type
MC MC
P
28.
MC
MC MC MC MC MC MC MC
107. 108. 109. 110. 111. 112. 113.
E E E E E E E
MC
54.
MC
MC MC MC
115.
E
95. 96.
MC MC
Item
Type
114. 117. 118.
E P P
116.
E
MC
MC MC MC E E P
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Test Bank for Intermediate Accounting, Fourteenth Edition
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. Companies frequently describe the terms of all long-term liability agreements in notes to the financial statements. 5. 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. 6. Land held for speculation is reported in the property, plant, and equipment section of the balance sheet. 7. The account form and the report form of the balance sheet are both acceptable under GAAP. 8. The primary purpose of a statement of cash flows is to report the cash effects of operations during a period. 9. The statement of cash flows reports only the cash effects of operations during a period and financing transactions. 10. Financial flexibility is a company’s ability to respond and adapt to financial adversity and unexpected needs and opportunities. 11. Collection of a loan is reported as an investing activity in the statement of cash flows. 12. Companies determine cash provided by operating activities by converting net income on an accrual basis to a cash basis. 13. Significant financing and investing activities that do not affect cash are not reported in the statement of cash flows or any other place. 14. Financial statement readers often assess liquidity by using the current cash debt coverage ratio. 15. Free cash flow is net income less capital expenditures and dividends. 16. Because of the historical cost principle, fair values may not be disclosed in the balance sheet. 17. Companies have the option of disclosing information about the nature of their operations and the use of estimates in preparing financial statements.
Balance Sheet and Statement of Cash Flows
5-7
18. Companies may use parenthetical explanations, notes, cross references, and supporting schedules to disclose pertinent information. 19. The accounting profession has recommended that companies use the word reserve only to describe amounts deducted from assets. 20. On the balance sheet, an adjunct account reduces either an asset, a liability, or an owners’ equity account.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F T T T F
Item 6. 7. 8. 9. 10.
Ans. F T F F T
Item 11. 12. 13. 14. 15.
Ans. T T F T F
Item 16. 17. 18. 19. 20.
Ans. F F T F F
MULTIPLE CHOICE—Conceptual 21.
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
22.
The balance sheet is useful for analyzing all of the following except a. liquidity. b. solvency. c. profitability. d. financial flexibility.
23.
Balance sheet information is useful for all of the following except to a. compute rates of return b. analyze cash inflows and outflows for the period c. evaluate capital structure d. assess future cash flows
24.
Balance sheet information is useful for all of the following except a. assessing a company's risk b. evaluating a company's liquidity c. evaluating a company's financial flexibility d. determining free cash flows.
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Test Bank for Intermediate Accounting, Fourteenth Edition
25.
A limitation of the balance sheet that is not also a limitation of the income statement is a. the use of judgments and estimates b. omitted items c. the numbers are affected by the accounting methods employed d. valuation of items at historical cost
S
26.
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.
S
27.
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.
P
28.
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.
29.
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.
30.
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.
31.
The basis for classifying assets as current or noncurrent is conversion to cash within a. the accounting cycle or one year, whichever is shorter. b. the operating cycle or one year, whichever is longer. c. the accounting cycle or one year, whichever is longer. d. the operating cycle or one year, whichever is shorter.
32.
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.
Balance Sheet and Statement of Cash Flows
5-9
33.
The current assets section of the balance sheet should include a. machinery. b. patents. c. goodwill. d. inventory.
34.
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.
35.
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.
36.
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.
37.
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.
38.
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
39.
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. 1 b. 2 c. 3 d. 1 and 2
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Test Bank for Intermediate Accounting, Fourteenth Edition
40.
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
41.
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.
42.
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.
43.
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.
44.
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
45.
Treasury stock should be reported as a(n) a. current asset. b. investment. c. other asset. d. reduction of stockholders' equity.
46.
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
47.
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
Balance Sheet and Statement of Cash Flows
P
S
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48.
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
49.
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
50.
Which of the following is a contra account? a. Premium on bonds payable b. Unearned revenue c. Patents d. Accumulated depreciation
51.
The financial statement which summarizes operating, investing, and financing activities of an entity for a period of time is the a. retained earnings statement. b. income statement. c. statement of cash flows. d. statement of financial position.
52.
The statement of cash flows provides answers to all of the following questions except a. where did the cash come from during the period? b. what was the cash used for during the period? c. what is the impact of inflation on the cash balance at the end of the year? d. what was the change in the cash balance during the period?
53.
The statement of cash flows reports all of the following except a. the net change in cash for the period. b. the cash effects of operations during the period. c. the free cash flows generated during the period. d. investing transactions.
54.
The statement of cash flows helps meet the objective of financial reporting, which is to assess all of the following except the a. amount of future cash flows. b. source of future cash flows. c. timing of future cash flows. d. uncertainty of future cash flows.
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Test Bank for Intermediate Accounting, Fourteenth Edition
55.
If common stock was issued to acquire an $8,000 machine, how would the transaction appear on the statement of cash flows? a. It would depend on whether you are using the direct or the indirect method. b. It would be a positive $8,000 in the financing section and a negative $8,000 in the investing section. c. It would be a negative $8,000 in the financing section and a positive $8,000 in the investing section. d. It would not appear on the statement of cash flows but rather on a schedule of noncash investing and financing activities.
56.
Which of the following events will appear in the cash flows from financing activities section of the statement of cash flows? a. Cash purchases of equipment. b. Cash purchases of bonds issued by another company. c. Cash received as repayment for funds loaned. d. Cash purchase of treasury stock.
57.
Making and collecting loans and disposing of property, plant, and equipment are a. operating activities. b. investing activities. c. financing activities. d. liquidity activities.
58.
In preparing a statement of cash flows, sale of treasury stock at an amount greater than cost would be classified as a(n) a. operating activity. b. financing activity. c. extraordinary activity. d. investing activity.
59.
In preparing a statement of cash flows, cash flows from operating activities a. are always equal to accrual accounting income. b. are calculated as the difference between revenues and expenses. c. can be calculated by appropriately adding to or deducting from net income those items in the income statement that do not affect cash. d. can be calculated by appropriately adding to or deducting from net income those items in the income statement that do affect cash.
60.
In preparing a statement of cash flows, which of the following transactions would be considered an investing activity? a. Sale of equipment at book value b. Sale of merchandise on credit c. Declaration of a cash dividend d. Issuance of bonds payable at a discount
61.
Preparing the statement of cash flows involves all of the following except determining the a. cash provided by operations. b. cash provided by or used in investing and financing activities. c. change in cash during the period. d. cash collections from customers during the period.
Balance Sheet and Statement of Cash Flows
5 - 13
62.
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.
63.
The current cash debt coverage ratio is often used to assess a. financial flexibility. b. liquidity. c. profitability. d. solvency.
64.
A measure of a company’s financial flexibility 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.
65.
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.
S
66.
One of the benefits of the statement of cash flows is that it helps users evaluate financial flexibility. Which of the following explanations is a description of financial flexibility? a. The nearness to cash of assets and liabilities. b. The firm's ability to respond and adapt to financial adversity and unexpected needs and opportunities. c. The firm's ability to pay its debts as they mature. d. The firm's ability to invest in a number of projects with different objectives and costs.
P
67.
Net cash provided by operating activities divided by average total liabilities equals the a. current cash debt coverage ratio. b. cash debt coverage ratio. c. free cash flow. d. current ratio.
S
68.
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
69.
The presentation of long-term liabilities in the balance sheet should disclose a. maturity dates. b. interest rates. c. conversion rights. d. All of the above.
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Test Bank for Intermediate Accounting, Fourteenth Edition
70.
Which of the following is not a required supplemental disclosure for the balance sheet? a. Contingencies b. Financial forecasts c. Accounting policies d. Contractual situations
71.
Typical contractual situations that are disclosed in the notes to the balance sheet include all of the following except a. debt covenants b. lease obligations c. advertising contracts d. pension obligations
72.
Accounting policies disclosed in the notes to the financial statements typically include all of the following except a. the cost flow assumption used b. the depreciation methods used c. significant estimates made d. significant inventory purchasing policies
73.
Which of the following best exemplifies a contingency that is reported in the notes to the financial statements? a. Losses from potential future lawsuits b. Loss from a lawsuit settled out of court prior to the end of the fiscal year c. Warranty claims on future sales d. Estimated loss from an ongoing lawsuit
74.
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.
75.
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.
76.
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.
77.
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
5 - 15
Balance Sheet and Statement of Cash Flows 78.
A generally accepted account title is a. Prepaid Revenue. b. Appropriation for Contingencies. c Earned Surplus. d. Reserve for Doubtful Accounts.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27. 28. 29.
d c b d d c b c d
30. 31. 32. 33. 34. 35. 36. 37. 38.
b b d d d d d c b
39. 40. 41. 42. 43. 44. 45. 46. 47.
d b d b d d d d d
48. 49. 50. 51. 52. 53. 54. 55. 56.
c d d c c c b d d
57. 58. 59. 60. 61. 62. 63. 64. 65.
b b c a d b b d c
66. 67. 68. 69. 70. 71. 72. 73. 74.
b b d d b c d d d
75. 76. 77. 78.
d d d b
Solutions to those Multiple Choice questions for which the answer is “none of these.” 29. Total assets minus total liabilities. 41. Current assets less current liabilities. 44. Many answers are possible.
MULTIPLE CHOICE—Computational 79.
Fulton Company owns the following investments: Trading securities (fair value) Available-for-sale securities (fair value) Held-to-maturity securities (amortized cost)
$120,000 70,000 94,000
Fulton will report investments in its current assets section of a. $0. b. exactly $120,000. c. $120,000 or an amount greater than $120,000, depending on the circumstances. d. exactly $190,000. 80.
For Grimmett Company, the following information is available: Capitalized leases Trademarks Long-term receivables
$600,000 195,000 225,000
In Grimmett’s balance sheet, intangible assets should be reported at a. $195,000. b. $225,000. c. $795,000. d. $825,000.
5 - 16
Test Bank for Intermediate Accounting, Fourteenth Edition
81.
Houghton Company has the following items: common stock, $900,000; treasury stock, $105,000; deferred taxes, $125,000 and retained earnings, $390,000. What total amount should Houghton Company report as stockholders’ equity? a. $1,060,000. b. $1,185,000. c. $1,310,000. d. $1,395,000.
82.
Kohler Company owns the following investments: Trading securities (fair value) Available-for-sale securities (fair value) Held-to-maturity securities (amortized cost)
$120,000 70,000 94,000
Kohler will report securities in its long-term investments section of a. exactly $190,000. b. exactly $214,000. c. exactly $284,000. d. $164,000 or an amount less than $164,000, depending on the circumstances. 83.
For Randolph Company, the following information is available: Capitalized leases Trademarks Long-term receivables
$560,000 180,000 210,000
In Randolph’s balance sheet, intangible assets should be reported at a. $180,000. b. $210,000. c. $740,000. d. $770,000. 84.
Olmsted Company has the following items: common stock, $900,000; treasury stock, $105,000; deferred taxes, $125,000 and retained earnings, $454,000. What total amount should Olmsted Company report as stockholders’ equity? a. $1,124,000. b. $1,249,000. c. $1,374,000. d. $1,499,000.
85.
Presented below are data for Antwerp Corp. Assets, January 1 Liabilities, January 1 Stockholders' Equity, Jan. 1 Dividends Common Stock Stockholders' Equity, Dec. 31 Net Income Stockholders' Equity at January 1, 2012 is a. $ 504. b. $ 560. c. $ 920. d. $1,424.
2012
2013
$2,600 1,680 ? 560 504 ? 560
$3,360 ? ? 420 448 ? 448
Balance Sheet and Statement of Cash Flows 86.
Presented below are data for Bandkok Corp. Assets, January 1 Liabilities, January 1 Stockholders' Equity, Jan. 1 Dividends Common Stock Stockholders' Equity, Dec. 31 Net Income
2012
2013
$5,400 3,240 ? 1,080 972 ? 1,280
$6,480 ? ? 810 864 ? 864
2013
2014
$4,560 ? ? 570 608 ? 684
? $2,736 2,750 646 650 2,166 ?
Stockholders' Equity at January 1, 2013 is a. $3,332. b. $2,160. c. $2,360. d. $3,440. 87.
Presented below are data for Caracas Corp. Assets, January 1 Liabilities, January 1 Stockholders' Equity, Jan. 1 Dividends Common Stock Stockholders' Equity, Dec. 31 Net Income Net income for 2014 is a. $584 income. b. $584 loss. c. $62 loss. d. $62 income.
88.
Lohmeyer Corporation reports: Cash provided by operating activities Cash used by investing activities Cash provided by financing activities Beginning cash balance What is Lohmeyer’s ending cash balance? a. $250,000. b. $320,000. c. $470,000. d. $540,000.
$220,000 110,000 140,000 70,000
5 - 17
5 - 18 89.
Test Bank for Intermediate Accounting, Fourteenth Edition Keisler Corporation reports: Cash provided by operating activities Cash used by investing activities Cash provided by financing activities Beginning cash balance
$240,000 110,000 140,000 70,000
What is Keisler’s ending cash balance? a. $270,000. b. $340,000. c. $490,000. d. $560,000. 90.
During 2012 the DLD Company had a net income of $55,000. In addition, selected accounts showed the following changes: Accounts Receivable $3,000 increase Accounts Payable 1,000 increase Building 4,000 decrease Depreciation Expense 1,500 increase Bonds Payable 8,000 increase What was the amount of cash provided by operating activities? a. $54,500 b. $55,000 c. $56,500 d. $64,500
91.
Harding Corporation reports the following information: Net income Depreciation expense Increase in accounts receivable
$450,000 140,000 60,000
Harding should report cash provided by operating activities of a. $250,000. b. $370,000. c. $530,000. d. $650,000. 92.
Sauder Corporation reports the following information: Net income Depreciation expense Increase in accounts receivable
$300,000 70,000 30,000
Sauder should report cash provided by operating activities of a. $200,000. b. $260,000. c. $340,000. d. $400,000.
Balance Sheet and Statement of Cash Flows 93.
Packard 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
$235,000 150,000 100,000 60,000 110,000 35,000
Packard’s cash debt coverage ratio is a. 0.94. b. 1.59. c. 2.35. d. 3.92. 94.
Packard 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
$235,000 150,000 100,000 60,000 110,000 35,000
Packard’s free cash flow is a. $50,000. b. $65,000. c. $125,000. d. $175,000. 95.
Pedigo 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 Pedigo’s cash debt coverage ratio is a. 1.10. b. 1.83. c. 2.75. d. 2.50.
$275,000 150,000 100,000 60,000 110,000 35,000
5 - 19
5 - 20 96.
Test Bank for Intermediate Accounting, Fourteenth Edition Pedigo 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 Pedigo free cash flow is a. $50,000. b. $105,000. c. $165,000. d. $215,000.
$275,000 150,000 100,000 60,000 110,000 35,000
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
79. 80. 81. 82.
c a b d
83. 84. 85. 86.
a b c c
87. 88. 89. 90.
d b b a
91. 92. 93. 94.
c c a b
95. 96.
a b
MULTIPLE CHOICE—CPA Adapted 97.
Stine Corp.'s trial balance reflected the following account balances at December 31, 2012: Accounts receivable (net) $24,000 Trading securities 6,000 Accumulated depreciation on equipment and furniture 15,000 Cash 16,000 Inventory 30,000 Equipment 25,000 Patent 4,000 Prepaid expenses 2,000 Land held for future business site 18,000 In Stine's December 31, 2012 balance sheet, the current assets total is a. $95,000. b. $87,000. c. $82,000. d. $78,000.
Balance Sheet and Statement of Cash Flows
5 - 21
Use the following information for questions 98 through 100. The following trial balance of Reese Corp. at December 31, 2012 has been properly adjusted except for the income tax expense adjustment. Reese Corp. Trial Balance December 31, 2012 Dr. Cr. Cash $ 975,000 Accounts receivable (net) 2,695,000 Inventory 2,085,000 Property, plant, and equipment (net) 7,366,000 Accounts payable and accrued liabilities $ 1,801,000 Income taxes payable 654,000 Deferred income tax liability 85,000 Common stock 2,350,000 Additional paid-in capital 3,680,000 Retained earnings, 1/1/12 3,450,000 Net sales and other revenues 13,460,000 Costs and expenses 11,180,000 Income tax expenses 1,179,000 $25,480,000 $25,480,000 Other financial data for the year ended December 31, 2012: •
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, 2014.
•
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 Reese's December 31, 2012 balance sheet, 98.
The current assets total is a. $6,280,000. b. $5,755,000. c. $5,605,000. d. $5,155,000.
99.
The current liabilities total is a. $1,950,000. b. $2,015,000. c. $2,475,000. d. $2,540,000.
100.
The final retained earnings balance is a. $4,551,000. b. $4,636,000. c. $5,076,000. d. $5,005,000.
5 - 22 101.
Test Bank for Intermediate Accounting, Fourteenth Edition On January 4, 2012, Kiley Co. leased a building to Dodd Corp. for a ten-year term at an annual rental of $100,000. At inception of the lease, Dodd received $400,000 covering the first two years' rent of $200,000 and a security deposit of $200,000. This deposit will not be returned to Dodd 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 $400,000 should be shown as a current and long-term liability in Kiley's December 31, 2012 balance sheet? a. b. c. d.
Current Liability $0 $100,000 $200,000 $200,000
Long-term Liability $400,000 $200,000 $200,000 $100,000
102.
In a statement of cash flows, receipts from sales of property, plant, and equipment and other productive assets should generally be classified as cash inflows from a. operating activities. b. financing activities. c. investing activities. d. selling activities.
103.
In a statement of cash flows, interest payments to lenders and other creditors should be classified as cash outflows for a. operating activities. b. borrowing activities. c. lending activities. d. financing activities.
104.
In a statement of cash flows, proceeds from issuing equity instruments should be classified as cash inflows from a. lending activities. b. operating activities. c. investing activities. d. financing activities.
105.
In a statement of cash flows, payments to acquire debt instruments of other entities (other than cash equivalents) should be classified as cash outflows for a. operating activities. b. investing activities. c. financing activities. d. lending activities.
106.
Which of the following facts concerning fixed assets should be included in the summary of significant accounting policies? a. b. c. d.
Depreciation Method No Yes Yes No
Composition Yes Yes No No
Balance Sheet and Statement of Cash Flows
5 - 23
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
97. 98.
d d
99. 100.
a c
101. 102.
b c
103. 104.
a d
105. 106.
b c
DERIVATIONS — Computational No.
Answer
Derivation
79.
c
80.
a
81.
b
82.
d
83.
a
84.
b
$900,000 – $105,000 + $454,000 = $1,249,000.
85.
c
$2,600 – $1,680 = $920.
86.
c
($5,400 – $3,240) + $1,280 – $1,080 = $2,360.
87.
d
$2,166 + $646 – $2,750 = ($62).
88.
b
$70,000 + $220,000 – $110,000 + $140,000 = $320,000.
89.
b
$70,000 + $240,000 – $110,000 + $140,000 = $340,000.
90.
a
$55,000 – $3,000 + $1,000 + $1,500 = $54,500.
91.
c
$450,000 + $140,000 – $60,000 = $530,000.
92.
c
$300,000 + $70,000 – $30,000 = $340,000.
93.
a
$235,000 ÷ ($150,000 + $100,000) = 0.94.
94.
b
$235,000 – $60,000 – $110,000 = $65,000.
95.
a
$275,000 ÷ ($150,000 + $100,000) = 1.10.
96.
b
$275,000 – $60,000 – $110,000 = $105,000.
$900,000 – $105,000 + $390,000 = $1,185,000.
DERIVATIONS — CPA Adapted No.
Answer
Derivation
97.
d
$24,000 + $6,000 + $16,000 + $30,000 + $2,000 = $78,000.
98.
d
$975,000 + [$2,695,000 – ($150,000 × 4)] + $2,085,000 = $5,155,000.
99.
a
$1,801,000 + ($654,000 – $525,000) + $20,000 = $1,950,000.
100.
c
$3,450,000 + $13,460,000 – $11,180,000 – ($1,179,000 – $525,000) = $5,076,000.
101.
b
Conceptual.
102.
c
Conceptual.
5 - 24
Test Bank for Intermediate Accounting, Fourteenth Edition
No.
Answer
Derivation
103.
a
Conceptual.
104.
d
Conceptual.
105.
b
Conceptual.
106.
c
Conceptual.
EXERCISES Ex. 5-107—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?
Solution 5-107 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.
Balance Sheet and Statement of Cash Flows
5 - 25
Ex. 5-108—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. __________________________________
Solution 5-108 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. 5-109—Current assets. Define current assets without using the word "asset."
Solution 5-109 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.
5 - 26
Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 5-110—Account classification. a. b. c. d. e.
ASSETS Current assets Investments Plant and equipment Intangibles Other assets
f. g. h. i. j. k. l.
LIABILITIES AND CAPITAL Current liabilities Long-term liabilities Preferred stock Common stock Additional paid-in capital Retained earnings 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 dividend distributable ____ 3. Appropriation for plant expansion ____ 4. Bank overdraft ____ 5. Bonds payable (due 2015) ____ 6. Premium on common stock ____ 7. Securities owned by another company which are collateral for that company's note ____ 8. Equity investments (trading) ____ 9. Inventory ____ 10. Discount on bonds payable ____ 11. Patents ____ 12. Unearned revenue Solution 5-110 1. 2. 3. 4.
b i k f
5. 6. 7. 8.
g j l a
9. 10. 11. 12.
a g d f
Balance Sheet and Statement of Cash Flows
5 - 27
Ex. 5-111—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. Accounts receivable
____ 12. Equity investments (trading)
____
6. Copyrights
____ 13. Accounts payable
____
7. 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
j.
Original cost less accumulated depreciation
k. Historical cost l.
Unexpired or unconsumed cost
Solution 5-111 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
5 - 28
Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 5-112—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, 2012. 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 2015 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 ____ 10. Unamortized discount on bonds payable due 2015 ____ 11. Common stock at par value ____ 12. Bond indenture covenants
____ 24. Investment in subsidiary; no plans to sell in near future ____ 25. Accounts payable ____ 26.
Preferred stock ($10 par)
____ 27.
Prepaid rent
____ 28. Copyright
____ 13. Unamortized premium on bonds payable due in 2016
____ 29. Accumulated amortization, patents
____ 14. Allowance for doubtful accounts
____ 30. Earnings not distributed to stockholders
____ 15. Accumulated depreciation— equipment
5 - 29
Balance Sheet and Statement of Cash Flows Solution 5-112 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. 5-113—Balance sheet classifications. The various classifications listed below have been used in the past by Maris 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 short-term 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.
5 - 30
Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 5-113 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. 5-114—Balance sheet classifications. The various classifications listed below have been used in the past by Hale 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, 2012. If an item is not reported on the December 31, 2012 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 2013. ____ 4. Accumulated depreciation—equipment. ____ 5. Appropriation for plant expansion. ____ 6. Amortization of patents for 2012. ____ 7. On December 31, 2012, Hale 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, 2015. ____ 9. Launching of Hale’s Internet retailing division in February, 2013. ____ 10. Cash dividends declared on December 15, 2012 payable to stockholders on January 15, 2013.
Balance Sheet and Statement of Cash Flows
5 - 31
Solution 5-114 1. e 2. b 3. x
4. 5. 6.
(c) h x
7. 8. 9.
x (f) x
10.
e
Ex. 5-115—Statement of cash flows. For each event listed below, select the appropriate category which describes the effect of the event on a statement of cash flows: a. Cash provided/used by operating activities. b. Cash provided/used by investing activities. c. Cash provided/used by financing activities. d. Not a cash flow. ____ 1. Payment on long-term debt ____ 2. Issuance of bonds at a premium ____ 3. Collection of accounts receivable ____ 4. Cash dividends declared ____ 5. Issuance of stock to acquire land ____ 6. Sale of available-for-sale securities (long-term) ____ 7. Payment of employees' wages ____ 8. Issuance of common stock for cash ____ 9. Payment of income tax payable ____ 10. Purchase of equipment ____ 11. Purchase of treasury stock (common) ____ 12. Sale of real estate held as a long-term investment
Solution 5-115 1. c 2. c 3. a
4. 5. 6.
d d b
7. 8. 9.
a c a
10. 11. 12.
b c b
5 - 32
Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 5-116—Statement of cash flows ratios. Financial statements for Hilton Company are presented below: Hilton Company Balance Sheet December 31, 2012 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 65,000 Retained earnings 60,000 $195,000
Hilton Company Statement of Cash Flows For the Year Ended December 31, 2012 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
$60,000
$(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) 30,000
Net increase in cash Cash, January 1, 2012 Cash, December 31, 2012
3,000 63,000
(61,000)
15,000 17,000 23,000 $40,000
At the beginning of 2012, Accounts Payable amounted to $12,000 and Bonds Payable was $20,000. Instructions Calculate the following for Hilton Company: a. Current cash debt coverage ratio b. Cash debt coverage ratio c. Free cash flow
Balance Sheet and Statement of Cash Flows Solution 5-116 Net cash provided by operating activities a. Current cash debt coverage ratio = —————————————————— Average current liabilities $63,000 $63,000 = ——————————— = ———— = 3.9 : 1 ($12,000 + $20,000) ÷ 2 $16,000 Net cash provided by operating activities b. Cash debt coverage ratio = —————————————————— Average total liabilities $63,000 $63,000 = ——————————— = ———— = 1.2 : 1 ($32,000 + $70,000) ÷ 2 $51,000 c. Free cash flow = Net cash provided by operating activities – capital expenditures and dividends = $63,000 – *$73,000 – $15,000 = $(25,000) *$25,000 + $48,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
PROBLEMS Pr. 5-117—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. Jasper Industries, Inc. Balance Sheet For the Period Ended 12/31/12 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 tax payable 42,000 Sales tax payable 17,000 $ 242,000 Long-Term Liabilities, 5% debenture bonds, due 2015 500,000 Reserve for contingencies 150,000 650,000 TOTAL LIABILITIES 892,000 Equity Capital stock, $10 par value, issued 12,000 shares with 60 shares held as treasury stock $150,000 Capital surplus 90,000 Dividends paid (20,000) Earned surplus 123,000 TOTAL EQUITY 343,000 TOTAL LIABILITIES AND EQUITY $1,235,000
Balance Sheet and Statement of Cash Flows
5 - 35
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 5-117 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. 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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 5-118—Balance sheet presentation. The following balance sheet was prepared by the bookkeeper for Kraus Company as of December 31, 2012. Kraus Company Balance Sheet as of December 31, 2012 Cash Accounts receivable (net) Inventory Investments Equipment (net) Patents
$ 85,000 52,200 57,000 76,300 106,000 32,000 $408,500
Accounts payable Long-term liabilities Stockholders' equity
$ 90,000 100,000 218,500
$408,500
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. Inventory does 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.)
Balance Sheet and Statement of Cash Flows
5 - 37
Solution 5-118 Kraus Company Balance Sheet As of December 31, 2012 Assets Current assets Cash Trading securities Accounts receivable Less: Allowance for doubtful accounts Inventories *Equipment held for sale Total current assets
$ 78,100 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
145,000 40,000
Intangible assets Patents Franchises Total assets
32,000 9,000
(1)
(2) 53,200 60,000 1,000 211,300
(3) (4)
57,700
(5) 105,000
41,000 $415,000
Liabilities and Stockholders' Equity Current liabilities Accounts payable Bank overdraft Total current liabilities
$ 94,000 2,500 96,500
Long-term liabilities Total liabilities
100,000 196,500
Stockholders' equity Total liabilities and stockholders' equity
218,500 $415,000
(1) ($85,000 – $9,400 + $2,500) (2) ($60,000 – $3,000) (3) ($57,000 + $3,000) (4) ($5,000 – $4,000) (5) ($106,000 + $40,000 – $5,000 + $4,000) (6) ($90,000 + $4,000) *An alternative is to show it as an other asset.
(6)
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Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 5-119—Balance sheet presentation. Given the following account information for Leong Corporation, prepare a balance sheet in report form for the company as of December 31, 2012. All accounts have normal balances. Equipment Interest Expense Interest Payable Retained Earnings Dividends Land Inventory Bonds Payable Notes Payable (due in 6 months) Common Stock Accumulated Depreciation - Equip. Prepaid Advertising Revenue Buildings Supplies Taxes Payable Utilities Expense Advertising Expense Salaries and Wages Expense Salaries and Wages Payable Accumulated Depr. - Bld. Cash Depreciation Expense
50,000 2,400 600 ? 50,400 137,320 102,000 78,000 19,400 60,000 10,000 5,000 341,400 80,400 1,860 3,000 1,320 1,560 53,040 900 15,000 35,000 8,000
Balance Sheet and Statement of Cash Flows
5 - 39
Solution 5-119 Leong Corporation Balance Sheet December 31, 2012 Assets Cash Inventory Supplies Prepaid advertising Total current assets Land Building Accumulated depreciation - bld Equipment Accumulated depreciation -eq Total assets Liabilities & Stockholders' Equity Notes payable Taxes payable Salaries and Wages payable Interest payable Total current liabilities Long-term liabilities Bond payable Total liabilities Common stock Retained earnings ($275,080*- $50,400) Total stockholders' equity Total liabilities & stockholders' equity
*$341,400 - $53,040 - $8,000 - $2,400 - $1,560 - $1,320
$ 35,000 102,000 1,860 5,000 $ 143,860 137,320 $ 80,400 (15,000) 50,000 (10,000)
65,400 40,000
242,720 $ 386,580
$ 19,400 3,000 900 600 $ 23,900 78,000 101,900 60,000 224,680 284,680 $ 386,580
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Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 5-120—Statement of cash flows preparation. Selected financial statement information and additional data for Stanislaus Co. is presented below. Prepare a statement of cash flows for the year ending December 31, 2012 December 31 2011
2012
Cash ...................................................... $42,000 Accounts receivable (net) ...................... 84,000 Inventory ................................................ 168,000 Land ...................................................... 58,800 Equipment ............................................. 504,000 TOTAL ....................................... $856,800
$75,000 144,200 201,600 16,000 789,600 $1,226,400
Accumulated depreciation ...................... $84,000 Accounts payable .................................. 50,400 Notes payable - Short-term .................... 67,200 Notes payable - Long-term .................... 168,000 Common stock ....................................... 420,000 Retained earnings.................................. 67,200 TOTAL ....................................... $856,800
$115,600 86,000 29,400 302,400 487,200 205,800 $1,226,400
Additional data for 2012: 1. Net income was $240,200. 2. Depreciation was $31,600. 3. Land was sold at its original cost. 4. Dividends of $101,600 were paid. 5. Equipment was purchased for $84,000 cash. 6. A long-term note for $201,600 was used to pay for an equipment purchase. 7. Common stock was issued to pay a $67,200 long-term note payable.
Balance Sheet and Statement of Cash Flows Solution 5-120 Stanislaus Co. Statement of Cash Flows For the year ended December 31, 2012 Net Income Cash flow from operating activities Depreciation expense Increase in accounts receivable Increase in inventory Increase in accounts payable Decrease in short-term notes payable Net cash provided by operating activities Cash flow from investing activities Purchase equipment Sale of land Net cash used by investing activities Cash flow from financing activities Payment of cash dividend Net cash used by financing activities Net increase in cash Cash at beginning of year Cash at end of the year
$240,200 31,600 (60,200) (33,600) 35,600 (37,800)
(64,400) 175,800
(84,000) 42,800 (41,200)
(101,600) (101,600) 33,000 42,000 75,000
Noncash investing and financing activities Payment of long-term note payable with issuance of $67,200 of common stock Payment for equipment with issuance of $201,600 long-term note
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Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 5-121—Statement of cash flows preparation. Selected financial statement information and additional data for Johnston Enterprises is presented below. Prepare a statement of cash flows for the year ending December 31, 2012 Johnston Enterprises Balance Sheet and Income Statement Data December 31, 2012 Current Assets: Cash Accounts Receivable Inventory Total Current Assets
December 31, 2011___
$163,000 228,000 391,000 782,000
$119,000 306,000 340,000 765,000
1,241,000 (476,000) $1,547,000
1,122,000 (442,000) $1,445,000
Current Liabilities: Accounts Payable Notes Payable Income Tax Payable Total Current Liabilities
$177,000 51,000 85,000 313,000
$102,000 68,000 76,500 246,500
Bonds Payable Total Liabilities
350,000 663,000
391,000 637,500
510,000 374,000 884,000 $1,547,000
467,500 340,000 807,500 $1,445,000
1,615,000 731,000 884,000
$1,513,000 731,000 782,000
153,000 391,000 34,000 12,000 294,000 118,000 $176,000
136,000 357,000 34,000 0 255,000 102,000 $153,000
Property, Plant, and Equipment Less: Accumulated Depreciation Total Assets
Stockholders' Equity: Common Stock Retained Earnings Total Stockholders' Equity Total Liabilities & Stockholders' Equity Sales Less Cost of Goods Sold Gross Profit Expenses: Depreciation Expense Salary Expense Interest Expense Loss on Sale of Equipment Income Before Taxes Less Income Tax Expense Net Income
Additional Information: During the year, Johnston sold equipment with an original cost of $153,000 and accumulated depreciation of $119,000 and purchased new equipment for $272,000.
Balance Sheet and Statement of Cash Flows Solution 5-121 Johnston Enterprises Statement of Cash Flows For the Year Ended December 31, 2012 Net Income
$ 176,000
Cash flow from operating activities Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Increase in accounts payable Decrease in notes payable Increase in tax payable Net cash provided by operating activities
153,000 12,000 78,000 (51,000) 75,000 (17,000) 8,500
Cash flow from investing activities Sale of equipment Purchase of equipment Net cash used by investing activities
22,000 (272,000)
Cash flow from financing activities Retirement of bonds payable Issuance of common stock Payment of dividends Net cash used by financing activities
(41,000) 42,500 (142,000)**
258,500 434,500
(250,000)
Net increase in cash Beginning cash Cash at end of year **Beginning R/E + Net income − Dividends = Ending R/E $340,000 + $176,000 − Dividends = $374,000 Dividends = $142,000
(140,500) 44,000 119,000 $163,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS True/False: 1. Although the presentation formats for the balance sheet and statement of cash flows are similar under IFRS and U.S. GAAP, IFRS requires far more extensive disclosure. 2. One significant difference between a balance sheet prepared using IFRS rather than U.S. GAAP is that long-term tangible assets will be reported at fair value rather than historical cost. 3. Both IFRS and U.S. GAAP require that specific items be reported on the balance sheet. 4. Both IFRS and U.S. GAAP require current assets to be listed first on the balance sheet. Answers to True/False: 1. False 2. True 3. False 4. False Multiple Choice Questions: 1. Which of the following statements about IFRS and U.S. GAAP accounting and reporting requirements for the balance sheet is not correct? a. The presentation formats required by IFRS and U.S. GAAP for the balance sheet are similar. b. One difference between the reporting requirements under IFRS and those of U.S. GAAP balance sheet is that an IFRS balance sheet may list long-term assets first. c. Both IFRS and U.S. GAAP require that property, plant and equipment be reported at historical cost on the balance sheet. d. Both IFRS and U.S. GAAP require that comparative information be reported. Use the following information to answer the next two questions. Franco Company uses IFRS and owns property, plant and equipment with a historical cost of 5,000,000 euros. At December 31, 2011, the company reported a valuation reserve of 8,365,000 euros. At December 31, 2012, the property, plant and equipment was appraised at 5,325,000 euros. 2. The property, plant and equipment will be reported on the December 31, 2012 balance sheet at a. 5,000,000 euros. b. 5,325,000 euros. c. 8,365,000 euros. d. 8,690,000 euros. 3. The valuation reserve at December 31, 2012 will be reported at a. 8,040,000 euros on the Statement of Stockholders' Equity. b. 8,365,000 euros in the Assets section of the Balance Sheet c. 8,690,000 euros in the stockholders' equity section of the Balance Sheet. d. 325,000 euros on the Income Statement.
Balance Sheet and Statement of Cash Flows
5 - 45
4. Similarities between IFRS and U.S. GAAP requirements for balance sheet presentation include all of the following except: a. Both require that changes to the valuation reserve be disclosed in the notes to the financial statements. b. Both require disclosure of significant accounting policies. c. Both require the preparation of financial statements annually. d. Both generally require the use of the current/ non-current classification for both assets and liabilities. Answers to Multiple Choice: 1. c 2. b 3. c 4. a IFRS Short Answer: 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to balance sheet reporting. 1. Among the similarities between U.S. and IFRS related to balance sheet presentation are as follows: •
• •
IAS 1 specifies minimum note disclosures. These must include information about (1) accounting policies followed, (2) judgments that management has made in the process of applying the entity’s accounting policies, and (3) the key assumptions and estimation uncertainty that could result in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. Comparative prior-period information must be presented and financial statements must be prepared annually. Current/non-current classification for assets and liabilities is normally required. In general, post-balance sheet events are not considered in classifying items as current or non-current.
Differences include (1) IFRS statements may report property, plant, and equipment first in the balance sheet. Some companies report the sub-total “net assets”, which equals total assets minus total liabilities. (2) While the use of the term “reserve” is discouraged in U.S. GAAP, there is no such prohibition in IFRS. 2. Briefly describe the convergence efforts related to financial statement presentation. 2. The IASB and the FASB are working on a project to converge their standards related to financial statement presentation. This joint project will establish a common, high-quality standard for presentation of information in the financial statements, including the classification and display of line items. A key feature of the proposed framework for financial statement presentation is that each of the statements will be organized in the same format to separate an entity’s financing activities from its operating and other activities (investing) and further separates financing activities into transactions with owners and creditors. Thus, the same classifications used in the balance sheet would also be used in the income statement and the statement of cash flows.
CHAPTER 6 ACCOUNTING AND THE TIME VALUE OF MONEY IFRS questions are available at the end of this chapter.
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 d b a c d b b a d c c b c c a
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. S 35. S 36.
Appropriate use of an annuity due table. Time value of money. Present value situations. Definition of interest. Interest variables. Identification of compounding approach. Future value factor. 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.
6-2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer a c a d d a d c a c b d d b c c b c b b b b c c d P S
No.
Description
S
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. Definition of present value. Compound interest concepts. Difference between ordinary annuity and annuity due. Future value of 1 and present value of 1 relationship. Identify future value of 1 concept. Determine best bonus option Identify future value of an ordinary annuity Identify future value of an ordinary annuity 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. Present value of ordinary annuity and present value of annuity due relationship Identify present value of ordinary annuity concept. Determine least costly option. Definition of deferred annuities.
37. 38. P 39. P 40. 41. 42. 43. P 44. 45. 46. 47. 48. 49. 50. P 51. 52. 53. 54. 55. 56. 57. 58. P
59. 60. 61.
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide.
MULTIPLE CHOICE—Computational Answer
No.
Description
a d d c b a b c c d a d b c c
62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76.
Calculate the future value of 1. Calculate amount of interest paid. 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.
Accounting and the Time Value of Money
6-3
MULTIPLE CHOICE—Computational (cont.) Answer
No.
Description
b b c d c a c a b c c d d b d d a b c d a b c d a a d c d a b b c a b b b c d a b d b b c b a
77. 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. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123.
Present value of a single sum. Present value of a single sum, unknown number of periods. Future value of a single sum. Calculate the present value of 1. Calculate the future value of 1. Calculate the present value of 1. Calculate interest rate. Calculate number of years. Calculate the future value of 1. Calculate the present value of 1. Calculate the present value of 1. Calculate the present value of 1 and present value of an ordinary annuity. Calculate number if years. Calculate the amount of annual deposit. Calculate the amount of annual deposit. Calculate the amount of annual deposit. 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. 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. Calculate present value of an ordinary annuity. Calculate interest rate. Calculate present value of an annuity due. Calculate effective interest rate. Calculate present value of an ordinary annuity. Calculate present value of an annuity due. Calculate annual interest rate. Calculate interest rate. Calculate annual lease payment. Calculate selling price of bonds.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
c d c a b a a d b
124. 125. 126. 127. 128. 129. 130. 131. 132.
Calculate interest expense of bonds. Identification of correct compound interest table. Calculate interest revenue of a zero-interest-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 E6-133 E6-134 E6-135 E6-136 E6-137 E6-138 E6-139 E6-140
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 P6-141 P6-142 P6-143 P6-144 P6-145 P6-146
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.
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.
Accounting and the Time Value of Money
6-5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1.
TF
2.
TF
21.
3.
TF
4.
TF
5.
6. 7. 8.
TF TF TF
27. 28. 29.
MC MC MC
30. 31. 32.
9.
TF
39.
MC
10. 11. 12. 43. P 44. 45.
TF TF TF MC MC MC
46. 47. 48. 65. 66. 68.
MC MC MC MC MC MC
69. 70. 71. 73. 74. 75.
13. 14. 16. 17.
TF TF TF TF
49. 50. P 51. 52.
MC MC MC NC
53. 67. 90. 91.
15. 18. 53. 54. 55. 56.
TF TF MC MC MC MC
57. 58. 59. 60. 72. 88.
MC MC MC MC MC MC
104. 105. 106. 107. 108. 109.
19.
TF
20.
TF
61.
Note:
P
P
TF = True-False MC = Multiple Choice
40.
Type
Item
Type
Item
Learning Objective 1 MC 22. MC 23. Learning Objective 2 TF 26. MC 62. Learning Objective 3 S MC 33. MC 36. S MC 34. MC 37. S P MC 35. MC 38. Learning Objective 4 MC 41. MC 42. Learning Objective 5 MC 76. MC 82. MC 77. MC 83. MC 78. MC 84. MC 79. MC 85. MC 80. MC 86. MC 81. MC 87. Learning Objective 6 MC 92. MC 96. MC 93. MC 97. MC 94. MC 98. MC 95. MC 99. Learning Objective 7 MC 110. MC 116. MC 111. MC 117. MC 112. MC 118. MC 113. MC 119. MC 114. MC 120. MC 115. MC 121. Learning Objective 8 MC 123. MC 146. E = Exercise P = Problem
Type
Item
Type
Item
Type
MC
24.
MC
25.
MC
MC
63.
124.
MC
MC MC MC
64. 125.
MC MC
MC MC MC MC MC MC
88. 89. 124. 126. 133. 134.
MC MC MC MC E E
135. 141.
E P
MC MC MC MC
100. 101. 102. 103.
MC MC MC MC
136. 142.
E P
MC MC MC MC MC MC
122. 127. 128. 137. 138. 139.
MC MC MC E E E
140. 141. 143. 144. 145.
E P P P P
MC
P
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Test Bank for Intermediate Accounting, Fourteenth Edition
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.
Accounting and the Time Value of Money
6-7
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 1. 2. 3. 4. 5.
Ans. F T F T T
Item 6. 7. 8. 9. 10.
Ans. F F T T T
Item 11. 12. 13. 14. 15.
Ans. F F F T T
Item 16. 17. 18. 19. 20.
Ans. 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.
What best describes the time value of money? a. The interest rate charged on a loan. b. Accounts receivable that are determined uncollectible. c. An investment in a checking account. d. The relationship between time and money.
23.
Which of the following situations does not base an accounting measure on present values? a. Pensions. b. Prepaid insurance. c. Leases. d. Sinking funds.
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Test Bank for Intermediate Accounting, Fourteenth Edition
24.
What is interest? a. Payment for the use of money. b. An equity investment. c. Return on capital. d. Loan.
25.
What is NOT a variable that is considered in interest computations? a. Principal. b. Interest rate. c. Assets. d. Time.
26.
If you invest $50,000 to earn 8% interest, which of the following compounding approaches would return the lowest amount after one year? a. Daily. b. Monthly. c. Quarterly. d. Annually.
27.
Which factor would be greater — the present value of $1 for 10 periods at 8% per period or the future value of $1 for 10 periods at 8% per period? a. Present value of $1 for 10 periods at 8% per period. b. Future value of $1 for 10 periods at 8% per period. c. The factors are the same. d. Need more information.
28.
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
29.
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
30.
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
31.
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
Accounting and the Time Value of Money
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32.
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
33.
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
34.
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
S
35.
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.
S
36.
On June 1, 2012, Pitts Company sold some equipment to Gannon 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, 2012. 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.
S
37.
Which of the following transactions would best use the present value of an annuity due of 1 table? a. Fernetti, Inc. rents a truck for 5 years with annual rental payments of $20,000 to be made at the beginning of each year. b. Edmiston 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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
P
38.
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.
P
39.
In the time diagram below, which concept is being depicted?
0
1 $1
2 $1
3 $1
4 $1
PV a. b. c. d. P
Present value of an ordinary annuity Present value of an annuity due Future value of an ordinary annuity Future value of an annuity due
40.
On December 1, 2012, Richards Company sold some machinery to Fleming 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, 2012, 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.
41.
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.
42.
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.
Accounting and the Time Value of Money
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43.
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.
44.
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, 2012, the present value of that sum decreases as the date draws closer to December 31, 2012.
45.
What is the primary difference between an ordinary annuity and an annuity due? a. The timing of the periodic payment. b. The interest rate. c. Annuity due only relates to present values. d. Ordinary annuity only relates to present values.
46.
What is the relationship between the future value of one and the present value of one? a. The present value of one equals the future value of one plus one. b. The present value of one equals one plus future value factor for n-1 periods. c. The present value of one equals one divided by the future value of one. d. The present value of one equals one plus the future value factor for n+1 value
47.
Peter invests $100,000 in a 3-year certificate of deposit earning 3.5% at his local bank. Which time value concept would be used to determine the maturity value of the certificate? a. Present value of one. b. Future value of one. c. Present value of an annuity due. d. Future value of an ordinary annuity.
48.
Jerry recently was offered a position with a major accounting firm. The firm offered Jerry either a signing bonus of $23,000 payable on the first day of work or a signing bonus of $26,000 payable after one year of employment. Assuming that the relevant interest rate is 10%, which option should Jerry choose? a. The options are equivalent. b. Insufficient information to determine. c. The signing bonus of $23,000 payable on the first day of work. d. The signing bonus of $26,000 payable after one year of employment.
49.
If Jethro wanted to save a set amount each month in order to buy a new pick-up truck when the new models are next available, which time value concept would be used to determine the monthly payment? a. Present value of one. b. Future value of one. c. Present value of an annuity due. d. Future value of an ordinary annuity.
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Test Bank for Intermediate Accounting, Fourteenth Edition
50.
Betty wants to know how much she should begin saving each month to fund her retirement. What kind of problem is this? a. Present value of one. b. Future value of an ordinary annuity. c. Present value of an ordinary. d. Future value of one.
51
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.
52.
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.
53.
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.
54.
Al Darby 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. $20,000 times the future value of a 5-year, 10% ordinary annuity of 1. b. $20,000 divided by the future value of a 5-year, 10% ordinary annuity of 1. c. $20,000 times the present value of a 5-year, 10% ordinary annuity of 1. d. $20,000 divided by the present value of a 5-year, 10% ordinary annuity of 1.
55.
Sue Gray 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.
Accounting and the Time Value of Money
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56.
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).
57.
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.
58.
What is the relationship between the present value factor of an ordinary annuity and the present value factor of an annuity due for the same interest rate? a. The ordinary annuity factor is not related to the annuity due factor. b. The annuity due factor equals one plus the ordinary annuity factor for n−1 periods. c. The ordinary annuity factor equals one plus the annuity due factor for n+1 periods. d. The annuity due factor equals the ordinary annuity factor for n+1 periods minus one.
59.
Paula purchased a house for $300,000. After providing a 20% down payment, she borrowed the balance from the local savings and loan under a 30-year 6% mortgage loan requiring equal monthly installments at the end of each month. Which time value concept would be used to determine the monthly payment? a. Present value of one. b. Future value of one. c. Present value of an ordinary annuity. d. Future value of an ordinary annuity.
60.
Stemway requires a new manufacturing facility. Management found three locations; all of which would provide needed capacity, the only difference is the price. Location A may be purchased for $500,000. Location B may be acquired with a down payment of $100,000 and annual payments at the end of each of the next twenty years of $50,000. Location C requires $40,000 payments at the beginning of each of the next twenty-five years. Assuming Stemway's borrowing costs are 8% per annum, which option is the least costly to the company? a. Location A. b. Location B. c. Location C. d. Location A and Location B.
6 - 14 61.
Test Bank for Intermediate Accounting, Fourteenth Edition 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.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26.
a d b a c d
27. 28. 29. 30. 31. 32.
b b a d c c
33. 34. 35. 36. 37. 38.
b c c a a c
39. 40. 41. 42. 43. 44.
a d d a d c
45. 46. 47. 48. 49. 50.
a c b d d b
51. 52. 53. 54. 55. 56.
c c b c b b
57. 58. 59. 60. 61.
b b c c d
Solution to Multiple Choice question for which the answer is “none of these.” 30. Present value of an Ordinary Annuity of 1.
MULTIPLE CHOICE—Computational 62.
Assume ABC Company deposits $50,000 with First National Bank in an account earning interest at 6% per annum, compounded semi-annually. How much will ABC have in the account after five years if interest is reinvested? a. $67,196. b. $50,000. c. $65,000. d. $66,912.
63.
Charlie Corp. is purchasing new equipment with a cash cost of $150,000 for an assembly line. The manufacturer has offered to accept $34,440 payment at the end of each of the next six years. How much interest will Charlie Corp. pay over the term of the loan? a. $34,440. b. $150,000. c. $184,440. d. $56,640.
64.
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%.
Accounting and the Time Value of Money
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Items 65 through 68 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 65 to 68 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
65.
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
66.
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)
67.
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
68.
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 69 through 72 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 69 to 72 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
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Test Bank for Intermediate Accounting, Fourteenth Edition
69.
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
70.
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
71.
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
72.
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
73.
At the end of two years, what will be the balance in a savings account paying 6% annually if $10,000 is deposited today? The future value of one at 6% for one period is 1.06. a. $10,000 b. $10,600 c. $11,200 d. $11,236
74.
Mordica Company will receive $250,000 in 7 years. If the appropriate interest rate is 10%, the present value of the $250,000 receipt is a. $127,500. b. $128,290. c. $377,500. d. $487,180.
75.
Dunston Company will receive $200,000 in a future year. If the future receipt is discounted at an interest rate of 10%, its present value is $102,632. In how many years is the $200,000 received? a. 5 years b. 6 years c. 7 years d. 8 years
Accounting and the Time Value of Money
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76.
Milner Company will invest $400,000 today. The investment will earn 6% for 5 years, with no funds withdrawn. In 5 years, the amount in the investment fund is a. $400,000. b. $520,000. c. $535,292. d. $536,116.
77.
Barber Company will receive $800,000 in 7 years. If the appropriate interest rate is 10%, the present value of the $800,000 receipt is a. $408,000. b. $410,528. c. $1,208,000. d. $1,558,976.
78.
Barkley Company will receive $300,000 in a future year. If the future receipt is discounted at an interest rate of 8%, its present value is $189,051. In how many years is the $300,000 received? a. 5 years b. 6 years c. 7 years d. 8 years
79.
Altman Company will invest $500,000 today. The investment will earn 6% for 5 years, with no funds withdrawn. In 5 years, the amount in the investment fund is a. $500,000. b. $650,000. c. $669,115. d. $670,145.
80.
John Jones won a lottery that will pay him $2,000,000 after twenty years. Assuming an appropriate interest rate is 5% compounded annually, what is the present value of this amount? a. $2,000,000. b. $5,306,600. c. $24,924,420. d. $753,780.
81.
Angie invested $100,000 she received from her grandmother today in a fund that is expected to earn 10% per annum. To what amount should the investment grow in five years if interest is compounded semi-annually? a. $155,134. b. $161,050. c. $162,890. d. $177,156.
82.
Bella requires $120,000 in four years to purchase a new home. What amount must be invested today in an investment that earns 6% interest, compounded annually? a. $95,051. b. $98,724. c. $145,337. d. $151,497.
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Test Bank for Intermediate Accounting, Fourteenth Edition
83.
What interest rate (the nearest percent) must Charlie earn on a $150,000 investment today so that he will have $380,000 after 12 years? a. 6%. b. 7%. c. 8%. d. 9%.
84.
Ethan has $80,000 to invest today at an annual interest rate of 4%. Approximately how many years will it take before the investment grows to $162,000? a. 18 years. b. 20 years. c. 16 years. d. 11 years.
85.
Jane wants to set aside funds to take an around the world cruise in four years. Assuming that Jane has $8,000 to invest today in an account expected to earn 6% per annum, how much will she have to spend on her vacation? a. $6,336. b. $10,100. c. $34,997. d. $10,706.
86.
Jane wants to set aside funds to take an around the world cruise in four years. Jane expects that she will need $10,000 for her dream vacation. If she is able to earn 8% per annum on an investment, how much will she have to set aside today so that she will have sufficient funds available? a. $2,219. b. $13,604. c. $7,350. d. $6,806.
87.
What would you pay for an investment that pays you $3,000,000 after forty years? Assume that the relevant interest rate for this type of investment is 6%. a. $93,540. b. $935,400. c. $291,660. d. $311,010.
88.
What would you pay for an investment that pays you $20,000 at the end of each year for the next ten years and then returns a maturity value of $300,000 after ten years? Assume that the relevant interest rate for this type of investment is 8%. a. $138,958. b. $134,202. c. $144,936. d. $273,158.
Accounting and the Time Value of Money
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89.
Anna has $30,000 to invest. She requires $50,000 for a down payment for a house. If she is able to invest at 6%, how many years will it be before she will accumulate the desired balance? a. 6 years. b. 7 years. c. 8 years. d. 9 years.
90.
Lucy and Fred want to begin saving for their baby's college education. They estimate that they will need $200,000 in eighteen years. If they are able to earn 6% per annum, how much must be deposited at the beginning of each of the next eighteen years to fund the education? a. $6,471. b. $6,105. c. $11,111. d. $5,924.
91.
Lucy and Fred want to begin saving for their baby's college education. They estimate that they will need $300,000 in eighteen years. If they are able to earn 5% per annum, how much must be deposited at the end of each of the next eighteen years to fund the education? a. $11,618. b. $25,664. c. $24,823. d. $10,664.
92.
Jane wants to set aside funds to take an around the world cruise in four years. Jane expects that she will need $10,000 for her dream vacation. If she is able to earn 8% per annum on an investment, how much will she need to set aside at the beginning of each year to accumulate sufficient funds? a. $2,219. b. $13,604. c. $7,350. d. $2,055.
93.
Pearson Corporation makes an investment today (January 1, 2012). They will receive $6,000 every December 31st for the next six years (2012 – 2017). If Pearson wants to earn 12% on the investment, what is the most they should invest on January 1, 2012? a. $24,668. b. $27,629. c. $48,691. d. $54,534.
94.
Garretson Corporation will receive $8,000 today (January 1, 2012), and also on each January 1st for the next five years (2013 – 2017). What is the present value of the six $8,000 receipts, assuming a 12% interest rate? a. $32,891. b. $36,838. c. $64,922. d. $72,712.
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Test Bank for Intermediate Accounting, Fourteenth Edition
95.
Spencer Corporation will invest $15,000 every December 31st for the next six years (2012 – 2017). If Spencer will earn 12% on the investment, what amount will be in the investment fund on December 31, 2017? a. $61,671. b. $69,072. c. $121,728. d. $136,335.
96.
Tipson Corporation will invest $15,000 every January 1st for the next six years (2012 – 2017). If Linton will earn 12% on the investment, what amount will be in the investment fund on December 31, 2017? a. $61,671 b. $69,072. c. $121,728. d. $136,335.
97.
Hiller Corporation makes an investment today (January 1, 2012). They will receive $40,000 every December 31st for the next six years (2012 – 2017). If Hiller wants to earn 12% on the investment, what is the most they should invest on January 1, 2012? a. $164,456. b. $184,191. c. $324,608. d. $363,560.
98.
Sonata Corporation will receive $20,000 today (January 1, 2012), and also on each January 1st for the next five years (2013 – 2017). What is the present value of the six $40,000 receipts, assuming a 12% interest rate? a. $164,456. b. $184,191. c. $324,608. d. $363,560.
99.
Renfro Corporation will invest $50,000 every December 31st for the next six years (2012 – 2017). If Renfro will earn 12% on the investment, what amount will be in the investment fund on December 31, 2017? a. $205,570 b. $230,240. c. $405,760. d. $454,450.
100.
Vannoy Corporation will invest $30,000 every January 1st for the next six years (2012 – 2017). If Wagner will earn 12% on the investment, what amount will be in the investment fund on December 31, 2017? a. $123,342. b. $138,144. c. $243,456. d. $272,670.
Accounting and the Time Value of Money 101.
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On January 1, 2012, Kline Company decided to begin accumulating a fund for asset replacement five years later. The company plans to make five annual deposits of $40,000 at 9% each January 1 beginning in 2012. What will be the balance in the fund, within $10, on January 1, 2017 (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.
$260,932 $239,388 $218,000 $200,000
Use the following 8% interest factors for questions 102 through 105.
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
102.
What will be the balance on September 1, 2018 in a fund which is accumulated by making $10,000 annual deposits each September 1 beginning in 2011, with the last deposit being made on September 1, 2018? The fund pays interest at 8% compounded annually. a. $106,366 b. $89,229 c. $75,600 d. $57,466
103.
If $6,000 is deposited annually starting on January 1, 2012 and it earns 8%, what will the balance be on December 31, 2019? a. $53,537 b. $57,820 c. $63,820 d. $68,925
104.
Korman Company wishes to accumulate $400,000 by May 1, 2020 by making 8 equal annual deposits beginning May 1, 2012 to a fund paying 8% interest compounded annually. What is the required amount of each deposit? a. $69,606 b. $37,606 c. $34,820 d. $40,312
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Test Bank for Intermediate Accounting, Fourteenth Edition
105.
What amount should be recorded as the cost of a machine purchased December 31, 2012, which is to be financed by making 8 annual payments of $8,000 each beginning December 31, 2013? The applicable interest rate is 8%. a. $56,000 b. $49,975 c. $85,093 d. $45,973
106.
How much must be deposited on January 1, 2012 in a savings account paying 6% annually in order to make annual withdrawals of $25,000 at the end of the years 2012 and 2013? The present value of one at 6% for one period is .9434. a. $45,835 b. $47,175 c. $50,000 d. $22,250
107.
How much must be invested now to receive $20,000 for 15 years if the first $20,000 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. $161,214 b. $175,723 c. $300,000 d. $146,250
108.
Jenks Company financed the purchase of a machine by making payments of $10,000 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 Jenks? a. $14,794 b. $39,927 c. $50,000 d. $58,667
109.
A machine is purchased by making payments of $6,000 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? a. $40,294 b. $36,631 c. $25,019 d. $22,745
Accounting and the Time Value of Money
6 - 23
110.
Lane Co. has a machine that cost $300,000. It is to be leased for 20 years with rent received at the beginning of each year. Lane 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. $32,034 b. $35,864 c. $44,592 d. $35,238
111.
Find the present value of an investment in plant and equipment if it is expected to provide annual earnings of $26,000 for 15 years and to have a resale value of $50,000 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. $197,758 b. $209,728 c. $247,758 d. $401,970
112.
On January 2, 2012, Wine Corporation wishes to issue $3,000,000 (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 Wine 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.
113.
0.4632 0.3855 6.7101 6.1446
$3,000,000 $2,631,204 $3,000,018 $3,318,078
The market price of a $500,000, ten-year, 12% (pays interest semiannually) bond issue sold to yield an effective rate of 10% is a. $561,445. b. $562,311. c. $566,635. d. $936,180.
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Test Bank for Intermediate Accounting, Fourteenth Edition
114.
John won a lottery that will pay him $150,000 at the end of each of the next twenty years. Assuming an appropriate interest rate is 8% compounded annually, what is the present value of this amount? a. $1,590,540. b. $32,183. c. $1,472,723. d. $6,864,294.
115.
Jonas won a lottery that will pay him $200,000 at the end of each of the next twenty years. Zebra Finance has offered to purchase the payment stream for $2,718,000. What interest rate (to the nearest percent) was used to determine the amount of the payment? a. 7%. b. 6%. c. 5%. d. 4%.
116.
James leases a ski chalet to his best friend, Janet. The lease term is five years with $16,000 annual payments due at the beginning of each year. What is the present value of the payments discounted at 8% per annum? a. $68,994. b. $63,884. c. $61,077. d. $57,990.
117.
Jeremy is in the process of purchasing a car. The list price of the car is $36,000. If Jeremy pays cash for the car, the dealer will reduce the price by 10%. Otherwise, the dealer will provide financing where Jeremy must pay $7,706 at the end of each of the next five years. Compute the effective interest rate to the nearest percent that Jeremy would pay if he chooses to make the five annual payments? a. 5%. b. 6%. c. 7%. d. 8%.
118.
What would you pay for an investment that pays you $15,000 at the end of each year for the next twenty years? Assume that the relevant interest rate for this type of investment is 12%. a. $125,487. b. $1,080,786. c. $15,550. d. $112,042.
119.
What would you pay for an investment that pays you $20,000 at the beginning of each year for the next ten years? Assume that the relevant interest rate for this type of investment is 10%. a. $122,890. b. $135,180. c. $129,902. d. $142,892.
Accounting and the Time Value of Money
6 - 25
120.
Ziggy is considering purchasing a new car. The cash purchase price for the car is $33,600. What is the annual interest rate if Ziggy is required to make annual payments of $7,800 at the end of the next five years? a. 4%. b. 5%. c. 6%. d. 7%.
121.
Charlie Corp. is purchasing new equipment with a cash cost of $200,000 for the assembly line. The manufacturer has offered to accept $45,920 payments at the end of each of the next six years. What is the interest rate that Charlie Corp. will be paying? a. 8%. b. 9%. c. 10%. d. 11%.
122.
Jeremy Leasing purchases and then leases small aircraft to interested parties. The company is currently determining the required rental for a small aircraft that cost them $600,000. If the lease is for twenty years and annual lease payments are required to be made at the end of each year, what will be the annual rental if Jeremy wants to earn a return of 10%? a. $64,070. b. $70,476. c. $10,476. d. $30,314.
123.
Stech Co. is issuing $6.5 million 12% bonds in a private placement on July 1, 2012. Each $1,000 bond pays interest semi-annually on December 31 and June 30 of each year. The bonds mature in ten years. At the time of issuance, the market interest rate for similar types of bonds was 8%. What is the expected selling price of the bonds? a. $8,266,764. b. $13,566,992. c. $8,244,598. d. $8,310,962.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
62. 63. 64. 65. 66. 67. 68. 69. 70.
a d d c b a b c c
71. 72. 73. 74. 75. 76. 77. 78. 79.
d a d b c c b b c
80. 81. 82. 83. 84. 85. 86. 87. 88.
d c a c a b c c d
89. 90. 91. 92. 93. 94. 95. 96. 97.
d b d d a b c d a
98. 99. 100. 101. 102. 103. 104. 105. 106.
b c d a a d c d a
107. 108. 109. 110. 111. 112. 113. 114. 115.
b b c a b b b c d
116. 117. 118. 119. 120. 121. 122. 123.
a b d b b c b a
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—CPA Adapted 124.
On January 1, 2012, Gore Co. sold to Cey Corp. $600,000 of its 10% bonds for $531,177 to yield 12%. Interest is payable semiannually on January 1 and July 1. What amount should Gore report as interest expense for the six months ended June 30, 2012? a. $26,559 b. $30,000 c. $31,871 d. $36,000
125.
On May 1, 2012, a company purchased a new machine which it does not have to pay for until May 1, 2014. The total payment on May 1, 2014 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
126.
On January 1, 2012, Ball Co. exchanged equipment for a $200,000 zero-interest-bearing note due on January 1, 2015. The prevailing rate of interest for a note of this type at January 1, 2012 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 2013 income statement? a. $0 b. $15,000 c. $16,500 d. $20,000
127.
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 128.
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On January 15, 2012, Dolan Corp. adopted a plan to accumulate funds for environmental improvements beginning July 1, 2016, at an estimated cost of $5,000,000. Dolan 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, 2012. 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
Dolan should make four annual deposits of a. $889,522. b. $978,474. c. $1,077,586. d. $1,250,000. 129.
On December 30, 2012, AGH, Inc. purchased a machine from Grant Corp. in exchange for a zero-interest-bearing note requiring eight payments of $70,000. The first payment was made on December 30, 2012, 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 AGH's December 31, 2012 balance sheet, the net note payable to Grant is a. $329,840. b. $360,220. c. $366,485. d. $399,840.
130.
On January 1, 2012, Ott Co. sold goods to Flynn Company. Flynn signed a zero-interestbearing note requiring payment of $90,000 annually for seven years. The first payment was made on January 1, 2012. 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
Ott should record sales revenue in January 2012 of a. $481,972. b. $438,156. c. $391,977. d. $321,300.
Present Value of Ordinary Annuity of 1 at 10% 4.3553 4.8684
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Test Bank for Intermediate Accounting, Fourteenth Edition
131.
On January 1, 2012, Haley Co. issued ten-year bonds with a face amount of $3,000,000 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 The total issue price of the bonds was a. $3,000,000. b. $2,940,000. c. $2,760,000. d. $2,632,800.
132.
On July 1, 2012, Ed Wynne signed an agreement to operate as a franchisee of Kwik Foods, Inc., for an initial franchise fee of $240,000. Of this amount, $80,000 was paid when the agreement was signed and the balance is payable in four equal annual payments of $40,000 beginning July 1, 2013. The agreement provides that the down payment is not refundable and no future services are required of the franchisor. Wynne'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 Wynne should record the acquisition cost of the franchise on July 1, 2012 at a. $174,400. b. $196,400. c. $240,000. d. $270,400.
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
124. 125.
c d
126. 127.
c a
128. 129.
b a
130. 131.
a d
132.
b
DERIVATIONS — Computational No.
Answer
Derivation
62.
a
$50,000 × 1.34392 = $67,196.
63.
d
($34,440 × 6) − $150,000 = $56,640.
64.
d
4 × 8 = 32 periods; 4% ÷ 4 = 1%.
65.
c
1.260 × PV = $10,000; PV = $10,000 ÷ 1.260.
66.
b
1.260 × $3,000.
0.59 1.69 2.91
Accounting and the Time Value of Money
No.
Answer
67.
a
Derivation ($6,000 × 1.260) + ($6,000 × 1.166) + ($6,000 × 1.080) + $6,000.
68.
b
$4,000 × (1.080)6 or $4,000 × 1.469 × 1.080.
69.
c
0.826 × PV = $4,000; PV = $4,000 ÷ 0.826.
70.
c
$6,000 × 0.621 × 0.909.
71.
d
$3,000 × 0.751.
72.
a
$5,000 + ($5,000 × 0.909) + ($5,000 × 0.826) + ($5,000 × 0.751).
73.
d
$10,000 × (1.06)2 = $11,236.
74.
b
$250,000 × 0.51316 = $128,290.
75.
c
$102,632 ÷ $200,000 = 0.51316; 0,51316 is PV factor for 7 years.
76.
c
$400,000 × 1.33823 = $535,292.
77.
b
$800,000 × 0.51316 = $410,528.
78.
b
$189,051 ÷ $300,000 = 0.63017; 0.63017 is PV factor for 6 years.
79.
c
$500,000 × 1.33823 = $669,115.
80.
d
$2,000,000 × .37689 = $753,780.
81.
c
$100,000 × 1.62890 = $162,890.
82.
a
$120,000 × .79209 = $95,051.
83.
c
$150,000 ÷ $380,000 = .39474; .39474 is PV factor for 8%.
84.
a
$162,000 ÷ $80,000 = 2.025; 2.025 is FV factor for 18 years.
85.
b
$8,000 × 1.26248 = $10,100.
86.
c
$10,000 × .73503 = $7,350.
87.
c
$3,000,000 × .09722 = $291,660.
88.
d
($20,000 × 6.71008) + ($300,000 × .46319) = $273,158.
89.
d
$50,000 ÷ $30,000 = 1.66667; 1.66667 is FV factor for 9 years.
90.
b
$200,000 ÷ (30.90565 × 1.06) = $6,105.
91.
d
$300,000 ÷ 28.13279 = $10,664.
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6 - 30
Test Bank for Intermediate Accounting, Fourteenth Edition
No.
Answer
92.
d
Derivation $10,000 ÷ (4.50611 × 1.08) = $2,055.
93.
a
$6,000 × 4.11141 = $24,668.
94.
b
$8,000 × 4.60478 = $36,838.
95.
c
$15,000 × 8.11519 = $121,728.
96.
d
$15,000 × 8.11519 × 1.12 = $136,335.
97.
a
$40,000 × 4.11141 = $164,456.
98.
b
$40,000 × 4.60478 = $184,191.
99.
c
$50,000 × 8.11519 = $405,760.
100.
d
$30,000 × 8.11519 × 1.12 = $272,670.
101.
a
$40,000 × (7.5233 – 1) = $260,932 or $40,000 × 5.9847 × 1.09.
102.
a
$10,000 × 10.63663 = $106,366.
103.
d
$6,000 × (12.48756 – 1) = $68,925 or $6,000 × 10.63663 × 1.08.
104.
c
(10.63663 × 1.08) × R = $400,000; R = $400,000 ÷ 11.48756 = $34,820.
105.
d
$8,000 × 5.7466 = $45,973.
106.
a
($25,000 × 0.9434) + [$25,000 × (0.9434)2] = $45,835.
107.
b
$20,000 × (7.78615 + 1) = $175,723 or $20,000 × 8.06069 × 1.09.
108.
b
$10,000 × 3.99271 = $39,927.
109.
c
$6,000 × (3.79079 × 1.10) = $6,000 × 4.16987 = $25,019.
110.
a
$300,000 = R × (8.51356 × 1.10); R = $300,000 ÷ 9.36492 = $32,034.
111.
b
($26,000 × 7.60608) + ($50,000 × .23939) = $209,728.
112.
b
$3,000,000 × .08 = $240,000 (annual interest payment) ($240,000 × 6.1446) + ($3,000,000 × 0.3855) = $2,631,204.
113.
b
$500,000 × .06 = $30,000 (semiannual interest payment) ($30,000 × 12.46221) + ($500,000 × .37689) = $562,311.
114.
c
$150,000 × 9.81815 = $1,472,723.
115.
d
$2,718,000 ÷ $200,000 = 13.59; 13.59 is PV factor for 4%.
Accounting and the Time Value of Money
No.
Answer
116.
a
$16,000 × 4.31214 = $68,994.
117.
b
($36,000 × .90) ÷ $7,706 = 4.20438, 4.20438 is PV factor for 6%.
118.
d
$15,000 × 7.46944 = $112,042.
119.
b
$20,000 × 6.75902 = $135,180.
120.
b
$33,600 ÷ $7,800 = 4.30769; 4.30769 is PV factor for 5%.
121.
c
$200,000 ÷ $45,920 = 4.35540; 4.35540 is PV factor for 10%.
122.
b
$600,000 ÷ 8.51356 = $70,476.
123.
a
($6,500,000 × .45639) + ($390,000 × 13.59033) = $8,266,764.
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Derivation
DERIVATIONS — CPA Adapted No.
Answer
124.
c
Derivation $531,177 × .06 = $31,871.
125.
d
Conceptual.
126.
c
$200,000 × .75 = $150,000 (present value of note) $150,000 × 1.10 = $165,000; $165,000 × 0.10 = $16,500.
127.
a
Conceptual.
128.
b
5.11 × R = $5,000,000; R = $5,000,000 ÷ 5.11 = $978,474.
129.
a
$70,000 × 4.712 = $329,840 or ($70,000 × 5.712) – $70,000 = $329,840.
130.
a
$90,000 × (4.8684 × 1.1) = $481,972.
131.
d
$3,000,000 × .08 = $240,000 ($240,000 × 6.145) + ($3,000,000 × 0.386) = $2,632,800.
132.
b
($40,000 × 2.91) + $80,000 = $196,400.
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Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Ex. 6-133—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.
b.
Future value of an ordinary annuity of 1.
_____ 5.
Present value of an ordinary annuity of 1.
_____ 6.
Present value of an annuity
c.
due of 1.
d.
$1
|
|
|
|
|
$1
$1
$1
? $1
|- - - - |
|
|
|
? $1
$1
$1
$1
|
|
|
|- - - - |
?
$1
$1
$1
$1
|
|
|
|
|
$1 e.
f.
?
|
|
|
|
|
$1
$1
$1
$1
?
|
|
|
|
|
Solution 6-133 1. e
2. a
3. f
4. b
5. d
6. c
Ex. 6-134—Compute estimated goodwill. (Tables needed.) Compute estimated goodwill if it is found by discounting excess earnings at 12% compounded quarterly. Excess annual earnings of $16,000 are expected for 8 years.
Solution 6-134 Present value of $4,000 for 32 periods at 3% ($4,000 × 20.38877) = $81,555.
Accounting and the Time Value of Money
6 - 33
Ex. 6-135—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 $20,000 for 10 years and to have a resale value of $50,000 at the end of that period. Assume an interest rate of 9% and that savings are realized at year end.
Solution 6-135 Present value of $20,000 for 10 periods at 9% (6.41766 × $20,000) = $128,353 Present value of $50,000 discounted for 10 periods at 9% (.42241 × $50,000) = 21,121 Present value of investment in equipment $149,474
Ex. 6-136—Future value of an annuity due. (Tables needed.) If $6,000 is deposited annually starting on January 1, 2012 and it earns 9%, how much will accumulate by December 31, 2021?
Solution 6-136 Future value of an annuity due of $6,000 for 10 periods at 9% ($6,000 × 15.19293 × 1.09) = $99,362.
Ex. 6-137—Present value of an annuity due.(Tables needed.) How much must be invested now to receive $25,000 for ten years if the first $25,000 is received today and the rate is 8%?
Solution 6-137 Present value of an annuity due of $25,000 for ten periods at 8% ($25,000 × 7.24689) = $181,172.
Ex. 6-138—Compute the annual rent. (Tables needed.) Crone Co. has machinery that cost $90,000. It is to be leased for 15 years with rent received at the beginning of each year. Crone wants a return of 10%. Compute the amount of the annual rent.
Solution 6-138 Present value factor for an annuity due for 15 periods at 10% (1.10 7.60608) = 8.36669 $90,000 ÷ 8.36669 = $10,757.
Ex. 6-139—Calculate market price of a bond. (Tables needed.) Determine the market price of a $300,000, ten-year, 10% (pays interest semiannually) bond issue sold to yield an effective rate of 12%.
6 - 34
Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 6-139 Present value of $15,000 for 20 periods at 6% ($15,000 × 11.46992) = Present value of $300,000 discounted for 20 periods at 6% ($300,000 × .31180) = Market price of the bond issue
$172,049 93,540 $265,589
Ex. 6-140—Calculate market price of a bond. On January 1, 2012 Lance Co. issued five-year bonds with a face value of $500,000 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 6-140 Present value of $500,000 discounted for 10 periods at 5% ($500,000 × .61391) = Present value of $30,000 for 10 periods at 5% ($30,000 × 7.72173) = Issue price of the bonds
$306,955 231,652 $538,607
PROBLEMS Pr. 6-141—Present value and future value computations. Part (a) Compute the amount that a $30,000 investment today would accumulate at 10% (compound interest) by the end of 6 years. Part (b) Tom wants to retire at the end of this year (2012). His life expectancy is 20 years from his retirement. Tom has come to you, his CPA, to learn how much he should deposit on December 31, 2012 to be able to withdraw $50,000 at the end of each year for the next 20 years, assuming the amount on deposit will earn 8% interest annually. Part (c) Judy Thomas has a $1,800 overdue debt for medical books and supplies at Joe's Bookstore. She has only $600 in her checking account and doesn't want her parents to know about this debt. Joe's tells her that she may settle the account in one of two ways since she can't pay it all now: 1. Pay $600 now and $1,500 when she completes her residency, two years from today. 2. Pay $2,400 one year after completion of residency, three years from today. Assuming that the cost of money is the only factor in Judy's decision and that the cost of money to her is 8%, which alternative should she choose? Your answer must be supported with calculations.
Accounting and the Time Value of Money
6 - 35
Solution 6-141 Part (a) Future value of $30,000 compounded @ 10% for 6 years ($30,000 × 1.77156) = $53,147. Part (b) Present value of a $50,000 ordinary annuity discounted @ 8% for 20 years ($50,000 × 9.81815) = $490,908. Part (c) Alternative 1 Present value of $1,500 discounted @ 8% for 2 years ($1,500 × .85734) = Present value of $1,500 now = Present value of $600 now = Present value of Alternative 1
$1,286 600 $1,886
Alternative 2 Present value of $2,400 discounted @ 8% for 3 years ($2,400 × .79383)
$1,905
On the present value basis, Alternative 1 is preferable.
Pr. 6-142—Annuity with change in interest rate. Jan Green established a savings account for her son's college education by making annual deposits of $8,000 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 $8,000 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 6-142 Years 1-6:
Future value of annuity due of $8,000 for 6 periods at 8%: (7.33592 × 1.08) × $8,000 = $63,382
Years 7-10: Future value of $63,382 for 4 periods at 10%: 1.4641 × $63,382 = $92,798 Future value of ordinary annuity of $8,000 for 4 periods at 10%: 4.6410 × $8,000 = $37,128 Sum in bank at end of tenth year: $37,128 + $92,798 = $129,926
Pr. 6-143—Present value of an ordinary annuity due. Jill Morris is presently leasing a small business computer from Eller Office Equipment Company. The lease requires 10 annual payments of $8,000 at the end of each year and provides the lessor (Eller) 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
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Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 6-143 (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 Eller? (b) What amount would each payment be if the ten annual payments are to be made at the beginning of each period?
Solution 6-143 (a) Present value of an ordinary annuity of $8,000 at 8% for 10 years is 6.71008 × $8,000 =
$53,681
(b) Present value factor for an annuity due of $8,000 at 8% for 10 years is 7.24689; $53,681 ÷ 7.24689 =
$7,407
Pr. 6-144—Finding the implied interest rate. Bates 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 $108,144. Bates Company has, however, chosen to lease the equipment for $30,000 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 $114,978. Bates Company has chosen to lease the machine for $24,000 per year on a 6-year lease. Payments are due at the start of each year.
Solution 6-144 Lease A — Calculation of the Implied Interest Rate: $30,000 × (factor for Present Value of Ordinary Annuity for 5 yrs.) = $108,144 Factor for Present Value of Ordinary Annuity for 5 yrs. = $108,144 ÷ $30,000 = 3.6048 The 3.6048 factor implies a 12% interest rate. Lease B — Calculation of the Implied Interest Rate: $24,000 × (factor for Present Value of Annuity Due for 6 yrs.) = $114,978 Factor for Present Value of Annuity Due for 6 yrs. = $114,978 ÷ $24,000 = 4.79075 The 4.79075 factor implies a 10% interest rate (present value of an annuity due table).
Accounting and the Time Value of Money
6 - 37
Pr. 6-145—Calculation of unknown rent and interest. Pine Leasing Company purchased specialized equipment from Wayne Company on December 31, 2011 for $600,000. 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, 2012 and are made every 6 months until July 1, 2016. Pine 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 Pine earn in 2012?
Solution 6-145 (a) Calculation of rent: 7.72173 1.05 = 8.10782 (present value of a 10-rent annuity due at 5%.) $600,000 8.10782 = $74,003. (b) Interest Revenue during 2012:
Rent No. 1 2 None
Cash Received $74,003 74,003 None
Date 1/1/12 7/1/12 12/31/12 Total
Interest Revenue $ -026,300 23,915 (Accrual) $50,215
Lease Receivable $525,997 478,294
Pr. 6-146—Deferred annuity. Carey 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, Carey wishes to sell the land now. It has located two potential buyers: Buyer A, who is willing to pay $480,000 for the land now, and Buyer B, who is willing to make 20 annual payments of $75,000 each, with the first payment to be made 5 years from today. Assuming that the appropriate rate of interest is 9%, to whom should Carey sell the land? Show calculations.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 6-146 Buyer A. The present value of the purchase price is $480,000. Buyer B. The present value of the purchase price is: Present value of ordinary annuity of $75,000 for 24 periods at 9% Less present value of ordinary annuity of $75,000 for 4 periods (deferred) at 9% Difference Multiplied by annual payments Present value of payments Conclusion: Carey should sell to Buyer B.
9.70661 3.23972 6.46689 × $75,000 $485,017
Accounting and the Time Value of Money
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IFRS QUESTIONS True / False 1. IFRS does not intend to issue detailed guidance on the selection of a discount rate when the time value of money is required to determine cash flows. 2. Under IAS 37 and the establishment of estimate provisions, discounting is required where the time value of money is material. 3. Under IFRS, the rate implicit in the lease is generally used to discount minimum lease payments. 4. Under IFRS, the discount rate should reflect risks for which future cash flow estimates have been adjusted. 5. Under IFRS, if an estimate is being developed for a large number of items with varied outcomes, then the expected value method is used. Answers to True / False questions: 1. True 2. True 3. True 4. False 5. True
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Test Bank for Intermediate Accounting, Fourteenth Edition
Multiple Choice Questions: 1.
Underwood Company maintains its accounting records using IFRS. The company recently signed a lease for a new office building, for a lease period of 10 years. Under the lease agreement, a security deposit of $20,000 is made, with the deposit to be returned at the expiration of the lease, with interest compounded at 10% per year. What amount will the company receive at the time the lease expires? a. b. c. d.
$51,875. $40,000. $122,892. $27,711.
Calculation: Future value of $20,000 @ 10% for 10 years ($20,000 × 2.59374) = $51,875 Use the following information to answer questions 2 & 3. Martin Industries maintains its accounting records using IFRS. The company purchases equipment with a price of $300,000. The manufacturer has offered a payment plan that would allow Martin to make 10 equal annual payments of $36,987, with the first payment due one year after the purchase. 2.
How much total interest will Martin pay on this payment plan? a. b. c. d.
$69,870 $36,987 $120,000 $30,000
Calculation: Total interest = Total payments—amount owed today $369,870 (10 × $36,987) − $300,000 = $69,870. 3.
Martin could borrow $300,000 from its bank to finance the purchase at an annual rate of 6%. Should Martin borrow from the bank or use the manufacturer's payment plan to pay for the equipment? a. Borrow from the bank. b. Use the manufacturer's payment plan. c. The rates for both the bank and manufacturer are the same, so Martin would be indifferent. d. There is not enough information to answer this question.
Calculation: Martin should use the manufacturer's payment plan, since it is about a 4% rate as compared to the bank's 6% rate. PV − OA9, i% = $300,000 $36,987 = 8.11096; Inspection of the10 period row reveals a rate of about 4%.
Accounting and the Time Value of Money 4.
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Barton Company, a company who maintains its accounting records using IFRS, manufactures furniture. Barton sells a $75,000 order to Save-A Lot Furniture in exchange for a zero-interest-bearing note due from the customer in two years. Since there is no stated interest rate on the note, the controller uses the current market rate of 8% to derive the present value factor. Based on this information and the incorporation of the time value of money, which of the following would be recorded by Barton to recognize this sale? a. b. c. d.
A credit to Discount on Notes Receivable for $10,699. A credit to Sales Revenue for $75,000. A debit to Notes Receivable for $64,301. A debit to Discount on Notes Receivable for $6,000.
Rationale: Notes Receivable 75,000 Sales Revenue 64,301 Discount on Notes Receivable 10,699 $75,000 PV (8%, 2) = $75,000 .85734 = $64,301 5.
Moore Industries manufactures exercise equipment. Recently the vice president of operations of the company has requested construction of a new plant to meet the increasing demand for the company's exercise equipment. After a careful evaluation of the request, the board of directors has decided to raise funds for the new plant by issuing $2,000,000 of 11% bonds on March 1, 2012, due on March 1, 2027, with interest payable each March 1 and September 1. At the time of issuance, the market interest rate for similar financial instruments is 10%. What is the selling price of the bonds? a. b. c. d.
$2,220,000 $1,269,776 $2,153,730 $1,690,970
Calculations: Formula for the interest payments: PV − OA = R (PVF − OAn, i) PV − OA = $110,000 (PVF − OA30, 5%) PV − OA = $110,000 (15.37245) PV − OA = $1,690,970 Formula for the principal: PV = FV (PVFn, i) PV = $2,000,000 (PVF30, 5%) PV = $2,000,000 (0.23138) PV = $462,760 The selling price of the bonds = $1,690,970 + $462,760 = $2,153,730.
6 - 42 6.
Test Bank for Intermediate Accounting, Fourteenth Edition Reegan Company owns a trade name that was purchased in an acquisition of Hamilton Company. The trade name has a book value of $3,500,000, but according to GAAP, it is assessed for impairment on an annual basis. To perform this impairment test, Reegan must estimate the fair value of the trade name. It has developed the following cash flow estimates related to the trade name based on internal information. Each cash flow estimate reflects Reegan's estimate of annual cash flows over the next 7 years. The trade name is assumed to have no residual value after the 7 years. (Assume the cash flows occur at the end of each year.) Probability Assessment 30% 50% 20%
Cash Flow Estimate $480,000 730,000 850,000
Reegan determines that the appropriate discount rate for this estimation is 6%. To the nearest dollar, what is the estimated fair value of the trade name? a. b. c. d.
$3,500,000 $ 679,000 $2,060,000 $3,790,436
Calculations: This exercise determines the present value of an ordinary annuity of expected cash flows as a fair value estimate. Cash Flow Probability Expected Estimate Assessment = Cash Flow $480,000 30% $144,000 730,000 50% 365,000 850,000 20% 170,000 $679,000 PV Factor, (n = 7, l = 6%) Present Value $679,000 5.58238 = $3,790,436 7. • •
Jamison Company uses IFRS for its financial reporting. It produces machines that sell globally. All sales are accompanied by a one-year warranty. At the end of the year, the company has the following data: 2,000 units were sold during the year. The trend over the past five years has been that 4% of the machines were defective in some way and had to be repaired. Of this 4%, half required a full replacement at a cost of $3,000 per unit and half were able to be repaired at an average cost of $300.
What is the expected value of the warranty cost provision? a. b. c. d.
$240,000 $132,000 $264,000 $120,000
Calculation: (2,000 4% 50% $3,000) + (2,000 4% 50% $300) = $120,000 + $12,000 = $132,000
Accounting and the Time Value of Money 8.
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Maxim Company leased an office under a five-year contract, which has been accounted for as an operating lease. Faced with the downturn in the economy, the viable company decided to sub-lease the office. However, they have had no luck with this effort and the landlord will not allow the lease to be cancelled. The payments are $6,000 per year and there are four years left on the lease. The company's most recent interest rate for financing from a bank is 6%. The risk-free rate on government bonds is 4%. What is the provision for the lease under IFRS? a. b. c. d.
$21,780 $22,572 $24,000 $20,791
Calculation: PV $6,000 (4 years, 6%) = $6,000 3.46511 = $20,791 9.
Dolphin Company leased an office under a six-year contract, which has been accounted for as an operating lease. Faced with the downturn in the economy, the viable company decided to sub-lease the office. However, they have had no luck with this effort and the landlord will not allow the lease to be cancelled. The payments are $10,000 per year and there are five years left on the lease. The company's most recent interest rate for financing from a bank is 9%. The risk-free rate on government bonds is 5%. What is the provision for the lease under IFRS? a. b. c. d.
$50,000 $44,519 $38,897 $43,295
Calculation: PV $10,000 (5 years, 9%) = $10,000 3.88965 = $38,897 10
Techtronics, a technology company that uses IFRS for its financial reporting, has been found to have polluted the property surrounding its plant. The property is leaded for 12 years and Techtronics has agreed that when the lease expires, the pollution will be remediated before transfer back to its owner. The lease has a renewal option for another 8 years. If this option is exercised, the cleanup will be done at the end of the renewal period. There is a 70% chance that the lease will not be renewed and the cleanup will cost $180,000. There is 30% chance that the lease will be renewed and the cleanup costs will be $375,000 at the end of the 20 years. If you assume that these estimates are derived from best estimates of likely outcomes and the risk-free rate is 5%, the expected present value of the cleanup provision is: a. b. c. d.
$238,500 $112,562 $277,500 $226,575
Calculation: ($180,000 70% 0.55684) + ($375,000 30% 0.37689) = $70,162 + $42,400 = $112,562
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Test Bank for Intermediate Accounting, Fourteenth Edition
Answers to Multiple Choice. 1. a 2. a 3. b 4. a 5. c 6. d 7. b 8. d 9. c 10. b
CHAPTER 7 CASH AND RECEIVABLES IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
T F F F F T F F T T T F F T F F T F T F
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
Items considered cash. Items considered cash. Items considered cash. Cash equivalents definition. Bank overdrafts. Cash equivalents. Classification of receivables. Items considered trade receivables. Trade discount uses. Sales discounts. Valuation of receivables. Percentage-of-receivables approach. Percentage-of-sales method. Reporting notes receivable. Stated interest rate vs. effective rate. Classification of notes receivable. Recourse liability. Buying receivables with recourse. Selling receivables with recourse. Computing receivables turnover.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
d b d d b a b d b d d d d d c d
21. 22. 23. P 24. 25. 26. 27. 28. 29. S 30. 31. 32. 33. 34. S 35. S 36.
Identification of cash items. Identification of cash items. Classification of travel advance. Items included as cash. Identification of cash items. Classification of post-dated checks. Classification of postage stamps. Compensating balance definition. Classification of cash restricted for plant expansion. 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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer d a d c a c d a b c a d c d a b a d b c d a c c a a d c a d b c c b c P
No.
Description
P
Trade discount uses. Classification of sales discounts. Reasons for trade discounts. Accounting for cash discounts and trade discounts. Theoretically correct approach for cash discounts. Accounts receivable valuation problems. Reason allowance method is preferable. Allowance method concept. Accounting for bad debts and earnings management. Recording bad debt expense. Journal entry for writing off an account. Journal entry for collection of an account previously written off. 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. Financial statement effect of a note recorded incorrectly. Imputed interest description. Reason a company sells receivables. Transfer of receivables as a sale. Definition of selling receivables with recourse. Factoring accounts receivable without recourse. Classification of accounts and notes receivable. Transfer of receivables with recourse. Accounts receivable turnover ratio. Accounts receivable turnover ratio. Items included in accounts receivable on balance sheet. Days to collect accounts receivable calculation. Reason for accounts receivable turnover increase. Balance per bank reconciling item. Entry to replenish Petty Cash. Purpose of Cash Over & Short account. Classification of bank service charges. Treatment of bank credits on bank reconciliation.
37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. S 60. S 61. P 62. 63. 64. 65. 66. *67. *68. *69. *70. *71.
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. * This topic is dealt with in an Appendix to the chapter. S
Cash and Receivables
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MULTIPLE CHOICE—Computational Answer
No.
Description
b d b c b c c b c a c d c b b d c b a b b d b b d b a a b c c d a b d c a c c b b c c c c
72 73. 74. 75. 76. 77. 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. 113. 114. 115. 116.
Calculate cash balance. Calculate effective interest on loan with required compensatory balance. Reporting cash. Cash and cash equivalents. Reporting cash. Cash and cash equivalents. Determine effective annual interest rate of sales discount. Calculate sales revenue using net method. Entry for credit sale using gross method. Entry for credit sale using net method. Calculate ending allowance for doubtful accounts balance. Calculate bad debt expense. Calculate ending allowance for doubtful accounts balance. 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. Determine appropriate interest rate for a zero-interest-bearing note. Calculate present value of a zero-interest-bearing note. Calculation of sales revenue. Entry for exchange of goods for note receivable. Calculate amount of interest. Calculate interest revenue on a zero-interest-bearing note. Calculate note payable amount. Calculate gain (loss) on transfer of receivables. Calculate gain (loss) on transfer of receivables. Calculation of gain (loss) on transfer of receivables. Calculate proceeds from transfer of receivables with recourse. Record assignment of accounts receivables. 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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Computational (cont.) Answer
No.
d b b c b c
*117. *118. *119. *120. *121. *122.
Description Entry to replenish petty cash. 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.
a d d b c d c c b a a
123. 124. 125. 126. 127. 128. 129. 130. 131. *132. *133.
Description 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. Assignment and factoring of accounts receivable. Calculate correct cash balance. Calculate the cash balance per books.
EXERCISES Item E7-134 E7-135 E7-136 E7-137 E7-138
Description Asset classification. Allowance for doubtful accounts. Entries for bad debt expense. Fair value option. Accounts receivable assigned.
PROBLEMS Item P7-139 P7-140 P7-141 *P7-142 *P7-143
Description Entries for bad debt expense. Amortization of discount on note. Accounts receivable assigned. Factoring accounts receivable. Bank reconciliation.
Cash and Receivables
CHAPTER LEARNING OBJECTIVES' 1. 2. 3. 4. 5. 6. 7. 8. 9. *10.
Identify items considered as 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 and valuation of notes receivable. Explain the fair value option. Explain accounting issues related to disposition of accounts and notes receivable. Explain how to report and analyze receivables. Explain common techniques employed to control cash.
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Test Bank for Intermediate Accounting, Fourteenth Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
P
Type
Item
Type
Item
1. 2.
TF TF
3. 21.
TF MC
4. 5.
TF TF
6. 28.
TF MC
7.
TF
8.
TF
33.
9. 10.
TF TF
36. 37.
MC MC
38. 39.
11. 12. 13. 42. 43. 44.
TF TF TF MC MC MC
45. 46. 47. 48. 49. 50.
MC MC MC MC MC MC
51. 52. 53. 82. 83. 84.
14. 15. 16.
TF TF TF
54. 55. 97.
MC MC MC
98. 99. 100.
137.
E
S
S P
22. 23.
S
29. 30.
17. 18. 19. 56.
TF TF TF MC
57. 58. 59. S 60.
MC MC MC MC
61. 104. 105. 106.
20. 62.
TF MC
63. 64.
MC MC
65. 66.
67. 68.
MC MC
69. 70.
MC MC
71. 117.
Note:
TF = True-False MC = Multiple Choice
Type
Item
Type
Item
Learning Objective 1 P MC 24. MC 26. MC 25. MC 27. Learning Objective 2 MC 31. MC 73. MC 32. MC 74. Learning Objective 3 S MC 34. MC 35. Learning Objective 4 MC 40. MC 78. MC 41. MC 79. Learning Objective 5 MC 85. MC 91. MC 86. MC 92. MC 87. MC 93. MC 88. MC 94. MC 89. MC 95. MC 90. MC 96. Learning Objective 6 MC 101. MC 129. MC 102. MC 130. MC 103. MC 140. Learning Objective 7
Learning Objective 8 MC 107. MC 111. MC 108. MC 112. MC 109. MC 113. MC 110. MC 114. Learning Objective 9 MC 115. MC MC 116. MC Learning Objective *10 MC 118. MC 120. MC 119. MC 121. E = Exercise P = Problem
Type
Item
Type
Item
Type
MC MC
72.
MC
MC MC
75. 76.
MC MC
77. 134.
MC E
MC MC
80. 81.
MC MC
123.
MC
MC MC MC MC MC MC
124. 125. 126. 127. 128. 135.
MC MC MC MC MC E
136. 139.
E P
MC MC MC MC
131. 138. 141. 142.
MC E P P
MC MC
122. 132.
MC MC
133. 143.
MC P
MC
MC MC P
Cash and Receivables
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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 equivalents are investments with original maturities of six months or less. 5. Bank overdrafts are always offset against the cash account in the balance sheet. 6. Short-term, highly liquid investments may be included with cash on the balance sheet. 7. All claims held against customers and others for money, goods, or services are reported as current assets. 8. Trade receivables include notes receivable and advances to officers and employees. 9. Trade discounts are used to avoid frequent changes in catalogs and to alter prices for different quantities purchased. 10. In the gross method, sales discounts are reported as a deduction from sales. 11. The net amount reported for short-term receivables is not affected when a specific account receivable is determined to be uncollectible. 12. The percentage-of-receivables approach of estimating uncollectible accounts emphasizes matching over valuation of accounts receivable. 13. The percentage-of-sales method results in a more accurate valuation of receivables on the balance sheet. 14. Companies record and report long-term notes receivable at the present value of the cash they expect to collect. 15. When the stated rate of interest exceeds the effective rate, the present value of the note receivable will be less than its face value. 16. Notes receivable are generally reported as noncurrent assets. 17. Recognition of a recourse liability will make a loss on sale of receivables larger than it would otherwise have been. 18. When buying receivables with recourse, the purchaser assumes the risk of collectibility and absorbs any credit loss. 19. For receivables sold with recourse, the seller guarantees payment to the purchaser if the debtor fails to pay.
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Test Bank for Intermediate Accounting, Fourteenth Edition
20. The receivables turnover ratio is computed by dividing net sales by the ending net receivables.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. T F F F F
Item 6. 7. 8. 9. 10.
Ans. T F F T T
Item 11. 12. 13. 14. 15.
Ans. T F F T F
Item 16. 17. 18. 19. 20.
Ans. F T F T F
MULTIPLE CHOICE—Conceptual
P
21.
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
22.
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
23.
Travel advances should be reported as a. supplies. b. cash because they represent the equivalent of money. c. investments. d. none of these.
24.
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
25.
All of the following may be included under the heading of "cash" except a. currency. b. money market funds. c. checking account balance. d. savings account balance.
Cash and Receivables
S
7-9
26.
In which account are post-dated checks received classified? a. Receivables. b. Prepaid expenses. c. Cash. d. Payables.
27.
In which account are postage stamps classified? a. Cash. b. Office supplies. c. Receivables. d. Inventory.
28.
What is a compensating balance? a. Savings account balances. b. Margin accounts held with brokers. c. Temporary investments serving as collateral for outstanding loans. d. Minimum deposits required to be maintained in connection with a borrowing arrangement.
29.
Under which section of the balance sheet is "cash restricted for plant expansion" reported? a. Current assets. b. Non-current assets. c. Current liabilities. d. Stockholders' equity.
30.
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.
31.
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.
32.
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.
33.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
34.
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
S
35.
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.
S
36.
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.
P
37.
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.
38.
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.
39.
Why do companies provide trade discounts? a. To avoid frequent changes in catalogs. b. To induce prompt payment. c. To easily alter prices for different customers. d. Both a. and c.
40.
The accounting for cash discounts and trade discounts are a. the same. b. always recorded net. c. not the same. d. tied to the timing of cash collections on the account.
Cash and Receivables
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41.
Of the approaches to record cash discounts related to accounts receivable, which is more theoretically correct? a. Net approach. b. Gross approach. c. Allowance approach. d. All three approaches are theoretically correct.
42.
All of the following are problems associated with the valuation of accounts receivable except for a. uncollectible accounts. b. returns. c. cash discounts under the net method. d. allowances granted.
43.
Why is the allowance method preferred over the direct write-off method of accounting for bad debts? a. Allowance method is used for tax purposes. b. Estimates are used. c. Determining worthless accounts under direct write-off method is difficult to do. d. Improved matching of bad debt expense with revenue.
44.
Which of the following concepts relates to using the allowance method in accounting for accounts receivable? a. Bad debt expense is an estimate that is based on historical and prospective information. b. Bad debt expense is based on the actual amounts determined to be uncollectible. c. Bad debt expense is an estimate that is based only on an analysis of the receivables aging. d. Bad debt expense is management's determination of which accounts will be sent to the attorney for collection.
45.
How can accounting for bad debts be used for earnings management? a. Determining which accounts to write-off. b. Changing the percentage of sales recorded as bad debt expense. c. Using an aging of the accounts receivable balance to determine bad debt expense. d. Reversing previous write-offs.
46.
What is the normal journal entry for recording bad debt expense under the allowance method? a. Debit Allowance for Doubtful Accounts, credit Accounts Receivable. b. Debit Allowance for Doubtful Accounts, credit Bad Debt Expense. c. Debit Bad Debt Expense, credit Allowance for Doubtful Accounts. d. Debit Accounts Receivable, credit Allowance for Doubtful Accounts.
47.
What is the normal journal entry when writing-off an account as uncollectible under the allowance method? a. Debit Allowance for Doubtful Accounts, credit Accounts Receivable. b. Debit Allowance for Doubtful Accounts, credit Bad Debt Expense. c. Debit Bad Debt Expense, credit Allowance for Doubtful Accounts. d. Debit Accounts Receivable, credit Allowance for Doubtful Accounts.
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Test Bank for Intermediate Accounting, Fourteenth Edition
48.
Which of the following is included in the normal journal entry to record the collection of accounts receivable previously written off when using the allowance method? a. Debit Allowance for Doubtful Accounts, credit Accounts Receivable. b. Debit Allowance for Doubtful Accounts, credit Bad Debt Expense. c. Debit Bad Debt Expense, credit Allowance for Doubtful Accounts. d. Debit Accounts Receivable, credit Allowance for Doubtful Accounts.
49.
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.
50.
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.
51.
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
52.
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
53.
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.
Cash and Receivables
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54.
At the beginning of 2011, Gannon Company received a three-year zero-interest-bearing $1,000 trade note. The market rate for equivalent notes was 8% at that time. Gannon reported this note as a $1,000 trade note receivable on its 2011 year-end statement of financial position and $1,000 as sales revenue for 2011. What effect did this accounting for the note have on Gannon's net earnings for 2011, 2012, 2013, and its retained earnings at the end of 2013, respectively? a. Overstate, overstate, understate, zero b. Overstate, understate, understate, understate c. Overstate, overstate, overstate, overstate d. None of these
55.
What is imputed interest? a. Interest based on the stated interest rate. b. Interest based on the implicit interest rate. c. Interest based on the average interest rate. d. Interest based on the coupon rate.
56.
Why would a company sell receivables to another company? a. To improve the quality of its credit granting process. b. To limit its legal liability. c. To accelerate access to amounts collected. d. To comply with customer agreements.
57.
When should a transfer of receivables be recorded as a sale? a. The transferred assets are isolated from the transferor. b. The transferor does not maintain effective control over the transferred assets through an agreement to repurchase or redeem them prior to their maturity. c. The transferee has the right to pledge or exchange the transferred assets. d. All of the above.
58.
What is "recourse" as it relates to selling receivables? a. The obligation of the seller of the receivables to pay the purchaser in case the debtor fails to pay. b. The obligation of the purchaser of the receivables to pay the seller in case the debtor fails to pay c. The obligation of the seller of the receivables to pay the purchaser in case the debtor returns the product related to the sale. d. The obligation of the purchaser of the receivables to pay the seller if all of the receivables are collected.
59.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
S
60.
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.
S
61.
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.
P
62.
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.
63.
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.
64.
Which of the following items should be included in accounts receivable reported on the balance sheet? a. Notes receivable. b. Interest receivable. c. Allowance for doubtful accounts. d. Advances to related parties and officers.
65.
How is days to collect accounts receivable determined? a. 365 days divided by accounts receivable turnover. b. Net sales divided by 365. c. Net sales divided by average net trade receivables. d. Accounts receivable turnover divided by 365 days.
66.
What is a possible reason for accounts receivable turnover to increase from one year to the next year a. Decreased credit sales during a recession. b. Write-off uncollectible receivables. c. Granting credit to customers with lower credit quality. d. Improved collection process.
Cash and Receivables
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*67.
Which of the following is an appropriate reconciling item to the balance per bank in a bank reconciliation? a. Bank service charge. b. Deposit in transit. c. Bank interest. d. Chargeback for NSF check.
*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.
Multiple Choice Answers—Conceptual Item
21. 22. 23. P 24. 25. 26. 27. 28.
Ans.
d b d d b a b d
Item
29. 30. 31. 32. 33. 34. S 35. S 36. S
Ans.
b d d d d d c d
Item P
37. 38. 39. 40. 41. 42. 43. 44.
Ans.
d a d c a c d a
Item
45. 46. 47. 48. 49. 50. 51. 52.
Ans.
b c a d c d a b
Item
53. 54. 55. 56. 57. 58. 59. S 60.
Ans.
a d b c d a c c
Item S
61. 62. 63. 64. 65. 66. *67. *68.
P
Ans.
Item
Ans.
a a d c a d b c
*69. *70. *71.
c b c
Solutions to those Multiple Choice questions for which the answer is “none of these.” 23. As receivables. 32. Many answers are possible. 33. Open accounts resulting from short-term extensions of credit to customers. 34. Open accounts resulting from short-term extensions of credit to customers. 54. Overstate, understate, understate, zero.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Computational 72.
Consider the following: Cash in Bank – checking account of $18,500, Cash on hand of $500, Post-dated checks received totaling $3,500, and Certificates of deposit totaling $124,000. How much should be reported as cash in the balance sheet? a. $ 18,500. b. $ 19,000. c. $ 22,500. d. $136,500.
73.
On January 1, 2012, Lynn Company borrows $2,000,000 from National Bank at 11% annual interest. In addition, Lynn 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 Lynn pays on its $2,000,000 loan is a. 10.0%. b. 11.0%. c. 11.5%. d. 11.6%.
74.
Kennison Company has cash in bank of $15,000, restricted cash in a separate account of $3,000, and a bank overdraft in an account at another bank of $1,000. Kennison should report cash of a. $14,000. b. $15,000. c. $17,000. d. $18,000.
75.
Kaniper Company has the following items at year-end: Cash in bank Petty cash Short-term paper with maturity of 2 months Postdated checks
$30,000 300 5,500 1,400
Kaniper should report cash and cash equivalents of a. $30,000. b. $30,300. c. $35,800. d. $37,200. 76.
Lawrence Company has cash in bank of $22,000, restricted cash in a separate account of $4,000, and a bank overdraft in an account at another bank of $2,000. Lawrence should report cash of a. $20,000. b. $22,000. c. $25,000. d. $26,000.
Cash and Receivables
77.
7 - 17
Steinert Company has the following items at year-end: Cash in bank Petty cash Short-term paper with maturity of 2 months Postdated checks
$35,000 500 8,200 2,100
Steinert should report cash and cash equivalents of a. $35,000. b. $35,500. c. $43,700. d. $45,800. 78.
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%
79.
AG Inc. made a $15,000 sale on account with the following terms: 1/15, n/30. If the company uses the net method to record sales made on credit, how much should be recorded as revenue? a. $14,700. b. $14,850. c. $15,000. d. $15,150.
80.
AG Inc. made a $15,000 sale on account with the following terms: 1/15, n/30. If the company uses the gross method to record sales made on credit, what is/are the debit(s) in the journal entry to record the sale? a. Debit Accounts Receivable for $14,850. b. Debit Accounts Receivable for $14,850 and Sales Discounts for $150. c. Debit Accounts Receivable for $15,000. d. Debit Accounts Receivable for $15,000 and Sales Discounts for $150.
81.
AG Inc. made a $15,000 sale on account with the following terms: 2/10, n/30. If the company uses the net method to record sales made on credit, what is/are the debit(s) in the journal entry to record the sale? a. Debit Accounts Receivable for $14,700. b. Debit Accounts Receivable for $14,700 and Sales Discounts for $300. c. Debit Accounts Receivable for $15,000. d. Debit Accounts Receivable for $15,000 and Sales Discounts for $300.
82.
Wellington Corp. has outstanding accounts receivable totaling $1.27 million as of December 31 and sales on credit during the year of $6.4 million. There is also a debit balance of $3,000 in the allowance for doubtful accounts. If the company estimates that 1% of its net credit sales will be uncollectible, what will be the balance in the allowance for doubtful accounts after the year-end adjustment to record bad debt expense? a. $12,700. b. $15,700. c. $61,000. d. $67,000.
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Test Bank for Intermediate Accounting, Fourteenth Edition
83.
Wellington Corp. has outstanding accounts receivable totaling $6.5 million as of December 31 and sales on credit during the year of $24 million. There is also a credit balance of $12,000 in the allowance for doubtful accounts. If the company estimates that 8% of its outstanding receivables will be uncollectible, what will be the amount of bad debt expense recognized for the year? a. $ 532,000. b. $ 520,000. c. $1,920,000. d. $ 508,000.
84.
Wellington Corp. has outstanding accounts receivable totaling $5 million as of December 31 and sales on credit during the year of $25 million. There is also a debit balance of $20,000 in the allowance for doubtful accounts. If the company estimates that 8% of its outstanding receivables will be uncollectible, what will be the balance in the allowance for doubtful accounts after the year-end adjustment to record bad debt expense? a. $2,000,000. b. $ 380,000. c. $ 400,000. d. $ 420,000.
85.
At the close of its first year of operations, December 31, 2012, Ming Company had accounts receivable of $1,080,000, after deducting the related allowance for doubtful accounts. During 2012, the company had charges to bad debt expense of $180,000 and wrote off, as uncollectible, accounts receivable of $80,000. What should the company report on its balance sheet at December 31, 2012, as accounts receivable before the allowance for doubtful accounts? a. $1,340,000 b. $1,180,000 c. $980,000 d. $880,000
86.
Before year-end adjusting entries, Dunn Company's account balances at December 31, 2012, for accounts receivable and the related allowance for uncollectible accounts were $1,200,000 and $90,000, respectively. An aging of accounts receivable indicated that $125,000 of the December 31 receivables are expected to be uncollectible. The net realizable value of accounts receivable after adjustment is a. $1,165,000. b. $1,075,000. c. $985,000. d. $1,110,000.
87.
During the year, Kiner Company made an entry to write off a $16,000 uncollectible account. Before this entry was made, the balance in accounts receivable was $200,000 and the balance in the allowance account was $18,000. The net realizable value of accounts receivable after the write-off entry was a. $200,000. b. $198,000. c. $166,000. d. $182,000.
Cash and Receivables
88.
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The following information is available for Murphy Company: Allowance for doubtful accounts at December 31, 2011 Credit sales during 2012 Accounts receivable deemed worthless and written off during 2012
$ 16,000 800,000 18,000
As a result of a review and aging of accounts receivable in early January 2013, however, it has been determined that an allowance for doubtful accounts of $11,000 is needed at December 31, 2012. What amount should Murphy record as "bad debt expense" for the year ended December 31, 2012? a. $9,000 b. $11,000 c. $13,000 d. $27,000 Use the following information for questions 89 and 90. A trial balance before adjustments included the following: Debit Sales Sales returns and allowance Accounts receivable Allowance for doubtful accounts
Credit $850,000
$28,000 86,000 1,520
89.
If the estimate of uncollectibles is made by taking 2% of net sales, the amount of the adjustment is a. $13,400. b. $16,440. c. $17,000. d. $19,480.
90.
If the estimate of uncollectibles is made by taking 10% of gross account receivables, the amount of the adjustment is a. $7,080. b. $8,600. c. $8,448. d. $10,120.
91.
Lankton Company has the following account balances at year-end: Accounts receivable Allowance for doubtful accounts Sales discounts
$80,000 4,800 3,200
Lankton should report accounts receivable at a net amount of a. $72,000. b. $75,200. c. $76,800. d. $80,000.
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Test Bank for Intermediate Accounting, Fourteenth Edition
92.
Smithson Corporation had a 1/1/12 balance in the Allowance for Doubtful Accounts of $20,000. During 2012, 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 12/31/12, Smithson estimates that 5% of accounts receivable will prove to be uncollectible. What is Bad Debt Expense for 2012? a. $4,000. b. $14,200. c. $18,400. d. $24,000.
93.
Black Corporation had a 1/1/12 balance in the Allowance for Doubtful Accounts of $18,000. During 2012, it wrote off $12,960 of accounts and collected $3,780 on accounts previously written off. The balance in Accounts Receivable was $360,000 at 1/1 and $432,000 at 12/31. At 12/31/12, Black estimates that 5% of accounts receivable will prove to be uncollectible. What should Black report as its Allowance for Doubtful Accounts at 12/31/12? a. $8,640. b. $8,820. c. $12,420. d. $21,600.
94.
Shelton Company has the following account balances at year-end: Accounts receivable Allowance for doubtful accounts Sales discounts
$120,000 7,200 4,800
Shelton should report accounts receivable at a net amount of a. $108,000. b. $112,800. c. $115,200. d. $120,000. 95.
Vasguez Corporation had a 1/1/12 balance in the Allowance for Doubtful Accounts of $30,000. During 2012, it wrote off $21,600 of accounts and collected $6,300 on accounts previously written off. The balance in Accounts Receivable was $600,000 at 1/1 and $720,000 at 12/31. At 12/31/12, Vasguez estimates that 5% of accounts receivable will prove to be uncollectible. What is Bad Debt Expense for 2012? a. $6,000. b. $21,300. c. $27,600. d. $36,000.
96.
McGlone Corporation had a 1/1/12 balance in the Allowance for Doubtful Accounts of $25,000. During 2012, it wrote off $18,000 of accounts and collected $5,250 on accounts previously written off. The balance in Accounts Receivable was $500,000 at 1/1 and $600,000 at 12/31. At 12/31/12, McGlone estimates that 5% of accounts receivable will prove to be uncollectible. What should McGlone report as its Allowance for Doubtful Accounts at 12/31/12? a. $12,000. b. $12,250. c. $17,250. d. $30,000.
Cash and Receivables
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97.
Lester Company received a seven-year zero-interest-bearing note on February 22, 2012, in exchange for property it sold to Porter 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, 2012, 7.5% on December 31, 2012, 7.7% on February 22, 2013, and 8% on December 31, 2013. What interest rate should be used to calculate the interest revenue from this transaction for the years ended December 31, 2012 and 2013, respectively? a. 0% and 0% b. 7% and 7% c. 7% and 7.7% d. 7.5% and 8%
98.
On December 31, 2012, Flint Corporation sold for $100,000 an old machine having an original cost of $180,000 and a book value of $80,000. The terms of the sale were as follows: $20,000 down payment $40,000 payable on December 31 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, 2012 rounded to the nearest dollar? (The present value of an ordinary annuity of 1 at 9% for 2 years is 1.75911.) a. $70,364 b. $90,364. c. $80,000. d. $140,728.
99.
Assume Royal Palm Corp., an equipment distributor, sells a piece of machinery with a list price of $600,000 to Arch Inc. Arch Inc. will pay $650,000 in one year. Royal Palm Corp. normally sells this type of equipment for 90% of list price. How much should be recorded as revenue? a. $540,000. b. $585,000. c. $600,000. d. $650,000.
100.
Equestrain Roads sold $80,000 of goods and accepted the customer's $80,000 10% 1-year note receivable in exchange. Assuming 10% approximates the market rate of return, what would be the debit in this journal entry to record the sale? a. No journal entry until cash is collected. b. Debit Notes Receivable for $80,000. c. Debit Accounts Receivable for $80,000. d. Debit Notes Receivable for $72,000.
101.
Equestrain Roads sold $80,000 of goods and accepted the customer's $80,000 10% 1-year note payable in exchange. Assuming 10% approximates the market rate of return, how much interest would be recorded for the year ending December 31 if the sale was made on June 30? a. $0. b. $2,000. c. $4,000. d. $8,000.
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Test Bank for Intermediate Accounting, Fourteenth Edition
102.
Equestrain Roads accepted a customer's $50,000 zero-interest-bearing six-month note payable in a sales transaction. The product sold normally sells for $46,000. If the sale was made on June 30, how much interest revenue from this transaction would be recorded for the year ending December 31? a. $0. b. $2,000. c. $4,000. d. $5,000.
103.
Assuming the market interest rate is 10% per annum, how much would Green Co. record as a note payable if the terms of the loan with a bank are that it would have to make one $80,000 payment in two years? a. $80,000. b. $72,563. c. $72,727. d. $66,116.
104.
Sun Inc. factors $3,000,000 of its accounts receivables without recourse for a finance charge of 5%. The finance company retains an amount equal to 10% of the accounts receivable for possible adjustments. Sun estimates the fair value of the recourse liability at $115,000. What would be recorded as a gain (loss) on the transfer of receivables? a. Loss of $150,000. b. Gain of $265,000. c. Loss of $565,000. d. Loss of $115,000.
105.
Sun Inc. factors $3,000,000 of its accounts receivables with recourse for a finance charge of 3%. The finance company retains an amount equal to 10% of the accounts receivable for possible adjustments. Sun estimates the fair value of the recourse liability at $150,000. What would be recorded as a gain (loss) on the transfer of receivables? a. Gain of $90,000. b. Loss of 240,000. c. Gain of $540,000. d. Loss of $150,000.
106.
Sun Inc assigns $3,000,000 of its accounts receivables as collateral for a $1 million 8% loan with a bank. Sun Inc. also pays a finance fee of 1% on the transaction upfront. What would be recorded as a gain (loss) on the transfer of receivables? a. Loss of $30,000. b. Loss of $240,000. c. Loss of $270,000. d. $0.
107.
Moon Inc. factors $2,000,000 of its accounts receivables with recourse for a finance charge of 4%. The finance company retains an amount equal to 8% of the accounts receivable for possible adjustments. Moon estimates the fair value of the recourse liability at $200,000. What would be the debit to Cash in the journal entry to record this transaction? a. $2,000,000. b. $1,920,000. c. $1,760,000. d. $1,560,000.
Cash and Receivables
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108.
Moon Inc assigns $3,000,000 of its accounts receivables as collateral for a $2 million loan with a bank. The bank assesses a 3% finance fee and charges interest on the note at 6%. What would be the journal entry to record this transaction? a. Debit Cash for $1,940,000, debit Finance Charge for $60,000, and credit Notes payable for $2,000,000. b. Debit Cash for $1,940,000, debit Finance Charge for $60,000, and credit Accounts Receivable for $2,000,000. c. Debit Cash for $1,940,000, debit Finance Charge for $60,000, debit Due from Bank for $1,000,000, and credit Accounts Receivable for $3,000,000. d. Debit Cash for $1,820,000, debit Finance Charge for $180,000, and credit Notes Payable for $2,000,000.
109.
Geary Co. assigned $800,000 of accounts receivable to Kwik Finance Co. as security for a loan of $670,000. Kwik charged a 2% commission on the amount of the loan; the interest rate on the note was 10%. During the first month, Geary collected $220,000 on assigned accounts after deducting $760 of discounts. Geary accepted returns worth $2,700 and wrote off assigned accounts totaling $5,960. The amount of cash Geary received from Kwik at the time of the transfer was a. $603,000. b. $654,000. c. $656,600. d. $670,000.
110.
Geary Co. assigned $800,000 of accounts receivable to Kwik Finance Co. as security for a loan of $670,000. Kwik charged a 2% commission on the amount of the loan; the interest rate on the note was 10%. During the first month, Geary collected $220,000 on assigned accounts after deducting $760 of discounts. Geary accepted returns worth $2,700 and wrote off assigned accounts totaling $5,960. Entries during the first month would include a a. debit to Cash of $220,760. b. debit to Bad Debt Expense of $5,960. c. debit to Allowance for Doubtful Accounts of $5,960. d. debit to Accounts Receivable of $229,420.
111.
On February 1, 2012, Henson Company factored receivables with a carrying amount of $500,000 to Agee Company. Agee 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 Henson Company for February. Assume that Henson factors the receivables on a without recourse basis. The loss to be reported is a. $0. b. $15,000. c. $25,000. d. $40,000.
7 - 24 112.
Test Bank for Intermediate Accounting, Fourteenth Edition On February 1, 2012, Henson Company factored receivables with a carrying amount of $500,000 to Agee Company. Agee 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 Henson Company for February. Assume that Henson factors the receivables on a with recourse basis. The recourse obligation has a fair value of $2,500. The loss to be reported is a. $15,000. b. $17,500. c. $25,000. d. $42,500.
113.
Maxwell 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. Maxwell estimates the recourse obligation at $2,400. What amount should Maxwell report as a loss on sale of receivables? a. $ -0-. b. $3,000. c. $5,400. d. $10,400.
114.
Wilkinson Corporation factored, with recourse, $400,000 of accounts receivable with Huskie Financing. The finance charge is 3%, and 5% was retained to cover sales discounts, sales returns, and sales allowances. Wilkinson estimates the recourse obligation at $9,600. What amount should Wilkinson report as a loss on sale of receivables? a. $ -0-. b. $12,000. c. $21,600. d. $41,600.
115.
Remington Corporation had accounts receivable of $100,000 at 1/1. The only transactions affecting accounts receivable were sales of $750,000 and cash collections of $700,000. The accounts receivable turnover is a. 5.0. b. 5.5. c. 6.0. d. 7.5.
116.
Laventhol Corporation had accounts receivable of $100,000 at 1/1. The only transactions affecting accounts receivable were sales of $1,200,000 and cash collections of $1,150,000. The accounts receivable turnover is a. 8.0. b. 8.8. c. 9.6. d. 12.0.
Cash and Receivables
7 - 25
*117. 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. *118. If the month-end bank statement shows a balance of $72,000, outstanding checks are $24,000, a deposit of $8,000 was in transit at month end, and a check for $1,000 was erroneously charged by the bank against the account, the correct balance in the bank account at month end is a. $55,000. b. $57,000. c. $41,000. d. $87,000. *119. In preparing its bank reconciliation for the month of April 2012, Henke, Inc. has available the following information. Balance per bank statement, 4/30/12 NSF check returned with 4/30/12 bank statement Deposits in transit, 4/30/12 Outstanding checks, 4/30/12 Bank service charges for April
$34,140 450 5,000 5,200 20
What should be the correct balance of cash at April 30, 2012? a. $34,370 b. $33,940 c. $33,490 d. $33,470 *120. Finley, Inc.’s checkbook balance on December 31, 2012 was $42,400. In addition, Finley held the following items in its safe on December 31. (1) A check for $900 from Peters, Inc. received December 30, 2012, which was not included in the checkbook balance. (2) An NSF check from Garner Company in the amount of $1,800 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, 2013. The original deposit has been included in the December 31 checkbook balance. (3) Coin and currency on hand amounted to $2,900. The proper amount to be reported on Finley's balance sheet for cash at December 31, 2012 is a. $42,600. b. $40,800. c. $44,400. d. $43,550.
7 - 26
Test Bank for Intermediate Accounting, Fourteenth Edition
*121. The cash account shows a balance of $90,000 before reconciliation. The bank statement does not include a deposit of $4,600 made on the last day of the month. The bank statement shows a collection by the bank of $1,880 and a customer's check for $640 was returned because it was NSF. A customer's check for $900 was recorded on the books as $1,080, and a check written for $158 was recorded as $194. The correct balance in the cash account was a. $91,024. b. $91,096. c. $91,456. d. $95,696. *122. In preparing its May 31, 2012 bank reconciliation, Catt Co. has the following information available: Balance per bank statement, 5/31/12 $35,000 Deposit in transit, 5/31/12 5,400 Outstanding checks, 5/31/12 4,900 Note collected by bank in May 1,250 The correct balance of cash at May 31, 2012 is a. $40,400. b. $34,250. c. $35,500. d. $36,750.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans
72. 73. 74. 75. 76. 77. 78. 79.
b d b c b c c b
80. 81. 82. 83. 84. 85. 86. 87.
c a c d c b b d
88. 89. 90. 91. 92. 93. 94. 95.
c b a b b d b b
96. 97. 98. 99. 100. 101. 102. 103.
d b a a b c c d
104. 105. 106. 107. 108. 109. 110. 111.
a b d c a c c b
112. 113. 114. 115. 116. *117. *118. *119.
b c c c c d b b
*120. *121. *122.
c. b c
MULTIPLE CHOICE—CPA Adapted 123.
On the December 31, 2012 balance sheet of Vanoy Co., the current receivables consisted of the following: Trade accounts receivable Allowance for uncollectible accounts Claim against shipper for goods lost in transit (November 2012) Selling price of unsold goods sent by Vanoy on consignment at 130% of cost (not included in Vanoy 's ending inventory) Security deposit on lease of warehouse used for storing some inventories Total
$ 60,000 (2,000) 3,000 26,000 30,000 $117,000
Cash and Receivables
7 - 27
At December 31, 2012, the correct total of Vanoy's current net receivables was a. $61,000. b. $87,000. c. $91,000. d. $117,000. 124.
Ace Co. prepared an aging of its accounts receivable at December 31, 2012 and determined that the net realizable value of the receivables was $600,000. Additional information is available as follows: Allowance for uncollectible accounts at 1/1/12—credit balance Accounts written off as uncollectible during 2012 Accounts receivable at 12/31/12 Uncollectible accounts recovered during 2012
$ 68,000 46,000 650,000 10,000
For the year ended December 31, 2012, Ace's uncollectible accounts expense would be a. $50,000. b. $46,000. c. $32,000. d. $18,000. 125.
For the year ended December 31, 2012, Dent Co. estimated its allowance for uncollectible accounts using the year-end aging of accounts receivable. The following data are available: Allowance for uncollectible accounts, 1/1/12 $84,000 Provision for uncollectible accounts during 2012 (2% on credit sales of $3,000,000) 60,000 Uncollectible accounts written off, 11/30/12 69,000 Estimated uncollectible accounts per aging, 12/31/12 104,000 After year-end adjustment, the uncollectible accounts expense for 2012 should be a. $69,000. b. $60,000. c. $104,000. d. $89,000.
126.
Nenn Co.'s allowance for uncollectible accounts was $190,000 at the end of 2012 and $180,000 at the end of 2011. For the year ended December 31, 2012, Nenn reported bad debt expense of $26,000 in its income statement. What amount did Nenn debit to the appropriate account in 2012 to write off actual bad debts? a. $10,000 b. $16,000 c. $26,000 d. $36,000
127.
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.
7 - 28 128.
Test Bank for Intermediate Accounting, Fourteenth Edition The following accounts were abstracted from Starr Co.'s unadjusted trial balance at December 31, 2012: Debit Credit Accounts receivable $750,000 Allowance for uncollectible accounts 8,000 Net credit sales $3,000,000 Starr estimates that 4% of the gross accounts receivable will become uncollectible. After adjustment at December 31, 2012, the allowance for uncollectible accounts should have a credit balance of a. $120,000. b. $112,000. c. $38,000. d. $30,000.
129.
On January 1, 2012, West Co. exchanged equipment for a $600,000 zero-interest-bearing note due on January 1, 2015. The prevailing rate of interest for a note of this type at January 1, 2012 was 10%. The present value of $1 at 10% for three periods is 0.75. What amount of interest revenue should be included in West's 2013 income statement? a. $0 b. $45,000 c. $49,500 d. $60,000
130.
On June 1, 2012, Yang Corp. loaned Gant $400,000 on a 12% note, payable in five annual installments of $80,000 beginning January 2, 2013. In connection with this loan, Gant was required to deposit $4,000 in a zero-interest-bearing escrow account. The amount held in escrow is to be returned to Gant 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, 2012. Gant made timely payments through November 1, 2012. On January 2, 2013, Yang received payment of the first principal installment plus all interest due. At December 31, 2012, Yang's interest receivable on the loan to Gant should be a. $0. b. $4,000. c. $8,000. d. $12,000.
131.
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
Cash and Receivables
7 - 29
*132. In preparing its August 31, 2012 bank reconciliation, Bing Corp. has available the following information: Balance per bank statement, 8/31/12 Deposit in transit, 8/31/12 Return of customer's check for insufficient funds, 8/30/12 Outstanding checks, 8/31/12 Bank service charges for August
$18,650 3,900 600 2,750 100
At August 31, 2012, Bing's correct cash balance is a. $19,800. b. $19,200. c. $19,100. d. $17,500. *133. Tresh, Inc. had the following bank reconciliation at March 31, 2012: Balance per bank statement, 3/31/12 Add: Deposit in transit
$37,200 10,300 47,500 12,600 $34,900
Less: Outstanding checks Balance per books, 3/31/12 Data per bank for the month of April 2012 follow: Deposits Disbursements
$43,700 49,700
All reconciling items at March 31, 2012 cleared the bank in April. Outstanding checks at April 30, 2012 totaled $6,000. There were no deposits in transit at April 30, 2012. What is the cash balance per books at April 30, 2012? a. $25,200 b. $28,900 c. $31,200 d. $35,500
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
123. 124.
a d
125. 126.
d b
127. 128.
c d
129. 130.
c c
131. *132.
b a
*133.
a
7 - 30
Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational No.
Answer
72
b
Derivation $18,500 + $500 = $19,000.
73.
d
$2,000,000 × .11 = $200,000 × (.11 – .05) = Interest
$220,000 12,000 $232,000
$232,000 ÷ $2,000,000 = .116 = 11.6%. 74.
b
75.
c
76.
b
77.
c
$35,000 + $500 + $8,200 = $43,700.
78.
c
.01 × 360 ÷ 20 = 18%.
79.
b
$15,000 × (1 – .01) = $14,850.
80.
c
$15,000 × 100% = $15,000.
81.
a
$15,000 × (1 – .02) = $14,700.
82.
c
($6,400,000 × .01) – $3,000 = $61,000.
83.
d
($6,500,000 × .08) – $12,000 = $508,000.
84.
c
$5,000,000 × .08 = $400,000.
85.
b
$1,080,000 + ($180,000 – $80,000) = $1,180,000.
86.
b
$1,200,000 – $125,000 = $1,075,000.
87.
d
($200,000 – $16,000) – ($18,000 – $16,000) = $182,000.
88.
c
$16,000 – $18,000 + X = $11,000; X = $13,000.
89.
b
($850,000 – $28,000) × .02 = $16,440.
90.
a
($86,000 × .10) – $1,520 = $7,080.
91.
b
$80,000 – $4,800 = $75,200.
92.
b
($480,000 × .05) – [$20,000 – ($14,400 – $4,200)] = $14,200.
93.
d
$432,000 × .05 = $21,600.
94.
b
$120,000 – $7,200 = $112,800.
$30,000 + $300 + $5,500 = $35,800.
Cash and Receivables
DERIVATIONS — Computational (cont.) No.
Answer
95.
b
Derivation $720,000 × .05 – [$30,000 – ($21,600 – $6,300)] = $21,300.
96.
d
$600,000 × .05 = $30,000.
97.
b
7% and 7%.
98.
a
$40,000 × 1.75911 = $70,364.
99.
a
($600,000 × .90) = $540,000.
100.
b
101.
c
$80,000 × .10 × 6/12 = $4,000.
102.
c
$50,000 – $46,000 = $4,000.
103.
d
$80,000 × .82645 = $66,116.
104.
a
$3,000,000 × .05 = $150,000.
105.
b
($3,000,000 × .03) + $150,000 = $240,000.
106.
d
107.
c
$2,000,000 – [$2,000,000 × (.04 + .08)] = $1,760,000.
108.
a
$2,000,000 × .03 = $60,000; $2,000,000 – $60,000 = $1,940,000.
109.
c
$670,000 – $13,400 = $656,600.
110.
c
111.
b
$500,000 × .03 = $15,000.
112.
b
($500,000 × .03) + $2,500 = $17,500.
113.
c
($100,000 × .03) + $2,400 = $5,400.
114.
c
($400,000 × .03) + $9,600 = $21,600.
115.
c
$750,000 ÷ [($100,000 + $150,000) ÷ 2] = 6.0.
116.
c
$1,200,000 ÷ [($100,000 + $150,000) ÷ 2] = 9.6.
*117.
d
$250 – $150 = $100.
*118.
b
$72,000 – $24,000 + $8,000 + $1,000 = $57,000.
7 - 31
7 - 32
Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer
*119.
b
Derivation $34,140 + $5,000 – $5,200 = $33,940.
*120.
c
$42,400 + $900 – $1,800 + $2,900 = $44,400.
*121.
b
$90,000 + $1,880 – $640 – $180 + $36 = $91,016.
*122.
c
$35,000 + $5,400 – $4,900 = $35,500.
DERIVATIONS — CPA Adapted No.
Answer
Derivation
123.
a
$60,000 – $2,000 + $3,000 = $61,000.
124.
d
Allowance for Doubtful Acct. balance $68,000 + $10,000 – $46,000 = $32,000 (before bad debt expense) $650,000 – $600,000 – $32,000 = $18,000 (bad debt expense).
125.
d
$104,000 – $84,000 + $69,000 = $89,000.
126.
b
$180,000 + $26,000 – $190,000 = $16,000.
127.
c
Conceptual.
128.
d
$750,000 × .04 = $30,000.
129.
c
$600,000 × .75 = $450,000 present value $450,000 × .10 = $45,000 (2012 interest) ($450,000 + $45,000) × .10 = $49,500 (2013 interest).
130.
c
$400,000 × 12% × 2 ÷ 12 = $8,000.
131.
b
Conceptual.
*132.
a
$18,650 + $3,900 – $2,750 = $19,800.
*133.
a
$37,200 + $43,700 – $49,700 = $31,200 (4/30 balance per bank) $31,200 – $6,000 = $25,200.
Cash and Receivables
7 - 33
EXERCISES Ex. 7-134—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 7-134 1. 2.
d a
3. 4.
d a
5. 6.
d c
7. 8.
b d
9. 10.
c a
Ex. 7-135—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.
7 - 34
Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 7-135 (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. 7-136—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 $120,000
Credit 730 $510,000
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 7-136 (1)
Bad Debt Expense ............................................................. Allowance for Doubtful Accounts ............................ Gross receivables $120,000 Rate 5% Total allowance needed 6,000 Present allowance (730) Adjustment needed $ 5,270
5,270 5,270
Cash and Receivables
7 - 35
Solution 7-136 (cont.) (2)
Bad Debt Expense ............................................................. Allowance for Doubtful Accounts ............................ Sales $510,000 Sales returns and allowances 8,000 Net sales 502,000 Rate 1% Bad debt expense $ 5,020
5,020 5,020
Ex. 7-137—Fair Value Option. Ellison Company sells large store-rack systems and frequently accepts notes receivable from customers as payment. Ellison conducts a through credit check on its customers, and it charges a fairly low interest rate (1/2 of 1% payable monthly) on these notes. Ellison has elected to use the fair value option for one of these notes and has the following data related to the carrying and fair value for its note
December 31, 2012 December 31, 2013
Carrying Value
Fair Value
€88,000 72,000
€85,000 76,000
Instructions Prepare the journal entry at December 31 (Ellison’s year-end) for 2012 and 2013, to record the fair value option for these notes. Solution 7-137 12/31/12
12/31/13
Unrealized Holding Gain/LossIncome............................................... Notes Receivable (€88,000 - €85,000).................... Notes Receivable [(€76,000 - €72,000) + €3,000]....... Unrealized Holding Gain/Loss - Income....................................
3,000 3,000
7,000 7,000
Ex. 7-138—Accounts receivable assigned. Accounts receivable in the amount of $500,000 were assigned to the Fast Finance Company by Marsh, Inc., as security for a loan of $400,000. 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, Marsh collected $260,000 on assigned accounts. This amount was remitted to the finance company along with one month's interest on the note.
7 - 36
Test Bank for Intermediate Accounting, Fourteenth Edition
Instructions Make all the entries for Marsh Inc. associated with the transfer of the accounts receivable, the loan, and the remittance to the finance company.
Solution 7-138 Cash .............................................................................................. Finance Charge .............................................................................. Notes Payable ....................................................................
384,000 16,000
Cash .............................................................................................. Accounts Receivable ..........................................................
260,000
Notes Payable ................................................................................ Interest Expense ............................................................................ Cash ...................................................................................
260,000 3,000
400,000
260,000
263,000
PROBLEMS Pr. 7-139—Entries for bad debt expense. The trial balance before adjustment of Risen Company reports the following balances:
Accounts receivable Allowance for doubtful accounts Sales (all on credit) Sales returns and allowances
Dr. $150,000
Cr. $ 2,500 850,000
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 7-139 (a)
(1)
Bad Debt Expense ........................................................ Allowance for Doubtful Accounts ....................... Gross receivables $150,000 Rate 6% Total allowance needed 9,000 Present allowance (2,500) Bad debt expense $ 6,500
6,500 6,500
Cash and Receivables
(2)
(b)
Bad Debt Expense ........................................................ Allowance for Doubtful Accounts ....................... Sales $850,000 Sales returns and allowances (40,000) Net sales 810,000 Rate 1% Bad debt expense $ 8,100
7 - 37
8,100 8,100
The percentage of receivables approach would be affected as follows: Gross receivables $150,000 Rate 6% Total allowance needed 9,000 Present allowance 2,500 Additional amount required $ 11,500
The journal entry is therefore as follows: Bad Debt Expense ........................................................ Allowance for Doubtful Accounts .......................
11,500 11,500
The entry would not change under the percentage of sales method.
Pr. 7-140—Amortization of discount on note. On December 31, 2012, Green Company finished consultation services and accepted in exchange a promissory note with a face value of $600,000, a due date of December 31, 2015, 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: 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
Interest Rate 5% 10% 1.15763 1.33100 .86384 .75132 3.15250 3.31000 2.72325 2.48685
Instructions (a) Determine the present value of the note. (b) Prepare a Schedule of Note Discount Amortization for Green Company under the effective interest method. (Round to whole dollars.)
Solution 7-140 (a) Present value of interest Present value of maturity value
= =
$30,000 × 2.48685 $600,000 × .75132
= =
$ 74,606 450,792 $525,398
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Test Bank for Intermediate Accounting, Fourteenth Edition
(b) Green Company Schedule of Note Discount Amortization Effective Interest Method 5% Note Discounted at 10% (Imputed)
Date 12/31/12 12/31/13 12/31/14 12/31/15
Cash Interest (5%)
Effective Interest (10%)
Discount Amortized
$30,000 30,000 30,000 $90,000
$ 52,540 54,794 57,268* $164,602
$22,540 24,794 27,268 $74,602
Unamortized Discount Balance $74,602 52,062 27,268 0
Present Value of Note $525,398 547,938 572,732 600,000
*$5 adjustment to compensate for rounding.
Pr. 7-141—Accounts receivable assigned. Prepare journal entries for Mars Co. for: (a) Accounts receivable in the amount of $1,000,000 were assigned to Utley Finance Co. by Mars as security for a loan of $850,000. Utley charged a 3% commission on the accounts; the interest rate on the note is 12%. (b) During the first month, Mars collected $400,000 on assigned accounts after deducting $900 of discounts. Mars wrote off a $1,060 assigned account. (c) Mars paid to Utley the amount collected plus one month's interest on the note.
Solution 7-141 (a) Cash ....................................................................................... Finance Charge ........................................................................ Notes Payable...............................................................
820,000 30,000
(b) Cash ....................................................................................... Sales Discounts ........................................................................ Allowance for Doubtful Accounts .............................................. Accounts Receivable.....................................................
400,000 900 1,060
(c) Notes Payable .......................................................................... Interest Expense....................................................................... Cash .............................................................................
400,000 8,500
850,000
401,960
408,500
Pr. 7-142—Factoring Accounts Receivable. On May 1, Dexter, Inc. factored $1,200,000 of accounts receivable with Quick Finance on a without recourse basis. Under the arrangement, Dexter was to handle disputes concerning
Cash and Receivables
7 - 39
service, and Quick Finance was to make the collections, handle the sales discounts, and absorb the credit losses. Quick 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 Dexter's books on May 1. (b) Prepare the journal entry required on Quick Finance’s books on May 1. (c) Assume Dexter factors the $1,200,000 of accounts receivable with Quick Finance on a with recourse basis instead. The recourse provision has a fair value of $21,000. Prepare the journal entry required on Dexter’s books on May 1.
Solution 7-142 (a) Cash ............................................................................................. 1,104,000 Due from Factor (2% × $1,200,000) .............................................. 24,000 Loss on Sale of Receivables (6% × $1,200,000)........................... 72,000 Accounts Receivable ....................................................
1,200,000
(b) Accounts Receivable .................................................................... 1,200,000 Due to Dexter ..................................................................... Financing Revenue ............................................................. Cash ..................................................................................
24,000 72,000 1,104,000
(c) Cash ............................................................................................. 1,104,000 Due from Factor .......................................................................... 24,000 Loss on Sale of Receivables ......................................................... 93,000 Accounts Receivable .......................................................... Recourse Liability ...............................................................
1,200,000 21,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
*Pr. 7-143—Bank reconciliation. Benson 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 11,784 11,100 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 7-143 (a) 1. Deposits in transit, $4,205 [$13,889 – ($11,784 – $2,100)] 2. Outstanding checks, $2,780 [$10,080 – ($11,100 – $3,800)] (b) Adjusted cash balance at April 30, $29,420 ($27,995 + $4,205 – $2,780) OR ($27,355 + $3,000 – $35 – $900)
Per Books $27,355 13,889 10,080 -0-0-0-
Cash and Receivables
7 - 41
IFRS QUESTIONS True/False: 1. iGAAP and U.S. GAAP are very similar in accounting for cash and receivables. 2. iGAAP does not permit the reversal of impairment losses, as does U.S. GAAP. 3. Under iGAAP, there is a specific standard that mandates segregation of receivables with different characteristics. 4. Under iGAAP, there is no specific standard related to pledging receivables. 5. Both the FASB and IASB have indicated that they believe all financial instruments should be recorded and reported at fair value. Answers to True/False: 1. True 2. False 3. False 4. True 5. True Multiple Choice Use the following information to answer Question 1 and 2. Harrison Company has a loan receivable with a carrying value of $15,000 at December 31, 2011. On January 3, 2012, the borrower, Thomas Clark Imports, declares bankruptcy, and Harrison estimates that it will collect only 60% of the loan balance. 1. Which of the following entries would Harrison make to record the impairment under iGAAP? a. Loan Receivable Impairment Loss
9,000
b. Loan Recovery Expense Loan Receivable
6,000
c. Impairment Loss Loan Receivable
9,000
d. Impairment Loss Loan Receivable
6,000
9,000 6,000 9,000 6,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
2. Assume that on January 5, 2013, Harrison learns that Thomas Clark Imports has emerged from bankruptcy. As a result, Harrison now estimates that all but $1,500 will be repaid on the loan. Under iGAAP, which of the following entries would be made on January 5, 2013? a. Loan Receivable 4,500 Recovery of Impairment Loss 4,500 b. Loan Receivable 1,500 Recovery of Impairment Loss 1,500 c. Bad Debt Expense 1,500 Impairment Loss 1,500 d. No journal entry is allowed under iGAAP. 3. The iGAAP approach for derecognizing a receivable focuses on which of the following? a. Risks b. Rewards c. Loss of control d. All of these 4. When comparing U.S. GAAP with iGAAP, which of the following is true regarding the reporting of securitizations? a. Both U.S. GAAP and iGAAP show these as off-balance-sheet treatments. b. Only iGAAP requires full or partial balance sheet recognition of securitizations. c. Only U.S. GAAP requires full or partial balance sheet recognition of securitizations. d. Both U.S. GAAP and iGAAP requires full or partial balance sheet recognition of securitizations. 5. Which of the following authoritative iGAAP guidance specifically addresses issues related to cash? a. AIS No.1 (Presentation of Financial Statements) b. IRFS No. 7 (Financial Instruments: Disclosures) c. IAS No. 39 (Financial Instruments: Recognition and Measurement) d. None of these standards specifically addresses cash issues. 6. Key similarities between U.S. GAAP and iGAAP include all of the following except a. the definition used for cash equivalents. b. accounting and reporting issues related to recognition and measurement of receivables, such as the use of allowance accounts. c. working toward implementing fair value measurement for all financial instruments. d. the same criteria is used to derecognize a receivable. 7. Genesis Company has seven loans receivable. The loans vary in size and have been extended to companies with different credit ratings. Given a downturn in the economy, it is expected that at least two of these loans will be impaired. Which of the following statements best describes the accounting for these loans under iGAAP? a. iGAAP implies that the loans should be reported as an aggregated portfolio. b. iGAAP uses an incurred loss model rather than an expected loss model, so no impairment on each of the two loans is recognized until an identifiable event occurs and is measurable. c. Under iGAAP, when impairment is permitted, the balance on each of the impaired loans becomes the new basis for the loan. d. iGAAP uses an expected loss model, so the entire diverse portfolio should be written down based on the anticipated impairment.
Cash and Receivables
7 - 43
8. iGAAP requires an impairment loss for a loan receivable be recognized when a. its carrying amount is less than its recoverable amount. b. its recoverable amount is less than its carrying amount. c. its present value of expected future cash flows is greater than its carrying amount. d. its principal amount is less than its interest amount. Use the following information to answer Questions 9 and 10. Johnstone Company has a loan receivable with a carrying value of $125,000 at December 31, 2011. On January 1, 2012, the borrower, Ralph Young Industries, declares bankruptcy, and Johnstone estimates that it will collect only 45% of the loan balance. 9. Which of the following entries would Johnstone make to record the impairment under iGAAP? a. Loan Receivable Impairment Loss
56,250
b. Loan Recovery Expense Loan Receivable
68,750
c. Impairment Loss Loan Receivable
56,250
d. Impairment Loss Loan Receivable
68,750
56,250 68,750 56,250 68,750
10. Assume that on January 4, 2013, Johnstone learns that Ralph Young Industries has emerged from bankruptcy. As a result, Johnstone now estimates that all but $11,500 will be paid on the loan. Under iGAAP, which of the following entries would be made on January 4, 2013? a. Loan Receivable 57,250 Recovery of impairment Loss 57,250 b. Loan Receivable 11,500 Recovery of impairment Loss 11,500 c. Bad Debt Expense 11,500 Impairment Loss 11,500 d. No journal entry is allowed under iGAAP. 11. Under iGAAP, the characteristics that would imply segregation of receivables would include a. past-due status. b. industry. c. collateral type. d. All of these could be used to determine whether segregation of receivables is implied. Answers to Multiple Choice 1. d 2. a 3. d 4. b 5. a 6. d 7. b 8. b 9. d 10. a 11. d
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Test Bank for Intermediate Accounting, Fourteenth Edition
Short Answer: 1. Briefly describe some of the similarities and differences between U.S. GAAP and iGAAP with respect to the accounting for cash and receivables. 1. Key similarities relate to (1) the definition used for cash equivalents, (2) accounting and reporting issues related to recognition and measurement of receivables, such as the use of allowance accounts, how to record trade and sales discounts, use of percentage of sales and receivables methods, pledging, and factoring and (3) both Boards are working to implement fair value measurement for all financial instruments but both Boards have faced bitter opposition from various factions. Key differences relate to (1) iGAAP has no guidance for segregation of receivables with different characteristics, (2) iGAAP and U.S. GAAP standards on the fair value option are similar but not identical. The international standard related to the fair value option is subject to certain qualifying criteria not in the U.S. standard. In addition, there is some difference in the financial instruments covered, (3) iGAAP and U.S. GAAP differ in the criteria used to derecognize a receivable. iGAAP is a combination of a risks and rewards and a loss of control approach. U.S. GAAP uses loss of control as the primary criterion. In addition, iGAAP permits partial derecognition—U.S. GAAP does not. 2. Walton Company, which uses iGAAP, has a note receivable with a carrying value of $30,000 at December 31, 2010. On January 2, 2011, the borrower declares bankruptcy, and Walton estimates that only $25,000 of the note will be collected. Briefly describe the accounting for the loan subsequent to the bankruptcy, assuming Walton estimates that more than $25,000 can be repaid. 2. Under iGAAP, Walton may record recovery of losses on prior impairments. Under U.S. GAAP, reversal of impairment is not permitted. Rather the balance on the loan after the impairment becomes the new basis for the loan.
CHAPTER 8 VALUATION OF INVENTORIES: A COST-BASIS APPROACH IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
T F F F T T F T F T T F F T T F F T F T
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
Work-in-process inventory. Merchandising and manufacturing inventory accounts. Perpetual inventory system. Determining when title passes. Inventory errors. Overstatement of purchases and ending inventory. Period vs. product costs. Reporting Purchase Discounts Lost. Cost flow assumption. FIFO periodic vs. perpetual system. Purchase commitments. Using LIFO for reporting purposes. LIFO liquidation. LIFO liquidations. Dollar-value LIFO Dollar-value LIFO method. LIFO-FIFO comparison. LIFO conformity rule. Selection of inventory method. Appropriateness of LIFO.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
c b b a c a d b b c d b a
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33.
Identify manufacturer inventory similar to merchandise inventory. Classification of raw materials. Accounts included in inventory. Reason inventories are included in net income computation. Characteristic of perpetual inventory system. Reporting consignment inventory in balance sheet. Reporting goods in transit purchased f.o.b. destination. Effect of inventory error on net income. Effect of goods in transit on the current ratio. Description of consigned inventory. Entries under perpetual inventory system. Classification of goods in transit. Classification of goods in transit.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
d d a b c b b d b a a d b c d d a b d b d a a c a d b a b a b a b a b c d d c b c a d c d d a
34. 35. 36. 37. S 38. P 39. P 40. S 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. S 59. P 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. S 80.
Identify inventory ownership. Identify a product financing arrangement. Identify ownership under product financing arrangement. Classification of goods on consignment. Valuation of inventories. Classification of beginning inventory. 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 beginning inventory overstatement. Identification of a product cost. Identification of a period cost. Method used to record cash discounts. Identification of inventory costs. Identification of product costs. Determine product costs. Interest capitalization in manufacturing inventory. Determine cost of purchased inventory, using net method. Determine cost of purchased inventory, using gross method. Recording inventory purchases at gross or net amounts. Recording inventory purchases at gross or net amounts. Nature of trade discounts. Identifying inventoriable costs. Method approximating current cost. Average cost inventory valuation. 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. Appropriateness of specific identification method. FIFO and rising prices. LIFO and falling prices. LIFO reserve definition. LIFO reserve account classification. Identify LIFO liquidation. Obtaining price index under dollar-value LIFO. Description of LIFO layer. Dollar-value LIFO method.
Valuation of Inventories: A Cost-Basis Approach
MULTIPLE CHOICE—Conceptual (cont.) Answer a d c P S
No.
Description
S
Identifying advantages of LIFO. LIFO for tax purposes and external reporting. LIFO advantages.
81. 82. 83.
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide.
MULTIPLE CHOICE—Computational Answer
No.
Description
c c d d d c b c d a a d d d b d b d a a c d b c b c b a d c d d c c c b b c
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. 115. 116. 117. 118. 119. 120. 121.
Classification as inventory. Classification as inventory. Perpetual inventory method. Perpetual inventory method. Calculate ending inventory. Calculate ending inventory. Calculate total assets and net income. Calculate total assets and net income. Effect of inventory and depreciation errors on income. Effect of inventory and depreciation errors on retained earnings. Effect of inventory errors on working capital. Calculate cost of goods available for sale. Accounting for a purchase return (net method). Adjust Accounts Payable using the net method. 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. Cost flow assumptions. Calculate units in ending inventory. Calculate cost of goods sold. Calculate cost of goods sold using average cost. Calculate ending inventory using average cost. Calculate ending inventory using FIFO. Calculate cost of goods sold using FIFO. Calculate ending inventory using LIFO. Calculate cost of goods sold using LIFO. LIFO reserve. LIFO reserve. LIFO liquidation. LIFO liquidation Dollar-value LIFO.
8-3
8-4
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Computational (cont.) Answer
No.
Description
b c b c c a b b d a c
122. 123. 124. 125. 126. 127. 128. 129. 130. 131. 132.
Dollar-value LIFO. 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 price index using double extension method. 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.
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
d a c d b d a b c c a c c a b
133. 134. 135. 136. 137. 138. 139. 140. 141. 142. 143. 144. 145. 146. 147.
Calculate ending inventory using dollar-value LIFO. Identification of inventory costs. Determine cost of purchased inventory. Determine cost of sales. Calculate Accounts Payable at year end. Calculate Accounts Payable at year end. Calculate Accounts Payable at year end. Determine cost of purchased inventory. Determine cost of purchased inventory. Calculate unit cost using moving-average method. Periodic and perpetual inventory methods. FIFO and LIFO with increasing prices. Calculate ending inventory using LIFO. Dollar-value LIFO and the double extension approach. Calculate ending inventory using dollar-value LIFO.
EXERCISES Item E8-148 E8-149 E8-150 E8-151 E8-152 E8-153 E8-154 E8-155 E8-156
Description Recording purchases at net amounts. Recording purchases at net amounts. Comparison of FIFO and LIFO. FIFO and LIFO inventory methods. FIFO and LIFO periodic inventory methods. Perpetual LIFO. Perpetual LIFO and periodic FIFO. Analysis of gross profit. Dollar-value LIFO.
Valuation of Inventories: A Cost-Basis Approach
PROBLEMS Item
Description
P8-157 P8-158 P8-159 P8-160 P8-161 P8-162
Inventory cut-off. Analysis of errors. Accounting for purchase discounts. Inventory methods. Dollar-value LIFO. Dollar-value LIFO.
CHAPTER LEARNING OBJECTIVES 1.
Identify major classifications of inventory.
2.
Distinguish between perpetual and periodic inventory systems.
3.
Identify the effects of inventory errors on the financial statements.
4.
Understand the items to include as inventory cost.
5.
Describe and compare the cost flow assumptions used to account for inventories.
6.
Explain the significance and use of a LIFO reserve.
7.
Understand the effect of LIFO liquidations.
8.
Explain the dollar-value LIFO method.
9.
Identify the major advantages and disadvantages of LIFO.
10.
Understand why companies select given inventory methods.
8-5
8-6
Test Bank for Intermediate Accounting, Fourteenth Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1.
TF
2.
TF
21.
3. 4. 24. 25. 26.
TF TF MC MC MC
27. 28. 29. 30. 31.
MC MC MC MC MC
32. 33. 34. 35. 36.
5. 6. P 40.
TF TF MC
41. 42. 43.
MC MC MC
44. 45. 46.
7. 8. 47. 48.
TF TF MC MC
49. 50. 51. 52.
MC MC MC MC
53. 54. 55. 56.
9. 10. P 60. 61. 62. 63. 64.
TF TF MC MC MC MC MC
65. 66. 67. 68. 69. 70. 71.
MC MC MC MC MC MC MC
72. 73. 74. 98. 99. 100. 101.
11.
TF
12.
TF
75.
13.
TF
14.
TF
77.
15. 16. 78. 79.
TF TF MC MC
80. 121. 122. 123.
MC MC MC MC
124. 125. 126. 127.
17.
TF
18.
TF
S
19.
TF
20.
TF
150.
Note:
S
S
TF = True-False MC = Multiple Choice E = Exercise P = Problem
81.
Type
Item
Type
Item
Learning Objective 1 MC 22. MC 23. Learning Objective 2 MC 37. MC 88. S MC 38. MC 89. P MC 39. MC 134. MC 86. MC 135. MC 87. MC 136. Learning Objective 3 MC 90. MC 93. MC 91. MC 94. MC 92. MC 158. Learning Objective 4 MC 57. MC 96. MC 58. MC 97. S MC 59. MC 137. MC 95. MC 140. Learning Objective 5 MC 102. MC 109. MC 103. MC 110. MC 104. MC 111. MC 105. MC 112. MC 106. MC 113. MC 107. MC 114. MC 108. MC 115. Learning Objective 6 MC 76. MC 117. Learning Objective 7 MC 119. MC 120. Learning Objective 8 MC 128. MC 132. MC 129. MC 133. MC 130. MC 146. MC 131. MC 147. Learning Objective 9 MC 82. MC 83. Learning Objective 10 E
Type
Item
Type
Item
Type
MC
84.
MC
85.
MC
MC MC MC MC MC
137. 138. 139. 157.
MC MC MC P
MC MC MC MC
141. 148. 149. 159.
MC E E P
MC MC MC MC MC MC MC
116. 142. 143. 144. 145. 150. 151.
MC MC MC MC MC E E
152. 153. 154. 160.
E E E P
MC
118.
MC
MC
155.
E
MC MC MC MC
156. 161. 162.
E P P
MC MC P
MC
Valuation of Inventories: A Cost-Basis Approach
8-7
TRUE FALSE—Conceptual 1.
A manufacturing concern would report the cost of units only partially processed as inventory in the balance sheet.
2.
Both merchandising and manufacturing companies normally have multiple inventory accounts.
3.
When using a perpetual inventory system, freight charges on goods purchased are debited to Freight-In.
4.
If a supplier ships goods f.o.b. destination, title passes to the buyer when the supplier delivers the goods to the common carrier.
5.
If ending inventory is understated, then net income is understated.
6.
If both purchases and ending inventory are overstated by the same amount, net income is not affected.
7.
Freight charges on goods purchased are considered a period cost and therefore are not part of the cost of the inventory.
8.
Purchase Discounts Lost is a financial expense and is reported in the “other expenses and losses” section of the income statement.
9.
The cost flow assumption adopted must be consistent with the physical movement of the goods.
10.
In all cases when FIFO is used, the cost of goods sold would be the same whether a perpetual or periodic system is used.
11.
The change in the LIFO Reserve from one period to the next is recorded as an adjustment to Cost of Goods Sold.
12.
Many companies use LIFO for both tax and internal reporting purposes.
13.
LIFO liquidation often distorts net income, but usually leads to substantial tax savings.
14.
LIFO liquidations can occur frequently when using a specific-goods approach.
15.
Dollar-value LIFO techniques help protect LIFO layers from erosion.
16.
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.
17.
A disadvantage of LIFO is that it does not match more recent costs against current revenues as well as FIFO.
18.
The LIFO conformity rule requires that if a company uses LIFO for tax purposes, it must also use LIFO for financial accounting purposes.
8-8
Test Bank for Intermediate Accounting, Fourteenth Edition
19.
Use of LIFO provides a tax benefit in an industry where unit costs tend to decrease as production increases.
20.
LIFO is inappropriate where unit costs tend to decrease as production increases.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. T F F F T
Item 6. 7. 8. 9. 10.
Ans. T F T F T
Item 11. 12. 13. 14. 15.
Ans. T F F T T
Item 16. 17. 18. 19. 20.
Ans. F F T F T
MULTIPLE CHOICE—Conceptual 21.
Which of the following inventories carried by a manufacturer is similar to the merchandise inventory of a retailer? a. Raw materials. b. Work-in-process. c. Finished goods. d. Supplies.
22.
Where should raw materials be classified on the balance sheet? a. Prepaid expenses. b. Inventory. c. Equipment. d. Not on the balance sheet.
23.
Which of the following accounts is not reported in inventory? a. Raw materials. b. Equipment. c. Finished goods. d. Supplies.
24.
Why are inventories included in the computation of net income? a. To determine cost of goods sold. b. To determine sales revenue. c. To determine merchandise returns. d. Inventories are not included in the computation of net income.
25.
Which of the following is a characteristic of a perpetual inventory system? a. Inventory purchases are debited to a Purchases account. b. Inventory records are not kept for every item. c. Cost of goods sold is recorded with each sale. d. Cost of goods sold is determined as the amount of purchases less the change in inventory.
Valuation of Inventories: A Cost-Basis Approach
8-9
26.
How is a significant amount of consignment inventory reported in the balance sheet? a. The inventory is reported separately on the consignor's balance sheet. b. The inventory is combined with other inventory on the consignor's balance sheet. c. The inventory is reported separately on the consignee's balance sheet. d. The inventory is combined with other inventory on the consignee's balance sheet.
27.
Where should goods in transit that were recently purchased f.o.b. destination be included on the balance sheet? a. Accounts payable. b. Inventory. c. Equipment. d. Not on the balance sheet.
28.
If a company uses the periodic inventory system, what is the impact on net income of including goods in transit f.o.b. shipping point in purchases, but not ending inventory? a. Overstate net income. b. Understate net income. c. No effect on net income. d. Not sufficient information to determine effect on net income.
29.
If a company uses the periodic inventory system, what is the impact on the current ratio of including goods in transit f.o.b. shipping point in purchases, but not ending inventory? a. Overstate the current ratio. b. Understate the current ratio. c. No effect on the current ratio. d. Not sufficient information to determine effect on the current ratio.
30.
What is consigned inventory? a. Goods that are shipped, but title transfers to the receiver. b. Goods that are sold, but payment is not required until the goods are sold. c. Goods that are shipped, but title remains with the shipper. d. Goods that have been segregated for shipment to a customer.
31.
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.
32.
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.
33.
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.
8 - 10 34.
Test Bank for Intermediate Accounting, Fourteenth Edition 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.
Use the following information for questions 35 and 36. During 2012 Carne Corporation transferred inventory to Nolan Corporation and agreed to repurchase the merchandise early in 2013. Nolan then used the inventory as collateral to borrow from Norwalk Bank, remitting the proceeds to Carne. In 2013 when Carne repurchased the inventory, Nolan used the proceeds to repay its bank loan. 35.
This transaction is known as a(n) a. consignment. b. installment sale. c. assignment for the benefit of creditors. d. product financing arrangement.
36.
On whose books should the cost of the inventory appear at the December 31, 2012 balance sheet date? a. Carne Corporation b. Nolan Corporation c. Norwalk Bank d. Nolan Corporation, with Carne making appropriate note disclosure of the transaction
37.
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
S
38.
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.
P
39.
The accountant for the Pryor Sales Company is preparing the income statement for 2012 and the balance sheet at December 31, 2012. Pryor uses the periodic inventory system. The January 1, 2012 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.
Valuation of Inventories: A Cost-Basis Approach
8 - 11
P
40.
If the beginning inventory for 2012 is overstated, the effects of this error on cost of goods sold for 2012, net income for 2012, and assets at December 31, 2013, respectively, are a. overstatement, understatement, overstatement. b. overstatement, understatement, no effect. c. understatement, overstatement, overstatement. d. understatement, overstatement, no effect.
S
41.
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.
42.
Dolan Co. received merchandise on consignment. As of March 31, Dolan 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.
43.
Green Co. received merchandise on consignment. As of January 31, Green 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.
44.
Feine Co. accepted delivery of merchandise which it purchased on account. As of December 31, Feine 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.
45.
On June 15, 2012, Wynne Corporation accepted delivery of merchandise which it purchased on account. As of June 30, Wynne had not recorded the transaction or included the merchandise in its inventory. The effect of this on its balance sheet for June 30, 2012 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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
46.
What is the effect of a $50,000 overstatement of last year's inventory on current years ending retained earning balance? a. Understated by $50,000. b. No effect. c. Overstated by $50,000. d. Need more information to determine.
47.
Which of the following is a product cost as it relates to inventory? a. Selling costs. b. Interest costs. c. Raw materials. d. Abnormal spoilage.
48.
Which of the following is a period cost? a. Labor costs. b. Freight in. c. Production costs. d. Selling costs.
49.
Which method may be used to record cash discounts a company receives for paying suppliers promptly? a. Net method. b. Gross method. c. Average method. d. a and b.
50.
Which of the following is included in inventory costs? a. Product costs. b. Period costs. c. Product and period costs. d. Neither product or period costs.
51.
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.
52.
All of the following costs should be charged against revenue in the period in which costs are incurred except for a. manufacturing overhead costs for a product manufactured and sold in the same accounting period. b. costs which will not benefit any future period. c. costs from idle manufacturing capacity resulting from an unexpected plant shutdown. d. costs of normal shrinkage and scrap incurred for the manufacture of a product in ending inventory.
Valuation of Inventories: A Cost-Basis Approach
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53.
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. Purchase discounts lost 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.
54.
The use of a Discounts Lost account implies that the recorded cost of a purchased inventory item is its a. invoice price. b. invoice price plus the purchase discount lost. c. invoice price less the purchase discount taken. d. invoice price less the purchase discount allowable whether taken or not.
55.
The use of a Purchase Discounts account implies that the recorded cost of a purchased inventory item is its a. invoice price. b. invoice price plus any purchase discount lost. c. invoice price less the purchase discount taken. d. invoice price less the purchase discount allowable whether taken or not.
Use the following information for questions 56 and 57. During 2012, which was the first year of operations, Oswald Company had merchandise purchases of $985,000 before cash discounts. All purchases were made on terms of 2/10, n/30. Three-fourths of the items purchased were paid for within 10 days of purchase. All of the goods available had been sold at year end. 56.
Which of the following recording procedures would result in the highest cost of goods sold for 2012? 1. Recording purchases at gross amounts 2. Recording purchases at net amounts, with the amount of discounts not taken shown under "other expenses" in the income statement a. 1 b. 2 c. Either 1 or 2 will result in the same cost of goods sold. d. Cannot be determined from the information provided.
57.
Which of the following recording procedures would result in the highest net income for 2012? 1. Recording purchases at gross amounts 2. Recording purchases at net amounts, with the amount of discounts not taken shown under "other expenses" in the income statement a. 1 b. 2 c. Either 1 or 2 will result in the same net income. d. Cannot be determined from the information provided.
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Test Bank for Intermediate Accounting, Fourteenth Edition
58.
When using the periodic inventory system, which of the following generally would not be separately accounted for in the computation of cost of goods sold? a. Trade discounts applicable to purchases during the period b. Cash (purchase) discounts taken during the period c. Purchase returns and allowances of merchandise during the period d. Cost of transportation-in for merchandise purchased during the period
S
59.
Costs which are inventoriable include all of the following except a. costs that are directly connected with the bringing of goods to the place of business of the buyer. b. costs that are directly connected with the converting of goods to a salable condition. c. buying costs of a purchasing department. d. selling costs of a sales department.
P
60.
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
61.
In situations where there is a rapid turnover, an inventory method which produces a balance sheet valuation similar to the first-in, first-out method is a. average cost. b. base stock. c. joint cost. d. prime cost.
62.
The pricing of issues from inventory must be deferred until the end of the accounting period under the following method of inventory valuation: a. moving average. b. weighted-average. c. LIFO perpetual. d. FIFO.
63.
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.
64.
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
Valuation of Inventories: A Cost-Basis Approach
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65.
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.
66.
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.
67.
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.
68.
Tanner 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
69.
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.
70.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
71.
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.
72.
Which of the following is a reason why the specific identification method may be considered ideal for assigning costs to inventory and cost of goods sold? a. The potential for manipulation of net income is reduced. b. There is no arbitrary allocation of costs. c. The cost flow matches the physical flow. d. Able to use on all types of inventory.
73.
In a period of rising prices which inventory method generally provides the greatest amount of net income? a. Average cost. b. FIFO. c. LIFO. d. Specific identification.
74.
In a period of falling prices, which inventory method generally provides the greatest amount of net income? a. Average cost. b. FIFO. c. LIFO. d. Specific identification.
75.
What is a LIFO reserve? a. The difference between the LIFO inventory and the amount used for internal reporting purposes. b. The tax savings attributed to using the LIFO method. c. The current effect of using LIFO on net income. d. Change in the LIFO inventory during the year.
76.
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.
77.
What happens when inventory in base year dollars decreases? a. LIFO reserve increases. b. LIFO layer is created. c. LIFO layer is liquidated. d. LIFO price index decreases.
Valuation of Inventories: A Cost-Basis Approach
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78.
How might a company obtain a price index in order to apply dollar-value LIFO? a. Calculate an index based on recent inventory purchases. b. Use a general price level index published by the government. c. Use a price index prepared by an industry group. d. All of the above.
79.
In the context of dollar-value LIFO, what is a LIFO layer? a. The difference between the LIFO inventory and the amount used for internal reporting purposes. b. The LIFO value of the inventory for a given year. c. The inventory in base year dollars. d. The LIFO value of an increase in the inventory for a given year.
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80.
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.
S
81.
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.
82.
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.
83.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27. 28. 29.
c b b a c a d b b
30. 31. 32. 33. 34. 35. 36. 37. 38.
c d b a d d a b c
39. 40. 41. 42. 43. 44. 45. 46. 47.
b b d b a a d b c
48. 49. 50. 51. 52. 53. 54. 55. 56.
d d a b d b d a a
57. 58. 59. 60. 61. 62. 63. 64. 65.
c a d b a b a b a
66. 67. 68. 69. 70. 71. 72. 73. 74.
b a b c d d c b c
75. 76. 77. 78. 79. 80. 81. 82. 83.
a d c d d a a d c
Solutions to those Multiple Choice questions for which the answer is “none of these.” 34. Goods in transit which were purchased f.o.b. shipping point. 45. Assets and liabilities were understated but stockholders’ equity was not affected. 82. If LIFO is used for tax purposes, then it must also be used for external financial reporting.
MULTIPLE CHOICE—Computational 84.
Morgan 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 82,000 6,000
What amount should Morgan report as inventories in its balance sheet? a. $82,000. b. $86,000. c. $168,000. d. $172,000. 85.
Lawson 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 97,000 6,000
What amount should Lawson report as inventories in its balance sheet? a. $97,000. b. $101,000. c. $183,000. d. $187,000.
Valuation of Inventories: A Cost-Basis Approach
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86.
Elkins Corporation uses the perpetual inventory method. On March 1, it purchased $20,000 of inventory, terms 2/10, n/30. On March 3, Elkins returned goods that cost $2,000. On March 9, Elkins paid the supplier. On March 9, Elkins should credit a. purchase discounts for $400. b. inventory for $400. c. purchase discounts for $360. d. inventory for $360.
87.
Malone Corporation uses the perpetual inventory method. On March 1, it purchased $50,000 of inventory, terms 2/10, n/30. On March 3, Malone returned goods that cost $5,000. On March 9, Malone paid the supplier. On March 9, Malone should credit a. purchase discounts for $1,000. b. inventory for $1,000. c. purchase discounts for $900. d. inventory for $900.
88.
Bell Inc. took a physical inventory at the end of the year and determined that $780,000 of goods were on hand. In addition, Bell, Inc. determined that $60,000 of goods that were in transit that were shipped f.o.b. shipping point were actually received two days after the inventory count and that the company had $90,000 of goods out on consignment. What amount should Bell report as inventory at the end of the year? a. $780,000. b. $840,000. c. $870,000. d. $930,000.
89.
Bell Inc. took a physical inventory at the end of the year and determined that $760,000 of goods were on hand. In addition, the following items were not included in the physical count. Bell, Inc. determined that $96,000 of goods were in transit that were shipped f.o.b. destination (goods were actually received by the company three days after the inventory count).The company sold $40,000 worth of inventory f.o.b. destination. What amount should Bell report as inventory at the end of the year? a. $760,000. b. $856,000. c. $800,000. d. $896,000.
90.
Risers Inc. reported total assets of $1,800,000 and net income of $200,000 for the current year. Risers determined that inventory was overstated by $15,000 at the beginning of the year (this was not corrected). What is the corrected amount for total assets and net income for the year? a. $1,800,000 and $200,000. b. $1,800,000 and $215,000. c. $1,785,000 and $185,000. d. $1,815,000 and $215,000.
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Test Bank for Intermediate Accounting, Fourteenth Edition Risers Inc. reported total assets of $3,200,000 and net income of $170,000 for the current year. Risers determined that inventory was understated by $46,000 at the beginning of the year and $20,000 at the end of the year. What is the corrected amount for total assets and net income for the year? a. $3,220,000 and $190,000. b. $3,180,000 and $196,000. c. $3,220,000 and $144,000. d. $3,200,000 and $170,000.
Use the following information for questions 92 through 94. Hudson, Inc. is a calendar-year corporation. Its financial statements for the years 2013 and 2012 contained errors as follows: 2013 2012 Ending inventory $4,500 overstated $12,000 overstated Depreciation expense $3,000 understated $9,000 overstated 92.
Assume that the proper correcting entries were made at December 31, 2012. By how much will 2013 income before taxes be overstated or understated? a. $1,500 understated b. $1,500 overstated c. $3,000 overstated d. $7,500 overstated
93.
Assume that no correcting entries were made at December 31, 2012. Ignoring income taxes, by how much will retained earnings at December 31, 2013 be overstated or understated? a. $1,500 understated b. $7,500 overstated c. $7,500 understated d. $13,500 understated
94.
Assume that no correcting entries were made at December 31, 2012, or December 31, 2013 and that no additional errors occurred in 2014. Ignoring income taxes, by how much will working capital at December 31, 2014 be overstated or understated? a. $0 b. $3,000 overstated c. $3,000 understated d. $7,500 understated
95.
The following information is available for Naab Company for 2012: Freight-in Purchase returns Selling expenses Ending inventory
$ 30,000 75,000 200,000 260,000
The cost of goods sold is equal to 400% of selling expenses. What is the cost of goods available for sale? a. $800,000. b. $1,090,000. c. $1,015,000. d. $1,060,000.
Valuation of Inventories: A Cost-Basis Approach
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Use the following information for questions 96 and 97. Winsor Co. records purchases at net amounts. On May 5 Winsor purchased merchandise on account, $20,000, terms 2/10, n/30. Winsor returned $1,500 of the May 5 purchase and received credit on account. At May 31 the balance had not been paid. 96.
The amount to be recorded as a purchase return is a. $1,350. b. $1,530 c. $1,500. d. $1,470.
97.
By how much should the account payable be adjusted on May 31? a. $0. b. $430. c. $400. d. $370.
Use the following information for questions 98 and 99. The following information was available from the inventory records of Rich 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) (4,300) 900
98.
Assuming that Rich 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. $9,454. b. $9,213. c. $9,234. d. $9,324.
99.
Assuming that Rich maintains perpetual inventory records, what should be the inventory at January 31, using the moving-average inventory method, rounded to the nearest dollar? a. $9,454. b. $9,213. c. $9,234. d. $9,324.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Use the following information for questions 100 and 101. Niles Co. has the following data related to an item of inventory: Inventory, March 1 100 units @ $2.10 Purchase, March 7 350 units @ $2.20 Purchase, March 16 70 units @ $2.25 Inventory, March 31 130 units 100.
The value assigned to ending inventory if Niles uses LIFO is a. $290. b. $276. c. $273. d. $292.
101.
The value assigned to cost of goods sold if Niles uses FIFO is a. $290. b. $276. c. $862. d. $848.
102.
Emley Company has been using the LIFO method of inventory valuation for 10 years, since it began operations. Its 2012 ending inventory was $60,000, but it would have been $90,000 if FIFO had been used. Thus, if FIFO had been used, Emley's income before income taxes would have been a. $30,000 greater over the 10-year period. b. $30,000 less over the 10-year period. c. $30,000 greater in 2012. d. $30,000 less in 2012.
Use the following information for questions 103 through 106. Transactions for the month of June were: Purchases June 1 (balance) 1,200 @ $3.20 3 3,300 @ 3.10 7 1,800 @ 3.30 15 2,700 @ 3.40 22 750 @ 3.50
June 2 6 9 10 18 25
Sales 900 @ $5.50 2,400 @ 5.50 1,500 @ 5.50 600 @ 6.00 2,100 @ 6.00 300 @ 6.00
103.
Assuming that perpetual inventory records are kept in units only, the ending inventory on a LIFO basis is a. $6,165. b. $6,240. c. $6,435. d. $6,705.
104.
Assuming that perpetual inventory records are kept in dollars, the ending inventory on a LIFO basis is a. $6,165. b. $6,240. c. $6,435. d. $6,705.
Valuation of Inventories: A Cost-Basis Approach
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105.
Assuming that perpetual inventory records are kept in dollars, the ending inventory on a FIFO basis is a. $6,165. b. $6,240. c. $6,435. d. $6,705.
106.
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. $6,144. b. $6,357. c. $6,435. d. $6,483.
107.
Milford Company had 500 units of “Tank” in its inventory at a cost of $4 each. It purchased, for $2,800, 300 more units of “Tank”. Milford then sold 400 units at a selling price of $10 each, resulting in a gross profit of $1,600. The cost flow assumption used by Johnson a. is FIFO. b. is LIFO. c. is weighted average. d. cannot be determined from the information given.
108.
Nichols 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”. Nichols 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 Nichols. a. is FIFO. b. is LIFO. c. is weighted average. d. cannot be determined from the information given.
109.
June Corp. sells one product and uses a perpetual inventory system. The beginning inventory consisted of 20 units that cost $20 per unit. During the current month, the company purchased 120 units at $20 each. Sales during the month totaled 90 units for $43 each. What is the number of units in the ending inventory? a. 20 units. b. 30 units. c. 50 units. d. 140 units.
110.
June Corp. sells one product and uses a perpetual inventory system. The beginning inventory consisted of 20 units that cost $20 per unit. During the current month, the company purchased 120 units at $20 each. Sales during the month totaled 90 units for $43 each. What is the cost of goods sold using the LIFO method? a. $400. b. $1,800. c. $2,400. d. $3,870.
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Test Bank for Intermediate Accounting, Fourteenth Edition
111.
Checkers uses the periodic inventory system. For the current month, the beginning inventory consisted of 2,400 units that cost $12 each. During the month, the company made two purchases: 1,000 units at $13 each and 4,000 units at $13.50 each. Checkers also sold 4,300 units during the month. Using the average cost method, what is the amount of cost of goods sold for the month? a. $55,685. b. $57,900. c. $53,950. d. $55,900.
112.
Chess Top uses the periodic inventory system. For the current month, the beginning inventory consisted of 300 units that cost $65 each. During the month, the company made two purchases: 450 units at $68 each and 225 units at $70 each. Chess Top also sold 750 units during the month. Using the average cost method, what is the amount of ending inventory? a. $15,750. b. $50,655. c. $50,100. d. $15,197.
113.
Checkers uses the periodic inventory system. For the current month, the beginning inventory consisted of 2,400 units that cost $12 each. During the month, the company made two purchases: 1,000 units at $13 each and 4,000 units at $13.50 each. Checkers also sold 4,300 units during the month. Using the FIFO method, what is the ending inventory? a. $40,146. b. $37,200. c. $41,850. d. $37,900.
114.
Chess Top uses the periodic inventory system. For the current month, the beginning inventory consisted of 300 units that cost $65 each. During the month, the company made two purchases: 450 units at $68 each and 225 units at $70 each. Chess Top also sold 750 units during the month. Using the FIFO method, what is the amount of cost of goods sold for the month? a. $50,655. b. $48,750. c. $51,225. d. $50,100.
115.
Checkers uses the periodic inventory system. For the current month, the beginning inventory consisted of 2,400 units that cost $12 each. During the month, the company made two purchases: 1,000 units at $13 each and 4,000 units at $13.50 each. Checkers also sold 4,300 units during the month. Using the LIFO method, what is the ending inventory? a. $40,146. b. $37,200. c. $41,850. d. $37,900.
Valuation of Inventories: A Cost-Basis Approach
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116.
Chess Top uses the periodic inventory system. For the current month, the beginning inventory consisted of 300 units that cost $65 each. During the month, the company made two purchases: 450 units at $68 each and 225 units at $70 each. Chess Top also sold 750 units during the month. Using the LIFO method, what is the amount of cost of goods sold for the month? a. $50,655. b. $48,750. c. $51,225. d. $50,100.
117.
Black 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 2012 was $100,000. The balance in the same account at the end of 2013 is $150,000. Black’s Cost of Goods Sold account has a balance of $750,000 from sales transactions recorded during the year. What amount should Black report as Cost of Goods Sold in the 2013 income statement? a. $700,000. b. $750,000. c. $800,000. d. $900,000.
118.
White 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 2012 was $120,000. The balance in the same account at the end of 2013 is $180,000. White’s Cost of Goods Sold account has a balance of $900,000 from sales transactions recorded during the year. What amount should White report as Cost of Goods Sold in the 2013 income statement? a. $840,000. b. $900,000. c. $960,000. d. $1,080,000.
119.
Milford Company had 400 units of “Tank” in its inventory at a cost of $8 each. It purchased 600 more units of “Tank” at a cost of $12 each. Milford then sold 700 units at a selling price of $20 each. The LIFO liquidation overstated normal gross profit by a. $ -0b. $400. c. $800. d. $1,200.
120.
Nichols Company had 400 units of “Dink” in its inventory at a cost of $10 each. It purchased 600 more units of “Dink” at a cost of $15 each. Nichols then sold 700 units at a selling price of $25 each. The LIFO liquidation overstated normal gross profit by a. $ -0b. $500. c. $1,000. d. $1,500.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Use the following information for 121 and 122 RF Company had January 1 inventory of $150,000 when it adopted dollar-value LIFO. During the year, purchases were $900,000 and sales were $1,500,000. December 31 inventory at year-end prices was $215,040, and the price index was 112. 121.
What is RF Company’s ending inventory? a. $150,000. b. $192,000. c. $197,040. d. $215,040.
122.
What is RF Company’s gross profit? a. $642,000. b. $647,040. c. $665,190. d. $1,302,960.
Use the following information for 123 and 124 Hay Company had January 1 inventory of $120,000 when it adopted dollar-value LIFO. During the year, purchases were $720,000 and sales were $1,200,000. December 31 inventory at yearend prices was $151,800, and the price index was 110. 123.
What is Hay Company’s ending inventory? a. $132,000. b. $138,000. c. $139,800. d. $151,800.
124.
What is Hay Company’s gross profit? a. $498,000. b. $499,800. c. $511,800. d. $1,060,200.
Use the following information for questions 125 through 127. Gross Corporation adopted the dollar-value LIFO method of inventory valuation on December 31, 2011. Its inventory at that date was $440,000 and the relevant price index was 100. Information regarding inventory for subsequent years is as follows: Date December 31, 2012 December 31, 2013 December 31, 2014 125.
Inventory at Current Prices $513,600 580,000 650,000
Current Price Index 107 125 130
What is the cost of the ending inventory at December 31, 2012 under dollar-value LIFO? a. $480,000. b. $513,600. c. $482,800. d. $470,800.
Valuation of Inventories: A Cost-Basis Approach
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126.
What is the cost of the ending inventory at December 31, 2013 under dollar-value LIFO? a. $464,000. b. $462,800. c. $465,680. d. $480,000.
127.
What is the cost of the ending inventory at December 31, 2014 under dollar-value LIFO? a. $512,480. b. $509,600. c. $500,000. d. $526,800.
128.
Wise Company adopted the dollar-value LIFO method on January 1, 2012, at which time its inventory consisted of 6,000 units of Item A @ $5.00 each and 3,000 units of Item B @ $16.00 each. The inventory at December 31, 2012 consisted of 12,000 units of Item A and 7,000 units of Item B. The most recent actual purchases related to these items were as follows: Quantity Items Purchase Date Purchased Cost Per Unit A 12/7/12 2,000 $ 6.00 A 12/11/12 10,000 5.75 B 12/15/12 7,000 17.00 Using the double-extension method, what is the price index for 2012 that should be computed by Wise Company? a. 108.33% b. 109.59% c. 111.05% d. 220.51%
129.
Web World began using dollar-value LIFO for costing its inventory last year. The base year layer consists of $350,000. Assuming the current inventory at end of year prices equals $483,000 and the index for the current year is 1.10, what is the ending inventory using dollar-value LIFO? a. $483,000. b. $448,000. c. $439,091. d. $531,300.
130.
Willy World began using dollar-value LIFO for costing its inventory two years ago. The ending inventory for the past two years in end-of-year dollars was $120,000 and $180,000 and the year-end price indices were 1.0 and 1.2, respectively. Assuming the current inventory at end of year prices equals $258,000 and the index for the current year is 1.25, what is the ending inventory using dollar-value LIFO? a. $213,000. b. $223,680. c. $228,000. d. $226,500.
8 - 28 131.
Test Bank for Intermediate Accounting, Fourteenth Edition Opera Corp. uses the dollar-value LIFO method of computing its inventory cost. Data for the past four years is as follows: Year ended December 31. 2011 2012 2013
Inventory at End-of-year Prices $130,000 252,000 270,000
Price Index 1.00 1.05 1.10
What is the 2011 inventory balance using dollar-value LIFO? a. $130,000. b. $123,808. c. $245,454. d. $270,000. 132.
Opera Corp. uses dollar-value LIFO method of computing its inventory cost. Data for the past four years is as follows: Year ended December 31. 2011 2012 2013
Inventory at End-of-year Prices $ 130,000 252,000 270,000
Price Index 1.00 1.05 1.10
What is the 2012 inventory balance using dollar-value LIFO? a. $252,000. b. $257,000. c. $245,500. d. $251,500. 133.
Opera Corp. uses dollar-value LIFO method of computing its inventory cost. Data for the past four years is as follows: Year ended December 31. 2011 2012 2013
Inventory at End-of-year Prices $ 130,000 252,000 270,000
What is the 2013 inventory balance using dollar-value LIFO? a. $270,000. b. $257,000. c. $245,500. d. $251,500.
Price Index 1.00 1.05 1.10
Valuation of Inventories: A Cost-Basis Approach
8 - 29
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
84. 85. 86. 87. 88. 89. 90. 91.
c c d d d c b c
92. 93. 94. 95. 96. 97. 98. 99.
d a a d d d b d
100. 101. 102. 103. 104. 105. 106. 107.
b d a a c d b c
108. 109. 110. 111. 112. 113. 114. 115.
b c b a d c d d
116. 117. 118. 119. 120. 121. 122. 123.
c c c b b c b c
124. 125. 126. 127. 128. 129. 130. 131.
b c c a b b d a
132. 133.
c d
MULTIPLE CHOICE—CPA Adapted 134.
How should the following costs affect a retailer's inventory valuation? a. b. c. d.
135.
Freight-in Increase Increase No effect No effect
Interest on Inventory Loan No effect Increase Increase No effect
The following information applied to Howe, Inc. for 2012: Merchandise purchased for resale $350,000 Freight-in 8,000 Freight-out 5,000 Purchase returns 2,000 Howe's 2012 inventoriable cost was a. $350,000. b. $353,000. c. $356,000. d. $361,000.
136.
The following information was derived from the 2012 accounting records of Perez Co.: Perez 's Goods Perez 's Central Warehouse Held by Consignees Beginning inventory $130,000 $ 14,000 Purchases 475,000 70,000 Freight-in 10,000 Transportation to consignees 5,000 Freight-out 30,000 8,000 Ending inventory 145,000 20,000
8 - 30
Test Bank for Intermediate Accounting, Fourteenth Edition Perez's 2012 cost of sales was a. $470,000. b. $500,000. c. $534,000. d. $539,000.
137.
Dole Corp.'s accounts payable at December 31, 2012, totaled $650,000 before any necessary year-end adjustments relating to the following transactions: •
On December 27, 2012, Dole wrote and recorded checks to creditors totaling $350,000 causing an overdraft of $100,000 in Dole's bank account at December 31, 2012. The checks were mailed out on January 10, 2013.
•
On December 28, 2012, Dole purchased and received goods for $150,000, terms 2/10, n/30. Dole records purchases and accounts payable at net amounts. The invoice was recorded and paid January 3, 2013.
•
Goods shipped f.o.b. destination on December 20, 2012 from a vendor to Dole were received January 2, 2013. The invoice cost was $65,000.
At December 31, 2012, what amount should Dole report as total accounts payable? a. $1,212,000. b. $1,147,000. c. $900,000. d. $800,000. 138.
The balance in Moon Co.'s accounts payable account at December 31, 2012 was $900,000 before any necessary year-end adjustments relating to the following: •
Goods were in transit to Moon from a vendor on December 31, 2012. The invoice cost was $40,000. The goods were shipped f.o.b. shipping point on December 29, 2012 and were received on January 4, 2013.
•
Goods shipped f.o.b. destination on December 21, 2012 from a vendor to Moon were received on January 6, 2013. The invoice cost was $25,000.
•
On December 27, 2012, Moon wrote and recorded checks to creditors totaling $30,000 that were mailed on January 10, 2013.
In Moon's December 31, 2012 balance sheet, the accounts payable should be a. $930,000. b. $940,000. c. $965,000. d. $970,000. 139.
Kerr Co.'s accounts payable balance at December 31, 2012 was $1,300,000 before considering the following transactions: •
Goods were in transit from a vendor to Kerr on December 31, 2012. The invoice price was $70,000, and the goods were shipped f.o.b. shipping point on December 29, 2012. The goods were received on January 4, 2013.
•
Goods shipped to Kerr, f.o.b. shipping point on December 20, 2012, from a vendor were lost in transit. The invoice price was $50,000. On January 5, 2013, Kerr filed a $50,000 claim against the common carrier.
Valuation of Inventories: A Cost-Basis Approach
8 - 31
In its December 31, 2012 balance sheet, Kerr should report accounts payable of a. $1,420,000. b. $1,370,000. c. $1,350,000. d. $1,300,000. 140.
Walsh Retailers purchased merchandise with a list price of $75,000, subject to trade discounts of 20% and 10%, with no cash discounts allowable. Walsh should record the cost of this merchandise as a. $52,500. b. $54,000. c. $58,500. d. $75,000.
141.
On June 1, 2012, Penny Corp. sold merchandise with a list price of $40,000 to Linn on account. Penny allowed trade discounts of 30% and 20%. Credit terms were 2/15, n/40 and the sale was made f.o.b. shipping point. Penny prepaid $800 of delivery costs for Ison as an accommodation. On June 12, 2012, Penny received from Linn a remittance in full payment amounting to a. $21,952. b. $22,736. c. $22,752. d. $22,392.
142.
Groh Co. recorded the following data pertaining to raw material X during January 2012: Units Date Received Cost Issued On Hand 1/1/12 Inventory $4.00 3,200 1/11/12 Issue 1,600 1,600 1/22/12 Purchase 4,000 $4.70 5,600 The moving-average unit cost of X inventory at January 31, 2012 is a. $4.35. b. $4.42. c. $4.50. d. $4.70.
143.
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
8 - 32
Test Bank for Intermediate Accounting, Fourteenth Edition
144.
Hite Co. was formed on January 2, 2012, to sell a single product. Over a two-year period, Hite's acquisition costs have increased steadily. Physical quantities held in inventory were equal to three months' sales at December 31, 2012, and zero at December 31, 2013. 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, 2012 2013 a. LIFO FIFO b. LIFO LIFO c. FIFO FIFO d. FIFO LIFO
145.
Keck Co. had 450 units of product A on hand at January 1, 2012, costing $21 each. Purchases of product A during January were as follows: Date Units Unit Cost Jan. 10 600 $22 18 750 23 28 300 24 A physical count on January 31, 2012 shows 600 units of product A on hand. The cost of the inventory at January 31, 2012 under the LIFO method is a. $14,100. b. $13,350. c. $12,750. d. $12,300.
146.
When the double extension approach to the dollar-value LIFO inventory cost flow method is used, the inventory layer added in the current year is multiplied by an index number. How would the following be used in the calculation of this index number? Ending inventory at current year cost a. Numerator b. Numerator c. Denominator d. Not used
147.
Ending inventory at base year cost Denominator Not used Numerator Denominator
Farr Co. adopted the dollar-value LIFO inventory method on December 31, 2012. Farr's entire inventory constitutes a single pool. On December 31, 2012, the inventory was $480,000 under the dollar-value LIFO method. Inventory data for 2013 are as follows: 12/31/13 inventory at year-end prices Relevant price index at year end (base year 2012)
$660,000 110
Using dollar value LIFO, Farr's inventory at December 31, 2013 is a. $528,000. b. $612,000. c. $600,000. d. $660,000.
Valuation of Inventories: A Cost-Basis Approach
8 - 33
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
134. 135.
a c
136. 137.
d b
138. 139.
d a
140. 141.
b c
142. 143.
c a
144. 145.
c c
146. 147.
a b
DERIVATIONS — Computational No.
Answer
84.
c
Derivation $27,000 + $59,000 + $82,000 = $168,000.
85.
c
$27,000 + $59,000 + $97,000 = $183,000.
86.
d
[($20,000 – $2,000) × .02] = $360.
87.
d
[($50,000 – $5,000) × .02] = $900.
88.
d
$780,000 + $60,000 + $90,000 = $930,000.
89.
c
$760,000 + $40,000 = $800,000.
90.
b
$1,800,000 and ($200,000 + $15,000) = $215,000.
91.
c
($3,200,000 + $20,000) and ($170,000 – $46,000 + $20,000) = $144,000.
92.
d
$4,500 + $3,000 = $7,500.
93.
a
$9,000 – ($4,500 + $3,000) = $1,500.
94.
a
The effect of the errors in ending inventories reverse themselves in the following year.
95.
d
$260,000 + (4 × $200,000) = $1,060,000.
96.
d
$1,500 – ($1,500 × .02) = $1,470.
97.
d
($20,000 – $1,500) × .02 = $370.
98.
b
($29,310 + $20,600 + $28,917) ÷ (3,000 + 2,000 + 2,700) = $10.237/unit $10.237 × 900 = $9,213.
99.
d
Avg. on 1/6 $49,910 ÷ 5,000 = $9.982/unit 1/26 $53,872 ÷ 5,200 = $10.36/unit $10.36 × 900 = $9,324.
100.
b
(100 × $2.10) + (30 × $2.20) = $276.
8 - 34
Test Bank for Intermediate Accounting, Fourteenth Edition
No.
Answer
101.
d
100 + 350 + 70 – 130 = 390 units (100 × $2.10) + (290 × $2.20) = $848.
102.
a
($90,000 – $60,000) = $30,000.
103.
a
Available (purchases) = 9,750 units Sales = 7,800 units EI = 9,750 – 7,800 = 1,950 units (1,200 × $3.20) + (750 × $3.10) = $6,165.
104.
c
(300 × $3.2) + (600 × $3.1) + (600 × $3.4) + (450 × $3.5) = $6,435.
Date 6/1 6/2 6/3
Derivation
Purchase (1,200 @ 3.2) 3,840
Sold (900 @ 3.2)
2,880
(2,400 @ 3.1)
7,440
6/9
(1,500 @ 3.3)
4,950
6/10
(300 @ 3.3) (300 @ 3.1)
1,920
(3,300 @ 3.1) 10,230
6/6 6/7
6/15
(1,800 @ 3.3)
(2,700 @ 3.4)
5,940
9,180
6/18
6/22 6/25
(2,100 @ 3.4) 7,140
(750 @ 3.5)
2,625 (300 @ 3.5)
1,050
Balance (1,200 @ 3.2) 3,840 (300 @ 3.2) 960 (300 @ 3.2) (3,300 @ 3.1) 11,190 (300 @ 3.2) (900 @ 3.1) 3,750 (300 @ 3.2) (900 @ 3.1) (1,800 @ 3.3) 9,690 (300 @ 3.2) (900 @ 3.1) (300 @ 3.3) 4,740 (300 @ 3.2) (600 @ 3.1) 2,820 (300 @ 3.2) (600 @ 3.1) (2,700 @ 3.4) 12,000 (300 @ 3.2) (600 @ 3.1) 4,860 (600 @ 3.4) (750 @ 3.5) 7,485 (300 @ 3.2) (600 @ 3.1) (600 @ 3.4) (450 @ 3.5) 6,435
105.
d
(750 × $3.5) + (1,200 × $3.4) = $6,705.
106.
b
$31,815 ÷ 9,750 units = $3.26 $3.26 × 1,950 = $6,357.
107.
c
(400 × $10) – $1,600 = $2,400 COGS [(500 × $4) + $2,800] – $2,400 = $2,400 E.I. ($4,800 ÷ 800) × 400 units = $2,400 E.I. under weighted avg.
Valuation of Inventories: A Cost-Basis Approach
8 - 35
No.
Answer
Derivation
108.
b
(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.
c
20 + 120 – 90 = 50 units.
110.
b
90 × $20/unit = $1,800.
111. =
a
[(2,400 × $12) + (1,000 × $13) + (4,000 × $13.50] (2,400 + 1,000 + 4,000) $12.95; $12.95 × 4,300 = $55,685.
112.
d
[(300 × $65) + (450 × $68) + (225 × $70)] (300 + 450 + 225) = $67.54; $67.54 × (975 – 750) = $15,197.
113.
c
(2,400 + 1,000 + 4,000) – 4,300 = 3,100; 3,100 × $13.50 = $41,850.
114.
d
(300 × $65) + [(750 – 300) × $68] = $50,100.
115.
d
(2,400 + 1,000 + 4,000) – 4,300 = 3,100; (2,400 × $12) + [(3,100 – 2,400) × $13] = $37,900.
116.
c
(225 × $70) + (450 × $68) + (75 × $65) = $51,225.
117.
c
$750,000 + ($150,000 – $100,000) = $800,000.
118.
c
$900,000 + ($180,000 – $120,000) = $960,000.
119.
b
[(700 – 600) × ($12 – $8)] = $400.
120.
b
[(700 – 600) × ($15 – $10)] = $500.
121.
c
$215,040 ÷ 1.12 = $192,000 – $150,000 = $42,000. $150,000 + ($42,000 × 1.12) = $197,040.
122.
b
$150,000 + $900,000 – $197,040 = $852,960 COGS $1,500,000 – $852,960 = $647,040.
123.
c
$151,800 ÷ 1.10 = $138,000 – $120,000 = $18,000. $120,000 + ($18,000 × 1.10) = $139,800.
124.
b
$120,000 + $720,000 – $139,800 = $700,200 COGS $1,200,000 – $700,200 = $499,800.
125.
c
$513,600 ÷ 1.07 = $480,000 $440,000 + [(480,000 – $440,000) × 1.07] = $482,800.
126.
c
$580,000 ÷ 1.25 = $464,000 ($440,000 × 1) + ($24,000 × 1.07) = $465,680.
8 - 36
Test Bank for Intermediate Accounting, Fourteenth Edition
No.
Answer
Derivation
127.
a
$650,000 ÷ 1.30 = $500,000 ($440,000 × 1) + ($24,000 × 1.07) + ($36,000 × 1.3) = $512,480.
128.
b
[(2,000 × $6) + (10,000 × $5.75) + (7,000 × $17)] ÷ [(12,000 × $5) + (7,000 × $16)] = 1.0959 = 109.59%.
129.
b
$483,000 ÷ 1.10 = $439,091; $439,091 – $350,000 = $89,091; $350,000 + ($89,091 × 1.10) = $448,000.
130.
d
$258,000 ÷ 1.25 = $206,400; $206,400 – ($180,000 ÷ 1.20) = $56,400; $120,000 + [($180,000 ÷ 1.20) – $120,000) × 1.2] = $156,000 $156,000 + ($56,400 × 1.25) = $226,500.
131.
a
$130,000 × 1.00 = $130,000.
132.
c
$252,000 ÷ 1.05 = $240,000; $240,000 – $130,000 = $110,000. $130,000 + ($110,000 × 1.05) = $245,500.
133.
d
$270,000 ÷ 1.10 = $245,455; $245,455 – ($252,000 ÷ 1.05) = $5,455; $252,000 ÷ 1.05 = $240,000; $240,000 – $130,000 = $110,000; $130,000 + ($110,000 × 1.05) + ($5,455 × 1.10) = $251,500.
DERIVATIONS — CPA Adapted No.
Answer
Derivation
134.
a
Conceptual.
135.
c
$350,000 + $8,000 – $2,000 = $356,000.
136.
d
$130,000 + $14,000 + $475,000 + $70,000 + $10,000 + $5,000 – $145,000 – $20,000 = $539,000.
137.
b
$650,000 + $350,000 + $147,000 = $1,147,000.
138.
d
$900,000 + $40,000 + $30,000 = $970,000.
139.
a
$1,300,000 + $70,000 + $50,000 = $1,420,000.
140.
b
$75,000 × .8 × .9 = $54,000.
141.
c
$40,000 × .7 × .8 = $22,400 ($22,400 × .98) + 800 = $22,752.
142.
c
[(1,600 × $4.00) + (4,000 × $4.70)] ÷ 5,600 = $4.50.
143.
a
Conceptual.
Valuation of Inventories: A Cost-Basis Approach
No.
Answer
Derivation
144.
c
Conceptual.
145.
c
(450 × $21) + (150 × $22) = $12,750.
146.
a
Conceptual.
147.
b
$660,000 ÷ 1.1 = $600,000 $480,000 + ($120,000 × 1.1) = $612,000.
8 - 37
EXERCISES Ex. 8-148—Recording purchases at net amounts. Flint Co. records purchase discounts lost and uses perpetual inventories. Prepare journal entries in general journal form for the following: (a) Purchased merchandise costing $1,500 with terms 2/10, n/30. (b) Payment was made thirty days after the purchase.
Solution 8-148 (a) Inventory (.98 × $900) .............................................................. Accounts Payable .........................................................
1,470
(b) Accounts Payable .................................................................... Purchase Discounts Lost .......................................................... Cash .............................................................................
1,470 30
1,470
1,500
Ex. 8-149—Recording purchases at net amounts. Dill Co. records purchases at net amounts and uses periodic inventories. Prepare entries for the following: June 11 Purchased merchandise on account, $8,000, terms 2/10, n/30. 15 Returned part of June 11 purchase, $500, and received credit on account. 30 Prepared the adjusting entry required for financial statements.
Solution 8-149 June 11 Purchases (.98 × $8,000) ............................................. Accounts Payable ............................................. 15 Accounts Payable (.98 × $500) ..................................... Purchase Returns and Allowances .................... 30 Purchase Discounts Lost (.02 × $7,500) ....................... Accounts Payable .............................................
7,840 7,840 490 490 150 150
8 - 38
Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 8-150—Comparison of FIFO and LIFO. During periods of rising prices, the use of FIFO (as compared with LIFO) will result in what effect on the financial statements?
Solution 8-150 During periods of rising prices, the use of FIFO will result in higher inventory, lower cost of goods sold, and higher gross profit, net income, income taxes, and retained earnings.
Ex. 8-151—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 @ $40 600 units @ $44
Perpetual inventories are maintained. Instructions What is the cost of the ending inventory for item 27 under the following methods? calculations.) (a) FIFO. (b) LIFO.
Solution 8-151 (a) 700 @ $30 = 200 @ $36 =
$21,000 7,200 $28,200
(b) 800 @ $36 = 100 @ $30 =
$28,800 3,000 $31,800
Ex. 8-152—FIFO and LIFO periodic inventory methods. The Rock 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 31 100 units
(Show
Valuation of Inventories: A Cost-Basis Approach
8 - 39
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 8-152 (a) 70 @ $6.00 = 30 @ $5.40 =
(b)
$420 162 $582
70 @ $6.00 = $ 420 300 @ $5.40 = 1,620 $2,040
Ex. 8-153—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 29 300 @ $4.55
Sales 200 @ $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 8-153 200 @ $4.20 = $ 840 200 @ $4.10 = 820 100 @ $4.40 = 440 300 @ $4.55 = 1,365 $3,465
8 - 40
Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 8-154—Perpetual LIFO and Periodic FIFO. Matlock 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 2012. 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 $3.75 $3.90 — — $4.10
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 8-154 (a)
400 @ $3.75 = 440 @ $3.90 = 600 @ $4.10 = 1,440
$1,500 1,716 2,460 $5,676
(b)
400 @ $3.75 = 460 @ $3.90 = 860
$1,500 1,794 $3,294
Ex. 8-155—Analysis of gross profit. During 2012, King’s Drug Company experienced a significant increase in the rate of gross profit on sales, compared with the rate it has averaged in recent years. You are asked to determine the most likely reason for this improvement. Support your answer. The following data are from the records of the company: 2012 sales (at an average price of $40 a unit) were $2,250,000. 2012 purchases (at an average cost of $24 a unit) were $1,200,000. The company uses the LIFO inventory method and has used it since 1985. Solution 8-155 6,250 more units were sold than were purchased. This has resulted in the partial liquidation of the beginning LIFO inventory layers. Assuming rising prices, the increased rate of gross profit is most likely due to the matching of old, lower inventory costs against current sales. Computations Units sold: $2,250,000 ÷ $40 = 56,250 Units purchased: $1,200,000 ÷ $24 = 50,000
Valuation of Inventories: A Cost-Basis Approach
8 - 41
Ex. 8-156—Dollar-value LIFO method. Part A.
Judd Company has a beginning inventory in year one of $500,000 and an ending inventory of $605,000. 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, Judd's inventory is $713,000 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 8-156 Part A. Computation of Ending Inventory, Year One Ending Inventory Layers at at Base-Year Price Base-Year Prices Price Index $605,000 ÷ 1.10 = $550,000 $500,000 × 1.00 = $50,000 × 1.10 =
Ending Inventory at Dollar-Value LIFO $500,000 55,000 $555,000
Part B. Computation of Ending Inventory, Year Two Ending Inventory Layers at at Base-Year Price Base-Year Prices Price Index $713,000 ÷ 1.15 = $620,000 $500,000 × 1.00 = $50,000 × 1.10 = $70,000 × 1.15 =
Ending Inventory at Dollar-Value LIFO $500,000 55,000 80,500 $635,500
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Test Bank for Intermediate Accounting, Fourteenth Edition
PROBLEMS Pr. 8-157—Inventory cut-off. Vogts Company sells TVs. The perpetual inventory was stated as $33,500 on the books at December 31, 2012. 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, 2013, costing $5,000 were included in inventory at December 31, 2012. The sale was recorded in 2013. 2. TVs costing $12,000 received December 30, 2012, were recorded as received on January 2, 2013. 3. TVs received during 2012 costing $4,600 were recorded twice in the inventory account. 4. TVs shipped to a customer December 28, 2012, f.o.b. shipping point, which cost $8,000, were not received by the customer until January, 2013. 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, 2012.
Solution 8-157 Inventory per books Add: Shipment received 12/30/12 TVs on hand
Deduct:
TVs recorded twice TVs shipped 12/28/12 Correct inventory 12/31/12
$33,500 $12,000 6,100
4,600 8,000
18,100 51,600
12,600 $39,000
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Valuation of Inventories: A Cost-Basis Approach Pr. 8-158—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 EXAMPLE: Excluded goods in rented warehouse from inventory count.
NE
Accounts Inventory Payable Sales U
NE
NE
Cost of Goods Sold O
____________________________________________________________________________ 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 8-158 1. 2. 3. 4.
NE NE U U
NE O O NE
O O NE NE
NE NE U U
O NE U NE
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Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 8-159—Accounting for purchase discounts. Otto Corp. purchased merchandise during 2012 on credit for $400,000; terms 2/10, n/30. All of the gross liability except $80,000 was paid within the discount period. The remainder was paid within the 30-day term. At the end of the annual accounting period, December 31, 2012, 90% of the merchandise had been sold and 10% remained in inventory. The company uses a periodic system. Instructions (a) Assuming that the net method is used for recording purchases, prepare the entries for the purchase and two subsequent payments. (b) What dollar amounts should be reported for the final inventory and cost of goods sold under the (1) net method; (2) gross method? Assume that there was no beginning inventory.
Solution 8-159 (a) Purchases ............................................................................................ 392,000 Accounts Payable ..................................................................... (To record the purchase at net amount: .98 × $400,000 = $392,000.) Accounts Payable ................................................................................. 313,600 Cash ......................................................................................... (To record payment within the discount period: $400,000 – $80,000 = $320,000; .98 × $320,000 = $313,600.) Accounts Payable ................................................................................. Purchase Discounts Lost ...................................................................... Cash ......................................................................................... (To record the final payment.) (b) (1) Net method: Purchases: Final inventory: 10% × $392,000 = Cost of goods sold: 90% × $392,000 =
392,000
313,600
78,400 1,600 80,000
$392,000 39,200 $352,800
(The $1,600 discount lost is reported in the other expense section of the income statement.) (2) Gross method: Purchases: Less purchase discounts: .02 × $320,000 = Goods available Final inventory: 10% × $393,600 = Cost of goods sold: 90% × $393,600 =
$400,000 6,400 393,600 39,360 $354,240
(Assuming that the $6,400 discount is prorated between the cost of goods sold, 90%, and the final inventory, 10%.)
OR
Purchases: Less purchase discounts: .02 × $320,000 = Goods available Final inventory: 10% × $400,000 = Cost of goods sold: $393,600 – $40,000 =
$400,000 6,400 393,600 40,000 $353,600
(Assuming that the $6,400 discount is used to reduce cost of goods sold. Final inventory is carried at the gross amount.)
Valuation of Inventories: A Cost-Basis Approach
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Pr. 8-160—Inventory methods. Jones Company was formed on December 1, 2011. The following information is available from Jones's inventory record for Product X. Units Unit Cost January 1, 2012 (beginning inventory) 1,600 $18.00 Purchases: January 5, 2012 2,600 $20.00 January 25, 2012 2,400 $21.00 February 16, 2012 1,000 $22.00 March 15, 2012 1,800 $23.00 A physical inventory on March 31, 2012, shows 2,200 units on hand. Instructions Prepare schedules to compute the ending inventory at March 31, 2012, under each of the following inventory methods: (a) FIFO. (b) LIFO. (c) Weighted-average. Show supporting computations in good form.
Solution 8-160 (a)
Jones Company COMPUTATION OF INVENTORY FOR PRODUCT X UNDER FIFO INVENTORY METHOD March 31, 2012
March 15, 2012 February 16, 2012 March 31, 2012, inventory
(b)
Units 1,800 400 2,200
Unit Cost $23.00 22.00
Total Cost $41,400 8,800 $50,200
Jones Company COMPUTATION OF INVENTORY FOR PRODUCT X UNDER LIFO INVENTORY METHOD March 31, 2012
Beginning inventory January 5, 2012 (portion) March 31, 2012, inventory
Units 1,600 600 2,200
Unit Cost $18.00 20.00
Total Cost $28,800 12,000 $40,800
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Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 8-160 (cont.) (c)
Jones Company COMPUTATION OF INVENTORY FOR PRODUCT X UNDER WEIGHTED-AVERAGE INVENTORY METHOD March 31, 2012 Units 1,600 2,600 2,400 1,000 1,800 9,400
Beginning inventory January 5, 2012 January 25, 2012 February 16, 2012 March 15, 2012
Unit Cost $18.00 20.00 21.00 22.00 23.00
Weighted average cost ($194,600 ÷ 9,400)
Total Cost $ 28,800 52,000 50,400 22,000 41,400 $194,600
$20.70
March 31, 2012, inventory
2,200
$20.70
$45,540
Pr. 8-161—Dollar-value LIFO. Aber Company manufactures one product. On December 31, 2011, Aber adopted the dollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO inventory method was $270,000. Inventory data are as follows: Inventory at year-end prices $378,000 552,000 575,000
Year 2012 2013 2014
Price index (base year 2009) 1.05 1.15 1.25
Instructions Compute the inventory at December 31, 2012, 2013, and 2014, using the dollar-value LIFO method for each year.
Solution 8-161 Aber Company Dollar-Value LIFO Computations At December 31, 2012, 2013, and 2014
At 12/31, 2012:
Ending Inventory at Base-Year Price $378,000 ÷ 1.05 = $360,000
Layers at Base-Year Prices $270,000 $90,000
× ×
At 12/31, 2013:
$552,000 ÷ 1.15 = $480,000
$270,000 $90,000 $120,000
× × ×
Price Index 1.00 = 1.05 =
1.00 1.05 1.15
= = =
Ending Inventory Dollar-Value LIFO $270,000 94,500 $364,500 $270,000 94,500 138,000 $502,500
Valuation of Inventories: A Cost-Basis Approach
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Solution 8-161 (cont.) At 12/31, 2014:
$575,000 ÷ 1.25 = $460,000
$270,000 $90,000 $100,000
× × ×
1.00 1.05 1.15
= = =
$270,000 94,500 115,000 $479,500
Pr. 8-162—Dollar-value LIFO. Gott Company adopted the dollar-value LIFO inventory method on 12/31/11. On this date, its inventory consisted of the following items. Item X Y
Number of Units 200 600
Cost Per Unit $2.00 4.50
Additional information: 1. 2. 3. 4.
Total Cost $ 400 2,700 $3,100 December 31 2012 2013 300 400 $3.00 $3.25 800 1,200 $5.50 $6.00
Units of X in inventory Cost of each X unit Units of Y in inventory Cost of each Y unit
Instructions (a) Compute the price index for 2012. Round to 2 decimal places. (b) Calculate the 12/31/12 inventory. Label all numbers. (c) Compute the price index for 2013. Round to 2 decimal places. (d) Calculate the 12/31/13 inventory. Label all numbers.
Solution 8-162 (a) Ending Inventory In End of Year Dollars: X 300 × $3.00 = Y 800 × $5.50 =
Ending Inventory In Base Dollars X 300 × $2.00 = Y 800 × $4.50 =
$ 900 4,400 $5,300
$ 600 3,600 $4,200
Index = $5,300 ÷ $4,200 = 1.262 or 1.26 (b) Base Layer Incremental Layer 2012 Ending Inventory (c) Ending Inventory In End of Year Dollars: X 400 × $3.25 = Y 1,200 × $6.00 =
$3,100 1,100 $4,200
$1,300 7,200 $8,500
Index = $8,500 ÷ $6,200 = 1.371 or 1.37
× ×
1.00 = 1.26 =
Ending Inventory In Base Dollars X 400 × $2.00 = Y 1,200 × $4.50 =
$3,100 1,386 $4,486
$ 800 5,400 $6,200
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Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 8-162 (cont.) (d) Base Layer Incremental Layer 2013 Ending Inventory
$3,100 1,100 2,000 $6,200
× × ×
1.00 = 1.26 = 1.37 =
$3,100 1,386 2,740 $7,226
Short Answer: 1.
As compared with the FIFO method of costing inventories, does the LIFO method result in a larger or smaller net income in a period of rising prices? What is the comparative effect on net income in a period of falling prices? 1. The LIFO method results in a smaller net income because later costs, which are higher than earlier costs, are matched against revenue. Conversely, in a period of falling prices, the LIFO method would result in a higher net income because later costs in this case would be lower than earlier costs, and these later costs would be matched against revenue.
2.
Explain the following terms. (a) LIFO layer (b) LIFO reserve
(c) LIFO effect
2. (a) LIFO layer – a LIFO layer (increment) is formed when the ending inventory at baseyear prices exceeds the beginning inventory at base-year prices. (b) LIFO reserve – the difference between the inventory method used for internal purposes and LIFO. (c) LIFO effect – the change in the LIFO reserve ( Allowance to Reduce Inventory to LIFO) from one period to the next.
Valuation of Inventories: A Cost-Basis Approach
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IFRS QUESTIONS True / False 1.
Who owns the goods, as well as the costs to include in inventory, are essentially accounted for the same under IFRS and U.S. GAAP.
2.
U.S. GAAP has less detailed rules related to the accounting for inventories, compared to IFRS.
3.
IFRS does not permit the LIFO method to account for inventories.
4.
Many U.S. companies that have international operations use LIFO for U.S. purposes but use FIFO for their foreign subsidiaries.
5.
Both U.S. GAAP and IFRS permit the use of the LIFO method to account for inventories.
Answers to True / False questions: 1. True 2. False 3. True 4. True 5. False
Multiple Choice Questions: 1.
Under IFRS, an entity should initially recognize inventory when a. it has control of the inventory b. it expects it to provide future economic benefits c. the cost of the inventory can be reliably measured d. all of these choices are correct
2.
With respect to accounting for inventories, which of the following is a difference that exists for IFRS, as opposed to U.S. GAAP? a. There is required recognition of certain development costs. b. The FIFO method of inventories is prohibited. c. The specific identification method of inventories is only allowed when goods are interchangeable. d. The weighted average method of inventories is prohibited.
3.
Under IFRS, which of the following would be included in the cost of inventories? a. Product specific designer costs b. Abnormal waste materials c. Selling costs d. All of these would be included in the cost of inventories.
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Test Bank for Intermediate Accounting, Fourteenth Edition
4.
Which of the following best describes the IFRS requirement for applying the same cost formula to all inventories? a. When they are purchased from different suppliers. b. When they are purchased from the same geographic region. c. When they are similar in nature or use. d. When they sell for the same price.
5.
Under IFRS, inventories are classified as a. noncurrent assets b. current assets c. stockholders' equity d. current liabilities
Use the following information to answer questions 6-8. Barton Company uses a periodic inventory system. On January 1, 2012, Barton Company had 600 units of inventory on hand at a cost of $8 per unit. During 2012, Barton made the following inventory purchases. April 1 June 1 September 1 November 1
Purchased 200 units at $10 Purchased 150 units at $12 Purchased 400 units at $14 Purchased 500 units at $15
Assume Barton Company sold 1,150 units of inventory during 2012. 6.
If you assume that Barton follows IFRS and uses the FIFO method, what is the ending inventory and cost of goods sold, respectively? a. Ending inventory = $5,800; Cost of Goods Sold = $15,900 b. Ending inventory = $8,260; Cost of Goods Sold = $13,440 c. Ending inventory = $8,211; Cost of Goods Sold = $13,489 d. Ending inventory = $10,300; Cost of Goods Sold = $11,400
7.
If you assume that Barton follows IFRS and uses the Average-cost method, what is the ending inventory and cost of goods sold, respectively? a. Ending inventory = $5,800; Cost of Goods Sold = $15,900 b. Ending inventory = $8,260; Cost of Goods Sold = $13,440 c. Ending inventory = $8,211; Cost of Goods Sold = $13,489 d. Ending inventory = $10,300; Cost of Goods Sold = $11,400
Valuation of Inventories: A Cost-Basis Approach
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8.
Based on your answers to Questions 6 and 7, which of the following is a disadvantage of using the IFRS FIFO method, as compared to Average-cost under U.S. GAAP? a. Under FIFO, during periods of inflation, inventory costs matched against sales are greater than the inventory replacement cost. b. When price levels increase and inventory quantities do not decrease, taxes are greater under FIFO c. FIFO may cause poorer buying habits as management attempts to manipulate net income. d. FIFO typically causes lower reported earnings.
9.
Which of the following is an advantage for U.S. companies with international operations to use LIFO for U.S. purposes, as opposed to using FIFO for foreign subsidiaries? a. LIFO creates paper profits. b. LIFO generally approximates the physical flow of items. c. Under LIFO, inventory is less vulnerable to price declines. d. LIFO eliminates balance sheet distortion.
10.
Both U.S. GAAP and IFRS exclude which of the following from the cost of inventory? a. Selling costs b. General administrative costs c. Most storage costs d. All of these are excluded by U.S. GAAP and IFRS.
Answer to Multiple Choice. 1. d 2. a 3. a 4. c 5. b 6. d 7. c 8. b 9. c 10. d
CHAPTER 9 INVENTORIES: ADDITIONAL VALUATION ISSUES IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
T F F T F T T F F T F T F T F F T F T T
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20
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. Reporting inventory at net realizable value. Valuing inventory at net realizable value. Valuation using relative sales value. Definition of a basket purchase. Recording purchase commitments. Loss on purchase commitments. Recording noncancelable purchase contract. Gross profit method. Gross profit percentage. Disadvantage of gross profit method. Conventional retail method. Definition of markup. Accounting for abnormal shortages. Computing inventory turnover ratio. Average days to sell inventory. LIFO retail method.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
d d c b a c d d a b d c a d a c
21. 22. 23. 24. 25. 26. 27. S 28. 29. 30. 31. 32. 33. 34. 35. S 36.
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. Recording inventory loss under direct method. Lower-of-cost-or-market description. Definition of "floor". Rationale of the "ceiling". Reason inventories are stated at LCM. Acceptable approaches in applying LCM. Methods used to record inventory loss. Reason for reporting inventory at sales price. Recording inventory at net realizable value.
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MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
b d a d a a b d c a d d b d c a d b a b a d a b d a b b a c c
37. 38. 39. 40. 41. 42. P 43. 44. 45. 46. S 47. 48. 49. 50. 51. 52. 53. 54. 55. *56. S 57. S 58. 59. 60. 61. 62. 63. P 64. P 65. 66. *67.
Net realizable value under LCM. Definition of "net realizable value." Valuation of inventory at net realizable value. Appropriate use of net realizable value. Material purchase commitments. Loss recognition on purchase commitments. Reporting purchase commitments loss. Accounting for purchase commitments. Record unrealized losses on purchase commitments. Use of gross profit method. Gross profit method assumptions. Appropriate use of the gross profit method. Appropriate use of the gross profit method. Advantage of retail inventory method. Conventional 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. Knowledge of the cost ratio for retail inventory methods. Information needed in retail inventory method. Reasons for using retail inventory method. Condition necessary to use retail method. Conventional retail method. Net markups and the conventional retail method. Freight-in and the conventional retail method. Common inventory disclosures. Inventory cost flow assumptions. Computing average days to sell inventory. Inventory turnover ratio. Dollar-value LIFO retail method.
MULTIPLE CHOICE—Computational Answer
No.
Description
a b b d b c c b d c b a c
68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80.
Value inventory at LCM. Lower-of-cost-or-market. Lower-of-cost-or-market. Value inventory at LCM. Value inventory at LCM. Value inventory at LCM. Determine market value under LCM. Value inventory under LCM. Determine cost amount under LCM. Value inventory under LCM. Value inventory under LCM. Value inventory under LCM. Value inventory under LCM.
Inventories: Additional Valuation Issues
MULTIPLE CHOICE—Computational (cont.) Answer
No.
c c b b c b d a a c c c b a a d d a a b c b a a c c d d c a c b b b a b b c a a c c b d d d a c a
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. 113. 114. 115. 116. *117. *118. 119. 120. 121. 122. 123. 124. 125. 126. 127. *128. *129.
.
Description Determining net realizable value. Determining net realizable value. Relative sales value method. Relative sales value method. Relative sales method of inventory valuation. Calculate cost using relative sales value method. Calculate cost using relative sales value method. Calculate cost using relative sales value method. Entry for purchase commitment loss. Recording purchase under purchase commitment. Entry for purchase commitment loss. Recognizing loss on purchase commitments. Recognizing loss on purchase commitments. Estimating ending inventory using gross profit method. Estimating ending inventory using gross profit method. Calculate cost of goods sold given a markup on cost. Calculate merchandise purchases given a markup on cost. Calculate total sales from cost information. Markup on cost equivalent to a markup on selling price. 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. Determine items to be included in inventory. Determine gross profit as percentage of cost. Calculate gross profit amount. Calculate ending inventory using gross profit method. Calculate ending inventory using gross profit method. Calculate ending inventory using gross profit method. Calculate ending inventory using conventional retail. Calculate ending inventory using conventional retail. Calculate ending inventory using conventional retail. Calculate cost of retail ratio to approximate LCM. Calculate ending inventory at retail. Calculate cost to retail ratio approximating LCM. Calculate cost of inventory lost using retail method. Calculate ending inventory at cost using LIFO retail. Determine cost to retail ratio using LIFO retail. Calculate ending inventory at retail. Calculate ending inventory at retail. Average days to sell inventory. Average days to sell inventory. Calculate inventory turnover ratio. Calculate inventory turnover ratio. Determine cost to retail ratio to approximate LCM. Calculate ending inventory at retail. Calculate ending inventory using conventional retail. Determine cost to retail ratio using LIFO cost. Calculate ending inventory cost using dollar-value LIFO.
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MULTIPLE CHOICE—Computational (cont.) Answer
No.
b a
*130. *131.
Description Calculate cost of ending inventory using LIFO retail. Calculate ending inventory cost using dollar-value LIFO.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. * This topic is dealt with in an Appendix to the chapter. S
MULTIPLE CHOICE—CPA Adapted Answer
No.
d b b a a d a
132. 133. 134. 135. 136. 137. *138.
Description 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. Determine cost of ending inventory using retail method. Determine cost of ending inventory using retail method. Calculate ending inventory using LIFO retail.
EXERCISES Item E9-139 E9-140 E9-141 E9-142 E9-143 E9-144 E9-145 E9-146 E9-147 E9-148
Description Lower-of-cost-or-market. Lower-of-cost-or-market. Lower-of-cost-or-market. Lower-of-cost-or-market. Lower-of-cost-or-market. Relative sales value method. Gross profit method. Gross profit method. Gross profit method. Comparison of inventory methods.
Inventories: Additional Valuation Issues
PROBLEMS Item P9-149 P9-150 *P9-151 *P9-152 *P9-153 *P9-154 *P9-155
Description Gross profit method. Retail inventory method. Retail inventory method. LIFO retail inventory method, fluctuating prices. LIFO retail inventory method, stable prices. Dollar-value LIFO retail method. Retail LIFO.
CHAPTER LEARNING OBJECTIVES 1. Describe and apply the lower-of-cost-or-market rule. 2. Explain when companies value inventories at net realizable value. 3. Explain when companies use the relative sales value method to value inventories. 4. Discuss accounting issues related to purchase commitments. 5. Determine ending inventory by applying the gross profit method. 6. Determine ending inventory by applying the retail inventory method. 7. Explain how to report and analyze inventory. *8. Determine ending inventory by applying the LIFO retail methods.
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*SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2. 3. 4. 21. 22.
TF TF TF TF MC MC
23. 24. 25. 26. 27. S 28.
MC MC MC MC MC MC
29. 30. 31. 32. 33. 34.
5. 6.
TF TF
S
35. 36.
MC MC
37. 38.
7. 8.
TF TF
83. 84.
MC MC
85. 86.
9. 10.
TF TF
11. 41.
TF MC
12. 13. 14. 46.
TF TF TF MC
47. 48. 49. 94.
MC MC MC MC
15. 16. 17. 50. 51.
TF TF TF MC MC
52. 53. 54. 55. 56.
MC MC MC MC MC
S
18. 19.
TF TF
63. 64.
MC MC
P
P
20. 56. 67.
TF MC MC
117. 118. 128.
MC MC MC
129. 130. 131.
Note:
S
P
42. 43. 95. 96. 97. 98.
S
TF = True-False MC = Multiple Choice E = Exercise P = Problem
57. 58. 59. 60. 61. 65. 66.
Type
Item
Type
Item
Learning Objective 1 MC 68. MC 74. MC 69. MC 75. MC 70. MC 76. MC 71. MC 77. MC 72. MC 78. MC 73. MC 79. Learning Objective 2 MC 39. MC 81. MC 40. MC 82. Learning Objective 3 MC 87. MC 144. MC 88. MC Learning Objective 4 MC 44. MC 89. MC 45. MC 90. Learning Objective 5 MC 99. MC 103. MC 100. MC 104. MC 101. MC 105. MC 102. MC 106. Learning Objective 6 MC 62. MC 114. MC 110. MC 115. MC 111. MC 116. MC 112. MC 119. MC 113. MC 120. Learning Objective 7 MC 121. MC 123. MC 122. MC 124. Learning Objective *8 MC 138. MC 152. MC 148. E 153. MC 151. P 154.
Type
Item
Type
Item
Type
MC MC MC MC MC MC
80. 132. 133. 134. 139. 140.
MC MC MC MC E E
141. 142. 143. 148.
E E E E
MC MC
91. 92.
MC MC
93.
MC
MC MC MC MC
107. 108. 109. 135.
MC MC MC MC
145. 146. 147. 149.
E E E P
MC MC MC MC MC
125. 126. 127. 136. 137.
MC MC MC MC MC
148. 150.
E P
155.
P
MC MC E
MC MC P P P
Inventories: Additional Valuation Issues
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TRUE-FALSE—Conceptual 1.
A company should abandon the historical cost principle when the future utility of the inventory item falls below its original cost.
2.
The lower-of-cost-or-market method is used for inventory despite being less conservative than valuing inventory at market value.
3.
The purpose of the “floor” in lower-of-cost-or-market considerations is to avoid overstating inventory.
4.
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.
5.
GAAP requires reporting inventory at net realizable value, even if above cost, whenever there is a controlled market with a quoted price applicable to all quantities.
6.
A reason for valuing inventory at net realizable value is that sometimes it is too difficult to obtain the cost figures.
7.
In a basket purchase, the cost of the individual assets acquired is determined on the basis of their relative sales value.
8.
A basket purchase occurs when a company agrees to buy inventory weeks or months in advance.
9.
Most purchase commitments must be recorded as a liability.
10.
If the contract price on a noncancelable purchase commitment exceeds the market price, the buyer should record any expected losses on the commitment in the period in which the market decline takes place.
11.
When a buyer enters into a formal, noncancelable purchase contract, an asset and a liability are recorded at the inception of the contract.
12.
The gross profit method can be used to approximate the dollar amount of inventory on hand.
13.
In most situations, the gross profit percentage is stated as a percentage of cost.
14.
A disadvantage of the gross profit method is that it uses past percentages in determining the markup.
15.
When the conventional retail method includes both net markups and net markdowns in the cost-to-retail ratio, it approximates a lower-of-cost-or-market valuation.
16.
In the retail inventory method, the term markup means a markup on the original cost of an inventory item.
17.
In the retail inventory method, abnormal shortages are deducted from both the cost and retail amounts and reported as a loss.
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Test Bank for Intermediate Accounting, Fourteenth Edition
18.
The inventory turnover ratio is computed by dividing the cost of goods sold by the ending inventory on hand.
19.
The average days to sell inventory represents the average number of days’ sales for which a company has inventory on hand.
*20.
The LIFO retail method assumes that markups and markdowns apply only to the goods purchased during the period.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. T F F T F
Item 6. 7. 8. 9. 10.
Ans. T T F F T
Item 11. 12. 13. 14. 15.
Ans. F T F T F
Item 16. 17. 18. 19. 20.
Ans. F T F T T
MULTIPLE CHOICE—Conceptual 21.
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.
22.
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.
23.
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
24.
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.
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25.
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.
26.
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.
27.
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.
28.
When the cost-of-goods-sold method is used to record inventory at market a. there is a direct reduction in the selling price of the product that results in a loss being recorded on the income statement prior to the sale. b. a loss is recorded directly in the inventory account by crediting inventory and debiting loss on inventory decline. c. only the portion of the loss attributable to inventory sold during the period is recorded in the financial statements. d. the market value figure for ending inventory is substituted for cost and the loss is buried in cost of goods sold.
29.
Lower-of-cost-or-market as it applies to inventory is best described as the a. drop of future utility below its original cost. b. method of determining cost of goods sold. c. assumption to determine inventory flow. d. change in inventory value to market value.
30.
The floor to be used in applying the lower-of-cost-or-market method to inventory is determined as the a. net realizable value. b. net realizable value less normal profit margin. c. replacement cost. d. selling price less costs of completion and disposal.
31.
What is the rationale behind the ceiling when applying the lower-of-cost-or-market method to inventory? a. Prevents understatement of the inventory value. b. Allows for a normal profit to be earned. c. Allows for items to be valued at replacement cost. d. Prevents overstatement of the value of obsolete or damaged inventories.
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32.
Why are inventories stated at lower-of-cost-or-market? a. To report a loss when there is a decrease in the future utility. b. To be conservative. c. To report a loss when there is a decrease in the future utility below the original cost. d. To permit future profits to be recognized.
33.
Which of the following is not an acceptable approach in applying the lower-of-cost-ormarket method to inventory? a. Inventory location. b. Categories of inventory items. c. Individual item. d. Total of the inventory.
34.
Which method(s) may be used to record a loss due to a price decline in the value of inventory? a. Cost-of-goods-sold. b. Sales method. c. Loss method d. Both a and c.
35.
Why might inventory be reported at sales prices (net realizable value or market price) rather than cost? a. When there is a controlled market with a quoted price applicable to all quantities and when there are no significant costs of disposal. b. When there are no significant costs of disposal. c. When a non-cancellable contract exists to sell the inventory. d. When there is a controlled market with a quoted price applicable to all quantities.
36.
Recording inventory at net realizable value is permitted, even if it is above cost, when there are no significant costs of disposal involved and a. the ending inventory is determined by a physical inventory count. b. a normal profit is not anticipated. c. there is a controlled market with a quoted price applicable to all quantities. d. the internal revenue service is assured that the practice is not used only to distort reported net income.
37.
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
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38.
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.
39.
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.
40.
Inventory may be recorded at net realizable value if a. there is a controlled market with a quoted price. b. there are no significant costs of disposal. c. the inventory consists of precious metals or agricultural products. d. all of these.
41.
If a material amount of inventory has been ordered through a formal purchase contract at the balance sheet date for future delivery at firm prices, a. this fact must be disclosed. b. disclosure is required only if prices have declined since the date of the order. c. disclosure is required only if prices have since risen substantially. d. an appropriation of retained earnings is necessary.
42.
The credit balance that arises when a net loss on a purchase commitment is recognized should be a. presented as a current liability. b. subtracted from ending inventory. c. presented as an appropriation of retained earnings. d. presented in the income statement.
43.
In 2012, Orear Manufacturing signed a contract with a supplier to purchase raw materials in 2013 for $700,000. Before the December 31, 2012 balance sheet date, the market price for these materials dropped to $510,000. The journal entry to record this situation at December 31, 2012 will result in a credit that should be reported a. as a valuation account to Inventory on the balance sheet. b. as a current liability. c. as an appropriation of retained earnings. d. on the income statement.
44.
At the end of the fiscal year, Apha Airlines has an outstanding non-cancellable purchase commitment for the purchase of 1 million gallons of jet fuel at a price of $4.10 per gallon for delivery during the coming summer. The company prices its inventory at the lower of cost or market. If the market price for jet fuel at the end of the year is $4.50, how would this situation be reflected in the annual financial statements? a. Record unrealized gains of $400,000 and disclose the existence of the purchase commitment. b. No impact. c. Record unrealized losses of $400,000 and disclose the existence of the purchase commitment. d. Disclose the existence of the purchase commitment.
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45.
At the end of the fiscal year, Apha Airlines has an outstanding purchase commitment for the purchase of 1 million gallons of jet fuel at a price of $4.60 per gallon for delivery during the coming summer. The company prices its inventory at the lower of cost or market. If the market price for jet fuel at the end of the year is $4.25, how would this situation be reflected in the annual financial statements? a. Record unrealized gains of $350,000 and disclose the existence of the purchase commitment. b. No impact. c. Record unrealized losses of $350,000 and disclose the existence of the purchase commitment. d. Disclose the existence of the purchase commitment.
46.
How is the gross profit method used as it relates to inventory valuation? a. Verify the accuracy of the perpetual inventory records. b. Verity the accuracy of the physical inventory. c. To estimate cost of goods sold. d. To provide an inventory value of LIFO inventories.
47.
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.
48.
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.
49.
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.
50.
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.
51.
An inventory method which is designed to approximate inventory valuation at the lower of cost or market is a. last-in, first-out. b. first-in, first-out. c. conventional retail method. d. specific identification.
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52.
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.
53.
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.
54.
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.
55.
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.
*56.
When calculating the cost ratio for the retail inventory method, a. if it is the conventional method, the beginning inventory is included and markdowns are deducted. b. if it is the LIFO method, the beginning inventory is excluded and markdowns are deducted. c. if it is the LIFO method, the beginning inventory is included and markdowns are not deducted. d. if it is the conventional method, the beginning inventory is excluded and markdowns are not deducted.
S
57.
Which of the following is not required when using the retail inventory method? a. All inventory items must be categorized according to the retail markup percentage which reflects the item's selling price. b. A record of the total cost and retail value of goods purchased. c. A record of the total cost and retail value of the goods available for sale. d. Total sales for the period.
S
58.
Which of the following is not a reason the retail inventory method is used widely? a. As a control measure in determining inventory shortages b. For insurance information c. To permit the computation of net income without a physical count of inventory d. To defer income tax liability
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59.
What condition is not necessary in order to use the retail method to provide inventory results? a. Retailer keeps a record of the total costs of products sold for the period. b. Retailer keeps a record of the total costs and retail value of goods purchased. c. Retailer keeps a record of the total costs and retail value of goods available for sale. d. Retailer keeps a record of sales for the period.
60.
What method yields results that are essentially the same as those of the conventional retail method? a. FIFO. b. Lower-of-average-cost-or-market. c. Average cost. d. LIFO.
61.
What is the effect of net markups on the cost-retail ratio when using the conventional retail method? a. Increases the cost-retail ratio. b. No effect on the cost-retail ratio. c. Depends on the amount of the net markdowns. d. Decreases the cost-retail ratio.
62.
What is the effect of freight-in on the cost-retail ratio when using the conventional retail method? a. Increases the cost-retail ratio. b. No effect on the cost-retail ratio. c. Depends on the amount of the net markups. d. Decreases the cost-retail ratio.
63.
Which of the following is not a common disclosure for inventories? a. Inventory composition. b. Inventory location. c. Inventory financing arrangements. d. Inventory costing methods employed.
P
64.
Which of the following statements is false regarding an assumption of inventory cost flow? a. The cost flow assumption need not correspond to the actual physical flow of goods. b. The assumption selected may be changed each accounting period. c. The FIFO assumption uses the earliest acquired prices to cost the items sold during a period. d. The LIFO assumption uses the earliest acquired prices to cost the items on hand at the end of an accounting period.
P
65.
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.
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66.
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.
*67.
When using dollar-value LIFO, if the incremental layer was added last year, it should be multiplied by a. last year's cost ratio and this year's index. b. this year's cost ratio and this year's index. c. last year's cost ratio and last year's index. d. this year's cost ratio and last year's index.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27.
d d c b a c d
28. 29. 30. 31. 32. 33. 34.
d a b d c a d
35. 36. 37. 38. 39. 40. 41.
a c b d a d a
42. 43. 44. 45. 46. 47. 48.
a b d c a d d
49. 50. 51. 52. 53. 54. 55.
b d c a d b a
*56. 57. 58. 59. 60. 61. 62.
b a d a b d a
63. 64. 65. 66. *67.
b b a c c
Solutions to those Multiple Choice questions for which the answer is “none of these.” 48.
The gross profit percentage applicable to the goods in ending inventory is different from the percentage applicable to the goods sold during the period.
53.
Many answers are possible.
MULTIPLE CHOICE—Computational 68.
Oslo 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: Historical cost Replacement cost Estimated cost to dispose Estimated selling price
Product #1 $20.00 22.50 5.00 40.00
Product #2 $ 35.00 27.00 13.00 65.00
In pricing its ending inventory using the lower-of-cost-or-market, what unit values should Oslo use for products #1 and #2, respectively? a. $20.00 and $32.50. b. $23.00 and $32.50. c. $23.00 and $30.00. d. $22.50 and $27.00.
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69.
Muckenthaler Company sells product 2005WSC for $30 per unit. The cost of one unit of 2005WSC is $27, and the replacement cost is $26. The estimated cost to dispose of a unit is $6, and the normal profit is 40%. At what amount per unit should product 2005WSC be reported, applying lower-of-cost-or-market? a. $12. b. $24. c. $26. d. $27.
70.
Lexington Company sells product 1976NLC for $50 per unit. The cost of one unit of 1976NLC is $45, and the replacement cost is $43. The estimated cost to dispose of a unit is $10, and the normal profit is 40%. At what amount per unit should product 1976NLC be reported, applying lower-of-cost-or-market? a. $20. b. $40. c. $43. d. $45.
71.
Given the acquisition cost of product Z is $64, the net realizable value for product Z is $58, the normal profit for product Z is $5, and the market value (replacement cost) for product Z is $60, what is the proper per unit inventory price for product Z? a. $64. b. $60. c. $53. d. $58.
72.
Given the acquisition cost of product ALPHA is $17, the net realizable value for product ALPHA is $16.70, the normal profit for product ALPHA is $1.24, and the market value (replacement cost) for product ALPHA is $14.72, what is the proper per unit inventory price for product ALPHA? a. $17.00. b. $15.46 c. $14.72. d. $16.70.
73.
Given the acquisition cost of product Dominoe is $43.31, the net realizable value for product Dominoe is $38.49, the normal profit for product Dominoe is $4.32, and the market value (replacement cost) for product Dominoe is $40.68, what is the proper per unit inventory price for product Dominoe? a. $40.68. b. $34.18. c. $38.49. d. $43.31
74.
Given the historical cost of product Z is $80, the selling price of product Z is $95, costs to sell product Z are $11, the replacement cost for product Z is $83, and the normal profit margin is 40% of sales price, what is the market value that should be used in the lower-ofcost-or-market comparison? a. $80. b. $84. c. $83. d. $46.
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75.
Given the historical cost of product Z is $80, the selling price of product Z is $95, costs to sell product Z are $11, the replacement cost for product Z is $83, and the normal profit margin is 40% of sales price, what is the amount that should be used to value the inventory under the lower-of-cost-or-market method? a. $46. b. $80. c. $84. d. $83.
76.
Given the historical cost of product Dominoe is $43, the selling price of product Dominoe is $60, costs to sell product Dominoe are $11, the replacement cost for product Dominoe is $40, and the normal profit margin is 20% of sales price, what is the cost amount that should be used in the lower-of-cost-or-market comparison? a. $49. b. $40. c. $37. d. $43.
77.
Given the historical cost of product Dominoe is $43, the selling price of product Dominoe is $60, costs to sell product Dominoe are $11, the replacement cost for product Dominoe is $40, and the normal profit margin is 20% of sales price, what is the amount that should be used to value the inventory under the lower-of-cost-or-market method? a. $43. b. $37. c. $40. d. $49.
78.
Robust Inc. has the following information related to an item in its ending inventory. Product 66 has a cost of $3,250, a replacement cost of $3,100, a net realizable value of $3,200, and a normal profit margin of $200. What is the final lower-of-cost-or-market inventory value for product 66? a. $3,200. b. $3,100. c. $3,250. d. $3,100.
79.
Robust Inc. has the following information related to an item in its ending inventory. Packit (Product # 874) has a cost of $524, a replacement cost of $402, a net realizable value of $468, and a normal profit margin of $21. What is the final lower-of-cost-or-market inventory value for Packit? a. $447. b. $524. c. $402. d. $468.
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80.
Robust Inc. has the following information related to an item in its ending inventory. Acer Top has a cost of $251, a replacement cost of $234, a net realizable value of $266, and a normal profit margin of $34. What is the final lower-of-cost-or-market inventory value for Acer Top? a. $232. b. $251. c. $234. d. $266.
81.
Mortenson Corporation sells its product, a rare metal, in a controlled market with a quoted price applicable to all quantities. The total cost of 5,000 pounds of the metal now held in inventory is $150,000. The total selling price is $360,000, and estimated costs of disposal are $10,000. At what amount should the inventory of 5,000 pounds be reported in the balance sheet? a. $140,000. b. $150,000. c. $350,000. d. $360,000.
82.
Rodriguez Corporation sells its product, a rare metal, in a controlled market with a quoted price applicable to all quantities. The total cost of 5,000 pounds of the metal now held in inventory is $210,000. The total selling price is $490,000, and estimated costs of disposal are $5,000. At what amount should the inventory of 5,000 pounds be reported in the balance sheet? a. $205,000. b. $210,000. c. $485,000. d. $490,000.
83.
Turner Corporation acquired two inventory items at a lump-sum cost of $80,000. The acquisition included 3,000 units of product LF, and 7,000 units of product 1B. LF normally sells for $24 per unit, and 1B for $8 per unit. If Turner sells 1,000 units of LF, what amount of gross profit should it recognize? a. $3,000 b. $9,000. c. $16,000. d. $19,000.
84.
Robertson Corporation acquired two inventory items at a lump-sum cost of $60,000. The acquisition included 3,000 units of product CF, and 7,000 units of product 3B. CF normally sells for $18 per unit, and 3B for $6 per unit. If Robertson sells 1,000 units of CF, what amount of gross profit should it recognize? a. $2,250. b. $6,750. c. $12,000. d. $14,250.
Inventories: Additional Valuation Issues 85.
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At a lump-sum cost of $72,000, Pratt Company recently purchased the following items for resale: Item M N O
No. of Items Purchased 4,000 2,000 6,000
Resale Price Per Unit $3.75 12.00 6.00
The appropriate cost per unit of inventory is: M N O a. $3.75 $12.00 $6.00 b. $3.11 $19.86 $3.32 c. $3.60 $11.52 $5.76 d. $6.00 $6.00 $6.00 86.
Confectioners, a chain of candy stores, purchases its candy in bulk from its suppliers. For a recent shipment, the company paid $1,800 and received 8,500 pieces of candy that are allocated among three groups. Group 1 consists of 2,500 pieces that are expected to sell for $0.15 each. Group 2 consists of 5,500 pieces that are expected to sell for $0.36 each. Group 3 consists of 500 pieces that are expected to sell for $0.72 each. Using the relative sales value method, what is the cost per item in Group 1? a. $0.150. b. $0.100. c. $0.120. d. $0.225.
87.
Confectioners, a chain of candy stores, purchases its candy in bulk from its suppliers. For a recent shipment, the company paid $1,800 and received 8,500 pieces of candy that are allocated among three groups. Group 1 consists of 2,500 pieces that are expected to sell for $0.15 each. Group 2 consists of 5,500 pieces that are expected to sell for $0.36 each. Group 3 consists of 500 pieces that are expected to sell for $0.72 each. Using the relative sales value method, what is the cost per item in Group 2? a. $0.225. b. $0.360. c. $0.210. d. $0.239.
88.
Confectioners, a chain of candy stores, purchases its candy in bulk from its suppliers. For a recent shipment, the company paid $1,800 and received 8,500 pieces of candy that are allocated among three groups. Group 1 consists of 2,500 pieces that are expected to sell for $0.15 each. Group 2 consists of 5,500 pieces that are expected to sell for $0.36 each. Group 3 consists of 500 pieces that are expected to sell for $0.72 each. Using the relative sales value method, what is the cost per item in Group 3? a. $0.477. b. $0.225. c. $0.720. d. $0.540.
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Test Bank for Intermediate Accounting, Fourteenth Edition
89.
During the current fiscal year, Jeremiah Corp. signed a long-term noncancellable purchase commitment with its primary supplier. Jeremiah agreed to purchase $2.5 million of raw materials during the next fiscal year under this contract. At the end of the current fiscal year, the raw material to be purchased under this contract had a market value of $2.3 million. What is the journal entry at the end of the current fiscal year? a. Debit Unrealized Holding Gain or Loss for $200,000 and credit Estimated Liability on Purchase Commitment for $200,000. b. Debit Estimated liability on Purchase Commitments for $200,000 and credit Unrealized Holding Gain or Loss for $200,000. c. Debit Unrealized Holding Gain or Loss for $2,300,000 and credit Estimated Liability on Purchase Commitments for $2,300,000. d. No journal entry is required.
90.
During the prior fiscal year, Jeremiah Corp. signed a long-term noncancellable purchase commitment with its primary supplier to purchase $2.5 million of raw materials. Jeremiah paid the $2.5 million to acquire the raw materials when the raw materials were only worth $2.3 million. Assume that the purchase commitment was properly recorded. What is the journal entry to record the purchase? a. Debit Inventory for $2,300,000, and credit Cash for $2,300,000. b. Debit Inventory for $2,300,000, debit Unrealized Holding Gain or Loss for $200,000, and credit Cash for $2,500,000. c. Debit Inventory for $2,300,000, debit Estimated Liability on Purchase Commitments for $200,000 and credit Cash for $2,500,000. d. Debit Inventory for $2,500,000, and credit Cash for $2,500,000.
91.
During 2012, Larue Co., a manufacturer of chocolate candies, contracted to purchase 200,000 pounds of cocoa beans at $4.00 per pound, delivery to be made in the spring of 2013. Because a record harvest is predicted for 2013, the price per pound for cocoa beans had fallen to $3.30 by December 31, 2012. Of the following journal entries, the one which would properly reflect in 2012 the effect of the commitment of Larue Co. to purchase the 100,000 pounds of cocoa is a. Cocoa Inventory ............................................................ 400,000 Accounts Payable .............................................. 400,000 b. Cocoa Inventory ............................................................ 330,000 Loss on Purchase Commitments .................................. 70,000 Accounts Payable .............................................. 400,000 c. Unrealized Holding Gain or Loss-Income ...................... 70,000 Estimated Liability on Purchase Commitments .. 70,000 d. No entry would be necessary in 2012
92.
RS Corporation, a manufacturer of ethnic foods, contracted in 2012 to purchase 500 pounds of a spice mixture at $5.00 per pound, delivery to be made in spring of 2013. By 12/31/12, the price per pound of the spice mixture had risen to $5.40 per pound. In 2012, AJ should recognize a. a loss of $2,500. b. a loss of $200. c. no gain or loss. d. a gain of $200.
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93.
LF Corporation, a manufacturer of Mexican foods, contracted in 2012 to purchase 1,000 pounds of a spice mixture at $5.00 per pound, delivery to be made in spring of 2013. By 12/31/12, the price per pound of the spice mixture had dropped to $4.70 per pound. In 2012, LF should recognize a a loss of $5,000. b. a loss of $300. c. no gain or loss. d. a gain of $300.
94.
The following information is available for October for Barton Company. Beginning inventory Net purchases Net sales Percentage markup on cost
$150,000 450,000 900,000 66.67%
A fire destroyed Barton’s October 31 inventory, leaving undamaged inventory with a cost of $9,000. Using the gross profit method, the estimated ending inventory destroyed by fire is a. $51,000. b. $231,000. c. $240,000. d. $300,000. 95.
The following information is available for October for Norton Company. Beginning inventory Net purchases Net sales Percentage markup on cost
$200,000 600,000 1,200,000 66.67%
A fire destroyed Norton’s October 31 inventory, leaving undamaged inventory with a cost of $12,000. Using the gross profit method, the estimated ending inventory destroyed by fire is a. $68,000. b. $308,000. c. $320,000. d. $400,000. Use the following information for questions 96 and 97. Miles Company, a wholesaler, budgeted the following sales for the indicated months: Sales on account Cash sales Total sales
June $2,700,000 270,000 $2,970,000
July $2,760,000 300,000 $3,060,000
August $2,850,000 390,000 $3,240,000
All merchandise is marked up to sell at its invoice cost plus 20%. Merchandise inventories at the beginning of each month are at 30% of that month's projected cost of goods sold.
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96.
The cost of goods sold for the month of June is anticipated to be a. $2,160,000. b. $2,250,000. c. $2,280,000. d. $2,475,000.
97.
Merchandise purchases for July are anticipated to be a. $2,448,000. b. $3,114,000. c. $2,550,000. d. $2,595,000.
98.
Reyes Company had a gross profit of $480,000, total purchases of $560,000, and an ending inventory of $320,000 in its first year of operations as a retailer. Reyes’s sales in its first year must have been a. $720,000. b. $880,000. c. $240,000. d. $800,000.
99.
A markup of 30% on cost is equivalent to what markup on selling price? a. 23% b. 30% c. 70% d. 77%
100.
Kesler, 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
$385,000 301,000 14,000 525,000
The estimate of the cost of inventory at March 31 would be a. $147,000. b. $252,000. c. $278,250. d. $196,000. 101.
On January 1, 2012, the merchandise inventory of Glaus, Inc. was $1,000,000. During 2012 Glaus purchased $2,000,000 of merchandise and recorded sales of $2,500,000. The gross profit rate on these sales was 25%. What is the merchandise inventory of Glaus at December 31, 2012? a. $500,000. b. $625,000. c. $1,125,000. d. $1,875,000.
Inventories: Additional Valuation Issues
9 - 23
102.
For 2012, cost of goods available for sale for Tate Corporation was $1,800,000. The gross profit rate was 20%. Sales for the year were $1,600,000. What was the amount of the ending inventory? a. $0. b. $520,000. c. $360,000. d. $320,000.
103.
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
$360,000 60,000 300,000 25%
The amount of the inventory loss is estimated to be a. $72,000. b. $36,000. c. $90,000. d. $60,000. 104.
The inventory account of Irick Company at December 31, 2012, included the following items: Inventory Amount Merchandise out on consignment at sales price (including markup of 40% on selling price) $30,000 Goods purchased, in transit (shipped f.o.b. shipping point) 24,000 Goods held on consignment by Irick 26,000 Goods out on approval (sales price $15,200, cost $12,800) 15,200 Based on the above information, the inventory account at December 31, 2012, should be reduced by a. $40,400. b. $45,200. c. $64,400. d. $64,000.
105.
The sales price for a product provides a gross profit of 20% of sales price. What is the gross profit as a percentage of cost? a. 20%. b. 17%. c. 25%. d. Not enough information is provided to determine.
106.
Gamma Ray Corp. has annual sales totaling $975,000 and an average gross profit of 20% of cost. What is the dollar amount of the gross profit? a. $195,000. b. $146,250. c. $162,500. d. $243,750.
9 - 24
Test Bank for Intermediate Accounting, Fourteenth Edition
107.
On August 31, a hurricane destroyed a retail location of Vinny's Clothier including the entire inventory on hand at the location. The inventory on hand as of June 30 totaled $640,000. Since June 30 until the time of the hurricane, the company made purchases of $170,000 and had sales of $500,000. Assuming the rate of gross profit to selling price is 40%, what is the approximate value of the inventory that was destroyed? a. $640,000. b. $363,000. c. $410,000. d. $510,000.
108.
On October 31, a fire destroyed PH Inc.'s entire retail inventory. The inventory on hand as of January 1 totaled $1,360,000. From January 1 through the time of the fire, the company made purchases of $330,000 and had sales of $720,000. Assuming the rate of gross profit to selling price is 40%, what is the approximate value of the inventory that was destroyed? a. $1,360,000. b. $1,346,000. c. $970,000. d. $1,258,000.
109.
On March 15, a fire destroyed Interlock Company's entire retail inventory. The inventory on hand as of January 1 totaled $3,300,000. From January 1 through the time of the fire, the company made purchases of $1,366,000, incurred freight-in of $156,000, and had sales of $2,420,000. Assuming the rate of gross profit to selling price is 30%, what is the approximate value of the inventory that was destroyed? a. $4,096,000. b. $2,972,000. c. $3,128,000. d. $4,822,000.
110.
Dicer uses the conventional retail method to determine its ending inventory at cost. Assume the beginning inventory at cost (retail) were $260,000 ($396,000), purchases during the current year at cost (retail) were $1,370,000 ($2,200,000), freight-in on these purchases totaled $86,000, sales during the current year totaled $2,100,000, and net markups (markdowns) were $48,000 ($72,000). What is the ending inventory value at cost? a. $306,328. b. $312,330. c. $314,824. d. $472,000.
111.
Boxer Inc. uses the conventional retail method to determine its ending inventory at cost. Assume the beginning inventory at cost (retail) were $196,500 ($297,000), purchases during the current year at cost (retail) were $1,704,000 ($2,596,800), freight-in on these purchases totaled $79,500, sales during the current year totaled $2,433,000, and net markups were $207,000. What is the ending inventory value at cost? a. $667,800. b. $523,098. c. $426,723. d. $456,924.
Inventories: Additional Valuation Issues
9 - 25
112.
Barker Pet supply uses the conventional retail method to determine its ending inventory at cost. Assume the beginning inventory at cost (retail) were $531,200 ($653,800), purchases during the current year at cost (retail) were $2,137,200 ($2,772,200), freight-in on these purchases totaled $127,800, sales during the current year totaled $2,604,000, and net markups (markdowns) were $4,000 ($192,600). What is the ending inventory value at cost? a. $633,400. b. $516,222. c. $822,000. d. $493,334.
113.
Crane 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 $ 30,000 175,000 2,500 — — — —
Retail $ 50,000 240,000 — 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. $207,500 ÷ $290,000 b. $207,500 ÷ $298,500 c. $205,000 ÷ $300,000 d. $207,500 ÷ $288,500 Use the following information for questions 114 through 118. The following data concerning the retail inventory method are taken from the financial records of Welch Company. Cost Retail Beginning inventory $ 98,000 $ 140,000 Purchases 448,000 640,000 Freight-in 12,000 — Net markups — 40,000 Net markdowns — 28,000 Sales — 672,000 114.
The ending inventory at retail should be a. $148,000. b. $120,000. c. $128,000. d. $84,000.
9 - 26
Test Bank for Intermediate Accounting, Fourteenth Edition
115.
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. $558,000 and $820,000. b. $558,000 and $792,000. c. $558,000 and $780,000. d. $546,000 and $780,000.
116.
If the foregoing figures are verified and a count of the ending inventory reveals that merchandise actually on hand amounts to $108,000 at retail, the business has a. realized a windfall gain. b. sustained a loss. c. no gain or loss as there is close coincidence of the inventories. d. none of these.
*117. Assuming no change in the price level if the LIFO inventory method were used in conjunction with the data, the ending inventory at cost would be a. $85,200. b. $84,000. c. $81,600. d. $86,400. *118. Assuming that the LIFO inventory method were used in conjunction with the data and that the inventory at retail had increased during the period, then the computation of retail in the cost to retail ratio would a. exclude both markups and markdowns and include beginning inventory. b. include markups and exclude both markdowns and beginning inventory. c. include both markups and markdowns and exclude beginning inventory. d. exclude markups and include both markdowns and beginning inventory. 119.
Drake Corporation had the following amounts, all at retail: Beginning inventory Purchase returns Abnormal shortage Sales Employee discounts
$ 3,600 6,000 4,000 72,000 1,600
What is Drake’s ending inventory at retail? a. $74,400. b. $76,000. c. $77,600. d. $78,400
Purchases Net markups Net markdowns Sales returns Normal shortage
$140,000 18,000 2,800 1,800 2,600
Inventories: Additional Valuation Issues 120.
9 - 27
Goren Corporation had the following amounts, all at retail: Beginning inventory Purchase returns Abnormal shortage Sales Employee discounts
$ 3,600 6,000 4,000 72,000 1,600
Purchases Net markups Net markdowns Sales returns Normal shortage
$110,000 18,000 2,800 1,800 2,600
What is Goren’s ending inventory at retail? a. $44,400. b. $46,000. c. $47,600. d. $48,400 121.
Fry 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
$ 60,000 530,000 590,000 90,000 $500,000
The average days to sell inventory for Fry are a. 43.5 days. b. 50.3 days. c. 54.5 days. d. 65.2 days. 122.
East 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
$ 60,000 482,000 542,000 80,000 $462,000
The average days to sell inventory for East are a. 68.3 days. b. 75.7 days. c. 55.3 days. d. 90.9 days. 123.
The 2012 financial statements of Sito Company reported a beginning inventory of $80,000, an ending inventory of $120,000, and cost of goods sold of $800,000 for the year. Sito’s inventory turnover ratio for 2012 is a. 10.0 times. b. 8.0 times. c. 6.7 times. d. 5.7 times.
9 - 28 124.
Test Bank for Intermediate Accounting, Fourteenth Edition Boxer Inc. reported inventory at the beginning of the current year of $360,000 and at the end of the current year of $411,000. If net sales for the current year are $3,321,900 and the corresponding cost of sales totaled $2,819,100, what is the inventory turnover ratio for the current year? a. 8.61. b. 6.86. c. 7.83. d. 7.31.
Use the following information for questions 125 through 129. Plank Co. uses the retail inventory method. The following information is available for the current year. Cost Retail Beginning inventory $ 156,000 $244,000 Purchases 590,000 830,000 Freight-in 10,000 — Employee discounts — 4,000 Net markups — 30,000 Net Markdowns — 40,000 Sales — 780,000 125.
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. $600,000 and $860,000. b. $600,000 and $856,000. c. $746,000 and $1,100,000. d. $756,000 and $1,104,000.
126.
The ending inventory at retail should be a. $320,000. b. $300,000. c. $288,000. d. $280,000.
127.
The approximate cost of the ending inventory by the conventional retail method is a. $191,800. b. $189,840. c. $196,000. d. $204,960.
*128. If the ending inventory is to be valued at approximately LIFO cost, the calculation of the cost ratio should be based on cost and retail of a. $756,000 and $1,104,000. b. $756,000 and $1,064,000. c. $600,000 and $820,000. d. $600,000 and $860,000.
Inventories: Additional Valuation Issues
9 - 29
*129. Assuming that the LIFO inventory method is used, that the beginning inventory is the base inventory when the index was 100, and that the index at year end is 112, the ending inventory at dollar-value LIFO retail cost is a. $160,920. b. $185,514. c. $191,800. d. $204,960. Use the following information for questions 130 and 131. Eaton Company, which uses the retail LIFO method to determine inventory cost, has provided the following information for 2012: Cost Retail Inventory, 1/1/12 $ 141,000 $210,000 Net purchases 567,000 843,000 Net markups 102,000 Net markdowns 45,000 Net sales 795,000 *130. Assuming stable prices (no change in the price index during 2012), what is the cost of Eaton's inventory at December 31, 2012? a. $192,150. b. $207,150. c. $204,000. d. $198,450. *131. Assuming that the price index was 105 at December 31, 2012 and 100 at January 1, 2012, what is the cost of Eaton's inventory at December 31, 2012 under the dollar-value-LIFO retail method? a. $200,535. b. $208,372. c. $210,458. d. $197,700.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans
68. 69. 70. 71. 72. 73. 74. 75. 76. 77.
a b b d b c c b d c
78. 79. 80. 81. 82. 83. 84. 85. 86. 87.
b a c c c b b c b d
88. 89. 90. 91. 92. 93. 94. 95. 96. 97.
a a c c c b a a d d
98. 99. 100. 101. 102. 103. 104. 105. 106. 107.
a a b c b a a c c d
108. 109. 110. 111. 112. 113. 114. 115. 116. *117.
d c a c b b b a b b
*118. 119. 120. 121. 122. 123. 124. 125. 126. 127.
c a a c c b d d d a
*128. *129. *130. *131.
c. a b a
9 - 30
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—CPA Adapted 132.
Ryan Distribution Co. has determined its December 31, 2012 inventory on a FIFO basis at $500,000. Information pertaining to that inventory follows: Estimated selling price Estimated cost of disposal Normal profit margin Current replacement cost
$510,000 20,000 60,000 450,000
Ryan records losses that result from applying the lower-of-cost-or-market rule. At December 31, 2012, the loss that Ryan should recognize is a. $0. b. $10,000. c. $40,000. d. $50,000. 133.
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.
134.
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.
135.
Keen Company's accounting records indicated the following information: Inventory, 1/1/12 Purchases during 2012 Sales during 2012
$ 900,000 4,500,000 5,700,000
A physical inventory taken on December 31, 2012, resulted in an ending inventory of $1,050,000. Keen's gross profit on sales has remained constant at 25% in recent years. Keen suspects some inventory may have been taken by a new employee. At December 31, 2012, what is the estimated cost of missing inventory? a. $75,000. b. $225,000. c. $300,000. d. $375,000.
Inventories: Additional Valuation Issues 136.
9 - 31
Henke 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, 2012, are as follows: Cost Retail Inventory, 2/1/12 $ 200,000 $ 250,000 Purchases 1,000,000 1,575,000 Markups, net 175,000 Sales 1,650,000 Estimated normal shoplifting losses 20,000 Markdowns, net 110,000 Under the lower-of-cost-or-market method, Henke's estimated inventory at July 31, 2012 is a. $132,000. b. $144,000. c. $156,000. d. $220,000.
137.
At December 31, 2012, the following information was available from Kohl Co.'s accounting records: Cost Retail Inventory, 1/1/12 $147,000 $ 203,000 Purchases 833,000 1,155,000 Additional markups 42,000 Available for sale $980,000 $1,400,000 Sales for the year totaled $1,150,000. Markdowns amounted to $10,000. Under the lowerof-cost-or-market method, Kohl's inventory at December 31, 2012 was a. $294,000. b. $175,000. c. $182,000. d. $168,000.
*138. On December 31, 2012, Pacer Co. adopted the dollar-value LIFO retail inventory method. Inventory data for 2013 are as follows: LIFO Cost Retail Inventory, 12/31/12 $450,000 $630,000 Inventory, 12/31/13 ? 825,000 Increase in price level for 2013 10% Cost to retail ratio for 2013 70% Under the LIFO retail method, Pacer's inventory at December 31, 2013, should be a. $542,400. b. $577,500. c. $586,500. d $600,150.
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
132.
d
133.
b
134.
b
135.
a
136.
a
137.
d
*138.
a
9 - 32
Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational No.
Answer Derivation
68.
a
Product 1: RC = $22.50, NRV = $40 – $5 = $35 NRV – PM = $35 – ($40 × .3) = $23, cost = $20. Product 2: RC = $27, NRV = $65 – $13 = $52 NRV – PM = $52 – ($65 × .3) = $32.50, cost = $35.
69.
b
NRV = $30 – $6 = $24, RC = $26 NRV – PM = $24 – ($30 × .40) = $12, cost = $27.
70.
b
NRV = $50 – $10 = $40, RC = $43 NRV – PM = $40 – ($50 × .40) = $20, cost = $45.
71.
d
$58 MV, $64 Cost, LCM = $58.
72.
b
$15.46 ($16.70 – $1.24) MV, $17.00 Cost, LCM = $15.46.
73.
c
$38.49 MV, $43.31 Cost, LCM = $38.49.
74.
c
Ceiling $84 ($95 – $11); Floor $46 ($84 – $38), RC $83; $83 MV.
75.
b
Ceiling $84 ($95 – $11), Floor $46 ($84 – $38), RC $83; $83 MV, $80 Cost, LCM = $80.
76.
d
$43 Cost.
77.
c
Ceiling $49 ($60 – $11), Floor $37 ($49 – $12), RC $40; $40 MV, $43 Cost, LCM = $40.
78.
b
$3,100 MV, $3,250 Cost, LCM = $3,100.
79.
a
$447 ($468 – $21) MV, $524 Cost, LCM = $447.
80.
c
$234 MV, $251 Cost, LCM = $234.
81.
c
$360,000 – $10,000 = $350,000.
82.
c
$490,000 – $5,000 = $485,000.
83.
b
LF 3,000 × $24 = ($72,000 ÷ $128,000) × $80,000 = $45,000 1B 7,000 × $8 = $56,000; $56,000 + $72,000 = $128,000 (1,000 × $24) – ($45,000 × 1,000/3,000) = $9,000.
84.
b
CF 3,000 × $18 = ($54,000 ÷ $96,000) × $60,000 = $33,750 3B 7,000 × $6 = $42,000; $42,000 + $54,000 = $96,000 (1,000 × $18) – ($33,750 × 1,000/3,000) = $6,750.
Inventories: Additional Valuation Issues
9 - 33
DERIVATIONS — Computational (cont.) No. Answer Derivation 85.
c
Item # of Items × Price M 4,000 × $3.75 = $15,000 15 ÷ 75 × $72,000 = $14,400 ÷ 4,000 = $3.60 N 2,000 × $12.00= 24,000 24 ÷ 75 × $72,000 = $23,040 ÷ 2,000 = $11.52 O 6,000 × $6.00 = 36,000 36 ÷ 75 × $72,000 = $34,560 ÷ 6,000 = $5.76 $75,000
86.
b
(2,500 × $0.15) + (5,500 × $0.36) + (500 × $0.72) = $2,715; [(2,500 × $0.15) ÷ $2,715] × $1,800 = $249 ÷ 2,500 = $0.100.
87.
d
(2,500 × $0.15) + (5,500 × $0.36) + (500 × $0.72) = $2,715; [(5,500 × $0.36) ÷ $2,715] × $1,800 = $1,313 ÷ 5,500 = $0.239.
88.
a
(2,500 × $0.15) + (5,500 × $0.36) + (500 × $0.72) = $2,715; [(500 × $0.72) ÷ $2,715] × $1,800 = $239 ÷ 500 = $0.477.
89.
a
$2.5 million – $2.3 million = $200,000.
90.
c
$2.5 million – $2.3 million = $200,000.
91.
c
($4.00 – $3.30) × 100,000 = $70,000.
92.
c
No gain or loss since 12/31 price ($5.40) > contract price ($5.00).
93.
b
($5.00 – $4.70) × 1,000 = $300.
94.
a
($150,000 + $450,000) – ($900,000 ÷ 5/3) – $9,000 = $51,000.
95.
a
($200,000 + $600,000) – ($1,200,000 ÷ 5/3) – $12,000 = $68,000.
96.
d
(1 + .2)C = 2,970,000; C = $2,475,000.
97.
d
COGS:
98.
a
$480,000 + ($540,000 – $320,000) = $720,000.
99.
a
.30 = .23 = 23% 1 + .30
100.
b
COGS = $525,000 ÷ 1.25 = $420,000 ($385,000 + $301,000 – $14,000) – $420,000 = $252,000.
101.
c
COGS = $2,500,000 × .75 = $1,875,000 $1,000,000 + $2,000,000 – $1,875,000 = $1,125,000.
102.
b
$1,800,000 – ($1,600,000 × .80) = $520,000.
July = $3,060,000 ÷ 1.2 = $2,550,000 Aug. = $3,240,000 ÷ 1.2 = $2,700,000 July's purchase = ($2,550,000 × .7) + ($2,700,000 × .3) = $2,595,000.
9 - 34
Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No. Answer Derivation 103.
a
$360,000 $60,000 + $300,000 – ————— = $72,000. 1.25
104.
a
($30,000 × 40%) + $26,000 + ($15,200 – $12,800) = $40,400.
105.
c
20% ÷ (100% – 20%) = 25%.
106.
c
$975,000 – ($975,000 ÷ 1.20) = $162,500.
107.
d
($640,000 + $170,000) – [$500,000 × (1 – .40)] = $510,000.
108.
d
($1,360,000 + $330,000) – [$720,000 × (1 – .40)] = $1,258,000.
109.
c
$3,300,000 + $1,366,000 + $156,000 – [$2,420,000 × (1 – .30)] = $3,128,000.
110.
a
$396,000 + $2,200,000 + $48,000 – $2,100,000 – $72,000 = $472,000; ($260,000 + $1,370,000 + $86,000) ÷ ($396,000 + $2,200,000 + $48,000) = .649; $472,000 × .649 = $306,328.
111.
c
$297,000 + $2,596,800 + $207,000 – $2,433,000 = $667,800; ($196,500 + $1,704,000 + $79,500) ÷ ($297,000 + $2,596,800 + $207,000) = 63.9%; $667,800 × .639 = $426,723.
112.
b
$653,800 + $1,386,100 + $4,000 – $2,604,000 – $192,600 = $633,400; ($531,200 + $2,137,200 + $127,800) ÷ ($653,800 + $2,772,200 + $4,000) = 81.5%; $633,400 × .815 = $516,222.
113.
b
Cost: Retail:
114.
b
$140,000 + $640,000 + $40,000 – $28,000 – $672,000 = $120,000.
115.
a
Cost: $98,000 + $448,000 + $12,000 = $558,000. Retail: $140,000 + $640,000 + $40,000 = $820,000.
116.
b
Conceptual.
$30,000 + $175,000 + $2,500 = $207,500. $50,000 + $240,000 + $8,500 = $298,500.
*117. b
$98,000 ———— × $120,000 = $84,000. $140,000
*118. c
Conceptual.
119.
a
$3,600 + $134,000 + $18,000 – $4,000 – $70,200 – $1,600 – $2,800 – $2,600 = $74,400.
120.
a
$3,600 + $104,000 + $18,000 – $4,000 – $70,200 – $1,600 – $2,800 – $2,600 = $44,400.
Inventories: Additional Valuation Issues
9 - 35
DERIVATIONS — Computational (cont.) No.
Answer Derivation
121.
c
$500,000 ÷ [($60,000 + $90,000) ÷ 2] = 6.7; 365 ÷ 6.7 = 54.5.
122.
c
$462,000 ÷ [($60,000 + $80,000) ÷ 2] = 6.6; 365 ÷ 6.6 = 55.3.
123.
b
$800,000 ÷ [($80,000 + $120,000) ÷ 2] = 8 times
124.
d
$2,819,100 ÷ [($360,000 + $411,000) ÷ 2] = 7.31.
125.
d
Cost: $156,000 + $590,000 + $10,000 = $756,000. Retail: $244,000 + $830,000 + $30,000 = $1,104,000.
126.
d
$244,000 + $830,000 – $4,000 + $30,000 – $40,000 – $780,000 = $280,000.
127.
a
$280,000 × .685 = $191,800.
*128.
c
Cost: $590,000 + $10,000 = $600,000. Retail: $830,000 + $30,000 – $40,000 = $820,000.
*129.
a
Base year price = EI =
$280,000 = $250,000 1.12
$244,000 @ cost = $156,000 $6,000 × .732* × 1.12 = 4,920 $160,920 $600,000 * ————— = .732 $820,000 *130.
b
Cost to retail ratio = $567,000 ÷ ($843,000 + $102,000 – $45,000) = 0.63 EI = $210,000 + $843,000 + $102,000 – $45,000 – $795,000 = $315,000 at retail $315,000 – $210,000 = $105,000 Cost of inventory = $141,000 + ($105,000 × .63) = $207,150.
*131.
a
Base year price: EI = $315,000 ÷ 1.05 = $300,000 $210,000 @ cost = $ 141,000 90,000 × .63 × 1.05 = 59,535 $300,000 $200,535
DERIVATIONS — CPA Adapted No.
Answer
Derivation
132.
d
$500,000 – $450,000 (RC) = $50,000.
133.
b
Conceptual.
9 - 36
Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — CPA Adapted (cont.) No.
Answer
Derivation
134.
b
Conceptual.
135.
a
$5,700,000 × .75 = $4,275,000 (COGS) $900,000 + $4,500,000 – $4,275,000 – $1,050,000 = $75,000.
136.
a
($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 – $1,650,000) × 0.6 = $132,000.
137.
d
$980,000 ÷ $1,400,000 = 0.7 ($1,400,000 – $10,000 – $1,150,000) × 0.7 = $168,000.
*138.
a
$825,000 ÷ 1.1 = $750,000 $450,000 + ($120,000 × 1.1 × .7) = $542,400.
EXERCISES Ex. 9-139—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 $8.05 $10.50 $11.75 $5.00 $7.20 Net realizable value 8.85 9.80 12.20 4.25 6.90 Net realizable value less normal profit 8.15 9.00 11.40 3.75 5.70 Market replacement cost 7.90 10.10 12.50 3.80 5.40
Solution 9-139 Case 1 Case 2 Case 3
$ 8.05 $9.80 $11.75
Case 4 Case 5
$3.80 $5.70
Ex. 9-140—Lower-of-cost-or-market. Determine the unit value that should be used for inventory costing following "lower of cost or market value" as described in ARB No. 43. A B C D E F Cost $2.35 $2.45 $2.15 $2.54 $2.34 $2.40 Replacement cost 2.26 2.55 2.20 2.52 2.33 2.46 Net realizable value 2.50 2.50 2.50 2.48 2.50 2.50 Net realizable value less normal profit 2.32 2.30 2.30 2.30 2.30 2.30
Inventories: Additional Valuation Issues
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Solution 9-140 Case A Case B Case C
$2.32 $2.45 $2.15
Case D Case E Case F
$2.48 $2.33 $2.40
Ex. 9-141—Lower-of-cost-or-market. Assume in each case that the selling expenses are $10 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 of cost or market. Selling Replacement Price Upper Limit Cost Lower Limit Cost LCM (a)
$54
$______
$38
$______
$40
$______
(b)
47
______
36
______
40
______
(c)
56
______
39
______
40
______
(d)
48
______
42
______
40
______
Solution 9-141 (a) (b) (c) (d)
Upper Limit $44 37 46 38
Lower Limit $39 32 41 33
LCM $39 36 40 38
Ex. 9-142—Lower-of-cost-or-market. The December 31, 2012 inventory of Gwynn 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 $16.00
Replacement Cost $22.00 $40.00 $115.00 $15.80
Estimated Disposal Cost $6.50 $12.00 $25.00 $3.00
Expected Selling Price $37.50 $48.00 $160.00 $22.00
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, 2012.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 9-142
Product A B C D
Designated Market
Cost
Lower-ofCost-orMarket
$23.50
$25.00
$23.50
Ceiling $37.50 – $6.50 = $31.00
Floor $31.00 – $8.00 = $23.50
$48.00 – $12.00 = $36.00
$36.00 – $12.00 = $24.00
$36.00
$42.00
$36.00
$160.00 – $25.00 = $135.00
$135.00 – $48.00 = $87.00
$115.00
$120.00
$115.00
$22.00 – $3.00 = $19.00
$19.00 – $2.20 = $16.80
$16.80
$16.00
$16.00
Ex. 9-143—Lower-of-cost-or-market. At 12/31/12, the end of Jenner Company's first year of business, inventory was $4,100 and $2,800 at cost and at market, respectively. Following is data relative to the 12/31/13 inventory of Jenner:
Item A B C D E
Original Cost Per Unit $ .65 .45 .70 .75 .90
Replacement Cost $ .45 .40 .75 .65 .85
Net Realizable Value
Net Realizable Value Less Normal Profit
Appropriate Inventory Value
Selling price is $1.00/unit for all items. Disposal costs amount to 10% of selling price and a "normal" profit is 30% of selling price. There are 1,000 units of each item in the 12/31/13 inventory. Instructions (a) Prepare the entry at 12/31/12 necessary to implement the lower-of-cost-or-market procedure assuming Jenner uses a contra account for its balance sheet. (b) Complete the last three columns in the 12/31/13 schedule above based upon the lower-ofcost-or-market rules. (c) Prepare the entry(ies) necessary at 12/31/13 based on the data above. (d) How are inventory losses disclosed on the income statement? Solution 9-143 (a) Loss Due to Market Decline of Inventory .................................. Allowance to Reduce Inventory to Market .....................
1,300 1,300
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Inventories: Additional Valuation Issues Solution 9-143 (Cont.) (b) Item A B C D E
Original Cost Per Unit $ .65 .45 .70 .75 .90 $3.45
Replacement Cost $ .45 .40 .75 .65 .85
Net Realizable Value $ .90 .90 .90 .90 .90
Net Realizable Value Less Normal Profit $ .60 .60 .60 .60 .60
Appropriate Inventory Value $ .60 .45 .70 .65 .85 $3.25*
*$3.25 × 1,000 = $3,250 (c) Allowance to Reduce Inventory to Market ................................ Cost of Goods Sold.......................................................
1,300
Loss Due to Market Decline of Inventory .................................. Allowance to Reduce Inventory to Market ..................... (Cost of inventory at 12/31/07 = $7,250)
200
1,300
200
OR A student can record a recovery of $1,100. (d) Inventory losses can be disclosed separately (below gross profit in operating expenses) or they can be shown as part of cost of goods sold.
Ex. 9-144 – Relative sales value method. Doran Realty Company purchased a plot of ground for $900,000 and spent $2,100,000 in developing it for building lots. The lots were classified into Highland, Midland, and Lowland grades, to sell at $120,000, $90,000, and $60,000 each, respectively. Instructions Complete the table below to allocate the cost of the lots using a relative sales value method. No. of Grade Lots Highland 20 Midland 40 Lowland 100 160
Selling Price $ $ $
Total Revenue
% of Total Sales
Apportioned Cost Total Per Lot $ $ $ $ $
Total Revenue $ 2,400,000 3,600,000 6,000,000 $12,000,000
% of Total Sales 20% 30% 50%
Apportioned Cost Total Per Lot $ 600,000 $30,000 900,000 $22,500 1,500,000 $15,000 $3,000,000
$
$
Solution 9-144 No. of Grade Lots Highland 20 Midland 40 Lowland 100 160
Selling Price $120,000 $90,000 $60,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 9-145—Gross profit method. An inventory taken the morning after a large theft discloses $60,000 of goods on hand as of March 12. The following additional data is available from the books: Inventory on hand, March 1 Purchases received, March 1 – 11 Sales (goods delivered to customers)
$ 84,000 63,000 105,000
Past records indicate that sales are made at 50% above cost. Instructions Estimate the inventory of goods on hand at the close of business on March 11 by the gross profit method and determine the amount of the theft loss. Show appropriate titles for all amounts in your presentation.
Solution 9-145 Beginning Inventory Purchases Goods Available Goods Sold ($105,000 ÷ 150%) Estimated Ending Inventory Physical Inventory Theft Loss
$ 84,000 63,000 147,000 70,000 77,000 60,000 $ 17,000
Ex. 9-146—Gross profit method. On January 1, a store had inventory of $48,000. January purchases were $46,000 and January sales were $80,000. 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 $7,500 remained undamaged after the fire. Compute the amount of the fire loss, assuming the store had no insurance coverage. Label all figures.
Solution 9-146 Beginning Inventory Purchases Goods available Cost of sale ($80,000 ÷ 125%) Estimated ending inventory Cost of undamaged inventory ($7,500 ÷ 125%) Estimated fire loss
$ 48,000 46,000 94,000 (64,000) 30,000 (6,000) $24,000
Inventories: Additional Valuation Issues
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Ex. 9-147—Gross profit method. Utley 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 15,000 90,000 45,000 58,000
Instructions Calculate the estimated cost of the inventory on May 31.
Solution 9-147 Collections of accounts Add accounts receivable, May 31 Deduct accounts receivable, May 1 Sales during May
$ 90,000 15,000 (21,000) $ 84,000
Inventory, May 1 Purchases during May Goods available Cost of sales ($84,000 ÷ 120%) Estimated cost of inventory, May 31
$ 45,000 58,000 103,000 (70,000) $ 33,000
Ex. 9-148—Comparison of inventory methods. In the cases cited below, five different conditions are possible when X is compared with Y. These possibilities are as follows: a. X equals Y b. X is greater than Y c. X is less than Y
d. X is equal to or greater than Y e. X is equal to or less than Y
Instructions In the space provided show the relationship of X and Y for each of the following independent statements. ____ 1. "Cost or market, whichever is lower," may be applied to (1) the inventory as a whole or to (2) categories of inventory items. Compare (X) the reported value of inventory when procedure (1) is used with (Y) the reported value of inventory when procedure (2) is used. ____ 2. Prices have been rising steadily. Physical turnover of goods has occurred approximately 4 times in the last year. Compare (X) the ending inventory computed by LIFO method with (Y) the same ending inventory computed by the moving average method.
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Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 9-148 (Cont.) ____ 3. The retail inventory method has been used by a store during its first year of operation. Compare (X) markdown cancellations with (Y) markdowns. ____ 4. Prices have been rising steadily. At the beginning of the year a company adopted a new inventory method; the physical quantity of the ending inventory is the same as that of the beginning inventory. Compare (X) the reported value of inventory if LIFO was the new method with (Y) the reported value of inventory if FIFO was the new method. ____ 5. Prices have been rising steadily. Physical turnover of goods has occurred five times in the last year. Compare (X) unit prices of ending inventory items at moving average pricing with (Y) those at weighted average pricing.
Solution 9-148 1. d
2. c
3. e
4.
c
5. b
PROBLEMS Pr. 9-149—Gross profit method. On December 31, 2012 Felt Company's inventory burned. Sales and purchases for the year had been $1,600,000 and $980,000, respectively. The beginning inventory (Jan. 1, 2012) was $170,000; in the past Felt's gross profit has averaged 40% of selling price. Instructions Compute the estimated cost of inventory burned, and give entries as of December 31, 2012 to close merchandise accounts.
Solution 9-149 Beginning inventory Add: Purchases Cost of goods available Sales Less 40% Estimated inventory lost
$ 170,000 980,000 1,150,000 $1,600,000 (640,000)
960,000 $ 190,000
Sales .............................................................................................. 1,600,000 Income Summary................................................................ Cost of Goods Sold ........................................................................ Fire Loss ........................................................................................ Inventory ............................................................................. Purchases...........................................................................
1,600,000
960,000 190,000 170,000 980,000
Inventories: Additional Valuation Issues
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Pr. 9-150—Retail inventory method. When you undertook the preparation of the financial statements for Telfer Company at January 31, 2013, the following data were available: At Cost At Retail Inventory, February 1, 2012 $70,800 $ 98,500 Markdowns 35,000 Markups 63,000 Markdown cancellations 20,000 Markup cancellations 10,000 Purchases 219,500 294,000 Sales 325,000 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, 2013, using the retail method which approximates lower of cost or market. Your solution should be in good form with amounts clearly labeled.
Solution 9-150 At Cost Beginning inventory, 2/1/12 $ 70,800 Purchases $219,500 Less purchase returns 4,300 215,200 Totals $286,000 Add markups (net) Totals Deduct markdowns (net) Sales price of goods available Sales less sales returns Ending inventory, 1/31/13 at retail Ending inventory at cost: Ratio of cost to retail = $286,000 ÷ $440,000 = 65%; $110,000 × 65% = $71,500 $ 71,500
At Retail $ 98,500 $294,000 5,500 288,500 387,000 53,000 440,000 15,000 425,000 315,000 $ 110,000
*Pr. 9-151—Retail inventory method. The records of Lohse Stores included the following data: Inventory, May 1, at retail, $14,500; at cost, $10,440 Purchases during May, at retail, $42,900; at cost, $31,550 Freight-in, $2,000; purchase discounts, $250 Additional markups, $3,800; markup cancellations, $400; net markdowns, $1,300 Sales during May, $44,500 Instructions Calculate the estimated inventory at May 31 on a LIFO basis. Show your calculations in good form and label all amounts.
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Test Bank for Intermediate Accounting, Fourteenth Edition
*Solution 9-151 Inventory, May 1 Purchases Freight-in Purchase discounts Net markups Net markdowns Totals excluding beginning inventory Goods available Sales Inventory, May 31 Estimated inventory, May 31 ($15,000 × .72)
Cost $10,440 31,550 2,000 (250)
33,300 $43,740
Retail $14,500 42,900
3,400 (1,300) 45,000 59,500 (44,500) $15,000
Ratio .72
.74
$ 10,800
*Pr. 9-152—LIFO retail inventory method, fluctuating prices. Flint Department Store wishes to use the retail LIFO method of valuing inventories for 2013. The appropriate data are as follows: At Cost At Retail December 31, 2012 inventory (base layer) $1,250,000 $2,100,000 Purchases (net of returns, allowances, markups, and markdowns) 2,100,000 3,500,000 Sales 3,080,000 Price index for 2013 105 Instructions Complete the following schedule (fill in all blanks and show calculations in the parentheses): Computation of Retail Inventory for 2013
Cost
Retail
Inventory, December 31, 2012 Purchases (net of returns, allowances, markups, and markdowns)
$1,250,000
$2,100,000
Total available
$
%
____________________________________ Inventory, December 31, 2013, at retail
Ratio
$
Inventories: Additional Valuation Issues
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*Pr. 9-152 (Cont.) Adjustment of Inventory to LIFO Basis
Cost
Ending inventory at base year prices ( )
$
Beginning inventory at base year prices
$
Increase at base year prices
$
Increase at 2013 retail (
)
Increase at 2013 cost
)
(
Retail
Inventory, December 31, 2013, at LIFO cost
$
$
*Solution 9-152 Computation of Retail Inventory for 2013 Inventory, December 31, 2012 Purchases (net of returns, allowances, markups, and markdowns) Total available Less: Sales Inventory, December 31, 2013, at retail Adjustment of Inventory to LIFO Basis Ending inventory at base year prices ($2,520,000 ÷ 1.05) Beginning inventory at base year prices Increase at base year prices Increase at 2013 retail ($300,000 × 1.05) Increase at 2013 cost ($315,000 × 60%) Inventory, December 31, 2013 at LIFO cost
Cost $1,250,000
Retail $2,100,000
Ratio
2,100,000 $3,350,000
3,500,000 5,600,000 3,080,000 $2,520,000
60%
Cost
Retail
$1,250,000
$2,400,000 2,100,000 $ 300,000 $ 315,000
189,000 $1,439,000
*Pr. 9-153—LIFO retail inventory method, stable prices. Potter Variety Store uses the LIFO retail inventory method. Information relating to the computation of the inventory at December 31, 2012, follows: Cost Retail Inventory, January 1, 2012 $146,000 $220,000 Purchases 480,000 700,000 Freight-in 80,000 Sales 750,000 Net markups 160,000 Net markdowns 60,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
Instructions Assuming that there was no change in the price index during the year, compute the inventory at December 31, 2012, using the LIFO retail inventory method.
*Solution 9-153 Potter Variety Store LIFO Retail Computation December 31, 2012 Inventory, January 1, 2012 Purchases Freight-in Net markups Net markdowns Total (excluding beginning inventory) Total (including beginning inventory) Less sales Inventory, Dec. 31, 2012, at retail Ending inventory Beginning inventory Increment Increment at cost ($50,000 × 70%) Ending inventory at LIFO cost
At Cost $146,000 480,000 80,000
At Retail $ 220,000 700,000
560,000 $706,000
160,000 (60,000) 800,000 1,020,000 750,000 $ 270,000
$146,000
$ 270,000 (220,000) $ 50,000
Ratio
70%
35,000 $181,000
*Pr. 9-154—Dollar-value LIFO-retail method. The records of Heese Stores provided the following data for the year: Cost (Base inventory) Inventory, January 1 $150,000 Net purchases 830,800 Sales
Retail $ 250,000 1,318,000 1,185,000
Other data are: Freight-in, $14,000; net markups, $8,000; net markdowns, $6,000; and the price index for the year is 110. Instructions Determine the approximate valuation of the final inventory by the dollar-value, LIFO-retail method. Label all figures. Cost Retail Ratio
Inventories: Additional Valuation Issues
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*Solution 9-154 Cost $150,000 830,800 14,000
Inventory, January 1 Net purchases Freight-in Net markups Net markdowns Totals excluding beginning inventory Goods available Sales Ending inventory Ending inventory deflated ($385,000 ÷ 1.10) Base inventory Layer added New layer at end of year dollars ($100,000 × 1.10 × .64) Estimated inventory at dollar value, LIFO
Retail $ 250,000 1,318,000
844,800 $994,800
8,000 (6,000) 1,320,000 1,570,000 (1,185,000) $ 385,000
$150,000
$ 350,000 (250,000) $ 100,000
Ratio
.64
70,400 $220,400
*Pr. 9-155—Retail LIFO. Klein Book Store uses the conventional retail method and is now considering converting to the LIFO retail method for the period beginning 1/1/13. Available information consists of the following:
Inventory 1/1 Purchases (net) Net markups Net markdowns Sales (net) Loss from breakage Applicable price index
2012 Cost Retail $ 12,500 $ 22,500 250,000 347,500 — 5,000 — 2,500 — 316,000 — 500 — 100
2013 Cost Retail $ ? $ ? 245,000 345,000 — 10,000 — 5,000 — 322,000 — -0— 110
Following is a schedule showing the computation of the cost of inventory on hand at 12/31/12 based on the conventional retail method. Cost Retail Ratio Inventory 1/1/12 $ 12,500 $ 22,500 Purchases (net) 250,000 347,500 Net markups — 5,000 Goods available $262,500 375,000 70% Sales (net) (316,000) Net markdowns (2,500) Loss from breakage (500) Inventory 12/31/12 at retail $ 56,000 Inventory 12/31/12 at LCM ($56,000 × 70%) $ 39,200
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Test Bank for Intermediate Accounting, Fourteenth Edition
Instructions (a) Prepare the journal entry to convert the inventory from the conventional retail to the LIFO retail method. Show detailed calculations to support your entry. (b) Prepare a schedule showing the computation of the 12/31/13 inventory based on the LIFO retail method as adjusted for fluctuating prices. Without prejudice to your answer to (a) above, assume that you computed the 1/1/13 inventory (retail value $49,000) under the LIFO retail method at a cost of $35,000.
*Solution 9-155 (a) Goods available Less: Beginning inventory Net markdowns Cost to retail
Cost $262,500 (12,500) $250,000
Retail $375,000 (22,500) (2,500) $350,000
5/7 × $56,000 = $40,000 – $39,200 = $800 adjustment Inventory ................................................................................. Adjustment to Record Inventory at Cost ........................ (b) Inventory Purchases Net markups Net markdowns Total Total goods available Sales Ending inventory at retail—end of year dollars Ending inventory deflated ($77,000 ÷ 1.10) Beginning Layer added ($21,000 × 1.10 × 70%) Ending inventory at cost
Cost $ 34,000 245,000
245,000 $279,000
$ 35,000 16,170 $ 51,170
800 800 Retail $ 49,000 345,000 10,000 (5,000) 350,000 399,000 (322,000) $ 77,000 $ 70,000 49,000 $ 21,000
Ratio
70%
Inventories: Additional Valuation Issues
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IFRS QUESTIONS True / False 1. IFRS permits an entity to reverse inventory write-downs in certain situations, whereas U.S. GAAP does not. 2. IFRS defines market as replacement cost subject to certain constraints. 3. IFRS uses a ceiling to determine market. 4. Similar to U.S. GAAP, certain agricultural products and mineral products can be reported at net realizable value using IFRS. 5. IFRS records market in the lower-of-cost-or-market differently than U.S. GAAP. Answers to True/False 1. True 2. False 3. False 4. True 5. True Multiple Choice Questions 1. Where is the authoritative IFRS guidance related to accounting and reporting for inventories found? a. IAS 2 b. IAS 18 c. IAS 41 d. All of these standards deal with inventory. 2. All of the following are key similarities between U.S. GAAP and IFRS with respect to accounting for inventories except a. guidelines on ownership of goods are similar. b. costs to include in inventories are similar. c. LIFO cost flow assumption where appropriate is used by both sets of standards. d. fair value valuation of inventories is prohibited by both sets of standards. 3. All of the following are key differences between U.S. GAAP and IFRS with respect to accounting for inventories except the a. definition of the lower-of-cost-or-market test for inventory valuation differs between U.S. GAAP and IFRS. b. inventory basis determination for writedowns differs between U.S. GAAP and IFRS. c. guidelines are more principles based under IFRS than they are under U.S. GAAP. d. average costing method is prohibited under IFRS.
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Test Bank for Intermediate Accounting, Fourteenth Edition
4. Alonzo Company in Italy prepares its financial statements in accordance with IFRS. In 2012, it reported cost of goods sold of €600 million and average inventory of €150 million. What is Alonzo's inventory turnover ratio? a. 4 days b. 25 days c. 91.25 days d. 100 days 5. Starfish Company (a company using U.S. GAAP and LIFO inventory method) is considering changing to IFRS and the FIFO inventory method. How would a comparison of these methods affect Starfish's financials? a. During a period of inflation, the current ratio would decrease when IFRS and the FIFO inventory method are used as compared to U.S. GAAP and LIFO. b. During a period of inflation, the taxes will decrease when IFRS and the FIFO inventory method are used as compared to U.S. GAAP and LIFO. c. During a period of inflation, net income would be greater if IFRS and the FIFO inventory method are used as compared to U.S.GAAP and LIFO. d. During a period of inflation, working capital would decrease when IFRS and the FIFO inventory method are used as compared to U.S. GAAP and LIFO.
6. Which of the following statements is true regarding IFRS and inventories? a. In order to determine market valuation of inventories, IFRS uses a ceiling and a floor. b. IFRS permits the option of valuing inventories at fair value. c. With respect to inventories, IFRS defines market as net realizable value. d. IFRS allows inventory to be written up above its original cost. 7. State Company manufactured a forklift machine at a cost of $60,000. The product is sold for $66,000 at a 5% discount. The delivery costs are estimated to be $6,000. Under IFRS, how much should be the carrying amount of this inventory? a. $60,000 b. $66,000 c. $54,000 d. $56,700 8. The following information relates to Moore Company's inventory: Cost of inventory = $860 Selling price of inventory = $1,000 Normal profit margin = 10% of selling price Current replacement cost = $740 Cost of completion and disposal = $100 Under IFRS, which of the following would be the correct measurement value for the inventory? a. $860 b. $740 c. $1,000 d. $900
Inventories: Additional Valuation Issues
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9. Assume that Darcy Industries had the following inventory values: Inventory cost (on December 31, 2011) = $1,500 Inventory market (on December 31, 2011) = $1,350 Inventory net realizable value (on December 31, 2011) = $1,320 Inventory market (on June 30, 2012) = $1,560 Inventory net realizable value (on June 30, 2012) = $1,570 Under IFRS, what is the inventory carrying value on December 31, 2011? a. $1,500 b. $1,350 c. $1,320 d. $1,390 10. Assume that Darcy Industries had the following inventory values: Inventory cost (on December 31, 2011) = $1,500 Inventory market (on December 31, 2011) = $1,350 Inventory net realizable value (on December 31, 2011) = $1,320 Inventory market (on June 30, 2012) = $1,560 Inventory net realizable value (on June 30, 2012) = $1,570 Under IFRS, what is the inventory carrying value on June 30, 2012? a. $1,500 b. $1,560 c. $1,570 d. $1,320 Answers to Multiple Choice 1. d 2. c 3. d 4. c 5. c 6. c 7. d 8. d 9. c 10. a
Short Answer 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to the accounting for inventories. 1. Key Similarities are (1) the guidelines on who owns the goods—goods in transit, consigned goods, special sales agreements, and the costs to include in inventory are essentially accounted for the same under IFRS and U.S. GAAP; (2) use of specific identification cost flow assumption, where appropriate; (3) unlike property plant and equipment, IFRS does not permit the option of valuing inventories at fair value. As indicated above, IFRS requires inventory to be written down, but inventory cannot be written up above its original cost; (4) certain agricultural products and minerals and mineral products can be reported at net realized value using IFRS.
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Key differences are related to (1) the LIFO cost flow assumption—U.S. GAAP permits the use of LIFO for inventory valuation. IFRS prohibits it use. FIFO and average-cost are the only two acceptable cost flow assumptions permitted under IFRS; (2) lower-of-cost-or-market test for inventory valuation—IFRS defines market as net realizable value. U.S. GAAP on the other hand defines market as replacement cost subject to the constraints of net realizable value (the ceiling) and net realizable value less a normal markup (the floor). That is, IFRS does not use a ceiling or a floor to determine market; (3) inventory write-downs—under U.S. GAAP, if inventory is written down under the lower-of-cost-or-market valuation, the new basis is now considered its cost. As a result, the inventory may be written back up to its original cost in a subsequent period. Under IFRS, the write-down may be reversed in a subsequent period up to the amount of the pervious write-down. Both the write-down and any subsequent reversal should be reported on the income statement; (4) The requirements for accounting and reporting for inventories are more principles-based under IFRS. That is, U.S. GAAP provides more detailed guidelines in inventory accounting.
2. Explain the main obstacle to achieving convergence in the area of inventory accounting. 2. IFRS specifically prohibits the LIFO cost flow method. Conversely, the LIFO cost flow assumption is widely used in the United States because of its favorable tax advantages. In addition, many argue that LIFO from a financial reporting point of view provides a better matching of current costs against revenue and therefore a more realistic income is computed. The problem is compounded in the United States because LIFO cannot be used for tax purposes unless it is used for financial reporting purposes. As a result, unless the tax law is changed, it is unlikely that U.S. GAAP will eliminate the use of the LIFO cost flow assumption because of its substantial tax advantages for many companies. Also, U.S. GAAP has more detailed rules related to accounting and reporting of inventories than IFRS. We expect that these more detailed rules will be used internationally because they provide practical guidance for some inventory accounting and reporting issues.
CHAPTER 10 ACQUISITION AND DISPOSITION OF PROPERTY, PLANT, AND EQUIPMENT IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F T F T F T F F F T T T T F F T T F F T
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20
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. Overhead costs in self-constructed assets. Overhead costs in self-constructed assets. Interest capitalization. Qualifying assets for interest capitalization. Avoidable interest. Interest capitalization on land purchase. Deferred-payment contracts. Accounting for nonmonetary exchanges. Nonmonetary exchanges. Recognizing losses on nonmonetary exchanges. Costs subsequent to acquisition. Definition of improvements. Ordinary repairs benefit period. Involuntary conversion gains/losses. Loss from scrapped asset.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
d b d c c c d a b b d d d a c a b
21. 22. 23. 24. 25. 26. 27. 28. 29. S 30. S 31. 32. 33. 34. 35. 36. 37.
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. Accounting for overhead costs. Determine costs capitalized for self-constructed assets. 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.
10 - 2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
b d d c a c a a b c d d a c b b d c d a c d a d c
38. 39. 40. S 41. S 42. S 43. S 44. S 45. P 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. P 58. S 59. S 60. 61. 62.
Interest capitalization—weighted-average factor. Classification of interest earned on securities purchased with borrowed funds. Write-off of capitalized interest costs. Conditions for interest capitalization. Capitalization of interest on constructed assets. 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. Valuation of plant assets. Plant asset acquired by issuance of stock. Valuation of nonmonetary exchanges. Gain recognition on a nonmonetary exchange. Gain recognition on a nonmonetary exchange. Accounting for donated assets. Valuation of donated assets. Identify conditions for capital expenditures. Capital expenditure. Identification of a capital expenditure. Identification of a capital expenditure. Accounting for revenue expenditures. Accounting for capital expenditures. Gain or loss on plant asset disposal. Determine loss on sale of depreciable asset. Knowledge of involuntary conversions.
P S
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide.
MULTIPLE CHOICE—Computational Answer
No.
b d d c c d d a b a b a c b a d a
63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79.
Description Determine cost of land. Determine cost of building. Calculate cost of land and building. Calculate cost of equipment. Calculate cost of equipment. Overhead included in self-constructed asset. Overhead included in self-constructed asset. Calculate interest to be capitalized. Calculate average accumulated expenditures. Calculate interest to be capitalized. Calculate average accumulated expenditures. Calculate average accumulated expenditures. Calculate amount of interest to be capitalized. Calculate weighted-average accumulated expenditures. Calculate weighted-average accumulated expenditures. Calculate weighted-average accumulated expenditures. Calculate actual interest cost incurred during year.
Acquisition and Disposition of Property, Plant, and Equipment
MULTIPLE CHOICE—Computational (cont.) Answer
No.
b c c b d b b d d a c a a c b a c a d c c c b d b d b c b d a d b a b b d b d c c b b
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. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122.
Description Calculate amount of interest to be capitalized. Calculate amount of interest to be capitalized. Calculate weighted-average accumulated expenditures. Calculate interest to be capitalized. Calculate weighted-average accumulated expenditures. Calculate interest to be capitalized. Calculate weighted-average accumulated expenditures. Calculate weighted-average interest rate. Calculate amount of avoidable interest. Calculate amount of actual interest. Calculate amount of interest expense. Exchange of nonmonetary assets. Exchange lacking commercial substance. Exchange lacking commercial substance. Valuation of a nonmonetary exchange. Valuation of a nonmonetary exchange. Calculate gain on exchange lacking commercial substance. Allocation of cost in a lump sum purchase. Allocation of cost in a lump sum purchase. Calculate cost of land acquired. Determine cost of purchased machine. Calculate cost of truck purchased. Calculate cost of machine purchased. Allocation of cost of a lump sum purchase. Calculate cost of equipment. Acquisition of equipment by exchange of stock held as an investment. 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. Calculate gain on nonmonetary exchange. Calculate loss on nonmonetary exchange. Calculate gain on nonmonetary exchange. Calculate loss on nonmonetary exchange. 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.
10 - 3
10 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—CPA Adapted Answer
No.
c b b a a b d a
123. 124. 125. 126. 127. 128. 129. 130.
Description Determine cost of land. Classification of sale of building. Determine interest cost to be capitalized. Valuation of a nonmonetary exchange. Exchange lacking commercial substance. Accounting for donated assets. Costs subsequent to acquisition. Valuation of replacement equipment.
EXERCISES Item E10-131 E10-132 E10-133 E10-134 E10-135 E10-136 E10-137
Description Plant asset accounting. Weighted-average accumulated expenditures. Capitalization of interest. Nonmonetary exchange. Nonmonetary exchange. Donated assets. Capitalizing vs. expensing.
PROBLEMS Item P10-138 P10-139 P10-140 P10-141 P10-142 P10-143 P10-144 P10-145 P10-146
Description Capitalizing acquisition costs. Capitalization of interest. Capitalization of interest. Asset acquisition Nonmonetary exchange. Nonmonetary exchange. Nonmonetary exchange. Nonmonetary exchange. Nonmonetary exchange.
CHAPTER LEARNING OBJECTIVES 1.
Describe property, plant, and equipment.
2.
Identify the costs to include in the initial valuation of property, plant, and equipment.
3.
Describe the accounting problems associated with self-constructed assets.
4.
Describe the accounting problems associated with interest capitalization.
5.
Understand accounting issues related to acquiring and valuing plant assets.
6.
Describe the accounting treatment for costs subsequent to acquisition.
7.
Describe the accounting treatment for the disposal of property, plant, and equipment.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1.
TF
2.
TF
21.
3. 4. 5.
TF TF TF
24. 25. 26.
MC MC MC
27. 28. 29.
6. 7.
TF TF
31. 32.
MC MC
68. 69.
8. 9. 10. 11. 33. 34.
TF TF TF TF MC MC
35. 36. 37. 38. 39. 40.
MC MC MC MC MC MC
S
12. 13. 14. 15. S 43. S 44. S 45. P 46. 47.
TF TF TF TF MC MC MC MC MC
48. 49. 50. 51. 52. 53. 91. 92. 93.
MC MC MC MC MC MC MC MC MC
94. 95. 96. 97. 98. 99. 100. 101. 102.
16. 17.
TF TF
18. 54.
TF MC
55. 56.
19. 20.
TF TF
60. 61.
MC MC
62. 119.
Note:
S S
S
S
TF = True-False MC = Multiple Choice P = Problem E = Exercise
41. 42. 70. 71. 72. 73.
Type
Item
Type
Item
Learning Objective 1 MC 22. MC 23. Learning Objective 2 MC 30. MC 65. MC 63. MC 66. MC 64. MC 67. Learning Objective 3 MC 132. E MC 133. E Learning Objective 4 MC 74. MC 80. MC 75. MC 81. MC 76. MC 82. MC 77. MC 83. MC 78. MC 84. MC 79. MC 85. Learning Objective 5 MC 103. MC 112. MC 104. MC 113. MC 105. MC 114. MC 106. MC 115. MC 107. MC 116. MC 108. MC 117. MC 109. MC 118. MC 110. MC 126. MC 111. MC 127. Learning Objective 6 S MC 57. MC 59. P MC 58. MC 129. Learning Objective 7 MC 120. MC 122. MC 121. MC
Type
Item
Type
Item
Type
MC MC MC
123. 124. 131.
MC MC E
137. 138.
E P
MC MC MC MC MC MC
86. 87. 88. 89. 90. 125.
MC MC MC MC MC MC
131. 133. 137. 139. 140.
E E E P P
MC MC MC MC MC MC MC MC MC
128. 131. 134. 135. 136. 137. 141. 142. 143.
MC E E E E E P P P
144. 145. 146.
P P P
MC MC
130. 131.
MC E
137.
E
MC
MC
10 - 6
Test Bank for Intermediate Accounting, Fourteenth Edition
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. Variable overhead costs incurred to self-construct an asset should be included in the cost of the asset. 7. Companies should assign no portion of fixed overhead to self-constructed assets. 8. When capitalizing interest during construction of an asset, an imputed interest cost on stock financing must be included. 9. Assets under construction for a company’s own use do not qualify for interest cost capitalization. 10. Avoidable interest is the amount of interest cost that a company could theoretically avoid if it had not made expenditures for the asset. 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. Assets purchased on long-term credit contracts should be recorded at the present value of the consideration exchanged. 13. 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. 14. If a nonmonetary exchange lacks commercial substance, and cash is received, a partial gain or loss is recognized. 15. When a company exchanges nonmonetary assets and a loss results, the company recognizes the loss only if the exchange has commercial substance. 16. Costs incurred subsequent to the acquisition of an asset are capitalized if they provide future benefits. 17. Improvements are often referred to as betterments and involve the substitution of a better asset for the one currently used.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 7
18. When an ordinary repair occurs, several periods will usually benefit. 19. Companies always treat gains or losses from an involuntary conversion as extraordinary items. 20. If a company scraps an asset without any cash recovery, it recognizes a loss equal to the asset’s book value.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F T F T F
Item 6. 7. 8. 9. 10.
Ans. T F F F T
Item 11. 12. 13. 14. 15.
Ans. T T T F F
Item 16. 17. 18. 19. 20.
Ans. T T F F T
MULTIPLE CHOICE—Conceptual 21.
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.
22.
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 d. Yields services over a number of years
23.
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.
24.
Cotton Hotel Corporation recently purchased Emporia Hotel and the land on which it is located with the plan to tear down the Emporia Hotel and build a new luxury hotel on the site. The cost of the Emporia 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.
10 - 8
Test Bank for Intermediate Accounting, Fourteenth Edition
25.
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.
26.
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 cost. c. private driveways and parking lots. d. assumption of any liens or mortgages on the property.
27.
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 a. the significance of the cost allocated to the building in relation to the combined cost of the lot and building. b. the length of time for which the building was held prior to its demolition. c. the contemplated future use of the parking lot. d. the intention of management for the property when the building was acquired.
28.
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.
29.
Fences and parking lots are reported on the balance sheet as a. current assets. b. land improvements. c. land. d. property and equipment.
S
30.
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.
S
31.
To be consistent with the historical cost principle, overhead costs incurred by an enterprise constructing its own building should be a. allocated on the basis of lost production. b. eliminated completely from the cost of the asset. c. allocated on an opportunity cost basis. d. allocated on a pro rata basis between the asset and normal operations.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 9
32.
Which of the following costs are capitalized for self-constructed assets? a. Materials and labor only b. Labor and overhead only c. Materials and overhead only d. Materials, labor, and overhead
33.
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.
34.
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.
35.
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.
36.
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.
37.
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.
10 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition 38.
Construction of a qualifying asset is started on April 1 and finished on December 1. The fraction used to multiply an expenditure made on April 1 to find weighted-average accumulated expenditures is a. 8/8. b. 8/12. c. 9/12. d. 11/12.
39.
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.
40.
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.
S
41.
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.
S
42.
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.
S
43.
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.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 11
S
44.
When boot is involved in an exchange having commercial substance. a. gains or losses are recognized in their entirely. 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.
S
45.
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 gain or loss is recognized. b. the fair value of the asset given up, and a gain but not 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.
P
46.
Ringler Corporation exchanges one plant asset for a similar 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.
47.
Plant assets purchased on long-term credit contracts should be accounted for at a. the total value of the future payments. b. the future amount of the future payments. c. the present value of the future payments. d. none of these.
48.
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. fair value of the stock.
49.
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 value of the land.
50.
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.
10 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition 51.
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 (cash paid/received is less than 25% of the fair value of the exchange). d. part of a gain when the exchange has no commercial substance and cash is received (cash paid or received is less than 25% of the fair value of the exchange).
52.
When an enterprise is the recipient of a donated asset, the account credited may be a a. paid-in capital account. b. revenue account. c. deferred revenue account. d. all of these.
53.
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 fair 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.
54.
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.
55.
An improvement made to a machine increased its fair 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.
56.
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
57.
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
Acquisition and Disposition of Property, Plant, and Equipment
10 - 13
P
58.
In accounting for plant assets, which of the following outlays made subsequent to acquisition should be fully expensed in the period the expenditure is made? a. Expenditure made to increase the efficiency or effectiveness of an existing asset b. Expenditure made to extend the useful life of an existing asset beyond the time frame originally anticipated c. Expenditure made to maintain an existing asset so that it can function in the manner intended d. Expenditure made to add new asset services
S
59.
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.
S
60.
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.
61.
The sale of a depreciable asset resulting in a loss indicates that the proceeds from the sale were a. less than current fair value. b. greater than cost. c. greater than book value. d. less than book value.
62.
Which of the following statements about involuntary conversions is false? a. An involuntary conversion may result from condemnation or fire. b. The gain or loss from an involuntary conversion may be reported as an extraordinary item. c. The gain or loss from an involuntary conversion should not be recognized when the enterprise reinvests in replacement assets. d. All of these.
10 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26.
d b d c c c
27. 28. 29. 30. 31. 32.
d a b b d d
33. 34. 35. 36. 37. 38.
d a c a b b
39. 40. 41. 42. 43. 44.
d d c a c a
45. 46. 47. 48. 49. 50.
a b c d d a
51. 52. 53. 54. 55. 56.
c b b d c d
57. 58. 59. 60. 61. 62.
a c d a d c
Solutions to those Multiple Choice questions for which the answer is “none of these.” 21.
Long-lived tangible assets used in the enterprise’s operations.
40.
Capitalized interest is depreciated over the related asset’s useful life.
56.
Capital expenditures include additions, betterments, improvements, and extraordinary repairs.
MULTIPLE CHOICE—Computational Use the following information for questions 63 and 64. Wilson Co. purchased land as a factory site for $800,000. Wilson paid $80,000 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 $2,500,000. An assessment made by the city for pavement was $6,400. Interest costs during construction were $170,000. 63.
The cost of the land that should be recorded by Wilson Co. is a. $880,480. b. $886,880. c. $889,880. d. $896,280.
64.
The cost of the building that should be recorded by Wilson Co. is a. $2,503,800. b. $2,504,840. c. $2,513,200. d. $2,514,240.
Acquisition and Disposition of Property, Plant, and Equipment 65.
10 - 15
On February 1, 2012, Nelson Corporation purchased a parcel of land as a factory site for $250,000. An old building on the property was demolished, and construction began on a new building which was completed on November 1, 2012. 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 1,290,000 (Salvaged materials resulting from demolition were sold for $10,000.) Nelson should record the cost of the land and new building, respectively, as a. $275,000 and $1,315,000. b. $260,000 and $1,330,000. c. $260,000 and $1,325,000. d. $265,000 and $1,325,000.
66.
Worthington Chandler Company purchased equipment for $12,000. Sales tax on the purchase was $800. 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. $12,000 b. $12,800 c. $13,225 d. $13,575
67.
Fogelberg Company purchased equipment for $15,000. Sales tax on the purchase was $900. Other costs incurred were freight charges of $240, repairs of $420 for damage during installation, and installation costs of $270. What is the cost of the equipment? a. $15,000. b. $15,900. c. $16,410. d. $16,830.
68.
During self-construction of an asset by Samuelson Company, the following were among the costs incurred: Fixed overhead for the year Portion of $1,000,000 fixed overhead that would be allocated to asset if it were normal production Variable overhead attributable to self-construction
$1,000,000 50,000 35,000
What amount of overhead should be included in the cost of the self-constructed asset? a. $ -0b. $35,000 c. $50,000 d. $85,000
10 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition 69.
During self-construction of an asset by Richardson Company, the following were among the costs incurred: Fixed overhead for the year Portion of $1,000,000 fixed overhead that would be allocated to asset if it were normal production Variable overhead attributable to self-construction
$1,000,000 60,000 75,000
What amount of overhead should be included in the cost of the self-constructed asset? a. $ -0b. $ 60,000 c. $ 75,000 d. $135,000 70.
Mendenhall Corporation constructed a building at a cost of $10,000,000. Average accumulated expenditures were $4,000,000, actual interest was $600,000, and avoidable interest was $400,000. If the salvage value is $800,000, and the useful life is 40 years, depreciation expense for the first full year using the straight-line method is a. $240,000. b. $245,000. c. $260,000. d. $340,000.
71.
Messersmith Company is constructing a building. Construction began in 2012 and the building was completed 12/31/12. Messersmith made payments to the construction company of $1,500,000 on 7/1, $3,150,000 on 9/1, and $3,000,000 on 12/31. Average accumulated expenditures were a. $1,537,500. b. $1,800,000. c. $4,650,000. d. $7,650,000.
72.
Huffman 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 $800,000. 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. $480,000. b. $490,000. c. $520,000. d. $680,000.
73.
Gutierrez Company is constructing a building. Construction began in 2012 and the building was completed 12/31/12. Gutierrez made payments to the construction company of $2,000,000 on 7/1, $4,400,000 on 9/1, and $4,000,000 on 12/31. Average accumulated expenditures were a. $2,100,000. b. $2,466,667. c. $6,400,000. d. $10,400,000.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 17
74.
On May 1, 2012, Goodman Company began construction of a building. Expenditures of $240,000 were incurred monthly for 5 months beginning on May 1. The building was completed and ready for occupancy on September 1, 2012. For the purpose of determining the amount of interest cost to be capitalized, the average accumulated expenditures on the building during 2012 were a. $200,000. b. $240,000. c. $960,000. d. $1,200,000.
75.
During 2012, Kimmel Co. incurred average accumulated expenditures of $600,000 during construction of assets that qualified for capitalization of interest. The only debt outstanding during 2012 was a $750,000, 10%, 5-year note payable dated January 1, 2010. What is the amount of interest that should be capitalized by Kimmel during 2012? a. $0. b. $15,000. c. $60,000. d. $75,000.
76.
On March 1, Felt Co. began construction of a small building. Payments of $160,000 were made monthly for three 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. $40,000. b. $80,000. c. $160,000. d. $320,000.
77.
On March 1, Imhoff Co. began construction of a small building. Payments of $240,000 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. $120,000. b. $240,000. c. $480,000. d. $960,000.
Use the following information for questions 78 through 80. On March 1, 2012, Newton Company purchased land for an office site by paying $900,000 cash. Newton began construction on the office building on March 1. The following expenditures were incurred for construction: Date Expenditures March 1, 2012 $ 600,000 April 1, 2012 840,000 May 1, 2012 1,500,000 June 1, 2012 2,400,000
10 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition The office was completed and ready for occupancy on July 1. To help pay for construction, $1,200,000 was borrowed on March 1, 2012 on a 9%, 3-year note payable. Other than the construction note, the only debt outstanding during 2012 was a $500,000, 12%, 6-year note payable dated January 1, 2012. 78.
The weighted-average accumulated expenditures on the construction project during 2012 were a. $640,000. b. $4,890,000. c. $520,000. d. $1,160,000.
79.
The actual interest cost incurred during 2012 was a. $150,000. b. $168,000. c. $84,000. d. $140,000.
80.
Assume the weighted-average accumulated expenditures for the construction project are $870,000. The amount of interest cost to be capitalized during 2012 is a. $130,500. b. $138,000. c. $150,000. d. $168,000.
81.
During 2012, Bass Corporation constructed assets costing $2,000,000. The weightedaverage accumulated expenditures on these assets during 2012 was $600,000. To help pay for construction, $880,000 was borrowed at 10% on January 1, 2012, and funds not needed for construction were temporarily invested in short-term securities, yielding $18,000 in interest revenue. Other than the construction funds borrowed, the only other debt outstanding during the year was a $1,000,000, 10-year, 9% note payable dated January 1, 2006. What is the amount of interest that should be capitalized by Bass during 2012? a. $120,000. b. $60,000. c. $116,800. d. $188,800.
Use the following information for questions 82 through 85. On January 2, 2012, Indian River Groves began construction of a new citrus processing plant. The automated plant was finished and ready for use on September 30, 2013. Expenditures for the construction were as follows: January 2, 2012 September 1, 2012 December 31, 2012 March 31, 2013 September 30, 2013
$300,000 900,000 900,000 900,000 600,000
Acquisition and Disposition of Property, Plant, and Equipment
10 - 19
Indian River Groves borrowed $1,650,000 on a construction loan at 12% interest on January 2, 2012. This loan was outstanding during the construction period. The company also had $6,000,000 in 9% bonds outstanding in 2012 and 2013. 82.
What were the weighted-average accumulated expenditures for 2012? a. $800,000 b. $750,000 c. $600,000 d. $1,500,000
83.
The interest capitalized for 2012 was: a. $270,000 b. $72,000 c. $228,000 d. $90,000
84.
What were the weighted-average accumulated expenditures for 2013 by the end of the construction period? a. $585,000 b. $2,452,500 c. $2,979,000 d. $2,079,000
85.
The interest capitalized for 2013 was: a. $187,110 b. $177,458 c. $ 38,610 d. $ 148,500
Use the following information to answer questions 86 - 90. Arlington Company is constructing a building. Construction began on January 1 and was completed on December 31. Expenditures were $4,000,000 on March 1, $3,300,000 on June 1, and $5,000,000 on December 31. Arlington Company borrowed $2,000,000 on January 1 on a 5year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 10%, 3-year, $4,000,000 note payable and an 11%, 4-year, $7,500,000 note payable. 86.
What are the weighted-average accumulated expenditures? a. $7,300,000 b. $5,258,333 c. $12,300,000 d. $6,150,000
87.
What is the weighted-average interest rate used for interest capitalization purposes? a. 11% b. 10.85% c. 10.5% d. 10.65%
10 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 88.
What is the avoidable interest for Arlington Company? a. $240,000 b. $773,013 c. $273,802 d. $587,012
89.
What is the actual interest for Arlington Company? a. $1,465,000 b. $1,485,000 c. $1,225,000 d. $587,012
90.
What amount of interest should be charged to expense? a. $637,987 b. $1,225 c. $877,987 d. $691,987
91.
Dodson Company traded in a manual pressing machine for an automated pressing machine and gave $16,000 cash. The old machine cost $186,000 and had a net book value of $142,000. The old machine had a fair value of $120,000. Which of the following is the correct journal entry to record the exchange? a. Equipment Loss on Disposal Accumulated Depreciation Equipment Cash
136,000 22,000 44,000
b. Equipment Equipment Cash
136,000
c. Cash Equipment Loss on Disposal Accumulated Depreciation Equipment
16,000 120,000 22,000 44,000
186,000 16,000 120,000 16,000
d. Equipment 246,000 Accumulated Depreciation Equipment Cash
202,000 44,000 186,000 16,000
Use the following information to answer questions 92 & 93. Below is the information relative to an exchange of assets by Stanton Company. The exchange lacks commercial substance.
Case I Case II
Old Equipment Book Value Fair Value $225,000 $225,000 $150,000 $135,000
Cash Paid $45,000 $21,000
Acquisition and Disposition of Property, Plant, and Equipment 92.
Which of the following would be correct for Stanton to record in Case I?
a. b. c. d. 93.
10 - 21
Record Equipment at: $270,000 $300,000 $225,000 $270,000
Record a gain of (loss) of: $0 $30,000 $(15,000) $30,000
Which of the following would be correct for Stanton to record in Case II?
a. b. c. d.
Record Equipment at: $171,000 $150,000 $156,000 $150,000
Record a gain of (loss) of: $15,000 $6,000 $(15,000) $(6,000)
Use the following information for questions 94 and 95. Glen Inc. and Armstrong Co. have an exchange with no commercial substance. The asset given up by Glen Inc. has a book value of $48,000 and a fair value of $60,000. The asset given up by Armstrong Co. has a book value of $80,000 and a fair value of $76,000. Boot of $16,000 is received by Armstrong Co. 94. What amount should Glen Inc. record for the asset received? a. $60,000 b. $64,000 c. $76,000 d. $80,000 95.
What amount should Armstrong Co. record for the asset received? a. $60,000 b. $64,000 c. $76,000 d. $80,000
96.
Hardin Company received $60,000 in cash and a used computer with a fair value of $180,000 from Page Corporation for Hardin Company's existing computer having a fair value of $240,000 and an undepreciated cost of $225,000 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 $165,000 b. $1,153 and $166,153 c. $15,000 and $180,000 d. $60,000 and $225,000
Use the following information to answer questions 97 & 98. Jamison Company purchased the assets of Booker Company at an auction for $2,800,000. An independent appraisal of the fair value of the assets is listed below: Land $950,000 Building 1,400,000 Equipment 1,050,000 Trucks 1,700,000
10 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 97.
Assuming that specific identification costs are impracticable and that Jamison allocates the purchase price on the basis of the relative fair values, what amount would be allocated to the Trucks? a. $933,333 b. $1,400,000 c. $1,680,000 d. $1,700,000
98.
Assuming that specific identification costs are impracticable and that Jamison allocates the purchase price on the basis of the relative fair values, what amount would be allocated to the Building? a. $1,059,460 b. $1,400,000 c. $2,550,000 d. $768,627
99.
On December 1, Miser Corporation exchanged 3,000 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 Miser at a cost of $40 per share, and on the exchange date the common shares of Miser had a fair value of $50 per share. Miser received $9,000 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. $111,000. b. $120,000. c. $141,000. d. $150,000.
100.
Storm Corporation purchased a new machine on October 31, 2012. A $3,600 down payment was made and three monthly installments of $10,800 each are to be made beginning on November 30, 2012. The cash price would have been $34,800. Storm paid no installation charges under the monthly payment plan but a $600 installation charge would have been incurred with a cash purchase. The amount to be capitalized as the cost of the machine on October 31, 2012 would be a. $36,600. b. $36,000. c. $35,400. d. $34,800.
101.
Horner Company buys a delivery van with a list price of $45,000. 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 $600 and the company paid an extra $450 to have a special device installed. What should be the recorded cost of the van? a. $37,485. b. $38,468. c. $38,535. d. $38,085.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 23
102.
On August 1, 2012, Hayes Corporation purchased a new machine on a deferred payment basis. A down payment of $9,000 was made and 4 monthly installments of $7,500 each are to be made beginning on September 1, 2012. The cash equivalent price of the machine was $36,000. Hayes incurred and paid installation costs amounting to $1,500. The amount to be capitalized as the cost of the machine is a. $36,000. b. $37,500. c. $39,000. d. $40,500.
103.
On April 1, Mooney Corporation purchased for $1,710,000 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 $600,000 $560,000 Warehouse 400,000 360,000 Office building 800,000 680,000 $1,800,000 $1,600,000 What are the appropriate amounts that Mooney should record for the land, warehouse, and office building, respectively? a. Land, $560,000; warehouse, $360,000; office building, $680,000. b. Land, $600,000; warehouse, $400,000; office building, $800,000. c. Land, $598,500; warehouse, $384,750; office building, $363,375. d. Land, $570,000; warehouse, $380,000; office building, $760,000.
104.
On August 1, 2012, Mendez Corporation purchased a new machine on a deferred payment basis. A down payment of $2,000 was made and 4 annual installments of $18,000 each are to be made beginning on September 1, 2012. The cash equivalent price of the machine was $69,000. Due to an employee strike, Mendez could not install the machine immediately, and thus incurred $900 of storage costs. Costs of installation (excluding the storage costs) amounted to $2,400. The amount to be capitalized as the cost of the machine is a. $69,000. b. $71,400. c. $72,300. d. $78,000.
10 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition 105.
Siegle Company exchanged 600 shares of Guinn Company common stock, which Siegle was holding as an investment, for equipment from Mayo Company. The Guinn Company common stock, which had been purchased by Siegle 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 Mayo's books of $31,500. What journal entry should Siegle make to record this exchange? a. Equipment .......................................................................... 30,000 Investment in Guinn Co. Common Stock ................... 30,000 b. Equipment .......................................................................... 31,500 Investment in Guinn Co. Common Stock ................... 30,000 Gain on Disposal of Investment ................................. 1,500 c. Equipment .......................................................................... 31,500 Loss on Disposal of Investment ......................................... 3,300 Investment in Guinn Co. Common Stock ................... 34,800 d. Equipment .......................................................................... 34,800 Investment in Guinn Co. Common Stock ................... 30,000 Gain on Disposal of Investment ................................. 4,800
106.
On January 2, 2012, Rapid 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 $36,000 Accumulated depreciation as of January 2, 2012 24,000 Average published retail value 11,000 New Truck List price $60,000 Cash price without trade-in 54,000 Cash paid with trade-in 45,000 What should be the cost of the new truck for financial accounting purposes? a. $45,000. b. $54,000. c. $57,000. d. $60,000.
107.
On December 1, 2012, Kelso Company acquired new equipment in exchange for old equipment that it had acquired in 2009. The old equipment was purchased for $70,000 and had a book value of $26,600. On the date of the exchange, the old equipment had a fair value of $28,000. In addition, Kelso paid $91,000 cash for the new equipment, which had a list price of $126,000. The exchange lacked commercial substance. At what amount should Kelso record the new equipment for financial accounting purposes? a. $91,000. b. $117,600. c. $119,000. d. $126,000.
Use the following information for questions 108 and 109. A machine cost $360,000, has annual depreciation of $60,000, and has accumulated depreciation of $270,000 on December 31, 2012. On April 1, 2013, when the machine has a fair value of $82,500, it is exchanged for a machine with a fair value of $405,000 and the proper amount of cash is paid. The exchange lacked commercial substance.
Acquisition and Disposition of Property, Plant, and Equipment 108.
109.
10 - 25
The gain to be recorded on the exchange is a. $0. b. $7,500 loss. c. $15,000 gain. d. $45,000 gain. The new machine should be recorded at a. $322,500. b. $367,500. c. $397,500. d. $405,000.
Use the following information for questions 110 and 111. Equipment that cost $88,000 and has accumulated depreciation of $40,000 is exchanged for equipment with a fair value of $64,000 and $16,000 cash is received. The exchange lacked commercial substance. 110.
The gain to be recognized from the exchange is a. $6,400 gain. b. $8,000 gain. c. $24,000 gain. d. $32,000 gain.
111.
The new equipment should be recorded at a. $64,000. b. $48,000. c. $40,000. d. $38,400.
Use the following information for questions 112 through 114. Two independent companies, Hager Co. and Shaw 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: Hager's Land Shaw's Land Cost and book value $576,000 $360,000 Fair value based upon appraisal 720,000 630,000 The exchange was made, and based on the difference in appraised fair values, Shaw paid $90,000 to Hager. The exchange lacked commercial substance. 112.
For financial reporting purposes, Hager should recognize a pre-tax gain on this exchange of a. $0. b. $18,000. c. $90,000. d. $144,000.
10 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition 113.
The new land should be recorded on Hager's books at a. $504,000. b. $576,000. c. $630,000. d. $720,000.
114.
The new land should be recorded on Shaw's books at a. $360,000. b. $450,000. c. $630,000. d. $720,000.
115.
Timmons Company traded machinery with a book value of $240,000 and a fair value of $400,000. It received in exchange from Lewis Company a machine with a fair value of $360,000 and cash of $40,000. Lewis’s machine has a book value of $380,000. What amount of gain should Timmons recognize on the exchange? a. $ -0b. $16,000 c. $40,000 d. $160,000
116.
Lewis Company traded machinery with a book value of $570,000 and a fair value of $540,000. It received in exchange from Timmons Company a machine with a fair value of $600,000. Lewis also paid cash of $60,000 in the exchange. Timmons’s machine has a book value of $570,000. What amount of gain or loss should Lewis recognize on the exchange? a. $60,000 gain b. $ -0-. c. $3,000 loss d. $30,000 loss
117.
Durler Company traded machinery with a book value of $540,000 and a fair value of $900,000. It received in exchange from Hoyle Company a machine with a fair value of $810,000 and cash of $90,000. Hoyle’s machine has a book value of $855,000. What amount of gain should Durler recognize on the exchange? a. $ -0b. $36,000 c. $90,000 d. $360,000
118.
Hoyle Company traded machinery with a book value of $570,000 and a fair value of $540,000. It received in exchange from Durler Company a machine with a fair value of $600,000. Hoyle also paid cash of $60,000 in the exchange. Durler’s machine has a book value of $570,000. What amount of gain or loss should Hoyle recognize on the exchange? a. $60,000 gain b. $ -0c. $3,000 loss d. $30,000 loss
Acquisition and Disposition of Property, Plant, and Equipment
10 - 27
119.
Peterson Company purchased machinery for $480,000 on January 1, 2009. Straight-line depreciation has been recorded based on a $30,000 salvage value and a 5-year useful life. The machinery was sold on May 1, 2013 at a gain of $9,000. How much cash did Peterson receive from the sale of the machinery? a. $69,000 b. $81,000 c. $99,000 d. $129,000
120.
Sutherland Company purchased machinery for $640,000 on January 1, 2009. Straight-line depreciation has been recorded based on a $40,000 salvage value and a 5-year useful life. The machinery was sold on May 1, 2013 at a gain of $12,000. How much cash did Sutherland receive from the sale of the machinery? a. $92,000. b. $108,000. c. $132,000. d. $172,000.
121.
Ecker Company purchased a new machine on May 1, 2004 for $264,000. At the time of acquisition, the machine was estimated to have a useful life of ten years and an estimated salvage value of $12,000. The company has recorded monthly depreciation using the straight-line method. On March 1, 2013, the machine was sold for $36,000. What should be the loss recognized from the sale of the machine? a. $0. b. $5,400. c. $12,000. d. $17,400.
122.
On January 1, 2004, Mill Corporation purchased for $304,000, equipment having a useful life of ten years and an estimated salvage value of $16,000. Mill has recorded monthly depreciation of the equipment on the straight-line method. On December 31, 2012, the equipment was sold for $56,000. As a result of this sale, Mill should recognize a gain of a. $0. b. $11,200. c. $27,200. d. $56,000.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
63. 64. 65. 66. 67. 68. 69. 70. 71.
b d d c c d d a b
72. 73. 74. 75. 76. 77. 78. 79. 80.
a b a c b a d a b
81. 82. 83. 84. 85. 86. 87. 88. 89.
c c b d b b d d a
90. 91. 92. 93. 94. 95. 96. 97. 98.
c a a c b a c a d
99. 100. 101. 102. 103. 104. 105. 106. 107.
c c c b d b d b c
108. 109. 110. 111. 112. 113. 114. 115. 116.
b d a d b a b b d
117. 118. 119. 120. 121. 122.
b d c c b b
10 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—CPA Adapted 123.
On December 1, 2012, Hogan Co. purchased a tract of land as a factory site for $900,000. 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 2012 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 Hogan 's December 31, 2012 balance sheet, what amount should be reported as land? a. $926,000. b. $962,000. c. $988,000. d. $996,000. 124.
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.
125.
A company is constructing an asset for its own use. Construction began in 2012. The asset is being financed entirely with a specific new borrowing. Construction expenditures were made in 2012 and 2013 at the end of each quarter. The total amount of interest cost capitalized in 2013 should be determined by applying the interest rate on the specific new borrowing to the a. total accumulated expenditures for the asset in 2012 and 2013. b. average accumulated expenditures for the asset in 2012 and 2013. c. average expenditures for the asset in 2013. d. total expenditures for the asset in 2013.
126.
Colt Football Co. had a player contract with Watts that is recorded in its books at $4,800,000 on July 1, 2012. Day Football Co. had a player contract with Kurtz that is recorded in its books at $6,000,000 on July 1, 2012. On this date, Colt traded Watts to Day for Kurtz and paid a cash difference of $600,000. The fair value of the Kurtz contract was $7,200,000 on the exchange date. The exchange had no commercial substance. After the exchange, the Kurtz contract should be recorded in Colt's books at a. $5,400,000. b. $6,000,000. c. $6,600,000. d. $7,200,000.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 29
127.
Huff Co. exchanged nonmonetary assets with Sayler Co. No cash was exchanged and the exchange had no commercial substance. The carrying amount of the asset surrendered by Huff exceeded both the fair value of the asset received and Sayler's carrying amount of that asset. Huff should recognize the difference between the carrying amount of the asset it surrendered and a. the fair value of the asset it received as a loss. b. the fair value of the asset it received as a gain. c. Sayler's carrying amount of the asset it received as a loss. d. Sayler's carrying amount of the asset it received as a gain.
128.
Chase County owned an idle parcel of real estate consisting of land and a factory building. Chase gave title to this realty to Patton Co. as an incentive for Patton to establish manufacturing operations in the County. Patton paid nothing for this realty, which had a fair market value of $250,000 at the date of the grant. Patton 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.
129.
On September 10, 2012, Jenks Co. incurred the following costs for one of its printing presses: Purchase of attachment $65,000 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. $77,000. c. $88,000. d. $95,000.
130.
On January 2, 2012, York 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
$170,000 10,000 4,000 20,000
The old boiler was sold for $4,000. What amount should York capitalize as the cost of the new boiler? a. $190,000. b. $186,000. c. $180,000. d. $170,000.
10 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
123. 124.
c b
125. 126.
b a
127. 128.
a b
129. 130.
d a
DERIVATIONS — Computational No.
Answer Derivation
63.
b
$800,000 + $80,000 – $5,400 + $3,480 + $2,400 + $6,400 = $886,880.
64.
d
$31,200 + $2,600 + $10,440 + $2,500,000 + $170,000 = $2,714,240.
65.
d
Land: $250,000 + $20,000 + $5,000 – $10,000 = $265,000. Building: $35,000 + $1,290,000 = $1,325,000.
66.
c
$12,000 + $800 + $200 + $225 = $13,225.
67.
c
$15,000 + $900 + $240 + $270 = $16,410.
68.
d
$50,000 + $35,000 = $85,000.
69.
d
$60,000 + $75,000 = $135,000.
70.
a
[($10,000,000 + $400,000) – $800,000] ÷ 40 = $240,000.
71.
b
($1,500,000 × 6/12) + ($3,150,000 × 4/12) = $1,800,000.
72.
a
[($20,000,000 + $800,000) – $1,600,000] ÷ 40 = $480,000.
73.
b
($2,000,000 × 6/12) + ($4,400,000 × 4/12) = $2,466,667.
74.
a
($240,000 × 4/12) + ($240,000 × 3/12) + ($240,000 × 2/12) + ($240,000 × 1/12) = $200,000.
75.
c
$600,000 × .10 = $60,000.
76.
b
$160,000 (3/12 + 2/12 + 1/12) = $80,000.
77.
a
$240,000 (3/12 + 2/12 + 1/12) = $120,000.
78.
d
($1,500,000 × 4/12) + ($840,000 × 3/12) + ($1,500,000 × 2/12) + ($2,400,000 × 1/12) = $1,160,000.
79.
a
($1,200,000 × 9% × 10/12) + ($500,000 × 12%) = $150,000.
80.
b
($1,200,000 × .09) + ($250,000 × .12) = $138,000.
81.
c
($880,000 × .1) + ($320,000 × .09) = $116,800.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 31
DERIVATIONS — Computational (cont.) No.
Answer Derivation
82.
c
($300,000 × 12/12) + ($900,000 × 4/12) + ($900,000 × 0/12) = $600,000.
83.
b
$600,000 (from # 82) × 12% = $72,000.
84.
d
[($300,000 + $900,000 + $900,000 + $72,000) × 9/12] + ($900,000 × 6/12) + ($600,000 × 0/12) = $2,079,000.
85.
b
$1,650,000 × 12% × 9/12 = $148,500; ($2,172,000 × 9/12) + ($900,000 × 6/12) = $2,079,000; [($2,079,000 – $1,650,000) × 9% × 9/12] + $148,500 = $177,458.
86.
b
($4,000,000 × 10/12) + ($3,300,000 × 7/12) + ($5,000,000 × 0/12) = $5,258,333.
87.
d
[($4,000,000 × .10) + ($7,500,000 × .11)] ÷ ($4,000,000 + $7,500,000) = 10.65%.
88.
d
$2,000,000 × 12% = $240,000; ($4,000,000 × 10/12) + ($3,300,000 × 7/12) = $5,258,333; [($5,258,333 – $2,000,000) × 10.65%] + $240,000 = $587,012.
89.
a
($2,000,000 × .12) + ($4,000,000 × .10) + ($7,500,000 × .11) = $1,465,000.
90.
c
($2,000,000 × .12) + ($4,000,000 × .10) + ($7,500,000 × .11) = $1,465,000; [($5,258,333 – $2,000,000) × 10.65%] + $2,000,000 × .12 = $587,012. $1,465,000 – $587,012 = $877,987.
91.
a
Equipment = $120,000 + $16,000; Loss: $142,000 – $120,000 = 22,000.
92.
a
$225,000 + $45,000 = $270,000.
93.
c
$135,000 + $21,000 = $156,000; $135,000 – $150,000 = $15,000.
94.
b
$48,000 + $16,000 = $64,000.
95.
a
$60,000 (fair value).
96.
c
$240,000 – $225,000 = $15,000; $180,000 (fair value).
97.
a
[$1,700,000 ÷ ($950,000 + $1,400,000 + $1,050,000 + $1,700,000)] × $2,800,000 = $933,333.
98.
d
[$1,400,000 ÷ ($950,000 + $1,400,000 + $1,050,000 + $1,700,000)] × $2,800,000 = $768,627.
99.
c
(3,000 × $50) – $9,000 = $141,000.
100.
c
$34,800 + $600 = $35,400.
101.
c
($45,000 × .85 × .98) + $600 + $450 = $38,535.
10 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
102.
b
$36,000 + $1,500 = $37,500.
103.
d
Land: 60/180 × $1,710,000 = $570,000. Warehouse: 40/180 × $1,710,000 = $380,000. Office Building: 80/180 × $1,710,000 = $760,000.
104.
b
$69,000 + $2,400 = $71,400.
105.
d
$34,800 – $30,000 = $4,800 (gain).
106.
b
Fair value of new truck = $54,000. Loss: ($54,000 – $45,000) – $12,000 = ($3,000). New Machine: $12,000 + $45,000 – $3,000 = $54,000.
107.
c
$28,000 + $91,000 = $119,000.
108.
b
$82,500 – ($360,000 – $285,000) = $7,500.
109.
d
$322,500 + $82,500 = $405,000.
110.
a
$16,000 × $32,000 = $6,400. $16,000 + $64,000
111.
d
$64,000 – ($32,000 – $6,400) = $38,400.
112.
b
$90,000 × $144,000 = $18,000. $90,000 + $630,000
113.
a
$630,000 – ($144,000 – $18,000) = $504,000 or $90,000 $576,000 − x $576,000 = $504,000. $720,000
114.
b
$360,000 + $90,000 = $450,000 or $720,000 – ($630,000 – $360,000) = $450,000.
115.
b
($400,000 – $240,000) × [$40,000 ÷ ($40,000 + $360,000)] = $16,000.
116.
d
$540,000 – $570,000 = ($30,000).
117.
b
($900,000 – $540,000) × [$90,000 ÷ ($90,000 + $810,000)] = $36,000.
118.
d
$540,000 – $570,000 = ($30,000).
119.
c
[($480,000 – $30,000) ÷ 5] × 4 1/3 = $390,000 ($480,000 – $390,000) + $9,000 = $99,000.
Acquisition and Disposition of Property, Plant, and Equipment
DERIVATIONS — Computational (cont.) No.
Answer Derivation
120.
c
[($640,000 – $40,000) ÷ 5] × 4 1/3 = $520,000 ($640,000 – $520,000) + $12,000 = $132,000.
121.
b
($264,000 – $12,000) ÷ (10 × 12) = $2,100 per month $36,000 – [$264,000 – ($2,100 × 106 mo.)] = –$5,400.
122.
b
($304,000 – $16,000) ÷ (10 × 12) = $2,400/mo.; $56,000 – [$304,000 – ($2,400 × 108)] = $11,200.
DERIVATIONS — CPA Adapted No.
Answer Derivation
123.
c
$900,000 + $70,000 + $10,000 + $16,000 – $8,000 = $988,000.
124.
b
Conceptual.
125.
b
Conceptual.
126.
a
($7,200,000 – $600,000) – $4,800,000 = $1,800,000 (deferred gain) $7,200,000 – $1,800,000 = $5,400,000 (Basis).
127.
a
Conceptual.
128.
b
Conceptual.
129.
d
$65,000 + $5,000 + $18,000 + $7,000 = $95,000.
130.
a
$170,000 + $20,000 = $190,000.
10 - 33
10 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Ex. 10-131—Plant asset accounting. During 2012 and 2013, Sawyer 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
2012 Net Book Value of Plant 2012 Assets at Net 12/31/12 Income
1. The cost of installing a new computer system in 2012 was not recorded in 2012. _______ It was charged to expense in 2013.
2013 Net Book Value of Plant 2013 Assets at Net 12/31/13 Income
______
______
______
_______
______
______
______
_______
______
______
______
_______
______
______
______
_______
______
______
______
_______
______
______
______
2. In 2013 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 2012, which extended its useful life by 5 years, was charged to accumulated depreciation in 2012. 4. Interest cost qualifying for capitalization in 2012 was charged to interest expense in 2012. 5. In 2012 land was bought for an employee parking lot. The $2,000 title search fee was charged to expense in 2012. 6. The cost of moving several manufacturing facilities from metropolitan locations to suburban areas in 2012 was capitalized. The cost was written off over a 10-year period beginning in 2012.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 35
Solution 10-131
1. 2. 3. 4. 5. 6.
Net Book Value of Plant Assets at 12/31/12 U NE NE U U NE
2012 Net Income O NE NE U U NE
Net Book Value of Plant Assets at 12/31/13 U O NE U U NE
2013 Net Income U O NE O NE NE
Ex. 10-132—Weighted-Average Accumulated Expenditures. On April 1, Paine Co. began construction of a small building. Payments of $180,000 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 $180,000 180,000 180,000 180,000
Capitalization Period 4/12 3/12 2/12 1/12
Weighted-Average Expenditures $ 60,000 45,000 30,000 15,000 $150,000
Solution 10-132 Date April 1 May 1 June 1 July 1
Ex. 10-133—Capitalization of interest. On March 1, Mocl Co. began construction of a small building. The following expenditures were incurred for construction: March 1 May 1 July 1
$ 150,000 360,000 200,000
April 1 June 1
$ 148,000 540,000
The building was completed and occupied on July 1. To help pay for construction $100,000 was borrowed on March 1 on a 12%, three-year note payable. The only other debt outstanding during the year was a $1,000,000, 10% note issued two years ago. Instructions (a) Calculate the weighted-average accumulated expenditures. (b) Calculate avoidable interest.
10 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 10-133 (a) Date March 1 April 1 May 1 June 1 July 1
(b)
Expenditures $ 150,000 148,000 360,000 540,000 200,000
Weighted-Average Accum. Expend. $100,000 92,000 $192,000
Capitalization Period 4/12 3/12 2/12 1/12 0
Rate .12 .10
Weighted-Average Accum. Expend. $50,000 37,000 60,000 45,000 0 $192,000
Avoidable Interest $ 12,000 9,200 $21,200
Ex. 10-134—Nonmonetary exchange. A machine cost $140,000, has annual depreciation expense of $28,000, and has accumulated depreciation of $70,000 on December 31, 2012. On April 1, 2013, when the machine has a fair value of $56,000, it is exchanged for a similar machine with a fair value of $168,000 and the proper amount of cash is paid. The exchange lacked commercial substance. Instructions Prepare all entries that are necessary at April 1, 2013.
Solution 10-134 Depreciation Expense ($28,000 × 3/12) ......................................... Accumulated Depreciation—Machinery ..............................
7,000
Accumulated Depreciation—Machinery .......................................... Machinery ...................................................................................... Loss on Disposal of Machinery ....................................................... Machinery .......................................................................... Cash ($168,000 – $56,000) ...............................................
77,000 168,000 7,000
7,000
140,000 112,000
Ex. 10-135—Nonmonetary exchange. Equipment that cost $240,000 and has accumulated depreciation of $189,000 is exchanged for equipment with a fair value of $96,000 and $24,000 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.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 37
Solution 10-135 (a) Cost Accumulated depreciation Book value Fair value ($96,000 + $24,000) Gain Gain recognized (24/120 × $69,000)
$240,000 (189,000) 51,000 120,000 $69,000 $ 13,800
(b) Accumulated Depreciation—Equipment .................................. Equipment .............................................................................. Cash ....................................................................................... Equipment ................................................................... Gain on Disposal of Equipment ................................... Check: Fair value Less deferred gain Basis of new equipment
189,000 40,800 24,000 240,000 13,800
$96,000 (55,200) $40,800
Ex. 10-136—Donated assets. Cheng 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 Cheng if Cheng will build a branch plant in Bel Aire. The appraised value of the property is $350,000 and of the warehouse is $700,000. Instructions Prepare the entry by Cheng for the receipt of the properties.
Solution 10-136 Buildings (Warehouse) ................................................................... Land............................................................................................... Contribution Revenue .........................................................
700,000 350,000 1,050,000
10 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 10-137—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 amortization, depletion, or depreciation only expense only asset(s) and expense some other account or combination of accounts
____ 1. A motor in one of North 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. ____ 3. Orlando 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. Jantzen 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. Jim Parra and Mary Lawson, 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 Milton 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 Lyon 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. Lambert 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.)
Acquisition and Disposition of Property, Plant, and Equipment
10 - 39
Solution 10-137 1. 2. 3. 4. 5.
b a or c a e a
6. 7. 8. 9. 10.
a b a e d
PROBLEMS Pr. 10-138—Capitalizing acquisition costs. Gibbs Manufacturing Co. was incorporated on 1/2/12 but was unable to begin manufacturing activities until 8/1/12 because new factory facilities were not completed until that date. The Land and Buildings account at 12/31/12 per the books was as follows: Date 1/31/12 2/28/12 4/1/12 5/1/12 5/1/12 5/1/12 8/1/12 8/1/12 12/31/12
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 4,500 170,000 170,000 30,000 75,000 $664,900
Additional information: 1. To acquire the land and building on 1/31/12, 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 fair value per share of $140. 2. When the old building was removed, Gibbs 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, 2012. 5. General expenses covered the following for the period 1/2/12 to 8/1/12. 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. Instructions Determine the proper balances as of 12/31/12 for a separate land account and a separate buildings account. Use separate T-accounts (one for land and one for buildings) labeling all the relevant amounts and disclosing all computations.
10 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 10-138 Land Land and old building ($100,000 plus $140,000) Removal of old building ($4,000 – $1,500) Legal fees Special assessment Balance
240,000 2,500 2,000 4,500 249,000
Buildings Legal Fees Partial payment Insurance (3 months) Final payment Superintendent's salary Balance
1,500 170,000 450 170,000 10,000 351,950
Pr. 10-139—Capitalization of interest. During 2012, Barden Building Company constructed various assets at a total cost of $10,500,000. The weighted average accumulated expenditures on assets qualifying for capitalization of interest during 2012 were $7,000,000. The company had the following debt outstanding at December 31, 2012: 1. 10%, 5-year note to finance construction of various assets, dated January 1, 2012, with interest payable annually on January 1
$4,500,000
2. 12%, ten-year bonds issued at par on December 31, 2006, with interest payable annually on December 31
5,000,000
3. 9%, 3-year note payable, dated January 1, 2011, with interest payable annually on January 1
2,500,000
Instructions Compute the amounts of each of the following (show computations). 1. Avoidable interest. 2. Total interest to be capitalized during 2012.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 41
Solution 10-139 1.
Weighted Average Accumulated Expenditures $4,500,000 2,500,000 $7,000,000
Applicable Interest Rate .10 .11*
*Computation of weighted average interest rate: Principal 12% ten-year bonds $5,000,000 9% 3-year note 2,500,000 $7,500,000
Avoidable Interest $450,000 275,000 $725,000 = Avoidable Interest
Interest $600,000 225,000 $825,000
Weighted average interest rate = $825,000 ÷ $7,500,000 = 11%. 2. Actual interest cost during 2012: Construction note, $4,500,000 × .10 12% ten-year bonds, $5,000,000 × .12 9% three-year note, $2,500,000 × .09
$ 450,000 600,000 225,000 $1,275,000
The interest cost to be capitalized is $725,000 (the lesser of the $725,000 avoidable interest and the $1,275,000 actual interest).
Pr. 10-140—Capitalization of interest. Early in 2012, Dobbs Corporation engaged Kiner, Inc. to design and construct a complete modernization of Dobbs's manufacturing facility. Construction was begun on June 1, 2012 and was completed on December 31, 2012. Dobbs made the following payments to Kiner, Inc. during 2012: Date Payment June 1, 2012 $4,800,000 August 31, 2012 7,200,000 December 31, 2012 6,000,000 In order to help finance the construction, Dobbs issued the following during 2012: 1. $4,000,000 of 10-year, 9% bonds payable, issued at par on May 31, 2012, 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, 2012. In addition to the 9% bonds payable, the only debt outstanding during 2012 was a $1,000,000, 12% note payable dated January 1, 2008 and due January 1, 2018, 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 2012. 3. Total amount of interest cost to be capitalized during 2012.
10 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 10-140 1. Date June 1 August 31 December 31
2.
3.
Capitalization Expenditures $4,800,000 7,200,000 6,000,000
Weighted-Average Accumulated Expenditures $4,000,000 1,200,000 $5,200,000
Weighted-Average Accumulated Expenditures $2,800,000 2,400,000 0 $5,200,000
Period 7/12 4/12 0
Appropriate Interest Rate .09 .12
Avoidable Interest $360,000 144,000 $504,000
Actual interest incurred during 2012: 9% bonds payable, $4,000,000 × .09 × 7/12 12% note payable, $1,000,000 × .12
$210,000 120,000 $330,000
The interest cost to be capitalized is $330,000 (the lesser of the $504,000 avoidable interest and the $330,000 actual interest cost).
Pr. 10-141—Asset acquisition. Ford Inc. plans to acquire an additional machine on January 1, 2012 to meet the growing demand for its product. Stever Company offers to provide the machine to Ford using either of the options listed below (each option gives Ford exactly the same machine and gives Stever Company approximately the same net present value cash equivalent at 10%). Option 1 — Cash purchase $1,600,000. Option 2 — Installment purchase requiring 15 annual payments of $210,358 due December 31 each year. The expected economic life of this machine to Ford is 15 years. Salvage value at that time is estimated to be $100,000. Straight-line depreciation is used. Interest expense under Option 2 is computed using the effective interest method. Instructions Based upon current generally accepted accounting principles, state how, if at all, the book value of the machine and the liability should appear on the December 31, 2012 balance sheet of Ford Inc., for each option. Present your answer on an answer sheet in the following format. If an item should not appear in the balance sheet, write "not shown" opposite the option. Assets Account Name Option 1
Option 2
Amount
Liabilities Account Name Amount
Acquisition and Disposition of Property, Plant, and Equipment
10 - 43
Solution 10-141
Option 1
Option 2
Assets Account Name Amount Machinery $1,600,000 Accum. Depr. 100,000
Liabilities Account Name Amount "not shown"
Machinery Accum. Depr.
Notes Payable— Current $ 55,394 Notes Payable— Long-term 1,494,248
$1,600,000 100,000
Computations: At January 1, 2012, the note payable is $1,600,000. At December 31, 2012, after the first payment of $210,358 has been made ($160,000 interest) $1,549,642 principal remains, of which $1,494,248 is long-term and $55,394 is current [$210,358 – (10% × $1,549,642)]. Note: $210,358 × 7.60608 (Table 6-4) = $1,600,000, the present value of the liability on January 1, 2012.
Pr. 10-142—Nonmonetary exchanges. Moore 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 2013: March 31, 2013— Negotiations which began in 2012 were completed and a building purchased 1/1/04 (depreciation has been properly charged through December 31, 2012) at a cost of $4,800,000 with a fair value of $3,000,000 was exchanged for a second building which also had a fair value of $3,000,000. The exchange had no commercial substance. Both parcels of land on which the buildings were located were equal in value, and had a fair value equal to book value. June 30, 2013— Machinery with a cost of $480,000 and accumulated depreciation through January 1 of $360,000 was exchanged with $300,000 cash for a parcel of land with a fair value of $460,000. Instructions Prepare all appropriate journal entries for Moore Corporation for the above dates.
Solution 10-142 3/31/13 Depreciation Expense ..................................................... Accumulated Depreciation—Buildings .............. ($4,800,000 × 5% × 1/4)
60,000
Buildings .................................................................... 2,580,000 Accumulated Depreciation—Buildings ............................. 2,220,000 Buildings ........................................................... ($4,800,000 × 5% × 9 1/4 = $2,220,000)
60,000
4,800,000
10 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 10-142 (cont.) 6/30/11 Depreciation Expense. ..................................................... Accumulated Depreciation—Machinery ............. ($480,000 × 10% × 1/2)
24,000 24,000
Land ................................................................................ 460,000 Accumulated Depreciation—Machinery ........................... 384,000 Gain on Disposal of Machinery .......................... Machinery.......................................................... Cash .................................................................. [$160,000 – ($480,000 – $384,000)] = $64,000
64,000 480,000 300,000
Pr. 10-143—Nonmonetary exchange. Rogers Co. had a sheet metal cutter that cost $144,000 on January 5, 2008. This old cutter had an estimated life of ten years and a salvage value of $24,000. On April 3, 2013, the old cutter is exchanged for a new cutter with a fair value of $72,000. The exchange lacked commercial substance. Rogers also received $18,000 cash. Assume that the last fiscal period ended on December 31, 2012, and that straight-line depreciation is used. Instructions (a) Show the calculation of the amount of the gain or loss to be recognized by Rogers Co. (b) Prepare all entries that are necessary on April 3, 2013. Show a check of the amount recorded for the new cutter.
Solution 10-143 (a)
(b)
Cost Accumulated depreciation (5 1/4 × $12,000) Book value Fair value ($72,000 + $18,000) Gain
$144,000 (63,000) 81,000 90,000 $ 9,000
Gain recognized (18/90 × $9,000)
$ 1,800
Depreciation Expense ......................................................... Accumulated Depreciation—Machinery ...................
3,000
Accumulated Depreciation—Machinery .............................. Machinery ........................................................................... Cash ................................................................................... Machinery .............................................................. Gain on Disposal of Machinery ...............................
63,000 64,800 18,000
Check: Fair value Less deferred gain Basis of new machinery
$72,000 (7,200) $64,800
3,000
144,000 1,800
Acquisition and Disposition of Property, Plant, and Equipment
10 - 45
Pr. 10-144—Nonmonetary exchange. Layne Co. has a machine that cost $425,000 on March 20, 2009. This old machine had an estimated life of ten years and a salvage value of $25,000. On December 23, 2013, the old machine is exchanged for a new machine with a fair value of $270,000. The exchange lacked commercial substance. Layne also received $30,000 cash. Assume that the last fiscal period ended on December 31, 2012, and that straight-line depreciation is used. Instructions (a) Show the calculation of the amount of gain or loss to be recognized by Layne Co. from the exchange. (Round to the nearest dollar.) (b) Prepare all entries that are necessary on December 23, 2013. Show a check of the amount recorded for the new machine.
Solution 10-144 (a)
(b)
Cost Accumulated depreciation (4 3/4 × $40,000) Book value Fair value ($270,000 + $30,000) Gain
$425,000 (190,000) 235,000 300,000 $ 65,000
Gain recognized (30/300 × $65,000)
$
Depreciation Expense ........................................................ Accumulated Depreciation Machinery ..................... Accumulated Depreciation Machinery................................. Machinery........................................................................... Cash ................................................................................... Machinery ............................................................... Gain on Disposal of Machinery ............................... Check: Fair value Deferred gain Basis of new machine
6,500 40,000 40,000 190,000 211,500 30,000 425,000 6,500
$270,000 (58,500) $211,500
Pr. 10-145—Nonmonetary exchange. Hodge Co. exchanged Building 24 which has an appraised value of $6,400,000, a cost of $10,120,000, and accumulated depreciation of $4,800,000 for Building M belonging to Fine Co. Building M has an appraised value of $6,016,000, a cost of $12,040,000, and accumulated depreciation of $6,336,000. 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 Hodge's books. (Round to the nearest dollar.)
10 - 46 Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 10-145 Hodge Co.: Cost Accumulated depreciation Book value Fair value Gain
$10,120,000 4,800,000 5,320,000 6,400,000 $ 1,080,000
Gain recognized (384/6,400 × $1,080,000) $64,800 Accumulated Depreciation—Buildings ................................ 4,800,000 Building M ........................................................................... 5,000,800 Cash ................................................................................... 384,000 Building 24 .............................................................. Gain on Disposal of Plant Assets ............................ Check: Fair value Deferred gain Basis for Building M Fine Co.: Cost Accumulated depreciation Book value Fair value Gain
10,120,000 64,800
$6,016,000 (1,015,200) $5,000,800
$12,040,000 6,336,000 5,704,000 6,016,000 $ 312,000
Accumulated Depreciation—Buildings ................................ 6,336,000 Building 24 .......................................................................... 6,088,000 Building M ............................................................... Cash .......................................................................
12,040,000 384,000
Pr. 10-146—Nonmonetary exchange. Beeman Company exchanged machinery with an appraised value of $2,925,000, a recorded cost of $4,500,000 and accumulated depreciation of $2,250,000 with Lacey Corporation for machinery Lacey owns. The machinery has an appraised value of $2,825,000, a recorded cost of $5,400,000, and accumulated depreciation of $2,970,000. Lacey also gave Beeman $100,000 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.)
Acquisition and Disposition of Property, Plant, and Equipment
10 - 47
Solution 10-146 (a)
Commercial Substance Beeman Machinery...................................... 2,825,000 Cash.............................................. 100,000 Accum. Depreciation— Machinery ................................. 2,250,000 Gain on Disposal of Machinery .................... 675,000 Machinery ....................... 4,500,000 Lacey Machinery...................................... 2,925,000 Accum. Depreciation— Machinery ................................. 2,970,000 Gain on Disposal of Machinery .................... 395,000 Machinery ....................... 5,400,000 Cash ............................... 100,000
(b)
Cost A/D BV FV Gain
$4,500,000 2,250,000 2,250,000 2,925,000 $ 675,000
Cost A/D BV FV Gain
$5,400,000 2,970,000 2,430,000 2,825,000 $ 395,000
No Commercial Substance Beeman Machinery................................................................................... 2,173,077 Cash........................................................................................... 100,000 Accumulated Deprecation—Machinery....................................... 2,250,000 Gain on Disposal of Machinery .................................... Machinery ....................................................................
23,077 4,500,000
$100,000 ÷ ($100,000 + $2,825,000) × $675,000 = $23,077 Lacey Machinery................................................................................... 2,530,000 Accumulated Depreciation—Machinery ...................................... 2,970,000 Machinery .................................................................... Cash ............................................................................
5,400,000 100,000
10 - 48 Test Bank for Intermediate Accounting, Fourteenth Edition
Short Answer: 1. What are the major characteristics of plant assets? 1. The major characteristics of plant assets are (1) that they are acquired for use in operations and not for resale, (2) that they are long-term in nature and usually subject to depreciation, and (3) that they have physical substance. 2. What interest rates should be used in determining the amount of interest to be capitalized? How should the amount of interest to be capitalized be determined? 2. The avoidable interest is determined by multiplying (an) interest rate(s) by the weightedaverage amount of accumulated expenditures on qualifying assets. For the portion of weighted-average accumulated expenditures which is less than or equal to any amounts borrowed specifically to finance construction of the assets, the capitalization rate is the specific interest rate incurred. For the portion of weighted-average accumulated expenditures which is greater than specific debt incurred, the interest rate is a weighted average of all other interest rates incurred. The amount of interest to be capitalized is the avoidable interest, or the actual interest incurred, whichever is lower.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 49
IFRS QUESTIONS True/False 1. Under international accounting standards, historical cost is the preferred treatment for property, plant, and equipment. 2. Recently changes to IFRS require companies to capitalize borrowing costs related to qualifying assets. 3. Under IFRS, interest costs incurred during construction of a plant asset cannot be capitalized. 4. Under IFRS, if a company uses the revaluation model for fixed assets, companies must revalue the class of assets regularly. 5. Under IFRS, assets that qualify for interest capitalization are assets that are in use or ready for their intended use. Answers to True/False: 1. True 2. True 3. False 4. True 5. False Multiple Choice 1. Under IFRS, Sampson Company, who has a non-current asset which has been classified as held-for-sale, should a. test the asset's value monthly for impairment. b. value the asset at its depreciated historical cost. c. depreciate the asset over its remaining life. d. not depreciate the asset. 2. Miller Company, a company who uses IFRS reporting standards, sells a non-current asset classified as held-for-sale. Which of the following statements is true regarding the treatment of a gain on a subsequent increase in the fair value less cost? a. The gain should not be recognized. b. The gain should be recognized in full in the income statement. c. The gain should be recognized but only in retained earnings. d. The gain should be recognized to the extent that it is not in excess of the cumulative impairment loss that has been recognized.
10 - 50 Test Bank for Intermediate Accounting, Fourteenth Edition
3. Danson Company, a company who uses IFRS reporting standards, has a non-current asset that has been classified as held-for-sale. When the asset no longer meets this definition, Danson should a. remove the asset from the statement of financial position. b. remeasure the asset at fair value. c. measure the asset at the lower of its carrying value before it was classified as held-forsale and its recoverable amount at the date when the company decided not to sell it. d. leave the non-current asset on the financial statements at the current carrying value. 4. Elton Industries, a company who uses IFRS reporting standards, has assets and liabilities of a disposal group classified as held-for-sale shown on its statement of financial position. Which of the following presents the best treatment for these? a. These assets and liabilities should be netted and presented as a single amount - either a current asset or a current liability on the statement of financial position. b. On the balance sheet, the disposal group assets should be shown separately from other assets, while the disposal group liabilities should be shown separately from other liabilities. c. The assets and liabilities should be netted and presented as a deduction from equity on the statement of financial position. d. There should be no separate disclosure of these assets and liabilities on the statement of financial position.
Acquisition and Disposition of Property, Plant, and Equipment
10 - 51
5. Woodson Company, a company who uses IFRS reporting standards, has identified a group of plant assets for disposal. On January 1, 2012, the carrying value of these assets was $17.5 million. The assets were revalued to $16.5 million on January 5, 2012, when they were identified as property for the disposal group. In addition, Woodson thinks that it will cost $1.5 million to sell these assets. What carrying amount should these assets reflect for year-end financial statements to be prepared on January 10, 2012? a. $17.5 million b. $16.5 million c. $16.0 million d. $15.0 million 6. Thomas Company, a company who uses IFRS reporting standards, is disposing of a plant asset. The amount of gain or loss from this disposal is a. reported as the difference between the sales proceeds and the carrying amount of the asset. b. not reported. c. reported as the fair value less the recoverable amount. d. reported as the difference between the net cash flows of the productive years of the asset and its carrying value. 7. On January 1, 2012, Jackson Company has a building with a carrying value of $50,000 and a remaining useful life 5 years that was recently valued at $150,000. Assuming that the company uses straight-line depreciation, IFRS would show the depreciation as a. $10,000 b. $30,000 c. $20,000 d. More than one of these answers could be correct. 8. Tram Industries, a company who uses IFRS reporting standards, is installing a new plant. The company has incurred the following costs 1. Operating losses before commercial production $ 200,000 2. Cost of the plant 1,500,000 3. Initial delivery and handling charges 300,000 4. Cost of site preparation 175,000 Which of these costs can Tram capitalize in accordance with IFRS? a. 1, 2, 3, & 4 b. 2 & 4 c. 2, 3, & 4 d. 1, 2, & 4
10 - 52 Test Bank for Intermediate Accounting, Fourteenth Edition 9. Icon Industries, a company who uses IFRS reporting standards, is installing a new plant. The company has incurred the following costs 1. Consultants used for advice on the acquisition of the plant $245,000 2. Interest charges paid to the supplier of plant for deferred credit $275,000 3. Estimated dismantling cost to be incurred after 8 years $400,000 4. Cost of the plant $2,300,000 Which of these costs can Tram capitalize in accordance with IFRS? a. 1, 2, 3, & 4 b. 4 only c. 1 & 4 d. 1, 3, & 4 10. All of the following are true regarding the revaluation model allowed under IFRS except a. once selected, the revaluation policy applies to an entire class of property, plant and equipment. b. revaluations must be made regularly to ensure that the carrying value is not materially different from fair value. c. after initial recognition, the revalued amount is fair value less subsequent depreciation and impairment losses. d. when an asset is revalued, any increase in carrying amount is reported as miscellaneous revenue. Answers to Multiple Choice: 1. d 2. d 3. c 4. b 5. d 6. a 7. d 8. c 9. d 10. d
CHAPTER 11 DEPRECIATION, IMPAIRMENTS, AND DEPLETION IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
T F T T F F T F F T T 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
Nature of depreciation. Nature of depreciation. Depreciation, depletion, and amortization. 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. Group or composite approach. Use of the composite approach. Accounting for changes in estimates. Computation of impairment loss amount. First step in determining an impairment. Reporting impaired assets held for disposal. Method used to compute depletion. Costs included in depletion base. Computing asset turnover ratio. Profit margin on sales ratio.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
d b c b a a d d d a a d d c c b
21. 22. 23. S 24. S 25. P 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36.
Knowledge of depreciation accounting. Conceptual rationale for depreciation accounting. Depreciation and retaining funds. Definition of depreciation. Service life vs. physical life. Definition of depreciable cost. Economic factors affecting useful service life. Factors involved in computing depreciation. Straight-line method assumption. 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.
11 - 2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
b d c c b b c b b d d d a d d c b b d d d c d c
37. 38. P 39. S 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. S 52. S 53. P 54. 55. 56. 57. *58. *59. *60.
Group method of depreciation. Identification of composite life. Group method of depreciation. Composite or group depreciation. Partial-year depreciation computation. Depreciation for part year. Change in estimated life of depreciable asset. Reporting a change in estimate. Recording an asset impairment. Depreciation and cost depletion similarities. Difference between depreciation and cost depletion. Depreciation and liquidating dividends. Classification of depletion expense. Units-of-production depletion expense. Reserve recognition accounting. Items part of depletion cost. Required disclosures for depreciation. Definition of book value. Disclosure of depreciation policy. Asset turnover ratio. Return on total assets ratio. Objectives of MACRS method. Factors to consider in MACRS tax depreciation. Effect of accelerated depreciation on the income statement.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. * This topic is dealt with in an Appendix to the chapter. S
MULTIPLE CHOICE—Computational Answer
No.
Description
c c b c b c b c b c b b b b c
61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75.
Factors involved in depreciation. Calculate depreciation using activity method. Calculate double-declining balance depreciation. Calculate double-declining balance depreciation. Calculate depreciation using activity method. Calculate depreciation using activity method. Calculate depreciation using activity method. Calculate depreciation using double-declining balance method. Calculate depreciation using activity method. Calculate depreciation using double-declining balance method. Calculate depreciation using double-declining balance. Calculate depreciation using double-declining balance. Calculate depreciation using double-declining balance. Calculate depreciation using double-declining balance. Sum-of-the-years'-digits method.
Depreciation, Impairments, and Depletion
11 - 3
MULTIPLE CHOICE—Computational (cont.) Answer
No.
Description
b a c c b c a
76. 77. 78. 79. 80. 81. 82.
c
83.
a a d c d c a b b c a d a c b a b c c c b d b a b c a d c c c a d
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. *115. *116.
Sum-of-the-years'-digits method. Calculate depreciation using sum-of-the-years'-digits. Calculate depreciation using sum-of-the-years'-digits. Determine acquisition cost from sum-of-the-years'-digits. Determine acquisition cost from sum-of-the-years'-digits. Calculate gain on sale of machinery. Determine depreciation expense from change in Accumulated Depreciation account. Determine depreciation expense from change in Accumulated Depreciation account. Determine composite rate of depreciation. Determine composite life of a group of assets. Depreciation and partial periods. Change in estimated useful life. Depreciation and partial periods. Change in estimated useful life. Entry under composite method. Calculate depreciation expense after change in estimate. Compute composite depreciation rate. Compute composite life of assets. Determine amount of impairment loss. Recognizing loss on impairment. Recognizing loss on impairment. Recognizing loss on impairment. Change in estimated life of equipment. Determine depreciation expense after major overhaul. Determine depreciation expense after major overhaul. Record permanent impairment in value of fixed asset. 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. Calculate depletion per ton. Entry to record depletion. Calculate asset turnover ratio. Calculate return on total assets. Calculate asset turnover ratio. Calculate return on total assets. Calculate asset turnover ratio. Calculate asset turnover ratio. Calculate MACRS depreciation for the year. Calculate MACRS depreciation using optional straight-line method.
11 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
c b b a d b b b c
117. 118. 119. 120. 121. 122. 123. 124. 125.
Calculate depreciation using 150% declining balance. Double-declining balance method. Determine accumulated depreciation balance using sum-of-the-years'-digits. Calculate depreciation expense using sum-of-the-years'-digits. Effect of salvage value on accumulated depreciation. Effect of including salvage value in depreciation base. Effect of decreasing charge methods on sale of asset. Units-of-production depletion expense. Calculate depletion expense for the year.
EXERCISES Item E11-126 E11-127 E11-128 E11-129 E11-130 E11-131 E11-132 E11-133
Description Definitions. Depreciation methods. True or False. Calculate depreciation. Calculate depreciation. Asset depreciation and disposition. Composite depreciation. Depletion allowance.
PROBLEMS Item P11-134 P11-135 P11-136 P11-137
Description Depreciation methods. Adjustment of depreciable base. Impairment. Impairment.
CHAPTER LEARNING OBJECTIVES 1.
Explain the concept of depreciation.
2.
Identify the factors involved in the depreciation process.
3.
Compare activity, straight-line, and decreasing charge methods of depreciation.
4.
Explain special depreciation methods.
5.
Explain the accounting issues related to asset impairment.
6.
Explain the accounting procedures for depletion of natural resources.
7.
Explain how to report and analyze property, plant, and equipment and natural resources.
*8.
Describe income tax methods of depreciation.
Depreciation, Impairments, and Depletion
11 - 5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2.
TF TF
3. 21.
TF MC
4. 5.
TF TF
6. S 25.
TF MC
7. 8. 9. S 29. 30. 31. 32.
TF TF TF MC MC MC MC
33. 34. 35. 36. 62. 63. 64.
MC MC MC MC MC MC MC
11. 12. 13.
TF TF TF
37. 38. P 39.
MC MC MC
14. 15. 16.
TF TF TF
42. 43. 44.
MC MC MC
45. 94. 95.
17. 18. 46.
TF TF MC
47. 48. 49.
MC MC MC
50. 51. S 52.
19. 20.
TF TF
53. 54.
MC MC
55. 56.
58.
MC
59.
MC
60.
Note:
S P
22. 23. P
26. 27. 65. 66. 67. 68. 69. 70. 71.
S S
TF = True-False MC = Multiple Choice P = Problem E = Exercise
40. 41. 84.
Type
Item
Type
Item
Learning Objective 1 S MC 24. MC MC 126. E Learning Objective 2 MC 28. MC 62. MC 61. MC 127. Learning Objective 3 MC 72. MC 79. MC 73. MC 80. MC 74. MC 81. MC 75. MC 82. MC 76. MC 83. MC 77. MC 117. MC 78. MC 118. Learning Objective 4 MC 85. MC 88. MC 86. MC 89. MC 87. MC 90. Learning Objective 5 MC 96. MC 99. MC 97. MC 100. MC 98. MC 101. Learning Objective 6 MC 102. MC 105. MC 103. MC 106. MC 104. MC 107. Learning Objective 7 MC 57. MC 110. MC 109. MC 111. Learning Objective *8 MC 115. MC 116.
Type
Item
Type
Item
Type
MC MC MC MC MC MC MC
119. 120. 121. 122. 123. 127. 128.
MC MC MC MC MC E E
129. 130. 131. 134.
E E E P
MC MC MC
91. 92. 93.
MC MC MC
128. 132.
E E
MC MC MC
127. 135. 136.
E P P
137.
P
MC MC MC
108. 124. 125.
MC MC MC
133.
E
MC MC
112. 113.
MC MC
114.
MC
MC E
MC
11 - 6
Test Bank for Intermediate Accounting, Fourteenth Edition
TRUE-FALSE—Conceptual 1.
Depreciation is a means of cost allocation, not a matter of valuation.
2.
Depreciation is based on the decline in the fair market value of the asset.
3.
Depreciation, depletion, and amortization all involve the allocation of the cost of a longlived asset to expense.
4.
The cost of an asset less its salvage value is its depreciation base.
5.
The three factors involved in the depreciation process are the depreciation base, the useful life, and the risk of obsolescence.
6.
Inadequacy is the replacement of one asset with another more efficient and economical asset.
7.
The major objection to the straight-line method is that it assumes the asset’s economic usefulness and repair expense are the same each year.
8.
The units-of-production approach to depreciation is appropriate when depreciation is a function of time instead of activity.
9.
An accelerated depreciation method is appropriate when the asset’s economic usefulness is the same each year.
10.
The declining-balance method does not deduct the salvage value in computing the depreciation base.
11.
Gains or losses on disposals of assets do not distort periodic income when the group or composite method is used to compute depreciation.
12.
Companies frequently use the composite approach when the assets are similar in nature and have approximately the same useful lives.
13.
Changes in estimates are handled prospectively by dividing the asset’s book value less any salvage value by the remaining estimated life.
14.
An impairment loss is the amount by which the carrying amount of the asset exceeds the sum of the expected future net cash flows from the use of that asset.
15.
The first step in determining whether an impairment has occurred is to estimate the future net cash flows expected from the use of that asset and its eventual disposition.
16.
Impaired assets held for disposal should be reported at the lower of cost or net realizable value.
17.
Normally, companies compute depletion on a straight-line basis.
18.
Intangible development costs and restoration costs are part of the depletion base.
Depreciation, Impairments, and Depletion
11 - 7
19.
The asset turnover ratio is computed by dividing net sales by ending total assets.
20.
The profit margin on sales ratio is a measure for analyzing the use of property, plant, and equipment.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. T F T T F
Item 6. 7. 8. 9. 10.
Ans. F T F F T
Item 11. 12. 13. 14. 15.
Ans. T F T F T
Item 16. 17. 18. 19. 20.
Ans. T F T F T
MULTIPLE CHOICE—Conceptual
S
21.
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.
22.
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
23.
Depreciation accounting a. provides funds. b. funds replacements. c. retains funds. d. all of these.
24.
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.
11 - 8
Test Bank for Intermediate Accounting, Fourteenth Edition
S
25.
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.
P
26.
The term "depreciable base," or "depreciation base," as it is used in accounting, refers to a. the total amount to be charged (debited) to expense over an asset's useful life. b. the cost of the asset less the related depreciation recorded to date. c. the estimated market value of the asset at the end of its useful life. d. the acquisition cost of the asset.
27.
Economic factors that shorten the service life of an asset include a. obsolescence. b. supersession. c. inadequacy. d. all of these.
28.
Which of the following is not one of the basic questions that must be answered before the amount of depreciation charge can be computed? a. What is the depreciation base to use for the asset? b. What is the asset's useful life? c. What method of cost apportionment is best for this asset? d. What product or service is the asset related to?
29.
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.
30.
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.
31.
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.
S
Depreciation, Impairments, and Depletion
11 - 9
32.
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.
33.
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.
34.
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.
35.
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
36.
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.
37.
Each year a company has been investing an increasingly greater amount in machinery. Since there is a large number of small items with relatively similar useful lives, the company has been applying straight-line depreciation at a uniform rate to the machinery as a group. The ratio of this group's total accumulated depreciation to the total cost of the machinery has been steadily increasing and now stands at .75 to 1.00. The most likely explanation for this increasing ratio is the a. company should have been using one of the accelerated methods of depreciation. b. estimated average life of the machinery is less than the actual average useful life. c. estimated average life of the machinery is greater than the actual average useful life. d. company has been retiring fully depreciated machinery that should have remained in service.
38.
For the composite method, the composite a. rate is the total cost divided by the total annual depreciation. b. rate is the total annual depreciation divided by the total depreciable cost. c. life is the total cost divided by the total annual depreciation. d. life is the total depreciable cost divided by the total annual depreciation.
11 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition P
39.
Watkins Truck Rental uses the group depreciation method for its fleet of trucks. When it retires one of its trucks and receives cash from a salvage company, the carrying value of property, plant, and equipment will be decreased by the a. original cost of the truck. b. original cost of the truck less the cash proceeds. c. cash proceeds received. d. cash proceeds received and original cost of the truck.
S
40.
Composite or group depreciation is a depreciation system whereby a. the years of useful life of the various assets in the group are added together and the total divided by the number of items. b. the cost of individual units within an asset group is charged to expense in the year a unit is retired from service. c. a straight-line rate is computed by dividing the total of the annual depreciation expense for all assets in the group by the total cost of the assets. d. the original cost of all items in a given group or class of assets is retained in the asset account and the cost of replacements is charged to expense when they are acquired.
S
41.
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.
42.
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.
43.
Myers Company acquired machinery on January 1, 2007 which it depreciated under the straight-line method with an estimated life of fifteen years and no salvage value. On January 1, 2012, Myers estimated that the remaining life of this machinery was six years with no salvage value. How should this change be accounted for by Myers? a. As a prior period adjustment b. As the cumulative effect of a change in accounting principle in 2012 c. By setting future annual depreciation equal to one-sixth of the book value on January 1, 2012 d. By continuing to depreciate the machinery over the original fifteen year life
44.
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.
Depreciation, Impairments, and Depletion
11 - 11
45.
Lynch 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.
46.
Which of following is not a similarity in the accounting treatment for depreciation and cost depletion? a. The estimated life is based on economic or productive life. b. Assets subject to either are reported in the same classification on the balance sheet. c. The rates may be changed upon revision of the estimated productive life used in the original rate computations. d. Both depreciation and depletion are based on time.
47.
Which of the following is not a difference between the accounting treatment for depreciation and cost depletion? a. Depletion applies to natural resources while depreciation applies to plant and equipment. b. Depletion refers to the physical exhaustion or consumption of the asset while depreciation refers to the wear, tear, and obsolescence of the asset. c. Many formulas are used in computing depreciation but only one is used to any extent in computing depletion. d. The cost of the asset is the starting point from which computation of the amount of the periodic charge is made to operations for depreciation, but the fair value reassessed each year as the starting point for the periodic charge for depletion.
48.
Dividends representing a return of capital to stockholders are not uncommon among companies which a. use accelerated depreciation methods. b. use straight-line depreciation methods. c. recognize both functional and physical factors in depreciation. d. none of these.
49.
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.
50.
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.
11 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition 51.
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.
S
52.
Of the following costs related to the development of natural resources, which one is not a part of depletion cost? a. Acquisition cost of the natural resource deposit b. Exploration costs c. Tangible equipment costs associated with machinery used to extract the natural resource d. Intangible development costs such as drilling costs, tunnels, and shafts
S
53.
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.
P
54.
The book value of a plant asset is a. the fair market value of the asset at a balance sheet date. b. the asset's acquisition cost less the total related depreciation recorded to date. c. equal to the balance of the related accumulated depreciation account. d. the assessed value of the asset for property tax purposes.
55.
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.
56.
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.
57.
The rate of return on total assets is computed by dividing a. Net income by ending total assets. b. Net sales by average total assets. c. Net sales by ending total assets. d. Net income by average total assets.
Depreciation, Impairments, and Depletion
11 - 13
*58.
A major objective of MACRS for tax depreciation is to a. reduce the amount of depreciation deduction on business firms' tax returns. b. assure that the amount of depreciation for tax and book purposes will be the same. c. help companies achieve a faster write-off of their capital assets. d. require companies to use the actual economic lives of assets in calculating tax depreciation.
*59.
Under MACRS, which one of the following is not considered in determining depreciation for tax purposes? a. Cost of asset b. Property recovery class c. Half-year convention d. Salvage value
*60.
If income tax effects are ignored, accelerated depreciation methods a. provide funds for the earlier replacement of fixed assets. b. increase funds provided by operations. c. tend to offset the effect of steadily increasing repair and maintenance costs on the income statement. d. tend to decrease the fixed asset turnover ratio.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26.
d b c b a a
27. 28. 29. 30. 31. 32.
d d d a a d
33. 34. 35. 36. 37. 38.
d c c b b d
39. 40. 41. 42. 43. 44.
c c b b c b
45. 46. 47. 48. 49. 50.
b d d d a d
51. 52. 53. 54. 55. 56.
d c b b d d
57. *58. *59. *60.
d c d c
Solutions to those Multiple Choice questions for which the answer is “none of these.” 48.
do not expect to purchase additional property after depleting existing property.
MULTIPLE CHOICE—Computational 61.
Ferguson Company purchased a depreciable asset for $120,000. 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. $11,000 b. $12,000 c. $110,000 d. $120,000
11 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition 62.
Hamilton Company purchased a depreciable asset for $240,000. The estimated salvage value is $20,000, 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. $22,000 b. $24,000 c. $220,000 d. $240,000
63.
Solar Products purchased a machine for $39,000 on July 1, 2012. The company intends to depreciate it over 4 years using the double-declining balance method. Salvage value is $3,000. Depreciation for 2012 is a. $19,500 b. $9,750 c. $14,625 d. $9,000
64.
Solar Products purchased a machine for $39,000 on July 1, 2012. The company intends to depreciate it over 4 years using the double-declining balance method. Salvage value is $3,000. Depreciation for 2013 is a. $19,500 b. $9,750 c. $14,625 d. $9,000
65.
Gardner Corporation purchased a truck at the beginning of 2012 for $90,000. The truck is estimated to have a salvage value of $3,600 and a useful life of 120,000 miles. It was driven 18,000 miles in 2012 and 32,000 miles in 2013. What is the depreciation expense for 2012? a. $13,500 b. $12,960 c. $21,600 d. $36,000
66.
Gardner Corporation purchased a truck at the beginning of 2012 for $90,000. The truck is estimated to have a salvage value of $3,600 and a useful life of 120,000 miles. It was driven 18,000 miles in 2012 and 32,000 miles in 2013. What is the depreciation expense for 2013? a. $24,000 b. $36,000 c. $23,040 d. $38,400
67.
Kinder Company purchased a depreciable asset for $280,000. The estimated salvage value is $14,000, and the estimated useful life is 10,000 hours. Kinder 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. $26,600 b. $29,260 c. $30,800 d. $266,000
Depreciation, Impairments, and Depletion
11 - 15
68.
Jamar Company purchased a depreciable asset for $225,000. The estimated salvage value is $15,000, 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. $26,250 b. $39,375 c. $42,188 d. $56,250
69.
Engels Company purchased a depreciable asset for $800,000. The estimated salvage value is $40,000, and the estimated useful life is 10,000 hours. Engels 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. $76,000 b. $83,600 c. $88,000 d. $760,000
70.
Hart Company purchased a depreciable asset for $450,000. The estimated salvage value is $30,000, 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. $52,500 b. $78,750 c. $84,375 d. $112,500
71.
On July 1, 2012, Gonzalez Corporation purchased factory equipment for $225,000. Salvage value was estimated to be $6,000. The equipment will be depreciated over ten years using the double-declining balance method. Counting the year of acquisition as one-half year, Gonzalez should record depreciation expense for 2013 on this equipment of a. $45,000. b. $40,500. c. $39,420. d. $36,000.
72.
Krause Corporation purchased factory equipment that was installed and put into service January 2, 2012, at a total cost of $120,000. Salvage value was estimated at $8,000. The equipment is being depreciated over four years using the double-declining balance method. For the year 2013, Krause should record depreciation expense on this equipment of a. $28,000. b. $30,000. c. $56,000. d. $60,000.
73.
On April 13, 2012, Neill Co. purchased machinery for $168,000. Salvage value was estimated to be $7,000. 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, Neill should record depreciation expense for 2013 on this machinery of a. $29,120. b. $28,560. c. $28,770. d. $29,306.
11 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition 74.
Matile Co. purchased machinery that was installed and ready for use on January 3, 2012, at a total cost of $115,000. Salvage value was estimated at $15,000. The machinery will be depreciated over five years using the double-declining balance method. For the year 2013, Matile should record depreciation expense on this machinery of a. $24,000. b. $27,600. c. $30,000. d. $46,000.
75.
A plant asset has a cost of $32,000 and a salvage value of $8,000. The asset has a threeyear life. If depreciation in the third year amounted to $4,000, which depreciation method was used? a. Straight-line b. Declining-balance c. Sum-of-the-years'-digits d. Cannot tell from information given
76.
On January 1, 2012, Graham Company purchased a new machine for $2,800,000. The new machine has an estimated useful life of nine years and the salvage value was estimated to be $100,000. Depreciation was computed on the sum-of-the-years'-digits method. What amount should be shown in Graham's balance sheet at December 31, 2013, net of accumulated depreciation, for this machine? a. $2,260,000 b. $1,780,000 c. $1,742,221 d. $1,659,000
77.
On January 1, 2006, Forbes Company purchased equipment at a cost of $100,000. The equipment was estimated to have a salvage value of $10,000 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, 2013? a. $2,500 b. $2,778 c. $5,000 d. $11,250
78.
On September 19, 2012, McCoy Co. purchased machinery for $285,000. Salvage value was estimated to be $15,000. The machinery will be depreciated over eight years using the sum-of-the-years'-digits method. If depreciation is computed on the basis of the nearest full month, McCoy should record depreciation expense for 2013 on this machinery of a. $61,354. b. $58,267. c. $58,125. d. $52,500.
Depreciation, Impairments, and Depletion
11 - 17
79.
On January 3, 2011, Munoz Co. purchased machinery. The machinery has an estimated useful life of eight years and an estimated salvage value of $60,000. The depreciation applicable to this machinery was $130,000 for 2013, computed by the sum-of-the-years'digits method. The acquisition cost of the machinery was a. $720,000. b. $780,000. c. $840,000. d. $936,000.
80.
On January 2, 2010, Stacy 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 $30,000. The depreciation applicable to this equipment was $140,000 for 2013, computed under the sum-of-the-years'-digits method. What was the acquisition cost of the equipment? a. $1,070,000 b. $1,130,000 c. $1,100,000 d. $1,083,333
81.
Orton Corporation, which has a calendar year accounting period, purchased a new machine for $60,000 on April 1, 2008. At that time Orton expected to use the machine for nine years and then sell it for $6,000. The machine was sold for $33,000 on Sept. 30, 2013. 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. $6,000. b. $4,500. c. $3,000. d. $0.
82.
On January 1, 2012, the Accumulated Depreciation—Machinery account of a particular company showed a balance of $740,000. At the end of 2012, after the adjusting entries were posted, it showed a balance of $790,000. During 2012, one of the machines which cost $250,000 was sold for $121,000 cash. This resulted in a loss of $8,000. Assuming that no other assets were disposed of during the year, how much was depreciation expense for 2012? a. $171,000 b. $187,000 c. $50,000 d. $121,000
83.
During 2012, Noller Co. sold equipment that had cost $294,000 for $176,400. This resulted in a gain of $12,900. The balance in Accumulated Depreciation—Equipment was $975,000 on January 1, 2012, and $930,000 on December 31. No other equipment was disposed of during 2012. Depreciation expense for 2012 was a. $45,000. b. $57,900. c. $85,500. d. $175,500.
11 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition Use the following information for questions 84 and 85: A schedule of machinery owned by Mallon Co. is presented below: Estimated Estimated Total Cost Salvage Value Life in Years Machine A $260,000 $20,000 12 Machine C 390,000 30,000 10 Machine M 195,000 15,000 6 Mallon computes depreciation by the composite method. 84.
The composite rate of depreciation (in percent) for these assets is a. 10.18. b. 10.77. c. 11.03. d. 11.67.
85.
The composite life (in years) for these assets is a. 9.1. b. 9.3. c. 9.8. d. 10.0.
86.
Stevenson Company purchased a depreciable asset for $350,000 on April 1, 2010. The estimated salvage value is $35,000, 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, 2013 when the asset is sold? a. $126,000 b. $147,000 c. $173,250 d. $194,250
87.
Williamson Corporation purchased a depreciable asset for $400,000 on January 1, 2010. The estimated salvage value is $40,000, and the estimated useful life is 9 years. The straight-line method is used for depreciation. In 2013, Williamson changed its estimates to a total useful life of 5 years with a salvage value of $60,000. What is 2013 depreciation expense? a. $40,000 b. $60,000 c. $110,000 d. $120,000
88.
Rollins Company purchased a depreciable asset for $500,000 on April 1, 2010. The estimated salvage value is $50,000, and the estimated total useful life is 5 years. The straight-line method is used for depreciation. What is the balance in accumulated depreciation on May 1, 2013 when the asset is sold? a. $196,667 b. $210,000 c. $247,500 d. $277,500
Depreciation, Impairments, and Depletion
11 - 19
89.
Fanestil Corporation purchased a depreciable asset for $630,000 on January 1, 2010. The estimated salvage value is $63,000, and the estimated total useful life is 9 years. The straight-line method is used for depreciation. In 2013, Fanestill changed its estimates to a useful life of 5 years with a salvage value of $105,000. What is 2013 depreciation expense? a. $63,000 b. $105,000 c. $168,000 d. $189,000
90.
If Lawson, Inc. uses the composite method and its composite rate is 7.5% per year, what entry should it make when plant assets that originally cost $80,000 and have been used for 10 years are sold for $24,000? a. Cash 24,000 Accumulated Depreciation - Plant Assets 56,000 Plant Assets 80,000 b.
c.
d.
Cash Loss on Sale of Plant Assets Plant Assets
24,000 56,000
Cash Accumulated Depreciation - Plant Assets Plant Assets Gain on Sale of Plant Assets
24,000 60,000
Cash
24,000
80,000
80,000 4,000
Plant Assets 91.
24,000
Archer Company purchased equipment in January of 2002 for $150,000. The equipment was being depreciated on the straight-line method over an estimated useful life of 20 years, with no salvage value. At the beginning of 2012, when the equipment had been in use for 10 years, the company paid $25,000 to overhaul the equipment. As a result of this improvement, the company estimated that the useful life of the equipment would be extended an additional 5 years. What should be the depreciation expense recorded for this equipment in 2012. a. $5,000 b. $6,667 c. $7,500 d. $9,167
Use the following information to answer questions 92 and 93. Ebert Inc. owns the following assets: Asset Cost A $140,000 B 75,000 C 164,000 92.
Salvage $14,000 7,500 8,000
What is the composite depreciation rate of Ebert's assets? a. 14.0% b. 10.3% c. 12.9% d. 11.1%
Estimated Useful Life 10 years 5 years 12 years
11 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 93.
What is the composite life of Ebert's assets? a. 14.0 years b. 9.7 years c. 8.9 years d. 10.3 years
94.
Technique Co. has equipment with a carrying amount of $1,600,000. The expected future net cash flows from the equipment are $1,630,000, and its fair value is $1,360,000. The equipment is expected to be used in operations in the future. What amount (if any) should Technique report as an impairment to its equipment? a. No impairment should be reported. b. $240,000 c. $30,000 d. $270,000
95.
Robertson Inc. bought a machine on January 1, 2002 for $400,000. The machine had an expected life of 20 years and was expected to have a salvage value of $40,000. On July 1, 2012, the company reviewed the potential of the machine and determined that its undiscounted future net cash flows totaled $200,000 and its discounted future net cash flows totaled $140,000. If no active market exists for the machine and the company does not plan to dispose of it, what should Robertson record as an impairment loss on July 1, 2012? a. $ 0 b. $11,000 c. $20,000 d. $71,000
96.
Holcomb Corpsssoration owns machinery with a book value of $285,000. It is estimated that the machinery will generate future cash flows of $300,000. The machinery has a fair value of $210,000. Holcomb should recognize a loss on impairment of a. $ -0-. b. $15,000. c. $75,000. d. $90,000.
97.
Kohlman Corporation owns machinery with a book value of $380,000. It is estimated that the machinery will generate future cash flows of $350,000. The machinery has a fair value of $280,000. Kohlman should recognize a loss on impairment of a. $ -0-. b. $ 30,000. c. $100,000. d. $ 70,000.
98.
Marsh Corporation purchased a machine on July 1, 2010, for $1,250,000. The machine was estimated to have a useful life of 10 years with an estimated salvage value of $70,000. During 2013, it became apparent that the machine would become uneconomical after December 31, 2017, and that the machine would have no scrap value. Accumulated depreciation on this machine as of December 31, 2012, was $295,000. What should be the charge for depreciation in 2013 under generally accepted accounting principles? a. $177,000 b. $191,000 c. $205,000 d. $238,750
Depreciation, Impairments, and Depletion
11 - 21
99.
Rivera Company purchased a tooling machine on January 3, 2006 for $700,000. 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 2013, the company paid $175,000 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 2013? a. $48,125 b. $58,333 c. $70,000 d. $77,000
100.
Gates Co. purchased machinery on January 2, 2007, for $660,000. The straight-line method is used and useful life is estimated to be 10 years, with a $60,000 salvage value. At the beginning of 2013 Gates spent $144,000 to overhaul the machinery. After the overhaul, Gates estimated that the useful life would be extended 4 years (14 years total), and the salvage value would be $30,000. The depreciation expense for 2013 should be a. $42,375. b. $51,750. c. $60,000. d. $55,500.
101.
Newell, Inc. purchased equipment in 2011 at a cost of $800,000. Two years later it became apparent to Newell, Inc. that this equipment had suffered an impairment of value. In early 2013, the book value of the asset is $480,000 and it is estimated that the fair value is now only $320,000. The entry to record the impairment is a. No entry is necessary as a write-off violates the historical cost principle. b. Retained Earnings ........................................................ 160,000 Accumulated Depreciation—Equipment ............ 160,000 c. Loss on Impairment of Equipment ................................ 160,000 Accumulated Depreciation—Equipment ............ 160,000 d. Retained Earnings ........................................................ 160,000 Reserve for Loss on Impairment of Equipment .. 160,000
102.
Percy Resources Company acquired a tract of land containing an extractable natural resource. Percy 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 $1,000,000 after restoration. Relevant cost information follows: Land Estimated restoration costs
$7,500,000 1,500,000
If Percy maintains no inventories of extracted material, what should be the charge to depletion expense per ton of extracted material? a. $3.25 b. $3.75 c. $4.00 d. $4.50
11 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 103.
In January, 2012, Yoder Corporation purchased a mineral mine for $5,100,000 with removable ore estimated by geological surveys at 2,000,000 tons. The property has an estimated value of $300,000 after the ore has been extracted. The company incurred $1,500,000 of development costs preparing the mine for production. During 2012, 500,000 tons were removed and 400,000 tons were sold. What is the amount of depletion that Yoder should expense for 2012? a. $960,000 b. $1,200,000 c. $1,260,000 d. $1,680,000
104.
During 2012, Eldred Corporation acquired a mineral mine for $3,000,000 of which $400,000 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 2012, 1,500,000 units were extracted and 1,200,000 units were sold. What is the amount of depletion expensed for 2012? a. $260,000. b. $312,000. c. $360,000. d. $390,000.
105.
In March, 2012, Maley Mines Co. purchased a coal mine for $8,000,000. Removable coal is estimated at 1,500,000 tons. Maley is required to restore the land at an estimated cost of $960,000, and the land should have a value of $840,000. The company incurred $2,000,000 of development costs preparing the mine for production. During 2012, 450,000 tons were removed and 300,000 tons were sold. The total amount of depletion that Maley should record for 2012 is a. $1,832,000. b. $2,024,000. c. $2,748,000. d. $3,036,000.
106.
In 2004, Horton Company purchased a tract of land as a possible future plant site. In January, 2012, valuable sulphur deposits were discovered on adjoining property and Horton Company immediately began explorations on its property. In December, 2012, after incurring $800,000 in exploration costs, which were accumulated in an expense account, Horton discovered sulphur deposits appraised at $4,500,000 more than the value of the land. To record the discovery of the deposits, Horton should a. make no entry. b. debit $800,000 to an asset account. c. debit $4,500,000 to an asset account. d. debit $5,300,000 to an asset account.
107.
Balcom Corporation acquires a coal mine at a cost of $1,500,000. Intangible development costs total $360,000. After extraction has occurred, Balcom must restore the property (estimated fair value of the obligation is $180,000), after which it can be sold for $510,000. Balcom estimates that 5,000 tons of coal can be extracted. What is the amount of depletion per ton? a. $306 b. $510 c. $300 d. $372
Depreciation, Impairments, and Depletion
11 - 23
108.
Balcom Corporation acquires a coal mine at a cost of $1,500,000. Intangible development costs total $360,000. After extraction has occurred, Balcom must restore the property (estimated fair value of the obligation is $180,000), after which it can be sold for $510,000. Balcom estimates that 5,000 tons of coal can be extracted. If 900 tons are extracted the first year, which of the following would be included in the journal entry to record depletion? a. Debit to Accumulated Depletion for $275,400 b. Debit to Inventory for $275,400 c. Credit to Inventory for $270,000 d. Credit to Accumulated Depletion for $459,000
109.
In 2012, MegaStores reported net income of $5.7 billion, net sales of $164.7 billion, and average total assets of $61.0 billion. What is MegaStores' asset turnover ratio? a. 0.37 times b. 0.09 times. c. 2.7 times. d. 10.7 times.
110.
In 2012, MegaStores reported net income of $5.7 billion, net sales of $164.7 billion, and average total assets of $61.0 billion. What is MegaStores' return on total assets? a. 9.3% b. 10.7% c. 37.0% d. 270%
Use the following information for questions 111 and 112: For 2012, Hoyle Company reports beginning of the year total assets of $900,000, end of the year total assets of $1,100,000, net sales of $750,000, and net income of $150,000. 111.
Hoyle’s 2012 asset turnover ratio is a. 0.14 times. b. 0.15 times. c. 0.68 times. d. 0.75 times.
112.
The rate of return on assets for Hoyle in 2012 is a. 12.0%. b. 13.6%. c. 15.0%. d. 16.7%.
113.
Markowitz Company reported the following data: Sales Net Income Assets at year end Liabilities at year end
2012 $3,000,000 300,000 1,800,000 1,100,000
What is Markowitz’s asset turnover for 2013? a. 1.56 b. 1.61 c. 1.81 d. 2.17
2013 $3,900,000 400,000 2,500,000 1,500,000
11 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition 114.
Froelich Company reported the following data: 2012 $3,000,000 300,000 1,800,000 1,100,000
Sales Net Income Assets at year end Liabilities at year end
2013 $4,200,000 400,000 2,500,000 1,500,000
What is Froelich’s asset turnover for 2013? a. 1.68 b. 1.72 c. 1.95 d. 2.33
Use the following information for questions 115 and 116: On January 1, 2012, Guzman Company purchased a machine costing $250,000. The machine is in the MACRS 5-year recovery class for tax purposes and has an estimated $50,000 salvage value at the end of its economic life. *115. Assuming the company uses the general MACRS approach, the amount of MACRS deduction for tax purposes for the year 2012 is a. $50,000. b. $100,000. c. $80,000. d. $40,000. *116. Assuming the company uses the optional straight-line method, the amount of MACRS deduction for tax purposes for the year 2012 is a. $40,000. b. $50,000. c. $20,000. d. $25,000.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
61. 62. 63. 64. 65. 66. 67. 68.
c c b c b c b c
69. 70. 71. 72. 73. 74. 75. 76.
b c b b b b c b
77. 78. 79. 80. 81. 82. 83. 84.
a c c b c a c a
85. 86. 87. 88. 89. 90. 91. 92.
a d c d c a b b
93. 94. 95. 96. 97. 98. 99. 100.
c a d a c b a b
101. 102. 103. 104. 105. 106. 107. 108.
c c c b d b a b
109. 110. 111. 112. 113. 114. *115. *116.
c a d c c c a d
Depreciation, Impairments, and Depletion
11 - 25
MULTIPLE CHOICE—CPA Adapted 117.
Pike Co. purchased a machine on July 1, 2012, for $800,000. The machine has an estimated useful life of five years and a salvage value of $160,000. The machine is being depreciated from the date of acquisition by the 150% declining-balance method. For the year ended December 31, 2012, Pike should record depreciation expense on this machine of a. $240,000. b. $160,000. c. $120,000. d. $96,000.
118.
A machine with a five-year estimated useful life and an estimated 10% salvage value was acquired on January 1, 2011. The depreciation expense for 2013 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%.
119.
On April 1, 2011, Verlin Co. purchased new machinery for $300,000. 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, 2013, should be a. $200,000. b. $180,000. c. $120,000. d. $100,000.
120.
Hahn 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 Hahn's depreciable assets at December 31, 2013 are as follows: Acquisition year Cost Residual value Accumulated depreciation Estimated useful life
2011 $210,000 30,000 144,000 5 years
Using the same depreciation method as used in 2011, 2012, and 2013, how much depreciation expense should Hahn record in 2014 for this asset? a. $24,000 b. $36,000 c. $42,000 d. $48,000
11 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition 121.
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.
122.
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.
124.
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. 123.
Straight-line Yes Yes No No
Gain Decrease Decrease Increase Increase
Loss Decrease Increase Decrease Increase
Giger Company acquired a tract of land containing an extractable natural resource. Giger 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 $800,000 after restoration. Relevant cost information follows: Land Estimated restoration costs
$5,600,000 1,200,000
If Giger maintains no inventories of extracted material, what should be the charge to depletion expense per ton of extracted material? a. $1.36 b. $1.20 c. $1.12 d. $0.96
Depreciation, Impairments, and Depletion 125.
11 - 27
In January 2012, Fehr Mining Corporation purchased a mineral mine for $6,300,000 with removable ore estimated by geological surveys at 2,500,000 tons. The property has an estimated value of $600,000 after the ore has been extracted. Fehr incurred $1,725,000 of development costs preparing the property for the extraction of ore. During 2012, 340,000 tons were removed and 300,000 tons were sold. For the year ended December 31, 2012, Fehr should include what amount of depletion in its cost of goods sold? a. $775,200 b. $684,000 c. $891,000 d. $1,009,800
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
117. 118.
c b
119. 120.
b a
121. 122.
d b
123. 124.
b b
125.
c
DERIVATIONS — Computational No. Answer
Derivation
61.
c
$120,000 – $10,000 = $110,000.
62.
c
$240,000 – $20,000 = $220,000.
63.
b
($39,000 – 0) × .50 × 6/12 = $9,750.
64.
c
($39,000 – 0) × .50 × 6/12 = $9,750; ($39,000 – $9,750) × .50 = $14,625.
65.
b
($90,000 – $3,600) ÷ 120,000 = $.72; $.72 × 18,000 = $12,960.
66.
c
($90,000 – $3,600) ÷ 120,000 = $.72; $.72 × 32,000 = $23,040.
67.
b
[$280,000 – $14,000) ÷ 10,000] × 1,100 = $29,260.
68.
c
$225,000 × [(1 ÷ 8) × 2] = $56,250 ($225,000 – $56,250) × [(1 ÷ 8) × 2] = $42,188.
69.
b
[($800,000 – $40,000) ÷ 10,000] × 1,100 = $83,600.
70.
c
$450,000 × [(1 ÷ 8) × 2] = $112,500 ($450,000 – $112,500) × [(1 ÷ 8) × 2] = $84,375.
71.
b
[$225,000 – ($225,000 × 0.1)] × 0.2 = $40,500.
11 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No. Answer
Derivation
72.
b
[$120,000 × (1 – 0.5)] × 0.5 = $30,000.
73.
b
[$168,000 – ($168,000 × 0.2 × 0.75)] × 0.2 = $28,560.
74.
b
[$115,000 – ($115,000 × 0.4)] × 0.4 = $27,600.
75.
c
($32,000 – $8,000) × 1/6 = $4,000.
76.
b
$2,800,000 – [($2,800,000 – $100,000) × (9/45 + 8/45)] = $1,780,000.
77.
a
($100,000 – $10,000) × 1/36 = $2,500.
78.
c
($270,000 × 8/36 × 9/12) + ($270,000 × 7/36 × 3/12) = $58,125.
79.
c
(AC – $60,000) × 6/36 = $130,000 AC = $840,000.
80.
b
(AC – $30,000) × 7/55 = $140,000 AC = $1,130,000.
81.
c
$60,000 – [($60,000 – $6,000) ÷ 9 × 5] = $30,000 (BV) $33,000 – $30,000 = $3,000 (gain).
82.
a
($790,000 – $740,000) + [$250,000 – ($121,000 + $8,000)] = $171,000.
83.
c
$930,000 – {$975,000 – [$294,000 – ($176,400 – $12,900)]} = $85,500.
84.
a
($260,000 – $20,000) ÷ 12 = $20,000 ($390,000 – $30,000) ÷ 10 = 36,000 ($195,000 – $15,000) ÷ 6 = 30,000 $845,000 $86,000 $86,000 ————— = 10.18 $845,000
85.
a
($240,000 + $360,000 + $180,000) ÷ $86,000 = 9.1.
86.
d
[($350,000 – $35,000) ÷ 5] × 3 1/12 = $194,250.
87.
c
$400,000 – [($400,000 – $40,000) × 3/9] = $280,000 ($280,000 – $60,000) ÷ (5 – 3) = $110,000.
88.
d
[($500,000 – $50,000) ÷ 5] × 3 1/12 = $277,500.
89.
c
$630,000 – [$630,000 – $63,000) 3/9] = $441,000 ($441,000 – $105,000) ÷ (5 – 3) = $168,000.
Depreciation, Impairments, and Depletion
11 - 29
DERIVATIONS — Computational (cont.) No. Answer
Derivation
90.
a
$80,000 – $24,000 = $56,000 Accumulated Depreciation.
91.
b
[($150,000 – 0) 20] × 10 = $75,000 [($150,000 – $75,000) + $25,000] ÷ [(20 – 10) + 5] = $6,667.
92
b
[($140,000 – $14,000) 10] + [($75,000 – $7,500) 5] + [($164,000 – $8,000) 12] = $39,100; $39,100 ($140,000 + $75,000 + $164,000) = 10.3%.
93.
c
($126,000 + $67,500 + $156,000) $39,100(from #92) = 8.9 yrs.
94.
a
$1,630,000 > $1,600,000; No impairment.
95.
d
$200,000 < $211,000 [$400,000 – [($400,000 – $40,000) ÷ 20) × 10.5] $211,000 – $140,000 = $71,000.
96.
a
$300,000 > $285,000; No loss recognized.
97.
c
$350,000 < $380,000; $280,000 – $380,000 = ($100,000).
98.
b
($1,250,000 – $295,000) ÷ 5 = $191,000.
99.
a
[($700,000 ÷ 10) × 7] – $175,000 = $315,000 new (AD) $700,000 – $315,000 = $385,000; $385,000 ÷ 8 = $48,125 per year.
100.
b
[($600,000 10) × 6] – $144,000 = $216,000 new (AD) $660,000 – $216,000 = $444,000 (BV) ($444,000 – $30,000) ÷ 8 = $51,750 per year.
101.
c
$480,000 – $320,000 = $160,000.
102.
c
($7,500,000 + $1,500,000 – $1,000,000) ÷ 2,000,000 = $4.00.
103.
c
[($5,100,000 – $300,000 + $1,500,000) ÷ 2,000,000] × 400,000 = $1,260,000.
104.
b
[($3,000,000 – $400,000) ÷ 10,000,000] × 1,200,000 = $312,000.
105.
d
[($8,000,000 + $960,000 – $840,000 + $2,000,000) ÷ 1,500,000] × 450,000 = $3,036,000.
106.
b
Discovery value is generally not recognized.
107.
a
($1,500,000 + $360,000 + $180,000 – $510,000) ÷ 5,000 = $306.
108.
b
($1,500,000 + $360,000 + $180,000 – $510,000) ÷ 5,000 = $306; 900 × $306 = $275,400 dr. to Inventory.
11 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No. Answer
Derivation
109.
c
$164.7 ÷ $61 = 2.7 times.
110.
a
$5.7 ÷ $61 = 9.3%
111.
d
$750,000 ÷ [($900,000 + $1,100,000) ÷ 2] = 0.75
112.
c
$150,000 ÷ [($900,000 + $1,100,000) ÷ 2] = 15%
113.
c
$3,900,000 ÷ [($1,800,000 + $2,500,000) ÷ 2] = 1.81
114.
c
$4,200,000 ÷ [($1,800,000 + $2,500,000) ÷ 2] = 1.95.
*115.
a
$250,000 × 20% = $50,000.
*116.
d
$250,000 ÷ 5 ÷ 2 = $25,000.
DERIVATIONS — CPA Adapted No. Answer
Derivation
117.
c
$800,000 × 0.3 × 0.5 = $120,000.
118.
b
Conceptual.
119.
b
$300,000 × (5/15 + 4/15) = $180,000.
120.
a
2/15 × ($210,000 – $30,000) = $24,000.
121.
d
Conceptual.
122.
b
Conceptual.
123.
b
Conceptual.
124.
b
($5,600,000 + $1,200,000 – $800,000) ÷ 5,000,000 = $1.20.
125.
c
[($6,300,000 – $600,000 + $1,725,000) ÷ 2,500,000] × 300,000 = $891,000.
Depreciation, Impairments, and Depletion
11 - 31
EXERCISES Ex. 11-126—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?
Solution 11-126 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. 11-127—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 initially 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.
11 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 11-127 (cont.) ____ 9. The methods of depreciation based upon output assume that obsolescence will not significantly affect the usefulness of the asset. ____ 10. The revision of prior periods' depreciation estimates would be disclosed on the retained earnings statement.
Solution 11-127 1. 2.
T F
3. 4.
F T
5. 6.
F F
7. 8.
T F
9. 10.
T F
Ex. 11-128—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. b. c. d.
Declining-balance Group Composite Straight-line
e. Sum-of-the-years'-digits f. Units of output g. Working hours
____ 1. The depreciation charged by this method decreases by the same amount each year. ____ 2. These methods are used for depreciating multiple-asset accounts. ____ 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. ____ 5. 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.
Solution 11-128 1. e 2. b, c 3. f, g
4. a, e 5. d
Depreciation, Impairments, and Depletion
11 - 33
Ex. 11-129—Calculate depreciation. A machine which cost $300,000 is acquired on October 1, 2012. Its estimated salvage value is $30,000 and its expected life is eight years. Instructions Calculate depreciation expense for 2012 and 2013 by each of the following methods, showing the figures used. (a) Double-declining balance (b) Sum-of-the-years'-digits
Solution 11-129 (a) 2012: 25% × $300,000 × ¼
=
$18,750
2013: 25% × $187,500
=
$70,313
(b) 2012: 8/36 × $270,000 × ¼
=
$15,000
2013: 8/36 × $270,000 × ¾ 7/36 × $270,000 × ¼
= =
$45,000 13,125 $58,125
Ex. 11-130—Calculate depreciation. A machine cost $800,000 on April 1, 2012. Its estimated salvage value is $80,000 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 2012 (b) Double-declining balance for 2013 (c) Sum-of-the-years'-digits for 2013
Solution 11-130 (a) 1/8 × $720,000 × ¾
= $ 67,500
(b) 2013: 25% × $650,000* = $162,500 *[$800,000 - ($800,000 x .25 x 9/12)] (c) 8/36 × $720,000 × ¼ = $ 40,000 7/36 × $720,000 × ¾ = 105,000 $145,000
11 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 11-131—Asset depreciation and disposition. Answer each of the following questions. 1. A plant asset purchased for $250,000 has an estimated life of 10 years and a residual value of $20,000. 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 $300,000 at the beginning of the year has an estimated life of 5 years and a residual value of $30,000. Depreciation for the second year, determined by the sum-of-the-years'-digits method is $______________. 3. A plant asset with a cost of $320,000 and accumulated depreciation of $90,000, is given together with cash of $120,000 in exchange for a similar asset worth $330,000. The gain or loss recognized on the disposal (indicate by "G" or "L") is $______________. 4. A plant asset with a cost of $270,000, estimated life of 5 years, and residual value of $45,000, is depreciated by the straight-line method. This asset is sold for $200,000 at the end of the second year of use. The gain or loss on the disposal (indicate by "G" or "L") is $___________.
Solution 11-131 1. 2. 3. 4.
$40,000 $72,000 $20,000 L $20,000 G
Ex. 11-132—Composite depreciation. Kemp Co. uses the composite method to depreciate its equipment. The following totals are for all of the equipment in the group: Initial Cost $900,000
Residual Value $100,000
Depreciable Cost $800,000
Depreciation Per Year $80,000
Instructions (a) What is the composite rate of depreciation? (To nearest tenth of a percent.) (b) A machine with a cost of $23,000 was sold for $14,000 at the end of the third year. What entry should be made?
Solution 11-132 (a)
$80,000 ———— = 8.9% $900,000
(b) Cash ....................................................................................... Accumulated Depreciation − Equipment.................................. Equipment.....................................................................
14,000 9,000 23,000
Depreciation, Impairments, and Depletion
11 - 35
Ex. 11-133—Depletion allowance. Rojas Company purchased for $3,800,000 a mine estimated to contain 2 million tons of ore. When the ore is completely extracted, it was expected that the land would be worth $200,000. A building and equipment costing $1,800,000 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 $300,000 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 11-133 Item Ore Building and Equipment Labor and Operating Expenses Total Cost
Base $3,600,000 1,800,000 300,000
Tons 2,000,000 2,000,000 750,000
Per Ton $1.80 0.90 .40 $3.10
PROBLEMS Pr. 11-134—Depreciation methods. On July 1, 2012, Sparks Company purchased for $2,880,000 snow-making equipment having an estimated useful life of 5 years with an estimated salvage value of $120,000. 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 2012 and 2013 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
2012 $2,880,000 ______ ______ ______
2013 $2,880,000 _______ _______ _______
Double-Declining Balance Method Equipment Less: Accumulated Depreciation Year-End Book Value Depreciation Expense for the Year
$2,880,000 ______ ______ ______
$2,880,000 _______ _______ _______
(b) Assume the company had used straight-line depreciation during 2012 and 2013. During 2014, the company determined that the equipment would be useful to the company for only one more year beyond 2014. Salvage value is estimated at $160,000. Compute the amount of depreciation expense for the 2014 income statement.
11 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 11-134 (a) Sum-of-the-Years'-Digits Accumulated Depreciation Book Value Depreciation Expense
2012 $ 460,000 2,420,000 460,000
2013 $ 1,288,000 1,592,000 828,000
Double-Declining Balance Accumulated Depreciation Book Value Depreciation Expense
$ 576,000 2,304,000 576,000
$1,497,600 1,382,400 921,600
(b) Cost Depreciation Salvage
$2,880,000 (828,000) (160,000) $1,892,000 × 1/2 = $946,000, 2014 depreciation
Pr. 11-135—Adjustment of Depreciable Base. A truck was acquired on July 1, 2010, at a cost of $162,000. The truck had a six-year useful life and an estimated salvage value of $18,000. The straight-line method of depreciation was used. On January 1, 2013, the truck was overhauled at a cost of $15,000, which extended the useful life of the truck for an additional two years beyond that originally estimated (salvage value is still estimated at $18,000). 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, 2013 and December 31, 2013.
Solution 11-135 Cost Less salvage value Depreciable base, July 1, 2010 Less depreciation to date [($144,000 ÷ 6) × 2 1/2] Depreciable base, Jan. 1, 2013 (unadjusted) Overhaul Depreciable base, Jan. 1, 2013 (adjusted)
$162,000 18,000 144,000 60,000 84,000 15,000 $99,000
January 1, 2013 Accumulated Depreciation—Trucks ............................................... Cash ...................................................................................
15,000
December 31, 2013 Depreciation Expense .................................................................... Accumulated Depreciation—Trucks ($99,000 ÷ 5.5 yrs) .....
18,000
15,000
18,000
Depreciation, Impairments, and Depletion
11 - 37
Pr. 11-136—Impairment. Presented below is information related to equipment owned by Finley Company at December 31, 2012. Cost Accumlated depreciation to date Expected future net cash flows Fair value
$7,000,000 ,800,000 5,000,000 3,400,000
Assume that Finley will continue to use this asset in the future. As of December 31, 2012, the equipment has a remaining useful life of 4 years. Instructions (a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2012. (b) Prepare the journal entry to record depreciation expense for 2013. (c) The fair value of the equipment at December 31, 2013 is $4,100,000. Prepare the journal entry (if any) necessary to record this increase in fair value.
Solution 11-136 (a)
December 31, 2012 Loss on Impairment ................................................. Accumulated Depreciation—Equipment.............
2,800,000 2,800,000
Note: The assent fails the recoverability test ($5,000,000 < $6,200,000) Cost ................................................. Accumulated depreciation ............... Carrying amount .............................. Fair value ........................................ Loss on impairment ......................... (b)
$7,000,000 800,000 6,200,000 3,400,000 $2,800,000
December 31, 2013 Depreciation Expense ............................................. Accumulated Depreciation—Equipment............. New carrying amount....................... Useful life ........................................ Depreciation per year ......................
(c)
850,000 850,000
$3,400,000 4 years $ 850,000
No entry necessary. Restoration of any impairment loss is not permitted.
11 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 11-137—Impairment. Dexter Company uses special strapping equipment in its packaging business. The equipment was purchased in January 2011 for $8,000,000 and had an estimated useful life of 8 years with no salvage value. At December 31, 2012, new technology was introduced that would accelerate the obsolescence of Dexter’s equipment. Dexter’s controller estimates that expected future net cash flows on the equipment will be $5,000,000 and that the fair value of the equipment is $4,400,000. Dexter intends to continue using the equipment, but it is estimated that the remaining useful life is 4 years. Dexter uses straight-line depreciation. Instructions (a) Prepare the journal entry (if any) to record the impairment at December 31, 2012. (b) Prepare any journal entries for the equipment at December 31, 2013. The fair value of the equipment at December 31, 2013, is estimated to be $4,600,000. (c) Repeat the requirements for (a) and (b), assuming that Roland intends to dispose of the equipment and that it has not been disposed of as of December 31, 2013.
Solution 11-137 (a)
Carrying value of asset: $8,000,000 – $2,000,000* = $6,000,000. *($8,000,000 8) 2 Future cash flows ($5,000,000) < Carrying value ($6,000,000) Impairment entry: Loss on Impairment ................................................. Accumulated Depreciation .................................
1,600,000* 1,600,000
*$6,000,000 – $4,400,000 (b)
Depreciation Expense .............................................. Accumulated Depreciation .................................
1,100,000** 1,100,000
**($4,400,000 4) (c)
No depreciation is recorded on impaired assets to be disposed of. Recovery of impairment losses are recorded. 12/31/12 Loss on Impairment ................................ Accumulated Depreciation ................
1,600,000
12/31/13 Accumulated Depreciation ...................... Recovery of Impairment Loss ($4,600,000 – $4,400,000) ............
200,000
1,600,000
200,000
Depreciation, Impairments, and Depletion
11 - 39
IFRS QUESTIONS True / False 1.
Under both IFRS and U.S. GAAP, interest costs incurred during construction must be capitalized.
2.
As with U.S. GAAP, IFRS requires that both direct and indirect costs in self-constructed assets be capitalized.
3.
IFRS, like U.S. GAAP, capitalizes all direct costs in self-constructed assets.
4.
Even though IFRS does not employ the first-stage recoverability test used under U.S. GAAP − comparing the undiscounted cash flows to the carrying amount, the fact that IFRS uses a fair value test to measure impairment loss makes IFRS stricter than U.S. GAAP
5.
U.S. GAAP, like IFRS permits write-up for subsequent recoveries of impairment, back up to the original amount before the impairment in all circumstances.
6.
Unlike U.S. GAAP, interest costs incurred during construction are not capitalized under IFRS.
7.
Asset revaluations are permitted under IFRS and U.S. GAAP.
8.
In general, IFRS adheres to very different principles than U.S. GAAP.
9.
U.S. GAAP, per SFAS No. 153, now requires that gains on exchanges of nonmonetary assets be recognized if the exchange lacks commercial substance.
10.
IFRS permits the same depreciation methods as U.S GAAP, with the exception of the units-of-production method, which is not allowed under IFRS.
Answers to True / False questions 1. True 2. False 3. True 4. True 5. False 6. False 7. False 8. False 9. False 10. False
11 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition Multiple-Choice Questions 1.
IFRS uses a fair value test to measure impairment loss. However, IFRS does not use the first-stage recoverability test under U.S. GAAP − comparing the undiscounted cash flow to the carrying amount. As a result, the IFRS test is a. not as strict as U.S. GAAP. b. more strict than U.S. GAAP. c. essentially the same strictness as U.S. GAAP. d. None of the above.
2.
Acceptable depreciation methods under IFRS include a. Straight-line. b. Accelerated. c. Units-of-production. d. All of the above.
3.
The primary IFRS related to property, plant and equipment is found in a. IAS 1 and IAS 34. b. IAS 11 and IAS 17. c. IAS 16 and IAS 23. d. IAS 27 and IAS 39.
4.
The accounting exchanges of nonmonetary assets has recently converged between IFRS and U.S. GAAP, per SFAS No. 153, now requires a. that gains on exchanges of nonmonetary assets be recognized if the exchange has commercial substance. b. that gains on exchanges of nonmonetary assets be recognized if the exchange does not have commercial substance. c. that gains on exchanges of nonmonetary assets be recognized if the exchange does not have commercial substance, and has never been impaired. d. All of the above. 5.
In measuring an impairment loss, IFRS uses a. undiscounted cash flows. b. discounted cash flows. c. a fair value test. d. a replacement value test.
6.
IFRS permits companies to carry assets at historical cost or use a revaluation model for fixed assets. According to IAS 16, if revaluation is used: 1. it must be applied to all assets in a class of assets. 2. assets must be revalued on an annual basis. 3. assets must be depreciated on the straight-line basis. 4. salvage values must be zero. a. b. c. d.
1 is correct 2 is correct 1 and 2 are correct All are correct
Depreciation, Impairments, and Depletion
11 - 41
Questions 7 through 10 are based on the following information: Simpson Company applies revaluation accounting to plant assets with a carrying value of $1,600,000, a useful life of 4 years, and no salvage value. Depreciation is calculated on the straight-line basis. At the end of year 1, independent appraisers determine that the asset has a fair value of $1,500,000. 7.
The journal entry to record depreciation for year one will include a a. debit to Accumulated Depreciation for $400,000. b. debit to Depreciation Expense for $100,000. c. credit to Accumulated Depreciation for $100,000. d. debit to Depreciation Expense for $400,000.
8.
The journal entry to adjust the plant assets to fair value and record revaluation surplus in year one will include a a. debit to Accumulated Depreciation for $100,000. b. credit to Depreciation Expense for $300,000. c. credit to Plant Assets for $300,000. d. credit to Revaluation Surplus for $300,000.
9.
The financial statements for year one will include the following information a. Accumulated depreciation $400,000. b. Depreciation expense $100,000. c. Plant assets $1,500,000. d. Revaluation surplus $100,000.
10.
The entry to record depreciation for this same asset in year two will include a a. debit to Accumulated Depreciation for $400,000. b. debit to Depreciation Expense for $500,000. c. credit to Accumulated Depreciation for $300,000. d. debit to Depreciation Expense for $400,000.
Answers to multiple choice: 1. b 2. d 3. c 4. a 5. c 6. c 7. d 8. d 9. c 10. b
11 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition Short Answer: 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to the accounting for property, plant, and equipment. 1. IFRS adheres to many of the same principles of U.S. GAAP in the accounting for property, plant, and equipment. Key similarities are: (1) Under IFRS, capitalization of interest or borrowing costs incurred during construction of assets can either be expensed or capitalized. Once certain criteria are met, interest must be capitalized (this accounting has recently converged to U.S. GAAP; (2) IFRS, like U.S. GAAP, capitalizes all direct costs in self-constructed assets. IFRS does not address the capitalization of fixed overhead, although in practice, these costs are generally capitalized; (3) The accounting for exchange of nonmonetary assets has recently converged between IFRS and if the exchange has commercial substance. This is the framework used in IFRS; (4) IFRS also views depreciation as an allocation of cost over an asset’s life; IFRS permits the same depreciation methods (straightline, accelerated, units-of-production) as U.S. GAAP. Key Difference: IFRS permits asset revaluation depreciation procedures must be followed. According to IAS 16, if revaluation is used, it must be applied to all assets in a class of assets and assets must be revalued on an annual basis. 2.
At a recent executive committee meeting, the controller for Marino Company remarked, “With only a single key difference between U.S. GAAP and IFRS for property, plant, and equipment, it should be smooth sailing for the FASB and IASB to converge their standards in this area.” Prepare a response to the controller. 2. While there is a single key difference, it is an important one—the issue of revaluations. With respect to frameworks, the IASB and the FASB are working on a joint project to converge their conceptual frameworks. One element of that project will examine the measurement bases used in accounting. It is too early to say whether a converged conceptual framework will recommend fair value measurement (and revaluation accounting) for property, plant, and equipment. However, this is likely to be one of the more contentious issues, given the long-standing use of historical cost as a measurement basis in U.S. GAAP.
CHAPTER 12 INTANGIBLE ASSETS IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F F F F T T T F T T T F T T F F F F F F
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
Characteristics of intangible assets. Internally created intangibles. Recording internally generated intangibles. Amortization of limited-life intangible assets. Amortization of intangible assets. Amortizing limited-life intangibles. Accounting for a customer list. Amortization of patents. Modification of an existing patent. Basic concept of goodwill. Internally generated goodwill. Recording internally generated 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. Recording research and development costs. Reporting intangible assets.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
b c a c a b d d b c a b d c d b c a c
21 22 23 24. 25. 26. 27. 28. S 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. S 39.
Characteristics of intangible assets. Characteristics of intangible assets. Characteristics of intangible assets. Accounting for internally-created intangibles. Research and development costs. Amortization methods for intangible assets. Cost of intangible asset. Factors in determining useful life. Classifying intangible assets. Impairment of intangibles. Determining intangible asset useful life. Amortization of intangibles. Patent amortization. Patent amortization. Legal fees associated with patent infringement. Identification of intangible assets. Amortization of intangible assets. Entry to record patent amortization. Trademark costs capitalized.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
c b d c b a d a b d c b a d d d d b d d c b a d a a b d c c d d b d c d
40. 41. 42. 43. S 44. 45. 46. 47. 48. 49. S 50. P 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. P 63. S 64. 65. 66. 67. P 68. 69. 70. 71. 72. 73. 74. 75.
Composition of goodwill. When to record goodwill. Intangibles during acquisition of company. Seperability of goodwill. Goodwill as master valuation account. Reporting of "negative goodwill." Accounting for goodwill. Recording goodwill. Impairment of intangible asset. Recoverability test. 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. Classification of R & D expense. Costs to defend a patent. Purpose of R & D costs. Classification of R & D costs. Classification of 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 goodwill. Intangible asset disclosure. Expense classification. Reporting patent amortization. Reporting intangibles. Reporting expenses and losses. Reporting expenses and losses. Cost of computer software. Cost of computer software. Amortization of computer software costs. Amortization of computer software costs.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. * This topic is dealt with in an Appendix to the chapter. S
Intangible Assets
MULTIPLE CHOICE—Computational Answer
No.
d d c d c c b b b c b b a b c c d a b b c d b b d c c a a c c c c a b
76. 77. 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.
Description Valuation of patent. Valuation of patent. Valuation of patent. Basket purchase of patents. Intangible asset amortization. Intangible asset amortization. Computing patent 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. Calculate patent amortization. Calculate goodwill amount. Calculate goodwill amount. Calculate amount of goodwill. Calculate goodwill impairment. Proper accounting when fair value of net assets acquired exceeds cost. Calculate impairment loss. Calculate patent carrying value. Calculate patent carrying value. Calculate loss on impairment of goodwill. Calculate loss on impairment of goodwill. Calculate R & D expense. Calculate R & D expense. Calculate R & D expense. Calculate R & D expense. Calculate R & D expense. Reporting intangible assets. Computing computer software costs. Computing computer software costs. Computing computer software costs. Computing computer software costs. Computing computer software costs.
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
a c d c c d c a c a
111. 112. 113. 114. 115. 116. 117. 118. 119. 120.
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 trademark. Capitalization of legal fees. Amortization of goodwill. Calculate R & D expense. Determine R & D expense for the year.
12 - 3
12 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Item E12-121 E12-122 E12-123 E12-124 E12-125 E12-126 E12-127 E12-128 E12-129 E12-130 E12-131 E12-132 E12-133 E12-134 E12-135 E12-136 E12-137 E12-138 E12-139 E12-140 E12-141 E12-142 E12-143
Description Essay – characteristics of intangible assets. Essay – cost of intangibles. Essay – types of intangibles. Essay – definition of and accounting for intangibles. Essay – stock issued for intangible. Essay – costs associated with patents. Intangible assets multiple choice. Essay – intangible asset amortization. Essay – useful life of intangibles. Entries for amortization and impairment. Essay - Intangible assets theory. Identify intangibles. Essay – Goodwill and negative goodwill. Carrying value of patent. Accounting for patent. Essay – goodwill. Essay – impairment. Goodwill impairment. Impairment of copyrights. Essay – R & D costs. Essay – start-up costs. Acquisition of tangible and intangible assets. Computer software amortization.
PROBLEMS Item P12-144 P12-145
Description Intangible assets. Goodwill, impairment.
CHAPTER LEARNING OBJECTIVES 1.
Describe the characteristics of intangible assets.
2.
Identify the costs to include in the initial valuation of intangible assets.
3.
Explain the procedure for amortizing intangible assets.
4.
Describe the types of intangible assets.
5.
Explain the conceptual issues related to goodwill.
6.
Describe the accounting procedures for recording goodwill.
7.
Explain the accounting issues related to intangible-asset impairments.
8.
Identify the conceptual issues related to research and development costs.
9.
Describe the accounting for research and development and similar costs.
10.
Indicate the presentation of intangible assets and related items.
*11.
Understand the accounting treatment for computer software costs.
Intangible Assets
12 - 5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1.
TF
21.
MC
22.
2. 3.
TF TF
24. 25.
MC MC
76. 77.
s
4. 5. 6.
TF TF TF
26. 27. 28.
MC MC MC
7. 8. 9. 33. 34.
TF TF TF MC MC
35. 36. 37. 38. 39.
MC MC MC MC MC
83. 84. 85. 86. 87.
10. 40.
TF MC
41. 42.
MC MC
43. 118.
11. 12.
TF TF
44. 45.
MC MC
46. 47.
13. 14.
TF TF
15. 16.
TF TF
48. 49.
17. 18.
TF TF
p
51. 52.
MC MC
53. 54.
19. 56. 60.
TF MC MC
61. 62. p 63.
MC MC MC
64. 100. 101.
20. 32.
TF MC
65. 66.
MC MC
p
72. 73.
MC MC
74. 75.
MC MC
Note:
TF = True-False MC = Multiple Choice
s
29. 30. 32.
s
67. 68.
*106.
*107.
Type
Item
Type
Item
Learning Objective 1 MC 23. MC 121. Learning Objective 2 MC 78. MC 122. MC 79. MC 125. Learning Objective 3 MC 80. MC 128. MC 81. MC 129. MC 82. MC 130. Learning Objective 4 MC 88. MC 114. MC 89. MC 115. MC 111. MC 116. MC 112. MC 117. MC 113. MC 127. Learning Objective 5 MC 124. E MC 145. P Learning Objective 6 MC 90. MC 92. MC 91. MC 93. Learning Objective 7 s MC 50. MC 96. MC 95. MC 97. Learning Objective 8 MC 55. MC 58. MC 57. MC 59. Learning Objective 9 MC 102. MC 119. MC 103. MC 120. MC 104. MC 140. Learning Objective 10 MC 69. MC 71. MC 70. MC 105. Learning Objective *11 MC *108. MC *110. MC *109. MC 143. E = Exercise P = Problem
Type
Item
Type
Item
Type
E
123.
E
E E
126.
E
E E E
131.
E
MC MC MC MC E
132. 133. 134. 135. 139.
E E E E E
144.
P
MC MC
94. 136.
MC E
142.
E
MC MC
98. 99.
MC MC
137. 138.
E E
MC MC
145.
P
MC MC E
141. 144.
E P
MC MC MC E
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Test Bank for Intermediate Accounting, Fourteenth Edition
TRUE-FALSE—Conceptual 1.
Intangible assets derive their value from the right (claim) to receive cash in the future.
2.
Internally created intangibles are recorded at cost.
3.
Internally generated intangible assets are initially recorded at fair value.
4.
Amortization of limited-life intangible assets should not be impacted by expected residual values.
5.
Some intangible assets are not required to be amortized every year.
6.
Limited-life intangibles are amortized by systematic charges to expense over their useful life.
7.
The cost of acquiring a customer list from another company is recorded as an intangible asset.
8.
The cost of purchased patents should be amortized over the remaining legal life of the patent.
9.
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.
10.
In a business combination, a company assigns the cost, where possible, to the identifiable tangible and intangible assets, with the remainder recorded as goodwill.
11.
Internally generated goodwill should not be capitalized in the accounts.
12.
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.
13.
All intangibles are subject to periodic consideration of impairment with corresponding potential write-downs.
Intangible Assets
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14.
If the fair value of an unlimited life intangible other than goodwill is less than its book value, an impairment loss must be recognized.
15.
If market value of an impaired asset recovers after an impairment has been recognized, the impairment may be reversed in a subsequent period.
16.
The same recoverability test that is used for impairments of property, plant, and equipment is used for impairments of indefinite-life intangibles.
17.
Periodic alterations to existing products are an example of research and development costs.
18.
Research and development costs that result in patents may be capitalized to the extent of the fair value of the patent.
19.
Research and development costs are recorded as an intangible asset if it is felt they will provide economic benefits in future years.
20.
Contra accounts must be reported for intangible assets in a manner similar to accumulated depreciation and property, plant, and equipment.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F F F F T
Item 6. 7. 8. 9. 10.
Ans. T T F T T
Item 11. 12. 13. 14. 15.
Ans. T F T T F
Item 16. 17. 18. 19. 20.
Ans. F F F F F
MULTIPLE CHOICE—Conceptual 21.
Which of the following does not describe intangible assets? a. They lack physical existence. b. They are financial instruments. c. They provide long-term benefits. d. They are classified as long-term assets.
22.
Which of the following characteristics do intangible assets possess? a. Physical existence. b. Claim to a specific amount of cash in the future. c. Long-lived. d. Held for resale.
12 - 8
Test Bank for Intermediate Accounting, Fourteenth Edition
23.
Which characteristic is not possessed by intangible assets? a. Physical existence. b. Short-lived. c. Result in future benefits. d. Expensed over current and/or future years.
24.
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.
25.
Which of the following costs incurred internally to create an intangible asset is generally expensed? a. Research and development costs. b. Filing costs. c. Legal costs. d. All of the above.
26.
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
27.
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.
28.
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.
29.
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.
Intangible Assets
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30.
Companies should test indefinite life intangible assets at least annually for: a. recoverability. b. amortization. c. impairment. d. estimated useful life.
31.
One factor that is not considered in determining the useful life of an intangible asset is a. salvage value. b. provisions for renewal or extension. c. legal life. d. expected actions of competitors.
32.
Which intangible assets are amortized? Limited-Life Indefinite-Life a. Yes Yes b. Yes No c. No Yes d. No No
33.
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.
34.
Broadway Corporation was granted a patent on a product on January 1, 2001. To protect its patent, the corporation purchased on January 1, 2012 a patent on a competing product which was originally issued on January 10, 2008. Because of its unique plant, Broadway 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 9 years. d. expensed in 2012.
35.
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.
S
12 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition 36.
Which of the following is not an intangible asset? a. Trade name b. Research and development costs c. Franchise d. Copyrights
37.
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.
38.
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.
39.
When a company develops a trademark the costs directly related to securing it should generally be capitalized. Which of the following costs associated with a trademark would not be allowed to be capitalized? a. Attorney fees. b. Consulting fees. c. Research and development fees. d. Design costs.
40.
In a business combination, companies record identifiable intangible assets that they can reliably measure. All other intangible assets, too difficult to identify or measure, are recorded as: a. other assets. b. indirect costs. c. goodwill. d. direct costs.
41.
Goodwill may be recorded when: a. it is identified within a company. b. one company acquires another in a business combination. c. the fair value of a company’s assets exceeds their cost. d. a company has exceptional customer relations.
Intangible Assets
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42.
When a new company is acquired, which of these intangible assets, unrecorded on the acquired company’s books, might be recorded in addition to goodwill? a. A brand name. b. A patent. c. A customer list. d. All of the above.
43.
Which of the following intangible assets could not be sold by a business to raise needed cash for a capital project? a. Patent. b. Copyright. c. Goodwill. d. Brand Name.
44.
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 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.
45.
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 fair values of identifiable assets acquired less the fair value of liabilities assumed exceeded the cost to Easton. Proper accounting treatment by Easton is to report the excess amount as a. a gain. b. part of current income in the year of combination. c. a deferred credit and amortize it. d. paid-in capital.
46.
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.
12 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition 47.
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.
48.
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.
49.
The recoverability test is used to determine any impairment loss on which of the following types of intangible assets? a. Indefinite life intangibles other than goodwill. b. Indefinite life intangibles. c. Goodwill. d. Limited life intangibles.
50.
Buerhle 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
51.
The carrying amount of an intangible is a. the fair 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.
52.
Which of the following research and development related costs should be capitalized and depreciated 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
Intangible Assets
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53.
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
54.
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.
55.
Which of the following would be considered research and development? a. Routine efforts to refine an existing product. b. Periodic alterations to existing production lines. c. Marketing research to promote a new product. d. Construction of prototypes.
56.
Which of the following costs should be capitalized in the year incurred? a. Research and development costs. b. Costs to internally generate goodwill. c. Organizational costs. d. Costs to successfully defend a patent.
57.
Research and development costs a. are intangible assets. b. may result in the development of a patent. c. are easily identified with specific projects. d. all of the above.
58.
Which of the following is considered research and development costs? a. Planned search or critical investigation aimed at discovery of new knowledge. b. Translation of research findings or other knowledge into a plan or design for a new product or process. c. Translation of research findings or other knowledge into a significant improvement of an existing product. d. all of the above.
12 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition 59.
Which of the following is considered research and development costs? a. Planned search or critical investigation aimed at discovery of new knowledge. b. Translation of research findings or other knowledge into a plan or design for a new product or process. c. Neither a nor b. d. Both a and b.
60.
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
61.
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.
62.
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.
63. 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.
Intangible Assets
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64. 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. 65. Which of the following intangible assets should be shown as a separate item on the balance sheet? a. Goodwill b. Franchise c. Patent d. Trademark 66. The notes to the financial statements should include information about acquired intangible assets, and aggregate amortization expense for how many succeeding years? a. 6 b. 5 c. 4 d. 3 67. Which of the following should be reported under the “Other Expenses and Losses” section of the income statement? a. Goodwill impairment losses. b. Trade name amortization expense. c. Patent impairment losses d. None of the above. 68. 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 Patents account. b. shown in the current income statement. c. reflected as credits in the Patents account. d. reflected as a contra property, plant and equipment item. 69. Intangible assets are reported on the balance sheet a. with an accumulated depreciation account. b. in the property, plant, and equipment section. c. separately from other assets. d. none of the above.
12 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition 70. Which of the following is often reported as an extraordinary item? a. Amortization expense. b. Impairment losses for intangible assets other than goodwill. c. Impairment losses on goodwill. d. None of the above. 71. Which of the following is often reported as an extraordinary item? a. Amortization expense. b. Impairment losses for intangible assets. c. Research and development costs. d. None of the above. *72. Which of the following costs incurred with developing computer software for internal use should be capitalized? a. Evaluation of alternatives. b. Coding. c. Training. d. Maintenance. *73. When developing computer software to be sold, which of the following costs should be capitalized? a. Designing. b. Coding. c. Testing. d. None of the above. *74. Capitalized costs incurred to develop internal use computer software should be amortized using the: a. percent-of-revenue approach. b. percent-of-completion approach. c. straight-line approach. d. accelerated amortization approach. *75. Capitalized costs incurred while developing computer software to be sold should be amortized using the: a. lower of the straight-line method or the percent-of-revenue method. b. higher of the percent-of-revenue method or the percent-of-completion method. c. lower of the percent-of-revenue method or the percent-of-completion method. d. higher of the straight-line method or the percent-of-revenue method.
Intangible Assets
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Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27. 28.
b c a c a b d d
29. 30. 31. 32. 33. 34. 35. 36.
b c a b d c d b
37. 38. 39. 40. 41. 42. 43. 44.
c a c c b d c b
45. 46. 47. 48. 49. 50. 51. 52.
a d a b d c b a
53. 54. 55. 56. 57. 58. 59. 60.
d d d d b d d c
61. 62. 63. 64. 65. 66. 67. 68.
b a d a a b d c
69. 70. 71. 72. 73. 74. 75.
c d d b d c d
MULTIPLE CHOICE—Computational 76. Lynne Corporation acquired a patent on May 1, 2012. Lynne paid cash of $40,000 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. $39,000 c. $40,000 d. $41,000 77. Contreras Corporation acquired a patent on May 1, 2012. Contreras paid cash of $35,000 to the seller. Legal fees of $900 were paid related to the acquisition. What amount should be debited to the patent account? a. $900 b. $34,100 c. $35,000 d. $35,900 78. Mini Corp. acquires a patent from Maxi Co. in exchange for 2,500 shares of Mini Corp.’s $5 par value common stock and $90,000 cash. When the patent was initially issued to Maxi Co., Mini Corp.’s stock was selling at $7.50 per share. When Mini Corp. acquired the patent, its stock was selling for $9 a share. Mini Corp. should record the patent at what amount? a. $102,500 b. $108,750 c. $112,500 d. $90,000
12 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 79. Alonzo Co. acquires 3 patents from Shaq Corp. for a total of $300,000. The patents were carried on Shaq’s books as follows: Patent AA: $5,000; Patent BB: $2,000; and Patent CC: $3,000. When Alonzo acquired the patents their fair values were: Patent AA: $20,000; Patent BB: $240,000; and Patent CC: $60,000. At what amount should Alonzo record Patent BB? a. $100,000 b. $200,000 c. $2,000 d. $225,000 80. Jeff Corporation purchased a limited-life intangible asset for $150,000 on May 1, 2010. 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, 2012? a. $ -0b. $30,000 c. $40,000 d. $45,000 81. Rich Corporation purchased a limited-life intangible asset for $270,000 on May 1, 2010. 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, 2012? a. $ -0-. b. $54,000 c. $72,000 d. $81,000 82. Thompson Company incurred research and development costs of $100,000 and legal fees of $20,000 to acquire a patent. The patent has a legal life of 20 years and a useful life of 10 years. What amount should Thompson record as Patent Amortization Expense in the first year? a. $ -0-. b. $ 2,000. c. $ 6,000. d. $12,000. 83. ELO Corporation purchased a patent for $180,000 on September 1, 2010. It had a useful life of 10 years. On January 1, 2012, 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 2012? a. $41,200. b. $40,000. c. $37,600. d. $31,200.
Intangible Assets
12 - 19
84.
Danks Corporation purchased a patent for $900,000 on September 1, 2010. It had a useful life of 10 years. On January 1, 2012, Danks spent $220,000 to successfully defend the patent in a lawsuit. Danks feels that as of that date, the remaining useful life is 5 years. What amount should be reported for patent amortization expense for 2012? a. $206,000. b. $200,000. c. $188,000. d. $156,000.
85.
The general ledger of Vance Corporation as of December 31, 2012, 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
$ 30,000 27,000 70,000 440,000 90,000
In the preparation of Vance's balance sheet as of December 31, 2012, what should be reported as total intangible assets? a. $530,000. b. $557,000. c. $560,000. d. $587,000. 86.
In January, 2008, Findley Corporation purchased a patent for a new consumer product for $960,000. 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 2013 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 2013, assuming amortization is recorded at the end of each year? a. $640,000. b. $480,000. c. $96,000. d. $64,000.
87.
Day Company purchased a patent on January 1, 2012 for $600,000. The patent had a remaining useful life of 10 years at that date. In January of 2013, Day successfully defends the patent at a cost of $270,000, extending the patent’s life to 12/31/24. What amount of amortization expense would Kerr record in 2013? a. $60,000 b. $67,500 c. $72,500 d. $90,000
12 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 88.
On January 2, 2012, Klein Co. bought a trademark from Royce, Inc. for $1,200,000. An independent research company estimated that the remaining useful life of the trademark was 10 years. Its unamortized cost on Royce’s books was $900,000. In Klein’s 2012 income statement, what amount should be reported as amortization expense? a. $120,000. b. $ 90,000. c. $ 60,000. d. $ 45,000.
89. A company acquires a patent for a drug with a remaining legal and useful life of six years on January 1, 2011 for $2,100,000. The company uses straight-line amortization for patents. On January 2, 2013, 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 2013 is a. $350,000. b. $ 70,000. c. $ 95,454. d. $ 80,500. 90. Blue Sky Company’s 12/31/12 balance sheet reports assets of $7,500,000 and liabilities of $3,000,000. All of Blue Sky’s assets’ book values approximate their fair value, except for land, which has a fair value that is $450,000 greater than its book value. On 12/31/12, Horace Wimp Corporation paid $7,650,000 to acquire Blue Sky. What amount of goodwill should Horace Wimp record as a result of this purchase? a. $ -0b. $150,000 c. $2,700,000 d. $3,150,000 91. Dotel Company’s 12/31/12 balance sheet reports assets of $12,000,000 and liabilities of $5,000,000. All of Dotel’s assets’ book values approximate their fair value, except for land, which has a fair value that is $800,000 greater than its book value. On 12/31/12, Egbert Corporation paid $12,200,000 to acquire Dotel. What amount of goodwill should Egbert record as a result of this purchase? a. $ -0b. $ 200,000 c. $4,400,000 d. $5,200,000
Intangible Assets
12 - 21
92. Floyd Company purchases Haeger Company for $3,200,000 cash on January 1, 2013. The book value of Haeger Company’s net assets, as reflected on its December 31, 2012 balance sheet is $2,480,000. An analysis by Floyd on December 31, 2012 indicates that the fair value of Haeger’s tangible assets exceeded the book value by $240,000, and the fair value of identifiable intangible assets exceeded book value by $180,000. How much goodwill should be recognized by Floyd Company when recording the purchase of Haeger Company? a. $ -0b. $720,000 c. $480,000 d. $300,000 93. General Products Company bought Special Products Division in 2012 and appropriately recorded $500,000 of goodwill related to the purchase. On December 31, 2013, the fair value of Special Products Division is $4,000,000 and it is carried on General Product’s books for a total of $3,400,000, including the goodwill. An analysis of Special Products Division’s assets indicates that goodwill of $400,000 exists on December 31, 2013. What goodwill impairment should be recognized by General Products in 2013? a. $0. b. $200,000. c. $50,000. d. $300,000. 94.
During 2012, Bond Company purchased the net assets of May Corporation for $2,000,000. On the date of the transaction, May had $600,000 of liabilities. The fair value of May's assets when acquired were as follows: Current assets Noncurrent assets
$ 1,080,000 2,520,000 $3,600,000
How should the $1,000,000 difference between the fair value of the net assets acquired ($3,000,000) and the cost ($2,000,000) be accounted for by Bond? a. The $1,000,000 difference should be credited to retained earnings. b. The $1,000,000 difference should be recognized as a gain. c. The current assets should be recorded at $1,080,000 and the noncurrent assets should be recorded at $1,520,000. d. A deferred credit of $1,000,000 should be set up and then amortized to income over a period not to exceed forty years.
12 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 95.
The following information is available for Barkley Company’s patents: Cost Carrying amount Expected future net cash flows Fair value
$2,580,000 1,290,000 1,200,000 975,000
Barkley would record a loss on impairment of a. $ 90,000. b. $ 315,000. c. $1,290,000. d. $1,380,000. 96. Harrel Company acquired a patent on an oil extraction technique on January 1, 2012 for $7,500,000. It was expected to have a 10 year life and no residual value. Harrel uses straight-line amortization for patents. On December 31, 2013, the expected future cash flows expected from the patent were expected to be $900,000 per year for the next eight years. The present value of these cash flows, discounted at Harrel’s market interest rate, is $4,200,000. At what amount should the patent be carried on the December 31, 2013 balance sheet? a. $7,500,000 b. $7,200,000 c. $6,000,000 d. $4,200,000 97. Malrom Manufacturing Company acquired a patent on a manufacturing process on January 1, 2012 for $6,250,000. It was expected to have a 10 year life and no residual value. Malrom uses straight-line amortization for patents. On December 31, 2013, the expected future cash flows expected from the patent were expected to be $500,000 per year for the next eight years. The present value of these cash flows, discounted at Malrom’s market interest rate, is $3,000,000. At what amount should the patent be carried on the December 31, 2013 balance sheet? a. $6,250,000 b. $5,000,000 c. $4,000,000 d. $3,000,000 98. Twilight Corporation acquired End-of-the-World Products on January 1, 2012 for $8,000,000, and recorded goodwill of $1,500,000 as a result of that purchase. At December 31, 2012, the End-of-the-World Products Division had a fair value of $6,800,000. The net identifiable assets of the Division (excluding goodwill) had a fair value of $5,800,000 at that time. What amount of loss on impairment of goodwill should Twilight record in 2012? a. $ -0b. $500,000 c. $700,000 d. $1,200,000
Intangible Assets
12 - 23
99. Jenks Corporation acquired Linebrink Products on January 1, 2012 for $6,000,000, and recorded goodwill of $1,125,000 as a result of that purchase. At December 31, 2012, Linebrink Products had a fair value of $5,100,000. The net identifiable assets of the Linebrink (excluding goodwill) had a fair value of $4,350,000 at that time. What amount of loss on impairment of goodwill should Jenks record in 2012? a. $ -0b. $375,000 c. $525,000 d. $900,000 100.
In 2012, Edwards Corporation incurred research and development costs as follows: Materials and equipment Personnel Indirect costs
$ 90,000 130,000 150,000 $370,000
These costs relate to a product that will be marketed in 2011. It is estimated that these costs will be recouped by December 31, 2015. The equipment has no alternative future use. What is the amount of research and development costs that should be expensed in 2012? a. $0. b. $220,000. c. $280,000. d. $370,000. 101.
Hall Co. incurred research and development costs in 2013 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 2013 on above equipment 500,000 Personnel costs of persons involved in research and development projects 750,000 Consulting fees paid to outsiders for research and development projects 300,000 Indirect costs reasonably allocable to research and development projects 225,000 $5,225,000 The amount of research and development costs charged to Hall's 2013 income statement should be a. $1,700,000. b. $2,000,000. c. $2,225,000. d. $4,700,000.
12 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition 102.
Loazia Inc. incurred the following costs during the year ended December 31, 2013: 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
$230,000 45,000 270,000 360,000
The total amount to be classified and expensed as research and development in 2013 is a. $605,000. b. $905,000. c. $635,000. d. $335,000. 103. MaBelle Corporation incurred the following costs in 2012: Acquisition of R&D equipment with a useful life of 4 years in R&D projects $600,000 Start-up costs incurred when opening a new plant 140,000 Advertising expense to introduce a new product 700,000 Engineering costs incurred to advance a product to full production stage 500,000 What amount should MaBelle record as research & development expense in 2012? a. $ 650,000 b. $ 740,000 c. $1,100,000 d. $1,240,000 104. Leeper Corporation incurred the following costs in 2012: Acquisition of R&D equipment with a useful life of 4 years in R&D projects $800,000 Cost of making minor modifications to an existing product 140,000 Advertising expense to introduce a new product 700,000 Engineering costs incurred to advance a product to full production stage 750,000 What amount should Leeper record as research & development expense in 2012? a. $ 950,000 b. $ 940,000 c. $1,450,000 d. $1,640,000
Intangible Assets
12 - 25
105. Platteville Corporation has the following account balances at 12/31/12: Amortization expense $ 30,000 Goodwill 420,000 Patent, net of $90,000 amortization 210,000 What amount should Platteville report for intangible assets on the 12/31/12 balance sheet? a. $210,000 b. $300,000 c. $630,000 d. $660,000 *106. Shangra-La Company incurred $2,000,000 ($500,000 in 2011 and $1,500,000 in 2012) to develop a computer software product. $600,000 of this amount was expended before technological feasibility was established in early 2012. The product will earn future revenues of $4,000,000 over its 5-year life, as follows: 2012 – $1,000,000; 2013 – $1,000,000; 2014 – $800,000; 2015 – $800,000; and 2016 – $400,000. What portion of the $2,000,000 computer software costs should be expensed in 2012? a. $350,000 b. $400,000 c. $450,000 d. $1,500,000 *107. Logan Company incurred $4,000,000 ($1,100,000 in 2011 and $2,900,000 in 2012) to develop a computer software product. $1,200,000 of this amount was expended before technological feasibility was established in early 2012. The product will earn future revenues of $8,000,000 over its 5-year life, as follows: 2012 – $2,000,000; 2013 – $2,000,000; 2014 – $1,600,000; 2015 – $1,600,000; and 2016 – $800,000. What portion of the $4,000,000 computer software costs should be expensed in 2012? a. $700,000. b. $750,000. c. $800,000. d. $2,900,000. *108. Geller Inc. incurred $700,000 of capitalizable costs to develop computer software during 2012. The software will earn total revenues over its 4-year life as follows: 2012 $400,000; 2013 - $500,000; 2014 - $600,000; and 2015 - $500,000. What amount of the computer software costs should be expensed in 2012? a. $700,000 b. $140,000 c. $175,000 d. $245,000
12 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition *109. Tripiani Inc. incurred $800,000 of capitalizable costs to develop computer software during 2012. The software will earn total revenues over its 5-year life as follows: 2012 $500,000; 2013 - $600,000; 2014 - $600,000; 2015 - $200,000; and 2016 - $100,000. What amount of the computer software costs should be expensed in 2012? a. $200,000 b. $160,000 c. $180,000 d. $266,667 *110. Tripiani Inc. incurred $900,000 of capitalizable costs to develop computer software during 2012. The software will be used internally over its 5-year life. What amount of the computer software costs should be expensed in 2012? a. $900,000 b. $180,000 c. $202,500 d. $300,000
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
*76. *77. 78. 79. 80. 81.
d d c d c c
82. 83. 84. 85. 86. 87.
b b b c b b
88. 89. 90. 91. 92. 93.
a b c c d a
94. 95. 96. 97. 98. 99.
b b c d b b
100. 101. 102. 103. 104. 105.
d c c a a c
*106. *107. *108. *109. *110.
c c c a b
MULTIPLE CHOICE—CPA Adapted 111.
Lopez Corp. incurred $1,260,000 of research and development costs to develop a product for which a patent was granted on January 2, 2008. Legal fees and other costs associated with registration of the patent totaled $240,000. On March 31, 2013, Lopez paid $450,000 for legal fees in a successful defense of the patent. The total amount capitalized for the patent through March 31, 2013 should be a. $690,000. b. $1,500,000. c. $1,710,000. d. $1,950,000.
Intangible Assets
12 - 27
112.
On June 30, 2013, Cey, Inc. exchanged 4,000 shares of Seely Corp. $30 par value common stock for a patent owned by Gore Co. The Seely stock was acquired in 2013 at a cost of $110,000. At the exchange date, Seely common stock had a fair value of $46 per share, and the patent had a net carrying value of $220,000 on Gore's books. Cey should record the patent at a. $110,000. b. $120,000. c. $184,000. d. $220,000.
113.
On May 5, 2013, MacDougal Corp. exchanged 6,000 shares of its $25 par value treasury common stock for a patent owned by Masset Co. The treasury shares were acquired in 2012 for $135,000. At May 5, 2013, MacDougal's common stock was quoted at $34 per share, and the patent had a carrying value of $165,000 on Masset's books. MacDougal should record the patent at a. $135,000. b. $150,000. c. $165,000. d. $204,000.
114.
Ely Co. bought a patent from Baden Corp. on January 1, 2013, for $450,000. An independent consultant retained by Ely estimated that the remaining useful life at January 1, 2013 is 15 years. Its unamortized cost on Baden’s accounting records was $225,000; the patent had been amortized for 5 years by Baden. How much should be amortized for the year ended December 31, 2013 by Ely Co.? a. $0. b. $22,500. c. $30,000. d. $45,000.
115.
January 2, 2010, Koll, Inc. purchased a patent for a new consumer product for $450,000. 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, 2013, the product was permanently withdrawn from the market under governmental order because of a potential health hazard in the product. What amount should Koll charge against income during 2013, assuming amortization is recorded at the end of each year? a. $ 45,000 b. $270,000 c. $315,000 d. $360,000
12 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition 116.
On January 1, 2009, Russell Company purchased a copyright for $2,000,000, having an estimated useful life of 16 years. In January 2013, Russell paid $300,000 for legal fees in a successful defense of the copyright. Copyright amortization expense for the year ended December 31, 2013, should be a. $0. b. $125,000. c. $143,750. d. $150,000.
117.
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
118.
Which of the following costs of goodwill should be amortized over their estimated useful lives? Costs of goodwill from a Costs of developing business combination goodwill internally a. No No b. No Yes c. Yes Yes d. Yes No
119.
During 2013, 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
350,000 250,000 560,000 425,000
In Leon's 2013 income statement, research and development expense should be a. $560,000. b. $985,000. c. $1,335,000. d. $1,585,000.
Intangible Assets 120.
12 - 29
Riley Co. incurred the following costs during 2013: Significant modification to the formulation of a chemical product Trouble-shooting in connection with breakdowns during commercial production Cost of exploration of new formulas Seasonal or other periodic design changes to existing products Laboratory research aimed at discovery of new technology
$160,000 150,000 200,000 185,000 275,000
In its income statement for the year ended December 31, 2013, Riley should report research and development expense of a. $635,000. b. $785,000. c. $820,000. d. $970,000.
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
111. 112.
a c
113. 114.
d c
115. 116.
c d
117. 118.
c a
119. 120.
c a
DERIVATIONS — Computational No.
Answer Derivation
76.
d
$40,000 + $1,000 = $41,000.
77.
d
$35,000 + $900 = $35,900.
78.
c
(2,500 X $9) + $90,000 = $112,500.
79.
d
$300,000 X ($240,000 / $320,000) = $225,000.
80.
c
($150,000 ÷ 10) × 2 2/3 = $40,000.
81.
c
($270,000 ÷ 10) × 2 2/3 = $72,000.
82.
b
$20,000 ÷ 10 = $2,000.
83.
b
$180,000 – [($180,000 ÷ 10) × 1 1/3] = $156,000. ($156,000 + $44,000) ÷ 5 = $40,000.
84.
b
$900,000 – [($900,000 ÷ 10) × 1 1/3] = $780,000. ($780,000 + $220,000) ÷ 5 = $200,000.
85.
c
$30,000 + $440,000 + $90,000 = $560,000.
86.
b
($960,000 ÷ 10) × 5 = $480,000.
87.
b
[($600,000 – $60,000) + $270,000] ÷ 12 = $67,500.
12 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
88.
a
$1,200,000 ÷ 10 = $120,000.
89.
b
$2,100,000 – [($2,100,000 ÷ 6) × 2] = $1,400,000. $1,400,000 ÷ 20 = $70,000.
90.
c
($7,500,000 + $450,000) – $3,000,000 = $4,950,000 $7,650,000 – $4,950,000 = $2,700,000.
91.
c
($12,000,000 + $800,000) – $5,000 = $7,800,000. $12,200,000 – $7,800,000 = $4,400,000.
92.
d
$2,480,000 + $240,000 + $180,000 = $2,900,000. $3,200,000 – $2,900,000 = $300,000.
93.
a
Since $4,000,000 > $3,400,000, $0 impairment.
94.
b
$3,000,000 – $2,000,000 = $1,000,000 gain.
95.
b
$1,290,000 – $975,000 = $315,000.
96.
c
$7,500,000 – [($7,500,000 ÷ 10) × 2] = $6,000,000.
97.
d
$6,250,000 – [($6,250,000 ÷ 10) × 2] = $5,000,000. Since $5,000,000 > ($500,000 × 8), patent is reported at $3,000,000 (present value of cash flows.
98.
b
$6,800,000 – $5,800,000 = $1,000,000 $1,500,000 – $1,000,000 = $500,000.
99.
b
$5,100,000 – $4,350,000 = $750,000 $1,125,000 – $ 750,000 = $375,000.
100.
d
Expense total of $370,000.
101.
c
$5,225,000 – $3,000,000 = $2,225,000.
102.
c
$230,000 + $45,000 + $360,000 = $635,000.
103.
a
($600,000 ÷ 4) + $500,000 = $650,000.
104.
a
($800,000 ÷ 4) + $750,000 = $950,000.
105.
c
$420,000 +$210,000 = $630,000.
Intangible Assets
No.
Answer Derivation
*106.
c
($2,000,000 – $600,000) × ($1,000,000 ÷ $4,000,000) = $350,000. $350,000 + ($600,000 – $500,000) = $450,000.
*107.
c
($4,000,000 – $1,200,000) × ($2,000,000 ÷ $8,000,000) = $700,000. $700,000 + ($1,200,000 – $1,100,000) = $800,000.
*108.
c
$700,000 X ¼ = $175,000 (greater than $140,000).
*109.
a
$800,000 X $500,000 / $2,000,000 = $200,000 (greater than $160,000).
*110.
b
$900,000 X 1/5 = $180,000.
DERIVATIONS — CPA Adapted 111.
a
$240,000 + $450,000 = $690,000.
112.
c
4,000 × $46 = $184,000.
113.
d
6,000 × $34 = $204,000.
114.
c
$450,000 ÷ 15 = $30,000.
115.
c
$450,000 – [($450,000 ÷ 10) × 3] = $315,000.
116.
d
($2,000,000 – [($2,000,000 ÷ 16) × 4] = $1,500,000 ($1,500,000 + $300,000) ÷ 12 = $150,000.
117.
c
Conceptual.
118.
a
Conceptual.
119.
c
$350,000 + $560,000 + $425,000 = $1,335,000.
120.
a
$160,000 + $200,000 + $275,000 = $635,000.
12 - 31
12 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Ex. 12-121 Intangible assets have two main characteristics: (1) they lack physical existence, and (2) they are not financial instruments. Instructions (a) Explain why intangibles are classified as assets if they have no physical existence. (b) Explain why intangibles are not considered financial instruments. Solution 12-121 (a) Intangible assets derive their value from the rights and privileges they grant to the company that owns them. (b) Intangibles are not considered financial instruments because they do not derive their value from the right (claim) to receive cash or cash equivalents in the future. Ex. 12-122 Intangible assets may be internally generated or purchased from another party. In either case, what costs should be included in the initial valuation of the asset is an issue. Instructions (a) Identify the typical costs included in the cash purchase of an intangible asset. (b) Discuss how to determine the cost of an intangible asset acquired in a non-cash transaction. (c) Describe how to determine the cost of several intangible assets acquired in a “basket purchase.” Provide a numerical example involving intangibles being acquired for a total price of $90,000. Solution 12-122 (a) The typical costs included in the purchase of an intangible asset are: purchase price, legal fees, and other incidental expenses. (b) In a non-cash acquisition of an intangible asset, the initial cost of the intangible is either the fair value of the consideration given or the fair value of the intangible received, whichever is more clearly evident. (c) When several intangible assets are acquired in a “basket purchase”, the cost of the individual assets is based on their relative fair values. For example: Asset Patent A Patent B Totals
FV $ 60,000 40,000 $100,000
% 60 40 100
Allocation 60% x $90,000 = $ 54,000 40% x $90,000 = 36,000 $90,000
Intangible Assets
12 - 33
Ex. 12-123 Why does the accounting profession make a distinction between internally created intangible assets and purchased intangible assets? Solution 12-123 When intangible assets are created internally, it is often difficult to determine the validity of any future service potential. To permit deferral of these types of costs would lead to a great deal of subjectivity because management could argue that almost any expense could be capitalized on the basis that it will increase future benefits. The cost of purchased intangible assets, however, is capitalized because its cost can be objectively verified and reflects its fair value at the date of acquisition.
Ex. 12-124—Short essay questions. 1. 2.
What are intangible assets? How are limited-life intangibles accounted for subsequent to acquisition?
Solution 12-124 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. 12-125 If intangible assets are acquired for stock, how is the cost of the intangible determined? Solution 12-125 If intangible assets are acquired for stock, the cost of the intangible is the fair value of the consideration given or the fair value of the consideration received, whichever is more clearly evident. Ex. 12-126 Redstone Company spent $190,000 developing a new process, $45,000 in legal fees to obtain a patent, and $91,000 to market the process that was patented. How should these costs be accounted for in the year they are incurred? Solution 12-126 The $190,000 should be expensed when incurred as research and development expense. The $91,000 is expensed as selling and promotion expense when incurred. The $45,000 of costs to legally obtain the patent should be capitalized and amortized over the useful or legal life of the patent, whichever is shorter.
12 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 12-127—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 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. 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 value d. excess earnings Solution 12-127 1. d
2. d
3. d
4. b
5. c
Ex. 12-128 Intangible assets have either a limited useful life or an indefinite useful life. How should these two different types of intangibles be amortized? Solution 12-128 Limited-life intangible assets should be amortized by systematic charges to expense over the shorter of their useful life or legal life. An intangible asset with an indefinite life is not amortized.
Intangible Assets
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Ex. 12-129 What are factors to be considered in estimating the useful life of an intangible asset? Solution 12-129 Factors to be considered in determining useful life are: a. The expected use of the asset by the entity. b. The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate. c. Any legal, regulatory, or contractual provisions that may limit useful life. d. Any legal, regulatory or contractual provisions that enable renewal or extension of the asset’s legal or contractual life without substantial cost. e. The effects of obsolescence, demand, competition, and other economic factors. f. The level of maintenance expenditure required to obtain the expected future cash flows from the asset. Ex. 12-130 Barkley Corp. obtained a trade name in January 2011, incurring legal costs of $30,000. The company amortizes the trade name over 8 years. Barkley successfully defended its trade name in January 2012, incurring $9,800 in legal fees. At the beginning of 2013, based on new marketing research, Barkley determines that the fair value of the trade name is $24,000. Estimated total future cash flows from the trade name are $26,000 on January 4, 2013. Instructions Prepare the necessary journal entries for the years ending December 31, 2011, 2012, and 2013. Show all computations.
12 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 12-130 2011 Dec. 31
2012 Dec. 31
2013 Dec. 31
Amortization Expense Trade Names ($30,000 ÷ 8 years)
3,750 3,750
Amortization Expense 6,900 Trade Names [($30,000 - $3,750 + $9,800) ÷ 7 years] Loss on Impairment Trade Names
6,900
3,450 3,450
Carrying value = $30,000 - $3,750 + $9,800 - $5,150 = $30,900 Total future cash flows = 26,000 Therefore, an impairment loss has occurred Carrying value Fair value Loss on impairment 2013 Dec. 31
Amortization Expense Trade Names ($24,000 ÷ 6 years)
= $30,900 = (24,000) = $ 6,900
4,000 4,000
Ex. 12-131—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 12-131 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 expense recognition principle—deducting expenses in the same period(s) that revenues are reported. Ex. 12-132 Listed below is a selection of accounts found in the general ledger of Marshall Corporation as of December 31, 2013: Accounts receivable Goodwill Organization costs Prepaid insurance Radio broadcasting rights Premium on bonds payable Trade name
Research & development costs Internet domain name Initial operating loss Non-competition agreement Customer list Video copyrights Notes receivable
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Instructions List those accounts that should be classified as intangible assets. Solution 12-132 Goodwill Radio broadcasting rights Trade name Internet domain name
Non-competition agreement Customer list Video copyrights
Ex. 12-133 Define the following terms. (a) Goodwill (b) Negative goodwill Solution 12-133 (a) Varying approaches are used to define goodwill. They are: • Goodwill should be measured initially as the excess of the fair value of the acquisition cost over the fair value of the net assets acquired. • Goodwill is sometimes defined as one or more unidentified intangible assets and identifiable intangible assets that are not reliably measurable. Examples of elements of goodwill include new channels of distribution, synergies of combining sales forces, and a superior management team. • Goodwill may also be defined as the intrinsic value that a business has acquired beyond the mere value of its net assets whether due to the personality of those conducting it, the nature of its location, its reputation, or any other circumstance incidental to the business and tending to make it permanent. Another definition is the capitalized value of the excess of estimated future profits of a business over the rate of return on capital considered normal in the industry. (b) Negative goodwill develops when the fair value of the assets purchased is higher than the cost. This situation may develop from a market imperfection. In this case, the seller would have been better off to sell the assets individually than in total. However, situations do occur (e.g., a forced liquidation or distressed sale due to the death of the company founder), in which the purchase price is less than the value of the identifiable net assets. Ex. 12-134—Carrying value of patent. Sisco Co. purchased a patent from Thornton Co. for $540,000 on July 1, 2010. Expenditures of $204,000 for successful litigation in defense of the patent were paid on July 1, 2013. Sisco 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, 2013.
12 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 12-134 Cost of patent Amortization 7/1/10 to 7/1/13 [($540,000 ÷ 20) × 3] Carrying value at 7/1/13 Cost of successful defense Carrying value Amortization 7/1/13 to 12/31/13 [$663,000 × 1/(20 – 3) × 1/2] Carrying value at 12/31/13
$540,000 (81,000) 459,000 204,000 663,000 (19,500) $643,500
Ex. 12-135—Accounting for patent. In early January 2011, Lerner Corporation applied for a patent, incurring legal costs of $40,000. In January 2012, Lerner incurred $9,000 of legal fees in a successful defense of its patent. Instructions (a) Compute 2011 amortization, 12/31/11 carrying value, 2012 amortization, and 12/31/12 carrying value if the company amortizes the patent over 10 years. (b) Compute the 2013 amortization and the 12/31/13 carrying value, assuming that at the beginning of 2013, based on new market research, Lerner determines that the fair value of the patent is $34,000. Estimated future cash flows from the patent are $35,000 on January 3, 2013.
Solution 12-135 (a) 2011 amortization: $40,000 ÷ 10 yrs. = $4,000 12/31/11 carrying value: $40,000 – $4,000 = $36,000 2012 amortization: ($36,000 + $9,000) ÷ 9 yrs. = $5,000 12/31/12 carrying value: ($36,000 + $9,000) – $5,000 = $40,000 (b) Since the expected future cash flows ($35,000) are less than the carrying value ($40,000), an impairment loss must be computed. Loss on impairment: $40,000 carrying value – $34,000 fair value = $6,000 2013 amortization: $34,000 ÷ 8 yrs. = $4,250 12/31/13 carrying value: $34,000 – $4,250 = $29,750 Ex. 12-136 Under what circumstances is it appropriate to record goodwill in the accounts? How should goodwill, properly recorded on the books, be written off in accordance with generally accepted accounting principles? Solution 12-136 Goodwill is recorded only when it is acquired through a business combination. Goodwill acquired in a business combination is considered to have an indefinite life and therefore should not be amortized, but should be tested for impairment on at least an annual basis.
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Ex. 12-137 Fred’s Company is considering the write-off of a limited life intangible asset because of its lack of profitability. Explain to the management of Fred’s how to determine whether a writeoff is permitted. Solution 12-137 Accounting standards require that if events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, then the carrying amount of the asset should be assessed. The assessment or review takes the form of a recoverability test that compares the sum of the expected future cash flows from the asset (undiscounted) to the carrying amount. If the cash flows are less than the carrying amount, the asset has been impaired. The impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the asset. The fair value of assets is measured by their market value if an active market for them exists. If no market price is available, the present value of the expected future net cash flows from the asset may be used. Ex. 12-138 Leon Corp. purchased Spinks Co. 4 years ago and at that time recorded goodwill of $360,000. The Sinks Division’s net assets, including goodwill, have a carrying amount of $850,000. The fair value of the division is estimated to be $900,000. Instructions (a) Explain whether or not Leon Corp. must prepare an entry to record impairment of the goodwill. Include the entry, if necessary. (b) Repeat instruction (a) assuming that the fair value of the division is estimated to be $800,000 and the implied goodwill is $270,000. Solution 12-138 (a) The fair value of the division ($900,000) exceeds the carrying amount of its assets ($850,000). Therefore, goodwill is not impaired and no entry is necessary. (b) The fair value of the division ($800,000) is less than the carrying amount of its assets ($850,000). Therefore, goodwill is impaired. The amount of the impairment loss is $90,000, the difference between the recorded goodwill ($360,000) and the implied goodwill ($270,000). Loss on Impairment Goodwill
90,000 90,000
Ex. 12-139—Impairment of copyrights. Presented below is information related to copyrights owned by Wamser Corporation at December 31, 2012. Cost $3,600,000 Carrying amount 3,100,000 Expected future net cash flows 2,800,000 Fair value 1,900,000 Assume Wamser will continue to use this asset in the future. As of December 31, 2012, the copyrights have a remaining useful life of 5 years.
12 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition Instructions (a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2012. (b) Prepare the journal entry to record amortization expense for 2013. (c) The fair value of the copyright at December 31, 2013 is $2,000,000. Prepare the journal entry (if any) necessary to record this increase in fair value. Solution 12-139 (a)
December 31, 2012 Loss on Impairment.................................................................... Copyrights........................................................................ Carrying amount Fair value Loss on impairment
(b)
1,200,000
$3,100,000 1,900,000 $ 1,200,000
December 31, 2013 Amortization Expense ................................................................ Copyrights........................................................................ New carrying amount Useful life Amortization
1,200,000
380,000 380,000
$1,900,000 ÷ 5 years $ 380,000
(c) No entry necessary. Restoration of any impairment loss is not permitted for assets held for future use. Ex. 12-140 Research and development activities may include (a) personnel costs, (b) materials and equipment costs, and (c) indirect costs. What is the recommended accounting treatment for these three types of R&D costs? Solution 12-140 (a) Personnel (labor) type costs incurred in R & D activities should be expensed as incurred. (b) Materials and equipment costs should be expensed immediately unless the items have alternative future uses. If the items have alternative future uses, the materials should be recorded as inventories and allocated as consumed and the equipment should be capitalized and depreciated as used. (c) Indirect costs of R & D activities should be reasonably allocated to R & D (except for general and administrative costs, which must be clearly related to be included) and expensed.
Intangible Assets
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Ex. 12-141 Recently, a group of university students decided to incorporate for the purposes of selling a process to recycle the waste product from manufacturing cheese. Some of the initial costs involved were legal fees and office expenses incurred in starting the business, state incorporation fees, and stamp taxes. One student wishes to charge these costs against revenue in the current period. Another wishes to defer these costs and amortize them in the future. Which student is correct and why? Solution 12-141 These costs are referred to as start-up costs, or more specifically organizational costs in this case. Accounting for start up costs is straightforward—expense these costs as incurred. The profession recognizes that these costs are incurred with the expectation that future revenues will occur or increased efficiencies will result. However, to determine the amount and timing of future benefits is so difficult that a conservative approach—expensing these costs as incurred—is required. Ex. 12-142—Acquisition of tangible and intangible assets. Vasquez Manufacturing Company decided to expand further by purchasing Wasserman Company. The balance sheet of Wasserman Company as of December 31, 2013 was as follows: Wasserman Company Balance Sheet December 31, 2013 Assets Cash Receivables Inventory Plant assets (net) Total assets
$ 210,000 550,000 275,000 1,025,000 $2,060,000
Liabilities and Equities Accounts payable Common stock Retained earnings
$ 375,000 800,000 885,000
Total liabilities and equities
$2,060,000
An appraisal, agreed to by the parties, indicated that the fair value of the inventory was $350,000 and that the fair value of the plant assets was $1,325,000. The fair value of the receivables is equal to the amount reported on the balance sheet. The agreed purchase price was $2,275,000, and this amount was paid in cash to the previous owners of Wasserman Company. Instructions Determine the amount of goodwill (if any) implied in the purchase price of $2,275,000. Show calculations. Solution 12-142 Purchase price Less tangible net assets acquired: Book value ($2,060,000 – $375,000) Appraisal increment—inventory Appraisal increment—plant assets Total fair value of tangible net assets acquired Goodwill
$2,275,000 $1,685,000 75,000 300,000 2,060,000 $ 215,000
12 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition *Ex. 12-143 MacroSoft Inc. has capitalized $900,000 of software costs. Sales from this product were $360,000 in the first year. MacroSoft estimates additional revenues of $840,000 over the product’s economic life of 5 years. Instructions Prepare the journal entry to record software cost amortization for the first year. Show all computations. Solution 12-143 Computations: Percent of revenue approach $900,000 x [$360,000/($360,000 + $840,000)] = $270,000 Straight-line approach $900,000 x 1/5 = $180,000 Journal Entry: Amortization Expense Computer Software Costs
270,000 270,000
PROBLEMS Pr. 12-144—Intangible assets. The following transactions involving intangible assets of Minton Corporation occurred on or near December 31, 2012. Complete the chart below by writing the journal entry(ies) needed at that date to record the transaction and at December 31, 2013 to record any resultant amortization. If no entry is required at a particular date, write "none needed."
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Pr. 12-144 (Cont.) On Date of Transaction
On December 31, 2013
1. Minton paid Grand Company $500,000 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 $600,000 developing a new manufacturing process. It has applied for a patent, and it believes that its application will be successful. 3. In January, 2013, Minton's application for a patent (#2 above) was granted. Legal and registration costs incurred were $150,000. The patent runs for 20 years. The manufacturing process will be useful to Minton for 10 years. 4. Minton incurred $120,000 in successfully defending one of its patents in an infringement suit. The patent expires during December, 2016. 5. Minton incurred $480,000 in an unsuccessful patent defense. As a result of the adverse verdict, the patent, with a remaining unamortized cost of $252,000, is deemed worthless. 6. Minton paid Sneed Laboratories $104,000 for research and development work performed by Sneed under contract for Minton. The benefits are expected to last six years. Solution 12-144 On Date of Transaction 1. Franchises .......... Cash .............. 2. Research and Devel. Expense ... Cash .............. 3. Patents ................ Cash ..............
4. Patents ................ Cash ..............
On December 31, 2013 1. “None needed.”
500,000 500,000
2. "None needed." 600,000 600,000 150,000 150,000
120,000 120,000
3. Amortization Expense .................... 15,000 Patents ................
15,000
4. Amortization Expense .................... 30,000 Patents ................
30,000
12 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 12-144 (Cont.) 5. Legal Fees Exp.... Cash ..............
480,000
Patent Expense ... Patents ..........
252,000
6. Research and Devel. Expense ... Cash ..............
5. “None needed.” 480,000 252,000 6. "None needed."
104,000 104,000
Pr. 12-145—Goodwill, impairment. On May 31, 2013, Armstrong Company paid $3,300,000 to acquire all of the common stock of Hall Corporation, which became a division of Armstrong. Hall reported the following balance sheet at the time of the acquisition: Current assets Noncurrent assets
$ 900,000 2,700,000
Total assets
$3,600,000
Current liabilities Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity
$ 600,000 500,000 2,500,000 $3,600,000
It was determined at the date of the purchase that the fair value of the identifiable net assets of Hall was $2,800,000. At December 31, 2013, Hall reports the following balance sheet information: Current assets Noncurrent assets (including goodwill recognized in purchase) Current liabilities Long-term liabilities Net assets
$ 800,000 2,400,000 (700,000) (500,000) $2,000,000
It is determined that the fair value of the Hall division is $2,100,000. The recorded amount for Hall’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, 2013. (b) Determine the impairment loss, if any, to be recorded on December 31, 2013. (c) Assume that the fair value of the Hall division is $1,950,000 instead of $2,100,000. Prepare the journal entry to record the impairment loss, if any, on December 31, 2013. Solution 12-145 (a) Goodwill = Fair value of the division less the fair value of the identifiable assets. $3,300,000 – $2,800,000 = $500,000. (b) No impairment loss is recorded, because the fair value of Hall ($2,100,000) is greater than the carrying value ($2,000,000) of the new assets.
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Solution 12-145 (Cont.) (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 Hall division Carrying value of division Increase in fair value of PP&E Less goodwill
$1,950,000 $2,000,000 200,000 (500,000) (1,700,000) 250,000 (500,000) $ (250,000)
Implied value of goodwill Carrying amount of goodwill Loss on impairment Loss on Impairment ................................................................ Goodwill........................................................................
250,000 250,000
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IFRS QUESTIONS True/False Questions 1. As in U.S. GAAP, under IFRS the costs associated with research and development are segregated into two components. 2. Costs in the research phase are expensed under U.S. GAAP, but capitalized under IFRS. 3. Costs in the research phase are always expensed under both IFRS and U.S. GAAP. 4. IFRS differs from U.S. GAAP in the development phase in that costs are capitalized once technological feasibility is achieved. 5. The increased acceptance of IFRS has caused costs associated with internally generated intangible assets to be capitalized under U.S. GAAP. 6. IFRS permits some capitalization of internally generated intangible assets, if it is probable there will be a future benefit and the amount can be readily measured. 7. While IFRS requires an impairment test at each reporting date for long-lived assets, it requires no such test for intangibles once a legal or useful life has been determined. 8. IFRS allows reversal of impairment losses when there has been a change in economic conditions or in the expected use of the asset. Under U.S GAAP, impairment losses cannot be reversed for assets to be held and used. 9. IFRS and U.S. GAAP are similar in the accounting for impairments of assets held for disposal. 10. Under U.S. GAAP, impairment loss is measured as the excess of the carrying amount over the assets discounted cash flow. Answers to True/False: 1. True 2. False 3. True 4. True 5. False 6. True 7. False 8. True 9. True 10. False
Multiple-Choice Questions 1. As in U.S. GAAP, under IFRS the costs associated with research and development are segregated into a. two components, the research phase and the production phase. b. two components, the research phase and the development phase. c. three components, the planning phase, the research phase and the production phase. d. three components, the analysis phase, the development phase and the production phase.
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2. In accounting for internally generated intangible assets, U.S. GAAP requires that a. all costs, no matter how immaterial, be capitalized. b. only material costs be capitalized. c. planned costs be capitalized, while costs in excess of plan be expensed. d. all costs be expensed. 3. The following costs are incurred during the research and development phases of a laser bone scanner Laboratory research aimed at discovery of new knowledge $600,000 Search for application of new research findings 400,000 Salaries of research staff designing new laser bone scanner 1,200,000 Material, labor and overhead costs of prototype laser scanner 850,000 Costs of testing prototype and design modifications 450,000 Engineering costs incurred to advance the laser scanner to full production stage 700,000 (technological feasibility reached) Identify which of these are research phase items and will be immediately expensed under U.S. GAAP and IFRS. U.S. GAAP IFRS a. $1,000,000 $1,000,000 b. 2,200,000 1,200,000 c. 4,200,000 4,200,000 d. 4,200,000 3,500,000 4. The following costs are incurred during the research and development phases of a laser bone scanner Laboratory research aimed at discovery of new knowledge Search for application of new research findings Salaries of research staff designing new laser bone scanner Material, labor and overhead costs of prototype laser scanner Costs of testing prototype and design modifications Engineering costs incurred to advance the laser scanner to full production stage (technological feasibility reached)
$600,000 400,000 1,200,000 850,000 450,000 700,000
Identify which of these are development phase items and will be immediately expensed under U.S. GAAP and IFRS. U.S. GAAP IFRS a. $1,000,000 $1,000,000 b. 2,200,000 1,200,000 c. 2,200,000 3,200,000 d. 3,200,000 3,200,000 5. The primary IFRS related to intangible assets and impairments is found in a. IAS 38 and IAS 10. b. IAS 16 and IAS 36. c. IAS 1 and IAS 34. d. IAS 38 and IAS 36.
12 - 48 Test Bank for Intermediate Accounting, Fourteenth Edition
6. IFRS allows reversal of impairment losses when a. the reversal is greater than the amount of the original impairment. b. the reversal falls in a subsequent fiscal year of the company's operations. c. there has been a change in economic conditions or in the expected use of the asset. d. reversal of impairment losses is never allowed. 7. Under U.S. GAAP, impairment losses a. can be reversed but only if the reversal is greater than the amount of the original impairment. b. can be reversed but only if the reversal falls in a subsequent fiscal year of the company's operations. c. cannot be reversed for assets to be held and used. d. none of the above. 8. IFRS and U.S. GAAP a. are diametrically opposed in their accounting for impairments of assets held for disposal. b. are similar in the accounting for impairments of assets held for disposal. c. are moving toward common ground in their accounting for impairments of assets held for disposal. d. are moving further apart in their accounting for impairments of assets held for disposal. 9. Under IFRS, costs in the development phase are a. never capitalized, but expensed as they are under U.S. GAAP. b. capitalized if they exceed development phase costs incurred for previously successful ventures. c. capitalized once technological feasibility is achieved. d. capitalized on an interim basis, but then expensed prior to the end of the company's fiscal year.
Answers to Multiple Choice: 1. b 2. d 3. a 4. d 5. d 6. c 7. c 8. c 9. c
Intangible Assets
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Short Answer 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to the accounting for intangible assets. 1. Similarities include (1) in U.S. GAAP and IFRS, the costs associated with research and development are segregated into the two components; (2) IFRS and U.S. GAAP are similar for intangibles acquired in a business combination. That is, an intangible asset is recognized separately from goodwill if it represents contractual or legal rights or is capable of being separated or divided and sold, transferred, licensed, rented, or exchanged; (3) Under both GAAPs, limited life intangibles are subject to amortization, but goodwill indefinite life intangibles are not amortized; rather they are assessed for impairment on an annual basis; (4) IFRS and U.S. GAAP are similar in the accounting for impairments of assets held for disposal. Notable differences are: (1) while costs in the research phase are always expensed under both IFRS and U.S. GAAP, under IFRS costs in the development phase are capitalized once technological feasibility is achieved; (2) IFRS permits some capitalization of internally generated intangible assets (e.g. brand value), if it is probable there will be a future benefit and the amount can be reliably measured. U.S. GAAP requires expensing of all costs associated with internally generated intangibles; (3) IFRS requires an impairment test at each reporting date for long-lived assets and intangibles and records an impairment if the asset’s carrying amount exceeds its recoverable amount; the recoverable amount is the higher of the asset’s fair value less costs to sell and its value in use. Value in use is the future cash flows to be derived from the particular asset, discounted to present value. Under U.S. GAAP, impairment loss is measured as the excess of the carrying amount over the asset’s fair value; (4) IFRS allows reversal of impairment losses when there has been a change in economic conditions or in the expected use of the asset. Under U.S. GAAP, impairment losses cannot be reversed for assets to be held and used; the impairment loss results in a new cost basis for the asset; (5) under IFRS, acquired in-process research and development (IPR&D) is recognized as a separate intangible asset if it meets the definition of an intangible asset and its fair value can be measured reliably. U.S. requires acquired IPR&D to be written off. 2. Briefly discuss the convergence efforts that are underway in the area of intangible assets. 2. The IASB and FASB have identified a project relating to the accounting for research and development that could possibly converge IFRS and U.S. GAAP on the issue of in-process R&D. One possibility is to amend U.S. GAAP to allow capitalization of in-process R&D similar to the provisions in IFRS. A second project, in a very preliminary stage, would consider expanded recognition of internally generated intangible assets. As indicated, IFRS permits more recognition of intangibles compared to U.S. GAAP. Thus, it will be challenging to develop converged standards for intangible assets, given the long-standing prohibition on capitalizing intangible assets and research and development in U.S. GAAP.
CHAPTER 13 CURRENT LIABILITIES AND CONTINGENCIES IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F F T T F F T F T F T F T 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.
Zero-interest-bearing note payable. Dividends in arrears. Examples of unearned revenues. Reporting discount on Notes Payable. Currently maturing long-term debt. Excluding short-term debt refinanced. Accounting for sales tax collected. Accounting for sick pay. Social security taxes as liabilities. Definition of accumulation rights. Recognizing compensated absences expense. Accruing estimated loss contingency. Disclosing gain contingencies. Sales-type warranty profit. Fair value of asset retirement obligation. Reporting a litigation liability. Expense warranty approach. Acid-test ratio components. Affect on current ratio. Reporting current liabilities.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
d d a a b d c d c d c d c d b a
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36.
Definition of a liability. Nature of current liabilities. Recording of accounts payable. Classification of notes payable. Classification of discounts on notes payable. Identify current liability. Bonds reported as current liability. Identify item which is not a current liability. Dividends reported as current liability. Classification of stock dividends distributable. Identify item which is not a current liability. Identify current liability. Characteristic of current liability. Definition of a liability. Importance of liability section of balance sheet. Current liabilities and operating cycle.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
a c d d a b c d d d a d b d d d c d d d b c d b a d d d b a c d b c c c a b d d c d a b a b d c
37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. S 48. S 49. P 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. P 74. S 75. S 76. 77. 78. 79. 80. 81. 82. 83. 84.
Present value and concept of a liability. Zero-interest-bearing notes payable. Callable debt reporting. Condition to exclude short-term obligation. Ability to consummate refinancing of short-term debt. Disclosure of preferred dividends not declared. Example of unearned revenue. Short-term obligations expected to be refinanced. Ability to consummate refinancing of short-term obligations. Determine what is a liability. Classification of sales taxes. Disclosure for short-term debt refinanced. Vested rights vs. accumulated rights. Deductions in computing net pay. 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. Compensated absences. Requirements for compensated absences accrual. Condition for sick pay accrual. Payroll tax deduction. Definition of a contingency. Recording contingent liability. Example of contingent liability. Recording contingent liability. 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. Asset retirement obligation. Asset retirement obligation. Classification of warranty liability. Liability accrual due to governmental action. Accrual of product warranties. Determining loss amount to report. Reporting lawsuit loss and liability. Accrual method for warranty costs. Accrual warranty method. Cash-basis warranty method. Characteristic of expense warranty approach. Accounting for discount coupon. Condition to recognize asset retirement obligation. Recording liability for pending litigation. Computation of acid-test ratio. Current ratio information.
Current Liabilities and Contingencies
13 - 3
MULTIPLE CHOICE—Conceptual (cont.) Answer c a d d d P S
No.
Description
S
Presentation of current liabilities. Current ratio formula. Disclosure of accrued liabilities. Acid-test ratio elements. Items included in current ratio and acid-test ratio.
P
85. 86. 87. 88. 89.
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide.
MULTIPLE CHOICE—Computational Answer
No.
Description
b d a d b c b d b d b b c a a d d c c c d a d a b d d c b d a b d d
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. 115. 116. 117. 118. 119. 120. 121. 122. 123.
Adjusting entry involving discount on short-term note payable. Calculate effective interest on discounted note. Calculate cost of inventory purchase. Calculate interest expense. Calculate interest expense. Reporting 5-year note in financial statements. Calculate unearned revenue. Calculate amount of sales tax payable. Determine amount of short-term debt to be reported. Determine amount of short-term debt to be reported. Calculate sales taxes for the month. Calculate amount of sales taxes payable. Determine amount of sales subject to sales tax. Short-term debt to be excluded. Short-term debt to be excluded. Federal/state unemployment taxes. Federal/state unemployment taxes. Vacation liability accrual. Vacation liability accrual. Calculate payroll tax expense. Calculation of vacation expense to be recognized. Calculation of accrued liability to be recognized for compensated balances. Effect of payroll taxes on assets / liabilities. Record vacation liability accrual. Record loss contingency amount. Record asset retirement obligation. Calculate extended warranty contract profit. Calculate warranty liability. Calculate rebate expense and liability. Asset retirement obligation. Calculate insurance expense and loss. Calculate rebate expense and liability. Asset retirement obligation. Calculate warranty liability.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Computational (cont.) Answer
No.
Description
b d b d d d b d a d b c
124. 125. 126. 127. 128. 129. 130. 131. 132. 133. 134. 135.
Calculate liability for premiums. Calculate warranty liability. Calculate liability for premiums. Determine premiums expense for the year. Calculate estimated liability for premiums. Calculate estimated liability for premiums. Determine amount to accrue as a loss contingency. Accrue warranty expense for the year. Calculate warranty liability. Determine amount to accrue as a gain contingency. Calculate liability for unredeemed coupons. Calculate the quick (acid-test) ratio.
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
a b c d a d b c d d c
136. 137. 138. 139. 140. 141. 142. 143. 144. 145. 146.
Knowledge of accounts payable. Determine current and long-term portions of debt. Determine accrued interest payable. Determine amount of short-term debt to be reported. Calculate accrued salaries payable. Accrual of payroll taxes. Calculate unearned service contract revenue. Determine liability from unredeemed trading stamps. Determine range of loss accrual. Calculate the estimated warranty liability. Disclosure of a casualty claim.
EXERCISES Item E13-147 E13-148 E13-149 E13-150 E13-151 E13-152
Description Notes payable. Payroll entries. Compensated absences. Contingent liabilities. Premiums. Premiums.
PROBLEMS Item P13-153 P13-154 P13-155 P13-156
Description Accounts and notes payable. Refinancing of short-term debt. Premiums. Warranties.
Current Liabilities and Contingencies
CHAPTER LEARNING OBJECTIVES 1.
Describe the nature, type, and valuation of current liabilities.
2.
Explain the classification issues of short-term debt expected to be refinanced.
3.
Identify types of employee-related liabilities.
4.
Identify the criteria used to account for and disclose gain and loss contingencies.
5.
Explain the accounting for different types of loss contingencies.
6.
Indicate how to present and analyze liabilities and contingencies.
13 - 5
13 - 6
Test Bank for Intermediate Accounting, Fourteenth Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2. 3. 4. 21.
TF TF TF TF MC
22. 23. 24. 25. 26.
MC MC MC MC MC
27. 28. 29. 30. 31.
5. 6. 7. 40.
TF TF TF MC
41. 42. 43. 44.
MC MC MC MC
45. 46. 47. S 48.
8. 9. 10. 11.
TF TF TF TF
46. 49. P 50. 51.
MC MC MC MC
52. 53. 54. 55.
12. 13.
TF TF
46. 59.
MC MC
60. 61.
14. 15. 16. 17. 69. 70. 71.
TF TF TF TF MC MC MC
72. 73. P 74. S 75. S 76. 77. 78.
MC MC MC MC MC MC MC
79. 80. 81. 82. 114. 115. 116.
18. 19.
TF TF
20. 83.
TF MC
S
Note:
S
TF = True-False MC = Multiple Choice
84. 85.
Type
Item
Type
Item
Learning Objective 1 MC 32. MC 37. MC 33. MC 38. MC 34. MC 39. MC 35. MC 90. MC 36. MC 91. Learning Objective 2 MC 95. MC 99. MC 96. MC 100. MC 97. MC 101. MC 98. MC 102. Learning Objective 3 MC 56. MC 106. MC 57. MC 107. MC 58. MC 108. MC 105. MC 109. Learning Objective 4 MC 62. MC 64. MC 63. MC 65. Learning Objective 5 MC 117. MC 124. MC 118. MC 125. MC 119. MC 126. MC 120. MC 127. MC 121. MC 128. MC 122. MC 129. MC 123. MC 130. Learning Objective 6 P MC 86. MC 88. MC 87. MC 89. E = Exercise P = Problem
Type
Item
Type
Item
Type
MC MC MC MC MC
92. 93. 94. 136. 137.
MC MC MC MC MC
138. 147. 153.
MC E P
MC MC MC MC
103. 104. 139. 154.
MC MC MC P
MC MC MC MC
110. 111. 112. 113.
MC MC MC MC
140. 141. 148. 149.
MC MC E E
MC MC
66. 67.
MC MC
68. 150.
MC E
MC MC MC MC MC MC MC
131. 132. 133. 134. 142. 143. 144.
MC MC MC MC MC MC MC
145. 146. 151. 152. 155. 156.
MC MC E E P P
MC MC
135. 153.
MC P
154. 155.
P P
Current Liabilities and Contingencies
13 - 7
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. A short-term obligation can be excluded from current liabilities if the company intends to refinance it on a long-term basis. 7. Many companies do not segregate the sales tax collected and the amount of the sale at the time of the sale. 8. A company must accrue a liability for sick pay that accumulates but does not vest. 9. 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. 10. Accumulated rights exist when an employer has an obligation to make payment to an employee even after terminating his employment. 11. Companies should recognize the expense and related liability for compensated absences in the year earned by employees. 12. 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. 13. A company discloses gain contingencies in the notes only when a high probability exists for realizing them. 14. The expected profit from a sales type warranty that covers several years should all be recognized in the period the warranty is sold. 15. The fair value of an asset retirement obligation is recorded as both an increase to the related asset and a liability. 16. The cause for litigation must have occurred on or before the date of the financial statements to report a liability in the financial statements. 17. Under the expense warranty approach, companies charge warranty costs only to the period in which they comply with the warranty.
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Test Bank for Intermediate Accounting, Fourteenth Edition
18. Prepaid insurance should be included in the numerator when computing the acid-test (quick) ratio. 19. Paying a current liability with cash will always reduce the current ratio. 20. Current liabilities are usually recorded and reported in financial statements at their full maturity value.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F F T T F
Item 6. 7. 8. 9. 10.
Ans. F T F T F
Item 11. 12. 13. 14. 15.
Ans. T F T F T
Item 16. 17. 18. 19. 20.
Ans. T F F F T
MULTIPLE CHOICE—Conceptual 21.
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.
22.
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
23.
Which of the following is true about accounts payable? 1. Accounts payable should not be reported at their present value. 2. When accounts payable are recorded at the net amount, a Purchase Discounts account will be used. 3. When accounts payable are recorded at the gross amount, a Purchase Discounts Lost account will be used. a. b. c. d.
1 2 3 Both 2 and 3 are true.
Current Liabilities and Contingencies
13 - 9
24.
Among the short-term obligations of Lance Company as of December 31, the balance sheet date, are notes payable totaling $250,000 with the Madison National Bank. These are 90-day notes, renewable for another 90-day period. These notes should be classified on the balance sheet of Lance Company as a. current liabilities. b. deferred charges. c. long-term liabilities. d. intermediate debt.
25.
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.
26.
Which of the following may be a current liability? a. Withheld Income Taxes b. Deposits Received from Customers c. Deferred Revenue d. All of these
27.
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.
28.
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
29.
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
30.
Stock dividends distributable should be classified on the a. income statement as an expense. b. balance sheet as an asset. c. balance sheet as a liability. d. balance sheet as an item of stockholders' equity.
13 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition 31.
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.
32.
An account which would be classified as a current liability is a. dividends payable in the company's stock. b. accounts payable—debit balances. c. losses expected to be incurred within the next twelve months in excess of the company's insurance coverage. d. none of these.
33.
Which of the following is a characteristic of a current liability but not a long-term liability? a. Unavoidable obligation. b. Present obligation that entails settlement by probable future transfer or use of cash, goods, or services. c. Liquidation is reasonably expected to require use of existing resources classified as current assets or create other current liabilities. d. Transaction or other event creating the liability has already occurred.
34.
Which of the following is not considered a part of the definition of a liability? a. Unavoidable obligation. b. Transaction or other event creating the liability has already occurred. c. Present obligation that entails settlement by probable future transfer or use of cash, goods, or services. d. Liquidation is reasonably expected to require use of existing resources classified as current assets or create other current liabilities.
35.
Why is the liability section of the balance sheet of primary importance to bankers? a. To evaluate the entity's credit quality. b. To assist in understanding the entity's liquidity. c. To better understand sources of repayment. d. To evaluate operating efficiency.
36.
What is the relationship between current liabilities and a company's operating cycle? a. Liquidation of current liabilities is reasonably expected within the company's operating cycle (or one year if less). b. Current liabilities are the result of operating transactions. c. Current liabilities can't exceed the amount incurred in one operating cycle. d. There is no relationship between the two.
37.
What is the relationship between present value and the concept of a liability? a. Present values are used to measure certain liabilities. b. Present values are not used to measure liabilities. c. Present values are used to measure all liabilities. d. Present values are only used to measure long-term liabilities.
Current Liabilities and Contingencies
13 - 11
38.
What is a discount as it relates to zero-interest-bearing notes payable? a. The discount represents the lender's costs to underwrite the note. b. The discount represents the credit quality of the borrower. c. The discount represents the cost of borrowing. d. The discount represents the allowance for uncollectible amounts.
39.
Where is debt callable by the creditor reported on the debtor's financial statements? a. Long-term liability. b. Current liability if the creditor intends to call the debt within the year, otherwise a longterm liability. c. Current liability if it is probable that creditor will call the debt within the year, otherwise a long-term liability. d. Current liability.
40.
Which of the following is not a condition necessary to exclude a short-term obligation from current liabilities? a. Intend to refinance the obligation on a long-term basis. b. Obligation must be due with one year. c. Demonstrate the ability to complete the refinancing. d. Subsequently refinance the obligation on a long-term basis.
41.
Which of the following does not demonstrate evidence regarding the ability to consummate a refinancing of short-term debt? a. Management indicated that they are going to refinance the obligation. b. Actually refinance the obligation. c. Have capacity under existing financing agreements that can be used to refinance the obligation. d. Enter into a financing agreement that clearly permits the entity to refinance the obligation.
42.
A company has not declared a dividend on its cumulative preferred stock for the past three years. What is the required accounting treatment or disclosure in this situation? a. Record a liability for cumulative amount of preferred stock dividends not declared. b. Disclose the amount of the dividends in arrears. c. Record a liability for the current year's dividends only. d. No disclosure or recognition is required.
43.
Which of the following situations may give rise to unearned revenue? a. Providing trade credit to customers. b. Selling inventory. c. Selling magazine subscriptions. d. Providing manufacturer warranties.
44.
Which of the following statements is correct? a. A company may exclude a short-term obligation from current liabilities if the firm intends to refinance the obligation on a long-term basis. b. A company may exclude a short-term obligation from current liabilities if the firm can demonstrate an ability to consummate a refinancing. c. A company may exclude a short-term obligation from current liabilities if it is paid off after the balance sheet date and subsequently replaced by long-term debt before the balance sheet is issued. d. None of these.
13 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition 45.
The ability to consummate the refinancing of a short-term obligation may be demonstrated by a. actually refinancing the obligation by issuing a long-term obligation after the date of the balance sheet but before it is issued. b. entering into a financing agreement that permits the enterprise to refinance the debt on a long-term basis. c. actually refinancing the obligation by issuing equity securities after the date of the balance sheet but before it is issued. d. all of these.
46.
Which of the following statements is false? a. A company may exclude a short-term obligation from current liabilities if the firm intends to refinance the obligation on a long-term basis and demonstrates an ability to complete the refinancing. b. Cash dividends should be recorded as a liability when they are declared by the board of directors. c. Under the cash basis method, warranty costs are charged to expense as they are paid. d. FICA taxes withheld from employees' payroll checks should never be recorded as a liability since the employer will eventually remit the amounts withheld to the appropriate taxing authority.
47.
Which of the following is not a correct statement about sales taxes? a. Sales taxes are an expense of the seller. b. Many companies record sales taxes in the sales account. c. If sales taxes are included in the sales account, the first step to find the amount of sales taxes is to divide sales by 1 plus the sales tax rate. d. All of these are true.
S
48.
If a short-term obligation is excluded from current liabilities because of refinancing, the footnote to the financial statements describing this event should include all of the following information except a. a general description of the financing arrangement. b. the terms of the new obligation incurred or to be incurred. c. the terms of any equity security issued or to be issued. d. the number of financing institutions that refused to refinance the debt, if any.
S
49.
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; accumulated rights do not represent monetary compensation.
P
50.
An employee's net (or take-home) pay is determined by gross earnings minus amounts for income tax withholdings and the employee's a. portion of FICA taxes and unemployment taxes. b. and employer's portion of FICA taxes, and unemployment taxes. c. portion of FICA taxes, unemployment taxes, and any voluntary deductions. d. portion of FICA taxes and any voluntary deductions.
Current Liabilities and Contingencies
13 - 13
51.
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
52.
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.
53.
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.
54.
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.
1. 2. 3. Either 1 or 2 is acceptable.
55.
What are compensated absences? a. Unpaid time off. b. A form of healthcare. c. Payroll deductions. d. Paid time off.
56.
Which gives rise to the requirement to accrue a liability for the cost of compensated absences? a. Payment is probable. b. Employee rights vest or accumulate. c. Amount can be reasonably estimated. d. All of the above.
57.
Under what conditions is an employer required to accrue a liability for sick pay? a. Sick pay benefits can be reasonably estimated. b. Sick pay benefits vest. c. Sick pay benefits equal 100% of the pay. d. Sick pay benefits accumulate.
13 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition 58.
Which of the following taxes does not represent a common payroll deduction? a. Federal income taxes. b. FICA taxes. c. State unemployment taxes. d. State income taxes.
59.
What is a contingency? a. An existing situation where certainty exists as to a gain or loss that will be resolved when one or more future events occur or fail to occur. b. An existing situation where uncertainty exists as to possible loss that will be resolved when one or more future events occur. c. An existing situation where uncertainty exists as to possible gain or loss that will not be resolved in the foreseeable future. d. An existing situation where uncertainty exists as to possible gain or loss that will be resolved when one or more future events occur or fail to occur.
60.
When is a contingent liability recorded? a. When the amount can be reasonably estimated. b. When the future events are probable to occur and the amount can be reasonably estimated. c. When the future events are probable to occur. d. When the future events will possibly occur and the amount can be reasonably estimated.
61.
Which of the following is an example of a contingent liability? a. Obligations related to product warranties. b. Possible receipt from a litigation settlement. c. Pending court case with a probable favorable outcome. d. Tax loss carryforwards.
62.
Which of the following terms is associated with recording a contingent liability? a. Possible. b. Likely. c. Remote. d. Probable.
63.
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.
64.
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.
Current Liabilities and Contingencies
13 - 15
65.
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.
66.
Jeff Beck is a farmer who owns land which borders on the right-of-way of the Northern Railroad. On August 10, 2012, due to the admitted negligence of the Railroad, hay on the farm was set on fire and burned. Beck 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 Beck in exchange for a release of his right to reimbursement for the loss he has sustained from the fire. Beck appears inclined to accept the Railroad's offer. The Railroad's 2012 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.
67.
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.
68.
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.
69.
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.
70.
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.
13 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition 71.
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.
72.
Ortiz Corporation, a manufacturer of household paints, is preparing annual financial statements at December 31, 2012. Because of a recently proven health hazard in one of its paints, the government has clearly indicated its intention of having Ortiz recall all cans of this paint sold in the last six months. The management of Ortiz 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
73.
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.
P
74.
Espinosa 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.
S
75.
Dean 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. the Dean 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.
S
76.
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.
Current Liabilities and Contingencies
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77.
Which of the following best describes the accrual method of accounting for warranty costs? a. Expensed when paid. b. Expensed when warranty claims are certain. c. Expensed based on estimate in year of sale. d. Expensed when incurred.
78.
Which of the following best describes the cash-basis method of accounting for warranty costs? a. Expensed based on estimate in year of sale. b. Expensed when liability is accrued. c. Expensed when warranty claims are certain. d. Expensed when incurred.
79.
Which of the following is a characteristic of the expense warranty approach, but not the sales warranty approach? a. Estimated liability under warranties. b. Warranty expense. c. Unearned warranty revenue. d. Warranty revenue.
80.
An electronics store is running a promotion where for every video game purchased, the customer receives a coupon upon checkout to purchase a second game at a 50% discount. The coupons expire in one year. The store normally recognized a gross profit margin of 40% of the selling price on video games. How would the store account for a purchase using the discount coupon? a. The reduction in sales price attributed to the coupon is recognized as premium expense. b. The difference between the cost of the video game and the cash received is recognized as premium expense. c. Premium expense is not recognized. d. The difference between the cost of the video game and the selling price prior to the coupon is recognized as premium expense.
81.
What condition is necessary to recognize an asset retirement obligation? a. Company has an existing legal obligation and can reasonably estimate the amount of the liability. b. Company can reasonably estimate the amount of the liability. c. Company has an existing legal obligation. d. Obligation event has occurred.
82.
Which of the following are not factors that are considered when evaluating whether or not to record a liability for pending litigation? a. Time period in which the underlying cause of action occurred. b. The type of litigation involved. c. The probability of an unfavorable outcome. d. The ability to make a reasonable estimate of the amount of the loss.
13 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 83.
How do you determine the acid-test ratio? a. The sum of cash and short-term investments divided by short-term debt. b. Current assets divided by current liabilities. c. Current assets divided by short-term debt. d. The sum of cash, short-term investments and net receivables divided by current liabilities.
84.
What does the current ratio inform you about a company? a. The extent of slow-moving inventories. b. The efficient use of assets. c. The company's liquidity. d. The company's profitability.
S
85.
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
P
86.
The ratio of current assets to current liabilities is called the a. current ratio. b. acid-test ratio. c. current asset turnover ratio. d. current liability turnover ratio.
87.
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.
88.
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.
89.
Each of the following are included in both the current ratio and the acid-test ratio except a. cash. b. short-term investments. c. net receivables. d. inventory.
Current Liabilities and Contingencies
13 - 19
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27. 28. 29. 30.
d d a a b d c d c d
31. 32. 33. 34. 35. 36. 37. 38. 39. 40.
c d c d b a a c d d
41. 42. 43. 44. 45. 46. 47. 48. 49. 50.
a b c d d d a d b d
51. 52. 53. 54. 55. 56. 57. 58. 59. 60.
d d c d d d b c d b
61. 62. 63. 64. 65. 66. 67. 68. 69. 70.
a d d d b a c d b c
71. 72. 73. 74. 75. 76. 77. 78. 79. 80.
c c a b d d c d a b
81. 82. 83. 84. 85. 86. 87. 88. *89.
a b d c c a d d d
Solutions to those Multiple Choice questions for which the answer is “none of these.” 22. A long-term debt maturing currently to be paid with current assets is a current liability. 32. Accounts Payable, Wages Payable, etc., would be examples of current liabilities. 44. The company must both intend to refinance the obligation on a long-term basis and demonstrate the ability to consummate the refinancing to exclude a short-term obligation from current liabilities.
MULTIPLE CHOICE—Computational 90.
Glaus Corp. signed a three-month, zero-interest-bearing note on November 1, 2012 for the purchase of $250,000 of inventory. The face value of the note was $253,675. Assuming Glaus 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, 2012 will include a a. debit to Discount on Note Payable for $1,225. b. debit to Interest Expense for $2,450. c. credit to Discount on Note Payable for $1,255. d. credit to Interest Expense for $2,450.
91.
The effective interest on a 12-month, zero-interest-bearing note payable of $300,000, discounted at the bank at 8% is a. 8.51%. b. 8%. c. 11.49%. d. 8.70%.
13 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 92.
On September 1, Hydra purchased $13,300 of inventory items on credit with the terms 1/15, net 30, FOB destination. Freight charges were $280. Payment for the purchase was made on September 18. Assuming Hydra uses the perpetual inventory system and the net method of accounting for purchase discounts, what amount is recorded as inventory from this purchase? a. $13,167. b. $13,447. c. $13,580. d. $13,300.
93.
Sodium Inc. borrowed $280,000 on April 1. The note requires interest at 12% and principal to be paid in one year. How much interest is recognized for the period from April 1 to December 31? a. $0. b. $33,600. c. $8,400. d. $25,200.
94.
Collier borrowed $350,000 on October 1 and is required to pay $360,000 on March 1. What amount is the note payable recorded at on October 1 and how much interest is recognized from October 1 to December 31? a. $350,000 and $0. b. $350,000 and $6,000. c. $360,000 and $0. d. $350,000 and $10,000.
95.
Purest owes $2 million that is due on February 28. The company borrows $1,600,000 on February 25 (5-year note) and uses the proceeds to pay down the $2 million note and uses other cash to pay the balance. How much of the $2 million note is classified as longterm in the December 31 financial statements. a. $2,000,000. b. $0. c. $1,600,000. d. $400,000.
96.
Vista newspapers sold 6,000 of annual subscriptions at $125 each on September 1. How much unearned revenue will exist as of December 31? a. $0. b. $500,000. c. $250,000. d. $750,000.
97.
Purchase Retailer made cash sales during the month of October of $221,000. The sales are subject to a 6% sales tax that was also collected. Which of the following would be included in the summary journal entry to reflect the sale transactions? a. Debit Cash for $221,000. b. Credit Sales Taxes Payable for $12,510. c. Credit Sales Revenue for $208,490. d. Credit Sales Taxes Payable for $13,260.
Current Liabilities and Contingencies
13 - 21
98.
On February 10, 2012, after issuance of its financial statements for 2011, House Company entered into a financing agreement with Lebo Bank, allowing House Company to borrow up to $6,000,000 at any time through 2014. Amounts borrowed under the agreement bear interest at 2% above the bank's prime interest rate and mature two years from the date of loan. House Company presently has $2,250,000 of notes payable with First National Bank maturing March 15, 2012. The company intends to borrow $3,750,000 under the agreement with Lebo and liquidate the notes payable to First National. The agreement with Lebo also requires House to maintain a working capital level of $9,000,000 and prohibits the payment of dividends on common stock without prior approval by Lebo Bank. From the above information only, the total short-term debt of House Company as of the December 31, 2012 balance sheet date is a. $0. b. $2,250,000. c. $3,000,000. d. $6,000,000.
99.
On December 31, 2012, Irey Co. has $4,000,000 of short-term notes payable due on February 14, 2013. On January 10, 2013, Irey arranged a line of credit with County Bank which allows Irey to borrow up to $3,000,000 at one percent above the prime rate for three years. On February 2, 2013, Irey borrowed $2,400,000 from County Bank and used $1,000,000 additional cash to liquidate $3,400,000 of the short-term notes payable. The amount of the short-term notes payable that should be reported as current liabilities on the December 31, 2012 balance sheet which is issued on March 5, 2013 is a. $0. b. $600,000. c. $1,000,000. d. $1,600,000.
Use the following information for questions 100 and 101. Stine Co. is a retail store operating in a state with a 6% retail sales tax. The retailer may keep 2% of the sales tax collected. Stine Co. records the sales tax in the Sales Revenue account. The amount recorded in the Sales Revenue account during May was $222,600. 100.
The amount of sales taxes (to the nearest dollar) for May is a. $13,089. b. $12,600. c. $13,356. d. $14,157.
101.
The amount of sales taxes payable (to the nearest dollar) to the state for the month of May is a. $12,826. b. $12,348. c. $13,089. d. $13,873.
13 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 102.
Vopat, Inc., is a retail store operating in a state with a 5% retail sales tax. The state law provides that the retail sales tax collected during the month must be remitted to the state during the following month. If the amount collected is remitted to the state on or before the twentieth of the following month, the retailer may keep 3% of the sales tax collected. On April 10, 2012, Vopat remitted $135,800 tax to the state tax division for March 2012 retail sales. What was Vopat 's March 2012 retail sales subject to sales tax? a. $2,716,000. b. $2,660,000. c. $2,800,000. d. $2,741,667.
103.
Jenkins Corporation has $2,500,000 of short-term debt it expects to retire with proceeds from the sale of 90,000 shares of common stock. If the stock is sold for $20 per share subsequent to the balance sheet date, but before the balance sheet is issued, what amount of short-term debt could be excluded from current liabilities? a. $1,800,000 b. $2,500,000 c. $700,000 d. $0
104.
Ermler Corporation has $1,800,000 of short-term debt it expects to retire with proceeds from the sale of 50,000 shares of common stock. If the stock is sold for $20 per share subsequent to the balance sheet date, but before the balance sheet is issued, what amount of short-term debt could be excluded from current liabilities? a. $1,000,000 b. $1,800,000 c. $800,000 d. $0
105.
Preston Co., which has a taxable payroll of $700,000, 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 Preston Co.? a. $81,900 b. $57,400 c. $28,000 d. $19,600
106.
Roark Co., which has a taxable payroll of $600,000, 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 Roark Co.? a. $70,200 b. $49,200 c. $24,000 d. $16,800
Current Liabilities and Contingencies
13 - 23
107.
A company gives each of its 50 employees (assume they were all employed continuously through 2012 and 2013) 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 2012, they made $21 per hour and in 2013 they made $24 per hour. During 2013, 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 2012 and 2013 balance sheets, respectively? a. $100,800; $140,400 b. $115,200; $144,000 c. $100,800; $144,000 d. $115,200; $140,400
108.
A company gives each of its 50 employees (assume they were all employed continuously through 2012 and 2013) 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 2012, they made $24.50 per hour and in 2013 they made $28 per hour. During 2013, 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 2012 and 2013 balance sheets, respectively? a. $117,600; $163,800 b. $134,400; $168,000 c. $117,600; $168,000 d. $134,400; $163,800
109.
The total payroll of Teeter Company for the month of October, 2012 was $600,000, of which $150,000 represented amounts paid in excess of $106,800 to certain employees. $500,000 represented amounts paid to employees in excess of the $7,000 maximum subject to unemployment taxes. $150,000 of federal income taxes and $15,000 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 $106,800 and 1.45% in excess of $106,800. What amount should Teeter record as payroll tax expense? a. $197,700. b. $188,400. c. $38,400. d. $47,400.
Use the following information for questions 110 and 111. Vargas Company has 35 employees who work 8-hour days and are paid hourly. On January 1, 2011, the company began a program of granting its employees 10 days of paid vacation each year. Vacation days earned in 2011 may first be taken on January 1, 2012. Information relative to these employees is as follows: Year 2011 2012 2013
Hourly Wages $21.50 22.50 23.75
Vacation Days Earned by Each Employee 10 10 10
Vacation Days Used by Each Employee 0 8 10
Vargas has chosen to accrue the liability for compensated absences at the current rates of pay in effect when the compensated time is earned.
13 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition 110.
What is the amount of expense relative to compensated absences that should be reported on Vargas’s income statement for 2011? a. $0. b. $57,400. c. $63,000. d. $60,200.
111.
What is the amount of the accrued liability for compensated absences that should be reported at December 31, 2013? a. $79,100. b. $75,600. c. $66,500. d. $79,800.
112.
CalCount pays a weekly payroll of $170,000 that includes federal taxes withheld of $25,400, FICA taxes withheld of $15,780, and 401(k) withholdings of $18,000. What is the effect of assets and liabilities from this transaction? a. Assets decrease $170,000 and liabilities do not change. b. Assets decrease $128,820 and liabilities increase $41,180. c. Assets decrease $128,820 and liabilities decrease $41,180. d. Assets decrease $110,820 and liabilities increase $59,180.
113.
CalCount provides its employees two weeks of paid vacation per year. As of December 31, 65 employees have earned two weeks of vacation time to be taken the following year. If the average weekly salary for these employees is $1,140, what is the required journal entry? a. Debit Salaries and Wages Expense for $148,200 and credit Salaries and Wages Payable for $148,200. b. No journal entry required. c. Debit Salaries and Wages Payable for $147,600 and credit Salaries and Wages Expense for $147,600. d. Debit Salaries and Wages Expense for $74,100 and credit Salaries and Wages Payable for $74,100.
114.
Tender Foot Inc. is involved in litigation regarding a faulty product sold in a prior year. The company has consulted with its attorney and determined that it is possible that they may lose the case. The attorneys estimated that there is a 40% chance of losing. If this is the case, their attorney estimated that the amount of any payment would be $500,000. What is the required journal entry as a result of this litigation? a. Debit Litigation Expense for $500,000 and credit Litigation liability for $500,000. b. No journal entry is required. c. Debit Litigation Expense for $200,000 and credit Litigation Liability for $200,000. d. Debit Litigation Expense for $300,000 and credit Litigation Liability for $300,000.
115.
Recycle Exploration is involved with innovative approaches to finding energy reserves. Recycle recently built a facility to extract natural gas at a cost of $15 million. However, Recycle is also legally responsible to remove the facility at the end of its useful life of twenty years. This cost is estimated to be $21 million (the present value of which is $8 million). What is the journal entry required to record the asset retirement obligation? a. No journal entry required. b. Debit Natural Gas Facility for $21,000,000 and credit Asset Retirement Obligation for $21,000,000
Current Liabilities and Contingencies
116.
13 - 25
c. Debit Natural Gas Facility for $6,000,000 and credit Asset Retirement Obligation for $6,000,000. d. Debit Natural Gas Facility for $8,000,000 and credit Asset Retirement Obligation for $8,000,000. Warranty4U provides extended service contracts on electronic equipment sold through major retailers. The standard contract is for three years. During the current year, Warranty4U provided 42,000 such warranty contracts at an average price of $81 each. Related to these contracts, the company spent $400,000 servicing the contracts during the current year and expects to spend $2,100,000 more in the future. What is the net profit that the company will recognize in the current year related to these contracts? a. $902,000. b. $3,002,000. c. $300,667. d. $734,000.
117.
Electronics4U manufactures high-end whole home electronic systems. The company provides a one-year warranty for all products sold. The company estimates that the warranty cost is $200 per unit sold and reported a liability for estimated warranty costs $7.8 million at the beginning of this year. If during the current year, the company sold 60,000 units for a total of $243 million and paid warranty claims of $9,000,000 on current and prior year sales, what amount of liability would the company report on its balance sheet at the end of the current year? a. $3,000,000. b. $4,200,000. c. $10,800,000. d. $12,000,000.
118.
A company offers a cash rebate of $1 on each $4 package of light bulbs sold during 2012. Historically, 10% of customers mail in the rebate form. During 2012, 3,000,000 packages of light bulbs are sold, and 160,000 $1 rebates are mailed to customers. What is the rebate expense and liability, respectively, shown on the 2012 financial statements dated December 31? a. $300,000; $300,000 b. $300,000; $140,000 c. $140,000; $140,000 d. $160,000; $140,000
119.
A company buys an oil rig for $2,000,000 on January 1, 2012. The life of the rig is 10 years and the expected cost to dismantle the rig at the end of 10 years is $400,000 (present value at 10% is $154,220). 10% is an appropriate interest rate for this company. What expense should be recorded for 2012 as a result of these events? a. Depreciation expense of $240,000 b. Depreciation expense of $200,000 and interest expense of $15,422 c. Depreciation expense of $200,000 and interest expense of $40,000 d. Depreciation expense of $215,420 and interest expense of $15,422
120.
Ziegler Company self insures its property for fire and storm damage. If the company were to obtain insurance on the property, it would cost them $1,500,000 per year. The company estimates that on average it will incur losses of $1,200,000 per year. During 2012, $525,000 worth of losses were sustained. How much total expense and/or loss should be recognized by Ziegler Company for 2012? a. $525,000 in losses and no insurance expense
13 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition b. $525,000 in losses and $675,000 in insurance expense c. $0 in losses and $1,200,000 in insurance expense d. $0 in losses and $1,500,000 in insurance expense 121.
A company offers a cash rebate of $2 on each $6 package of batteries sold during 2012. Historically, 10% of customers mail in the rebate form. During 2012, 6,000,000 packages of batteries are sold, and 210,000 $2 rebates are mailed to customers. What is the rebate expense and liability, respectively, shown on the 2012 financial statements dated December 31? a. $1,200,000; $1,200,000 b. $1,200,000; $780,000 c. $780,000; $780,000 d. $420,000; $780,000
122.
A company buys an oil rig for $3,000,000 on January 1, 2012. The life of the rig is 10 years and the expected cost to dismantle the rig at the end of 10 years is $600,000 (present value at 10% is $231,330). 10% is an appropriate interest rate for this company. What expense should be recorded for 2012 as a result of these events? a. Depreciation expense of $360,000 b. Depreciation expense of $300,000 and interest expense of $23,133 c. Depreciation expense of $300,000 and interest expense of $60,000 d. Depreciation expense of $323,133 and interest expense of $23,133
123.
During 2011, Vanpelt Co. introduced a new line of machines that carry a three-year warranty against manufacturer’s defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 3% in the year after sale, and 4% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows: 2011 2012 2013
Sales $ 600,000 1,500,000 2,100,000 $4,200,000
Actual Warranty Expenditures $ 9,000 65,000 135,000 $209,000
What amount should Vanpelt report as a liability at December 31, 2013? a. $0 b. $12,000 c. $54,000 d. $169,000 124.
Palmer Frosted Flakes Company offers its customers a pottery cereal bowl if they send in 3 boxtops from Palmer Frosted Flakes boxes and $1. The company estimates that 60% of the boxtops will be redeemed. In 2012, the company sold 675,000 boxes of Frosted Flakes and customers redeemed 330,000 boxtops receiving 110,000 bowls. If the bowls cost Palmer Company $3 each, how much liability for outstanding premiums should be recorded at the end of 2012? a. $270,000 b. $50,000 c. $75,000 d. $138,000
Current Liabilities and Contingencies 125.
13 - 27
During 2011, Stabler Co. introduced a new line of machines that carry a three-year warranty against manufacturer’s defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 3% in the year after sale, and 4% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows: 2011 2012 2013
Sales $ 400,000 1,000,000 1,400,000 $2,800,000
Actual Warranty Expenditures $ 6,000 40,000 90,000 $136,000
What amount should Stabler report as a liability at December 31, 2013? a. $0 b. $28,000 c. $36,000 d. $116,000 126.
LeMay Frosted Flakes Company offers its customers a pottery cereal bowl if they send in 4 boxtops from LeMay Frosted Flakes boxes and $1. The company estimates that 60% of the boxtops will be redeemed. In 2012, the company sold 500,000 boxes of Frosted Flakes and customers redeemed 220,000 boxtops receiving 55,000 bowls. If the bowls cost LeMay Company $3 each, how much liability for outstanding premiums should be recorded at the end of 2012? a. $150,000 b. $40,000 c. $60,000 d. $84,000
Use the following information for questions 127, 128, and 129. Mott Co. includes one coupon in each bag of dog food it sells. In return for eight coupons, customers receive a leash. The leashes cost Mott $3 each. Mott estimates that 40 percent of the coupons will be redeemed. Data for 2012 and 2013 are as follows: Bags of dog food sold Leashes purchased Coupons redeemed 127.
The premium expense for 2012 is a. $37,500. b. $45,000. c. $52,500. d. $75,000.
128.
The premium liability at December 31, 2012 is a. $11,250. b. $15,000. c. $26,250. d. $30,000.
2012 500,000 18,000 120,000
2013 600,000 22,000 150,000
13 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition 129.
The premium liability at December 31, 2013 is a. $16,875 b. $31,875. c. $33,750. d. $63,750.
130.
Winter 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. Winter's lawyer states that it is probable that Winter will lose the suit and be found liable for a judgment costing Winter anywhere from $1,600,000 to $8,000,000. However, the lawyer states that the most probable cost is $4,800,000. As a result of the above facts, Winter should accrue a. a loss contingency of $1,600,000 and disclose an additional contingency of up to $6,400,000. b. a loss contingency of $4,800,000 and disclose an additional contingency of up to $3,200,000. c. a loss contingency of $4,800,000 but not disclose any additional contingency. d. no loss contingency but disclose a contingency of $1,600,000 to $8,000,000.
131.
Nance Company estimates its annual warranty expense as 2% of annual net sales. The following data relate to the calendar year 2012: Net sales Warranty liability account Balance, Dec. 31, 2012 Balance, Dec. 31, 2012
$1,500,000 $10,000 50,000
debit before adjustment credit after adjustment
Which one of the following entries was made to record the 2012 estimated warranty expense? a. Warranty Expense ............................................................. 30,000 Retained Earnings (prior-period adjustment) ............ 5,000 Warranty Liability ..................................................... 25,000 b. Warranty Expense ............................................................. 25,000 Retained Earnings (prior-period adjustment) ...................... 5,000 Warranty Liability ..................................................... 30,000 c. Warranty Expense ............................................................. 20,000 Warranty Liability ..................................................... 20,000 d. Warranty Expense ............................................................. 30,000 Warranty Liability ..................................................... 30,000 132.
In 2012, Payton 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 2012 and 2013 are presented below: 2012 2013 Sales $600,000 $800,000 Actual warranty expenditures 20,000 40,000
Current Liabilities and Contingencies
13 - 29
What is the estimated warranty liability at the end of 2013? a. $38,000. b. $58,000. c. $98,000. d. $16,000. 133.
On January 3, 2012, Boyer Corp. owned a machine that had cost $300,000. The accumulated depreciation was $180,000, estimated salvage value was $18,000, and fair value was $480,000. On January 4, 2012, this machine was irreparably damaged by Pine Corp. and became worthless. In October 2012, a court awarded damages of $480,000 against Pine in favor of Boyer. At December 31, 2012, the final outcome of this case was awaiting appeal and was, therefore, uncertain. However, in the opinion of Boyer’s attorney, Pine’s appeal will be denied. At December 31, 2012, what amount should Boyer accrue for this gain contingency? a. $480,000. b. $390,000. c. $300,000. d. $0.
134.
Fuller Food Company distributes to consumers coupons which may be presented (on or before a stated expiration date) to grocers for discounts on certain products of Fuller. The grocers are reimbursed when they send the coupons to Fuller. In Fuller's experience, 50% of such coupons are redeemed, and generally one month elapses between the date a grocer receives a coupon from a consumer and the date Fuller receives it. During 2012 Fuller issued two separate series of coupons as follows: Issued On 1/1/12 7/1/12
Total Value $500,000 720,000
Consumer Expiration Date 6/30/12 12/31/12
Amount Disbursed as of 12/31/12 $236,000 300,000
The only journal entries to date recorded debits to coupon expense and credits to cash of $715,000. The December 31, 2012 balance sheet should include a liability for unredeemed coupons of a. $0. b. $60,000. c. $124,000. d. $360,000. 135.
Presented below is information available for Morton Company. Current Assets Cash Short-term investments Accounts receivable Inventory Prepaid expenses Total current assets
$
4,000 75,000 61,000 110,000 30,000 $280,000
Total current liabilities are $110,000. The acid-test ratio for Morton is a. 2.55 to 1. b. 2.27 to 1. c. 1.27 to 1. d. 0.72 to 1.
13 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
90. 91. 92. 93. 94. 95. 96.
b d a d b c b
97. 98. 99. 100. 101. 102. 103.
d b d b b c a
104. 105. 106. 107. 108. 109. 110.
a d d c c c d
111. 112. 113. 114. 115. 116. 117.
a d a b d d c
118. 119. 120. 121. 122. 123. 124.
b d a b d d b
125. 126. 127. 128. 129. 130. 131.
d b d d d b d
132. 133. 134. 135.
a d b c
Current Liabilities and Contingencies
13 - 31
MULTIPLE CHOICE—CPA Adapted 136.
Which of the following is generally associated with payables classified as accounts payable? Periodic Payment Secured of Interest by Collateral a. No No b. No Yes c. Yes No d. Yes Yes
137.
On January 1, 2012, Beyer Co. leased a building to Heins Corp. for a ten-year term at an annual rental of $140,000. At inception of the lease, Beyer received $560,000 covering the first two years' rent of $280,000 and a security deposit of $280,000. This deposit will not be returned to Heins 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 $560,000 should be shown as a current and long-term liability, respectively, in Beyer's December 31, 2012 balance sheet? Current Liability Long-term Liability a. $0 $560,000 b. $140,000 $280,000 c. $280,000 $280,000 d. $280,000 $140,000
138.
On September 1, 2012, Herman Co. issued a note payable to National Bank in the amount of $1,800,000, bearing interest at 12%, and payable in three equal annual principal payments of $600,000. On this date, the bank's prime rate was 11%. The first payment for interest and principal was made on September 1, 2013. At December 31, 2013, Herman should record accrued interest payable of a. $72,000. b. $66,000. c. $48,000. d. $44,000.
139.
Included in Vernon Corp.'s liability account balances at December 31, 2012, were the following: 7% note payable issued October 1, 2012, maturing September 30, 2013 8% note payable issued April 1, 2012, payable in six equal annual installments of $150,000 beginning April 1, 2013
$250,000 600,000
Vernon's December 31, 2012 financial statements were issued on March 31, 2013. On January 15, 2013, the entire $600,000 balance of the 8% note was refinanced by issuance of a long-term obligation payable in a lump sum. In addition, on March 10, 2013, Vernon consummated a noncancelable agreement with the lender to refinance the 7%, $250,000 note on a long-term basis, on readily determinable terms that have not yet been implemented. On the December 31, 2012 balance sheet, the amount of the notes payable that Vernon should classify as short-term obligations is a. $175,000. b. $125,000. c. $50,000. d. $0.
13 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition 140.
Edge Company’s salaried employees are paid biweekly. Occasionally, advances made to employees are paid back by payroll deductions. Information relating to salaries for the calendar year 2013 is as follows: 12/31/12 12/31/13 Employee advances $24,000 $ 36,000 Accrued salaries payable 130,000 ? Salaries expense during the year 1,300,000 Salaries paid during the year (gross) 1,250,000 At December 31, 2013, what amount should Edge report for accrued salaries payable? a. $180,000. b. $168,000. c. $144,000. d. $50,000.
141.
Risen Corp.'s payroll for the pay period ended October 31, 2012 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 $32,000 16,000 2,000 8,000 — $94,000 $34,000 7% each 3%
What amount should Risen accrue as its share of payroll taxes in its October 31, 2012 balance sheet? a. $21,600. b. $15,020. c. $14,180. d. $7,600. 142.
Felton 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 $720,000 at December 31, 2011 before year-end adjustment. Service contract costs are charged as incurred to the service contract expense account, which had a balance of $180,000 at December 31, 2011. Outstanding service contracts at December 31, 2011 expire as follows: During 2012 During 2013 During 2014 $150,000 $240,000 $105,000 What amount should be reported as unearned service contract revenues in Felton's December 31, 2011 balance sheet? a. $540,000. b. $495,000. c. $360,000. d. $330,000.
Current Liabilities and Contingencies 143.
13 - 33
Yount Trading Stamp Co. records stamp service revenue and provides for the cost of redemptions in the year stamps are sold to licensees. Yount's past experience indicates that only 80% of the stamps sold to licensees will be redeemed. Yount's liability for stamp redemptions was $6,000,000 at December 31, 2011. Additional information for 2012 is as follows: Stamp service revenue from stamps sold to licensees Cost of redemptions
$4,000,000 2,720,000
If all the stamps sold in 2012 were presented for redemption in 2013, the redemption cost would be $2,000,000. What amount should Yount report as a liability for stamp redemptions at December 31, 2012? a. $7,280,000. b. $5,280,000. c. $4,880,000. d. $3,280,000. 144.
Neer 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.
145.
During 2012, Eaton 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 3% in the second 12 months following sale. Sales and actual warranty expenditures for the years ended December 31, 2012 and 2013 are as follows:
2012 2013
Sales $ 800,000 1,000,000 $1,800,000
Actual Warranty Expenditures $12,000 35,000 $47,000
At December 31, 2013, Eaton should report an estimated warranty liability of a. $0. b. $15,000. c. $35,000. d. $43,000. 146.
In March 2013, an explosion occurred at Kirk Co.'s plant, causing damage to area properties. By May 2013, no claims had yet been asserted against Kirk. However, Kirk's management and legal counsel concluded that it was reasonably possible that Kirk would be held responsible for negligence, and that $4,000,000 would be a reasonable estimate of the damages. Kirk's $5,000,000 comprehensive public liability policy contains a $400,000 deductible clause. In Kirk's December 31, 2012 financial statements, for which the auditor's fieldwork was completed in April 2013, 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 2012 because the event occurred in 2013.
13 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
136. 137.
a b
138. 139.
c d
140. 141.
a d
142. 143.
b c
144. 145.
d d
146.
c
DERIVATIONS — Computational No.
Answer
90.
b
$253,675 – $250,000 = $3,675. $3,675 × 2/3 = $2,450.
Derivation
91.
d
$24,000 ÷ ($300,000 – $24,000) = 0.0870 = 8.70%.
92.
a
($13,300 × .99) = $13,167.
93.
d
$280,000 × .12 × 9/12 = $25,200.
94.
b
($360,000 – $350,000) × 3/5 = $6,000.
95.
c
$1,600,000.
96.
b
(6,000 × $125) × 8/12 = $500,000.
97.
d
$221,000 × .06 = $13,260.
98.
b
$2,250,000.
99.
d
$4,000,000 – $2,400,000 = $1,600,000.
100.
b
S + .06S = $222,600, S = $210,000. $222,600 – $210,000 = $12,600.
101.
b
$12,600 × .98 = $12,348.
102.
c
.05S × .97 = $135,800, S = $2,800,000.
103.
a
90,000 × $20 = $1,800,000.
104.
a
50,000 × $20 = $1,000,000.
105.
d
[(.062 – .054) + .02] × $700,000 = $19,600.
106.
d
[(.062 – .054) + .02] × $600,000 = $16,800.
107.
c
50 × 12 × 8 × $21 = $100,800; 50 × 15 × 8 × $24 = $144,000.
108.
c
50 × 12 × 8 × $24.50 = $117,600; 50 × 15 × 8 × $28 = $168,000.
Current Liabilities and Contingencies
13 - 35
DERIVATIONS — Computational (cont.) No.
Answer
Derivation
109.
c
($450,000 × 7.65%) + ($150,000 × 1.45%) + ($100,000 × 1.8%) = $38,400.
110.
d
$21.50 × 8 × 10 × 35 = $60,200.
111.
a
($23.75 × 8 × 10 × 35) + ($22.50 × 8 × 2 × 35) = $79,100.
112.
d
$25,400 + $15,780 + $18,000 = $59,180; $170,000 – $59,180 = $110,820.
113.
a
65 × 2 weeks × $1,140/week = $148,200.
114.
b
Likelihood of loss is only possible, not probable.
115.
d
Present value of the removal cost.
116.
d
[(42,000 × $81) 3 yrs.] – $400,000 = $734,000.
117.
c
$7,800,000 + (60,000 × $200) – $9,000,000 = $10,800,000.
118.
b
3,000,000 × .10 × $1 = $300,000; $300,000 – $160,000 = $140,000.
119.
d
($2,000,000 + $154,220) ÷ 10 = $215,420; $154,220 × .10 = $15,422.
120.
a
121.
b
6,000,000 × .10 × $2 = $1,200,000; $1,200,000 – $420,000 = $780,000.
122.
d
($3,000,000 + $231,330) ÷ 10 = $323,133; $231,330 × .10 = $23,133.
123.
d
($4,200,000 × .09) – $209,000 = $169,000.
124.
b
{[(675,000 × .60) – 330,000] ÷ 3} × $2 = $50,000.
125.
d
($2,800,000 × .09) – $136,000 = $116,000.
126.
b
{[(500,000 × .60) – 220,000] ÷ 4} × $2 = $40,000.
127.
d
[(500,000 × .4) ÷ 8] × $3 = $75,000.
128.
d
[(200,000 – 120,000) ÷ 8] × $3 = $30,000.
129.
d
{[(600,000 × .4) – 150,000] ÷ 8} × $3 = $33,750. $33,750 + $30,000 = $63,750.
130.
b
$4,800,000 and $3,200,000.
131.
d
$1,500,000 × .02 = $30,000.
13 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer
Derivation
132.
a
[($600,000 + $800,000) × .07] – $60,000 = $38,000.
133.
d
$0, gain contingencies are not accrued.
134.
b
($720,000 × .5) – $300,000 = $60,000.
135.
c
$4,000 + $75,000 + $61,000 ————————————— = 1.27 to 1. $110,000
DERIVATIONS — CPA Adapted No.
Answer
Derivation
136.
a
Conceptual—accounts payable generally are zero-interest-bearing and unsecured.
137.
b
$140,000 and $280,000.
138.
c
$1,200,000 × .12 ×
139.
d
Conceptual—both notes have been refinanced by long-term obligations.
140.
a
$1,300,000 + $130,000 – $1,250,000 = $180,000.
141.
d
($94,000 × .07) + ($34,000 × .03) = $7,600.
142.
b
$150,000 + $240,000 + $105,000 = $495,000.
143.
c
($2,000,000 × .8) + $6,000,000 – $2,720,000 = $4,880,000.
144.
d
Conceptual.
145.
d
($1,800,000 × .05) – $47,000 = $43,000.
146.
c
Conceptual.
4 = $48,000. 12
Current Liabilities and Contingencies
13 - 37
EXERCISES Ex. 13-147—Notes payable. On August 31, Jenks Co. partially refunded $450,000 of its outstanding 10% note payable made one year ago to Arma State Bank by paying $450,000 plus $45,000 interest, having obtained the $495,000 by using $131,000 cash and signing a new one-year $400,000 note discounted at 9% by the bank. Instructions (1) Make the entry to record the partial refunding. Assume Jenks Co. makes reversing entries when appropriate. (2) Prepare the adjusting entry at December 31, assuming straight-line amortization of the discount.
Solution 13-147 (1) Notes Payable .......................................................................... Interest Expense ...................................................................... Discount on Notes Payable (9% × $400,000) ........................... Notes Payable .............................................................. Cash .............................................................................
450,000 45,000 36,000
(2) Interest Expense (1/3 × $36,000) ............................................. Discount on Notes Payable ...........................................
12,000
400,000 131,000
12,000
Ex. 13-148—Payroll entries. Total payroll of Watson Co. was $1,840,000, of which $320,000 represented amounts paid in excess of $106,800 to certain employees. The amount paid to employees in excess of $7,000 was $1,440,000. Income taxes withheld were $450,000. 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 salaries and wages to $106,800 and 1.45% in excess of $106,800. Instructions (a) Prepare the journal entry for the salaries and wages paid. (b) Prepare the entry to record the employer payroll taxes.
Solution 13-148 (a) Salaries and Wages Expense .................................................. 1,840,000 Withholding Taxes Payable .......................................... FICA Taxes Payable ..................................................... Cash ............................................................................. * [($1,840,000 – $320,000) × 7.65%] + ($320,000 × 1.45%)
450,000 120,920* 1,269,080
13 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 13-148 (cont.) (b) Payroll Tax Expense .............................................................. FICA Taxes Payable ($1,520,000 × 7.65%) + ($320,000 × 1.45%)........... FUTA Taxes Payable [($1,840,000 – $1,440,000) × .8%] ......................... SUTA Taxes Payable ($400,000 × 1.2%) .....................
128,920 120,920 3,200 4,800
Ex. 13-149—Compensated absences. Yates Co. began operations on January 2, 2012. 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 $20.00 in 2012 and $21.25 in 2013. The average vacation days used by each employee in 2013 was 9. Yates 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 2012 and 2013.
Solution 13-149 2012
Salaries and Wages Expense ............................................. 24,000 (1) Salaries and Wages Payable ..................................
24,000
(1) 15 × 8 × $20.00 = $2,400; $2,400 × 10 = $24,000. 2013
Salaries and Wages Expense ............................................. 1,350 Salaries and Wages Payable .............................................. 21,600 (2) Cash .......................................................................
22,950 (3)
Salaries and Wages Expense ............................................. 25,500 (4) Salaries and Wages Payable ..................................
25,500
(2) $2,400 × 9 = $21,600. (3) 15 8 $21.25 = $2,550; $2,550 9 = $22,950. (4) $2,550 10 = $25,500.
Ex. 13-150—Contingent liabilities. Below are three independent situations. 1. In August, 2012 a worker was injured in the factory in an accident partially the result of his own negligence. The worker has sued Wesley 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.
Current Liabilities and Contingencies
13 - 39
Ex. 13-150 (cont.) 2. A suit for breach of contract seeking damages of $2,400,000 was filed by an author against Greer Co. on October 4, 2012. Greer's legal counsel believes that an unfavorable outcome is probable. A reasonable estimate of the award to the plaintiff is between $800,000 and $1,800,000. No amount within this range is a better estimate of potential damages than any other amount. 3. Quinn is involved in a pending court case. Quinn’s lawyers believe it is probable that Quinn 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 13-150 1.
Wesley 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 $800,000. Greer 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.
Quinn 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. 13-151—Premiums. Irving Music Shop gives its customers coupons redeemable for a poster plus a Dixie Chicks CD. One coupon is issued for each dollar of sales. On the surrender of 100 coupons and $5.00 cash, the poster and CD are given to the customer. It is estimated that 80% of the coupons will be presented for redemption. Sales for the first period were $700,000, and the coupons redeemed totaled 420,000. Sales for the second period were $840,000, and the coupons redeemed totaled 750,000. Irving Music Shop bought 20,000 posters at $2.00/poster and 20,000 CDs at $6.00/CD. Instructions Prepare the following entries for the two periods, assuming all the coupons expected to be redeemed from the first period were redeemed by the end of the second period.
13 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 13-151 (cont.) Entry
Period 1
Period 2
(a) To record coupons redeemed ——————————————————————————————————————————— (b) To record estimated liability ———————————————————————————————————————————
Solution 13-151 Entry
Period 1
Period 2
(a) Premium Liability 4,200 Premium Expense [(420,000 ÷ 100) × ($8.00 – $5)] 12,600 18,300 Cash (420,000 ÷ 100) × $5 21,000 37,500 Inventory of Premiums 33,600 60,000 ——————————————————————————————————————————— (b) Premium Expense Premium Liability *[(700,000 × .80) – 420,000] ÷ 100 × $3.00
4,200*
1,860 4,200
1,860
Ex. 13-152—Premiums. Edwards Co. includes one coupon in each bag of dog food it sells. In return for 4 coupons, customers receive a dog toy that the company purchases for $1.50 each. Edwards's experience indicates that 60 percent of the coupons will be redeemed. During 2012, 100,000 bags of dog food were sold, 12,000 toys were purchased, and 40,000 coupons were redeemed. During 2013, 120,000 bags of dog food were sold, 16,000 toys were purchased, and 60,000 coupons were redeemed. Instructions Determine the premium expense to be reported in the income statement and the premium liability on the balance sheet for 2012 and 2013.
Solution 13-152 Premium expense Premium liability (1) (2) (3) (4)
2012 $22,500 (1) 7,500 (2)
2013 $27,000 (3) 12,000 (4)
100,000 × .6 = 60,000; 60,000 ÷ 4 = 15,000; 15,000 × $1.50 = $22,500. 40,000 ÷ 4 = 10,000; 15,000 – 10,000 = 5,000; 5,000 × $1.50 = $7,500. 120,000 × .6 = 72,000; 72,000 ÷ 4 = 18,000; 18,000 × $1.50 = $27,000. 60,000 ÷ 4 = 15,000; 5,000 + 18,000 – 15,000 = 8,000; 8,000 × $1.50 = $12,000.
Current Liabilities and Contingencies
13 - 41
PROBLEMS Pr. 13-153—Accounts and Notes Payable. Described below are certain transactions of Larson Company for 2012: 1.
On May 10, the company purchased goods from Fry Company for $75,000, terms 2/10, n/30. Purchases and accounts payable are recorded at net amounts. The invoice was paid on May 18.
2.
On June 1, the company purchased equipment for $90,000 from Raney Company, paying $30,000 in cash and giving a one-year, 9% note for the balance.
3.
On September 30, the company discounted at 10% its $200,000, 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, 2012 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 Larson Company's December 31, 2012 balance sheet.
Solution 13-153 (a) May 10, 2012 Purchases/Inventory................................................................. Accounts Payable .........................................................
73,500
May 18, 2012 Accounts Payable .................................................................... Cash .............................................................................
73,500
June 1, 2012 Equipment ................................................................................ Cash ............................................................................. Notes Payable .............................................................. September 30, 2012 Cash ........................................................................................ Discount on Notes Payable ...................................................... Notes Payable ..............................................................
73,500
73,500 90,000 30,000 60,000
180,000 20,000 200,000
(b) Interest Expense ...................................................................... Interest Payable ($60,000 × .09 × 7/12) ........................
3,150
Interest Expense ...................................................................... Discount on Notes Payable ($20,000 × 3/12) ................
5,000
3,150
5,000
13 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition (c) Current Liabilities Interest payable Note payable—Raney Company Note payable—First State Bank Less: Discount on note
$ $200,000 15,000
3,150 60,000
185,000 $248,150
Pr. 13-154—Refinancing of short-term debt. At the financial statement date of December 31, 2012, the liabilities outstanding of Packard Corporation included the following: 1. 2. 3. 4.
Cash dividends on common stock, $40,000, payable on January 15, 2013. Note payable to Galena State Bank, $470,000, due January 20, 2013. Serial bonds, $1,400,000, of which $350,000 mature during 2013. Note payable to Third National Bank, $300,000, due January 27, 2013.
The following transactions occurred early in 2013: January 15: The cash dividends on common stock were paid. January 20: The note payable to Galena State Bank was paid. January 25: The corporation entered into a financing agreement with Galena State Bank, enabling it to borrow up to $500,000 at any time through the end of 2015. Amounts borrowed under the agreement would bear interest at 1% above the bank's prime rate and would mature 3 years from the date of the loan. The corporation immediately borrowed $400,000 to replace the cash used in paying its January 20 note to the bank. January 26: 40,000 shares of common stock were issued for $350,000. $300,000 of the proceeds was used to liquidate the note payable to Third National Bank. February 1: The financial statements for 2012 were issued. Instructions Prepare a partial balance sheet for Packard Corporation, showing the manner in which the above liabilities should be presented at December 31, 2012. The liabilities should be properly classified between current and long-term, and appropriate note disclosure should be included.
Solution 13-154 Current liabilities: Dividends payable Notes payable— Galena State Bank Currently maturing portion of serial bonds Total current liabilities
$ 40,000 470,000 350,000
Long-term debt: Note payable—Third National Bank, refinanced in January, 2013—Note 1 Serial bonds not maturing currently Total long-term debt Total liabilities
300,000 1,050,000
$ 860,000
1,350,000 $2,210,000
Current Liabilities and Contingencies
13 - 43
Note 1: On January 26, 2013, the corporation issued 40,000 shares of common stock and received proceeds totaling $350,000, of which $300,000 was used to liquidate a note payable that matured on January 27, 2013. Accordingly, such note payable has been classified as long-term debt at December 31, 2012.
Pr. 13-155—Premiums. Paige Candy Company offers a coffee mug as a premium for every ten $1 candy bar wrappers presented by customers together with $2. The purchase price of each mug to the company is $1.80; in addition it costs $1.20 to mail each mug. The results of the premium plan for the years 2012 and 2013 are as follows (assume all purchases and sales are for cash): 2012 2013 Coffee mugs purchased 720,000 800,000 Candy bars sold 5,600,000 6,750,000 Wrappers redeemed 2,800,000 4,200,000 2012 wrappers expected to be redeemed in 2013 2,000,000 2013 wrappers expected to be redeemed in 2014 2,700,000 Instructions (a) Prepare the general journal entries that should be made in 2012 and 2013 related to the above plan by Paige Candy. (b) Indicate the account names, amounts, and classifications of the items related to the premium plan that would appear on the Paige Candy Company balance sheet and income statement at the end of 2012 and 2013. Solution 13-155 (a)
2012 Inventory of Premiums ................................................................... 1,296,000 Cash ................................................................................... (720,000 × $1.80 = $1,296,000)
1,296,000
Cash .............................................................................................. 5,600,000 Sales Revenue ................................................................... (5,600,000 × $.1 = $5,600,000)
5,600,000
Cash .............................................................................................. 224,000 Premium Expense .......................................................................... 280,000 Inventory of Premiums ........................................................ [2,800,000 ÷ 10 = 280,000 × ($2.00 – $1.20) = $224,000 280,000 × $1.80 = $504,000]
504,000
Premium Expense .......................................................................... Premiums Liability .............................................................. (2,000,000 ÷ 10 = 200,000 × $1 = $200,000)
200,000
200,000
2013 Inventory of Premiums ................................................................... 1,440,000 Cash .................................................................................. (800,000 × $1.80 = $1,440,000)
1,440,000
13 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition
Cash ............................................................................................... 6,750,000 Sales Revenve .................................................................... (6,750,000 × $1 = $6,750,000) Cash ............................................................................................... 336,000 Premium Liability ............................................................................ 200,000 Premium Expense .......................................................................... 220,000 Inventory of Premium .......................................................... [4,200,000 ÷ 10 = 420,000 × ($2.00 – $1.20) = $336,000 420,000 × $1.80 = $756,000] Premium Expense .......................................................................... Premium Liability................................................................. (2,700,000 ÷ 10 = 270,000 × $1 = $270,000)
6,750,000
756,000
270,000 270,000
(b) Balance Sheet Name Inventory of Premiums Premium Liability
Class Current Asset Current Liability
2012 $792,000 200,000
2013 $1,476,000 270,000
Class Operating Expense
2012 $480,000
2013 $490,000
Income Statement Name Premium Expense
Pr. 13-156—Warranties. Miley 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 2012, the company sold 900 computers. Based on past experience, the company has estimated the total 2-year warranty costs as $40 for parts and $60 for labor. (Assume sales all occur at December 31, 2012.) In 2013, Miley incurred actual warranty costs relative to 2012 computer sales of $12,000 for parts and $18,000 for labor. Instructions (a) Under the expense warranty approach, give the entries to reflect the above transactions (accrual method) for 2012 and 2013. (b) Under the cash-basis method, what are the Warranty Expense balances for 2012 and 2013? (c) The transactions of part (a) create what balance under current liabilities in the 2012 balance sheet?
Solution 13-156 (a)
2012 Accounts Receivable ...................................................................... 1,350,000 Sales Revenue....................................................................
1,350,000
Current Liabilities and Contingencies Warranty Expense .......................................................................... Warranty Liability ............................................................... 2013 Warranty Liability ............................................................................ Inventory............................................................................. Cash, Inventory, Accrued Payroll ........................................ (b)
2012 2013
$0. $30,000.
(c)
2012
Current Liabilities—Warranty Liability $45,000. (The remainder of the $90,000 liability is a long-term liability.)
13 - 45
90,000 90,000
30,000 12,000 18,000
13 - 46 Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS True / False Questions 1. Short-term debt obligations are classified as current liabilities unless an agreement to refinance is completed before the financial statements are issued. 2.
For purposes of recognizing a provision,”probable” is defined as more likely than not
3.
A Provision differs from other liabilities in that there is greater uncertainty about the timing and amount of settlement.
4.
IFRS allows for reduced disclosure of contingent liabilities if the disclosure could increase the company`s chance of losing a lawsuit.
5.
Contingent liabilities are not reported in the financial statements but may be disclosed in the notes to the financial statements if the likelihood of an unfavorable outcome is possible.
6.
A company can exclude a short-term obligation from current liablities if it intends to refinance the obligation and has an unconditional right to defer settlement of the obligation for at least 12 months following the due date.
7.
Provisions are only recorded if it is likely that the company will have to settle an obligation at some point in the future.
8.
An onerous contract is one in which the unavoidable costs of satisfying the obligations outweigh the economic benefits to be received.
9.
Contingent assets are not reported in the statement of financial position.
10.
IFRS uses the term “contigent” for assets and liabilities not recognized in the financial statement.
Answers to True / False: 1. False 2. True 3. True 4. False 5. True 6. False 7. False 8. True 9. True 10. True
CHAPTER 14 LONG-TERM LIABILITIES IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
T F T F F T F F F T T F T T T 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.
Bond interest payments. Debenture bonds. Definition of serial bonds. Market rate vs. coupon rate. Definition of stated interest rate. Stated rate and coupon rate. Amortization of premium and discount. Issuance of bonds. Interest paid vs. interest expense. Accounting for bond issue costs. Refunding of bond issue. Long-term notes payable. Implicit interest rate. Definition of unrealized holiday gain/loss. Off-balance-sheet financing. Debt to total assets ratio. Refinancing long-term debt. Times interest earned ratio. Loss recognized on impaired loan. Gain/loss in troubled debt restructuring.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
a a b a d a d d d d b a d d c d d c
21. 22. 23. P 24. S 25. S 26. S 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38.
Liability identification. Bond terms. Definition of "debenture bonds." Definition of bearer bonds. Definition of income bonds. Effective-interest vs. straight-line method. Interest rate of the bond indenture. Rate of interest earned by the bondholders. Calculating the issue price of bonds. Calculating the issue price of bonds. Premium and interest rates. Interest and discount amortization. Effective-interest amortization method. Impact of effective-interest method. Recording bonds issued between interest dates. Bonds issued at other than an interest date. Classification of bond issuance costs. Bond issuance costs.
14 - 2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
b d d c c a d d c d c d d d c c. c d b b c
39. 40. 41. P 42. P 43. S 44. 45. 46. 47. 48. S 49. S 50. 51. 52. 53. 54. *55. *56. *57. *58. *59.
Classification of treasury bonds. Early extinguishment of bonds payable. Gain or loss on extinguishment of debt. In-substance defeasance. Reporting long-term debt. Debt instrument exchanged for property. Valuation of note issued in noncash transaction. Stated interest rate of note. Accounting for the fair value option. 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. 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.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. * This topic is dealt with in an Appendix to the chapter. S
MULTIPLE CHOICE—Computational Answer
No.
Description
a b a c c c c c a d d c a d d b c d a
60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78.
Calculate the present value of bond principal. Calculate the present value of bond interest. Determine the issue price of bonds. Proceeds from bond issuance. Bonds issued between interest dates. Proceeds from bond issuance. Bonds issued between interest dates. Effective-interest method interest expense. Effective-interest method carrying value. Straight-line method carrying value. Straight-line amortization/interest expense. Effective-interest method interest expense. Effective-interest method carrying value. Straight-line method carrying value. Straight-line method amortization/interest expense. Interest expense using effective-interest method. Interest expense using effective-interest method. Entry to record issuance of bonds. Calculate bond interest expense.
Long-Term Liabilities
MULTIPLE CHOICE—Computational (cont.) Answer
No.
b c b b b c b b b c c b b b b b b a c b d a c d b d a
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.
Description Entry to record issuance of bonds. Calculate bond interest expense. Calculate interest expense for two periods. Calculate unamortized bond discount balance. Calculate unamortized bond premium balance. Calculate interest expense for two periods. Entry to record bond redemption. Entry to record bond redemption. Calculate loss on bond redemption. Calculate loss on bond redemption. Calculate gain on retirement of bonds. Calculate gain on retirement of bonds. Calculate loss on retirement of bonds. Bond retirement with call premium. Calculate loss on retirement of bonds. Early extinguishment of debt. Early extinguishment of debt. Interest on noninterest-bearing note. Interest on installment note payable. Determine balance of discount on notes payable. Calculate times interest earned ratio. Calculate times interest earned ratio. Calculate income before taxes with times interest earned ratio. Determine total long-term liabilities. Transfer of equipment in debt settlement. Recognizing gain on debt restructure. Interest and troubled debt restructuring.
MULTIPLE CHOICE—CPA Adapted Answer
No.
a b a c a d d c c c d
106. 107. 108. 109. 110. 111. 112. 113. 114. 115. *116.
Description Determine proceeds from bond issue. Determine unamortized bond premium. Determine unamortized bond discount. Calculate bond interest expense. Calculate loss on retirement of bonds. Calculate loss on retirement of bonds. Calculate gain on retirement of bonds. Determine carrying value of bonds to be retired. Carrying value of bonds with call provision. Classification of gain from debt refunding. Classification of gain from troubled debt restructuring.
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14 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Item E14-117 E14-118 E14-119 E14-120 E14-121 E14-122 *E14-123 *E14-124 *E14-125
Description Terms related to long-term debt. Bond issue price and premium amortization. Amortization of discount or premium. Entries for bonds payable. Retirement of bonds. Early extinguishment of debt. Accounting for a troubled debt settlement. Accounting for troubled debt restructuring. Accounting for troubled debt.
PROBLEMS Item P14-126 P14-127 P14-128 P14-129 P14-130 *P14-131
Description Bond discount amortization. Bond interest and discount amortization. Entries for bonds payable. Entries for bonds payable. Fair value option Accounting for a troubled debt settlement.
CHAPTER LEARNING OBJECTIVES 1.
Describe the formal procedures associated with issuing long-term debt.
2.
Identify various types of bond issues.
3.
Describe the accounting valuation for bonds at date of issuance.
4.
Apply the methods of bond discount and premium amortization.
5.
Describe the accounting for the extinguishment of debt.
6.
Explain the accounting for long-term notes payable.
7.
Describe the accounting for the fair value option.
8.
Explain the reporting of off-balance-sheet financing arrangements.
9.
Indicate how to present and analyze long-term debt.
*10.
Describe the accounting for a debt restructuring.
Long-Term Liabilities
14 - 5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
Type
Item
Type
Item
Type
Item
Type
Item
Type
Learning Objective 1 1.
TF
21.
MC
22.
MC Learning Objective 2
2.
TF
3.
TF
23.
MC
P
24.
MC
S
25.
MC
Learning Objective 3 4.
TF
27.
MC
30.
MC
62.
MC
117.
E
5.
TF
28.
MC
60.
MC
63.
MC
118.
E
6.
TF
29.
MC
61.
MC
65.
MC
126.
P
Learning Objective 4 7.
TF
34.
MC
67.
MC
75.
MC
83.
MC
119.
E
8.
TF
35.
MC
68.
MC
76.
MC
84.
MC
120.
E
9.
TF
36.
MC
69.
MC
77.
MC
106.
MC
126.
P
10.
TF
37.
MC
70.
MC
78.
MC
107.
MC
127.
P
26.
MC
38.
MC
71.
MC
79.
MC
108.
MC
128.
P
31.
MC
39.
MC
72.
MC
80.
MC
109.
MC
129.
P
32.
MC
64.
MC
73.
MC
81.
MC
117.
E
33.
MC
66.
MC
74.
MC
82.
MC
118.
E
Learning Objective 5
P
11.
TF
85.
MC
89.
MC
93.
MC
111.
MC
115.
MC
122.
E
40.
MC
86.
MC
90.
MC
94.
MC
112.
MC
117.
E
128.
P
41.
MC
87.
MC
91.
MC
95.
MC
113.
MC
120.
E
42.
MC
88.
MC
92.
MC
110.
MC
114.
MC
121.
E
101.
MC
Learning Objective 6 12. 13.
TF
P
43.
MC
45.
MC
47.
MC
97.
MC
TF
S
44.
MC
46.
MC
96.
MC
98.
MC
Learning Objective 7 14.
TF
47
MC
130.
P Learning Objective 8
15.
TF
48.
MC
S
49.
MC Learning Objective 9
16.
TF
18.
TF
51.
MC
53.
MC
99.
MC
14 - 6 17.
Test Bank for Intermediate Accounting, Fourteenth Edition TF
S
50.
MC
52.
MC
54.
MC
100.
MC
Learning Objective *10 19.
TF
56.
MC
59.
MC
105.
MC
124.
E
20.
TF
57.
MC
103.
MC
106.
MC
125.
E
55.
MC
58.
MC
104.
MC
123.
E
131.
P
Note:
TF = True-False MC = Multiple Choice
E = Exercise P = Problem
102.
MC
Long-Term Liabilities
14 - 7
TRUE FALSE—Conceptual 1. Companies usually make bond interest payments semiannually, although the interest rate is generally expressed as an annual rate. 2. A mortgage bond is referred to as a debenture bond. 3. Bond issues that mature in installments are called serial bonds. 4. If the market rate is greater than the coupon rate, bonds will be sold at a premium. 5. The interest rate written in the terms of the bond indenture is called the effective yield or market rate. 6. The stated rate is the same as the coupon rate. 7. Amortization of a premium increases bond interest expense, while amortization of a discount decreases bond interest expense. 8. A bond may only be issued on an interest payment date. 9. The cash paid for interest will always be greater than interest expense when using effective-interest amortization for a bond. 10. Bond issue costs are capitalized as a deferred charge and amortized to expense over the life of the bond issue. 11. The replacement of an existing bond issue with a new one is called refunding. 12. If a long-term note payable has a stated interest rate, that rate should be considered to be the effective rate. 13. The implicit interest rate is the rate that equates the cash received with the amounts received in the future. 14. An unrealized holding gain or loss is the net change in the fair value of the liability from one period to another, exclusive of interest expense recognized but not recorded. 15. Off-balance-sheet financing is an attempt to borrow monies in such a way to minimize the reporting of debt on the balance sheet. 16. The debt to total assets ratio will go up if an equal amount of assets and liabilities are added to the balance sheet. 17. If a company plans to retire long-term debt from a bond retirement fund, it should report the debt as current. 18. The times interest earned ratio is computed by dividing income before interest expense by interest expense.
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Test Bank for Intermediate Accounting, Fourteenth Edition
*19. The loss to be recognized by a creditor on an impaired loan is the difference between the investment in the loan and the expected undiscounted future cash flows from the loan. *20. In a troubled debt restructuring, the loss recognized by the creditor will equal the gain recognized by the debtor.
True False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. T F T F F
Item 6. 7. 8. 9. 10.
Ans. T F F F T
Item 11. 12. 13. 14. 15.
Ans. T F T T T
Item 16. 17. 18. 19. 20.
Ans. T F F F F
MULTIPLE CHOICE—Conceptual 21.
An example of an item which is not a liability is a. dividends payable in stock. b. advances from customers on contracts. c. accrued estimated warranty costs. d. the portion of long-term debt due within one year.
22.
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.
23.
The term used for bonds that are unsecured as to principal is a. junk bonds. b. debenture bonds. c. indebenture bonds. d. callable bonds.
P
24.
Bonds for which the owners' names are not registered with the issuing corporation are called a. bearer bonds. b. term bonds. c. debenture bonds. d. secured bonds.
S
25.
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.
Long-Term Liabilities S
14 - 9
26.
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.
27.
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.
28.
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.
Use the following information for questions 29 and 30: Fox Co. issued $100,000 of ten-year, 10% bonds that pay interest semiannually. The bonds are sold to yield 8%. 29.
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. 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.
30.
Another step in calculating the issue 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.
31.
Reich, 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.
14 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition 32.
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.
33.
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.
34.
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.
35.
If bonds are issued between interest dates, the entry on the books of the issuing corporation could include a a. debit to Interest Payable. b. credit to Interest Receivable. c. credit to Interest Expense. d. credit to Unearned Interest.
36.
When the interest payment dates of a bond are May 1 and November 1, and a bond issue is sold on June 1, the amount of cash received by the issuer will be a. decreased by accrued interest from June 1 to November 1. b. decreased by accrued interest from May 1 to June 1. c. increased by accrued interest from June 1 to November 1. d. increased by accrued interest from May 1 to June 1.
37.
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.
38.
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.
Long-Term Liabilities
14 - 11
39.
Treasury bonds should be shown on the balance sheet as a. an asset. b. a deduction from bonds payable issued to arrive at net bonds payable and outstanding. c. a reduction of stockholders' equity. d. both an asset and a liability.
40.
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.
41.
The generally accepted method of accounting for gains or losses from the early extinguishment of debt treats any gain or loss as a. an adjustment to the cost basis of the asset obtained by the debt issue. b. an 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. an amount received or paid to obtain a new debt instrument and, as such, should be amortized over the life of the new debt. d. a difference between the reacquisition price and the net carrying amount of the debt which should be recognized in the period of redemption.
P
42.
"In-substance defeasance" is a term used to refer to an arrangement whereby a. a company gets another company to cover its payments due on long-term debt. b. a governmental unit issues debt instruments to corporations. c. a company provides for the future repayment of a long-term debt by placing purchased securities in an irrevocable trust. d. a company legally extinguishes debt before its due date.
P
43.
A corporation borrowed money from a bank to build a building. The long-term note signed by the corporation is secured by a mortgage that pledges title to the building as security for the loan. The corporation is to pay the bank $80,000 each year for 10 years to repay the loan. Which of the following relationships can you expect to apply to the situation? a. The balance of mortgage payable at a given balance sheet date will be reported as a long-term liability. b. The balance of mortgage payable will remain a constant amount over the 10-year period. c. The amount of interest expense will decrease each period the loan is outstanding, while the portion of the annual payment applied to the loan principal will increase each period. d. The amount of interest expense will remain constant over the 10-year period.
S
44.
A debt instrument with no ready market is exchanged for property whose fair value is currently indeterminable. When such a transaction takes place a. the present value of the debt instrument must be approximated using an imputed interest rate. b. it should not be recorded on the books of either party until the fair value of the property becomes evident. c. the board of directors of the entity receiving the property should estimate a value for the property that will serve as a basis for the transaction. d. the directors of both entities involved in the transaction should negotiate a value to be assigned to the property.
14 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition 45.
When a note payable is issued for property, goods, or services, the present value of the note is measured by a. the fair value of the property, goods, or services. b. the fair value of the note. c. using an imputed interest rate to discount all future payments on the note. d. any of these.
46.
When a note payable is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless a. no interest rate is stated. b. the stated interest rate is unreasonable. c. the stated face amount of the note is materially different from the current cash sales price for similar items or from current fair value of the note. d. any of these.
47.
If a company chooses the fair value option, a decrease in the fair value of the liability is recorded by crediting a. Bonds Payable. b. Gain on Restructuring of Debt. c. Unrealized Holding Gain/Loss-Income. d. None of these.
48.
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."
S
49.
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 flow. 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.
S
50.
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.
Long-Term Liabilities
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51.
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.
52.
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.
53.
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.
54.
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.
*55.
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 or revenue should be recognized in the future.
*56.
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.
*57.
In a troubled debt restructuring in which the debt is restructured by a transfer of assets with a fair value less than the carrying amount of the debt, the debtor would recognize a. no gain or loss on the restructuring. b. a gain on the restructuring. c. a loss on the restructuring. d. none of these.
14 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition *58.
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.
*59.
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.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26.
a a b a d a
27. 28. 29. 30. 31. 32.
d d d d b a
33. 34. 35. 36. 37. 38.
d d c d d c
39. 40. 41. 42. 43. 44.
b d d c c a
45. 46. 47. 48. 49. 50.
d d c d c d
51. 52. 53. 54. *55. *56.
d d c c c d
*57. *58. *59.
b b c
Solutions to those Multiple Choice questions for which the answer is “none of these.” 30.
multiply $5,000 by the table value for 20 periods and 4% from the present value of an annuity table.
MULTIPLE CHOICE—Computational Use the following information for questions 60 through 62: On January 1, 2012, Ellison Co. issued eight-year bonds with a face value of $2,000,000 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
Long-Term Liabilities
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60.
The present value of the principal is a. $1,068,000. b. $1,080,000. c. $1,246,000. d. $1,254,000.
61.
The present value of the interest is a. $689,640. b. $699,120. c. $745,200. d. $753,660.
62.
The issue price of the bonds is a. $1,767,120. b. $1,769,640. c. $1,779,120. d. $1,999,200.
63.
Downing Company issues $3,000,000, 6%, 5-year bonds dated January 1, 2012 on January 1, 2012. 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.
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
$3,000,000 $3,129,896 $3,131,285 $3,130,385
64. Feller Company issues $10,000,000 of 10-year, 9% bonds on March 1, 2012 at 97 plus accrued interest. The bonds are dated January 1, 2012, and pay interest on June 30 and December 31. What is the total cash received on the issue date? a. $9,700,000 b. $10,225,000 c. $9,850,000 d. $9,550,000
14 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition 65. Everhart Company issues $15,000,000, 6%, 5-year bonds dated January 1, 2012 on January 1, 2012. The bonds pays 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.
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
$15,000,000 $15,649,482 $15,656,427 $15,651,924
66.
Farmer Company issues $20,000,000 of 10-year, 9% bonds on March 1, 2012 at 97 plus accrued interest. The bonds are dated January 1, 2012, and pay interest on June 30 and December 31. What is the total cash received on the issue date? a. $19,400,000 b. $20,450,000 c. $19,700,000 d. $19,100,000
67.
A company issues $15,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2012. Interest is paid on June 30 and December 31. The proceeds from the bonds are $14,703,109. Using effective-interest amortization, how much interest expense will be recognized in 2012? a. $585,000 b. $1,170,000 c. $1,176,374 d. $1,176,249
68.
A company issues $15,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2012. Interest is paid on June 30 and December 31. The proceeds from the bonds are $14,703,109. Using effective-interest amortization, what will the carrying value of the bonds be on the December 31, 2012 balance sheet? a. $14,709,482 b. $15,000,000 c. $14,718,844 d. $14,706,232
69.
A company issues $15,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2011. Interest is paid on June 30 and December 31. The proceeds from the bonds are $14,703,109. Using straight-line amortization, what is the carrying value of the bonds on December 31, 2013? a. $14,752,673 b. $14,955,466 c. $14,725,375 d. $14,747,642
Long-Term Liabilities
14 - 17
70.
A company issues $15,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2012. Interest is paid on June 30 and December 31. The proceeds from the bonds are $14,703,109. What is interest expense for 2013, using straight-line amortization? a. $1,540,207 b. $1,170,000 c. $1,176,894 d. $1,184,845
71.
A company issues $10,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2012. Interest is paid on June 30 and December 31. The proceeds from the bonds are $9,802,072. Using effective-interest amortization, how much interest expense will be recognized in 2012? a. $390,000 b. $780,000 c. $784,248 d. $784,166
72.
A company issues $10,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2012. Interest is paid on June 30 and December 31. The proceeds from the bonds are $9,802,072. Using effective-interest amortization, what will the carrying value of the bonds be on the December 31, 2012 balance sheet? a. $9,806,320 b. $10,000,000 c. $9,812,562 d. $9,804,154
73.
A company issues $10,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2011. Interest is paid on June 30 and December 31. The proceeds from the bonds are $9,802,072. Using straight-line amortization, what is the carrying value of the bonds on December 31, 2013? a. $9,835,116 b. $9,970,312 c. $9,816,916 d. $9,831,762
74.
A company issues $10,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2012. Interest is paid on June 30 and December 31. The proceeds from the bonds are $9,802,072. What is interest expense for 2013, using straight-line amortization? a. $770,104 b. $780,000 c. $784,596 d. $789,896
75.
On January 1, 2012, Huber Co. sold 12% bonds with a face value of $800,000. The bonds mature in five years, and interest is paid semiannually on June 30 and December 31. The bonds were sold for $861,600 to yield 10%. Using the effective-interest method of amortization, interest expense for 2012 is a. $80,000. b. $85,914. c. $86,160. d. $96,000.
14 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 76.
On January 2, 2012, a calendar-year corporation sold 8% bonds with a face value of $900,000. These bonds mature in five years, and interest is paid semiannually on June 30 and December 31. The bonds were sold for $830,400 to yield 10%. Using the effectiveinterest method of computing interest, how much should be charged to interest expense in 2012? a. $72,000. b. $83,040. c. $83,316. d. $90,000. The following information applies to both questions 77 and 78. On October 1, 2012 Macklin Corporation issued 5%, 10-year bonds with a face value of $2,000,000 at 104. Interest is paid on October 1 and April 1, with any premiums or discounts amortized on a straight-line basis. 77.
The entry to record the issuance of the bonds would include a credit of a. $50,000 to Interest Payable. b. $80,000 to Discount on Bonds Payable. c. $1,920,000 to Bonds Payable. d. $80,000 to Premium on Bonds Payable.
78.
Bond interest expense reported on the December 31, 2012 income statement of Macklin Corporation would be a. $23,000 b. $25,000 c. $27,000 d. $46,000
The following information applies to both questions 79 and 80. On October 1, 2012 Bartley Corporation issued 5%, 10-year bonds with a face value of $3,000,000 at 104. Interest is paid on October 1 and April 1, with any premiums or discounts amortized on a straight-line basis. 79.
The entry to record the issuance of the bonds would include a a. credit of $75,000 to Interest Payable. b. credit of $120,000 to Premium on Bonds Payable. c. credit of $2,880,000 to Bonds Payable. d. debit of $120,000 to Discount on Bonds Payable.
80.
Bond interest expense reported on the December 31, 2012 income statement of Bartley Corporation would be a. $40,500 b. $69,000 c. $34,500 d. $37,500
81.
At the beginning of 2012, Wallace Corporation issued 10% bonds with a face value of $1,500,000. These bonds mature in the five years, and interest is paid semiannually on June 30 and December 31. The bonds were sold for $1,389,600 to yield 12%. Wallace uses a calendar-year reporting period. Using the effective-interest method of amortization, what amount of interest expense should be reported for 2012? (Round your answer to the nearest dollar.) a. $172,080 b. $167,255
Long-Term Liabilities
14 - 19
c. $166,750 d. $166,250 82.
On January 1, Patterson Inc. issued $3,000,000, 9% bonds for $2,817,000. The market rate of interest for these bonds is 10%. Interest is payable annually on December 31. Patterson uses the effective-interest method of amortizing bond discount. At the end of the first year, Patterson should report unamortized bond discount of a. $164,700. b. $171,300. c. $154,830. d. $153,000.
83.
On January 1, Martinez Inc. issued $4,000,000, 11% bonds for $4,260,000. The market rate of interest for these bonds is 10%. Interest is payable annually on December 31. Martinez uses the effective-interest method of amortizing bond premium. At the end of the first year, Martinez should report unamortized bond premium of: a. $246,840 b. $246,000 c. $231,400 d. $220,000
84.
At the beginning of 2012, Winston Corporation issued 10% bonds with a face value of $1,200,000. These bonds mature in five years, and interest is paid semiannually on June 30 and December 31. The bonds were sold for $1,111,680 to yield 12%. Winston uses a calendar-year reporting period. Using the effective-interest method of amortization, what amount of interest expense should be reported for 2012? (Round your answer to the nearest dollar.) a. $133,000 b. $133,400 c. $133,804 d. $137,664
85.
Kant Corporation retires its $500,000 face value bonds at 102 on January 1, following the payment of interest. The carrying value of the bonds at the redemption date is $481,250. The entry to record the redemption will include a a. credit of $18,750 to Loss on Bond Redemption. b. credit of $18,750 to Discount on Bonds Payable. c. debit of $28,750 to Gain on Bond Redemption. d. debit of $10,000 to Premium on Bonds Payable.
86.
Carr Corporation retires its $500,000 face value bonds at 105 on January 1, following the payment of interest. The carrying value of the bonds at the redemption date is $518,725. The entry to record the redemption will include a a. credit of $18,725 to Loss on Bond Redemption. b. debit of $18,725 to Premium on Bonds Payable. c. credit of $6,275 to Gain on Bond Redemption. d. debit of $25,000 to Premium on Bonds Payable.
87.
At December 31, 2012 the following balances existed on the books of Foxworth Corporation: Bonds Payable $3,000,000 Discount on Bonds Payable 240,000
14 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition Interest Payable 75,000 Unamortized Bond Issue Costs 180,000 If the bonds are retired on January 1, 2013, at 102, what will Foxworth report as a loss on redemption? a. $555,000 b. $480,000 c. $405,000 d. $300,000 88.
At December 31, 2012 the following balances existed on the books of Rentro Corporation: Bonds Payable $2,500,000 Discount on Bonds Payable 200,000 Interest Payable 60,000 Unamortized Bond Issue Costs 150,000 If the bonds are retired on January 1, 2013, at 102, what will Rentro report as a loss on redemption? a. $250,000 b. $337,500 c. $400,000 d. $460,000
89.
The December 31, 2012, balance sheet of Hess Corporation includes the following items: 9% bonds payable due December 31, 2021 Unamortized premium on bonds payable
$2,000,000 54,000
The bonds were issued on December 31, 2011, at 103, with interest payable on July 1 and December 31 of each year. Hess uses straight-line amortization. On March 1, 2013, Hess retired $800,000 of these bonds at 98 plus accrued interest. What should Hess record as a gain on retirement of these bonds? Ignore taxes. a. $37,600. b. $21,600. c. $37,200. d. $40,000. 90.
On January 1, 2006, Hernandez Corporation issued $3,600,000 of 10% ten-year bonds at 103. The bonds are callable at the option of Hernandez at 105. Hernandez has recorded amortization of the bond premium on the straight-line method (which was not materially different from the effective-interest method). On December 31, 2012, when the fair value of the bonds was 96, Hernandez repurchased $800,000 of the bonds in the open market at 96. Hernandez has recorded interest and amortization for 2012. Ignoring income taxes and assuming that the gain is material, Hernandez should report this reacquisition as a. a loss of $39,200. b. a gain of $39,200. c. a loss of $48,800. d. a gain of $48,800.
Long-Term Liabilities
14 - 21
91.
The 10% bonds payable of Nixon Company had a net carrying amount of $760,000 on December 31, 2012. The bonds, which had a face value of $800,000, were issued at a discount to yield 12%. The amortization of the bond discount was recorded under the effective-interest method. Interest was paid on January 1 and July 1 of each year. On July 2, 2013, several years before their maturity, Nixon retired the bonds at 102. The interest payment on July 1, 2013 was made as scheduled. What is the loss that Nixon should record on the early retirement of the bonds on July 2, 2013? Ignore taxes. a. $16,000. b. $50,400. c. $44,800. d. $56,000.
92.
A corporation called an outstanding bond obligation four years before maturity. At that time there was an unamortized discount of $600,000. To extinguish this debt, the company had to pay a call premium of $200,000. Ignoring income tax considerations, how should these amounts be treated for accounting purposes? a. Amortize $800,000 over four years. b. Charge $800,000 to a loss in the year of extinguishment. c. Charge $200,000 to a loss in the year of extinguishment and amortize $600,000 over four years. d. Either amortize $800,000 over four years or charge $800,000 to a loss immediately, whichever management selects.
93.
The 12% bonds payable of Nyman Co. had a carrying amount of $2,080,000 on December 31, 2012. The bonds, which had a face value of $2,000,000, were issued at a premium to yield 10%. Nyman uses the effective-interest method of amortization. Interest is paid on June 30 and December 31. On June 30, 2013, several years before their maturity, Nyman retired the bonds at 104 plus accrued interest. The loss on retirement, ignoring taxes, is a. $0. b. $16,000. c. $24,800. d. $80,000.
94.
Didde Company issues $15,000,000 face value of bonds at 96 on January 1, 2011. The bonds are dated January 1, 2011, pay interest semiannually at 8% on June 30 and December 31, and mature in 10 years. Straight-line amortization is used for discounts and premiums. On September 1, 2014, $9,000,000 of the bonds are called at 102 plus accrued interest. What gain or loss would be recognized on the called bonds on September 1, 2014? a. $900,000 loss b. $408,000 loss c. $540,000 loss d. $680,000 loss
14 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 95.
Cortez Company issues $3,000,000 face value of bonds at 96 on January 1, 2011. The bonds are dated January 1, 2011, pay interest semiannually at 8% on June 30 and December 31, and mature in 10 years. Straight-line amortization is used for discounts and premiums. On September 1, 2014, $1,800,000 of the bonds are called at 102 plus accrued interest. What gain or loss would be recognized on the called bonds on September 1, 2014? a. $180,000 loss b. $81,600 loss c. $108,000 loss d. $136,000 loss
96.
On January 1, 2012, Ann Price loaned $90,156 to Joe Kiger. A zero-interest-bearing note (face amount, $120,000) was exchanged solely for cash; no other rights or privileges were exchanged. The note is to be repaid on December 31, 2014. The prevailing rate of interest for a loan of this type is 10%. The present value of $120,000 at 10% for three years is $90,156. What amount of interest income should Ms. Price recognize in 2012? a. $9,016. b. $12,000. c. $36,000. d. $27,048.
97.
On January 1, 2012, Jacobs Company sold property to Dains Company which originally cost Jacobs $950,000. There was no established exchange price for this property. Danis gave Jacobs a $1,500,000 zero-interest-bearing note payable in three equal annual installments of $500,000 with the first payment due December 31, 2012. The note has no ready market. The prevailing rate of interest for a note of this type is 10%. The present value of a $1,500,000 note payable in three equal annual installments of $500,000 at a 10% rate of interest is $1,243,500. What is the amount of interest income that should be recognized by Jacobs in 2012, using the effective-interest method? a. $0. b. $50,000. c. $124,350. d. $150,000.
98.
On January 1, 2012, Crown Company sold property to Leary Company. There was no established exchange price for the property, and Leary gave Crown a $3,000,000 zerointerest-bearing note payable in 5 equal annual installments of $600,000, with the first payment due December 31, 2012. The prevailing rate of interest for a note of this type is 9%. The present value of the note at 9% was $2,163,000 at January 1, 2012. What should be the balance of the Discount on Notes Payable account on the books of Leary at December 31, 2012 after adjusting entries are made, assuming that the effective-interest method is used? a. $0 b. $642,330 c. $669,600 d. $837,000
Long-Term Liabilities 99.
14 - 23
Putnam Company’s 2012 financial statements contain the following selected data: Income taxes Interest expense Net income
$40,000 25,000 60,000
Putnam’s times interest earned for 2012 is a. 3.0 times b. 3.4 times. c. 4.0 times. d. 5.0 times. 100.
In the recent year Hill Corporation had net income of $280,000, interest expense of $60,000, and tax expense of $80,000. What was Hill Corporation's times interest earned ratio for the year? a. 7.0 b. 5.0 c. 4.7 d. 3.7
101.
In recent year Cey Corporation had net income of $350,000, interest expense of $70,000, and a times interest earned ratio of 9. What was Cey Corporation's income before taxes for the year? a. $700,000 b. $630,000 c. $560,000 d. None of the above.
102.
The adjusted trial balance for Lifesaver Corp. at the end of the current year, 2012, contained the following accounts. 5-year Bonds Payable 8% $2,000,000 Interest Payable 50,000 Premium on Bonds Payable 100,000 Notes Payable (3 mo.) 40,000 Notes Payable (5 yr.) 165,000 Mortgage Payable ($15,000 due currently) 200,000 Salaries and wages Payable 18,000 Income Taxes Payable (due 3/15 of 2013) 25,000 The total long-term liabilities reported on the balance sheet are a. $2,365,000. b. $2,350,000. c. $2,465,000. d. $2,450,000.
Use the following information for questions *103 through *105: On December 31, 2010, Nolte Co. is in financial difficulty and cannot pay a note due that day. It is a $1,200,000 note with $120,000 accrued interest payable to Piper, Inc. Piper agrees to accept from Nolte equipment that has a fair value of $580,000, an original cost of $960,000, and accumulated depreciation of $460,000. Piper also forgives the accrued interest, extends the maturity date to December 31, 2013, reduces the face amount of the note to $500,000, and reduces the interest rate to 6%, with interest payable at the end of each year.
14 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition *103. Nolte should recognize a gain or loss on the transfer of the equipment of a. $0. b. $80,000 gain. c. $120,000 gain. d. $380,000 loss. *104. Nolte should recognize a gain on the partial settlement and restructure of the debt of a. $0. b. $30,000. c. $110,000. d. $150,000. *105. Nolte should record interest expense for 2013 of a. $0. b. $30,000. c. $60,000. d. $90,000.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
60. 61. 62. 63. 64. 65. 66.
a b a c c c c
67. 68. 69. 70. 71. 72. 73.
c a d d c a d
74. 75. 76. 77. 78. 79. 80.
d b c d a b c
81. 82. 83. 84. 85. 86. 87.
b b b c b b b
88. 89. 90. 91. 92. 93. 94.
c c b b b b b
95. 96. 97. 98. 99. 100. 101.
b a c b d a c
102. *103. *104. *105.
d b d a
MULTIPLE CHOICE—CPA Adapted 106.
On July 1, 2012, Spear Co. issued 3,000 of its 10%, $1,000 bonds at 99 plus accrued interest. The bonds are dated April 1, 2012 and mature on April 1, 2022. Interest is payable semiannually on April 1 and October 1. What amount did Spear receive from the bond issuance? a. $3,045,000 b. $3,000,000 c. $2,970,000 d. $2,895,000
Long-Term Liabilities
14 - 25
107.
On January 1, 2012, Solis Co. issued its 10% bonds in the face amount of $4,000,000, which mature on January 1, 2022. The bonds were issued for $4,540,000 to yield 8%, resulting in bond premium of $540,000. Solis uses the effective-interest method of amortizing bond premium. Interest is payable annually on December 31. At December 31, 2012, Solis's adjusted unamortized bond premium should be a. $540,000. b. $503,200. c. $486,000. d. $406,000.
108.
On July 1, 2011, Noble, Inc. issued 9% bonds in the face amount of $10,000,000, which mature on July 1, 2017. The bonds were issued for $9,390,000 to yield 10%, resulting in a bond discount of $610,000. Noble uses the effective-interest method of amortizing bond discount. Interest is payable annually on June 30. At June 30, 2013, Noble's unamortized bond discount should be a. $528,100. b. $510,000. c. $488,000. d. $430,000.
109.
On January 1, 2012, Huff Co. sold $3,000,000 of its 10% bonds for $2,655,888 to yield 12%. Interest is payable semiannually on January 1 and July 1. What amount should Huff report as interest expense for the six months ended June 30, 2012? a. $132,798 b. $150,000 c. $159,353 d. $180,000
110.
On January 1, 2013, Doty Co. redeemed its 15-year bonds of $3,500,000 par value for 102. They were originally issued on January 1, 2001 at 98 with a maturity date of January 1, 2016. The bond issue costs relating to this transaction were $210,000. Doty amortizes discounts, premiums, and bond issue costs using the straight-line method. What amount of loss should Doty recognize on the redemption of these bonds (ignore taxes)? a. $126,000 b. $84,000 c. $70,000 d. $0
111.
On its December 31, 2012 balance sheet, Emig Corp. reported bonds payable of $9,000,000 and related unamortized bond issue costs of $480,000. The bonds had been issued at par. On January 2, 2013, Emig retired $4,500,000 of the outstanding bonds at par plus a call premium of $105,000. What amount should Emig report in its 2013 income statement as loss on extinguishment of debt (ignore taxes)? a. $0 b. $105,000 c. $240,000 d. $345,000
14 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition 112.
On January 1, 2008, Goll Corp. issued 4,000 of its 10%, $1,000 bonds for $4,160,000. These bonds were to mature on January 1, 2016 but were callable at 101 any time after December 31, 2011. Interest was payable semiannually on July 1 and January 1. On July 1, 2013, Goll called all of the bonds and retired them. Bond premium was amortized on a straight-line basis. Before income taxes, Goll's gain or loss in 2013 on this early extinguishment of debt was a. $120,000 gain. b. $48,000 gain. c. $40,000 loss. d. $32,000 gain.
113.
On June 30, 2013, Omara Co. had outstanding 8%, $4,000,000 face amount, 15-year bonds maturing on June 30, 2023. 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, 2013 were $140,000 and $40,000, respectively. On June 30, 2013, Omara 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. $3,960,000. b. $3,860,000. c. $3,820,000. d. $3,760,000.
114.
A ten-year bond was issued in 2011 at a discount with a call provision to retire the bonds. When the bond issuer exercised the call provision on an interest date in 2013, the carrying amount of the bond was less than the call price. The amount of bond liability removed from the accounts in 2013 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.
115.
Paige Co. took advantage of market conditions to refund debt. This was the fourth refunding operation carried out by Paige within the last three years. The excess of the carrying amount of the old debt over the amount paid to extinguish it should be reported as a a. gain, net of income taxes. b. loss, net of income taxes. c. part of continuing operations. d. deferred credit to be amortized over the life of the new debt.
*116. Eddy Co. is indebted to Cole under a $600,000, 12%, three-year note dated December 31, 2011. Because of Eddy's financial difficulties developing in 2013, Eddy owed accrued interest of $72,000 on the note at December 31, 2013. Under a troubled debt restructuring, on December 31, 2013, Cole agreed to settle the note and accrued interest for a tract of land having a fair value of $540,000. Eddy's acquisition cost of the land is $435,000. Ignoring income taxes, on its 2013 income statement Eddy should report as a result of the troubled debt restructuring Gain on Disposal Restructuring Gain a. $237,000 $0 b. $165,000 $0 c. $105,000 $60,000 d. $105,000 $132,000
Long-Term Liabilities
14 - 27
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
106. 107.
a b
108. 109.
a c
110. 111.
a d
112. 113.
d c
114. 115.
c c
*116.
d
DERIVATIONS — Computational No.
Answer Derivation
60.
a
$2,000,000 × .534 = $1,068,000.
61.
b
($2,000,000 × .03) × 11.652 = $699,120.
62.
a
$1,068,000 + $699,120 = $1,767,120.
63.
c
($3,000,000 × .78120) + ($90,000 × 8.75206) = $3,131,285.
64.
c
($10,000,000 × .97) + ($900,000 × 2/12) = $9,850,000.
65.
c
($15,000,000 × .78120) + ($450,000 × 8.75206) = $15,656,427.
66.
c
($20,000,000 × .97) + ($1,800,000 × 2/12) = $19,700,000.
67.
c
($14,703,109 × .04) + 14,706,233 × .04) = $1,176,374.
68.
a
$14,703,109 + [($14,703,109 × .04) – $585,000] + [$14,706,233 × .04) – $585,000] = $14,709,482.
69.
d
$14,703,109 + ($296,891 × 3/20) = $14,747,642.
70.
d
($15,000,000 × .078) + ($296,891 ÷ 20) = $1,184,845.
71.
c
($9,802,072 × .04) + ($9,804,154 × .04) = $784,248.
72.
a
$9,802,072 + [($9,802,072 × .04) – $390,000] + [($9,804,154 × .04) – $390,000] = $9,806,321.
73.
d
$9,802,072 + ($197,928 × 3/20) = $9,831,762.
74.
d
($10,000,000 × .078) + ($197,928 ÷ 20) = $789,896.
75.
b
$861,600 × .05 [$861,600 – ($48,000 – $43,080)] × .05
= $43,080 = 42,834 $85,914
76.
c
$830,400 × .05 [$830,400 + ($41,520 – $36,000)] × .05
= $41,520 = 41,796 $83,316
14 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
77.
d
($2,000,000 × 1.04) – $2,000,000 = $80,000 premium.
78.
a
[($2,000,000 × .05) × 3/12] – [($80,000 ÷ 10) × 3/12] = $23,000.
79.
b
($3,000,000 × 1.04) – $3,000,000 = $120,000 premium.
80.
c
[($3,000,000 × .05) × 3/12] – [($120,000 ÷ 10) × 3/12] = $34,500.
81.
b
($1,389,600 × .06) = $83,376; [$83,376 – ($1,500,000 × .05)] = $8,376 ($1,389,600 + $8,376) × .06 = $83,879 $83,376 + $83,879 = $167,255.
82.
b
($2,817,000 × .10) – ($3,000,000 × .09) = $11,700 ($3,000,000 – $2,817,000) – $11,700 = $171,300.
83.
b
($4,000,000 × .11) – ($4,260,000 × .10) = $14,000 ($4,260,000 – $4,000,000) – $14,000 = $246,000.
84.
c
($1,111,680 × .06) = $66,701; [$66,701 – ($1,200,000 × .05)] = $6,701 ($1,111,680 + $6,701) × .06 = $67,103 $66,701 + $67,103 = $133,804.
85.
b
$500,000 – $481,250 = $18,750 discount.
86.
b
$518,725 – $500,000 = $18,725 premium.
87.
b
($3,000,000 × 1.02) – ($3,000,000 – $240,000 – $180,000) = $480,000.
88.
c
($2,500,000 × 1.02) – ($2,500,000 – $200,000 – $150,000) = $400,000.
89.
c
$54,000 2 × × .4 = $821,200 (CV of retired bonds) $2,054,000 – 18 6
$821,200 – ($800,000 × .98) = $37,200.
$108,000 × 7 × 2/9 = $807,200 (CV of retired bonds) $3,600,000x1.03 – 10 $807,200 – ($800,000 .96) = $39,200.
90.
b
91.
b
$760,000 + [($760,000 × .06) – ($800,000 × .05)] = $765,600 (CV of bonds) $765,600 – ($800,000 × 1.02) = $50,400.
92.
b
$600,000 + $200,000 = $800,000.
93.
b
$2,080,000 – [($2,000,000 × .06) – ($2,080,000 × .05)] = $2,064,000 (CV of bonds) ($2,000,000 × 1.04) – $2,064,000 = $16,000.
Long-Term Liabilities
14 - 29
DERIVATIONS — Computational (cont.) No.
Answer Derivation
94.
b
{$14,400,000 + [$600,000 × (3 2/3 ÷ 10)]} × .60 = $8,772,000 $9,180,000 – $8,772,000 = $408,000.
95.
b
{$2,880,000 + [$120,000 × (3 2/3 ÷ 10)]} × .60 = $1,754,400 $1,836,000 – $1,754,400 = $81,600.
96.
a
$90,156 × .10 = $9,016.
97.
c
$1,243,500 × .10 = $124,350.
98.
b
$3,000,000 – $2,163,000 – ($2,163,000 × .09) = $642,330.
99.
d
$60,000 + $40,000 + $25,000 ————————————— = 5 times. $25,000
100.
a
($280,000 + $60,000 + $80,000) ÷ $60,000 = 7.0.
101.
c
($350,000 + $70,000 + X) ÷ $70,000 = 9 ($420,000 + X) = 9 × $70,000 X = $210,000; IBT = $560,000 ($350,000 + $210,000).
102.
d
$2,000,000 + $100,000 + $165,000 + ($200,000 – $15,000) = $2,450,000.
*103.
b
$580,000 – ($960,000 – $460,000) = $80,000.
*104.
d
($1,200,000 + $120,000) – [$580,000 + $500,000 + ($500,000 × 06 × 3)] = $150,000.
*105.
a
0. The effective-interest rate is 0%.
DERIVATIONS — CPA Adapted No.
Answer Derivation
106.
a
($3,000,000 × .99) + ($3,000,000 × .10 × 3/12) = $3,045,000.
107.
b
$540,000 – [($4,000,000 × .10) – ($4,540,000 × .08)] = $503,200.
108.
a
2011–2012:$9,390,000 + [($9,390,000 × .1) – ($10,000,000 × .09)] = $9,429,000. 2012–2013:$9,429,000 + ($942,900 – $900,000) = $9,471,900 $10,000,000 – $9,471,900 = $528,100.
109.
c
$2,655,888 × .06 = $159,353.
110.
a
($3,500,000 × 1.02) – $3,220,000 + $280,000 12 = $126,000. 15
14 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — CPA Adapted (cont.) No.
Answer Derivation
111.
d
($4,500,000 + $105,000) – [($9,000,000 – $480,000) × 1/2] = $345,000.
112.
d
$160,000 11 – ($4,000,000 × 1.01) = $32,000. $4,160,000 − 20
113.
c
$4,000,000 – ($140,000 + $40,000) = $3,820,000.
114.
c
Conceptual.
115.
c
Conceptual.
*116.
d
$540,000 – $435,000 = $105,000 ($600,000 + $72,000) – $540,000 = $132,000.
EXERCISES Ex. 14-117—Terms related to long-term debt. Place the letter of the best matching phrase before each word. ____ 1. Indenture
____ 6. Times Interest Earned Ratio
____ 2. Treasury Bonds
____ 7. Mortgage
____ 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. Bonds payable reacquired by the issuing corporation that have not been canceled. h. Price paid by issuing corporation for its own bonds. i. Book value of bonds at any given date. j.
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.
Long-Term Liabilities
14 - 31
Ex. 14-117 (Cont.) m. Ratio of debt to equity. n. Exclusive right to manufacture a product. o. A document that pledges title to property as security for a loan.
Solution 14-117 1. k 2. g
3. 4.
c i
5. 6
b l
7. 8
o f
9. 10.
h d
Ex. 14-118—Bond issue price and premium amortization. On January 1, 2013, Piper Co. issued ten-year bonds with a face value of $4,000,000 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 $3,536,000. Prepare the amortization table for 2013, assuming that amortization is recorded on interest payment dates.
Solution 14-118 (a) .312 × $4,000,000 = $1,248,000 11.470 × $200,000 = 2,294,000 $3,542,000 (b) Date 1/1/13 6/30/13 12/31/13
Cash
Expense
Amortization
$200,000 200,000
$212,160 212,890
12,160 12,890
Carrying Amount $3,536,000 3,548,160 3,561,050
14 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 14-119—Amortization of discount or premium. Grider Industries, Inc. issued $8,000,000 of 8% debentures on May 1, 2012 and received cash totaling $7,098,102. The bonds pay interest semiannually on May 1 and November 1. The maturity date on these bonds is November 1, 2020. 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 (5/1/12 through 4/30/13) these bonds were outstanding. (Show computations and round to the nearest dollar.)
Solution 14-119 Date 5/1/12 11/1/12 5/1/13
Interest Expense
Cash Interest
Discount Amortized
$354,905 356,650
$320,000 320,000
$34,905 36,650 $71,555
Total
Carrying Value of Bonds $7,098,102 7,133,007 7,169,657
Ex. 14-120—Entries for Bonds Payable. Prepare journal entries to record the following transactions related to long-term bonds of Quirk Co. (a) On April 1, 2011, Quirk issued $1,000,000, 9% bonds for $1,075,736 including accrued interest. Interest is payable annually on January 1, and the bonds mature on January 1, 2021. (b) On July 1, 2013 Quirk retired $300,000 of the bonds at 102 plus accrued interest. Quirk uses straight-line amortization.
Solution 14-120 (a) Cash ............................................................................................. 1,075,736 Bonds Payable .................................................................... Interest Expense ($1,000,000 × 9% × 3/12) ........................ Premium on Bonds Payable ................................................ (b) Interest Expense ........................................................................... Premium on Bonds Payable ($53,236 × .3 × 6/117) ...................... Cash ($300,000 × 9% × 6/12) .............................................
12,680 820
Bonds Payable .............................................................................. Premium on Bonds Payable ($53,236 × .3 × 90/117) .................... Cash ................................................................................... Gain on Redemption of Bonds ............................................
300,000 12,284
1,000,000 22,500 53,236
13,500
306,000 6,284
Long-Term Liabilities
14 - 33
Ex. 14-121—Retirement of bonds. Prepare journal entries to record the following retirement. (Show computations and round to the nearest dollar.) The December 31, 2012 balance sheet of Wolfe Co. included the following items: 7.5% bonds payable due December 31, 2020 Unamortized discount on bonds payable
$1,600,000 64,000
The bonds were issued on December 31, 2010 at 95, with interest payable on June 30 and December 31. (Use straight-line amortization.) On April 1, 2013, Wolfe retired $320,000 of these bonds at 101 plus accrued interest.
Solution 14-121 Interest Expense ............................................................................ Cash ($320,000 × 7.5% × 3/12) .......................................... Discount on Bonds Payable ($64,000 × 1/5 × 1/8 × 3/12) ...
6,400
Bonds Payable ............................................................................... Loss on Redemption of Bonds ....................................................... Discount on Bonds Payable [(1/5 × $64,000) – $400] ......... Cash ...................................................................................
320,000 15,600
6,000 400
12,400 323,200
Ex. 14-122—Early extinguishment of debt. Hurst, Incorporated sold its 8% bonds with a maturity value of $4,500,000 on August 1, 2011 for $4,419,000. At the time of the sale the bonds had 5 years until they reached maturity. Interest on the bonds is payable semiannually on August 1 and February 1. The bonds are callable at 104 at any time after August 1, 2013. By October 1, 2013, the market rate of interest has declined and the market price of Hurst's bonds has risen to a price of 101. The firm decides to refund the bonds by selling a new 6% bond issue to mature in 5 years. Hurst begins to reacquire its 8% bonds in the market and is able to purchase $750,000 worth at 101. The remainder of the outstanding bonds is reacquired by exercising the bonds' call feature. In the final analysis, how much was the gain or loss experienced by Hurst in reacquiring its 8% bonds? (Assume the firm used straight-line amortization.) Show calculations.
Solution 14-122 Reacquisition price: $750,000 × 1.01 = $3,750,000 × 1.04 = Less net carrying amount: $4,419,000 + ($81,000 × 26/60) = Loss on early extinguishment
$ 757,500 3,900,000
$4,657,500 4,454,100 $ 203,400
14 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition *Ex. 14-123—Accounting for a troubled debt settlement. Mann, Inc., which owes Doran Co. $1,000,000 in notes payable with accrued interest of $90,000, is in financial difficulty. To settle the debt, Doran agrees to accept from Mann equipment with a fair value of $950,000, an original cost of $1,400,000, and accumulated depreciation of $325,000. Instructions (a) Compute the gain or loss to Mann on the settlement of the debt. (b) Compute the gain or loss to Mann on the transfer of the equipment. (c) Prepare the journal entry on Mann 's books to record the settlement of this debt. (d) Prepare the journal entry on Doran's books to record the settlement of the receivable.
*Solution 14-123 (a) Note payable Interest payable Carrying amount of debt Fair value of equipment Gain on restructuring of debt
$1,000,000 90,000 1,090,000 950,000 $ 140,000
(b) Cost Accumulated depreciation Book value Fair value of plant assets Loss on disposal of equipment
$1,400,000 325,000 1,075,000 950,000 $ 125,000
(c) Notes Payable............................................................................... 1,000,000 Interest Payable ............................................................................ 90,000 Accumulated Depreciation ............................................................ 325,000 Loss on Disposal of Equipment ..................................................... 125,000 Equipment ......................................................................... Gain on Restructuring of Debt ...........................................
1,400,000 140,000
(d) Equipment ..................................................................................... Allowance for Doubtful Accounts ................................................... Notes Receivable .............................................................. Interest Receivable ............................................................
1,000,000 90,000
950,000 140,000
*Ex. 14-124—Accounting for a troubled debt restructuring. On December 31, 2011, Short Co. is in financial difficulty and cannot pay a note due that day. It is a $750,000 note with $75,000 accrued interest payable to Bryan, Inc. Bryan agrees to forgive the accrued interest, extend the maturity date to December 31, 2013, and reduce the interest rate to 4%. The present value of the restructured cash flows is $642,000.
Long-Term Liabilities
14 - 35
Instructions Prepare entries for the following: (a) The restructure on Short’s books. (b) The payment of interest on December 31, 2012. (c) The restructure on Bryan’s books. *Solution 14-124 (a) Interest Payable ............................................................................ Notes Payable ($750,000 × 4% × 2).................................. Gain on Restructuring of Debt. ..........................................
75,000
(b) Notes Payable .............................................................................. Cash .................................................................................
30,000
(c) Allowance for Doubtful Accounts .................................................. Notes Receivable .............................................................. Interest Receivable ...........................................................
183,000
60,000 15,000
30,000
108,000 75,000
*Ex. 14-125—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 14-125 (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.
14 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition
PROBLEMS Pr. 14-126—Bond discount amortization. On June 1, 2011, Everly Bottle Company sold $1,000,000 in long-term bonds for $877,600. 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 four years. Make sure all columns and rows are properly labeled. (Round to the nearest dollar.) (b) The sales price of $877,600 was determined from present value tables. Specifically explain how one would determine the price using present value tables. (c)
Assuming that interest and discount amortization are recorded each May 31, prepare the adjusting entry to be made on December 31, 2013. (Round to the nearest dollar.)
Solution 14-126 (a) Date 6/1/11 5/31/12 5/31/13 5/31/14 5/31/15
Credit Cash
Debit Interest Expense
Credit Bond Discount
$80,000 80,000 80,000 80,000
$87,760 88,535 89,390 90,329
$7,760 8,535 9,390 10,329
(b)
(1) (2)
(c)
Interest Expense.......................................................................... Interest Payable ............................................................... Discount on Bonds Payable .............................................
Carrying Amount of Bonds $877,600 885,360 893,895 903,285 913,614
Find the present value of $1,000,000 due in 10 years at 10%. Find the present value of 10 annual payments of $80,000 at 10%. Add (1) and (2) to obtain the present value of the principal and the interest payments. 52,144* 46,667** 5,477
*7/12 $89,390 (from Table) = $52,144 **7/12 8% $1,000,000 = $46,667
Pr. 14-127—Bond interest and discount amortization. Grove Corporation issued $2,400,000 of 8% bonds on October 1, 2012, due on October 1, 2017. 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. Grove Corporation closes its books annually on December 31.
Long-Term Liabilities
14 - 37
Instructions (a) Complete the following amortization schedule for the dates indicated. (Round all answers to the nearest dollar.) Use the effective-interest method. Credit Cash
Debit Interest Expense
Credit Bond Discount
October 1, 2012 April 1, 2013 October 1, 2013
Carrying Amount of Bonds $2,214,672
(b) Prepare the adjusting entry for December 31, 2013. Use the effective-interest method. (c) Compute the interest expense to be reported in the income statement for the year ended December 31, 2013.
Solution 14-127 (a) October 1, 2012 April 1, 2013 October 1, 2013
Credit Cash
Debit Interest Expense
Credit Bond Discount
$96,000 96,000
$110,733 111,471
$14,733 15,471
(b) Interest Expense ($2,244,876 × 10% × 3/12) ................................. Interest Payable (1/2 × $96,000) ........................................ Discount on Bonds Payable ($56,121 – $48,000) ..............
Carrying Amount of Bonds $2,214,672 2,229,405 2,244,876
56,121 48,000 8,121
(c) $ 55,367(1/2 of $110,733) 111,471 56,121 $222,959
Pr. 14-128—Entries for bonds payable. Prepare the necessary journal entries to record the following transactions relating to the long-term issuance of bonds of Pitts Co.: March 1 Issued $2,000,000 face value Pitts Co. second mortgage, 8% bonds for $2,180,400, including accrued interest. Interest is payable semiannually on December 1 and June 1 with the bonds maturing 10 years from this past December 1. The bonds are callable at 102. June 1 Paid semiannual interest on Pitts Co. bonds. (Use straight-line amortization of any premium or discount.) December 1 Paid semiannual interest on Pitts Co. bonds and purchased $1,000,000 face value bonds at the call price in accordance with the provisions of the bond indenture.
14 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 14-128 March 1: Cash ................................................................................... 2,180,400 Bonds Payable ........................................................ Premium on Bonds Payable .................................... Interest Expense ($2,000,000 × 8% × 3/12) ............ June 1: Interest Expense ................................................................. Premium on Bonds Payable ($140,400 × 3/117) ................. Cash ........................................................................
76,400 3,600
Dec. 1: Interest Expense ................................................................. Premium on Bonds Payable ($140,400 × 6/117) ................. Cash ........................................................................
72,800 7,200
2,000,000 140,400 40,000
80,000
80,000
Bonds Payable .................................................................... 1,000,000 Premium on Bonds Payable* .............................................. 64,800 Gain on Redemption of Bonds ................................. Cash ........................................................................
44,800 1,020,000
*1/2 × ($140,400 – $3,600 – $7,200) = $64,800.
Pr. 14-129—Entries for bonds payable. Prepare journal entries to record the following transactions relating to long-term bonds of Kirby, Inc. (Show computations.) (a) On June 1, 2011, Kirby, Inc. issued $3,000,000, 6% bonds for $2,938,200, which includes accrued interest. Interest is payable semiannually on February 1 and August 1 with the bonds maturing on February 1, 2021. The bonds are callable at 102. (b) On August 1, 2011, Kirby paid interest on the bonds and recorded amortization. Kirby uses straight-line amortization. (c) On February 1, 2013, Kirby paid interest and recorded amortization on all of the bonds, and purchased $1,800,000 of the bonds at the call price. Assume that a reversing entry was made on January 1, 2013.
Solution 14-129 (a) Cash ............................................................................................. 2,938,200 Discount on Bonds Payable .......................................................... 121,800 Bonds Payable .................................................................. Interest Expense ($3,000,000 × 6% × 4/12)....................... (b) Interest Expense ($3,000,000 × 6% × 6/12) + $2,100 ................... Cash .................................................................................. Discount on Bonds Payable ($121,800 × 2/116) ................
3,000,000 60,000
92,100 90,000 2,100
Long-Term Liabilities
14 - 39
Solution 14-129 (Cont.) (c) Interest Expense ($90,000 + $6,300) ............................................ Cash ................................................................................. Discount on Bonds Payable ($121,800 × 6/116) ..............
96,300 90,000 6,300
Bonds Payable ............................................................................. 1,800,000 Loss on Redemption of Bonds ...................................................... 96,480 Discount on Bonds Payable [.6 × ($121,800 – $21,000)] .. Cash .................................................................................
60,480 1,836,000
Pr. 14-130—Fair value option Harper Company commonly issues long-term notes payable to its various lenders. Harper has had a pretty good credit rating such that its effective borrowing rate is quite low (less than 8% on an annual basis). Harper has elected to use the fair value option for the long-term notes issued to Barclay’s Bank and has the following data related to the carrying and fair value for these notes.
December 31, 2011 December 31, 2012 December 31, 2013
Carrying Value $81,000 66,000 54,000
Fair Value $81,000 64,000 57,000
Instructions (a) Prepare the journal entry at December 31 (Harper’s year-end) for 2011, 2012, and 2013 to record the fair value option for these notes. (b) At what amount will the note be reported on Harper’s 2012 balance sheet? (c) What is the effect of recording the fair value option on these notes on Harper’s 2013 income?
Solution 14-130 (a) December 31, 2011 No entry since the carrying value is equal to the notes’ fair value. December 31, 2012 Notes Payable Unrealized Holding Gain or Loss−Income
2,000
December 31, 2013 Unrealized Holding Gain or Loss−Income Notes Payable [($57,000 – $54,000) + $2,000]
5,000
2,000
5,000
(b) The note will be reported at $64,000 on Harper’s 2012 balance sheet. (c) Harper’s 2013 income is $5,000 lower since the change in fair value is reported as part of net income. *Pr. 14-131—Accounting for a troubled debt restructuring. Ludwig, Inc., which owes Giffin Co. $2,400,000 in notes payable, is in financial difficulty. To eliminate the debt, Giffin agrees to accept from Ludwig land having a fair value of $1,830,000 and a recorded cost of $1,350,000.
14 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition
Instructions (a) Compute the amount of gain or loss to Ludwig, Inc. on the transfer (disposition) of the land. (b) Compute the amount of gain or loss to Ludwig, Inc. on the restructuring of the debt. (c) Prepare the journal entry on Ludwig 's books to record the restructuring of this debt. (d) Compute the gain or loss to Giffin Co. from restructuring of its receivable from Ludwig. (e) Prepare the journal entry on Giffin's books to record the restructuring of this receivable.
*Solution 14-131 (a)
Fair value of the land Cost of the land to Ludwig, Inc. Gain on disposal of land
$1,830,000 1,350,000 $ 480,000
(b)
Carrying amount of debt Fair value of the land given Gain on restructuring of debt
$2,400,000 1,830,000 $ 570,000
(c)
Notes Payable ............................................................................. 2,400,000 Land ................................................................................. Gain on Disposal of Land ................................................. Gain on Restructuring of Debt ..........................................
(d)
Carrying amount of receivable Land received in restructuring Loss on restructured debt
(e)
Land ............................................................................................ 1,830,000 Allowance for Doubtful Accounts ................................................. 570,000 Notes Receivable .............................................................
1,350,000 480,000 570,000
$2,400,000 1,830,000 $570,000
2,400,000
Long-Term Liabilities
14 - 41
IFRS QUESTIONS True/False 1. Similar to U.S. practice, IFRS requires that companies present current and noncurrent liabilities on the face of the balance sheet, with current liabilities generally presented in order of liquidity. 2. Similar to U.S. practice, IFRS requires that companies present current and noncurrent liabilities on the face of the balance sheet, with current liabilities generally presented in order of magnitude. 3. Both IFRS and U.S. GAAP prohibit the recognition of liabilities for future losses. 4. IFRS and U.S. GAAP are similar in the treatment of asset retirement obligations. 5. The recognition criteria for an asset retirement obligation (ARO) are more stringent under IFRS. 6. IFRS and U.S. GAAP are dissimilar in their treatment of contingencies. 7. The criteria for recognizing contingent assets are more stringent under U.S. GAAP. 8. Under IFRS, the measurement of a provision related to a contingency is based on an average estimate of the expenditure required to settle the obligation. 9. U.S. GAAP permits recognition of a restructuring liability, once a company has committed to a restructuring plan. 10. The recognition criteria for an ARO are more stringent under U.S. GAAP: The ARO is not recognized unless there is a present legal obligation and the fair value of the obligation can be reasonably estimated. Answers to True/False: 1. True 2. False 3. True 4. True 5. False 6. False 7. False 8. False 9. False 10. True
Multiple Choice Questions 1. The primary IFRS related to reporting and recognition of liabilities is found in a. IAS 10 and IAS 39. b. IAS 17 and IAS 23. c. IAS 1 and IAS 37. d. IAS 27 and IAS 32.
14 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition 2. Similar to U.S. practice, IFRS requires that companies present current and noncurrent liabilities on the face of the balance sheet with current liabilities a. generally presented in order of magnitude. b. presented in alphabetic order. c. presented in order of liquidity. d. presented in the order in which they were incurred. 3. Under IFRS, the measurement of a provision related to a contingency is based on a. the best estimate of the expenditure required to settle the obligation. b. the minimum amount from among a number of alternative estimates. c. an average from among a number of alternative estimates. d. whatever management feels that shareholders would be willing to accept because of the impact on current earnings. 4. Both U.S. GAAP and IFRS prohibit a. the recognition of a restructuring liability, once a company has committed to a restructuring plan. b. the recognition of liabilities for future losses. c. communicating information on a restructuring plan to employees, before a liability can be established. d. all of the above. 5. IFRS and U.S. GAAP are a. similar in the treatment of asset retirement obligations (AROs). b. significantly different when it comes to the treatment of asset retirement obligations (AROs). c. continuing to evolve in the area of asset retirement obligations (AROs). d. in conflict with respect to the accounting for and presentation of asset retirement obligations (AROs). 6. Both IFRS and U.S. GAAP permit valuation of long-term debt and other liabilities at a. present value discounted at the firm's cost of capital. b. current market values of the obligations, based on changes in the discount rate with unrealized gains and losses reflected in a separate account in stockholders' equity. c. fair value with gains and losses on changes in fair value recorded in income in certain situations. d. historic costs without reflecting changes in valuation as obligations will be retired at their maturity date. 7. As there is no comparable institution to the SEC in international securities markets, many international companies (those not registered with the SEC) a. voluntarily adhere to SEC criteria in providing information related to contractual obligations. b. are not required to provide disclosures such as those related to contractual obligations. c. follow the requirements established for contractual obligations put forth by the IASB. d. follow the requirements established for contractual obligations put forth by the FASB.
Long-Term Liabilities
14 - 43
8. Under U.S. GAAP, contingent assets for insurance recoveries are recognized if __________; IFRS requires the recovery be "___________" before recognition of an asset is permitted. a. probable and virtually certain b. possible and very likely c. possible and definite d. certain and probable 9. IFRS rules for establishing restructuring liabilities could be used as an earnings management tool because IFRS rules are a. more-stringent that U.S. GAAP. b. less-stringent that U.S. GAAP. c. virtually the same as U.S. GAAP. d. totally different than U.S. GAAP. 10. A concern with IFRS is that its less-stringent rules for establishing restructuring liabilities could be used as a. a more appropriate method than that employed under U.S. GAAP. b. an appropriate method, but complex and difficult to explain to shareholders. c. a method readily employed to make the understanding of financial information more comprehensible to shareholders. d. an earinings management tool.
Answers to multiple choice: 1. c 2. c 3. a 4. b 5. a 6. c 7. b 8. a 9. b 10. d
IFRS Short Answer: 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to the accounting for liabilities. 1. Among the similarities are: (1) IFRS requires that companies present current and noncurrent liabilities on the face of the balance sheet, with current liabilities generally presented in order of liquidity, (2) Both GAAPs prohibit the recognition of liabilities for future losses; (3) IFRS and U.S. GAAP are similar in the treatment of asset retirement obligations (AROs), and (4) IFRS and U.S. GAAP are similar in their treatment of contingencies. Although the two GAAPs are similar with respect to the above topics, there are differences, including: (1) Under IFRS, the measurement of a provision related to a contingency is based on the best estimate of the expenditure required to settle the obligation. If a range of estimates is predicted and no amount in the range is more likely than any other amount in the range, the ‘mid-point’ of the range is used to measure the liability. In U.S. GAAP, the
14 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition minimum amount in a range is used; (2) IFRS permits recognition of a restructuring liability, once a company has committed to a restructuring plan. U.S. GAAP has additional criteria (i.e., related to communicating the plan to employees), before a restructuring liability can be established; (3) the recognition criteria for an asset retirement obligation are more stringent under U.S. GAAP—the ARO is not recognized unless there is a present legal obligation and the fair value of the obligation can be reasonably estimated; and (4) the criteria for recognizing contingent assets for insurance recoveries are recognized if probable; IFRS requires the recovery be “virtually certain,” before recognition of an asset is permited. 2. Briefly discuss how accounting convergence efforts addressing liabilities is related to the IASB/FASB conceptual framework project. 2. The IASB and FASB are working on a conceptual framework project, part of which will examine the definition of a liability. In addition, this project will address the difference in measurements used between IFRS and U.S. GAAP for contingent liabilities. Also, in its project on business combinations, the IASB is considering changing its definition of a contingent asset to converge with U.S. GAAP.
CHAPTER 15 STOCKHOLDERS’ EQUITY IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
T F T F T F T F F T F T T F F T T F F T
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
State a corporation incorporates in. Definition of preemptive right. Common stock as residual interest. Earned capital definition. Reporting true no-par stock. Allocating proceeds in lump sum sales. Accounting for stock issued for noncash consideration. Definition of treasury stock. Reporting treasury stock under cost method. Selling treasury stock below cost. Participating preferred stock. Callable preferred stock. Restricting legal capital. Disclosing dividend policy. Affect of dividends on total stockholders’ equity. Property dividends definition. Accounting for small stock dividend. Stock splits and large stock dividends. Computing rate of return on common stock equity. Computing payout ratio.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
c b a b c c d d d b a b a d b a d c
21. 22. 23. S 24. S 25. 26. 27. 28. 29. 30. 31. 32. P 33. S 34. S 35. S 36. P 37. 38.
Nature of stockholders' interest. Pre-emptive right. Pre-emptive right. Definition of legal capital. Definition of residual owner. 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. Legal restrictions for profit distributions. Acquisition of treasury shares. Treasury shares definition. Purchase of treasury stock at greater than par value.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
a a b c c b b c c b c c a a b b b b b a a b b c b a b c a c a a
39. 40. 41. 42. 43. 44. P 45. S 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. P 67. *68. *69. *70.
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. 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. Disclosures in the balance sheet. Return on common stock equity calculation. Payout ratio calculation. Book value per share. Computing book value per share. Dividends and treasury stock. Noncumulative preferred stock and dividends in arrears. Disclosure of preferred dividends in arrears.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. *This topic is dealt with in an Appendix to the chapter. S
MULTIPLE CHOICE—Computational Answer
No.
Description
a b b c d b c
71. 72. 73. 74. 75. 76. 77.
Composition of stockholders' equity. Calculation of total paid-in capital. Allocating proceeds in lump sum sales. Allocating proceeds in lump sum sales. Computing total paid-in capital. Allocating proceeds in lump sum sales. Allocating proceeds in lump sum sales.
Stockholders’ Equity
MULTIPLE CHOICE—Computational (cont.) Answer
No.
d d b c c d c a c c a a c d b d d a c a b b b a a c a d d c c a b c a b b b d b c b
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. 113. 114. *115. *116. *117. *118. *119.
Description Computing paid-in capital from treasury stock transactions. 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. Calculate dividends for cumulative preferred shares. Calculate dividends for common shares. Calculate dividends for common shares. Reduction in retained earnings from property dividends. Reduction in retained earnings from property dividends. Reduction in retained earnings caused by a property dividend. Reduction in retained earnings from property dividends. Reduction in retained earnings from property dividends. 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 retained earnings available for dividends. Calculate decrease in retained earnings. Calculate the payout ratio. Calculate book value per share. Use same descrip. as 101. Use same descrip. as 102. Calculate rate of return on common stock equity. Calculate price-earnings ratio. Calculate dividends paid to common stockholders. Rate of return on common stock equity. Determine the rate of return on common stock equity. Determine book value per share. Computation of payout ratio. Computation of book value per share. Allocation of cash dividend to common and preferred shares. Cash dividends for cumulative preferred shares. Cash dividends for cumulative participating preferred shares. Cash dividend allocation with participating preferred shares. Cash dividend for cumulative preferred shares.
15 - 3
15 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—CPA Adapted Answer
No.
d b c b c d b d d a c
120. 121. 122. 123. 124. 125. 126. 127. 128. 129. *130.
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. Allocation of cash dividend to common and preferred shares.
EXERCISES Item E15-131 E15-132 E15-133 E15-134 E15-135 E15-136 E15-137 E15-138 E15-139 *E15-140 *E15-141
Description Lump sum issuance of stock. Treasury stock. Treasury stock. Treasury stock. Treasury stock. Stockholders’ equity. Stock dividends. Stock dividends and stock splits. Computation of selected ratios. Dividends on preferred stock. Dividends on preferred stock.
PROBLEMS Item P15-142 P15-143 P15-144 P15-145 *P15-146
Description Equity transactions. Treasury stock transactions. Stock dividends. Equity transactions. Dividends on preferred and common stock.
Stockholders’ Equity
15 - 5
CHAPTER LEARNING OBJECTIVES 1.
Discuss the characteristics of the corporate form of organization.
2.
Identify the key components of stockholders' equity.
3.
Explain the accounting procedures for issuing shares of stock.
4.
Describe the accounting for treasury stock.
5.
Explain the accounting for and reporting of preferred stock.
6.
Describe the policies used in distributing dividends.
7.
Identify the various forms of dividend distributions.
8.
Explain the accounting for small and large stock dividends, and for stock splits.
9.
Indicate how to present and analyze stockholders’ equity.
*10.
Explain the different types of preferred stock dividends and their effect on book value per share.
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Test Bank for Intermediate Accounting, Fourteenth Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
1.
TF
4.
TF
5. 6. 7.
TF TF TF
8. 9. 10. S 36.
TF TF TF MC
11. 12. 13.
Item
Type
Item
2.
TF
3.
25.
MC
26.
29. 30. 31.
MC MC MC
37. 38. 39. 40.
MC MC MC MC
TF TF
43. 44.
MC MC
TF
14.
TF
S
P
32. 33. S 34. P
41. 42. 78. 79. P S
45. 46.
15. 16. 47.
TF TF MC
48. 49. 50.
MC MC MC
51. 52. 53.
17. 18. 56. 57. 58.
TF TF MC MC MC
59. 60. 61. 62. 95.
MC MC MC MC MC
96. 97. 98. 99. 100.
19. 20.
TF TF
63. 64.
MC MC
65. 66.
68. 69.
MC MC
70. 115.
MC MC
116. 117.
Note:
TF = True-False MC = Multiple Choice E = Exercise P = Problem
Type
Item
Type
Item
Learning Objective 1 TF 21. MC 22. Learning Objective 2 MC 27. MC 28. Learning Objective 3 S MC 35. MC 73. MC 71. MC 74. MC 72. MC 75. Learning Objective 4 MC 80. MC 84. MC 81. MC 85. MC 82. MC 86. MC 83. MC 122. Learning Objective 5 MC 87. MC 89. MC 88. MC Learning Objective 6 Learning Objective 7 MC 54. MC 91. MC 55. MC 92. MC 90. MC 93. Learning Objective 8 MC 101. MC 106. MC 102. MC 107. MC 103. MC 108. MC 104. MC 127. MC 105. MC 128. Learning Objective 9 P MC 67. MC 110. MC 109. MC 111. Learning Objective *10 MC 118. MC 130. MC 119. MC 140.
Type
Item
Type
Item
Type
MC
23.
MC
S
24.
MC
MC MC MC
76. 77. 120.
MC MC MC
121. 131. 142.
MC E P
MC MC MC MC
123. 124. 132. 133.
MC MC E E
134. 135. 143.
E E P
MC MC MC
94. 125. 126.
MC MC MC
136. 144. 145.
E P P
MC MC MC MC MC
129. 137. 138. 144. 145.
MC E E P P
MC MC
112. 113.
MC MC
114. 139.
MC E
MC E
141. 146.
E P
MC
MC
Stockholders’ Equity
15 - 7
TRUE-FALSE—Conceptual 1.
A corporation is incorporated in only one state regardless of the number of states in which it operates.
2.
The preemptive right allows stockholders the right to vote for directors of the company.
3.
Common stock is the residual corporate interest that bears the ultimate risks of loss.
4.
Earned capital consists of additional paid-in capital and retained earnings.
5.
True no-par stock should be carried in the accounts at issue price without any additional paid-in capital reported.
6.
Companies allocate the proceeds received from a lump-sum sale of securities based on the securities’ par values.
7.
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.
8.
Treasury stock is a company’s own stock that has been reacquired and retired.
9.
The cost method records all transactions in treasury shares at their cost and reports the treasury stock as a deduction from capital stock.
10.
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.
11.
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.
12.
Callable preferred stock permits the corporation at its option to redeem the outstanding preferred shares at stipulated prices.
13.
The laws of some states require that corporations restrict their legal capital from distribution to stockholders.
14.
The SEC requires companies to disclose their dividend policy in their annual report.
15.
All dividends, except for liquidating dividends, reduce the total stockholders’ equity of a corporation.
16.
Dividends payable in assets of the corporation other than cash are called property dividends or dividends in kind.
17.
When a stock dividend is less than 20-25 percent of the common stock outstanding, a company is required to transfer the fair value of the stock issued from retained earnings.
18.
Stock splits and large stock dividends have the same effect on a company’s retained earnings and total stockholders’ equity.
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Test Bank for Intermediate Accounting, Fourteenth Edition
19.
The rate of return on common stock equity is computed by dividing net income by the average common stockholders’ equity.
20.
The payout ratio is determined by dividing cash dividends paid to common stockholders by net income available to common stockholders.
True-False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. T F T F T
Item 6. 7. 8. 9. 10.
Ans. F T F F T
Item 11. 12. 13. 14. 15.
Ans. F T T F F
Item 16. 17. 18. 19. 20.
Ans. T T F F T
MULTIPLE CHOICE—Conceptual
S
21.
The residual interest in a corporation belongs to the a. management. b. creditors. c. common stockholders. d. preferred stockholders.
22.
The pre-emptive 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.
23.
The pre-emptive 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 pre-emptive 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.
24.
In a corporate form of business organization, legal capital is best defined as a. the amount of capital the state of incorporation allows the company to accumulate over its existence. b. the par value of all capital stock issued. c. the amount of capital the federal government allows a corporation to generate. d. the total capital raised by a corporation within the limits set by the Securities and Exchange Commission.
Stockholders’ Equity S
15 - 9
25.
Stockholders of a business enterprise are said to be the residual owners. The term residual owner means that shareholders a. are entitled to a dividend every year in which the business earns a profit. b. have the rights to specific assets of the business. c. bear the ultimate risks and uncertainties and receive the benefits of enterprise ownership. d. can negotiate individual contracts on behalf of the enterprise.
26.
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.
27.
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.
28.
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.
29.
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.
30.
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.
31.
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
15 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition 32.
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.
P
33.
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
S
34.
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.
S
35.
Which of the following is not a legal restriction related to profit distributions by a corporation? a. The amount distributed to owners must be in compliance with the state laws governing corporations. b. The amount distributed in any one year can never exceed the net income reported for that year. c. Profit distributions must be formally approved by the board of directors. d. Dividends must be in full agreement with the capital stock contracts as to preferences and participation.
S
36.
In January 2012, Finley Corporation, a newly formed company, issued 10,000 shares of its $10 par common stock for $15 per share. On July 1, 2012, Finley 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.
P
37.
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.
38.
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.
Stockholders’ Equity
P
15 - 11
39.
“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.
40.
Porter Corp. purchased its own par value stock on January 1, 2012 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 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.
41.
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.
42.
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.
43.
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
44.
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.
45.
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.
15 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition S
46.
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.
47.
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.
48.
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.
49.
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.
50.
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.
51.
Houser Corporation owns 4,000,000 shares of stock in Baha Corporation. On December 31, 2012, Houser 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.
52.
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.
Stockholders’ Equity
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53.
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.
54.
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.
55.
Which dividends do not reduce stockholders' equity? a. Cash dividends b. Stock dividends c. Property dividends d. Liquidating dividends
56.
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.
57.
Quirk 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. Fair value on the declaration date d. Fair value on the payment date
58.
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. fair 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.
59.
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.
15 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition 60.
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.
61.
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.
62.
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
63.
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
64.
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.
65.
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.
66.
Younger 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.
Stockholders’ Equity P
15 - 15
67.
Assume common stock is the only class of stock outstanding in the Manley Corporation. Total stockholders' equity divided by the number of common stock shares outstanding is called a. book value per share. b. par value per share. c. stated value per share. d. fair value per share.
*68.
Dividends are not paid on a. noncumulative preferred stock. b. nonparticipating preferred stock. c. treasury common stock. d. Dividends are paid on all of these.
*69.
Noncumulative preferred dividends in arrears a. are not paid or disclosed. b. must be paid before any other cash dividends can be distributed. c. are disclosed as a liability until paid. d. are paid to preferred stockholders if sufficient funds remain after payment of the current preferred dividend.
*70.
How should cumulative preferred dividends in arrears be shown in a corporation's statement of financial position? a. Note disclosure b. Increase in stockholders' equity c. Increase in current liabilities d. Increase in current liabilities for the amount expected to be declared within the year or operating cycle, and increase in long-term liabilities for the balance
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27. 28.
c b a b c c d d
29. 30. 31. 32. 33. 34. 35. 36.
d b a b a d b a
37. 38. 39. 40. 41. 42. 43. 44.
d c a a b c c b
45. 46. 47. 48. 49. 50. 51. 52.
b c c b c c a a
53. 54. 55. 56. 57. 58. 59. 60.
b b b b b a a b
61. 62. 63. 64. 65. 66. 67. *68.
b c b a b c a c
*69. *70.
a a
15 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Computational Use the following information for questions 71 and 72. Presented below is information related to Hale 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)
$4,800,000 550,000 2,000,000 400,000 1,500,000 150,000
71.
The total stockholders' equity of Hale Corporation is a. $9,100,000. b. $9,250,000. c. $7,600,000. d. $7,750,000.
72.
The total paid-in capital (cash collected) related to the common stock is a. $4,800,000. b. $5,350,000. c. $5,750,000. d. $5,200,000.
73.
Manning Company issued 10,000 shares of its $5 par value common stock having a fair value of $25 per share and 15,000 shares of its $15 par value preferred stock having a fair value of $20 per share for a lump sum of $520,000. How much of the proceeds would be allocated to the common stock? a. $54,167 b. $236,364 c. $270,833 d. $276,250
74.
Norton Company issues 4,000 shares of its $5 par value common stock having a fair value of $25 per share and 6,000 shares of its $15 par value preferred stock having a fair value of $20 per share for a lump sum of $204,000. What amount of the proceeds should be allocated to the preferred stock? a. $182,750 b. $127,500 c. $111,273 d. $95,625
75.
Berry Corporation has 50,000 shares of $10 par common stock authorized. The following transactions took place during 2012, the first year of the corporation’s existence: Sold 10,000 shares of common stock for $18 per share. Issued 10,000 shares of common stock in exchange for a patent valued at $200,000. At the end of the Berry’s first year, total paid-in capital amounted to a. $80,000. b. $180,000. c. $200,000. d. $380,000.
Stockholders’ Equity
15 - 17
76.
Glavine Company issues 6,000 shares of its $5 par value common stock having a fair value of $25 per share and 9,000 shares of its $15 par value preferred stock having a fair value of $20 per share for a lump sum of $312,000. The proceeds allocated to the common stock is a. $32,500 b. $141,818 c. $162,500 d. $170,182
77.
Wheeler Company issued 5,000 shares of its $5 par value common stock having a fair value of $25 per share and 7,500 shares of its $15 par value preferred stock having a fair value of $20 per share for a lump sum of $260,000. The proceeds allocated to the preferred stock is a. $232,917 b. $162,500 c. $141,818 d. $118,182
78.
Pember Corporation started business in 2007 by issuing 200,000 shares of $20 par common stock for $36 each. In 2012, 30,000 of these shares were purchased for $52 per share by Pember Corporation and held as treasury stock. On June 15, 2013, these 30,000 shares were exchanged for a piece of property that had an assessed value of $810,000. Perber’s stock is actively traded and had a market price of $60 on June 15, 2013. The cost method is used to account for treasury stock. The amount of paid-in capital from treasury stock transactions resulting from the above events would be a. $1,200,000. b. $720,000. c. $585,000. d. $240,000.
79.
On September 1, 2012, Valdez Company reacquired 16,000 shares of its $10 par value common stock for $15 per share. Valdez 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 $160,000. b. Common Stock for $160,000. c. Common Stock for $160,000 and Paid-in Capital in Excess of Par for $60,000. d. Treasury Stock for $240,000.
80.
Gannon Company acquired 8,000 shares of its own common stock at $20 per share on February 5, 2012, and sold 4,000 of these shares at $27 per share on August 9, 2013. The fair value of Gannon's common stock was $24 per share at December 31, 2012, and $25 per share at December 31, 2013. The cost method is used to record treasury stock transactions. What account(s) should Gannon credit in 2013 to record the sale of 4,000 shares? a. Treasury Stock for $108,000. b. Treasury Stock for $80,000 and Paid-in Capital from Treasury Stock for $28,000. c. Treasury Stock for $80,000 and Retained Earnings for $28,000. d. Treasury Stock for $96,000 and Retained Earnings for $12,000.
15 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 81.
Long Co. issued 100,000 shares of $10 par common stock for $1,200,000. Long acquired 10,000 shares of its own common stock at $15 per share. Three months later Long sold 5,000 of these shares at $19 per share. If the cost method is used to record treasury stock transactions, to record the sale of the 5,000 treasury shares, Long should credit a. Treasury Stock for $95,000. b. Treasury Stock for $50,000 and Paid-in Capital from Treasury Stock for $45,000. c. Treasury Stock for $75,000 and Paid-in Capital from Treasury Stock for $20,000. d. Treasury Stock for $75,000 and Paid-in Capital in Excess of Par for $20,000.
82.
An analysis of stockholders' equity of Hahn Corporation as of January 1, 2012, is as follows: Common stock, par value $20; authorized 100,000 shares; issued and outstanding 90,000 shares Paid-in capital in excess of par Retained earnings Total
$1,800,000 700,000 760,000 $3,260,000
Hahn uses the cost method of accounting for treasury stock and during 2012 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 2012, what should Hahn report at December 31, 2012, as total additional paid-in capital? a. $695,000 b. $700,000 c. $705,000 d. $715,000 83.
Percy Corporation was organized on January 1, 2012, with an authorization of 1,200,000 shares of common stock with a par value of $6 per share. During 2012, the corporation had the following capital transactions: January 5 July 28 December 31
issued 900,000 shares @ $10 per share purchased 120,000 shares @ $11 per share sold the 120,000 shares held in treasury @ $18 per share
Percy 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, 2012? a. $-0-. b. $2,760,000. c. $3,600,000. d. $4,440,000.
Stockholders’ Equity 84.
15 - 19
Sosa Co.'s stockholders' equity at January 1, 2012 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
$2,250,000 700,000 2,190,000 $5,140,000
During 2012, Sosa 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 2012. Assuming Sosa uses the cost method to record treasury stock transactions, the total amount of all additional paid-in capital accounts at December 31, 2012 is a. $691,600. b. $670,000. c. $708,400. d. $727,600. 85.
Presented below is the stockholders' equity section of Oaks Corporation at December 31, 2012: 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 300,000 $1,450,000 During 2013, 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, 2013, Oaks reported net income of $450,000. Assuming Oaks accounts for treasury stock under the cost method, what should it report as total stockholders' equity on its December 31, 2013, balance sheet? a. $1,765,000. b. $1,761,400. c. $1,757,800. d. $1,315,000.
86.
On December 1, 2012, Abel Corporation exchanged 30,000 shares of its $10 par value common stock held in treasury for a used machine. The treasury shares were acquired by Abel 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 fair value of $55 per share (the shares were originally issued at $30 per share). As a result of this exchange, Abel's total stockholders' equity will increase by a. $300,000. b. $1,200,000. c. $1,650,000. d. $1,350,000.
15 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 87.
Luther Inc., has 3,000 shares of 6%, $50 par value, cumulative preferred stock and 100,000 shares of $1 par value common stock outstanding at December 31, 2013, and December 31, 2012. The board of directors declared and paid a $7,500 dividend in 2012. In 2013, $36,000 of dividends are declared and paid. What are the dividends received by the preferred stockholders in 2013? a. $25,500 b. $18,000 c. $ 10,500 d. $ 9,000
88.
Anders, Inc., has 10,000 shares of 5%, $100 par value, cumulative preferred stock and 40,000 shares of $1 par value common stock outstanding at December 31, 2013. There were no dividends declared in 2011. The board of directors declares and pays a $90,000 dividend in 2012 and in 2013. What is the amount of dividends received by the common stockholders in 2013? a. $30,000 b. $50,000 c. $90,000 d. $0
89.
Colson Inc. declared a $240,000 cash dividend. It currently has 9,000 shares of 7%, $100 par value cumulative preferred stock outstanding. It is one year in arrears on its preferred stock. How much cash will Colson distribute to the common stockholders? a. $114,000. b. $126,000. c. $177,000. d. None.
90.
Pierson Corporation owned 10,000 shares of Hunter Corporation. These shares were purchased in 2009 for $90,000. On November 15, 2013, Pierson declared a property dividend of one share of Hunter for every ten shares of Pierson held by a stockholder. On that date, when the market price of Hunter was $21 per share, there were 90,000 shares of Pierson outstanding. What gain and net reduction in retained earnings would result from this property dividend? Gain Net Reduction in Retained Earnings a. $0 $189,000 b. $0 $ 81,000 c. $108,000 $ 81,000 d. $108,000 $ 27,000
Stockholders’ Equity
15 - 21
91.
Stinson Corporation owned 30,000 shares of Matile Corporation. These shares were purchased in 2009 for $270,000. On November 15, 2013, Stinson declared a property dividend of one share of Matile for every ten shares of Stinson held by a stockholder. On that date, when the market price of Matile was $21 per share, there were 270,000 shares of Stinson outstanding. What gain and net reduction in retained earnings would result from this property dividend? Gain Net Reduction in Retained Earnings a. $0 $243,000 b. $0 $567,000 c. $324,000 $81,000 d. $324,000 $243,000
92.
Winger Corporation owned 300,000 shares of Fegan Corporation stock. On December 31, 2012, when Winger's account "Equity Investment (Fegan Corporation") had a carrying value of $5 per share, Winger distributed these shares to its stockholders as a dividend. Winger originally paid $8 for each share. Fegan has 1,000,000 shares issued and outstanding, which are traded on a national stock exchange. The quoted market price for a Fegan share was $7 on the declaration date and $9 on the distribution date. What would be the reduction in Winger's stockholders' equity as a result of the above transactions? a. $1,200,000. b. $1,500,000. c. $2,400,000. d. $2,700,000.
93.
Gibbs Corporation owned 20,000 shares of Oliver Corporation’s $5 par value common stock. These shares were purchased in 2009 for $180,000. On September 15, 2013, Gibbs declared a property dividend of one share of Oliver for every ten shares of Gibbs held by a stockholder. On that date, when the market price of Oliver was $21 per share, there were 180,000 shares of Gibbs outstanding. What NET reduction in retained earnings would result from this property dividend? a. $162,000 b. $378,000 c. $108,000 d. $216,000
94.
Melvern’s Corporation has an investment in 10,000 shares of Wallace Company common stock with a cost of $436,000. These shares are used in a property dividend to stockholders of Melvern’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 fair value per share of Wallace 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. $680,000. b. $660,000. c. $630,000. d. $436,000.
15 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 95.
Hernandez Company has 490,000 shares of $10 par value common stock outstanding. During the year, Hernandez declared a 10% stock dividend when the market price of the stock was $30 per share. Four months later Hernandez declared a $.50 per share cash dividend. As a result of the dividends declared during the year, retained earnings decreased by a. $1,739,500. b. $735,000. c. $269,500. d. $245,000.
96.
On June 30, 2012, when Ermler Co.'s stock was selling at $65 per share, its capital accounts were as follows: Capital stock (par value $50; 80,000 shares issued) Premium on capital stock Retained earnings
$4,000,000 600,000 4,200,000
If a 100% stock dividend were declared and distributed, capital stock would be a. $4,000,000. b. $4,600,000. c. $8,000,000. d. $8,800,000. 97.
The stockholders' equity section of Gunkel Corporation as of December 31, 2012, 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 95,000 $145,000 On March 1, 2013, the board of directors declared a 15% stock dividend, and accordingly 1,500 additional shares were issued. On March 1, 2011, the fair value of the stock was $6 per share. For the two months ended February 28, 2013, Gunkel sustained a net loss of $10,000. What amount should Gunkel report as retained earnings as of March 1, 2013? a. $76,000. b. $82,000. c. $86,000. d. $92,000.
Stockholders’ Equity
98.
15 - 23
The stockholders' equity of Howell Company at July 31, 2012 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
$3,200,000 160,000 650,000 $4,010,000
On August 1, 2012, the board of directors of Howell declared a 10% stock dividend on common stock, to be distributed on September 15th. The market price of Howell's common stock was $35 on August 1, 2012, and $38 on September 15, 2012. What is the amount of the debit to retained earnings as a result of the declaration and distribution of this stock dividend? a. $320,000. b. $560,000. c. $608,000. d. $400,000. 99.
On January 1, 2012, Dodd, Inc., declared a 15% stock dividend on its common stock when the fair 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 Dodd’s retained earnings as a result of the above transaction? a. $180,000 decrease b. $360,000 decrease c. $600,000 decrease d. $300,000 decrease 100.
On January 1, 2012, Culver 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 15% stock dividend to be issued to stockholders of record on December 16, 2012. What was the impact of the 15% stock dividend on the balance of the retained earnings account? a. $750,000 decrease b. $120,000 decrease c. $132,000 decrease d. No effect
15 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition
101.
At the beginning of 2013, Flaherty Company had retained earnings of $250,000. During the year Flaherty reported net income of $100,000, sold treasury stock at a “gain” of $36,000, declared a cash dividend of $60,000, and declared and issued a small stock dividend of 3,000 shares ($10 par value) when the fair value of the stock was $20 per share. The amount of retained earnings available for dividends at the end of 2013 was a. $230,000. b. $260,000. c. $266,000. d. $296,000.
102.
Masterson Company has 420,000 shares of $10 par value common stock outstanding. During the year Masterson declared a 10% stock dividend when the market price of the stock was $36 per share. Three months later Masterson declared a $.60 per share cash dividend. As a result of the dividends declared during the year, retained earnings decreased by a. $1,789,200 b. $1,512,000 c. $277,200 d. $264,000
Questions 103 and 104 are based on the following information. Layne Corporation had the following information in its financial statements for the years ended 2012 and 2013: Cash dividends for the year 2013 $ 8,000 Net income for the year ended 2013 83,000 Market price of stock, 12/31/12 10 Market price of stock, 12/31/13 12 Common stockholders’ equity, 12/31/12 1,600,000 Common stockholders’ equity, 12/31/13 1,800,000 Outstanding shares, 12/31/13 180,000 Preferred dividends for the year ended 2013 15,000
103.
What is the payout ratio for Layne Corporation for the year ended 2013? a. 27.7% b. 18.1% c. 11.8% d. 9.6%
104.
What is the book value per share for Layne Corporation for the year ended 2013? a. $10.00 b. $9.92 c. $9.44 d. $8.89
Stockholders’ Equity
15 - 25
105.
At the beginning of 2013, Hamilton Company had retained earnings of $180,000. During the year Hamilton reported net income of $75,000, sold treasury stock at a “gain” of $27,000, declared a cash dividend of $45,000, and declared and issued a small stock dividend of 1,500 shares ($10 par value) when the fair value of the stock was $30 per share. The amount of retained earnings available for dividends at the end of 2013 was: a. $214,500. b. $192,000. c. $187,500. d. $165,000.
106.
Mingenback Company has 560,000 shares of $10 par value common stock outstanding. During the year Mingenback declared a 10% stock dividend when the market price of the stock was $48 per share. Two months later Mingenback declared a $.60 per share cash dividend. As a result of the dividends declared during the year, retained earnings decreased by: a. $352,000. b. $369,600. c. $2,688,000. d. $3,057,600.
Questions 107 and 108 are based on the following information. Sealy Corporation had the following information in its financial statements for the years ended 2012 and 2013: Cash dividends for the year 2013 $ 5,000 Net income for the year ended 2013 78,000 Market price of stock, 12/31/12 10 Market price of stock, 12/31/13 12 Common stockholders’ equity, 12/31/12 1,000,000 Common stockholders’ equity, 12/31/13 1,200,000 Outstanding shares, 12/31/13 100,000 Preferred dividends for the year ended 2013 10,000 107.
What is the rate of return on common stock equity for Sealy Corporation for the year ended 2013? a. 7.1% b. 6.5% c. 6.2% d. 5.7%
108.
What is the price-earnings ratio for Sealy Corporation for the year ended 2013? a. 14.7 b. 15.4 c. 17.6 d. 19.0
15 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition
109.
Mays, Inc. had net income for 2012 of $3,180,000 and earnings per share on common stock of $5. Included in the net income was $450,000 of bond interest expense related to its long-term debt. The income tax rate for 2012 was 30%. Dividends on preferred stock were $600,000. The payout ratio on common stock was 25%. What were the dividends on common stock in 2012? a. $645,000. b. $795,000. c. $723,750. d. $967,500.
110.
Presented below is information related to Orender, Inc.:
Common stock 4% Preferred stock Retained earnings (includes net income for current year) Net income for year
December 31, 2013 2012 $ 75,000 $ 60,000 350,000 350,000 90,000 75,000 40,000 32,000
What is Orender’s rate of return on common stock equity for 2013? a. 26.7% b. 17.3% c. 15.8% d. 24.2% Use the following information for questions 111 and 112. The following data are provided:
10% Cumulative preferred stock, $50 par Common stock, $10 par Additional paid-in capital Retained earnings (includes current year net income) Net income
December 31, 2013 2012 $100,000 $100,000 160,000 90,000 80,000 65,000 240,000 215,000 70,000
Additional information: On May 1, 2013, 7,000 shares of common stock were issued. The preferred dividends were not declared during 2013. The market price of the common stock was $50 at December 31, 2013. 111.
The rate of return on common stock equity for 2013 is a. 70 ÷ 420. b. 70 ÷ 480. c. 60 ÷ 420. d. 60 ÷ 480.
Stockholders’ Equity 112.
15 - 27
The book value per share of common stock at 12/31/13 is a. 470 ÷ 16. b. 240 ÷ 16. c. 370 ÷ 16. d. 480 ÷ 15.
Use the following information for questions 113 and 114. Turner Corporation had the following information in its financial statements for the year ended 2012 and 2013: Cash dividends for the year 2013 Net income for the year ended 2013 Market price of stock, 12/31/13 Common stockholders’ equity, 12/31/12 Common stockholders’ equity, 12/31/13 Outstanding shares, 12/31/13 Preferred dividends for the year ended 2013
$ 15,000 155,000 24 2,200,000 2,400,000 160,000 30,000
113.
What is the payout ratio for Turner Corporation for the year ended 2013? a. 9.7% b. 12.0% c. 19.4% d. 29.0%
114.
What is the book value per share for Turner Corporation for the year ended 2013? a. $14.81 b. $15.00 c. $13.75 d. $14.38
Use the following information for questions 115 through 117. Written, Inc. has outstanding 500,000 shares of $2 par common stock and 100,000 shares of nopar 8% preferred stock with a stated value of $5. The preferred stock is cumulative and nonparticipating. Dividends have been paid in every year except the past two years and the current year. *115. Assuming that $250,000 will be distributed as a dividend in the current year, how much will the common stockholders receive? a. Zero. b. $130,000. c. $170,000. d. $210,000. *116. Assuming that $105,000 will be distributed as a dividend in the current year, how much will the preferred stockholders receive? a. $35,000. b. $40,000. c. $80,000. d. $105,000.
15 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition *117. Assuming that $305,000 will be distributed, and the preferred stock is also participating, how much will the common stockholders receive? a. $185,000. b. $150,000. c. $155,000. d. $80,000. *118. Yoder, Inc. has 100,000 shares of $10 par value common stock and 50,000 shares of $10 par value, 6%, cumulative, participating preferred stock outstanding. Dividends on the preferred stock are one year in arrears. Assuming that Yoder wishes to distribute $270,000 as dividends, the common stockholders will receive a. $60,000. b. $110,000. c. $160,000. d. $210,000. *119. Mann Co. has outstanding 60,000 shares of 8% preferred stock with a $10 par value and 150,000 shares of $3 par value common stock. Dividends have been paid every year except last year and the current year. If the preferred stock is cumulative and nonparticipating and $300,000 is distributed, the common stockholders will receive a. $0. b. $204,000. c. $252,000. d. $300,000.
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.
a b b c d b c
78. 79. 80. 81. 82. 83. 84.
d d b c c d c
85. 86. 87. 88. 89. 90. 91.
a c c a a c d
92. 93. 94. 95. 96. 97. 98.
b d d a c a b
99. 100. 101. 102. 103. 104. 105.
b b a a c a d
106. 107. 108. 109. 110. 111. 112.
d c c a b c a
113. 114. *115. *116. *117. *118. *119.
b b b d b c b
MULTIPLE CHOICE—CPA Adapted 120.
A corporation was organized in January 2009 with authorized capital of $10 par value common stock. On February 1, 2012, shares were issued at par for cash. On March 1, 2012, 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, 2012 March 1, 2012 a. Yes No b. Yes Yes c. No No d. No Yes
Stockholders’ Equity
15 - 29
121.
On July 1, 2012, Nall 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 $140,000. At this date Nall'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 Nall's preferred stock should be a. $70,000. b. $84,000. c. $90,000. d. $77,000.
122.
Horton Co. was organized on January 2, 2012, with 500,000 authorized shares of $10 par value common stock. During 2012, Horton 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 20,000 shares of treasury stock at $13 per share. Horton 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, 2012? a. $0. b. $20,000. c. $40,000. d. $60,000.
123.
In 2012, Hobbs Corp. acquired 9,000 shares of its own $1 par value common stock at $18 per share. In 2013, Hobbs issued 6,000 of these shares at $25 per share. Hobbs uses the cost method to account for its treasury stock transactions. What accounts and what amounts should Hobbs credit in 2013 to record the issuance of the 6,000 shares?
a. b. c. d. 124.
Treasury Stock $108,000 $108,000
Additional Paid-in Capital $42,000 $144,000 $102,000
Retained Earnings $105,000
Common Stock
$42,000
$6,000 $6,000
At its date of incorporation, Sauder, Inc. issued 100,000 shares of its $10 par common stock at $11 per share. During the current year, Sauder 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? a. b. c. d.
Retained Earnings Decrease No effect Decrease No effect
Additional Paid-in Capital Decrease Decrease No effect No effect
15 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition 125.
Farmer Corp. owned 20,000 shares of Eaton Corp. purchased in 2009 for $300,000. On December 15, 2012, Farmer declared a property dividend of all of its Eaton Corp. shares on the basis of one share of Eaton for every 10 shares of Farmer common stock held by its stockholders. The property dividend was distributed on January 15, 2013. On the declaration date, the aggregate market price of the Eaton shares held by Farmer was $500,000. The entry to record the declaration of the dividend would include a debit to Retained Earnings of a. $0. b. $200,000. c. $300,000. d. $500,000.
126.
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
127.
On May 1, 2012, Ziek Corp. declared and issued a 10% common stock dividend. Prior to this dividend, Ziek had 100,000 shares of $1 par value common stock issued and outstanding. The fair value of Ziek 's common stock was $20 per share on May 1, 2012. As a result of this stock dividend, Ziek's total stockholders' equity a. increased by $200,000. b. decreased by $200,000. c. decreased by $10,000. d. did not change.
128.
How would the declaration and subsequent issuance of a 10% stock dividend by the issuer affect each of the following when the fair 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
129.
15 - 31
On December 31, 2012, the stockholders' equity section of Arndt, 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
$ 90,000 116,000 154,000 $360,000
On March 31, 2013, Arndt declared a 10% stock dividend, and accordingly 900 additional shares were issued, when the fair value of the stock was $18 per share. For the three months ended March 31, 2013, Arndt sustained a net loss of $32,000. The balance of Arndt’s retained earnings as of March 31, 2013, should be a. $105,800. b. $113,000. c. $114,800. d. $122,000. *130. At December 31, 2012 and 2013, Plank Corp. had outstanding 3,000 shares of $100 par value 8% cumulative preferred stock and 15,000 shares of $10 par value common stock. At December 31, 2012, dividends in arrears on the preferred stock were $12,000. Cash dividends declared in 2013 totaled $45,000. What amounts were payable on each class of stock? Preferred Stock $24,000 $33,000 $36,000 $45,000
a. b. c. d.
Common Stock $21,000 $12,000 $9,000 $0
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
120. 121.
d b
122. 123.
c b
124. 125.
c d
126. 127.
b d
128. 129.
d a
*130.
c
DERIVATIONS — Computational No. Answer Derivation 71.
a
$4,800,000 + $400,000 + $550,000 + $2,000,000 + $1,500,000 – $150,000 = $9,100,000.
72.
b
$4,800,000 + $550,000 = $5,350,000.
73.
b
(10,000 $25) + (15,000 $20) = $550,000 ($250,000 ÷ $550,000) $520,000 = $236,364.
74.
c
(4,000 $25) + (6,000 $20) = $220,000 ($120,000 ÷ $220,000) $204,000 = $111,273.
75.
d
(10,000 $18) + $200,000 = $380,000.
15 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition 76.
b
[(6,000 $25) ÷ [(6,000 $25) + (9,000 $20)]] $312,000 = $141,818.
77.
c
[(7,500 $20) ÷ [(5,000 $25) + (7,500 $20)]] $260,000 = $141,818.
78.
d
($60 – $52) 30,000 = $240,000.
79.
d
16,000 $15 = $240,000.
80.
b
4,000 $20 = $80,000; 4,000 $7 = $28,000.
81.
c
5,000 $15 = $75,000; 5,000 $4 = $20,000.
82.
c
$700,000 + (2,000 $5) – (500 $10) = $705,000.
83.
d
(900,000 $4) + (120,000 $7) = $4,440,000.
84.
c
$700,000 + (3,600 $5) – (2,400 $4) = $708,400.
85.
a
$1,450,000 – (3,000 $28) – (3,000 $35) + (1,800 $30) + $450,000 = $1,765,000.
86.
c
30,000 $55 = $1,650,000.
87.
c
3,000 $50 .06 = $9,000 ($9,000 – $7,500) + $9,000 = $10,500.
88.
a
10,000 $100 .05 = $50,000 ($90,000 2) – ($50,000 3) = $30,000.
89.
a
9,000 $100 .07 = $63,000 $240,000 – ($63,000 2) = $114,000.
90.
c
($90,000 ÷ $10) $21 = $189,000 [$21 – ($90,000 ÷ 10,000)] 9,000 = $108,000 $189,000 – $108,000 = $81,000.
91.
d
($270,000 ÷ $10) $21 = $567,000 [$21 – ($270,000 ÷ 30,000)] 27,000 = $324,000 $567,000 – $324,000 = $243,000.
92.
b
(300,000 $7) – [($7 – $5) 300,000] = $1,500,000.
93.
d
(180,000 ÷ 10) $21 = $378,000 $378,000 – [$378,000 – ($180,000 18/20)] = $216,000.
94.
d
(10,000 $63) = $630,000 $630,000 – ($630,000 – $436,000) = $436,000.
Stockholders’ Equity 95.
a
490,000 .10 × $30 = $1,470,000 $1,470,000 + (490,000 1.10 $.50) = $1,739,500.
96.
c
(80,000 $50) + $4,000,000 = $8,000,000.
97.
a
$95,000 – $10,000 – (1,500 $6) = $76,000.
98.
b
160,000 .10 $35 = $560,000.
99.
b
120,000 .15 $20 = $360,000.
100.
b
100,000 .15 $8 = $120,000.
101.
a
$250,000 + $100,000 – $60,000 – (3,000 $20) = $230,000.
102.
a
(420,000 .10 $36) + ($420,000 1.10 $.60) = $1,789,200.
103.
c
$8,000 ÷ ($83,000 – $15,000) = 11.8%.
104.
a
$1,800,000 ÷ 180,000 = $10.00.
105.
d
$180,000 + $75,000 – $45,000 – (1,500 $30) = $165,000.
106.
d
(560,000 .10 $48) + (560,000 1.05 $.10) = $3,057,600.
107.
c
($78,000 – $10,000) ÷ [($1,000,000 + $1,200,0002)] = 6.2%.
108.
c
($78,000 – $10,000) ÷ 100,000 = $.68. $12 ÷ .68 = 17.6.
109.
a
X ——————————— = .25, X = $645,000. ($3,180,000 – $600,000)
110.
b
111.
c
$40, 000 − (.04 $350, 000)
( $60, 000 + $75, 000) + ( $75, 000 + $90, 000) 2
15 - 33
= .173 = 17.3%.
$70, 000 − ( $100, 000 .10)
( $160, 000 + $80, 000 + $240, 000 − $10, 000) + ( $90, 000 + $65, 000 + $215, 000) 2 = $60 ÷ 420.
112.
a
$160,000 + $80,000 + (240,000 – $10,000) ——————————————————— = $470 ÷ 16. 16,000
113.
b
$15,000 ÷ ($155,000 – $30,000) = 12.0%.
114.
b
$2,400,000 ÷ 160,000 = $15.00.
15 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition
*115.
b
$250,000 – (100,000 $5 .08 3) = $130,000.
*116.
d
100,000 $5 .08 3 = $120,000 > $105,000.
*117.
b
8% $1,000,000 = $80,000 7%* $1,000,000 = 70,000 $150,000
(current year) (participating)
*$500,000 8% 3 =$ 120,000 $1,000,000 8% = 80,000 $200,000 $305,000 – $200,000 —————————— = 7%. $1,000,000 + $500,000 *118.
c
(preferred dividends) (common current dividends)
Common Stock $1,000,000 6% =$60,000 (current year) $1,000,000 10%*= 100,000 (participating) $160,000 *$270,000 – $60,000 – ($500,000 6% × 2) = $150,000 $150,000 ————-- = 10%. $1,500,000
*119.
b
$300,000 – ($600,000 8% × 2) = $204,000.
DERIVATIONS — CPA Adapted No. Answer Derivation 120.
d
Conceptual.
121.
b
($24 2,500) + ($18 5,000) = $150,000. $90,000 ————— × $140,000 = $84,000. $150,000
122.
c
20,000 $2 = $40,000.
123.
b
(6,000 $18) = $108,000; (6,000 $7) = $42,000.
124.
c
Conceptual.
125.
d
$500,000 (fair value).
Stockholders’ Equity
126.
b
Conceptual.
127.
d
Conceptual.
128.
d
Conceptual.
129.
a
$154,000 – $32,000 – (900 $18) = $105,800.
*130.
c
($300,000 .08) + $12,000 = $36,000 $45,000 – $36,000 = $9,000.
15 - 35
EXERCISES Ex. 15-131—Lump sum issuance of stock. Parker Corporation has issued 2,000 shares of common stock and 400 shares of preferred stock for a lump sum of $76,000 cash. Instructions (a) Give the entry for the issuance assuming the par value of the common was $5 and the fair value $30, and the par value of the preferred was $40 and the fair 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 fair value of $26 per share.
Solution 15-131 (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 fair value 60/80 × $76,000 = 20/80 × $76,000 =
76,000 10,000 47,000 16,000 3,000
$57,000 common 19,000 preferred $76,000)
(b) Cash ............................................................................................. Common Stock.................................................................. Paid-in Capital in Excess of Par—Common ...................... Preferred Stock ................................................................. Paid-in Capital in Excess of Par—Preferred ......................
76,000 10,000 42,000 16,000 8,000
15 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 15-132—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.
Solution 15-132 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. 15-133—Treasury stock. Agler 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 160 shares of capital stock to be held as treasury stock, paying $60 per share. (b) Sold 120 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.
Stockholders’ Equity
15 - 37
Solution 15-133 (a) Treasury Stock ............................................................................... Cash ......................................................................................
9,600
(b) Cash ............................................................................................. Treasury Stock ...................................................................... Paid-in Capital from Treasury Stock ......................................
7,800
(c) Cash .............................................................................................. Paid-in Capital from Treasury Stock ............................................... Treasury Stock ......................................................................
2,000 400
9,600
7,200 600
2,400
Ex. 15-134—Treasury stock. Ellison 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 6,000 shares of its common stock at $29 a share. (b) Sold 3,000 treasury shares at $30 a share. (c) Sold 1,500 shares of treasury stock at $26 a share.
Solution 15-134 (a) (b)
(c)
Treasury Stock ............................................................................ Cash ................................................................................
174,000
Cash............................................................................................ Treasury Stock................................................................. Paid-in Capital from Treasury Stock.................................
90,000
Cash............................................................................................ Paid-in Capital from Treasury Stock ............................................ Retained Earnings ....................................................................... Treasury Stock.................................................................
39,000 3,000 1,500
174,000 87,000 3,000
43,500
15 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 15-135—Treasury stock. In 2012, Mordica Co. issued 300,000 of its 500,000 authorized shares of $10 par value common stock at $35 per share. In January, 2013, Mordica repurchased 20,000 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) 7,000 shares of treasury stock are reissued at $33 per share. Prepare the journal entry to record the reissuance by the cost method.
Solution 15-135 (a)
The two methods of accounting for treasury stock are the cost method and the par value method.
(b)
Treasury Stock ............................................................................ Cash ................................................................................
600,000
Cash ............................................................................................ Paid-in Capital from Treasury Stock ................................. Treasury Stock .................................................................
231,000
(c)
600,000 21,000 210,000
Ex. 15-136—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.
________
________
________
Stockholders’ Equity
15 - 39
Solution 15-136 Increase 1. Treasury stock is resold at more than cost.
Decrease
X
2. Operating loss for the period.
X
3. Retirement of bonds payable at more than book value.
X
4. Declaration of a stock dividend.
X
5. Acquisition of machinery for common stock.
X
6. Conversion of bonds payable into common stock.
X
7. Not declaring a dividend on cumulative preferred stock. 8. Declaration of cash dividend. 9. Payment of cash dividend.
No Effect
X X X
Ex. 15-137—Stock dividends. Describe the journal entry for a stock dividend on common stock (which has a par value).
Solution 15-137 A stock dividend results in the transfer from retained earnings to paid-in capital of an amount equal to the fair 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 fair value over par value is credited to Paid-in Capital in Excess of Par.
15 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 15-138—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 15-138 Number of Shares Outstanding Par Value per Share Total Par Outstanding Retained Earnings Total Stockholders' Equity Composition of Stockholders' Equity
Ex. 15-139—Computation of selected financial ratios. The following information pertains to Parsons 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% 10,000 none $10 120,000 $2.70 $48.00 $400,000 $270,000 $300,000 10,000 $250,000 $740,000
Stockholders’ Equity
15 - 41
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 15-139 (a)
(10,000 × $100) + (120,000 × $10) + $400,000 + $270,000 + $300,000 – $250,000 = $2,920,000.
(b)
[$740,000 – (10,000 × $100 × 8%)] ÷ (120,000 – 10,000) = 660,000 ÷ 110,000 = $6.00 per share.
(c) ($2,920,000 – $1,000,000) ÷ (120,000 – 10,000) = $1,920,000 ÷ 110,000 = $17.45 per share. (d)
$2.70 ÷ $6 = 45% or [($2.70 × 110,000) ÷ ($740,000 – $80,000)].
(e)
($740,000 – $80,000) ÷ ($2,920,000 – $1,000,000) = 34.4%.
*Ex. 15-140—Dividends on preferred stock. The stockholders' equity section of Lemay Corporation shows the following on December 31, 2013: Preferred stock—6%, $100 par, 5,000 shares outstanding Common stock—$10 par, 60,000 shares outstanding Paid-in capital in excess of par Retained earnings Total stockholders' equity
$ 500,000 600,000 200,000 118,000 $1,418,000
Instructions Assuming that all of the company's retained earnings are to be paid out in dividends on 12/31/13 and that preferred dividends were last paid on 12/31/11, show how much the preferred and common stockholders should receive if the preferred stock is cumulative and fully participating.
*Solution 15-140 Dividends in arrears (6% of $500,000) Current year's dividends Participating dividend (2%) [($22,000 ÷ $1,100,000) x $500,000]
Preferred $30,000 30,000
Common $ — 36,000
Total $ 30,000 66,000
10,000 $70,000
12,000 $48,000
22,000 $118,000
15 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition *Ex. 15-141—Dividends on preferred stock. In each of the following independent cases, it is assumed that the corporation has $600,000 of 6% preferred stock and $2,400,000 of common stock outstanding, each having a par value of $10. No dividends have been declared for 2011 and 2012. (a) As of 12/31/13, it is desired to distribute $250,000 in dividends. How much will the preferred stockholders receive if their stock is cumulative and nonparticipating? (b) As of 12/31/13, it is desired to distribute $600,000 in dividends. How much will the preferred stockholders receive if their stock is cumulative and participating up to 11% in total? (c) On 12/31/13, the preferred stockholders received a $180,000 dividend on their stock which is cumulative and fully participating. How much money was distributed in total for dividends during 2013?
*Solution 15-141 (a) $108,000 ($600,000 x .06 x 3 yrs.). (b) $138,000 ($600,000 x .06 x 3 yrs.) + [$600,000 x (.11 -.06)]. (c) $612,000 ($432,000* to common and $180,000 to preferred). * ($2,400,000 x .06) + [($180,000 - $108,000) ÷ $600,000) x $2,400,000].
PROBLEMS Pr. 15-142—Equity transactions. Presented below is information related to Wyrick 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 $10 a share for the common stock. 3. 5,000 shares of preferred stock are sold for cash at $110 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.
Stockholders’ Equity
15 - 43
Solution 15-142 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 ..............
550,000
4. Organization Expense .................................................................... Common Stock ................................................................... Paid-in Capital in Excess of Stated Value ...........................
6,000
80,000 220,000 500,000 50,000 1,000 5,000
Pr. 15-143—Treasury stock transactions. The original sale of the $50 par value common shares of Gray 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 350 shares of common stock as treasury shares at $62. (b) Sold 100 shares of treasury stock at $60. (c) Sold 50 treasury shares at $68.
Solution 15-143 (a)
(b)
(c)
Treasury Stock .................................................................................. Cash .........................................................................................
21,700
Cash.................................................................................................. Retained Earnings ............................................................................. Treasury Stock .........................................................................
6,000 200
Cash.................................................................................................. Paid-in Capital from Treasury Stock ......................................... Treasury Stock .........................................................................
3,400
21,700
6,200
300 3,100
15 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 15-144—Stock dividends. The stockholders' equity section of Benton Corporation's balance sheet as of December 31, 2012 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 2013: 1. Jan. 5
20,000 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
30,000 shares of authorized and unissued common stock were sold for $12 per share.
4. March 1
A 30% stock dividend was declared and issued. Fair 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. Fair value on March 31 was $18 per share.
6. July 1
A 15% stock dividend was declared and issued. Fair 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 Item Shares Issued Par Value Beginning Balance—1/1/13 400,000 $2,000,000 Event #1—Jan. 5 20,000 100,000 Balance 420,000 $2,100,000 Event # 2—Jan. 16 (and events 3 through 7)
Paid-in Capital In Excess of Par Retained Earnings $850,000 $3,000,000 60,000 -0$910,000 $3,000,000
Stockholders’ Equity
15 - 45
Solution 15-144 Event #2—Jan. 16 -0-0-0(84,000) ——————————————————————————————————————————— Balance 420,000 $2,100,000 $910,000 $2,916,000 #3—Feb. 10 30,000 150,000 210,000 -0——————————————————————————————————————————— Balance 450,000 $2,250,000 $1,120,000 $2,916,000 #4—March 1 135,000 675,000 -0(675,000) ——————————————————————————————————————————— Balance 585,000 $2,925,000 $1,120,000 $2,241,000 #5—April 1 585,000 -0-0-0——————————————————————————————————————————— Balance 1,170,000 $2,925,000 $1,120,000 $2,241,000 #6—July 1 175,500 438,750 1,316,250 (1,755,000) ——————————————————————————————————————————— Balance 1,345,500 $3,363,750 $2,436,250 $486,000 #7—Aug. 1 -0-0-0(257,140) ——————————————————————————————————————————— Balance 1,345,500 $3,363,750 $2,436,250 $216,900
Pr. 15-145—Equity transactions. Foley Corporation has the following capital structure at the beginning of the year: 5% 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 (a) 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 15% common stock dividend was declared. The average fair value of the common stock is $18 a share. 3. Assume that net income for the year was $120,000 (record the closing entry) and the board of directors appropriated $70,000 of retained earnings for plant expansion. (b) Construct the stockholders' equity section incorporating all the above information.
15 - 46 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 15-145 (a) 1. Retained Earnings ................................................................. Dividends Payable—Preferred ($300,000 × .05) ......... Dividends Payable—Common..................................... 2.
90,000 15,000 75,000
40,000 shares 15% 6,000 shares as stock dividend $18 $108,000 total dividend Retained Earnings ................................................................. Common Stock Dividend Distributable ....................... Paid-in Capital in Excess of Par .................................
108,000
3. Income Summary................................................................... Retained Earnings ......................................................
120,000
Retained Earnings ................................................................. Retained Earnings Appropriated for Plant Expansion .
70,000
60,000 48,000
120,000
(b) Stockholders' equity 5% 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 Common stock dividend distributable Paid-in capital in excess of par Total paid-in capital Retained earnings—unappropriated* $292,000 Appropriated for plant expansion 70,000 Total retained earnings Total stockholders' equity
70,000
$ 300,000 400,000 60,000 158,000 918,000
362,000 $1,280,000
*$440,000 – $90,000 – $108,000 + $120,000 – $70,000 = $292,000
*Pr. 15-146—Dividends on preferred and common stock. Rensing, Inc., has $800,000 of 6% preferred stock and $1,200,000 of common stock outstanding, each having a par value of $10 per share. No dividends have been paid or declared during 2011 and 2012. As of December 31, 2013, it is desired to distribute $396,000 in dividends. Instructions How much will the preferred and common stockholders receive under each of the following assumptions: (a) The preferred is noncumulative and nonparticipating. (b) The preferred is cumulative and nonparticipating. (c) The preferred is cumulative and fully participating. (d) The preferred is cumulative and participating to 12% total.
Stockholders’ Equity
15 - 47
*Solution 15-146 (a)
Common $ — 348,000 $348,000
Total $ 48,000 348,000 $396,000
$144,000
Common $ — — 252,000 $252,000
Total $96,000 48,000 252,000 $396,000
Dividends in arrears, 6% of $800,000 for two years Current year's dividend Participating dividend 9% ($180,000 ÷ $2,000,000)
Preferred $96,000 48,000 72,000 $216,000
Common $ — 72,000 108,000 $180,000
Total $96,000 120,000 180,000 $396,000
Dividends in arrears, 6% of $800,000 for two years Current year's dividend Participating dividend (4%) Remainder to common
Preferred $96,000 48,000 32,000 — $176,000
Common $ — 72,000 48,000 100,000 $220,000
Total $96,000 120,000 80,000 100,000 $396,000
Current year's dividend (6% of $800,000) Remainder to common
Preferred $ 48,000 $ 48,000
(b) Dividends in arrears, 6% of $800,000 for two years Current year's dividend Remainder to common
(c)
(d)
Preferred $96,000 48,000
15 - 48 Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS True/False 1. In the United States, like many other countries, banks are major creditors as well as the largest investors. 2. The IFRS statement of recognized income and expenses is identical to the U.S. GAAP statement of retained earnings – beginning balance retained earnings, plus net income, less dividends, equals ending balance retained earnings. 3. When the statement of recognized income and expenses is utilized the requirement for additional note disclosure is reduced. 4. Under IFRS compliance requirements the U.S. GAAP formatted income statement need not be replaced with the iGAAP statement of recognized income and expenses. 5. Under IFRS compliance requirements the revaluation surplus is not considered contributed capital. Answers to True/False: 1. False 2. False 3. False 4. True 5. True
Multiple Choice 1. The accounting for treasury stock retirements under IFRS a. is to charge the entire amount to paid-in capital. b. may have the excess charged to paid-in capital, depending on the original transaction related to the issuance of the stock. c. is to charge the excess of the cost of treasury stock over par value to retained earnings. d. is to allocate the difference between paid-in capital and retained earnings. 2. The Revaluation Surplus of IFRS is a. similar to U.S. GAAP in that it allows both increases and decreases in valuation. b. similar to U.S. GAAP in that it only allows for the decrease in valuation. c. similar to U.S. GAAP in that it only allows for the increase in valuation. d. different than U.S. GAAP in that it allows the increase in valuation. 3. The IFRS statement of recognized income and expenses a. does not recognize charges to equity such as revaluation surplus values. b. is a required report under IFRS reporting requirements. c. reports the items that were charged directly to equity such as revaluation surplus. d. is similar to the U.S. GAAP income statement in that it only reports revenues and expenses of the period.
Stockholders’ Equity
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4. Under IFRS compliance requirements the Revaluation Surplus is a. only utilized to record the changes in depreciable items – plant and equipment. b. considered as revenue when utilizing the U.S. GAAP formatted income statement. c. utilized to record the changes in property, plant, and equipment. d. reported as contributed capital. 5. The current project of the IASB and the FASB related to financial statement presentation indicates a. that the IFRS statement of recognized income and expenses will most likely be adopted by the FASB as a U.S. requirement in the near future. b. that the IFRS statement of recognized income and expenses will probably be eliminated. c. that the U.S. GAAP standard for reporting comprehensive income will most likely be adopted by the IASB for IFRS. d. that hybrid financial instruments are unacceptable.
Answers to Multiple Choice: 1. 2. 3. 4. 5.
b d c c b
Short Answer 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to the accounting for stockholders’ equity. 1. Key similarities between IFRS and U.S. GAAP for transactions related to stockholders’ equity pertain to (1) issuance of shares, (2) purchase of treasury stock, (3) declaration and payment of dividends, (4) the accounting for start up costs—that is, they should be expensed as incurred, (5) the costs associated with issuing stock reduce the proceeds from the issuance and reduce paid in capital, and (6) the accounting for par, no par and no par stock with a stated value. Major differences relate to terminology used, introduction of items such as revaluation surplus, and presentation of stockholder equity information. In addition, the accounting for treasury stock retirements differs between IFRS and U.S. GAAP. Under U.S. GAAP a company has the option of charging the excess of the cost of treasury stock over par value to (1) retained earnings, (2) allocate the difference between paid-in capital and retained earnings, or (3) charge the entire amount to paid-in capital. Under IFRS, the excess may have to be charged to paid-in capital, depending on the original transaction related to the issuance of the stock. An IFRS/U.S. GAAP difference relates to the account Revaluation Surplus. Revaluation surplus arises under IFRS because companies are permitted to revalue their property, plant and equipment to fair value under certain circumstances. This account is part of general reserves under IFRS and is not considered contributed capital. While both IFRS and U.S. GAAP consider the statement of stockholders’ equity a primary financial statement, under IFRS, a company has the option of preparing a statement of stockholders’ equity similar to U.S. GAAP or preparing a statement of recognized income and expense (SoRIE).
15 - 50 Test Bank for Intermediate Accounting, Fourteenth Edition The statement of SoRIE reports the items that were charged directly to equity such as revaluation surplus and then adds the net income for the period to arrive at total recognized income and expense. In this situation, additional note disclosure is required to provide reconciliations of other equity items. 2. Briefly discuss the implications of the financial statement presentation project for the reporting of stockholders’ equity. 2. It is likely that the statement of stockholders’ equity and its presentation will be examined closely in the financial statement presentation project. The statement of recognized income and expense now permitted under IFRS will probably be eliminated. In addition the options of how to present other comprehensive income under U.S. GAAP will change in any converged standard in this area. Also, the FASB has been working on a standard that will likely converge to IFRS in the area of hybrid financial instruments.
CHAPTER 16 DILUTIVE SECURITIES AND EARNINGS PER SHARE IFRS questions are available at the end of this chapter.
TRUE-FALSE—Dilutive Securities—Conceptual Answer
No.
Description
T F T F F T F T F T F F T F T F T. F. T F
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
Accounting for convertible bond issue. Reporting gain/loss on convertible debt retirement. Reporting additional payment to encourage conversion. Exercise of convertible preferred stock. Convertible preferred stock exercise. Allocating proceeds between debt and detachable warrants. Allocating proceeds from nondetachable warrants. Intrinsic value of a stock option. Compensation expense in fair value method. Service period in stock option plans. Accounting for nonexercise of stock options. Accounting for stock option forfeiture. 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. Reporting EPS in complex capital structure. Dilutive stock options. Contingent issue shares. Reporting EPS for income from continuing operations.
MULTIPLE CHOICE—Dilutive Securities, Conceptual Answer
No.
Description
d d b c a d b d d d d c b c a c a d a
21. 22. 23. S 24. S 25. S 26. 27. 28. 29. 30. P 31. P 32. S 33. S 34. 35. 36. 37. 38. *39.
Nature of convertible bonds. Recording conversion of bonds. Classification of early extinguishment of convertible bonds. Reasons for issuing convertible debt. Reporting gain/loss on conversion of bonds. Accounting for conversion of preferred stock. Recording conversion of preferred stock. Bonds issued with detachable stock warrants. Debt equity features of debt issued with stock warrants. Classification of stock warrants outstanding. Bonds issued with detachable stock warrants. Distribution of stock rights. Difference between convertible debt and stock warrants. 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. Characteristics of noncompensatory stock purchase plan. Compensation expense in an incentive stock option plan.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Dilutive Securities, Conceptual (cont.) Answer
No.
Description
d b b
*40. *41. *42.
Stock appreciation rights plan. Incentive stock option plan. Share-based liability awards.
MULTIPLE CHOICE—Dilutive Securities, Computational Answer
No.
Description
a b a c b b b d b c c c c b b b c b b c c b b d d c c c c b a c b b a
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.
Conversion of convertible bonds. Conversion of convertible bonds. Exercise of stock purchase rights. Conversion of convertible bonds. Amortization of bond discount. Unamortized bond discount related to converted bonds. Conversion of convertible bonds. Conversion of convertible preferred stock. Bonds issued with detachable stock warrants. Bonds issued with detachable stock warrants. 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. Exercise of stock purchase rights. Bonds issued with detachable stock warrants. Bonds issued with detachable stock warrants. Recording paid-in capital from stock warrants. Determine compensation expense in a stock option plan. Determine compensation expense in a stock option plan. Impact of stock options on net income. Determine compensation expense in a stock option plan. Determine compensation expense in a stock option plan. Determine compensation expense in a stock option plan. Determine paid-in capital amount in a stock option plan. Determine compensation expense in a stock option plan. Net income effect in a stock option plan. Determine compensation expense in a stock option plan. Impact of stock options on stockholders’ equity. Determine compensation expense in a stock option plan. Determine compensation expense in a stock option plan. Issuance of treasury stock in a stock option plan. Compensation expense recognized in first year in an SAR plan. Compensation expense recognized in second year in an SAR plan. Compensation expense recognized in third year in an SAR plan.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. *This topic is dealt with in an Appendix to the chapter. S
Dilutive Securities and Earnings per Share
MULTIPLE CHOICE—Dilutive Securities, CPA Adapted Answer
No.
Description
d a c c
78. 79. 80. *81.
Cash proceeds from issuance of convertible bonds. Bond issue with detachable stock warrants. Compensation expense in a stock option plan. Compensation expense recognized in an SAR plan.
MULTIPLE CHOICE—Earnings Per Share, Conceptual Answer
No.
Description
c d d c b b d b a d a b d d
82. 83. 84. 85. S 86. P 87. 88. 89. 90. 91. 92. 93. 94. *95.
Simple capital structure. Computing EPS for a simple capital structure. Computation of weighted-average shares outstanding. Effect of treasury stock on EPS. Reporting EPS by companies. Diluted EPS and conversion of bonds. Diluted EPS. Dilutive convertible securities. Cumulative convertible preferred stock income adjustment. Treasury stock method. Treasury stock method. Treasury stock method. Antidilutive securities. EPS calculation with two dilutive convertible securities.
MULTIPLE CHOICE—Earnings Per Share, Computational Answer
No.
Description
c c b b c a c c d b b c d c d c c b c b b d
96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117.
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. Basic EPS with convertible preferred stock. EPS and a stock split. Weighted average number of common shares outstanding. Diluted EPS and the treasury stock method. Diluted EPS with convertible bonds. Diluted EPS and contingent issuances. Basic EPS. Diluted EPS with convertible bonds and preferred stock. Number of shares in computing diluted EPS. Diluted EPS. EPS and contingent issuances. 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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Earnings Per Share, Computational (cont.) Answer
No.
Description
c b b b c a c b c d
118. 119. 120. 121. 122. 123. 124. 125. 126. 127.
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. 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.
MULTIPLE CHOICE—Earnings Per Share, CPA Adapted Answer
No.
Description
b b d b b d a
128. 129. 130. 131. 132. 133. 134.
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. "If converted" method.
EXERCISES Item E16-135 E16-136 E16-137 E16-138 E16-139 E16-140 E16-141 E16-142 *E16-143
Description Convertible bonds. Convertible bonds (essay). Convertible debt and debt with warrants (essay). Stock options. Weighted average shares outstanding. Earnings per share (essay). Earnings per share. Diluted earnings per share. Stock appreciation rights.
PROBLEMS Item P16-144 P16-145 P16-146 P16-147 P16-148
Description Convertible bonds and stock warrants. Earnings per share. Basic and diluted earnings per share. Basic and diluted earnings per share. Basic and diluted earnings per share.
Dilutive Securities and Earnings per Share
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CHAPTER LEARNING OBJECTIVES 1.
Describe the accounting for the issuance, conversion, and retirement of convertible securities.
2.
Explain the accounting for convertible preferred stock.
3.
Contrast the accounting for stock warrants and stock warrants issued with other securities.
4.
Describe the accounting for stock compensation plans under generally accepted accounting principles.
5.
Discuss the controversy involving stock compensation plans.
6.
Compute earnings per share in a simple capital structure.
7.
Compute earnings per share in a complex capital structure.
*8.
Explain the accounting for stock-appreciation rights plans.
*9.
Compute earnings per share in a complex situation.
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Test Bank for Intermediate Accounting, Fourteenth Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2. 3.
TF TF TF
21. 22. 23.
MC MC MC
S S
24. 25. 43.
4.
TF
5.
TF
S
26.
6. 7. 8. 28.
TF TF TF MC
29. 30. P 31. P 32.
MC MC MC MC
S
33. 51. 52. 53.
9. 10. 11. 12.
TF TF TF TF
S
34. 35. 36. 37.
MC MC MC MC
13. 14. 15. 16.
TF TF TF TF
82. 83. 84. 85.
MC MC MC MC
S
17. 18. 19. 20. P 87. 88. 89.
TF TF TF TF MC MC MC
90. 91. 92. 93. 94. 104. 105.
MC MC MC MC MC MC MC
106. 107. 108. 109. 110. 111. 112.
39. 40.
MC MC
41. 42.
MC MC
75. 76.
95.
MC
38. 61. 62. 63.
Note: TF = True-False MC = Multiple Choice E = Exercise P = Problem
86. 96. 97. 98.
Type
Item
Type
Item
Learning Objective 1 MC 44. MC 47. MC 45. MC 48. MC 46. MC 49. Learning Objective 2 MC 27. MC 50. Learning Objective 3 MC 54. MC 58. MC 55. MC 59. MC 56. MC 60. MC 57. MC 79. Learning Objective 4 MC 64. MC 68. MC 65. MC 69. MC 66. MC 70. MC 67. MC 71. Learning Objective 6 MC 99. MC 103. MC 100. MC 128. MC 101. MC 129. MC 102. MC 130. Learning Objective 7 MC 113. MC 120. MC 114. MC 121. MC 115. MC 122. MC 116. MC 123. MC 117. MC 124. MC 118. MC 125. MC 119. MC 126. Learning Objective 8* MC 77. MC 143. MC 81. MC Learning Objective 9*
Type
Item
Type
Item
Type
MC MC MC
78. 135. 136.
MC E E
144.
P
MC MC MC MC
137. 144.
E P
MC MC MC MC
72. 73. 74. 80.
MC MC MC MC
138.
E
MC MC MC MC
139. 140. 146. 147.
E E P P
MC MC MC MC MC MC MC
127. 131. 132. 133. 134. 140. 141.
MC MC MC MC MC E E
142. 145. 146. 147. 148.
E P P P P
MC
E
Dilutive Securities and Earnings per Share
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TRUE-FALSE—Conceptual 1.
The recording of convertible bonds at the date of issue is the same as the recording of straight debt issues.
2.
Companies recognize the gain or loss on retiring convertible debt as an extraordinary item.
3.
The FASB states that when an issuer makes an additional payment to encourage conversion, the payment should be reported as an expense.
4.
The market value method is used to account for the exercise of convertible preferred stock.
5.
Companies recognize a gain or loss when stockholders exercise convertible preferred stock.
6.
A company should allocate the proceeds from the sale of debt with detachable stock warrants between the two securities based on their market values.
7.
Nondetachable warrants, as with detachable warrants, require an allocation of the proceeds between the bonds and the warrants.
8.
The intrinsic value of a stock option is the difference between the market price of the stock and the exercise price of the options at the grant date.
9.
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.
If preferred stock is cumulative and no dividends are declared, the company subtracts the current year preferred dividend in computing earnings per share.
14.
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.
15.
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.
16.
Preferred dividends are subtracted from net income but not income before extraordinary items in computing earnings per share.
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Test Bank for Intermediate Accounting, Fourteenth Edition
17.
When a company has a complex capital structure, it must report both basic and diluted earnings per share.
18.
In computing diluted earnings per share, stock options are considered dilutive when their option price is greater than the market price.
19.
In a contingent issue agreement, the contingent shares are considered outstanding for computing diluted EPS when the earnings or market price level is met by the end of the year.
20.
A company should report per share amounts for income before extraordinary items, but not for income from continuing operations.
True-False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. T F T F F
Item 6. 7. 8. 9. 10.
Ans. T F T F T
Item 11. 12. 13. 14. 15.
Ans. F F T F T
Item 16. 17. 18. 19. 20.
Ans. F T F T F
MULTIPLE CHOICE—Dilutive Securities, Conceptual
S
21.
Convertible bonds a. have priority over other indebtedness. b. are usually secured by a first or second mortgage. c. pay interest only in the event earnings are sufficient to cover the interest. d. may be exchanged for equity securities.
22.
The conversion of bonds is most commonly recorded by the a. incremental method. b. proportional method. c. market value method. d. book value method.
23.
When a bond issuer offers some form of additional consideration (a “sweetener”) to induce conversion, the sweetener is accounted for as a(n) a. extraordinary item. b. expense. c. loss. d. none of these.
24.
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.
Dilutive Securities and Earnings per Share
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S
25.
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.
S
26.
The conversion of preferred stock into common requires that any excess of the par value of the common shares issued over the carrying amount of the preferred being converted 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 a direct reduction of retained earnings.
27.
The conversion of preferred stock may be recorded by the a. incremental method. b. book value method. c. market value method. d. par value method.
28.
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.
29.
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.
30.
Stock warrants outstanding should be classified as a. liabilities. b. reductions of capital contributed in excess of par value. c. assets. d. none of these.
31.
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.
P
16 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition P
32.
The distribution of stock rights to existing common stockholders will increase paid-in capital at the
a. b. c. d.
Date of Issuance of the Rights Yes Yes No No
Date of Exercise of the Rights Yes No Yes No
S
33.
The major difference between convertible debt and stock warrants is that upon exercise of the warrants a. the stock is held by the company for a defined period of time before they are issued to the warrant holder. b. the holder has to pay a certain amount of cash to obtain the shares. c. the stock involved is restricted and can only be sold by the recipient after a set period of time. d. no paid-in capital in excess of par can be a part of the transaction.
S
34.
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.
35.
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.
36.
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.
37.
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.
38.
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.
Dilutive Securities and Earnings per Share
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*39.
Under the intrinsic value method, compensation expense resulting from an incentive stock option is generally a. not recognized because no excess of market price over the option price exists at the date of grant. b. recognized in the period of the grant. c. allocated to the periods benefited by the employee's required service. d. recognized in the period of exercise.
*40.
For stock appreciation rights, the measurement date for computing compensation is the date a. the rights mature. b. the stock’s price reaches a predetermined amount. c. of grant. d. of exercise.
*41.
An executive pays no taxes at time of exercise in a(an) a. stock appreciation rights plan. b. incentive stock option plan. c. nonqualified stock option plan. d. Taxes would be paid in all of these.
*42.
A company estimates the fair value of SARs, using an option-pricing model, for a. share-based equity awards. b. share-based liability awards. c. both equity awards and liability awards. d. neither equity awards or liability awards.
Multiple Choice Answers—Dilutive Securities, Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24.
d d b c
25. 26. 27. 28.
a d b d
29. 30. 31. 32.
d d d c
33. 34. 35. 36.
b c a c
37. 38. *39. *40.
a d c d
*41. *42.
b b
Solutions to those Multiple Choice questions for which the answer is “none of these.” 30. additions to contributed capital.
MULTIPLE CHOICE—Dilutive Securities, Computational 43.
Fogel Co. has $5,000,000 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, 2012, the holders of $1,600,000 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 $350,000. Fogel should record, as a result of this conversion, a a. credit of $272,000 to Paid-in Capital in Excess of Par. b. credit of $240,000 to Paid-in Capital in Excess of Par. c. credit of $112,000 to Premium on Bonds Payable. d. loss of $16,000.
16 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition 44.
On July 1, 2012, an interest payment date, $80,000 of Parks Co. bonds were converted into 1,600 shares of Parks Co. common stock each having a par value of $45 and a market value of $54. There is $3,200 unamortized discount on the bonds. Using the book value method, Parks would record a. no change in paid-in capital in excess of par. b. a $4,800 increase in paid-in capital in excess of par. c. a $9,600 increase in paid-in capital in excess of par. d. a $6,400 increase in paid-in capital in excess of par.
45.
Morgan Corporation had two issues of securities outstanding: common stock and an 8% convertible bond issue in the face amount of $20,000,000. Interest payment dates of the bond issue are June 30th and December 31st. The conversion clause in the bond indenture entitles the bondholders to receive forty shares of $20 par value common stock in exchange for each $1,000 bond. On June 30, 2012, the holders of $3,000,000 face value bonds exercised the conversion privilege. The market price of the bonds on that date was $1,100 per bond and the market price of the common stock was $35. The total unamortized bond discount at the date of conversion was $1,250,000. In applying the book value method, what amount should Morgan credit to the account "paid-in capital in excess of par," as a result of this conversion? a. $412,500. b. $200,000. c. $1,800,000. d. $900,000.
Use the following information for questions 46 through 48. Chang Corporation issued $6,000,000 of 9%, ten-year convertible bonds on July 1, 2012 at 96.1 plus accrued interest. The bonds were dated April 1, 2010 with interest payable April 1 and October 1. Bond discount is amortized semiannually on a straight-line basis. On April 1, 2013, $1,200,000 of these bonds were converted into 500 shares of $20 par value common stock. Accrued interest was paid in cash at the time of conversion. 46.
If "interest payable" were credited when the bonds were issued, what should be the amount of the debit to "interest expense" on October 1, 2012? a. $129,000. b. $135,200. c. $141,000. d. $270,000.
47.
What should be the amount of the unamortized bond discount on April 1, 2013 relating to the bonds converted? a. $46,800. b. $43,200. c. $23,400. d. $44,400.
48.
What was the effective interest rate on the bonds when they were issued? a. 9% b. Above 9% c. Below 9% d. Cannot determine from the information given.
Dilutive Securities and Earnings per Share
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49.
Litke Corporation issued at a premium of $5,000 a $100,000 bond issue convertible into 2,000 shares of common stock (par value $25). At the time of the conversion, the unamortized premium is $2,000, the market value of the bonds is $110,000, and the stock is quoted on the market at $60 per share. If the bonds are converted into common, what is the amount of paid-in capital in excess of par to be recorded on the conversion of the bonds? a. $55,000 b. $52,000 c. $62,000 d. $70,000
50.
In 2012, Eklund, Inc., issued for $103 per share, 80,000 shares of $100 par value convertible preferred stock. One share of preferred stock can be converted into three shares of Eklund's $25 par value common stock at the option of the preferred stockholder. In August 2013, all of the preferred stock was converted into common stock. The market value of the common stock at the date of the conversion was $30 per share. What total amount should be credited to additional paid-in capital from common stock as a result of the conversion of the preferred stock into common stock? a. $1,360,000. b. $1,040,000. c. $2,000,000. d. $2,240,000.
51.
On December 1, 2012, Lester Company issued at 103, four hundred of its 9%, $1,000 bonds. Attached to each bond was one detachable stock warrant entitling the holder to purchase 10 shares of Lester's common stock. On December 1, 2012, 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. $387,280. b. $391,400. c. $400,000. d. $412,000.
52.
On March 1, 2012, Ruiz Corporation issued $1,000,000 of 8% nonconvertible bonds at 104, which are due on February 28, 2032. In addition, each $1,000 bond was issued with 25 detachable stock warrants, each of which entitled the bondholder to purchase for $50 one share of Ruiz common stock, par value $25. The bonds without the warrants would normally sell at 95. On March 1, 2012, the fair value of Ruiz’s common stock was $40 per share and the fair value of the warrants was $2.00. What amount should Ruiz record on March 1, 2010 as paid-in capital from stock warrants? a. $36,800 b. $42,600 c. $52,600 d. $50,000
16 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition 53.
During 2012, Gordon Company issued at 104 five hundred, $1,000 bonds due in ten years. One detachable stock warrant entitling the holder to purchase 15 shares of Gordon’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 Gordon’s stockholders' equity? a. $0 b. $20,000 c. $20,800 d. $19,760
54.
On April 7, 2012, Kegin Corporation sold a $3,000,000, twenty-year, 8 percent bond issue for $3,180,000. Each $1,000 bond has two detachable warrants, each of which permits the purchase of one share of the corporation's common stock for $30. The stock has a par value of $25 per share. Immediately after the sale of the bonds, the corporation's securities had the following market values: 8% bond without warrants Warrants Common stock
$1,008 21 28
What accounts should Kegin credit to record the sale of the bonds? a. Bonds Payable $3,000,000 Premium on Bonds Payable 116,400 Paid-in Capital—Stock Warrants 63,600 b. Bonds Payable $3,000,000 Premium on Bonds Payable 24,000 Paid-in Capital—Stock Warrants 126,000 c. Bonds Payable $3,000,000 Premium on Bonds Payable 52,800 Paid-in Capital—Stock Warrants 127,200 d. Bonds Payable $3,000,000 Premiums on Bonds Payable 180,000 Use the following information for questions 55 and 56. On May 1, 2012, Payne Co. issued $500,000 of 7% bonds at 103, which are due on April 30, 2022. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Payne’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, 2012, the fair value of Payne’s common stock was $35 per share and of the warrants was $2. 55.
On May 1, 2012, Payne should credit Paid-in Capital from Stock Warrants for a. $19,200. b. $20,000. c. $20,600. d. $35,000.
56.
On May 1, 2012, Payne should record the bonds with a a. discount of $20,000. b. discount of $5,600. c. discount of $5,000. d. premium of $15,000.
Dilutive Securities and Earnings per Share
16 - 15
57.
On July 4, 2012, Chen Company issued for $6,300,000 a total of 60,000 shares of $100 par value, 7% noncumulative preferred stock along with one detachable warrant for each share issued. Each warrant contains a right to purchase one share of Chen $10 par value common stock for $15 per share. The stock without the warrants would normally sell for $6,150,000. The market price of the rights on July 1, 2012, was $2.50 per right. On October 31, 2012, when the market price of the common stock was $19 per share and the market value of the rights was $3.00 per right, 24,000 rights were exercised. As a result of the exercise of the 24,000 rights and the issuance of the related common stock, what journal entry would Chen make? a. Cash ................................................................................... 360,000 Common Stock ....................................................... 240,000 Paid-in Capital in Excess of Par ............................. 120,000 b. Cash ................................................................................... 360,000 Paid-in Capital—Stock Warrants ........................................ 60,000 Common Stock ....................................................... 240,000 Paid-in Capital in Excess of Par ............................. 180,000 c. Cash ................................................................................... 360,000 Paid-in Capital—Stock Warrants ........................................ 150,000 Common Stock ....................................................... 240,000 Paid-in Capital in Excess of Par ............................. 270,000 d. Cash ................................................................................... 360,000 Paid-in Capital—Stock Warrants ........................................ 90,000 Common Stock ....................................................... 240,000 Paid-in Capital in Excess of Par ............................. 210,000
58.
Vernon 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 4,000, $1,000 bonds with the warrants attached was $410,000. The market price of the Vernon bonds without the warrants was $360,000, and the market price of the warrants without the bonds was $40,000. What amount should be allocated to the warrants? a. $40,000 b. $41,000 c. $48,000 d. $50,000
Use the following information for questions 59 and 60. On May 1, 2012, Marly Co. issued $1,000,000 of 7% bonds at 103, which are due on April 30, 2022. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Marly’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, 2012, the fair value of Marly’s common stock was $35 per share and of the warrants was $2. 59.
On May 1, 2012, Marly should record the bonds with a a. discount of $40,000. b. discount of $10,000. c. discount of $11,200. d. premium of $30,000.
16 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition 60.
On May 1, 2012, Marly should credit Paid-in Capital from Stock Warrants for a. $70,000 b. $41,200 c. $40,000 d. $38,400
61.
On July 1, 2012, Ellison Company granted Sam Wine, an employee, an option to buy 600 shares of Ellison Co. stock for $30 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $2,700. Wine exercised his option on October 1, 2012 and sold his 600 shares on December 1, 2012. Quoted market prices of Ellison Co. stock in 2012 were: July 1 $30 per share October 1 $36 per share December 1 $40 per share The service period is for three years beginning January 1, 2012. As a result of the option granted to Wine, using the fair value method, Ellison should recognize compensation expense on its books in the amount of a. $2,700. b. $900. c. $675. d. $0.
62.
On January 1, 2012, Trent Company granted Dick Williams, an employee, an option to buy 300 shares of Trent Co. stock for $30 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $2,700. Williams exercised his option on September 1, 2012, and sold his 300 shares on December 1, 2012. Quoted market prices of Trent Co. stock during 2012 were: January 1 $30 per share September 1 $36 per share December 1 $40 per share The service period is for two years beginning January 1,2012. As a result of the option granted to Williams, using the fair value method, Trent should recognize compensation expense for 2012 on its books in the amount of a. $3,000. b. $2,700. c. $1,350. d. $0.
63.
On December 31, 2012, Gonzalez Company granted some of its executives options to purchase 120,000 shares of the company’s $10 par common stock at an option price of $50 per share. The Black-Scholes option pricing model determines total compensation expense to be $900,000. The options become exercisable on January 1, 2013, and represent compensation for executives’ services over a three-year period beginning January 1, 2013. At December 31, 2013 none of the executives had exercised their options. What is the impact on Gonzalez’s net income for the year ended December 31, 2013 as a result of this transaction under the fair value method? a. $300,000 increase. b. $900,000 decrease. c. $300,000 decrease. d. $0.
Dilutive Securities and Earnings per Share 64.
16 - 17
On January 1, 2013 Reese Company granted Jack Buchanan, an employee, an option to buy 200 shares of Reese Co. stock for $40 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $2,400. Buchanan exercised his option on September 1, 2013, and sold his 100 shares on December 1, 2013. Quoted market prices of Reese Co. stock during 2013 were: January 1 $40 per share September 1 $48 per share December 1 $54 per share The service period is for two years beginning January 1, 2013. As a result of the option granted to Buchanan, using the fair value method, Reese should recognize compensation expense for 2013 on its books in the amount of a. $0. b. $1,200. c. $2,400 d. $2,800
65.
On June 30, 2012, Yang Corporation granted compensatory stock options for 30,000 shares of its $24 par value common stock to certain of its key employees. The market price of the common stock on that date was $31 per share and the option price was $28. Using a fair value option pricing model, total compensation expense is determined to be $96,000. The options are exercisable beginning January 1, 2014, providing those key employees are still in the employ of the company at the time the options are exercised. The options expire on June 30, 2015. On January 4, 2014, when the market price of the stock was $36 per share, all options for the 30,000 shares were exercised. The service period is for two years beginning January 1, 2012. Using the fair value method, what should be the amount of compensation expense recorded by Yang Corporation for these options on December 31, 2012? a. $96,000 b. $48,000 c. $22,500 d. $0
66.
In order to retain certain key executives, Smiley Corporation granted them incentive stock options on December 31, 2011. 100,000 options were granted at an option price of $35 per share. Market prices of the stock were as follows: December 31, 2012 $46 per share December 31, 2013 51 per share The options were granted as compensation for executives’ services to be rendered over a two-year period beginning January 1, 2012. The Black-Scholes option pricing model determines total compensation expense to be $1,000,000. What amount of compensation expense should Smiley recognize as a result of this plan for the year ended December 31, 2012 under the fair value method? a. $1,750,000. b. $1,100,000. c. $1,000,000. d. $500,000.
16 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 67.
On January 1, 2013, Ritter Company granted stock options to officers and key employees for the purchase of 20,000 shares of the company's $1 par common stock at $20 per share as additional compensation for services to be rendered over the next three years. The options are exercisable during a five-year period beginning January 1, 2016 by grantees still employed by Ritter. The Black-Scholes option pricing model determines total compensation expense to be $180,000. The market price of common stock was $26 per share at the date of grant. The journal entry to record the compensation expense related to these options for 2013 would include a credit to the Paid-in Capital—Stock Options account for a. $0. b. $36,000. c. $40,000. d. $60,000.
68.
On January 1, 2013, Evans Company granted Tim Telfer, an employee, an option to buy 2,000 shares of Evans Co. stock for $25 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $15,000. Telfer exercised his option on September 1, 2013, and sold his 1,000 shares on December 1, 2013. Quoted market prices of Evans Co. stock during 2013 were January 1 $25 per share September 1 $30 per share December 1 $34 per share The service period is for three years beginning January 1, 2013. As a result of the option granted to Telfer, using the fair value method, Evans should recognize compensation expense for 2013 on its books in the amount of a. $18,000. b. $15,000. c. $5,000. d. $3,000.
69.
On December 31, 2012, Kessler Company granted some of its executives options to purchase 75,000 shares of the company's $10 par common stock at an option price of $50 per share. The options become exercisable on January 1, 2013, and represent compensation for executives' services over a three-year period beginning January 1, 2013. The Black-Scholes option pricing model determines total compensation expense to be $450,000. At December 31, 2013, none of the executives had exercised their options. What is the impact on Kessler's net income for the year ended December 31, 2013 as a result of this transaction under the fair value method? a. $150,000 increase b. $0 c. $150,000 decrease d. $450,000 decrease
Dilutive Securities and Earnings per Share 70.
16 - 19
Weiser Corp. on January 1, 2009, 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 $360,000. The options are exercisable beginning January 1, 2012, provided those key employees are still in Weiser’s employ at the time the options are exercised. The options expire on January 1, 2013. On January 1, 2012, when the market price of the stock was $29 per share, all 40,000 options were exercised. The amount of compensation expense Weiser should record for 2009 under the fair value method is a. $0. b. $60,000. c. $120,000. d. $180,000.
71.
On December 31, 2012, Houser Company granted some of its executives options to purchase 75,000 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 $1,500,000. The options become exercisable on January 1, 2013, and represent compensation for executives' past and future services over a three-year period beginning January 1, 2013. What is the impact on Houser's total stockholders' equity for the year ended December 31, 2012, as a result of this transaction under the fair value method? a. $1,500,000 decrease b. $500,000 decrease c. $0 d. $500,000 increase
72.
On June 30, 2012, Norman Corporation granted compensatory stock options for 40,000 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 $480,000. The options are exercisable beginning January 1, 2013, provided those key employees are still in Norman’s employ at the time the options are exercised. The options expire on June 30, 2014. On January 4, 2013, when the market price of the stock was $42 per share, all 40,000 options were exercised. What should be the amount of compensation expense recorded by Norman Corporation for the calendar year 2012 using the fair value method? a. $0. b. $192,000. c. $240,000. d. $480,000.
16 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 73.
In order to retain certain key executives, Jensen Corporation granted them incentive stock options on December 31, 2011. 70,000 options were granted at an option price of $35 per share. Market prices of the stock were as follows: December 31, 2012 December 31, 2013
$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, 2012. The Black-Scholes option pricing model determines total compensation expense to be $700,000. What amount of compensation expense should Jensen recognize as a result of this plan for the year ended December 31, 2012 under the fair value method? a. $350,000. b. $700,000. c. $550,000. d. $1,750,000. 74.
Grant, Inc. had 50,000 shares of treasury stock ($10 par value) at December 31, 2012, which it acquired at $11 per share. On June 4, 2013, Grant issued 25,000 treasury shares to employees who exercised options under Grant's employee stock option plan. The market value per share was $13 at December 31, 2012, $15 at June 4, 2013, and $18 at December 31, 2013. The stock options had been granted for $12 per share. The cost method is used. What is the balance of the treasury stock on Grant's balance sheet at December 31, 2013? a. $175,000. b. $225,000. c. $275,000. d. $300,000.
Use the following information for questions 75 through 77. On January 1, 2012, Korsak, Inc. established a stock appreciation rights plan for its executives. It entitled them to receive cash at any time during the next four years for the difference between the market price of its common stock and a pre-established price of $20 on 80,000 SARs. Current market prices of the stock are as follows: January 1, 2012 December 31, 2012 December 31, 2013 December 31, 2014
$35 per share 38 per share 30 per share 33 per share
Compensation expense relating to the plan is to be recorded over a four-year period beginning January 1, 2012. *75.
What amount of compensation expense should Korsak recognize for the year ended December 31, 2012? a. $240,000 b. $360,000 c. $300,000 d. $1,440,000
Dilutive Securities and Earnings per Share
16 - 21
*76.
What amount of compensation expense should Korsak recognize for the year ended December 31, 2013? a. $0 b. $40,000 c. $400,000 d. $200,000
*77.
On December 31, 2014, 16,000 SARs are exercised by executives. What amount of compensation expense should Korsak recognize for the year ended December 31, 2014? a. $380,000 b. $260,000 c. $780,000 d. $104,000
Multiple Choice Answers—Dilutive Securities, Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
43. 44. 45. 46. 47.
a b a c b
48. 49. 50. 51. 52.
b b d b c
53. 54. 55. 56. 57.
c c c b b
58. 59. 60. 61. 62.
b c b b c
63. 64. 65. 66. 67.
c b b d d
68. 69. 70. 71. 72.
c c c c b
73. 74. *75. *76. *77.
a c b b a
MULTIPLE CHOICE—Dilutive Securities, CPA Adapted 78.
On January 2, 2012, Farr Co. issued 10-year convertible bonds at 105. During 2012, 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 Farr’s common stock was 50 percent above its par value. On January 2, 2012, 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.
79.
Lang 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.
16 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 80.
On January 1, 2012, Sharp Corp. granted an employee an option to purchase 9,000 shares of Sharp's $5 par value common stock at $20 per share. The Black-Scholes option pricing model determines total compensation expense to be $210,000. The option became exercisable on December 31, 2013, after the employee completed two years of service. The market prices of Sharp's stock were as follows: January 1, 2012 December 31, 2013
$30 50
For 2011, should recognize compensation expense under the fair value method of a. $135,000. b. $45,000. c. $105,000. d. $0. *81.
On January 2, 2012, for past services, Rosen Corp. granted Nenn Pine, its president, 20,000 stock appreciation rights that are exercisable immediately and expire on January 2, 2013. On exercise, Nenn is entitled to receive cash for the excess of the market price of the stock on the exercise date over the market price on the grant date. Nenn did not exercise any of the rights during 2012. The market price of Rosen's stock was $30 on January 2, 2012, and $45 on December 31, 2012. As a result of the stock appreciation rights, Rosen should recognize compensation expense for 2012 of a. $0. b. $120,000. c. $300,000. d. $600,000.
Multiple Choice Answers—Dilutive Securities, CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
78.
d
79.
a
80.
c
*81.
c
MULTIPLE CHOICE—Earnings Per Share—Conceptual 82.
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
83.
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.
Dilutive Securities and Earnings per Share
16 - 23
84.
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.
85.
What effect will the acquisition of treasury stock have on stockholders' equity and earnings per share, respectively? a. Decrease and no effect b. Increase and no effect c. Decrease and increase d. Increase and decrease
S
86.
Due to the importance of earnings per share information, it is required to be reported by all Public Companies Nonpublic Companies a. Yes Yes b. Yes No c. No No d. No Yes
P
87.
A convertible bond issue should be included in the diluted earnings per share computation as if the bonds had been converted into common stock, if the effect of its inclusion is a. b. c. d.
Dilutive Yes Yes No No
Antidilutive Yes No Yes No
88.
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.
89.
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.
90.
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
16 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition 91.
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.
92.
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.
93.
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.
94.
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.
*95.
Assume there are two dilutive convertible securities. The one that should be used first to recalculate earnings per share is the security with the a. greater earnings adjustment. b. greater earnings per share adjustment. c. smaller earnings adjustment. d. smaller earnings per share adjustment.
Multiple Choice Answers—Earnings Per Share—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
82. 83.
c d
84. 85.
d c
86. 87.
b b
88. 89.
d b
90. 91.
a d
92. 93.
a b
94. *95.
d d
Solution to Multiple Choice question for which the answer is “none of these.” 83.
annual preferred dividend.
Dilutive Securities and Earnings per Share
16 - 25
MULTIPLE CHOICE—Earnings Per Share—Computational 96.
Hill 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 $1,680,000 for the year ending December 31, 2012. Earnings per share of common stock for 2012 would be a. $2.80. b. $1.33. c. $1.60. d. $1.87.
97.
At December 31, 2012, Hancock 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, 2012. Net income for the year ended December 31, 2012, was $1,530,000. What should be Hancock's 2012 earnings per common share, rounded to the nearest penny? a. $3.03 b. $3.82 c. $3.60 d. $3.40
98.
Milo Co. had 800,000 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. 851,000. b. 872,000. c. 893,000. d. 914,000.
99.
On January 1, 2013, Gridley Corporation had 187,500 shares of its $2 par value common stock outstanding. On March 1, Gridley sold an additional 375,000 shares on the open market at $20 per share. Gridley issued a 20% stock dividend on May 1. On August 1, Gridley purchased 210,000 shares and immediately retired the stock. On November 1, 300,000 shares were sold for $25 per share. What is the weighted-average number of shares outstanding for 2013? a. 765,000 b. 562,500 c. 358,333 d. 258,333
100.
The following information is available for Barone Corporation: January 1, 2013 April 1, 2013 July 1, 2013 October 1, 2013
Shares outstanding Shares issued Treasury shares purchased Shares issued in a 100% stock dividend
1,500,000 240,000 90,000 1,650,000
The number of shares to be used in computing earnings per common share for 2013 is a. 3,390,600. b. 3,285,000. c. 3,270,000. d. 2,047,500.
16 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition 101.
At December 31, 2012 Rice Company had 300,000 shares of common stock and 10,000 shares of 6%, $100 par value cumulative preferred stock outstanding. No dividends were declared on either the preferred or common stock in 2012 or 2013. On January 30, 2014, prior to the issuance of its financial statements for the year ended December 31, 2013, Rice declared a 100% stock dividend on its common stock. Net income for 2013 was $1,140,000. In its 2013 financial statements, Rice's 2013 earnings per common share should be a. $1.80. b. $1.89. c. $3.60. d. $3.80.
102.
Fultz Company had 300,000 shares of common stock issued and outstanding at December 31, 2012. During 2013, no additional common stock was issued. On January 1, 2013, Fultz issued 400,000 shares of nonconvertible preferred stock. During 2013, Fultz declared and paid $210,000 cash dividends on the common stock and $175,000 on the nonconvertible preferred stock. Net income for the year ended December 31, 2013, was $1,120,000. What should be Fultz's 2013 earnings per common share, rounded to the nearest penny? a. $1.35 b. $2.45 c. $3.15 d. $3.73
103.
At December 31, 2012 Pine Company had 200,000 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 2012 or 2013. On February 10, 2014, prior to the issuance of its financial statements for the year ended December 31, 2013, Pine declared a 100% stock split on its common stock. Net income for 2013 was $900,000. In its 2013 financial statements, Pine’s 2013 earnings per common share should be a. $4.25. b. $4.00. c. $2.13. d. $1.25.
104.
Stine Inc. had 400,000 shares of common stock issued and outstanding at December 31, 2012. On July 1, 2013 an additional 400,000 shares were issued for cash. Stine also had stock options outstanding at the beginning and end of 2013 which allow the holders to purchase 120,000 shares of common stock at $28 per share. The average market price of Stine’s common stock was $35 during 2013. The number of shares to be used in computing diluted earnings per share for 2013 is a. 896,000 b. 824,000 c. 696,000 d. 624,000
Dilutive Securities and Earnings per Share
16 - 27
105.
Kasravi Co. had net income for 2013 of $400,000. The average number of shares outstanding for the period was 200,000 shares. The average number of shares under outstanding options, at an option price of $30 per share is 12,000 shares. The average market price of the common stock during the year was $36. What should Kasravi Co. report for diluted earnings per share for the year ended 2013? a. $2.00 b. $1.98 c. $1.90 d. $1.89
106.
On January 2, 2013, Worth Co. issued at par $1,000,000 of 7% convertible bonds. Each $1,000 bond is convertible into 20 shares of common stock. No bonds were converted during 2013. Worth had 200,000 shares of common stock outstanding during 2013. Worth’s 2013 net income was $300,000 and the income tax rate was 30%. Worth’s diluted earnings per share for 2013 would be (rounded to the nearest penny): a. $1.74. b. $1.59. c. $1.50. d. $1.68.
107.
Beaty Inc. purchased Dunbar Co. and agreed to give stockholders of Dunbar Co. 10,000 additional shares in 2014 if Dunbar Co.’s net income in 2013 is $500,000; in 2012 Dunbar Co.’s net income is $520,000. Beaty Inc. has net income for 2012 of $300,000 and has an average number of common shares outstanding for 2012 of 100,000 shares. What should Beaty report as diluted earnings per share for 2012? a. $3.33 b. $3.00 c. $2.73 d. $2.51
Use the following information for questions 108 and 109. Hanson Co. had 200,000 shares of common stock, 20,000 shares of convertible preferred stock, and $1,000,000 of 7.5% convertible bonds outstanding during 2013. The preferred stock is convertible into 40,000 shares of common stock. During 2013, Hanson paid dividends of $.90 per share on the common stock and $3 per share on the preferred stock. Each $1,000 bond is convertible into 45 shares of common stock. The net income for 2013 was $600,000 and the income tax rate was 30%. 108.
Basic earnings per share for 2013 is (rounded to the nearest penny) a. $2.20. b. $2.42. c. $2.51. d. $2.70.
109.
Diluted earnings per share for 2013 is (rounded to the nearest penny) a. $2.08. b. $2.11. c. $2.29. d. $2.50.
16 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition 110.
Fugate Company had 750,000 shares of common stock issued and outstanding at December 31, 2012. On July 1, 2013 an additional 750,000 shares were issued for cash. Fugate also had stock options outstanding at the beginning and end of 2013 which allow the holders to purchase 225,000 shares of common stock at $20 per share. The average market price of Fugate's common stock was $25 during 2013. What is the number of shares that should be used in computing diluted earnings per share for the year ended December 31, 2013? a. 1,545,000 b. 1,305,000 c. 1,181,250 d. 1,170,000
111.
Shipley Corporation had net income for the year of $600,000 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 ($2,500,000), 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. $2.06 b. $2.79. c. $2.94. d. $3.22.
112.
Colt Corporation purchased Massey Inc. and agreed to give stockholders of Massey Inc. 50,000 additional shares in 2014 if Massey Inc.’s net income in 2013 is $600,000 or more; in 2012 Massey Inc.’s net income is $615,000. Colt has net income for 2010 of $1,200,000 and has an average number of common shares outstanding for 2012 of 500,000 shares. What should Colt report as earnings per share for 2012?
a. b. c. d. 113.
Basic Earnings Per Share $2.40 $2.18 $2.40 $2.18
Diluted Earnings Per Share $2.40 $2.40 $2.18 $2.18
On January 2, 2012, Perez Co. issued at par $10,000 of 8% bonds convertible in total into 1,000 shares of Perez's common stock. No bonds were converted during 2012. Throughout 2012, Perez had 1,000 shares of common stock outstanding. Perez's 2012 net income was $4,000, and its income tax rate is 30%. No potentially dilutive securities other than the convertible bonds were outstanding during 2012. Perez's diluted earnings per share for 2012 would be (rounded to the nearest penny) a. $2.00. b. $2.28. c. $2.40. d. $4.56.
Dilutive Securities and Earnings per Share
16 - 29
114.
At December 31, 2012, Kifer Company had 600,000 shares of common stock outstanding. On October 1, 2013, an additional 120,000 shares of common stock were issued. In addition, Kifer had $10,000,000 of 6% convertible bonds outstanding at December 31, 2012, which are convertible into 270,000 shares of common stock. No bonds were converted into common stock in 2013. The net income for the year ended December 31, 2013, was $3,000,000. Assuming the income tax rate was 30%, the diluted earnings per share for the year ended December 31, 2013, should be (rounded to the nearest penny) a. $5.43. b. $4.00. c. $3.80. d. $3.33.
115.
On January 2, 2013, Mize Co. issued at par $300,000 of 9% convertible bonds. Each $1,000 bond is convertible into 60 shares. No bonds were converted during 2013. Mize had 100,000 shares of common stock outstanding during 2013. Mize 's 2013 net income was $160,000 and the income tax rate was 30%. Mize's diluted earnings per share for 2013 would be (rounded to the nearest penny) a. $1.36. b. $1.52. c. $1.60. d. $1.79.
116.
At December 31, 2012, Sager Co. had 1,200,000 shares of common stock outstanding. In addition, Sager had 450,000 shares of preferred stock which were convertible into 750,000 shares of common stock. During 2013, Sager paid $750,000 cash dividends on the common stock and $500,000 cash dividends on the preferred stock. Net income for 2013 was $4,250,000 and the income tax rate was 40%. The diluted earnings per share for 2013 is (rounded to the nearest penny) a. $1.55. b. $2.18. c. $3.14. d. $3.55.
Use the following information for questions 117 and 118. Lerner Co. had 200,000 shares of common stock, 20,000 shares of convertible preferred stock, and $1,500,000 of 10% convertible bonds outstanding during 2013. The preferred stock is convertible into 40,000 shares of common stock. During 2013, Lerner paid dividends of $1.35 per share on the common stock and $4.50 per share on the preferred stock. Each $1,000 bond is convertible into 45 shares of common stock. The net income for 2013 was $900,000 and the income tax rate was 30%. 117.
Basic earnings per share for 2013 is (rounded to the nearest penny) a. $3.32. b. $3.63. c. $3.76. d. $4.05.
118.
Diluted earnings per share for 2013 is (rounded to the nearest penny) a. $3.21. b. $3.37. c. $3.53. d. $3.69.
16 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition 119.
Yoder, Incorporated, has 4,200,000 shares of common stock outstanding on December 31, 2012. An additional 800,000 shares of common stock were issued on April 1, 2013, and 400,000 more on July 1, 2013. On October 1, 2013, Yoder 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 2013. What is the number of shares to be used in computing basic earnings per share and diluted earnings per share, respectively? a. 5,000,000 and 5,000,000 b. 5,000,000 and 5,100,000 c. 5,000,000 and 5,400,000 d. 5,400,000 and 6,200,000
120.
Nolte Co. has 4,800,000 shares of common stock outstanding on December 31, 2012. An additional 200,000 shares are issued on April 1, 2013, and 480,000 more on September 1. On October 1, Nolte 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, 2013 is a. 5,110,000 and 5,110,000. b. 5,110,000 and 5,170,000. c. 5,110,000 and 5,350,000. d. 5,880,000 and 5,320,000.
121.
At December 31, 2012, Tatum Company had 2,000,000 shares of common stock outstanding. On January 1, 2013, Tatum issued 500,000 shares of preferred stock which were convertible into 1,000,000 shares of common stock. During 2013, Tatum declared and paid $1,800,000 cash dividends on the common stock and $600,000 cash dividends on the preferred stock. Net income for the year ended December 31, 2013, was $6,000,000. Assuming an income tax rate of 30%, what should be diluted earnings per share for the year ended December 31, 2013? (Round to the nearest penny.) a. $1.80 b. $2.00 c. $3.00 d. $2.50
122.
At December 31, 2012, Emley Company had 1,200,000 shares of common stock outstanding. On September 1, 2013, an additional 400,000 shares of common stock were issued. In addition, Emley had $8,000,000 of 6% convertible bonds outstanding at December 31, 2012, which are convertible into 800,000 shares of common stock. No bonds were converted into common stock in 2013. The net income for the year ended December 31, 2013, was $3,000,000. Assuming the income tax rate was 30%, what should be the diluted earnings per share for the year ended December 31, 2013, rounded to the nearest penny? a. $1.41 b. $2.25 c. $1.56 d. $1.63
Dilutive Securities and Earnings per Share 123.
16 - 31
Grimm Company has 2,000,000 shares of common stock outstanding on December 31, 2012. An additional 150,000 shares of common stock were issued on July 1, 2013, and 300,000 more on October 1, 2013. On April 1, 2013, Grimm 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 2013. 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, 2013? a. 2,150,000 and 2,330,000 b. 2,150,000 and 2,150,000 c. 2,150,000 and 2,390,000 d. 2,450,000 and 2,630,000
Use the following information for questions 124 and 125. Information concerning the capital structure of Piper Corporation is as follows: December 31, 2013 2012 Common stock 150,000 shares 150,000 shares Convertible preferred stock 15,000 shares 15,000 shares 6% convertible bonds $2,400,000 $2,400,000 During 2013, Piper paid dividends of $0.80 per share on its common stock and $2.00 per share on its preferred stock. The preferred stock is convertible into 30,000 shares of common stock. The 6% convertible bonds are convertible into 75,000 shares of common stock. The net income for the year ended December 31, 2013, was $400,000. Assume that the income tax rate was 30%. 124.
What should be the basic earnings per share for the year ended December 31, 2013, rounded to the nearest penny? a. $1.77 b. $1.95 c. $2.47 d. $2.67
125.
What should be the diluted earnings per share for the year ended December 31, 2013, rounded to the nearest penny? a. $2.13 b. $1.96 c. $1.89 d. $1.57
126.
Warrants exercisable at $20 each to obtain 50,000 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. 50,000. b. 40,000. c. 10,000. d. 12,500.
16 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition 127.
Terry Corporation had 400,000 shares of common stock outstanding at December 31, 2012. 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 Terry's stock at an option price of $37 per share. The average market price of Terry's common stock for 2012 was $50. What is the number of shares that should be used in computing diluted earnings per share for the year ended December 31, 2012? a. 400,000 b. 431,622 c. 466,600 d. 423,400
Multiple Choice Answers—Earnings Per Share—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
96. 97. 98. 99. 100.
c c b b c
101. 102. 103. 104. 105.
a c c d b
106. 107. 108. 109. 110.
b c d c d
111. 112. 113. 114. 115.
c c b c b
116. 117. 118. 119. 120.
b d c b b
121. 122. 123. 124. 125.
b c a c b
126. 127.
c d
MULTIPLE CHOICE—Earnings Per Share—CPA Adapted 128.
Didde Co. had 300,000 shares of common stock issued and outstanding at December 31, 2012. No common stock was issued during 2013. On January 1, 2013, Didde issued 200,000 shares of nonconvertible preferred stock. During 2013, Didde declared and paid $150,000 cash dividends on the common stock and $120,000 on the preferred stock. Net income for the year ended December 31, 2013 was $930,000. What should be Didde's 2013 earnings per common share? a. $3.10 b. $2.70 c. $2.60 d. $2.20
129.
At December 31, 2013 and 2012, Miley Corp. had 180,000 shares of common stock and 10,000 shares of 6%, $100 par value cumulative preferred stock outstanding. No dividends were declared on either the preferred or common stock in 2013 or 2012. Net income for 2013 was $480,000. For 2013, earnings per common share amounted to a. $2.67. b. $2.33. c. $2.11. d. $2.00.
Dilutive Securities and Earnings per Share
16 - 33
130.
Marsh Co. had 2,400,000 shares of common stock outstanding on January 1 and December 31, 2013. In connection with the acquisition of a subsidiary company in June 2012, Marsh is required to issue 100,000 additional shares of its common stock on July 1, 2014, to the former owners of the subsidiary. Marsh paid $300,000 in preferred stock dividends in 2013, and reported net income of $5,100,000 for the year. Marsh's diluted earnings per share for 2013 should be a. $2.13. b. $2.04. c. $2.00. d. $1.92.
131.
Foyle, Inc., had 610,000 shares of common stock issued and outstanding at December 31, 2012. On July 1, 2013, an additional 40,000 shares of common stock were issued for cash. Foyle also had unexercised stock options to purchase 32,000 shares of common stock at $15 per share outstanding at the beginning and end of 2013. The average market price of Foyle's common stock was $20 during 2013. What is the number of shares that should be used in computing diluted earnings per share for the year ended December 31, 2013? a. 630,000 b. 638,000 c. 658,000 d. 662,000
132.
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.
133.
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.
134.
The if-converted method of computing earnings per share data assumes conversion of convertible securities as of the a. beginning of the earliest period reported (or at time of issuance, if later). b. beginning of the earliest period reported (regardless of time of issuance). c. middle of the earliest period reported (regardless of time of issuance). d. ending of the earliest period reported (regardless of time of issuance).
Multiple Choice Answers—Earnings Per Share—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
128.
b
129.
b
130.
d
131.
b
132.
b
133.
d
134.
a
16 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Dilutive Securities, Computational No.
Answer Derivation
43.
a
$1,600,000 + ($350,000 × .32) – (1,600 × 30 × $30) = $272,000.
44.
b
$80,000 – (1,600 × $45) – $3,200 = $4,800.
45.
a
($3,00,000 ÷ $1,000) × 40 × $20 = $2,400,000 (common stock) ($3,000,000 ÷ $20,000,000) × $1,250,000 = $187,500 (unamortized discount) $3,000,000 – $2,400,000 – $187,500 = $412,500.
46.
c
($6,000,000 – $5,766,000) ÷ 117 = $2,000/month ($6,000,000 × .09 × 3/12) + ($2,000 × 3) = $141,000.
47.
b
$234,000 ÷ 117 = $2,000/month $1,200,000 $234,000 – [($2,000 × 3) + ($2,000 × 6] × ————— = $43,200 $6,000,000
48.
b
Bonds issued at a discount, market rate > coupon rate.
49.
b
$100,000 + $2,000 – (2,000 × $25) = $52,000.
50.
d
$8,240,000 – (80,000 × 3 × $25) = $2,240,000.
51.
b
($400,000 × .95) + (400 × $50) = $400,000; $400,000 × 1.03 = $412,000 $380,000 ———— × $412,000 = $391,400. $400,000
52.
c
($1,000,000 × .95) + (1,000 × 25 × $2) = $1,000,000; $1,000,000 × 1.04 = $1,040,000 $50,000 ———— × $1,040,000 = $52,000. $1,000,000
53.
c
($500,000 × .96) + (500 × $40) = $500,000; $500,000 × 1.04 = $520,000 $20,000 ———— × $520,000 = $20,800. $500,000
54.
c
(3,000 × $1,008) + (6,000 × $21) = $3,150,000 $3,024,000 ————— × $3,180,000 = $3,052,800, bonds: $3,000,000 $3,150,000 $126,000 Premium: $52,800; ————— × $3,180,000 = $127,200. $3,150,000
Dilutive Securities and Earnings per Share
DERIVATIONS — Dilutive Securities, Computational (cont.) No. 55.
Answer Derivation c
($500,000 × .96) + (10,000 × $2) = $500,000; $500,000 × 1.03 = $515,000 $20,000 ———— × $515,000 = $20,600. $500,000 $480,000 × $515,000 = $5,600. $500,000
56.
b
$500,000 –
57.
b
Dr. Cash: 24,000 × $15 = $360,000 Dr. Paid-in Capital—Stock Warrants: $150,000 × 24/60 = $60,000 Cr. Common Stock: 24,000 × $10 = $240,000 Cr. Paid-in Capital in Excess of Par: ($5 + $2.50) × 24,000 = $180,000.
58.
b
[$40,000 ÷ ($40,000 + $360,000)] × $410,000 = $41,000.
59.
c
($1,000,000 .96) + (1,000 20 $2) = $1,000,000 ($480,000 $1,000,000) ($1,000,000 1.03) = $988,800 $1,000,000 – $988,800 = $11,200.
60.
b
500 20 $2 = $20,000 ($20,000 $500,000) $515,000 = $20,600.
61.
b
$2,700 3 = $900.
62.
c
$2,700 2 = 1,350.
63.
c
$900,000 3 = $300,000 decrease.
64.
b
$2,400 2 = $1,200.
65.
b
$96,000 2 = $48,000.
66.
d
$1,000,000 2 = $500,000.
67.
d
$180,000 ÷ 3 = $60,000.
68.
c
$15,000 ÷ 3 = $5,000.
69.
c
$450,000 ÷ 3 = $150,000.
70.
c
$360,000 ÷ 3 = $120,000/year.
16 - 35
16 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Dilutive Securities, Computational (cont.) No. 71.
Answer Derivation c
2
$1,500,000 – $1,500,000× = $500,000 increase (from the credit to Paid-in 3 Capital—Stock Options). Offset by $500,000 decrease (from the debit to Compensation Expense).
72.
b
12 $480,000× = $192,000. 30
73.
a
$700,000 ÷ 2 = $350,000.
74.
c
25,000 × $11 = $275,000.
*75.
b
($38 – $20) × 80,000 × .25 = $360,000.
*76.
b
($30 – $20) × 80,000 × .5 = $400,000 $400,000 – $360,000 = $40,000.
*77.
a
($33 – $20) × 80,000 × .75 = $780,000 $780,000 – $400,000 = $380,000.
DERIVATIONS — Dilutive Securities, CPA Adapted No.
Answer Derivation
78.
d
Conceptual.
79.
a
Conceptual.
80.
c
$210,000 ÷ 2 = $105,000.
*81.
c
($45 – $30) × 20,000 = $300,000.
DERIVATIONS — Earnings Per Share, Computational No. 96.
97.
Answer Derivation c
c
$1,680,000 ———————————— = $1.60. 6 600,000 + (900,000 × — ) 12 $1,530,000 ———————————— = $3.60. 3 400,000 + (100,000 × —- ) 12
Dilutive Securities and Earnings per Share
16 - 37
DERIVATIONS — Earnings Per Share, Computational (cont.) No.
Answer Derivation
98.
b
800,000 + (126,000 × 8/12) – (63,000 × 4/12) + (54,000 × 2/12) = 872,000.
99.
b
[(187,500 × 2 × 1.20) + (562,500 × 2 × 1.20) + (675,000 × 3) + (465,000 × 3) + (765,000 × 2)] ÷ 12 = 562,500.
100.
c
[(1,500,000 × 3 × 2) + (1,740,000 × 3 × 2) + (1,650,000 × 3 × 2) + (3,300,000 × 3)] ÷ 12 = 3,270,000.
101.
a
[$1,140,000 – (10,000 × $100 × .06)] ÷ (300,000 × 2) = $1.80.
102.
c
$1,120,000 – $175,000 —————————— = $3.15. 300,000
103.
c
[$900,000 – (10,000 $100 .05)] (200,000 2) = $2.13.
104
d
(400,000 6/12) + (800,000 6/12) + [((35 – 28) 35) 120,000] = 624,000.
105.
b
[($36 – $30) $36] 12,000 = 2,000 $400,000 (200,000 + 2,000) = $1.98.
106.
b
($1,000,000 $1,000) 20 = 20,000 $1,000,000 .07 (1 – .30) = $49,000 ($300,000 + $49,000) (200,000 + 20,000) = $1.59.
107.
c
Since $520,000 $500,000 include 10,000 shares in DEPS $300,000 (100,000 + 10,000) = $2.73.
108.
d
[$600,000 – (20,000 $3] 200,000 = $2.70.
109.
c
[$600,000 + ($1,000,000 .075 .7)] [200,000 + 40,000 + (1,000 45)] = $2.29.
110.
d
750,000 + (750,000 × 6/12) + [(25 – 20)/25 × 225,000] = 1,170,000.
111.
c
[$600,000 + ($2,500,000 × .07 × .60)] ÷ (200,000 + 40,000) = $2.94.
112.
c
Basis: Diluted:
113.
b
$1,200,000 ÷ 500,000 = $2.40. $1,200,000 ÷ (500,000 + 50,000) = $2.18
$4,000 + ($10,000 × .08 × .70) —————————————— = $2.28. 1,000 + 1,000
16 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Earnings Per Share, Computational (cont.) No.
Answer Derivation $3,000,000 + ($10,000,000 × .06 × .7) ————————————————— = $3.80. 3 600,000 + (120,000 × —- ) + 270,000 12
114.
c
115.
b
$160,000 + ($300,000 × .09 × .7) ————————————————— = $1.52. 100,000 + [($300,000 ÷ $1,000) × 60)]
116.
b
$4,250,000 —————————— = $2.18. 1,200,000 + 750,000
117.
d
$900,000 – (20,000 × $4.50) ————————————— = $4.05. 200,000
118.
c
$900,000 + ($1,500,000 × .10 × .7) ———————————————— = $3.53. 200,000 + 45,000 + 40,000
119.
b
4,200,000 + (800,000 × 9/12) + (400,000 × 6/12) = 5,000,000 (BEPS) 5,000,000 + (20,000 × 20 × 3/12) = 5,100,000 (DEPS).
120.
b
4,800,000 + (200,000 × 9/12) + (480,000 × 4/12) = 5,110,000. 5,110,000 + [($6,000,000 ÷ $1,000) × 40 × 3/12] = 5,170,000.
121.
b
$6,000,000 —————————— = $2.00. 2,000,000 + 1,000,000
122.
c
$3,000,000 + ($8,000,000 × .06 × .7) —————————————————— = $1.56. 1,200,000 + (400,000 4/12) + 800,000
123.
a
124.
c
2,000,000 + (150,000 × 6/12) + (300,000 × 3/12) = 2,150,000 2,150,000 + (6,000 × 40 × 9/12) = 2,330,000. $400,000 – (15,000 × $2.00) ————————————— = $2.47. 150,000
Dilutive Securities and Earnings per Share
16 - 39
DERIVATIONS — Earnings Per Share, Computational (cont.) No.
Answer Derivation $400,000 + ($2,400,000 × .06 × .7) ———————————————— = $1.96. 150,000 + 75,000 + 30,000
125.
b
126.
c
50,000 × $20 ÷ $25 = 40,000 50,000 – 40,000 = 10,000.
127.
d
90,000 – (90,000 × $37 ÷ $50) = 23,400 400,000 + 23,400 = 423,400.
DERIVATIONS — Earnings Per Share, CPA Adapted No.Answer 128. b
Derivation $930,000 – $120,000 ————————— = $2.70. 300,000
129.
b
$480,000 – (10,000 × $100 × .06) ——————————————— = $2.33. 180,000
130.
d
$5,100,000 – $300,000 ——————————– = $1.92. 2,400,000 + 100,000
131.
b
610,000 + (40,000 × 6/12) + [32,000 – (32,000 × $15 ÷ $20)] = 638,000.
132.
b
Conceptual.
133.
d
Conceptual.
134.
a
Conceptual.
EXERCISES Ex. 16-135—Convertible Bonds. Garr Co. issued $3,000,000 of 12%, 5-year convertible bonds on December 1, 2012 for $3,013,000 plus accrued interest. The bonds were dated April 1, 2012 with interest payable April 1 and October 1. Bond premium is amortized each interest period on a straight-line basis. Garr Co. has a fiscal year end of September 30. On October 1, 2013, $1,500,000 of these bonds were converted into 20,000 shares of $15 par common stock. Accrued interest was paid in cash at the time of conversion.
16 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition Instructions (a) Prepare the entry to record the interest expense at April 1, 2013. Assume that interest payable was credited when the bonds were issued (round to nearest dollar). (b) Prepare the entry to record the conversion on October 1, 2013. Assume that the entry to record amortization of the bond premium and interest payment has been made.
Solution 16-135 (a)
Interest Payable........................................................................... Interest Expense.......................................................................... Premium on Bonds Payable ........................................................ Cash ................................................................................ Calculations: Issuance price Par value Total premium Months remaining Premium per month Premium amortized (4 × $250)
(b)
60,000 119,000 1,000
$3,013,000 3,000,000 $ 13,000 52 $250 $1,000
Bonds Payable ............................................................................ 1,500,000 Premium on Bonds Payable ........................................................ 5,250 Common Stock (20,000 × $15) ........................................ Paid-in Capital in Excess of Par ....................................... Calculations: Premium related to 1/2 of the bonds Less premium amortized Premium remaining
180,000
300,000 1,205,250
$6,500 ($13,000 ÷ 2) 1,250 [($6,500 ÷ 52) × 10] $ 5,250
Ex. 16-136—Convertible Bonds. Koch 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 Koch Co. account for the conversion of the bonds into common stock under the book value method? Discuss the rationale for this method.
Dilutive Securities and Earnings per Share
16 - 41
Solution 16-136 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.
Ex. 16-137—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 16-137 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.
Ex. 16-138—Stock options. Prepare the necessary entries from 1/1/12-2/1/14 for the following events using the fair value method. If no entry is needed, write "No Entry Necessary." 1. On 1/1/12, the stockholders adopted a stock option plan for top executives whereby each might receive rights to purchase up to 15,000 shares of common stock at $40 per share. The par value is $10 per share. 2. On 2/1/12, options were granted to each of five executives to purchase 15,000 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 2/1/14. It is assumed that the options were for services performed equally in 2012 and 2013. The Black-Scholes option pricing model determines total compensation expense to be $1,600,000. 3. At 2/1/14, four executives exercised their options. The fifth executive chose not to exercise his options, which therefore were forfeited.
16 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 16-138 1.
1/1/12 No entry necessary.
2.
2/1/12 No entry necessary. 12/31/12 Compensation Expense ............................................................... Paid-in Capital—Stock Options ........................................ 12/31/13 Compensation Expense ............................................................... Paid-in Capital—Stock Options ........................................
3.
800,000 800,000 800,000 800,000
2/1/14 Cash (4 × 15,000 × $40) ............................................................. 2,400,000 Paid-in Capital—Stock Options ($1,600,000 × 4/5) ..................... 1,280,000 Common Stock ................................................................ Paid-in Capital in Excess of Par ....................................... Paid-in Capital—Stock Options .................................................... Paid-in Capital—Expired Stock Options ...........................
600,000 3,080,000
320,000 320,000
Ex. 16-139—Weighted average shares outstanding. On January 1, 2013, Warren 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 400,000 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 2013.
Solution 16-139
Jan. 1 March 1 July 1 Oct. 1
Increase (Decrease) — 150,000 1,150,000 (400,000)
Outstanding 1,000,000 1,150,000 2,300,000 1,900,000
Months Outstanding 2 4 3 3 12 (25,800,000 ÷ 12)
2/1 2/1
Share Months 4,000,000 9,200,000 6,900,000 5,700,000 25,800,000 2,150,000
Dilutive Securities and Earnings per Share
16 - 43
Ex. 16-140—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 Solution 16-140 (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. 16-141—Earnings per share. Santana Corporation has 400,000 shares of common stock outstanding throughout 2013. In addition, the corporation has 5,000, 20-year, 9% bonds issued at par in 2011. Each $1,000 bond is convertible into 20 shares of common stock after 9/23/14. During the year 2013, the corporation earned $900,000 after deducting all expenses. The tax rate was 30%. Instructions Compute the proper earnings per share for 2010. Solution 16-141 Net income $900,000 Earnings per share: ————————— = ———— = $2.25 Outstanding shares 400,000 Net income + Interest after taxes Earnings per share assuming bond conversion: ——————————————— Assumed outstanding shares $900,000 + $315,000 ($450,000 × .7 = $315,000); —————————— = $2.43 400,000 + 100,000 Therefore the bonds are antidilutive, and earnings per common share outstanding of $2.25 should be reported.
16 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 16-141 (Cont.) Note that the convertible security is antidilutive: Bond interest after taxes $315,000 ————————————— = ———— = $3.15 Assumed incremental shares 100,000
Ex. 16-142—Diluted earnings per share. Dunbar Company had 400,000 shares of common stock outstanding during the year 2013. In addition, at December 31, 2013, 60,000 shares were issuable upon exercise of executive stock options which require a $40 cash payment upon exercise (options granted in 2011). The average market price during 2013 was $50. Instructions Compute the number of shares to be used in determining diluted earnings per share for 2013.
Solution 16-142 Shares outstanding Add: Assumed issuance Deduct: Proceeds/Average market price ($2,400,000 ÷ $50) Number of shares
400,000 90,000 490,000 (48,000) 442,000
*Ex. 16-143—Stock appreciation rights. On January 1, 2011, Orr Co. established a stock appreciation rights plan for its executives. They could receive cash at any time during the next four years equal to the difference between the market price of the common stock and a preestablished price of $16 on 600,000 SARs. The market price is as follows: 12/31/11—$21; 12/31/12—$18; 12/31/13—$19; 12/31/14—$20. On December 31, 2013, 100,000 SARs are exercised, and the remaining SARs are exercised on December 31, 2014. Instructions (a) Prepare a schedule that shows the amount of compensation expense for each of the four years starting with 2011. (b) Prepare the journal entry at 12/31/12 to record compensation expense. (c) Prepare the journal entry at 12/31/14 to record the exercise of the remaining SARs.
Dilutive Securities and Earnings per Share
16 - 45
*Solution 16-143 (a)
Schedule of Compensation Expense 600,000 SARs
Date 12/31/11
Market Price $21
Set Price $16
Value of SARs $3,000,000
Percent Accrued 25%
12/31/12
18
16
1,200,000
50%
12/31/13
19
16
1,800,000
75%
12/31/14
20
16
2,000,000 ($4 × 500,000)
100%
Accrued to Date $750,000 (150,000) 600,000 750,000 1,350,000 650,000 2,000,000
(b) Liability Under Stock Appreciation Plan ....................................... Compensation Expense ................................................... (c)
Expense $750,000 (150,000) 750,000 650,000
150,000
Liability Under Stock Appreciation Plan ....................................... 2,000,000 Cash ................................................................................
150,000
2,000,000
PROBLEMS Pr. 16-144—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, 2013, Lane Corporation called its 10% convertible bonds for conversion. The $6,000,000 par bonds were converted into 240,000 shares of $20 par common stock. On August 1, there was $700,000 of unamortized premium applicable to the bonds. The fair value of the common stock was $20 per share. Ignore all interest payments. 2. Packard, Inc. decides to issue convertible bonds instead of common stock. The company issues 10% convertible bonds, par $3,000,000, at 97. The investment banker indicates that if the bonds had not been convertible they would have sold at 94. 3. Gomez Company issues $10,000,000 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 $9,870,000 and the value of the warrants is $630,000. The bonds with the warrants sold at 101.
Solution 16-144 1. Bonds Payable ............................................................................... 6,000,000 Premium on Bonds Payable ........................................................... 700,000 Common Stock ................................................................... Paid-in Capital in Excess of Par ..........................................
4,800,000 1,900,000
16 - 46 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 16-144 (Cont.) 2. Cash ............................................................................................... 2,910,000 Discount on Bonds Payable ............................................................ 90,000 Bonds Payable ....................................................................
3,000,000
3. Cash ............................................................................................... 10,100,000 Discount on Bonds Payable ............................................................ 506,000 Bonds Payable .................................................................... 10,000,000 Paid-in Capital—Stock Warrants ......................................... 606,000 ($630,000 ÷ $10,500,000 × $10,100,000 = $606,000)
Pr. 16-145—Earnings per share. Colson Corp. had $600,000 net income in 2013. On January 1, 2013 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 2013. The tax rate is 40%. During 2013, 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. Colson issued $2,000,000 of 8% convertible bonds at face value during 2012. Each $1,000 bond is convertible into 30 shares of common stock. Instructions Compute diluted earnings per share for 2013. Complete the schedule and show all computations.
Security
Net Income
Adjustment
Adjusted Net Income
Shares
Adjustment
Adjusted Shares
EPS
Solution 16-145 Security
Net Income
Adjustment
Adjusted Net Income
Shares
Adjustment
Adjusted Shares
EPS
Com. Stock
$600,000
$(140,000)
$460,000
200,000
5,000a
205,000
$2.24
460,000
205,000
6,000b
211,000
2.18
556,000
211,000
60,000
271,000
2.05
696,000
271,000
120,000
391,000
1.78
Options Bonds
460,000
96,000c
Preferred
556,000
140,000
a
20,000 × 3/4 = 30,000 × 1/3 =
15,000 (10,000) 5,000 SA
Dilutive Securities and Earnings per Share
16 - 47
Solution 16-145 (Cont.) b
30,000 $1,200,000 ÷ $50 = (24,000) 6,000 SA
(or) [(50 – 40) ÷ 50] × 30,000 = 6,000 SA
c
$96,000 ———— = $1.60 60,000
$2,000,000 × .08 × .6 = $96,000
$140,000 ———— = $1.17 120,000
Pr. 16-146—Basic and diluted EPS. Assume that the following data relative to Kane Company for 2013 is available: Net Income
$2,100,000
Transactions in Common Shares Jan. 1, 2013, Beginning number Mar. 1, 2013, Purchase of treasury shares June 1, 2013, Stock split 2-1 Nov. 1, 2013, Issuance of shares
Change (60,000) 640,000 180,000
Cumulative 700,000 640,000 1,280,000 1,460,000
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 2013, $30 (market price and option price adjusted for split).
90,000 shares
Instructions (a) Compute the basic earnings per share for 2013. (Round to the nearest penny.) (b) Compute the diluted earnings per share for 2013. (Round to the nearest penny.)
Solution 16-146 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 × 180,000)
700,000 (50,000) 650,000 1,300,000 30,000 1,330,000
16 - 48 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 16-146 (Cont.) Additional shares for purposes of diluted earnings per share: Potentially dilutive securities 8% convertible preferred stock Stock options Proceeds from exercise of 90,000 options (90,000 × $25) Shares issued upon exercise of options Less: treasury stock purchasable with proceeds ($2,250,000 ÷ $30) Dilutive securities—additional shares
200,000 $2,250,000 90,000 75,000
15,000 215,000
$2,100,000 – $80,000 (a) Basic earnings per share: —————————— = $1.52 1,330,000 (b) Diluted earnings per share:
$2,100,000 ———–—————— = $1.36 1,330,000 + 215,000
Pr. 16-147—Basic and diluted EPS. Presented below is information related to Starr Company. 1. Net Income [including an extraordinary gain (net of tax) of $70,000]
$280,000
2. Capital Structure a. Cumulative 8% preferred stock, $100 par, 6,000 shares issued and outstanding
$600,000
b. $10 par common stock, 74,000 shares outstanding on January 1. On April 1, 40,000 shares were issued for cash. On October 1, 16,000 shares were purchased and retired.
$1,000,000
c. On January 2 of the current year, Starr purchased Oslo Corporation. One of the terms of the purchase was that if Starr's net income for the following year is $2,400,000 or more, 50,000 additional shares would be issued to Oslo stockholders next year. 3. Other Information a. Average market price per share of common stock during entire year b. Income tax rate Instructions Compute earnings per share for the current year.
$30 30%
Dilutive Securities and Earnings per Share
16 - 49
Solution 16-147 Income before extraordinary item Less preferred dividends Available to common before extraordinary item Add extraordinary gain (net of tax) Income available to common
$210,000 (48,000) 162,000 70,000 $232,000
Weighted average shares outstanding: January 1 3/4 × 40,000 1/4 × 16,000
74,000 30,000 (4,000) 100,000
Basic earnings per share: Income before extraordinary item Extraordinary item (net of tax) Net income
$1.62 .70 $2.32
(a) (b) (c)
Calculations: $162,000 ———— 100,000
(a)
$70,000 ———— 100,000
(b)
Diluted earnings per share: Income before extraordinary item Extraordinary item (net of tax) Net Income
(c)
$ .1.08 .46 $1.55
$232,000 ———— 100,000
(a) (b) (c)
Calculations: (a)
$162,000 ———————— 100,000 + 50,000
(b)
$70,000 ———— 150,000
(c)
$232,000 ———————— 100,000 + 50,000
Pr. 16-148—Basic and diluted EPS. The following information was taken from the books and records of Ludwick, Inc.: 1. Net income
$ 350,000
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.
16 - 50 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 16-148 (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 16-148 Basic EPS = $350,000 ÷ 200,000 sh. = $1.75 Security
Net Income
Adjustment
Adjusted Net Income
Shares
Adjustment
Adjusted Shares
Diluted EPS
Com. Stock
$350,000
—
$350,000
200,000
—
200,000
$1.75
Warrants
350,000
—
350,000
200,000
6,0001
206,000
1.70
Conv. Bonds
350,000
$12,6002
362,600
206,000
15,000
221,000
1.64
16,000 1
2
320,000 ———— = (10,000) 32 6,000
SA
$300,000 .06 .7 = $12,600
$12,600 ———— = $.84 15,000
Dilutive Securities and Earnings per Share
16 - 51
IFRS QUESTIONS True/False 1. IFRS and U.S. GAAP have significant differences in the reporting of securities with characteristics of debt and equity, such as convertible debt. 2. Under IFRS, all of the proceeds of convertible debt are recorded as long-term debt. 3. Under IFRS, convertible bonds are “bifurcated” —separated into the equity component (the value of the conversion option) of the bond issue and the debt component. 4. Under both U.S. GAAP and IFRS, the calculation of basic and diluted earnings per share is identical. 5. Under IFRS recording for the issuance of Bonds Payable, the Discount on Bonds Payable and the Paid-in Capital-Convertible Bonds could be utilized. Answers to True/False: 1. True 2. False 3. True 4. False 5. True
Multiple Choice: 1. With regard to recognizing stock-based compensation a. IFRS and U.S. GAAP follow the same model. b. IFRS and U.S. GAAP standards are undergoing major reform on valuation issues. c. it has been agreed that these standards will not be merged due to the differences in currencies. d. the reform of U.S. GAAP standards will not be addressed until IFRS standards have been finalized. 2. The primary IFRS reporting standards related to financial instruments, including dilutive securities, is a. IAS 33. b. IAS 39. c. IFRS 2. d. IAS 2.
16 - 52 Test Bank for Intermediate Accounting, Fourteenth Edition
3. When $5,000,000 in convertible bonds are issued at par with $800,000 in value of the equity option embedded in the bond, the IFRS journal entry will include a debit of a. $800,000 to Paid-in Capital — Convertible Bonds and a credit to Bonds Payable. b. $800,000 to Premium on Bonds Payable and a credit to Paid-in Capital — Convertible Bonds. c. $800,000 to Bonds Payable and a credit to Paid-in Capital — Convertible Bonds. d. $4,200,000 to Cash along with a debit of $800,000 to Discount on Bonds Payable and a credit to Bonds Payable and a credit to Paid-in Capital — Convertible Bonds. 4. With regard to contracts that can be settled in either cash or shares a. IFRS requires that share settlement must be used. b. IFRS gives companies a choice of either cash or shares. c. U.S. GAAP requires that share settlement must be used. d. the FASB project proposes that the IASB adopt the U.S. GAAP approach, requiring that share settlement must be used. 5. With regard to recognizing stock-based compensation under IFRS the fair value of shares and options awarded to employees is recognized a. in the first fiscal period of the employees’ service. b. over the fiscal periods to which the employees’ services relate. c. in the last fiscal period of the employees’ service when the total value can be calculated. d. after last fiscal period of the employees’ service when the total value can be calculated.
Answers to Multiple Choice: 1. a 2. b 3. c 4. a 5. b Short Answer 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to the accounting for dilutive securities, stock-based compensation, and earnings per share.
Dilutive Securities and Earnings per Share
16 - 53
1. IFRS and U.S. GAAP are substantially the same in the accounting for dilutive securities, stock-based compensation, and earnings per share. For example, both IFRS and U.S. GAAP follow the same model for recognizing stock-based compensation. That is, the fair value of shares and options awarded to employees is recognized over the period to which the employees’ services relate. The main differences concern (1) the accounting for convertible debt. Under U.S. GAAP all of the proceeds of convertible debt are recorded as long term debt. Under IFRS, convertible bonds are “bifurcated”, or separated into the equity component – the value of the conversion option – of the bond issue and the debt component; (2) a minor difference in EPS reporting – the FASB allows companies to rebut the presumption that contracts that can be settled in either cash or shares will be settled in shares. IFRS requires that share settlement must be used in this situation; (3) other EPS differences relate to the treasury stock method and how the proceeds from extinguishment of a liability should be accounted for and how to make the computation for the weighted-average of contingently issuable shares. 2. Briefly discuss the convergence efforts that are under way by the IASB and FASB in the area of dilutive securities and earnings per share. 2. The FASB has been working on a standard that will likely converge to iGAAP in the accounting for convertible debt. Similar to the FASB, the IASB is examining the classification of hybrid securities; the IASB is seeking comment on a discussion document similar to the FASB Preliminary Views document: “Financial Instruments with Characteristics of Equity “. It is hoped that the boards will develop a converged standard in this area. While U.S. GAAP and iGAAP are similar as to the presentation of EPS, the Boards have been working together to resolve remaining differences related to earnings per share computations.
CHAPTER 17 INVESTMENTS IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F T F F T F T F T T F T F T F 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.
Examples of debt securities. Definition of trading securities. Available-for-sale unrealized gains/losses. 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. Effect of dividends on investment under equity. Reporting revenue under fair value method. Definition of controlling interest. Using fair value option. Accounting for changes in fair value. Temporary declines and write downs. Necessary of reclassification adjustment. Transfer of held-to-maturity securities. Transfers from trading to available-for-sale.
Answer
No.
Description
c b c c a a c b a d b c d c c d c a c
21. 22. 23. 24. P 25. S 26. S 27. S 28. S 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39.
Debt securities. Valuation of debt securities. Held-to-maturity securities. Unrealized gain/loss recognition for securities. Accounting for accrued interest. Identifying securities accounted for at amortized cost. Accounting for available-for-sale 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.
MULTIPLE CHOICE—Conceptual
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
d c c b a c b d a d d d a d c b b d c b a c b d c b a c a d
40. 41. 42. S 43. S 44. P 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. P 57. 58. 59. *60. *61. *62. *63. *64. *65. *66. *67. *68. *69.
Effective-interest rate method. Debt securities purchased between interest dates. Sale of debt security prior to maturity. Passive interest 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. Effect of using the fair value method in error. Determine value of investment. Fair value option. Accounting for impairments. Reclassification adjustment in comprehensive income. Reclassification of securities. Reclassification of securities. Transfer of a debt security. Definition of “gains trading” or “cherry picking”. Accounting for transfers between Categories. Accounting for derivatives. Characteristics of a derivative instrument. Identifying companies that are arbitrageurs. Identifying equity securities. Accounting for fair value hedges. Gains/losses on cash flow hedges. Identifying an embedded derivative. Requirements for financial instrument disclosures. Variable-interest entity. Risk-and-reward model and voting-interest approach.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. *This topic is dealt with in an Appendix to the chapter. S
MULTIPLE CHOICE—Computational Answer
No.
Description
c b d b a c a b c a b
70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80.
Recording the purchase of debt securities. Computing cost of bond investment. 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.
Investments
MULTIPLE CHOICE—Computational (cont.) Answer
No.
Description
b d a d b d b c b c a a b a b c c a c b b b c c c b c b d b
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.
Determine gain on sale of debt securities. Computation of revenue from HTM securities. Calculation of premium amortization. Calculation of other comprehensive income. Calculation of loss on sale of bonds. Calculation of loss on sale of trading security. Determination of unrealized loss on trading security. Determination of accumulated other comprehensive income. Entry to record unrealized gain on AFS securities. 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 purchase price of equity method investment. 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
111. 112. 113. 114. 115. 116. 117. 118. 119.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Item E17-120 E17-121 E17-122 E17-123 E17-124 E17-125 E17-126 *E17-127 *E17-128
Description Investment in debt securities at a premium. Investment in debt securities at a discount. Investments in equity securities (essay). Investment in equity securities. Fair value and equity methods (essay). Fair value and equity methods. Comprehensive income calculation. Fair value hedge. Cash flow hedge.
PROBLEMS Item P17-129 P17-130 P17-131 *P17-132 *P17-133
Description Trading equity securities. Trading securities. Available-for-sale securities. Derivative financial instrument. Free-standing derivative.
CHAPTER LEARNING OBJECTIVES 1.
Identify the three categories of debt securities and describe the accounting and reporting treatment for each category.
2.
Understand the procedures for discount and premium amortization on bond investments.
3.
Identify the categories of equity securities and describe the accounting and reporting treatment for each category.
4.
Explain the equity method of accounting and compare it to the fair value method for equity securities.
5.
Describe the accounting for the fair value option.
6.
Discuss the accounting for impairments of debt and equity investments.
7.
Explain why companies report reclassification adjustments.
8.
Describe the accounting for transfer of investment securities between categories.
*9.
Explain who uses derivatives and why.
*10.
Understand the basic guidelines for accounting for derivatives.
*11.
Describe the accounting for derivative financial instruments.
*12.
Explain how to account for a fair value hedge.
*13.
Explain how to account for a cash flow hedge.
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*14.
Identify special reporting issues related to derivative financial instruments that cause unique accounting problems.
*15.
Describe the accounting for variable-interest entities.
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2.
TF TF
3. 21.
TF MC
22. 23.
4. 5. 6. 7. S 28. S 29.
TF TF TF TF MC MC
30. 31. 32. 33. 34. 35.
MC MC MC MC MC MC
36. 37. 38. 39. 40. 41.
8. 9. 10.
TF TF TF
11. 43. 86.
TF MC MC
87. 88. 89.
12. 13. 14. S 44. P 45.
TF TF TF MC MC
46. 47. 48. 49. 50.
MC MC MC MC MC
95. 96. 97. 98. 99.
15.
TF
16.
TF
51.
17.
TF
53.
MC
122.
18.
TF
54.
MC
19. 20.
TF TF
60.
MC
61.
MC
S
55. 56.
MC MC
P
57. 58.
Type Item Type Item Learning Objective 1 S MC 24. MC 26. P S MC 25. MC 27. Learning Objective 2 MC 42. MC 77. MC 72. MC 78. MC 73. MC 79. MC 74. MC 80. MC 75. MC 81. MC 76. MC 82. Learning Objective 3 MC 90. MC 93. MC 91. MC 94. MC 92. MC 112. Learning Objective 4 MC 100. MC 105. MC 101. MC 106. MC 102. MC 107. MC 103. MC 108. MC 104. MC 109. Learning Objective 5 MC 52. MC 110. Learning Objective 6 E 130. P Learning Objective 7 Learning Objective 8 MC 59. MC 122. MC 119. MC 129. Learning Objective 9* Learning Objective 10*
62.
MC
63.
MC
64.
MC
127.
E
132.
Learning Objective 11* P 133. P Learning Objective 12*
Type
Item
Type
Item
Type
MC MC
70. 71.
MC MC
MC MC MC MC MC MC
83. 84. 85. 111. 120. 121.
MC MC MC MC E E
MC MC MC
113. 114. 122.
MC MC E
129. 130. 131.
P P P
MC MC MC MC MC
115. 116. 117. 118. 123.
MC MC MC MC E
124. 125. 126.
E E E
130.
P
MC
E P
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Test Bank for Intermediate Accounting, Fourteenth Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS (cont.) Learning Objective 13* 65.
MC
128.
E Learning Objective 14*
66. 67. Note:
MC MC
68.
MC
69.
TF = True-False MC = Multiple Choice
Learning Objective 15* MC E = Exercise P = Problem
TRUE-FALSE—Conceptual 1.
Debt securities include corporate bonds and convertible debt, but not U.S. government securities.
2.
Trading securities are securities bought and held primarily for sale in the near term to generate income on short-term price differences.
3.
Unrealized holding gains and losses are recognized in net income for available-for-sale debt securities.
4.
A company can classify a debt security as held-to-maturity if it has the positive intent to hold the securities to maturity.
5.
Companies do not report changes in the fair value of available-for-sale debt securities as income until the security is sold.
6.
The Securities Fair Value Adjustment account has a normal credit balance.
7.
Companies report trading securities at fair value, with unrealized holding gains and losses reported in net income.
8.
Equity security holdings between 20 and 50 percent indicates that the investor has a controlling interest over the investee.
9.
The Unrealized Holding Gain/Loss—Equity account is reported as a part of other comprehensive income.
10. Significant influence over an investee may be indicated by material intercompany transactions and interchange of managerial personnel. 11.
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.
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12. All dividends received by an investor from the investee decrease the investment’s carrying value under the equity method. 13. Under the fair value method, the investor reports as revenue its share of the net income reported by the investee. 14. A controlling interest occurs when one corporation acquires a voting interest of more than 50 percent in another corporation. 15. Companies may not use the fair value option for investments that follow the equity method of accounting. 16. Changes in the fair value of a company's debt instruments are included as part of earnings in any given period. 17. 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. 18. A reclassification adjustment is necessary when a company reports realized gains/losses as part of net income but also shows unrealized gains/losses as part of other comprehensive income. 19. If a company transfers held-to-maturity securities to available-for-sale securities, the unrealized gain or loss is recognized in income. 20. 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 1. 2. 3. 4. 5.
Ans. F T F F T
Item 6. 7. 8. 9. 10.
Ans. F T F T T
Item 11. 12. 13. 14. 15.
Ans. F T F T F
Item 16. 17. 18. 19. 20.
Ans. T F T F T
MULTIPLE CHOICE—Conceptual 21.
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.
22.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
23.
Securities which could be classified as held-to-maturity are a. redeemable preferred stock. b. warrants. c. municipal bonds. d. treasury stock.
24.
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.
P
25. 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.
S
26. 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.
S
27. 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.
S
28. 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.
S
29. 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%.
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30.
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.
31.
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.
32.
Watt Co. purchased $300,000 of bonds for $315,000. If Watt 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.
33.
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.
34.
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.
35.
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.
36.
Jordan 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.
37.
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.
17 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition 38.
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.
39.
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.
40.
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.
41.
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.
42. 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. S
43. When a company has acquired a "passive interest" in another corporation, the acquiring company should account for the investment a. by using the equity method. b. by using the fair value method. c. by using the effective interest method. d. by consolidation.
Investments S
44. Santo 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.
P
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Fair Value Method No Effect Increase No Effect Decrease
Equity Method Decrease Decrease No Effect No Effect
45. 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
46.
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.
47.
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.
48.
Koehn Corporation accounts for its investment in the common stock of Sells Company under the equity method. Koehn Corporation should ordinarily record a cash dividend received from Sells 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.
49.
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.
17 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition 50.
Judd, Inc., owns 35% of Cosby Corporation. During the calendar year 2012, Cosby had net earnings of $300,000 and paid dividends of $30,000. Judd mistakenly recorded these transactions using the fair value method rather than the equity method of accounting. What effect would this have on the investment account, net income, and retained earnings, respectively? a. Understate, overstate, overstate b. Overstate, understate, understate c. Overstate, overstate, overstate d. Understate, understate, understate
51.
Dublin Co. holds a 30% stake in Club Co. which was purchased in 2013 at a cost of $3,000,000. After applying the equity method, the Investment in Club Co. account has a balance of $3,040,000. At December 31, 2013 the fair value of the investment is $3,120,000. Which of the following values is acceptable for Dublin to use in its balance sheet at December 31, 2013? I. $3,000,000 II. $3,040,000 III. $3,120,000 a. I, II, or III. b. I or II only. c. II only. d. II or III only.
52.
The fair value option allows a company to a. value its own liabilities at fair value. b. record income when the fair value of its bonds increases. c. report most financial instruments at fair value by recording gains and losses as a separate component of stockholders’ equity. d. All of the above are true of the fair value option.
53.
Impairments are a. based on discounted cash flows for securities. b. recognized as a realized loss if the impairment is judged to be temporary. c. based on fair value for available-for-sale investments and on negotiated values for held-to-maturity investments. d. evaluated at each reporting date for every investment.
54.
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.
55.
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.
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56.
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.
57.
A debt security is transferred from one category to another. Generally acceptable accounting principles require that for this particular reclassification (1) the security be transferred at fair value at the date of transfer, and (2) the unrealized gain or loss at the date of transfer currently carried as a separate component of stockholders' equity be amortized over the remaining life of the security. What type of transfer is being described? a. Transfer from trading to available-for-sale b. Transfer from available-for-sale to trading c. Transfer from held-to-maturity to available-for-sale d. Transfer from available-for-sale to held-to-maturity
58.
“Gains trading” or “cherry picking” involves a. moving securities whose value has decreased since acquisition from available-for-sale to held-to-maturity in order to avoid reporting losses. b. reporting investment securities at fair value but liabilities at amortized cost. c. selling securities whose value has increased since acquisition while holding those whose value has decreased since acquisition. d. All of the above are considered methods of “gains trading” or “cherry picking.”
59.
Transfers between categories a. result in companies omitting recognition of fair value in the year of the transfer. b. are accounted for at fair value for all transfers. c. are considered unrealized and unrecognized if transferred out of held-to-maturity into trading. d. will always result in an impact on net income.
*60.
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.
*61.
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.
P
17 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition *62.
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.
*63.
Which of the following are considered equity securities? I. Convertible debt. II. Redeemable preferred stock. III. Call or put options. a. I and II only. b. I and III only. c. II only. d. III only.
*64.
The accounting for fair value hedges records the derivative at its a. amortized cost. b. carrying value. c. fair value. d. historical cost.
*65.
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.
*66.
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.
*67.
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.
*68.
A variable-interest entity has a. insufficient equity investment at risk. b. stockholders who have decision-making rights. c. stockholders who absorb the losses or receive the benefits of a normal stockholder. d. All of the above are characteristics of a variable-interest entity.
Investments *69.
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Under U.S. GAAP, which of the following models may be used to determine if an investment is consolidated? Risk-and-reward model Voting-interest approach a. Yes No b. No Yes c. No No d. Yes Yes
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27.
c b c c a a c
28. 29. 30. 31. 32. 33. 34.
b a d b c d c
35. 36. 37. 38. 39. 40. 41.
c d c a c d c
42. 43. 44. 45. 46. 47. 48.
c b a c b d a
49. 50. 51. 52. 53. 54. 55.
d d d a d c b
56. 57. 58. 59. *60. *61. *62.
b d c b a c b
*63. *64. *65. *66. *67. *68. *69.
d c b a c a d
MULTIPLE CHOICE—Computational 70.
On August 1, 2012, Dambro Co. acquired 400, $1,000, 9% bonds at 97 plus accrued interest. The bonds were dated May 1, 2012, and mature on April 30, 2018, with interest paid each October 31 and April 30. The bonds will be added to Dambro’s available-forsale portfolio. The preferred entry to record the purchase of the bonds on August 1, 2012 is a. Debt Investments ................................................................ 397,000 Cash ....................................................................... 397,000 b. Debt Investments ................................................................ Interest Receivable ............................................................. Cash .......................................................................
388,000 9,000
c. Debt Investments ................................................................ Interest Revenue ................................................................ Cash .......................................................................
388,000 9,000
d. Debt Investments ................................................................ Interest Revenue ................................................................ Discount on Debt Investments................................. Cash ......................................................................
400,000 9,000
397,000
397,000
12,000 397,000
71. Kern Company purchased bonds with a face amount of $600,000 between interest payment dates. Kern purchased the bonds at 102, paid brokerage costs of $9,000, and paid accrued interest for three months of $15,000. The amount to record as the cost of this long-term investment in bonds is a. $636,000. b. $621,000. c. $612,000. d. $600,000.
17 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition Use the following information for questions 72 and 73. Patton Company purchased $600,000 of 10% bonds of Scott Co. on January 1, 2013, paying $564,150. The bonds mature January 1, 2023; interest is payable each July 1 and January 1. The discount of $35,850 provides an effective yield of 11%. Patton Company uses the effectiveinterest method and plans to hold these bonds to maturity. 72. On July 1, 2013, Patton Company should increase its Debt Investments account for the Scott Co. bonds by a. $3,588. b. $2,056. c. $1,794. d. $1,028. 73. For the year ended December 31, 2013, Patton Company should report interest revenue from the Scott Co. bonds of: a. $63,588. b. $62,113. c. $62,052. d. $60,000. Use the following information for questions 74 and 75. Landis Co. purchased $1,000,000 of 8%, 5-year bonds from Ritter, Inc. on January 1, 2012, with interest payable on July 1 and January 1. The bonds sold for $1,041,580 at an effective interest rate of 7%. Using the effective-interest method, Landis Co. decreased the Available-for-Sale Debt Securities account for the Ritter, Inc. bonds on July 1, 2012 and December 31, 2012 by the amortized premiums of $3,540 and $3,660, respectively. 74. At December 31, 2012, the fair value of the Ritter, Inc. bonds was $1,060,000. What should Landis Co. report as other comprehensive income and as a separate component of stockholders' equity? a. $25,620. b. $18,420. c. $7,200. d. No entry should be made. 75. At April 1, 2013, Landis Co. sold the Ritter bonds for $1,030,000. After accruing for interest, the carrying value of the Ritter bonds on April 1, 2013 was $1,033,750. Assuming Landis Co. has a portfolio of Available-for-Sale Debt Securities, what should Landis Co. report as a gain or loss on the bonds? a. ($29,370). b. ($21,870). c. ($3,750). d. $ 0.
Investments 76.
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On August 1, 2012, Fowler Company acquired $600,000 face value 10% bonds of Kasnic Corporation at 104 plus accrued interest. The bonds were dated May 1, 2012, and mature on April 30, 2017, with interest payable each October 31 and April 30. The bonds will be held to maturity. What entry should Fowler make to record the purchase of the bonds on August 1, 2012? a. Debt Investments ................................................................ 624,000 Interest Revenue ................................................................ 15,000 Cash ....................................................................... 639,000 b. Debt Investments ................................................................ Cash .......................................................................
639,000
c. Debt Investments ................................................................ Interest Revenue ..................................................... Cash .......................................................................
639,000
d. Debt Investments ................................................................ Premium on Bonds ............................................................. Cash .......................................................................
600,000 39,000
639,000 15,000 624,000
639,000
77.
On October 1, 2012, Renfro Co. purchased to hold to maturity, 2,000, $1,000, 9% bonds for $1,980,000 which includes $30,000 accrued interest. The bonds, which mature on February 1, 2021, pay interest semiannually on February 1 and August 1. Renfro uses the straight-line method of amortization. The bonds should be reported in the December 31, 2012 balance sheet at a carrying value of a. $1,950,000. b. $1,951,500. c. $1,980,000. d. $1,980,500.
78.
On November 1, 2012, Howell Company purchased 900 of the $1,000 face value, 9% bonds of Ramsey, Incorporated, for $948,000, which includes accrued interest of $13,500. The bonds, which mature on January 1, 2017, pay interest semiannually on March 1 and September 1. Assuming that Howell 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 Howell's December 31, 2012, balance sheet at a. $900,000. b. $934,500. c. $933,120. d. $948,000.
79.
On November 1, 2012, Horton Co. purchased Lopez, Inc., 10-year, 9%, bonds with a face value of $500,000, for $450,000. An additional $15,000 was paid for the accrued interest. Interest is payable semiannually on January 1 and July 1. The bonds mature on July 1, 2019. Horton uses the straight-line method of amortization. Ignoring income taxes, the amount reported in Horton's 2012 income statement as a result of Horton's available-forsale investment in Lopez was a. $8,750. b. $8,333. c. $7,500. d. $6,666.
17 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 80.
On October 1, 2012, Menke Co. purchased to hold to maturity, 500, $1,000, 9% bonds for $520,000. An additional $15,000 was paid for accrued interest. Interest is paid semiannually on December 1 and June 1 and the bonds mature on December 1, 2016. Menke uses straight-line amortization. Ignoring income taxes, the amount reported in Menke's 2012 income statement from this investment should be a. $11,250. b. $10,050. c. $12,450. d. $13,650.
81.
During 2010, Hauke Co. purchased 3,000, $1,000, 9% bonds. The carrying value of the bonds at December 31, 2012 was $2,940,000. The bonds mature on March 1, 2017, and pay interest on March 1 and September 1. Hauke sells 1,500 bonds on September 1, 2014, for $1,482,000, after the interest has been received. Hauke uses straight-line amortization. The gain on the sale is a. $0. b. $7,200. c. $12,000. d. $16,800.
Use the following information for 82 and 83. On January 3, 2012, Moss Co. acquires $400,000 of Adam Company’s 10-year, 10% bonds at a price of $425,672 to yield 9%. Interest is payable each December 31. The bonds are classified as held-to-maturity. 82.
Assuming that Moss Co. uses the effective-interest method, what is the amount of interest revenue that would be recognized in 2013 related to these bonds? a. $40,000 b. $42,568 c. $38,312 *d. $38,160
83.
Assuming that Moss Co. uses the straight-line method, what is the amount of premium amortization that would be recognized in 2014 related to these bonds? a. $2,568 b. $1,688 c. $1,840 d. $2,008
Questions 84 and 85 are based on the following information: Richman Co. purchased $600,000 of 8%, 5-year bonds from Carlin, Inc. on January 1, 2012, with interest payable on July 1 and January 1. The bonds sold for $624,948 at an effective interest rate of 7%. Using the effective interest method, Richman Co. decreased the Available-for-Sale Debt Securities account for the Carlin, Inc. bonds on July 1, 2012 and December 31, 2012 by the amortized premiums of $2,124 and $2,196, respectively.
Investments
17 - 19
84.
At December 31, 2012, the fair value of the Carlin, Inc. bonds was $636,000. What should Richman Co. report as other comprehensive income and as a separate component of stockholders’ equity? a. $0 b. $4,320 c. $11,052 d. $15,372
85.
At February 1, 2013, Richman Co. sold the Carlin bonds for $618,000. After accruing for interest, the carrying value of the Carlin bonds on February 1, 2013 was $620,250. Assuming Richman Co. has a portfolio of available-for-sale debt investments, what should Richman Co. report as a gain (or loss) on the bonds? a. $0. b. ($2,250). c. ($13,122). d. ($17,622).
86.
During 2012 Logic Company purchased 6,000 shares of Midi, Inc. for $30 per share. The investment was classified as a trading security. During the year Logic Company sold 1,500 shares of Midi, Inc. for $35 per share. At December 31, 2012 the market price of Midi, Inc.’s stock was $28 per share. What is the total amount of gain/(loss) that Logic Company will report in its income statement for the year ended December 31, 2012 related to its investment in Midi, Inc. stock? a. ($12,000) b. $7,500 c. ($4,500) d. ($1,500)
Use the following information for questions 87 and 88. Instrument Corp. has the following investments which were held throughout 2012–2013: Fair Value Cost 12/31/12 12/31/13 Trading $450,000 $600,000 $570,000 Available-for-sale 450,000 480,000 540,000 87.
What amount of gain or loss would Instrument Corp. report in its income statement for the year ended December 31, 2013 related to its investments? a. $30,000 gain. b. $30,000 loss. c. $210,000 gain. d. $120,000 gain.
88.
What amount would be reported as accumulated other comprehensive income related to investments in Instrument Corp.’s balance sheet at December 31, 2012? a. $60,000 gain. b. $90,000 gain. c. $30,000 gain. d. $180,000 gain.
17 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 89.
At December 31, 2013, Atlanta Co. has a stock portfolio valued at $120,000. Its cost was $99,000. If the Securities Fair Value Adjustment (Available-for-Sale) has a debit balance of $6,000, which of the following journal entries is required at December 31, 2013? a. Fair Value Adjustment (available-for-sale) Unrealized Holding Gain or Loss-Equity b. Fair Value Adjustment (available-for-sale) Unrealized Holding Gain or Loss-Equity c. Unrealized Holding Gain or Loss-Equity Fair Value Adjustment (available-for-sale) d. Unrealized Holding Gain or Loss-Equity Fair Value Adjustment (available-for-sale)
90.
21,000 21,000 15,000 15,000 21,000 21,000 15,000 15,000
Kramer Company's trading securities portfolio which is appropriately included in current assets is as follows: December 31, 2012 Fair Unrealized Cost Value Gain (Loss) Catlett Corp. $250,000 $205,000 $(45,000) Lyman, Inc. 245,000 265,000 20,000 $495,000 $470,000 $(25,000) Ignoring income taxes, what amount should be reported as a charge against income in Kramer's 2012 income statement if 2012 is Kramer's first year of operation? a. $0. b. $20,000. c. $25,000. d. $45,000.
91.
On its December 31, 2012, balance sheet, Trump Co. reported its investment in availablefor-sale securities, which had cost $600,000, at fair value of $550,000. At December 31, 2013, the fair value of the securities was $585,000. What should Trump report on its 2013 income statement as a result of the increase in fair value of the investments in 2013? a. $0. b. Unrealized loss of $15,000. c. Realized gain of $35,000. d. Unrealized gain of $35,000.
92. During 2012, Woods Company purchased 40,000 shares of Holmes Corp. common stock for $630,000 as an available-for-sale investment. The fair value of these shares was $600,000 at December 31, 2012. Woods sold all of the Holmes stock for $17 per share on December 3, 2013, incurring $28,000 in brokerage commissions. Woods Company should report a realized gain on the sale of stock in 2013 of a. $22,000. b. $50,000. c. $52,000. d. $80,000.
Investments
17 - 21
Use the following information for questions 93 and 94. On its December 31, 2012 balance sheet, Calhoun Company appropriately reported a $10,000 debit balance in its Fair Value Adjustment (available-for-sale) account. There was no change during 2013 in the composition of Calhoun’s portfolio of equity investments held as available-forsale securities. The following information pertains to that portfolio: Security X Y Z
Cost $125,000 100,000 175,000 $400,000
Fair value at 12/31/13 $160,000 85,000 125,000 $370,000
93. What amount of unrealized loss on these securities should be included in Calhoun's stockholders' equity section of the balance sheet at December 31, 2013? a. $40,000. b. $30,000. c. $10,000. d. $0. 94. The amount of unrealized loss to appear as a component of comprehensive income for the year ending December 31, 2013 is a. $40,000. b. $30,000. c. $10,000. d. $0. 95.
On January 2, 2013 Pod Company purchased 25% of the outstanding common stock of Jobs, Inc. and subsequently used the equity method to account for the investment. During 2013 Jobs, Inc. reported net income of $630,000 and distributed dividends of $270,000. The ending balance in the Investment in Pod Company account at December 31, 2013 was $480,000 after applying the equity method during 2013. What was the purchase price Pod Company paid for its investment in Jobs, Inc? a. $255,000 b. $390,000 c. $570,000 d. $705,000
96. Ziegler Corporation purchased 25,000 shares of common stock of the Sherman Corporation for $40 per share on January 2, 2010. Sherman Corporation had 100,000 shares of common stock outstanding during 2013, paid cash dividends of $120,000 during 2013, and reported net income of $400,000 for 2013. Ziegler Corporation should report revenue from investment for 2013 in the amount of a. $30,000. b. $70,000. c. $100,000. d. $110,000. Use the following information for questions 97 and 98. Harrison Co. owns 20,000 of the 50,000 outstanding shares of Taylor, Inc. common stock. During 2013, Taylor earns $1,200,000 and pays cash dividends of $960,000.
17 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 97. If the beginning balance in the investment account was $750,000, the balance at December 31, 2013 should be a. $1,230,000. b. $990,000. c. $846,000. d. $750,000. 98. Harrison should report investment revenue for 2013 of a. $480,000. b. $384,000. c. $96,000. d. $0. Use the following information for questions 99 through 102. The summarized balance sheets of Goebel Company and Dobbs Company as of December 31, 2012 are as follows: Goebel Company Balance Sheet December 31, 2012 Assets $1,200,000 Liabilities Capital stock Retained earnings Total equities
$ 150,000 600,000 450,000 $1,200,000 Dobbs Company Balance Sheet December 31, 2012
Assets
$900,000
Liabilities Capital stock Retained earnings Total equities
$225,000 555,000 120,000 $900,000
99.
If Goebel Company acquired a 20% interest in Dobbs Company on December 31, 2012 for $195,000 and the fair value method of accounting for the investment were used, the amount of the debit to Equity Investments (Dobbs) would have been a. $135,000. b. $111,000. c. $195,000. d. $180,000.
100.
If Goebel Company acquired a 30% interest in Dobbs Company on December 31, 2012 for $225,000 and the equity method of accounting for the investment were used, the amount of the debit to Equity Investments (Dobbs) would have been a. $285,000. b. $225,000. c. $180,000. d. $202,500.
Investments
17 - 23
101.
If Goebel Company acquired a 20% interest in Dobbs Company on December 31, 2011 for $135,000 and during 2013 Dobbs 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 Equity Investments (Dobbs) account at the end of 2013 of a. $111,000. b. $135,000. c. $150,000. d. $144,000.
102.
If Goebel Company acquired a 30% interest in Dobbs Company on December 31, 2012 for $210,000 and during 2013 Dobbs 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 Equity Investments (Dobbs) account at the end of 2013 of a. $210,000. b. $223,500. c. $232,500. d. $201,000.
Use the following information for questions 103 and 104. Blanco Company purchased 200 of the 1,000 outstanding shares of Darby Company's common stock for $600,000 on January 2, 2013. During 2013, Darby Company declared dividends of $100,000 and reported earnings for the year of $400,000. 103.
If Blanco Company used the fair value method of accounting for its investment in Darby Company, its Equity Investment (Darby) account on December 31, 2013 should be a. $580,000. b. $660,000. c. $600,000. d. $680,000.
104.
If Blanco Company uses the equity method of accounting for its investment in Darby Company, its Equity Investment (Darby) account at December 31, 2013 should be a. $580,000. b. $600,000. c. $660,000. d. $680,000. Use the following information for questions 105 and 106. Brown Corporation earns $600,000 and pays cash dividends of $200,000 during 2012. Dexter Corporation owns 3,000 of the 10,000 outstanding shares of Brown. 105.
What amount should Dexter show in the investment account at December 31, 2012 if the beginning of the year balance in the account was $800,000? a. $980,000. b. $800,000. c. $920,000. d. $1,200,000.
17 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition 106.
How much investment income should Dexter report in 2012? a. $200,000. b. $180,000. c. $120,000. d. $600,000.
107.
Myers Co. acquired a 60% interest in Gannon Corp. on December 31, 2012 for $1,260,000. During 2013, Gannon had net income of $800,000 and paid cash dividends of $200,000. At December 31, 2013, the balance in the investment account should be a. $1,260,000. b. $1,740,000. c. $1,620,000. d. $1,860,000.
Use the following information for questions 108 and 109. Tracy Co. owns 4,000 of the 10,000 outstanding shares of Penn Corp. common stock. During 2013, Penn earns $360,000 and pays cash dividends of $120,000. 108.
If the beginning balance in the investment account was $720,000, the balance at December 31, 2013 should be a. $720,000. b. $816,000. c. $864,000. d. $960,000.
109.
Tracy should report investment revenue for 2013 of a. $48,000. b. $96,000. c. $120,000. d. $144,000.
110.
The following information relates to Windom Company for 2013: 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 Windom’s 2013 other comprehensive income is a. $50,000. b. $80,000. c. $100,000. d. $120,000.
$30,000 70,000 20,000
Investments
17 - 25
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
70. 71. 72. 73. 74. 75.
c b d b a c
76. 77. 78. 79. 80. 81.
a b c a b b
82. 83. 84. 85. 86. 87.
d a d b d b
88. 89. 90. 91. 92. 93.
c b c a a b
94. 95. 96. 97. 98. 99.
a b c c a c
100. 101. 102. 103. 104. 105.
b b b c c c
106. 107. 108. 109. 110.
b c b d b
MULTIPLE CHOICE—CPA Adapted 111.
On October 1, 2012, Wenn Co. purchased 800 of the $1,000 face value, 8% bonds of Loy, Inc., for $936,000, including accrued interest of $16,000. The bonds, which mature on January 1, 2019, pay interest semiannually on January 1 and July 1. Wenn used the straight-line method of amortization and appropriately recorded the bonds as available-forsale. On Wenn's December 31, 2013 balance sheet, the carrying value of the bonds is a. $920,000. b. $912,000. c. $908,800. d. $896,000.
112.
Valet Corp. began operations in 2013. An analysis of Valet’s equity securities portfolio acquired in 2013 shows the following totals at December 31, 2013 for trading and available-for-sale securities: Trading Available-for-Sale Securities Securities Aggregate cost $90,000 $110,000 Aggregate fair value 70,000 95,000 What amount should Valet report in its 2013 income statement for unrealized holding loss? a. $35,000. b. $5,000. c. $15,000. d. $20,000.
113.
At December 31, 2013, Jeter Corp. had the following equity securities that were purchased during 2013, its first year of operation: Fair Unrealized Cost Value Gain (Loss) Trading Securities: Security A $ 95,000 $ 60,000 $(35,000) B 15,000 20,000 5,000 Totals $110,000 $ 80,000 $(30,000) 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)
17 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition All market declines are considered temporary. Fair value adjustments at December 31, 2013 should be established with a corresponding charge against Income Stockholders’ Equity a. $50,000 $ 0 b. $35,000 $30,000 c. $30,000 $20,000 d. $30,000 $ 0 114.
On December 29, 2013, James Co. sold an equity security that had been purchased on January 4, 2012. James owned no other equity securities. An unrealized holding loss was reported in the 2012 income statement. A realized gain was reported in the 2013 income statement. Was the equity security classified as available-for-sale and did its 2012 market price decline exceed its 2013 market price recovery? 2012 Market Price Decline Exceeded 2013 Available-for-Sale Market Price Recovery a. Yes Yes b. Yes No c. No Yes d. No No
Use the following information for questions 115 through 117. Rich, Inc. acquired 30% of Doane Corp.'s voting stock on January 1, 2012 for $600,000. During 2012, Doane earned $240,000 and paid dividends of $150,000. Rich's 30% interest in Doane gives Rich the ability to exercise significant influence over Doane's operating and financial policies. During 2013, Doane earned $300,000 and paid dividends of $90,000 on April 1 and $90,000 on October 1. On July 1, 2013, Rich sold half of its stock in Doane for $396,000 cash. 115.
Before income taxes, what amount should Rich include in its 2012 income statement as a result of the investment? a. $240,000. b. $150,000. c. $72,000. d. $45,000.
116.
The carrying amount of this investment in Rich's December 31, 2012 balance sheet should be a. $600,000. b. $627,000. c. $672,000. d. $690,000.
117.
What should be the gain on sale of this investment in Rich's 2013 income statement? a. $96,000. b. $82,500. c. $73,500. d. $60,000.
Investments
17 - 27
118.
On January 1, 2013, Reston Co. purchased 25% of Ace Corp.'s common stock; no goodwill resulted from the purchase. Reston appropriately carries this investment at equity and the balance in Reston’s investment account was $960,000 at December 31, 2013. Ace reported net income of $600,000 for the year ended December 31, 2013, and paid common stock dividends totaling $240,000 during 2013. How much did Reston pay for its 25% interest in Ace? a. $870,000. b. $1,020,000. c. $1,050,000. d. $1,170,000.
119.
On December 31, 2012, Patel Co. purchased equity securities as trading securities. Pertinent data are as follows: Fair Value Security Cost At 12/31/13 A $132,000 $117,000 B 168,000 186,000 C 288,000 268,000 On December 31, 2013, Patel transferred its investment in security C from trading to available-for-sale because Patel intends to retain security C as a long-term investment. What total amount of gain or loss on its securities should be included in Patel's income statement for the year ended December 31, 2013? a. $3,000 gain. b. $17,000 loss. c. $20,000 loss. d. $35,000 loss.
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
111. 112.
d d
113. 114.
c d
115. 116.
c b
117. 118.
c a
119.
b
DERIVATIONS — Computational No.
Answer Derivation
70.
c
Dr. Debt Investments: 400 × $1,000 × .97 = $388,000 Dr. Interest Revenue: $400,000 × .045 × 3/6 = $9,000 Cr. Cash: $388,000 + $9,000 = $397,000.
71.
b
($600,000 × 1.02) + $9,000 = $621,000.
72.
d
($564,150 × .055) – ($600,000 × .05) = $1,028.
73.
b
$564,150 × .055 = $31,028 ($564,150 + $1,028) × .055 - $31,085; $31,028 + $31,085 = $62,113.
74.
a
$1,060,000 – ($1,041,580 – $3,540 – $3,660) = $25,620.
75.
c
$1,033,750 – $1,030,000 = $3,750.
17 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
76.
a
Dr. Debt Investments: $600,000 × 1.04 = $624,000 Dr. Interest Revenue: $600,000 × .05 × 3/6 = $15,000 Cr. Cash: $624,000 + $15,000 = $639,000.
77.
b
$1,950,000 + ($50,000 × 3/100) = $1,951,500.
78.
c
$948,000 – $13,500 = $934,500 $934,500 – ($34,500 × 2/50) = $933,120.
79.
a
($500,000 × .045) + ($50,000 × 2/80) – $15,000 = $8,750.
80.
b
($500,000 × .09 × 3/12) – ($20,000 × 3/50) = $10,050.
81.
b
Discount amortization: $60,000 × 8/50 = $9,600 ($2,940,000 + $9,600) ÷ 2 = $1,474,800; $1,482,000 – $1,474,800 = $7,200 gain.
82.
d
($425,672 .09) – ($400,000 .10) = ($1,688) ($425,672 – $422) .09 = $38,160.
83.
a
($425,672 – $400,000) ÷ 10 = $2,568.
84.
d
$636,000 – ($624,948 – $2,124 – $2,196) = $15,372.
85.
b
$620,250 – $618,000 = $2,250.
86.
d
[($35 – $30) 1,500] – [($30 – $28) 4,500] = ($1,500).
87.
b
$600,000 – $570,000 = $30,000 loss.
88.
c
$480,000 – $450,000 = $30,000 gain.
89.
b
($120,000 – $99,000) – $6,000 = $15,000 unrealized gain.
90.
c
$25,000 (unrealized loss).
91.
a
$0 (available-for-sale securities).
92.
a
[(40,000 × $17) – $28,000] – $630,000 = $22,000.
93.
b
($400,000 – $370,000) = $30,000.
94.
a
$10,000 + $30,000 = $40,000.
95.
b
X + [($630,000 – $270,000) .25] = $480,000 X + $90,000 = $480,000 X = $390,000.
96.
c
$400,000 × (25,000 ÷ 100,000) = $100,000.
Investments
DERIVATIONS — Computational (cont.) No.
Answer Derivation
97.
c
$750,000 + [($1,200,000 – $960,000) × (20,000 ÷ 50,000)] = $846,000.
98.
a
$1,200,000 × (20,000 ÷ 50,000) = $480,000.
99.
c
$195,000, acquisition cost.
100.
b
$225,000, acquisition cost.
101.
b
$135,000, acquisition cost.
102.
b
$210,000 + ($75,000 × .3) – ($30,000 × .3) = $223,500.
103.
c
$600,000, acquisition cost.
104.
c
$600,000 + ($400,000 × .2) – ($100,000 × .2) = $660,000.
105.
c
$800,000 + ($600,000 × .3) – ($200,000 × .3) = $920,000.
106.
b
$600,000 × .3 = $180,000.
107.
c
$1,260,000 + ($800,000 × .6) – ($200,000 × .6) = $1,620,000.
108.
b
$720,000 + ($360,000 × .4) – ($120,000 × .4) = $816,000.
109.
d
$360,000 × .4 = $144,000.
110.
b
$30,000 + $70,000 – $20,000 = $80,000.
DERIVATIONS — CPA Adapted No. 111.
Answer Derivation d
$936,000 – $16,000 = $930,000 15 $930,000 – $120,000 × — 75
(
) = $896,000.
$90,000 – $70,000 = $20,000.
112.
d
113.
c
114.
d
Conceptual.
115.
c
$240,000 × 30% = $72,000.
116.
b
$600,000 + $72,000 – ($150,000 × 30%) = $627,000.
17 - 29
17 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — CPA Adapted (cont.) No.
Answer Derivation
117.
c
$627,000 – ($90,000 × 30%) + ($300,000 × 50% × 30%) = $645,000. $396,000 – ($645,000 ÷ 2) = $73,500.
118.
a
$960,000 – ($600,000 × 25%) + ($240,000 × 25%) = $870,000.
119.
b
$18,000 – $15,000 – $20,000 = $17,000 loss.
EXERCISES Ex. 17-120—Investment in debt securities at premium. On April 1, 2012, West Co. purchased $320,000 of 6% bonds for $332,600 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, 2017. Instructions (a) Prepare the journal entry on April 1, 2012. (b) The bonds are sold on November 1, 2013 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 17-120 (a) Debt Investments .......................................................................... Interest Revenue ($320,000 × .06 × 1/4) ....................................... Cash ................................................................................
332,600 4,800
(b) Interest Revenue ($6,300 × 4 ÷ 63) ............................................... Debt Investments .............................................................
800
Cash ($320,000 × .06 × 1/3) ......................................................... Interest Revenue ..............................................................
6,400
Cash ............................................................................................. Gain on Sale of Investments ............................................ Debt Investments ............................................................ $332,600 – [($12,600 ÷ 63) × 19]
329,600
337,400
800
6,400
800 328,800
Investments
17 - 31
Ex. 17-121—Investment in debt securities at a discount. On May 1, 2012, Kirmer Corp. purchased $600,000 of 12% bonds, interest payable on January 1 and July 1, for $562,600 plus accrued interest. The bonds mature on January 1, 2018. 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, 2012. (b) The bonds are sold on August 1, 2013 for $565,000 plus accrued interest. Prepare all entries required to properly record the sale.
Solution 17-121 (a)
(b)
Debt Investments ........................................................................ Interest Revenue ($600,000 × .12 × 4/12) ................................... Cash ................................................................................
562,600 24,000
Debt Investments ($37,400 ÷ 68 × 1) .......................................... Interest Revenue .............................................................
550
Cash ($600,000 × .12 × 1/12) ...................................................... Interest Revenue .............................................................
6,000
Cash............................................................................................ Loss on Sale of Investments........................................................ Debt Investments ............................................................. $562,600 + [($37,400 ÷ 68) 15]
565,000 5,850
586,600
550
6,000
570,850
Ex. 17-122—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.
17 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 17-122 Case I. At the end of last year, the company would have recognized an unrealized holding loss and recorded a 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. Solution 17-122 (cont.) 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 Equity Investments (available-for-sale) account is recorded at fair value, and the Unrealized Holding Loss—Income account is debited for the unrealized loss. The Equity Investments (trading) account is credited for cost.
Ex. 17-123—Investment in equity securities. Agee Corp. acquired a 30% interest in Trent Co. on January 1, 2013, for $500,000. At that time, Trent had 1,000,000 shares of its $1 par common stock issued and outstanding. During 2013, Trent paid cash dividends of $160,000 and thereafter declared and issued a 5% common stock dividend when the fair value was $2 per share. Trent's net income for 2013 was $360,000. What is the balance in Agee’s equity investment account at the end of 2013?
Solution 17-123 Cost Share of net income (.30 × $360,000) Share of dividends (.30 × $160,000) Balance in equity investment account
$500,000 108,000 (48,000) $560,000
Ex. 17-124—Fair value and equity methods. (Essay) Compare the fair value and equity methods of accounting for investments in stocks subsequent to acquisition.
Solution 17-124 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.
Investments
17 - 33
Ex. 17-125—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 Crane Company uses (a) the fair value method and (b) the equity method for accounting for its investments in Hudson Company. (a) Fair Value Method (b) Equity Method Investment Dividend Investment Investment Transaction Account Revenue Account Revenue ——————————————————————————————————————————— 1. At the beginning of Year 1, Crane bought 40% of Hudson's common stock at its book value. Total book value of all Hudson's common stock was $800,000 on this date. ——————————————————————————————————————————— 2. During Year 1, Hudson reported $60,000 of net income and paid $30,000 of dividends. ——————————————————————————————————————————— 3. During Year 2, Hudson reported $30,000 of net income and paid $40,000 of dividends. ——————————————————————————————————————————— 4. During Year 3, Hudson 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. ——————————————————————————————————————————— Solution 17-125
Transaction
(a) Fair Value Method (b) Equity Method Investment Dividend Investment Investment Account Revenue Account Revenue
———————————————————————————————————————————————
1.
320,000
320,000
———————————————————————————————————————————————
2. 12,000
24,000 (12,000)
24,000
———————————————————————————————————————————————
3. 16,000
12,000 (16,000)
12,000
———————————————————————————————————————————————
4. 2,000
(4,000) (2,000)
(4,000)
———————————————————————————————————————————————
5.
320,000
30,000
322,000
32,000
———————————————————————————————————————————————
17 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 17-126—Comprehensive income calculation. The following information is available for Irwin Company for 2013: 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 29,000 8,000
Instructions (1) Determine other comprehensive income for 2013. (2) Compute comprehensive income for 2013.
Solution 17-126 (1) 2013 other comprehensive income = $31,000 ($10,000 realized gain + $29,000 unrealized holding gain – $8,000 reclassification adjustment). (2) 2013 comprehensive income = $151,000 ($120,000 + $31,000).
*Ex. 17-127—Fair value hedge. On January 2, 2013, Tylor Co. issued a 4-year, $750,000 note at 6% fixed interest, interest payable semiannually. Tylor now wants to change the note to a variable rate note. As a result, on January 2, 2013, Tylor 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 $750,000. At each 6-month period, the variable interest rate will be reset. The variable rate is reset to 6.6% on June 30, 2013. Instructions (a) Compute the net interest expense to be reported for this note and related swap transaction as of June 30, 2013. (b) Compute the net interest expense to be reported for this note and related swap transaction as of December 31, 2013.
*Solution 17-127 (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 × $750,000 6.6% × ½ × $750,000 Net interest expense
6/30/13 $750,000 3% $ 22,500 22,500 $ 0
12/31/13 $750,000 3% $ 22,500 22,500 $ 0
$ 21,000 0 $ 21,000
$ 24,750 $ 24,750
Investments
17 - 35
*Ex. 17-128—Cash flow hedge. On January 2, 2012, Sloan Company issued a 5-year, $6,000,000 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% Sloan Company decides it prefers fixed-rate financing and wants to lock in a rate of 6%. As a result, Sloan 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, 2013. Instructions (a) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2012. (b) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2013.
*Solution 17-128 (a) and (b) Variable-rate debt Variable rate Debt payment
12/31/12 $6,000,000 6.8% $ 408,000
12/31/13 $6,000,000 7.4% $ 444,000
Debt payment Swap receive variable Net income effect Swap payable—fixed Net interest expense
$ 408,000 (408,000) $ 0 420,000 $ 420,000
$ 444,000 (444,000) $ 0 420,000 $ 420,000
PROBLEMS Pr. 17-129—Trading equity securities. Korman Company has the following securities in its portfolio of trading securities on December 31, 2012: Cost Fair Value 5,000 shares of Thomas Corp., Common $159,000 $139,000 10,000 shares of Gant, Common 182,000 190,000 $341,000 $329,000 All of the securities had been purchased in 2012. In 2013, Korman completed the following securities transactions: March 1 April 1
Sold 5,000 shares of Thomas Corp., Common @ $31 less fees of $1,500. Bought 600 shares of Werth Stores, Common @ $45 plus fees of $550.
17 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 17-129 (cont.) The Korman Company portfolio of trading securities appeared as follows on December 31, 2013: Cost Fair Value 10,000 shares of Gant, Common $182,000 $195,500 600 shares of Werth Stores, Common 27,550 25,500 $209,550 $221,000 Instructions Prepare the general journal entries for Korman Company for: (a) the 2012 adjusting entry. (b) the sale of the Thomas Corp. stock. (c) the purchase of the Werth Stores' stock. (d) the 2013 adjusting entry.
Solution 17-129 (a)
(b)
(c)
(d)
12-31-12 Unrealized Holding Gain or Loss—Income .................................. Fair Value Adjustment (trading) ........................................ ($341,000 – $329,000)
12,000 12,000
3-1-13 Cash [(5,000 $31) – $1,500] ..................................................... Loss on Sale of Investments ........................................................ Equity Investments ...........................................................
153,500 5,500
4-1-13 Equity Investments ...................................................................... Cash [(600 $45) + $550] ...............................................
27,550
12-31-13 Fair Value Adjustment (trading) ................................................... Unrealized Holding Gain or Loss—Income .......................
23,450
159,000
27,550
23,450
Pr. 17-130—Trading equity securities. Perez Company began operations in 2011. 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
2011 $ 15,000 (25,000) —
At January 1, 2014, Perez owned the following trading securities: BKD Common (15,000 shares) LRF Preferred (2,000 shares) Drake Convertible bonds (100 bonds)
Cost $450,000 210,000 115,000
2012 $(20,000) — 10,000
2013 $ 14,000 (20,000) —
Investments
17 - 37
Pr. 17-130 (cont.) During 2014, the following events occurred: 1. Sold 5,000 shares of BKD for $170,000. 2. Acquired 1,000 shares of Horton Common for $40 per share. Brokerage commissions totaled $1,000. At 12/31/14, the fair values for Perez's trading securities were: BKD Common, $28 per share LRF Preferred, $110 per share Drake Bonds, $1,020 per bond Horton Common, $45 per share Instructions (a) Prepare a schedule which shows the balance in the Fair Value Adjustment (trading) account at December 31, 2013 (after the adjusting entry for 2013 is made). (b) Prepare a schedule which shows the aggregate cost and fair values for Perez's trading securities portfolio at 12/31/14. (c) Prepare the necessary adjusting entry based upon your analysis in (b) above.
Solution 17-130 (a)
Balance 12/31/11 (result of that year's adjusting entry) Deduct unrealized gain for 2012 Add: Unrealized loss for 2013 Balance at 12/31/13
(b)
Aggregate cost and fair value for trading securities at 12/31/14 BKD Common 10,000 shares LRF Preferred 2,000 shares Horton Common, 1,000 shares Drake Bonds, 100 bonds Total
(c)
Adjusting entry at 12/31/14: Fair Value Adjustment (trading) ................................................... Unrealized Holding Gain or Loss—Income ...................... (Balance at 1/1/14 $35,000 Balance needed at 12/31/14 19,000 Recovery $16,000)
$(25,000) 10,000 (20,000) $(35,000)
Cost $300,000 210,000 41,000 115,000 $666,000
Fair Value $280,000 220,000 45,000 102,000 $647,000
16,000 16,000
17 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 17-131—Available-for-sale equity securities. During the course of your examination of the financial statements of Doppler Corporation for the year ended December 31, 2013, you found a new account, "Investments." Your examination revealed that during 2013, Doppler began a program of investments, and all investment-related transactions were entered in this account. Your analysis of this account for 2013 follows: Doppler Corporation Analysis of Investments For the Year Ended December 31, 2013 Date—2013
Debit
Credit
(a) Harmon Company Common Stock Feb. 14 Purchased 4,000 shares @ $55 per share. $220,000 July 26 Received 400 shares of Harmon Company common stock as a stock dividend. (Memorandum entry in general ledger.) Sept. 28 Sold the 400 shares of Harmon Company common stock received July 26 @ $65 per share.
$28,000
(b) Debit Apr. Oct.
Taber Inc., Common Stock 30 Purchased 20,000 shares @ $40 per share. 28 Received dividend of $1.20 per share.
Credit
$800,000 $24,000
Additional information: 1. The fair value for each security as of the 2013 date of each transaction follow: Security Feb. 14 Apr. 30 July 26 Sept. 28 Harmon Co. $55 $62 $70 Taber Inc. $40 Doppler Corp. 25 28 30 33
Dec. 31 $74 33 35
2. All of the investments of Doppler are nominal in respect to percentage of ownership (5% or less). 3. Each investment is considered by Doppler’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, 2013.
Solution 17-131 (1) (a) Harmon — 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
Investments
17 - 39
Solution 17-131 (cont.) Sold 100 shares Correct entry: Cash (400 × $65)...................................................................... Equity Investments........................................................ Gain on Sale of Investments .........................................
26,000
Entry made: Cash ......................................................................................... Equity Investments........................................................
26,000
Correction: Equity Investments ................................................................... Gain on Sale of Investments .........................................
6,000
20,000 6,000
26,000
6,000
(b) Taber—should record cash dividend as dividend income. Correct entry: Cash ......................................................................................... Dividend Revenue.........................................................
24,000
Entry made: Cash ......................................................................................... Equity Investments........................................................
24,000
Correction: Equity Investments ................................................................... Dividend Revenue......................................................... (To properly record dividends under fair value method)
24,000
24,000
24,000 24,000
(2) Valuation at End of Year:
Harmon Taber
Quantity 4,000 shares 20,000 shares
Cost $ 200,000 800,000 $1,000,000
Increase (Decrease) $ 96,000 (140,000) $ 44,000
Fair Value $296,000 660,000 $956,000
Year-end Adjustment: Unrealized Holding Gain or Loss—Equity....................................... Fair Value Adjustment (available-for-sale) .......................
44,000 44,000
17 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition *Pr. 17-132—Derivative financial instrument. Hummel Co. purchased a put option on Olney common shares on July 7, 2012, for $100. The put option is for 200 shares, and the strike price is $30. The option expires on January 31, 2013. The following data are available with respect to the put option: Date September 30, 2012 December 31, 2012 January 31, 2013
Market Price of Olney Shares $32 per share $31 per share $33 per share
Time Value of Put Option $55 21 0
Instructions Prepare the journal entries for Hummel Co. for the following dates: (a)
July 7, 2012—Investment in put option on Olney shares.
(b)
September 30, 2012— Hummel prepares financial statements.
(c)
December 31, 2012— Hummel prepares financial statements.
(d)
January 31, 2013—Put option expires.
*Solution 17-132 (a)
(b)
(c)
(d)
July 7, 2012 Put Option ................................................................................... Cash ................................................................................
100
September 30, 2012 Unrealized Holding Gain or Loss—Income .................................. Put Option ($100 – $55) ...................................................
45
December 31, 2012 Unrealized Holding Gain or Loss—Income .................................. Put Option ($55 – $21) .....................................................
34
January 31, 2013 Loss on Settlement of Put Option ................................................ Put Option ($21 – $0) .......................................................
21
100
45
34
21
*Pr. 17-133—Free-standing derivative. Welch Co. purchased a put option on Reese common shares on July 7, 2013, for $215. The put option is for 300 shares, and the strike price is $51. The option expires on July 31, 2013. The following data are available with respect to the put option: Date March 31, 2013 June 30, 2013 July 6, 2013
Market Price of Reese Shares $47 per share $50 per share $46 per share
Time Value of Put Option $120 56 16
Investments
17 - 41
*Pr. 17-133 (cont.) Instructions Prepare the journal entries for Welch Co. for the following dates: (a)
January 7, 2013—Investment in put option on Reese shares.
(c)
March 31, 2013— Welch prepares financial statements.
(d)
June 30, 2013— Welch prepares financial statements.
(e)
July 6, 2013— Welch settles the call option on the Reese shares.
*Solution 17-133 (a)
(b)
January 7, 2013 Put Option ................................................................................... Cash ................................................................................
215
March 31, 2013 Put Option ................................................................................... Unrealized Holding Gain or Loss—Income ($4 × 300) .....
1,200
Unrealized Holding Gain or Loss—Income .................................. Put Option ($215 – $120) ................................................. (c)
June 30, 2013 Unrealized Holding Gain or Loss—Income .................................. Put Option ($3 × 300) ...................................................... Unrealized Holding Gain or Loss—Income .................................. Put Option ($120 – $56)...................................................
(d)
July 6, 2013 Unrealized Holding Gain or Loss—Income .................................. Put Option ($56 – $16)..................................................... Cash (300 × $5) .......................................................................... Gain on Settlement of Put Option..................................... Put Option* ......................................................................
*Value of Put Option settlement: Put Option 215 1,200
316
95 900 64 40
215
1,200 95 95 900 900 64 64
40 40 1,500 1,184 316
17 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS True/False 1. IFRS requires that gains and losses on available-for-sale securities be reported directly in equity. 2. Under IFRS, impairment charges related to available-for-sale debt securities may be reversed, but impairment charges related to available-for-sale equity securities may not be reversed. 3. Reclassification in and out of trading securities is permitted under IFRS, although this type of reclassification should be rare. 4. IFRS requires that Company A consolidate Company B when it controls and owns at least 50% of Company B. 5. Under IFRS, both the investor and the associate company should follow the same accounting practices, requiring adjustments be made to the investor’s books in order to prepare financial information. Answers to True/False 1. True 2. True 3. False 4. True 5. False Multiple Choice 1. Match the approach and location where gains and losses from available-for-sale securities are reported: Location where gains/ Approach losses reported_ __ a. GAAP Equity b. IFRS Equity c. GAAP Income d. IFRS Comprehensive income
Investments
17 - 43
Use the following information for questions 2 and 3 Rushia Company has an available-for-sale investment in the 10%, 10-year bonds of Pear Co. The investment’s carrying value is $3,200,000 at December 31, 2012. On January 9, 2013, Rushia learns that Pear Co. has lost its primary manufacturing facility in an uninsured fire. As a result, Rushia determines that the investment is impaired and now has a fair value of $2,300,000. In June, 2014, Pear Co. has succeeded in rebuilding its manufacturing facility, and its prospects have improved as a result. 2.
If Rushia Company determines that the fair value of the investment is now $3,900,000 and is using U.S. GAAP for its external financial reporting, which of the following is true? a. Rushia is prohibited from recording the recovery in value of the impaired investment. b. Rushia may record a recovery of $900,000. c. Rushia may record a recovery of $700,000. d. Rushia may record a recovery of $1,600,000.
3.
If Rushia Company determines that the fair value of the investment is now $2,900,000 and is using IFRS for its external financial reporting, which of the following is true? a. Rushia is prohibited from recording the recovery in value of the impaired investment. b. Rushia may record a recovery of $600,000. c. Rushia may record a recovery of $900,000. d. Rushia may record a recovery, but is limited to 80% of the value of the recovery.
Answers to multiple choice 1. b 2. a 3. b
Short Answer: 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to the accounting for investments. 1. The accounting and reporting under IFRS and U.S. GAAP are for the most part very similar, although the criteria used to determine the accounting is often different. For example, among the notable similarities are: (1) the accounting for trading, availablefor-sale, and held-to-maturity securities is essentially the same between IFRS and U.S. GAAP; (2) both IFRS and U.S. GAAP use the same test to determine whether the equity method of accounting should be used – that is, significant influence with a general guide of over 20% ownership. IFRS uses the term associate investment rather than equity investment to describe its investment under the equity method; (3) reclassifications of securities from one category to another generally follow the same accounting under the two GAAP systems. Reclassification in and out of trading securities is prohibited under IFRS. It is not prohibited under U.S. GAAP, but this type of reclassification should be rare.
17 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition
Differences include: (1) Gains and losses related to available-for-sale securities are reported in other comprehensive income under U.S. GAAP. Under IFRS, these gains and losses are reported directly in equity; (2) under IFRS, both the investor and an associate company should follow the same accounting policies. As a result, in order to prepare financial information, adjustments are made to the associate’s policies to conform to the investor’s books; (3) the basis for consolidation under IFRS is control. Under U.S. GAAP, a bipolar approach is used which is a risk-and-reward model (often referred to as a variable-entity approach) and a voting-interest approach. However, under both systems, for consolidation to occur, the investor company must generally own 50% of another company; (4) U.S. GAAP does not permit the reversal of an impairment charge related to available-for-sale debt and equity investments. IFRS follows the same approach for available-for-sale equity investments but permits reversal for available-for-sale debt securities and held-to-maturity securities. 2. Ramirez Company has an available-for-sale investment in the 6%, 20-year bonds of Soto Company. The investment was originally purchased for $1,200,000 in 2009. Early in 2012, Ramirez recorded an impairment of $200,000 on the Soto investment, due to Soto’s financial distress. In 2013, Soto returned to profitability and the Soto investment was no longer impaired. What entry does Ramirez make in 2013 under (a) U.S. GAAP and (b) IFRS? 2. Under U.S. GAAP, Ramirez makes no entry, because impaired investments may not be written up if they recover in value. Under IFRS, Ramirez makes the following entry: Debt Investments…………………………………… 200,000 Recovery of Impairment Loss ………………………..
200,000
CHAPTER 18 REVENUE RECOGNITION IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F T T F T F T T F 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.
Recognition of revenue. Realization of revenue. Delayed recognition of revenue. Recognizing revenue when right of return exists. Recognizing revenue prior to product completion. Use of percentage-of-completion method. Input measure for contract progress. Reporting Construction in Process and Billings on Construction in Process. Construction in Process account balance. Recognition of revenue under completed-contract method. Principal advantage of completed-contract method. Recognizing loss on an unprofitable contract. Recognizing current period loss on a profitable contract. Recognizing revenue under completion-of-production basis. Recording a loss on an unprofitable contract. Deferring revenue under installment-sales method. Deferring gross profit under installment-sales method. Classification of deferred gross profit. Recognizing revenue under cost-recovery method. Recognizing profit under cost-recovery method.
Answer
No.
Description
c b a b d b d d c d b c b c b a b d
21. 22. 23. S 24. P 25. P 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. S 38.
Revenue recognition principle. Definition of "realized." Definition of "earned." Revenue recognition representations. Definition of recognition. Revenue recognition principle. 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. Appropriate accounting method for long-term contracts. Percentage-of-completion method. Percentage-of-completion method. Classification of progress billings and construction in process. Calculation of gross profit using percentage-of-completion. Disclosure of earned but unbilled revenues. Disadvantage of using percentage-of-completion. Percentage-of-completion input measures.
MULTIPLE CHOICE—Conceptual
18 - 2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer a c a c d a d b c c b b c d b b d b d b d d a b a d
No.
Description
S
Advantage of completed-contract method Revenue, cost, and gross profit under the completed-contract method. Loss recognition on a long-term contract. Accounting for long-term contract losses. Criteria for revenue recognition of completion of production. Completion-of-production basis. Revenue recognition of completion of production. Treatment of estimated contract cost increase. Presentation of deferred gross profit. Appropriate use of the installment-sales method. Valuing repossessed assets. Gross profit deferred under the installment-sales method. Income realization on installment sales. Conservative revenue recognition method. Income recognition under the cost-recovery method. Income recognition under the cost-recovery method. Cost recovery basis of revenue recognition. Deposit method of revenue recognition. Cost recovery method. Types of franchising arrangements. Accounting for consignment sales. Allocation of initial franchise fee. Recognition of continuing franchise fees. Future bargain purchase option. Option to purchase franchisee's business agreement. Revenue recognition by the consignor.
39. 40. 41. 42. 43. 44. S 45. S 46. 47. 48. 49. 50. S 51. P 52. 53. 54. 55. 56. 57. *58. *59. *60. *61. *62. *63. *64.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. *This topic is dealt with in an Appendix to the chapter. S
MULTIPLE CHOICE—Computational Answer
No.
Description
c d b c b c c c b d c b c a
65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78.
Computation of total revenue and accounts receivable. Computation of total construction expenses. Computation of costs and profits in excess of billings balance. Computation of total revenue and construction expenses. Gross profit recognized under percentage-of-completion. Computation of construction in process amount. 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 c a d b a b b b d d a d a d a c b a d c b d a
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.
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. Gross profit recognized under percentage-of-completion. Computation of construction in process amount. Loss recognized using completed-contract method. Revenue recognition using completed-contract method. Reporting a current liability with completed-contract-method. Reporting inventory under completed-contract method. 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 realized gross profit amount. Computation of loss on repossession. Calculation of gross profit rate. Computation of net income from installment sales. Computation of realized and deferred gross profit. Calculation of gross profit rate. Computation of net income from installment sales. Computation of realized and deferred gross profit. Computation of realized gross profit amount. Computation of realized gross profit-cost recovery method. Revenue recognized under the cost-recovery method. Cancellation of franchise agreement. Accounting for initial and annual continuing franchise fees. Franchise fee with a bargain purchase option. Sales on consignment. Reporting inventory on consignment.
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
a b d d c b c c c c a
110. 111. 112. 113. 114. 115. 116. 117. 118. 119. 120.
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. Revenue recognized under completed-production 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. Effect of collections received on service contracts.
18 - 3
18 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Item E18-121 E18-122 E18-123 E18-124 E18-125 E18-126 E18-127 E18-128 E18-129 E18-130 *E18-131
Description Revenue recognition (essay). Revenue recognition (essay). Long-term contracts (essay). Journal entries—percentage-of-completion. Percentage-of-completion method. Percentage-of-completion method. Percentage-of-completion and completed-contract methods. Installment sales. Installment sales. Installment sales. Franchises.
PROBLEMS Item
Description
P18-132 P18-133 P18-134 P18-135
Long-term construction project accounting. Accounting for long-term construction contracts. Long-term contract accounting—completed-contract. Installment sales.
CHAPTER LEARNING OBJECTIVES 1.
Apply the revenue recognition principle.
2.
Describe accounting issues for revenue recognition at point of sale.
3.
Apply the percentage-of-completion method for long-term contracts.
4.
Apply the completed-contract method for long-term contracts.
5.
Identify the proper accounting for losses on long-term contracts.
6.
Describe the installment-sales method of accounting.
7.
Explain the cost-recovery method of accounting.
*8.
Explain revenue recognition for franchises and consignment sales.
Revenue Recognition
18 - 5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1. 2.
TF TF
3. 21.
TF MC
22. 23.
4. 5.
TF TF
6. 27.
TF MC
28. 29.
7. 8. 9. 31. 32. 33.
TF TF TF MC MC MC
34. 35. 36. 37. S 38. 65.
MC MC MC MC MC MC
66. 67. 68. 69. 70. 71.
10. 11. S 39.
TF TF MC
40. 77. 79.
MC MC MC
81. 85. 86.
12. 13.
TF TF
14. 15.
TF TF
41. 42.
16. 17. 18. 47. 48.
TF TF TF MC MC
49. 50. S 51. 89. 90.
MC MC MC MC MC
91. 92. 93. 94. 95.
19. 20.
TF TF
P
52. 53.
MC MC
54. 55.
58. 59.
MC MC
60. 61.
MC MC
62. 63.
Note: TF = True-False MC = Multiple Choice E = Exercise P = Problem
Type
Item
Type
Item
Learning Objective 1 S P MC 24. MC 26. P MC 25. MC 110. Learning Objective 2 MC 30. MC MC 122. E Learning Objective 3 MC 72. MC 80. MC 73. MC 82. MC 74. MC 83. MC 75. MC 84. MC 76. MC 111. MC 78. MC 112. Learning Objective 4 MC 87. MC 123. MC 88. MC 127. MC 113. MC 133. Learning Objective 5 S MC 43. MC 45. S MC 44. MC 46. Learning Objective 6 MC 96. MC 101. MC 97. MC 102. MC 98. MC 115. MC 99. MC 116. MC 100. MC 117. Learning Objective 7 MC 56. MC 103. MC 57. MC 104. Learning Objective 8* MC 64. MC 106. MC 105. MC 107.
Type
Item
Type
Item
Type
MC MC
121. 122.
E E
MC MC MC MC MC MC
123. 124. 125. 126. 127. 132.
E E E E E P
133.
P
E E P
134.
P
MC MC
114. 132.
MC P
133.
P
MC MC MC MC MC
118. 119. 120. 128. 129.
MC MC MC E E
130. 135.
E P
108. 109.
MC MC
131.
E
MC MC MC MC
18 - 6
Test Bank for Intermediate Accounting, Fourteenth Edition
TRUE-FALSE—Conceptual 1.
Companies should recognize revenue when it is realized and when cash is received.
2.
Revenues are realized when a company exchanges goods and services for cash or claims to cash.
3.
Delayed recognition of revenue is appropriate if the sale does not represent substantial completion of the earnings process.
4.
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.
5.
Companies can recognize revenue prior to completion and delivery of the product under certain circumstances.
6.
Companies must use the percentage-of-completion method when estimates of progress toward completion are reasonably dependable.
7.
The most popular input measure used to determine the progress toward completion is the cost-to-cost basis.
8.
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.
9.
The Construction in Process account includes only construction costs under the percentage-of-completion method.
10.
Under the completed-contract method, companies recognize revenue and costs only when the contract is completed.
11.
The principal advantage of the completed-contract method is that reported revenue reflects final results rather than estimates.
12.
Companies must recognize a loss on an unprofitable contract under the percentage-ofcompletion method but not the completed-contract method.
13.
A loss in the current period on a profitable contract must be recognized under both the percentage-of-completion and completed-contract method.
14.
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.
15.
The provision for a loss on an unprofitable contract may be combined with the Construction in Process account balance under percentage-of-completion but not completed-contract.
16.
Under the installment-sales method, companies defer revenue and income recognition until the period of cash collection.
Revenue Recognition
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17.
The installment-sales method defers only the gross profit instead of both the sales price and cost of goods sold.
18.
Deferred gross profit is generally treated as an unearned revenue and classified as a current liability.
19.
Under the cost-recovery method, a company recognizes no revenue or profit until cash payments by the buyer exceed the cost of the merchandise sold.
20.
Companies recognize profit under the cost-recovery method only when cash collections exceed the total cost of the goods sold.
True-False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F T T F T
Item 6. 7. 8. 9. 10.
Ans. F T T F F
Item 11. 12. 13. 14. 15.
Ans. T F F T F
Item 16. 17. 18. 19. 20.
Ans. F T T F T
MULTIPLE CHOICE—Conceptual 21.
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.
22.
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.
23.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
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24.
Which of the following is not an accurate representation concerning revenue recognition? a. Revenue from selling products is recognized at the date of sale, usually interpreted to mean the date of delivery to customers. b. Revenue from services rendered is recognized when cash is received or when services have been performed. c. Revenue from permitting others to use enterprise assets is recognized as time passes or as the assets are used. d. Revenue from disposing of assets other than products is recognized at the date of sale.
P
25.
The process of formally recording or incorporating an item in the financial statements of an entity is a. allocation. b. articulation. c. realization. d. recognition.
P
26.
Dot Point, Inc. is a retailer of washers and dryers and offers a three-year service contract on each appliance sold. Although Dot Point sells the appliances on an installment basis, all service contracts are cash sales at the time of purchase by the buyer. Collections received for service contracts should be recorded as a. service revenue. b. deferred service revenue. c. a reduction in installment accounts receivable. d. a direct addition to retained earnings.
27.
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.
28.
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.
29.
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.
Revenue Recognition
18 - 9
30.
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.
31.
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.
32.
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.
33.
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
34.
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.
35.
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.
18 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition 36.
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.
37.
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.
S
38.
One of the more popular input measures used to determine the progress toward completion in the percentage-of-completion method is a. revenue-percentage basis. b. cost-percentage basis. c. progress completion basis. d. cost-to-cost basis.
S
39.
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.
40.
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.
41.
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.
Revenue Recognition
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42.
Cost estimates at the end of the second year indicate a loss will result on completion of the entire contract. Which of the following statements is correct? a. Under the completed-contract method, the loss is not recognized until the year the construction is completed. b. Under the percentage-of-completion method, the gross profit recognized in the first year must not be changed. c. Under the completed-contract method, when the billings exceed the accumulated costs, the amount of the estimated loss is reported as a current liability. d. Under the completed-contract method, when the Construction in Process balance exceeds the billings, the estimated loss is added to the accumulated costs.
43.
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.
44.
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.
S
45.
For which of the following products is it appropriate to recognize revenue at the completion of production even though no sale has been made? a. Automobiles b. Large appliances c. Single family residential units d. Precious metals
S
46.
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.
47.
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.
18 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition 48.
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.
49.
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.
50.
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.
S
51.
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.
P
52.
A manufacturer of large equipment sells on an installment basis to customers with questionable credit ratings. Which of the following methods of revenue recognition is least likely to overstate the amount of gross profit reported? a. At the time of completion of the equipment (completion of production method) b. At the date of delivery (sales method) c. The installment-sales method d. The cost–recovery method
53.
A seller is properly using the cost-recovery method for a sale. Interest will be earned on the future payments. Which of the following statements is not correct? a. After all costs have been recovered, any additional cash collections are included in income. b. Interest revenue may be recognized before all costs have been recovered. c. The deferred gross profit is offset against the related receivable on the balance sheet. d. Subsequent income statements report the gross profit as a separate item of revenue when it is recognized as earned.
Revenue Recognition
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54.
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.
55.
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.
56.
The deposit method of revenue recognition is used when a. the product can be marketed at quoted prices and units are interchangeable. b. cash is received before the sales transaction is complete. c. the contract is short-term or the percentage-of-completion method can’t be used. d. there are no significant costs of distribution.
57.
The cost-recovery method a. is prohibited under current GAAP due to its conservative nature. b. requires a company to defer profit recognition until all cash payments are received from the buyer. c. is used by sellers when there is a reasonable basis for estimating collectibility. d. recognizes total revenue and total cost of goods sold in the period of sale.
*58.
Types of franchising arrangements include all of the following except a. service sponsor-retailer. b. wholesaler-service sponsor. c. manufacturer-wholesaler. d. wholesaler-retailer.
*59.
In consignment sales, the consignee a. records the merchandise as an asset on its books. b. records a liability for the merchandise held on consignment. c. recognizes revenue when it ships merchandise to the consignor. d. prepares an “account report” for the consignor which shows sales, expenses, and cash receipts.
*60.
Some of the initial franchise fee may be allocated to a. continuing franchise fees. b. interest revenue on the future installments. c. options to purchase the franchisee's business. d. All of these may reduce the amount of the initial franchise fee that is recognized as revenue.
18 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition *61.
Continuing franchise fees should be recorded by the franchisor a. as revenue when earned and receivable from the franchisee. b. as revenue when received. c. in accordance with the accounting procedures specified in the franchise agreement. d. as revenue only after the balance of the initial franchise fee has been collected.
*62.
Occasionally a franchise agreement grants the franchisee the right to make future bargain purchases of equipment or supplies. When recording the initial franchise fee, the franchisor should a. increase revenue recognized from the initial franchise fee by the amount of the expected future purchases. b. record a portion of the initial franchise fee as unearned revenue which will increase the selling price when the franchisee subsequently makes the bargain purchases. c. defer recognition of any revenue from the initial franchise fee until the bargain purchases are made. d. None of these.
*63.
A franchise agreement grants the franchisor an option to purchase the franchisee's business. It is probable that the option will be exercised. When recording the initial franchise fee, the franchisor should a. record the entire initial franchise fee as a deferred credit which will reduce the franchisor's investment in the purchased outlet when the option is exercised. b. record the entire initial franchise fee as unearned revenue which will reduce the amount of cash paid when the option is exercised. c. record the portion of the initial franchise fee which is attributable to the bargain purchase option as a reduction of the future amounts receivable from the franchisee. d. None of these.
*64.
Revenue is recognized by the consignor when the a. goods are shipped to the consignee. b. consignee receives the goods. c. consignor receives an advance from the consignee. d. consignor receives an account sales from the consignee.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27.
c b a b d b d
28. 29. 30. 31. 32. 33. 34.
d c d b c b c
35. 36. 37. 38. 39. 40. 41.
b a b d a c a
42. 43. 44. 45. 46. 47. 48.
c d a d b c c
49. 50. 51. 52. 53. 54. 55.
b b c d b b d
56. 57. *58. *59. *60. *61. *62.
b d b d d a b
*63. *64.
a d
Revenue Recognition
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MULTIPLE CHOICE—Computational Use the following information for questions 65-68: Seasons Construction is constructing an office building under contract for Cannon Company. The contract calls for progress billings and payments of $930,000 each quarter. The total contract price is $11,160,000 and Seasons estimates total costs of $10,650,000. Seasons estimates that the building will take 3 years to complete, and commences construction on January 2, 2012. 65.
At December 31, 2012, Seasons estimates that it is 30% complete with the construction, based on costs incurred. What is the total amount of Revenue from Long-Term Contracts recognized for 2012 and what is the balance in the Accounts Receivable account assuming Cannon Cafe has not yet made its last quarterly payment? Revenue Accounts Receivable a. $3,720,000 $3,720,000 b. $3,195,000 $ 930,000 c. $3,348,000 $ 930,000 d. $3,195,000 $3,720,000
66.
At December 31, 2013, Seasons Construction estimates that it is 75% complete with the building; however, the estimate of total costs to be incurred has risen to $10,800,000 due to unanticipated price increases. What is the total amount of Construction Expenses that Seasons will recognize for the year ended December 31, 2013? a. $8,100,000 b. $4,725,000 c. $4,792,500 d. $4,905,000
67.
At December 31, 2013, Seasons Construction estimates that it is 75% complete with the building; however, the estimate of total costs to be incurred has risen to $10,800,000 due to unanticipated price increases. What is reported in the balance sheet at December 31, 2013 for Seasons as the difference between the Construction in Process and the Billings on Construction in Process accounts, and is it a debit or a credit? Difference between the accounts Debit/Credit a. $2,535,000 Credit b. $930,000 Debit c. $660,000 Debit d. $930,000 Credit
68.
Seasons Construction completes the remaining 25% of the building construction on December 31, 2014, as scheduled. At that time the total costs of construction are $11,250,000. What is the total amount of Revenue from Long-Term Contracts and Construction Expenses that Seasons will recognize for the year ended December 31, 2014? Revenue Expenses a. $11,160,000 $11,250,000 b. $2,790,000 $ 2,812,000 c. $2,790,000 $ 3,150,000 d. $2,812,500 $ 2,812,500
18 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition The following information relates to questions 69 and 70. Cooper Construction Company had a contract starting April 2013, to construct a $12,000,000 building that is expected to be completed in September 2015, at an estimated cost of $11,000,000. At the end of 2013, the costs to date were $5,060,000 and the estimated total costs to complete had not changed. The progress billings during 2013 were $2,400,000 and the cash collected during 2013 was 1,600,000. 69.
For the year ended December 31, 2013, Cooper would recognize gross profit on the building of: a. $421,667 b. $460,000 c. $540,000 d. $0
70.
At December 31, 2013 Cooper would report Construction in Process in the amount of: a. $460,000 b. $5,060,000 c. $5,520,000 d. $4,720,000
71.
Hayes Construction Corporation contracted to construct a building for $3,000,000. Construction began in 2012 and was completed in 2013. Data relating to the contract are summarized below: Year ended December 31, 2012 2013 Costs incurred $1,200,000 $900,000 Estimated costs to complete 800,000 — Hayes uses the percentage-of-completion method as the basis for income recognition. For the years ended December 31, 2012, and 2013, respectively, Hayes should report gross profit of a. $540,000 and $360,000. b. $1,800,000 and $1,200,000. c. $600,000 and $300,000. d. $0 and $900,000.
72.
Monroe Construction Company uses the percentage-of-completion method of accounting. In 2013, Monroe began work on a contract it had received which provided for a contract price of $20,000,000. Other details follow: 2013 Costs incurred during the year $9,600,000 Estimated costs to complete as of December 31 6,400,000 Billings during the year 8,800,000 Collections during the year 5,200,000 What should be the gross profit recognized in 2013? a. $800,000 b. $10,400,000 c. $2,400,000 d. $4,000,000
Revenue Recognition
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Use the following information for questions 73 and 74. In 2013, Fargo Corporation began construction work under a three-year contract. The contract price is $3,600,000. Fargo 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, 2013, follow: Balance Sheet Accounts receivable—construction contract billings Construction in progress Less contract billings Costs and recognized profit in excess of billings
$150,000 $450,000 360,000
Income Statement Income (before tax) on the contract recognized in 2013
90,000
$90,000
73.
How much cash was collected in 2013 on this contract? a. $150,000 b. $210,000 c. $30,000 d. $360,000
74.
What was the initial estimated total income before tax on this contract? a. $450,000 b. $480,000 c. $600,000 d. $720,000
75.
Adler Construction Co. uses the percentage-of-completion method. In 2012, Adler began work on a contract for $5,500,000 and it was completed in 2013. Data on the costs are: Year Ended December 31 2012 2013 Costs incurred $1,950,000 $1,400,000 Estimated costs to complete 6300,000 — For the years 2012 and 2013, Adler should recognize gross profit of a. b. c. d.
2012 $0 $1,290,000 $1,350,000 $1,350,000
2013 $2,150,000 $860,000 $800,000 $2,150,000
Use the following information for questions 76 and 77. Gomez, Inc. began work in 2012 on contract #3814, which provided for a contract price of $9,600,000. Other details follow: 2012 2013 Costs incurred during the year $1,600,000 $4,900,000 Estimated costs to complete, as of December 31 4,800,000 0 Billings during the year 1,800,000 7,200,000 Collections during the year 1,200,000 5,850,000
18 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 76.
Assume that Gomez uses the percentage-of-completion method of accounting. The portion of the total gross profit to be recognized as income in 2012 is a. $600,000. b. $800,000. c. $2,400,000. d. $3,200,000.
77.
Assume that Gomez uses the completed-contract method of accounting. The portion of the total gross profit to be recognized as income in 2013 is a. $1,200,000. b. $1,800,000. c. $3,100,000. d. $9,600,000.
Use the following information for questions 78 and 79. Kiner, Inc. began work in 2012 on a contract for $12,600,000. Other data are as follows: 2012 2013 Costs incurred to date $5,400,000 $8,400,000 Estimated costs to complete 3,600,000 — Billings to date 4,200,000 12,600,000 Collections to date 3,000,000 10,800,000 78.
If Kiner uses the percentage-of-completion method, the gross profit to be recognized in 2012 is a. $2,160,000. b. $2,400,000. c. $3,240,000. d. $3,600,000.
79.
If Kiner uses the completed-contract method, the gross profit to be recognized in 2013 is a. $2,040,000. b. $4,200,000. c. $2,100,000. d. $8,400,000.
Use the following information for questions 80 and 81. 80.
Horner Construction Co. uses the percentage-of-completion method. In 2012, Horner began work on a contract for $11,000,000; it was completed in 2013. The following cost data pertain to this contract: Year Ended December 31 2012 2013 Cost incurred during the year $3,900,000 $2,800,000 Estimated costs to complete at the end of year 2,600,000 — The amount of gross profit to be recognized on the income statement for the year ended December 31, 2013 is a. $1,600,000. b. $1,720,000. c. $1,800,000. d. $4,300,000.
Revenue Recognition 81.
If the completed-contract method of accounting was used, the amount of gross profit to be recognized for years 2012 and 2013 would be a. b. c. d.
82.
18 - 19
2012 $4,500,000. $4,300,000. $0. $0.
2013 $0. $(200,000). $4,300,000. $4,500,000.
Remington Construction Company uses the percentage-of-completion method. During 2012, the company entered into a fixed-price contract to construct a building for Sherman Company for $18,000,000. The following details pertain to the contract: Percentage of completion Estimated total cost of contract Gross profit recognized to date
At December 31, 2012 25% $13,500,000 1,125,000
At December 31, 2013 60% $15,000,000 1,800,000
The amount of construction costs incurred during 2013 was a. $9,000,000. b. $5,625,000. c. $3,375,000. d. $1,500,000. Use the following information for questions 83 and 84. Eilert Construction Company had a contract starting April 2013, to construct a $18,000,000 building that is expected to be completed in September 2014, at an estimated cost of $16,500,000. At the end of 2013, the costs to date were $7,590,000 and the estimated total costs to complete had not changed. The progress billings during 2013 were $3,600,000 and the cash collected during 2013 was $2,400,000. Eilert uses the percentage-of-completion method. 83.
For the year ended December 31, 2013, Eilert would recognize gross profit on the building of a. $0. b. $632,500. c. $690,000. d. $810,000.
84.
At December 31, 2013, Eilert would report Construction in Process in the amount of a. $8,280,000. b. $7,590,000. c. $7,080,000. d. $690,000.
18 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 85.
Hiser Builders, Inc. is using the completed-contract method for a $8,400,000 contract that will take two years to complete. Data at December 31, 2013, the end of the first year, are as follows: Costs incurred to date Estimated costs to complete Billings to date Collections to date
$3,840,000 4,920,000 3,600,000 3,000,000
The gross profit or loss that should be recognized for 2013 is a. $0. b. a $360,000 loss. c. a $180,000 loss. d. a $158,400 loss. Use the following information for questions 86 through 88. Gorman Construction Co. began operations in 2013. Construction activity for 2013 is shown below. Gorman uses the completed-contract method.
Contract 1 2 3
Contract Price $3,200,000 3,600,000 3,300,000
Billings Through 12/31/13 $3,150,000 1,500,000 1,900,000
Collections Through 12/31/13 $2,600,000 1,000,000 1,800,000
Costs to 12/31/13 $2,150,000 820,000 2,250,000
Estimated Costs to Complete — $1,880,000 1,200,000
86.
Which of the following should be shown on the income statement for 2013 related to Contract 1? a. Gross profit, $450,000 b. Gross profit, $1,000,000 c. Gross profit, $1,050,000 d. Gross profit, $600,000
87.
Which of the following should be shown on the balance sheet at December 31, 2013 related to Contract 2? a. Inventory, $680,000 b. Inventory, $820,000 c. Current liability, $680,000 d. Current liability, $1,500,000
88.
Which of the following should be shown on the balance sheet at December 31, 2013 related to Contract 3? a. Inventory, $200,000 b. Inventory, $350,000 c. Inventory, $2,100,000 d. Inventory, $2,250,000
Revenue Recognition
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89.
Oliver Co. uses the installment-sales method. When an account had a balance of $11,200, 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 $3,200 as repossessed, or for $4,000 if the company spent $400 reconditioning it. The gross profit rate on this sale was 70%. The gain or loss on repossession was a a. $7,840 loss. b. $8,000 loss. c. $800 gain. d. $240 gain.
90.
Spicer Corporation has a normal gross profit on installment sales of 30%. A 2011 sale resulted in a default early in 2013. At the date of default, the balance of the installment receivable was $40,000, and the repossessed merchandise had a fair value of $22,500. Assuming the repossessed merchandise is to be recorded at fair value, the gain or loss on repossession should be a. $0. b. a $5,500 loss. c. a $5,500 gain. d. a $12,500 loss.
91.
Fryman Furniture uses the installment-sales method. No further collections could be made on an account with a balance of $36,000. It was estimated that the repossessed furniture could be sold as is for $10,800, or for $12,600 if $600 were spent reconditioning it. The gross profit rate on the original sale was 40%. The loss on repossession was a. $9,600. b. $9,000. c. $24,000. d. $25,200.
92.
Melton Company sold some machinery to Addison Company on January 1, 2012. The cash selling price would have been $758,160. Addison entered into an installment sales contract which required annual payments of $200,000, including interest at 10%, over five years. The first payment was due on December 31, 2012. What amount of interest income should be included in Melton's 2013 income statement (the second year of the contract)? a. $20,000 b. $63,398 c. $40,000 d. $55,816
18 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 93.
Carperter Company has used the installment method of accounting since it began operations at the beginning of 2013. The following information pertains to its operations for 2013: Installment sales $ 2,100,000 Cost of installment sales 1,470,000 Collections of installment sales 840,000 General and administrative expenses 210,000 The amount to be reported on the December 31, 2013 balance sheet as Deferred Gross Profit should be a. $ 252,000. b. $ 378,000. c. $ 504,000. d. $1,260,000.
94.
Daily, Inc. appropriately used the installment method of accounting to recognize income in its financial statement. Some pertinent data relating to this method of accounting include: 2012 2013 Installment sales $750,000 $900,000 Cost of sales 450,000 630,000 Gross profit $300,000 $270,000 Collections during year: On 2012 sales On 2013 sales
150,000
150,000 180,000
What amount to be realized gross profit should be reported on Daily’s income statement for 2013? a. $99,000 b. $114,000 c. $132,000 d. $162,000 95.
Sutton 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 $2,800 refuses to make any more payments and the merchandise is repossessed. The gross profit rate on the original sale is 40%. Sutton estimates that the television can be sold as is for $875, or for $1,050 if $70 is spent to refurbish it. The loss on repossession is a. $1,925. b. $1,120. c. $ 805. d. $ 700.
Use the following information for questions 96-98. During 2012, Vaughn Corporation sold merchandise costing $3,000,000 on an installment basis for $4,000,000. The cash receipts related to these sales were collected as follows: 2012, $1,600,000; 2013, $1,400,000; 2014, $1,000,000.
Revenue Recognition
18 - 23
96.
What is the rate of gross profit on the installment sales made by Vaughn Corporation during 2012? a. 75% b. 60% c. 40% d. 25%
97.
If expenses, other than the cost of the merchandise sold, related to the 2012 installment sales amounted to $180,000, by what amount would Vaughn’s net income for 2012 increase as a result of installment sales? a. $ 220,000 b. $ 355,000 c. $ 400,000 d. $1,420,000
98.
What amount would be shown in the December 31, 2013 financial statement for realized gross profit on 2012 installment sales, and deferred gross profit on 2012 installment sales, respectively? a. $350,000 and $750,000 b. $650,000 and $350,000 c. $750,000 and $250,000 d. $350,000 and $250,000
Use the following information for questions 99 – 101. During 2012, Martin Corporation sold merchandise costing $2,800,000 on an installment basis for $4,000,000. The cash receipts related to these sales were collected as follows: 2012, $1,600,000; 2013, $1,400,000; 2014, $1,000,000. 99.
What is the rate of gross profit on the installment sales made by Martin Corporation during 2012? a. 30% b. 40% c. 60% d. 70%
100.
If expenses, other than the cost of the merchandise sold, related to the 2012 installment sales amounted to $160,000, by what amount would Martin’s net income for 2012 increase as a result of installment sales? a. $1,440,000 b. $ 480,000 c. $ 360,000 d. $ 320,000
101.
What amount would be shown in the December 31, 2013 financial statements for realized gross profit on 2012 installment sales, and deferred gross profit on 2012 installment sales, respectively? a. $420,000 and $300,000 b. $780,000 and $420,000 c. $300,000 and $900,000 d. $420,000 and $900,000
18 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition Use the following information for questions 102 and 103. Coaster manufactures and sells logging equipment. Due to the nature of its business, Coaster is unable to reliably predict bad debts. During 2012, Coaster sold equipment costing $3,600,000 for $5,400,000. The terms of the sale were 20% down, with equal payments due quarterly over the next 3 years. All payments for 2012 were made on schedule. Round answers to two places. 102.
Assuming that Coaster uses the installment method of accounting for its installment sales, what amount of realized gross profit will Coaster report in its income statement for the year ended December 31, 2012? a. $2,520,000 b. $1,680,000 c. $ 840,000 d. $ 554,400
103.
Assuming that Coaster uses the cost-recovery method of accounting for its installment sales, what amount of realized gross profit will Coaster report in its income statement for the year ended December 31, 2013? a. $0 b. $ 360,000 c. $ 475,200 d. $1,440,000
104.
On January 1, 2013, Shaw Co. sold land that cost $420,000 for $560,000, receiving a note bearing interest at 10%. The note will be paid in three annual installments of $225,190 starting on December 31, 2013. Because collection of the note is very uncertain, Shaw will use the cost-recovery method. How much revenue from this sale should Shaw recognize in 2013? a. $0 b. $42,000 c. $56,000 d. $140,000
*105. On April 1, 2013 Weston, Inc. entered into a franchise agreement with a local businessman. The franchisee paid $300,000 and gave a $200,000, 8%, 3-year note payable with interest due annually on March 31. Weston recorded the $500,000 initial franchise fee as revenue on April 1, 2013. On December 30, 2013, the franchisee decided not to open an outlet under Weston's name. Weston canceled the franchisee's note and refunded $160,000, less accrued interest on the note, of the $300,000 paid on April 1. What entry should Weston make on December 30, 2013? a. Loss on Repossessed Franchise ........................................ 160,000 Cash ........................................................................ 160,000 b. Loss on Repossessed Franchise ........................................ 148,000 Cash ........................................................................ 148,000 c. Loss on Repossessed Franchise ........................................ 348,000 Cash ........................................................................ 148,000 Notes Receivable .................................................... 200,000 d. Revenue from Franchise Fees ............................................ 500,000 Interest Income........................................................ 12,000 Cash ........................................................................ 148,000 Notes Receivable .................................................... 200,000 Revenue from Repossessed Franchise ................... 140,000
Revenue Recognition
18 - 25
*106. On January 1, 2013 Dairy Treats, Inc. entered into a franchise agreement with a company allowing the company to do business under Dairy Treats's name. Dairy Treats had performed substantially all required services by January 1, 2013, and the franchisee paid the initial franchise fee of $700,000 in full on that date. The franchise agreement specifies that the franchisee must pay a continuing franchise fee of $60,000 annually, of which 20% must be spent on advertising by Dairy Treats. What entry should Dairy Treats make on January 1, 2013 to record receipt of the initial franchise fee and the continuing franchise fee for 2013? a. Cash ................................................................................... 760,000 Franchise Fee Revenue .......................................... 700,000 Revenue from Franchise Fees................................. 60,000 b. Cash ................................................................................... 760,000 Unearned Franchise Fees ....................................... 760,000 c. Cash ................................................................................... 760,000 Franchise Fee Revenue .......................................... 700,000 Revenue from Franchise Fees................................. 48,000 Unearned Franchise Fees ....................................... 12,000 d. Prepaid Advertising ............................................................. 12,000 Cash ................................................................................... 760,000 Franchise Fee Revenue .......................................... 700,000 Revenue from Franchise Fees................................. 60,000 Unearned Franchise Fees ....................................... 12,000 *107. Wynne Inc. charges an initial franchise fee of $1,380,000, with $300,000 paid when the agreement is signed and the balance in five annual payments. The present value of the future payments, discounted at 10%, is $818,808. The franchisee has the option to purchase $180,000 of equipment for $144,000. Wynne has substantially provided all initial services required and collectibility of the payments is reasonably assured. The amount of revenue from franchise fees is a. $ 300,000. b. $1,082,808. c. $1,118,808. d. $1,380,000. Use the following information for questions 108 and 109. On May 1, 2013, TV Inc. consigned 80 TVs to Ed's TV. The TVs cost $360. Freight on the shipment paid by Ed’s TV was $800. On July 10, TV Inc. received an account sales and $17,200 from Ed's TV. Thirty TVs had been sold and the following expenses were deducted: Freight $800 Commission (20% of sales price) ? Advertising 520 Delivery 280 *108. The total sales price of the TVs sold by Ed's TV was a. $20,500. b. $21,500. c. $21,850. d. $23,500.
18 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition *109. The inventory of TVs will be reported on whose balance sheet and at what amount? Balance Sheet of TV Inc. TV Inc. Ed's TV Ed's TV
a. b. c. d.
Amount of Inventory $18,500 $18,000 $18,500 $18,000
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
65. 66. 67. 68. 69. 70. 71.
c d b c b c c
72. 73. 74. 75. 76. 77. 78.
c b d c b c a
79. 80. 81. 82. 83. 84. 85.
b a c b c a b
86. 87. 88. 89. 90. 91. 92.
c c a d b a b
93. 94. 95. 96. 97. 98. 99.
b b d d a d a
100. 101. 102. 103. 104. *105. *106.
d a c b a d c
*107. *108. *109.
b d a
MULTIPLE CHOICE—CPA Adapted 110.
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.
111.
Green Construction Co. has consistently used the percentage-of-completion method of recognizing revenue. During 2012, Green entered into a fixed-price contract to construct an office building for $16,000,000. Information relating to the contract is as follows: At December 31 2012 2013 Percentage of completion 15% 45% Estimated total cost at completion $12,000,000 $12,800,000 Gross profit recognized (cumulative) 800,000 1,920,000 Contract costs incurred during 2013 were a. $3,840,000. b. $3,960,000. c. $4,200,000. d. $5,760,000.
Revenue Recognition 112.
18 - 27
Bruner Constructors, Inc. has consistently used the percentage-of-completion method of recognizing income. In 2012, Bruner started work on a $28,000,000 construction contract that was completed in 2013. The following information was taken from Bruner's 2012 accounting records: Progress billings Costs incurred Collections Estimated costs to complete
$8,800,000 8,400,000 5,600,000 16,800,000
What amount of gross profit should Bruner have recognized in 2012 on this contract? a. $2,800,000 b. $1,866,667 c. $1,400,000 d. $933,333 113.
During 2012, Gates Corp. started a construction job with a total contract price of $7,000,000. The job was completed on December 15, 2013. Additional data are as follows: Actual costs incurred Estimated remaining costs Billed to customer Received from customer
2012 $2,700,000 2,700,000 2,400,000 2,000,000
2013 $3,050,000 — 4,600,000 4,800,000
Under the completed-contract method, what amount should Gates recognize as gross profit for 2013? a. $450,000 b. $625,000 c. $950,000 d. $1,250,000 114.
Hogan Farms produced 1,200,000 pounds of cotton during the 2013 season. Hogan sells all of its cotton to Ott Co., which has agreed to purchase Hogan's entire production at the prevailing market price. Recent legislation assures that the market price will not fall below $.70 per pound during the next two years. Hogan's costs of selling and distributing the cotton are immaterial and can be reasonably estimated. Hogan reports its inventory at expected exit value. During 2013, Hogan sold and delivered to Ott 900,000 pounds at the market price of $.70. Hogan sold the remaining 300,000 pounds during 2014 at the market price of $.72. What amount of revenue should Hogan recognize in 2013? a. $630,000 b. $648,000 c. $840,000 d. $864,000
18 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition 115.
Braun, 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: 2012 2013 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: 2012 2013 Total
24%
30%
$108,000
$ 36,000 198,000 $234,000
$108,000
What amount of installment accounts receivable should be presented in Braun's December 31, 2013 balance sheet? a. $720,000 b. $810,000 c. $780,000 d. $866,666 116.
Hartz Co., which began operations on January 1, 2013, appropriately uses the installmentsales method of accounting. The following information pertains to Hartz's operations for the year 2013: Installment sales Regular sales Cost of installment sales Cost of regular sales General and administrative expenses Collections on installment sales
$2,000,000 800,000 1,200,000 480,000 160,000 480,000
The deferred gross profit account in Hartz's December 31, 2013 balance sheet should be a. $192,000. b. $320,000. c. $608,000. d. $800,000. 117.
On January 1, 2012, Orton Co. sold a used machine to King, Inc. for $700,000. On this date, the machine had a depreciated cost of $490,000. King paid $100,000 cash on January 1, 2012 and signed a $600,000 note bearing interest at 10%. The note was payable in three annual installments of $150,000 beginning January 1, 2013. Orton appropriately accounted for the sale under the installment method. King made a timely payment of the first installment on January 1, 2013 of $260,000, which included interest of $60,000 to date of payment. At December 31, 2013, Orton has deferred gross profit of a. $140,000. b. $132,000. c. $120,000. d. $102,000.
Revenue Recognition 118.
18 - 29
Piper Co. began operations on January 1, 2013 and appropriately uses the installment method of accounting. The following information pertains to Piper's operations for 2013: Installment sales Cost of installment sales General and administrative expenses Collections on installment sales
2,400,000 1,440,000 240,000 1,100,000
The balance in the deferred gross profit account at December 31, 2013 should be a. $440,000. b. $660,000. c. $520,000. d. $960,000. 119.
Moon 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.
120.
Crane, Inc. is a retailer of home appliances and offers a service contract on each appliance sold. Crane sells appliances on installment contracts, but all service contracts must be paid in full at the time of sale. Collections received for service contracts should be recorded as an increase in a a. deferred revenue account. b. sales contracts receivable valuation account. c. stockholders' valuation account. d. service revenue account.
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
110. 111.
a b
112. 113.
d d
114. 115.
c b
116. 117.
c c
118. 119.
c c
120.
a
DERIVATIONS — Computational No.
Answer Derivation
65.
c
$11,160,000 .30 = $3,348,000.
66.
d
($10,800,000 .75) – ($10,650,000 .30) = $4,905,000.
67.
b
($11,160,000 .75) – ($930,000 8) = $930,000 debit.
68.
c
$11,160,000 .25 = $2,790,000 $11,250,000 – ($10,800,000 .75) = $3,150,000.
18 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
69.
b
($12,000,000 – $11,000,000) ($5,060,000 ÷ $11,000,000) = $460,000.
70.
c
$5,060,000 + $460,000 = $5,520,000.
71.
c
$1,200,000 —————————— × ($3,000,000 – $2,000,000) = $600,000 $1,200,000 + $800,000 ($3,000,000 – $2,100,000) – $600,000 = $300,000.
72.
c
$9,600,000 ——————————— × ($20,000,000 – $16,000,000) = $2,400,000. $9,600,000 + $6,400,000
73.
b
$360,000 – $150,000 = $210,000.
74.
d
$450,000 – $90,000 = $360,000 $360,000 ————————— × ($3,600,000 – Total estimated cost) = $90,000 Total estimated cost Total estimated cost = $2,880,000 $3,600,000 – $2,880,000 = $720,000.
75.
c
$1,950,000 —————- × ($5,500,000 – $3,250,000) = $1,350,000 $3,250,000 ($5,500,000 – $3,350,000) – $1,350,000 = $800,000.
76.
b
$1,600,000 ————— × ($9,600,000 – $6,400,000) = $800,000. $6,400,000
77.
c
$9,600,000 – $6,500,000 = $3,100,000.
78.
a
$5,400,000 ————— × ($12,600,000 – $9,000,000) = $2,160,000. $9,000,000
79.
b
$12,600,000 – $8,400,000 = $4,200,000.
80.
a
[$3,900,000 ÷ ($3,900,000 + $2,600,000)] × $4,500,000 = $2,700,000 ($11,000,000 – $6,700,000) – $2,700,00 = $1,600,000.
81.
c
$11,000,000 – $6,700,000 = $4,300,000.
Revenue Recognition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
82.
b
($15,000,000 × .60) – ($13,500,000 × .25) = $5,625,000.
83.
c
($7,590,000 ÷ $16,500,000) × $1,500,000 = $690,000.
84.
a
($7,590,000 ÷ $16,500,000) × $1,500,000 = $690,000. $7,590,000 + $690,000 = $8,280.000.
85.
b
$8,400,000 – ($3,840,000 + $4,920,000) = –$360,000.
86.
c
$3,200,000 – $2,150,000 = $1,050,000.
87.
c
$1,500,000 – $820,000 = $680,000.
88.
a
($2,250,000 – $150,000) – $1,900,000 = $200,000.
89.
d
$11,200 – $7,840 = $3,360 ($4,000 – $400) – $3,360 = $240 gain.
90.
b
$40,000 – $12,000 = $28,000 $28,000 – $22,500 = $5,500 loss.
91.
a
$36,000 – $14,400 = $21,600 ($12,600 – $600) – $21,600 = $9,600 loss.
92.
b
2012: $200,000 – ($758,160 × 10%) = $124,184. 2013: ($758,160 – $124,184) × 10% = $63,398.
93.
b
[($2,100,000 – $1,470,000) ÷ $2,100,000] × $1,260,000 = $378,000.
94.
b
($300,000 ÷ $750,000) × $150,000 = $60,000 [($270,000 ÷ $900,000) × $180,000] + $60,000 = $114,000.
95.
d
[$2,800 × (1 – .40)] – ($1,050 – $70) = $700.
96.
d
($4,000,000 – $3,000,000) ÷ $4,000,000 = 25%
97.
a
($1,600,000 × .25) – $180,000 = $220,000,
98.
d
$1,400,000 × .25 = $350,000; $1,000,000 × .25 = $250,000.
99.
a
($4,000,000 – $2,800,000) ÷ $4,000,000 = 30%.
100.
d
($1,600,000 .30) – $160,000 = $320,000.
101.
a
$1,400,000 .30 = $420,000 $1,200,000 – [($1,600,000 + $1,400,000) .30] = $300,000.
18 - 31
18 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
102.
c
($5,400,000 – $3,600,000) ÷ $5,400,000 = 33 1/3% ($5,400,000 .20) + [(5,400,000 .80) 4/12)] = $2,520,000 $2,520,000 33 1/3% = $840,000.
103.
b
[($5,400,000 .20) + ($5,400,000 .80 8/12] – $3,600,000 = $360,000.
104.
a
$0.
*105.
d
Revenue = $500,000 Interest income = $200,000 × 8% × 9/12 = $12,000 Cash = $160,000 – $12,000 = $148,000 Repossession revenue: $300,000 – $160,000 = $140,000.
*106.
c
Cash = $700,000 + $60,000 = $760,000 Franchise Fee Revenue = $700,000 Unearned Franchise Fees = $60,000 × 20% = $12,000 Revenue from Franchise Fees = $60,000 – $12,000 = $48,000.
*107
b
$300,000 + $818,808 – $36,000 = $1,082,808.
*108.
d
Sales – (Sales × 20%) – $800 – $520 – $280 = $17,200 .8 Sales = $18,800 Sales = $23,500.
*109.
a
($360 × 50) + [($800 ÷ 80) × 50] = $18,500.
DERIVATIONS — CPA Adapted No.
Answer Derivation
110.
a
Conceptual.
111.
b
($12,800,000 × 45%) – ($12,000,000 × 15%) = $3,960,000.
112.
d
$8,400,000 —————— × ($28,000,000 – $25,200,000) = $933,333. $25,200,000
113.
d
$7,000,000 – $2,700,000 – $3,050,000 = $1,250,000.
114.
c
1,200,000 lbs. × $.70 = $840,000.
115.
b
($36,000 ÷ 24%) + ($198,000 ÷ 30%) = $810,000.
116.
c
$2,000,000 – $1,200,000 = $800,000 gross profit (40% gross profit rate) $800,000 – ($480,000 × .4) = $608,000.
Revenue Recognition
18 - 33
DERIVATIONS — CPA Adapted (cont.) No.
Answer Derivation
117.
c
$600,000 + $100,000 = $700,000 $700,000 – $490,000 = $210,000 gross profit (30% gross profit rate) ($600,000 – $200,000) × 30% = $120,000.
118.
c
$2,400,000 – $1,440,000 = $960,000 (40% gross profit rate) $960,000 – ($1,100,000 × 40%) = $520,000.
119.
c
Conceptual.
120.
a
Conceptual.
EXERCISES Ex. 18-121— 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 18-121 (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. 18-122—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.
18 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 18-122 Revenue is also recognized (1) during production, (2) at completion, and (3) at collection. (1) During production. 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-ofcompletion method should be used. (2) At completion. Examples of revenue recognition at completion of production involve precious metals and agricultural products with quoted prices. These sales prices are reasonably assured, there are low additional costs of distribution, and unit costs cannot be determined because of joint costs. (3) At collection. 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. 18-123—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 completed-contract. 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 percentage-ofcompletion method and the completed-contract method?
Solution 18-123 (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.
Revenue Recognition
18 - 35
Solution 18-123 (cont.) 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.
Ex. 18-124—Journal entries—percentage-of-completion. Dixon 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 $10,000,000. The estimated total costs to complete the project were $7,500,000. Instructions (a) Make the entry to record construction costs of $4,500,000, on construction in process to date. (b) Make the entry to record progress billings of $2,500,000. (c) Make the entry to recognize the profit that can be recognized to date, on a percentage-ofcompletion basis.
18 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 18-124 (a)
(b)
(c)
Construction in Process ............................................................... 4,500,000 Materials, Cash, Payables................................................
4,500,000
Accounts Receivable ................................................................... 2,500,000 Billings on Construction in Process ..................................
2,500,000
Construction Expenses ................................................................ 4,500,000 Construction in Process (60% complete) ..................................... 1,500,000 Revenue from Long-Term Contracts ................................
6,000,000
Ex. 18-125—Percentage-of-completion method. Dalton Construction Co. contracted to build a bridge for $10,000,000. Construction began in 2012 and was completed in 2013. Data relating to the construction are: Costs incurred Estimated costs to complete
2012 $3,300,000 2,700,000
2013 $2,750 —
Dalton uses the percentage-of-completion method. Instructions (a) How much revenue should be reported for 2012? Show your computation. (b) Make the entry to record progress billings of $3,300,000 during 2012. (c) Make the entry to record the revenue and gross profit for 2012. (d) How much gross profit should be reported for 2013? Show your computation.
Solution 18-125 (a)
(b)
(c)
$3,300,000 ————— × $10,000,000 = $5,500,000 $6,000,000 Accounts Receivable ................................................................... 3,300,000 Billings on Construction in Process .................................
3,300,000
Construction Expenses ................................................................ 3,300,000 Construction in Process ............................................................... 2,200,000 Revenue from Long-Term Contracts ................................
5,500,000
Revenue Recognition
18 - 37
Solution 18-125 (cont.) (d)
Revenue Costs Total gross profit Recognized in 2012 Recognized in 2013 Or Total revenue Recognized in 2012 Recognized in 2013 Costs in 2013 Gross profit in 2013
$10,000,000 6,050,000 3,950,000 (2,200,000) $ 1,750,000 $10,000,000 (5,500,000) 4,500,000 (2,750,000) $ 1,750,000
Ex. 18-126—Percentage-of-completion method. Penner Builders contracted to build a high-rise for $21,000,000. Construction began in 2012 and is expected to be completed in 2015. Data for 2012 and 2013 are: 2012 $2,700,000 10,800,000
Costs incurred to date Estimated costs to complete
2013 $7,800,000 7,200,000
Penner uses the percentage-of-completion method. Instructions (a) How much gross profit should be reported for 2012? Show your computation. (b) How much gross profit should be reported for 2013? (c) Make the journal entry to record the revenue and gross profit for 2013.
Solution 18-126 (a)
$2,700,000 ————— × $7,500,000 = $1,500,000 $13,500,000
(b)
$7,800,000 —————— × $6,000,000 = $3,120,000 $15,000,000 Less 2012 gross profit Gross profit in 2013
(c)
1,500,000 $1,620,000
Construction in Process ............................................................... 1,620,000 Construction Expenses ................................................................ 5,100,000 Revenue from Long-Term Contracts ................................
6,720,000
18 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 18-127—Percentage-of-completion and completed-contract methods. On February 1, 2012, Marsh Contractors agreed to construct a building at a contract price of $5,400,000. Marsh estimated total construction costs would be $4,000,000 and the project would be finished in 2014. Information relating to the costs and billings for this contract is as follows: 2012 $1,500,000 2,500,000 2,200,000 2,000,000
Total costs incurred to date Estimated costs to complete Customer billings to date Collections to date
2013 $2,640,000 1,760,000 4,000,000 3,500,000
2014 $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 2012, 2013, and 2014. Percentage-of-Completion Completed-Contract Gross Profit Gross Profit 2012
__________
2012
__________
2013
__________
2013
__________
2014
__________
2014
__________
2012 2013 2014
Completed-Contract Gross Profit — — $800,000d
Solution 18-127
2012 2013 2014
Percentage-of-Completion Gross Profit $525,000a $ 75,000b $440,000c
a$1,500,000
————— × $1,400,000 = $525,000 $4,000,000 b$2,640,000
————— × $1,000,000 = $600,000 $4,400,000 Less 2012 gross profit 2013 gross profit cTotal revenue
Total costs Total gross profit Recognized to date 2014 gross profit dTotal revenue
Total costs Total gross profit
(525,000) $75,000 $5,400,000 4,600,000 800,000 (600,000) $ 200,000 $5,400,000 4,600,000 $800,000
Revenue Recognition
18 - 39
Ex. 18-128—Installment sales. Newton Co. had installment sales of $1,000,000 and cost of installment sales of $650,000 in 2012. A 2012 sale resulted in a default in 2014, at which time the balance of the installment receivable was $40,000. The repossessed merchandise had a fair value of $21,000. Instructions (a) Calculate the rate of gross profit on 2012 installment sales. (b) Make the entry to record the repossession.
Solution 18-128 (a) $350,000 ÷ $1,000,000 = 35% (b) Repossessed Merchandise ........................................................... Deferred Gross Profit, 2012 (.35 × $40,000).................................. Loss on Repossession .................................................................. Installment Accounts Receivable, 2012 .................................
21,000 14,000 5,000 40,000
Ex. 18-129—Installment sales. Sawyer Furniture Company concluded its first year of operations in which it made sales of $900,000, all on installment. Collections during the year from down payments and installments totaled $300,000. Purchases for the year totaled $620,000; 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 18-129 (a)
(b)
(c)
(d)
Installment Accounts Receivable ................................................. Installment Sales ..............................................................
900,000
Cash ............................................................................................ Installment Accounts Receivable ......................................
300,000
Cost of Installment Sales ($620,000 – $80,000)........................... Inventory ..........................................................................
540,000
Installment Sales ......................................................................... Cost of Installment Sales .................................................. Deferred Gross Profit (40%) .............................................
900,000
Deferred Gross Profit (40% × $300,000) ...................................... Realized Gross Profit ......................................................
120,000
900,000 300,000
540,000
540,000 360,000
120,000
18 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 18-130—Installment sales. Finley Company sells office equipment. On January 1, 2013, Finley entered into an installment sale contract with Miller Company for a six-year period expiring January 1, 2019. Equal annual payments under the installment sale are $894,000 and are due on January 1. The first payment was made on January 1, 2013. Additional information is as follows: The cash selling price of the equipment, i.e., the amount that would be realized on an outright sale, is $4,584,000. The cost of sales relating to the equipment is $3,438,000. The finance charges relating to the installment period are $780,000 based on a stated interest rate of 7% which is appropriate. For tax purposes, Finley appropriately uses the accrual basis for recording finance charges. Circumstances are such that the collection of the installment sale is reasonably assured. The installment sale qualified for the installment method of reporting for tax purposes. Assume that the income tax rate is 30%. Instructions What income (loss) before income taxes should Finley appropriately record as a result of this transaction for the year ended December 31, 2013? Show supporting computations in good form.
Solution 18-130 (Note: For financial accounting purposes, the installment-sales method is not used, and the full gross profit is recognized in the year of sale, because collection of the receivable is reasonably assured.) Finley Company Computation of Income Before Income Taxes On Installment Sale Contract For the Year Ended December 31, 2013 Sales $4,584,000 Cost of Sales 3,438,000 Gross Profit 1,146,000 Interest Revenue (Schedule I) 343,800 Income before Income Taxes $802,200 Schedule I Computation of Interest Revenue on Installment Sale Contract Cash selling price (sales) Payment made on January 1, 2013 Balance outstanding at 12/31/13 Interest rate Interest Revenue
$4,584,000 894,000 3,690,000 7% $ 258,300
Revenue Recognition
18 - 41
*Ex. 18-131—Franchises. Pasta Inn charges an initial fee of $900,000 for a franchise, with $180,000 paid when the agreement is signed and the balance in four annual payments. The present value of the annual payments, discounted at 10%, is $570,600. The franchisee has the right to purchase $60,000 of kitchen equipment and supplies for $50,000. An additional part of the initial fee is for advertising to be provided by Pasta Inn during the next five years. The value of the advertising is $1,000 a month. Collectibility of the payments is reasonably assured and Pasta Inn has performed all the initial services required by the contract. Instructions Prepare the entry to record the initial franchise fee. Show supporting computations in good form. *Solution 18-131 Total fee Discount
$900,000 $ 720,000 (570,600)
Bargain purchase Advertising ($1,000 × 60)
Cash ......................................................................................... Notes Receivable ...................................................................... Discount on Notes Receivable ...................................... Revenue from Franchise Fees ..................................... Unearned Franchise Fees ............................................
(149,400) (10,000) (60,000) $680,600
180,000 720,000 149,400 680,600 70,000
PROBLEMS Pr. 18-132—Long-term construction project accounting. Dobson 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. Dobson began work on a lump-sum contract at the beginning of 2013. 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
18 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 18-132 (cont.) 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 Latest forecast total cost
$2,250,000 $ 464,000 798,000 193,000
1,455,000 3,000,000
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 2013. (b)
Indicate the amount of gross profit that would be reported on this contract at the end of 2013.
(c) (d)
Make the journal entry to record the income (loss) for 2013 on Dobson's books. Indicate the account(s) and the amount(s) that would be shown on the balance sheet of Dobson Construction at the end of 2013 related to its construction accounts. Also indicate where these items would be classified on the balance sheet. Billings collected during the year amounted to $1,980,000.
(e)
Assume the latest forecast on total costs at the end of 2013 was $4,080,000. How much income (loss) would Dobson report for the year 2013?
Solution 18-132 (a)
Costs to date Less materials on job site
$1,455,000 (105,000) $1,350,000
Costs Incurred to Date —————————— = Percentage of Completion Total Estimated Costs $1,350,000 ————— = 45% $3,000,000 (b)
45% × $4,000,000 = Costs incurred Gross profit
$1,800,000 1,350,000 $ 450,000
(c)
Construction Expenses ................................................................ 1,350,000 Construction in Process ............................................................... 450,000 Revenue from Long-Term Contracts ................................
1,800,000
Revenue Recognition
18 - 43
Solution 18-132 (cont.) (d)
(e)
Current Assets Accounts receivable
$270,000 ($2,250,000 – $1,980,000)
Current Liability Billings in excess of contract costs and recognized profit
$50,000 ($2,250,000 – $2,200,000)
Total loss reported in 2013 Contract price Estimated cost to complete Amount of loss to be reported
$4,000,000 4,080,000 $ (80,000)
Pr. 18-133—Accounting for long-term construction contracts. The board of directors of Ogle 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 Ogle'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.
Ogle commenced doing business on January 1, 2013. Construction activities for the year ended December 31, 2013, were as follows:
Project A B C D E
Project A B C D E
3. 4.
Total Contract Price $ 510,000 700,000 475,000 200,000 460,000 $2,345,000
Billings Through 12/31/13 $ 340,000 210,000 475,000 100,000 400,000 $1,525,000
Contract Costs Incurred Through 12/31/13 $ 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 12/31/11 $ 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 2014.
18 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition 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, 2013, 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 2013, assuming that the percentage-of-completion method is used.
(c)
Indicate the balances that would appear in the balance sheet at December 31, 2013 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 18-133 (a) (1) and (2) Projects Contract price Contract costs incurred Additional costs to complete Total cost Total gross profit or (loss)
A $510,000 424,000
B $700,000 195,000
C $475,000 350,000
D $200,000 123,000
E $460,000 320,000
101,000 525,000
455,000 650,000
-0350,000
97,000 220,000
80,000 400,000
$ (15,000)
$ 50,000
$125,000
$ (20,000)
$ 60,000
The amount reported as income (loss) under the completed-contract method for 2013 is: Project A B C D E
$(15,000) -0125,000 (20,000) -0$ 90,000
The amount reported as income (loss) under the percentage-of-completion method for 2013 is: Project A B C D E
$(15,000) 15,000 125,000 (20,000) 48,000 $153,000
$50,000 × ($195,000 ÷ $650,000)
$60,000 × ($320,000 ÷ $400,000)
Revenue Recognition
18 - 45
Solution 18-133 (cont.) (b)
(c)
(d)
Construction in Process ............................................................... Construction Expenses ................................................................ Revenue from Long-term Contracts ................................. Billings Cash collections Accounts receivable Billings on Construction in Process
$100,000 65,000 $ 35,000 100,000
Costs incurred Loss reported Construction in process
$123,000 (20,000) $103,000
15,000 195,000 210,000
The account balances would be the same.
Pr. 18-134—Long-term contract accounting (completed-contract). Evans Construction, Inc. experienced the following construction activity in 2013, the first year of operations. Cash Cost Estimated Total Billings Collections Incurred Additional Contract through through through Costs to Contract Price 12/31/13 12/31/13 12/31/13 Complete X $260,000 $175,000 $155,000 $182,000 $ 63,000 Y 330,000 115,000 115,000 100,000 242,000 Z 233,000 233,000 198,000 158,000 -0$823,000 $523,000 $468,000 $440,000 $305,000 Each of the above contracts is with a different customer, and any work remaining at December 31, 2013 is expected to be completed in 2014. Instructions Prepare a partial income statement and a partial balance sheet to indicate how the above contract information would be reported. Evans uses the completed-contract method.
Solution 18-134 Evans Construction, Inc. Income Statement For the Year 2013 Revenue from long-term contracts (contract Z) Cost of construction (contract Z) Gross profit Provision for loss (contract Y)* *Contract costs through 12/31/13 Estimated costs to complete Total estimated costs Total contract price Loss recognized in 2013
$233,000 158,000 $ 75,000 12,000 $100,000 242,000 342,000 330,000 $ 12,000
18 - 46 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 18-134 (cont.) Evans Construction, Inc. Balance Sheet As of 12/31/13 Current assets: Accounts receivable ($523,000 – $468,000) Inventories Construction in process (contract X) Less: Billings Unbilled contract costs Current liabilities: Billings ($115,000) in excess of contract costs ($100,000) Estimated loss from long-term contracts
$ 55,000 $182,000 175,000 7,000 15,000 12,000
Pr. 18-135—Installment sales. Houser Appliances accounts for all sales of its merchandise on the installment basis. Following is the unadjusted trial balance at 12/31/14. Cash Installment accounts receivable—2012 Installment accounts receivable—2013 Installment accounts receivable—2014 Inventory Repossessed merchandise Accounts payable Deferred gross profit—2012 Deferred gross profit—2013 Common stock Retained earnings Installment sales Cost of installment sales Loss on repossessions Operating expenses
$38,000 20,000 50,000 90,000 27,800 4,600 $ 37,400 15,000 26,600 117,000 10,000 125,000 85,000 2,600 13,000 $331,000
$331,000
Additional information: 2012 gross profit rate: 30% Total cash receipts during 2014: $110,000 Merchandise sold in 2013 was repossessed in 2014 and the following entry was prepared: Deferred Gross Profit—2013..................................................... Repossessed Merchandise ....................................................... Loss on Repossessions ............................................................ Installment Accounts Receivable—2013 .......................
2,800 4,600 2,600 10,000
Revenue Recognition
18 - 47
Pr. 18-135 (cont.) Instructions (a) What is the gross profit rate for 2013? Show supporting computations. (b)
What is the gross profit rate for 2014? Show supporting computations.
(c)
Of the total cash receipts in 2014, how much represents collections from installment sales of: (Show supporting computations.) (1) 2012? (2) 2013? (3) 2014?
(d)
What is the total realized gross profit in 2014? Show supporting computations.
Solution 18-135 (a)
Determined from the repossession entry: Deferred gross profit Installment accounts receivable
b)
Installment sales Cost of sales Gross profit
$125,000 85,000 $ 40,000
Gross profit
$40,000 ————- = 32% gross profit rate $125,000
Installment sales (c)
(d)
$2,800 ———— = 28% $10,000
2012
Deferred gross profit balance Gross profit rate Beginning accounts receivable Beginning accounts receivable Ending accounts receivable Cash collected
$ 15,000 ÷ 30% $ 50,000 $ 50,000 (20,000) $ 30,000
2013
Deferred gross profit balance Gross profit rate Beginning accounts receivable* Beginning accounts receivable* Ending accounts receivable* Cash collected
$ 26,600 ÷ 28% $95,000 $95,000 (50,000) $ 45,000
2014
Installment sales—2014 Accounts receivable—2014 Cash collected
$125,000 (90,000) $ 35,000
Total realized gross profit in 2014 From 2012 $30,000 × 30% = 2013 $45,000 × 28% = 2014 $35,000 × 32% =
$ 9,000 12,600 11,200 $32,800 *Excluding accounts receivable for repossessed merchandise.
18 - 48 Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS True/False 1. The International Accounting Standards Board (IASB) defines revenue to include both revenues and gains. 2. IFRS bases revenue recognition on the concepts of “earned” and “realized or realizable.” 3. IFRS prohibits use of the percentage-of-completion method of accounting for long-term construction contracts. 4. IFRS requires immediate recognition of a loss if the overall contract is going to be unprofitable. 5. Terry Company is unable to reliably estimate revenues and costs associated with its only longterm construction contract. Under IFRS, Terry Company must use the completed-contract method to account for this contract. Answers to True/False: 1. True 2. False 3. False 4. True 5. False
Multiple Choice 1. The joint project of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) related to revenue recognition includes I. Evaluating a “customer-consideration” model II. Eliminating inconsistencies in the existing conceptual guidance III. Establishing a single, comprehensive standard a. II and III only. b. I and II only. c. I, II, and III. d. Neither I, II, nor III are currently included in the joint project of the FASB and IASB. 2. Belgium Co. is constructing a tunnel for $800 million. Construction began in 2011 and is estimated to be completed in 2016. At December 31, 2013, Belgium has incurred costs totaling $356 million with $85 million of that incurred in 2013, $143 million in 2012, and the remainder during 2011. Belgium believes that it completed 30% of the tunnel during 2013, although that may change based on future activity. Belgium Co. uses iGAAP for its accounting and regards its cost numbers as very uncertain. What amount of revenue should Belgium Co. recognize for the year ended December 31, 2013? a. No revenue should be recognized until the contract is completed in 2016. b. $356 million c. $240 million d. $85 million
Revenue Recognition
18 - 49
3. Portugal, Inc. has the following amounts related to its activities for the year ended December 31, 2013: Sales to customers $5,000,000 Gain on sale of equipment $ 360,000 Gain on sale of investments $ 760,000 Loss on sale of land $ 240,000 Portugal, Inc. uses IFRS for its external financial reporting. How much revenue should Portugal, Inc. report on its income statement for the year ended December 31, 2013? a. $5,000,000 b. $5,760,000 c. $6,120,000 d. $5,880,000 4. Under IFRS, the standard for revenue recognition states that the I. Revenue be realized or realizable. II. Economic benefits associated with the transaction will flow to the company selling the goods. III. Costs must be capable of being reliably measured. a. I, II, and III. b. I and III only. c. II only. d. II and III only. 5. IFRS for revenue recognition a. is enforced by an international enforcement body, the IASB, which is comparable to the U.S. SEC. b. bases revenue recognition on the concepts of “earned” and “realized or realizable.” c. permits use of the completed-contract method when costs are difficult to estimate. d. contains limited industry-specific guidance. Answers to Multiple Choice: 1. c 2. d 3. c 4. d 5. d Short Answer: 1. What is a major difference between IFRS and U.S. GAAP as regards revenue recognition practices? 1. The general concepts and principles used for revenue recognition are similar between U.S. GAAP and IFRS. When they differ is in the detail. U.S. GAAP provides specific guidance related to revenue recognition in many different industries. That is not the case for IFRS. Also, the SEC has issued broad and specific guidance for public companies in the United States related to revenue recognition. Again the IASB does not have a regulatory body that provides additional guidance .
2. IFRS prohibits the use of the completed-contract method in accounting for long-term contracts. If revenues and costs are difficult to estimate, how must companies account for long-term contracts? 2. If revenues and costs are difficult to estimate, then companies recognize revenue only to the extent of the cost incurred – a zero-profit approach.
CHAPTER 19 ACCOUNTING FOR INCOME TAXES IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F F T T F T F T F T F T T F F 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.
Taxable income. Use of pretax financial income. Taxable amounts. Deferred tax liability. Deductible amounts. Deferred tax asset. Need for valuation allowance account. Positive and negative evidence. Computation of income tax expense. Taxable temporary differences. Taxable temporary difference examples. Permanent differences. 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. Classification of deferred tax assets and liabilities. Classification of deferred tax accounts. Method used for accounting for income taxes.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
b c b a a b c d b c d c d d d b a d
21. 22. 23. 24. P 25. S 26. P 27. S 28. S 29. S 30. S 31. 32. 33. 34. 35. 36. 37. 38.
Differences between taxable and accounting income. Differences between taxable and accounting income. Determination of deferred tax expense. Differences arising from depreciation methods. Temporary difference and a revenue item. 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. Identification of deductible temporary differences. Identification of temporary difference.
19 - 2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer c c b a d c d c b d d c c
No.
Description
S
Accounting for change in tax rate. Appropriate tax rate for deferred tax amounts. Recognition of tax benefit of a loss carryforward. Recognition of valuation account for deferred tax asset. Definition of uncertain tax positions. Recognition of tax benefit with uncertain tax position. 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.
39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. S 50. 51.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. *This topic is dealt with in an Appendix to the chapter. S
MULTIPLE CHOICE—Computational Answer
No.
Description
c b a a d c b d c d b d a a a c a b a a d b c d b d b b
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.
Calculate book basis and tax basis of an asset. Calculate deferred tax liability balance. 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. Calculate amount of DTA valuation account. Calculate current portion of provision for income taxes. 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. Calculate taxable income for the year. Calculate deferred tax asset amount. Calculate deferred tax liability balance. Calculate income taxes payable amount.
Accounting for Income Taxes
19 - 3
MULTIPLE CHOICE—Computational (cont.) Answer
No.
Description
a b b a c d b b d d b a a d c
80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94.
Calculate deferred tax asset amount. Calculate taxable income for the year. Calculate pretax financial income. Calculate deferred tax liability with changing tax rates. Calculate deferred tax liability amount. Calculate income tax expense with changing tax rates. 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. Calculate income tax payable after NOL carryforward. Calculate deferred tax asset after NOL carryforward.
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
a a c d d b a a c c
95. 96. 97. 98. 99. 100. 101. 102. 103. 104.
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 E19-105 E19-106 E19-107 E19-108 E19-109 E19-110 E19-111 E19-112 E19-113
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.
19 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
PROBLEMS Item P19-114 P19-115 P19-116 P19-117
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.
2.
Describe a temporary difference that results in future taxable amounts.
3.
Describe a temporary difference that results in future deductible amounts.
4. 5.
Explain the purpose of a deferred tax asset valuation allowance. Describe the presentation of income tax expense in the income statement.
6.
Describe various temporary and permanent differences.
7. 8.
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.
9.
Describe the presentation of deferred income taxes in financial statements.
10.
Indicate the basic principles of the asset-liability method.
*11.
Understand and apply the concepts and procedures of interperiod tax allocation.
Accounting for Income Taxes
19 - 5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type TF TF
3. 4. 24.
TF TF MC
5. 6. 56.
Type
Item
21. 22.
MC MC
23. 95.
25. 52. 53.
MC MC MC
54. 55. 58.
TF TF MC
59. 61. 62.
MC MC MC
63. 106. 107.
7.
TF
8.
TF
64.
9. 26.
TF MC
65. 66.
MC MC
67. 99.
10. 11. 12. P 27. S 28.
TF TF TF MC MC
S
29. 30. S 31. 32. 33.
MC MC MC MC MC
34. 35. 36. 37. 38.
13. 14.
TF TF
S
39. 40.
MC MC
83. 84.
15. 16.
TF TF
17. 41.
TF MC
42. 88.
18. 19. 43.
TF TF MC
44. 45. 46.
MC MC MC
47. 48. 49.
20.
TF
51.
MC
S
1. 2.
Item
Note:
P
S
TF = True-False MC = Multiple Choice E = Exercise P = Problem
Type
Item
Type
Item
Learning Objective 1 MC 96. MC 114. MC 105. E 115. Learning Objective 2 MC 97. MC 107. MC 98. MC 108. MC 106. E 114. Learning Objective 3 MC 108. E 114. E 109. E 115. E 113. E 116. Learning Objective 4 MC Learning Objective 5 MC 100. MC MC 113. E Learning Objective 6 MC 68. MC 73. MC 69. MC 74. MC 70. MC 75. MC 71. MC 76. MC 72. MC 77. Learning Objective 7 MC 85. MC 87. MC 86. MC 117. Learning Objective 8 MC 89. MC 91. MC 90. MC 92. Learning Objective 9 S MC 50. MC 100. MC 57. MC 101. MC 60. MC 102. Learning Objective 10
Type
Item
Type
Item
Type
P P
116.
P
E E P
115. 116.
P P
78. 79. 80. 81. 82.
MC MC MC MC MC
110. 111. 112. 114. 116.
E E E P P
MC MC
93. 94.
MC MC
113.
E
MC MC MC
103. 104. 116.
MC MC P
P P P
MC MC MC MC MC MC P
19 - 6
Test Bank for Intermediate Accounting, Fourteenth Edition
TRUE-FALSE—Conceptual 1.
Taxable income is a tax accounting term and is also referred to as income before taxes.
2.
Pretax financial income is the amount used to compute income tax payable.
3.
Taxable amounts increase taxable income in future years.
4.
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.
5.
Deductible amounts cause taxable income to be greater than pretax financial income in the future as a result of existing temporary differences.
6.
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.
7.
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.
8.
Companies should consider both positive and negative evidence to determine whether it needs to record a valuation allowance to reduce a deferred tax asset.
9.
A company should add a decrease in a deferred tax liability to income tax payable in computing income tax expense.
10.
Taxable temporary differences will result in taxable amounts in future years when the related assets are recovered.
11.
Examples of taxable temporary differences are subscriptions received in advance and advance rental receipts.
12.
Permanent differences do not give rise to future taxable or deductible amounts.
13.
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.
14.
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.
15.
Under the loss carryback approach, companies must apply a current year loss to the most recent year first and then to an earlier year.
16.
The tax effect of a loss carryforward represents future tax savings and results in the recognition of a deferred tax asset.
17.
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.
18.
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.
Accounting for Income Taxes
19 - 7
19.
Companies should classify the balances in the deferred tax accounts on the balance sheet as noncurrent assets and noncurrent liabilities.
20.
The FASB believes that the deferred tax method is the most consistent method for accounting for income taxes.
True-False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F F T T F
Item 6. 7. 8. 9. 10.
Ans. T F T F T
Item 11. 12. 13. 14. 15.
Ans. F T T F F
Item 16. 17. 18. 19. 20.
Ans. T T T F F
MULTIPLE CHOICE—Conceptual 21.
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.
22
Taxable income of a corporation differs from pretax financial income because of
a. b. c. d. 23.
Permanent Differences No No Yes Yes
Temporary Differences No Yes Yes No
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.
19 - 8 24.
Test Bank for Intermediate Accounting, Fourteenth Edition 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
P
25.
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
S
26.
At the December 31, 2012 balance sheet date, Unruh Corporation reports an accrued receivable for financial reporting purposes but not for tax purposes. When this asset is recovered in 2013, a future taxable amount will occur and a. pretax financial income will exceed taxable income in 2013. b. Unruh will record a decrease in a deferred tax liability in 2013. c. total income tax expense for 2011 will exceed current tax expense for 2013. d. Unruh will record an increase in a deferred tax asset in 2013.
P
27.
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. b. c. d.
S
28.
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.
item II only items I and II only items II and III only items I and IV only
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.
Accounting for Income Taxes
19 - 9
S
29.
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.
S
30.
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.
S
31.
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.
32.
Stuart 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 Stuart 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.
33.
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.
34.
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.
35.
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.
Type of Difference Permanent Permanent Temporary Temporary
Deferred Tax Asset Liability Asset Liability
19 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition 36.
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.
S
Type of Difference Temporary Temporary Permanent Permanent
Deferred Tax Liability Asset Liability Asset
37.
Which of the following temporary differences results in a deferred tax asset in the year the temporary difference originates? I. Accrual for product warranty liability. II. Subscriptions received in advance. III. Prepaid insurance expense. a. I and II only. b. II only. c. III only. d. I and III only.
38.
Which of the following is not considered a permanent difference? a. Interest received on municipal bonds. b. Fines resulting from violating the law. c. Premiums paid for life insurance on a company’s CEO when the company is the beneficiary. d. Stock-based compensation expense.
39.
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.
40.
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.
41.
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.
Accounting for Income Taxes
19 - 11
42.
Recognizing a valuation allowance for a deferred tax asset requires that a company a. consider all positive and negative information in determining the need for a valuation allowance. b. consider only the positive information in determining the need for a valuation allowance. c. take an aggressive approach in its tax planning. d. pass a recognition threshold, after assuming that it will be audited by taxing authorities.
43.
Uncertain tax positions I. Are positions for which the tax authorities may disallow a deduction in whole or in part. II. Include instances in which the tax law is clear and in which the company believes an audit is likely. III. Give rise to tax expense by increasing payables or increasing a deferred tax liability. a. I, II, and III. b. I and III only. c. II only. d. I only.
44.
With regard to uncertain tax positions, the FASB requires that companies recognize a tax benefit when a. it is probable and can be reasonably estimated. b. there is at least a 51% probability that the uncertain tax position will be approved by the taxing authorities. c. it is more likely than not that the tax position will be sustained upon audit. d. Any of the above exist.
45.
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.
46.
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.
47.
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.
19 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition
S
48.
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.
49.
Tanner, Inc. incurred a financial and taxable loss for 2013. 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 2013 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 2013.
50.
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.
51.
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.
Item
Ans.
21. 22. 23. 24. 25.
b c b a a
26. 27. 28. 29. 30.
b c d b c
31. 32. 33. 34. 35.
d c d d d
36. 37. 38. 39. 40.
b a d c c
41. 42. 43. 44. 45.
b a d c d
46. 47. 48. 49. 50.
c b d d c
51.
c
Accounting for Income Taxes
19 - 13
MULTIPLE CHOICE—Computational Use the following information for questions 52 and 53. At the beginning of 2013, Pitman Co. purchased an asset for $900,000 with an estimated useful life of 5 years and an estimated salvage value of $75,000. For financial reporting purposes the asset is being depreciated using the straight-line method; for tax purposes the double-decliningbalance method is being used. Pitman Co.’s tax rate is 40% for 2013 and all future years. 52.
At the end of 2013, what is the book basis and the tax basis of the asset? Book basis Tax basis a. $660,000 $465,000 b. $735,000 $465,000 c. $735,000 $540,000 d. $660,000 $540,000
53.
At the end of 2013, which of the following deferred tax accounts and balances is reported on Pitman’s balance sheet? Account _ Balance a. Deferred tax asset $78,000 b. Deferred tax liability $78,000 c. Deferred tax asset $117,000 d. Deferred tax liability $117,000
54.
Lehman Corporation purchased a machine on January 2, 2011, 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: 2011 2012 2013
$400,000 640,000 384,000
2014 2015 2016
$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 Lehman's balance sheet at December 31, 2012, 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 55 through 57. Mathis Co. at the end of 2012, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 600,000 Estimated litigation expense 1,500,000 Installment sales (1,200,000) Taxable income $ 900,000
19 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition The estimated litigation expense of $1,500,000 will be deductible in 2014 when it is expected to be paid. The gross profit from the installment sales will be realized in the amount of $600,000 in each of the next two years. The estimated liability for litigation is classified as noncurrent and the installment accounts receivable are classified as $600,000 current and $600,000 noncurrent. The income tax rate is 30% for all years. 55.
The income tax expense is a. $180,000. b. $270,000. c. $300,000. d. $600,000.
56.
The deferred tax asset to be recognized is a. $0. b. $90,000 current. c. $450,000 current. d. $450,000 noncurrent.
57.
The deferred tax liability—current to be recognized is a. $90,000. b. $270,000. c. $180,000. d. $360,000.
Use the following information for questions 58 through 60. Hopkins Co. at the end of 2012, 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
$ 900,000 1,200,000 (1,800,000) $ 300,000
The estimated litigation expense of $1,200,000 will be deductible in 2013 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $600,000 in each of the next three years. The income tax rate is 30% for all years. 58.
Income tax payable is a. $0. b. $90,000. c. $180,000. d. $270,000.
59.
The deferred tax asset to be recognized is a. $90,000 current. b. $180,000 current. c. $270,000 current. d. $360,000 current.
Accounting for Income Taxes
19 - 15
60.
The deferred tax liability to be recognized is Current Noncurrent a. $180,000 $360,000 b. $180,000 $270,000 c. $0 $540,000 d. $0 $450,000
61.
Eckert 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
Eckert 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 $1,800,000. 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? a. $1,500,000 b. $1,125,000 c. $1,800,000 d. $2,100,000 62.
Cross Company reported the following results for the year ended December 31, 2012, its first year of operations: 2012 Income (per books before income taxes) $ 1,250,000 Taxable income 2,000,000 The disparity between book income and taxable income is attributable to a temporary difference which will reverse in 2013. What should Cross record as a net deferred tax asset or liability for the year ended December 31, 2012, assuming that the enacted tax rates in effect are 40% in 2012 and 35% in 2013? a. $300,000 deferred tax liability b. $262,500 deferred tax asset c. $300,000 deferred tax asset d. $262,500 deferred tax liability
63.
In 2012, Krause Company accrued, for financial statement reporting, estimated losses on disposal of unused plant facilities of $1,800,000. The facilities were sold in March 2013 and a $1,800,000 loss was recognized for tax purposes. Also in 2012, Krause 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 2012 and 2013, and that Krause paid $780,000 in income taxes in 2012, the amount reported as net deferred income taxes on Krause's balance sheet at December 31, 2012, should be a a. $510,000 asset. b. $270,000 asset. c. $270,000 liability. d. $540,000 asset.
19 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition 64.
Horner Corporation has a deferred tax asset at December 31, 2013 of $120,000 due to the recognition of potential tax benefits of an operating loss carryforward. The enacted tax rates are as follows: 40% for 2010–2012; 35% for 2013; and 30% for 2014 and thereafter. Assuming that management expects that only 50% of the related benefits will actually be realized, a valuation account should be established in the amount of: a. $60,000 b. $24,000 c. $21,000 d. $18,000
65.
Watson Corporation prepared the following reconciliation for its first year of operations: Pretax financial income for 2013 $1,400,000 Tax exempt interest (100,000) Originating temporary difference (300,000) Taxable income $1,000,000 The temporary difference will reverse evenly over the next two years at an enacted tax rate of 40%. The enacted tax rate for 2013 is 28%. What amount should be reported in its 2013 income statement as the current portion of its provision for income taxes? a. $280,000 b. $400,000 c. $392,000 d. $560,000
Use the following information for questions 66 and 67. Mitchell Corporation prepared the following reconciliation for its first year of operations: Pretax financial income for 2013 Tax exempt interest Originating temporary difference Taxable income
$ 900,000 (75,000) (125,000) $700,000
The temporary difference will reverse evenly over the next two years at an enacted tax rate of 40%. The enacted tax rate for 2013 is 35%. 66.
What amount should be reported in its 2013 income statement as the deferred portion of income tax expense? a. $50,000 debit b. $90,000 debit c. $50,000 credit d. $70,000 credit
67.
In Mitchell’s 2013 income statement, what amount should be reported for total income tax expense? a. $325,000 b. $315,000 c. $295,000 d. $245,000
Accounting for Income Taxes 68.
19 - 17
Ewing 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. Ewing'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 Ewing's income tax rate is 30%. If Ewing's December 31, 2013, balance sheet includes a deferred tax liability of $450,000 arising from the difference between book and tax treatment of the installment sales, it should also include installment accounts receivable of a. $3,750,000. b. $1,500,000. c. $1,125,000. d. $450,000.
69.
Ferguson Company has the following cumulative taxable temporary differences: 12/31/13 $1,800,000
12/31/12 $1,280,000
The tax rate enacted for 2013 is 40%, while the tax rate enacted for future years is 30%. Taxable income for 2013 is $3,200,000 and there are no permanent differences. Ferguson's pretax financial income for 2013 is a. $5,000,000. b. $3,720,000. c. $2,680,000. d. $1,400,000. Use the following information for questions 70 through 72. Lyons Company deducts insurance expense of $105,000 for tax purposes in 2012, but the expense is not yet recognized for accounting purposes. In 2013, 2014, and 2015, no insurance expense will be deducted for tax purposes, but $35,000 of insurance expense will be reported for accounting purposes in each of these years. Lyons Company has a tax rate of 40% and income taxes payable of $90,000 at the end of 2012. There were no deferred taxes at the beginning of 2012. 70.
What is the amount of the deferred tax liability at the end of 2012? a. $42,000 b. $36,000 c. $15,000 d. $0
71.
What is the amount of income tax expense for 2012? a. $132,000 b. $126,000 c. $105,000 d. $90,000
19 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 72.
Assuming that income tax payable for 2013 is $120,000, the income tax expense for 2013 would be what amount? a. $162,000 b. $134,000 c. $120,000 d. $106,000
Use the following information for questions 73 and 74. Kraft Company made the following journal entry in late 2012 for rent on property it leases to Danford Corporation. Cash Unearned Rent Revenue
90,000 90,000
The payment represents rent for the years 2013 and 2014, the period covered by the lease. Kraft Company is a cash basis taxpayer. Kraft has income tax payable of $138,000 at the end of 2012, and its tax rate is 35%. 73.
What amount of income tax expense should Kraft Company report at the end of 2012? a. $79,500 b. $106,500 c. $122,250 d. $169,500
74.
Assuming the income taxes payable at the end of 2013 is $153,000, what amount of income tax expense would Kraft Company record for 2013? a. $121,500 b. $137,250 c. $168,750 d. $184,500
75.
The following information is available for Kessler 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
Kessler estimates its annual warranty expense as a percentage of sales. The amount charged to warranty expense on its books was $105,000. Assuming a 40% income tax rate, what amount was actually paid this year for warranty claims? a. $115,000 b. $100,000 c. $105,000 d. $95,000
Accounting for Income Taxes
19 - 19
Use the following information for questions 76–78. At the beginning of 2012; Elephant, Inc. had a deferred tax asset of $8,000 and a deferred tax liability of $12,000. Pre-tax accounting income for 2012 was $600,000 and the enacted tax rate is 40%. The following items are included in Elephant’s pre-tax income: Interest income from municipal bonds Accrued warranty costs, estimated to be paid in 2013 Operating loss carryforward Installment sales revenue, will be collected in 2013 Prepaid rent expense, will be used in 2013
$ 48,000 $104,000 $ 76,000 $ 52,000 $24,000
76.
What is Elephant, Inc.’s taxable income for 2012? a. $600,000 b. $504,000 c. $696,000 d. $904,000
77.
Which of the following is required to adjust Elephant, Inc.’s deferred tax asset to its correct balance at December 31, 2012? a. A debit of $41,600 b. A credit of $30,400 c. A debit of $30,400 d. A debit of $33,600
78.
The ending balance in Elephant, Inc’s deferred tax liability at December 31, 2012 is a. $18,400 b. $30,400 c. $20,800 d. $62,400
Use the following information for questions 79 and 80. Rowen, Inc. had pre-tax accounting income of $1,350,000 and a tax rate of 40% in 2013, its first year of operations. During 2013 the company had the following transactions: Received rent from Jane, Co. for 2014 Municipal bond income Depreciation for tax purposes in excess of book depreciation Installment sales revenue to be collected in 2014 79.
$48,000 $60,000 $30,000 $81,000
For 2013, what is the amount of income taxes payable for Rowen, Inc? a. $452,400 b. $490,800 c. $514,800 d. $579,600
19 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 80.
At the end of 2013, which of the following deferred tax accounts and balances is reported on Rowen, Inc.’s balance sheet? Account _ Balance a. Deferred tax asset $19,200 b. Deferred tax liability $19,200 c. Deferred tax asset $31,200 d. Deferred tax liability $31,200
81.
Based on the following information, compute 2013 taxable income for South Co. assuming that its pre-tax accounting income for the year ended December 31, 2013 is $460,000. Future taxable Temporary difference (deductible) amount Installment sales $384,000 Depreciation $120,000 Unearned rent ($400,000) a. b. c. d.
82.
$564,000 $356,000 $964,000 $444,000
Fleming Company has the following cumulative taxable temporary differences: 12/31/13 12/31/12 $960,000 $1,350,000 The tax rate enacted for 2013 is 40%, while the tax rate enacted for future years is 30%. Taxable income for 2013 is $2,400,000 and there are no permanent differences. Fleming’s pretax financial income for 2013 is: a. b. c. d.
83.
$1,440,000 $2,010,000 $2,595,000 $3,360,000
Larsen Corporation reported $100,000 in revenues in its 2012 financial statements, of which $55,000 will not be included in the tax return until 2013. The enacted tax rate is 40% for 2012 and 35% for 2013. What amount should Larsen report for deferred income tax liability in its balance sheet at December 31, 2012? a. $19,250 b. $22,000 c. $24,500 d. $28,000
Accounting for Income Taxes 84.
19 - 21
Duncan Inc. uses the accrual method of accounting for financial reporting purposes and appropriately uses the installment method of accounting for income tax purposes. Profits of $900,000 recognized for books in 2012 will be collected in the following years: Collection of Profits 2013 $150,000 2014 $300,000 2015 $450,000 The enacted tax rates are: 40% for 2012, 35% for 2013, and 30% for 2014 and 2015. Taxable income is expected in all future years. What amount should be included in the December 31, 2012, balance sheet for the deferred tax liability related to the above temporary difference? a. $ 52,500 b. $225,000 c. $277,500 d. $360,000
85.
At December 31, 2012 Raymond Corporation reported a deferred tax liability of $150,000 which was attributable to a taxable type temporary difference of $500,000. The temporary difference is scheduled to reverse in 2016. During 2013, a new tax law increased the corporate tax rate from 30% to 40%. Raymond should record this change by debiting a. Retained Earnings for $50,000. b. Retained Earnings for $15,000. c. Income Tax Expense for $15,000. d. Income Tax Expense for $50,000.
86.
Palmer Co. had a deferred tax liability balance due to a temporary difference at the beginning of 2012 related to $800,000 of excess depreciation. In December of 2012, a new income tax act is signed into law that lowers the corporate rate from 40% to 35%, effective January 1, 2014. If taxable amounts related to the temporary difference are scheduled to be reversed by $400,000 for both 2013 and 2014, Palmer should increase or decrease deferred tax liability by what amount? a. Decrease by $40,000 b. Decrease by $20,000 c. Increase by $20,000 d. Increase by $40,000
87.
A reconciliation of Gentry Company's pretax accounting income with its taxable income for 2012, its first year of operations, is as follows: Pretax accounting income Excess tax depreciation Taxable income
$3,000,000 (180,000) $2,820,000
The excess tax depreciation will result in equal net taxable amounts in each of the next three years. Enacted tax rates are 40% in 2012, 35% in 2013 and 2014, and 30% in 2015. The total deferred tax liability to be reported on Gentry's balance sheet at December 31, 2012, is a. $72,000. b. $60,000. c. $63,000. d. $54,000.
19 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 88.
Khan, Inc. reports a taxable and financial loss of $1,300,000 for 2013. Its pretax financial income for the last two years was as follows: 2011 2012
$600,000 800,000
The amount that Khan, Inc. reports as a net loss for financial reporting purposes in 2013, assuming that it uses the carryback provisions, and that the tax rate is 30% for all periods affected, is a. $1,300,000 loss. b. $ -0-. c. $390,000 loss. d. $910,000 loss. Use the following information for questions 89 and 90. Wilcox Corporation reported the following results for its first three years of operation: 2012 income (before income taxes) 2013 loss (before income taxes) 2014 income (before income taxes)
$ 150,000 (1,350,000) 1,500,000
There were no permanent or temporary differences during these three years. Assume a corporate tax rate of 30% for 2012 and 2013, and 40% for 2014. 89.
Assuming that Wilcox elects to use the carryback provision, what income (loss) is reported in 2013? (Assume that any deferred tax asset recognized is more likely than not to be realized.) a. $(1,350,000) b. $ -0c. $(1,305,000) d. $ (825,000)
90.
Assuming that Wilcox elects to use the carryforward provision and not the carryback provision, what income (loss) is reported in 2013? a. $(1,350,000) b. $(810,000) c. $ -0d. $(1,305,000)
91.
Rodd Co. reports a taxable and pretax financial loss of $600,000 for 2013. Rodd's taxable and pretax financial income and tax rates for the last two years were: 2011 2012
$600,000 600,000
30% 35%
The amount that Rodd should report as an income tax refund receivable in 2013, assuming that it uses the carryback provisions and that the tax rate is 40% in 2013, is a. $180,000. b. $210,000. c. $240,000. d. $270,000.
Accounting for Income Taxes 92.
19 - 23
Nickerson Corporation began operations in 2011. 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 2011 45% $1,250,000 $562,500 2012 40% 1,500,000 600,000 2013 35% 2014 30% In 2013, Nickerson had an operating loss of $1,550,000. What amount of income tax benefits should be reported on the 2013 income statement due to this loss? a. $682,500 b. $622,500 c. $620,000 d. $465,000
Use the following information for questions 93 and 94. Operating income and tax rates for C.J. Company’s first three years of operations were as follows: Income _ Enacted tax rate 2012 $200,000 35% 2013 ($500,000) 30% 2014 $840,000 40% 93.
Assuming that C.J. Company opts to carryback its 2013 NOL, what is the amount of income tax payable at December 31, 2014? a. $136,000 b. $336,000 c. $246,000 d. $216,000
94.
Assuming that C.J. Company opts only to carryforward its 2013 NOL, what is the amount of deferred tax asset or liability that C.J. Company would report on its December 31, 2013 balance sheet? Amount _ Deferred tax asset or liability a. $150,000 Deferred tax liability b. $175,000 Deferred tax liability c. $200,000 Deferred tax asset d. $150,000 Deferred tax asset
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
52. 53. 54. 55. 56.
c b a a d
58. 59. 60. 61. 62.
b d c d b
64. 65. 66. 67. 68.
a a a c a
70. 71. 72. 73. 74.
a a d b c
76. 77. 78. 79. 80.
b d b b a
83. 84. 85. 86. 87.
a c d b b
89. 90. 91. 92. 93.
d b a a d
19 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition 57.
c
63.
d
69.
b
75.
d
81. 82.
b b
88.
d
94.
c
Accounting for Income Taxes
19 - 25
MULTIPLE CHOICE—CPA Adapted 95.
Munoz Corp.'s books showed pretax financial income of $1,800,000 for the year ended December 31, 2013. In the computation of federal income taxes, the following data were considered: Gain on an involuntary conversion $780,000 (Munoz 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 120,000 Federal estimated tax payments, 2013 150,000 Enacted federal tax rate, 2013 30% What amount should Munoz report as its current federal income tax liability on its December 31, 2013 balance sheet? a. $120,000 b. $156,000 c. $270,000 d. $306,000
96.
Haag Corp.'s 2013 income statement showed pretax accounting income of $1,250,000. To compute the federal income tax liability, the following 2013 data are provided: Income from exempt municipal bonds $ 50,000 Depreciation deducted for tax purposes in excess of depreciation deducted for financial statement purposes 100,000 Estimated federal income tax payments made 250,000 Enacted corporate income tax rate 30% What amount of current federal income tax liability should be included in Hagg's December 31, 2013 balance sheet? a. $ 80,000 b. $110,000 c. $125,000 d. $330,000
97.
On January 1, 2013, Gore, Inc. purchased a machine for $900,000 which will be depreciated $90,000 per year for financial statement reporting purposes. For income tax reporting, Gore elected to expense $100,000 and to use straight-line depreciation which will allow a cost recovery deduction of $80,000 for 2013. Assume a present and future enacted income tax rate of 30%. What amount should be added to Gore's deferred income tax liability for this temporary difference at December 31, 2013? a. $54,000 b. $30,000 c. $27,000 d. $24,000
19 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition 98.
On January 1, 2013, Piper Corp. purchased 40% of the voting common stock of Betz, Inc. and appropriately accounts for its investment by the equity method. During 2013, Betz reported earnings of $540,000 and paid dividends of $180,000. Piper assumes that all of Betz's undistributed earnings will be distributed as dividends in future periods when the enacted tax rate will be 30%. Ignore the dividend-received deduction. Piper's current enacted income tax rate is 25%. The increase in Piper's deferred income tax liability for this temporary difference is a. $108,000. b. $90,000. c. $64,800. d. $43,200.
99.
Foltz Corp.'s 2012 income statement had pretax financial income of $250,000 in its first year of operations. Foltz 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 2012, and the enacted tax rates for 2012 to 2016 are as follows: 2012 2013 2014 2015 2016
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 Foltz's December 31, 2012 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 $70,000 100.
Didde Corp. prepared the following reconciliation of income per books with income per tax return for the year ended December 31, 2013: Book income before income taxes $1,500,000 Add temporary difference Construction contract revenue which will reverse in 2014 160,000 Deduct temporary difference Depreciation expense which will reverse in equal amounts in each of the next four years (640,000) Taxable income $1,020,000 Didde's effective income tax rate is 34% for 2013. What amount should Didde report in its 2013 income statement as the current provision for income taxes? a. $54,400 b. $346,800 c. $510,000 d. $564,400
Accounting for Income Taxes
19 - 27
101.
In its 2012 income statement, Cohen Corp. reported depreciation of $1,480,000 and interest revenue on municipal obligations of $280,000. Cohen reported depreciation of $2,200,000 on its 2012 income tax return. The difference in depreciation is the only temporary difference, and it will reverse equally over the next three years. Cohen's enacted income tax rates are 35% for 2012, 30% for 2013, and 25% for 2014 and 2015. What amount should be included in the deferred income tax liability in Hertz's December 31, 2012 balance sheet? a. $192,000 b. $248,000 c. $300,000 d. $350,000
102.
Dunn, 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 $1,500,000 will be collected in the following years when the enacted tax rates are: Collection of Income Enacted Tax Rates 2012 $150,000 35% 2013 300,000 30% 2014 450,000 30% 2015 600,000 25% The installment income is Dunn's only temporary difference. What amount should be included in the deferred income tax liability in Dunn's December 31, 2012 balance sheet? a. $375,000 b. $427,500 c. $472,500 d. $525,000
103.
For calendar year 2012, Kane Corp. reported depreciation of $1,200,000 in its income statement. On its 2012 income tax return, Kane reported depreciation of $1,800,000. Kane's income statement also included $225,000 accrued warranty expense that will be deducted for tax purposes when paid. Kane's enacted tax rates are 30% for 2012 and 2013, and 24% for 2014 and 2015. The depreciation difference and warranty expense will reverse over the next three years as follows: Depreciation Difference Warranty Expense 2013 $240,000 $ 45,000 2014 210,000 75,000 2015 150,000 105,000 $600,000 $225,000 These were Kane's only temporary differences. In Kane's 2012 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.
19 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition 104.
Wright Co., organized on January 2, 2012, had pretax accounting income of $640,000 and taxable income of $1,600,000 for the year ended December 31, 2012 The only temporary difference is accrued product warranty costs which are expected to be paid as follows: 2013 2014 2015 2016
$320,000 160,000 160,000 320,000
The enacted income tax rates are 35% for 2012, 30% for 2013 through 2015, and 25% for 2016. If Wright expects taxable income in future years, the deferred tax asset in Wright's December 31, 2012 balance sheet should be a. $192,000. b. $224,000. c. $272,000. d. $336,000.
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
95. 96.
a a
97. 98.
c d
99. 100.
d b
101. 102.
a a
103. 104.
c c
DERIVATIONS — Computational No.
Answer Derivation
52.
c
$900,000 – [($900,000 – $75,000) 5)] = $735,000; $900,000 – (900,000 1/5 2) = $540,000.
53.
b
($735,000 – $540,000) .40 = $78,000.
54.
a
($640,000 – $400,000) × 30% = $72,000.
55.
a
Income tax payable = ($900,000 × 30%) = $270,000 Change in deferred tax liability = ($1,200,000 × 30%) = $360,000 Change in deferred tax asset = ($1,500,000 × 30%) = $450,000 $270,000 + $360,000 – $450,000 = $180,000.
56.
d
($1,500,000 × 30%) = $450,000.
57.
c
($600,000 × 30%) = $180,000.
58.
b
($300,000 × 30%) = $90,000.
59.
d
($1,200,000 × 30%) = $360,000.
60.
c
($1,800,000 × 30%) = $540,000.
Accounting for Income Taxes
19 - 29
DERIVATIONS — Computational (cont.) No.
Answer Derivation
61.
d
(30% × Temporary Difference) = $90,000; Temporary Difference = ($90,000 ÷ 30%) = $300,000; $1,800,000 + $300,000 = $2,100,000.
62.
b
($2,000,000 – $1,250,000) × 35% = $262,500.
63.
d
($1,800,000 × 30%) = $540,000.
64.
a
$120,000 .50 = $60,000.
65.
a
$1,000,000 .28 = $280,000.
66.
a
$125,000 × .40 = $50,000 debit.
67.
c
($700,000 × .35) + ($125,000 × .40) = $295,000.
68.
a
$450,000 ÷ 30% = $1,500,000 temporary difference $1,500,000 ÷ 40% = $3,750,000.
69.
b
$3,200,000 + ($1,800,000 – $1,280,000) = $3,720,000.
70.
a
$105,000 × .40 = $42,000.
71.
a
$90,000 + ($105,000 × .40) = $132,000.
72.
d
$120,000 – ($35,000 × .40) = $106,000.
73.
b
$138,000 – ($90,000 × .35) = $106,500.
74.
c
$153,000 + ($45,000 × .35) = $168,750.
75.
d
$105,000 – ($4,000 ÷ .40) = $95,000.
76.
b
$600,000 – $48,000 + $104,000 – $76,000 – $52,000 – $24,000 = $504,000.
77.
d
($104,000 .40) – $8,000 = $33,600.
78.
b
($52,000 + $24,000) .40 = $30,400.
79.
b
$1,350,000 + $48,000 – $60,000 – $30,000 – $81,000 = $1,227,000 $1,227,000 .40 = $490,800.
80.
a
$48,000 .40 = $19,200 DTA.
81.
b
$460,000 - $384,000 – $120,000 + $400,000 = $356,000.
82.
b
$2,400,000 – ($1,350,000 – $960,000) = $2,010,000.
19 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
83.
a
$55,000 .35 = $19,250.
84.
c
($150,000 .35) + [($300,000 + $450,000) .30] = $277,500.
85.
d
$500,000 (.40 – .30) = $50,000 ITE.
86.
b
$400,000 × (.35 – .40) = $20,000 decrease.
87.
b
($60,000 × 35%) + ($60,000 × 35%) + ($60,000 × 30%) = $60,000.
88.
d
$1,300,000 – (30% × $1,300,000) = $910,000.
89.
d
($150,000 × 30%) = $45,000; $1,200,000 × 40% = $480,000; ($1,350,000 – $45,000 – $480,000) = $825,000.
90.
b
($1,350,000 × 40%) = $540,000; $1,350,000 – $540,000 = $810,000.
91.
a
($600,000 × 30%) = $180,000.
92.
a
($1,250,000 × .45) + [($1,550,000 – $1,250,000) × .40] = $682,500.
93.
d
[$840,000 – ($500,000 – $200,000)] .40 = $216,000.
94.
c
$500,000 .40 = $200,000.
DERIVATIONS — CPA Adapted No.
Answer Derivation
95.
a
($1,800,000 – $780,000 – $120,000) × 30% = $270,000; $270,000 – $150,000 = $120,000.
96.
a
($1,250,000 – $50,000 – $100,000) × 30% = $330,000; $330,000 – $250,000 = $80,000.
97.
c
($100,000 + $80,000 – $90,000) × 30% = $27,000.
98.
d
($540,000 – $180,000) × 40% = $144,000; $144,000 × 30% = $43,200.
99.
d
($50,000 × 30%) = $15,000; ($250,000 – $50,000) × 35% = $70,000.
100.
b
($1,020,000 × 34%) = $346,800.
101.
a
($240,000 × 30%) + ($240,000 × 25%) + ($240,000 × 25%) = $192,000.
102.
a
($300,000 × 30%) + ($450,000 × 30%) + ($600,000 × 25%) = $375,000.
Accounting for Income Taxes
19 - 31
DERIVATIONS — CPA Adapted (cont.) No.
Answer Derivation
103.
c
($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.
104.
c
($320,000 + $160,000 + $160,000) × 30% = $192,000; $320,000 × 25% = $80,000; $192,000 + $80,000 = $272,000.
EXERCISES Ex. 19-105—Computation of taxable income. The records for Bosch Co. show this data for 2013: •
Gross profit on installment sales recorded on the books was $360,000. Gross profit from collections of installment receivables was $240,000.
•
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 Bosch may deduct 14% for 2013.
•
Interest received on tax exempt Iowa State bonds was $9,000.
•
The estimated warranty liability related to 2013 sales was $21,600. Repair costs under warranties during 2013 were $13,600. The remainder will be incurred in 2014.
•
Pretax financial income is $600,000. The tax rate is 30%.
Instructions (a) Prepare a schedule starting with pretax financial income and compute taxable income. (b) Prepare the journal entry to record income taxes for 2013.
Solution 19-105 (a)
(b)
Pretax financial income Permanent differences Life insurance Tax-exempt interest Temporary differences Installment sales ($360,000 – $240,000) Extra depreciation ($42,000 – $30,000) Warranties ($21,600 – $13,600) Taxable income
$600,000 3,800 (9,000) (120,000) (12,000) 8,000 $470,800
Income Tax Expense [$141,240 + ($39,600 – $2,400)] .............. Deferred Tax Asset (30% × $8,000) ........................................... Deferred Tax Liability (30% × $132,000) ......................... Income Tax Payable (30% × $470,800) ..........................
178,440 2,400 39,600 141,240
19 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 19-106—Future taxable and deductible amounts. Define temporary differences, future taxable amounts, and future deductible amounts.
Solution 19-106 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. 19-107—Deferred income taxes. Pole Co. at the end of 2013, 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) 940,000 $ 310,000
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 $940,000 will be deductible in 2016 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 2013, assuming a tax rate of 40% for all years.
Solution 19-107 (a) Future taxable (deductible) amounts Extra depreciation Litigation (b)
2014
2015
$350,000
$350,000
Income Tax Expense ($124,000 + $420,000 – $376,000) ........... Deferred Tax Asset ($940,000 × 40%) ........................................ Deferred Tax Liability ($1,050,000 × 40%) ...................... Income Tax Payable ($310,000 × 40%) ..........................
2016
Total
$350,000 $1,050,000 (940,000) (940,000) 168,000 376,000 420,000 124,000
Accounting for Income Taxes
19 - 33
Ex. 19-108—Deferred income taxes. Hunt Co. at the end of 2012, 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 (1,500,000) Taxable income $ 450,000 Estimated warranty expense of $800,000 will be deductible in 2013, $300,000 in 2014, and $100,000 in 2015. The use of the depreciable assets will result in taxable amounts of $500,000 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 2012, assuming an income tax rate of 40% for all years.
Solution 19-108 (a)
(b)
2013 Future taxable (deductible) amounts Warranties $(800,000) Excess depreciation 500,000
2014
2015
Total
$(300,000) $(100,000) $(1,200,000) 500,000 500,000 1,500,000
Income Tax Expense [$180,000 + ($600,000 – $480,000)] ......... Deferred Tax Asset ($1,200,000 × 40%) ..................................... Deferred Tax Liability ($1,500,000 × 40%) ...................... Income Tax Payable ($450,000 × 40%) ..........................
300,000 480,000 600,000 180,000
Ex. 19-109—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 19-109 (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%.
19 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 19-110—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. 2. Advance rental receipts. 3. Fine for polluting. 4. Estimated future warranty costs. 5. Excess of contributions over pension expense. 6. Expenses incurred in obtaining tax-exempt revenue. 7. Installment sales. 8. Excess tax depreciation over accounting depreciation. 9. Long-term construction contracts. 10. Premiums paid on life insurance of officers (company is the beneficiary).
Solution 19-110 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. 19-111—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-sales 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.
Accounting for Income Taxes
19 - 35
Solution 19-111 (a)
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.
(b)
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.
(c)
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.
Ex. 19-112—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 19-112 (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.
19 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 19-113—Operating loss carryforward. In 2012, its first year of operations, Kimble Corp. has a $700,000 net operating loss when the tax rate is 30%. In 2013, Kimble has $320,000 taxable income and the tax rate remains 30%. Instructions Assume the management of Kimble 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 2013 operations are known). (a) (b)
What are the entries in 2012 to record the tax loss carryforward? What entries would be made in 2013 to record the current and deferred income taxes and to recognize the loss carryforward? (Assume that at the end of 2013 it is more likely than not that the deferred tax asset will be realized.)
Solution 19-113 (a)
(b)
Deferred Tax Asset ($700,000 × 30%)......................................... Benefit Due to Loss Carryforward ....................................
210,000
Benefit Due to Loss Carryforward ................................................ Allowance to Reduce Deferred Tax Asset to Expected Realizable Value ..........................................
210,000
Income Tax Expense ($320,000 × 30%) ...................................... Deferred Tax Asset ..........................................................
96,000
Allowance to Reduce Deferred Tax Asset to Expected Realizable Value ..................................................................... Benefit Due to Loss Carryforward ....................................
210,000
210,000
96,000
96,000 96,000
19 - 37
Accounting for Income Taxes
PROBLEMS Pr. 19-114—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 Abbott Company for the year ended December 31, 2012, 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 80,000 (20,000) $510,000
Excess tax depreciation will reverse equally over a four-year period, 2013-2016. It is estimated that the litigation liability will be paid in 2016. Rent revenue will be recognized during the last year of the lease, 2016. Interest revenue from the New York bonds is expected to be $20,000 each year until their maturity at the end of 2016.
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 2012.
Solution 19-114 (a)
2013 Future taxable (deductible) amounts: Depreciation $80,000 Litigation Unearned rent
(b) Temporary Differences Depreciation Litigation Unearned rent Totals (c)
Deferred tax expense Deferred tax benefit Net deferred tax expense
Future Taxable (Deductible) Amounts $320,000 (70,000) (80,000) $170,000
2014
2015
$80,000
$80,000
Tax Rate 30% 30% 30%
$96,000 (45,000) $51,000
2016
Total
$80,000 $320,000 (70,000) (70,000) (80,000) (80,000)
Deferred Tax (Asset) Liability $96,000 $(21,000) (24,000) $(45,000) $96,000
19 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 19-114 (cont.) (d) Income Tax Expense ($153,000 + $51,000) ................................ Deferred Tax Asset ..................................................................... Deferred Tax Liability ...................................................... Income Tax Payable ($510,000 × 30%) ..........................
204,000 45,000 96,000 153,000
Pr. 19-115—Multiple temporary differences. The following information is available for the first three years of operations for Cooper Company: 1. Year 2012 2013 2014
Taxable Income $500,000 360,000 400,000
2. On January 2, 2012, 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: 2012 $198,000
2013 $270,000
Tax Depreciation 2014 2015 $90,000 $42,000
Total $600,000
3. On January 2, 2013, $270,000 was collected in advance for rental of a building for a threeyear period. The entire $270,000 was reported as taxable income in 2013, but $180,000 of the $270,000 was reported as unearned revenue at December 31, 2013 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 2012. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2013. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2013. (e) Compute the net deferred tax expense (benefit) for 2013. (f) Prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2013.
Solution 19-115 (a) Year 2012 2013 2014 2015 2016
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
Temporary Difference $ (78,000) (150,000) 30,000 78,000 120,000 $ -0-
Accounting for Income Taxes
19 - 39
Solution 19-115 (cont.) (b)
2013 Future taxable (deductible) amounts: Depreciation $(150,000)
2014
2015
2016
Total
$30,000
$78,000
$120,000
$78,000
Deferred tax liability: $78,000 × 40% = $31,200 at the end of 2012. (c) Future taxable (deductible) amounts: Depreciation Rent
2014
2015
2016
Total
$30,000 (90,000)
$78,000 (90,000)
$120,000
$228,000 (180,000)
(d)
Future Taxable (Deductible) Amounts $228,000 (180,000) $ 48,000
Temporary Differences Depreciation Rent Totals (e)
(f)
Tax Rate 40% 40%
Deferred Tax (Asset) Liability $91,200 $(72,000) $(72,000) $91,200
Deferred tax asset at end of 2013 Deferred tax asset at beginning of 2013 Deferred tax (benefit)
$(72,000) -0$(72,000)
Deferred tax liability at end of 2013 Deferred tax liability at beginning of 2013 Deferred tax expense
$91,200 31,200 $60,000
Deferred tax (benefit) Deferred tax expense Net deferred tax benefit for 2013
$(72,000) 60,000 $(12,000)
Income Tax Expense ($144,000 – $12,000) ................................ Deferred Tax Asset ..................................................................... Deferred Tax Liability ....................................................... Income Tax Payable ($360,000 × 40%) ...........................
132,000 72,000 60,000 144,000
Pr. 19-116—Deferred tax asset. Farmer Inc. began business on January 1, 2012. Its pretax financial income for the first 2 years was as follows: 2012 2013
$240,000 560,000
The following items caused the only differences between pretax financial income and taxable income.
19 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 19-116 (cont.) 1. In 2012, the company collected $240,000 of rent; of this amount, $80,000 was earned in 2012; the other $160,000 will be earned equally over the 2013–2014 period. The full $240,000 was included in taxable income in 2012. 2. The company pays $10,000 a year for life insurance on officers. 3. In 2013, the company terminated a top executive and agreed to $90,000 of severance pay. The amount will be paid $30,000 per year for 2013–2015. The 2013 payment was made. The $90,000 was expensed in 2013. For tax purposes, the severance pay is deductible as it is paid. The enacted tax rates existing at December 31, 2012 are: 2012 2013
30% 35%
2014 2015
40% 40%
Instructions (a) Determine taxable income for 2012 and 2013. (b) Determine the deferred income taxes at the end of 2012, and prepare the journal entry to record income taxes for 2012. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2013. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2013. (e) Compute the net deferred tax expense (benefit) for 2013. (f) Prepare the journal entry to record income taxes for 2013. (g) Show how the deferred income taxes should be reported on the balance sheet at December 31, 2013.
Solution 19-116 (a) Pretax financial income Permanent differences: Life insurance Temporary differences: Rent Severance pay Taxable income (b)
2012 $240,000
2013 $560,000
10,000 250,000
10,000 570,000
160,000 -0$410,000
(80,000) 60,000 $550,000
2013
2014
Total
$(80,000) 35% $(28,000)
$(80,000) 40% $(32,000)
$(160,000)
Income Tax Expense ($123,000 – $60,000) ................................ Deferred Tax Asset ...................................................................... Income Tax Payable ($410,000 × 30%) .........................
63,000 60,000
Future taxable (deductible) amounts: Rent Tax rate Deferred tax (asset) liability
$(60,000) at end of 2012
123,000
Accounting for Income Taxes
19 - 41
Solution 19-116 (cont.) (c) Future taxable (deductible) amounts: Rent Severance pay (d) Temporary Difference Rent Severance pay Totals
2014
2015
Total
$(80,000) (30,000)
$(30,000)
$(80,000) (60,000)
Future Taxable (Deductible) Amounts $ (80,000) (60,000) $(140,000)
Tax Rate 40% 40%
(e)
Deferred tax asset at end of 2013 Deferred tax asset at beginning of 2013 Net deferred tax (expense) for 2013
(f)
Income Tax Expense ($192,500 + $4,000) .................................. Deferred Tax Asset .......................................................... Income Tax Payable ($550,000 × 35%) ...........................
(g)
Deferred Tax (Asset) Liability $(32,000) (24,000) $(56,000)
$(56,000) (60,000) $ (4,000) 196,500 4,000 192,500
The deferred income taxes should be reported on the December 31, 2013 balance sheet as follows: Current assets Deferred tax asset ($110,000* × 40%) $44,000 Other assets Deferred tax asset ($30,000 × 40%)
$12,000
*$80,000 + $30,000
Pr. 19-117—Interperiod tax allocation with change in enacted tax rates. Murphy Company purchased equipment for $300,000 on January 2, 2012, 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: 2012 2013 2014 Pretax financial income $224,000 $260,000 $300,000 Taxable income 184,000 260,000 340,000 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 2012 is 30% but that in the middle of 2013, Congress raises the income tax rate to 35% retroactive to the beginning of 2013.
19 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 19-117 (a) Book depreciation Tax depreciation Temporary difference 2012
2013
2014
(b)
2012
2013
2014
2012 $ 100,000 140,000 $(40,000)
2013 $100,000 100,000 $ -0-
2014 $100,000 60,000 $40,000
Total $300,000 300,000 $ -0-
Income Tax Expense ....................................................... Deferred Tax Liability ($40,000 × .30) ................... Income Tax Payable ($184,000 × .30) ..................
67,200
Income Tax Expense ....................................................... Income Tax Payable ($260,000 × .30) ..................
78,000
Income Tax Expense ....................................................... Deferred Tax Liability ....................................................... Income Tax Payable ($340,000 × .30) ..................
90,000 12,000
Income Tax Expense ....................................................... Deferred Tax Liability ($40,000 × .30) ................... Income Tax Payable ($184,000 × .30) ..................
67,200
Income Tax Expense ....................................................... Deferred Tax Liability ............................................ Income Tax Payable ($260,000 × .35) ..................
93,000
Income Tax Expense ....................................................... Deferred Tax Liability ....................................................... Income Tax Payable ($340,000 × .35) ..................
105,000 14,000
*Future taxable amount Deferred tax @ 30% Deferred tax @ 35% Adjustment
2013 $40,000 12,000 14,000 $ 2,000
12,000 55,200
78,000
102,000
12,000 55,200
2,000* 91,000
119,000
Accounting for Income Taxes
19 - 43
IFRS QUESTIONS True/False Questions 1. Under IFRS an affirmative judgment approach is used for recognizing deferred tax assets by recognizing assets up to the amount that is probable to be realized. 2. Under U.S. GAAP, the rate used to compute deferred taxes is either the enacted tax rate, or a substantially enacted tax rate (virtually certain). 3. Under IFRS, a deferred tax liability is classified as current or noncurrent based on the classification of the asset or liability to which it relates. 4. Under IFRS, all tax effects are charged or credited to income. 5. Under IFRS, all potential liabilities associated with uncertain tax positions are recognized. Answers to True/False: 1. True 2. False 3. False 4. False 5. True
Multiple Choice Questions 1. Which of the following is false regarding accounting for deferred taxes under IFRS? a. A deferred tax liability is classified as current or noncurrent based on the classification of the asset or liability to which it relates. b. A deferred tax asset is recognized up to the amount that is probable to be realized. c. Tax effects of certain items are recognized in equity. d. The rate used to compute deferred taxes is either the enacted tax rate, or a substantially enacted tax rate (virtually certain). 2. Jerome Co. has the following deferred tax liabilities at December 31, 2012: Amount $100,000 $300,000 $90,000
Related to Installment sales, expected to be collected in 2013 Fixed asset, 10-year remaining useful life, 2012 tax depreciation exceeds book depreciation Prepaid insurance related to 2013
What amount would Jerome Co. report as a noncurrent deferred tax liability under IFRS and under U.S. GAAP? IFRS U.S. GAAP a. $0 $400,000 b. $490,000 $300,000 c. $300,000 $300,000 d. $490,000 $490,000
19 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition 3. With regard to recognition of deferred tax assets, IFRS requires
a.
Approach Affirmative judgment
b.
Impairment approach
c.
Affirmative judgment
d.
Impairment approach
Recognition Recognize an asset up to the amount that is probable to be realized Recognize asset in full, reduced by valuation allowance if it’s more likely than not that all or a portion of the asset won’t be realized Recognize asset in full, reduced by valuation allowance if it’s more likely than not that all or a portion of the asset won’t be realized Recognize an asset up to the amount that is probable to be realized
4. Match the approach, IFRS or U.S. GAAP, with the location where tax effects are reported:
a. b. c. d.
Approach IFRS U.S. GAAP IFRS U.S. GAAP
Location Charge or credit only taxable temporary differences to income Charge or credit certain tax effects to equity Charge or credit certain tax effects to equity Charge or credit only deductible temporary differences to income
5. Alice, Inc. has the following deferred tax assets at December 31, 2012: Amount $120,000 $50,000 $170,000
Related to Rent revenue collected in advance related to 2013 Warranty liability, expected to be paid in 2013 Accrued liability related to a lawsuit expected to settle in 2016
What amount would Alice, Inc. report as a current deferred tax asset under IFRS and under U.S. GAAP? _IFRS_ U.S. GAAP a $340,000 $340,000 b. $0 $170,000 c. $170,000 $340,000 d. $340,000 $170,000
Answers to Multiple Choice: 1. a 2. b 3. a 4. c 5. b
Accounting for Income Taxes
19 - 45
Short Answer: 1. Breifly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to income tax accounting.
19 - 46 Test Bank for Intermediate Accounting, Fourteenth Edition
1. Both IFRS and U.S. GAAP use the asset and liability approach for recording deferred tax assets. In general, the differences between IFRS and U.S. GAAP involve limited differences in the exceptions to the asset-liability approach, some minor differences in the recognition, measurement and disclosure criteria, and differences in implementation guidance. Following are some key elements for comparison • Under IFRS, an affirmative judgment approach is used by which a deferred tax asset is recognized up to the amount that is probable to be realized. U.S. GAAP uses an impairment approach. In this situation, the deferred tax asset is recognized in full. It is then reduced by a valuation account if it is more likely than not that all or a portion of the deferred tax asset will not be realized. • IFRS uses the enacted tax rate or substantially enacted tax rate (Substantially enacted means virtually certain). For U.S. GAAP the enacted tax rate must be used. • The tax effects related to certain items are reported in equity under IFRS. That is not the case under U.S. GAAP, which charges or credits the tax effects to income. • U.S. GAAP requires companies to assess the likelihood of uncertain tax positions being sustainable upon audit. Potential liabilities must be accrued and disclosed if the position is “more likely than not” to be disallowed. Under IFRS, all potential liabilities must be recognized. With respect to measurement, IFRS uses an expected value approach to measure the tax liability which differs from U.S. GAAP. • The classification of deferred taxes under IFRS is always noncurrent. As indicated in the chapter, U.S. GAAP classifies deferred taxes based on the classification of the asset or liability to which it relates. 2. Describe the current convergence efforts of the FASB and IASB in the area of accounting for taxes. 2. The FASB and the IASB have been working to address some of the differences in the accounting for income taxes. Some of the issues under discussion are the term “probable” under IFRS for recognition of a deferred tax asset, which might be interpreted to mean “more likely than not”. If changed, the reporting for impairments of deferred tax assets will be essentially the same between U.S. GAAP and IFRS. In addition, the IASB is considering adoption of the classification approach used in U.S. GAAP for deferred tax assets and liabilities. Also, U.S. GAAP will likely continue to use the enacted tax rate in computing deferred taxes, except in situations where the U.S. taxing jurisdiction is not involved. In that case, companies should use IFRS which is based on enacted rates or substantially enacted tax rates. Finally, the issue of allocation of deferred income taxes to equity for certain transactions under IFRS must be addressed in order to conform to U.S. GAAP which allocates the effects to income.
CHAPTER 20 ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITS IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F T F T T F F T F T F F T 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.
Funded pension plan. Qualified pension plans. Defined-contribution plan liability. Defined-benefit plans. Vested benefit obligation. Accumulated benefit obligation. Definition of service cost. Definition of interest cost. Recognizing accumulated benefit obligation. Pension Asset /Liability balance. Plan amendment and projected benefit obligation increase. Years-of-service amortization method. Expected return and actual return. Unexpected gains and losses. Accumulated OCI (G/L) account and the corridor. Amortization of net 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
d c d c b b a c a a d d d a c b
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36.
Factors considered by actuaries. Process of funding a pension plan. Accounting problems in pension plans. Nature of a defined-contribution plan. Nature of a defined-benefit plan. Defined-contribution plan characteristics. Accounting for a defined-benefit plan. Pension obligation measurement using future salaries. Definition of accumulated benefit obligation. Projected benefit obligation as a measure of pension obligation. Alternative measures of the pension obligation. Characteristics of vested benefits. Pension funding and pension expense recognition. Components of pension expense. Service cost calculated using future compensation levels. Settlement interest rates.
20-2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
a b b c a c c b a d b a a a d a a b c c c c a c b d b
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.
Nature of plan assets. Definition of actual return on plan assets. Pension Asset / Liability. Items included in pension expense. Definition of pension expense. Recognition of prior service costs. Amortization of prior service costs. Amortization methods for prior service costs. Defined-benefit plan amendment. Unexpected gains and losses. Recording gains and losses. Use of fair value of plan asset. Gain or loss caused by a plant closing. Reporting pension asset. Intangible asset—deferred pension cost. Identification of a balance sheet account. Recognition of pension asset. Disclosures of pension plan information. Function of Pension Benefit Guaranty Corporation. Postretirement health care benefits. Disclosures of postretirement benefits. Postretirement asset. Postretirement benefits. Accrual period. Expected postretirement benefit obligation. Recognition of prior service cost. Item not recognized.
*This topic is dealt with in an Appendix to the chapter.
MULTIPLE CHOICE—Computational Answer
No.
Description
d c a b a a b d d b b a d
64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76.
Calculate pension expense. Calculate pension expense. Calculate pension expense. Calculate pension expense. Determine pension expense. Determine pension liability to be reported. Determine amortization of gain / loss. Calculate pension expense. Calculate pension expense. Calculate pension expense. Calculate actual return on plan assets. Calculate unexpected gain on plan assets. Calculate net loss amortization.
Accounting for Pensions and Postretirement Benefits
MULTIPLE CHOICE—Computational Answer
No.
Description
b c b c b c b b a c d c b d b d d c d a b a b
77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. *97. *98. *99.
Calculate projected benefit obligation balance. Calculate fair value of plan assets. Calculate amortization of prior service cost. Calculate interest cost. Determine actual return on plan assets. Calculate the unexpected gain on plan assets. Determine the corridor. Calculate amortization of net gain. Calculate pension asset / liability recognized in the balance sheet. Calculate pension liability. Calculate pension liability. Calculate pension liability. Calculate amount of intangible asset. Calculate pension liability. Determine pension liability to be reported. Determine pension asset / liability to be reported. Determine balance of projected benefit obligation. Determine fair value of plan assets. Determine pension asset / liability to be reported. Determine pension liability to be reported. Calculate postretirement expense. Calculate postretirement expense. Calculate postretirement expense.
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
d b c d a b
100. 101. 102. 103. 104. 105.
Determine the projected benefit obligation. Nature of interest cost. Determine pension asset / liability to be reported. Determine pension asset / liability to be reported. Calculate pension liability. Calculate pension liability.
EXERCISES Item E20-106 E20-107 E20-108
Description Pension accounting terminology. Pension asset terminology. Measuring and recording pension expense.
20-3
20-4
Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES (cont.) Item E20-109 E20-110 E20-111 E20-112 E20-113 E20-114 E20-115 E20-116 *E20-117 *E20-118
Description Measuring and recording pension expense. Additional pension liability. Pension reconciliation schedule. Pension plan calculations. Pension plan calculation and entries. Corridor amortization. Corridor approach (amortization of net gains and losses.) Pension plan calculations and journal entry. Computing and recording postretirement expense. Computing postretirement expense and APBO.
PROBLEMS Item P20-119 P20-120 P20-121 P20-122
Description Measuring, recording, and reporting pension expense and liability. Measuring and recording pension expense. Preparing a pension work sheet. Amortization of prior service cost.
CHAPTER LEARNING OBJECTIVES 1.
Distinguish between accounting for the employer's pension plan and accounting for the pension fund.
2.
Identify types of pension plans and their characteristics.
3.
Explain alternative measures for valuing the pension obligation.
4.
List the components of pension expense.
5.
Use a worksheet for employer's pension plan entries.
6.
Describe the amortization of prior service costs.
7.
Explain the accounting for unexpected gains and losses.
8.
Explain the corridor approach to amortizing gains and losses.
9.
Describe the requirements for reporting pension plans in financial statements.
*10.
Identify the differences between pensions and postretirement healthcare benefits.
*11.
Contrast accounting for pensions to accounting for other postretirement benefits.
Accounting for Pensions and Postretirement Benefits
20-5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1.
TF
2.
TF
21.
3.
TF
4.
TF
23.
5. 6.
TF TF
28. 29.
MC MC
30. 31.
7. 8. 33. 34. 35.
TF TF MC MC MC
36. 37. 38. 39. 40.
MC MC MC MC MC
64. 65. 66. 67. 68.
9.
TF
10.
TF
41.
11. 12.
TF TF
42. 43.
MC MC
44. 45.
13. 14.
TF TF
46. 75.
MC MC
82. 107.
15. 16. 47.
TF TF MC
48. 49. 70.
MC MC MC
76. 83. 84.
17. 18. 19. 20. 50.
TF TF TF TF MC
51. 52. 53. 54. 55.
MC MC MC MC MC
56. 69. 86. 87. 88.
57.
MC
57. 58.
MC MC
Note:
59. 60.
MC MC
61. 62.
TF = True-False MC = Multiple Choice
Type
Item
Type
Item
Learning Objective 1 MC 22. MC Learning Objective 2 MC 24. MC 25. Learning Objective 3 MC 32. MC 117. MC 106. E Learning Objective 4 MC 71. MC 80. MC 72. MC 81. MC 73. MC 100. MC 74. MC 101. MC 75. MC 106. Learning Objective 5 MC 77. MC 78. Learning Objective 6 MC 79. MC 109. MC 108. E 119. Learning Objective 7 MC 112. E 120. E 119. P 121. Learning Objective 8 MC 85. MC 112. MC 109. E 113. MC 111. E 114. Learning Objective 9 MC 89. MC 94. MC 90. MC 95. MC 91. MC 96. MC 92. MC 102. MC 93. MC 103. Learning Objective *10 Learning Objective *11 MC 63. MC 98. MC 97. MC 99. E = Exercise P = Problem
Type
Item
Type
Item
Type
MC
S
26.
MC
S
27.
MC
MC MC E E E
107. 108. 109. 116. 120.
E E E E P
MC
121.
P
E P
122.
P
E E E
115. 120.
E P
MC MC MC MC MC
104. 105. 110. 111. 119.
MC MC E E P
120.
P
MC MC
111. 117.
E E
118.
E
E
P P
20-6
Test Bank for Intermediate Accounting, Fourteenth Edition
TRUE-FALSE—Conceptual 1.
A pension plan is contributory when the employer makes payments to a funding agency.
2.
Qualified pension plans permit deductibility of the employer’s contributions to the pension fund.
3.
An employer does not have to report a liability on its balance sheet in a defined-benefit plan.
4.
Employers are at risk with defined-benefit plans because they must contribute enough to meet the cost of benefits that the plan defines.
5.
Companies compute the vested benefit obligation using only vested benefits, at current salary levels.
6.
The accumulated benefit obligation bases the deferred compensation amount on both vested and nonvested service using future salary levels.
7.
Service cost is the expense caused by the increase in the accumulated benefit obligation because of employees’ service during the current year.
8.
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.
9.
Companies recognize the accumulated benefit obligation in their accounts and in their financial statements.
10.
The Pension Asset / Liability account balance equals the difference between the projected benefit obligation and the fair value of pension plan assets.
11.
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.
12.
The FASB requires only the years-of-service method for amortization of prior service cost.
13.
The difference between the expected return and the actual return is referred to as the unexpected gain or loss.
14.
The unexpected gains and losses from changes in the projected benefit obligation are called asset gains and losses.
15.
The Accumulated Other Comprehensive Income (G/L) account is amortized only if it exceeds 10 percent of the larger of the beginning balances of the projected benefit obligation or the market-related plan assets value.
16.
If the Accumulated Other Comprehensive Income (G/L) account is less than the corridor, the net gains and losses are subject to amortization.
Accounting for Pensions and Postretirement Benefits
20-7
17.
When a company amends its defined benefit plan, and recognizes prior service, the projected benefit obligation is increased to recognize this additional liability.
18.
Companies report Accumulated Other Comprehensive Income (PSC) as a liability on the balance sheet.
19.
Other Comprehensive Income (PSC) is reported as part of net income.
20.
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 1. 2. 3. 4. 5.
Ans. F T F T T
Item 6. 7. 8. 9. 10.
Ans. F F T F T
Item 11. 12. 13. 14. 15.
Ans. F F T F T
Item 16. 17. 18. 19. 20.
Ans. F T F F T
MULTIPLE CHOICE—Conceptual 21.
In determining the present value of the prospective benefits (often referred to as the projected benefit obligation), the following are considered by the actuary: a. retirement and mortality rate. b. interest rates. c. benefit provisions of the plan. d. all of these factors.
22.
In a defined-benefit plan, the process of funding refers to a. determining the projected benefit obligation. b. determining the accumulated benefit obligation. c. making the periodic contributions to a funding agency to ensure that funds are available to meet retirees' claims. d. determining the amount that might be reported for pension expense.
23.
In all pension plans, the accounting problems include all the following except a. measuring the amount of pension obligation. b. disclosing the status and effects of the plan in the financial statements. c. allocating the cost of the plan to the proper periods. d. determining the level of individual premiums.
24.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
25.
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.
26.
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 defined by the terms of the plan. 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.
27.
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.
28.
Alternative methods exist for the measurement of the pension obligation (liability). Which measure requires the use of future salaries in its computation? a. Vested benefit obligation b. Accumulated benefit obligation c. Projected benefit obligation d. Restructured benefit obligation
29.
The accumulated benefit obligation measures a. the pension obligation on the basis of the plan formula applied to years of service to date and based on existing salary levels. b. the pension obligation on the basis of the plan formula applied to years of service to date and based on future salary levels. c. an estimated total benefit at retirement and then computes the level cost that will be sufficient, together with interest expected to accumulate at the assumed rate, to provide the total benefits at retirement. d. the shortest possible period for funding to maximize the tax deduction.
30.
The projected benefit obligation is the measure of pension obligation that a. is required to be used for reporting the service cost component of pension expense. b. requires pension expense to be determined solely on the basis of the plan formula applied to years of service to date and based on existing salary levels. c. requires the longest possible period for funding to maximize the tax deduction. d. is not sanctioned under generally accepted accounting principles for reporting the service cost component of pension expense.
Accounting for Pensions and Postretirement Benefits
20-9
31.
Differing measures of the pension obligation can be based on a. all years of service—both vested and nonvested—using current salary levels. b. only the vested benefits using current salary levels. c. both vested and nonvested service using future salaries. d. all of these.
32.
Vested benefits a. usually require a certain minimum number of years of service. b. are those that the employee is entitled to receive even if fired. c. are not contingent upon additional service under the plan. d. are defined by all of these.
33.
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.
34.
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.
35.
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.
36.
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.
37.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
38.
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.
39.
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. as other comprehensive income (G/L) d. as accumulated other comprehensive income (PSC).
40.
Which of the following items should be included in pension expense calculated by an employer who sponsors a defined-benefit pension plan for its employees?
a. b. c. d.
Fair value of plan assets Yes Yes No No
Amortization of prior service cost Yes No Yes No
41.
A corporation has a defined-benefit plan. A pension liability will result at the end of the 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.
42.
When a company adopts a pension plan, prior service costs should be charged to a. accumulated other comprehensive income (PSC). b. operations of prior periods. c. Other comprehensive income (PSC). d. retained earnings.
43.
When a company amends a pension plan, for accounting purposes, prior service costs 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 in the period the plan is amended.
44.
Prior service cost is amortized on a a. straight-line basis over the expected future years of service. b. years-of-service method or on a straight-line basis 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.
Accounting for Pensions and Postretirement Benefits
20-11
45.
Whenever a defined-benefit plan is amended and credit is given to employees for years of service provided before the date of amendment a. both the accumulated benefit obligation and the projected benefit obligation are usually greater than before. b. both the accumulated benefit obligation and the projected benefit obligation are usually less than before. c. the expense and the liability should be recognized at the time of the plan change. d. the expense should be recognized immediately, but the liability may be deferred until a reasonable basis for its determination has been identified.
46.
The actuarial gains or losses that result from changes in the projected benefit obligation are called
a. b. c. d.
Asset Gains & Losses Yes No Yes No
Liability Gains & Losses Yes No No Yes
47.
Gains and losses that relate to the computation of pension expense should be a. recorded currently as an adjustment to pension expense in the period incurred. b. recorded currently and in the future by applying the corridor method which provides the amount to be amortized. c. amortized over a 15-year period. d. recorded only if a loss is determined.
48.
The fair value of pension plan assets is used to determine the corridor and to calculate the expected return on plan assets. Expected Return Corridor on Plan Assets a. Yes Yes b. Yes No c. No Yes d. No No
49.
A pension fund gain or loss that is caused by a plant closing should be a. recognized immediately as a gain or loss on the plant closing. b. spread over the current year and future years. c. charged or credited to the current pension expense. d. recognized as a prior period adjustment.
50.
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.
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Test Bank for Intermediate Accounting, Fourteenth Edition
51.
A pension asset is reported when a. the accumulated benefit obligation exceeds the fair value of pension plan assets. b. the accumulated benefit obligation exceeds the fair value of pension plan assets, but a prior service cost exists. c. pension plan assets at fair value exceed the accumulated benefit obligation. d. pension plan assets at fair value exceed the projected benefit obligation.
52.
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.
53.
According to the FASB, recognition of a liability is required when the projected benefit obligation exceeds the fair value of plan assets. Conversely, when the fair value of plan assets exceeds the projected benefit obligation, the Board a. requires recognition of an asset. b. requires recognition of an asset if the excess fair value of plan assets exceeds the corridor amount. c. recommends recognition of an asset but does not require such recognition. d. does not permit recognition of an asset.
54.
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 changed 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
55.
The main purpose of the Pension Benefit Guaranty Corporation is to a. require minimum funding of pensions. b. require plan administrators to publish a comprehensive description and summary of their plans. c. administer terminated plans and to impose liens on the employer's assets for certain unfunded pension liabilities. d. all of these.
56.
Which of the following statements is true about postretirement health care benefits? a. They are generally funded. b. The benefits are well-defined and level in dollar amount. c. The beneficiary is the retiree, spouse, and other dependents. d. The benefit is payable monthly.
*57.
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
Accounting for Pensions and Postretirement Benefits
20-13
*58.
A postretirement asset is computed as the excess of the a. expected postretirement benefit obligation over the fair value of plan assets. b. accumulated postretirement benefit obligation over the fair value of plan assets. c. fair value of plan assets over the accumulated postretirement benefit obligation. d. accumulated postretirement benefit obligation over the fair value of plan assets, but not vice versa.
*59.
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.
*60.
Gains or losses can represent changes in a. EPBO or the fair value of pension plan assets. b. EPBO or the book value of pension plan assets. c. APBO or the fair value of pension plan assets. d. APBO or the book value of pension plan assets.
*61.
Which of the following statements about the expected postretirement benefit obligation (EPBO) is not correct? a. The EPBO is an actuarial present value. b. The EPBO is recorded in the accounts. c. The EPBO is used in measuring periodic expense. d. All of these are correct.
*62.
Which of the following statements about the recognition of a prior service cost related to a postretirement obligation is correct? a. The prior service amount is recognized in the income statement in the current period. b. The prior service cost is recognized in the income statement net of tax. c. Restatement of previously issued annual financial statements is required. d. The prior service cost amount affects comprehensive income in the current period.
*63.
Which of the following is recognized in the accounts and in the financial statements? a. Accumulated postretirement benefit obligation b. Postretirement asset / liability c. Expected postretirement benefit obligation d. All of these.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25. 26. 27.
d c d c b b a
28. 29. 30. 31. 32. 33. 34.
c a a d d d a
35. 36. 37. 38. 39. 40. 41.
c b a b b c a
42. 43. 44. 45. 46. 47. 48.
c c b a d b a
49. 50. 51. 52. 53. 54. 55.
a a d a a b c
56. *57. *58. *59. *60. *61. *62.
c c c a c b d
*63.
b
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Computational 64.
Presented below is pension information related to Woods, Inc. for the year 2013: Service cost $92,000 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 2013 is a. $128,000. b. $164,000. c. $182,000. d. $140,000.
65.
Kraft, Inc. sponsors a defined-benefit pension plan. The following data relates to the operation of the plan for the year 2013. Service cost $ 250,000 Contributions to the plan 220,000 Actual return on plan assets 180,000 Projected benefit obligation (beginning of year) 2,400,000 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 2013 is a. $250,000. b. $310,000. c. $330,000. d. $490,000.
66.
Presented below is information related to Jensen Inc. pension plan for 2013. Service cost $1,100,000 Actual return on plan assets 210,000 Interest on projected benefit obligation 390,000 Amortization of net loss 90,000 Amortization of prior service cost due to increase in benefits 165,000 Expected return on plan assets 180,000 What amount should be reported for pension expense in 2013? a. $1,565,000 b. $1,535,000 c. $1,715,000 d. $1,355,000
Accounting for Pensions and Postretirement Benefits
67.
20-15
Barton, 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, 2013. January 1, 2013 December 31, 2013 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) The service cost component of pension expense for 2013 is $390,000 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 2013? a. $390,000 b. $552,000 c. $561,000 d. $462,000
Use the following information for questions 68 through 70. The following information for Cooper Enterprises is given below: December 31, 2013 Assets and obligations Plan assets (at fair value) $200,000 Accumulated benefit obligation 370,000 Projected benefit obligation 400,000 Other Items Pension asset / liability, January 1, 2013 10,000 Contributions 120,000 Accumulated other comprehensive loss 167,900 There were no actuarial gains or losses at January 1, 2013. The average remaining service life of employees is 10 years. 68.
What is the pension expense that Cooper Enterprises should report for 2013? a. $152,100 b. $220,000 c. $120,000 d. $167,900
69.
What is the amount that Cooper Enterprises should report as its pension liability on its balance sheet as of December 31, 2013? a. $200,000 b. $30,000 c. $370,000 d. $400,000
70.
The amortization of Other Comprehensive Loss for 2014 is: a. $0 b. $12,790 c. $23,000 d. $16,790
20-16 71.
Test Bank for Intermediate Accounting, Fourteenth Edition The following information is related to the pension plan of Long, Inc. for 2013. Actual return on plan assets $200,000 Amortization of net gain 82,500 Amortization of prior service cost due to increase in benefits 150,000 Expected return on plan assets 230,000 Interest on projected benefit obligation 362,500 Service cost 900,000 Pension expense for 2013 is a. $1,295,000. b. $1,265,000. c. $1,130,000. d. $1,100,000.
72.
Presented below is pension information for Green Company for the year 2013: Expected return on plan assets Interest on vested benefits Service cost Interest on projected benefit obligation Amortization of prior service cost due to increase in benefits
$24,000 15,000 40,000 21,000 18,000
The amount of pension expense to be reported for 2013 is a. $103,000. b. $79,000. c. $60,000. d. $55,000. 73.
Hubbard, 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, 2013. 1/1/13 12/31/13 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 2013 is $940,000 and the amortization of prior service cost due to an increase in benefits is $180,000. The settlement rate is 10% and the expected rate of return is 8%. What is the amount of pension expense for 2013? a. $1,816,000 b. $1,780,000 c. $1,708,000 d. $1,540,000
Accounting for Pensions and Postretirement Benefits
20-17
Use the following information for questions 74 through 76. The following data are for the pension plan for the employees of Lockett 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)
1/1/12 $2,500,000 2,700,000 2,300,000 -0-
12/31/12 $2,600,000 2,800,000 3,000,000 480,000 10% 8%
12/31/13 $3,400,000 3,700,000 3,300,000 500,000 9% 7%
Lockett’s contribution was $420,000 in 2013 and benefits paid were $375,000. Lockett estimates that the average remaining service life is 15 years. 74.
The actual return on plan assets in 2013 was a. $300,000. b. $255,000. c. $200,000. d. $155,000.
75.
Assume that the actual return on plan assets in 2013 was $265,000. The unexpected gain on plan assets in 2013 was a. $32,000. b. $55,000. c. $35,000. d. $34,000.
76.
The corridor for 2013 was $300,000. The amount of AOCI-net loss amortized in 2013 was a. $33,333. b. $32,000. c. $14,000. d. $12,000.
Use the following information for questions 77 and 78. On January 1, 2013, Newlin 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 2013 are: Service cost Amortization of prior service costs due to increase in benefits Contributions Benefits paid Actual return on plan assets Amortization of net gain
$180,000 60,000 300,000 155,000 237,000 18,000
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Test Bank for Intermediate Accounting, Fourteenth Edition
77.
The balance of the projected benefit obligation at December 31, 2013 is a. $2,635,000. b. $2,335,000. c. $2,305,000. d. $2,287,000.
78.
The fair value of plan assets at December 31, 2013 is a. $2,380,000. b. $2,200,000. c. $2,182,000. d. $2,164,000.
79.
Rathke, Inc. has a defined-benefit pension plan covering its 50 employees. Rathke agrees to amend its pension benefits. As a result, the projected benefit obligation increased by $1,800,000. Rathke determined that all its employees are expected to receive benefits under the plan over the next 5 years. In addition, 20% are expected to retire or quit each year. Assuming that Rathke uses the years-of-service method of amortization for prior service cost, the amount reported as amortization of prior service cost in year one after the amendment is a. $360,000. b. $600,000. c. $180,000. d. $480,000.
Use the following information for questions 80 through 84. The following information relates to the pension plan for the employees of Turner 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)
1/1/12 $2,640,000 2,790,000 2,550,000 -0-
12/31/12 $2,760,000 2,988,000 3,120,000 (432,000) 11% 8%
12/31/13 $3,600,000 4,002,000 3,444,000 (480,000) 11% 7%
Turner estimates that the average remaining service life is 16 years. Turner's contribution was $378,000 in 2013 and benefits paid were $282,000. 80.
The interest cost for 2013 is a. $268,920. b. $303,600. c. $328,680. d. $440,220.
81.
The actual return on plan assets in 2013 is a. $204,000. b. $228,000. c. $294,000. d. $324,000.
Accounting for Pensions and Postretirement Benefits
20-19
82.
The unexpected gain or loss on plan assets in 2013 is a. $19,680 loss. b. $11,280 gain. c. $9,600 gain. d. $107,280 gain.
83.
The corridor for 2013 is a. $309,600. b. $312,000. c. $339,000. d. $400,200.
84.
The amount of AOCI (net gain) amortized in 2013 is a. $7,650. b. $7,500. c. $5,813. d. $4,988.
85.
Presented below is information related to Decker Manufacturing Company as of December 31, 2013: Projected benefit obligation Accumulated OCI -net gain Accumulated OCI (PSC)
$800,000 300,000 405,000
The amount for the prior service cost is related to an increase 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, 2013 is a. Pension liability of $200,000 b. Pension liability of $600,000 c. Pension liability of $800,000 d. Pension liability of $1,205,000 Use the following information for questions 86 and 87. Foster Corporation received the following report from its actuary at the end of the year: December 31, 2012 December 31, 2013 Projected benefit obligation $1,800,000 $2,000,000 Accumulated benefit obligation 1,300,000 1,480,000 Fair value of pension plan assets 1,380,000 1,440,000 86.
The amount reported as the pension liability at December 31, 2012 is a. $ -0-. b. $400,000. c. $420,000. d. $500,000.
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Test Bank for Intermediate Accounting, Fourteenth Edition
87.
The amount reported as the pension liability at December 31, 2013 is a. $2,000,000 b. $1,480,000 c. $520,000 d. $560,000
Use the following information for questions 88 and 89. The following information relates to Jackson, Inc.:
Plan assets (at fair value) Pension expense Projected benefit obligation Annual contribution to plan Accumulated OCI (PSC)
For the Year Ended December 31, 2012 2013 $1,310,000 $1,824,000 570,000 450,000 1,620,000 1,984,000 600,000 450,000 480,000 420,000
88.
The amount reported as the liability for pensions on the December 31, 2012 balance sheet is a. $ -0-. b. $30,000. c. $310,000. d. $280,000.
89.
The amount reported as the liability for pensions on the December 31, 2013 balance sheet is a. $ -0-. b. $160,000. c. $1,984,000. d. $420,000.
90.
Presented below is information related to Noble Inc. as of December 31, 2013. Accumulated OCI (G/L) $ 90,000 Projected benefit obligation 3,600,000 Accumulated benefit obligation 3,420,000 Vested benefits 1,620,000 Plan assets (at fair value) 3,354,000 Accumulated OCI (PSC) -0The amount reported as the pension liability on Noble's balance sheet at December 31, 2013 is as follows: a. $ -0-. b. $66,000. c. $90,000. d. $246,000.
Accounting for Pensions and Postretirement Benefits
91.
20-21
Rossi Company has a defined-benefit plan. At the end of 2013, it has determined the following information related to its pension plan: Projected benefit obligation $750,000 Accumulated benefit obligation 660,000 Fair value of pension plan assets 610,000 The amount of pension liability that is reported in Rossi's balance sheet at the end of 2013 is a. $150,000. b. $140,000. c. $90,000. d. $50,000.
92.
Presented below is pension information related to Waters Company as of December 31, 2013: Accumulated benefit obligation $3,000,000 Projected benefit obligation 3,500,000 Plan assets (at fair value) 3,700,000 Accumulated OCI (G / L) 100,000 The amount to be reported as Pension Asset / Liability as of December 31, 2013 is a. Pension Liability of $500,000. b. Pension Asset of $700,000. c. Pension Liability of $200,000. d. Pension Asset of $200,000.
Use the following information for questions 93 and 94. On January 1, 2011, Parks Co. has the following balances: Projected benefit obligation Fair value of plan assets
$4,200,000 3,750,000
The settlement rate is 10%. Other data related to the pension plan for 2013 are: Service cost $240,000 Amortization of prior service costs 54,000 Contributions 270,000 Benefits paid 300,000 Actual return on plan assets 264,000 Amortization of net gain 18,000 93.
The balance of the projected benefit obligation at December 31, 2013 is a. $4,572,000. b. $4,590,000. c. $4,554,000. d. $4,560,000.
94.
The fair value of plan assets at December 31, 2013 is a. $3,456,000. b. $3,714,000. c. $3,984,000. d. $4,284,000.
20-22 95.
Test Bank for Intermediate Accounting, Fourteenth Edition Huggins Company has the following information at December 31, 2013 related to its pension plan: Projected benefit obligation $4,000,000 Accumulated benefit obligation 3,200,000 Plan assets (fair value) 4,500,000 Accumulated OCI (PSC) 300,000 The amount of pension asset / liability Huggins Company would recognize at December 31, 2013 is a. Pension liability of $300,000. b. Pension asset of $1,300,000. c. Pension liability of $800,000. d. Pension asset of $500,000.
96.
The following pension plan information is for Farr Company at December 31, 2013. Projected benefit obligation Accumulated benefit obligation Plan assets (at fair value) Accumulated OCI (PSC) Pension expense for 2013 Contribution for 2013
$8,700,000 7,500,000 6,150,000 540,000 3,000,000 2,400,000
The amount to be reported as the liability for pensions on the December 31, 2013 balance sheet is a. $2,550,000. b. $2,250,000. c. $1,650,000. d. $1,350,000. *97.
The following facts relate to the Patton Co. postretirement benefits plan for 2013: Service cost $190,000 Discount rate 9% APBO, January 1, 2013 $1,500,000 EPBO, January 1, 2013 $2,000,000 Benefit payments to employees $115,000 The amount of postretirement expense for 2013 is a. $190,000. b. $325,000. c. $370,000. d. $440,000.
Accounting for Pensions and Postretirement Benefits
*98.
20-23
The following facts relate to the postretirement benefits plan of Keller, Inc. for 2013: Service cost $780,000 Discount rate 8% APBO, January 1, 2013 $4,000,000 EPBO, January 1, 2013 $4,800,000 Average remaining service to full eligibility 20 years Average remaining service to expected retirement 25 years The amount of postretirement expense for 2013 is a. $1,100,000. b. $1,260,000. c. $1,300,000. d. $1,164,000.
*99.
The following facts relate to the Gamble Co. postretirement benefits plan for 2013: Service cost $156,000 Discount rate 10% EPBO, January 1, 2013 $1,095,000 APBO, January 1, 2013 $900,000 Actual return on plan assets in 2013 $31,500 Expected return on plan assets in 2013 $24,000 The amount of postretirement expense for 2013 is a. $214,500. b. $222,000. c. $241,500. d. $246,000.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
64. 65. 66. 67. 68. 69.
d c a b a a
70. 71. 72. 73. 74. 75.
b d d b b b
76. 77. 78. 79. 80. 81.
d b c b c b
82. 83. 84. 85. 86. 87.
c b b a c d
88. 89. . 90. 91. 92. 93.
c b d b d d
94. 95. 96. 97. 98. 99.
c d a b a b
20-24
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—CPA Adapted 100.
The following information pertains to Hopson Co.'s pension plan: Actuarial estimate of projected benefit obligation at 1/1/13 Assumed discount rate Service costs for 2013 Pension benefits paid during 2013
$72,000 10% $28,000 $15,000
If no change in actuarial estimates occurred during 2013, Hopson's projected benefit obligation at December 31, 2013 was a. $74,200. b. $85,000. c. $90,200. d. $92,200. 101.
Interest cost included in 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).
102.
Logan 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, 2013: Projected benefit obligation $650,000 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 The market-related asset value equals the fair value of plan assets. No contributions have been made for 2013 pension cost. In its December 31, 2013 balance sheet, Logan should report a pension asset / liability of a. Pension liability of $650,000 b. Pension asset of $825,000 c. Pension asset of $175,000 d. Pension liability of $525,000
103.
Seigel 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. accumulated benefit obligation. d. funded status relative to the projected benefit obligation.
Accounting for Pensions and Postretirement Benefits
20-25
104.
Ohlman, Inc. maintains a defined-benefit pension plan for its employees. As of December 31, 2013, 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, 2013, Ohlman should report a 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.
105.
At December 31, 2013, the following information was provided by the Vargas Corp. pension plan administrator: Fair value of plan assets $4,500,000 Accumulated benefit obligation 5,580,000 Projected benefit obligation 7,700,000 What is the amount of the pension liability that should be shown on Vargas' December 31, 2013 balance sheet? a. $7,700,000 b. $3,200,000 c. $2,120,000 d. $1,080,000
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
100. 101.
d b
102. 103.
c d
104. 105.
a b
DERIVATIONS — Computational No.
Answer Derivation
64.
d
$92,000 + $54,000 + $12,000 – $18,000 = $140,000.
65.
c
$250,000 + ($2,400,000 × .10) – ($1,600,000 × .10) = $330,000.
66.
a
$1,100,000 + $390,000 + $90,000 + $165,000 – $180,000 = $1,565,000.
67.
b
$390,000 + $60,000 + ($4,800,000 × .10) – ($4,200,000 × .09) = $552,000.
68.
a
$200,000 + $120,000 - $167,900 = $152,100.
69.
a
$400,000 - $200,000 = $200,000.
70.
b
($167,900 - $40,000) ÷ 10 = $12,790.
71.
d
$900,000 + $362,500 – $230,000 – $82,500 + $150,000 = $1,100,000.
20-26
Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
72.
d
$40,000 + $21,000 + $18,000 – $24,000 = $55,000.
73.
b
$940,000 + ($11,400,000 × .10) – ($6,000,000 × .08) + $180,000 = $1,780,000.
74.
b
($3,300,000 – $3,000,000) – $420,000 + $375,000 = $255,000
75.
b
$265,000 – ($3,000,000 × .07) = $55,000.
76.
d
($480,000 – $300,000) ÷ 15 = $12,000.
77.
b
$2,100,000 + $180,000 + ($2,100,000 × .10) – $155,000 = $2,335,000.
78.
c
$1,800,000 + $237,000 + $300,000 – $155,000 = $2,182,000.
79.
b
50 + 40 + 30 + 20 + 10 = 150. $1,800,000 ÷ 150 = $12,000/service yr. $12,000 × 50 = $600,000.
80.
c
$2,988,000 × .11 = $328,680.
81.
b
($3,444,000 – $3,120,000) – ($378,000 – $282,000) = $228,000.
82.
c
$228,000 – ($3,120,000 × .07) = $9,600.
83.
b
$3,120,000 × .10 = $312,000.
84.
b
($432,000 – $312,000) ÷ 16 = $7,500.
85.
a
$800,000 – $600,000 = $200,000.
86.
c
$1,800,000 – $1,380,000 = $420,000.
87.
d
$2,000,000 – $1,440,000 = $560,000.
88.
c
$1,620,000 – $1,310,000 = $310,000.
89.
b
$1,984,000 – $1,824,000 = $160,000.
90.
d
$3,600,000 – $3,354,000 = $246,000.
91.
b
$750,000 – $610,000 = $140,000.
92.
d
$3,700,000 – $3,500,000 = $200,000.
93.
d
$4,200,000 + $240,000 – $300,000 + ($4,200,000 × .10) = $4,560,000.
94.
c
$3,750,000 + $264,000 + $270,000 – $300,000 = $3,984,000.
95.
d
$4,500,000 – $4,000,000 = $500,000 (Asset).
Accounting for Pensions and Postretirement Benefits
20-27
DERIVATIONS — Computational (cont.) 96.
a
$8,700,000 – $6,150,000 = $2,550,000.
*97.
b
$190,000 + $135,000 = $325,000.
*98.
a
$780,000 + $320,000 = $1,100,000.
*99.
b
$156,000 + $90,000 – $24,000 = $222,000.
DERIVATIONS — CPA Adapted No.
Answer Derivation
100.
d
$72,000 + $28,000 + ($72,000 × .10) – $15,000 = $92,200.
101.
b
Conceptual.
102.
c
$825,000 - $650,000 = $175,000.
103.
d
Conceptual.
104.
a
Conceptual.
105.
b
$7,700,000 – $4,500,000 = $3,200,000.
EXERCISES Ex. 20-106—Pension accounting terminology. Briefly explain the following terms: (a) Service cost (b) Interest cost (c) Prior service cost (d) Vested benefits Solution 20-106 (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.
(d)
Vested benefits are those the employee is entitled to receive even if the employee is no longer employed under the plan.
20-28
Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 20-107—Pension assets. Discuss the following ideas related to pension assets: (a) Market-related asset value. (b) Actual return on plan assets. (c) Expected return on plan assets. (d) Unexpected gains and losses on plan assets.
Solution 20-107 (a)
Market-related asset value is a moving average of pension plan assets calculated over not more than five years. The actual return is what the plan assets earn during the period including market appreciation (depreciation). (We assume that the fair value of the plan assets is used in all computations.)
(b)
The actual return on plan assets is computed by finding the change in the fair value of plan assets during the period. This change is adjusted by deducting contributions and adding benefits paid out during the year.
(c)
The expected return on plan assets is found by multiplying the expected rate of return by the market-related asset value at the beginning of the period.
(d)
An unexpected asset gain occurs when the actual return on plan assets is greater than the expected return on plan assets and an unexpected loss occurs when the actual return is less than the expected return.
Ex. 20-108—Measuring and recording pension expense. Kessler, 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, 2013: January 1, 2013 December 31, 2013 Projected benefit obligation $2,500,000 $2,850,000 Fair value of plan assets 1,250,000 1,600,000 Accumulated benefit obligation 1,930,000 2,620,000 Accumulated OCI – (PSC) 540,000 300,000 The service cost component for 2013 is $120,000 and the amortization of prior service cost is $240,000. The company's actual funding of the plan in 2013 amounted to $490,000. The expected return on plan assets and the settlement rate were both 8%. Instructions (a) Determine the pension expense to be reported in 2013. (b) Prepare the journal entry to record pension expense and the employers' contribution to the pension plan in 2013.
Accounting for Pensions and Postretirement Benefits
20-29
Solution 20-108 (a)
Service cost Interest on projected benefit obligations ($2,500,000 × 8%) Expected return on plan assets ($1,250,000 × 8%) Amortization of prior service cost Pension expense—2013
(b)
Pension Expense ....................................................................... Pension Asset / Liability .............................................................. Cash ............................................................................... Other Comprehensive Income (PSC) .............................
$120,000 200,000 (100,000) 240,000 $460,000 460,000 270,000 490,000 240,000
Ex. 20-109—Measuring and recording pension expense. Presented below is information related to Jones Department Stores, Inc. pension plan for 2013. Accumulated benefit obligation (at year-end) $600,000 Service cost 520,000 Funding contribution for 2013 480,000 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) 450,000 Fair value of plan assets (at beginning of period) 360,000
Instructions (a) Compute the amount of pension expense to be reported for 2013. (Show computations.) (b) Prepare the journal entry to record pension expense and the employer's contribution for 2013. Solution 20-109 (a)
Service cost Interest on projected benefit obligation ($450,000 × 10%) Expected return on plan assets ($360,000 × 9%) Amortization of PSC Amortization of net gains Pension expense—2013
(b)
Pension Expense ........................................................................ Other Comprehensive Income (G/L) ........................................... Cash ................................................................................ Other Comprehensive Income (PSC) ............................... Pension Asset / Liability ...................................................
$520,000 45,000 (32,400) 100,000 (48,000) $584,600 584,600 48,000 480,000 100,000 52,600
20-30
Test Bank for Intermediate Accounting, Fourteenth Edition
Ex. 20-110— Recording pension asset / liability. Miles Co. had the following selected balances at December 31, 2013: Projected benefit obligation Accumulated benefit obligation Fair value of plan assets Accumulated OCI (PSC)
$4,750,000 4,550,000 4,340,000 170,000
Instructions Calculate the pension asset / liability to be recorded at December 31, 2013. Solution 20-110 $4,750,000 - $ 4,340,000 = $410,000 pension liability. Ex. 20-111—Pension calculations. Montoya Company has available the following information about its defined-benefit pension plan for the year ending December 31, 2013: Service cost for 2013 $ 25,000 Accumulated benefit obligation 683,000 Plan assets at fair value 630,000 Accumulated OCI (PSC) 300,000 Vested benefit obligation 505,000 Market-related asset value 725,000 Projected benefit obligation 825,000 Accumulated OCI net gain 90,000 Interest on projected benefit obligation 64,000 Instructions (a) Calculate the pension asset / liability to be recorded at December 31, 2013. (b) Calculate the 2014 amortization of the net gain. The average remaining service life of employees is 10 years. Solution 20-111 (a) $825,000 - $630,000 = $195,000 Pension liability. (b) [$90,000 – ($825,000 X 10%)] ÷ 10 = $750. Ex. 20-112—Pension plan calculations. The following information is for the pension plan for the employees of Payne, Inc. Accumulated benefit obligation Projected benefit obligation Fair value of plan assets AOCI – Net (gain) or loss Settlement rate Expected rate of return
12/31/12 $2,800,000 3,140,000 3,180,000 (425,000) 8% 7%
12/31/13 $3,760,000 4,000,000 3,630,000 (480,000) 8% 6%
Accounting for Pensions and Postretirement Benefits
20-31
Payne estimates that the average remaining service life is 15 years. Payne's contribution was $520,000 in 2013 and benefits paid were $280,000. Instructions (a) Calculate the interest cost for 2013. (b) Calculate the actual return on plan assets in 2013. (c) Calculate the unexpected gain or loss in 2013. (d) Calculate the corridor for 2013 and the amortization of the net gain for 2013. Solution 20-112 (a)
$3,140,000 × 8% = $251,200
(b)
Fair value of plan assets (12/31/13) Fair value of plan assets (1/1/13) Contributions Benefits paid Actual return on plan assets
$3,630,000 (3,180,000) 450,000 (520,000) 280,000 $ 210,000
(c)
Actual return (see b.) Expected return ($3,180,000 × 6%) Unexpected gain
$ 210,000 190,800 $ 19,200
(d)
.10 × $3,180,000 = $318,000; .10 × $3,140,000 = $314,000. The corridor is the larger, $318,000. $425,000 – $318,000 = $107,000; $107,000 ÷ 15 = $7,133 amortization of net gain.
Ex. 20-113—Pension plan calculations and entries. Selected Information about the pension plan of Roman Co. is as follows: 12/31/12 12/31/13 Accumulated benefit obligation $4,700,000 $4,930,000 Projected benefit obligation 4,900,000 5,150,000 Accumulated OCI (PSC) 1,800,000 1,600,000 Fair value of plan assets 4,750,000 4,800,000 Pension expense 1,000,000 1,650,000 Contribution 985,000 1,350,000 Discount rate (for year) 9% 8% Instructions (a) What is the corridor for 2013? (b) Calculate the pension asset / liability at December 31, 2013. (c) Prepare the entry for 2013 to record the pension expense and contribution. Solution 20-113 (a)
.10 × $4,900,000 = $490,000; .10 × $4,750,000 = $475,000 The corridor is the larger, $490,000.
(b)
Projected benefit obligation Fair value of plan assets Pension asset / liability
$5,150,000 (4,900,000) $ 250,000
20-32
Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 20-113 (cont.) (c)
Pension Expense ........................................................................ 1,650,000 Cash ................................................................................ Other Comprehensive Income (PSC) ............................... Pension Asset / Liability ...................................................
1,350,000 200,000 100,000
Ex. 20-114—Corridor amortization. Explain corridor amortization.
Solution 20-114 The FASB invented the corridor approach for amortizing pension plan gains and losses when they get too large. The net gain or loss gets too large when it exceeds the arbitrarily selected criterion of 10% of the larger of the beginning balances of the projected benefit obligation or the market-related asset value. Generally, the straight-line method, based on service lives, is used to amortize these gains and losses.
Ex. 20-115—Corridor approach (amortization of net gains and losses.) Gibbs Company has 200 employees who are expected to receive benefits under the company's defined-benefit pension plan. The total number of service-years of these employees is 2,000. The actuary for the company's pension plan calculated the following net gains and losses: For the Year Ended December 31 2012 2013 2014
(Gain) Or Loss $610,000 (554,000) 990,000
Prior to 2012, there was no unrecognized net gain or loss. Information about the company's projected benefit obligation and market-related (and fair) value of plan assets follows: As of January 1 2012 2013 2014 Projected benefit obligation $2,100,000 $2,340,000 $2,940,000 Fair value of plan assets 1,680,000 2,460,000 2,550,000 Instructions Based on the above information about Gibbs Company, prepare a schedule which reflects the amount of net gain or loss to be amortized by the company as a component of pension expense for the years 2012, 2013, and 2014. The company amortizes net gains or losses using the straight-line method over the average service life of participating employees.
Accounting for Pensions and Postretirement Benefits
20-33
Solution 20-115 Corridor Test and Gain/Loss Amortization Schedule Beginning of Year Accumulated OCI PBO Plan Assets Corridor (Gain / Loss) 2012 $2,100,000 $1,680,000 $210,000 $ -02013 2,340,000 2,460,000 246,000 610,000 2014 2,940,000 2,550,000 294,000 19,600**
Amortization $ -036,400* -0-
Average Service Years = 2,000 ÷ 200 = 10 years *$610,000 – $246,000 = $364,000 ÷ 10 = $36,400 **$610,000 – $554,000 – $36,400 = $19,600.
Ex. 20-116—Pension plan calculations and journal entry. On January 1, 2012, McGee Co. had the following balances: Projected benefit obligation $7,700,000 Fair value of plan assets 7,700,000 Other data related to the pension plan for 2012: Service cost Contributions to the plan Benefits paid Actual return on plan assets Settlement rate Expected rate of return
315,000 459,000 450,000 462,000 9% 6%
Instructions (a) Determine the projected benefit obligation at December 31, 2013. There are no net gains or losses. (b) Determine the fair value of plan assets at December 31, 2013. (c) Calculate pension expense for 2013. (d) Prepare the journal entry to record pension expense and the contributions for 2013.
Solution 20-116 (a)
Projected benefit obligation, January 1 Service cost Interest cost (9% × $7,700,000) Benefits paid Projected benefit obligation, December 31
$7,700,000 315,000 693,000 (450,000) $8,258,000
(b)
Fair value of plan assets, January 1 Actual return Contributions Benefits paid Fair value of plan assets, December 31
$7,700,000 462,000 459,000 (450,000) $8,171,000
(c)
Service cost Interest cost (9% × $7,700,000) Actual (and expected) return on plan assets Pension expense
$315,000 693,000 (462,000) $546,000
20-34
Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 20-116 (cont.) (d) .. Pension Expense ........................................................................ Pension Asset / Liability ................................................... Cash ................................................................................
546,000 87,000 459,000
*Ex. 20-117—Computing and recording postretirement expense. The following information is related to the Stone Co. postretirement benefits plan for 2013: Service cost $168,000 Discount rate 10% EPBO, January 1, 2013 820,000 APBO, January 1, 2013 690,000 Actual return on plan assets in 2013 22,400 Expected return on plan assets in 2013 29,000 Contributions (funding) 224,000 Instructions (a) Compute the amount of postretirement expense for 2013. (Show computations.) (b) Prepare the journal entry to record postretirement expense and Stone's contributions for 2013.
*Solution 20-117 (a)
Service cost Interest cost (10% × $690,000) Actual return on plan assets Unexpected loss Postretirement expense—2013
$168,000 69,000 (22,400) (6,600) $208,000
(b)
Postretirement Expense .............................................................. Postretirement Asset / Liability .................................................... Cash ...............................................................................
208,000 16,000 224,000
*Ex. 20-118—Computing postretirement expense and APBO. The following information is related to the postretirement benefits plan of Heerey, Inc. for 2013: Service cost $ 280,000 Discount rate 8% APBO, January 1, 2013 2,200,000 EPBO, January 1, 2013 2,400,000 Actual return on plan assets in 2013 104,000 Expected return on plan assets in 2013 95,600 Amortization of PSC, due to benefit increase 107,200 Contributions (funding) 400,000 Benefit payments 208,000
Accounting for Pensions and Postretirement Benefits
20-35
Instructions (a) Compute the amount of postretirement expense for 2013. (Show computations.) (b) Compute the amount of the APBO at December 31, 2013.
*Solution 20-118 (a)
Service cost Interest cost (8% × $2,200,000) Actual return on plan assets Unexpected gain Amortization of PSC Postretirement expense—2013
(b)
APBO, January 1, 2013 Service cost Interest cost Benefit payments APBO, December 31, 2013
$280,000 176,000 (104,000) 8,400 107,200 $467,600 $2,200,000 280,000 176,000 (208,000) $2,448,000
PROBLEMS Pr. 20-119—Measuring, recording, and reporting pension expense and liability. Tucker, Inc. on January 1, 2013 initiated a noncontributory, defined-benefit pension plan that grants benefits to its 100 employees for services rendered in years prior to the adoption of the pension plan. The total expected service-years of the 100 employees who are expected to receive benefits under the plan is 1,200. An actuarial consulting firm has indicated that the present value of the projected benefit obligation on January 1, 2013 was $5,280,000. On December 31, 2013 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 6,362,400 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 2013. Assume the prior service cost is amortized over the average remaining service life of the employees. (b) Prepare the journal entries to reflect accounting for the company's pension plan for the year ended December 31, 2013. (c) Indicate the amounts that are reported on the income statement and the balance sheet for 2013.
20-36
Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 20-119 (a)
Service cost Interest on projected benefit obligation ($5,280,000 × 8%) Amortization of prior service cost* Pension expense—2013
*1,200 100
$ 600,000 422,400 440,000 $1,462,400
= 12 years average remaining service life
$5,280,000 = $440,000 12
(b)
(c)
Pension Expense ........................................................................ 1,462,400 Pension Asset / Liability............................................................... 577,600 Cash ................................................................................ OCI - PSC........................................................................
Income statement Pension Expense
1,600,000 440,000
$1,462,400
Note that the Other comprehensive income (PSC) charge is added to net income to determine Total comprehensive income. The presentation of net income and other comprehensive income can be shown in a single combined statement, separate statements, or in the statement of stockholders’ equity. Balance Sheet Liabilities Pension liability
$4,762,400
Stockholders’ Equity Accumulated OCI (PSC)
$4,840,000
Pr. 20-120—Measuring and recording pension expense. Presented below is information related to the pension plan of Zimmer Inc. for the year 2013. 1. The service cost related to pension expense is $240,000 using the projected benefits approach. 2. The projected benefit obligation and the accumulated benefit obligation at the beginning of the year are $350,000 and $280,000, respectively. The expected return on plan assets is 9% and the settlement rate is 10%.
Accounting for Pensions and Postretirement Benefits
20-37
Pr. 20-120 (cont.) 3. The accumulated OCI – prior service cost at the beginning of the year is $140,000. The company has a workforce of 200 employees, all who are expected to receive benefits under the plan. The total number of service-years is 1,000 and the service-years attributable to 2013 is 200. The company has decided to use the years-of-service method of amortization for these costs. 4. At the beginning of the period, fair value of pension plan assets, $280,000. The company had an Accumulated OCI (loss) at the beginning of the period of $90,000. Any amortization of unrecognized net loss is recognized on a straight-line basis over the average remaining service-life of the employees. 5. The contribution made to the pension fund in 2013 was $226,000. Instructions (a) Determine the pension expense to be reported on the income statement for 2013. (Round all computations to nearest dollar.) (b) Prepare the journal entry(ies) to record pension expense for 2013. Solution 20-120 (a)
Service cost Interest on projected benefit obligation (10% × $350,000) Expected return on plan assets (9% × $280,000) Amortization of prior service cost (1) Amortization of loss (2) Pension expense
$240,000 35,000 (25,200) 28,000 11,000 $288,800
(1) $140,000 1,000
= $140
200 × $140 = $28,000 (2) Fair value of plan assets
$280,000 10% $ 28,000 $350,000 10% $ 35,000
Projected benefit obligation
Net loss (beginning of period) ($ 90,000) Higher of 10% of projected benefit obligation or fair value of plan assets 35,000 Amount to be amortized ($ 55,000) 1,000
Expected Future Years of Service =
200
= 5 years Number of Employees
$55,000 5 years
= $11,000
20-38
Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 20-120 (cont.) (b)
Pension Expense ........................................................................ OCI (G/L) ............................................................................ OCI-PSC ............................................................................ Pension Asset / Liability ...................................................... Cash ...................................................................................
288,800 11,000 28,000 23,800 226,000
Pr. 20-121—Preparing a pension work sheet. The accountant for Marlin Corporation has developed the following information for the company's defined-benefit pension plan for 2013: Service cost $500,000 Actual return on plan assets 240,000 Annual contribution to the plan 900,000 Amortization of prior service cost 125,000 Benefits paid to retirees 60,000 Settlement rate 10% Expected rate of return on plan assets 8% The accumulated benefit obligation at December 31, 2013, amounted to $3,250,000. Instructions (a) Using the above information for Marlin Corporation, complete the pension work sheet for 2013. Indicate (credit) entries by parentheses. Calculated amounts should be supported. (b) Prepare the journal entry to reflect the accounting for the company's pension plan for the year ending December 31, 2013.
Pr. 20-121 (cont.)
Accounting for Pensions and Postretirement Benefits Page 20-39
Marlin Corporation Pension Work Sheet—2013 —————————————————————————————————————————————————————————— General Journal Entries Memo Entries ————————————————————————————————————————————————————————— Annual OCI Pension Projected Pension Gain / Asset / Benefit Plan Expense Cash PSC Loss Liability Obligation Assets —————————————————————————————————————————————————————————— Bal., Dec. 31, 2012 625,000 1,000,000 (3,500,000) 2,750,000 —————————————————————————————————————————————————————————— Service Cost —————————————————————————————————————————————————————————— Interest Cost —————————————————————————————————————————————————————————— Actual return —————————————————————————————————————————————————————————— Unexpected gain/loss —————————————————————————————————————————————————————————— Amortization of PSC —————————————————————————————————————————————————————————— Contributions —————————————————————————————————————————————————————————— Benefits —————————————————————————————————————————————————————————— Gain/loss amort. —————————————————————————————————————————————————————————— Journal entry for 2013 Balance, Dec. 31, 2013
Solution 20-121
Marlin Corporation Pension Work Sheet—2013 —————————————————————————————————————————————————————————— General Journal Entries Memo Entries —————————————————————————————————————————————————————————— OCI
625,000 Dr.
Bal., Dec. 31, 2013
500,000 Dr.
-020,000 Cr. 460,000 Cr. 4,290,000 Cr. 3,830,000 Dr.
Page 20-41
Page 20-40
AOCI, 12/31/12
Test Bank for Intermediate Accounting, Fourteenth Edition
Annual Prior Gain / Pension Projected Pension Service Loss Asset / Benefit Plan Expense Cash Cost Liability Obligation Assets —————————————————————————————————————————————————————————— Bal., Dec. 31, 2012 750,000 Cr. 3,500,000 Cr. 2,750,000 Dr. —————————————————————————————————————————————————————————— Service Cost 500,000 Dr. 500,000 Cr. —————————————————————————————————————————————————————————— Interest Cost (1) 350,000 Dr. 350,000 Cr. —————————————————————————————————————————————————————————— Actual return 240,000 Cr. 240,000 Dr. —————————————————————————————————————————————————————————— Unexpected gain/loss (2) 20,000 Dr. 20,000 Cr. —————————————————————————————————————————————————————————— Amortization of PSC 125,000 Dr. 125,000 Cr. —————————————————————————————————————————————————————————— Contributions 900,000 Cr. 900,000 Dr. —————————————————————————————————————————————————————————— Benefits 60,000 Dr. 60,000 Cr. —————————————————————————————————————————————————————————— Gain/loss Amort.. —————————————————————————————————————————————————————————— Journal entry for 2013 755,000Dr. 900,000Cr 125,000 Cr. 20,000 Cr. 290,000 Dr.
Accounting for Pensions and Postretirement Benefits
20-41
Solution 20-121 (cont.)
(b)
(1)
$3,500,000 × 10% = $350,000
(2)
$240,000 – ($2,750,000 × 8%) = $20,000
Pension Expense ........................................................................ Pension Asset / Liability............................................................... Cash ................................................................................ Other Comprehensive Income (PSC) .............................. Other Comprehensive Income (G/L) ................................
755,000 290,000 900,000 125,000 20,000
Pr. 20-122—Amortization of prior service cost using years-of-service method. On January 1, 2012, Solano Incorporated amended its pension plan which caused an increase of $3,600,000 in its projected benefit obligation. The company has 400 employees who are expected to receive benefits under the company's defined-benefit pension plan. The personnel department provided the following information regarding expected employee retirements:
Number of Employees 40 120 60 160 20 400
Expected Retirements On December 31 2012 2013 2014 2015 2016
The company plans to use the years-of-service method in calculating the amortization of prior service cost as a component of pension expense. Instructions Prepare a schedule which shows the amount of annual prior service cost amortization that the company will recognize as a component of pension expense from 2012 through 2016.
Solution 20-122 Computation of Service-Years Year 2012 2013 2014 2015 2016
40
120 120
60 60 60
160 160 160 160
40
240
180
640
Cost Per Service Year: $3,600,000 ÷ 1,200 = $3,000.
20 20 20 20 20 100
Total 400 360 240 180 20 1,200
20-42
Test Bank for Intermediate Accounting, Fourteenth Edition
Solution 20-122 (cont.) Solano Incorporated Computation of Annual Prior Service Cost Amortization Total Service-Years 400 360 240 180 20 1,200
Year 2012 2013 2014 2015 2016
Cost Per Service-Year $3,000 3,000 3,000 3,000 3,000
Annual Amortization $1,200,000 1,080,000 720,000 540,000 60,000 $3,600,000
Pr. 20-123 – Pension Worksheet – Missing Amounts The accounting staff of Elias Inc. has prepared the following pension worksheet. Unfortunately, several entries in the worksheet are not readable. The company has asked your assistance in completing the worksheet and completing the accounting tasks related to the pension plan for 2013. General Journal Entries
Items
Annual Pension Expense
Cash
OCI —Prior Service Cost
Memo Record
OCI — Gain/Loss
Pension Asset/Liability
700 Cr.
Projected Benefit Obligation
Plan Assets
4,200
3,500
Balance, Jan. 1, 2013 Service cost
(1)
600
Interest cost
(2)
280
Actual return
(3)
Unexpected gain Amortization of PSC Contributions
115
430 (4)
(5)
85 1,200
1,200
Benefits Liability increase Journal entry
300 (6) (7)
(8)
(9)
300
545
(10)
(11)
Accumulated OCI, Dec. 31, 2012
700
0
Balance, Dec. 31, 2013
615
430
495
5,325
4,830
Accounting for Pensions and Postretirement Benefits
20-43
Instructions (a) Determine the missing amounts in the 2013 pension worksheet, indicating whether the amounts are debits or credits. (b) Prepare the journal entry to record 2013 pension expense for Elias Inc.
SOLUTION 20-123 (a)
Below is the completed worksheet, indicating debit and credit entries. General Journal Entries Annual Pension Expense
Balance, Jan. 1, 2013 Service cost Interest cost Actual return Unexpected gain Amortization of PSC Contributions Benefits Liability increase Journal entry Accumulated OCI, Dec. 31, 2012 Balance, Dec. 31, 2013
(b)
OCI—Prior Service Cost Cash
Memo Record OCI—Gain/ Loss
Pension Asset/Liability 700 Cr.
600 Dr. 280 Dr. 430 Cr. 115 Dr. 85 Dr.
Projected Benefit Obligation 4,200 Cr. 600 Cr. 280 Cr.
3,500 Dr.
430 Dr. 115 Cr. 85 Cr. 1,200 Cr.
650 Dr.
Plan Assets
1,200 Cr.
85 Cr. 700 Dr. 615 Dr.
300 Dr. 545 Cr.
545 Dr. 430 Dr. 0 430 Dr.
Pension Expense .............................................................. Other Comprehensive Income (G/L).................................. Pension Asset/Liability ...................................................... Cash ............................................................................ Other Comprehensive Income (PSC)...........................
1,200 Dr. 300 Cr.
205 Dr. 495 Cr.
650 430 205 1,200 85
5,325 Cr.
4,830 Dr.
20-44
Test Bank for Intermediate Accounting, Fourteenth Edition
Pr. 20-124 - Pension Worksheet Howard Corp. sponsors a defined-benefit pension plan for its employees. On January 1, 2013, the following balances related to this plan. Plan assets (fair value) Projected benefit obligation Pension asset/liability Prior service cost OCI – Loss
$500,000 600,000 100,000 Cr. 75,000 65,000
As a result of the operation of the plan during 2013, the actuary provided the following additional data at December 31, 2013. Service cost for 2013 $ 75,000 Actual return on plan assets in 2013 45,000 Amortization of prior service cost 15,000 Contributions in 2013 115,000 Benefits paid retirees in 2013 80,000 Settlement rate 7% Expected return rate 8% Average remaining service life of active employees 10 years Instructions (a) Compute pension expense for Howard Corp. for the year 2013 by preparing a pension worksheet. (b) Prepare the journal entry for pension expense.
(a)
Annual Pension Expense
Pension Asset/Liability
Memo Record Projected Benefit Plan Obligation Assets
100,000 Cr. 600,000 Cr. 500,000 Dr. 75,000 Cr. 42,000 Cr. 45,000 Dr.
75,000 Dr. 42,000 Dr. 45,000 Cr. 5,000 Dr. 15,000 Dr. 500 Dr.
5,000 Cr. 15,000 Cr. 500 Cr. 115,000 Cr.
115,000 Dr. 80,000 Dr. 80,000 Cr.
92,500 Dr. 115,000 Cr. 15,000 Cr. 75,000 Dr. 60,000 Dr.
5,500 Cr. 65,000 Dr. 59,500 Dr.
43,000 Dr. 57,000 Cr.
637,000 Cr. 580,000 Dr.
*$42,000 = $600,000 X .07. **$5,000 = ($500,000 X .08) – $45,000.
Value of 1/1 Plan Assets
10% Corridor
Accumulated OCI (G/L), 1/1
Minimum Amortization of Loss for 2013
2013 $600,000 $500,000 ****($65,000 – $60,000) = $5,000 ÷ 10 = $500.
$60,000
$65,000
*$500****
Year
1/1 Projected Benefit Obligation
Page 20-45
***
Accounting for Pensions and Postretirement Benefits
Balance, Jan. 1, 2013 Service cost Interest cost* Actual return Unexpected gain** Amortization of PSC Amortization of loss*** Contributions Benefits Journal entry for 2013 Accumulated OCI, Dec. 31, 2012 Balance, Dec. 31, 2013
Howard Corp. Pension Worksheet—2013 General Journal Entries OCI—Prior Service OCI— Cash Cost Gain/Loss
20-46
Test Bank for Intermediate Accounting, Fourteenth Edition
SOLUTION 20-124 (Continued) (b) Pension Expense .............................................................................. Pension Asset/Liability ...................................................................... Other Comprehensive Income (PSC) ...................................... Other Comprehensive Income (G/L) ........................................ Cash ........................................................................................
92,500 43,000 15,000 5,500 115,000
Accounting for Pensions and Postretirement Benefits
20-47
IFRS QUESTIONS True/False 1. The accounting for defined-benefit pension plans is the same under U.S. GAAP and IFRS. 2.
Prior service cost is recognized on the balance sheet under both U.S. GAAP and IFRS.
3.
Prior service cost is amortized into income over the expected service lives of employees under both U.S. GAAP and IFRS.
4.
Under IFRS companies may recognize actuarial gains and losses in income immediately.
5.
Under U.S. GAAP companies may either recognize actuarial gains and losses in income immediately or amortize them over the expected service lives of employees.
Answers to True/False: 1. False 2. False 3. True 4. True 5. False
Multiple Choice 1. The International Accounting Standards Board has proposed changes to IFRS pension accounting including all of the following except a. elimination of smoothing via the corridor approach. b. different presentation of pension costs in the income statement. c. requiring recognition of actuarial gains and losses over the expected service lives of employees. d. a new category of pensions for accounting purpose – “contribution-based promises.” 2.
Midland Company follows U.S. GAAP for its external financial reporting whereas Bailey Company follows IFRS for its external financial reporting. The amount contributed by Midland for its defined contribution plan for 2013 amounted to $59,000 and the amount contributed by Bailey for its defined contribution plan for 2013 amounted to $76,000. The remaining service lives of employees at both firms is estimated to be 10 years. What is the amount of expense related to pension costs recognized by each company in its income statement for the year ended December 31, 2013? a. b. c. d.
Midland $ 5,900 $59,000 $59,000 $ 5,900
Bailey $76,000 $76,000 $ 7,600 $ 7,600
20-48 3.
Test Bank for Intermediate Accounting, Fourteenth Edition Midland Company follows U.S. GAAP for its external financial reporting whereas Bailey Company follows IFRS for its external financial reporting. Both companies have definedbenefit pension plans. At December 31, 2013, prior to any adjusting entries, Midland Company’s actuarial loss subject to amortization/recognition amounted to $59,000 and Bailey Company’s actuarial loss subject to amortization/recognition amounted to $76,000. The remaining services lives of employees at both firms is estimated to be 10 years. What is the maximum amount of loss that could be recognized by each company in its income statement for the year ended December 31, 2013? a. b. c. d.
Midland $ 5,900 $59,000 $59,000 $ 5,900
Bailey $76,000 $76,000 $ 7,600 $ 7,600
4.
Which of the following is true with regard to pension accounting under U.S. GAAP and IFRS? a. Accounting for defined-benefit pensions is typically a less important issue in the U. S. than in other parts of the world. b. The accounting for defined-benefit pension plans is the same under U.S. GAAP and IFRS. c. Prior service cost is recognized on the balance sheet under both U.S. GAAP and IFRS. d. Prior service cost is amortized into income over the expected service lives of employees under both U.S. GAAP and IFRS.
5.
Pension liabilities will be impacted in countries where population aging is an issue. According to the text, which of the following countries/areas is the most rapidly aging in the developed world? a. Japan b. Europe c. United States d. All three areas are aging at the same approximate rate.
6.
Midland Company follows U.S. GAAP for its external financial reporting whereas Bailey Company follows IFRS for its external financial reporting. The remaining service lives of employees at both firms is estimated to be 10 years. The following information is available for each company at December 31, 2013 related to their respective defined-benefit pension plans. Midland Bailey Net of pension assets and liabilities $110,000 $130,000 Prior service cost $220,000 $175,000 What is the amount of prior service cost recognized by each company in its income statement for the year ended December 31, 2013? Midland Bailey a. $220,000 $175,000 b. $ 22,000 $175,000 c. $ 22,000 $ 17,500 d. $220,000 $ 17,500
Accounting for Pensions and Postretirement Benefits
7.
20-49
Midland Company follows U.S. GAAP for its external financial reporting whereas Bailey Company follows IFRS for its external financial reporting. The remaining service lives of employees at both firms is estimated to be 10 years. The following information is available for each company at December 31, 2013 related to their respective defined-benefit pension plans. Midland Bailey Net of pension assets and liabilities $110,000 $130,000 Prior service cost $220,000 $175,000 What is the amount of Pension Asset/Liability recognized by each company in its income statement for the year ended December 31, 2013? Midland Bailey a. $110,000 $130,000 b. $ 11,000 $130,000 c. $110,000 $ 13,000 d. $ 11,000 $ 13,000
8.
Midland Company follows U.S. GAAP for its external financial reporting whereas Bailey Company follows IFRS for its external financial reporting. The remaining service lives of employees at both firms is estimated to be 10 years. The following information is available for each company at December 31, 2013 related to their respective defined-benefit pension plans. Midland Bailey Net of pension assets and liabilities $110,000 $130,000 Prior service cost (after amortization, if any) $220,000 $175,000 What is the amount of Prior Service Cost recognized by each company on its balance sheet at December 31, 2013? Midland Bailey a. $220,000 $175,000 b. $-0$175,000 c. $-0$-0d. $220,000 $-0-
9.
The IASB and the FASB are studying several issues related to accounting for pensions including all of the following except a. eliminating smoothing provisions. b. requiring companies to report actual asset returns and any actuarial gains and losses directly in the income statement. c. requiring companies to report various components of pension expense, such as interest cost, separately in the income statement along with other interest expense. d. All of the above issues are under study by the IASB and the FASB.
10.
Which of the following is false regarding the accounting for pensions under IFRS and U.S. GAAP? a. Prior service cost is recognized on the balance sheet under U.S. GAAP only. b. Under U.S. GAAP companies must amortize actuarial gains and losses over the expected service lives of employees. c. Prior service cost is amortized into income over the expected service lives of employees under U.S. GAAP only. d. Under IFRS companies may recognize actuarial gains and losses in income immediately.
20-50
Test Bank for Intermediate Accounting, Fourteenth Edition
Answers to Multiple Choice: 1. c 2. b 3. a 4. d 5. a 6. c 7. a 8. d 9. d 10. c Short Answer 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to the accounting for pensions. 1. The primary IFRS literature has recently been amended, resulting in significant convergence between IFRS and U.S. GAAP in this area. For example, IFRS and U.S. GAAP separate pension plans into defined contribution plans and defined benefit plans. The accounting for defined contribution plans is similar. For defined benefit plans, both IFRS and U.S. GAAP recognize the net of the pension assets and liabilities on the balance sheet and both GAAPs amortize prior service costs into income over the expected service lives of employees. Notable differences are that (1) Unlike U.S. GAAP, which recognizes prior service cost on the balance sheet (as an element of Accumulated Other Comprehensive Income), IFRS does not recognize prior service costs on the balance sheet, (2) Under IFRS companies have the choice of recognizing actuarial gains and losses in income immediately or amortizing them over the expected remaining working lives of employees. U.S. GAAP does not permit choice; actuarial gains and losses (and prior service cost) are recognized in Accumulated Other Comprehensive Income and amortized to income over remaining service lives.
2. Briefly discuss the IASB/FASB convergence efforts in the area of postretirement-benefit accounting. 2. The FASB and the IASB are working collaboratively on a postretirement-benefit project. As discussed in the chapter, the FASB has issued a rule addressing the recognition of benefit plans in financial statements. The FASB has begun work on the second phase of the project, which will reexamine expense measurement of postretirement benefit plans. The IASB also has added a project in this area but they are on different schedule. The IASB has recently issued a discussion paper on pensions proposing: (1) elimination of smoothing via the corridor approach, (2) a different presentation of pension costs in the income statement, and (3) a new category of pensions for accounting purposes - so-called “contribution-based promises”.
CHAPTER 21 ACCOUNTING FOR LEASES IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
T F F T F F T F F T F F T F T F T F T T
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
Benefits of leasing. Accounting for long-term leases. 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 direct-financing and sales-type leases. Lessors’ classification of leases. Direct-financing leases. Accounting for operating lease. Computing annual lease payments. Guaranteed residual value definition. Guaranteed vs. unguaranteed residual value. Unguaranteed residual value and minimum lease payments. Net investment and guaranteed/unguaranteed residual value. Difference between direct-financing and sales-type leases. Gross profit in sales-type lease. Review of estimated unguaranteed residual value. FASB required lease disclosures.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
d d b c a b b a c d d c a b a a d a c
21. 22. 23. 24. S 25. S 26. P 27. 28. 29. 30. 31. 32. 33. 34. P 35. 36. 37. 38. S 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. 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. Identification of lease type for lessor. Elements of lease receivable by lessor. Recognition of unearned lease income. Direct-financing lease receivable.
21 - 2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer d a c c b c d c c d b d
No.
Description
S
Third party guarantee of residual value. Lessor’s accounting for residual value. Accounting for initial direct costs. Difference between direct financing and sales-type lease. Amount of revenue in sales-type lease. Accounting for a sales-type lease. Accounting for initial direct costs. Disclosing obligations under capital leases. Leasing criteria to avoid asset capitalization. Recording asset and interest expense in sale-leaseback lease. Accounting for sale-leaseback lease. Gain/loss recognition in a sale-leaseback.
40. 41. 42. S 43. P 44. 45. 46. 47. 48. *49. *50. *51.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. *This topic is dealt with in an Appendix to the chapter. S
MULTIPLE CHOICE—Computational Answer
No.
Description
b c c d a c c d c c a b d c c d a c d c b c a b b c a c
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.
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. Calculate leased asset amount. Compute interest expense for first year. Compute principal reduction for second year. Calculate depreciation expense for lessee. Compute interest expense for first year. Calculate leased asset and lease liability amounts. Calculate annual lease payments. 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.
Accounting for Leases
MULTIPLE CHOICE—Computational (cont.) Answer
No.
Description
d a d a d b b c c c c a b c c b d d b b
80. 81. 82. 83. 84 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. *98. *99.
Revenues and expenses recorded by lessor/operating lease. Operating lease expense for year. Calculate expense of an operating lease. Calculate income from operating lease. Journal entry in direct-financing lease. Calculate lease payments. Journal entry for lessee. Journal entry for lessee. 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 income for lessor/sales-type lease. Calculate profit on sales-type lease and interest income. 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. Gain recognized by lessee in a sale-leaseback. Sale-leaseback/operating lease.
MULTIPLE CHOICE—CPA Adapted Answer
No.
c a d a d d c a d d
100. 101. 102. 103. 104. 105. 106. 107. *108. *109.
Description 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. Reporting gain on a sale-leaseback. Accounting for the gain on a sale-leaseback.
EXERCISES Item E21-110 E21-111 E21-112 E21-113 E21-114 E21-115 *E21-116 *E21-117
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. Lessee and lessor accounting (sale-leaseback). Sale-leaseback.
21 - 3
21 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
PROBLEMS Item P21-118 P21-119 P21-120
Description Lessee accounting—capital lease. Lessee accounting—capital lease. Lessor accounting—direct-financing lease.
CHAPTER LEARNING OBJECTIVES 1.
Explain the nature, economic substance, and advantages of lease transactions.
2.
Describe the accounting criteria and procedures for capitalizing leases by the lessee.
3.
Contrast the operating and capitalization methods of recording leases.
4.
Identify the classifications of leases for the lessor.
5.
Describe the lessor's accounting for direct-financing leases.
6.
Identify special features of lease arrangements that cause unique accounting problems.
7.
Describe the effect of residual values, guaranteed and unguaranteed, on lease accounting.
8.
Describe the lessor's accounting for sales-type leases.
9.
List the disclosure requirements for leases.
*10 .
Understand and apply lease-accounting concepts to various lease arrangements.
*11.
Describe the lessee's accounting for sale-leaseback transactions.
Accounting for Leases
21 - 5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1.
TF
2.
TF
21.
3. 4. 5. S 26. P 27. 28. 29.
TF TF TF MC MC MC MC
30. 31. 32. 33. 52. 53. 54.
MC MC MC MC MC MC MC
55. 56. 58. 59. 60. 61. 62.
6.
TF
7.
TF
34.
8. 9.
TF TF
36. 37.
MC MC
57. 78.
10. 11.
TF TF
38. 39.
MC MC
79. 80.
12.
TF
13.
TF
85.
14. 15.
TF TF
S
16. 40.
TF MC
41. 86.
17. 18. 19.
TF TF TF
S
42. 43. P 44.
MC MC MC
45. 46. 89.
20.
TF
47.
MC
48.
49. 50.
MC MC
51. 98.
MC MC
99. 108.
Note:
S
TF = True-False MC = Multiple Choice E = Exercise P = Problem
Type
Item
Type
Item
Learning Objective 1 MC 22. MC 23. Learning Objective 2 MC 63. MC 70. MC 64. MC 71. MC 65. MC 72. MC 66. MC 73. MC 67. MC 74. MC 68. MC 75. MC 69. MC 76. Learning Objective 3 P MC 35. MC 81. Learning Objective 4 MC 83. MC 116. MC 94. MC Learning Objective 5 MC 84. MC 113. MC 95. MC 114. Learning Objective 6 MC 119. P Learning Objective 7 MC 87. MC 120. MC 88. MC Learning Objective 8 MC 90. MC 105. MC 92. MC 106. MC 93. MC 107. Learning Objective 9 MC Learning Objective 11* MC 109. MC 117. MC 116. E
Type
Item
Type
Item
Type
MC
24.
MC
S
25.
MC
MC MC MC MC MC MC MC
77. 91. 96. 97. 100. 101. 102.
MC MC MC MC MC MC MC
103. 104. 105. 110. 111. 118. 119.
MC MC MC E E P P
MC
82.
MC
112.
E
120.
P
113. 115.
E E
E
E E
P
MC MC MC
E
21 - 6
Test Bank for Intermediate Accounting, Fourteenth Edition
TRUE-FALSE—Conceptual 1.
Leasing equipment reduces the risk of obsolescence to the lessee, and passes the risk of residual value to the lessor.
2.
The FASB agrees with the capitalization approach and requires companies to capitalize all long-term leases.
3.
A lease that contains a purchase option must be capitalized by the lessee.
4.
Executory costs should be excluded by the lessee in computing the present value of the minimum lease payments.
5.
A capitalized leased asset is always depreciated over the term of the lease by the lessee.
6.
A lessee records interest expense in both a capital lease and an operating lease.
7.
A benefit of leasing to the lessor is the return of the leased property at the end of the lease term.
8.
The distinction between a direct-financing lease and a sales-type lease is the presence or absence of a transfer of title.
9.
Lessors classify and account for all leases that don’t qualify as sales-type leases as operating leases.
10.
Direct-financing leases are in substance the financing of an asset purchase by the lessee.
11.
Under the operating method, the lessor records each rental receipt as part interest revenue and part rental revenue.
12.
In computing the annual lease payments, the lessor deducts only a guaranteed residual value from the fair value of a leased asset.
13.
When the lessee agrees to make up any deficiency below a stated amount that the lessor realizes in residual value, that stated amount is the guaranteed residual value.
14.
Both a guaranteed and an unguaranteed residual value affect the lessee’s computation of amounts capitalized as a leased asset.
15.
From the lessee’s viewpoint, an unguaranteed residual value is the same as no residual value in terms of computing the minimum lease payments.
16.
The lessor will recover a greater net investment if the residual value is guaranteed instead of unguaranteed.
17.
The primary difference between a direct-financing lease and a sales-type lease is the manufacturer’s or dealer’s gross profit.
18.
The gross profit amount in a sales-type lease is greater when a guaranteed residual value exists.
Accounting for Leases
21 - 7
19.
Companies must periodically review the estimated unguaranteed residual value in a sales-type lease.
20.
The FASB requires lessees and lessors to disclose certain information about leases in their financial statements or in the notes.
True-False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. T F F T F
Item 6. 7. 8. 9. 10.
Ans. F T F F T
Item 11. 12. 13. 14. 15.
Ans. F F T F T
Item 16. 17. 18. 19. 20.
Ans. F T F T T
MULTIPLE CHOICE—Conceptual 21.
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.
22.
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
23.
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.
24.
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.
21 - 8
Test Bank for Intermediate Accounting, Fourteenth Edition
S
25.
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.
S
26.
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.
P
27.
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.
28.
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.
29.
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.
30.
Minimum lease payments may include a a. penalty for failure to renew. b. bargain purchase option. c. guaranteed residual value. d. any of these.
31.
Executory costs include a. maintenance. b. property taxes. c. insurance. d. all of these.
Accounting for Leases
P
21 - 9
32.
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.
33.
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.
34.
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.
35.
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.
36.
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
37.
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
38.
In a lease that is appropriately recorded as a direct-financing lease by the lessor, unearned income a. should be amortized over the period of the lease using the effective interest method. b. should be amortized over the period of the lease using the straight-line method. c. does not arise. d. should be recognized at the lease's expiration.
21 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition S
39.
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 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.
S
40.
If the residual value of a leased asset is guaranteed by a third party a. it is treated by the lessee as no residual value. b. the third party is also liable for any lease payments not paid by the lessee. c. the net investment to be recovered by the lessor is reduced. d. it is treated by the lessee as an additional payment and by the lessor as realized at the end of the lease term.
41.
When lessors account for residual values related to leased assets, they a. always include the residual value because they always assume the residual value will be realized. b. include the unguaranteed residual value in sales revenue. c. recognize more gross profit on a sales-type lease with a guaranteed residual value than on a sales-type lease with an unguaranteed residual value. d. All of the above are true with regard to lessors and residual values.
42.
The initial direct costs of leasing a. are generally borne by the lessee. b. include incremental costs related to internal activities of leasing, and internal costs related to costs paid to external third parties for originating a lease arrangement. c. are expensed in the period of the sale under a sales-type lease. d. All of the above are true with regard to the initial direct costs of leasing.
S
43.
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 initial direct costs by the lessor to periods benefited by the lease arrangements.
P
44.
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.
Accounting for Leases
21 - 11
45.
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.
46.
Which of the following statements is correct? a. In a direct-financing lease, initial direct costs are added to the net investment in the lease. b. In a sales-type lease, initial direct costs are expensed in the year of incurrence. c. For operating leases, initial direct costs are deferred and allocated over the lease term. d. All of these.
47.
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.
48.
To avoid leased asset capitalization, companies can devise lease agreements that fail to satisfy any of the four leasing criteria. Which of the following is not one of the ways to accomplish this goal? a. Lessee uses a higher interest rate than that used by lessor. b. Set the lease term at something less than 75% of the estimated useful life of the property. c. Write in a bargain purchase option. d. Use a third party to guarantee the asset’s residual value.
*49.
If the lease in a sale-leaseback transaction meets one of the four leasing criteria and is therefore accounted for as a capital lease, who records the asset on its books and which party records interest expense during the lease period?
a. b. c. d. *50.
Party recording the asset on its books Seller-lessee Purchaser-lessor Purchaser-lessor Seller-lessee
Party recording interest expense Purchaser-lessor Seller-lessee Purchaser-lessor Seller-lessee
In a sale-leaseback transaction where none of the four leasing criteria are satisfied, which of the following is false? a. The seller-lessee removes the asset from its books. b. The purchaser-lessor records a gain. c. The seller-lessee records the lease as an operating lease. d. All of the above are false statements.
21 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition *51.
When a company sells property and then leases it back, any gain on the sale should usually be a. recognized in the current year. b. recognized as a prior period adjustment. c. recognized at the end of the lease. d. deferred and recognized as income over the term of the lease.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25.
d d b c a
26. 27. 28. 29. 30.
b b a c d
31. 32. 33. 34. 35.
d c a b a
36. 37. 38. 39. 40.
a d a c d
41. 42. 43. 44. 45.
a c c b c
46. 47. 48. *49. *50.
d c c d b
*51.
d
MULTIPLE CHOICE—Computational 52.
On December 1, 2013, Goetz 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 90,000 660,000 $930,000
The entire amount of $930,000 was charged to rent expense in 2013. What amount should Goetz have charged to expense for the year ended December 31, 2013? a. $90,000 b. $95,500 c. $185,500 d. $660,000 53.
On January 1, 2013, Dean Corporation signed a ten-year noncancelable lease for certain machinery. The terms of the lease called for Dean to make annual payments of $200,000 at the end of each year for ten years with title to pass to Dean at the end of this period. The machinery has an estimated useful life of 15 years and no salvage value. Dean uses the straight-line method of depreciation for all of its fixed assets. Dean accordingly accounted for this lease transaction as a capital lease. The lease payments were determined to have a present value of $1,342,016 at an effective interest rate of 8%. With respect to this capitalized lease, Dean should record for 2013 a. lease expense of $200,000. b. interest expense of $89,468 and depreciation expense of $76,136. c. interest expense of $107,361 and depreciation expense of $89,468. d. interest expense of $91,362 and depreciation expense of $134,202.
Accounting for Leases
21 - 13
Use the following information for questions 54 through 59. (Annuity tables on page 21-25.) On January 1, 2013, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt 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, 2013 is $4,000,000; however, the book value to Holt is $3,300,000. (c) The building has an estimated economic life of 10 years, with no residual value. Yancey 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) Yancey's incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc. (f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property. 54.
What is the amount of the minimum annual lease payment? (Rounded to the nearest dollar.) a. $250,981 b. $640,981 c. $650,981 d. $660,981
55.
What is the amount of the total annual lease payment? a. $250,981 b. $640,981 c. $650,981 d. $660,981
56.
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
57.
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
58.
Yancey, Inc. would record depreciation expense on this storage building in 2013 of (Rounded to the nearest dollar.) a. $0. b. $330,000. c. $400,000. d. $650,981.
21 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition 59.
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
60.
Metcalf Company leases a machine from Vollmer Corp. under an agreement which meets the criteria to be a capital lease for Metcalf. The six-year lease requires payment of $170,000 at the beginning of each year, including $25,000 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. Metcalf should record the leased asset at a. $848,760. b. $814,435. c. $723,943. d. $694,665.
61.
On December 31, 2013, Lang Corporation leased a ship from Fort Company for an eightyear period expiring December 30, 2021. Equal annual payments of $400,000 are due on December 31 of each year, beginning with December 31, 2013. The lease is properly classified as a capital lease on Lang 's books. The present value at December 31, 2013 of the eight lease payments over the lease term discounted at 10% is $2,347,370. Assuming all payments are made on time, the amount that should be reported by Lang Corporation as the total obligation under capital leases on its December 31, 2014 balance sheet is a. $2,182,108. b. $2,000,318. c. $1,742,107. d. $2,400,000.
Use the following information for questions 62 and 63. On January 1, 2013, Sauder Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Sauder to make annual payments of $200,000 at the beginning of each year for five years with title to pass to Sauder at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Sauder uses the straight-line method of depreciation for all of its fixed assets. Sauder accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $833,972 at an effective interest rate of 10%. 62.
In 2013, Sauder should record interest expense of a. $63,397. b. $116,604. c. $83,396. d. $136,604.
63.
In 2014, Sauder should record interest expense of a. $43,396. b. $49,732. c. $63,396. d. $69,736.
Accounting for Leases 64.
21 - 15
On December 31, 2013, Kuhn Corporation leased a plane from Bell Company for an eight-year period expiring December 30, 2021. Equal annual payments of $225,000 are due on December 31 of each year, beginning with December 31, 2013. The lease is properly classified as a capital lease on Kuhn’s books. The present value at December 31, 2013 of the eight lease payments over the lease term discounted at 10% is $1,320,396. Assuming the first payment is made on time, the amount that should be reported by Kuhn Corporation as the lease liability on its December 31, 2013 balance sheet is a. $1,320,396. b. $1,227,435. c. $1,188,357. d. $1,095,396.
Use the following information for questions 65 and 66. On January 1, 2013, Ogleby Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Ogleby to make annual payments of $120,000 at the end of each year for five years with title to pass to Ogleby at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Ogleby uses the straight-line method of depreciation for all of its fixed assets. Ogleby accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $454,896 at an effective interest rate of 10%. 65.
With respect to this capitalized lease, for 2013 Ogleby should record a. rent expense of $120,000. b. interest expense of $45,490 and depreciation expense of $90,978. c. interest expense of $45,490 and depreciation expense of $64,985. d. interest expense of $60,000 and depreciation expense of $90,978.
66.
With respect to this capitalized lease, for 2014 Ogleby should record a. interest expense of $45,490 and depreciation expense of $64,985. b. interest expense of $40,938 and depreciation expense of $64,985. c. interest expense of $38,039 and depreciation expense of $64,985. d. interest expense of $28,938 and depreciation expense of $64,985.
67.
Emporia Corporation is a lessee with a capital lease. The asset is recorded at $630,000 and has an economic life of 8 years. The lease term is 5 years. The asset is expected to have a fair value of $210,000 at the end of 5 years, and a fair value of $70,000 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. $126,000 b. $112,000 c. $84,000 d. $70,000
21 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition 68.
Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $129,057, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. If Pisa, Inc.’s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%, what is the amount recorded for the leased asset at the lease inception? PV Annuity Due PV Ordinary Annuity 8%, 4 periods 3.57710 3.31213 10%, 4 periods 3.48685 3.16986 a. b. c. d.
69.
Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $129,057, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. Pisa, Inc.’s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Assuming that this lease is properly classified as a capital lease, what is the amount of interest expense recorded by Pisa, Inc. in the first year of the asset’s life? PV Annuity Due PV Ordinary Annuity 8%, 4 periods 3.57710 3.31213 10%, 4 periods 3.48685 3.16986 a. b. c. d.
70.
$461,650 $409,092 $427,453 $450,000
$0 $36,931 $26,607 $34,197
Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $129,057, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4 year useful life and no salvage value. Pisa, Inc.’s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Assuming that this lease is properly classified as a capital lease, what is the amount of principal reduction recorded when the second lease payment is made in Year 2? PV Annuity Due PV Ordinary Annuity 8%, 4 periods 3.57710 3.31213 10%, 4 periods 3.48685 3.16986 a. b. c. d.
$129,057 $92,125 $94,860 $102,450
Accounting for Leases 71.
Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $129,057, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. Pisa, Inc.’s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Pisa, Inc. uses the straight-line method to depreciate similar assets. What is the amount of depreciation expense recorded by Pisa, Inc. in the first year of the asset’s life? PV Annuity Due PV Ordinary Annuity 8%, 4 periods 3.57710 3.31213 10%, 4 periods 3.48685 3.16986 a. b. c. d.
72.
$0 because the asset is depreciated by Tower Company. $106,863 $115,413 $112,500
Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2013 it leased equipment with a cost of $400,000 to Silver Point Co. The 5-year lease calls for a 10% down payment and equal annual payments at the end of each year. The equipment has an expected useful life of 5 years. Silver Point’s incremental borrowing rate is 10%, and it depreciates similar equipment using the double-declining balance method. The selling price of the equipment is $650,000, and the rate implicit in the lease is 8%, which is known to Silver Point Co. What is the amount of interest expense recorded by Silver Point Co. for the year ended December 31, 2013? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092 a. b. c. d.
73.
21 - 17
$58,500 $46,800 $52,000 $65,000
Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2013 it leased equipment with a cost of $400,000 to Silver Point Co. The 5-year lease calls for a 10% down payment and equal annual payments of $146,518 at the end of each year. The equipment has an expected useful life of 5 years. Silver Point’s incremental borrowing rate is 10%, and it depreciates similar equipment using the double-declining balance method. The selling price of the equipment is $650,000, and the rate implicit in the lease is 8%, which is known to Silver Point Co. What is the book value of the leased asset at December 31, 2013? a. $650,000 b. $520,000 c. $390,000 d. $416,000
21 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 74.
Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2013 it leased equipment with a cost of $400,000 to Silver Point Co. The 5-year lease calls for a 10% down payment and equal annual payments at the end of each year. The equipment has an expected useful life of 5 years. If the selling price of the equipment is $650,000, and the rate implicit in the lease is 8%, what are the equal annual payments? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092 a. b. c. d.
$146,517 $135,662 $151,644 $162,796
Use the following information for questions 75 through 80. (Annuity tables on page 21-25.) Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2013 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 $310,426 are due on December 31 of each year. (b) The fair value of the machine on January 1, 2013, is $800,000. 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) Alt depreciates all machinery it owns on a straight-line basis. (d) Alt's incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates. (e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful. 75.
What type of lease is this from Alt Corporation's viewpoint? a. Operating lease b. Capital lease c. Sales-type lease d. Direct-financing lease
76.
If Alt 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, 2013? a. Depreciation Expense b. Rent Expense c. Interest Expense d. Depreciation Expense and Interest Expense
77.
If the present value of the future lease payments is $800,000 at January 1, 2013, what is the amount of the reduction in the lease liability for Alt Corp. in the second full year of the lease if Alt Corp. accounts for the lease as a capital lease? (Rounded to the nearest dollar.) a. $230,426 b. $246,426 c. $253,469 d. $266,140
Accounting for Leases
21 - 19
78.
From the viewpoint of Yates, what type of lease agreement exists? a. Operating lease b. Capital lease c. Sales-type lease d. Direct-financing lease
79.
If Yates records this lease as a direct-financing lease, what amount would be recorded as Lease Receivable at the inception of the lease? a. $310,426 b. $771,982 c. $800,000 d. $931,276
80.
Which of the following lease-related revenue and expense items would be recorded by Yates if the lease is accounted for as an operating lease? a. Rent Revenue b. Interest Income c. Depreciation Expense d. Rent Revenue and Depreciation Expense
81.
Hook Company leased equipment to Emley Company on July 1, 2012, for a one-year period expiring June 30, 2013, for $60,000 a month. On July 1, 2013, Hook leased this piece of equipment to Terry Company for a three-year period expiring June 30, 2016, 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, 2008, is being depreciated on a straightline basis over an eight-year period with no salvage value. Assuming that both the lease to Emley and the lease to Terry 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, 2013? Hook Emley Terry 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 82 and 83. Hull Co. leased equipment to Riggs Company on May 1, 2013. At that time the collectibility of the minimum lease payments was not reasonably predictable. The lease expires on May 1, 2014. Riggs could have bought the equipment from Hull for $4,000,000 instead of leasing it. Hull's accounting records showed a book value for the equipment on May 1, 2010, of $3,500,000. Hull's depreciation on the equipment in 2013 was $450,000. During 2013, Riggs paid $900,000 in rentals to Hull for the 8-month period. Hull incurred maintenance and other related costs under the terms of the lease of $80,000 in 2013. After the lease with Riggs expires, Hull will lease the equipment to another company for two years. 82.
Ignoring income taxes, the amount of expense incurred by Riggs from this lease for the year ended December 31, 2013, should be a. $370,000. b. $450,000. c. $820,000. d. $900,000.
21 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 83.
The income before income taxes derived by Hull from this lease for the year ended December 31, 2013, should be a. $370,000. b. $450,000. c. $820,000. d. $900,000.
84.
On January 2, 2013, Gold Star Leasing Company leases equipment to Brick Co. with 5 equal annual payments of $80,000 each, payable beginning December 31, 2013. Brick Co. agrees to guarantee the $50,000 residual value of the asset at the end of the lease term. Brick’s incremental borrowing rate is 10%, however it knows that Gold Star’s implicit interest rate is 8%. What journal entry would Gold Star make at January 2, 2013 assuming this is a direct–financing lease?
8%, 5 periods 10%, 5 periods
85.
PV Annuity Due 4.31213 4.16986
a. Lease Receivable Equipment
450,000
b. Lease Receivable Loss Equipment
319,416 130,584
c. Lease Receivable Equipment
334,310
d. Lease Receivable Equipment
353,671
PV Ordinary Annuity 3.99271 3.79079
PV Single Sum .68508 .62092
450,000
450,000 334,310 353,671
Mays Company has a machine with a cost of $600,000 which also is its fair value on the date the machine is leased to Park Company. The lease is for 6 years and the machine is estimated to have an unguaranteed residual value of $60,000. If the lessor's interest rate implicit in the lease is 12%, the six beginning-of-the-year lease payments would be a. $138,541. b. $123,698. c. $117,270. d. $100,000.
Accounting for Leases 86.
On January 2, 2013, Gold Star Leasing Company leases equipment to Brick Co. with 5 equal annual payments of $80,000 each, payable beginning December 31, 2013. Brick Co. agrees to guarantee the $50,000 residual value of the asset at the end of the lease term. Brick’s incremental borrowing rate is 10%, however it knows that Gold Star’s implicit interest rate is 8%. What journal entry would Brick Co. make at December 31, 2013 to record the first lease payment? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092 a. Lease Liability Cash b. Lease Liability Interest Expense Cash c. Lease Liability Interest Expense Cash d. Lease Liability Interest Expense Cash
87.
21 - 21
80,000 80,000 51,706 28,294 80,000 46,570 33,430 80,000 16,570 33,430 50,000
On January 2, 2012, Gold Star Leasing Company leases equipment to Brick Co. with 5 equal annual payments of $80,000 each, payable beginning December 31, 2012. Brick Co. agrees to guarantee the $50,000 residual value of the asset at the end of the lease term. Brick’s incremental borrowing rate is 10%, however it knows that Gold Star’s implicit interest rate is 8%. What journal entry would Brick Co. make at December 31, 2013 to record the second lease payment? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092 a. Lease Liability Cash
80,000 80,000
b. Lease Liability 51,226 Interest Expense 28,774 Cash 80,000 c. Lease Liability 55,843 Interest Expense 24,157 Cash 80,000 d. Lease Liability 47,520 Interest Expense 32,480 Cash 80,000
21 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 88.
Geary Co. leased a machine to Dains Co. Assume the lease payments were made on the basis that the residual value was guaranteed and Geary 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 Less accumulated depreciation--capital lease
$400,000 384,000 $ 16,000
Interest payable Lease liability
$ 1,520 14,480 $16,000
If, at the end of the lease, the fair value of the residual value is $7,800, what gain or loss should Geary record? a. $6,680 gain b. $6,280 loss c. $8,200 loss d. $7,800 gain 89.
Harter Company leased machinery to Stine Company on July 1, 2013, for a ten-year period expiring June 30, 2023. Equal annual payments under the lease are $125,000 and are due on July 1 of each year. The first payment was made on July 1, 2013. The rate of interest used by Harter and Stine is 9%. The cash selling price of the machinery is $875,000 and the cost of the machinery on Harter's accounting records was $775,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Harter, what amount of interest revenue would Harter record for the year ended December 31, 2013? a. $78,750 b. $67,500 c. $33,750 d. $0
90.
Pye Company leased equipment to the Polan Company on July 1, 2013, for a ten-year period expiring June 30, 2023. Equal annual payments under the lease are $120,000 and are due on July 1 of each year. The first payment was made on July 1, 2013. The rate of interest contemplated by Pye and Polan is 9%. The cash selling price of the equipment is $840,000 and the cost of the equipment on Pye's accounting records was $744,000. 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 Pye would record for the year ended December 31, 2013? a. $96,000 and $75,600 b. $96,000 and $64,800 c. $96,000 and $32,400 d. $0 and $0
Use the following information for questions 91 and 92. Metro Company, a dealer in machinery and equipment, leased equipment to Sands, Inc., on July 1, 2013. The lease is appropriately accounted for as a sale by Metro and as a purchase by Sands. The lease is for a 10-year period (the useful life of the asset) expiring June 30, 2023. The first of 10 equal annual payments of $828,000 was made on July 1, 2013. Metro had purchased the equipment for $5,200,000 on January 1, 2013, and established a list selling price of $7,200,000 on the equipment. Assume that the present value at July 1, 2013, of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $6,000,000.
Accounting for Leases
21 - 23
91.
Assuming that Sands, Inc. uses straight-line depreciation, what is the amount of depreciation and interest expense that Sands should record for the year ended December 31, 2013? a. $300,000 and $206,880 b. $300,000 and $240,000 c. $360,000 and $206,880 d. $360,000 and $240,000
92.
What is the amount of profit on the sale and the amount of interest income that Metro should record for the year ended December 31, 2013? a. $0 and $206,880 b. $800,000 and $206,880 c. $800,000 and $240,000 d. $1,200,000 and $480,000
93.
Roman Company leased equipment from Koenig Company on July 1, 2013, for an eightyear period expiring June 30, 2021. Equal annual payments under the lease are $500,000 and are due on July 1 of each year. The first payment was made on July 1, 2013. The rate of interest contemplated by Roman and Koenig is 8%. The cash selling price of the equipment is $3,103,125 and the cost of the equipment on Koenig's accounting records was $2,750,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Koenig, what is the amount of profit on the sale and the interest income that Koenig would record for the year ended December 31, 2013? a. $0 and $0 b. $0 and $104,125 c. $353,125 and $104,125 d. $353,125 and $124,125
Use the following information for questions 94 through 98. Gage Co. purchases land and constructs a service station and car wash for a total of $360,000. At January 2, 2012, 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 Gage. Fair value of the land at time of the sale was $40,000. The lease is a 10-year, noncancelable lease. Gage 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 Gage at termination of the lease. A partial amortization schedule for this lease is as follows: Payments Interest Amortization Balance Jan. 2, 2012 $400,000.00 Dec. 31, 2012 $65,098.13 $40,000.00 $25,098.13 374,901.87 Dec. 31, 2013 65,098.13 37,490.19 27,607.94 347,293.93 Dec. 31, 2014 65,098.13 34,729.39 30,368.74 316,925.19 94.
From the viewpoint of the lessor, what type of lease is involved above? a. Sales-type lease b. Sale-leaseback c. Direct-financing lease d. Operating lease
21 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition 95.
What is the discount rate implicit in the amortization schedule presented above? a. 12% b. 10% c. 8% d. 6%
96.
The total lease-related expenses recognized by the lessee during 2013 is which of the following? (Rounded to the nearest dollar.) a. $64,000 b. $65,098 c. $73,490 d. $61,490
97.
What is the amount of the lessee's liability to the lessor after the December 31, 2014 payment? (Rounded to the nearest dollar.) a. $400,000 b. $374,902 c. $347,294 d. $316,925
*98.
The total lease-related income recognized by the lessee during 2013 is which of the following? a. $ -0b. $2,667 c. $4,000 d. $40,000
*99.
On June 30, 2013, Falk Co. sold equipment to an unaffiliated company for $1,400,000. The equipment had a book value of $1,260,000 and a remaining useful life of 10 years. That same day, Falk leased back the equipment at $14,000 per month for 5 years with no option to renew the lease or repurchase the equipment. Falk's rent expense for this equipment for the year ended December 31, 2013, should be a. $168,000. b. $84,000. c. $70,000. d. $56,000.
Multiple Choice Answers—Computational Item
Ans
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
52. 53. 54. 55. 56. 57. 58.
b. c c d c a c
59. 60. 61. 62. 63. 64. 65.
d c c a b d c
66. 67. 68. 69. 70. 71. 72.
c d a c d c b
73. 74. 75. 76. 77. 78. 79.
c a b b c a c
80. 81. 82. 83. 84. 85. 86.
d a d a d b b
87. 88. 89. 90. 91. 92. 93.
c c c c a b c
94. 95. 96. 97. *98. *99.
c b d d b b
Accounting for Leases
21 - 25
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
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 100.
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
101.
On December 31, 2013, Burton, Inc. leased machinery with a fair value of $1,050,000 from Cey Rentals Co. The agreement is a six-year noncancelable lease requiring annual payments of $200,000 beginning December 31, 2013. The lease is appropriately accounted for by Burton as a capital lease. Burton's incremental borrowing rate is 11%. Burton 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.
21 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition In its December 31, 2013 balance sheet, Burton should report a lease liability of a. $758,160. b. $850,000. c. $939,180. d. $958,160. 102.
On December 31, 2012, Harris Co. leased a machine from Catt, Inc. for a five-year period. Equal annual payments under the lease are $840,000 (including $40,000 annual executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2012, and the second payment was made on December 31, 2013. 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 $3,336,000. The lease is appropriately accounted for as a capital lease by Harris. In its December 31, 2013 balance sheet, Harris should report a lease liability of a. $2,536,000. b. $2,496,000. c. $2,282,400. d. $1,989,600.
103.
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 104 and 105. On January 2, 2013, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $250,000 starting at the end of the first year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this transaction as a capital lease. The drill press has an estimated useful life of 15 years, with no salvage value. Hernandez uses straight-line depreciation for all of its plant assets. Aggregate lease payments were determined to have a present value of $1,500,000, based on implicit interest of 10%. 104.
In its 2013 income statement, what amount of interest expense should Hernandez report from this lease transaction? a. $0 b. $93,750 c. $125,000 d. $150,000
105.
In its 2013 income statement, what amount of depreciation expense should Hernandez report from this lease transaction? a. $250,000 b. $200,000 c. $150,000 d. $100,000
Accounting for Leases
21 - 27
106.
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.
107.
Torrey Co. manufactures equipment that is sold or leased. On December 31, 2013, Torrey leased equipment to Dalton for a five-year period ending December 31, 2018, at which date ownership of the leased asset will be transferred to Dalton. Equal payments under the lease are $440,000 (including $40,000 executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2013. Collectibility of the remaining lease payments is reasonably assured, and Torrey has no material cost uncertainties. The normal sales price of the equipment is $1,540,000, and cost is $1,200,000. For the year ended December 31, 2013, what amount of income should Torrey realize from the lease transaction? a. $340,000 b. $440,000 c. $460,000 d. $660,000
*108. Jamar Co. sold its headquarters building at a gain, and simultaneously leased back the building. The lease was reported as a capital lease. At the time of the sale, the gain should be reported as a. operating income. b. an extraordinary item, net of income tax. c. a separate component of stockholders' equity. d. a deferred gain. *109. On December 31, 2013, Haden Corp. sold a machine to Ryan and simultaneously leased it back for one year. Pertinent information at this date follows: Sales price Carrying amount Present value of reasonable lease rentals ($7,500 for 12 months @ 12%) Estimated remaining useful life
$900,000 825,000 85,000 12 years
In Haden’s December 31, 2013 balance sheet, the deferred profit from the sale of this machine should be a. $85,000. b. $75,000. c. $10,000. d. $0.
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
100. 101.
c a
102. 103.
d a
104. 105.
d d
106. 107.
c a
*108 *109 .
d d
21 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational No.
Answer Derivation $660, 000 1 52. b $90,000 + = $95,500. 12 10 53.
c
$1,342,016 × .08 = $107,361, $1,342,016 ÷ 15 = $89,468.
54.
c
$4,000,000 ÷ 6.14457 = $650,981 (PV of Ordinary Annuity Table).
55.
d
$650,981 + $10,000 = $660,981.
56.
c
Conceptual.
57.
a
Conceptual, FV exceeds cost.
58.
c
$4,000,000 ÷ 10 = $400,000.
59.
d
8/10 = .8 > 75% of economic life.
60.
c
($170,000 - $25,000) × 4.99271 = $723,943.
61.
c
$2,347,370 – $400,000 = $1,947,370 × .10 = $194,737 $1,947,370 – ($400,000 – $194,737) = $1,742,107.
62.
a
($833,972 – $200,000) × .10 = $63,397.
63.
b
[$633,972 – ($200,000 - $63,397)] × .10 = $49,732.
64.
d
$1,320,396 – $225,000 = $1,095,396.
65.
c
$454,896 × .10 = $45,490; ($454,896 – 0) ÷ 7 = $64,985.
66.
c
[$454,896 – ($120,000 – $45,490)] × .10 = $38,039.
67.
d
($630,000 – $70,000) ÷ 8 = $70,000.
68
a
$129,057 3.57710 = $461,650.
69.
c
$129,057 3.57710 = $461,650 ($461,650 – $129,057) .08 = $26,607.
70.
d
$129,057 3.57710 = $461,650 $129,057 – [($461,650 – $129,057) .08] = $102,450.
71.
c
$129,057 3.57710 = $461,650 ($461,650 – 0) 4 = $115,413.
72.
b
($650,000 .90) 3.99271 = $146,517 $146,517 3.99271 = $585,000 $585,000 .08 = $46,800.
Accounting for Leases
DERIVATIONS — Computational (cont.) No.
Answer Derivation
73.
c
$650,000 – (650,000 .40) = $390,000
74.
a
($650,000 .90) 3.99271 = $146,517.
75.
b
$310,426 × 2.48685 = $771,983; $771,983 ———— = 96% > 90%. $800,000
76.
b
Conceptual.
77.
c
$800,000 – [$310,426 – ($800,000 × .1)] = $569,574. $310,426 – ($569,574 × .1) = $253,469.
78.
a
Fails to meet Group II requirements.
79.
c
Fair value = $800,000.
80.
d
Conceptual.
81.
a
Hook: Emley: Terry:
82.
d
$900,000.
83.
a
$900,000 – $80,000 – $450,000 = $370,000.
84.
d
($80,000 3.99271) + ($50,000 .68508) = $353,671.
85.
b
[$600,000 – ($60,000 × .50663)] ÷ 4.60478 = $123,698.
86.
b
($80,000 3.99271) + ($50,000 .68508) = $353,671. $80,000 – ($353,671 .08) = $51,706.
87.
c
($80,000 3.99271) + ($50,000 .68508) = $353,671 $80,000 – ($353,671 .08) = $51,706 ($353,671 – $51,706) .08 = $24,157 Interest exp.
88.
c
$7,800 – $16,000 = ($8,200).
89.
c
($875,000 – $125,000) × .09 × 6/12 = $33,750.
90.
c
$840,000 – $744,000 = $96,000; ($840,000 – $120,000) × .09 × 6/12 = $32,400.
($60,000 × 6) + ($75,000 6) – (4,800,000 ÷ 8) = $210,000 ($60,000) × 6 = $(360,000) ($75,000) × 6 = $(450,000).
21 - 29
21 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation $6, 000, 000 1 = $300,000. 91. a 10 2 ($6,000,000 – $828,000) × .04 = $206,880. 92.
b
$6,000,000 – $5,200,000 = $800,000. ($6,000,000 – $828,000) × .04 = $206,880.
93.
c
$3,103,125 – $2,750,000 = $353,125. ($3,103,125 – $500,000) × .04 = $104,125.
94.
c
Conceptual.
95.
b
$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%.
96.
d
[($400,000 – $40,000) ÷ 15] + $37,490 = $61,490.
97.
d
$316,925 (See amortization table.)
*98.
b
($400,000 – $360,000) ÷ 15 = $2,667.
*99.
b
$14,000 × 6 = $84,000.
DERIVATIONS — CPA Adapted No.
Answer Derivation
100.
c
Conceptual.
101.
a
($200,000 × 4.7908) – $200,000 = $758,160.
102.
d
$3,336,000 – $840,000 + $40,000 = $2,536,000 (2012). $2,536,000 – [$800,000 – ($2,536,000 × .10)] = $1,989,600 (2013).
103.
a
Conceptual.
104.
d
$1,500,000 × .10 = $150,000.
105.
d
$1,500,000 ÷ 15 = $100,000.
106.
c
Conceptual.
107.
a
$1,540,000 – $1,200,000 = $340,000.
*108.
d
Conceptual.
Accounting for Leases
21 - 31
DERIVATIONS — CPA Adapted (cont.) No.
Answer Derivation $85,000 *109. d = 9.44%, < 10% of FV of asset it is a minor leaseback. $900,000
EXERCISES Ex. 21-110—Capital lease (Essay). Explain the procedures used by the lessee to account for a capital lease.
Solution 21-110 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.
Ex. 21-111—Capital lease amortization and journal entries. Hughey Co. as lessee records a capital lease of machinery on January 1, 2013. The seven annual lease payments of $525,000 are made at the end of each year. The present value of the lease payments at 10% is $2,556,000. Hughey 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 2013 and 2014. (b) Prepare all of Hughey's journal entries for 2013.
Solution 21-111 (a) Date 1/1/13 12/31/13 12/31/14
Annual Payments
10% Interest
Reduction Of Liability
$525,000 525,000
$255,600 228,660
$269,400 296,340
Lease Liability $2,556,000 2,286,600 1,990,260
21 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 21-111 (cont.) (b) Leased Equipment ....................................................................... 2,556,000 Lease Liability .................................................................. Interest Expense.......................................................................... Lease Liability .............................................................................. Cash ................................................................................
255,600 269,400
Depreciation Expense (7/28 × $2,556,000) .................................. Accumulated Depreciation ..............................................
639,000
2,556,000
525,000
639,000
Ex. 21-112—Operating lease. Maris Co. purchased a machine on January 1, 2013, for $1,200,000 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, 2013, under a cancelable lease, Maris leased the machine to Dunbar Company for $360,000 a year for a four-year period ending March 31, 2017. Maris incurred total maintenance and other related costs under the provisions of the lease of $15,000 relating to the year ended December 31, 2013. Harley paid $360,000 to Maris on April 1, 2013. 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 Maris Co. from this lease for the year ended December 31, 2013? (b) What should be the amount of rent expense incurred by Dunbar from this lease for the year ended December 31, 2013?
Solution 21-112 (a)
(b)
Revenue 4/1/13—12/31/13 ($360,000 × 9/12) Expenses: Depreciation ($240,000 × 9/12) Maintenance, etc. Income before taxes
$270,000 $180,000 15,000
195,000 $ 75,000
Rent expense, 4/1/13—12/31/13 ($360,000 × 9/12) = $270,000.
Ex. 21-113—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 21-113 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.
Accounting for Leases
21 - 33
Solution 21-113 (cont.) (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. 21-114—Direct-financing lease (essay). Explain the procedures used to account for a direct-financing lease. Solution 21-114 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.
Ex. 21-115—Lessor accounting—sales-type lease. Hayes Corp. is a manufacturer of truck trailers. On January 1, 2013, Hayes Corp. leases ten trailers to Lester 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 Hayes Corp. with an 8% return on net investment (present value factor for 6 periods at 8% is 4.62288).
2.
Titles to the trailers pass to Lester at the end of the lease.
3.
The fair value of each trailer is $50,000. The cost of each trailer to Hayes Corp. is $45,000. Each trailer has an expected useful life of nine years.
4.
Collectibility of the lease payments is reasonably predictable and there are no important uncertainties surrounding the amount of costs yet to be incurred by Hayes 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 Hayes Corp. for the first three years. (d) Prepare the journal entries for the lessor for 2013 and 2014 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).
21 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 21-115 (a) It is a sales-type lease to the lessor, Hayes Corp. Hayes's (the manufacturer) profit upon sale is $50,000, which is recognized in the year of sale (2013). 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 1/1/13 12/31/13 12/31/14 12/31/15 (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, 2013 Lease Receivable ........................................................................ Cost of Goods Sold...................................................................... Sales Revenue ................................................................. Inventory .......................................................................... December 31, 2013 Cash ............................................................................................ Lease Receivable............................................................. Interest Revenue .............................................................. December 31, 2014 Cash ............................................................................................ Lease Receivable............................................................. Interest Revenue ..............................................................
Lease Receivable $500,000 431,842 358,231 278,731
500,000 450,000 500,000 450,000 108,158 68,158 40,000 108,158 73,611 34,547
*Ex. 21-116—Lessee and lessor accounting (sale-leaseback). On January 1, 2013, Morris Company sells land to Lopez Corporation for $8,000,000, and immediately leases the land back. The following information relates to this transaction: 1. The term of the noncancelable lease is 20 years and the title transfers to Morris Company at the end of the lease term. 2. The land has a cost basis of $6,720,000 to Morris. 3. The lease agreement calls for equal rental payments of $814,816 at the end of each year. 4. The land has a fair value of $8,000,000 on January 1, 2013. 5. The incremental borrowing rate of Morris Company is 10%. Morris is aware that Lopez Corporation set the annual rentals to ensure a rate of return of 8%. 6. Morris Company pays all executory costs which total $255,000 in 2013.
Accounting for Leases
21 - 35
*Ex. 21-116 (cont.) 7. 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) Prepare the journal entries for the entire year 2013 on the books of Morris Company to reflect the above sale and lease transactions (include a partial amortization schedule and round all amounts to the nearest dollar.) (b) Prepare the journal entries for the entire year 2013 on the books of Lopez Corporation to reflect the above purchase and lease transactions. *Solution 21-116 (a)
Morris Company (Lessee) January 1, 2013 Cash............................................................................................ 8,000,000 Land ................................................................................ Unearned Profit on Sale-Leaseback ................................ Leased Land ............................................................................... 8,000,000 Lease Liability .................................................................. Throughout 2013 Executory Costs (Insurance and Taxes) ...................................... 255,000 Accounts Payable and Cash ............................................ December 31, 2013 Unearned Profit on Sale-Leaseback ............................................ Revenue from Sale-Leaseback ($1,280,000 ÷ 20) ........... Interest Expense ......................................................................... Lease Liability ............................................................................. Cash ................................................................................
6,720,000 1,280,000
8,000,000
255,000
64,000 64,000 640,000 174,816 814,816
Partial Lease Amortization Schedule Date 1/1/13 12/31/13 (b)
Annual Lease Payment
Interest 8%
Reduction of Lease Liability
$814,816
$640,000
$174,816
Balance $8,000,000 7,825,184
Lopez Corporation (Lessor) January 1, 2013 Land ............................................................................................ 8,000,000 Cash ................................................................................
8,000,000
Lease Receivable ........................................................................ 8,000,000 Land ................................................................................
8,000,000
December 31, 2013 Cash............................................................................................ Lease Receivable ............................................................ Interest Revenue .............................................................
814,816 174,816 640,000
21 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition *Ex. 21-117—Sale-leaseback. On January 1, 2013, Hester Co. sells machinery to Beck Corp. at its fair value of $960,000 and leases it back. The machinery had a carrying value of $840,000, the lease is for 10 years and the implicit rate is 10%. The lease payments of $142,000 start on January 1, 2013. Hester uses straight-line depreciation and there is no residual value. Instructions (a) Prepare all of Hester's entries for 2013. (b) Prepare all of Beck's entries for 2013.
*Solution 21-117 (a)
Hester Co. (Lessee) January 1, 2013 Cash ............................................................................................ Machinery ........................................................................ Unearned Profit on Sale-Leaseback .................................
840,000 120,000
Leased Machinery ....................................................................... Lease Liability ..................................................................
960,000
Lease Liability .............................................................................. Cash. ...............................................................................
142,000
December 31, 2013 Depreciation Expense.................................................................. Accumulated Depreciation—Capital Lease ......................
(b)
960,000
960,000
142,000
96,000 96,000
Unearned Profit on Sale-Leaseback ............................................ Depreciation Expense ......................................................
12,000
Interest Expense [10% × ($960,000 – $142,000)] ........................ Interest Payable ...............................................................
81,800
Beck Corp. (Lessor) January 1, 2013 Machinery .................................................................................... Cash ................................................................................
12,000
81,800
960,000 960,000
Lease Receivable ........................................................................ Machinery ........................................................................
960,000
Cash ............................................................................................ Lease Receivable.............................................................
142,000
December 31, 2013 Interest Receivable ...................................................................... Interest Revenue ..............................................................
960,000
142,000
81,800 81,800
Accounting for Leases
21 - 37
PROBLEMS Pr. 21-118—Lessee accounting—capital lease. Eubank Company, as lessee, enters into a lease agreement on July 1, 2012, 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 $845,378 are due on June 30 of each year. 2. The fair value of the equipment on July 1, 2012 is $2,800,000. The equipment has an economic life of 6 years with no salvage value. 3. Eubank depreciates similar machinery it owns on the sum-of-the-years'-digits basis. 4. The lessee pays all executory costs. 5. Eubank'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 Eubank Company has entered into and what accounting treatment is applicable. (b) Prepare the journal entries on Eubank'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, 2012. 2. December 31, 2012. 3. June 30, 2013. 4. December 31, 2013.
Solution 21-118 (a)
Capitalized amount: $845,378 × PV of an ordinary annuity for 4 periods at 8% $845,378 × 3.31213 = $2,800,000 Because the present value of the lease payments ($2,800,000) equals the fair value, $2,800,000, of the leased property, it is a capital lease and must be accounted for under the capital lease method.
(b)
1.
2.
July 1, 2012 Leased Equipment................................................................. 2,800,000 Lease Liability ............................................................ December 31, 2012 Depreciation Expense............................................................ Accumulated Depreciation—Capital Leases [($2,800,000 × 4/10) × 6/12] .................................. Interest Expense ($224,000 × 6/12) ....................................... Interest Payable .........................................................
2,800,000
560,000 560,000 112,000 112,000
21 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 21-118 (cont.) Lease Amortization Schedule Date 7/1/12 6/30/13 6/30/14 3.
4.
Annual Lease Payment
Interest on Unpaid Liability
Reduction of Lease Liability
$845,378 845,378
$224,000 174,290
$621,378 671,088
June 30, 2013 Interest Expense ..................................................................... Lease Liability ......................................................................... Cash ............................................................................. (Interest payable entry assumed to have been reversed 1/1/13) December 31, 2013 Depreciation Expense ............................................................. Accumulated Depreciation—Capital Leases .................. [($2,800,000 × 4/10) × 6/12 plus ($2,800,000 × 3/10) × 6/12] Interest Expense ($174,290 × 6/12) ........................................ Interest Payable ............................................................
Balance of Lease Liability $2,800,000 2,178,622 1,507,534
224,000 621,378 845,378
980,000 980,000
87,145 87,145
Pr. 21-119—Lessee accounting—capital lease. Krause Company on January 1, 2013, 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, Daly Corp., at the inception of the lease of $3,000,000. Krause's incremental borrowing rate is 8%. Krause 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 Krause Company that Daly 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. Instructions (a) What kind of lease is this to Krause 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 Krause record during the first year of the lease? (Include an amortization schedule through 1/1/14 and round to the nearest dollar.)
Accounting for Leases
21 - 39
Solution 21-119 (a)
This lease is a capital lease to Krause 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, 2013 Leased Equipment ...................................................................... 2,872,427 Lease Liability ..................................................................
2,872,427
January 1, 2013 Leases Liability ............................................................................ Property Tax Expense ................................................................. Cash ................................................................................
200,000 19,000
July 1, 2013 Lease Liability ............................................................................. Property Tax Expense ................................................................. Interest Expense ........................................................................ Cash ................................................................................
93,103 19,000 106,897
Date Initial PV 1/1/13 7/1/13 1/1/14
219,000
Lease Amortization Schedule Semi-Annual Interest Reduction of Lease Payment 4% Lease Liability $200,000 200,000 200,000
— 106,897 103,173
$200,000 93,103 96,827
219,000
Balance $2,872,427 2,672,427 2,579,324 2,482,497
21 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 21-119 (cont.) December 31, 2013 Depreciation Expense.................................................................. Accumulated Depreciation—Capital Leases..................... Interest Expense.......................................................................... Interest Payable .............................................................. *($2,872,427 – $60,000) ÷ 10 = $281,243.
281,243* 281,243 103,173 103,173
Pr. 21-120—Lessor accounting—direct-financing lease. Lucas, Inc. enters into a lease agreement as lessor on January 1, 2013, 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 $12,000,000 when the lease expires at which time the fair value is expected to be $20,000,000. 2. The airplane has a cost of $51,000,000 to Lucas, 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 $7,746,572 allow Lucas 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 Lucas. Instructions (a) What type of lease is this? Discuss. (b) Prepare a lease amortization schedule for the lessor for the first two years (2013-2014). (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 2013 and 2014.
Solution 21-120 (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 $12,000,000 at the termination of the lease when the asset is expected to have a fair value of $20,000,000 constitutes a bargain purchase option. Additionally, the payments are collectible, and there are no uncertainties as to future lessor costs.
(b) Date 1/1/13 12/31/13 12/31/14
Lessor's Lease Amortization Schedule Annual Interest on Lease Receivable Lease Payment Lease Receivable Recovery Lease Receivable $51,000,000 $7,746,572* $4,080,000 $3,666,572 47,333,428 7,746,572 3,786,674 3,959,898 43,373,530
*[$51,000,000 – ($12,000,000 × .54027)] ÷ 5.74664 = $7,746,572.
Accounting for Leases
21 - 41
Solution 21-120 (cont.) (c)
January 1, 2013 Lease Receivable ....................................................................... 51,000,000 Airplanes......................................................................... 51,000,000 December 31, 2013 Cash........................................................................................... 7,746,572 Lease Receivable ........................................................... Interest Revenue ............................................................
3,666,572 4,080,000
December 31, 2014 Cash........................................................................................... 7,746,572 Lease Receivable ........................................................... Interest Revenue ............................................................
3,959,898 3,786,674
21 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS True/False 1. IFRS requires that companies provide a year-by-year breakout of future noncancelable lease payments due in years 1 through 5. 2. IFRS for leases is more “rules-based” than U.S. GAAP and includes many bright-line criteria to determine ownership. 3. The IFRS leasing standard is the subject of over 30 interpretations since its issuance in 1982. 4. IFRS does not provide detailed guidance for leases of natural resources, sale-leasebacks, and leveraged leases. 5. Because IFRS is very general in its provisions for lease accounting, the required disclosures for leases under IFRS are more detailed and extensive than those required under U.S. GAAP. Answers to True/False: 1. False 2. False 3. False 4. True 5. False
Multiple Choice 1. Which of the following statements is true when comparing the accounting for leasing transactions under U.S. GAAP with IFRS? a. IFRS requires that companies provide a year-by-year breakout of future noncancelable lease payments due in years 1 through 5. b. IFRS for leases is more “rules-based” than U.S. GAAP and includes many bright-line criteria to determine ownership. c. The IFRS leasing standard is the subject of over 30 interpretations since its issuance in 1982. d. IFRS does not provide detailed guidance for leases of natural resources, sale-leasebacks, and leveraged leases. Answer to Multiple Choice: 1. d Short Answer 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to the accounting for leases. 1. Both U.S. GAAP and IFRS share the same objective of recording leases by lessees and lessors according to their economic substance – that is, according to the definitions of assets and liabilities. Leasing was on the FASB’s initial agenda in 1973 and GAAP rules were issued in 1976 (before the conceptual framework was developed). U.S. GAAP for leases has been the subject of more than 30 interpretations since its issuance. The IFRS standard is subject to just three interpretations. One reason for this small number of interpretations is that IFRS does not specifically address a number of leasing transactions that are covered by U.S. GAAP. Examples include lease agreements for natural resources,
Accounting for Leases
21 - 43
sale-leasebacks, real estate leases, and leveraged leases. U.S. GAAP for leases is much more “rule-based” with specific bright-line criteria to determine if a lease arrangement transfers the risks and rewards of ownership; IFRS is more general in its provisions. 2. Briefly discuss the IASB and FASB efforts to converge their accounting guidelines for leases. 2. Lease accounting is one of the areas identified in the IASB/FASB Memorandum of Understanding and also a topic recommended by the SEC in its off-balance-sheet study for standard-setting attention. The joint project will initially primarily focus on lessee accounting. One of the first areas to be studied is, “What are the assets and liabilities to be recognized related to a lease contract?” Should the focus remain on the leased item or the right to use the leased item? This question is tied to the Boards’ joint project on the conceptual framework – defining an “asset” and a “liability”.
CHAPTER 22 ACCOUNTING CHANGES AND ERROR ANALYSIS TRUE-FALSE—Conceptual Answer
No.
Description
F T F T F T T T F T F F T F T 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.
Change in accounting estimate. Errors in financial statements. Adoption of a new principle. Retrospective application of accounting principle. Reporting cumulative effect of change in principle. Disclosure requirements for a change in principle. Indirect effect of an accounting change. Retrospective application impracticality. Reporting changes in accounting estimates. Change in principle vs. change in estimate. Accounting for change in depreciation method. Accounting for change in reporting entities. Example of a change in reporting entities. Accounting error vs. change in estimate. Accounting for corrections of errors. New principle created by FASB standard. Balance sheet errors. Definition of counterbalancing errors. Accounting for counterbalancing errors. Correcting entries for noncounterbalancing errors.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
b b c d a c c d b c a b b c d c c b
21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38.
Accounting changes and consistency concept. Identify changes in accounting principle. Identify a non-retrospective change. Identify a change in accounting principle. 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. 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 change in reporting entity. Retroactive reporting a change in reporting entity. Identify a correction of an error. Identification of counterbalancing errors.
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Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
c c
39. 40.
Impact of failure to record purchase and count ending inventory. Impact of failure to record purchase and count ending inventory.
MULTIPLE CHOICE—Computational Answer
No.
Description
b b c d c d b c b c a b a a a c d c c a a b c d c a c
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.
Calculate cumulative effect of a change in depreciation method. Calculate cumulative effect of a change in depreciation method. Calculate net income with change in accounting principle with tax effects. Calculate cumulative effect of accounting change. Calculate depreciation expense after change in accounting principle. Calculate cumulative effect of a change on retained earnings. Calculate cumulative 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 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 errors on net income. Calculate effect of errors on working capital. Calculate effect of errors on retained earnings. Effect of errors on income and retained earnings. Calculate effect of errors on net income. Calculate effect of errors on retained earnings. Calculate effect of errors on working capital. Determine cumulative effect of error on income statement. Determine the understatement of retained earnings. Calculate effect of error on net income. Compute effect of error on retained earnings.
MULTIPLE CHOICE—CPA Adapted Answer b c a a b d b c a
No. 68. 69. 70. 71. 72. 73. 74. 75. 76.
Description 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. Reporting royalty income when amount realized differs from estimate. Depreciation expense to be recorded following an error. Impact of failure to accrue insurance costs. Retained earnings balance with multiple errors.
Accounting Changes and Error Analysis
EXERCISES Item
Description
E22-77 E22-78 E22-79 E22-80 E22-81 E22-82 E22-83 E22-84 E22-85
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. Effects of errors. Effects of errors.
PROBLEMS Item
Description
P22-86 P22-87 P22-88
Accounting for changes and error corrections. Corrections of errors. Error corrections and adjustments.
CHAPTER LEARNING OBJECTIVES 1.
Identify the types of accounting changes.
2.
Describe the accounting for changes in accounting principles.
3.
Understand how to account for retrospective accounting changes.
4.
Understand how to account for impracticable changes.
5.
Describe the accounting for changes in estimates.
6.
Identify changes in a reporting entity.
7.
Describe the accounting for correction of errors.
8.
Identify economic motives for changing accounting methods.
9.
Analyze the effect of errors.
22 - 3
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Test Bank for Intermediate Accounting, Fourteenth Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1.
TF
2.
TF
21.
3. 4.
TF TF
22. 23.
MC MC
24. 25.
5. 6. 7.
TF TF TF
26. 41. 42.
MC MC MC
43. 44. 45.
8. 27.
TF MC
28. 29.
MC MC
50. 51.
9. 10. 11.
TF TF TF
30. 31. 32.
MC MC MC
33. 34. 52.
12.
TF
13.
TF
35.
14. 15. 16.
TF TF TF
37. 55. 56.
MC MC MC
74. 77. 78.
17. 18. 19. 20.
TF TF TF TF
38. 39. 40. 57.
MC MC MC MC
58. 59. 60. 61.
Note:
TF = True-False MC = Multiple Choice E = Exercise P = Problem
Type
Item
Type
Item
Learning Objective 1 MC Learning Objective 2 MC 68. MC 78. MC 77. E Learning Objective 3 MC 46. MC 49. MC 47. MC 69. MC 48. MC 78. Learning Objective 4 MC 70. MC 79. MC 78. E 80. Learning Objective 5 MC 53. MC 72. MC 54. MC 73. MC 71. MC 77. Learning Objective 6 MC 36. MC 77. Learning Objective 7 MC 79. E 86. E 81. E 87. E 83. E 88. Learning Objective 9 MC 62. MC 66. MC 63. MC 67. MC 64. MC 75. MC 65. MC 76.
Type
Item
Type
Item
Type
MC MC E
79. 80. 86.
E E P
E E
86.
P
MC MC E
78. 79. 81.
E E E
82. 86. 88.
E P P
E
78.
E
81.
E
84. 85. 86. 87.
E E P P
E
P P P MC MC MC MC
Accounting Changes and Error Analysis
22 - 5
TRUE-FALSE—Conceptual 1.
A change in accounting principle is a change that occurs as the result of new information or additional experience.
2.
Errors in financial statements result from mathematical mistakes or oversight or misuse of facts that existed when preparing the financial statements.
3.
Adoption of a new principle in recognition of events that have occurred for the first time or that were previously immaterial is treated as an accounting change.
4.
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.
5.
When a company changes an accounting principle, it should report the change by reporting the cumulative effect of the change in the current year’s income statement.
6.
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.
7.
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.
8.
Retrospective application is considered impracticable if a company cannot determine the prior period effects using every reasonable effort to do so.
9.
Companies report changes in accounting estimates retrospectively.
10.
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.
11.
Companies account for a change in depreciation methods as a change in accounting principle.
12.
When companies make changes that result in different reporting entities, the change is reported prospectively.
13.
Changing the cost or equity method of accounting for investments is an example of a change in reporting entity.
14.
Accounting errors include changes in estimates that occur because a company acquires more experience, or as it obtains additional information.
15.
Companies record corrections of errors from prior periods as an adjustment to the beginning balance of retained earnings in the current period.
16.
If an FASB standard creates a new principle, expresses preference for, or rejects a specific accounting principle, the change is considered clearly acceptable.
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Test Bank for Intermediate Accounting, Fourteenth Edition
17.
Balance sheet errors affect only the presentation of an asset or liability account.
18.
Counterbalancing errors are those that will be offset and that take longer than two periods to correct themselves.
19.
For counterbalancing errors, restatement of comparative financial statements is necessary even if a correcting entry is not required.
20.
Companies must make correcting entries for noncounterbalancing errors, even if they have closed the prior year’s books.
True-False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F T F T F
Item 6. 7. 8. 9. 10.
Ans. T T T F T
Item 11. 12. 13. 14. 15.
Ans. F F T F T
Item 16. 17. 18. 19. 20.
Ans. T F F T T
MULTIPLE CHOICE—Conceptual 21.
Accounting changes are often made and the monetary impact is reflected in the financial statements of a company even though, in theory, this may be a violation of the accounting concept of a. materiality. b. consistency. c. conservatism. d. objectivity.
22.
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 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
23.
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
24.
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.
Accounting Changes and Error Analysis
22 - 7
25.
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.
26.
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.
27.
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.
28.
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.
29.
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.
30.
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
22 - 8
Test Bank for Intermediate Accounting, Fourteenth Edition
31.
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
32.
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.
33.
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.
34.
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.
35.
Which of the following describes a change in reporting entity? a. A company acquires a subsidiary that is to be accounted for as a purchase. b. A manufacturing company expands its market from regional to nationwide. c. A company divests itself of a European branch sales office. d. Changing the companies included in combined financial statements.
36.
Presenting consolidated financial statements this year when statements of individual companies were presented last year is a. a correction of an error. b. an accounting change that should be reported prospectively. c. an accounting change that should be reported by restating the financial statements of all prior periods presented. d. not an accounting change.
Accounting Changes and Error Analysis
22 - 9
37.
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.
38.
Counterbalancing errors do not include a. errors that correct themselves in two years. b. errors that correct themselves in three years. c. an understatement of purchases. d. an overstatement of unearned revenue.
39.
A company using a perpetual inventory system neglected to record a purchase of merchandise on account at year end. This merchandise was omitted from the year-end physical count. How will these errors affect assets, liabilities, and stockholders' equity at year end and net income for the year? Assets No effect No effect Understate Understate
a. b. c. d. 40.
Liabilities Understate Overstate Understate No effect
Stockholders' Equity Overstate Understate No effect Understate
Net Income Overstate. Understate. No effect. Understate.
If, at the end of a period, a company erroneously excluded some goods from its ending inventory and also erroneously did not record the purchase of these goods in its accounting records, these errors would cause a. the ending inventory and retained earnings to be understated. b. the ending inventory, cost of goods sold, and retained earnings to be understated. c. no effect on net income, working capital, and retained earnings. d. cost of goods sold and net income to be understated.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23.
b b c
24. 25. 26.
d a c
27. 28. 29.
c d b
30. 31. 32.
c a b
33. 34. 35.
b c d
36. 37. 38.
c c b
39. 40.
c c
22 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Computational 41.
On January 1, 2010, Neal Corporation acquired equipment at a cost of $900,000. Neal adopted the sum-of-the-years’-digits 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 2013, a decision was made to change to the straight-line method of depreciation for this equipment. The depreciation expense for 2013 would be a. $46,875. b. $75,000. c. $112,500. d. $180,000.
42.
On January 1, 2010, Knapp Corporation acquired machinery at a cost of $500,000. Knapp 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 2013, a decision was made to change to the straight-line method of depreciation for the machinery. The depreciation expense for 2013 would be a. $25,600. b. $36,572. c. $50,000. d. $71,428.
43.
On January 1, 2010, Piper Co., purchased a machine (its only depreciable asset) for $450,000. 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, 2013, for financial statement reporting, Piper decided to change to the straight-line method for depreciation of the machine. Assume that Piper can justify the change. Piper's income before depreciation, before income taxes, and before the cumulative effect of the accounting change (if any), for the year ended December 31, 2013, is $375,000. The income tax rate for 2013, as well as for the years 2010-2012, is 30%. What amount should Piper report as net income for the year ended December 31, 2013? a. $90,000 b. $136,500 c. $231,000 d. $262,500
Use the following information for questions 44 and 45. Ventura Corporation purchased machinery on January 1, 2012 for $840,000. The company used the sum-of-the-years’-digits method and no salvage value to depreciate the asset for the first two years of its estimated six-year life. In 2013, Ventura changed to the straight-line depreciation method for this asset. The following facts pertain: 2012 2013 Straight-line $140,000 $140,000 Sum-of-the-years’-digits 240,000 200,000
Accounting Changes and Error Analysis
22 - 11
44.
Ventura is subject to a 40% tax rate. The cumulative effect of this accounting change on beginning retained earnings is a. $180,000. b. $160,000. c. $96,000. d. $0.
45.
The amount that Ventura should report for depreciation expense on its 2014 income statement is a. $160,000. b. $140,000. c. $100,000. d. none of the above.
46.
During 2013, 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: 2011 2012 2013
Completed-Contract $ 475,000 625,000 700,000 $1,800,000
Percentage-of-Completion $ 700,000 950,000 1,050,000 $2,700,000
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. $540,000 on the 2013 income statement. b. $330,000 on the 2013 income statement. c. $540,000 on the 2013 retained earnings statement. d. $330,000 on the 2013 retained earnings statement. Use the following information for questions 47 and 48. On January 1, 2010, Nobel Corporation acquired machinery at a cost of $800,000. Nobel 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 2013, a decision was made to change to the double-declining balance method of depreciation for this machine. 47.
Assuming a 30% tax rate, the cumulative effect of this accounting change on beginning retained earnings, is a. $89,600. b. $0. c. $105,280. d. $150,400.
48.
The amount that Nobel should record as depreciation expense for 2013 is a. $80,000. b. $112,000. c. $160,000. d. none of the above.
22 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition 49.
On December 31, 2013 Dean Company changed its method of accounting for inventory from weighted average cost method to the FIFO method. This change caused the 2013 beginning inventory to increase by $630,000. The cumulative effect of this accounting change to be reported for the year ended 12/31/13, assuming a 40% tax rate, is a. $630,000. b. $378,000. c. $252,000. d. $0.
50.
Heinz Company began operations on January 1, 2012, and uses the FIFO method in costing its raw material 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)
2012 $640,000 560,000 980,000
2013 $ 712,000 636,000 1,030,000
Based on the above information, a change to the LIFO method in 2013 would result in net income for 2013 of a. $1,070,000. b. $1,030,000. c. $ 954,000. d. $ 950,000. 51.
Lanier Company began operations on January 1, 2012, and uses the FIFO method in costing its raw material 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 2012 2013 FIFO $320,000 $360,000 LIFO 240,000 300,000 Net Income (computed under the FIFO method) 500,000 550,000 Based upon the above information, a change to the LIFO method in 2013 would result in net income for 2013 of a. $490,000. b. $550,000. c. $570,000. d. $610,000.
52.
Equipment was purchased at the beginning of 2010 for $340,000. At the time of its purchase, the equipment was estimated to have a useful life of six years and a salvage value of $40,000. The equipment was depreciated using the straight-line method of depreciation through 2012. At the beginning of 2013, the estimate of useful life was revised to a total life of eight years and the expected salvage value was changed to $25,000. The amount to be recorded for depreciation for 2013, reflecting these changes in estimates, is a. $20,625. b. $33,000. c. $38,000. d. $39,375.
Accounting Changes and Error Analysis
22 - 13
Use the following information for questions 53 and 54. Swift Company purchased a machine on January 1, 2010, for $500,000. 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, 2013, Swift 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 2013 to reflect this additional information. 53.
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 2010, 2011, 2012, and 2013. What should be reported in Swift's income statement for the year ended December 31, 2013, as the cumulative effect on prior years of changing the estimated useful life of the machine? a. $0 b. $33,000 c. $50,000 d. $175,000
54.
What is the amount of depreciation expense on this machine that should be charged in Swift's income statement for the year ended December 31, 2013? a. $ 50,000 b. $ 62,500 c. $100,000 d. $125,000
Use the following information for questions 55 and 56. Armstrong Inc. is a calendar-year corporation. Its financial statements for the years ended 12/31/12 and 12/31/13 contained the following errors:
Ending inventory Depreciation expense
2012 $20,000 overstatement 8,000 understatement
2013 $32,000 understatement 16,000 overstatement
55.
Assume that the 2012 errors were not corrected and that no errors occurred in 2011. By what amount will 2012 income before income taxes be overstated or understated? a. $28,000 overstatement b. $12,000 overstatement c. $28,000 understatement d. $12,000 understatement
56.
Assume that no correcting entries were made at 12/31/12, or 12/31/13. Ignoring income taxes, by how much will retained earnings at 12/31/13 be overstated or understated? a. $32,000 overstatement b. $28,000 overstatement c. $40,000 understatement d. $12,000 understatement
22 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition Use the following information for questions 57 through 59. Langley Company's December 31 year-end financial statements contained the following errors: Dec. 31, 2012 Dec. 31, 2013 Ending inventory $15,000 understated $22,000 overstated Depreciation expense 4,000 understated An insurance premium of $36,000 was prepaid in 2012 covering the years 2012, 2013, and 2014. The prepayment was recorded with a debit to insurance expense. In addition, on December 31, 2013, fully depreciated machinery was sold for $19,000 cash, but the sale was not recorded until 2014. There were no other errors during 2013 or 2014 and no corrections have been made for any of the errors. Ignore income tax considerations. 57.
What is the total net effect of the errors on Langley's 2013 net income? a. Net income understated by $29,000. b. Net income overstated by $15,000. c. Net income overstated by $26,000. d. Net income overstated by $30,000.
58.
What is the total net effect of the errors on the amount of Langley's working capital at December 31, 2013? a. Working capital overstated by $10,000 b. Working capital overstated by $3,000 c. Working capital understated by $9,000 d. Working capital understated by $24,000
59.
What is the total effect of the errors on the balance of Langley's retained earnings at December 31, 2013? a. Retained earnings understated by $20,000 b. Retained earnings understated by $9,000 c. Retained earnings understated by $5,000 d. Retained earnings overstated by $7,000
60.
Accrued salaries payable of $51,000 were not recorded at December 31, 2012. Office supplies on hand of $34,000 at December 31, 2013 were erroneously treated as expense instead of supplies inventory. Neither of these errors was discovered nor corrected. The effect of these two errors would cause a. 2013 net income to be understated $85,000 and December 31, 2013 retained earnings to be understated $34,000. b. 2012 net income and December 31, 2012 retained earnings to be understated $51,000 each. c. 2012 net income to be overstated $17,000 and 2013 net income to be understated $34,000. d. 2013 net income and December 31, 2013 retained earnings to be understated $34,000 each.
Accounting Changes and Error Analysis
22 - 15
Use the following information for questions 61 through 63. Bishop Co. began operations on January 1, 2012. Financial statements for 2012 and 2013 contained the following errors: Dec. 31, 2012 Dec. 31, 2013 Ending inventory $132,000 too high $166,000 too low Depreciation expense 84,000 too high — Insurance expense 60,000 too low 60,000 too high Prepaid insurance 60,000 too high — In addition, on December 31, 2013 fully depreciated equipment was sold for $28,800, but the sale was not recorded until 2014. No corrections have been made for any of the errors. Ignore income tax considerations. 61.
The total effect of the errors on Bishop's 2013 net income is a. understated by $386,800. b. understated by $254,800. c. overstated by $137,200. d. overstated by $269,200.
62.
The total effect of the errors on the balance of Bishop's retained earnings at December 31, 2013 is understated by a. $338,800. b. $278,800. c. $194,800. d. $146,800.
63.
The total effect of the errors on the amount of Bishop's working capital at December 31, 2013 is understated by a. $410,800. b. $326,800. c. $194,800. d. $134,800.
Use the following information for questions 64 and 65. Link Co. purchased machinery that cost $1,350,000 on January 4, 2011. The entire cost was recorded as an expense. The machinery has a nine-year life and a $90,000 residual value. The error was discovered on December 20, 2013. Ignore income tax considerations. 64.
Link's income statement for the year ended December 31, 2013, should show the cumulative effect of this error in the amount of a. $1,210,000. b. $1,070,000. c. $930,000. d. $0.
65.
Before the correction was made, and before the books were closed on December 31, 2013, retained earnings was understated by a. $1,350,000. b. $1,210,000. c. $1,070,000. d. $930,000.
22 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition Use the following information for questions 66 and 67. Ernst Company purchased equipment that cost $1,500,000 on January 1, 2012. The entire cost was recorded as an expense. The equipment had a nine-year life and a $60,000 residual value. Ernst uses the straight-line method to account for depreciation expense. The error was discovered on December 10, 2014. Ernst is subject to a 40% tax rate. 66.
Ernst’s net income for the year ended December 31, 2012, was understated by a. $804,000. b. $900,000. c. $1,340,000. d. $1,500,000.
67.
Before the correction was made and before the books were closed on December 31, 2014, retained earnings was understated by a. $664,000. b. $672,000. c. $708,000. d. $900,000.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
41. 42. 43. 44.
b b c d
45. 46. 47. 48.
c d b c
49. 50. 51. 52.
b c a b
53. 54. 55. 56.
a a a c
57. 58. 59. 60.
d c c a
61. 62. 63. 64.
a b c d
65. 66. 67.
c a c
MULTIPLE CHOICE—CPA Adapted 68.
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
69.
On December 31, 2013, Grantham, 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 $2,000,000 increase in the beginning inventory at January 1, 2013. Assume a 30% income tax rate. The cumulative effect of this accounting change on beginning retained earnings is a. $0. b. $600,000. c. $1,400,000. d. $2,000,000.
Accounting Changes and Error Analysis
22 - 17
70.
On January 1, 2013, Frost Corp. changed its inventory method to FIFO from LIFO for both financial and income tax reporting purposes. The change resulted in a $900,000 increase in the January 1, 2013 inventory. Assume that the income tax rate for all years is 30%. The cumulative effect of the accounting change should be reported by Frost in its 2013 a. retained earnings statement as a $630,000 addition to the beginning balance. b. income statement as a $630,000 cumulative effect of accounting change. c. retained earnings statement as a $900,000 addition to the beginning balance. d. income statement as a $900,000 cumulative effect of accounting change.
71.
On January 1, 2010, Lake Co. purchased a machine for $1,056,000 and depreciated it by the straight-line method using an estimated useful life of eight years with no salvage value. On January 1, 2013, Lake determined that the machine had a useful life of six years from the date of acquisition and will have a salvage value of $96,000. An accounting change was made in 2013 to reflect these additional data. The accumulated depreciation for this machine should have a balance at December 31, 2013 of a. $584,000. b. $616,000. c. $640,000. d. $704,000.
72.
On January 1, 2010, Hess Co. purchased a patent for $714,000. The patent is being amortized over its remaining legal life of 15 years expiring on January 1, 2025. During 2013, Hess 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, 2013? a. $428,400 b. $489,600 c. $504,000 d. $523,650
73.
During 2012, a textbook written by Mercer Co. personnel was sold to Roark Publishing, Inc., for royalties of 10% on sales. Royalties are receivable semiannually on March 31, for sales in July through December of the prior year, and on September 30, for sales in January through June of the same year. •
Royalty income of $162,000 was accrued at 12/31/12 for the period July-December 2012. • Royalty income of $180,000 was received on 3/31/13, and $234,000 on 9/30/13. • Mercer learned from Roark that sales subject to royalty were estimated at $2,430,000 for the last half of 2013. In its income statement for 2013, Mercer should report royalty income at a. $414,000. b. $432,000. c. $477,000. d. $495,000.
22 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 74.
On January 1, 2012, Janik Corp. acquired a machine at a cost of $800,000. 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 Janik's 2012 financial statements. The oversight was discovered during the preparation of Janik's 2013 financial statements. Depreciation expense on this machine for 2013 should be a. $0. b. $160,000. c. $200,000. d. $320,000.
75.
On December 31, 2013, special insurance costs, incurred but unpaid, were not recorded. If these insurance costs were related to work in process, what is the effect of the omission on accrued liabilities and retained earnings in the December 31, 2013 balance sheet? Accrued Liabilities No effect No effect Understated Understated
a. b. c. d. 76.
Retained Earnings No effect Overstated No effect Overstated
Black, Inc. is a calendar-year corporation whose financial statements for 2012 and 2013 included errors as follows: Year 2012 2013
Ending Inventory $162,000 overstated 59,000 understated
Depreciation Expense $135,000 overstated 45,000 understated
Assume that purchases were recorded correctly and that no correcting entries were made at December 31, 2012, or at December 31, 2013. Ignoring income taxes, by how much should Black's retained earnings be retroactively adjusted at January 1, 2014? a. $149,000 increase b. $41,000 increase c. $14,000 decrease d. $13,000 increase
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
68. 69.
b c
70. 71.
a a
72. 73.
b d
74. 75.
b c
76.
a
DERIVATIONS — Computational No. Answer
Derivation
41.
b
[(8 + 7 + 6) ÷ 36] × $900,000 = $ 525,000 (AD) ($900,000 - $ 525,000) ÷ 5 = $ 75,000.
42.
b
{$500,000 – [($500,000 × .2) + ($400,000 × .2) + ($320,000 × .2)]} ÷ 7 = $36,572.
Accounting Changes and Error Analysis
22 - 19
DERIVATIONS — Computational (cont.) No. Answer
Derivation
43.
c
[(5/15 + 4/15 + 3/15) × $450,000] = $360,000 (AD) ($450,000 – $360,000) = $90,000 (BV) [$375,000 – ($90,000 ÷ 2)] × (1 – .3) = $231,000.
44.
d
$0, No cumulative effect; handle prospectively.
45.
c
[$840,000 – ($240,000 + $200,000)] ÷ 4 = $100,000.
46.
d
[($700,000 + $950,000) – ($475,000 + $625,000)] × (1 – .40) = $330,000.
47.
b
$0, No cumulative effect; handle prospectively.
48.
c
{($800,000 – [($800,000 ÷ 10) × 3]} ÷ 7 × 2 = $160,000.
49.
b
$630,000 × (1 – .40) = $378,000.
50.
c
$1,030,000 – ($712,000 – $636,000) = $954,000.
51.
a
$550,000 – ($360,000 – $300,000) = $490,000.
52.
b
$340,000 – {[($340,000 – $40,000) ÷ 6] × 3} = $190,000 ($190,000 – $25,000) ÷ (8 – 3) = $33,000.
53.
a
$0, no cumulative effect, handle prospectively (change in estimate).
54.
a
($500,000 ÷ 6) × 3 = $250,000 $250,000 ÷ 5 = $50,000.
55.
a
$20,000 + $8,000 = $28,000 overstatement.
56.
c
$32,000 + $8,000 = $40,000 understatement.
57.
d
$15,000 (o) + $22,000 (o) + $12,000 (o) – $19,000 (u) = $30,000 (o).
58.
c
$22,000 (o) – $12,000 (u) – $19,000 (u) = $9,000 (u).
59.
c
$4,000 (o) + $22,000 (o) – $12,000 (u) – $19,000 (u) = $5,000 (u).
60.
a
2013 NI = $51,000 (u) + $34,000 (u) = $85,000 (u). 2013 RE = $34,000 (u) [The 2012 $51,000 (o) is offset by 2013 $51,000 (u)].
61.
a
$132,000 (u) + $166,000 (u) + $60,000 (u) + $28,800 (u) = $386,800 (u).
62.
b
$166,000 (u) + $84,000 (u) – $60,000 (o) + $60,000 (u) + $28,800 (u) = $278,800 (u).
63.
c
$166,000 (u) + $28,800 (u) = $194,800 (u).
64.
d
CE = $0, correction of error.
22 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No. Answer
Derivation
65.
c
$1,350,000 –
66.
a
($1,500,000 – [($1,500,000 – $60,000) ÷ 9]) × (1 – .40) = $804,000.
67.
c
$1,500,000 – [($1,500,000 – $60,000) ÷ 9 × 2] = $1,180,000. $1,180,000 × (1 – .40) = $708,000.
$1,350, 000 − $90, 000 2 = $1,070,000 9
DERIVATIONS — CPA Adapted No. Answer
Derivation
68.
b
Conceptual.
69.
c
$2,000,000 × (1 – .3) = $1,400,000.
70.
a
$900,000 × (1 – .3) = $630,000.
71.
a
$1,056,000 × 3/8 = $396,000 $396,000 + [($1,056,000 – $396,000 – $96,000) × 1/3] = $584,000.
72.
b
$714,000 × 3/15 = $142,800 $714,000 – $142,800 – [($714,000 – $142,800) × 1/7] = $489,600.
73.
d
($180,000 – $162,000) + $234,000 + ($2,430,000 × .10) = $495,000.
74.
b
$800,000 ÷ 5 = $160,000.
75.
c
Conceptual.
76.
a
$59,000 (u) + $135,000 (u) – $45,000 (o) = $149,000 (u).
Accounting Changes and Error Analysis
22 - 21
EXERCISES Ex. 22-77—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. ____
1.
Change from presenting nonconsolidated to consolidated financial statements.
____
2.
Change due to charging a new asset directly to an expense account.
____
3.
Change from expensing to capitalizing certain costs, due to a change in periods benefited.
____
4.
Change from FIFO to LIFO inventory procedures.
____
5.
Change due to failure to recognize an accrued (uncollected) revenue.
____
6.
Change in amortization period for an intangible asset.
____
7.
Changing the companies included in combined financial statements.
____
8.
Change in the loss rate on warranty costs.
____
9.
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.
____ 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.
____ 18.
Change in expected recovery of an account receivable.
Solution 22-77 1. c 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 18. b
22 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 22-78—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 (retrospective application impractical)
(d)
Change from presentation of statements of individual companies to presentation of consolidated statements
(e)
Change due to failure to record depreciation in a previous period
(f)
Change in the realizability of certain receivables
(g)
Change from LIFO to FIFO method for inventory valuation purposes
Solution 22-78 (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 entity; retrospective restatement of financial statements of all prior periods presented; adjustment of beginning retained earnings of the current period.
(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 estimate; currently and prospectively.
(g)
Change in accounting principle; retrospective restatement of all affected prior financial statements; adjustment of beginning retained earnings of the current period.
Accounting Changes and Error Analysis
22 - 23
Ex. 22-79—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 Helton Corporation for 2013. 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
____
1.
In 2013, the company changed its method of recognizing income from the completed-contract method to the percentage-of-completion method.
____
2.
At the end of 2013, 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 2012, the allowance seemed appropriate.
____
3.
Depreciation on a truck, acquired in 2010, was understated because the service life had been overestimated. The understatement had been made in order to show higher net income in 2011 and 2012.
____
4.
The company switched from a LIFO to a FIFO inventory valuation method during the current year.
____
5.
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.
____
6.
During 2013, a long-term bond with a carrying value of $3,600,000 was retired at a cost of $4,100,000.
____
7.
After negotiations with the IRS, income taxes for 2011 were established at $42,900. They were originally estimated to be $28,600.
____
8.
In 2013, the company incurred interest expense of $29,000 on a 20-year bond issue.
____
9.
In computing the depreciation in 2011 for equipment, an error was made which overstated income in that year $75,000. The error was discovered in 2013.
____ 10.
In 2013, the company changed its method of depreciating plant assets from the double-declining balance method to the straight-line method.
Solution 22-79 1. 2.
c a
3. 4.
b c
5. 6.
a d
7. 8.
a d
9. 10.
b a
22 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 22-80—Change in accounting principle. In 2013, Fischer 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 2010 $78,200 $81,700 2011 84,500 88,100 2012 87,000 91,400 2013 92,500 96,700 Instructions (a) Indicate the net income that would be shown on comparative financial statements issued at 12/31/13 for each of the four years, assuming that the company changed to the FIFO method in 2013. (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: 2010, $80,400; 2011, $86,120; 2012, $90,300; and 2013, $93,600. Indicate the net income that would be shown on comparative financial statements issued at 12/31/13 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 12/31/13 for 2010, 2011, and 2012?
Solution 22-80 (a)
2010, $81,700; 2011, $88,100; 2012, $91,400; 2013, $96,700, (Retrospective restatement).
(b) (c)
2010, $81,700; 2011, $88,100; 2012, $91,400; 2013, $96,700, (Retrospective restatement). 2010, $81,700; 2011, $88,100; 2012, $91,400. (retrospective application impractical)
Ex. 22-81—Change in estimate, change in entity, correction of errors. Discuss the accounting procedures for and illustrate the following: (a) Change in estimate (b) Change in entity (c) Correction of an error
Solution 22-81 (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.
Accounting Changes and Error Analysis
22 - 25
Solution 22-81 (cont.) (b)
A change in accounting entity results in financial statements of a different entity. Examples of changes in entity are: (a) consolidated statements replacing individual statements, (b) different subsidiaries in the group for which consolidated statements are presented, (c) different companies included in combined financial statements, and (d) a pooling of interests. The financial statements of all prior periods presented should be restated to show the financial information for the new reporting entity for all periods.
(c)
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. 22-82—Changes in depreciation methods, estimates. On January 1, 2008, Powell Company purchased a building and machinery that have the following useful lives, salvage value, and costs. Building, 25-year estimated useful life, $5,000,000 cost, $500,000 salvage value Machinery, 10-year estimated useful life, $700,000 cost, no salvage value The building has been depreciated under the straight-line method through 2012. In 2013, the company decided to switch to the double-declining balance method of depreciation for the building. Powell also decided to change the total useful life of the machinery to 8 years, with a salvage value of $35,000 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 2013. (b) Compute depreciation expense on the machinery for 2013.
Solution 22-82 Computation of 2013 depreciation expense on the building: Cost of building Accumulated depreciation [($5,000,000 – $500,000) ÷ 25] × 5 years Book value, 1/1/13
$5,000,000 900,000 $4,100,000
2013 Depreciation expense: $4,100,000 × 10% = $410,000 Depreciation Expense .................................................................... Accumulated Depreciation—Building.....................................
410,000 410,000
22 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 22-82 (cont.) Computation of 2013 depreciation expense on machinery: Cost of machinery Accumulated depreciation [($700,000 – $0) ÷ 10] × 5 years Book value, 1/1/13
$700,000 350,000 $350,000
2013 Depreciation expense: ($350,000 – $35,000) ÷ (8 – 5) = $315,000 ÷ 3 = $105,000
Ex. 22-83—Noncounterbalancing error. Quigley Co. bought a machine on January 1, 2011 for $1,050,000. It had a $90,000 estimated residual value and a ten-year life. An expense account was debited on the purchase date. Quigley uses straight-line depreciation. This was discovered in 2013. Instructions Prepare the entry or entries related to the machine for 2013.
Solution 22-83 Machine ............................................................................................... 1,050,000 Retained Earnings .................................................................... Accumulated Depreciation−machinery (2 × $96,000) ................
858,000 192,000
Depreciation Expense .......................................................................... Accumulated Depreciation−machinery ......................................
96,000
96,000
Ex. 22-84—Effects of errors. Show how the following independent errors will affect net income on the Income Statement and the stockholders' equity section of the Balance Sheet using the symbol + (plus) for overstated, – (minus) for understated, and 0 (zero) for no effect. 2012 2013 Income Balance Income Balance Statement Sheet Statement Sheet 1. Ending inventory in 2012 overstated. 2. Failed to accrue 2012 interest revenue. 3. A capital expenditure for factory equipment (useful life, 5 years) was erroneously charged to maintenance expense in 2012.
Accounting Changes and Error Analysis
22 - 27
Ex. 22-84 (cont.) 2012 Income Balance Statement Sheet
2013 Income Balance Statement Sheet
4. Failed to count office supplies on hand at 12/31/12. Cash expenditures have been charged to a supplies expense account during the year 2012. 5. Failed to accrue 2012 wages. 6. Ending inventory in 2012 understated. 7. Overstated 2012 depreciation expense; 2013 expense correct.
Solution 22-84 2012 Income Balance Statement Sheet
2013 Income Balance Statement Sheet
1. Ending inventory in 2012 overstated.
+
+
–
0
2. Failed to accrue 2012 interest revenue.
–
–
+
0
3. A capital expenditure for factory equipment (useful life, 5 years) was erroneously charged to maintenance expense in 2012.
–
–
+
–
4. Failed to count office supplies on hand at 12/31/12. Cash expenditures have been charged to Supplies Expense during the year 2012.
–
–
+
0
5. Failed to accrue 2012 wages.
+
+
–
0
6. Ending inventory in 2012 understated.
–
–
+
0
7. Overstated 2012 depreciation expense; 2013 expense correct
–
–
0
–
22 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 22-85—Effects of errors. Joseph Co. began operations on January 1, 2012. Financial statements for 2012 and 2013 contained the following errors: Dec. 31, 2012 Dec. 31, 2013 Ending inventory $80,000 too high $114,000 too high Depreciation expense 48,000 too low — Accumulated depreciation 48,000 too low 48,000 too low Insurance expense 42,000 too high 42,000 too low Prepaid insurance 36,000 too low In addition, on December 26, 2013 fully depreciated equipment was sold for $53,000, but the sale was not recorded until 2014. No corrections have been made for any of the errors. Instructions Ignoring income taxes, show your calculation of the total effect of the errors on 2013 net income.
Solution 22-85 2012 ending inventory 2013 ending inventory Insurance expense Unrecorded gain Overstatement of 2013 income
$ (80,000) 114,000 42,000 (53,000) $ 23,000
Note: The error in depreciation expense has no effect on 2013 income. The error in prepaid insurance is related to the error in insurance expense.
PROBLEMS Pr. 22-86—Accounting for changes and error corrections. Dyke Company's net incomes for the past three years are presented below: 2014 2013 2012 $480,000 $450,000 $360,000 During the 2014 year-end audit, the following items come to your attention: 1. Dyke bought equipment on January 1, 2011 for $294,000 with a $24,000 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 2014, Dyke 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: 2014 2013 2012 Straight-line 36,000 36,000 36,000 Double-declining 46,080 57,600 72,000
Accounting Changes and Error Analysis
22 - 29
Pr. 22-86 (cont.) The net income for 2014 was computed using the double-declining balance method, on the January 1, 2014 book value, over the useful life remaining at that time. The depreciation recorded in 2014 was $72,000. 3. Dyke, in reviewing its provision for uncollectibles during 2014, 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 2013 and 2014 when the expense had been $18,000 and $12,000, respectively. The company recorded bad debt expense under the new rate for 2014. The company would have recorded $6,000 less of bad debt expense on December 31, 2014 under the old rate. 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 2012 through 2014.
(c)
Assume that the beginning retained earnings balance (unadjusted) for 2012 was $1,260,000. At what adjusted amount should this beginning retained earnings balance for 2012 be stated, assuming that comparative financial statements were prepared?
(d)
Assume that the beginning retained earnings balance (unadjusted) for 2014 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 22-86 (a)
Equipment ................................................................................... Depreciation Expense ................................................................. Accumulated Depreciation (4 years, 11-14) ..................... Retained Earnings ...........................................................
(b)
2012: $360,000 – $45,000 = $315,000. 2013: $450,000 – $45,000 = $405,000. 2014: $480,000 – $45,000 = $435,000.
(c)
Retained earnings (unadjusted) Correction of 2011 error ($294,000 – $45,000) Retained earnings (adjusted)
$1,260,000 249,000 $1,509,000
(d)
Retained earnings (unadjusted) Correction of error ($294,000 – $135,000) Retained earnings (adjusted)
$1,800,000 159,000 $1,959,000
294,000 45,000 180,000 159,000
22 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 22-87—Correction of errors. Vance Company reported net incomes for a three-year period as follows: 2011, $191,000; 2012, $199,000; 2013, $180,000. In reviewing the accounts in 2014 after the books for the prior year have been closed, you find that the following errors have been made in summarizing activities: 2011 2012 2013 Overstatement of ending inventory $42,000 $51,000 $29,000 Understatement of accrued advertising expense 6,600 12,000 7,200 Instructions (a) Determine corrected net incomes for 2011, 2012, and 2013. (b)
Give the entry to bring the books of the company up to date in 2014, assuming that the books have been closed for 2013.
Solution 22-87 (a)
2011 $191,000 (42,000)
Net income (unadjusted) Overstatement of ending inventory—2011 Overstatement of ending inventory—2012 Overstatement of ending inventory—2013 Understatement of accrued advertising expense—2011 (6,600) Understatement of accrued advertising expense—2012 Understatement of accrued advertising expense—2013 Net income (corrected) $142,400 (b) Retained Earnings......................................................................... Advertising Expense ........................................................... Inventory .............................................................................
2012 2013 $199,000 $180,000 42,000 (51,000) 51,000 (29,000) 6,600 (12,000) 12,000 (7,200) $184,600 $206,800 36,200 7,200 29,000
Pr. 22-88—Error corrections and adjustments. The controller for Haley Corporation is concerned about certain business transactions that the company experienced during 2013. The controller, after discussing these matters with various individuals, has come to you for advice. The transactions at issue are presented below. 1. The company has decided to switch from the direct write-off method in accounting for bad debt expense to the percentage-of-sales approach. Assume that Haley Corporation has recognized bad debt expense as the receivables have actually become uncollectible in the following way: 2012 2013 From 2012 sales 31,800 15,000 From 2013 sales 45,000 The controller estimates that an additional $65,400 will be charged off in 2014: $11,400 applicable to 2012 sales and $54,000 to 2013 sales.
Accounting Changes and Error Analysis
22 - 31
Pr. 22-88 (cont.) 2. Inventory has been shipped on consignment. These transactions have been recorded as ordinary sales and billed as such on account. At December 31, 2013, inventory billed and in the hands of consignees amounted to $450,000. The percentage markup on selling price is 20%. Assume that consigned inventory is sold the following year. The company uses the perpetual inventory system. 3. During the current year, the company sold $600,000 of goods on the installment basis. The cost of sales associated with these goods sold is $420,000. The company inadvertently handled these sales and related costs as part of the regular sales transactions. Cash of $172,000, including a down payment of $60,000, was collected on these installment sales during the current year. Due to questionable collectibility, the installment−sales method was considered appropriate. Instructions (a) Assume that Haley Corporation reported net income of $1,200,000 for 2013. Present a schedule showing the corrected net income after reviewing the above transactions. (b)
Prepare the journal entries necessary at December 31, 2013, assuming that the books have been closed.
Solution 22-88 (a)
Reported net income 1. Additional charge for bad debts 2012 debts written off in 2013 2013 debts to be written off in 2014
$1,200,000 $ 15,000 (54,000)
2. Consignment—(20% × $450,000) 3. Gross profit— Recognized Should be (30% × $172,000) Corrected net income (b)
(39,000) (90,000)
180,000 (51,600)
1. Retained Earnings ................................................................. Allowance for Doubtful Accounts ................................
65,400
2. Consignment Out (Inventory) ................................................. Retained Earnings ................................................................. Accounts Receivable..................................................
360,000 90,000
3. Retained Earnings ................................................................. Deferred Gross Profit .................................................
128,400
(128,400) $942,600
65,400
450,000
128,400
22 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS True/False 1. IFRS requires that changes in estimate be accounted for using the retrospective method. 2. IFRS requires that any indirect effect of a change in accounting policy, such as increased royalty payments, be recognized in income in the year of the change in policy. 3. IFRS requires that companies with equity method investments conform the accounting policies of their investees to their accounting policies prior to applying the equity method of accounting. 4. Both IFRS and U.S. GAAP allow that if determining the effect of a change in accounting principle is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so. 5. U.S. GAAP does not specifically address how companies should account for the indirect effects of changes in accounting principle. Answers to True/False: 1. False 2. False 3. True 4. True 5. False
Multiple Choice 1. Is the following exception applicable to IFRS or U.S. GAAP? “If determining the effect of a change in accounting principle is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so.” IFRS U.S. GAAP a. Yes Yes b. Yes No c. No Yes d. No No 2. Is the following exception applicable to IFRS or U.S. GAAP? “If determining the effect of a correction of an error is considered impracticable, then a company should report the effect of the error correction in the period in which it believes it practicable to do so.” IFRS U.S. GAAP a. Yes Yes b. Yes No c. No Yes d. No No
Accounting Changes and Error Analysis
22 - 33
3. Detailed guidance regarding the accounting and reporting for the indirect effects of changes in accounting principle is available under a. both U.S. GAAP and IFRS. b. neither U.S. GAAP nor IFRS. c. U.S. GAAP only. d. IFRS only. 4. Ben, Inc. follows IFRS for its external financial reporting. Ben, Inc. owns 25% of the outstanding stock of Black, Inc. and accordingly uses the equity method to account for its investment. Which of the following is true regarding Ben, Inc.’s policies related to Black, Inc.? a. Ben, Inc. will increase the investment account for its pro-rata share of Black, Inc.’s net loss for the year. b. Ben, Inc. will increase the investment account for its pro-rata share of the dividends paid out by Black, Inc. for the year. c. Ben, Inc. will conform the accounting policies of Black, Inc. to its own accounting policies. d. None of the above is true regarding how Ben, Inc. accounts for its investment in Black, Inc. 5. Ben, Inc. follows U.S. GAAP for its external financial reporting. Ben, Inc. owns 25% of the outstanding stock of Black, Inc. and accordingly uses the equity method to account for its investment. Which of the following is true regarding Ben, Inc.’s policies related to Black, Inc.? a. Ben, Inc. will increase the investment account for its pro-rata share of Black, Inc.’s net loss for the year. b. Ben, Inc. will increase the investment account for its pro-rata share of the dividends paid out by Black, Inc. for the year. c. Ben, Inc. will conform the accounting policies of Black, Inc. to its own accounting policies. d. None of the above is true regarding how Ben, Inc. accounts for its investment in Black, Inc. 6. Haystack, Inc. owns 30% of the outstanding stock of Hallmark, Inc. and accordingly uses the equity method to account for its investment. The stock was purchased on January 1, 2013 for $780,000. During the year ended December 31, 2013, Hallmark, Inc. reported the following: Dividends declared and paid $ 400,000 Net income 2,400,000 Haystack, Inc. uses the FIFO method for costing its inventories, while Hallmark, Inc. uses the LIFO method to conform with other companies in its industry. Haystack, Inc. determines that if Hallmark, Inc. had used the FIFO method, its income would have been $350,000 higher during 2013. What is the balance in the Investment in Hallmark, Inc. that will be reported on Haystack, Inc.’s balance sheet at December 31, 2013 assuming Haystack, Inc. follows IFRS for its external financial reporting? a. $1,725,000 b. $1,380,000 c. $1,485,000 d. $1,275,000
22 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition 7. Haystack, Inc. owns 30% of the outstanding stock of Hallmark, Inc. and accordingly uses the equity method to account for its investment. The stock was purchased on January 1, 2013 for $780,000. During the year ended December 31, 2013, Hallmark, Inc. reported the following: Dividends declared and paid $ 400,000 Net income 2,400,000 Haystack, Inc. uses the FIFO method for costing its inventories, while Hallmark, Inc. uses the LIFO method to conform with other companies in its industry. Haystack, Inc. determines that if Hallmark, Inc. had used the FIFO method, its income would have been $350,000 higher during 2013. What is the balance in the Investment in Hallmark, Inc. that will be reported on Haystack, Inc.’s balance sheet at December 31, 2013 assuming Haystack, Inc. follows U.S. GAAP for its external financial reporting? a. $1,725,000 b. $1,380,000 c. $1,485,000 d. $1,275,000 8. Ridge, Inc. follows IFRS for its external financial reporting, and Cannon Company follows U.S. GAAP for its external financial reporting. During 2013, both companies changed depreciation methods, from double-declining balance to straight-line. Compared to double-declining balance, for Ridge, Inc. the change resulted in a decrease in reported depreciation expense of $60,000, and for Cannon Company the change resulted in a reported decrease in depreciation expense of $70,000. The remaining useful lives of the assets impacted by the change in depreciation method is 10 years for both companies. How would this change impact the net income reported by Ridge, Inc. and Cannon Company for the year ended December 31, 2013? Ridge, Inc. Cannon Company a. Decrease $60,000 Decrease $70,000 b. Increase $6,000 Increase $7,000 c. Increase $60,000 Increase $70,000 d. Increase $60,000 Increase $7,000 9. Mars, Inc. follows IFRS for its external financial reporting. On January 1, 2013, Mars, Inc. purchased 25% of the outstanding stock of Jerome Company (which uses U.S. GAAP for its external financial reporting) for $740,000, and appropriately uses the equity method to account for its investment. Jerome Company reports the following activity for the year ended December 31, 2013: Net loss $60,000 Dividends declared and paid 20,000 Jerome Company uses the completed-contract method for revenue recognition related to its long-term construction contracts, while Mars, Inc. uses the percentage-of-completion method. Mars, Inc. determines that if Jerome Company had used the percentage-of-completion method, its income would have been $100,000 higher during 2013. What is the balance in the Investment in Jerome Company that will be reported on Mars, Inc.’s balance sheet at December 31, 2013? a. $775,000 b. $720,000 c. $740,000 d. $735,000
Accounting Changes and Error Analysis
22 - 35
10. Mars, Inc. follows IFRS for its external financial reporting, while Jerome Company uses U.S. GAAP for its external financial reporting. During the year ended December 31, 2013, both companies changed from using the completed-contract method of revenue recognition for long-term construction contracts to the percentage-of-completion method. Both companies experienced an indirect effect, related to increased profit-sharing payments in 2013, of $24,000. As a result of this change, how much expense related to the profit-sharing payment must be recognized by each company on the income statement for the year ended December 31, 2013? Mars, Inc. Jerome Company a. $24,000 $24,000 b. $24,000 $-0c. $-0$-0d. $-0$24,000 Answers to multiple choice: 1. a 2. b 3. c 4. c 5. d 6. c 7. b 8. c 9. c 10. d Short Answer 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to reporting accounting changes. 1. The FASB has issued guidance on changes in accounting principles, changes in estimates, and corrections of errors, which essentially converges U.S. GAAP to IAS 8. Key remaining differences are as follows: • •
•
One area in which IFRS and U.S. GAAP differ is the reporting of error corrections in previously issued financial statements. While both GAAPs require restatement, U.S. GAAP is an absolute standard – that is, there is no exception to this rule. Under U.S. GAAP and IFRS, if determining the effect of a change in accounting principle is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so, which may be the current period. Under IFRS, the impracticality exception applies to both changes in accounting principles and to the correction of errors. Under U.S. GAAP, this exception only applies to changes in accounting principle. IAS 8 does not specifically address the accounting and reporting for indirect effects of changes in accounting principles. As indicated in the chapter, U.S. GAAP has detailed guidance on the accounting and reporting of indirect effects.
2. How might differences in presentation of comparative data under U.S. and IFRS affect adoption of IFRS by U.S. companies? 2. Currently, under U.S. GAAP, when a company prepares financial statements on a new basis, comparative information must be provided for a three-year period. Under IFRS, up to two years of comparative data must be provided. Use of the shorter comparative data period must be addressed before U.S. companies can adopt IFRS.
CHAPTER 23 STATEMENT OF CASH FLOWS IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F T T F T F T 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.
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. Net income and net cash flow from operating activities. Converting net income to net cash flow from operating activities. Reporting cash receipts/disbursements in direct method. Indirect method adjustments. 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. Amortization of bond premium. Purchases and sales of trading securities. Disclosing noncash investing and financing activities. Use of cash flow worksheet. Reporting stock dividends on worksheet.
Answer
No.
Description
c c c b d d c b b b d c c b b c b c c
21. 22. S 23. S 24. 25. 26. S 27. 28. 29. 30. 31. 32. P 33. P 34. S 35. S 36. 37. 38. 39.
Objective of the statement of cash flows. Primary purpose of the statement of cash flows. Answers provided by the statement of cash flows. First step in cash flow statement preparation. Definition of cash equivalents. Cash flow effect of a short-term nontrade note payable. Reporting revenues and expenses on a cash basis. The effect of an inventory increase on cash flows from operating activities. Cash flow effects of a stock dividend. Effect of a change in dividends payable. Effect of cash dividend declaration on operating cash flows. Cash flow effects of major repairs on machinery. Classifying items as investing activities. Classification of a financing activity. Reporting amortization of bond premium. Converting accrual based expense to cash basis. Adjustment to income for inventory increase. Adjustment under the direct and indirect methods. Adjustment to cost of goods sold under the direct method.
MULTIPLE CHOICE—Conceptual
23 - 2
Test Bank for Intermediate Accounting, Fourteenth Edition
MULTIPLE CHOICE—Conceptual (cont.) Answer
No.
Description
a a b c c b b d a d c
40. 41. 42. 43. 44. 45. 46. 47. 48. 49. S 50.
Adjustment for an increase in accounts payable. Adjustment for a decrease in prepaid insurance. Direct method vs. indirect method. Direct method vs. indirect method. Addition to net income under indirect method. Deduction from net income under indirect method. Statement of cash flows information. Adjustment for equity method investment income. Reporting extraordinary transactions. Events not shown on statement of cash flows. Reporting significant noncash transactions.
P S
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide.
MULTIPLE CHOICE—Computational Answer
No.
Description
b b c d c a d a c b d c c c b c c b a c a b c d b d c a a a a
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 cash received from customers (direct method). Determine taxes paid (direct method). Determine net cash flow from financing 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 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.
Statement of Cash Flows
MULTIPLE CHOICE—Computational (cont.) Answer
No.
Description
a c d c a a a d c a c a c b d a b d b a c b c b
82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105.
Compute cash flow from investing activities. Compute cash flow from financing activities. Compute cash provided by operating activities. Compute cash provided by investing activities. Compute cash used by financing activities. Compute net cash provided by operating activities. Compute net cash provided by operating activities. Determine net income for period. Compute cash payments for operating expenses. Compute cash payments to suppliers. Compute cash collections from customers. Compute cash payments to suppliers. Determine cash collected from accounts receivable. Determine cash paid on accounts payable to suppliers. Compute net cash provided by investing activities. Compute net cash provided by financing activities. Compute net cash flow from investing activities. Compute net cash flow from financing activities. 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. Determine net cash flow from operating activities.
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
a c c b b b c a a c b
106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116.
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. Cash disbursements for insurance (direct method).
23 - 3
23 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
EXERCISES Item E23-117 E23-118 E23-119 E23-120 E23-121 E23-122 E23-123 E23-124 E23-125 E23-126 E23-127
Description Direct and indirect methods (essay). 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).
PROBLEMS Item P23-128 P23-129 P23-130
Description Statement of cash flows (indirect method). Statement of cash flows (direct/indirect). A complex statement of cash flows (indirect method).
CHAPTER LEARNING OBJECTIVES 1.
Describe the purpose of the statement of cash flows.
2.
Identify the major classifications of cash flows.
3.
Differentiate between net income and net cash flows from operating activities.
4.
Contrast the direct and indirect methods of calculating net cash flow from operating activities.
5.
Determine net cash flows from investing and financing activities.
6.
Prepare a statement of cash flows.
7.
Identify sources of information for a statement of cash flows.
8.
Discuss special problems in preparing a statement of cash flows.
9.
Explain the use of a worksheet in preparing a statement of cash flows.
Statement of Cash Flows
23 - 5
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
Type
Item
Type
Item
1.
TF
2.
TF
21.
3.
TF
4.
TF
5.
6.
TF
7.
TF
8.
TF
9.
MC
28.
32. 51. 52. 53.
MC MC MC MC
55. 56. 57. 59.
MC MC MC MC
62. 63. 106. 107.
10. 11. 12. P 33. P 34. S 35. S 36.
TF TF TF MC MC MC MC
58. 60. 61. 64. 65. 66. 67.
MC MC MC MC MC MC MC
68. 69. 70. 71. 72. 73. 74.
13. 14. 15. 37.
TF TF TF MC
38. 39. 40. 41.
MC MC MC MC
42. 43. 44. 45.
16. 17. 18. 30. 47.
TF TF MC MC MC
48. 49. S 50. 53. 76.
MC MC MC MC MC
98. 99. 100. 101. 102.
19.
TF
20.
TF
Note:
S
TF = True-False MC = Multiple Choice E = Exercise P = Problem
27.
Type
Item
Type
Item
Learning Objective 1 S MC 22. MC 23. Learning Objective 2 S TF 24. MC 25. Learning Objective 3 MC Learning Objective 4 MC 29. MC 30. Learning Objective 5 MC 108. MC 113. MC 109. MC 114. MC 110. MC 118. MC 111. MC 119. Learning Objective 6 MC 75. MC 82. MC 76. MC 83. MC 77. MC 84. MC 78. MC 85. MC 79. MC 86. MC 80. MC 87. MC 81. MC 88. Learning Objective 7 MC 46. MC 93. MC 90. MC 94. MC 91. MC 95. MC 92. MC 96. Learning Objective 8 MC 103. MC 120. MC 104. MC 121. MC 105. MC 122. MC 118. E 125. MC 119. E 126. Learning Objective 9
Type
Item
Type
Item
Type
MC
26.
MC
117.
E
MC
31.
MC
117.
E
MC E E E
120. 121. 122.
E E E
MC MC MC MC MC MC MC
89. 112. 115. 116. 121. 122. 123.
MC MC MC MC E E E
124. 125. 126. 127. 128. 129. 130.
E E E E P P P
MC MC MC MC
97. 118. 120.
MC E E
E E E E E
127. 128. 129. 130.
E P P P
MC
23 - 6
Test Bank for Intermediate Accounting, Fourteenth Edition
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.
2.
The statement of cash flows provides information to help investors and creditors assess the cash and noncash investing and financing transactions during the period.
3.
Companies classify some cash flows relating to investing or financing activities as operating activities.
4.
The first step in the preparation of the statement of cash flows is to determine the net cash flow from operating activities.
5.
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.
6.
Under the accrual basis of accounting, net income is usually the same as net cash flow from operating activities.
7.
A company can convert net income to net cash flow from operating activities through either the direct method or the indirect method.
8.
The direct method, also called the reconciliation method, reports cash receipts and cash disbursements from operating activities.
9.
The indirect method adjusts net income for items that affected reported net income but did not affect cash.
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 the 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.
16.
A company should add back bond premium amortization to net income to arrive at net cash flow from operating activities.
Statement of Cash Flows
23 - 7
17.
Companies report the cash flows from purchases and sales of trading securities as cash flows from operating activities.
18.
Noncash investing and financing activities are disclosed either in a separate schedule or in a separate note to the financial statements.
19.
When numerous adjustments are necessary, companies often use a cash flow worksheet instead of preparing a statement of cash flows.
20.
The issuance of stock dividends is entered on the cash flow worksheet, but is not reported in the statement of cash flows.
True-False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F T T F T
Item 6. 7. 8. 9. 10.
Ans. F T F T F
Item 11. 12. 13. 14. 15.
Ans. T F F T F
Item 16. 17. 18. 19. 20.
Ans. F T T F T
MULTIPLE CHOICE—Conceptual 21.
It is an objective of the statement of cash flows to a. disclose changes during the period in all asset and all equity accounts. b. disclose the change in working capital during the period. c. provide information about the operating, investing, and financing activities of an entity during a period. d. none of these.
22.
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.
S
23.
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?
S
24.
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
23 - 8
S
Test Bank for Intermediate Accounting, Fourteenth Edition
25.
Cash equivalents are a. treasury bills, commercial paper, and money market funds purchased with excess cash. b. investments with original maturities of three months or less. c. readily convertible into known amounts of cash. d. all of these.
26.
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.
27.
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.
28.
An increase in inventory balance would be reported in a statement of cash flows using the indirect method (reconciliation method) 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.
29.
A statement of cash flows typically would not disclose the effects of a. capital stock issued at an amount greater than par value. b. stock dividends declared. c. cash dividends paid. d. a purchase and immediate retirement of treasury stock.
30.
When preparing a statement of cash flows (indirect method), 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.
Statement of Cash Flows 31.
Declaration of a cash dividend on common stock affects cash flows from operating activities under the direct and indirect methods as follows: a. b. c. d.
P
23 - 9
Direct Method Outflow Inflow Outflow No effect
Indirect Method Inflow Inflow Outflow No effect
32.
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.
33.
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 P
34.
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
S
35.
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 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition S
36.
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? Increase in Depreciation Prepaid Expenses a. Deducted From Deducted From b. Added To Added To c. Deducted From Added To d. Added To Deducted From
37.
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.
38.
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
39.
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.
40.
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.
Indirect Method Increase Decrease Increase Decrease
Direct Method Decrease Increase Increase Decrease
Statement of Cash Flows 41.
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? a. b. c. d.
42.
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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
43.
Which of the following statements is correct? a. The indirect method starts with income before extraordinary items. b. The direct method is known as the reconciliation method. c. The direct method is more consistent with the primary purpose of the statement of cash flows. d. All of these.
44.
When using the indirect method to prepare the operating section of a statement of cash flows, which of the following is added to net income to compute cash provided by/used by operating activities? a. Increase in accounts receivable. b. Gain on sale of land. c. Amortization of patent. d. All of the above are added to net income to arrive at cash flow from operating activities.
45.
When using the indirect method to prepare the operating section of a statement of cash flows, which of the following is deducted from net income to compute cash provided by/used by operating activities? a. Decrease in accounts receivable. b. Gain on sale of land. c. Amortization of patent. d. All of the above are deducted from net income to arrive at cash flow from operating activities.
46.
Which of the following is false concerning the statement of cash flows? a. When pension expense exceeds cash funding, the difference is deducted from investing activities on the statement of cash flows. b. The FASB requires companies to classify all income taxes paid as operating cash outflows. c. Under U.S. GAAP, the purchase of land by issuing stock will be shown as a cash outflow under investing activities and a cash inflow under financing activities. d. All of the above are true concerning the statement of cash flows.
23 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition
S
47.
Dolan Company reports its income from investments under the equity method and recognized income of $25,000 from its investment in Moss Co. during the current year, even though no dividends were declared or paid by Moss during the year. On Dolan'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.
48.
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.
49.
Which of the following is shown on a statement of cash flows? a. A stock dividend b. A stock split c. An appropriation of retained earnings d. None of these
50.
How should significant noncash transactions be reported in the statement of cash flows according to FASB Statement No. 95? a. They should be incorporated in the statement of cash flows in a section labeled, "Significant Noncash Transactions." b. Such transactions should be incorporated in the section (operating, financing, or investing) that is most representative of the major component of the transaction. c. These noncash transactions are not to be incorporated in the statement of cash flows. They may be summarized in a separate schedule at the bottom of the statement or appear in a separate supplementary schedule to the financials. d. They should be handled in a manner consistent with the transactions that affect cash flows.
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25.
c c c b d
26. 27. 28. 29. 30.
d c b b b
31. 32. 33. 34. 35.
d c c b b
36. 37. 38. 39. 40.
c b c c a
41. 42. 43. 44. 45.
a b c c b
46. 47. 48. 49. 50.
b d a d c
Item
Ans.
Statement of Cash Flows
23 - 13
MULTIPLE CHOICE—Computational Use the following information for questions 51 and 52. Napier Co. provided the following information on selected transactions during 2013: 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
$500,000 1,000,000 1,900,000 300,000 700,000 200,000 800,000 100,000
51.
The net cash provided (used) by investing activities during 2013 is a. $100,000. b. $(600,000). c. $(1,100,000). d. $(2,500,000).
52.
The net cash provided by financing activities during 2013 is a. $1,100,000. b. $1,300,000. c. $1,600,000. d. $1,800,000.
Use the following information for questions 53 through 55. The balance sheet data of Kohler Company at the end of 2013 and 2012 follow: 2013 Cash $ 100,000 Accounts receivable (net) 240,000 Merchandise inventory 280,000 Prepaid expenses 40,000 Buildings and equipment 360,000 Accumulated depreciation—buildings and equipment (72,000) Land 360,000 Totals $1,308,000 Accounts payable Accrued expenses Notes payable—bank, long-term Mortgage payable Common stock, $10 par Retained earnings (deficit)
$272,000 48,000 120,000 936,000 32,000 $1,308,000
2012 $ 140,000 180,000 180,000 100,000 300,000 (32,000) 160,000 $1,028,000 $220,000 72,000 160,000 636,000 (60,000) $1,028,000
23 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition Land was acquired for $200,000 in exchange for common stock, par $200,000, during the year; all equipment purchased was for cash. Equipment costing $20,000 was sold for $8,000; book value of the equipment was $16,000 and the loss was reported as an ordinary item in net income. Cash dividends of $40,000 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, 2013, for Naley Company: 53.
The net cash provided by operating activities was a. $104,000. b. $132,000. c. $112,000. d. $96,000.
54.
The net cash provided (used) by investing activities was a. $52,000. b. $(80,000). c. $(272,000). d. $(72,000).
55.
The net cash provided (used) by financing activities was a. $ -0-. b. $(40,000). c. $(80,000). d. $120,000.
56.
The following information on selected cash transactions for 2013 has been provided by Mancuso Company: Proceeds from sale of land Proceeds from long-term borrowings Purchases of plant assets Purchases of inventories Proceeds from sale of Mancuso common stock
$190,000 400,000 144,000 680,000 240,000
What is the cash provided (used) by investing activities for the year ended December 31, 2013, as a result of the above information? a. $46,000 b. $256,000. c. $190,000. d. $830,000. 57.
Selected information from Dinkel Company's 2013 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
$ 600,000 1,800,000 240,000 90,000 180,000 150,000
Statement of Cash Flows
23 - 15
Dinkel's statement of cash flows for the year ended December 31, 2013, would show net cash provided (used) by financing activities of a. $90,000. b. $(330,000). c. $240,000. d. $2,040,000. Use the following information for questions 58 through 62. Harlan 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 Harlan Mining Co. for 2013 and 2012 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
12/31/13 $306,000 270,000 288,000 $456,000 (240,000)
216,000 $1,080,000
12/31/12 $ 144,000 162,000 360,000 $720,000 (228,000)
$ 132,000 264,000 270,000 162,000 252,000 $1,080,000
492,000 $1,158,000 $ 72,000 294,000 450,000 162,000 180,000 $1,158,000
INCOME STATEMENT For the Year Ended December 31, 2013 Sales Cost of sales Gross profit Selling expenses Administrative expenses Income from operations Interest expense Income before taxes Income taxes Net income
$6,300,000 5,364,000 936,000 $450,000 144,000
594,000 342,000 54,000 192,000 72,000 $ 216,000
The following additional data were provided: 1. Dividends for the year 2013 were $144,000. 2. During the year, equipment was sold for $180,000. This equipment cost $264,000 originally and had a book value of $216,000 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 58 through 62 relate to a statement of cash flows (direct method) for the year ended December 31, 2013, for Harlan Mining Company.
23 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition 58.
The net cash provided by operating activities is a. $306,000. b. $216,000. c. $180,000. d. $150,000.
59.
The net cash provided (used) by investing activities is a. $(264,000). b. $36,000. c. $180,000. d. $(216,000).
60.
Under the direct method, the cash received from customers is a. $6,408,000. b. $6,192,000. c. $6,300,000. d. $6,330,000.
61.
Under the direct method, the total taxes paid is a. $72,000. b. $30,000. c. $42,000. d. $102,000.
62.
The net cash provided (used) by financing activities is a. $(180,000). b. $36,000. c. $(324,000). d. $144,000.
63.
During 2013, Stout Inc. had the following activities related to its financial operations: Carrying value of convertible preferred stock in Stout, converted into common shares of Stout $ 360,000 Payment in 2013 of cash dividend declared in 2012 to preferred shareholders 186,000 Payment for the early retirement of long-term bonds payable (carrying amount $2,420,000) 2,450,000 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 Stout's statement of cash flows for 2013 should be a. $1,790,000. b. $1,976,000. c. $2,336,000. d. $2,348,000.
Statement of Cash Flows
23 - 17
64.
Hager Company sold some of its plant assets during 2013. 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 $185,000. The information concerning the sale of the plant assets should be shown on Hager's statement of cash flows (indirect method) for the year ended December 31, 2013, as a(n) a. subtraction from net income of $35,000 and a $50,000 increase in cash flows from financing activities. b. addition to net income of $35,000 and a $85,000 increase in cash flows from investing activities. c. subtraction from net income of $35,000 and a $85,000 increase in cash flows from investing activities. d. addition of $85,000 to net income.
65.
An analysis of the machinery accounts of Noller Company for 2013 is as follows: Machinery, Net of Accumulated Accumulated Machinery Depreciation Depreciation Balance at January 1, 2013 $500,000 $125,000 $375,000 Purchases of new machinery in 2013 for cash 200,000 — 200,000 Depreciation in 2013 — 100,000 (100,000) Balance at Dec. 31, 2013 $700,000 $225,000 $475,000 The information concerning Noller's machinery accounts should be shown in Noller's statement of cash flows (indirect method) for the year ended December 31, 2013, 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.
66.
Equipment which cost $213,000 and had accumulated depreciation of $114,000 was sold for $121,000. This transaction should be shown on the statement of cash flows (indirect method) as a(n) a. addition to net income of $22,000 and a $121,000 cash inflow from financing activities. b. deduction from net income of $22,000 and a $99,000 cash inflow from investing activities. c. deduction from net income of $22,000 and a $121,000 cash inflow from investing activities. d. addition to net income of $22,000 and a $99,000 cash inflow from financing activities.
67.
During 2013, equipment was sold for $312,000. The equipment cost $504,000 and had a book value of $288,000. Accumulated Depreciation—Equipment was $1,374,000 at 12/31/12 and $1,470,000 at 12/31/13. Depreciation expense for 2013 was a. $120,000. b. $192,000. c. $312,000. d. $384,000.
23 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition Use the following information for questions 68 and 69. Equipment that cost $350,000 and had a book value of $156,000 was sold for $180,000. Data from the comparative balance sheets are: 12/31/13 12/31/12 Equipment $2,160,000 $1,950,000 Accumulated Depreciation 660,000 570,000 68.
Depreciation expense for 2013 was a. $308,000. b. $284,000. c. $54,000. d. $36,000.
69.
Equipment purchased during 2013 was a. $560,000. b. $350,000. c. $210,000. d. $366,000.
Use the following information for questions 70 through 74. Financial statements for Kiner Company are given below: Kiner Company Balance Sheet January 1, 2013 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
Common stock Retained earnings
$ 152,000
920,000 480,000 $1,552,000
Statement of Cash Flows
23 - 19
Kiner Company Statement of Cash Flows For the Year Ended December 31, 2013 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, 2013 Cash, December 31, 2013
$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, 2013 are $2,216,000. Accumulated depreciation on the equipment sold was $112,000. 70.
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.
71.
The book value of the buildings and equipment at December 31, 2013 was a. $1,016,000. b. $1,040,000. c. $1,424,000. d. $1,176,000.
72.
The accounts payable at December 31, 2013 were a. $88,000. b. $216,000. c. $64,000. d. $296,000.
23 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition 73.
The balance in the Retained Earnings account at December 31, 2013 was a. $360,000. b. $880,000. c. $760,000. d. $1,000,000.
74.
Capital stock (plus any additional paid-in capital) at December 31, 2013 was a. $800,000. b. $920,000. c. $520,000. d. $1,240,000.
Use the following information for questions 75 and 76. The balance in retained earnings at December 31, 2012 was $720,000 and at December 31, 2013 was $582,000. Net income for 2013 was $500,000. A stock dividend was declared and distributed which increased common stock $250,000 and paid-in capital $110,000. A cash dividend was declared and paid. 75.
The amount of the cash dividend was a. $248,000. b. $278,000. c. $388,000. d. $638,000.
76.
The stock dividend should be reported on the statement of cash flows (indirect method) as a. an outflow from financing activities of $250,000. b. an outflow from financing activities of $360,000. c. an outflow from investing activities of $360,000. d. Stock dividends are not shown on a statement of cash flows.
77.
The following information was taken from the 2013 financial statements of Dunlop Corporation: Bonds payable, January 1, 2013 Bonds payable, December 31, 2013
$ 500,000 3,000,000
During 2013 • 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, 2013, what amount should Dunlop report as proceeds from issuance of bonds payable? a. $2,500,000 b. $2,750,000 c. $2,800,000 d. $3,200,000
Statement of Cash Flows 78.
23 - 21
Lindsay Corporation had net income for 2013 of $2,000,000. 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
Lindsay's net cash provided by operating activities for 2013 was a. $3,560,000. b. $3,440,000. c. $3,320,000. d. $1,680,000. 79.
Net cash flow from operating activities for 2013 for Spencer Corporation was $450,000. The following items are reported on the financial statements for 2013: Cash dividends paid on common stock Depreciation and amortization Increase in accounts receivables
20,000 12,000 24,000
Based on the information above, Spencer’s net income for 2013 was a. $462,000. b. $446,000. c. $414,000. d. $406,000. 80.
During 2013, Orton Company earned net income of $434,000 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
Based upon this information what amount will be shown for net cash provided by operating activities for 2013? a. $542,000 b. $515,000 c. $335,000 d. $317,000 81.
Minear Company reported net income of $390,000 for the year ended 12/31/13. Included in the computation of net income were: depreciation expense, $60,000; amortization of a patent, $32,000; income from an investment in common stock of Brett Inc., accounted for under the equity method, $48,000; and amortization of a bond discount, $12,000. Minear also paid an $80,000 dividend during the year. The net cash provided by operating activities would be reported at: a. $446,000. b. $366,000. c. $334,000. d. $254,000.
23 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition 82.
In preparing Titan Inc.’s statement of cash flows for the year ended December 31, 2013, the following amounts were available: Collect note receivable $370,000 Issue bonds payable 426,000 Purchase treasury stock 210,000 What amount should be reported on Titan, Inc.’s statement of cash flows for investing activities? a. $370,000 b. $160,000 c. $796,000 d. $216,000
83.
In preparing Titan Inc.’s statement of cash flows for the year ended December 31, 2013, the following amounts were available: Collect note receivable $370,000 Issue bonds payable 426,000 Purchase treasury stock 210,000 What amount should be reported on Titan, Inc’s statement of cash flows for financing activities? a. $ 56,000 b. $796,000 c. $216,000 d. $160,000
84.
Jarvis, Inc. reported net income of $39,000 for the year ended December 31, 2013 Included in net income were depreciation expense of $8,400 and a gain on sale of equipment of $1,700. Each of the following accounts increased during 2013: Accounts receivable $2,200 Inventory $4,500 Prepaid rent $6,800 Available-for-sale securities $1,000 Accounts payable $5,000 What is the amount of cash provided by operating activities for Jarvis, Inc. for the year ended December 31, 2013? a. $36,200 b. $38,900 c. $27,200 d. $37,200
85.
Jarvis, Inc. reported net income of $39,000 for the year ended December 31, 2013 Included in net income were depreciation expense of $8,400 and a gain on sale of equipment of $1,700. The equipment had an historical cost of $40,000 and accumulated depreciation of $24,000. Each of the following accounts increased during 2013: Patents $7,500 Prepaid rent $6,800 Available-for-sale securities $1,000 Bonds payable $5,000
Statement of Cash Flows
23 - 23
What is the amount of cash provided by or used by investing activities for Jarvis, Inc. for the year ended December 31, 2013? a. ( $ 6,800) b. $16,700 c. $ 9,200 d. $14,200 86.
Jarvis, Inc. reported net income of $34,000 for the year ended December 31, 2013. Included in net income was a gain on early extinguishment of debt of $60,000 related to bonds payable with a book value of $1,200,000. Each of the following accounts increased during 2013: Notes receivable $45,000 Deferred tax liability $10,000 Treasury stock $150,000 What is the amount of cash used by financing activities for Jarvis, Inc. for the year ended December 31, 2013? a. $1,290,000 b. $1,300,000 c. $ 220,000 d. $ 255,000
87.
During 2013, Greta Company earned net income of $172,000 which included depreciation expense of $39,000. In addition, the Company experienced the following changes in the account balances listed below: Decreases Accounts receivable ..... $ 6,000 Prepaid expenses .......... 16,500 Accrued liabilities ............ 12,000
Increases Accounts payable…... $22,500 Inventory……………. ..18,000
Based upon this information what amount will be shown for net cash provided by operating activities for 2013. a. $226,000. b. $212,500. c. $122,500. d. $113,500. 88.
Cashman Company reported net income of $285,000 for the year ended 12/31/13. Included in the computation of net income were: depreciation expense, $45,000; amortization of a patent, $24,000; income from an investment in common stock of Linda Inc., accounted for under the equity method, $36,000; and amortization of a bond premium, $9,000. Cashman also paid a $60,000 dividend during the year. The net cash provided by operating activities would be reported at: a. $309,000. b. $261,000. c. $249,000. d. $201,000.
23 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition 89.
Net cash flow from operating activities for 2013 for Graham Corporation was $350,000. The following items are reported on the financial statements for 2013: Depreciation and amortization $ 20,000 Cash dividends paid on common stock 12,000 Increase in accounts receivable 24,000 Based only on the information above, Graham’s net income for 2013 was: a. $306,000. b. $314,000. c. $346,000. d. $354,000.
90.
Donnegan Company reported operating expenses of $365,000 for 2013. The following data were extracted from the company’s financial records: 12/31/12 12/31/13 Prepaid Expenses $ 60,000 $69,000 Accrued Expenses 210,000 255,000 On a statement of cash flows for 2013, using the direct method, cash payments for operating expenses should be: a. $419,000. b. $401,000. c. $329,000. d. $311,000.
91.
The following information was taken from the 2013 financial statements of Jenny Gardner Corporation: Inventory, January 1, 2013 $ 90,000 Inventory, December 31, 2013 120,000 Accounts payable, January 1, 2013 75,000 Accounts payable, December 31, 2013 120,000 Sales 600,000 Cost of goods sold 420,000 If the direct method is used in the 2013 statement of cash flows, what amount should Jenny Gardner report as cash payments to suppliers? a. $405,000 b. $435,000 c. $465,000 d. $495,000
92.
Alex Company prepares its statement of cash flows using the direct method for operating activities. For the year ended December 31, 2013, Alex Company reports the following activity: Sales on account $1,200,000 Cash sales 740,000 Decrease in accounts receivable 610,000 Increase in accounts payable 72,000 Increase in inventory 48,000 Cost of good sold 900,000
Statement of Cash Flows
23 - 25
What is the amount of cash collections from customers reported by Alex Company for the year ended December 31, 2013? a. $1,940,000 b. $1,810,000 c. $2,550,000 d. $1,330,000 93.
Alex Company prepares its statement of cash flows using the direct method for operating activities. For the year ended December 31, 2013, Alex Company reports the following activity: Sales on account $1,200,000 Cash sales 740,000 Decrease in accounts receivable 610,000 Increase in accounts payable 72,000 Increase in inventory 48,000 Cost of goods sold 900,000 What is the amount of cash payments to suppliers reported by Alex Company for the year ended December 31, 2013? a. $ 876,000 b. $ 924,000 c. $1,020,000 d. $ 780,000
Questions 94 through 97 are based on the data shown below related to the statement of cash flows for Putnam, Inc.: Putnam, Inc. Comparative Balance Sheets December 31, 2013 2012 Assets: Current Assets: Cash Accounts Receivable (net) Inventory Prepaid Expenses Total Current Assets Long-Term Investments Plant Assets: Property, Plant & Equipment Accumulated Depreciation Total Plant Assets Total Assets
$ 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
23 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition Equities: Current Liabilities: Accounts Payable Accrued Expenses Dividends Payable Total Current Liabilities Long-Term Notes Payable Stockholders' Equity: Common Stock Retained Earnings Total Equities
$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
Putnam, Inc. Comparative Income Statements
Net Credit Sales Cost of Goods Sold Gross Profit Expenses (including Income Tax) Net Income
December 31, 2013 2012 $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 2013 and 2012, 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. 94.
What amount of cash was collected from 2013 accounts receivable? a. $7,500,000. b. $7,020,000. c. $6,540,000. d. $3,270,000.
95.
What amount of cash was paid on accounts payable to suppliers during 2013? a. $4,605,000. b. $4,425,000. c. $4,095,000. d. $3,735,000.
96.
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.
Statement of Cash Flows 97.
23 - 27
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.
Use the following information for questions 98 and 99. Fleming Company provided the following information on selected transactions during 2013: Dividends paid to preferred stockholders Loans made to affiliated corporations Proceeds from issuing bonds Proceeds from issuing preferred stock Proceeds from sale of equipment Purchases of inventories Purchase of land by issuing bonds Purchases of treasury stock
$ 150,000 700,000 800,000 1,050,000 450,000 1,200,000 300,000 600,000
98.
The net cash provided (used) by investing activities during 2013 is a. $(600,000). b. $(250,000). c. $100,000. d. $450,000.
99.
The net cash provided (used) by financing activities during 2013 is a. $(1,650,000). b. $450,000. c. $750,000. d. $1,100,000.
100.
The net cash provided by operating activities in Sosa Company's statement of cash flows for 2013 was $135,000. For 2013, 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, Sosa’s net income for 2013 was a. $135,000. b. $82,000. c. $8,000. d. $136,000.
101.
During 2013, Oldham Corporation, which uses the allowance method of accounting for doubtful accounts, recorded a provision for bad debt expense of $30,000 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. $30,000 increase. b. $10,000 increase. c. $20,000 increase. d. $20,000 decrease.
23 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition Use the following information for questions 102 and 103. A flood damaged a building and contents. Floods are unusual and infrequent in this area. The receipts from insurance companies totaled $400,000, which was $120,000 less than the book values. The tax rate is 30%. 102.
On the statement of cash flows (indirect method), the receipts from insurance companies should a. be shown as an addition to net income of $280,000. b. be shown as an inflow from investing activities of $280,000. c. be shown as an inflow from investing activities of $400,000. d. not be shown.
103.
On the statement of cash flows (indirect method), the flood loss should a. be shown as an addition to net income of $84,000. b. be shown as an addition to net income of $120,000. c. be shown as an inflow from investing activities of $84,000. d. not be shown.
104.
Zook Incorporated, had net income for 2013 of $4,000,000. 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, 2013, based solely on the above information? a. $5,820,000. b. $5,870,000. c. $5,740,000. d. $5,840,000. 105.
The net income for the year ended December 31, 2013, for Oliva Company was $1,500,000. Additional information is as follows: Depreciation on plant assets Amortization of leasehold improvements Provision for doubtful accounts on short-term receivables Provision for doubtful accounts on long-term receivables Interest paid on short-term borrowings Interest paid on long-term borrowings
$600,000 340,000 120,000 100,000 80,000 60,000
Based solely on the information given above, what should be the net cash provided by operating activities in the statement of cash flows for the year ended December 31, 2013? a. $2,560,000. b. $2,660,000. c. $2,640,000. d. $2,800,000.
Statement of Cash Flows
23 - 29
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
51. 52. 53. 54. 55. 56. 57. 58.
b b c d c a d a
59. 60. 61. 62. 63. 64. 65. 66.
c b d c c c b c
67. 68. 69. 70. 71. 72. 73. 74.
c b a c a b c d
75. 76. 77. 78. 79. 80. 81. 82.
b d c a a a a a
83. 84. 85. 86. 87. 88. 89. 90.
c d c a a a d c
91. 92. 93. 94. 95. 96. 97. 98.
a c a c b d a b
99. 100. 101. 102. 103. 104. 105.
d b a c b c b
MULTIPLE CHOICE—CPA Adapted Use the following information for questions 106 and 107. 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. 106.
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
107.
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 108 and 109. Smiley Corp.'s transactions for the year ended December 31, 2013 included the following: • Purchased real estate for $575,000 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.
23 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition 108.
Smiley's net cash used in investing activities for 2013 was a. $700,000. b. $375,000. c. $200,000. d. $75,000.
109.
Smiley's net cash used in financing activities for 2013 was a. $25,000. b. $225,000. c. $450,000. d. $475,000.
Use the following information for questions 110 and 111. Peavy Corp.'s transactions for the year ended December 31, 2013 included the following: • • • • • • •
Acquired 50% of Gant Corp.'s common stock for $160,000 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 2018, 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.
110.
Peavy’s net cash provided by investing activities for 2013 was a. $316,000. b. $416,000. c. $476,000. d. $636,000.
111.
Peavy’s net cash provided by financing activities for 2013 was a. $432,000. b. $520,000. c. $552,000. d. $640,000.
Use the following information for questions 112 through 114. Jamison Corp.'s balance sheet accounts as of December 31, 2013 and 2012 and information relating to 2013 activities are presented below. December 31, 2013 2012 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
Statement of Cash Flows 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
23 - 31
$1,440,000 — 1,400,000 500,000 980,000 $4,320,000
Information relating to 2013 activities: • Net income for 2013 was $1,500,000. • Cash dividends of $600,000 were declared and paid in 2013. • Equipment costing $1,000,000 and having a carrying amount of $320,000 was sold in 2013 for $360,000. • A long-term investment was sold in 2013 for $320,000. There were no other transactions affecting long-term investments in 2013. • 20,000 shares of common stock were issued in 2013 for $25 a share. • Short-term investments consist of treasury bills maturing on 6/30/14. 112.
Net cash provided by Jamison’s 2013 operating activities was a. $1,500,000. b. $2,120,000. c. $2,080,000. d. $2,160,000.
113.
Net cash used in Jamison’s 2013 investing activities was a. $2,320,000. b. $1,820,000. c. $1,680,000. d. $1,720,000.
114.
Net cash provided by Jamison’s 2013 financing activities was a. $480,000. b. $520,000. c. $1,080,000. d. $1,680,000.
115.
Foxx Corp.'s comparative balance sheet at December 31, 2013 and 2012 reported accumulated depreciation balances of $850,000 and $600,000, respectively. Property with a cost of $50,000 and a carrying amount of $38,000 was the only property sold in 2013. Depreciation charged to operations in 2013 was a. $238,000. b. $250,000. c. $262,000. d. $212,000.
23 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition 116.
Nagel Co.'s prepaid insurance was $90,000 at December 31, 2013 and $45,000 at December 31, 2012. Insurance expense was $31,000 for 2013 and $27,000 for 2012. What amount of cash disbursements for insurance would be reported in Nagel's 2013 net cash provided by operating activities presented on a direct basis? a. $94,000. b. $76,000. c. $59,000. d. $31,000.
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
106. 107.
a c
108. 109.
c b
110. 111.
b b
112. 113.
c a
114. 115.
a c
116.
b
DERIVATIONS — Computational No. Answer
Derivation
51.
b
$100,000 – $700,000 = ($600,000).
52.
b
$1,000,000 – $300,000 – $200,000 + $800,000 = $1,300,000.
53.
c
$32,000 + $40,000 + $60,000 = $132,000 (NI) ($20,000 – $4,000) – $8,000 = $8,000 (Loss) $72,000 + $4,000 – $32,000 = $44,000 (Depr. exp.) $132,000 – $60,000 – $100,000 + $60,000 + $8,000 + $44,000 + $52,000 – $24,000 = $112,000.
54.
d
$8,000 – ($360,000 + $20,000 – $300,000) = ($72,000).
55.
c
($160,000) + $120,000 – $40,000 = ($80,000).
56.
a
$190,000 – $144,000 = $46,000.
57.
d
$600,000 + $1,800,000 – $240,000 – $90,000 – $180,000 + $150,000 = $2,040,000.
58.
a
$216,000 + $36,000 + ($240,000 + $48,000 – $228,000) – $108,000 + $72,000 + $60,000 – $30,000 = $306,000.
59.
c
$180,000.
60.
b
$162,000 + $6,300,000 – $270,000 = $6,192,000.
61.
d
$294,000 + $72,000 – $264,000 = $104,000.
62.
c
($144,000) + ($180,000) = ($324,000).
63.
c
$300,000 – $186,000 – $2,450,000 = $2,336,000.
Statement of Cash Flows
23 - 33
DERIVATIONS — Computational (cont.) No. Answer
Derivation
64.
c
$85,000 – ($750,000 – $700,000) = $55,000, $85,000 (proceeds).
65.
b
Conceptual.
66.
c
$121,000 – ($213,000 – $114,000) = $22,000, $121,000 (proceeds).
67.
c
$1,470,000 – $1,374,000 + ($504,000 – $288,000) = $312,000.
68.
b
$660,000 – $570,000 + ($350,000 – $156,000) = $284,000.
69.
a
$2,160,000 – $1,950,000 + $350,000 = $560,000.
70.
c
$96,000 – $48,000 = $48,000 (BV); $48,000 + $112,000 = $160,000.
71.
a
($1,200,000 – $400,000) – $48,000 + $384,000 – $120,000 = $1,016,000.
72.
b
$152,000 + $64,000 = $216,000.
73.
c
$480,000 + $400,000 – $120,000 = $760,000.
74.
d
$920,000 + $320,000 = $1,240,000.
75.
b
$720,000 + $500,000 – ($250,000 + $110,000) – X = $582,000 X = $278,000.
76.
d
Conceptual.
77.
c
$3,000,000 – $500,000 + $500,000 – $200,000 = $2,800,000.
78.
a
$2,000,000 + $1,200,000 + $240,000 - $420,000 + $540,000 = $3,560,000.
79.
a
X + $12,000 – $24,000 = $450,000; X = $462,000.
80.
a
$434,000 + $78,000 + $45,000 – $36,000 + $12,000 – $24,000 + $33,000 = $542,000.
81.
a
$390,000 + $60,000 + $32,000 – $48,000 + $12,000 = $446,000.
82.
a
$370,000.
83.
c
426,000 – $210,000 = $216,000.
84.
d
$39,000 + $8,400 – $1,700 – $2,200 – $4,500 – $6,800 + $5,000 = $37,200.
85.
c
[($40,000 – $24,000) + $1,700] – $7,500 – $1,000 = $9,200.
86.
a
$1,200,000 - $60,000 + $150,000 = $1,290,000.
23 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No. Answer
Derivation
87.
a
$172,000 + $39,000 + $22,500 – $18,000 + $6,000 + $16,500 – $12,000 = $226,000.
88.
a
$285,000 + $45,000 + $24,000 – $9,000 – $36,000 = $309,000.
89.
d
X + $20,000 – $24,000 = $350,000 X – $4,000 = $350,000; X = $354,000.
90.
c
$365,000 + $9,000 - $45,000 = $329,000.
91.
a
$420,000 + ($120,000 – $90,000) – ($120,000 – $75,000) = $405,000.
92.
c
$1,200,000 + $740,000 + $610,000 = $2,550,000.
93
a
$900,000 – $72,000 + $48,000 = $876,000.
94.
c
$1,080,000 + $7,020,000 – $1,560,000 = $6,540,000.
95.
b
$1,095,000 + ($3,915,000 + $1,950,000 – $1,260,000) – $1,275,000 = $4,425,000.
96.
d
$225,000 + ($2,190,000 – $1,440,000) = $975,000.
97.
a
$825,000 + ($3,000,000 – $2,400,000) = $1,425,000.
98.
b
($700,000) + $450,000 = ($250,000).
99.
d
($150,000) + $800,000 + $1,050,000 + ($600,000) = $1,100,000.
100.
b
$135,000 – $45,000 – $8,000 = $82,000.
101.
a
$30,000.
102.
c
Conceptual, $400,000 (proceeds), (extraordinary item).
103.
b
Conceptual, $520,000 – $400,000 = $120,000.
104.
c
$4,000,000 + $45,000 + $1,650,000 – $65,000 + $80,000 + $30,000 = $5,740,000.
105.
b
$1,500,000 + $600,000 + $340,000 + $120,000 + $100,000 = $2,660,000.
Statement of Cash Flows
23 - 35
DERIVATIONS — CPA Adapted No. Answer
Derivation
106.
a
Conceptual.
107.
c
Conceptual.
108.
c
($575,000) + $500,000 – $125,000 = ($200,000).
109.
b
$575,000 – $600,000 + $250,000 – $450,000 = ($225,000).
110.
b
($160,000) – $220,000 + $796,000 = $416,000.
111.
b
$160,000 + $392,000 – $120,000 + $88,000 = $520,000.
112.
c
$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.
113.
a
$320,000 + $360,000 – ($3,400,000 + $1,000,000 – $2,000,000) – $600,000 = $2,320,000.
114.
a
20,000 × $25 = $500,000 $500,000 + $580,000 – $600,000 = $480,000.
115.
c
$850,000 – $600,000 + ($50,000 – $38,000) = $262,000.
116.
b
$90,000 + $31,000 – $45,000 = $76,000.
EXERCISES Ex. 23-117—Direct and indirect methods. Compare the direct method and the indirect method by explaining each method.
Solution 23-117 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.
23 - 36 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 23-118—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 prepared using the indirect method. 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
X
Cash flows from investing activities Inflows Outflows
X
+X –X
(C) (D)
Net cash provided (used) by investing activities Cash flows from financing activities Inflows Outflows
(A) (B)
X
+X –X
(E) (F)
Net cash provided (used) by financing activities
X
Net increase (decrease) in cash
X
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. Sales discounts lapsed and not taken by customers. (Sales recorded at net originally.)
____
3. Accrued estimated income taxes for the period. These taxes will be paid next year.
____
4. Amortization of premium on bonds payable.
____
5. Premium amortized on investment in bonds.
____
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.
Statement of Cash Flows
23 - 37
Ex. 23-118 (cont.) ____ 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). ____ 13. Trading securities are sold at a loss. ____ 14. Two-year notes issued at discount for a patent. ____ 15. Amortization of Discount on Notes Receivable (long-term). ____ 16. Decrease in Retained Earnings Appropriated for Self-insurance.
Solution 23-118 1. 2. 3. 4. 5. 6.
B and C B A B A A
7. 8. 9. 10. 11. 12.
D None None A B F
13. 14. 15. 16.
A and C None B None
Ex. 23-119—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.
Solution 23-119 (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
23 - 38 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 23-119 (cont.) (d) Not shown on statement of cash flows: Stock dividends Appropriations of retained earnings
Ex. 23-120—Effects of transactions on statement of cash flows. Any given transaction may affect a statement of cash flows (using the indirect method) 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, 2013. (Ignore any income tax effects.) ____
1. Preferred stock with a carrying value of $44,000 was redeemed for $50,000 on January 1, 2013.
____
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, 2013.
____
3. Machinery which originally cost $3,000 and has a book value of $1,800 is sold for $1,400 on December 31, 2013.
____
4. Land is acquired through the issuance of bonds payable on July 1, 2013.
____
5. 1,000 shares of stock, stated value $10 per share, are issued for $25 per share in 2013.
____
6. An appropriation of retained earnings for treasury stock in the amount of $35,000 is established in 2013.
____
7. A cash dividend of $8,000 is paid on December 31, 2013.
____
8. The portfolio of long-term investments (available-for-sale) is at an aggregate market value higher than aggregate cost at December 31, 2013.
Statement of Cash Flows
23 - 39
Solution 23-120 1. f 2. g
3. a, c 4. g
5. e 6. g
7. f 8. g
Ex. 23-121—Effects of transactions on statement of cash flows. Indicate for each of the following what should be disclosed on a statement of cash flows (indirect method). 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)
The balance in Investment in Hoyt Co. Stock increased $12,000 as a result of using the equity method.
(c)
Issuance of a stock dividend increased common stock $40,000 and paid-in capital $16,000.
(d)
Amortization of bond discount, $1,600.
(e)
Machinery that cost $100,000 and had accumulated depreciation of $48,000 was sold for $53,000.
(f)
Issued 8,000 shares of common stock ($10 par) with a market value of $15 per share for machinery. (Show the amount, too.)
(g)
Amortization of patents, $3,000.
(h)
Cash dividends paid, $60,000.
Solution 23-121 (a)
Add $10,000
(e)
Investing $53,000; Deduct $1,000 (gain)
(b)
Deduct $12,000
(f)
Noncash $120,000
(c)
Not shown
(g)
Add $3,000
(d)
Add $1,600
(h)
Financing ($60,000)
Ex. 23-122—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) (indirect method). 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.
23 - 40 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 23-122 (cont.) (a)
For 2013, income before an extraordinary loss was $460,000. A tornado damaged a building and its contents. The proceeds from insurance companies totaled $120,000, which was $40,000 less than the book values. The tax rate was 30%. (Show the calculation of the net income shown on the SCF, and indicate how other items should be shown on the SCF.)
(b)
Amortization of bond premium, $1,100.
(c)
The balance in Retained Earnings was $875,000 on December 31, 2012 and $1,310,000 on December 31, 2013. Net income was $1,170,000. A stock dividend was declared and distributed which increased common stock $325,000 and paid-in capital $150,000. (Show calculation of the cash dividend and indicate how it and the stock dividend would be shown on the SCF.) Equipment, which cost $115,000 and had accumulated depreciation of $53,000, was sold for $65,000.
(d) (e)
The deferred tax liability increased $18,000.
(f)
Issued 3,000 shares of preferred stock, $50 par, with a market value of $110 per share for land. (Show the amount, too.)
Solution 23-122 (a) Income before extraordinary item Extraordinary loss Tax savings Net income on SCF Other items on SCF: Investing activity Add to net income
$460,000 $ 40,000 (12,000)
28,000 $432,000
$120,000 $40,000
(b) Deduct $1,100. (c) Retained earnings 12/31/13 $1,310,000 (or) Retained earnings 12/31/12 875,000 Increase 435,000 Stock dividend 475,000 910,000 Net income 1,170,000 Cash dividend $ 260,000 Stock dividend—Not shown. Cash dividend—Financing activity ($260,000). (d) Investing activity $65,000. Deduct $3,000 (gain on sale). (e) Add $18,000. (f)
Noncash $330,000.
Net income $1,170,000 Increase in retained earnings 435,000 Total dividends 735,000 Stock dividends 475,000 Cash dividend $ 260,000
Statement of Cash Flows
23 - 41
Ex. 23-123—Calculations for statement of cash flows. During 2013 equipment was sold for $73,000. This equipment cost $120,000 and had a book value of $70,000. Accumulated depreciation for equipment was $325,000 at 12/31/12 and $310,000 at 12/31/13. Instructions What three items should be shown on a statement of cash flows (indirect method) from this information? Show your calculations.
Solution 23-123 (1) Cash inflow from investing activities
$73,000
(2) Sales price Book value Gain on sale
$73,000 70,000 $ 3,000 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. 23-124—Calculations for statement of cash flows. Milner Co. sold a machine that cost $74,000 and had a book value of $44,000 for $48,000. Data from Milner's comparative balance sheets are: 12/31/13 12/31/12 Machinery $800,000 $670,000 Accumulated depreciation 190,000 136,000 Instructions What four items should be shown on a statement of cash flows (indirect method) from this information? Show your calculations.
Solution 23-124 (1) Cash inflow from investing activities
$48,000
(2) Sales price Book value Gain on sale
$48,000 44,000 $ 4,000 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
23 - 42 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 23-124 (cont.) (4) Cost of machine sold Add increase in machinery Purchase of machinery
$ 74,000 130,000 $204,000 Cash outflow from investing activities
Ex. 23-125—Cash flows from operating activities (indirect and direct methods). Presented below is the income statement of Cowan, 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 Accounts receivable Inventories Salaries payable (operating expenses) Accounts payable Income taxes payable
Debit $12,000 25,000
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: (a) using the indirect method. (b) using the direct method.
Statement of Cash Flows
23 - 43
Solution 23-125 (a)
Cowan, Inc. Statement of Cash Flows (Partial) (Indirect Method) 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
(b)
$42,000
$(25,000) 19,400 (8,000) 17,000 (3,000) 16,700 2,600
19,700 $61,700
Cowan, Inc. Statement of Cash Flows (Partial) (Direct Method)
Cash flows from operating activities Cash received from customers ($380,000 – $25,000) Cash paid to suppliers ($225,000 – $19,400 – $17,000) Operating expenses paid ($85,000 + $8,000 – $16,700) Taxes paid ($28,000 + $3,000 – $2,600) Net cash provided by operating activities
$355,000 $188,600 76,300 28,400
293,300 $ 61,700
Ex. 23-126—Statement of cash flows (indirect method). The following information is taken from French Corporation's financial statements:
Cash Accounts receivable Allowance for doubtful accounts Inventory Prepaid expenses Land Buildings Accumulated depreciation Patents
December 31 2013 2012 $70,000 $ 27,000 102,000 80,000 (4,500) (3,100) 155,000 175,000 7,500 6,800 100,000 60,000 287,000 244,000 (32,000) (13,000) 20,000 35,000 $705,000 $611,700
23 - 44 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 23-126 (cont.) Accounts payable Accrued liabilities Bonds payable Common stock Retained earnings—appropriated Retained earnings—unappropriated Treasury stock, at cost
$ 90,000 54,000 125,000 100,000 80,000 271,000 (15,000) $705,000
Net income Depreciation expense Amortization of patents Cash dividends declared and paid Gain or loss on sale of patents
$ 84,000 63,000 60,000 100,000 10,000 302,700 (8,000) $611,700
For 2013 Year $63,300 19,000 5,000 25,000 none
Instructions Prepare a statement of cash flows for French Corporation for the year 2013. (Use the indirect method.)
Solution 23-126 French Corporation Statement of Cash Flows For the Year Ended December 31, 2013 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
$63,300
$19,000 5,000 (20,600) 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
19,700 83,000
(40,000) (43,000) 10,000
Statement of Cash Flows
23 - 45
Solution 23-126 (cont.) Net cash used by investing activities
(73,000)
Cash flows from financing activities Sale of bonds Purchase of treasury stock Payment of cash dividends
65,000 (7,000) (25,000)
Net cash provided by financing activities
33,000
Net increase in cash Cash, January 1, 2013 Cash, December 31, 2013
$43,000 27,000 $70,000
Ex. 23-127—Preparation of statement of cash flows (format provided). The balance sheets for Kinder Company showed the following information. Additional information concerning transactions and events during 2013 are presented below. Kinder 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 2013 2012 $ 40,900 $ 10,200 38,300 20,300 35,000 42,000 0 15,000 231,500 150,000 (37,700) (25,000) $308,000 $212,500 $ 17,000 21,000 70,000 130,000 70,000 $308,000
Additional data: 1. Net income for the year 2013, $66,000. 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 $25,000. 5. Purchased machinery costing $21,500, 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.
$ 26,500 17,000 50,000 90,000 29,000 $212,500
23 - 46 Test Bank for Intermediate Accounting, Fourteenth Edition Instructions Using the format provided on the next page, prepare a statement of cash flows (using the indirect method) for 2013 for Kinder Company. Kinder Company Statement of Cash Flows For the Year Ended December 31, 2013 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, 2013 Cash, December 31, 2013
$
Statement of Cash Flows
23 - 47
Solution 23-127 Kinder Company Statement of Cash Flows For the Year Ended December 31, 2013 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
$ 66,000
$ 12,700 (13,000) (18,000) 7,000 (9,500) 4,000 (16,800)
Net cash provided by operating activities Cash flows from investing activities Sale of long-term investments Purchase of machinery
49,200
28,000 (21,500)
Net cash provided by investing activities Cash flows from financing activities Paid dividends
6,500
(25,000)
Net cash used by financing activities
(25,000)
Net increase (decrease) in cash Cash, January 1, 2013 Cash, December 31, 2013
$ 30,700 10,200 $ 40,900
Noncash investing and financing activities Purchase of machinery by issuing a long-term note payable Paid a long-term note payable by issuing common stock
$ 60,000 $ 40,000
23 - 48 Test Bank for Intermediate Accounting, Fourteenth Edition
PROBLEMS Pr. 23-128—Statement of cash flows (indirect method). The net changes in the balance sheet accounts of Keating Corporation for the year 2013 are shown below. Account Cash Short-term investments Accounts receivable Allowance for doubtful accounts Inventory Prepaid expenses Investment in subsidiary (equity method) 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 $ 82,000
Credit $121,000
83,200 13,300 74,200 22,800 25,000 210,000 130,000 80,700 21,500 15,500 70,000 90,000 150,000 60,000 38,000 $643,600
$643,600
An analysis of the Retained Earnings—Unappropriated account follows: Retained earnings unappropriated, December 31, 2012 Add: Net income Transfer from appropriation for bonded indebtedness Total Deduct: Cash dividends Stock dividend Retained earnings unappropriated, December 31, 2013
$1,300,000 327,000 60,000 $1,687,000 $185,000 240,000
425,000 $1,262,000
1. On January 2, 2013 short-term investments (classified as available-for-sale) costing $121,000 were sold for $145,000. 2. The company paid a cash dividend on February 1, 2013. 3. Accounts receivable of $16,200 and $19,400 were considered uncollectible and written off in 2013 and 2012, 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 2013. 5. The wholly owned subsidiary reported a net loss for the year of $20,000. The loss was recorded by the parent. 6. At January 1, 2013, the cash balance was $166,000. Instructions Prepare a statement of cash flows (indirect method) for the year ended December 31, 2013. Keating Corporation has no securities which are classified as cash equivalents.
Statement of Cash Flows
23 - 49
Solution 23-128 Keating Corporation Statement of Cash Flows For the Year Ended December 31, 2013 Increase (Decrease) in Cash Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Equity in subsidiary loss 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
$ 25,000 163,000 (34,000) (15,500) (69,900) (74,200) 22,800 (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
285,000
145,000 (210,000) (33,000)
Net cash provided by investing activities Cash flows from financing activities Payment of cash dividend Sale of serial bonds
(42,000)
(98,000)
(185,000) 70,000
Net cash used by financing activities
(115,000)
Net increase in cash Cash, January 1, 2013 Cash, December 31, 2013
72,000 166,000 $238,000
23 - 50 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 23-129—Statement of cash flows (direct and indirect methods). Hartman, Inc. has prepared the following comparative balance sheets for 2012 and 2013: Cash Accounts receivable 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
2013 $ 287,000 149,000 150,000 18,000 1,280,000 (450,000) 153,000 $1,587,000
2012 $ 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 $158,000 and credited for the net income for the year. The income statement for 2013 is as follows: Sales Cost of sales Gross profit Operating expenses Net income
$1,980,000 1,089,000 891,000 670,000 $ 221,000
Instructions (a) From the information above, prepare a statement of cash flows (indirect method) for Hartman, Inc. for the year ended December 31, 2013. (b)
From the information above, prepare a schedule of cash provided by operating activities using the direct method.
Statement of Cash Flows
23 - 51
Solution 23-129 (a)
Hartman, Inc. Statement of Cash Flows For the Year Ended December 31, 2013 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
$221,000
$ 75,000 21,000 (32,000) 30,000 9,000 (15,000) 18,000
106,000
Net cash provided by operating activities
327,000
Cash used in investing activities Purchase of plant assets
(230,000)
Cash flows from financing activities Payment of cash dividend Retirement of mortgage payable Sale of preferred stock
(158,000) (450,000) 645,000
Net cash provided by financing activities
37,000
Net increase in cash Cash, January 1, 2013 Cash, December 31, 2013
(b)
Hartman, Inc. Schedule of Cash Provided by Operating Activities For Year Ended December 31, 2013
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) (2) (3)
134,000 153,000 $287,000
$1,980,000 – $32,000 $1,089,000 – $30,000 + $15,000 $670,000 – $75,000 – $21,000 – $9,000 – $18,000
$1,948,000 $1,074,000 547,000
1,621,000 $ 327,000
23 - 52 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 23-130—A complex statement of cash flows (indirect method). The net changes in the balance sheet accounts of Eusey, Inc. for the year 2013 are shown below: Account Debit Credit Cash $ 95,600 Accounts receivable $ 64,000 Allowance for doubtful accounts 10,000 Inventory 197,200 Prepaid expenses 20,000 Long-term investments 144,000 Land 400,000 Buildings 650,000 Machinery 100,000 Office equipment 28,000 Accumulated depreciation: Buildings 24,000 Machinery 20,000 Equipment 12,000 Accounts payable 183,200 Accrued liabilities 72,000 Dividends payable 128,000 Premium on bonds 36,000 Bonds payable 900,000 Preferred stock ($50 par) 60,000 Common stock ($10 par) 156,000 Additional paid-in capital—common 223,200 Retained earnings 87,200 $1,805,200 $1,805,200 Additional information: 1. Income Statement Data for Year Ended December 31, 2013 Income before extraordinary item Extraordinary loss: Condemnation of land Net income
$272,000 132,000 $140,000
2. Cash dividends of $128,000 were declared December 15, 2013, payable January 15, 2014. A 5% stock dividend was issued March 31, 2013, when the market value was $22.00 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 $350,000 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.
Statement of Cash Flows
23 - 53
Pr. 23-130 (cont.) 8. The company sold 12,000 shares of its common stock ($10 par) on June 15, 2013 for $25 a share. There were 87,600 shares outstanding on December 31, 2013. 9. Bonds were sold at 104 on December 31, 2013. 10. Land that was condemned had a book value of $240,000. Instructions Prepare a statement of cash flows (indirect method). Ignore tax effects.
Solution 23-130 Eusey, Inc. Statement of Cash Flows For the Year Ended December 31, 2013 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 Loss on condemnation of land
$ 140,000
$154,000 60,000 16,000 (50,000) 4,000 74,000 (197,200) (20,000) (183,200) 72,000 132,000
(1) (2) (3) (4) (5)
Net cash provided by operating activities Cash flows from investing activities Sale of long-term investments Proceeds from condemnation of land Purchase of land Sale of building and land Purchase of building Purchase of machinery
201,600 140,000 (6) 108,000 (7) (660,000) (8) 400,000 (9) (1,110,000) (10) (140,000) (11)
Net cash used by investing activities Cash flows from financing activities Sale of bonds Retirement of preferred stock Sale of common stock Net cash provided by financing activities Net increase in cash
61,600
(1,262,000) 936,000 (12) (80,000) (13) 300,000 (14) 1,156,000 $ 95,600
23 - 54 Test Bank for Intermediate Accounting, Fourteenth Edition Solution 23-130 (cont.) (1)
Net change Debit to accumulated depreciation Depreciation expense
$ 24,000 130,000 $154,000
(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
(4)
Sale price of building and land Book value of building and land Gain on sale
$400,000 350,000 $50,000
(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)
Condemned land (at cost) Extraordinary loss
$240,000 132,000 $108,000
(8)
Net change Condemned land and land sold (at cost)
$400,000 260,000 $660,000
(9)
Given.
(10)
Net change Building sold (at cost)
(11)
Given (exchange).
(12)
Bonds Payable Add Premium
(13)
Given.
(14)
12,000 × $25 = $300,000
$ 650,000 460,000 $1,110,000
$900,000 36,000 $936,000
Statement of Cash Flows Solution 23-130 (cont.) Other important reconciliations: Shares outstanding at various times 87,600 December 31, 2013 12,000 Issued June 15, 2013 75,600 Outstanding after stock dividend March 31, 2013 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
Retained Earnings Net income Dividends (cash) Dividends (stock) Preferred stock redemption
= $120,000 = 36,000 $156,000
= $180,000 = 43,200 $223,200
$140,000 (128,000) 12,000 (79,200) (67,200) (20,000) $(87,200)
23 - 55
23 - 56 Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS True/False 1. Under IFRS, companies are not required to prepare a statement of cash flows if the transactions are reported elsewhere in the financial statements. 2. A statement of cash flows prepared according to IFRS requirements must be prepared using the direct method for operating activities. 3. IFRS encourages companies to disclose the aggregate amount of cash flows attributable to the increase in operating capacity separately from cash flows required to maintain operating capacity. 4. In certain circumstances under IFRS, bank overdrafts are considered part of cash and cash equivalents. 5. IFRS requires that noncash investing and financing activities be excluded from the statement of cash flows. Answers to True/False: 1. False 2. False 3. True 4. True 5. True
Multiple Choice Questions 1. Which of the following is false with regard to IFRS and the statement of cash flows? a. The IASB is strongly in favor of requiring use of the direct method for operating activities. b. In certain circumstances under IFRS, bank overdrafts are considered part of cash and cash equivalents. c. IFRS requires that noncash investing and financing activities be excluded from the statement of cash flows. d. All of the above statements are false with regard to IFRS and the statement of cash flows. 2. Ocean Company follows IFRS for its external financial reporting. Which of the following methods of reporting are acceptable under IFRS for the items shown? Interest paid Dividends paid a. Operating Investing b. Investing Financing c. Financing Investing d. Operating Financing
Statement of Cash Flows
23 - 57
3. Ocean Company follows IFRS for its external financial reporting. Which of the following methods of reporting are acceptable under IFRS for the items shown? Interest received Dividends received a. Operating Investing b. Investing Financing c. Financing Investing d. Operating Financing 4. Wave, Inc. follows IFRS for its external financial reporting. The statement of cash flows reports changes in cash and cash equivalents, which of the following is not considered cash or a cash equivalent under IFRS? a. Coin. b. Bank overdrafts. c. Commercial paper. d. Accounts receivable. 5. Surf Company follows IFRS for its external financial reporting. The following amounts were available at December 31, 2013: Interest paid $22,000 Dividends paid 16,000 Taxes paid 37,000 Under IFRS, what is the maximum amount that could be reported for cash used by operating activities for Surf Company for the year ended December 31, 2013? a. $59,000 b. $38,000 c. $53,000 d. $75,000 6. Surf Company follows IFRS for its external financial reporting. The following amounts were available at December 31, 2013: Interest received $22,000 Dividends received 16,000 Under IFRS, what is the maximum amount that could be reported for cash provided by operating activities for Surf Company for the year ended December 31, 2013? a. $-0b. $22,000 c. $16,000 d. $38,000 7. Surf Company follows IFRS for its external financial reporting. The following amounts were available at December 31, 2013: Interest paid $22,000 Dividends paid 16,000 Taxes paid on operations 37,000 Under IFRS, what is the maximum amount that could be reported for cash used by financing activities for Surf Company for the year ended December 31, 2013? a. $59,000 b. $38,000 c. $53,000 d. $75,000
23 - 58 Test Bank for Intermediate Accounting, Fourteenth Edition 8. In the “On the Horizon” feature in the text, which of the following is discussed regarding convergence of U.S. GAAP with IFRS? a. Noncash investing and financing activities will be disclosed only in the notes. b. Bank overdrafts will be classified as part of financing activities. c. The statement of cash flows will present only changes in cash and will exclude changes in cash equivalents. d. All of the above are in “On the Horizon” regarding converging U.S. GAAP and IFRS. 9. Which of the following is true regarding the statement of cash flows and IFRS? a. Cash and cash equivalents are defined differently under IFRS than under U.S. GAAP. b. Companies preparing a complete set of financial statements under IFRS may exclude the statement of cash flows if the cash flow activity is reported in the notes to the financial statements. c. Under IFRS most companies choose to use the direct method of reporting cash flows from operating activities. d. Under IFRS noncash investing and financing activities are excluded from the statement of cash flows and instead are presented in the notes to the financial statements. Answers to Multiple Choice: 1. a 2. d 3. a 4. d 5. d 6. d 7. b 8. c 9. d Short Answer 1. Briefly describe some of the similarities and differences between U.S. GAAP and IFRS with respect to cash flow reporting. 1. As in U.S. GAAP, the statement of cash flows is a required statement for IFRS. In addition, the content and presentation of an IFRS balance sheet is similar to one used for U.S. GAAP. However, the disclosure requirements related to the statement of cash flows are more extensive under U.S. GAAP. Other similarities include: (1) Companies preparing financial statements under IFRS must prepare a statement of cash flows as an integral part; (2) Both IFRS and U.S. GAAP require that the statement of cash flows should have three major sections – operating, investing, and financing – along with changes in cash and cash equivalents; (3) Similar to U.S. GAAP, the cash flow statement can be prepared using either the indirect or direct method under IFRS. In both U.S. and international settings, companies choose for the most part to use the indirect method of reporting net cash flows from operating activities.
Statement of Cash Flows
23 - 59
Notable differences are: (1) IFRS encourages companies to disclose the aggregate amount of cash flows that are attributable to the increase in operating capacity separately from those cash flows that are required to maintain operating capacity; (2) The definition of cash equivalents used in IFRS is similar to that used in U.S. GAAP. A major difference is that in certain situations bank overdrafts are considered part of cash and cash equivalents under IFRS (which is not the case in U.S. GAAP). Under U.S. GAAP, bank overdrafts are classified as financing activities; (3) IFRS requires that noncash investing and financing activities be excluded from the statement of cash flows. Instead, these noncash activities should be reported elsewhere. This requirement is interpreted to mean that noncash investing and financing activities should be disclosed in the notes to the financial statements instead of in the financial statements. Under U.S. GAAP, companies may present this information in the cash flow statement. 2. What are some of the key obstacles for the FASB and IASB in their convergence project for the statement of cash flows? 2. Presently, the FASB and the IASB are involved in a joint project on the presentation and organization of information in the financial statements. The FASB favors presentation of operating cash flows using the direct method only. However, the majority of IASB members express a preference for not requiring use of the direct method of reporting operating cash flows. So the two Boards will have to resolve their differences in this area in order to issue a converged standard for the statement of cash flows.
CHAPTER 24 FULL DISCLOSURE IN FINANCIAL REPORTING IFRS questions are available at the end of this chapter.
TRUE-FALSE—Conceptual Answer
No.
Description
F T T F F T F T F T F T F T F 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.
Items affected by FASB standards. SEC reporting requirements. Definition of accounting policies. Related party transactions disclosure. Post-balance-sheet disclosures. FASB 131 requirements Allocation of joint or common costs. Disclosure of major customers. Reporting under the integral approach. Accounting principles in interim reports. Reporting extraordinary items in interim reports. Computing taxes in an interim period. Opinions issued by auditor. Definition of qualified opinion. Management’s discussion and analysis section. Information provided by MD&A section. Definition of financial projection. Financial forecast vs. financial projection. Fraudulent financial reporting. Internal environment influences.
MULTIPLE CHOICE—Conceptual Answer
No.
Description
d c c d b b c d d b d b c d a d
21. 22. 23. S 24. S 25. S 26. P 27. 28. 29. 30. 31. 32. 33. 34. S 35. S 36.
Disclosure of significant accounting policies. Disclosure of inventory accounting policy. Definition of errors and irregularities. Full disclosure principle description. APB Opinion No. 22 disclosure. Related party transactions. Post-balance-sheet events. Subsequent events disclosure. Recognition of subsequent events. Revenue of a segment. Segment revenue test. Segment revenue test. Disclosure of operating segment information. Bases of reporting disaggregated information. Items reconciled in segment reporting. Accounting principles used in interim reports.
24 - 2 a d
Test Bank for Intermediate Accounting, Fourteenth Edition P
37. 38.
Planned volume variance in interim period. Interim financial reporting.
MULTIPLE CHOICE—Conceptual (cont.) Answer
N/o.
Description
d b a c c b c c a a b b d c c c d
39. 40. 41. 42. 43. S 44. P 45. S 46. 47. *48. *49. *50. *51. *52. *53. *54. *55.
Application of accounting principles on interim reporting. Methods of inventory valuation—year end vs. interim. Partial LIFO liquidation reported in interim statements. Disclosing information in interim statements. Extraordinary items in interim reports. Issuing qualified opinion. Items covered in MD&A section. Difference between financial forecast and financial projection. Disclosures in financial forecasts. Acid-test ratio and current ratio. Receivables turnover ratio. Rate of return on common stock equity. Payout ratio. Measure of long-term solvency. Number of times interest earned. Using average amounts. Limitations of ratio analysis.
P
These questions also appear in the Problem-Solving Survival Guide. These questions also appear in the Study Guide. * This topic is dealt with in an Appendix to the chapter. S
MULTIPLE CHOICE—Computational Answer
No.
Description
b c a c d c d c c d b c a a c c c
56. 57. 58. 59. *60. *61. *62. *63. *64. *65. *66. *67. *68. *69. *70. *71. *72.
Determine reportable operating segments. Bonus expense in first quarter interim income statement. Property taxes and plant repairs recognized in interim period. Inventory loss reflected in interim statements. Calculate the current ratio. Calculate the number of times interest was earned. Calculate book value per share of common stock. Calculate rate of return on common stock equity. Calculate receivables turnover. Calculate inventory turnover. Calculate the profit margin on sales. Calculate the rate of return on common stock equity. Determine book value per share. Calculate the acid-test ratio. Calculate the acid-test ratio. Receivables turnover. Calculate inventory turnover.
Full Disclosure in Financial Reporting
MULTIPLE CHOICE—CPA Adapted Answer
No.
Description
c c b b b c b c c d c
73. 74. 75. 76. 77. 78. 79. 80. *81. *82. *83.
Significant accounting policies disclosed for plant assets. Criteria for reporting disaggregated information. Identification of reportable segments. Identification of a reportable segment. Advertising costs—year end vs. interim reporting. Total expense to be reported in interim statements. Extraordinary loss reported in interim statements. Extraordinary gain reported in interim statements. Acid-test ratio and inventory turnover ratio. Acid-test ratio and debt to total assets ratio. Receivables turnover and payout ratio.
EXERCISES Item E24-84 E24-85 E24-86 E24-87 E24-88 E24-89 *E24-90 *E24-91 *E24-92
Description Notes to financial statements. Segment reporting. Segment reporting. Interim reports. Inventory and cost of goods sold at interim dates. Forecasts. Financial statement analysis. Selected financial ratios. Computation of selected ratios.
PROBLEMS Item
Description
P24-93 P24-94
Segment Reporting. Interim Reports.
CHAPTER LEARNING OBJECTIVES 1. Review the full disclosure principle and describe implementation problems. 2. Explain the use of notes in financial statement preparation. 3. Discuss the disclosure requirements for major business segments. 4. Describe the accounting problems associated with interim reporting. 5. Identify the major disclosures in the auditor's report. 6. Understand management’s responsibilities for financials. 7. Identify issues related to financial forecasts and projections. 8. Describe the profession's response to fraudulent financial reporting. *9. Understand the approach to financial statement analysis. *10. Identify major analytic ratios and describe their calculation. *11. Explain the limitations of ratio analysis.
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24 - 4
Test Bank for Intermediate Accounting, Fourteenth Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTIONS Item
P
Type
1.
TF
3. 4.
TF TF
6. 7. 8.
TF TF TF
9. 10. 11. 12.
TF TF TF TF
13.
TF
45.
MC
Item
S
S P
Type
2.
TF
5. 25.
TF MC
S
30. 31. 32.
MC MC MC
33. 34. S 35.
36. 37. 38. 39.
MC MC MC MC
40. 41. 42. 43.
14.
TF
15.
17.
TF
18.
TF
19.
TF
20.
TF
48. 49. 50. 51.
MC MC MC MC
55.
MC
Note:
Item
52. 53. 54. 60.
21.
P
S
MC MC MC MC
TF = True-False MC = Multiple Choice E = Exercise P = Problem
26. 27.
Type
Item
Type
Item
Learning Objective 1 MC 22. MC 23. Learning Objective 2 MC 28. MC 73. MC 29. MC 84. Learning Objective 3 MC 56. MC 76. MC 74. MC 85. MC 75. MC 86. Learning Objective 4 MC 57. MC 78. MC 58. MC 79. MC 59. MC 80. MC 77. MC 87. Learning Objective 5 S TF 16. TF 44. Learning Objective 6
Type
Item
Type
MC
S
24.
MC
MC E E
93.
P
MC MC MC E
88. 94.
E P
81. 82. 83. 90.
MC MC MC E
Item
Type
91. 92.
E E
MC E
MC
46.
Learning Objective 7 MC 47. MC 89. Learning Objective 8
E
61. 62. 63. 64.
Learning Objective 10 MC 65. MC 69. MC 66. MC 70. MC 67. MC 71. MC 68. MC 72. Learning Objective 11
MC MC MC MC
Full Disclosure in Financial Reporting
24 - 5
TRUE-FALSE—Conceptual 1.
FASB standards directly affect financial statements, notes to the financial statements, and management’s discussion and analysis.
2.
The SEC requires that companies report to it certain substantive information that is not found in their annual reports.
3.
Accounting policies are the specific accounting principles and methods a company uses and considers most appropriate to present fairly its financial statements.
4.
In order to make adequate disclosure of related party transactions, companies should report the legal form, rather than the economic substance, of these transactions.
5.
If the loss on an account receivable results from a customer’s bankruptcy after the balance sheet date, the company only discloses this information in the notes to the financial statements.
6.
FASB Statement 131 requires that general purpose financial statements include selected information on a single basis of segmentation.
7.
The FASB requires allocations of joint, common, or company-wide costs for external reporting purposes.
8.
If 10 percent or more of company revenue is derived from a single customer, the company must disclose the total amount of revenue from each such customer by segment.
9.
Companies should report accounting transactions as they occur, and expense recognition should not change with the period of time covered under the integral approach.
10.
Companies should generally use the same accounting principles for interim reports and for annual reports.
11.
Companies report extraordinary items in interim reports by prorating them over the four quarters.
12.
To compute the year-to-date tax, companies apply the estimated annual effective tax rate to the year-to-date ordinary income at the end of each interim period.
13.
In most situations, an auditor issues a qualified opinion or disclaims an opinion.
14.
A qualified opinion is issued when the exception to the standard opinion is not of sufficient magnitude to invalidate the statements as a whole.
15.
Management’s discussion and analysis section covers three financial aspects of an enterprise’s business-liquidity, profitability, and solvency.
16.
The MD&A section must provide information about the effects of inflation and changing prices, if they are material to financial statement trends.
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Test Bank for Intermediate Accounting, Fourteenth Edition
17.
A financial projection is a set of prospective financial statements that present a company’s expected financial position and results of operations.
18.
The difference between a financial forecast and a financial projection is that a forecast provides information on what is expected to happen, while a projection provides information on what might take place.
19.
Fraudulent financial reporting is intentional or reckless conduct, whether act or omission, that results in materially misleading financial statements.
20.
Influences in a company’s internal environment may relate to industry conditions, poor internal control systems, or legal and regulatory considerations.
True-False Answers—Conceptual Item 1. 2. 3. 4. 5.
Ans. F T T F F
Item 6. 7. 8. 9. 10.
Ans. T F T F T
Item 11. 12. 13. 14. 15.
Ans. F T F T F
Item 16. 17. 18. 19. 20.
Ans. T F T T F
MULTIPLE CHOICE—Conceptual 21.
Which of the following should be disclosed in a Summary of Significant Accounting Policies? a. Types of executory contracts b. Amount for cumulative effect of change in accounting principle c. Claims of equity holders d. Depreciation method followed
22.
An example of an inventory accounting policy that should be disclosed in a Summary of Significant Accounting Policies is the a. amount of income resulting from the involuntary liquidation of LIFO. b. major backlogs of inventory orders. c. method used for pricing inventory. d. composition of inventory into raw materials, work-in-process, and finished goods.
23.
Errors and irregularities are defined as intentional distortions of facts. a. b. c. d.
Errors Yes Yes No No
Irregularities Yes No Yes No
Full Disclosure in Financial Reporting
24 - 7
S
24.
The full disclosure principle, as adopted by the accounting profession, is best described by which of the following? a. All information related to an entity's business and operating objectives is required to be disclosed in the financial statements. b. Information about each account balance appearing in the financial statements is to be included in the notes to the financial statements. c. Enough information should be disclosed in the financial statements so a person wishing to invest in the stock of the company can make a profitable decision. d. Disclosure of any financial facts significant enough to influence the judgment of an informed reader.
S
25.
The focus of APB Opinion No. 22 is on the disclosure of accounting policies. This information is important to financial statement readers in determining a. net income for the year. b. whether accounting policies are consistently applied from year to year. c. the value of obsolete items included in ending inventory. d. whether the working capital position is adequate for future operations.
S
26.
If a business entity entered into certain related party transactions, it would be required to disclose all of the following information except the a. nature of the relationship between the parties to the transactions. b. nature of any future transactions planned between the parties and the terms involved. c. dollar amount of the transactions for each of the periods for which an income statement is presented. d. amounts due from or to related parties as of the date of each balance sheet presented.
P
27.
Events that occur after the December 31, 2013 balance sheet date (but before the balance sheet is issued) and provide additional evidence about conditions that existed at the balance sheet date and affect the realizability of accounts receivable should be a. discussed only in the MD&A (Management's Discussion and Analysis) section of the annual report. b. disclosed only in the Notes to the Financial Statements. c. used to record an adjustment to Bad Debt Expense for the year ending December 31, 2013 d. used to record an adjustment directly to the Retained Earnings account
28.
Which of the following post-balance-sheet events would generally require disclosure, but no adjustment of the financial statements? a. Retirement of the company president b. Settlement of litigation when the event that gave rise to the litigation occurred prior to the balance sheet date. c. Employee strikes d. Issue of a large amount of capital stock
29.
Which of the following subsequent events (post-balance-sheet events) would require adjustment of the accounts before issuance of the financial statements? a. Loss of plant as a result of fire b. Changes in the quoted market prices of securities held as an investment c. Loss on an uncollectible account receivable resulting from a customer’s major flood loss d. Loss on a lawsuit, the outcome of which was deemed uncertain at year end.
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Test Bank for Intermediate Accounting, Fourteenth Edition
30.
Revenue of a segment includes a. only sales to unaffiliated customers. b. sales to unaffiliated customers and intersegment sales. c. sales to unaffiliated customers and interest revenue. d. sales to unaffiliated customers and other revenue and gains.
31.
An operating segment is a reportable segment if a. its operating profit is 10% or more of the combined operating profit of profitable segments. b. its operating loss is 10% or more of the combined operating losses of segments that incurred an operating loss. c. the absolute amount of its operating profit or loss is 10% or more of the company's combined operating profit or loss. d. none of these.
32.
A segment of a business enterprise is to be reported separately when the revenues of the segment exceed 10 percent of the a. total combined revenues of all segments reporting profits. b. total revenues of all the enterprise's industry segments. c. total export and foreign sales. d. combined net income of all segments reporting profits.
33.
All of the following information about each operating segment must be reported except a. unusual items. b. interest revenue. c. cost of goods sold. d. depreciation and amortization expense.
34.
The profession requires disaggregated information in the following ways: a. products or services. b. geographic areas. c. major customers. d. all of these.
35.
In presenting segment information, which of the following items must be reconciled to the entity's consolidated financial statements?
S
a. b. c. d. S
36.
Revenues Yes No Yes Yes
Operating Profit (Loss) Yes Yes No Yes
Identifiable Assets Yes Yes Yes No
APB Opinion No. 28 indicates that a. all companies that issue an annual report should issue interim financial reports. b. the discrete view is the most appropriate approach to take in preparing interim financial reports. c. the three basic financial statements should be presented each time an interim period is reported upon. d. the same accounting principles used for the annual report should be employed for interim reports.
Full Disclosure in Financial Reporting P
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37.
Rondelli Manufacturing Company employs a standard cost system. A planned volume variance in the first quarter of 2011, which is expected to be absorbed by the end of the fiscal year, ordinarily should a. be deferred at the end of the first quarter, regardless of whether it is favorable or unfavorable. b. never be deferred beyond the quarter in which it occurs. c. be deferred at the end of the first quarter if it is favorable; unfavorable variances are to be recognized in the period incurred. d. be deferred at the end of the first quarter if it is unfavorable; favorable variances are to be recognized in the period incurred.
38.
In considering interim financial reporting, how does the profession conclude that such reporting should be viewed? a. As a "special" type of reporting that need not follow generally accepted accounting principles. b. As useful only if activity is evenly spread throughout the year so that estimates are unnecessary. c. As reporting for a basic accounting period. d. As reporting for an integral part of an annual period.
39.
Accounting principles are modified for the following at interim dates. a. b. c. d.
40.
Losses Yes No Yes No
The following methods of estimating inventory can be used at interim dates for inventory pricing. May they also be used at year end? a. b. c. d.
41.
Revenue Yes Yes No No
Gross Profit Method No No Yes Yes
Retail Inventory Method No Yes No Yes
A company that uses the last-in, first-out (LIFO) method of inventory pricing finds at an interim reporting date that there has been a partial liquidation of the base period inventory level. The decline is considered temporary and the partial liquidation is expected to be replaced prior to year end. The amount shown as inventory at the interim reporting date should a. be shown at the actual level, and cost of sales for the interim reporting period should include the expected cost of replacement of the liquidated LIFO base. b. be shown at the actual level, and cost of sales for the interim reporting period should reflect the historical cost of the liquidated LIFO base. c. not give effect to the LIFO liquidation, and cost of sales for the interim reporting period should reflect the historical cost of the liquidated LIFO base. d. be shown at the actual level, and the decrease in inventory level should not be reflected in the cost of sales for the interim reporting period.
24 - 10 Test Bank for Intermediate Accounting, Fourteenth Edition 42.
Companies should disclose all of the following in interim reports except a. basic and diluted earnings per share. b. changes in accounting principles. c. post-balance-sheet events. d. seasonal revenue, cost, or expenses.
43.
The required approach for handling extraordinary items in interim reports is to a. prorate them over all four quarters. b. prorate them over the current and remaining quarters. c. charge or credit the loss or gain in the quarter that it occurs. d. disclose them only in the notes.
S
44.
If the financial statements examined by an auditor lead the auditor to issue an opinion that contains an exception that is not of sufficient magnitude to invalidate the statement as a whole, the opinion is said to be a. unqualified. b. qualified. c. adverse. d. exceptional.
P
45.
The MD&A section of a company's annual report is to cover the following three items: a. income statement, balance sheet, and statement of owners' equity. b. income statement, balance sheet, and statement of cash flows. c. liquidity, capital resources, and results of operations. d. changes in the stock price, mergers, and acquisitions.
S
46.
Which of the following best characterizes the difference between a financial forecast and a financial projection? a. Forecasts include a complete set of financial statements, while projections include only summary financial data. b. A forecast is normally for a full year or more and a projection presents data for less than a year. c. A forecast attempts to provide information on what is expected to happen, whereas a projection may provide information on what is not necessarily expected to happen. d. A forecast includes data which can be verified about future expectations, while the data in a projection is not susceptible to verification.
47.
A financial forecast per professional pronouncements presents to the best of the responsible party's knowledge and belief, a. an entity's expected financial position, results of operations, and cash flows. b. an assessment of the company's ability to be successful in the future. c. given one or more hypothetical assumptions, an entity's expected financial position, results of operations, and cash flows. d. an assessment of the company's ability to be successful in the future under a number of different assumptions.
*48.
Cash, short-term investments, and net receivables are the numerator for Acid-Test Ratio Current Ratio a. Yes No b. Yes Yes c. No No d No Yes
Full Disclosure in Financial Reporting
24 - 11
*49.
Theoretically, in computing the receivables turnover, the numerator should include a. net sales. b. net credit sales. c. sales. d. credit sales.
*50.
The rate of return on common stock equity is calculated by dividing a. net income by average common stockholders’ equity. b. net income less preferred dividends by average common stockholders’ equity. c. net income by ending common stockholders’ equity. d. net income less preferred dividends by ending common stockholders’ equity.
*51.
The payout ratio is calculated by dividing a. dividends per share by earnings per share. b. cash dividends by net income plus preferred dividends. c. cash dividends by market price per share. d. cash dividends by net income less preferred dividends.
*52.
Which of the following ratios measures long-term solvency? a. Acid-test ratio b. Receivables turnover c. Debt to total assets d. Current ratio
*53.
The calculation of the number of times interest is earned involves dividing a. net income by annual interest expense. b. net income plus income taxes by annual interest expense. c. net income plus income taxes and interest expense by annual interest expense. d. none of these.
*54.
When should an average amount be used for the numerator or denominator? a. When the numerator is a balance sheet item or items b. When the denominator is a balance sheet item or items c. When a ratio consists of an income statement item and a balance sheet item d. When the numerator is an income statement item or items
*55.
The basic limitations associated with ratio analysis include a. the lack of comparability among firms in a given industry. b. the use of estimated items in accounting. c. the use of historical costs in accounting. d. all of these.
24 - 12 Test Bank for Intermediate Accounting, Fourteenth Edition
Multiple Choice Answers—Conceptual Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
21. 22. 23. 24. 25.
d c c d b
26. 27. 28. 29. 30.
b c d d b
31. 32. 33. 34. 35.
d b c d a
36. 37. 38. 39. 40.
d a d d b
41. 42. 43. 44. 45.
a c c b c
46. 47. *48. *49. *50.
c a a b b
*51. *52. *53. *54 *55.
d c c c d
Solutions to those multiple choice questions for which the answer is “none of these:” 31.
The absolute amount of its profit or loss is 10% or more of the greater, in absolute amount, of (a) the combined profit of all operating segments that did not incur a loss, or (b) the combined loss of all operating segments that did incur a loss.
MULTIPLE CHOICE—Computational 56.
Presented below are four segments that have been identified by Haley Productions: Segments A B C D
Total Revenue (Unaffiliated) $255,000 600,000 225,000 90,000
Operating Profit (Loss) $30,000 (55,000) 6,000 4,000
Identifiable Assets $900,000 800,000 450,000 225,000
For which of the segments would information have to be disclosed in accordance with professional pronouncements? a. Segments A, B, C, and D b. Segments A, B, and C c. Segments A and B d. Segments A and D 57.
In January 2013, Post, Inc. estimated that its year-end bonus to executives would be $960,000 for 2013. The actual amount paid for the year-end bonus for 2012 was $880,000. The estimate for 2013 is subject to year-end adjustment. What amount, if any, of expense should be reflected in Post's quarterly income statement for the three months ended March 31, 2013? a. $ -0-. b. $220,000. c. $240,000. d. $960,000.
58.
On January 15, 2013, Vancey Company paid property taxes on its factory building for the calendar year 2013 in the amount of $840,000. In the first week of April 2013, Vancey made unanticipated major repairs to its plant equipment at a cost of $2,100,000. These repairs will benefit operations for the remainder of the calendar year. How should these expenses be reflected in Vancey's quarterly income statements?
Full Disclosure in Financial Reporting
a. b. c. d. 59.
3/31/13 $210,000 $210,000 $840,000 $735,000
Three Months Ended 6/30/13 9/30/13 $9,10,000 $9,10,000 $2,310,000 $210,000 $1,400,000 $ -0$735,000 $735,000
24 - 13
12/31/13 $9,10,000 $210,000 $ -0$735,000
An inventory loss from market decline of $1,600,000 occurred in May 2013, after its March 31, 2013 quarterly report was issued. None of this loss was recovered by the end of the year. How should this loss be reflected in the company's quarterly income statements? Three Months Ended 3/31/13 6/30/13 9/30/13 12/31/13 a. $ -0$ -0$ -0$1,600,000 b. $ -0$533,333 $533,333 $533,333 c. $ -0$1,600,000 $ -0$ -0d. $400,000 $400,000 $400,000 $400,000
Use the following information for questions 60 through 63. Information for Ramirez Corp. is given below: Ramirez Corp. Balance Sheet December 31, 2013 Assets Cash Accounts receivable (net) Inventories Plant and equipment, net of depreciation Patents Other intangible assets Total Assets
$ 100,000 650,000 813,000 661,000 87,000 25,000 $2,336,000
Equities Accounts payable $ 210,000 Federal income tax payable 63,000 Miscellaneous accrued payables 75,000 Bonds payable (10%, due 2015) 625,000 Preferred stock ($100 par, 6% cumulative nonparticipating) 250,000 Common stock (no par, 20,000 shares authorized, issued and outstanding) 375,000 Retained earnings 813,000 Treasury stock—500 shares of preferred (75,000) Total Equities $2,336,000
Ramirez Corp. Income Statement Year Ended December 31, 2013 Net sales Cost of goods sold Gross profit Operating expenses (including bond interest expense) Income before income taxes Income tax Net income
$3,000,000 2,000,000 1,000,000 500,000 500,000 150,000 $ 350,000
24 - 14 Test Bank for Intermediate Accounting, Fourteenth Edition Additional information: There are no preferred dividends in arrears, the balances in the Accounts Receivable and Inventory accounts are unchanged from January 1, 2013, and there were no changes in the Bonds Payable, Preferred Stock, or Common Stock accounts during 2013. Assume that preferred dividends for the current year have not been declared. *60.
At December 31, 2013, the current ratio was a. 750 ÷ 210. b. 2,225 ÷ 273. c. 1,563 ÷ 273. d. 1,563 ÷ 348.
*61.
The number of times interest was earned during 2013 was a. 350 ÷ 62.5. b. 500 ÷ 62.5. c. 562 ÷ 62.5. d. 437 ÷ 62.5.
*62.
At December 31, 2013, the book value per share of common stock was a. $55.66. b. $58.16. c. $59.41. d. $58.65.
*63.
The rate of return for 2011 based on the year-end common stockholders' equity was a. 350 ÷ 1,173. b. 350 ÷ 1,188. c. 335 ÷ 1,173. d. 335 ÷ 1,188.
Use the following information for questions 64 through 69. The following data are provided:
Cash Accounts receivable (net) Inventories Plant assets (net) Accounts payable Income+Taxes payable Bonds payable 10% Preferred stock, $50 par Common stock, $10 par Paid-in capital in excees of par Retained earnings Net credit sales Cost of goods sold Operating expenses Net income
December 31 2013 2012 $ 750,000 $ 500,000 800,000 600,000 1,300,000 1,100,000 4,000,000 3,250,000 550,000 400,000 100,000 50,000 700,000 700,000 1,000,000 1,000,000 1,200,000 900,000 800,000 650,000 2,000,000 1,750,000 6,400,000 4,200,000 1,450,000 750,000
Full Disclosure in Financial Reporting
24 - 15
Additional information: Depreciation included in cost of goods sold and operating expenses is $610,000. On May 1, 2013, 30,000 shares of common stock were issued. The preferred stock is cumulative. The preferred dividends were not declared during 2013. *64.
The receivables turnover for 2013 is a. 6,400 ÷ 800. b. 4,200 ÷ 800. c. 6,400 ÷ 700. d. 4,200 ÷ 700.
*65.
The inventory turnover for 2013 is a. 6,400 ÷ 1,300. b. 4,200 ÷ 1,300. c. 6,400 ÷ 1,200. d. 4,200 ÷ 1,200.
*66.
The profit margin on sales for 2013 is a. 2,200 ÷ 6,400. b. 750 ÷ 6,400. c. 2,200 ÷ 4,200. d. 750 ÷ 4,200.
*67.
The rate of return on common stock equity for 2013 is a. 750 ÷ 3,600. b. 750 ÷ 4,000. c. 650 ÷ 3,600. d. 650 ÷ 4,000.
*68.
The book value per share of common stock at 12/31/13 is a. 3,900 ÷ 120. b. 3,880 ÷ 120. c. 3,900 ÷ 110. d. 4,000 ÷ 110.
*69.
At December 31, 2013, the acid-test ratio was a. 1,550 ÷ 650. b. 1,550 ÷ 1,080. c. 2,100 ÷ 800. d. 2,850 ÷ 650.
*70.
Presented below is information related to Tolbert Company. Current Assets Cash Short-term investments Accounts receivable Inventories Prepaid expenses Total current assets
$ 8,000 150,000 122,000 220,000 60,000 $560,000
24 - 16 Test Bank for Intermediate Accounting, Fourteenth Edition Total current liabilities are $100,000. What is the acid-test ratio? a. 5.6 to 1. b. 5.0 to 1. c. 2.8 to 1. d. 1.6 to 1. *71.
Perez Company's net accounts receivable were $800,000 at December 31, 2012 and $880,,000 at December 31, 2013. Net cash sales for 2013 were $520,,000. The accounts receivable turnover for 2013 was 7.0. What were Perez's total net sales for 2013? a. $3,640,000. b. $5,880,000. c. $6,400,000. d. $5,360,000.
*72.
During 2013, Quirk, Incorporated purchased $3,400,000 of inventory. The cost of goods sold for 2013 was $3,600,000 and the ending inventory at December 31, 2013, was $400,000. What was the inventory turnover for 2013? a. 6.0. b. 6.4. c. 7.2. d. 9.0.
Multiple Choice Answers—Computational Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
56. 57. 58.
b c a
59. *60. *61.
c d c
*62. *63. *64.
d c c
*65. *66. *67.
d b c
*68. *69. *70.
a a c
*71. *72.
c c
MULTIPLE CHOICE—CPA Adapted 73.
Which of the following facts concerning plant assets should be included in the summary of significant accounting policies? a. b. c. d.
74.
Depreciation Method No Yes Yes No
Composition Yes Yes No No
Farr, Inc. is a multidivisional corporation which has both intersegment sales and sales to unaffiliated customers. Farr should report segment financial information for each division meeting which of the following criteria? a. Segment profit or loss is 10% or more of consolidated profit or loss. b. Segment profit or loss is 10% or more of combined profit or loss of all company segments. c. Segment revenue is 10% or more of combined revenue of all the company segments. d. Segment revenue is 10% or more of consolidated revenue.
Full Disclosure in Financial Reporting 75.
24 - 17
Unruh Corp. and its divisions are engaged solely in manufacturing operations. The following data (consistent with prior years' data) pertain to the industries in which operations were conducted for the year ended December 31, 2013. Assets Industry Revenue Profit 12/31/13 A $ 8,000,000 $1,320,000 $16,000,000 B 6,400,000 1,120,000 14,000,000 C 4,800,000 960,000 10,000,000 D 2,400,000 440,000 5,200,000 E 3,400,000 540,000 5,600,000 F 1,200,000 180,000 2,400,000 $26,200,000 $4,560,000 $53,200,000 In its segment information for 2013, how many reportable segments does Unruh have? a. Three b. Four c. Five d. Six
76.
The following information pertains to Nixon Corp. and its divisions for the year ended December 31, 2013. Sales to unaffiliated customers $3,500,000 Intersegment sales of products similar to those sold to unaffiliated customers 1,050,000 Interest earned on loans to other operating segments 70,000 Nixon and all of its divisions are engaged solely in manufacturing operations. Nixon has a reportable segment if that segment's revenue exceeds a. $462,000. b. $455,000. c. $357,000. d. $350,000.
77.
Advertising costs may be accrued or deferred to provide an appropriate expense in each period for Interim Year-end Financial Reporting Financial Reporting a. Yes No b. Yes Yes c. No No d. No Yes
78.
Mayo Corp. has estimated that total depreciation expense for the year ending December 31, 2013 will amount to $400,000, and that 2013 year-end bonuses to employees will total $800,000. In Mayo's interim income statement for the six months ended June 30, 2013, what is the total amount of expense relating to these two items that should be reported? a. $0. b. $200,000. c. $600,000. d. $1,200,000.
24 - 18 Test Bank for Intermediate Accounting, Fourteenth Edition 79.
Fina Corp. had the following transactions during the quarter ended March 31, 2013: Loss from hurricane damage Payment of fire insurance premium for calendar year 2013
$350,000 600,000
What amount should be included in Fina's income statement for the quarter ended March 31, 2013? Extraordinary Loss Insurance Expense a. $350,000 $600,000 b. $350,000 $150,000 c. $87,500 $150,000 d. $0 $600,000 80.
For interim financial reporting, an extraordinary gain occurring in the second quarter should be a. recognized ratably over the last three quarters. b. recognized ratably over all four quarters with the first quarter being restated. c. recognized in the second quarter. d. disclosed by note only in the second quarter.
*81.
How is the average inventory used in the calculation of each of the following? Acid-Test (Quick) Ratio Inventory Turnover Ratio a. Numerator Numerator b. Numerator Denominator c. Not Used Denominator d. Not Used Numerator
*82.
Which of the following ratios is(are) useful in assessing a company's ability to meet current maturing or short-term obligations? Acid-Test Ratio Debt to Total Assets Ratio a. No No b. No Yes c. Yes Yes d. Yes No
*83.
Which of the following ratios should be used in evaluating the effectiveness with which the company uses its assets? Receivables Turnover Payout Ratio a. Yes Yes b. No No c. Yes No d. No Yes
Multiple Choice Answers—CPA Adapted Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
73. 74.
c c
75. 76.
b b
77. 78.
b c
79. 80.
b c
*81. *82.
c d
*83.
c
Full Disclosure in Financial Reporting
24 - 19
DERIVATIONS — Computational No.
Answer Derivation
56.
b
Revenue test: Total revenue = $1,170,000 × 10% = $117,000. Operating profit test: $55,000 × 10% = $5,500. Asset test: Total assets = $2,375,000 × 10% = $237,500.
57.
c
$960,000 ÷ 4 = $240,000.
58.
a
$840,000 ÷ 4 = $210,000. $2,100,000 ÷ 3 = $700,000 + $210,000 = $910,000.
59.
c
Conceptual.
*60.
d
($100,000 + $650,000 + $813,000) 1,563 ———————————————— = ——— ($210,000 + $63,000 + $75,000) 348
*61.
c
$500,000 + ($625,000 .10) 562.5 ————————————— = ——— $625,000 .10 62.5
*62.
d
$375,000 + [$813,000 – (.06 × $250,000)] ——————————————————— = $58.65. 20,000
*63.
c
$350,000 – (.06 × $250,000) ——————————————————— = 335 ÷ 1,173. $375,000 + [$813,000 – (.06 $250,000)]
*64.
c
$6,400,000 ———————————— = 6,400 ÷ 700. ($600,000 + $800,000) ÷ 2
*65.
d
$4,800,000 ———————————— = 4,200 ÷ 1,200. ($1,300,000 + $1,100,000) ÷ 2
*66
b
$750,000 ÷ $6,400,000 = 750 ÷ 6,400.
*67.
c
———————————————————————————————————
$750,000 – ($1,000,000 ×.10) [($1,200,000 + $800,000 + $2,000,000 – $100,000) + ($900,000 + $650,000 + $1,750,000)] ÷2
= 650 ÷ 3,600.
*68.
a
$1,200,000 + $800,000 + ($2,000,000 – $100,000) ————————————————————— = 3,900 ÷ 1200 120,000
24 - 20 Test Bank for Intermediate Accounting, Fourteenth Edition
DERIVATIONS — Computational (cont.) No.
Answer Derivation
*69.
a
$750,000 + $800,000 —————————— = 1,550 ÷ 650. $550,000 + $100,000
*70.
c
$8,000 + $150,000 + $122,000 —————————————— = 2.80 to 1. $100,000
*71.
c
(X – $520,000) ———————————— = 7.0, X = $6,400,000. ($800,000 + $80,000) 2
*72.
c
$3,600,000 + $400,000 – $3,400,000 = $600,000. $3,600,000 ———————————— = 7.2. ($600,000 + $400,000) ÷ 2
DERIVATIONS — CPA Adapted No.
Answer Derivation
73.
c
Conceptual.
74.
c
Conceptual.
75.
b
Revenue test: $26,200,000 × 10% = $2,620,000 Profit test: $4,560,000 × 10% = $456,000 Asset test: $53,200,000 × 10% = $5,320,000 A, B, C, E.
76.
b
($3,500,000 + $1,050,000) × 10% = $455,000.
77.
b
Conceptual.
78.
c
($400,000 + $800,000) ÷ 2 = $600,000.
79.
b
Extraordinary loss = $350,000 Insurance expense = $600,000 ÷ 4 = $150,000.
80.
c
Conceptual.
*81.
c
Conceptual.
*82.
d
Conceptual.
*83.
c
Conceptual.
Full Disclosure in Financial Reporting
24 - 21
EXERCISES Ex. 24-84—Notes to financial statements. An article in Dun's Review made the following comments: "Every other year, say, companies should print the notes in big type and the base figures in smaller ones." Instructions (a) Are notes considered as part of the financial statements and what basic purpose do they serve? (b)
What are the general types of notes?
Solution 24-84 (a)
Notes are an integral part of the financial statements of a business enterprise. Notes are the accountant's means of more fully disclosing data relevant to the interpretation of the statements. Information pertinent to specific financial statement items can be explained in qualitative terms, and supplementary data of a quantitative nature can be provided to expand on the information in the financial statements. Restrictions imposed by financial arrangements or basic contractual agreements can be explained in notes.
(b)
The more common types of notes disclose such items as the following: (1) accounting methods used, (2) contingent assets or liabilities, (3) examination of creditor claims, (4) claims of equity holders, and (5) executory commitments.
Ex. 24-85—Segment reporting. The Financial Accounting Standards Board requires the reporting of disaggregated financial data about the different types of business activities in which an enterprise engages. Instructions Identify 4 of the 6 items of disaggregated information the FASB requires that an enterprise report.
Solution 24-85 The FASB requires that an enterprise report the following disaggregated information: 1. General information about its operating segments. 2. Segment profit and loss and related information. 3. Segment’s total assets. 4. Reconciliation of the total of operating segments’ profits and losses to its income before income taxes. 5. Information about products and services and geographic areas. 6. Total amount of revenues derived from major customers.
24 - 22 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 24-86—Segment reporting. Finney Company's condensed income statement is presented below: Revenues Expenses Cost of goods sold Operating and administrative expenses Depreciation expense Income before taxes Income tax expenses Net income
$1,900,000 $400,000 200,000 40,000
640,000 260,000 78,000 $ 182,000
Earnings per share (100,000 shares)
$1.82
The following data is compiled relative to Finney's operating segments: Percent Identified with Segment Hotels Grains Candy Revenues 42% 50% 8% Cost of goods sold 48 49 3 Operating and administrative expense 35 50 15 Depreciation expense 46 42 12 Included in the amounts allocated to each segment on the above percentages are the following expenses which relate to general corporate activities: Operating Segment Hotels Grains Candy Totals Operating and administrative expense $12,000 $9,000 $3,000 $24,000 Depreciation expense 3,500 4,000 2,500 10,000 Instructions (a) Prepare a schedule showing the amounts distributed to each segment. (b) Based only on the above information, which segments must be reported and why?
Solution 24-86 (a) Revenues (1) Expenses— Cost of goods sold (1) Operating and admin. expense (2) Depreciation expense (3) Total expenses Operating profit
Operating Segment Hotels Grains Candy $378,000 $450,000 $72,000
Totals $900,000
192,000 58,000 14,900 264,900 $113,100
400,000 176,000 30,000 606,000 294,000
(1)
Total times segment percentage.
(2)
Hotels = ($200,000 × 35%) – $12,000 = $58,000 Grains = ($200,000 × 50%) – $9,000 = $91,000 Candy = ($200,000 × 15%) – $3,000 = $27,000
196,000 91,000 12,800 299,800 $150,200
12,000 27,000 2,300 41,300 $30,700 $
Full Disclosure in Financial Reporting
24 - 23
Solution 24-86 (cont.) (3)
(b)
Hotels = ($40,000 × 46%) – $3,500 = $14,900 Grains = ($40,000 × 42%) – $4,000 = $12,800 Candy = ($40,000 × 12%) – $2,500 = $2,300
Two segments, Hotels and Grains, must be reported because they satisfy the revenue test; that is, the segment's revenues are 10% or more of the combined revenues of all operating segments. In addition, the Hotels and the Grains segments meet the 10% of the operating profit test.
Ex. 24-87—Interim reports. A few years ago, a publishing company in the fourth quarter had a net profit figure that exceeded sales for that quarter. Such a situation as this suggests that some difficult accounting issues are involved in interim reporting. Instructions (a) What are the major accounting problems related to interim reports? (b)
What problem exists with income taxes in interim reports and how does GAAP recommend that taxes be reported? What does GAAP require?
(c)
Many academicians have attempted to predict the year's net income after the first quarter's income is reported. These attempts are generally unsuccessful, no matter how sophisticated the prediction model. What might be the reason for this inability to predict?
Solution 24-87 (a)
The major accounting issues related to interim reporting are the treatment of (1) extraordinary items, (2) annually determined items such as income taxes, pension costs, executive compensation based on annual net income, and (3) the problem of seasonality.
(b)
The basic question with income taxes is whether in the preparation of interim income statements the provision for taxes should reflect the anticipated effective tax rate for the year or be computed on the basis of actual results for that interim period. APB Opinion No. 28 recommends that at the end of each interim period the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate so determined should be used in providing for income taxes on a current year-to-date basis. FASB Interpretation No. 18 requires that the estimated annual effective tax rate be applied to the year-to-date "ordinary" income at the end of each interim period to compute the yearto-date tax. Further, the interim period tax related to ordinary income shall be the difference between the amount so computed and the amounts reported for previous interim periods of the fiscal period.
(c)
The prediction models are probably unsuccessful because accountants have not treated the problem of seasonality correctly in their interim reports. The problem with the conventional approach is that fixed nonmanufacturing costs are not charged in proportion to sales. Rather, these costs are charged as incurred, or spread evenly over the four quarters. As a result, it is extremely difficult to make accurate predictions because some artificial concepts are used for matching purposes.
24 - 24 Test Bank for Intermediate Accounting, Fourteenth Edition Ex. 24-88—Inventory and cost of goods sold at interim dates. Discuss how inventory and cost of goods sold may be afforded special accounting treatment at interim dates.
Solution 24-88 The following exceptions are appropriate at interim reporting dates: a.
Companies may use the gross profit method for interim inventory pricing.
b.
When LIFO inventories are liquidated at an interim date and are expected to be replaced by year end, cost of goods sold should be based on expected replacement cost of the liquidated LIFO base rather than historical cost.
c.
Inventory market declines should not be deferred beyond the interim period unless they are temporary and no loss is expected for the fiscal period. Recoveries of such losses on the same inventory in later interim periods shall be recognized as gains.
d.
Planned variances under a standard cost system which are expected to be absorbed by year end may be deferred.
Ex. 24-89—Forecasts. Recent proposals by investors and others have suggested that corporations include financial forecasts in their annual reports. It further has been suggested that the CPA attest to those forecasts. Instructions (a) What arguments are advanced to support the publication of such forecasts? (b) What arguments are advanced that oppose the publication of such forecasts?
Solution 24-89 (a)
The basic argument for the publication of financial forecasts in corporate annual reports is to provide the investor with additional information about the future activities of the company upon which to base investment decisions. A second argument is that some investors have access to the forecast data currently; it would be more equitable if all investors had access to such information. The attestation by the CPA to such forecast data would provide the forecast data with reliability and permit the investor to have confidence in the forecast. A third argument is that circumstances now change so rapidly that historical information is no longer adequate for prediction.
(b)
One argument raised against the publication of such forecasts is the expectation that management would present a conservative forecast in order to "look good" when actual results of the year are in. A second point often considered is the prospect that the forecast would provide competitors with confidential information thus endangering business strategy and the performance of the firm. A third argument is that forecasts are narrow estimates, which makes them difficult to interpret given that the future is not a certainty, and as a result investors may be misled by them.
Full Disclosure in Financial Reporting
24 - 25
Solution 24-89 (cont.) The attestation by CPAs also can be questioned. There may be a conflict of interest because the forecast in the current year report and the actual results of the next year are both audited by the CPA. There would be concern that the reported results might be adjusted so that the forecast appears to be borne out by the actual results. Additionally, it can be questioned that the CPA has the training and qualifications to attest to forecasts. Also, the profession is hesitant to attest to forecasts until the problem of additional exposure to liability is clarified.
*Ex. 24-90—Financial statement analysis. The condensed financial statements of Marks Company for the years 2012-2013 are presented below: Marks Company Comparative Balance Sheets As of December 31, 2012 and 2013
Cash Receivables (net) Inventories Plant and equipment Accumulated depreciation
Accounts payable Dividends payable Bonds payable Common stock ($10 par) Retained earnings
2013 $ 420,000 460,000 380,000 1,700,000 (260,000) $2,700,000
2012 $ 120,000 300,000 340,000 1,112,000 (192,000) $1,680,000
$ 340,000 -0400,000 1,520,000 440,000 $2,700,000
$ 160,000 40,000 -01,200,000 280,000 $1,680,000
Additional data: Market value of stock at 12/31/13 is $80 per share. Marks sold 32,000 shares of common stock at par on July 1, 2013. Marks Company Condensed Income Statement For the Year Ended December 31, 2013 Sales Cost of goods sold Gross profit Administrative and selling expenses Net income
$2,400,000 1,700,000 700,000 500,000 $ 200,000
Instructions Compute the following financial ratios by placing the proper amounts in the parentheses provided for numerators and denominators.
24 - 26 Test Bank for Intermediate Accounting, Fourteenth Edition *Ex. 24-90 (cont.) a.
Current ratio at 12/31/13
( (
) )
b.
Acid test ratio at 12/31/13
( (
) )
c.
Receivables turnover in 2013
( (
) )
d.
Inventory turnover in 2013
( (
) )
e.
Profit margin on sales in 2013
( (
) )
f.
Earnings per share in 2013
( (
) )
g.
Rate of return on common stock equity in 2013
( (
) )
h.
Price earnings ratio at 12/31/13
( (
) )
i.
Debt to total assets at 12/31/13
( (
) )
j.
Book value per share at 12/31/13
( (
) )
*Solution 24-90 $1,260,000 a. ————— $340,000
$200,000 e. ————— $2,400,000
i.
$740,000 ————— $2,700,000
j.
$1,960,000 ————— 152,000
$880,000 ———— $340,000
f.
$200,000 ———— 136,000
$2,400,000 c. ————— $380,000
g.
$200,000 ————— $1,770,000
h.
$80 ——— $1.47
b.
$1,700,000 d. ————— $360,000
Full Disclosure in Financial Reporting
24 - 27
*Ex. 24-91—Selected financial ratios. The following information pertains to Wamser Company: Cash Accounts receivable Inventory Plant assets (net) Total assets
$ 40,000 125,000 75,000 360,000 $600,000
Accounts payable Accrued taxes and expenses payable Long-term debt Common stock ($10 par) Paid-in capital in excess of par Retained earnings Total equities
$ 75,000 25,000 100,000 160,000 40,000 200,000 $600,000
Net sales (all on credit) Cost of goods sold Net income
$1,000,000 750,000 90,000
Instructions Compute the following: (It is not necessary to use averages for any balance sheet figures involved.) (a) Current ratio (b) Inventory turnover (c) Receivables turnover (d) Book value per share (e) Earnings per share (f) Debt to total assets (g) Profit margin on sales (h) Return on common stock equity
*Solution 24-91 (a)
($40,000 + $125,000 + $75,000) ÷ ($75,000 + $25,000) = $240,000 ÷ $100,000 = 2.40.
(b)
$750,000 ÷ $75,000 = 10 times.
(c)
($1,000,000 ÷ $125,000) = 8 times.
(d)
($160,000 + $40,000 + $200,000) ÷ ($160,000 ÷ $10) = $25.
(e)
$90,000 ÷ ($160,000 ÷ $10) = $5.63.
(f)
($75,000 + $25,000 + $100,000) ÷ $600,000 = 33.3%.*
(g)
$90,000 ÷ $900,000 = 10%.
(h)
$90,000 ÷ ($160,000 + $40,000 + $200,000) = 22.5%.
*Rounded amounts.
24 - 28 Test Bank for Intermediate Accounting, Fourteenth Edition *Ex. 24-92—Computation of selected ratios. The following data is given:
Cash Accounts receivable (net) Inventories Plant assets (net)
December 31, 2013 2012 $ 66,000 $ 50,000 68,000 60,000 90,000 110,000 383,000 325,000
Accounts payable Salaries and wages payable Bonds payable 10% Preferred stock, $40 par Common stock, $10 par Paid-in capital Retained earnings
57,000 10,000 70,000 100,000 120,000 80,000 170,000
Net credit sales Cost of goods sold Net income
800,000 600,000 80,000
Instructions Compute the following ratios: (a) Acid-test ratio at 12/31/13 (b) Receivables turnover in 2013 (c) Inventory turnover in 2013 (d) Profit margin on sales in 2013 (e) Rate of return on common stock equity in 2013 (f) Book value per share of common stock at 12/31/13
*Solution 24-92 (a)
$134,000 ÷ $67,000 = 2.0.
(b)
$800,000 ÷ [($60,000 + $68,000) ÷ 2] = 12.5 times.
(c)
$600,000 ÷ [($110,000 + $90,000) ÷ 2] = 6 times.
(d)
$80,000 ÷ $800,000 = 10%.
(e)
($80,000 – $10,000) ÷ [($330,000 + $370,000) ÷ 2] = 20%.
(f)
$378,000 ÷ 12,000 = $30.83.
40,000 5,000 70,000 100,000 90,000 65,000 175,000
Full Disclosure in Financial Reporting
24 - 29
PROBLEMS Pr. 24-93—Segment reporting. A central issue in reporting on operating segments of a business enterprise is the determination of which segments are reportable. Instructions 1. What are the tests to determine whether or not an operating segment is reportable? 2. What is the test to determine if enough operating segments have been separately reported upon, and what is the guideline on the maximum number of operating segments to be shown?
Solution 24-93 1.
There are three basic tests to be applied to segments of a company to see if they are significant enough to be separately reportable. If a segment meets any one of the tests, it is deemed significant and reportable. The first test is based upon revenue. If a segment's revenue from sales to unaffiliated customers and intersegment sales and transfers is equal to 10 percent or more of the enterprise's combined revenues, the segment is reportable. The second test is based upon profits or losses. A segment is deemed reportable if the absolute amount of its profit or loss is 10 percent or more of the greater, in absolute amount, of: The combined profits of all operating segments reporting profits. The combined losses of all operating segments reporting losses. Third, a segment is significant and reportable if the identifiable assets of the segment equal or exceed 10 percent of the combined assets of all operating segments within the enterprise. Finally, all segments, whether deemed reportable or not, must be viewed from the standpoint of interperiod comparability because the primary purpose of presenting segment information is to aid the financial statement reader.
2.
The Financial Accounting Standards Board states that enough operating segments must be separately reported so that the total of revenues from sales to unaffiliated customers for the reportable segments equals or exceeds 75 percent of the combined sales to unaffiliated customers for the entire enterprise. If applying the prescribed tests does not yield the required percentage of revenues described above, additional segments must be reported on until the 75 percent test is met. The Financial Accounting Standards Board has stated that if an enterprise has many reportable segments, benefit to the reader may be lost if more than 10 segments are reported. In such a situation, the board suggests combining related reportable segments until the total is ten or fewer.
24 - 30 Test Bank for Intermediate Accounting, Fourteenth Edition Pr. 24-94—Interim reporting. Interim financial reporting has become an important topic in accounting. There has been considerable discussion as to the proper method of reflecting results of operations at interim dates. Accordingly, the Accounting Principles Board issued an opinion clarifying some aspects of interim financial reporting. Instructions (a) Discuss generally how revenue should be recognized at interim dates and specifically how revenue should be recognized for industries subject to large seasonal fluctuations in revenue and for long-term contracts using the percentage-of-completion method at annual reporting dates. (b)
Discuss generally how product and period costs should be recognized at interim dates. Also discuss how inventory and cost of goods sold may be afforded special accounting treatment at interim dates.
(c)
Discuss how the provision for income taxes is computed and reflected in interim financial statements.
Solution 24-94 (a)
Sales and other revenues should be recognized for interim financial statement purposes in the same manner as revenues are recognized for annual reporting purposes. This means normally at the point of sale or, in the case of services, at completion of the earnings process. In the case of industries whose sales vary greatly due to the seasonal nature of business, revenues should still be recognized as earned, but a disclosure should be made of the seasonal nature of the business in the notes. In the case of long-term contracts recognizing earnings on the percentage-of-completion basis, the current state of completion of the contract should be estimated and revenue recognized at interim dates in the same manner as at the normal year end.
(b)
For interim reporting purposes, product costs (costs directly attributable to the production of goods or services) should be matched with the product and associated revenues in the same manner as for annual reporting purposes. Period costs (costs not directly associated with the production of a particular good or service) should be charged to earnings as incurred or allocated among interim periods based on an estimate of time expired, benefit received, or other activity associated with the particular interim period(s). Also, if a gain or loss occurs during an interim period and is a type that would not be deferred at year end, the gain or loss should be recognized in full in the interim period in which it occurs. Finally, in allocating period costs among interim periods, the basis for allocation must be supportable and may not be based on merely an arbitrary assignment of costs between interim periods.
Full Disclosure in Financial Reporting
24 - 31
Solution 24-94 (cont.) The profession allowed for some variances from the normal method of determining cost of goods sold and valuation of inventories at interim dates in APB Opinion No. 28, but these methods are allowable only at interim dates and must be fully disclosed in a note to the financial statements. Some companies use the gross profit method of estimating cost of goods sold and ending inventory at interim dates instead of taking a complete physical inventory. This is an allowable procedure at interim dates, but the company must disclose the method used and any significant variances that subsequently result from reconciliation of the results obtained using the gross profit method and the results obtained after taking the annual physical inventory. At interim dates, companies using the LIFO cost-flow assumption may temporarily have a reduction in inventory level that results in a liquidation of base period layers of inventory. If this liquidation is considered temporary and is expected to be replaced prior to year end, the company should charge cost of goods sold at current prices. The difference between the carrying value of the inventory and the current replacement cost of the inventory is a current liability for replacement of LIFO base inventory temporarily depleted. When the temporary liquidation is replaced, inventory is debited for the original LIFO value and the liability is removed. Inventory losses from a decline in market value at interim dates should not be deferred but should be recognized in the period in which they occur. However, if in a subsequent interim period the market price of the written-down inventory increases, a gain should be recognized for the recovery up to the amount of the loss previously recognized. If a temporary decline in market value below cost can reasonably be expected to be recovered prior to year end, no loss should be recognized. Finally, if a company uses a standard cost system to compute cost of goods sold and to value inventories, variances from the standard should be deferred instead of being immediately recognized. (c)
The Board states that the provision for income taxes shown in interim financial statements must be based upon the effective tax rate expected for the entire annual period for ordinary earnings. The effective tax rate is, in accordance with previous APB opinions, based on earnings for financial statement purposes as opposed to taxable income which may consider temporary differences. This effective tax rate is the combined federal and state(s) income tax rate applied to expected annual earnings, taking into consideration all anticipated investment tax credits, foreign tax rates, percentage depletion, capital gains rates, and other available tax planning alternatives. Ordinary earnings do not include unusual or extraordinary items, discontinued operations, or cumulative effects of changes in accounting principles, all of which will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year. The amount shown as the provision for income taxes at interim dates should be computed on a year-to-date basis. For example, the provision for income taxes for the second quarter of a company's fiscal year is the result of applying the expected rate to year-to-date earnings and subtracting the provision recorded for the first quarter. There are several variables in this computation (expected earnings may change; tax rates may change), and the year-to-date method of computation provides the only continuous method of approximating the provision for income taxes at interim dates. However, if the effective rate or expected annual earnings change between interim periods, the change is not reflected retroactively but the effect of the change is absorbed in the current interim period.
24 - 32 Test Bank for Intermediate Accounting, Fourteenth Edition
IFRS QUESTIONS True/False 1. Due to the broader range of options available under U.S. GAAP compared to IFRS, note disclosures are generally more expansive under U.S. GAAP than under IFRS. 2. IFRS requires companies to prepare interim reports on a quarterly basis. 3. IFRS requires segment reporting, and uses the management approach to identify reportable segments. 4. IFRS requires companies to disclose transactions with related parties, including the name of the related party and any doubtful amounts related to outstanding balances for the related party. 5. Neither U.S. GAAP nor IFRS requires interim reports. Answers to True/False: 1. False 2. False 3. True 4. False 5. True
Multiple Choice 1.
If Benjamin Company and Iris, Inc. are similar companies in every regard, except Benjamin Company uses IFRS while Iris, Inc. uses U.S. GAAP, which of the following is true? a. Iris, Inc. is required to issue interim statements every 6 months. b. Benjamin Company need not recognize post-balance sheet events. c. Benjamin Company is not required by IFRS to issue interim statements. d. All of the above are true.
2.
Benjamin Company uses IFRS, while Iris, Inc. uses U.S. GAAP, for their external financial reporting. On January 16, 2013, both companies settled lawsuits relating to industrial accidents that occurred in 2011. Benjamin Company paid $450,000 and Iris, Inc. paid $230,000. Assuming that no accrual had been previously made, what amount of loss should be reported on the income statement for the year ended December 31, 2012 for each company? Benjamin Company Iris, Inc. a. $-0$-0b. $450,000 $230,000 c. $-0$230,000 d. $450,000 $-0-
Full Disclosure in Financial Reporting
24 - 33
3.
IFRS requires which of the following disclosures regarding related parties? I. The name of the related party. II. The amount and terms of the outstanding balance. III. Doubtful amounts related to the outstanding balance. a. I, II, and III. b. I and II. c. I and III. d. II and III.
4.
Nicole, Inc. uses IFRS for its external financial reporting. During 2011, an employee of the company was injured in the factory. Discussions with corporate attorneys resulted in a determination that the company would be required to pay between $1,500,000 and $3,000,000 to settle the injury claim. Nicole, Inc. accrued a contingent liability on December 31, 2011 for $1,500,000. On February 4, 2013, Nicole, Inc. settled the lawsuit for $300,000. What amount of loss should be reported on the income statement for the year ended December 31, 2012 for Nicole, Inc. related to this lawsuit? a. $300,000 b. $1,800,000 c. $1,500,000 d. No extra loss will be recorded in 2012, the remaining loss will be recorded in 2013.
5.
Identifiable assets for the 4 industry segments of Brittle Company are as follows: Candy $120,000 Stix $240,000 Chips $980,000 Gum $ 45,000 Brittle Company uses IFRS for its external financial reporting. Using only the identifiable assets test, which of the segments are reportable? a. Under IFRS, all four segments must be reported. b. Candy, Stix, and Chips only. c. Chips only. d. Stix and Chips only.
6.
Operating profits and losses for the 4 industry segments of Brittle Company are as follows: Candy ($590,000) Stix $ 20,000 Chips $ 85,000 Gum $ 9,000 Brittle Company uses IFRS for its external financial reporting. Using only the operating profits (loss) test, which of the segments are reportable? a. Under IFRS, all four segments must be reported. b. Stix, Chips, and Gum only. c. Candy and Chips only. d. Candy only.
24 - 34 Test Bank for Intermediate Accounting, Fourteenth Edition
7.
Which of the following is true regarding IFRS and GAAP? a. Due to the broader range of options available under U.S. GAAP compared to IFRS, note disclosures are generally more expansive under U.S. GAAP than under IFRS. b. IFRS requires companies to prepare interim reports on a quarterly basis. c. IFRS requires segment reporting, and uses the management approach to identify reportable segments. d. iGAAP requires companies to disclose transactions with related parties, including the name of the related party and any doubtful amounts related to outstanding balances for the related party.
*8. IFRS is important for U.S. investors for all of the following reasons except a. the SEC requires that foreign companies that list on U.S. stock exchanges provide a reconciliation between IFRS and U.S. GAAP. b. many U.S. companies, such as McDonald’s, generate 50% of their sales outside the U.S. c. mergers frequently take place between companies from different countries. d. financial markets are among the most significant international markets. *9. Challenges to convergence of IFRS with U.S. GAAP include all of the following except a. cultural differences exist between countries. b. the litigious environment in the U.S. is best suited to very detailed standards. c. legal barriers to change include the difficulty associated with changing loan covenants. d. political issues result in politicians setting the final accounting standards. *10.High-quality standards in an international environment include which of the following? a. They permit a wide variety of alternative practices. b. They are stated in ambiguous terms to allow practitioners the opportunity to interpret and implement. c. They are comprehensive, covering major transactions facing companies. d. All of the above are necessary for high-quality international standards. Answers to Multiple Choice: 1. c 2. b 3. d 4. b 5. d 6. c 7. c 8. a 9. d 10. c
Short Answer Bill Novak is working on an audit of an IFRS client. In his review of the client’s interim reports, he notes that the reports are prepared on a discrete basis. That is, each interim report is viewed as a distinct period. Is this acceptable under IFRS? If so, explain how that treatment could affect comparisons to U.S. GAAP company?
1.
1.
While U.S. has a preference for the integral approach, IFRS leans toward the discrete approach to interim reports. Thus, if an IFRS company expenses interim amounts, like advertising expenditures that could benefit later interim periods, it may be difficult to compare to a U.S. company that would spread the cost across interim periods.
COMPREHENSIVE EXAMINATION A PART 1 (Chapters 1-6) 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, 2012 Stine Corporation accepted delivery of merchandise which it purchased on account. As of June 30 Stine had not recorded the transaction or included the merchandise in its inventory. The effect of this error on its balance sheet for June 30, 2012 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 debt expense. d. accrue interest revenue on notes receivable.
A-2
Comprehensive Exam A
____ 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. ____ 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. Consistency is best demonstrated when a. expenses are reported as charges against the period in which incurred. b. the effect of changes in accounting methods 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 assets section of a balance sheet should never include a. a receivable from a customer not collectible for over one year. b. the premium paid on short-term bond investment. c. goodwill arising from the purchase of a going business. d. customers' accounts with credit balances.
Comprehensive Exam A
A-3
Problem A-II — Adjusting and Reversing Entries. The following list of accounts and their balances represents the unadjusted trial balance of Alt Company at December 31, 2012: Cash Equity Investments (trading) Accounts Receivable Allowance for Doubtful Accounts Inventory Prepaid Rent Plant Assets Accumulated Depreciation-Plan Assets Accounts Payable Bonds Payable Common Stock Retained Earnings Sales Revenue Cost of Goods Sold Freight-Out Salaries and Wages Expense Interest Expense Rent Revenue Miscellaneous Expense Insurance Expense
$ 29,090 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 11,050 $620,190
$620,190
Additional Data: Problem A-II — (cont.) 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, 2011; Policy 2, original cost of $7,200, 3-yr. term, taken out on Oct. 1, 2012; Policy 3, original cost of $1,300, 1-yr. term, taken out on Jan. 1, 2012. 2. On September 30, 2012, Alt 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, 2011, the balance of the Plant and Equipment account was $240,000. 4. On December 28, 2012, the bookkeeper incorrectly credited Sales for a receipt on account in the amount of $10,000. 5. At December 31, 2012, salaries and wages accrued but unpaid were $4,200. 6. Alt estimates that 1% of sales will become uncollectible. 7. On August 1, 2012, Alt purchased, as a short-term investment, 60 $1,000, 7% bonds of Allen Corp. at par. The bonds mature on August 1, 2013. Interest payment dates are July 31 and January 31.
A-4
Comprehensive Exam A
8. On April 30, 2012, Alt 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 Exam 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 Expense recognition
k. Revenue recognition l. Full disclosure m. Cost constraint n. Industry practices o. Faithful representation
____
1. Chose the solution that will be least likely to overstate assets or income.
____
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. Information must make a difference or a company need not disclose it.
____
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 price-level changes (do not use "historical cost"). ____ 14. Not reporting assets at liquidation prices (do not use "historical cost"). ____ 15. Characterized by completeness, neutrality, and being free from error. ____ 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. Select two (do not use "periodicity") (19 and 20). ____ 20. See item 19 above.
A-6
Comprehensive Exam A
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. Tanner Corporation Balance Sheet For the year ended December 31, 2012 Assets Current Assets: Cash Equity investments-trading (fair value, $32,000) Accounts receivable Inventory Supplies inventory 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: 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 Exam 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 Statement 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 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, 2012 follow: ____
1. Common Stock, $10 par
_____ 16. Inventory
____
2. Loss on Disposal 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 Expenses
____
6. Notes Payable (Short Term)
_____ 21. Interest Expense
____
7. Accum. Depreciation—Buildings
_____ 22. Income Taxes Payable
____
8. Mortgage Payable due 2014
_____ 23. Insurance Expense
____
9. Depletion Expense
_____ 24. Advertising Expense
____ 10. Freight-Out
_____ 25. Equity Investments
____ 11. Sales Revenue
_____ 26. Accounts Receivable
____ 12. Dividends
_____ 27. Land
____ 13. Retained Earnings Dec. 31, 2011
_____ 28. Accounts Payable
____ 14. Cash ____ 15. Sales Discounts
_____ 29. Error made in computing 2010 depreciation expense _____ 30. Gain on Redemption of Debt
A-8
Comprehensive Exam A
Problem A-VI — Future Value and Present Value. In computing your answers to the cases below, you can round your answer to the nearest dollar. Present value tables are provided on the next page. Use the following information in answering Cases 1 and 2 below: On January 1, 2006, Gray Company sold $800,000 of 10% bonds, due January 1, 2016. Interest on these bonds is paid on July 1 and January 1 each year. According to the terms of the bond contract, Gray must establish a sinking fund for the retirement of the bond principal starting no later than January 1, 2014. Since Gray was in a tight cash position during the years 2006 through 2011, the first contribution into the fund was made on January 1, 2012. Case 1: Assume that, starting with the January 1, 2012 contribution, Gray desires to make a total of four equal annual contributions into this fund. Compute the amount of each of these contributions assuming the interest rate is 8% compounded annually.
Case 2: Assume, instead, that starting with the January 1, 2014 contribution, Gray desires to make a total of five equal semiannual contributions into this fund. Compute the amount of each of these contributions assuming the annual interest rate is 12%, compounded semiannually.
Case 3: On January 2, 2012, Nelson Company loaned $90,000 to Holt Company. The terms of this loan agreement stipulate that Holt is to make 5 equal annual payments to Nelson at 10% interest compounded annually. Assume the payments are to begin on December 31, 2012. Compute the amount of each of these payments.
Case 4: Jim Marsh, a lawyer contemplating retirement on his 65th birthday, decides to create a fund on an 8% basis which will enable him to withdraw $50,000 per year beginning June 30, 2015, and ending June 30, 2019. To provide this fund, he intends to make equal contributions on June 30 of each of the years 2010 through 2014. (a) How much must the balance of the fund equal after the last contribution on June 30, 2014 in order for him to satisfy his objective? (b) What are each of his contributions to the fund?
Comprehensive Exam A Table 1 Future Value of 1 8% 9%
10%
12%
1.08000 1.16640 1.25971 1.36049 1.46933
1.10000 1.21000 1.33100 1.46410 1.61051
1.1200 1.2544 1.4049 1.5735 1.7623
10%
12%
0.90909 0.82645 0.75132 0.68301 0.62092
0.8928 0.7971 0.7117 0.6355 0.5674
10%
12%
1.00000 2.10000 3.31000 4.64100 6.10510
1.0000 2.1200 3.3744 4.7793 6.3528
Table 4 Present Value of an Ordinary Annuity of 1 6% 8% 9%
10%
12%
0.94340 1.83339 2.67301 3.46511 4.21236
0.90909 1.73554 2.48685 3.16986 3.79079
0.8928 1.6900 2.4018 3.0373 3.6047
10%
12%
1.00000 1.90909 2.73554 3.48685 4.16986
1.0000 1.8928 2.6900 3.4018 4.0373
Periods
6%
1 2 3 4 5
1.06000 1.12360 1.19102 1.26248 1.33823
Periods
6%
1 2 3 4 5
0.94340 0.89000 0.83962 0.79209 0.74726
Periods 1 2 3 4 5
Periods 1 2 3 4 5
Periods 1 2 3 4 5
A-9
1.09000 1.18810 1.29503 1.41158 1.53862
Table 2 Present Value of 1 8% 9% 0.92593 0.85734 0.79383 0.73503 0.68058
0.91743 0.84168 0.77218 0.70843 0.64993
Table 3 Future Value of an Ordinary Annuity of 1 6% 8% 9% 1.00000 2.06000 3.18360 4.37462 5.63709
1.00000 2.08000 3.24640 4.50611 5.86660
0.92593 1.78326 2.57710 3.31213 3.99271
1.00000 2.09000 3.27810 4.57313 5.98471
0.91743 1.75911 2.53130 3.23972 3.88965
Table 5 Present Value of an Annuity Due of 1 6% 8% 9% 1.00000 1.94340 2.83339 3.67301 4.46511
1.00000 1.92593 2.78326 3.57710 4.31213
1.00000 1.91743 2.75911 3.53130 4.23972
A-10
Comprehensive Exam A
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 ....................................................................... Insurance Expense ......................................................... (Both Policies 1 and 3 have expired and their costs belong in Insurance Expense. The monthly premium on Policy 2 is $7,200 ÷ 36 = $200. At 12/31/12, 33 mos. of insurance, or $6,600, remains unexpired)
6,600
2. Rent Revenue ............................................................................. Unearned Rent ................................................................ (Monthly rent is $21,600 ÷ 18 = $1,200. At 12/31/12, 15 mos. of rent, or $18,000, remains unearned)
18,000
3. Depreciation Expense ................................................................. Accumulated Depreciation .............................................. [(Equipment retired during 2012 = $240,000 – $160,000 = $80,000) 10% of $160,000 = $16,000 5% of $80,000 = 4,000 Total depreciation = $20,000]
20,000
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 Debt Expense ...................................................................... Allowance for Doubtful Accounts ..................................... (Corrected Sales balance is $214,800 – $10,000 = $204,800. 1% of $204,800 is $2,048.)
2,048
7. Interest Receivable ..................................................................... Interest Revenue ............................................................. (Monthly interest is $60,000 × .07 × 1/12 = $350. 5 months' accrued interest is $1,750)
1,750
6,600
18,000
20,000
10,000
4,200
2,048
8. Rent Expense .......................................................................... 24,000 Prepaid Rent ................................................................ (To record 8 months' of rent expired at $3,000 per month)
1,750
24,000
(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.
Comprehensive Exam A
A-11
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.
2.
Equity investments should be reported at their fair value.
3.
The amount of Allowance for Doubtful Accounts should be disclosed and deducted from Accounts Receivable.
4.
The inventory costing method (cost, lower of cost or market) and the basis for pricing the inventory (LIFO, FIFO, etc.) should be disclosed.
5.
Investment in Subsidiary should be classified as an investment.
6.
Treasury Stock is misclassified under Investments. It should appear as a deduction from the Stockholders' Equity section.
7.
Buildings and Land should be separated.
8.
"Reserve for" Depreciation should be either "Allowance for" or "Accumulated" Depreciation.
9.
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-12
Comprehensive Exam A
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, k l q
19. 20. 21. 22. 23. 24.
m l n f l l
25. 26. 27. 28. 29. 30.
Problem A-VI — Solution. Case 1. $800,000 is the amount of an 8% annuity due for 4 periods. Use the table factor for the future value of an 8% ordinary annuity for 4 periods, and multiply by (1.08): 4.50611 × (1.08) = 4.86660. Periodic payments = $800,000 ÷ 4.86660 = $164,386 Case 2. Since interest is compounded semiannually, divide the 12% annual interest rate by 2, and use the table factor for the future value of a 6% ordinary annuity for 5 periods. Periodic payments = $800,000 ÷ 5.63709 = $141,917 Case 3. $90,000 is the present value of a 10% ordinary annuity for 5 periods. Periodic payments = $90,000 ÷ 3.79079 = $23,742 Case 4. (a) At June 30, 2014, the balance in the fund is the present value of an 8% ordinary annuity of $50,000 for 5 periods. Balance in the fund = $50,000 × 3.99271 = $199,636 (b) At June 30, 2014, $199,636 is the future value of an 8% ordinary annuity for five periods. Periodic payments = $199,636 ÷ 5.8666 = $34,029
b a c f p m
COMPREHENSIVE EXAMINATION B PART 2 (Chapters 7–9) 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. How should unearned discounts, finance charges, and interest included in the face amount of installment accounts receivable be presented in the balance sheet? a. As a current liability. b. As a deduction from the related installment accounts receivable. c. Within the net amount of installment accounts receivable. d. As an addition to the related installment accounts receivable. ____ 3. Durler Company's account balances at December 31 for Accounts Receivable and the related Allowance for Doubtful Accounts are $800,000 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. $800,000. b. $787,000. c. $759,000. d. $772,000. ____ 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. 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
B-2
Comprehensive Exam B
____ 6. Certain information relative to the 2012 operations of Ball Co. follows: Accounts receivable, January 1, 2012 Accounts receivable collected during 2012 Cash sales during 2012 Inventory, January 1, 2012 Inventory, December 31, 2012 Purchases of inventory during 2012 Gross profit on sales
$48,000 92,000 24,000 36,000 33,000 80,000 27,000
What is Ball's accounts receivable balance at December 31, 2012? a. $36,000. b. $42,000. c. $48,000. d. $66,000. Problem B-II — Lower of Cost or Market Presented below is data relative to the 12/31/12 inventory of Lance Company: Item A B C D E Total
Number Units In Inventory 5,000 5,000 5,000 5,000 5,000 25,000
Original Cost Per Unit $1.09 1.30 1.50 1.60 1.80
Item
Upper Limit ("Ceiling")
Lower Limit ("Floor")
Total Original Cost $5,450 6,500 7,500 8,000 9,000 $36,450
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 last four columns above.
Comprehensive Exam B
B-3
Problem B-III — Notes Receivable. On December 31, 2011 Berry Corporation sold some of its product to Flynn Company, accepting a 3%, four-year promissory note having a maturity value of $500,000 (interest payable annually on December 31). Berry Corporation pays 6% for its borrowed funds. Flynn Company, however, pays 8% for its borrowed funds. The product sold is carried on the books of Berry at a manufactured cost of $310,000. Assume Berry uses a perpetual inventory system. Instructions (a) Prepare the journal entries to record the transaction on the books of Berry Corporation at December 31, 2011. (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 2012 on the books of Berry Corporation. (c) Make all appropriate entries for 2013 on the books of Berry Corporation.
For Use on Problem B-III Table 1 Future Value of 1 Periods 1 2 3 4 5
2% 1.02000 1.04040 1.06121 1.08243 1.10408
3% 1.03000 1.06090 1.09273 1.12551 1.15927
4% 1.04000 1.08160 1.12486 1.16986 1.21665
6% 1.06000 1.12360 1.19102 1.26248 1.33823
8% 1.08000 1.16640 1.25971 1.36049 1.46933
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 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
Table 3 Future Value of Ordinary Annuity of 1 Periodic Rents 1 2 3 4 5
2% 1.00000 2.02000 3.06040 4.12161 5.20404
3% 1.00000 2.03000 3.09090 4.18363 5.30914
4% 1.00000 2.04000 3.12160 4.24646 5.41632
6% 1.00000 2.06000 3.18360 4.37462 5.63709
8% 1.00000 2.08000 3.24640 4.50611 5.86660
B-4
Comprehensive Exam B Table 4 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
Comprehensive Exam B
B-5
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.
_____
_____
B-6
Comprehensive Exam B
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.
_____
_____
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 — Year-end Inventory Cutoff. Abel Company's business year ends on December 31. Listed below are purchase transactions which occurred during the last few days of 2012 or during the first few days of 2013. The inventory, determined by physical count, was taken after the close of business on December 31, 2012. The only adjusting entry recorded to date has been to enter the December 31 physical inventory on the books and to remove the beginning inventory. Instructions (a) On the accompanying chart, indicate the effect of each of these transactions on the ending inventory and on reported net income for 2012, by writing the words overstated, understated, or no effect in the appropriate column. Both columns must be answered for each transaction. (b) Prepare all necessary correcting entries for 2012. (c) Indicate which of the correcting entries must be reversed in 2011 by preparing the necessary reversing entries.
Comprehensive Exam B
B-7
12/31/12 Physical Inventory
2012 Income
1. An invoice for $9,000, terms f.o.b. shipping point, was received and entered December 30. The invoice shows that the merchandise was shipped December 29, and the receiving report indicates the merchandise was received January 2.
______
_______
2. An invoice for $300, terms f.o.b. shipping point, was received and entered December 30. The invoice shows that merchandise was shipped December 29, and the receiving report shows the merchandise was received December 31.
______
_______
3. An invoice for $4,000, terms f.o.b. shipping point, was received and entered January 2. The invoice shows the merchandise was shipped December 30, and the receiving report indicates the merchandise was received December 31.
______
_______
4. An invoice for $800, terms f.o.b. destination, was received and entered December 30. The receiving report shows the merchandise was received January 2.
______
_______
5. An invoice for $500, terms f.o.b. destination, was received and entered December 29. The receiving report indicates that the merchandise was received December 31.
______
_______
6. An invoice for $1,500, terms f.o.b. destination, was received and entered January 2. The receiving report indicates the merchandise was received December 31.
______
_______
7. Merchandise costing $12,000 and with a selling price of $18,000 was on consignment to Maris Distributing Company and was on that company's premises on December 31. No entry has been made for the consignment.
______
_______
B-8
Comprehensive Exam B
Problem B-VI — Conventional and LIFO Retail Method.* *Note to Instructor. Part B is based on Appendix 9-A. A. Landmark Book Store uses the conventional retail method. Instructions Given the following data, prepare a neat, labeled schedule showing the computation of the cost of inventory on hand at 12/31/12.
Inventory 1/1/12 Purchases Purchases Returns Purchase Discounts Sales (Gross) Sales Returns Employee Discounts Freight-in Freight-out Loss from Breakage Markups Markup Cancellations Markdowns Markdown Cancellations
Cost $ 28,900 366,600 9,000 7,000
Retail $ 40,000 610,000 20,000 615,000 15,000 5,000
23,500 50,000 2,500 38,000 18,000 13,500 8,500
B. Landmark Book Store has decided to switch to the LIFO retail method for the period beginning 1/1/13. Instructions Prepare a schedule showing the computation of the 12/31/13 inventory under the LIFO retail method adjusted for price level changes (i.e., dollar-value LIFO Retail.) Without prejudice to your answer in requirement A above, assume that the 12/31/12 inventory computed under the LIFO Retail method was $40,000 and $27,500 at retail and cost, respectively, for purposes of this requirement. Data for 2013 follows: Cost Retail Purchases (net) $360,000 $485,000 Sales (net) 402,000 Markups (net) 30,000 Markdowns (net) 15,000 2012 Price Index 100 2013 Price Index 120
Comprehensive Exam B
B-9
Problem B-VII — Multiple Choice — Inventory For each of the following questions, select the letter of the statement which best answers the question and write it on the line to the left of the question. ____ 1. Wade 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
$1,000,000 500,000 26,000 850,000
The estimate of the cost of inventory at March 31 would be a. $624,000. b. $680,000. c. $794,000. d. $836,500. ____ 2. 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. ____ 3. A company has been using the FIFO cost method of inventory valuation since it was started 10 years ago. Its 2012 ending inventory was $120,000, but it would have been $90,000 if LIFO had been used. Thus, if LIFO had been used, this company's income before taxes would have been a. $30,000 less in 2012. b. $30,000 less over the 10-year period. c. $30,000 greater over the 10-year period. d. $30,000 greater in 2012. ____ 4. Why are inventories included in the computation of net income? a. To determine cost of goods sold. b. To determine sales revenue. c. To determine merchandise returns. d. Inventories are not included in the computation of net income. ____ 5. On December 31, 2012, Hill Company, which sells only one product, adopted the periodic last-in, first-out method of inventory valuation. The inventory was valued at $40,000 on the December 31, 2012 balance sheet. The number of items in its inventory remained constant during 2013. The December 31, 2013 inventory valuation would be a. less than $40,000 if prices were steadily decreasing. b. less than $40,000 if prices were steadily increasing. c. greater than $40,000 if prices were steadily increasing. d. $40,000 regardless of any price changes.
B-10
Comprehensive Exam B
____ *6. Kramer Company values its inventory by using the retail method (LIFO basis, stable prices). The following information is available for the year 2012. Beginning inventory Purchases Freight-in Markups (net) Markdowns (net) Sales
Cost $ 78,000 368,000 16,000 — —
Retail $140,000 628,000 18,000 6,000 610,000
At what amount would Kramer Company report its ending inventory? a. $95,700. b. $96,000. c. $100,300. d. $102,000.
Comprehensive Exam B
B-11
Solutions — Comprehensive Examination B Problem B-I — Solution. 1. b 2. c 3. d
4. d 5. c 6. b
Solutions to computational Multiple Choice Questions. 3. $800,000 – $28,000 = $772,000. 6. $80,000 + $3,000 + $27,000 – $24,000 + $48,000 – $92,000 = $42,000.
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) $5,450 5,750 5,500 8,000 8,500 $33,200
Problem B-III — Solution. (a)
12/31/11 Notes Receivable ....................................................................... Discount on Notes Receivable ........................................ Sales Revenve .................................................................
500,000 82,803 417,197
Computation of Present Value of Note: (using 8%) $500,000 × .73503 = $367,515 15,000 × 3.31213 = 49,682 Present value of note 417,197 Face value of note 500,000 Amount of discount $ 82,803 12/31/11 Cost of Goods Sold .................................................................... Inventory .........................................................................
310,000 310,000
B-12
(b)
Comprehensive Exam B
12/31/12 Cash .......................................................................................... Interest Revenue ............................................................. Discount on Notes Receivable .................................................... Interest Revenue ............................................................. ($417,197 × .08 = $33,376 – $15,000)
(c)
12/31/13 Cash .......................................................................................... Interest Revenue ............................................................. Discount on Notes Receivable .................................................... Interest Revenue ............................................................. [($417,197 + $18,376) × .08 = $34,846 – $15,000]
15,000 15,000 18,376 18,376
15,000 15,000 19,846 19,846
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. (a)
1. 2. 3. 4. 5. 6. 7.
Understated/Understated No effect/No effect No effect/Overstated No effect/Understated No effect/No effect No effect/Overstated Understated/Understated
(b)
1. Inventory ............................................................................... Cost of Goods Sold ................................................... 2. None
9,000
3. Purchases ............................................................................. Accounts Payable ......................................................
4,000
4. Accounts Payable ................................................................. Purchases . ................................................................
800
5. None
9,000
4,000
800
Comprehensive Exam B
(c)
6. Purchases ............................................................................. Accounts Payable ......................................................
1,500
7. Inventory ............................................................................... Cost of Goods Sold ...................................................
12,000
3. Accounts Payable ................................................................. Purchases .................................................................
4,000
4. Purchases ............................................................................. Accounts Payable ......................................................
800
6. Accounts Payable ................................................................. Purchases .................................................................
1,500
B-13
1,500
12,000
4,000
800
1,500
Problem B-VI — Solution. A. Beginning Inventory Purchases Purchase Returns Purchase Discounts Freight-In Markups Markup Cancellations Goods Available Cost Ratio = 62% Sales Sales Returns Employee Discounts Goods Broken Markdowns Markdown Cancellations Ending Inventory @ Retail Est. Ending Inventory @ Cost (62% × $37,500)
Cost $ 28,900 366,600 (9,000) (7,000) 23,500
$403,000 $615,000 (15,000)
Retail $ 40,000 610,000 (20,000)
38,000 (18,000) 650,000
(600,000) (5,000) (2,500)
13,500 (8,500)
(5,000) $ 37,500 $ 23,250
B-14
Comprehensive Exam B
*B. Inventory, December 31, 2012 Net purchases Net markups Net markdowns Total (excluding beginning inventory) Total (including beginning inventory) Net sales Inventory, December 31, 2013, at retail Cost to retail percentage ($360,000 ÷ $500,000) 12/31/13 inventory at base ($138,000 ÷ 1.20) 12/31/12 inventory at base Increase at base Increase at current prices, at cost ($75,000 × 1.20 × .72) 12/31/13 inventory at LIFO cost
Cost $ 27,500 360,000
360,000 $387,500
72% $ 27,500 64,800 $ 92,300
Problem B-VII — Solution. 1. c 2. c 3. b
4. a 5. d *6. b
Solutions to computational Multiple Choice Questions. 1. 6.
Retail__ $ 40,000 485,000 30,000 (15,000) 500,000 540,000 (402,000) $ 138,000
$1,474,000– (80% × $850,000) = $794,000. $384,000 ÷ $640,000 = 60%. $78,000 + (60% × $30,000) = $96,000.
$ 115,000 (40,000) $ 75,000
COMPREHENSIVE EXAMINATION C PART 3 (Chapters 10–14) 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. Perry Corporation acquired land, buildings, and equipment from a bankrupt company at a lump-sum price of $550,000. At the time of acquisition Perry paid $50,000 to have the assets appraised. The appraisal disclosed the following values: Land Buildings Equipment
$320,000 256,000 64,000
What cost should be assigned to the land, buildings, and equipment, respectively? a. $400,000, $320,000, and $80,000. b. $275,000, $220,000, and $55,000. c. $300,000, $240,000, and $60,000. d. $200,000, $200,000, and $200,000. ____ 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 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.
C-2
Comprehensive Exam C
Use the following data to answer questions 5 through 9: Davis Company purchased a new piece of equipment on July 1, 2012 at a cost of $1,080,000. The equipment has an estimated useful life of 5 years and an estimated salvage value of $90,000. The current year end is 12/31/13. Davis records depreciation to the nearest month. ____ 5. What is straight-line depreciation for 2013? a. $99,000. b. $108,000. c. $198,000. d. $216,000. ____ 6. What is sum-of-the-years'-digits depreciation for 2013? a. $263,999. b. $947,000. c. $324,000. d. $330,000. ____ 7. What is double-declining-balance depreciation for 2013? a. $2,59,200. b. $345,600. c. $396,000. d. $432,000. ____ 8. If Davis expensed the total cost of the equipment at 7/1/12, what was the effect on 2012 and 2013 income before taxes, assuming Davis uses straightline depreciation? a. $882,000 understated and $198,000 overstated. b. $972,000 understated and $108,000 overstated. c. $981,000 understated and $198,000 overstated. d. $1,080,000 understated and $108,000 overstated. ____ 9. If, at the end of 2014, Davis Company decides the equipment still has five more years of life beyond 12/31/14, with a salvage value of $90,000, what is straight-line depreciation for 2014? (Assume straight-line used in all years.) a. $108,000. b. $115,500. c. $130,500. d. $198,000.
Comprehensive Exam C
C-3
Use the following data for questions 10 through 17. Each question is independent of the other questions. Sawyer Corporation has a machine (Machine A) that it acquired on 1/1/12 for $360,000. On 12/31/12 such machines have a selling price and fair market value of $414,000. When used in production, such machines have an estimated useful life of 10 years with no salvage value. Use the straight-line method. Brown Corporation has a machine (Machine B) that it acquired on 1/1/12 for $486,000. On 12/31/12 such machines have a selling price and fair market value of $360,000. When used in production, such machines have an estimated useful life of 10 years with no salvage value. Use the straight-line method. On 12/31/12 Brown gave Machine B plus $54,000 cash to Sawyer in return for Machine A. ____ 10. Assume that both Sawyer and Brown 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 Brown’s books? a. $486,000. b. $414,000. c. $540,000. d. $360,000. ____ 11. Given the assumptions in 10 above, at what amount will Machine B be recorded on Sawyer's books? a. $313,043. b. $486,000. c. $360,000. d. $421,044. ____ 12. Assume that instead of dealers, both Sawyer and Brown are machine manufacturers and use the machines in production. Assume the exchange lacks commercial substance. At what amount will Brown record Machine A? a. $360,000. b. $414,000. c. $486,000. d. $540,000. ____ 13. Given the assumption in 12 above, at what amount will Sawyer record Machine B? a. $371,739. b. $270,000. c. $335,736. d. $281,739.
C-4
Comprehensive Exam C
____ 14. Given the assumption in 12 above except that the fair values of Machines A and B are $504,000 and $450,000, respectively, at what amount will Brown record Machine A? a. $437,400. b. $504,000. c. $450,000. d. $491,400. ____ 15. Return to the original problem. Assume that Sawyer is a dealer selling new machines and that Brown is a manufacturer. Assume that the exchange has commercial substance. For this transaction, at what amount will Sawyer record the truck? a. $360,000. b. $491,400. c. $414,000. d. $437,400. ____ 16. Given the assumptions in 15 above, at what amount will Brown record Machine A? a. $360,000. b. $414,000. c. $405,000. d. $364,500. ____ 17. Given the assumptions in 15 above except that the selling prices and fair market values of A and B are $504,000 and $450,000, respectively, at what amount will Brown record Machine A? a. $437,400. b. $405,000. c. $504,000. d. $450,000. 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. Accumulated amortization, or depletion or depreciation only. c. Expense only. d. Asset(s) and expense. ____ 19. Jim Dolan and Matt Stine, 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. Accumulated amortization, depletion, or depreciation only. c. Expense only. d. Asset(s) and expense.
Comprehensive Exam C
C-5
____ 20. Property, plant, and equipment are conventionally presented in the balance sheet at a. replacement cost less accumulated depreciation. b. historical cost less salvage value. c. original cost less accumulated depreciation. d. acquisition cost less net book value thereof. ____ 21. As generally used in accounting, what is depreciation? a. It is a process of asset valuation for balance sheet purposes. b. It applies only to long-lived intangible assets. c. It is used to indicate a decline in market value of a long-lived asset. d. It is an accounting process which allocates long-lived asset cost to accounting periods. 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
Comprehensive Exam C
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 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. Quality control during commercial production including routine testing. ____ 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.
Comprehensive Exam 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. Jensen Co. Merton Co. Equipment (cost) $900,000 $1,650,000 Accumulated depreciation 290,000 900,000 Fair value of equipment 700,000 700,000 1. Jensen Co. and Merton Co. traded the above equipment. The exchange has commercial substance. Jensen Co.'s Books:
Merton Co.'s Books:
2. Jensen Co. and Merton Co. traded the above equipment. The exchange lacks commercial substance. Jensen Co.'s Books:
Merton Co.'s Books:
Assume that the following cases are independent and rely on the following data. Make entries on the books of both companies. Jensen Co. Merton Co. Equipment (cost) $900,000 $1,650,000 Accumulated depreciation 290,000 1,050,000 Fair value of equipment 560,000 700,000 Cash received (paid) (140,000) 140,000
3. Jensen Co. and Merton Co. traded the above equipment. The exchange has commercial substance. Jensen Co.'s Books:
Merton Co.'s Books:
4. Jensen Co. and Merton Co. traded the above equipment. The exchange lacks commercial substance. Jensen Co.'s Books:
Merton Co.'s Books:
C-8
Comprehensive Exam C
Problem C-V — Long-Term Debt. 1. On March 31, 2009, Hanson Corporation sold $7,000,000 of its 8%, 10-year bonds for $6,730,500 including accrued interest. The bonds were dated January 1, 2009. Interest is paid semiannually on January 1 and July 1. On April 1, 2013, Hanson purchased 1/2 of the bonds on the open market at 99 plus accrued interest and canceled them. Hanson uses the straight-line method for amortization of bond premiums and discounts. (a) What was the amount of the gain or loss on retirement of the bonds?
(b) Prepare the journal entry needed at April 1, 2013 to record retirement of the bonds. Assume that interest and premium or discount amortization have been recorded through January 1, 2013. Record interest and amortization on only the bonds retired.
(c) Prepare the journal entry needed at July 1, 2013 to record interest and premium or discount amortization.
2. On January 1 of the current year, Feller Corporation issued $3,000,000 of 10% debenture bonds on a basis to yield 9%, receiving $3,134,580. 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 Exam C
C-9
3. On October 1, 2012, Noller Company issued $4,000,000 par value, 10%, 10-year bonds dated July 1, 2012, with interest payable semiannually on January 1 and July 1. The bonds are issued at $4,542,000 (to yield 8%) plus accrued interest. 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, 2012, the end of the fiscal year.
(c) Prepare the entry for the interest payment on January 1, 2013.
Problem C-VI — Depreciation Methods. A high-speed multiple-bit drill press costing $720,000 has an estimated salvage value of $60,000 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
Comprehensive Exam C
Problem C-VII — Current Liabilities. Moon Company includes 1 coupon in each box of soap powder that it packs, 20 coupons being redeemable for a premium consisting of a kitchen utensil. In 2012, Moon Company purchased 18,000 premiums at $1.00 each and sold 540,000 boxes of soap powder @ $4.00 per box. Based on past experience, it is estimated that 60% of the coupons will be redeemed. During 2012, 144,000 coupons were presented for redemption. During 2013, 29,000 premiums were purchased at $1.10. The company sold 1,200,000 boxes of soap at $4.00 and 495,000 coupons were presented for redemption. Instructions Prepare all the entries that would be made relative to sales of soap powder and to the premium plan in both 2012 and 2013. Assume a FIFO inventory flow.
*Problem C-VIII — Accounting for Troubled Debt Restructurings. On December 31, 2012, Federal Bank enters into a debt restructuring agreement with Carson Company which is experiencing financial difficulties. The bank restructures a $3,000,000 note receivable by: 1. Reducing the principal obligation from $4,000,000 to $3,200,000. 2. Extending the maturity date from 12/31/12 to 12/31/15, and 3. Reducing the interest rate from 12% to 6%. Interest has been paid up to date as of 12/31/12. Instructions Discuss the nature of this transaction, indicating whether any gain or loss is recognized by either party and preparing any 12/31/12 journal entries that may be required by the debtor (Carson).
Comprehensive Exam C
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. 20. 21.
a c d
Solutions to selected computational Multiple Choice questions. 6. ($990,000 × 5/15 × 1/2) + ($990,000 × 4/15 × 1/2) = $297,000. 7. $1,080,000 × .4 × 1/2 = $216,000; ($1,080,000 – $216,000) × .4 = $345,000. 9. ($1,080,000 – $297,000 – $90,000) × 1/6 = $115,500. 11. $360,000 – (360/414 × $54,000) = $313,043. 13. $360,000 – (360/414 × $90,000) = $281,739.
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
11. 12. 13. 14. 15.
b b a b a
Problem C-III — Solution. 1. 2. 3. 4. 5.
a b b a b
6. 7. 8. 9. 10.
a a a a b
C-11
C-12
Comprehensive Exam C
Problem C-IV — Solution. 1.
Jensen Co.'s Books
Merton Co.'s Books
Equipment Accum. Depreciation Gain on Disposal Equipment
700,000 290,000
2. Equipment Accum. Depreciation Equipment
610,000 290,000
3. Equipment Accum. Depreciation Loss on Disposal Equipment Cash
700,000 290,000 50,000
4. Same as 3.
90,000 900,000
Equipment Accum. Depreciation Loss on Disposal Equipment
700,000 900,000 50,000 1,650,000
Same as 1. 900,000
900,000 140,000
Equipment Accum. Depreciation Cash Gain on Disposal Equipment
560,000 1,050,000 140,000
Equipment Accum. Depreciation Cash Gain on Disposal Equipment
480,000 1,050,000 140,000
100,000 1,650,000
20,000 1,650,000
[$140,000 ÷ ($140,000 + $560,000) × $100,000 = $20,000 gain] Problem C-V — Solution. 1. (a) Face amount of bonds Total selling price Less accrued interest ($7,000,000 × .08 × 3/12) Carrying value at 3/31/09
$7,000,000 $6,730,500 400,000 $6,590,500
Discount at 3/31/09 $409,500 Less discount amortized ($409,500 ÷ 117 mos. × 48 months) 168,000 Unamortized discount at 4/1/13 Carrying value at 4/1/13
241,500 $6,758,500
Carrying value of 1/2 of the bonds Less acquisition price ($7,000,000 ×.99 × 1/2) Loss on retirement
$ 3,379,250 3,465,000 $ 85,750
(b) Interest Expense ...................................................................... Discount on Bonds Payable ($1,750 × 3) ..................... Cash ............................................................................ (To accrue interest to 4/1/13: $7,000,000 × .08 × 3/12 × 1/2 = $70,000)
75,250
Bonds Payable ........................................................................ 3,500,000 Loss on Redemption of Bonds .................................................. 85,750 Discount on Bonds Payable ($241,500 × 1/2) ............... Cash ............................................................................ (To remove carrying value of bonds)
5,250 70,000
120,750 3,465,000
Comprehensive Exam C
(c) Interest Expense ........................................................................... Discount on Bonds Payable ......................................... Cash ............................................................................ (Discount amortization: $409,500 ÷ 117 mos. × 6 mos. × 1/2 = $10,500)
C-13
150,500 10,500 140,000
2. (a) First year interest expense: $3,134,580 × .09 = $282,112 (b) Second year interest expense: $300,000 – $282,112 = $17,888
Premium amortization (First year).
$3,134,580 – $17,888 = $3,116,692 Book value of bonds at the beginning of the second year. $3,116,692 × .09 = $280,502
Interest expense.
3. (a) Cash ........................................................................................ 4,642,000 Bonds Payable ............................................................. Premium on Bonds Payable ......................................... Interest Payable ........................................................... (b) Interest Expense ...................................................................... Premium on Bonds Payable .................................................... Interest Payable ...........................................................
4,000,000 542,000 100,000
90,840 9,160 100,000
(Interest expense: $4,542,000 × .08 × 3/12 = $90,840) (c) Interest Payable ....................................................................... Cash ............................................................................
Problem C-VI -— Solution. 1. a. $144,000 b. $115,200 2. a. $72,000 b. $108,000 3. a. $120,000 b. $108,000 4. a. $66,000 b. $66,000
200,000 200,000
C-14
Comprehensive Exam C
Problem C-VII — Solution. 2012 Premium Inventory (2012) ................................................................... Cash (or Accounts Payable) .................................................... (18,000 × $1.00)
18,000 18,000
Cash (or Accounts Receivable) ........................................................... 2,160,000 Sales Revenve ......................................................................... (540,000 × $4.00) Premium Expense ............................................................................... Premium Inventory (2012) ....................................................... (144,000 ÷ 20 = 7,200× $1.00 = $7,200)
7,200
Premium Expense ............................................................................... Premium Liability ..................................................................... 540,000 × .60 = 324,000 coupons 324,000 – 144,000 = 180,000 ÷ 20 = 9,000 premiums 9,000 × $1.00 = $9,000)
9,000
2013 Premium Inventory (2013) ................................................................... Cash (or Accounts Payable) .................................................... (29,000 × $1.10)
7,200
9,000
31,900 31,900
Cash (or Accounts Receivable) ........................................................... 4,800,000 Sales Revenve ......................................................................... (1,200,000 × $4.00) Premium Liability .................................................................................... Premium Inventory (2012) .......................................................... (9,000 × $1.00 = $9,000; balance of 2012 coupons redeemed)
9,000
Premium Expense .................................................................................. Premium Inventory (2012) .......................................................... 18,000 – 7,200 – 9,000 = 1,800 × $1.00 = $1,800] Premium Inventory (2013) .......................................................... [495,000 ÷ 20 = 24,750 – (1,800 + 9,000) = 13,950 × $1.10 = $15,345]
17,145
Premium Expense .................................................................................. Premium Liability ........................................................................
22,275
[Total 2013 coupons estimated to be redeemed: Coupons redeemed in 2013 Coupons redeemed in 2013 attributable to 2012 Coupons estimated to be redeemed subsequent to 2013 Estimated liability 405,000 ÷ 20 = 20,250 × $1.10)
2,160,000
4,800,000
9,000
1,800 15,345
22,275
1,200,000 ×.60 = 720,000 495,000 (180,000)
315,000 405,000 $22,275]
Comprehensive Exam C
C-15
Problem C-VIlI — Solution. The transaction between Carson Company and Federal Bank represents a "troubled debt restructuring," wherein there is a continuation of the debt with a modification of terms. Because the total future cash flows after restructuring of $3,776,000 are less than the total prerestructure carrying amount of $4,000,000, the debtor must record a gain and the creditor must record a loss due to the restructuring of the debt. Carson Company would record the debt restructure as follows on December 31, 2012: Note Payable........................................................................................ Gain on Restructured Debt .......................................................
224,000* 224,000
*[$4,000,000 – ($3,200,000 + $192,000 + $192,000 + $192,000)] Because the new effective interest rate is 0%, all of the future cash flows reduce the principal balance, and no interest expense would be recognized by the debtor throughout the remainder of the note. Federal Bank would calculate its loss based upon the expected future cash flows discounted at the historical effective rate of the loan. The loss on restructuring is written off against the allowance account and the note receivable is reduced.
COMPREHENSIVE EXAMINATION D PART 4
(Chapters 15-17)
Problem D-I D-II D-III D-IV D-V D-VI D-VII D-VIII
Topic Treasury Stock. *Cash Dividends. Stock Dividends and Stock Splits. Earnings Per Share Concepts. Earnings Per Share Computations. Basic and Diluted Earnings Per Share. Available-for-Sale Equity Securities. Trading Securities.
*Part of this topic is dealt with in an Appendix to the chapter.
Approximate Time 20 min. 10 min. 10 min. 10 min. 10 min. 20 min. 15 min. 30 min. 125 min.
D-2
Test Bank for Intermediate Accounting, Fourteenth Edition
Problem D-I — Treasury Stock The stockholders' equity section of Carey Co.'s balance sheet at December 31, 2012, 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 (1, 2, and 4) and show proper disclosure (3) to reflect the following treasury stock transactions showing how each is accounted for under the cost method. (Show computations.) 1. On January 4, 2013, having idle cash, Carey Co. repurchased 20,000 shares of its outstanding stock for $500,000. 2. On March 4, Carey sold 5,000 of these reacquired shares at $28 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, 2013. Assume net income of $100,000 during the first quarter. 4. On June 30, 2013 the firm sold 10,000 of the reacquired shares for $21 per share.
*Problem D-II — Cash Dividends Bell Company has stock outstanding as follows: Common, $10 par value per share, 140,000 shares; Preferred, 5%; $100 par value per share, 8,000 shares. The Preferred is cumulative and participating up to an additional 4% of par; two years are in arrears (not including the current year); and the total amount of cash dividends declared for both classes of stock is $230,000. Instructions Prepare the entry for the dividend declaration, separating the dividend into the common and preferred portions.
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. The distribution is a multiple as contrasted to a fraction of the number of shares previously outstanding. ____ 2. The total number of shares outstanding is increased. ____ 3. The individual stockholder's share of net assets is increased. ____ 4. There is no transfer between retained earnings and capital stock accounts, other than to the extent occasioned by legal requirements. ____ 5. There is no change in the total stockholders' equity of the issuing corporation. ____ 6. The retained earnings available for dividends are increased. ____ 7. 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. ____ 8. Subsequent per-share earnings, if any, are decreased. ____ 9. The par (or stated value) of the stock is unchanged.
D-4
Test Bank for Intermediate Accounting, Fourteenth Edition
Problem D-IV — Earnings Per Share Concepts Indicate which of the following securities would be included in the computation of "basic earnings per share," and which would be included in the computation of "diluted earnings per share." Place a "B" before those which affect only basic EPS, a "D" before those which affect only diluted EPS, a "BD" before those which affect both basic and diluted EPS, and an "N" before those securities which do not affect EPS computations. Assume that, where applicable, the appropriate securities are dilutive.
____ 1. Warrants to purchase additional common shares. ____ 2. Common stock. ____ 3. Nonconvertible debenture bonds. ____ 4. Convertible, noncumulative preferred stock. ____ 5. Cumulative, nonconvertible preferred stock. ____ 6. Convertible bonds. ____ 7. Executive stock options. ____ 8. Notes payable.
Problem D-V — Earnings Per Share Computations Jones, Inc. has net income (30% tax rate) of $1,200,000 for 2013, and an average number of shares outstanding during the year of 500,000 shares. The corporation issued $2,000,000 par value of 10-year, 9% convertible bonds on January 1, 2011 at a $180,000 discount. The convertible bonds are convertible into 70,000 shares of common stock. Assume the company uses the straight-line method for amortizing bond discount. Instructions Compute the earnings per share data, excluding any notes if required.
Comprehensive Examination D
D-5
Problem D-VI — Basic and Diluted Earnings Per Share Assume that the following data relate to Rosen, Inc. for the year 2013: Net income (30% tax rate) Average common shares outstanding 2013 10% cumulative convertible preferred stock: Convertible into 80,000 shares of common 8% convertible bonds; convertible into 75,000 shares of common Stock options: Exercisable at the option price of $25 per share; average market price in 2013, $30
$3,000,000 1,000,000
shares
$1,600,000 $2,500,000
84,000
shares
Instructions Compute (a) basic earnings per share, and (b) diluted earnings per share.
Problem D-VII —Available-for-Sale Equity Investments On January 2, 2012, Norwin Company purchased 1,000 shares of Oslo Company common stock for $30,000. The stock has a par value of $10 and is part of the total stock outstanding of 20,000 shares of Oslo Company. Norwin Company intends the stock to be available for sale. Total stockholders' equity of Oslo Company on January 2, 2012 was $600,000. Instructions Prepare necessary journal entries on the books of Norwin Company for the following transactions. If no entry is required, write "none" in the space provided. (Round all calculations to the nearest cent.) (a)
January 2, 2012: Norwin purchases the shares described above.
(b)
December 31, 2012: Norwin receives a $.75 per share dividend from Oslo, and Oslo announces a net income for 2012 of $250,000.
(c)
December 31, 2012: According to The Wall Street Journal, Oslo common is selling for $27 per share. Norwin's management views this decline as being only temporary in nature. Oslo's common is Norwin's only available-for-sale security.
(d)
February 15, 2013: Norwin sells 500 of the shares purchased on January 2, 2012 at $32 per share.
D-6
Test Bank for Intermediate Accounting, Fourteenth Edition
Problem D-VIII — Trading Securities The information below relates to Milton Company's trading securities in 2012 and 2013. (a)
Prepare the journal entries for the following transactions.
January 1, 2012
Purchased $300,000 par value of GLF Company bonds at 97 plus accrued interest. The bonds pay interest annually at 9% each December 31. Broker's commission was $3,000.
September 1, 2012
Sold $150,000 par value of GLF Company bonds at 94 plus accrued interest. Broker's commission, taxes, and fees were $1,500.
September 5, 2012
Purchased 5,000 shares of Hayes, Inc. common stock for $30 per share. The broker's commission on the purchase amounted to $2,000.
December 31, 2012
Make the appropriate entry for the GLF Company bonds.
December 31, 2012
The market prices of the trading securities at December 31 were: Hayes, Inc. common stock, $31 per share; and GLF Company bonds, 99. Make the appropriate entry.
July 1, 2013
Milton sold 1/2 of the Hayes, Inc. common stock at $32 per share. Broker's commissions, taxes, and fees were $1,000.
December 1, 2013
Milton purchased 600 shares of Ramirez, Inc. common stock at $45 per share. Broker's commission was $500.
December 31, 2013
Make the appropriate entry for the GLF Company bonds.
December 31, 2013
The market prices of the trading securities at December 31 were: Hayes, Inc. common stock, $34 per share; GLF Company bonds, 98; and Ramirez, Inc. common stock, $47 per share. Make the appropriate entry.
(b)
Present the financial statement disclosure (balance sheet and income statement) of Milton Company's transactions in trading securities for each of the years 2012 and 2013. 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 ...................................
140,000
3. Stockholders' equity: Common stock, $10 par, 1,000,000 shares authorized, 600,000 shares issued, 585,000 shares outstanding Paid-in capital in excess of par value Paid-in capital from treasury stock Retained earnings Less: Cost of 15,000 shares held in treasury Total stockholders' equity
4. Cash ............................................................................................. Paid-in Capital from Treasury Stock .............................................. Retained Earnings ......................................................................... Treasury Stock ..................................................................
500,000
125,000 15,000
$ 6,000,000 1,500,000 15,000 3,350,000 10,865,000 (375,000) $10,490,000
210,000 15,000 25,000 250,000
*Problem D-II — Solution. Retained Earnings .............................................................................. Dividends Payable, Preferred .................................................. Dividends Payable, Common ..................................................
230,000 136,000 94,000
Computations: Arrears—$800,000 × 5% × 2 Preference—$800,000 × 5% Common—$1,400,000 × 5% Participating 2%*
Preferred $80,000 40,000 16,000 $136,000
* [($230,000 – $190,000) ÷ ($600,000 + $1,400,000)]
Common
$ 70,000 24,000 $ 94,000
Total $ 80,000 40,000 70,000 40,000 $230,000
D-8
Test Bank for Intermediate Accounting, Fourteenth Edition
Problem D-III — Solution. 1. C 2. A 3. B
4. E 5. A 6. B
7. F 8. A 9. F
Problem D-IV — Solution. 1. 2. 3. 4.
D BD N D
5. 6. 7. 8.
BD D D N
Problem D-V — Solution. Basic earnings per share ($1,200,000 ÷ 500,000 shares)
$2.40
Diluted earnings per share $1,200,000 + .7($180,000 + $18,000) ————————————————— 500,000 + 70,000
$2.35
Problem D-VI — Solution. (a)
$3,300,000 – $160,000 Basic EPS = ——————————— = $2.09 1,500,000
(b) Start Convertible preferred Convertible bonds Options
Shares 1,500,000 80,000 75,000 14,000** 1,669,000
*($2,500,000 × .08) × (1 – .30) **[($30 – $25) ÷ $30] × 84,000 $3,440,000 ÷ 1,669,000 = $2.06 DEPS
Earnings $3,140,000 160,000 140,000* 0 $3,440,000
Comprehensive Examination D
D-9
Problem D-VII — Solution. (a)
(b)
Equity Investments ..................................................................... Cash ...............................................................................
30,000
Cash .......................................................................................... Dividend Revenue ..........................................................
750
30,000
750
No entry to accrue investee profits because fair value, not equity, method is being used. (c)
(d)
Unrealized Holding Gain or Loss—Equity ................................... Fair Value Adjustment (Available-for-Sale) .....................
3,000
Cash (500 × $32) ....................................................................... Gain on Sale of Securities ............................................... Equity Investments (500 × $30) .......................................
16,000
3,000
1000 15,000
Problem D-VIII — Solution. January 1, 2012* Debt Investments ($300,000 ×.97) + $3,000 ....................................... Cash ........................................................................................ September 1, 2012 Cash ($141,000 + $9,000 – $1,500) .................................................... Loss on Sale of Investments ............................................................... Debt Investments .................................................................... Interest Revenue .....................................................................
294,000 294,000
148,500 7,500 147,000 9,000
September 5, 2012 Equity Investments .............................................................................. Cash ........................................................................................
152,000
December 31, 2012* Cash ($150,000 × .09) ......................................................................... Interest Revenue .....................................................................
13,500
152,000
13,500
December 31, 2012 Fair Value Adjustment (Trading) .......................................................... 4,500 Unrealized Holding Gain or Loss—Income ($299,000 – $303,500)
4,500
D - 10 Test Bank for Intermediate Accounting, Fourteenth Edition July 1, 2013 Cash ($80,000 – $1,000) ..................................................................... Gain on Sale of Investments .................................................... Equity Investments ..................................................................
79,000 3,000 76,000
December 1, 2013 Equity Investments .............................................................................. Cash ........................................................................................
27,500
December 31, 2013 Cash ................................................................................................. Interest Revenue .....................................................................
13,500
27,500
13,500
December 31, 2013 Fair Value Adjustment (Trading) ........................................................... Unrealized Holding Gain or Loss—Income ............................. ($326,500 – $345,200) - $4,500
14,200 14,200
December 31, Balance Sheet Current assets: Equity Investments, at fair value Income Statement Other revenue and gains: Interest Revenue Unrealized holding gain on trading securities Gain on sale of securities Other expenses and losses: Loss on sale of securities
2012
2013
$303,500
$345,200
$13,500 4,500
$13,500 14,200 3,000
7,500
COMPREHENSIVE EXAMINATION E PART 5
(Chapters 18-21)
Problem E-I E-II E-III E-IV E-V
Topic Long-Term Contracts. Installment Sales Method. Deferred Income Taxes. Pensions. Leases.
Approximate Time 15 min. 20 min. 25 min. 15 min. 25 min. 100 min.
E-2
Test Bank for Intermediate Accounting, Thirteenth Edition
Problem E-I — Long-Term Contracts. Edwards Company contracted on 4/1/12 to construct a building for $2,300,000. The project was completed in 2014. Additional data follow:
Costs incurred to date Estimated cost to complete Billings to date Collections to date
2012 $ 560,000 1,040,000 500,000 400,000
2013 $1,350,000 450,000 1,800,000 1,300,000
2014 $1,900,000 — 2,300,000 2,200,000
Instructions (a) Calculate the income recognized by Edwards under the percentage-of-completion method of accounting in each of the years 2012, 2013, and 2014. (b) Prepare all necessary entries for the year 2013. (c) Present the balance sheet disclosures at December 31, 2013. Proper headings or subheadings must be indicated.
Problem E-II — Installment Sales Method. Garber, Inc. accounts for all sales of its merchandise on the installment basis. Following is the unadjusted trial balance at 12/31/14: Cash Installment Accounts Receivable—2012 Installment Accounts Receivable—2013 Installment Accounts Receivable—2014 Inventory, 1/1/14 Repossessed Merchandise Accounts Payable Deferred Gross Profit—2012 Deferred Gross Profit—2013 Common Stock Retained Earnings Installment Sales Purchases Loss on Repossession Operating Expenses
$ 89,200 170,000 400,000 750,000 78,000 22,000 $ 136,000 84,000 175,000 600,000 406,200 1,000,000 738,000 4,000 150,000 $2,401,200
$2,401,200
Additional Data: 2012 Gross Profit Rate = 32%; Inventory 12/31/14 = $159,000; Repossessed merchandise 12/31/14 = $14,000; Merchandise sold in 2013 was repossessed in 2014 and the following entry was prepared (assume correctly): Deferred Gross Profit—2013 ................................ 14,000 Repossessed Merchandise................................... 22,000 Loss on Repossession ......................................... 4,000 Installment Accounts Receivable—2013 ... 40,000
Comprehensive Examination E
E-3
Problem E-II (cont.) Instructions (a)
Determine collections during 2014 on Installment A/R for each of the years 2012, 2013, and 2014.
(b)
Without prejudice to your answer in Part (a), assume that total collections on Installment Accounts Receivable during 2014 were $1,060,000; $220,000 from 2012, $300,000 from 2013, and $540,000 from 2014. Prepare all necessary adjusting and closing entries at 12/31/14.
Problem E-III — Deferred Income Taxes. In 2013, the initial year of its existence, Dexter 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 2013, Dexter 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 2013. These procedures created a $500,000 difference between book and taxable incomes. The future collection of the installment contracts receivables are expected to result in taxable amounts of $250,000 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 2014-2016. 3. Dexter leased some of its property to Baker Company on July 1, 2013. The lease was to expire on July 1, 2015 and the monthly rentals were to be $60,000. Baker, however, paid the first year's rent in advance and Dexter reported this entire amount on its tax return. These procedures resulted in a $360,000 difference between book and taxable incomes. (Note: this lease was an operating lease and Dexter classified the unearned rent as a current liability on its balance sheet.) 4. Dexter owns $200,000 of bonds issued by the State of Oregon upon which 5% interest is paid annually. In 2013, Dexter 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 Dexter's balance sheet.) 5. In 2013, Dexter 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.
E-4
Test Bank for Intermediate Accounting, Thirteenth Edition
Problem E-III (cont.) Instructions Assuming that the income statement of Dexter 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 2013.
(c)
Prepare a schedule of deferred tax (asset) and liability at the end of 2013.
(d)
Compute the net deferred tax expense (benefit) for 2013.
(e)
Make the journal entry recording income tax expense, income tax payable, and deferred income taxes for 2013.
(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.
Problem E-IV — Pensions. Presented below is information related to Stage Department Stores, Inc. pension plan for 2013. Service cost Funding contribution for 2013 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) Fair value of plan assts (at beginning of period)
$520,000 500,000 10% 9% 90,000 48,000 540,000 360,000
Instructions (a) Compute the amount of pension expense to be reported for 2013. (Show computations.) (b) Prepare the journal entry to record pension expense and the employer’s contribution for 2013.
Comprehensive Examination E
E-5
Problem E-V — Leases. On January 1, 2013, Foley Company (as lessor) entered into a noncancelable lease agreement with Pinkley Company for machinery which was carried on the accounting records of Foley at $5,436,000 and had a market value of $5,760,000. Minimum lease payments under the lease agreement which expires on December 31, 2022, total $8,520,000. Payments of $852,000 are due each January 1. The first payment was made on January 1, 2013 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. Pinkley 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 Foley from the lease for the year ended December 31, 2013?
(c)
Ignoring income taxes, what should be the expenses incurred by Pinkley from this lease for the year ended December 31, 2013?
(d)
What journal entries should be recorded by Pinkley Company on January 1, 2013?
(e)
What journal entries should be recorded by Foley Company on January 1, 2013?
E-6
Test Bank for Intermediate Accounting, Thirteenth Edition
Solutions — Comprehensive Examination E Problem E-I — Solution. (a)
2012 income = ($560,000 ÷ $1,600,000) × $700,000 = $245,000 2013 income = ($1,350,000 ÷ $1,800,000) × $500,000 = $375,000 – $245,000 = $130,000 2014 income = $400,000 – $375,000 = $25,000
(b)
Construction in Process .............................................................. Accounts Payable, Cash, Inventory, etc. .........................
790,000 790,000
Accounts Receivable .................................................................. 1,300,000 Billings on Construction in Process .................................
(c)
Cash ........................................................................................... Accounts Receivable .......................................................
900,000
Construction Expenses ............................................................... Construction in Process .............................................................. Revenue from Long-Term Contracts ...............................
790,000 130,000
Current assets: Accounts receivable
1,300,000
900,000
$1,000,000
Current liabilities: Billings ($1,800,000) in excess of costs and recognized profit ($1,725,000)
$75,000
Problem E-II — Solution. (a)
Collections in 2014 on installment accounts receivable: 2012
$84,000 ÷ ($170,000 + collections) = 32% Collections equal $92,500
2013
$175,000 ÷ ($400,000 + collections) = 35% * Collections equal $100,000
2014
Installment Sales – Installment Accounts Receivable = Collections $1,000,000 – $750,000 = $250,000
*14,000 ÷ 40,000 = 35%
920,000
Comprehensive Examination E
E-7
Problem E-II — Solution (cont.). (b)
Inventory 12/31/14....................................................................... Repossessed Merchandise 12/31/14........................................... Cost of Goods Sold .................................................................... Purchases ....................................................................... Inventory 1/1/14 ............................................................... Repossessed Merchandise .............................................
159,000 14,000 665,000 738,000 78,000 22,000
Installment Sales ......................................................................... 1,000,000 Cost of Goods Sold ......................................................... Deferred Gross Profit—2014 (33.5%) .............................
665,000 335,000
Deferred Gross Profit—2012 (32% × $220,000) ......................... Deferred Gross Profit—2013 (35% × $300,000) .......................... Deferred Gross Profit—2014 (33.5% × $540,000) ...................... Realized Gross Profit ......................................................
70,400 105,000 180,900 356,300
Realized Gross Profit ................................................................. Loss on Repossession .................................................... Operating Expenses ....................................................... Income Summary ............................................................
356,300
Income Summary ....................................................................... Retained Earnings ..........................................................
202,300
4,000 150,000 202,300
202,300
Problem E-III — Solution. (a)
The computation of income tax payable is as follows: Pretax financial income Permanent differences: State of Oregon 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
$1,200,000 (10,000) 12,000 (500,000) (60,000) 360,000 1,002,000 40% $400,800
2014
2015
2016
Total
$250,000 20,000 (360,000)
$250,000 20,000
$20,000
$500,000 60,000 (360,000)
E-8
Test Bank for Intermediate Accounting, Thirteenth Edition
Problem E-III — Solution (cont.). (c) Temporary Differences Installment Sales Depreciation Rent Totals (d)
(e)
(f)
Future Taxable (Deductible) Amounts $500,000 60,000 (360,000) $200,000
Tax Rate 40% 40 40
Deferred Tax (Asset) Liability $200,000 24,000 $(144,000) $(144,000) $224,000
Deferred tax asset at end of 2013 Deferred tax asset at beginning of 2013 Deferred tax (benefit)
$(144,000) -0$(144,000)
Deferred tax liability at end of 2013 Deferred tax liability at beginning of 2013 Deferred tax expense
$224,000 -0$224,000
Deferred tax expense Deferred tax (benefit) Net deferred tax expense for 2013
$224,000 (144,000) $ 80,000
Income Tax Expense ($400,800 + $80,000) ............................... Deferred Tax Asset ...................................................................... Deferred Tax Liability ...................................................... Income Tax Payable ....................................................... Income statement Income before income taxes Income tax expense: Current Deferred Net income
480,800 144,000 224,000 400,800
$1,200,000 $400,800 80,000
Balance sheet Current liabilities: Deferred tax liability ($200,000 – $144,000)
$56,000
Long-term liabilities: Deferred tax liability
$24,000
480,800 $719,200
Comprehensive Examination E Problem E-IV — Solution. (a)
Service cost Interest on projected benefit obligation ($540,000 10%) Expected return on plan assets ($360,000 9%) Amortization of PSC Amortization of net gains Pension expense—2013
(b)
Pension Expense ....................................................... 583,600 Other Comprehensive Income (G/L) ........................... 48,000 Cash ................................................................ 500,000 Other Comprehensive Income (PSC) ............... 90,000 Pension Asset/Liability ..................................... 41,600
$520,000 54,000 (32,400) 90,000 (48,000) $583,600
E-9
E - 10 Test Bank for Intermediate Accounting, Thirteenth Edition Problem E-V — Solution. (a)
From the viewpoint of the lessee (Pinkley Company), the lease is a capital lease because the present value of the minimum lease payments ($5,760,000) 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, Foley Company.
(b)
Profit on sale Interest on outstanding balance ($5,760,000 – $852,000) × .10 Income of lessor in 2012
490,800 $1,054,800
Interest on outstanding balance ($5,760,000 – $852,000) × .10 Depreciation ($5,760,000 ÷ 10) Expenses incurred by lessee in 2012
$490,000 576,000 $1,066,800
(c)
(d)
(e)
$564,000
Leased Equipment .................................................................... Lease Liability ................................................................
5,760,000
Lease Liability ............................................................................ Cash ..............................................................................
852,000
Lease Receivable ..................................................................... Cost of Goods Sold ................................................................... Sales Revenue .............................................................. Inventory .......................................................................
5,760,000 5,436,000
Cash ......................................................................................... Lease Receivable...........................................................
852,000
5,760,000
852,000
5,760,000 5,436,000
852,000
COMPREHENSIVE EXAMINATION F PART 6
(Chapters 22-24)
Problem F-I F-II F-III F-IV F-V
Topic Multiple Choice Questions. Statement of Cash Flows. Accounting Changes, Error Corrections, and Prior Period Adjustments. *Analysis of Financial Statements. Segment Reporting.
*This topic is dealt with in an Appendix to the chapter.
Approximate Time 25 min. 25 min. 30 min. 25 min. 15 min. 120 min.
F-2
Test Bank for Intermediate Accounting, Fourteenth Edition
Problem F-I — Multiple Choice Questions. 1.
Which of the following transactions would be considered a financing activity in preparing a statement of cash flows? a. Amortizing a discount on bonds payable b. Recording net income from operations c. Selling common stock d. Purchasing inventory
2.
The net income for the year ended December 31, 2013, for Tax Consultants INC. was $920,000. Additional information is as follows: Capital expenditures Depreciation on plant assets Cash dividends paid on common stock Increase in noncurrent deferred tax liability Amortization of patents
$1,200,000 450,000 180,000 45,000 21,000
Based on the information given above, what should be the net cash provided by operating activities in the statement of cash flows for the year ended December 31, 2013? a. $1,256,000. b. $1,346,000. c. $1,391,000. d. $1,436,000. 3.
Information concerning the debt of Cole Company is as follows: Short-term borrowings: Balance at December 31, 2012 Proceeds from borrowings in 2013 Payments made in 2013 Balance at December 31, 2013
$525,000 325,000 (450,000) $400,000
Current portion of long-term debt: Balance at December 31, 2012 Transfers from caption "Long-Term Debt" Payments made in 2013 Balance at December 31, 2013
$1,625,000 500,000 (1,225,000) $ 900,000
Long-term debt: Balance at December 31, 2012 Proceeds from borrowings in 2013 Transfers to caption "Current Portion of Long-Term Debt" Payments made in 2013 Balance at December 31, 2013
$9,000,000 2,250,000 (500,000) (1,500,000) $9,250,000
In preparing a statement of cash flows for the year ended December 31, 2013, for Cole Company, cash flows from financing activities would reflect Outflow a. $2,000,000 b. $2,250,000 c. $2,575,000 d. $3,175,000
Comprehensive Examination F
F-3
Problem F-I — (cont.) 4.
In considering interim financial reporting, how did the Accounting Principles Board conclude that such reporting should be viewed? a. As a "special" type of reporting that need not follow generally accepted accounting principles. b. As useful only if activity is evenly spread throughout the year so that estimates are unnecessary. c. As reporting for a basic accounting period. d. As reporting for an integral part of an annual period.
5.
Which of the following items represents a potential use of cash? a. Patent amortization b. Sale of plant assets at a loss c. Net loss from operations d. Declaration of a stock dividend
6.
Worthington Company purchased a machine on January 1, 2010, for $4,800,000. 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, 2013, Worthington 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 to reflect this additional information. What amount of depreciation expense should be reported in Worthington’s income statement for the year ended December 31, 2013? a. $800,000 b. $600,000 c. $480,000 d. $300,000
7.
On January 7, 2011, Yoder Corporation acquired machinery at a cost of $1,500,000. Yoder adopted the sum-of-the-years’-digits method of depreciation for this machine and had been recording depreciation over an estimated life of five years, with no residual value. At the beginning of 2013, a decision was made to change to the straight-line method of depreciation for this machine. Assuming a 30% tax rate, the cumulative effect of this accounting change, net of tax, is a. $0 b. $200,000 c. $210,000 d. $300,000
*8.
Information from Collins Company’s balance sheet is as follows: Current assets: Cash Short-term investments Accounts receivable Inventories Prepaid expenses Total current assets
$ 12,000,000 20,000,000 50,000,000 66,000,000 2,000,000 $150,000,000
F-4
Test Bank for Intermediate Accounting, Fourteenth Edition
Problem F-I (cont.) Current liabilities: Notes payable Accounts payable Accrued expenses Income taxes payable Current portion of long-term debt Total current liabilities
$ 11,000,000 18,000,000 13,000,000 3,000,000 5,000,000 $ 50,000,000
What is the acid-test (quick) ratio? a. 1:24 to 1 b. 1.64 to 1 c. 1.68 to 1 d. 3.00 to 1 *9.
Fargo, Inc. disclosed the following information as of and for the year ended December 31, 2013: Net cash sales 600,000 Net credit sales 900,000 Inventory at beginning 100,000 Inventory at end 150,000 Net income 30,000 Accounts receivable at beginning of year 110,000 Accounts receivable at end of year 130,000 Fargo’s receivables turnover is a. 6.9 to 1. b. 7.5 to 1. c. 12.5 to 1. d. 13.6 to 1.
*10.
The calculation of the number of times interest is earned involves dividing a. net income by annual interest expense. b. net income plus income taxes by annual interest expense. c. net income plus income taxes and interest expense by annual interest expense. d. none of the above.
Comprehensive Examination F
F-5
Problem F-II — Statement of Cash Flows. Sharp 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 2013 2012 $ 54,000 $ 36,000 53,000 57,000 161,000 123,000 180,000 285,000 300,000 300,000 (75,000) (60,000) 1,565,000 900,000 (177,000) (141,000) $2,061,000 $1,500,000 $ 202,000 450,000 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.
2.
Cash dividends were paid amounting to 4% of par value.
3.
Land was sold for $120,000.
4.
Sharp 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.
F-6
Test Bank for Intermediate Accounting, Fourteenth Edition
Problem F-III — Accounting Changes, Error Corrections, and Prior Period Adjustments. Molina Company’s reported net incomes for 2013 and the previous two years are presented below. 2013 2012 2011 $105,000 $95,000 $70,000 2013’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 2011 and 2012 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, prepare the journal entry or entries Molina Company should record during 2013. If no entry is required, write “none.” (b)
After recording the situation in part (a) above, prepare the year-end adjusting entry for December 31, 2013. If no entry, write “none.”
1.
Early in 2013, Molina determined that equipment purchased in January, 2011 at a cost of $645,000, with an estimated life of 5 years and salvage value of $45,000 is now estimated to continue in use until December 31, 2017 and will have a $15,000 salvage value. Molina recorded its 2013 depreciation at the end of 2013.
(a)
(b)
2.
Molina determined that it had understated its depreciation by $20,000 in 2012 owing to the fact that an adjusting entry did not get recorded.
(a)
(b)
3.
(a)
(b)
Molina bought a truck January 1, 2010 for $50,000 with a $5,000 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 2015. Molina uses straightline depreciation for its trucks.
Comprehensive Examination F
F-7
Problem F-III (cont.). 4.
During 2013, Molina 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.) The 2013 amount applies double-declining balance to the 1/1/13 carrying amount after straight-line was used.
Straight-line Double-declining
2013 $100,000 $200,000
2012 $100,000 $160,000
2011 $100,000 $200,000
(a)
(b)
5.
Molina, in reviewing its provision for uncollectibles during 2013, has determined that 1/2 of 1% is the appropriate amount of bad debt expense to be charged to operations. The company had used 1% as its rate in 2012 and 2011 when the expense had been $20,000 and $14,000, respectively. The company would have recorded $50,000 of bad debt expense on December 31, 2013 under the old rate.
(a)
(b)
6.
During 2013, Molina 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
2013 $51,000 $63,000
2012 $59,000 $67,000
2011 $42,000 $48,000
Assume no difference between LIFO and average cost inventory values in years prior to 2011. (a)
(b)
F-8
Test Bank for Intermediate Accounting, Fourteenth Edition
Problem F-IV — Analysis of Financial Statements. The market value of Farmington Corp.'s common shares was quoted at $54 per share at December 31, 2013, and 2012. Planetarium 's balance sheet at December 31, 2013, and 2012, and statement of income and retained earnings for the years then ended are presented below: Farmington Corp. Balance Sheet December 31 2013 2012 Assets: Current assets: Cash Short-term investments Accounts receivable (net) Inventories, lower of cost or market Prepaid expenses Total current assets Property, plant, and equipment (net) Investments, at equity Long-term receivables Copyrights and patents (net) Other assets Total assets Liabilities and Stockholders' Equity: Current liabilities: Notes payable Accounts payable Accrued expenses Income taxes payable Current portion of long-term debt Total current liabilities Long-term debt Deferred income taxes Other liabilities Total liabilities
$
9,000,000 17,200,000 109,000,000 122,000,000 4,000,000 $261,200,000
$
350,000,000 2,800,000 15,000,000 6,000,000 8,000,000 $643,000,000
315,000,000 3,500,000 20,000,000 7,000,000 9,100,000 $629,000,000
$
7,000,000 55,000,000 27,500,000 1,500,000 10,000,000 101,000,000
$ 17,000,000 52,000,000 30,000,000 2,000,000 9,500,000 110,500,000
180,000,000 69,000,000 15,000,000 365,000,000
190,000,000 65,000,000 9,500,000 375,000,000
Stockholders' equity: Common stock, par value $1; authorized 20,000,000 shares; issued and outstanding 12,000,000 shares 12,000,000 10% cumulative preferred shares, par value $100; $100 liquidating value; authorized 100,000 shares; issued and outstanding 60,000 shares 6,000,000 Additional paid-in capital 119,000,000 Retained earnings 141,000,000 Total stockholders' equity 278,000,000 Total liabilities and stockholders' equity $643,000,000
5,200,000 15,400,000 111,000,000 140,000,000 2,800,000 $274,400,000
12,000,000
6,000,000 119,000,000 117,000,000 254,000,000 $629,000,000
Comprehensive Examination F
F-9
*Problem F-IV (cont.). Farmington Corp. Statement of Income and Retained Earnings
Net sales Cost 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 Retained earnings at beginning of period Dividends on common stock Dividends on preferred stock Retained earnings at end of period
Year ended December 31 2013 2012 $540,000,000 $500,000,000 390,900,000 70,000,000 9,100,000 470,000,000
400,000,000 65,000,000 6,000,000 471,000,000
70,000,000 21,000,000 49,000,000
29,000,000 11,600,000 17,400,000
117,000,000 (24,400,000) (600,000) $141,000,000
113,100,000 (12,900,000) (600,000) $117,000,000
Instructions Based on the above information, compute the following (for the year 2013 only): (Show supporting computations in good form.) (a) Current ratio.
(b) Acid-test (quick) ratio.
(c) Receivables turnover.
(d) Inventory turnover.
(e) Book value per share of common stock.
(f)
Earnings per share on common stock.
(g) Price-earnings ratio on common stock.
(h) Payout ratio on common stock.
F - 10 Test Bank for Intermediate Accounting, Fourteenth Edition Problem F-V — Segment Reporting. Baden Company is a diversified company which has developed the following information about its five segments: SEGMENTS A B C D E Total sales $ 600,000 $1,700,000 $ 300,000 $ 320,000 $ 580,000 Operating profit (loss)
(270,000)
480,000
40,000
(300,000)
(10,000)
Identifiable assets
1,600,000
5,800,000
1,200,000
3,900,000
5,600,000
Instructions Identify which segments are significant enough to warrant disclosure in accordance with FASB No. 131, "Reporting Disaggregated Information about a Business Enterprise," by applying the following quantitative tests: a. b. c.
Revenue test Operating profit or loss test Identifiable assets test
Comprehensive Examination F
F - 11
Solutions — Comprehensive Examination F Problem F-I — Solution. 1. 2. 3. 4. 5.
c d d d c
6. 7. *8. *9. *10.
c a b b c
Problem F-II — Solution. Sharp Company Statement of Cash Flows For the Year Ended December 31, 2013
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 (38,000) 52,000 (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 (890,000)
Cash flows from financing activities Payment of cash dividends Issuance of bonds Net cash provided by financing activities
(45,000) 450,000
Net increase in cash Cash, January 1, 2013 Cash, December 31, 2013
174,000 278,000
(665,000)
405,000 18,000 36,000 $ 54,000
F - 12 Test Bank for Intermediate Accounting, Fourteenth Edition Problem F-III — Solution. 1. (a) (b)
2. (a)
(b) 3. (a)
(b)
4. (a) (b)
5. (a) (b)
6. (a)
(b)
None Depreciation Expense ............................................................ Accumulated Depreciation............................................. [($645,000 – $240,000 – $15,000) ÷ 5]
78,000
Retained Earnings ................................................................. Accumulated Depreciation.............................................
20,000
Truck...................................................................................... Accumulated Depreciation............................................. Retained Earnings .........................................................
50,000
Depreciation Expense ............................................................ Accumulated Depreciation.............................................
7,500
22,500 27,500
7,500
None Depreciation Expense ............................................................ Accumulated Depreciation.............................................
200,000 200,000
None Bad Debt Expense ................................................................. Allowance for Doubtful Accounts ...................................
25,000
Inventory (Beginning) ............................................................. Retained Earnings .........................................................
14,000
None
Current ratio: Total current assets —————————— Total current liabilities
(b)
20,000
None
*Problem F-IV — Solution. (a)
78,000
$261,200,000 = —————— = 2.59 to 1 $101,000,000
Acid-test (quick) ratio: Total quick assets $135,200,000 —————————— = ——————— = 1.34 to 1 Total current liabilities $101,000,000
25,000
14,000
Comprehensive Examination F
F - 13
*Problem F-IV — Solution (cont.) (c)
Receivables turnover: Net sales $540,000,000 ————————————— = ————————————————– = 4.91 times Average accounts receivable [($109,000,000 + $111,000,000) ÷ 2]
(d)
Inventory turnover: Cost of goods sold $390,900,000 ————————— = —————— = 2.98 times Average inventories $131,000,000
(e)
Book value per share of common stock:
Total stockholders' equity – liquidating value of preferred stock $272,000,000 ———————————————————————————— = —————— = $22.67 Common shares issued and outstanding at December 31, 2013 12,000,000 (f)
Earnings per share on common stock: Net income – dividends on preferred stock $48,400,000 ——————————————————————————— = —————— = $4.03 Average common shares issued and outstanding during 2013 12,000,000
(g)
Price-earnings ratio on common stock: Market value of common stock $54.00 ————————————————— = ———— = 13.4 Earnings per share on common stock $4.03
(h)
Payout ratio on common stock: Dividends on common stock $24,400,000 ——————————————————— = —————— = 50.4% Net income – dividends on preferred stock $48,400,000
F - 14 Test Bank for Intermediate Accounting, Fourteenth Edition Problem F-V — Solution. a.
Revenue test — a segment is reportable if its total sales are $350,000 or more (10% × $3,500,000). Segments A, B, and E satisfy the revenue test.
b.
Operating profit or loss test — a segment's absolute profit or loss must be $58,000 or more [10% of the absolute greater of $520,000 or ($580,000)]. Segments A, B, and D satisfy the operating profit or loss test.
c.
Identifiable assets test — a segment's identifiable assets must be $1,810,000 or more (10% × $18,100,000). Segments B, D, and E satisfy the identifiable test.
Segments A, B, D, and E are identified as significant and therefore reportable because they passed at least one of the significance tests.