09.26 Flashcards
Which of the following is true regarding the comparison between managerial and financial accounting?
- Managerial accounting is generally more precise.
- Managerial accounting has a past focus and financial accounting has a future focus.
- The emphasis on managerial accounting is relevance and the emphasis on financial accounting is timeliness.
- Managerial accounting need not follow Generally Accepted Accounting Principles (GAAP), while financial accounting must follow them.
Managerial accounting need not follow Generally Accepted Accounting Principles (GAAP), while financial accounting must follow them.
**Managerial accounting is for internal use, and as such, does not follow GAAP. Financial accounting is for external users and must follow GAAP.
Roro, Inc. paid $7,200 to renew its only insurance policy for three years on March 1, Year 5, the effective date of the policy. At March 31, Year 5, Roro’s unadjusted trial balance showed a balance of $300 for prepaid insurance and $7,200 for insurance expense.
What amounts should be reported for prepaid insurance and insurance expense in Roro’s financial statements for the three months ended March 31, Year 5?
Prepaid insurance
Insurance expense
Prepaid insurance- 7,000
Insurance expense- 500
**The $300 of prepaid insurance on March 31 before adjustment represents the remaining unexpired portion of the insurance policy before renewal. This amount must have expired by March 31 because there is only one insurance policy, and that policy was renewed March 1. The $300 is included in insurance expense for the three months ended March 31. In addition, one month of coverage has been used on the renewed policy as of March 31. Therefore $7,200/36 months or $200 is included in insurance expense for the three months ended March 31. In total, $500 of insurance expense is recognized. Prepaid insurance remaining at March 31 is $7,200 – $200 = $7,000.
Sanni Co. had $150,000 in cash-basis pretax income for the year. At the current year end, accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from their previous year-end balances. Compared to the accrual-basis method of accounting, Sanni's cash-basis pretax income is: Higher by $4,000. Lower by $4,000. Higher by $36,000. Lower by $36,000.
Higher by $36,000.
**The $20,000 AR decrease implies that cash received on account was $20,000 greater than accrual sales. Cash-basis income is, therefore, $20,000 greater than accrual income for this difference. The $16,000 accounts payable increase implies that more inventory was purchased and included in accrual cost of goods sold than was paid. Cash-basis income is, therefore, $16,000 more than accrual income for this difference. In total, cash-basis income is $36,000 greater than accrual income.
On October 31, year 1, a company with a calendar year end paid $90,000 for services that will be performed evenly over a six-month period from November 1, year 1, through April 30, year 2. The company expensed the $90,000 cash payment in October, year 1, to its services expense general ledger account. The company did not record any additional journal entries in year 1 related to the payment. What is the adjusting journal entry that the company should record to properly report the prepayment in its year 1 financial statements?
- Debit prepaid services and credit services expense for $30,000.
- Debit prepaid services and credit services expense for $60,000.
- Debit services expense and credit prepaid services for $30,000.
- Debit services expense and credit prepaid services for $60,000.
Debit prepaid services and credit services expense for $60,000.
**This question is testing your knowledge of what portion of a cash outlay should be recognized as an asset and what portion should be recognized as an expense. The entire cost of the service is $90,000 for 6 months; therefore, the monthly cost is $15,000 a month. On October 31, the company expensed the entire $90,000, but will receive future benefit over 4 months in the next year. The adjusting entry would be to reduce service expense for $60,000 (4 × $15,000) and increase prepaid services for $60,000.
Which one of the following financial items may not be measured and reported at fair value at the election of an entity?
- Accounts receivable
- Investment in debt securities to be held to maturity
- Investment in a subsidiary that is to be consolidated
- Accounts payable
Investment in a subsidiary that is to be consolidated
*A firm may not use fair value to measure and report an investment in a subsidiary that is to be consolidated. The financial asset “Investment in subsidiary” will be eliminated in the consolidating process and be replaced by the subsidiary’s assets and liabilities (and possibly goodwill) on the consolidated balance sheet.
Multico is a securities dealer whose principal market is with other securities dealers. To take advantage of a perceived opportunity, on December 31, the end of its fiscal year, Multico acquired a financial asset in a market other than its principal market for $50,000. At that date, the identical instrument could be sold in Multico's principal market for $50,100 with a $200 transaction cost. Which of the following amounts would constitute fair value to Multico for the financial asset at December 31? $49,800 $49,900 $50,000 $50,100
$50,100
**Since fair value is based on an exit price, the amount at which Multico could have sold the asset in its principal market is its fair value to Multico. Since the asset could have been sold by Multico in its principal market for $50,100, that is its fair value to Multico. The transaction cost to execute the sale should not be deducted from the market price to get fair value.
If a firm changes the valuation approach used to determine fair value, how would the amount of change in fair value resulting from the change in the valuation approach be reported?
- As a change in accounting principle
- As an adjustment to beginning retained earnings of the period of change in approach
- As a change in accounting estimate
- As gain on the income statement for the period of change in approach
As a change in accounting estimate
**The amount of change in fair value resulting from a change in the valuation approach used to determine fair value is reported as a change in accounting estimate. That means that the amount of the change, like the change in fair value resulting from market forces, will be reported in current income (as income from continuing operations).
In the determination of fair value for GAAP purposes, which one of the following is not a valuation technique or approach specified in ASC 820, Fair Value Measurement? Income approach Cost approach Expense approach Market approach
Expense approach
**The expense approach is not one of the approaches for the determination of fair value specified in ASC 820; it is an irrelevant distracter in this question.
A company’s cash-basis net income for the year ended December 31 was $75,000. The following information is from the company’s accounting records:
January 1 December 31 Accounts receivable $15,000 $20,000 Prepaid expenses 7,000 4,000 Accrued liabilities 2,500 2,000 What is the accrual-basis net income?
$72,500
$75,000
$77,500
$83,500
77,500
**Reconciling from cash basis to accrual basis net income can be done using the accounting equation and solving for the change in equity: ŁE = ŁA – ŁL. Insert into this formula the increase/decrease in assets or liabilities. The result is added/subtracted to/from cash-based income to obtain accrual-based income. Cash-based Net Income 75,000 \+ increase Accounts Receivable 5,000 – decrease Prepaid Expenses (3,000) \+ decrease Accounts Payable 500 Accrual-based Net Income 77,500
According to SFAC 7, Using Cash Flow Information and Present Value in Accounting Measurements, the most relevant measurement of an entity’s liabilities at initial recognition and fresh-start measurements should always reflect
- The expectations of the entity’s management.
- Historical cost.
- The credit standing of the entity.
- The single most-likely minimum or maximum possible amount.
The credit standing of the entity.
**The most relevant measure of a liability always reflects the credit standing of the entity obligated to pay, according to SFAC 7. Those who hold the entity’s obligations as assets incorporate the entity’s credit standing in determining the prices they are willing to pay.
Which of the following are observable inputs used for fair value measurements?
I. Bank prime rate.
II. Default rates on loans.
III. Financial forecasts.
I and II only.
**The bank prime rate and the default rates are both observable inputs. A financial forecast is developed by an entity and is an unobservable input or Level 3 input.
Class Corp. maintains its accounting records on the cash basis, but it restates its financial statements to the accrual method of accounting. Class had $60,000 in cash-basis pretax income for 20X2. The following information pertains to Class operations for the years ended December 31, 20X2 and 20X1:
20X2 20X1
Accounts receivable $40,000 $20,000
Accounts payable 15,000 30,000
Under the accrual method, what amount of income before taxes should Class report in its December 31, 20X2, Income Statement?
$25,000
$55,000
$65,000
$95,000
95,000
**Cash basis net income, pretax $60,000
Plus increase in accounts receivable (this represents sales that were not collected and thus are included in accrual income but not in cash-basis income) 20,000
Plus decrease in accounts payable (this represents payments in excess of expenses and thus causes accrual income to exceed cash-basis income) 15,000
Equals accrual basis net income, pretax $95,000
According to the FASB conceptual framework, an entity’s revenue may result from
- A decrease in an asset from primary operations.
- An increase in an asset from incidental transactions.
- An increase in a liability from incidental transactions.
- A decrease in a liability from primary operations.
A decrease in a liability from primary operations.
**Per SFAC 6, revenues are inflows of assets or settlements of liabilities, or both, during a period as a result of an entity’s major or primary operations. Two essential characteristics of revenues are that revenues (1) arise from a company’s primary earnings activities and (2) are recurring or continuing in nature. Therefore, this answer is correct because it meets the above criteria.
Under IFRS, which of the following is the first step within the hierarchy of guidance to which management refers, and whose applicability it considers, when selecting accounting policies?
- Consider the most recent pronouncements of other standard-setting bodies to the extent they do not conflict with the IFRS or the IASB Framework.
- Apply a standard from IFRS if it specifically relates to the transaction, other event, or condition.
- Consider the applicability of the definitions, recognition criteria, and measurement concepts in the IASB Framework.
- Apply the requirements in IFRS dealing with similar and related issues.
Apply a standard from IFRS if it specifically relates to the transaction, other event, or condition.
**The highest level in the hierarchy is an IFRS standard applicable to the transaction.
Compared to its 20X4 cash-basis net income, Potoma Co.’s 20X4 accrual-basis net income increased when it:
- Declared a cash dividend in 20X3 that it paid in 20X4.
- Wrote off more accounts receivable balances than it reported as uncollectible accounts expense in 2004.
- Had lower accrued expenses on December 31, 20X4, than on January 1, 2004.
- Sold used equipment for cash at a gain in 20X4.
Had lower accrued expenses on December 31, 20X4, than on January 1, 2004.
**If the accrued expenses account (a current liability, often called accrued expenses payable) decreased during 20X4, then a greater amount of cash was paid for those expenses in 20X4 than were accrued in 20X4. This would cause cash-basis net income to be less than accrual-basis net income. Cash-basis net income reflects expenses paid; accrual-basis net income reflects expenses recognized (accrued).
