10.08

Question 1

A company had the following outstanding shares as of January 1, year 2:

Preferred stock, $60 par, 4%, cumulative 10,000 shares
Common stock, $3 par 50,000 shares
On April 1, year 2, the company sold 8,000 shares of previously unissued common stock. No dividends were in arrears on January 1, year 2, and no dividends were declared or paid during year 2. Net income for year 2 totaled $236,000. What amount is basic earnings per share for the year ended December 31, year 2?

$3.66
$3.79
$4.07
$4.21

Answer 1

$3.79

**Basic EPS = Net Income - Preferred Dividends / Weighted shares outstanding. The numerator is $236,000 - preferred dividends [($60 × 10,000) × .04 = 24,000] = $212,000. The denominator is 50,000 (12/12) + 8,000 (9/12) = 56,000 shares. $212,000 / 56,000 = $3.786 or $3.79.

Question 2

Which of the following qualifies as a reportable operating segment?

• Corporate headquarters, which oversees $1 billion in sales for the entire company
• North American segment, whose assets are 12% of the company’s assets of all segments, and management reports to the chief operating officer
• South American segment, whose results of operations are reported directly to the chief operating officer, and has 5% of the company’s assets, 9% of revenues, and 8% of the profits
• Eastern Europe segment, which reports its results directly to the manager of the European division, and has 20% of the company’s assets, 12% of revenues, and 11% of profits

Answer 2

North American segment, whose assets are 12% of the company’s assets of all segments, and management reports to the chief operating officer

**Only the North American segment meets at least one of the three quantitative criteria at the 10% level (revenue, income, assets) AND reports to the chief operating decision maker of the firm as a whole. For all three criteria, the segment must account for 10% or more of the combined amount for all operating segments. Reporting to the company-wide chief operating decision maker is also a requirement of an operating segment.

Question 3

Alfisol, Inc. offers sales discounts of 2% on all credit sales paid within 15 days. For year 1, gross credit sales totaled $150,000 and 75% of Alfisol’s customers took advantage of the discount. Under the net method

• Each sale should not be recorded until payment is received and it is known whether the discount is taken.
• Allowance for sales discounts must be credited for $2,250.
• For cash receipts within the discount period, sales discounts must be debited for $2,250.
• For cash receipts after the discount period, discounts not taken must be credited for $750.

Answer 3

For cash receipts after the discount period, discounts not taken must be credited for $750.

**Under the net method, sales are initially recorded net of discounts. Payments received after the discount period total $37,500 ($150,000 × 25%), and the amount of discounts forfeited is $750 ($37,500 × 2%).

Question 4

Ward Co. estimates its uncollectible accounts expense to be 2% of credit sales. Ward's credit sales for 2004 were $1,000,000. During 2004, Ward wrote off $18,000 of uncollectible accounts. Ward's allowance for uncollectible accounts had a $15,000 balance on January 1, 2004. In its December 31, 2004 income statement, what amount should Ward report as uncollectible accounts expense?
$23,000
$20,000
$18,000
$17,000

Answer 4

$20,000

**The credit sales method does not adjust the allowance balance to a required ending amount, but rather simply places the appropriate percent of sales into uncollectible accounts expense and the allowance account. 2% × $1,000,000 = $20,000.

Question 5

Frame Co. has an 8% note receivable, in the original amount of $150,000, dated June 30, 2003. Payments of $50,000 in principal plus accrued interest are due annually on July 1, 2004, 2005, and 2006.

In its June 30, 2005, balance sheet, what amount should Frame report as a current asset for interest on the note receivable?

$0
$4,000
$8,000
$12,000

Answer 5

$8,000

**As of June 30, 2005, only one payment has been received (July 1, 2004). Thus, $100,000 of principal balance has been outstanding for an entire year as of the balance sheet date. Interest receivable on June 30, 2005 is thus $8,000 (.08 × $100,000).

Question 6

Ace Co. sold King Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments. This note was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of $1 for five periods are as follows:

8% 3.992
9% 3.890
What should be the total interest revenue earned by King on this note?

$9,000
$8,000
$5,560
$5,050

Answer 6

$5,560

**Total interest over the life of the note equals the total amount paid by Ace over the life of the note less the proceeds to Ace. The proceeds equal the present value of the payments at the 9% yield rate. The annual payment is found using the 8% rate because that rate is contractually set and determines the annual payment.
The annual payment P is found as: $20,000 = P(3.992). P = $5,010
Total interest revenue = total payments by Ace - proceeds to Ace
= 5($5,010) − $5,010(3.89) = $5,560.

Question 7

On November 1, 2004, Davis Co. discounted with recourse at 10%, a one-year, noninterest-bearing, $20,500 note receivable maturing on January 31, 2005.

What amount of contingent liability for this note must Davis disclose in its financial statements for the year ended December 31, 2004?

$0
$20,000
$20,333
$20,500

Answer 7

$20,500

**The firm is contingent for the maturity amount, which for a noninterest-bearing note is the face value. If the maker of the note fails to pay the bank or financial institution with whom Davis discounted the note, Davis would be called on to pay the entire maturity amount.

Question 8

Choose the correct accounting by the creditor for a loan impairment. Column (1): recognize a loss or expense upon recognizing the impairment. Column (2): rate of interest to use in computing the revised book value of the receivable after the impairment.
1                   2
-Yes     Original effective rate
-Yes     New implied effective rate
-No      Original effective rate
-No      New implied effective rate

Answer 8

1 2
-Yes Original effective rate

**A loan impairment is recorded by reducing the net book value of the receivable to the present value of probable future cash inflows, discounted at the original rate in the receivable. The original rate is used because the loan continues to exist. The loss to the firm is measured at the rate existing when the original loan was created. The difference between the book value and present value, at the date of recognizing the impairment, is recorded as an expense or loss. There is no reason to report overstated assets.

Question 9

West Retailers purchased merchandise with a list price of $20,000, subject to trade discounts of 20% and 10%, with no cash discounts allowable.

West should record the cost of this merchandise as

$14,000
$14,400
$15,600
$20,000

Answer 9

$14,400

**This is a chain discount and the correct recorded cost is $20,000(1 - .20)(1- .10) = $14,400. Each successive discount in a chain discount is applied to the previous net amount.

Question 10

On October 20, 2005, Grimm Co. consigned 40 freezers to Holden Co. for sale at $1,000 each and paid $800 in transportation costs.

On December 30, 2005, Holden reported the sale of 10 freezers and remitted $8,500. The remittance was net of the agreed 15% commission.

What amount should Grimm recognize as consignment sales revenue for 2005?

$7,700
$8,500
$9,800
$10,000

Answer 10

$10,000

**Consignment sales revenue is the revenue recognized on consignment sales.

In this case, total consignment revenue is 10 × $1,000 = $10,000. The commission and transportation costs are expenses that reduce earnings on consignment revenues, but they do not affect total revenues to be recognized.

Question 11

The following information pertained to Azur Co. for the year:

Purchases	$102,800
Purchase discounts	10,280
Freight-in	15,420
Freight-out	5,140
Beginning inventory	30,840
Ending inventory	20,560
What amount should Azur report as cost of goods sold for the year?

$102,800
$118,220
$123,360
$128,500

Answer 11

$118,220

**Cost of goods sold is determined (in a periodic inventory system) as:

Beginning Inventory 
\+ Net Purchases 
= Goods Available for Sale 
- Ending Inventory 
= Cost of Goods Sold
Net Purchases includes any purchase discounts (or allowances) and other cost of getting the goods in place and condition for resale, including freight-in. Freight-out (to customers) is a selling cost. Therefore, Azur Co.'s cost of goods sold would be:

Beginning Inventory $ 30,840 
\+ Net Purchases $107,940 
= Goods Available for Sale $138,780 
- Ending inventory 20,560
= Cost of Goods Sold $118,220 Note net purchase is computed as 
\+ Purchases $102,800 
- Net Purchases 107,940 
= Goods Available for Sale $138,780 
- Purchases Discounts (10,280) 
\+ Freight-in 15,420

Question 12

During periods of inflation, 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 valuation methods?
FIFO
LIFO

Answer 12

FIFO-YES

LIFO-NO

Question 13

Generally, which inventory costing method approximates most closely the current cost for each of the following?
Cost of goods sold
Ending inventory

Answer 13

Cost of goods sold-LIFO
Ending inventory-FIFO

**LIFO assumes the sale of the most recent purchases first and thus results in cost of goods sold that is the most current value. FIFO assumes the sale of the earliest purchases first (and beginning inventory before any purchases) and thus results in ending inventory that is the most current value. FIFO is sometimes called LISH: last in still here.

Question 14

When the FIFO inventory method is used during periods of rising prices, a perpetual inventory system results in an ending inventory cost that is

• The same as in a periodic inventory system.
• Higher than in a periodic inventory system.
• Lower than in a periodic inventory system.
• Higher or lower than in a periodic inventory system, depending on whether physical quantities have increased or decreased.

Answer 14

The same as in a periodic inventory system.

**FIFO produces the same results for periodic and perpetual systems. FIFO always assumes the sale of the earliest goods acquired. Therefore, unlike LIFO periodic, goods can never be assumed sold before they are acquired.
Cost of goods sold and ending inventory are the same under FIFO for both a periodic and a perpetual system.

Question 15

In 2005, Cobb adopted the dollar-value LIFO inventory method.

At that time, Cobb’s ending inventory had a base-year cost and an end-of-year cost of $300,000. In 2006, the ending inventory had a $400,000 base-year cost and a $440,000 end-of-year cost.

What dollar-value LIFO inventory cost would be reported in Cobb’s December 31, 2006, balance sheet?

$440,000
$430,000
$410,000
$400,000

Answer 15

$410,000

**The price level index for 2006 is 1.1 ($440,000/$400,000). Ending 2006 DV LIFO inventory equals the beginning inventory DV LIFO plus the increase in inventory at base-year dollars converted to 2006 prices:

Ending DV LIFO = Beginning DV LIFO + (increase at base-year dollars)(1.1)

= $300,000 + ($400,000 − $300,000)(1.1) = $410,000.

Question 16

In January, Stitch, Inc. adopted the dollar-value LIFO method of inventory valuation. At adoption, inventory was valued at $50,000. During the year, inventory increased $30,000 using base-year prices, and prices increased 10%. The designated market value of Stitch's inventory exceeded its cost at year-end. What amount of inventory should Stitch report in its year-end balance sheet?
$80,000
$83,000
$85,000
$88,000

Answer 16

$83,000

**Beginning inventory of $50,000 is at base-year dollars and the current year increase of $30,000 is also at base-year dollars. The current year layer must be converted to current year costs ($30,000 × 1.10) = $33,000. Ending dollar value LIFO is the beginning dollar value LIFO (in this case it was adopted in January so the beginning inventory must be $50,000) plus the current year layer of $33,000 or $83,000. Note that the sentence “The designated market value of Stitch’s inventory exceeded its cost at year end” is a distracter. It is simply stating that there is not an issue with the lower of cost or market since cost is lower.

Question 17

Kahn Co., in applying the lower of cost or market method, reports its inventory at replacement cost. Which of the following statements are correct?

-The original cost is greater
than replacement cost

-The net realizable value, less a normal profit margin, is greater than replacement cost

Answer 17

-The original cost is greater
than replacement cost-YES

-The net realizable value, less a normal profit margin, is greater than replacement cost-NO

**Under LCM, the market value of inventory is the middle of three figures (in amount):

replacement cost
net realizable value
net realizable value less normal profit margin.
If the middle figure (market) is less than cost, then the inventory is reported at market. The inventory in this question is reported at replacement cost, which means that replacement cost is market value and replacement cost is less than cost. Also, replacement cost is the middle of the three figures (or tied with one of the other two).

Net realizable value less normal profit margin could not exceed replacement cost because that would imply that replacement cost is the lowest of the three figures, which contradicts the fact that replacement cost is market value.

Therefore, in terms of the question,

(1) original cost is greater than replacement cost, and
(2) net realizable value less normal profit margin is not greater than replacement cost.

Question 18

The following two inventory items were purchased as a group in a liquidation sale for $1,000.

Replacement	Carrying Value
Item	   Cost	On Seller's Books
A	$400	$390
B	700	755
The firm purchasing the inventory records item A at what amount?
$341
$390
$364
$500

Answer 18

$364

**When items are purchased as a group, the total cost of the group is allocated to the individual items based on fair value. Replacement cost is the appropriate value to use in this case. The total replacement cost of the items is $1,100 ($400 + $700). Therefore, Item A is allocated 4/11 of the purchase cost, or $364 = ($400/$1,100)$1,000.

Question 19

How does the retail inventory method establish the lower-of-cost-or-market valuation for ending inventory?

• The procedure is applied on a cost basis at the unit level.
• By excluding net markups from the cost-to-retail ratio.
• By excluding beginning inventory from the cost-to-retail ratio.
• By excluding net markdowns from the cost-to-retail ratio.

Answer 19

By excluding net markdowns from the cost-to-retail ratio.

**Although the result is approximate, by excluding net markdowns from the denominator of the cost-to-retail ratio, the ratio is a smaller amount, resulting in a lower ending inventory valuation.

Question 20

Data for a firm using the Average LCM (conventional retail inventory method) retail inventory method is as follows:

Cost	Retail
Beginning inventory	$ 300	$ 467
Net purchases	1,200	2,000
Net additional markups		100
Net markdowns		(300)
Sales		$1,700
Compute cost of goods sold.

$1,169
$1,160
$1,177
$1,122

Answer 20

$1,169

**Ending inventory at retail = $567 (= $467 + $2,000 + $100-$300-$1,700). The cost-to-retail ratio includes both the beginning inventory amounts, purchases and net markups. C/R = $300 + $1,200/($467 + $2,000 + $100) = .5843. Ending inventory at cost = $567(.5843) = $331. Cost of goods sold = $300 + $1,200 - $331 = $1,169.