11.12.18

Question 1

Corey Co.’s income statement accounts for the year ended December 31, Year 2, included the following:
Sales: $800,000
Cost of sales: 320,000
Administrative expenses: 80,000
Interest expenses: 10,000

Other Information
Available-for-sale debt securities held by the company had fair values of $250,000 and $300,000 on December 31, Year 1, and December 31, Year 2, respectively. On December 31, Year 2, 70,000 shares of common stock, $1.00 par, were outstanding. Corey repurchased 25,000 shares on June 1, Year 2. Corey’s enacted tax rate for the current and future years is 30%.
Corey’s comprehensive income is

Answer 1

$308,000.

Corey’s income before income taxes for Year 2 is $390,000 ($800,000 sales – $320,000 cost of sales – $80,000 administrative expenses – $10,000 interest expense), and net income is $273,000 [$390,000 × (1.0 – .30)]. Corey’s other comprehensive income includes the unrealized holding gain on available-for-sale debt securities, net of tax. Other comprehensive income is $35,000 [$50,000 × (1.0 – .30)]. Thus, comprehensive income is $308,000 ($273,000 + $35,000).

Question 2

Which of the following should be disclosed for each reportable operating segment of an entity?

Profit or loss:
Total assets:

Answer 2

Yes
Yes

An operating segment is a component (1) engaged in business from which it may earn revenues and incur expenses, (2) whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resource allocation and to assess performance, and (3) for which separate financial information is available. An operating segment is reportable if it meets one of the quantitative thresholds (revenue, assets, or absolute amount of profit or loss). Disclosures include a measure of profit or loss and total assets for each reportable segment.

Question 3

In determining diluted earnings per share (DEPS), a potential common stock (PCS) was antidilutive in Year 2 and dilutive in Year 3. The potential common stock would be included in the computation for

Year 2:
Year 3:

Answer 3

No
Yes

DEPS is based on the number of common shares outstanding during the period plus the common shares that would have been outstanding if dilutive potential common shares had been issued. Thus, in a period in which the effect of potential common stock is antidilutive, it is not included in the determination of DEPS. It is included, however, in those periods in which its effect is dilutive.

Question 4

Among the items reported on Cord, Inc.’s income statement for the year ended December 31 were the following:
Compensation expense for a stock option plan: $50,000
Insurance premium on the life of an officer (Cord is the owner and beneficiary.): 25,000

Neither is deductible for tax purposes. Temporary differences amount to

Answer 4

$0

Expenses for compensation expense for a stock option plan and payment of a premium for life insurance covering a key executive are recognized in the financial statements but are not deductible under the provisions of the federal tax code. Because neither will result in taxable or deductible amounts in future years, they are permanent, not temporary differences.

Question 5

Which of the following governmental entities that use proprietary fund accounting should be reported in a statement of cash flows?

Public Benefit Corporation:
Governmental Utilities:

Answer 5

Yes
Yes

Because proprietary funds concentrate on the capital maintenance concept, their reporting requirements are similar to those for business enterprises. Thus, the measurement focus concentrates on the recording of revenues and expenses. The statements required for proprietary funds include (1) a statement of net position; (2) a statement of revenues, expenses, and changes in fund net position; and (3) a statement of cash flows.

Question 6

The renovation of Fir City’s municipal park was accounted for in a capital projects fund. Financing for the renovation, which was begun and completed during the current year, came from the following sources:
Grant from state government: $400,000
Proceeds from general obligation bond issue: 500,000
Transfer from Fir’s general fund: 100,000

In its governmental fund statement of revenues, expenditures, and changes in fund balances for the current year, Fir should report these amounts as

Revenues:
Other Financing Sources:

Answer 6

$400,000
$600,000

Governmental fund revenues are increases in fund financial resources other than from (1) interfund transfers, (2) debt issue proceeds, and (3) redemptions of demand bonds. Thus, revenues of a capital projects fund include grants. The grant (a voluntary nonexchange transaction) is recognized when all eligibility requirements, including time requirements, have been met. When modified accrual accounting is used, as in a capital projects fund, the grant also must be available. Other financing sources include proceeds from bonds and interfund transfers in. Thus, revenues of $400,000 and other financing sources of $600,000 ($500,000 + $100,000) are reported in the governmental fund statement of revenues, expenditures, and changes in fund balances.

Question 7

Benedict Company leased equipment to Mark, Inc., on January 1, Year 2. The lease is for an 8-year period expiring December 31, Year 9. The first of 8 equal annual payments of $600,000 was made on January 1, Year 2. Benedict had purchased the equipment on December 29, Year 1, for $3,200,000. The lease is appropriately accounted for as a sales-type lease by Benedict. Assume that the present value at January 1, Year 2, of all rent payments over the lease term discounted at a 10% interest rate was $3,520,000. What amount of interest income should Benedict record in Year 3 (the second year of the lease period) as a result of the lease?

Answer 7

$261,200.

The net investment to be recorded by the lessor at 1/1/Year 2 is given as $3,520,000, the present value of the minimum lease payments discounted at 10%. The net investment is immediately reduced by the $600,000 lease payment on 1/1/Year 2, resulting in a carrying amount for Year 2 of $2,920,000. Interest earned for the Year 2 at a rate of 10% ($2,920,000 × 10%) is $292,000. Thus, the $600,000 1/1/Year 3 lease payment consists of the $292,000 interest component and a $308,000 reduction of the net investment. Because the Year 3 net investment balance is $2,612,000 ($2,920,000 – $308,000), interest income for Year 3 is $261,200 ($2,612,000 × 10%).

Question 8

In accounting for inventories, GAAP require departure from the historical cost principle when the utility of inventory has fallen below cost. Inventory accounted for under certain cost flow methods can be measured at the lower of cost or net realizable value (NRV). The term “net realizable value (NRV)” as defined here means

Answer 8

Estimated selling price minus estimated costs of completion and disposal.

Inventory measured using any cost method other than LIFO or retail (e.g., FIFO or average cost) must be measured at the lower of cost or NRV. NRV is the estimated selling price in the ordinary course of business, minus reasonably predictable costs of completion, disposal, and transportation.

Question 9

A water district is administered by a separately elected board. The board has no power to levy taxes or issue bonds. The board is substantively the same as the county that approves the water district’s budget. The county

Answer 9

Should use the blending method to report the water district’s financial results.

Discrete presentation is reporting component unit financial data separately from that of the primary government (the county). However, some component units are, in substance, the same as the primary government (the county) and should be reported as a part of it by using the blending method. The water district is part of the county and is not legally separate. Also, the county has a financial benefit or burden relationship with the water district. The water district cannot levy taxes or issue bonds. Accordingly, the water district’s financial data should be blended in the county’s financial statements.

Question 10

The computation of the current value of an asset using the present value of future cash flows method does not include the

Answer 10

Cost of alternate uses of funds given up.

The calculation of the current value of an asset using the present value method requires (1) the discount period (the productive life of the asset), (2) the discount rate (the applicable interest rate), and (3) the future values (the future amounts of cash receipts or cash savings). This method does not consider opportunity costs (benefits of the best alternative use of funds).

Question 11

Savor Co. had $100,000 in cash-basis pretax income for Year 2. At December 31, Year 2, accounts receivable had increased by $10,000 and accounts payable had decreased by $6,000 from their December 31, Year 1, balances. Compared to the accrual basis method of accounting, Savor’s cash pretax income is

Answer 11

Lower by $16,000.

The increase in accounts receivable indicates that cash-basis pretax income is $10,000 lower than accrual-basis pretax income. Revenues from the increase in receivables are reported as earned in an earlier period (Year 2) than the future related cash inflows. The decrease in accounts payable indicates that cash-basis pretax income is $6,000 lower than accrual-basis pretax income. The cash outflows related to the increase in payables occurred in Year 2, but the related expense was accrued in Year 1. Hence, cash pretax income is lower than accrual-basis income by $16,000.

Question 12

Spring Corp. entered into a 5-year lease agreement with Fall Corp. Spring, the lessee, paid an additional $5,000 nonrefundable lease bonus to Fall upon signing the operating lease agreement. When would Fall recognize in income the nonrefundable lease bonus paid by Spring?

Answer 12

Over the life of the lease.

Nonrefundable lease bonuses should be recognized as rental revenue on a straight-line basis over the lease term.

Question 13

On October 15, Year 5, a major investment advisor issued a pessimistic report on the entity’s long-term prospects. The market price for its common stock subsequently declined by 50%. How should this event be presented in the financial statements?

Answer 13

No financial statement disclosure.

The market price for the entity’s common stock is not a financial event that affects the fairness of the presentation of the financial statements. Accordingly, no disclosure is necessary for changes in the market price of the securities.

Question 14

Paper Co. had net income of $70,000 during the year. Dividend payment was $10,000. The following information is available:
Mortgage repayment: $20,000
Available-for-sale securities purchased: 10,000 increase
Bonds payable-issued: 50,000 increase
Inventory: 40,000 increase
Accounts payable; 30,000 decrease

What amount should Paper report as net cash provided by operating activities in its statement of cash flows for the year?

Answer 14

$0.

The payment of dividends, the repayment of debt (the mortgage), and the issuance of debt (the bonds) are financing activities. The purchase of debt or equity instruments the (available-for-sale securities) is an investing activity. Operating cash flows exclude these financing and investing cash flows. Moreover, these items do not affect net income. Consequently, net cash provided by operating activities can be determined by adjusting net income for the changes in inventory and accounts payable. To account for the difference between cost of goods sold (a deduction from income) and cash paid to suppliers, a two-step adjustment is necessary. The difference between cost of goods sold and purchases is the change in inventory. The difference between purchases and the amount paid to suppliers is the change in accounts payable. Accordingly, the conversion of cost of goods sold to cash paid to suppliers requires subtracting the inventory increase and the accounts payable decrease. The net cash provided by operating activities is therefore $0 ($70,000 net income – $40,000 inventory increase – $30,000 accounts payable decrease).

Question 15

Kind Nurses Assoc. is a voluntary health and welfare organization. Nurses are paid to visit homes of elderly people and are reimbursed for mileage and supplies. Which of the following items should Kind record as a support activity expense in its statement of activities?

Answer 15

Fundraising costs.

NFPs must report expenses by functional and natural classifications. Examples of natural classifications are (1) salaries, (2) rent, (3) interest, (4) electricity, (5) depreciation, (6) awards and grants to others, and (7) professional fees. Program services distribute goods and services to beneficiaries, customers, or members to fulfill the purposes of the entity. Supporting activities are not program services and include management and general, membership development, and fundraising activities.

Question 16

A nongovernmental not-for-profit entity discovered that equipment purchased on January 1, Year 1, for $750,000 was incorrectly expensed instead of capitalized. The equipment should have been depreciated (straight-line method) over 5 years with no salvage value. What is the depreciation expense presented on the cash flow statement (indirect method) dated December 31, Year 3?

Answer 16

$150,000.

Any error related to a prior period discovered after the statements are available to be used must be reported as an error correction by restating the prior period statements. The carrying amounts of (1) assets, (2) liabilities, and (3) net assets at the beginning of the first period reported are adjusted for the cumulative effect of the error on the prior periods. Corrections of prior period errors must not be included in the change in net assets from operations for the current year. Thus, depreciation expense should not be adjusted for the prior-period errors. The correction is to restate the prior period statements or beginning net assets. Accordingly, the financial statements for Year 3 should report depreciation expense of $150,000 [($750,000 ÷ 5 years) – $0 salvage value]. This noncash expense is included in the change in net assets. It is therefore added to the change in net assets in the reconciliation to net cash flow from operating activities.

Question 17

A transportation company purchased a passenger bus for $100,000 on January 1, Year 1. The company expects the bus to be used for 20 years if it follows a maintenance schedule of replacing the engine after 10 years and replacing the seats every 8 years. It estimates that the current cost to replace the engine is $25,000 and the current cost to replace the seats is $10,000. The company uses straight-line depreciation and the bus has no residual value. The company considers any component equal to or greater than 10% of the overall cost to be significant. Under IFRS, how much depreciation expense should the company recognize for the bus for the year ended December 31, Year 1?

Answer 17

$7,000.

Under IFRS, each part of an item with a cost significant to the total cost must be depreciated separately. The engine and the seats are considered significant to the total cost and thus should be depreciated separately. The company uses straight-line depreciation, and the bus has no residual value. Therefore, the depreciation expense for the engine is $2,500 ($25,000 ÷ 10 years), for the seats is $1,250 ($10,000 ÷ 8 years), and for the rest of the bus is $3,250 [($100,000 – $25,000 – $10,000) ÷ 20 years]. The total depreciation expense the company should recognize for the bus for the year ended December 31, Year 1, is $7,000 ($2,500 + $1,250 + $3,250).

Question 18

A statement of cash flows is to be presented in general-purpose external financial statements by which of the following?

Answer 18

All business and not-for-profit entities.

A statement of cash flows is required as part of a full set of financial statements of all business entities (both publicly held and privately held) and nongovernmental not-for-profit entities.

Question 19

During the current fiscal year, Foxx, a nongovernmental not-for-profit entity, received pledges of $300,000. Of the pledged amount, $200,000 was designated by donors for use during the current year, and $100,000 was designated for next year. Five percent of the pledges are expected to be uncollectible. What amount should Foxx report as net assets with donor restrictions (contributions) in the statement of activities for the current year?

Answer 19

$95,000.

Contributions are classified as increases in net assets with donor restrictions if, for example, the donor stipulates that resources are to be used only after a specified date. Pledges in the amount of $100,000 were stipulated for use next year. Of this amount, 5% is expected to be uncollectible. Accordingly, $95,000 [$100,000 – ($100,000 × 5%)] is reported as net assets with donor restrictions (contributions).

Question 20

Fact Pattern: During the year just ended, Pitt Corp. incurred costs to develop and produce a routine, low-risk computer software product as follows:
Completion of detail program design: $13,000
Costs incurred for coding and testing to establish technological feasibility: 10,000
Other coding costs after establishment of technological feasibility: 24,000
Other testing costs after establishment of technological feasibility: 20,000
Costs of producing product masters for training materials: 15,000
Duplication of computer software and training materials from product masters (1,000 units): 25,000
Packaging product (500 units): 9,000

The guidance pertaining to accounting for the costs of computer software to be sold, leased, or otherwise marketed applies.

In Pitt’s December 31 balance sheet, what amount should be capitalized as software cost subject to amortization?

Answer 20

$59,000.

Costs incurred internally in creating a computer software product are expensed when incurred as research and development until technological feasibility has been established for the product. Afterward, all software production costs incurred until the product is available for general release to customers are capitalized and amortized separately for each product. Subsequently, the lower of unamortized cost or net realizable value at the end of the period is reported in the balance sheet. Hence, (1) the costs of completing the detail program design and establishing technological feasibility are expensed; (2) the costs of duplicating software, documentation, and training materials and packaging the product are inventoried; and (3) the costs of coding and other testing after establishing technological feasibility and the costs of producing product masters are capitalized and amortized. The amount capitalized as software cost subject to amortization is therefore $59,000 ($24,000 + $20,000 + $15,000).

Question 21

During the current year, Onal Co. purchased 10,000 shares of its own stock at $7 per share. The stock was originally issued at $6. The firm sold 5,000 of the treasury shares for $10 per share. The firm uses the cost method to account for treasury stock. What amount should Onal report in its income statement for these transactions?

Answer 21

$0.

An entity’s transactions in its own stock do not affect net income or the results of operations.

Question 22

When remeasuring foreign currency financial statements into the functional currency, which of the following items would be remeasured using historical exchange rates?

Answer 22

Inventories carried at cost.

The current rate of exchange is used for remeasuring certain balance sheet items and the historical rate for other balance sheet items. Nonmonetary balance sheet items and related revenue, expense, gain, and loss accounts are remeasured at the historical rate. Monetary accounts are remeasured at the current rate. Inventories valued at cost are nonmonetary items and are measured at historical rates.

Question 23

On March 31, Dallas Co. received an advance payment of 60% of the sales price for special order goods to be manufactured and delivered within 5 months. At the same time, Dallas subcontracted for production of the special order goods at a price equal to 40% of the main contract price. What liabilities should be reported in Dallas’s March 31 balance sheet?

Deferred revenues:
Payables to subcontractor:

Answer 23

60% of main contract price
None

The 60% advance payment is a deferred revenue (a contract liability) because it is an obligation to transfer goods to a customer for which consideration already has been received from the customer. The agreement with the subcontractor does not create a liability because the entity has no performance obligation to transfer goods or provide services. That obligation will not arise until the subcontractor has performed.

Question 24

Which of the following financial categories are used in a nongovernmental not-for-profit organization’s statement of financial position?

Answer 24

Assets, liabilities, and net assets.

The categories used in an NFP’s statement of financial position are assets, liabilities, and net assets. Assets and liabilities must be classified into reasonably homogeneous groups. Net assets are classified at a minimum as net assets without donor restrictions and net assets with donor restrictions.

Question 25

A state and local government must disclose required supplementary information (RSI) other than management’s discussion and analysis. Which of the following is not RSI?

Answer 25

Statement of activities.

RSI is presented in a separate section of the comprehensive annual financial report. RSI includes (1) schedules, (2) statistical data, (3) budgetary comparison schedules, and (4) other information that is an essential part of financial reporting. It should be presented with, but not as a part of, the basic financial statements of a governmental entity. But the government-wide statement of activities is a basic financial statement, not RSI.

Question 26

Posy Corp. acquired treasury shares at an amount greater than their par value but less than their original issue price. Compared with the cost method of accounting for treasury stock, does the par-value method report a greater amount for additional paid-in capital and a greater amount for retained earnings?

Additional Paid-in Capital:
Retained Earnings:

Answer 26

No
No

Under the cost method, the purchase of treasury stock (debit treasury stock, credit cash) has no effect on additional paid-in capital and retained earnings. Under the par-value method, given that the acquisition cost is greater than par but less than the original issue price, treasury stock is debited at par, and the additional paid-in capital associated with the original issue is also debited. Cash and paid-in capital from treasury stock transactions are credited. Hence, the par-value method does not report a greater amount for additional paid-in capital or retained earnings.

Question 27

Brill Co. made the following expenditures during Year 1:

Costs to develop computer software for internal use in Brill’s general management information system: $100,000
Costs of market research activities: 75,000

What amount of these expenditures should Brill report in its Year 1 income statement as research and development expenses?

Answer 27

$0.

Costs of market research are not R&D costs. Furthermore, general and administrative costs not clearly related to R&D activities are not included as R&D costs. Thus, costs to develop software for the company’s own general management information system are also not R&D costs.

Question 28

Roaster Company issued bonds with detachable stock warrants. Each warrant granted an option to buy one share of $40 par value common stock for $75 per share. Five hundred warrants were originally issued, and $4,000 was appropriately credited to warrants. If 90% of these warrants are exercised when the market price of the common stock is $85 per share, how much should be credited to capital in excess of par on this transaction?

Answer 28

$19,350.

If 90% of the warrants are exercised, 450 shares must be issued at $75 per share. The total debit to cash is $33,750. The debit to stock warrants outstanding reflects the exercise of 90% of $4,000 of warrants, or $3,600. The par value of the common stock issued is credited for $18,000 (450 shares × $40 par). The balance of $19,350 ($33,750 + $3,600 – $18,000) is credited to capital in excess of par. The transaction is based on the exercise price, not the fair value of the stock or warrants at the time of issuance.
Cash $33,750
Warrants 3,600
Common stock at par $18,000
Capital in excess of par 19,350

Question 29

Acquiree Co. is a 90%-owned subsidiary of Acquirer Co. The carrying amounts of the noncontrolling interest and the subsidiary are $1,000,000 and $10,000,000, respectively. The subsidiary’s fair value is $15,000,000. Acquirer transferred part of its interest to Third Co. on December 31 for $12,000,000 in cash but retained a noncontrolling interest equal to 20% of Acquiree’s voting interests. The fair value of the retained interest, which gives Acquirer significant influence, is $3,000,000. The fair values and carrying amounts are as of December 31. Acquirer must account for this transaction by recognizing a

Answer 29

Gain of $6,000,000.

The parent records a deconsolidation by recognizing a gain or loss in net income attributable to the parent. It equals the difference between (1) the sum of (a) the fair value of consideration received, (b) the fair value of any retained investment at the date of deconsolidation, and (c) the carrying amount of any noncontrolling interest (including accumulated other comprehensive income attributable to the noncontrolling interest at the date of deconsolidation and (2) the carrying amount of the subsidiary. Consequently, the gain is $6,000,000 [($12,000,000 + $3,000,000 + $1,000,000) – $10,000,000].

Question 30

Quoit, Inc., issued preferred stock with detachable common stock warrants. The issue price exceeded the sum of the warrants’ fair value and the preferred stocks’ par value. The preferred stocks’ fair value was not determinable. What amount should be assigned to the warrants outstanding?

Answer 30

The fair value of the warrants.

When securities are issued with detachable stock warrants, the proceeds should be allocated between the securities and the warrants based on their relative fair values at issuance. If the fair value of only the warrants is known, the warrants should be recorded at fair value with the remainder allocated to the securities.

Question 31

Which of the following is a transfer to a nongovernmental not-for-profit organization acting as an agent or intermediary that most likely is not recognized as a contribution?

Answer 31

A nongovernmental NFP enters into a revocable arrangement with a donor. The donor contributes assets to the NFP, and the NFP agrees to pay a fixed amount annually to the donor’s uncle.

Under trusts or other arrangements, NFPs may share benefits with the donor or third-party beneficiaries. A revocable split-interest agreement is accounted for only as an intention to give. Assets received are recognized at fair value when received and as refundable advances (a liability).

Question 32

A hotel enters into a contract with a customer to provide 10 rooms for 10 nights for $200 per room per night. In addition to the room price per night, the hotel collects a city occupancy tax of $7 per room per night. According to the hotel’s promotion, each customer that purchases in total more than 50 room nights is entitled to a credit of $3,000 on the entire purchase. What is the total transaction price of the contract?

Answer 32

$17,000.

The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. It excludes amounts collected on behalf of third parties. Thus, the amount collected for city occupancy taxes must not be included in the transaction price. In addition, any consideration payable to the customer, such as coupons, credit, or vouchers, reduces the transaction price. Accordingly, the total transaction price of the contract is $17,000 [(10 × 10 × $200) – $3,000].

Question 33

On January 2, Year 3, to better reflect the variable use of its only machine, Holly, Inc., elected to change its method of depreciation from the straight-line method to the units-of-production method. The original cost of the machine on January 2, Year 1, was $50,000 with no salvage value, and its estimated life was 10 years. Holly estimates that the machine’s total life is 50,000 machine hours. The machine hours usage was 8,500 during Year 2 and 3,500 during Year 1. Holly’s income tax rate is 30%, and the machine hours usage was 10,000 in Year 3. If Holly issues single-period statements only, it should report the accounting change in its Year 3 financial statements as a(n)

Answer 33

Change in estimate and depreciation expense of $10,526.

A change in depreciation method is a change in principle inseparable from a change in estimate. It is accounted for prospectively. The total depreciation for Year 1 and Year 2 under the straight-line method was $10,000 [($50,000 ÷ 10 years) × 2]. Thus, the carrying amount at the beginning of Year 3 was $40,000 ($50,000 – $10,000). Given that 12,000 machine hours (8,500 + 3,500) were used in Year 1 and Year 2, the remaining service potential was 38,000 hours (50,000 – 12,000). Accordingly, depreciation for Year 3 is calculated as follows: