11.12.18

Question 1

Talton Co. installed new assembly line production equipment at a cost of $185,000. Talton had to rearrange the assembly line and remove a wall to install the equipment. The rearrangement cost $12,000, and the wall removal cost $3,000. The rearrangement did not increase the life of the assembly line, but it did make it more efficient. What amount of these costs should be capitalized by Talton?

Answer 1

$200,000.

Property, plant, and equipment are measured initially at historical cost. This amount includes the price of the asset and the costs needed to bring it to the condition and location necessary for its intended use, e.g., shipping and installation costs. Furthermore, capital (asset) expenditures for acquisition or enhancement of service potential are included in the historical cost. However, revenue expenditures (expenses) maintain an asset’s normal service capacity. Consequently, the amount capitalized is $200,000 ($185,000 installation costs + $12,000 rearrangement cost that increased efficiency + $3,000 wall removal cost necessary for the intended use of the asset).

Question 2

A contributed plant asset for which the fair value has been determined, and for which incidental costs were incurred in acceptance of the asset, should be recorded at an amount equal to its

Answer 2

FV and incidental cost incurred.

A contributed plant asset should be debited at its fair value plus any incidental costs necessary to make the asset ready for its intended use. Contributions received ordinarily should be credited as revenues or gains in the periods they are received. However, a credit to a revenue or gain is not required for contributions by governments to business enterprises.

Question 3

Dogwood City’s water enterprise fund received interest of $10,000 on long-term investments. How should this amount be reported on the statement of cash flows?

Answer 3

Investing activities.

Reporting of cash flows of proprietary funds and entities engaged in business-type activities, e.g., governmental utilities, is required. Cash inflows should be classified as operating, noncapital financing, capital and related financing, and investing. Investing activities include making and collecting loans (other than program loans) and acquiring and disposing of debt and equity instruments. Cash inflows from investing activities include interest and dividends received as returns on loans (not program loans), debt of other entities, equity securities, and cash management or investment pools.

Question 4

Which of the following is true regarding interim financial reporting?

Answer 4

Each interim period is viewed as a discrete reporting period under IFRS and as an integral part of an annual period under U.S. GAAP.

Under U.S. GAAP, each interim period is viewed as an integral part of an annual period to which it relates. Thus, an inventory loss from a market decline may be deferred if no loss for the year is reasonably anticipated. Under IFRS, each interim period is viewed as a discrete reporting period. Accordingly, an inventory loss from a market decline must be recognized in the interim period even if no loss for the year is reasonably anticipated.

Question 5

The senior accountant for Carlton Co., a public company with a complex capital structure, has just finished preparing Carlton’s income statement for the current fiscal year. While reviewing the income statement, Carlton’s finance director noticed that the earnings-per-share data has been omitted. What changes will have to be made to Carlton’s income statement as a result of the omission of the earnings-per-share data?

Answer 5

Carlton’s income statement will have to be revised to include the earnings-per-share data.

A public entity must report EPS data on the face of the income statement. A public entity with only common stock outstanding must report basic earnings per share (BEPS) but not diluted earnings per share (DEPS) for income from continuing operations and net income. All other public entities must present BEPS and DEPS for income from continuing operations and net income with equal prominence. A nonpublic entity must follow the guidance for calculation and presentation of EPS only if it elects to report EPS.

Question 6

Which of the following is a criterion for a lease to be classified as a capital lease in the books of a lessee?

Answer 6

The lease contains a bargain purchase option.

A lease is classified as a capital lease by the lessee if, at its inception, any of the following four criteria is satisfied: (1) the lease provides for the transfer of ownership of the leased property, (2) the lease contains a bargain purchase option, (3) the lease term is 75% or more of the estimated economic life of the leased property, or (4) the present value of the minimum lease payments (excluding executory costs) is at least 90% of the fair value of the leased property to the lessor.

Question 7

On June 19, Don Co., a U.S. company, sold and delivered merchandise on a 30-day account to Cologne GmbH, a German corporation, for 200,000 euros. On July 19, Cologne paid Don in full. Relevant currency exchange rates were:

Spot rate
June 19: .988
July 19: .995

30-day forward rate
June 19: .990
July 19: 1.000

What amount should Don record on June 19 as an account receivable for its sale to Cologne?

Answer 7

$197,600.

Foreign currency transactions should be recorded using the spot rate on the day of the transaction. Thus, Don should record a receivable on June 19 of $197,600 (200,000 euros × $.988).

Question 8

Which of the following financial statements would provide information about the ongoing revenues and expenses associated with a voluntary health and welfare organization?

Answer 8

The statement of activities.

A statement of activities is an operating statement equivalent to a for-profit entity’s income statement. It presents changes in the classes of net assets, including reclassifications. It also includes information about how resources are used to provide programs and services.

Question 9

A labor union had the following receipts and expenses for the current year ended December 31:
Receipts:
Per capita dues: $680,000
Initiation fees: 90,000
Sales of organizational supplies: 60,000
Gift by donor for any purpose consistent with the union’s mission: 30,000
Gift by donor for the union’s general support: 25,000

Expenses:
Labor negotiations: $500,000
Fundraising: 100,000
Membership development; 50,000
Management and general: 200,000

Additional information: The union’s constitution provides that 10% of the per capita dues are designated for the Strike Insurance Fund to be distributed for strike relief at the discretion of the union’s executive board.
The statement of activities for the year ended December 31 reported donor-restricted support of $123,000. Which of the following adjustments, if any, should be made to the reported amount?

Answer 9

Decrease donor-restricted support by $123,000.

Contribution revenues or gains with donor-imposed restrictions are reported as donor-restricted support. But the $55,000 ($30,000 + $25,000) of gifts by donors has neither purpose nor time restrictions. Moreover, the $68,000 ($680,000 × 10%) board-designated for strike relief is from per capita dues (revenue from exchange transactions), not donors. Also, internal designations do not result in donor-restricted support.

Question 10

Which of the following transactions is an expenditure of a governmental unit’s general fund?

Answer 10

Routine employer contributions from the general fund to a pension trust fund.

Employers that participate in defined contribution plans recognize pension expenditures or expenses for the required contributions to the plan and a liability (asset) for unpaid (overpaid) contributions. Recognition in the fund financial statements is on the modified accrual or accrual basis depending on the reporting fund. The general fund is a governmental fund. Thus, it uses the modified accrual basis of accounting. It recognizes expenditures when the related liabilities are incurred. Expenditures are uses of governmental fund financial resources. They do not arise from interfund transfers. Interfund activity involves internal events. Transactions are external events. Interfund transfers are one-way asset flows with no repayment required. Because they are nonreciprocal, they are analogous to the external events classified as nonexchange transactions. By contrast, an expenditure for a pension contribution is in essence an exchange. The contribution is in exchange for employee services.

Question 11

As an inducement to enter a lease, Arts, Inc., a lessor, grants Hompson Corp., a lessee, 9 months of free rent under a 5-year operating lease. The lease is effective on July 1, Year 3, and provides for monthly rent payments of $1,000 to begin on April 1, Year 4. In Hompson’s income statement for the year ended June 30, Year 4, rent expense should be reported as

Answer 11

$10,200.

Rent expense for an operating lease is recognized on a straight-line basis unless another systematic or rational basis is more appropriate. This requirement holds regardless of whether the lease payments are made on a straight-line basis. The total lease payments for this operating lease are $51,000 [$1,000 monthly rent × (60 total months in the lease term – 9 months’ free rent)]. Allocating this $51,000 on the straight-line basis to the 5 years of the operating lease results in rent expense of $10,200 ($51,000 ÷ 5 years) per year. The amount of $12,000 would be the rent expense if 9 months of free rent had not been granted.

Question 12

Abbott Co. is preparing its statement of cash flows for the year. Abbott’s cash disbursements during the year included the following:
Payment of interest on bonds payable: $500,000
Payment of dividends to stockholders: 300,000
Payment to acquire 1,000 shares of Marks Co. common stock: 100,000

What should Abbott report as total cash outflows for financing activities in its statement of cash flows under U.S. GAAP?

Answer 12

$300,000.

The $300,000 dividend should be classified as a financing cash outflow. The payment of interest is an operating cash outflow under U.S. GAAP, and the payment to acquire the common stock of Marks is an investing cash outflow. Under IFRS, payment of dividends may be classified as an operating or a financing activity.

Question 13

Zeff Co. prepared the following reconciliation of its pretax financial statement income to taxable income for the year ended December 31, its first year of operations:
Pretax financial income: $160,000
Nontaxable interest received on municipal securities: (5,000)
Long-term loss accrual in excess of deductible amount: 10,000
Depreciation in excess of financial statement amount: (25,000)
Taxable income: $140,000

Zeff’s tax rate for the year is 40%. In its December 31 balance sheet, what should Zeff report as deferred income tax liability?

Answer 13

$6,000.

A deferred income tax liability arises from a taxable temporary difference. The $10,000 long-term loss accrual (a deductible temporary difference) results in a deferred tax asset. The $25,000 excess depreciation (a taxable temporary difference) results in a deferred tax liability. These items should be netted because all deferred tax assets and liabilities should be offset and presented as a single amount. Accordingly, the net deferred tax liability is $6,000 [($25,000 – $10,000) × 40%].

Question 14

Regulation S-X disclosure requirements of the Securities and Exchange Commission (SEC) apply to

Answer 14

The requirements for filing interim financial statements and pro forma financial information.

Regulation S-X governs the reporting of financial statements, including notes and schedules. Both interim and annual statements are covered by Regulation S-X.

Question 15

Grim Corporation operates a plant in a foreign country. It is probable that the plant will be expropriated. However, the foreign government has indicated that Grim will receive a definite amount of compensation for the plant. The amount of compensation is less than the fair market value but exceeds the carrying amount of the plant. The contingency should be reported in

Answer 15

The notes to the financial statements.

GAAP provide for recognition of loss but not gain contingencies if certain criteria are met. A loss contingency is an existing condition, situation, or set of circumstances involving uncertainty as to either the impairment of an asset’s value or the incurrence of a liability at a balance sheet date. Resolution of the uncertainty depends on the occurrence or nonoccurence of one or more future events. In the Grim Corporation case, an economic loss is expected because the amount of compensation is less than the fair market value of the plant expropriated. However, the amount of compensation exceeds the carrying amount of the plant. Thus, no accounting loss will result. The contingency should therefore be reported only in the notes to the financial statements.

Question 16

A nongovernmental not-for-profit entity discovered that equipment purchased on January 1, Year 1, for $450,000 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 required adjustment to net assets without donor restrictions at January 1, Year 5, when the error was discovered?

Answer 16

$90,000 credit.

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. Accumulated depreciation should be credited and net assets without donor restrictions should be debited for $360,000 [($450,000 ÷ 5 years) × 4 years], the total accumulated depreciation that should have been recorded for Years 1 through 4. Also, equipment should be debited and net assets without donor restrictions should be credited for $450,000 for the purchase of the equipment. Thus, the net effect on net assets without donor restrictions is a $90,000 credit ($450,000 credit – $360,000 debit).

Question 17

The best evidence of a standalone selling price of a promised good or service to a customer is

Answer 17

An observable price.

The standalone selling price is the price at which an entity would sell a promised good or service separately to a customer. The best evidence of a standalone selling price is the observable price of a good or service when it is sold separately in similar circumstances and to similar customers (e.g., a contractually stated price or list price of a good or service).

Question 18

On its December 31, Year 2, balance sheet, Shin Co. had income taxes payable of $13,000 and a current deferred tax asset of $20,000 before determining the need for a valuation account. Shin had reported a current deferred tax asset of $15,000 at December 31, Year 1. No estimated tax payments were made during Year 2. At December 31, Year 2, Shin determined that it was more likely than not that 10% of the deferred tax asset would not be realized. In its Year 2 income statement, what amount should Shin report as total income tax expense?

Answer 18

$10,000.

Deferred tax expense or benefit is the net change during the year in the entity’s deferred tax liabilities and assets. It is added to the current tax expense or benefit to determine total income tax expense for the year. The amount of income taxes payable (current tax expense) is given as $13,000. The deferred tax asset increased by $5,000, but $2,000 ($20,000 × 10%) was determined to be an appropriate credit to an allowance account. Total income tax expense for Year 2 can thus be calculated as follows:
Income tax payable: $13,000
Increase in deferred tax asset: (5,000)
Increase in valuation allowance: 2,000
Total income tax expense: $10,000

Question 19

The measurement focus of the governmental funds of a state or local governmental entity is on the determination of

Changes in financial position:
Financial position:

Answer 19

Yes
Yes

The financial statements of governmental funds measure financial flow data. They focus on reporting the sources, uses, and balances of current financial resources, that is, the determination of financial position and changes in it.

Question 20

On June 1, Year 1, Yola Corp. lent Dale $500,000 on a 12% note, payable in five annual installments of $100,000 beginning January 2, Year 2. In connection with this loan, Dale was required to deposit $5,000 in a noninterest-bearing escrow account. The amount held in escrow is to be returned to Dale 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, Year 1. Dale made timely payments through November 1, Year 1. On January 2, Year 2, Yola received payment of the first principal installment plus all interest due. At December 31, Year 1, Yola’s interest receivable on the loan to Dale is

Answer 20

$10,000.

Assuming the debtor made no payment on December 1, 2 months of interest should be accrued at year end. Consequently, the interest receivable on the loan is $10,000 [$500,000 × 12% × (2 ÷ 12)].