11.12.18

Question 1

A construction company recognizes revenue from construction contracts over time using the input method based on costs incurred. It reports the following:

Year 1
Construction costs: $100
Estimated cost to complete at year-end: 300

Year 2
Construction costs
Estimated cost to complete at year-end: $200
Estimated cost to complete at year-end: 0

The contract price is $1,000. What is the profit recognized in Year 2?

Answer 1

$550.

At the end of Year 1, total cost was expected to be $400 ($100 incurred + $300 estimated cost to complete), and estimated total profit was $600 ($1,000 price – $400 estimated total cost). Thus, the amount of profit recognized in Year 1 was $150 [$600 × ($100 cost incurred ÷ $400 estimated total cost)]. The project was completed in Year 2 at an additional cost of $200. Actual profit was therefore $700 ($1,000 – $300 actual total cost). Profit recognized in Year 2 is $550 ($700 total – $150 recognized in Year 1).

Question 2

A not-for-profit voluntary health and welfare entity should report a contribution for the construction of a new building as cash flows from which of the following in the statement of cash flows?

Answer 2

Financing activities.

Cash inflows from financing activities include receipts of restricted resources that by donor stipulation must be used for long-term purposes. A cash contribution for the construction of a new building is a resource that must be used for long-term purposes.

Question 3

Seafood Trading Co. commenced operations during the year as a large importer and exporter of seafood. The imports were all from one country overseas. The export sales were conducted as drop shipments and were merely transshipped at Seattle. Seafood Trading reported the following data:
Purchases during the year: $12.0 million
Shipping costs from overseas: 1.5 million
Shipping costs to export customers: 1.0 million
Inventory at year end: 3.0 million

What amount of shipping costs should be included in Seafood Trading’s year-end inventory valuation?

Answer 3

$375,000.

Freight costs of acquiring inventory are included in inventory. Freight costs incurred in shipping inventory to customers are not. The freight-in costs must be prorated to ending inventory and cost of goods sold. Because the entity began operations during the year, it has no beginning inventory. Accordingly, the freight-in costs assigned to ending inventory equal $375,000 [$1.5 million freight-in × ($3 million inventory ÷ $12 million purchases)].

Question 4

Selected information for Clay Corp. for the year ended December 31 follows:
Average days’ sales in inventories: 124
Average days’ sales in accounts receivable: 48

The average number of days in the operating cycle for the year was

Answer 4

$172.

The operating cycle is the time needed to turn cash into inventory, inventory into receivables, and receivables back into cash. It is equal to the sum of the number of days’ sales in inventory and the number of days’ sales in receivables. The number of days in Clay’s operating cycle is thus 172 (124 + 48).

Question 5

On January 1, Year 1, Sam Co. entered into a contract with a customer to sell a machine for two annual payments of $144,049 starting at the end of Year 1. The customer obtains control of the machine at contract inception. The cash selling price of the machine is $250,000. Sam determined that (1) the contract includes a significant financing component and (2) the contract includes an implicit interest rate of 10%. What amounts of revenue and interest income from this contract, if any, were recognized by Sam in Year 2?

Revenue from customers:
Interest income:

Answer 5

$0
$13,395

The revenue recognized must reflect the price that a customer would have paid for the promised goods or services if the cash payment had been made when the goods were transferred to the customer (the cash selling price). Because the customer obtained control over the machine at contract inception, the revenue from this contract of $250,000 was recognized on 1/1/Year 1. The contract includes a significant financing component. Thus, interest income from the adjustment of the transaction price for the effect of the time value of money must be recognized using the effective interest method. The interest component of the first installment payment on 12/31/Year 1 is $25,000 ($250,000 × 10%). The remaining amount of the principal to be paid is $130,951 [$250,000 – ($144,049 annual payment – $25,000 Year 1 interest)]. Interest income for Year 2 is therefore $13,095 ($130,951 × 10%).

Question 6

A large nongovernmental not-for-profit entity’s statement of activities must report the net change for net assets that are

Without donor restrictions:
With donor restrictions:

Answer 6

Yes
Yes

The statement of financial position must at a minimum report the amounts of net assets without donor restrictions, net assets with donor restrictions, and total net assets. The statement of activities should report the changes in each category.

Question 7

Vadis Co. sells appliances that include a standard 3-year assurance-type warranty. Service calls under the warranty are performed by an independent mechanic under a contract with Vadis. Based on experience, warranty costs are estimated at $30 for each machine sold. When should Vadis recognize these warranty costs?

Answer 7

When the machines are sold.

An assurance-type warranty creates a loss contingency. Under the accrual method, a provision for warranty costs is made when the related revenue is recognized.

Question 8

The following information is available for Sweden Company for its most recent year:
Net sales: $1,800,000
Freight-in: 45,000
Purchase discounts: 25,000
Ending inventory: 120,000

The gross margin is 40% of net sales. What is the cost of goods available for sale?

Answer 8

$1,200,000.

Because the gross margin equals 40% of net sales, cost of goods sold equals 60% of net sales, or $1,080,000. Cost of goods available for sale equals the cost of goods sold plus the cost of the goods in ending inventory. Hence, cost of goods available for sale equals $1,080,000 plus $120,000, or $1,200,000 (BI + PUR = GAFS* = COGS + EI). Freight-in and purchase discounts are not used to estimate COGS or GAFS in the gross margin approach.
Ending inventory: $120,000
Cost of goods sold: 1,080,000
Goods available for sale: $1,200,000

Question 9

Eureka City should report which of the following funds in a statement of cash flows?

Eureka City Hall Capital projects fund:
Eureka Water Enterprise fund:

Answer 9

No
Yes

Governmental funds (e.g., a capital projects fund) emphasize sources, uses, and balances of current financial resources. The required financial statements are the balance sheet and the statement of revenues, expenditures, and changes in fund balances. The emphasis of proprietary funds (e.g., an enterprise fund) is on operating income, changes in net position (or cost recovery), financial position, and cash flows. 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. Thus, the cash flows of an enterprise fund, but not a capital projects fund, must be reported in a separate fund financial statement. Furthermore, the required government-wide financial statements do not include a statement of cash flows.

Question 10

The following information pertains to Ali Corp. as of and for the year ended December 31:
Liabilities: $60,000
Equity: $500,000
Shares of common stock issued and outstanding: 10,000
Net income: $30,000

During the year, Ali’s officers exercised share options for 1,000 shares of stock at an option price of $8 per share. What was the effect of exercising the share options?

Answer 10

Debt-to-equity ratio decreased to 12%.

Exercising share options improves (decreases) the debt-to-equity ratio because equity is increased with no effect on debt. When share options are exercised, common stock and additional paid-in capital are credited and cash is debited.

Question 11

Ragg Coalition, a nongovernmental not-for-profit organization, received a gift of treasury bills. The cost to the donor was $20,000, with an additional $500 for brokerage fees that were paid by the donor prior to the transfer of the treasury bills. The treasury bills had a fair value of $15,000 at the time of the transfer. At what amount should Ragg report the treasury bills in its statement of financial position?

Answer 11

$15,000.

Contributions received ordinarily are accounted for when received at fair value as credits to revenues or gains. Debits are to assets, liabilities, or expenses. The fair value of the treasury bills is $15,000. Thus, the NFP’s statement of financial position reports the treasury bills at $15,000.

Question 12

The decision to elect the fair value option (FVO)

Answer 12

Is irrevocable until the next election date, if any.

The decision to elect the FVO is final and cannot be revoked unless a new election date occurs. For example, an election date occurs when an entity recognizes an investment in equity securities with readily determinable fair values issued by another entity. A second election date occurs if the accounting changes because the investment later becomes subject to equity-method accounting.

Question 13

Hut Co. has temporary taxable differences that will reverse during the next year and add to taxable income. These differences relate to noncurrent assets. Deferred income taxes based on these temporary differences should be classified in Hut’s balance sheet as a

Answer 13

Noncurrent liability.

Future taxable amounts reflecting the difference between the tax basis and the reported amount of the assets will result when the reported amount is recovered. Accordingly, Hut must recognize a deferred tax liability to record the tax consequences of these temporary differences. Deferred taxes are classified as noncurrent amounts.

Question 14

On January 2, Year 1, Kine Co. granted Morgan, its president, fully vested share options to buy 1,000 shares of Kine’s $10 par common stock. The options have an exercise price of $20 per share and are exercisable for 3 years following the grant date. Morgan exercised the options on December 31, Year 1. The market price of the shares was $50 on January 2, Year 1, and $70 on the following December 31. If the fair value of the options is not reasonably estimable at the grant date, by what net amount will equity increase as a result of the grant and exercise of the options? (Ignore tax considerations.)

Answer 14

$20,000.

Question 15

Bean Co. included interest expense and depreciation expense in its determination of segment profit, which Bean’s chief financial officer considered in determining the segment’s operating budget. Bean is required to report the segment’s financial data in accordance with GAAP. Which of the following items should Bean disclose in reporting segment data?

Interest Expense:
Depreciation expense:

Answer 15

Yes
Yes

The objective is to provide information about the different types of business activities of the entity and the economic environments in which it operates. Disclosures include a measure of profit or loss and total assets for each reportable segment. Other items typically disclosed include revenues from external customers and other operating segments, interest revenue and expense, depreciation, depletion, amortization, unusual items, equity in the net income of equity-based investees, income tax expense or benefit, and other significant noncash items.

Question 16

At December 31, S Corp. owned 80% of J Corp.’s common stock and 90% of C Corp.’s common stock. J’s net income for the year was $200,000 and C’s net income was $400,000. C and J had no interentity ownership or transactions during the year. Combined financial statements are being prepared for C and J in contemplation of their sale to an outside party. In the combined income statement, combined net income should be reported at

Answer 16

$600,000.

Combined financial statements are appropriate when common management or common control exists for two or more entities not subject to consolidation. The calculation of combined net income is similar to the calculation for consolidated net income. Thus, combined net income should be recorded at the total of the net income reported by the combined entities, adjusted for any profits or losses from transactions between the combined entities. In the combined income statement issued for J Corp. and C Corp., net income should be reported at $600,000 ($200,000 + $400,000).

Question 17

Zenk Co. wrote off obsolete inventory of $100,000 during the year. What was the effect of this write-off on Zenk’s ratio analysis?

Answer 17

Decrease in current ratio but not in quick ratio.

Inventory is included in the numerator of the current ratio but not the quick ratio. Consequently, an inventory write-off decreases the current ratio but not the quick ratio.

Question 18

Based on a physical inventory taken on December 31, Chewy Co. determined its chocolate inventory on a LIFO basis at $26,000 with a replacement cost of $20,000. Chewy estimated that, after further processing costs of $12,000, the chocolate could be sold as finished candy bars for $40,000. Chewy’s normal profit margin is 10% of sales. Under the lower-of-cost-or-market rule, what amount should Chewy report as chocolate inventory in its December 31 balance sheet?

Answer 18

$24,000.

Under LIFO, inventory is measured at the lower of cost or market (LCM). Market equals current replacement cost subject to maximum and minimum values. The maximum is NRV, and the minimum is NRV minus normal profit. When replacement cost is within this range, it is used as market. Cost is given as $26,000. NRV is $28,000 ($40,000 selling price – $12,000 additional processing costs), and NRV minus a normal profit equals $24,000 [$28,000 – ($40,000 × 10%)]. Because the lowest amount in the range ($24,000) exceeds replacement cost ($20,000), it is used as market. Because market value ($24,000) is less than cost ($26,000), it is also the inventory amount.

Question 19

Tone Company is the defendant in a lawsuit filed by Witt in Year 2 disputing the validity of a copyright held by Tone. At December 31, Year 2, Tone determined that Witt would probably be successful against Tone for an estimated amount of $400,000. Appropriately, a $400,000 loss was accrued by a charge to income for the year ended December 31, Year 2. On December 15, Year 3, Tone and Witt agreed to a settlement providing for a cash payment of $250,000 by Tone to Witt, and the transfer of Tone’s copyright to Witt. The carrying amount of the copyright on Tone’s accounting records was $60,000 at December 15, Year 3. What would be the effect of the settlement on Tone’s income before income tax in Year 3?

Answer 19

$90,000 increase.

In Year 2, a $400,000 contingent loss and an accrued liability in the amount of $400,000 were properly recognized. In Year 3, the actual loss of $310,000 ($250,000 cash + $60,000 carrying amount of the copyright) was $90,000 less than the previously estimated amount. This new information should be treated as a change in estimate and accounted for in the period of change. Consequently, the $90,000 difference will be credited to Year 3 income as a recovery of a previously recognized loss.

Question 20

Which of the following are presented in the proprietary funds statement of net position of a state or local government?

Answer 20

Deferred inflows of resources and deferred outflows of resources.

The statement of net position of proprietary funds presents the difference between (1) assets plus deferred outflows of resources and (2) liabilities plus deferred inflows of resources.