11.12.18

Question 1

Which of the following funds of a governmental unit uses the modified accrual basis of accounting to prepare its fund financial statements?

Answer 1

Special revenue funds.

Governmental fund types (general, special revenue, capital projects, debt service, and permanent funds) are required to use the modified accrual basis to prepare their fund financial statements.

Question 2

Which of the following transactions should be classified as investing activities on an entity’s statement of cash flows?

Answer 2

Sale of property, plant, and equipment.

Investing activities include (1) making and collecting loans; (2) acquiring and disposing of debt or equity instruments; and (3) acquiring and disposing of property, plant, and equipment and other productive assets (but not materials in inventory) held for or used in the production of goods and services.

Question 3

On January 1, Read, a nongovernmental not-for-profit organization, received $20,000 and an unconditional pledge of $20,000 for each of the next 4 calendar years to be paid on the first day of each year. The present value of an ordinary annuity for 4 years at a constant interest rate of 8% is 3.312. What amount of net assets with donor restrictions is reported in the year the pledge was received?

Answer 3

$66,240.

Contributions received are accounted for at fair value. The fair value of the annual $20,000 payments may be estimated using the present value of payments. The present value of the payments equals $66,240 ($20,000 × 3.312). Unconditional promises to give cash amounts in the future are reported as donor-restricted support unless the donor clearly intended support for current activities. Because unconditional promises to give amounts in future periods usually increase net assets with donor restrictions, the amount of $66,240 is reported accordingly. The $20,000 received on January 1 increases net assets without donor restrictions.

Question 4

In a statement of cash flows, if used equipment is sold at a gain, the amount shown as a cash inflow from investing activities equals the carrying amount of the equipment

Answer 4

Plus the gain.

Assuming a sale for cash, the cash inflow must equal the carrying amount plus the gain, that is, the total cash receipt.

Question 5

Which of the following risks, if any, are inherent in an interest-rate swap agreement?
I. The risk of exchanging a lower interest rate for a higher interest rate
II. The risk of nonperformance by the counterparty to the agreement

Answer 5

Both I & II.

An interest-rate swap is an exchange of fixed interest payments for payments based on a floating rate. The risks inherent in an interest-rate swap include both credit risk and market risk. Credit risk is the risk of accounting loss from a financial instrument because of the possibility that a loss may occur from the failure of another party to perform according to the terms of a contract. Market risk arises from the possibility that future changes in market prices may make a financial instrument less valuable or more onerous. Market risk therefore includes the risk that changes in interest rates will make the swap agreement less valuable or more onerous.
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Question 6

How should plan investments be reported in a defined benefit plan’s financial statements?

Answer 6

At fair value.

The annual financial statements of a defined benefit pension plan must include information about the net assets available for benefits at the end of the plan year. Plan investments, whether equity or debt securities, real estate, or other (excluding insurance contracts) must be presented at their fair value at the reporting date.

Question 7

Universe Co. issued 500,000 shares of common stock in the current year. Universe declared a 30% stock dividend. The market value was $50 per share, the par value was $10, and the average issue price was $30 per share. By what amount will Universe decrease shareholders’ equity for the dividend?

Answer 7

$0.

When a stock dividend is declared, a portion of retained earnings is reclassified as contributed capital. The net effect on total equity is thus $0.

Question 8

Linden Corporation is a defendant in a lawsuit in which the plaintiff is seeking $1,000,000 in damages. The company had terminated the plaintiff, George Russell, from his position with Linden after Russell allegedly sold specifications for one of Linden’s new products to a competitor. Linden’s attorney believes that it is quite possible Linden will lose the case and that, if so, damages could range from $100,000 to $200,000.

Regardless of the outcome of the case, Linden’s accountants estimate the company will incur an additional $5,000 in unemployment costs because of Russell’s termination. The amount that Linden should accrue because of the contingency in this situation is

Answer 8

$0.

Loss contingencies are accrued when the loss is probable. The $5,000 in unemployment costs that will probably be incurred are a routine cost of doing business.

Question 9

The date on which an employer becomes contingently obligated to make share-based payments compensation to an employee who renders the requisite service is the

Answer 9

Grant date.

GAAP generally require a public entity to measure the cost of employee services received in exchange for equity instruments at the fair value of the instruments on the grant date and to allocate that cost to the requisite service period. The grant date is the date at which (1) a mutual understanding of the key terms and conditions of a share-based payment award is reached by an employer and an employee, (2) the employer becomes contingently obligated to issue share-based payments to an employee who renders the requisite service, (3) any necessary approvals are obtained, and (4) the subsequent changes in the market price of the underlying stock begin to benefit or adversely affect the employee.

Question 10

On January 1, Year 1, a company with a calendar year end began developing a software program that it intends to market and sell to its customers. The software coding was completed on March 31, Year 1, at a cost of $200,000, and the software testing was completed on June 30, Year 1, at a cost of $100,000. The company achieved technological feasibility on July 31, Year 1, at which time the company began producing product masters at a cost of $125,000. What amount should the company report for the total research and development expense for the year ended December 31, Year 1?

Answer 10

$300,000.

For computer software to be marketed and sold to external customers, costs incurred before technological feasibility is established (coding, testing, etc.) are recognized as research and development costs and must be expensed as incurred. Thus, $300,000 ($200,000 + $100,000) must be reported as the research and development expense for the year ended December 31, Year 1.

Question 11

A nongovernmental not-for-profit entity prepaid $300,000 of rent on January 1, Year 1, for a 3-year rental period. Although the payment was properly recorded as prepaid rent, it was amortized over a period of 2 years. What is the adjustment, if any, to prepaid rent at January 1, Year 2?

Answer 11

$50,000 debit.

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, rent expense should not be adjusted for the prior-period errors. The correction is to restate the prior-period statements or beginning net assets. The amortization recognized in Year 1 was $150,000 ($300,000 prepaid rent ÷ 2 years). The amount that should have been recognized was $100,000 ($300,000 ÷ 3 years). Accordingly, prepaid rent should be debited and net assets without donor restrictions should be credited for $50,000 ($150,000 – $100,000).

Question 12

A planned volume variance in the first quarter, which is expected to be absorbed by the end of the fiscal period, ordinarily should be deferred at the end of the first quarter if it is

Favorable:
Unfavorable:

Answer 12

Yes
Yes

Entities using standard costing ordinarily should follow the same procedures for reporting variances at interim dates as at year end. However, purchase price variances or volume (capacity cost) variances that are planned and expected to be absorbed by year end should ordinarily be deferred at interim dates. Thus, deferral is appropriate whether the volume variance is favorable or unfavorable. This treatment does not apply to unplanned or unanticipated purchase price or volume variances.

Question 13

In its fiscal year ended June 30, Year 4, Barr College, a large nongovernmental not-for-profit entity, received $100,000 designated by the donor for scholarships for superior students. On July 26, Year 4, Barr selected the students and awarded the scholarships. How should the July 26 transaction be reported in Barr’s statement of activities for the year ended June 30, Year 5?

Answer 13

As both an increase and a decrease of $100,000 in net assets without donor restrictions.

When the NFP received the contribution, it should have been classified as net assets with donor restrictions because it was to be used for a specified purpose. When the purpose is fulfilled, the restriction expires. The amount then should be reclassified as a decrease in net assets with donor restrictions and an increase in net assets without donor restrictions. When the scholarships are awarded, net assets without donor restrictions is decreased.

Question 14

Based on 8% interest compounded annually from day of deposit to day of withdrawal, what is the present value today of $4,000 to be received 6 years from today?

1: .926
2: .857
3; .794
4: .735
5: .681

Answer 14

$4,000 x .926 x .681.

To calculate the present value of an amount to be received 6 years from today when present value factors for only 5 periods are available, multiply $4,000 by the present value of $1 factor for 5 periods. This discounts the $4,000 back 5 years. This result should then be discounted back 1 additional year, i.e., multiplied by the present value factor for one period.

Question 15

On September 1, Meen County’s enterprise fund issued a $12,000,000, 10%, 2-year note to finance the construction of a building. Assuming interest is accrued only when the year ends on September 30, the journal entry to prepare the enterprise fund’s operating statement is

Answer 15

Interest expense $100,000
Interest Payable $100,000

An enterprise fund is a proprietary fund that uses the accrual basis of accounting. Its operating statement is the statement of revenues, expenses, and changes in fund net position. Consequently, interest expense is debited (accrued) and interest payable is credited (accrued) for $100,000 [($12,000,000 × 10%) × (1 month ÷ 12 months)].

Question 16

Silken, Inc., a distributor of silk goods, is in its first year of operation. The company has purchased ten computers at $3,500 each with an estimated life of 6 years; five desks at $500 each with an estimated life of 10 years; and two word processors at $300 each, with an estimated life of 4 years. No residual value is anticipated for any of these assets. Silken wants to adopt a depreciation method that will be easy to use and reflect an appropriate depreciation expense for the business each accounting period. The most appropriate method would be

Answer 16

Composite depreciation.

Group and composite depreciation methods use the straight-line technique for an aggregate of assets. The composite method is used for dissimilar assets.

Question 17

Baker Co. began its operations during the current year. The following is Baker’s balance sheet at December 31:
Baker Co. 
Balance Sheet
Assets
Cash: $192,000
Accounts receivable: 82,000
Total assets: $274,000
Liabilities and stockholders’ equity
Accounts payable: $24,000
Common stock: 200,000
Retained earnings: 50,000
Total liabilities and stockholders’ equity: $274,000

Baker’s net income for the current year was $78,000, and dividends of $28,000 were declared and paid. Common stock was issued for $200,000. What amount should Baker report as cash provided by operating activities in its statement of cash flows for the current year?

Answer 17

$20,000.

Because the entity began operations in the current year, the beginning balances on the balance sheet are zero. Net income of $78,000 needs to be adjusted downward for the increase in accounts receivable of $82,000 (reflecting noncash revenue) and upward for the increase in accounts payable of $24,000 (an adjustment for the difference between purchases and cash paid to suppliers). The payment of a cash dividend and the issuance of stock for cash are an outflow and an inflow, respectively, from financing activities. The total cash provided by operating activities is $20,000 ($78,000 – $82,000 + $24,000).

Question 18

Fact Pattern:
On November 1, Year 1, Iba Co. entered into a contract with a customer to sell 150 machines for $75 each. The customer obtains control of the machines at contract inception. Iba’s cost of each machine is $45. Iba allows the customer to return any unused machine within 1 year from the sale date and receive a full refund. Iba uses the expected value method to estimate the variable consideration. Based on Iba’s experience and other relevant factors, it reasonably estimates that a total of 20 machines (12 machines in Year 1 and 8 machines in Year 2) will be returned. Iba estimates that (1) the machines are expected to be returned in salable condition and (2) the costs of recovering the machines will be immaterial. During Year 1, 10 machines were returned. At the end of Year 1, Iba continues to estimate that a total of 20 machines will be returned within 1 year from the sale date.

What amount of revenue from this contract will be recognized by Iba in Year 1?

Answer 18

$9,750.

Given a right of return, the consideration received from the customer is variable. Revenue from variable consideration is recognized only to the extent that it is probable that a significant reversal will not occur. Iba estimates that 20 machines will be returned. Thus, in Year 1 Iba recognizes revenue only for the sale of 130 machines (150 – 20), and the revenue recognized is $9,750 (130 × $75).

Question 19

On December 31, Year 3, Matricula Corp. reported $100,000 in current liabilities. Matricula issued audited financial statements on March 31, Year 4. On February 15, Year 4, the company issued $80,000 of common stock, the proceeds of which were intended to pay the current debt. What amount of current liabilities should Matricula report in its December 31, Year 3, balance sheet prepared under IFRS?

Answer 19

$100,000.

Financial liabilities due to be settled within 12 months should continue to be classified as current. This treatment applies even if (1) the original term exceeded 12 months and (2) an agreement to refinance, or reschedule payments, on a noncurrent basis is completed after the end of the reporting period and before the financial statements are authorized for issue.

Question 20

At the beginning of Year 1, a company hired an executive whose contract included the promise of payment of $100,000 in each of Years 6, 7, and 8 if the executive is employed at the end of Year 5. How should the compensation expense associated with this contract be recorded?

Answer 20

$60,000 in each of years 1 through 5.

Employee compensation expense requiring a requisite service period must be recognized equally over the vesting period. The vesting period begins on the grant date and ends once the requisite service conditions have been met. The grant date in this situation is the beginning of Year 1, once a mutual understanding of the key terms of the award has been reached and the employer is obligated to make the payments if the employee renders the requisite service. The requisite service period ends at the end of Year 5. Thus, the $300,000 ($100,000 × 3 years) of compensation expense will be recognized equally over Years 1 through 5. This results in $60,000 ($300,000 ÷ 5) of compensation expense being recognized each year in Years 1 through 5.