9-16-1 FAR -Roles and Concepts

Question 1

Reporting inventory at the lower of cost or market is a departure from the accounting principle of:

A. Historical cost.

B. Consistency.

C. Conservatism.

D. Full disclosure.

Answer 1

A

LCM departs from historical cost because it provides an ending valuation below cost when market value is below cost. The inventory is actually written down to a value below what was originally paid. This is one of the few such departures.

Question 2

Which of the following assumptions means that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis?

A. Going concern.

B. Periodicity.

C. Monetary unit.

D. Economic entity.

Answer 2

C. Monetary unit.

Question 3

Ande Co. estimates uncollectible accounts expense using the ratio of past actual losses from uncollectible accounts to past net credit sales, adjusted for anticipated conditions. The practice follows the accounting concept of:

A. Consistency.

B. Going concern.

C. Matching.

D. Substance over form.

Answer 3

C. Matching.

The matching principle requires that we recognize and match expenses with the revenues generated. For all sales in a given period, some will be uncollectible. The cost of those uncollectible accounts is matched in the period that the revenue is recognized.

Question 4

True/False-Consistency is the desired characteristics of the application of accounting principles in the same manner from year to year. Consistency permits comparison within one company over a period of time. Comparability permits comparison between companies.

Answer 4

True /False

Question 5

Which of the following characteristics of accounting information primarily allows users of financial statements to generate predictions about an organization?

A. Reliability.

B. Timeliness.

C. Neutrality.

D. Relevance.

Answer 5

D

The question is asking which of the following terms captures predictive value. Predictive value along with confirmatory value is a component of relevance.

Question 6

True/False- The term reliability is no longer part of the conceptual framework. Faithful representation is now used to capture completeness, neutrality, and free from material error.

Answer 6

True

Question 7

Which of the following characteristics relates to both accounting relevance and faithful representation?

A. Free from material error.

B. Completeness.

C. Neutrality.

D. Comparability.

Answer 7

D. Comparability.

Comparability is the quality of information that enables users to identify similarities and differences between sets of information. For information to be comparable, it must be both relevant (make a difference to a user) and reliable (be accurate and trustworthy).

Question 8

Faithful representation can be broken down into -3 parts

Answer 8

completeness,
free from material error,
neutrality.

Question 9

Relevance can be broken down into -2 parts

Answer 9

predictive value

confirmatory value

Question 10

What is the conceptual framework intended to establish?

A. GAAP in financial reporting by business enterprises.

B. The meaning of “present fairly in accordance with GAAP

C. The objectives and concepts for use in developing standards of financial accounting and reporting.

D. The hierarchy of sources of GAAP

Answer 10

C

The concepts statements, also collectively called The Conceptual Framework, provide the general underpinnings for specific GAAP. In a way, it is a “constitution” for developing specific accounting principles. The concepts statements are not GAAP, however.

Question 11

According to the conceptual framework, the quality of information that helps users increase the likelihood of correctly forecasting the outcome of past or present events is called:

A. Confirmatory value.

B. Predictive Value.

C. Representational faithfulness.

D. Faithful representation.

Answer 11

B

Predictive value is the ingredient that helps users increase the likelihood of forecasting the outcome of events. Financial statement information is useful if it helps users make decisions about investing and extending credit. These decisions involve predictions of a firm’s future financial performance, position, and cash flows.

Question 12

True/False - Royalty Expense
The net amount earned by the artist is also the royalty expense to the firm.

Royalty expense is recognized on the basis of the sales –Adjustments to the final amount earned for 20X0, after all return information is known, will be treated as an adjustment to royalty expense in *20X1.

New information in 20X1 will require a change in estimate, not retroactive application.

The $100,000 amount is the best estimate of the royalty cost to Bain in 20X0 that will ultimately be paid on 20X0 sales.

Answer 12

true

Question 13

The following trial balance of Trey Co. at December 31, 20X5 has been adjusted except for income tax expense.

                                    Dr.                      Cr.  Cash                         $550,000 A/ R net                     1,650,000 Prepaid taxes             300,000

Accounts payable $ 120,000
Common stock 500,000
Additional paid-in capital 680,000
Retained earnings 630,000
Foreign currency translation adjustment 430,000

Revenues 3,600,000
Expenses 2,600,000
__________ ____________
$5,530,000 $5,530,000
Additional information:
During 20X5, estimated tax payments of $300,000 were charged to prepaid taxes. Trey has not yet recorded income tax expense. There were no differences between the financial statement and the income tax income, and Trey’s tax rate is 30%.
Included in accounts receivable is $500,000 due from a customer. Special terms granted to this customer require payments in equal, semiannual installments of $125,000 every April 1 and October 1.
In Trey’s December 31, 20X5 Balance Sheet, what amount should be reported as total current assets?

Answer 13

current assets -$1,950,000

Current assets are assets that are collectible within one year. The sum of the stated current assets is $2,500,000 ($550,000+$1,650,000+$300,000).
**
However, once the current tax bill is calculated, the prepaid taxes of $300,000 are transferred into a tax expense account to cover the $300,000 in current year tax expense.

In addition, $250,000 of the special account receivable is not due for over one year and is, therefore, non-current. ($2,500,000-$300,000-$250,000). This response correctly adjusted for the tax situation but failed to adjust for the accounts receivable.

Question 14

The following information pertains to Eagle Co.’s 20X5 sales:
Cash Sales
_________
Gross $ 80,000
Returns and allowances 4,000

Credit sales
__________
Gross 120,000
Discounts 6,000

On January 1, 20X5, customers owed Eagle $40,000. On December 31, 20X5, customers owed Eagle $30,000. Eagle uses the direct write-off method for bad debts. No bad debts were recorded in 20X5. Under the cash basis of accounting, what amount of net revenue should Eagle report for 20X5?

Answer 14

Net cash sales collected
$80,000 - $4,000= $76,000
Plus cash collections from credit sales:

Beginning accounts receivable $40,000
Plus net credit sales $120,000 - $6,000= 114,000
Less ending accounts receivable (30,000)
Equals cash collections from credit sales 124,000
Equals revenue recognized under the cash basis of accounting (76,000+124,000) = $200,000

Question 15

In financial statements prepared on the income-tax basis, how should the nondeductible portion of expenses, such as meals and entertainment, be reported?

A. Included in the expense category in the determination of income.

B. Included in a separate category in the determination of income.

C. Excluded from the determination of income but included in the determination of retained earnings.

D. Excluded from the financial statements.

Answer 15

A

Despite the fact that these expenses are not deductible for tax purposes, they are still business expenses and need to be included in the determination of income on the financial statements.

In addition, the income tax return requires information on the total meals and entertainment expense in order to calculate the deductible amount.

Question 16

On January 1, 20X1, Sip Co. signed a five-year contract enabling it to use a patented manufacturing process beginning in 20X1.
A royalty is payable for each product produced, subject to a minimum annual fee. Any royalties in excess of the minimum will be paid annually. On the contract date, Sip prepaid a sum equal to two years’ minimum annual fees. In 20X1, only the minimum fees were incurred.
The royalty prepayment should be reported in Sip’s December 31, 20X1, financial statements as:

A. An expense only.

B. A current asset and an expense.

C. A current asset and noncurrent asset.

D. A noncurrent asset.

Answer 16

B

At the end of 20X1,

1/2 of the prepayment is recognized as an expense. The minimum fee was incurred in 20X1 equaling 1/2 of the prepayment amount. Sip has received the benefit of 1/2 of prepayment amount. The other 1/2 is applied to 20X2 and allows Sip to use the patent in that year. This amount had future value as of 12/31/01. That future value is expected to expire at the end of 20X2 and, thus, is classified as a current asset at the end of 20X1. Additional use in 20X2 beyond the minimum will be paid in that year.

Question 17

Class Corp. maintains its accounting records on the cash basis, but it restates its financial statements to the accrual method of accounting. Class had $60,000 in cash-basis pretax income for 20X2. The following information pertains to Class operations for the years ended December 31, 20X2 and 20X1:

                                 20X2                 20X1  A/R                           $40,000          $20,000 A/P                              15,000             30,000 Under the accrual method, what amount of income before taxes should Class report in its December 31, 20X2, Income Statement?

Answer 17

95,000

The increase in A/P should be added since it represents additional sales not recorded in cash method

The decrease in accounts payable ADDED from cash-basis income. It represents the decrease in accounts payable represents payments in excess of expenses and, thus, causes accrual income to exceed cash-basis income.

Question 18

Before 20X1, Droit Co. used the cash basis of accounting. As of December 31, 20X1, Droit changed to the accrual basis. Droit cannot determine the beginning balance of supplies inventory.
What is the effect of Droit’s inability to determine beginning supplies inventory on its 20X1 accrual basis net income and December 31, 20X1, accrual basis owners’ equity?

20X1 net income 12/31/X1 owner’s equity

No effect No effect
No effect Overstated
Overstated No effect
Overstated Overstated

Answer 18

20X1 net income 12/31/X1 owner’s equity
Overstated No effect

under accrual method : supplies exp. =
beginning supplies
+purchases
-ending supplies.
_______________
=supplies expense
**If beginning supplies cannot be determined, then it is assumed to be zero and supplies expense is understated, causing 20X1 income to be overstated. **However, total supplies expense for the entire life of the business is unaffected by the inability to determine beginning supplies for 20X1.
**Total supplies expense for the life of the business is total purchases less ending inventory in 20X1.
These two amounts are determinable, and thus, owners’ equity at the end of 20X1 can be determined.

Question 19

U Co. had cash purchases and payments on account during the current year totaling $455,000. U’s beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U’s accrual-basis purchases for the year?

A. $441,000

B. $469,000

C. $505,000

D. $519,000

Answer 19

A 441,000

Using an equation, or a T-account, to analyze accounts payable (AP) yields accrual purchases: Beginning AP ($64,000) + Accrual purchases - Cash payments ($455,000) = Ending AP ($50,000). Solving for accrual purchases yields $441,000.

Question 20

Based on 20X0 sales of compact discs recorded by an artist under a contract with Bain Co., the artist earned $100,000 after an adjustment of $8,000 for anticipated returns.
In addition, Bain paid the artist $75,000 in 20X0 as a reasonable estimate of the amount recoverable from future royalties to be earned by the artist.
What amount should Bain report in its 20X0 Income Statement for royalty expense?

A. $100,000

B. $108,000

C. $175,000

D. $183,000

Answer 20

A 100,000

EARNED IS 100,000
The 75K was paid be careful not to get tricked .

Question 21

Zeta Co. reported sales revenue of $4,600,000 in its Income Statement for the year ended December 31, 20X1. Additional information is as follows:

                              12/31/00          12/31/01 A/R                     $1,000,000    $1,300,000 Allowance for  uncollectible          (60,000)         (110,000)

Zeta wrote off uncollectible accounts totaling $20,000 during 20X1. Under the cash basis of accounting, Zeta would have reported 20X1 sales of:

A. $4,900,000

B. $4,350,000

C. $4,300,000

D. $4,280,000

Answer 21

D 4,280,000

4,600,000
-300,000 INCREASE IN A/R
   -20,000  WROTE OFF UNCOLLECTIBLE
\_\_\_\_\_\_\_\_
4,280,000

Question 22

Under East Co.’s accounting system, all paid insurance premiums are debited to prepaid insurance. For interim financial reports, East makes monthly estimated charges to insurance expense with credits to prepaid insurance.
Additional information for the year ended December 31, 20X5, is as follows:
Prepaid insurance at December 31, 20X4 =
$105,000
Charges to insurance expense during 20X5 (including a year-end adjustment of 17,500) =
437,500
Prepaid insurance at December 31, 20X5 =
122,500
What was the total amount of insurance premiums paid by East during 20X5?

A. $322,500

B. $420,000

C. $437,500

D. $455,000

Answer 22

D $455,000 LOOK @ T ACCOUNT

PREPAID INSURANCE IS A BALANCE SHEET ACCOUNT -CURRENT ASSET

                                    DEBIT          CREDIT

BEG BAL-                       105,000
CHARGES TO EXP                             437,500
PAID ?  **PLUG  **         455,000 
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
ENDING BALANCE       122,500

Question 23

At December 31, 20X5, Key’s unadjusted trial balance showed a balance of $90 for prepaid insurance and $4,410 for insurance expense.
What amounts should be reported for prepaid insurance and insurance expense in Key’s December 31, 20X5, financial statements?

Prepaid Insurance Insurance expense

$3,300 $1,200
$3,400 $1,200
$3,400 $1,100
$3,490 $1,010

Answer 23

Prepaid Insurance Insurance expense

$3,400 $1,100

NOTE-Insurance expense includes three items:
(1) $90 of prepaid insurance remaining in the trial balance that has expired,
(2) $200 of insurance expense related to the November & DEC
(3) 810
the exp portion of the $4,410 insurance exp amount in the unadjusted trial balance ($4,410-$3,600) = $810.

This firm must have expensed the entire $3,600 November 1 purchase because it was not reflected in prepaid insurance. The difference of $810 reflects actual expense. Therefore, total insurance expense equals $1,100 = $90 + $200 + $810.

Question 24

On January 15, 2008, Able Co. made a significant investment in the debt securities of Baker Co., which it intends to hold until the debt matures. Able’s fiscal year-end is December 31. If Able Co. intends to measure and report its investment in Baker Co. debt securities at fair value as permitted by FASB #159, “The Fair Value Option… “, on which one of the following dates must Able elect to implement the fair value option?

A. January 15, 2008

B. January 31, 2008

C. March 31, 2008

D. December 31, 2008

Answer 24

A. January 15, 2008

If Able Co. intends to elect to implement the fair value option for its investment in Baker’s debt, it must make its election on the date it first recognizes the investment, which is January 15, 2008.

Question 25

Which of the following statements concerning the determination of fair value at the date an asset is acquired or a liability is assumed is/are correct?
I. The exit price is conceptually different than the entry price.
II. The entry price and the exit price may be different amounts at the date an asset or liability is initially recognized.

A. I only.

B. II only.

C. Both I and II.

D. Neither I nor II.

Answer 25

C. Both I and II.

Both Statement I and Statement II are correct. An exit price and an entry price are conceptually different (Statement I) and in practice an entry price and an exit price may be different amounts at the date an asset or liability is initially recognized (Statement II). Such a difference may come about, for example, because the entry price is based on a transaction between related parties or because the selling entity was under financial duress at the time of the sale.

Question 26

Marco has an investment that is traded in two different markets, Front market and Side market. Marco has equal access to each market. In order to determine the fair value of its investment, Marco has obtained the following per share information for the securities as of the close of business December 31, the end of its fiscal year:

                                             Front Market   Side Market Selling Price                                 $52/sh             $50/sh Transaction Cost                          $ 6/sh                $ 1/sh If neither Front market nor Side market is a principal market for the security for Marco, using the market approach which one of the following would be the per share amount used for measuring the investment at fair value? 

A. $52/sh

B. $50/sh

C. $49/sh

D. $46/sh

Answer 26

B. $50/sh

Since neither market is the principal market for the security, Marco must determine the most advantageous market, which is the market in which the asset could be sold at a price that maximizes the amount that would be received. Marco would receive $52/sh - $6/sh = $46/sh in Front market and would receive $50/sh - $1/sh = $49/sh in Side market. Therefore, Side market is its most advantageous market, and fair value would be determined in that market as the price at which the security could be sold, or $50/sh. The market selling price would not be adjusted for the related direct transaction cost, even though it enters into determining the most advantageous market.

Question 27

Alphaco has two subsidiaries, Betaco and Charlieco, both of which are consolidated by Alphaco. Alphaco and Betaco have elected to measure their respective investments held-to-maturity at fair value. Charlieco measures its investments held-to-maturity using amortized cost. In its consolidated financial statements, for which companies, if any, may Alphaco elect to report investment held-to-maturity at fair value?

A. Alphaco only.

B. Alphaco and Betaco only.

C. Alphaco, Betaco, and Charlieco.

D. None of the companies; all investments held-to-maturity must be measured and reported at amortized cost.

Answer 27

C. Alphaco, Betaco, and Charlieco.

As the parent, Alphaco may elect to report all of the investments held-to-maturity at fair value in its consolidated statements (only), whether or not the fair value option was elected by its subsidiaries for their separate books and any separate reporting purposes.

Question 28

If a firm changes the valuation approach used to determine fair value, how would the amount of change in fair value resulting from the change in the valuation approach be reported?

A. As a change in accounting principle.

B. As an adjustment to beginning retained earnings of the period of change in approach.

C. As a change in accounting estimate.

D. As gain on the income statement for the period of change in approach

Answer 28

C. As a change in accounting estimate.

The amount of a change in fair value resulting from a change in the valuation approach used to determine fair value would be reported as a change in accounting estimate.

NOT a change in accounting principle,

Question 29

When the fair value of an asset is determined as the amount that currently would be required to replace the service capacity of the asset, which one of the following valuation techniques has been used?

A. Income approach.

B. Cost approach.

C. Expense approach.

D. Market approach

Answer 29

B When fair value is determined as the amount that currently would be required to replace the service capacity of an asset (i.e., current replacement cost), the cost approach has been used.

The income approach converts future amounts (e.g., of cash flows) to a current present value to determine fair value.

The market approach uses prices and other relevant information generated by market transactions involving items that are identical or comparable to those being valued in determining fair value

GAAP does NOT recognize an “expense approach” as a technique for determining fair value.

Question 30

Papa Company acquired land with an office building on it from its subsidiary, Sonny Company, for $110,000. Prior to the sale, Sonny’s carrying value of the land was $60,000 and its net carrying value of the building was $50,000. At the time of the transaction, Papa appropriately determined that the land had a fair value of $75,000 and the building had a fair value of $35,000. At what amount should the land and building be reported on Papa’s consolidated statements prepared immediately after the transaction?

Land                          Building 
$75,000                    $35,000
$55,000                     $55,000
$60,000                    $50,000
$50,000                    $60,000

Answer 30

Land Building
$60,000 $50,000

Even though there was no profit or loss on the intercompany transaction, it resulted in amounts being redistributed between the depreciable asset office building and the non-amortizable asset land, which would result in different amounts of depreciation expense than if the transaction had not occurred. Therefore, the intercompany transaction must be “eliminated” so that the consolidated statements would show land at $60,000 and buildings at $50,000. (Sonny also would need to assess the building for possible impairment.)

Question 31

Which of the following statements concerning inputs used in ascertaining fair value is/are correct?
I. Only observable inputs can be used.
II. Inputs that incorporate the entity’s assumptions may be used.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

Answer 31

B. II. Inputs that incorporate the entity’s assumptions may be used.

An entity’s assumptions may be used as inputs in determining fair value. Those assumptions would be level 3, unobservable inputs, but would be used when adequate observable inputs were not available to make fair value determinations.

NOTE- STATEMENT 1 is incorrect because of the word ONLY .

Question 32

Which of the following levels of the fair value hierarchy is the highest and which is the lowest in terms of desirability for use in determining fair value?

Highest Level Lowest Level 
Level 3               Level 1
 Level 1                 Level 4
Level 1                Level 3
 Level 4                Level 1

Answer 32

Highest Level Lowest Level
Level 1 Level 3

In the fair value hierarchy, level 1 is the highest or most desirable level, and level 3 is the lowest or least desirable level.

Question 33

Which of the following statements concerning the fair value hierarchy used in ascertaining fair value is/are correct?
I. Quoted market prices should be adjusted for a “blockage factor” when a firm holds a sizable portion of the asset being valued.
II. Quoted market prices in markets that are not active because there are few relevant transactions cannot be used.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

Answer 33

D. Neither I nor II.

Neither Statement I nor Statement II is correct. Quoted market prices should NOT be adjusted for a “blockage factor” when a firm holds a sizable portion of the asset being valued (Statement I).
** A “blockage factor” occurs when an entity holds a sizable portion of an asset (or liability) relative to the trading volume of the asset or liability in the market. Using a “blockage factor” would adjust the market value for the impact of such a large block of securities being sold, but is not permitted in determining fair value.
Additionally, quoted market prices in markets that are not active because there are few relevant transactions can be used in determining fair value (Statement II). Such prices would be considered level 2 factors, observable inputs but not in active markets.

Question 34

Observable inputs, other than quoted prices in active markets for identical items, would constitute what level in the fair value hierarchy?

A. Level 1

B. Level 2

C. Level 3

D. Level 4

Answer 34

B. Level 2

Level 2 inputs are observable for assets or liabilities, either directly or indirectly, other than quoted prices in level 1. For example, quoted prices for similar items in an active market would be level 2 inputs.

Question 35

When an entity uses the fair value option for eligible financial assets and liabilities, which one of the following is not an expected outcome of the disclosures required of that entity?

A. Users being able to understand management’s reasons for using the fair value option.

B. Users being able to understand how changes in fair value affect net income.

C. Replace the kind and amount of information that would have been provided if the fair value option had not been used with information related to fair value.

D. Users being able to understand the difference between fair value and cash flows.

Answer 35

C. Replace the kind and amount of information that would have been provided if the fair value option had not been used with information related to fair value.

The disclosures required when the fair value option is used are not intended to replace the kind and amount of information that would have been provided if the fair value option had not been used. Rather, the intent is to provide the same kind and amount of information that would have been provided if the fair value option had not been elected.

Question 36

Which of the following statements, if any, concerning disclosures about fair value measurements in periods subsequent to initial recognition is/are correct?
I. The fair value hierarchy level within which fair value measurements fall must be disclosed.
II. Quantitative fair value measurement disclosures must be in tabular format.

A. Both I and II are correct.

B. I only.

C. II only.

D. Neither I nor II are correct.

Answer 36

A. Both I and II are correct.

Fair value measurement disclosures require both that fair value amounts be disclosed separately for each level of the fair value hierarchy and that quantitative disclosures be provided in tabular format.

Question 37

Which of the following statements concerning disclosures when fair value measurement is used is/are correct?
I. Disclosures must be provided that show information for each major category of assets and/or liabilities.
II. Most disclosures must be in both interim and annual financial statements.

A. I only.

B. II only.

C. Both I and II.

D. Neither I nor II.

Answer 37

C. Both I and II.

Both Statement I and Statement II are correct. Disclosures must be provided that show information for each major category of assets and/or liabilities (e.g., investments held-for-trading, investments available-for-sale, derivatives, etc.) (Statement I), and most disclosures must be in both interim and annual financial statements (Statement II).

Question 38

For a firm that elects to use fair value to measure eligible financial assets and financial liabilities, specific disclosures are required for which of the following financial statements?

Quarterly Fin. Statements Annual Fin. Statements
No No
No Yes
Yes No
Yes Yes

Answer 38

Quarterly Fin. Statements Annual Fin. Statements
Yes Yes

Firms which elect to measure financial assets and financial liabilities at fair value are required to make significant additional disclosures in both interim (quarterly, etc.) and annual financial statements.

Question 39

Which level of the fair value hierarchy, if any, requires the greatest amount of disclosures?

A. Level 1

B. Level 2

C. Level 3

D. None, all levels require the same disclosures.

Answer 39

Level 3 is the lowest level in the fair value hierarchy. It consists of unobservable inputs and requires the greatest amount of disclosures.

Question 40

Which one of the following is not a required disclosure in annual financial reports for an entity that uses fair value measurement?

A. The level of the fair value hierarchy within which fair value measurements fall.

B. The valuation techniques used to measure fair value.

C. Combined disclosures about fair value measurements required by all pronouncements.

D. A discussion of any change from the prior period in valuation techniques used to measure fair value.

Answer 40

C

Combined disclosures about fair value measurements required by all pronouncements are not required, but are encouraged.

Question 41

Under U.S. GAAP the disclosure requirements when fair value measurement is used are differentiated by which of the following classifications?

A. Between assets measured at fair value and liabilities measured at fair value.

B. Between fair value measurements that result in gains and fair value measurements that result in losses.

C. Between items measured at fair value on a recurring basis and items measured at fair value on a non-recurring basis.

D. Between items for which fair value measurement is required and items for which fair value measurement is elected.

Answer 41

C

Disclosure requirements when fair value measurement is used are differentiated between items measured at fair value on a recurring basis and items measured at fair value on a non-recurring basis. Items measured at fair value on a recurring basis are adjusted to (measured at) fair value period after period; an example would be investments held-for-trading. Items measured at fair value on a non-recurring basis are adjusted to (measured at) fair value only when certain conditions are met; an example would be the impairment of an asset.