Area I E. Special Purpose Frameworks

Question 1

In year 3, a company incurred $500,000 of legal costs defending several patents. Included in that amount was $400,000 of legal costs associated with successful outcomes and $100,000 of legal costs associated with unsuccessful outcomes. What amount of legal costs, if any, should the company expense for year 3?
$500,000
$400,000
$100,000
$0

Answer 1

C. $100,000

For legal costs in defense of a patent, if the defense is successful, then those costs are capitalized, not expensed. The idea is that those costs become part of the cost of the patent itself. This means that only the $100,000 of costs would be expensed.

Question 2

FAR1F10013
Return on Assets (ROA) is calculated using which formula?
A. (Net Income / Total Assets) x 100
B. (Operating Income / Total Assets) x 100
C. (Gross Profit / Total Assets) x 100
D. (Net Income / Shareholders’ Equity) x 100

Answer 2

A. (Net Income / Total Assets) x 100

Return on Assets is calculated by dividing Net Income by Total Assets, and then multiplying by 100. This ratio indicates how efficiently a company uses its assets to generate profit.

Question 3

When financial statements are prepared under a special purpose framework (also known as an other comprehensive basis of
accounting or OCBOA), the titles of the financial statements are often

Answer 3

modified to clearly indicate the basis of accounting being used. This is crucial to prevent users of the financial statements from confusing them with those prepared under Generally Accepted Accounting Principles (GAAP)

Question 4

types of financial statements prepared under various special purpose frameworks

Answer 4

• Cash Basis of Accounting
  Statement of Assets and Liabilities - Cash Basis ——> balance sheet
  Statement of Revenues Collected and Expenses Paid - Cash Basis —–> income statement
• Modified Cash Basis of Accounting
  Statement of Assets, Liabilities, and Equity - Modified Cash Basis —-> balance sheet
  Statement of Revenues Collected and Expenses Paid - Modified Cash Basis —-> income statement
• Tax Basis of Accounting
  Balance Sheet - Tax Basis
  Statement of Income - Tax Basis
  Statement of Cash Flows - Tax Basis (if applicable)
• Regulatory Basis of Accounting. The titles would depend on the specific regulatory requirements, but might include:
  Statement of Financial Position - Regulatory Basis —-> balance sheet
  Statement of Operations - Regulatory Basis—> income statement
• Contractual Basis of Accounting
  Again, titles would be based on the specific contract terms:
  Balance Sheet - Contractual Basis
  Income Statement - Contractual Basis

Question 5

Converting cash basis or modified cash basis financial statements to accrual basis financial statements involves several key
adjustments to ensure

Answer 5

that revenues are recognized when earned and expenses are recognized when incurred, regardless of when cash transactions occur

Question 6

to convert cash basis to modified cash basis of accounting:
if:
1. A/R increase
A/R decrease
2. A/P increase
A/P decrease
3. prepaid expense increase
prepaid expense decrease
4. accrued expense increase
accrued expense decrease
5. unearned revenue increase
unearned revenue decrease
6. depreciation and amortization
7. inventory increase
inventory decrease

Answer 6

1. add to cash basis revenue
   subtract from cash basis revenue
2. add to cash basis expense
   subtract from cash basis expense
3. subtract from cash basis expense
   add to cash basis decrease
4. add to cash basis expense
   subtract from cash basis expense
5. subtract from cash basis revenue
   add to cash basis revenue
6. If using a modified cash basis that doesn’t account for depreciation or amortization, add back depreciation and amortization expenses to reflect the systematic allocation of the cost of assets over their useful lives
7. subtract from cash basis COGS
   add to cash basis COGS

Question 7

Under cash basis of accounting,

Answer 7

revenues are recognized when cash is received, and expenses are recognized when cash is paid. No accounts receivable, accounts payable, or accruals are recorded.

Question 8

Modified Cash Basis Accounting is a hybrid between cash basis and accrual basis
accounting. It records some items by

Answer 8

addition, like depreciation or inventory, in an accrual manner, but otherwise follows the cash basis

Question 9

statement of cash flows is not required

Answer 9

under cash basis accounting since the income statement already reflects cash
inflows and outflows. However, it can be prepared to show the changes in the cash balance during the period.

Question 10

Balance Sheet (If on Modified Cash
Basis)

Answer 10

under the modified cash basis, a simple balance sheet can be prepared including cash, fixed assets (net of accumulated depreciation), and any other accounts that are recognized on an accrual basis

Under strict cash basis accounting, a balance sheet is not usually prepared because balance sheet includes non-cash accounts like receivables and payables

Question 11

income tax basis of accounting involves a process that aligns closely with the rules
and regulations governing income tax reporting in the United States. This method is often used by entities that want their
financial statements to correspond

Answer 11

with their tax returns

Question 12

income tax basis of accounting means that revenues, expenses, assets, and liabilities are recognized according to

Answer 12

the tax laws and regulations

Question 13

FAR2E10033
A company has an investment in a subsidiary that is reported at fair value. The investment’s carrying amount is $200,000, but due to a permanent decrease in the subsidiary’s value, the fair value is now $150,000. What is the impairment loss?
A) $50,000
B) $150,000
C) $200,000
D) $350,000

Answer 13

A) $50,000

Impairment loss is the difference between the carrying amount and fair value: $200,000 – $150,000 = $50,000.

Question 14

In January, Stitch, Inc. adopted the dollar-value LIFO method of inventory valuation. At adoption, inventory was valued at $50,000. During the year, inventory increased $30,000 using base-year prices, and prices increased 10%. The designated market value of Stitch’s inventory exceeded its cost at year end. What amount of inventory should Stitch report in its year-end balance sheet?

A. $80,000
B. $83,000
C. $85,000
D. $88,000

Answer 14

B. $83,000

First remember that LIFO is in layers.
So the original $50,000 is one layer and its value stays at $50,000. During the year the inventory increased by $30,000 using base-year prices, so the inventory goes to $80,000.
But, the “prices increased 10%”, so you need to multiply the $30,000 by the 1.10, which is another $3,000. So the inventory at year end would be valued at 50,000 + 30,000 + 3,000 = $83,000

Question 15

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 15

D. Relevance

Relevance is comprised of:
1. Confirmatory value and
2. Predictive value
3. Materiality
Relevance is one of the two primary qualitative characteristics. They are relevance and faithful representation.

Faithful representation is comprised of:
1. Completeness
2. Neutrality
3. Free from error

Question 16

FAR1F10056
A negative Direct Material Price Variance indicates:
A. Materials were more expensive than budgeted.
B. Materials were less expensive than budgeted.
C. Less material was used than budgeted.
D. More material was used than budgeted.

Answer 16

A. Materials were more expensive than budgeted.
A negative Direct Material Price Variance occurs when the actual price of materials is higher than the budgeted price, resulting in additional costs. Option B would result in a positive variance, while C and D relate to quantity, not price.

Question 17

FAR2B10018
A company pledges its receivables and borrows $50,000 from a bank. If the receivables pledged amount to $60,000, what journal entry is recorded?

A) Debit Cash $50,000; Credit Notes Payable $50,000
B) Debit Cash $50,000; Credit Pledged Receivables $50,000
C) Debit Pledged Receivables $60,000; Credit Cash $60,000
D) Debit Notes Payable $50,000; Credit Cash $50,000

Answer 17

A) Debit Cash $50,000; Credit Notes Payable $50,000

The journal entry for borrowing against pledged receivables involves debiting Cash for the amount received and crediting Notes Payable for the liability incurred. The amount of receivables pledged is not directly reflected in the entry.

Question 18

FAR2E30017
An investor with a 40% stake in an investee using the equity method records the investee’s net income of $10,000. What will be the impact on the investor’s equity?
A. Increase by $10,000
B. Increase by $4,000
C. Decrease by $4,000
D. Decrease by $10,000

Answer 18

B. Increase by $4,000

The investor’s equity increases by their share of the investee’s net income (40% of $10,000 = $4,000).

Question 19

FAR1F10007
For an investor analyzing a company’s ability to generate cash flow from operations, which metric would be most relevant?
A. Cash Flow from Operations
B. Net Profit Margin
C. Earnings per Share
D. Total Asset Turnover

Answer 19

A. Cash Flow from Operations

Cash Flow from Operations (A) is the most relevant metric for evaluating a company’s ability to generate cash from its regular business activities. Net Profit Margin (B) measures overall profitability, Earnings per Share (C) indicates profit per share of stock, and Total Asset Turnover (D) assesses asset efficiency.

Question 20

FAR1F10013
Return on Assets (ROA) is calculated using which formula?
A. (Net Income / Total Assets) x 100
B. (Operating Income / Total Assets) x 100
C. (Gross Profit / Total Assets) x 100
D. (Net Income / Shareholders’ Equity) x 100

Answer 20

A. (Net Income / Total Assets) x 100

Return on Assets is calculated by dividing Net Income by Total Assets, and then multiplying by 100. This ratio indicates how efficiently a company uses its assets to generate profit.

Question 21

FAR1A20050
If a company’s income statement shows a discrepancy in the depreciation expense, what should be checked first?
A) The accuracy of the asset’s purchase price.
B) The depreciation method and useful life used.
C) The total sales for the period.
D) The interest expense on loans.

Answer 21

B) The depreciation method and useful life used.

Discrepancies in depreciation often stem from errors in the chosen method or miscalculation of useful life. A) is less likely to cause a discrepancy in the period’s depreciation expense. C) and D) are unrelated to depreciation.

Question 22

FAR1F10015
Which formula is used to calculate Net Profit Margin?
A. (Gross Profit / Revenue) x 100
B. (Operating Income / Revenue) x 100
C. (Net Income / Revenue) x 100
D. (Net Income / Total Assets) x 100

Answer 22

C. (Net Income / Revenue) x 100

Net Profit Margin is calculated by dividing Net Income by Revenue, then multiplying by 100. It shows how much of each dollar in revenues is translated into profits. A represents Gross Profit Margin, B is for Operating Margin, and D for Return on Assets.

Question 23

FAR3D10004
Which of the following best describes a “more likely than not” threshold in the context of uncertain tax positions?
A. A probability of occurrence below 50%.
B. A probability of occurrence of exactly 50%.
C. A probability of occurrence above 50%.
D. A probability of occurrence of 100%.

Answer 23

C. A probability of occurrence above 50%.

The “more likely than not” threshold refers to a probability of occurrence above 50%. This means that it is more probable than not that the position will be sustained upon examination by tax authorities.

Question 24

FAR1F10012
To calculate Return on Sales (ROS), which of the following formulas is used?
A. (Net Income / Total Assets) x 100
B. (Net Income / Shareholders’ Equity) x 100
C. (Operating Income / Revenue) x 100
D. (Gross Profit / Revenue) x 100

Answer 24

C. (Operating Income / Revenue) x 100

Return on Sales is calculated as Operating Income divided by Revenue, multiplied by 100. It measures how much operating income is generated per dollar of revenue. A is the formula for Return on Assets, B for Return on Equity, and D for Gross Profit Margin.

Question 25

FAR1E10024
In modified cash basis accounting, how are long-term assets typically treated?
A) Expensed when purchased.
B) Capitalized and depreciated over time.
C) Recognized when they are fully paid off.
D) Not recorded until they are sold.

Answer 25

B) Capitalized and depreciated over time.

Modified cash basis accounting blends elements of both cash and accrual accounting. Long-term assets are capitalized and depreciated, similar to accrual accounting.

Question 26

FAR1A40017
How do prior period errors affect the statement of changes in equity when corrected?
A) They change the current period’s net income.
B) They are adjusted through retained earnings.
C) They affect the current period’s dividend declaration.
D) They require reissuing previous financial statements.

Answer 26

B) They are adjusted through retained earnings.

Prior period errors are typically corrected by adjusting the opening balance of retained earnings in the period in which the error is discovered.

They do not change the current period’s net income (Option A). They might impact dividend declarations indirectly (Option C), but the direct adjustment is in retained earnings. While correcting significant errors might lead to reissuing previous financial statements (Option D), the immediate adjustment is in the statement of changes in equity.

Question 27

FAR3B10003
What is a commitment in financial accounting?
A. An obligation arising from a company’s past transactions.
B. An uncertain future event leading to a possible asset or liability.
C. A firm contractual obligation to make future payments.
D. A reserve for asset replacement.
Incorrect
Commitments are firm, contractual obligations.

Answer 27

C. A firm contractual obligation to make future payments.

Commitments are firm, contractual obligations.

Question 28

FAR1B30012
When using the direct method to prepare a cash flow statement, which of the following would be included in the operating activities section?
A. Cash received from issuing bonds.
B. Interest paid on long-term debt.
C. Cash payments to suppliers.
D. Proceeds from the sale of equipment.

Answer 28

C. Cash payments to suppliers.

The direct method involves listing cash receipts and payments, including cash payments to suppliers, as part of operating activities. Cash received from issuing bonds (Choice A) and proceeds from the sale of equipment (Choice D) are financing and investing activities, respectively. Interest paid on long-term debt (Choice B), while often included in operating activities, is not as directly related to core operational transactions as payments to suppliers.

Question 29

FAR1A10016
If an expense was accidentally recorded as an asset, how should this error be corrected on the balance sheet?
A) Increase liabilities
B) Decrease assets and increase expenses
C) Increase revenues
D) Decrease shareholders’ equity

Answer 29

B) Decrease assets and increase expenses

The correction involves decreasing assets because the initial entry erroneously inflated assets. Simultaneously, expenses should be increased to reflect the true nature of the transaction.
Options A and C are incorrect as they pertain to liabilities and revenues, which are unrelated to this error. Option D is incorrect because shareholders’ equity is affected indirectly through retained earnings after adjusting expenses, not directly.

Question 30

FAR2F10022
If a purchased software undergoes an impairment, what journal entry should be recorded?
A. Debit Impairment Loss; Credit Software.
B. Debit Accumulated Amortization; Credit Impairment Loss.
C. Debit Software; Credit Cash.
D. Debit Cash; Credit Software.

Answer 30

A. Debit Impairment Loss; Credit Software.

When impairment occurs, the asset’s value on the balance sheet is reduced. The correct entry is to debit (increase) Impairment Loss and credit (decrease) the Software account.

Question 31

On January 1, a company enters into an operating lease for office space and receives control of the property to make leasehold improvements. The company begins alterations to the property on March 1 and the company’s staff moves into the property on May 1. The monthly rental payments begin on July 1. The recognition of rental expense for the new offices should begin in which of the following months?
A. January
B. March
C. May
D. July

Answer 31

A. January

The rent expense needs to start being recognized when the company receives control of the property, and on a straight line basis, even though the actual payments don’t begin until July.

Question 32

FAR3F10027
If the initial direct costs of a lease are $5,000, how should these be accounted for in the right-of-use asset?
A. Expensed immediately as incurred.
B. Added to the right-of-use asset and amortized over the lease term.
C. Deducted from the right-of-use asset.
D. Recognized as a separate asset.

Answer 32

B. Added to the right-of-use asset and amortized over the lease term.

Initial direct costs are included in the right-of-use asset and amortized over the lease term. This treatment spreads the cost over the benefit period of the lease.

Question 33

FAR1A40020
How should an error in recording a stock dividend be corrected in the statement of changes in equity?
A) By increasing retained earnings.
B) By reducing share premium.
C) By adjusting both share capital and retained earnings.
D) By decreasing current liabilities.

Answer 33

C) By adjusting both share capital and retained earnings.

A stock dividend impacts both share capital and retained earnings. An error in recording a stock dividend should be corrected by adjusting these two components in the statement of changes in equity.

Question 34

FAR1F10054

Which variance analysis would be most useful for assessing the efficiency of a production process?
A. Sales Volume Variance
B. Direct Material Price Variance
C. Direct Labor Efficiency Variance
D. Sales Price Variance

Answer 34

C. Direct Labor Efficiency Variance

Direct Labor Efficiency Variance is used to assess how efficiently labor is used in production. It compares the actual hours worked to the standard (budgeted) hours for the actual production level. Options A and D are related to sales, and B is related to the cost of materials, not the efficiency of labor.

Question 35

FAR1A10028
A company’s initial balance sheet showed inventory valued at $20,000. Later, it was found that inventory worth $3,000 was counted twice. What is the correct value of inventory?
A) $17,000
B) $23,000
C) $20,000
D) $26,000

Answer 35

A) $17,000

The error in counting inventory resulted in an overstatement. To correct it, subtract the overcounted amount ($3,000) from the initial value ($20,000), resulting in a corrected inventory value of $17,000.

Question 36

FAR2C007n
On December 31 of year 1, Kim Co. adopted dollar value LIFO. All of Kim’s inventories are in a single pool and have a year-end value of $50,000. At the end of year 2, Kim’s inventory balance at current year prices is $100,000, with a price index of 1.25.
Under dollar-value LIFO, Kim’s inventory balance at the end of year 2 would be?
A. $77,500
B. $80,000
C. $82,500
D. $87,500

Answer 36

D. $87,500

The first step is to convert the year 2 balance back to base-year prices using the 1.25 index: $100,000 / 1.25 = $80,000.

That means the ending inventory of $100,000 consists of a base year layer of $50,000 (the year-1 ending balance), and an incremental layer of $30,000 ($80,000 – $50,000).

Then, the incremental layer needs to be adjusted to current-year prices, using the price index of 1.25: $30,000 x 1.25 = $37,500.

So the year-2 ending inventory using dollar-value LIFO is $50,000 + $37,500 = $87,500.

Question 37

FAR2H506
On July 1, Love Co. issued 10-year, 5% bonds with $1,000 face value. The bonds were sold to yield 8%. Interest is paid annually, every June 30. Use the following PV factors:
At 5% At 8%
PV of $1 for 10 periods 0.614 0.450
PV of $1 ordinary annuity for 10 periods
7.722 7.000
What should the issue price be for each $1,000 bond?

A. $1,000
B. $950
C. $900
D. $800

Answer 37

D. $800
If there is no difference in stated interest and desired yield of the bond, the face amount and price of the bond is equal. However, if the stated interest and desired yield of the bond differ, you need to calculate the present value of the bond to determine its issue price. To determine the price based on the desired yield of the bond, calculate the present value of the bond face amount using the desired yield rate, which is 8% in this case, and the present value of the annual interest payments using the stated interest rate of 5%.
Therefore the price of the bond based on the desired yield was $800: First, multiply the $1,000 face value by the 0.450 PV factor since you’re calculating the PV of the first payment, which equals $450.
Then you would use the PV of an annuity factor to get the PV of the stated interest payments to yield 8%: Stated interest = $1,000 x 5% = payments of $50. So then multiply the $50 by the 7.000 PV factor of an annuity at 8%: $50 x 7.000 = $350
Add the two together: $450 + 350 = $800 issue price for each $1,000 bond.

Question 38

FAR1D10023
How does convertible preferred stock affect the calculation of diluted EPS?
A. It is ignored unless it is in-the-money.
B. It is always included regardless of its conversion rate.
C. It is included only if the conversion would decrease EPS.
D. It decreases the net income before calculating EPS.

Answer 38

C. It is included only if the conversion would decrease EPS.

Convertible preferred stock is included in diluted EPS calculations only if the conversion of the preferred stock into common stock would decrease the EPS. This reflects the potential dilutive effect of such conversions.

Question 39

FAR2E30010
What is the impact on the investor’s income statement when the investee reports a profit and the investor uses the equity method?
A. The investor reports increased revenue equal to its share of the investee’s profit.
B. The investor records an expense equal to its share of the investee’s profit.
C. The investor’s equity income increases by its proportionate share of the investee’s profit.
D. There is no impact on the investor’s income statement.

Answer 39

C. The investor’s equity income increases by its proportionate share of the investee’s profit.

Under the equity method, the investor reports its share of the investee’s profit as an increase in equity income, not as revenue (A) or an expense (B). There is an impact on the income statement (D), specifically under equity income.

Question 40

FAR3C10052
How should a not-for-profit entity record contributed services that meet the criteria for recognition?
A. Debit Expense; Credit Cash
B. Debit Expense; Credit Contributed Services Revenue
C. Debit Contributed Services Revenue; Credit Expense
D. Debit Cash; Credit Contributed Services Revenue

Answer 40

B. Debit Expense; Credit Contributed Services Revenue

Contributed services meeting recognition criteria are recorded by debiting the relevant Expense account (reflecting the service received) and crediting Contributed Services Revenue.

Question 41

FAR1A50003
When using the direct method to prepare the cash flow statement, which of the following items would be included in the cash flows from operating activities?
A. Cash paid to suppliers
B. Interest paid on long-term debt
C. Proceeds from sale of equipment
D. Repayment of bank loans

Answer 41

A. Cash paid to suppliers

Cash paid to suppliers is a component of cash flows from operating activities in the direct method, as it directly relates to the primary revenue-producing activities of the business.

Question 42

FAR1F10001
Which ratio would be most appropriate for assessing a company’s ability to meet short-term obligations with its most liquid assets?
A. Debt-to-Equity Ratio
B. Quick Ratio
C. Return on Equity
D. Earnings per Share

Answer 42

B. Quick Ratio

The Quick Ratio, also known as the acid-test ratio, measures a company’s ability to pay off its short-term liabilities with its most liquid assets (excluding inventory). This is crucial for assessing immediate financial stability. The Debt-to-Equity Ratio (A) measures long-term solvency, Return on Equity (C) assesses profitability relative to shareholders’ equity, and Earnings per Share (D) indicates the portion of a company’s profit allocated to each outstanding share of common stock.

Question 43

FAR3A10014
If a company changes its depreciation method, how should it report this change?
A) By disclosing it in the director’s report only.
B) As a retrospective change, adjusting past financial statements.
C) Prospective change, without adjusting past statements.
D) By adjusting only the future periods’ financial statements.

Answer 43

B) As a retrospective change, adjusting past financial statements.

A change in depreciation method is treated as a change in accounting principle and should be reported retrospectively. This means adjusting past financial statements as if the new method had been used from the start.

Question 44

FAR1A20006
In the context of an income statement, what does the term ‘gross profit’ represent?
A) Total revenue minus operating expenses.
B) Total revenue minus cost of goods sold.
C) Operating income minus non-operating expenses.
D) Net income before taxes.

Answer 44

B) Total revenue minus cost of goods sold.
Gross profit is calculated by subtracting the cost of goods sold from total revenue. It represents the profit a company makes after deducting the costs associated with producing and selling its products.
A) is incorrect as it describes operating income, not gross profit. C) and D) are also incorrect as they refer to different stages in the income statement.

Question 45

FAR3B10007
Which statement is true regarding the disclosure of contingencies?
A. All contingencies are disclosed regardless of the probability of occurrence.
B. No disclosure is required if the event is unlikely to occur.
C. Only contingencies with a financial impact over a certain threshold are disclosed.
D. The nature of the contingency and an estimate of its financial effect are disclosed.

Answer 45

D. The nature of the contingency and an estimate of its financial effect are disclosed.

The nature and estimated financial effect of a contingency are disclosed (D). Not all contingencies are disclosed (A), some may not require disclosure if unlikely (B), and the threshold is not the sole criterion (C).

Question 46

FAR2H10014
A concession in troubled debt restructuring could include:
A. A temporary increase in interest rates
B. A permanent decrease in the amount of collateral
C. A one-time fee charged to the debtor
D. Forbearance of principal or interest

Answer 46

D. Forbearance of principal or interest

In a troubled debt restructuring, forbearance of principal or interest is a common concession, where the creditor agrees to delay payments to help the debtor.

Question 47

FAR1C10007
In fund financial reporting, how are capital assets typically treated under the modified accrual basis?
A. Capitalized and depreciated
B. Expensed in the period acquired
C. Not reported
D. Reported as deferred outflows of resources

Answer 47

B. Expensed in the period acquired

Under the modified accrual basis of accounting, used in fund financial reporting, capital assets are generally expensed in the period they are acquired. This differs from the accrual basis used in government-wide reporting where capital assets are capitalized and depreciated.

Question 48

FAR2D10045
How are the costs to sell an asset held for sale treated in financial statements?
A. Capitalized to the asset’s carrying amount
B. Expensed as incurred
C. Amortized over the asset’s remaining useful life
D. Deferred until the asset is sold

Answer 48

B. Expensed as incurred

Costs to sell an asset held for sale are expensed as incurred.

Question 49

FAR3G10005
What is the primary difference between Type I and Type II subsequent events?
A) Type I events occur before the balance sheet date, while Type II events occur after.
B) Type I events require disclosure only, whereas Type II events require adjustment in the financial statements.
C) Type I events provide evidence about conditions existing at the balance sheet date, whereas Type II events are significant but don’t relate to conditions existing at that date.
D) There is no significant difference; both types of events are treated similarly in financial reporting.

Answer 49

C) Type I events provide evidence about conditions existing at the balance sheet date, whereas Type II events are significant but don’t relate to conditions existing at that date.

The key difference between Type I and Type II subsequent events is their relation to the conditions existing at the balance sheet date. Type I events provide additional evidence about these conditions and may require adjustment to the financial statements. Type II events, although significant, do not provide evidence about conditions existing at the balance sheet date and usually require only disclosure.

Question 50

FAR3C005nsim
A competitor has sued JIS Machinery for $4.5 million as a result of “predatory pricing”, and JIS’s attorney has advised it is probable that the company will lose the case, but the amount of the loss cannot be reasonably estimated.
What amount, if any, should JIS accrue as a liability based on the lawsuit?
A. $0
B. $450,000
C. $2,250,000
D. $4,500,000

Answer 50

A. $0
ASC 450-20-25-1 provides guidance regarding the recognition of contingencies. It states that when a loss contingency exists, the likelihood that the future event or events will confirm the loss or impairment of an asset or the incurrence of a liability can range from probable to remote. As indicated in the definition of contingency, the term loss is used for convenience to include many charges against income that are commonly referred to as expenses and others that are commonly referred to as losses. The Contingencies Topic uses the terms probable, reasonably possible, and remote to identify three areas within that range.
ASC 450-20-55-10 implementation guidance provides that the following factors should be considered in determining whether accrual and/or disclosure is required with respect to pending or threatened litigation and actual or possible claims and assessments:
The period in which the underlying cause (that is, the cause for action) of the pending or threatened litigation or of the actual or possible claim or assessment occurred
The degree of probability of an unfavorable outcome
The ability to make a reasonable estimate of the amount of loss.
ASC 450-20-25-2 states that an estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met:
Information available before the financial statements are issued or are available to be issued indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. Date of the financial statements means the end of the most recent accounting period for which financial statements are being presented. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.
The amount of loss can be reasonably estimated
Since in the given situation, although the probability of the loss is established since the amount of loss cannot be reasonably estimated, no amount of accrual can be made.

Question 51

FAR1A60039
If a discrepancy is found in the reported exchange rate used for currency translation in a subsidiary, the appropriate corrective action is to:
A. Use a standard exchange rate for all subsidiaries
B. Revise the exchange rate in the consolidated financial statements only
C. Recalculate the currency translation using the correct exchange rate
D. Report the discrepancy in the financial statement notes and take no further action

Answer 51

C. Recalculate the currency translation using the correct exchange rate

The appropriate action when a discrepancy is found in the reported exchange rate is to recalculate the currency translation using the correct exchange rate. This ensures that the financial statements accurately reflect the impact of foreign currency transactions.
A is incorrect because a standard exchange rate may not reflect the actual rates applicable to different transactions.
B is incorrect as the correction should be applied where the discrepancy occurred, not just in the consolidated statements.
D is incorrect as reporting the discrepancy does not correct it.

Question 52

FAR2C007n
In periods of rising prices, which of the following inventory costing method will provide the lowest ending inventory?
A. Weighted average
B. Dollar-value LIFO
C. Specific identification
D. FIFO

Answer 52

B. Dollar-value LIFO
If prices are rising, then dollar-value LIFO pushes the most expensive (most recent) items through COGS and the earlier items that were purchased at lower prices provide a lower ending inventory than the other costing methods.

Question 53

FAR3C10061
How should a not-for-profit entity recognize a cash contribution?
A. At the fair value of the cash received at the time of contribution
B. At the historical cost of the cash when it was originally obtained by the donor
C. At the projected future value of the cash
D. At the average value of cash over the past fiscal year

Answer 53

A. At the fair value of the cash received at the time of contribution

A cash contribution should be recognized at its fair value, which, in the case of cash, is the amount received at the time of the contribution.

Question 54

FAR2C10021
In a rollforward analysis, what would you classify a purchase of new inventory on credit as?

A. An addition to inventory
B. A reduction of inventory
C. An inventory valuation adjustment
D. An operating expense

Answer 54

A. An addition to inventory

Purchasing new inventory, regardless of the payment method (such as on credit), is considered an addition to the inventory account in a rollforward analysis.