area II I. Equity

Question 1

FAR1A30016
What is the impact of recording items in Other Comprehensive Income on a company’s net income?
A. It increases the net income.
B. It decreases the net income.
C. It has no direct impact on the net income.
D. It is variable depending on the company’s industry.

Answer 1

C. It has no direct impact on the net income.

Items in Other Comprehensive Income are recorded separately and do not directly affect the net income figure, which is derived from the income statement. They impact the total comprehensive income.

A and B are incorrect as there is no direct increase or decrease. D is incorrect as the industry of the company is irrelevant in this context.

Question 2

FAR2H10034
A bond with a face value of $200,000 is issued at a premium of 10%. What is the correct journal entry for the issuance of the bond?
A. Debit Cash $220,000; Credit Bonds Payable $220,000
B. Debit Cash $220,000; Credit Bonds Payable $200,000; Credit Premium on Bonds Payable $20,000
C. Debit Bonds Payable $200,000; Debit Premium on Bonds Payable $20,000; Credit Cash $220,000
D. Debit Cash $200,000; Credit Bonds Payable $200,000

Answer 2

B. Debit Cash $220,000; Credit Bonds Payable $200,000; Credit Premium on Bonds Payable $20,000

The correct journal entry for issuing a bond at a premium debits Cash for the amount received ($220,000) and credits Bonds Payable for the face value ($200,000) and Premium on Bonds Payable for the premium amount ($20,000).

Question 3

FAR1E10028
How are prepaid expenses recorded in modified cash basis accounting?
A) Expensed over the period of benefit.
B) Expensed when paid.
C) Not recorded until used.
D) Capitalized as a long-term asset.

Answer 3

A) Expensed over the period of benefit.

In modified cash basis accounting, prepaid expenses are often treated similarly to accrual accounting, being expensed over the period they benefit.

Question 4

FAR1A60029
When correcting an error in the calculation of foreign exchange gains or losses in a subsidiary, the adjustment should be made:
A. Directly in the subsidiary’s income statement
B. In the consolidated income statement
C. In the parent company’s balance sheet
D. In the notes to the financial statements without adjusting the figures

Answer 4

B. In the consolidated income statement

Errors in the calculation of foreign exchange gains or losses in a subsidiary should be corrected in the consolidated income statement. This reflects the accurate financial impact of foreign exchange movements on the group’s financial performance.

Question 5

FAR2E10022

A company bought trading securities for $100,000. At year-end, the fair value is $95,000. What journal entry should be made to recognize the investment income or loss?

A) Debit Investment Income $5,000; Credit Trading Securities $5,000
B) Debit Trading Securities $5,000; Credit Investment Income $5,000
C) Debit Investment Loss $5,000; Credit Trading Securities $5,000
D) Debit Trading Securities $5,000; Credit Investment Loss $5,000

Answer 5

D) Debit Trading Securities $5,000; Credit Investment Loss $5,000

Question 6

FAR1F10052
What does a favorable budget variance indicate?
A. The actual results were worse than budgeted.
B. The actual costs were higher than budgeted.
C. The actual results were better than budgeted.
D. The budget was accurately estimated.

Answer 6

C. The actual results were better than budgeted.

A favorable variance occurs when actual results are better than what was budgeted (e.g., higher revenues or lower costs than budgeted). Options A and B describe an unfavorable variance, while D implies no variance.

Question 7

FAR4A008n

Which of the following is not a governmental fund?

A. Internal service fund
B. General fund
C. Permanent fund
D. Debt service fund

Answer 7

A. Internal service fund

The 5 types of governmental funds are:

1) General fund, 2) Special revenue funds, 3) Debt service funds, 4) Capital projects funds, 5) Permanent funds

The 2 types of proprietary funds are:
1) Enterprise funds, 2) Internal service funds

The 4 types of fiduciary funds are:
1) Pension trust funds, 2) Investment trust funds, 3) Private purpose trust funds, 4) Custodial (agency) funds

Question 8

FAR2E10013
A company invested in a derivative financial instrument for speculation and the fair value at year-end is $15,000. The derivative was initially recorded at $10,000. What is the carrying amount of the derivative?
A) $10,000
B) $5,000
C) $15,000
D) $25,000

Answer 8

C) $15,000

Derivative financial instruments are reported at fair value. Thus, the carrying amount is $15,000.ff

Question 9

FAR1E10023
Which of the following would not be recorded in a cash basis financial statement?
A) Cash received from customers.
B) Cash paid for rent.
C) Accounts receivable.
D) Cash paid to suppliers.

Answer 9

C) Accounts receivable.

Accounts receivable are not recognized in cash basis accounting as it involves future cash receipts. Cash basis accounting only records transactions when cash changes hands.

Question 10

Palmyra Co. has net income of $11,000, a positive $1,000 net cumulative effect of a change in accounting principle, a $3,000 unrealized loss on available-for-sale securities, a positive $2,000 foreign currency translation adjustment, and a $6,000 increase in its common stock. What amount is Palmyra’s comprehensive income?
A. $4,000
B. $10,000
C. $11,000
D. $17,000

Answer 10

B. $10,000

The net effect of a change in accounting principle doesn’t affect this year’s income. The $3,000 unrealized loss on AFS securities(run through OCI) and the $2,000 gain of currency adjustment(also OCI) net to a $1,000 loss. With net income of $11,000 and the $1,000 from OCI, comprehensive income is $10,000.

Question 11

Spring Corp. entered into a five-year lease agreement with Fall Corp. Spring, the lessee, paid an additional $5,000 nonrefundable lease bonus to Fall upon signing the operating lease agreement. When would Fall recognize in income the nonrefundable lease bonus paid by Spring?
A. When received.
B. Over the life of the lease.
C. At the expiration of the lease.
D. At the inception of the lease.

Answer 11

B. Over the life of the lease.

The lease bonus would be recognized on a straight-line basis over the life of the lease.

Question 12

FAR1A20017
How should an understated revenue be corrected in the income statement?
A) By increasing the current period’s expenses.
B) By decreasing the current period’s revenues.
C) By increasing the current period’s revenues.
D) By increasing the next period’s revenues.

Answer 12

C) By increasing the current period’s revenues.

Understated revenue should be corrected by increasing the current period’s revenues to reflect the actual amount earned.

A) is incorrect as it involves expenses, not revenues. B) is incorrect because it further understates revenue. D) is incorrect as the adjustment should be made in the period where the error occurred, not the next period.

Question 13

FAR3F10018
If a lease does not transfer ownership but allows the lessee to use the asset for 95% of its economic life, how is it classified?
A. As an operating lease.
B. As a finance lease.
C. Based on the present value of lease payments.
D. Classification depends on the lessee’s decision at the end of the lease.

Answer 13

B. As a finance lease.

A lease that allows the lessee to use the asset for the major part of its economic life (95% in this case) is classified as a finance lease. This duration indicates the lessee obtains most of the economic benefits from the asset.

Question 14

FAR3D10010
What is the accounting treatment for a reduction in an uncertain tax position due to a lapse of the applicable statute of limitations?
A. The reduction is recognized as an expense.
B. The reduction increases current tax expense.
C. The reduction is recognized as a reduction in income tax expense.
D. The reduction is reported directly in equity.

Answer 14

C. The reduction is recognized as a reduction in income tax expense.

When there is a reduction in an uncertain tax position due to the lapse of the applicable statute of limitations, it is recognized as a reduction in income tax expense. This reflects the decrease in tax liability.

Question 15

FAR1E10011
A company pays $12,000 for a one-year insurance policy in advance. How should this be recorded at the end of the first month on an accrual basis?
A) Reduce Cash by $12,000
B) Record Insurance Expense of $1,000
C) Record Prepaid Insurance of $11,000
D) Record Insurance Expense of $12,000

Answer 15

C) Record Prepaid Insurance of $11,000

On an accrual basis, expenses are recognized when incurred, not when paid. After one month, $1,000 of the insurance (1/12 of $12,000) has been used, so $11,000 remains as prepaid insurance, an asset. Options A and D are incorrect as they reflect cash basis accounting.

Question 16

FAR3F10010
For leases with a significant residual value guarantee, how does this affect the lessee’s depreciation expense for the right-of-use asset?
A. Increases the depreciation expense.
B. Decreases the depreciation expense.
C. No impact on depreciation expense.
D. Depreciation is recognized in other comprehensive income.

Answer 16

A. Increases the depreciation expense.

For leases with a significant residual value guarantee, the depreciation expense for the right-of-use asset increases. This is because the residual value guarantee increases the depreciable base of the right-of-use asset.

Question 17

FAR1B011nsim
JRM co. is in the process of closing its books for the year ended December 31, year 2.

The following business events are not properly reflected in JRM’s December 31, year 2, unadjusted trial balance:
The controller determined that half of the recorded rent expense of $10,000 is attributable to year 3.
JRM depreciates its property, plant, and equipment using the straight-line method over 10 years. The property, plant, and equipment had an original cost of $20,000 and a salvage value of $5,000.
JRM uses the percentage-of-sales method to determine the addition to bad debt expense. Uncollectible accounts receivable for year 2 was estimated to be 0.25%.
On December 31, year 2, a customer declared bankruptcy and its accounts receivable of $855 is uncollectible.

Life insurance premiums for the period ended December 31, year 2, of $650 for key members of management are included in prepaid expenses.
Interest of $300 was earned and outstanding on notes receivable during year 2. The note receivable is due at the end of year 5.
Income taxes for year 2 are estimated to be $3,000.
Sales made during year 2 totaled $300,000.
Based on the business events above, calculate the net adjusted balance for the prepaid expenses account. The trial balance shows a debit balance of $1,000 for the prepaid expenses account.

A. $6,650
B. $6,000
C. $5,650
D. $5,350

Answer 17

D. $5,350

Prepaid expenses are assets. The trial balance shows a debit balance of $1000 in prepaid expenses account.

The controller determined that half of the recorded rent expense of $10,000 is attributable to year 3. Hence 50% of $10,000 = $5,000 of rent expenses have been paid in advance for the next year and is an asset. This should be added to the prepaid expenses. An adjustment debit of $5,000 is made to the prepaid expense account.
Life insurance premiums for the period ended December 31, year 2, of $650 for key members of management are included in prepaid expense. Since the period is ended, the expenses should be recognized and prepaid expense should be amortized. Hence an adjustment credit of $650 is made to the prepaid expenses account.
The adjusted trial balance will show a debit balance of $5,350 [$1000+$5000-$650] on the prepaid expenses account.

Question 18

FAR3F10020
How does the existence of a bargain purchase option affect the classification of a lease?
A. It has no impact on lease classification.
B. It automatically classifies the lease as an operating lease.
C. It indicates an operating lease if the lessee is unlikely to exercise the option.
D. It indicates a finance lease if the lessee is reasonably certain to exercise the option.

Answer 18

D. It indicates a finance lease if the lessee is reasonably certain to exercise the option.

The existence of a bargain purchase option leads to the classification of a lease as a finance lease if the lessee is reasonably certain to exercise this option, indicating they will obtain ownership at a price much lower than the fair value.

Question 19

Equity Issuance
A company issues 10,000 shares of common stock at a price of $15 per share.
Journal Entry

Answer 19

Debit ($) Cash (10,000 shares x $15/share) 150,000
Credit ($) Common Stock (assuming $1 par) 10,000
Credit ($) Additional Paid-In Capital
(difference between issue price and par
value) 140,000

Question 20

Stock Dividends
A company declares a 10% stock dividend on its 100,000 outstanding shares of common stock, par value $1 per share.
Journal Entry

Answer 20

Dividend declared:
Debit ($) Retained Earnings (10,000 shares x
$1 par value) 10,000
Credit ($) Common Stock Dividend
Distributable 10,000

Dividend paid out or distributed:
Debit ($) Common Stock Dividend
Distributable 10,000
Credit ($) Common Stock 10,000

Question 21

Stock Splits

Answer 21

● Stock splits do not require a journal entry as they don’t change the total value of equity.
● They increase the number of shares and decrease the par value per share proportionately.
● For example, in a 2-for-1 stock split, the number of shares doubles and the par value per share is halved

Question 22

Treasury Stock Transactions
Purchase of Treasury Stock:
A company buys back 5,000 shares of its stock for $20 per share.

Answer 22

Journal Entry

Debit ($) Treasury Stock (5,000 shares x
$20/share) 100,000
Credit ($) Cash 100,000

Reissuance of Treasury Stock:
The company later reissues 2,000 of these shares at $25 per share.
Journal Entry
Debit ($) Cash (2,000 shares x $25/share) 50,000
Credit ($) Treasury Stock (2,000 shares x
$20/share) 40,000
Credit ($) Additional Paid-In Capital (difference) 10,000

Question 23

Capital Account Activity in Pass-Through Entities:
A partner in a partnership contributes $50,000 cash to the business.
Journal Entry

Answer 23

Debit ($) Cash 50,000
Credit ($) Partner’s Capital Account 50,000

Question 24

FAR3D10036
What is the correct journal entry when a company creates a valuation allowance against a deferred tax asset?
A. Debit Valuation Allowance; Credit Deferred Tax Asset
B. Debit Deferred Tax Asset; Credit Valuation Allowance
C. Debit Income Tax Expense; Credit Valuation Allowance
D. Debit Valuation Allowance; Credit Income Tax Expense

Answer 24

C. Debit Income Tax Expense; Credit Valuation Allowance

Creating a valuation allowance against a deferred tax asset is recorded by debiting Income Tax Expense and crediting Valuation Allowance. This entry reflects the decrease in the recognized value of deferred tax assets due to uncertainty in their realization.

Question 25

FAR1A004n
Which of the following is the correct term for when FASB amends the Accounting Standards Codification?
A. ASU - an Accounting Standards Update
B. ASB - Accounting Standards Bulletin
C. ATB - Accounting Technical Bulletin
D. ARB - Accounting Research Bulletin

Answer 25

A. ASU - an Accounting Standards Update

When FASB amends or updates an accounting standard, it is a “Accounting Standards Update”, or an ASU.

Question 26

FAR2E20002
For an investment to be reported at amortized cost, which of the following criteria must it meet?
A) The investment must have significant short-term price volatility.
B) The business must have the intent and ability to hold the investment until maturity.
C) The investment must be in equity instruments.
D) The investment should be in assets with indefinite lives.

Answer 26

B) The business must have the intent and ability to hold the investment until maturity.

The intent and ability to hold the investment until maturity is a key criterion for reporting an investment at amortized cost. This approach assumes the investment will be held to collect contractual cash flows rather than for sale.

Question 27

FAR2G004n
Smokey’s Grill sells gift cards that can be redeemed for food and drinks. When someone comes in and uses a gift card to buy dinner, Smokey’s will debit what account?
A. Deferred revenue
B. Cash
C. Revenue
D. Accounts payable

Answer 27

A. Deferred revenue

When someone purchases a gift card, Smokey’s will debit cash and credit deferred revenue.

But when a gift card is used, deferred revenue will be debited and revenue will be credited, because that revenue has now been earned.

Question 28

FAR1A10042
The balance sheet shows equipment valued at $100,000. However, a review of purchase documents reveals that equipment worth $20,000 was sold during the year but not recorded. What is the correct equipment value on the balance sheet?
A) $80,000
B) $100,000
C) $120,000
D) $60,000

Answer 28

A) $80,000

The sale of equipment should have reduced the equipment account. Subtract the $20,000 worth of sold equipment from the original balance of $100,000, leading to a corrected value of $80,000.

Question 29

FAR3E10023
How does the fair value hierarchy treat quoted prices for an asset in an inactive market?
A. They are considered Level 1 inputs.
B. They are considered Level 2 inputs.
C. They are considered Level 3 inputs.
D. They are not considered in the fair value hierarchy.

Answer 29

B. They are considered Level 2 inputs.

Quoted prices for an asset in an inactive market are classified as Level 2 inputs in the fair value hierarchy. These are not as reliable as Level 1 inputs (active market prices) but are more observable than Level 3 inputs. Option A is incorrect because Level 1 requires active markets. Option C is incorrect as Level 3 involves significant unobservable inputs. Option D is incorrect as these inputs are considered, but at Level 2.

Question 30

FAR2E10024
A company holds equity securities purchased for $200,000. The fair value at year-end is $210,000. What journal entry correctly records the investment income?
A) Debit Equity Securities $200,000; Credit Investment Income $200,000
B) Debit Equity Securities $10,000; Credit Investment Income $10,000
C) Debit Investment Income $10,000; Credit Equity Securities $10,000
D) Debit Investment Income $210,000; Credit Equity Securities $210,000

Answer 30

B) Debit Equity Securities $10,000; Credit Investment Income $10,000

The journal entry reflects the increase in fair value ($10,000 gain) as a credit to Investment Income and a debit to Equity Securities.

Question 31

FAR2H10008
In evaluating a change in debt terms, the comparison of the new terms with the original terms primarily involves assessing changes in:
A. The credit rating of the borrower
B. The market value of the debt
C. The net present value of future cash flows
D. The interest rate environment

Answer 31

C. The net present value of future cash flows

The key factor in evaluating a change in debt terms is the impact on the net present value (NPV) of future cash flows. This directly reflects the economic substance of the change. The credit rating of the borrower, market value of the debt, and the interest rate environment are relevant factors but are secondary to the primary assessment of changes in NPV.

Question 32

FAR2F10024
How is the carrying amount of purchased software calculated?
A. Original cost minus accumulated amortization and impairment losses.
B. Original cost plus any subsequent expenditure.
C. Fair value at each reporting date.
D. Original cost plus accumulated amortization.

Answer 32

A. Original cost minus accumulated amortization and impairment losses.

The carrying amount is the original cost of the software minus any accumulated amortization and impairment losses recognized.

Question 33

FAR3C10070
When a not-for-profit entity receives a donation of artwork to be held as part of a collection, how should it be recognized?
A. At the fair market value at the time of donation
B. Not recognized if the entity has a policy to not sell the donated items
C. At the historical cost to the donor
D. At an appraised value every year

Answer 33

B. Not recognized if the entity has a policy to not sell the donated items

Donations of artwork to be held as part of a collection may not be recognized if the not-for-profit entity has a policy to not sell the donated items and to use them for public exhibition, education, or research in furtherance of public service.

Question 34

FAR1B10012
What does the ‘net assets’ category in a non-profit’s statement of financial position represent?
A. Total assets minus total liabilities
B. The sum of all revenue streams
C. The amount of cash on hand
D. Total liabilities minus total assets

Answer 34

A. Total assets minus total liabilities

In a non-profit organization’s financial statement, net assets represent the residual interest in the assets of the entity after deducting liabilities. It’s similar to equity in for-profit organizations. The other options do not accurately represent the calculation of net assets.