areaIII B. Contingencies and commitments

Question 1

Contingencies are potential

Answer 1

liabilities that may arise due to a past event, the outcome of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.

Question 2

contingencies recognition Criteria:

Answer 2

● Probable and Estimable: If it’s probable that a liability has been incurred at the date of the financial statements and the amount can be reasonably estimated, the contingency should be recognized by recording a liability and an expense.
● Possible but Not Probable or Estimable: If the liability is not probable or the amount cannot be reasonably estimated, a contingency should not be recognized in the financial statements

Question 3

contingencies disclosure Criteria:

Answer 3

All Contingencies: Whether recognized or not, contingencies should be disclosed in the notes to the financial statements. The
disclosure should include the nature of the contingency, an estimate of the potential financial impact, and the likelihood of the
unfavorable outcome

Question 4

Commitments are

Answer 4

obligations of a company that will likely lead to an outflow of resources but are not recognized as liabilities in the balance sheet because they do not meet the recognition criteria.

Types of Commitments:
● Operating Leases: Obligations to make future payments under non-cancelable leasing agreements.
● Purchase Commitments: Obligations to purchase goods or services at predetermined prices.
● Construction Commitments: Obligations for construction or development projects.

Question 5

commitments disclosure Criteria:

Answer 5

● General Disclosure: Disclose the nature, terms, and amounts of significant commitments in the notes to the financial statements.
● Future Impact: Include information about the timing and the amount of future cash flows associated with the commitments.
● Risks and Uncertainties: If there are significant risks or uncertainties related to the commitments, these should also be disclosed

Question 6

FAR2E10027
An investment’s fair value decreased from $50,000 to $48,000. How should the loss be recognized in the financial statements?
A) As a decrease in liabilities.
B) As a decrease in assets.
C) As an expense.
D) As a revenue.

Answer 6

C) As an expense.

A decrease in fair value is recognized as an expense (loss) in the income statement.

Question 7

Tinsel Co.’s balances in allowance for uncollectible accounts were $70,000 at the beginning of the current year and $55,000 at year end. During the year, receivables of $35,000 were written off as uncollectible. What amount should Tinsel report as uncollectible accounts expense at year end?
A. $15,000
B. $20,000
C. $35,000
D. $50,000

Answer 7

B. $20,000

The allowance started at $70,000 and $35,000 was written off, which would take the allowance down to $35,000. If the allowance ended at $55,000, it means that Tinsel expensed $20,000 to the allowance account(bad debt expense) to bring the allowance back up to the $55,000. 55,000 – 35,000 = 20,000
When a debt is written off under the allowance method, that amount is deducted from the allowance account, but it isn’t an expense. The bad debt expense happens when the allowance itself is adjusted to be where the company wants it to be.

Question 8

FAR3C10055

How should a not-for-profit entity measure the value of contributed services?
A. At the fair value of the services received
B. Based on the standard hourly rate for similar services
C. At the cost that would have been incurred to purchase the services
D. All of the above

Answer 8

D. All of the above

The value of contributed services should be measured at the fair value, which can be based on the standard hourly rate for similar services or the cost that would have been incurred to purchase those services.

Question 9

FAR1B008n

Donald Inc had the following balances at Dec 31st:

Gain on sale of equipment: $100,000
Foreign currency translation gain: $50,000
Net income: $300,000
Unrealized gain on AFS debt securities: $25,000
What would Donald report as comprehensive income for the year?

A. $450,000
B. $475,000
C. $175,000
D. $375,000

Answer 9

D. $375,000

Comprehensive income includes all changes in the firm’s equity during the year except for equity changes between the firm and its owners, such as paying dividends. Comprehensive income is net income + other comprehensive income. There are 4 items that can make up other comprehensive income:

1. Pension liability adjustment
2. Unrealized gains/losses on available-for-sale debt securities
3. Gains/losses from foreign currency translation
4. Gains/losses from the effective portion of cash flow hedges
   The gain on sale of equipment is already included in the determination of net income. So Donald’s comprehensive income would be:

Net income $300,000 + foreign currency gain $50,000 + unrealized AFS gain $25,000 = $375,000

Question 10

FAR1F10046
The Price-to-Earnings Growth (PEG) Ratio is calculated by dividing the P/E ratio by:
A. The growth rate of dividends.
B. The company’s debt growth rate.
C. The earnings growth rate.
D. The revenue growth rate.

Answer 10

C. The earnings growth rate.

The PEG Ratio is calculated by dividing the P/E ratio by the earnings growth rate. It adjusts the P/E ratio for the expected growth of earnings.

Question 11

FAR2G10025

How should a company account for changes in the estimated cash flows related to an ARO?
A) Adjust the ARO liability and recognize a gain or loss in the income statement.
B) Revise the asset’s depreciation expense accordingly.
C) Recognize the changes in the other comprehensive income.
D) No adjustment is required until the obligation is settled.

Answer 11

A) Adjust the ARO liability and recognize a gain or loss in the income statement.

Changes in the estimated cash flows of an ARO should result in an adjustment to the ARO liability, with a corresponding gain or loss recognized in the income statement.

Question 12

FAR2A10003
When calculating cash and cash equivalents, which of the following adjustments is typically necessary?
A. Adding back depreciation expense
B. Deducting outstanding checks
C. Adjusting for deferred revenue
D. Capitalizing lease expenses

Answer 12

B. Deducting outstanding checks

When calculating cash and cash equivalents, it is important to adjust the bank balance for items such as outstanding checks (B) which have been written but not yet cleared by the bank.

Adding back depreciation expense (A) is not relevant to cash calculations as it is a non-cash expense. Deferred revenue (C) is a liability and does not affect the calculation of cash. Capitalizing lease expenses (D) is related to the treatment of leases and does not directly impact the calculation of cash balances.

Question 13

FAR3C10066
How should a not-for-profit entity recognize a donated building that is to be used for its operations?
A. At the cost to construct a similar building
B. At the donor’s historical cost
C. At the fair market value at the time of donation
D. At the replacement cost

Answer 13

C. At the fair market value at the time of donation

A donated building should be recognized at its fair market value at the time of donation.

Question 14

FAR2G10028
How is the accretion expense related to an ARO recognized in the financial statements?
A) As a decrease in the ARO liability over time.
B) As a periodic increase in the ARO liability and an expense in the income statement.
C) Directly against the asset’s carrying amount.
D) As a reduction in equity.

Answer 14

B) As a periodic increase in the ARO liability and an expense in the income statement.

Accretion expense reflects the increase in the ARO liability over time due to the passage of time and is recognized as an expense in the income statement.

Question 15

FAR3G10021
What is the impact on the financial statements if a company discovers, after the balance sheet date but before the financial statements are issued, that a major customer who owes a significant receivable has gone bankrupt?
A) Increase in allowance for doubtful accounts.
B) Recognition of a loss in the income statement.
C) No change, but disclose the event in the notes.
D) Reversal of previously recognized revenue.

Answer 15

A) Increase in allowance for doubtful accounts.

The bankruptcy of a major customer is a Type I subsequent event, as it provides additional evidence about conditions that existed at the balance sheet date. The correct accounting treatment is to increase the allowance for doubtful accounts to reflect the increased credit risk associated with the receivable. This directly impacts the balance sheet and income statement.

Question 16

Which of the following documents is typically issued as part of the due-process activities of the Financial Accounting Standards Board (FASB) for amending the FASB Accounting Standards Codification?

A. A proposed statement of position.
B. A proposed accounting standards update.
C. A proposed accounting research bulletin.
D. A proposed staff accounting bulletin.

Answer 16

B. A proposed accounting standards update.

When there are updates to the Codification, they are referred to as Accounting Standards Updates (ASUs). Then the subsequent ASUs are numbered using the date they go into effect, such as ASU 2015-12.

Question 17

FAR1A50025
When the cash flow statement shows a decrease in accounts payable but the balance sheet reflects an increase, what should be the initial step in investigating this discrepancy?
A. Review the subsequent events after the balance sheet date for payments.
B. Check for any errors in recording accounts payable transactions.
C. Compare the accounts payable ledger with the general ledger.
D. Verify the accounts payable aging report for overdue payments.

Answer 17

B. Check for any errors in recording accounts payable transactions.

The first step should be to check for recording errors in accounts payable transactions which could lead to such discrepancies.

Question 18

FAR1C004aicpa
Ragg Coalition, a nongovernmental not-for-profit organization, received a gift of treasury bills. The cost to the donor was $20,000, with an additional $500 for brokerage fees that were paid by the donor prior to the transfer of the treasury bills. The treasury bills had a fair value of $15,000 at the time of the transfer. At what amount should Ragg report the treasury bills in its statement of financial position?
A. $15,000
B. $15,500
C. $20,000
D. $20,500

Answer 18

A. $15,000

Non-profits record donations at fair value, not the original cost to the donor.

Question 19

FAR1B20003
What distinguishes net assets with donor restrictions from net assets without donor restrictions in the statement of activities?
A) The ability to be liquidated into cash
B) The source of the funds
C) Specific purposes designated by donors
D) The duration of time for which they are held

Answer 19

C) Specific purposes designated by donors

Net assets with donor restrictions are distinguished by specific purposes or time frames designated by donors.

Question 20

FAR2C10035
Which statement is true when the inventory subledger has a higher balance than the general ledger?
A. It always indicates theft or loss of inventory.
B. It suggests that there might be unrecorded sales transactions.
C. It may indicate unrecorded purchases or returns in the general ledger.
D. It is a clear sign of overstated cost of goods sold.

Answer 20

C. It may indicate unrecorded purchases or returns in the general ledger.

Question 21

Which of the following items would best enable Driver Co. to determine whether the fair value of its investment in Favre Corp. is properly stated in the balance sheet?
A. Discounted cash flow of Favre’s operations.
B. Quoted market prices available from a business broker for a similar asset.
C. Quoted market prices on a stock exchange for an identical asset.
D. Historical performance and return on Driver’s investment in Favre.

Answer 21

C. Quoted market prices on a stock exchange for an identical asset.

The best source for fair value is quoted market prices for an identical asset in an active market. This describes “level 1” inputs, which is the most reliable source of determining fair value according to the hierarchy of fair value inputs.

Question 22

FAR2F001

Richter Corp uses the straight-line method for amortization and depreciation and that all amortization and depreciation is recorded on December 31 of each year. Richter uses separate general ledger accounts to record accumulated amortization for each intangible asset.

October 1, year 1 Richter received an unfavorable judgment in defense of a trademark and paid $25,000 in fees to their law firm. Calculate the amount of legal expenses to be recorded.

A. $0
B. $25,000
C. $5,000
D. $6,250

Answer 22

B. $25,000

Trademarks and trade names include corporate logos, advertising jingles, and product names that have been registered with the government and serve to identify specific companies and products. All expenditures associated with securing and defending trademarks and trade names are amortizable.
However, if you get an unfavorable judgment in defense of a trademark you cannot amortize the legal expenses and must deduct them as a current operating expense.
The journal entry to record the legal expenses:
Legal expense account Debit $25,000
Cash account credit $25,000

Question 23

FAR1B30027
If a grant received for a specific capital project was incorrectly recorded under operating activities, what is the correct adjustment?
A. Transfer from operating to investing activities.
B. Transfer from operating to financing activities.
C. Increase both operating and financing activities.
D. No adjustment needed.

Answer 23

B. Transfer from operating to financing activities.

Grants received for capital projects should be classified under financing activities. The correction involves transferring this amount from operating to financing activities.

Question 24

FAR2E30016
An investor uses the equity method for an investment in an investee. During the year, the investee reports a net loss of $8,000 and pays dividends of $3,000. The investor owns 20% of the investee. What is the correct journal entry for the investor’s share of the loss?
A. Debit Investment $1,600; Credit Loss from Investment $1,600
B. Debit Loss from Investment $1,600; Credit Investment $1,600
C. Debit Investment $1,600; Credit Income from Investment $1,600
D. Debit Loss from Investment $3,000; Credit Investment $3,000

Answer 24

B. Debit Loss from Investment $1,600; Credit Investment $1,600

The investor’s share of the loss (20% of $8,000 = $1,600) decreases the investment’s carrying value (credit) and is recognized as a loss (debit).

Question 25

FAR3G10011
A company’s warehouse, valued at $1 million, is destroyed by a fire after the balance sheet date but before the financial statements are issued. How should this subsequent event be treated in the financial statements?
A) Adjust the property, plant, and equipment (PPE) account by decreasing it by $1 million.
B) Disclose the event in the notes but make no adjustment to the PPE account.
C) Recognize an insurance receivable if the warehouse was insured.
D) Increase the contingency reserve by $1 million.

Answer 25

B) Disclose the event in the notes but make no adjustment to the PPE account.

The destruction of the warehouse is a Type II subsequent event as it is a significant event that occurred after the balance sheet date and does not relate to conditions existing at that date. The correct treatment is to disclose the event in the notes to the financial statements. No adjustment to the financial statements is required.

Question 26

FAR2G001n

At the end of the previous year, Tommy Inc. had accrued interest payable of $10,000. In the current year, Tommy reported interest expense of $20,000 and cash paid for interest of $5,000 in the statement of cash flows. What amount will Tommy report as accrued interest payable at the end of the current year?
A. $15,000
B. $25,000
C. $30,000
D. $35,000

Answer 26

B. $25,000

The starting interest payable balance was $10,000. Add the current year interest expense of $20,000 to get $30,000. Subtract the cash paid for interest of $5,000, and the ending interest payable balance is $25,000.

Question 27

FAR1A50028

When reconciling the cash flow from operating activities, what could explain a difference between the increase in inventory as per the balance sheet and the cash paid for inventory in the cash flow statement?

A. Inventory was purchased on credit.
B. Inventory was overvalued at year-end.
C. There was a significant amount of inventory write-off.
D. Goods were received in advance and recorded as prepaid inventory.

Answer 27

A. Inventory was purchased on credit.

If inventory was purchased on credit, it would increase inventory but not immediately affect cash, causing a discrepancy.

Question 28

Not an official AICPA question.

White Inc owes a bank $500,000 and one year of accrued interest at 10%. White is having financial difficulties and the bank agrees to restructure the loan to be $200,000 due in 10 years at the same 10% interest. What gain would White recognize on this debt restructuring?
A. There is no gain
B. $150,000
C. $240,000
D. $300,000

Answer 28

B. $150,000

The gain in this type of question compares the original loan amount to the total cash flows of the new deal.

The original loan is $500,000 + $50,000 of accrued interest = $550,000.

The cash flows from the new agreement total: $20,000 per year interest for 10 years = $200,000 + the new $200,000 principal amount = $400,000.

So overall White was relieved of $150,000 (550,000 – 400,000), so the gain is $150,000.

Question 29

FAR2E20024
In the context of impairment of debt investments at amortized cost, what does a ‘credit loss’ refer to?
A) The total loss in market value due to changes in credit spreads.
B) The difference between the contractual cash flows and the cash flows the company expects to receive.
C) Any loss in value due to a downgrade in the investment’s credit rating.
D) The loss recognized in the income statement due to impairment.

Answer 29

B) The difference between the contractual cash flows and the cash flows the company expects to receive.

A ‘credit loss’ refers to the difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (i.e., all cash shortfalls), discounted at the original effective interest rate.

Question 30

FAR1F007n
Jack Inc is converting their cash basis financial statements to the accrual basis. Jack Inc had the following transactions:

$500 of wages earned by employees but unpaid
$300 in office supplies received but not yet paid for
$200 in cash paid for employee bonuses from the prior year
$1,000 paid in rent for the following year
$500 that has been billed to customers but not yet received
$800 cash received for goods delivered in the prior year
$600 cash received from customers that paid in advance for their order
Which of the following is correct for the conversion to the accrual basis?

A. Subtract $800 for accrued expenses
B. Subtract $300 for accrued expenses
C. Subtract $500 to accounts receivable
D. Add $500 to accounts receivable

Answer 30

D. Add $500 to accounts receivable

Under the cash basis, nothing would be recorded yet for the $500 billed to customers but not yet received. Under the accrual basis this would be $500 in accounts receivable.

Question 31

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 31

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 32

During the year, Hauser Co. wrote off a customer’s account receivable. Hauser used the allowance method for uncollectible accounts. What impact would the write-off have on net income and total assets?
A. Net income: decrease. Total assets: decrease
B. Net income: decrease. Total assets: no effect
C. Net income: no effect. Total assets: decrease
D. Net income: no effect. Total assets: no effect

Answer 32

D. Net income: no effect. Total assets: no effect

Under the allowance method, the allowance for doubtful accounts sits as a contra account to AR. If a customer’s receivable is determined to be uncollectible, it is written off from AR, and deducted from the allowance account. This means there is no net effect on the balance sheet, and no effect on the income statement.
Under the direct write-off method, the bad debt would be expensed through the bad debt expense account, and both net income and total assets would be reduced.

Question 33

The important thing to remember is that discontinued operations

Answer 33

is reported net of tax.