areaIII C. Revenue recognition

Question 1

FAR1A50029
If the cash flow statement records a greater amount of cash used for acquiring a subsidiary than the investment recorded on the balance sheet, what might be a reason?
A. The subsidiary was acquired at a discount.
B. Part of the payment was deferred to future periods.
C. Goodwill was generated from the acquisition.
D. The cash payment included transaction costs.

Answer 1

D. The cash payment included transaction costs.

Transaction costs included in the cash payment would make the cash outflow higher than the investment amount recorded.

Question 2

FAR1E10034
Under income tax basis accounting, how is prepaid rent treated?
A) As an asset until used.
B) Expensed in the period paid.
C) Expensed in the period to which it relates.
D) As a liability until the period of use.

Answer 2

B) Expensed in the period paid.

In income tax basis accounting, prepaid expenses like rent are typically expensed in the period they are paid, as this is when they are often deductible for tax purposes. Options A and D treat it as an asset or liability, more in line with accrual accounting, while C aligns with matching principle in accrual accounting.

Question 3

FAR1C001aicpa
Fenn Museum, a nongovernmental not-for-profit organization, had the following balances in its statement of functional expenses:
Education: $300,000
Fundraising: $250,000
Management and general: $200,000
Research: $50,000
What amount should Fenn report as expenses for support services?

A. $350,000
B. $450,000
C. $500,000
D. $800,000

Answer 3

B. $450,000

In a non-profit you have two main groups of expenses: program services and support services. Program services are the services related to the mission and primary activities of the non-profit. On the other hand, support services are like admin-type expenses, such as management, general admin, and fundraising.

So in this case, the $250,000 of fundraising and the $200,000 of management and general expenses would be reported as support services on the statement of functional expenses.

Question 4

FAR2A10030
When a bank reconciliation reveals unrecorded bank service charges, how should this be handled in the general ledger?
A. Add the charges to the general ledger balance
B. Deduct the charges from the general ledger balance
C. Add the charges to the bank statement balance
D. No adjustment is required in the general ledger

Answer 4

B. Deduct the charges from the general ledger balance

Unrecorded bank service charges should be deducted from the general ledger balance (B), as these are expenses that reduce the company’s cash balance but have not yet been recorded in the company’s books.

Adding the charges to either balance (A and C) is incorrect. No adjustment (D) is incorrect as the general ledger needs to reflect all expenses related to the company’s cash account.

Question 5

FAR3B10001
Which of the following best describes a contingency in financial accounting?
A. A future event that will occur under certain conditions.
B. An obligation to transfer economic benefits as a result of past events.
C. A reserve for depreciation of assets.
D. A certain future event resulting from present obligations.

Answer 5

A. A future event that will occur under certain conditions.

A contingency is an uncertain future event that might affect a company’s financial position.

Question 6

FAR1A40035
What is the most likely cause of discrepancies in retained earnings reported in the statement of changes in equity?
A) Inaccurate reporting of issued share capital.
B) Errors in recognizing revenue or expenses.
C) Fluctuations in foreign exchange rates.
D) Inaccurate recording of current assets.

Answer 6

B) Errors in recognizing revenue or expenses.

Discrepancies in retained earnings often stem from errors in recognizing revenue or expenses, as these directly affect net income and subsequently retained earnings.

Inaccurate reporting of issued share capital (Option A) affects equity but not specifically retained earnings. Fluctuations in foreign exchange rates (Option C) mainly affect multinational corporations’ consolidated financial statements. Inaccurate recording of current assets (Option D) impacts the balance sheet.

Question 7

FAR1A002n
When an accounting standard is being proposed, the term “negative economic consequences” refers to:
A. Difficulty raising capital
B. The increased cost of complying with the new standard
C. Increased government intervention
D. Increased taxes

Answer 7

A. Difficulty raising capital

This term refers to the fear that the new standard could cause the firm’s earnings to fall, which would make it harder to raise capital.

Question 8

FAR2E008n
Which of the following is not an indicator that an investor holds significant influence over the investee, even if the investor owns less than 20% of the investee?
A. If the investor has any technological dependence on the investee
B. If no other investor has material ownership in the investee
C. If the investor participates in policy-making of the investee
D. If the investor has representation on the board of directors

Answer 8

A. If the investor has any technological dependence on the investee

If the investor has any technological dependence on the investee, that doesn’t give the investor significant influence, it would be the other way around.
But if the investee has any technological dependence on the investor, then it would represent significant influence.
All of the following are indicators that the investor has significant influence even if the ownership is less than 20%:
Representation on the board of directors
Participation in policy-making
Any material transactions between the investor and investee
Technological dependence on the investor
If no other investor has material ownership in the investee

Question 9

The funded status of a defined benefit pension plan for a company should be reported in:
A. The income statement
B. The statement of cash flows
C. The statement of financial position
D. The notes to the financial statements only

Answer 9

C. The statement of financial position

The funded status is reported on the balance sheet, as a liability. It is the difference between plan assets and the total projected benefit obligation.
A pension plan has to main parts: the future liabilities created by employees’ service, and the plan assets being accumulated to pay for those obligations. So the “funded status” is the difference between the two – in other words, the remaining liability that the current plan assets wouldn’t cover.

Question 10

FAR2G10010
A company records a journal entry to accrue interest expense of $1,000. What is the impact on the income statement and balance sheet?
A) Income statement: decrease in net income; Balance sheet: increase in assets
B) Income statement: increase in expenses; Balance sheet: increase in liabilities
C) Income statement: no impact; Balance sheet: increase in liabilities
D) Income statement: decrease in revenues; Balance sheet: decrease in assets

Answer 10

B) Income statement: increase in expenses; Balance sheet: increase in liabilities

Accruing interest expense increases expenses (reducing net income) on the income statement and increases liabilities (Interest Payable) on the balance sheet.

Question 11

FAR3B10028
A company has entered into a long-term, non-cancellable contract to purchase raw materials at a fixed price. How should this be reported in financial statements?
A. Recognize as a liability and corresponding asset.
B. Recognize as an expense.
C. No recognition; only disclosure in the financial statement notes.
D. No disclosure or recognition needed.

Answer 11

C. No recognition; only disclosure in the financial statement notes.

Long-term purchase commitments should be disclosed in the financial statement notes (C). They are not recognized as liabilities or expenses (A and B) until the goods are received or services are rendered.

Question 12

FAR2E30009
When using the equity method, what happens if the investee issues more shares and the investor does not purchase any of the new shares?
A. The investor’s percentage of ownership increases.
B. The investor’s percentage of ownership stays the same.
C. The investor’s percentage of ownership decreases.
D. The investor must switch to the cost method of accounting.

Answer 12

C. The investor’s percentage of ownership decreases.

If the investee issues more shares and the investor does not buy any, the investor’s percentage of ownership decreases due to dilution.

Question 13

FAR2I002n
Kirby Inc. issued 10,000 shares of common stock in year 1. In year 2 Kirby issued an additional 10,000 shares of common stock, and issued preferred stock convertible to 30,000 shares. In year 3 Kirby purchased 5,000 shares of its common stock to hold as treasury stock. How many outstanding shares of common stock does Kirby have at the end of year 3?
A. 15,000
B. 20,000
C. 45,000
D. 50,000

Answer 13

A. 15,000

The convertible shares don’t factor into the calculation – they haven’t been converted and aren’t common stock.
The first 20,000 shares from the first 2 years are counted, less the 5,000 shares held as treasury stock. The number of outstanding shares at the end of year 3 is 15,000 shares.

Question 14

FAR2D10025
Which of the following factors would not lead to an impairment of a long-lived asset?
A. Significant decrease in market value of the asset
B. Increase in the asset’s expected useful life
C. Significant physical damage to the asset
D. Sustained decrease in the asset’s cash flows

Answer 14

B. Increase in the asset’s expected useful life

An increase in the expected useful life of an asset would not lead to impairment. In fact, it could decrease the likelihood of impairment.

Question 15

Five-Step Model for Revenue Recognition

Answer 15

Step 1: Identify the Contract(s) with a Customer
Step 2: Identify the Performance Obligations in the Contract
Step 3: Determine the Transaction Price: Allocate the transaction price to the two performance obligations based on their standalone selling prices
Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract
Step 5: Recognize Revenue When (or as) the Entity Satisfies a Performance Obligation

Question 16

Unconditional pledges are promises

Answer 16

to give that are binding and do not depend on a specified future event occurring. Recognition Requirements:
● Recognition at Fair Value
● Receivable Recording
● Allowance for Uncollectible Pledges
● Multi-Year Pledges: For pledges receivable over multiple years, the present value of the expected future cash flows should be used.
Journal Entry Example:
● Assume a not-for-profit entity receives an unconditional pledge for $100,000, payable over four years.
The present value of the pledge, calculated using an appropriate discount rate, is $90,000.

Debit: Pledges Receivable 90,000
Credit: Contribution Revenue 90,000

Question 17

Conditional pledges are promises

Answer 17

to give that depend on the occurrence of a specified future event.
Recognition Requirements:
● Recognition as a Liability or Deferred Revenue: Conditional pledges are not recognized as revenue until the conditions
are substantially met.
● Disclosure in Notes
Journal Entry Example (Upon Meeting Conditions):
● Assume a conditional pledge of $50,000 is made, dependent on the not-for-profit matching funds from other sources.
Once the condition is met (e.g., the entity raises the matching funds), then revenue could be recognized:

Debit: Cash/Receivable 50,000
Credit: Contribution Revenue 50,000

Question 18

A nongovernmental, not-for-profit entity may act as an agent, intermediary, or trustee for a third party. In such cases, the funds received are

Answer 18

not for the entity’s own use but are to be passed on to or used on behalf of a third party.
Criteria for Not Recognizing as Contributions
● Lack of Control and Variance Power
● Beneficiary Identification: The primary beneficiaries are identifiable and are not the non-profit entity itself.
● Donor Restrictions present
● Pass-through Funds: Often these funds are pass-through, where the non-profit receives the money and then passes it
on to the designated third parties as per the donor’s instructions.

Examples of Transfers Not Recognized as Contributions
● Funds Held for Others
● Fees for Service as an Agent
● Donor-Advised Funds
In such cases, the receipt of funds is not recorded as revenue but is recorded as a liability, as the non-profit has an obligation to transfer these funds as directed.
Journal Entry Example:
● Assuming a non-profit receives $10,000 as a pass-through for another entity.

Debit: Cash 10,000
Credit: Liability to Third Party 10,000

Question 19

Recognition of Contract Costs
Initial Recognition:

Answer 19

● Costs to Obtain the Contract: Such as sales commissions, are recognized as an asset if they are expected to be recovered.
● Costs to Fulfill the Contract: Directly attributable costs (like materials, labor, overheads) are capitalized if they relate
directly to a specific contract, enhance the company’s ability to satisfy future performance obligations, and are expected
to be recovered.

Question 20

Construction subsequent Measurement

Answer 20

● Construction WIP: Reviewed at each reporting period and adjusted as necessary for any changes in estimated costs.
● Revenue Recognition: Adjusted based on the updated percentage-of-completion.
● Impairment: Assess the asset for impairment if there are indications that the carrying amount may not be recoverable.

Question 21

Contributed services must be recognized as revenue if they meet either of the following criteria:

Answer 21

● The services enhance a nonfinancial asset: Services that create or enhance nonfinancial assets (e.g., construction or
improvement of buildings).
● The services require specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if not provided by donation: This includes professional services like legal, accounting, or architectural services.

Example:
A law firm provides free legal services to a nonprofit organization. The fair value of these services, if they were to be paid for, is
estimated at $10,000. These services require specialized skills and are typically purchased if not provided by donation.

Recognizing Contributed Services: The nonprofit should recognize the fair value of the legal services as both revenue and expense (or asset, depending on the nature of the service).

Debit: Legal Expense 10,000
Credit: Contribution Revenue 10,000

This entry reflects the receipt of professional services as a contribution. The expense is recognized because the service has been consumed immediately. If the service contributed to creating or enhancing a nonfinancial asset, the debit would go to the asset account instead of expense.

Question 22

Contributions are recognized when control

Answer 22

over the assets is obtained and the contributions are unconditional.

Example 1: Financial Asset Contribution (Cash Donation): A not-for-profit organization receives a cash donation of $20,000 from a donor with no conditions attached. The full amount is recognized as revenue when received, as it is an unconditional contribution.
Debit: Cash 20,000
Credit: Contribution Revenue 20,000

Example 2: Nonfinancial Asset Contribution (Equipment Donation): A donor contributes equipment to the organization. The fair market value of the equipment at the time of donation is estimated to be $50,000
Nonfinancial contributions, like equipment, are recognized at their fair value at the date of donation.
Debit: Equipment 50,000
Credit: Contribution Revenue 50,000

Question 23

NFP
If the donated asset is to be used in the
organization’s operations (like a vehicle for delivering supplies), it is recorded

Answer 23

as an asset. If it’s intended for sale (like artwork for a charity auction), it would be recorded as an investment. But, this would depend on the NFP’s policies for such donations

Question 24

FAR2D10063
In reconciling PPE balances, what is the impact of a missed depreciation entry?
A. The subledger will show a higher balance than the general ledger
B. The general ledger will show a higher balance than the subledger
C. There will be no impact on the reconciliation
D. Both ledgers will be equally affected

Answer 24

A. The subledger will show a higher balance than the general ledger

If a depreciation entry is missed, the subledger will typically show a higher balance compared to the general ledger, as the asset is not appropriately depreciated in the subledger.

Question 25

FAR1A60020
Which of the following does NOT contribute to the calculation of Goodwill?
A) Fair value of net identifiable assets of the subsidiary.
B) Consideration transferred by the parent company.
C) Net profit of the subsidiary.
D) Fair value of the non-controlling interest.

Answer 25

C) Net profit of the subsidiary.

Net profit of the subsidiary does not directly contribute to the calculation of Goodwill. Goodwill is calculated based on the consideration transferred, fair value of net identifiable assets, and the fair value of non-controlling interests

Question 26

FAR2E10023

A company’s investment in a bond is initially valued at $20,000. By year-end, its fair value is $22,000. What is the investment income to be recognized in net income?

A) $2,000
B) $20,000
C) $22,000
D) $42,000

Answer 26

A) $2,000

Investment income is the increase in fair value, which is $22,000 – $20,000 = $2,000.

Question 27

FAR3D10038
How should a company record an increase in a valuation allowance for deferred tax assets?
A. Debit Deferred Tax Asset; Credit Valuation Allowance
B. Debit Valuation Allowance; Credit Deferred Tax Asset
C. Debit Income Tax Expense; Credit Valuation Allowance
D. Debit Valuation Allowance; Credit Income Tax Expense

Answer 27

C. Debit Income Tax Expense; Credit Valuation Allowance

An increase in a valuation allowance for deferred tax assets is recorded by debiting Income Tax Expense and crediting Valuation Allowance. This reflects the reduction in the realizable value of deferred tax assets.

Question 28

FAR3D10003
How should a change in judgment about an uncertain tax position be treated in financial statements?
A. It should be ignored as it reflects past transactions.
B. It should be recognized in the period in which the change occurs.
C. It should be adjusted in future tax payments only.
D. It should be disclosed in notes but not recognized in financial statements.

Answer 28

B. It should be recognized in the period in which the change occurs.

Changes in judgment about an uncertain tax position should be recognized in the financial statements in the period in which the change occurs. This ensures that the financial statements reflect the most current and accurate information.

Question 29

FAR1C003aicpa
During the current year, the Finn Foundation, a nongovernmental not-for-profit organization, received a $1,000,000 permanent endowment from Chris. Chris stipulated that the income must be used to provide recreational activities for the elderly. The endowment reported income of $80,000 in the current year. What amount of contribution revenue with donor restriction should Finn report at the end of the current year?
A. $1,080,000
B. $1,000,000
C. $80,000
D. $0

Answer 29

A. $1,080,000

Because the endowment and the income has stipulations from the donor, the entire $1,080,000 will be reported in contribution revenue with donor restriction.