CH1 Conceptual Framework & IFRS Questions

Question 1

Which of the following accounting pronouncements is the most authoritative?

a.
FASB Statement of Financial Accounting Concepts.
b.
FASB Technical Bulletin.
c.
FASB Statements of Financial Accounting Standards
d.
AICPA Statement of Position.

Answer 1

c.
FASB Statements of Financial Accounting Standards

Correct! Due to the large volume of pronouncements, it became necessary to determine which pronouncements would have a higher level of authority for circumstances where there appeared to be conflicts between published standards. A hierarchy has been established which includes 4 types of pronouncements at the highest level of authority. In order of authority, these include FASB Statements of Financial Accounting Standards, FASB Interpretations, AICPA Accounting Principles Board Opinions, and AICPA Accounting Research Bulletins.

Question 2

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 2

A proposed accounting standards update.

Correct! The Financial Accounting Standards Board (FASB), after a deliberative process that includes soliciting the views of all stakeholders, issues an Accounting Standards Update describing amendments to the Accounting Standards Codification.

Question 3

Which of the following phrases best describes a Level 1 input for measuring the fair value of an asset or liability?

a.
Inputs for the asset or liability based on the reporting entity’s internal data.
b.
Quoted prices for similar assets or liabilities in active markets.
c.
Inputs that are principally derived from or corroborated by observable market data.
d.
Unadjusted quoted prices for identical assets or liabilities in active markets.

Answer 3

d
Unadjusted quoted prices for identical assets or liabilities in active markets.

Correct! When reporting items at fair value, an entity is required to disclose the level of inputs used to measure fair value with level 1 being the most reliable and level 3 being the least. Level 1 consists of unadjusted quoted market prices for identical assets or liabilities in active markets. Quoted prices for similar assets or liabilities in active markets and inputs that are principally derived from or corroborated by observable market data would be level 2 inputs. Inputs based on the reporting entity’s internal data are level 3 inputs.

Question 4

According to the FASB conceptual framework, the objectives of financial reporting for business enterprises are based on

a.
Generally accepted accounting principles.
b.
Reporting on management’s stewardship.
c.
The need for conservatism.
d.
The needs of the users of the information.

Answer 4

d.
The needs of the users of the information.

Correct! The objective of financial reporting is to serve the needs of users. It is presumed that the objectives will be met when financial statements are prepared in conformity with generally accepted accounting principles. In order to meet the objective, the financial statements provide indirect information about management’s stewardship. Conservatism is a characteristic, not an objective.

Question 5

According to the FASB conceptual framework, the usefulness of providing information in financial statements is subject to the constraint of

a.
Consistency.
b.
Cost benefit.
c.
Reliability.
d.
Representational faithfulness.

Answer 5

b
Cost benefit.

Correct! To meet the objectives of financial reporting, the information must be useful. Usefulness is subject to the constraints of cost-benefit analysis, whereby the value of the information should not exceed the cost of its collection and presentation

Question 6

Accumulated other comprehensive income is reported in which of the following financial statements?

a.
The income statement.
b.
The statement of comprehensive income.
c.
The statement of cash flows.
d.
The statement of financial position.

Answer 6

d.
The statement of financial position (Balance Sheet).

Correct! Accumulated other comprehensive income is the cumulative total of amounts reported in comprehensive income, reduced by reclassifications. It is a component of stockholders’ equity and is reported in the statement of financial position.

Question 7

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?

a.
$500,000
b.
$400,000
c.
$100,000
d.
$0

Answer 7

c
$100,000

Correct! The cost of successfully defending a patent is capitalized, rather than expensed, and is added to the cost of the patent. When a defense is unsuccessful, the cost of defending the patent is recognized as an expense. In addition, it is an indication that the patent may be impaired.

Question 8

Comparability, understandability, timeliness, and verifiability are enhancing qualitative characteristics that contribute to:

Relevance Faithful Representation

a.
Yes               No
b.
No                No
c.
No                Yes
d.
Yes               Yes

Answer 8

d.
Yes Yes

Correct! Comparability, understandability, timeliness, and verifiability are enhancing qualitative characteristics that contribute to both relevance and faithful representation.

Question 9

The concept of verifiability means:

a.
Information about the past can be used to make decisions about the future.
b.
Different authorities will draw the same conclusions based on the information, such as different sources agreeing as to an amount.
c.
The information is free from bias.
d.
The information is capable of making a difference in the decisions made by users.

Answer 9

b
Different authorities will draw the same conclusions based on the information, such as different sources agreeing as to an amount.

Correct! Verifiability means that different authorities will draw the same conclusions based on the information, such as different sources agreeing as to an amount. Predictive value indicates that information about the past can be used to make decisions about the future. Neutrality indicates that information is free from bias. Whether or not information is capable of making a difference to users is determined by its materiality.

Question 10

Information is considered material to the financial statements if
I. It falls within industry-specific quantitative guidelines published by the Financial Accounting Standards Board.
II. Its omission could make a difference in the decisions made by a user relying on the financial statements.
III. Its misstatement could make a difference in the decisions made by a user relying on the financial statement.

Your Answer:

a.
II and III only
b.
I only
c.
I and III only
d.
I, II and III

Answer 10

a
II and III only

Correct! An item is material if it would make a difference to users of financial statements in making decisions about their relationship with the reporting entity. As a result, an item that is omitted or misstated will be considered material if the financial statement user would have made a different decision or derived additional support bolstering their existing decision if the item had not been omitted or misstated. What is or is not material is dependent on the users of the financial statements and how they are being used and, as a result, there can be no industry specific guidelines.

Question 11

Regarding a company’s reporting of assets on the balance sheet, which of the following statements is correct?

a.
Acquisition of the asset must be at least probable.
b.
The asset must have at least provided benefits in the past.
c.
The removal of any outside restriction on the use of the asset must be at least probable.
d.
Highly valuable resources which provide benefits to the company may not be reported on the balance sheet.

Answer 11

d.
Highly valuable resources which provide benefits to the company may not be reported on the balance sheet.

Correct! An asset is an economic resource that is within the control of the company, will provide future benefits, generally in the form of positive future cash flows, and results from a past transaction, event, or circumstance. Although an item must meet these requirements to be reported as an asset, an entity may have valuable resources that are not reported on the balance sheet, such as internally developed intangibles, because they did not qualify as assets at the time they were being acquired or they are not subject to reliable measurement. To be reported as an asset, acquisition must have occurred, not be probable. To be recognized as an asset, there must be future benefits to be derived. When something has provided past benefits, it may have been reported as an asset, such as office supplies which are an asset until used, or a depreciable asset, which remains as an asset only as long as there will be future benefit derived from it. A restriction does not prevent an item from being reported as an asset as assets may or may not be restricted, and, as a result, the probability that an outside restriction will be removed is not necessary.

Question 12

During 2013, customers purchased gift cards from LatteBucks, all of which expire on December 31, 2015. At the end of 2014, some of the gift cards still have not been redeemed. How should the unredeemed gift cards be reported on LatteBucks’ 2014 year-end financial statements?

a.
As sales revenue on the income statement
b.
As a current liability on the balance sheet
c.
As a prepaid asset on the balance sheet
d.
As an expense on the income statement

Answer 12

b.
As a current liability on the balance sheet

Correct! Since gift cards represent the right of the customer to receive goods or services that have already been paid for, they represent an obligation to the issuing company as it will either have to provide the goods or services or refund amounts received for the gift card. As a result, any unused and unexpired gift cards outstanding on the balance sheet date are recognized as a liability, which will be current since the gift cards expire within one year of the balance sheet date. They will not be recognized as revenue until the issuing entity has met its performance obligations. Prepaid assets and expenses are associated with expenditures, not money received, as is the case with gift cards.

Question 13

Althouse Co. discovered that equipment purchased on January 2 for $150,000 was incorrectly expensed at the time. The equipment should have been depreciated over five years with no salvage value. What amount, if any, should be adjusted to Althouse’s depreciation expense at January 2, the beginning of the third year, when the error was discovered?

a.
$0
b.
$30,000
c.
$60,000
d.
$150,000

Answer 13

a
$0

Correct! A change that relates to having incorrectly expensed the cost of equipment is recognized by adjusting beginning retained earnings for the net effect of the adjustment as of the beginning of the earliest period presented and applying the correct principle for all periods being reported upon. If the equipment had been capitalized for $150,000, as of the beginning of the 3rd year, accumulated depreciation would be 2/5 or $60,000 and the carrying value of the asset would be $90,000, reported along with an increase to beginning retained earnings of $90,000 as well. During year 3, depreciation expense of $30,000 will be recognized but there will be no adjustment to depreciation as of January 2 of year 3.

Question 14

Gil is a Baxley Co. salesman desperate to make quota by the end of 2015. On the afternoon of December 31, 2015, he convinces a longtime customer with excellent credit to sign a contract to accept delivery of Baxley Co.’s Widgetron Deluxe. Gil promises the customer a deep discount off the list price that they can ‘hash out later’ if the customer is 100% happy with the product. Gil does not tell the customer that the company’s policy in such cases is to offer the maximum discount of 30%. The customer states he will have to consult an astrologer and a groundhog to determine if he is happy with the product. Gil oversees the delivery that evening of the Widgetron Deluxe. Should the revenue from this sale be recognized in 2015? Why or why not?

a.
The revenue should be recognized because the product shipped and the customer has excellent credit.
b.
The revenue should be recognized because there is a binding contract to accept delivery of the goods.
c.
The revenue should not be recognized because the price is unknown.
d.
The revenue should not be recognized because of the unusual and subjective terms under which the buyer has the right to return the product.

Answer 14

d
The revenue should not be recognized because of the unusual and subjective terms under which the buyer has the right to return the product.

Correct! When a buyer of goods has the right to return products, the transaction is considered a sale with a right of return. When an entity makes regular sales under these terms and has a reasonable basis for estimating returns, revenue from the sale will be recognized and an allowance for returns will be established. When the rate of returns cannot be reasonably estimated, however, revenue is not recognized until the right of return expires. Even though the goods were shipped in 2015, until the buyer accepts the goods or the right to return them expires, revenue would not be recognized.

Question 15

On day 1, Clothes Co., sells clothing to Link Corp. for $40,000. Clothes ships the clothing on day 1 and Link is obligated to pay Clothes within six months. Link is given 12 months to return any of the clothing for a refund if they experience low demand. Link is also given 18 months to exchange any clothing due to low demand. At the time of sale, Clothes cannot reasonably estimate returns, but estimates $5,000 in exchanged goods. Clothes should recognize revenue for the aforementioned transaction

a.
On the day of the sale.
b.
Six months after the date of sale.
c.
12 months after the date of sale.
d.
18 months after the date of sale

Answer 15

c
12 months after the date of sale.

Correct! When a buyer has a right to return goods it is unable to sell, it is referred to as a sale with a right of return. If the amount of returns can be reasonably estimated, the sale is recorded when it is originally made with an allowance for estimated returns. When returns cannot be estimated, however, the sale is not recorded until the buyer’s right to return the goods has expired. In this case, that would be 12 months after the date of the original sale. The right to exchange goods is not a consideration because an exchange simply replaces certain items from inventory for other items without affecting the amount of the sale.

Question 16

Which of the following is most likely to be considered revenue, according to the Financial Accounting Standards Board’s definition?
Your Answer:

a.
A company in the business of manufacturing scientific devices recognizes a gain from the sale of agricultural land from the fringes of its corporate campus.
b.
A pharmaceutical firm receives an anonymous donation to settle a liability owed to a municipality.
c.
A web streaming company fulfills a 12-month service term paid by customers in advance.
d.
A clothing reseller recognizes a gain from early extinguishment of long-term debt.

Answer 16

c
A web streaming company fulfills a 12-month service term paid by customers in advance.

Correct! Revenue results from the sale of goods or services in an entity’s normal course of business. When a web streaming company fulfills a 12 month service term paid by customers in advance, it is completing its obligation to provide services and would recognize the amounts previously received as revenue. A company in the business of manufacturing scientific devices would recognize revenue when those devices are sold but when other assets, such as agricultural land, is old, it is a peripheral transaction and any gain or loss would be a nonoperating item. A donation received by an entity that is not a not-for-profit that receives a substantial portion of its funds from donations would not be considered proceeds from providing goods or service in the ordinary course of business and would, as a result, be reported as nonoperating income. Early extinguishment of a note does not provide proceeds, especially not from the delivery of goods or services in the ordinary course of business, and any gain or loss would be reported as a nonoperating item.

Question 17

During a period when an enterprise is under the direction of a particular management, its financial statements will directly provide information about

a.
Both enterprise performance and management performance.
b.
Management performance but not directly provide information about enterprise performance.
c.
Enterprise performance but not directly provide information about management performance.
d.
Neither enterprise performance nor management performance.

Answer 17

c
Enterprise performance but not directly provide information about management performance.

Correct Answer Explanation:

Correct! The objectives of financial reporting include providing direct information about an entity’s cash flows, financial position, and performance. The financial statements also provide indirect information about management’s performance.

Question 18

FASB’s conceptual framework explains both financial and physical capital maintenance concepts. Which capital maintenance concept is applied to currently reported net income, and which is applied to comprehensive income?

a.
Currently reported net income: Financial capital
Comprehensive income: Physical capital

b.
Currently reported net income: Physical capital
Comprehensive income: Physical capital

c.
Currently reported net income: Financial capital
Comprehensive income: Financial capital

d.
Currently reported net income: Physical capital
Comprehensive income: Financial capital

Answer 18

d
Currently reported net income: Physical capital
Comprehensive income: Financial capital

Correct! Under the physical capital maintenance concept, gains and losses are recognized only when assets are disposed of or liabilities are settled, which is the approach generally used in calculating currently reported net income. Financial capital is increased or decreased both when assets are disposed of or liabilities are settled, and when assets or liabilities change in value, resulting in holding gains and losses. Holding gains and losses are generally excluded from net income but included in other comprehensive income. Comprehensive income, which includes both net income and other comprehensive income, applies the financial capital approach since both gains and losses resulting from disposals and settlements are included, as well as holding gains and losses.

Question 19

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

a.
Historical cost.
b.
Consistency.
c.
Conservatism.
d.
Full disclosure.

Answer 19

a
Historical cost

Correct! Reporting inventory at the lower-of-cost-or-market is a departure from historical cost since the valuation reported on the balance sheet might be an amount lower than the historical cost. If the lower-of-cost-or-market concept is applied in each period, there is no violation of the consistency principle. Application of the lower-of-cost-or-market principle is an example, rather than a violation, of conservatism principle. The concept of full disclosure is violated if the footnotes do not indicate the fact that the lower-of-cost-or-market principle is being applied.

Question 20

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 20

b
$10,000

Correct! Only the unrealized loss on available-for-sale securities and the foreign currency translation adjustment have an effect on Palymyra Co.’s comprehensive income, the net effect of which is $10,000 (11,000 – 3,000 + 2,000 = 10,000). Neither the net cumulative effect of a change in accounting principle nor the increase in common stock has an effect on comprehensive income.

Question 21

On October 31, year 1, a company with a calendar year end paid $90,000 for services that will be performed evenly over a six-month period from November 1, year 1, through April 30, year 2. The company expensed the $90,000 cash payment in October, year 1, to its services expense general ledger account. The company did not record any additional journal entries in year 1 that were related to the payment. What is the adjusting journal entry that the company should record to properly report the prepayment in its year 1 financial statements?

a.
Debit prepaid services and credit services expense for $30,000.
b.
Debit prepaid services and credit services expense for $60,000.
c.
Debit services expense and credit prepaid services for $30,000.
d.
Debit services expense and credit prepaid services for $60,000.

Answer 21

b
Debit prepaid services and credit services expense for $60,000.

Correct! The company should have initially recorded the prepaid services as an asset, with the following journal entry:

Prepaid services $90,000
Cash $90,000

Then, for each month in the six-month period, the company would have recorded the use of the services with the following journal entry:

Services expense ($90,000 / 6 months)	$15,000
          Prepaid services	          $15,000

However, the company incorrectly expensed the entire cash payment in the month it was paid, which means $90,000 was debited to Services expense and credited to Cash. No prepaid asset was recorded. After two months (November and December), the books should show a remaining Prepaid expense balance of $60,000 and only $30,000 should have been expensed ($15,000 a month for two months; $90,000 / 6 = $15,000). The adjusting journal entry necessary to show these correct balances is a debit to Prepaid services of $60,000 and a credit to Services expense of $60,000.

Question 22

To meet the disclosure requirements related to risks and uncertainties, an entity will disclose which of the following?

I. The legal form of entity
II. The use of estimates
III. Concentrations of risk

a.
I, II, and III
b.
I and II only
c.
I and III only
d.
II and III only

Answer 22

d
II and III only

Correct! To comply with the disclosure requirements related to risks and uncertainties, an entity is required to disclose the nature of its operations, the use of estimates, certain significant estimates, and vulnerability to certain concentrations of risk. There is no requirement to disclose the legal form of entity.

Question 23

Which of the following should be disclosed in a summary of significant accounting policies?

Answer 23

a
Basis of consolidation.

Correct! The summary of significant accounting policies is used to describe the choices that the entity has made when it has the opportunity to choose between two or more acceptable methods for accounting for an item. This would include, for example, the basis for consolidation since the acquisition method may be applied, as would be required for most business combinations, or, in certain circumstances, another approach may be applied. Although a concentration of credit risk associated with financial instruments, the composition of plant assets, and the adequacy of pension plan assets in relation to vested benefits are all disclosed, they are not accounting policies and would not be disclosed in the summary of significant accounting policies.

Question 24

Gil is a Baxley Co. salesman desperate to make quota by the end of 2015. On the afternoon of December 31, 2015, he convinces a longtime customer with excellent credit to sign a contract to accept delivery of Baxley Co.’s Widgetron Deluxe. Gil promises the customer a deep discount off the list price that they can ‘hash out later’ if the customer is 100% happy with the product. Gil does not tell the customer that the company’s policy in such cases is to offer the maximum discount of 30%. The customer states he will have to consult an astrologer and a groundhog to determine if he is happy with the product. Gil oversees the delivery that evening of the Widgetron Deluxe. Should the revenue from this sale be recognized in 2015? Why or why not?

Your Answer:

a.
The revenue should be recognized because the product shipped and the customer has excellent credit.
b.
The revenue should be recognized because there is a binding contract to accept delivery of the goods.
c.
The revenue should not be recognized because the price is unknown.
d.
The revenue should not be recognized because of the unusual and subjective terms under which the buyer has the right to return the product.

Answer 24

d.
The revenue should not be recognized because of the unusual and subjective terms under which the buyer has the right to return the product.

Correct! When a buyer of goods has the right to return products, the transaction is considered a sale with a right of return. When an entity makes regular sales under these terms and has a reasonable basis for estimating returns, revenue from the sale will be recognized and an allowance for returns will be established. When the rate of returns cannot be reasonably estimated, however, revenue is not recognized until the right of return expires. Even though the goods were shipped in 2015, until the buyer accepts the goods or the right to return them expires, revenue would not be recognized.

Question 25

Which of the following should be disclosed in a summary of significant accounting policies?

a.
Basis of consolidation.
b.
Concentration of credit risk of financial instruments.
c.
Composition of plant assets.
d.
Adequacy of pension plan assets in relation to vested benefits.

Answer 25

a
Basis of consolidation

Correct! The summary of significant accounting policies is used to describe the choices that the entity has made when it has the opportunity to choose between two or more acceptable methods for accounting for an item. This would include, for example, the basis for consolidation since the acquisition method may be applied, as would be required for most business combinations, or, in certain circumstances, another approach may be applied. Although a concentration of credit risk associated with financial instruments, the composition of plant assets, and the adequacy of pension plan assets in relation to vested benefits are all disclosed, they are not accounting policies and would not be disclosed in the summary of significant accounting policies.

Question 26

According to the FASB conceptual framework, comprehensive income includes which of the following?

a.
Loss on discontinued operations and investments by owner.
b.
Loss on discontinued operations.
c.
Investments by owner.
d.
Neither loss on discontinued operations nor investments by owner.

Answer 26

b
Loss on discontinued operations.

Correct! Comprehensive income includes all changes to equity other than owner-related items. A loss on discontinued operations reduces net income, which is a component of comprehensive income. An investment by owners is an owner-related transaction, and is not included in comprehensive income.

Question 27

According to the FASB conceptual framework, which of the following situations violates the concept of neutrality?

a.
Data on segments having the same expected risks and growth rates are reported to analysts estimating future profits.
b.
Financial statements are issued nine months late.
c.
Management reports to stockholders regularly refer to new projects undertaken, but the financial statements never report project results.
d.
Financial statements include property with a carrying amount increased to management’s estimate of market value.

Answer 27

d
Financial statements include property with a carrying amount increased to management’s estimate of market value./

Correct! The concept of neutrality, which is an ingredient of faithful representation, indicates that the information in the financial statements is free from bias. This would not be the case when information is based on management’s estimate of market value, which would be influenced by management’s perceptions.

Question 28

Ina Co. had the following beginning and ending balances in its prepaid expense and accrued liabilities accounts for the current year:

Prepaid expenses Accured liabilities

Beginning balance $5,000 $8,000
Ending balance $10,000 $20,000

Debits to operating expenses totaled $100,000. What amount did Ina pay for operating expenses during the current year?

Answer 28

b

$93,000

Question 29

FASB’s conceptual framework explains both financial and physical capital maintenance concepts. Which capital maintenance concept is applied to currently reported net income, and which is applied to comprehensive income?

a.
Currently reported net income: Financial capital
Comprehensive income: Physical capital

b.
Currently reported net income: Physical capital
Comprehensive income: Physical capital

c.
Currently reported net income: Financial capital
Comprehensive income: Financial capital

d.
Currently reported net income: Physical capital
Comprehensive income: Financial capital

Answer 29

d
Currently reported net income: Physical capital
Comprehensive income: Financial capital

Correct! Under the physical capital maintenance concept, gains and losses are recognized only when assets are disposed of or liabilities are settled, which is the approach generally used in calculating currently reported net income. Financial capital is increased or decreased both when assets are disposed of or liabilities are settled, and when assets or liabilities change in value, resulting in holding gains and losses. Holding gains and losses are generally excluded from net income but included in other comprehensive income. Comprehensive income, which includes both net income and other comprehensive income, applies the financial capital approach since both gains and losses resulting from disposals and settlements are included, as well as holding gains and losses.

Question 30

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 30

b
$10,000

Correct! Only the unrealized loss on available-for-sale securities and the foreign currency translation adjustment have an effect on Palymyra Co.’s comprehensive income, the net effect of which is $10,000 (11,000 – 3,000 + 2,000 = 10,000). Neither the net cumulative effect of a change in accounting principle nor the increase in common stock has an effect on comprehensive income.

Question 31

Which of the following should be disclosed in a summary of significant accounting policies?

a.
Basis of consolidation.
b.
Concentration of credit risk of financial instruments.
c.
Composition of plant assets.
d.
Adequacy of pension plan assets in relation to vested benefits.

Answer 31

a
Basis of consolidation.

Correct! The summary of significant accounting policies is used to describe the choices that the entity has made when it has the opportunity to choose between two or more acceptable methods for accounting for an item. This would include, for example, the basis for consolidation since the acquisition method may be applied, as would be required for most business combinations, or, in certain circumstances, another approach may be applied. Although a concentration of credit risk associated with financial instruments, the composition of plant assets, and the adequacy of pension plan assets in relation to vested benefits are all disclosed, they are not accounting policies and would not be disclosed in the summary of significant accounting policies.

Question 32

According to the FASB conceptual framework, which of the following statements conforms to the realization concept?

a.
Equipment depreciation was assigned to a production department and then to product unit costs.
b.
Depreciated equipment was sold in exchange for a note receivable.
c.
Cash was collected on accounts receivable.
d.
Product unit costs were assigned to cost of goods sold when the units were sold.

Answer 32

b
Depreciated equipment was sold in exchange for a note receivable.

Correct! Realization is the conversion of an item or service into cash or a claim to cash as would be the case when equipment is sold for a note receivable. Realization occurs at the time that an entity converts goods or services into accounts receivable, and not necessarily when the receivable is collected. The assignment of costs to production or to cost of goods sold is a form of allocation rather than realization.

Question 33

According to the FASB conceptual framework, which of the following situations violates the concept of neutrality?

a
Data on segments having the same expected risks and growth rates are reported to analysts estimating future profits.
b.
Financial statements are issued nine months late.
c.
Management reports to stockholders regularly refer to new projects undertaken, but the financial statements never report project results.
d.
Financial statements include property with a carrying amount increased to management’s estimate of market value.

Answer 33

d
Financial statements include property with a carrying amount increased to management’s estimate of market value

Correct! The concept of neutrality, which is an ingredient of faithful representation, indicates that the information in the financial statements is free from bias. This would not be the case when information is based on management’s estimate of market value, which would be influenced by management’s perceptions.

Question 34

Ina Co. had the following beginning and ending balances in its prepaid expense and accrued liabilities accounts for the current year:

Prepaid expenses Accured liabilities

Beginning balance $5,000 $8,000
Ending balance $10,000 $20,000

Debits to operating expenses totaled $100,000. What amount did Ina pay for operating expenses during the current year?
Your Answer:

a.
$83,000
b.
$93,000
c.
$107,000
d.
$117,000

Answer 34

b
$93,000

Correct! The amount Ina paid for operating expenses during the current year is computed as follows:

Operating Expenses (given in problem): $100,000

PLUS Prepaid Expenses (increase): $5,000

MINUS Accrued liabilities (increase): ($12,000)

Cash paid for operating expenses: $93,000

Question 35

A shoe retailer allows customers to return shoes within 90 days of purchase. The company estimates that 5% of sales will be returned within the 90-day period. During the month, the company has sales of $200,000 and returns of sales made in prior months of $5,000. What amount should the company record as net sales revenue for new sales made during the month?

a.
$185,000
b.
$190,000
c.
$195,000
d.
$200,000

Answer 35

b
$190,000

Correct! The amount the company records as net sales for new sales made during the month will not be affected by actual returns on sales made in prior months but will instead reflect a provision for returns based on the 5% sales return estimate. (200,000 – (200,000 X 5%) = 190,000).

Question 36

Which of the following is not an appropriate method for recognizing expenses?

a.
Systematic and rational allocation
b.
Cause and effect
c.
Deferral and amortization
d.
Immediate recognition

Answer 36

c
Deferral and amortization

Correct! The appropriate methods for recognizing expenses include cause and effect, such as charging inventory to cost of goods sold; systematic and rational allocation, such as depreciation of property and equipment; and immediate recognition, such as recognizing salaries expense as it is incurred. Although some costs are deferred, it is not a method of expense recognition. Deferred costs may be recognized under the cause and effect approach, for example, or may be systematically and rationally allocated.

Question 37

Which of the following is accounted for as an extraordinary item under IFRS?

I. A loss that is considered both unusual in nature and infrequent of occurrence, taking into account the environment in which the entity operates
II. A gain on early retirement of debt

a.
Both I and II
b.
Neither I nor II
c.
I only
d.
II only

Answer 37

b
Neither I nor II

Correct! IFRS does not recognize items as extraordinary.

Question 38

A tax bill was enacted into law after an entity’s year end but before its financial statements were issued. Under the previous law, the entity’s tax rate will be 35% for all future periods while, under the new law, the tax rate will increase to 38%. Which rate will the company use to calculate the tax effects of temporary differences?

a.
35% under both US GAAP and IFRS
b.
38% under US GAAP and 35% under IFRS
c.
38% under both US GAAP and IFRS
d.
35% under US GAAP and 38% under IFRS

Answer 38

d
35% under US GAAP and 38% under IFRS

Correct! In calculating the tax effect of temporary differences, US GAAP requires an entity to use the enacted future tax rate. Since the change was enacted after the entity’s year end, they would apply 35%, the previous rate. Under IFRS, the tax effect is calculated using a substantially enacted tax rate, such as a rate that is enacted after the end of the company’s year but before issuance of its financial statements. Under IFRS, the 38% rate would be used.

Question 39

On January 2, 20X3, Smith purchased the net assets of Jones' Cleaning, a sole proprietorship, for $350,000, and commenced operations of Spiffy Cleaning, a sole proprietorship. The assets had a carrying amount of $375,000 and a market value of $360,000. In Spiffy's cash-basis financial statements for the year ended December 31, 20X3, Spiffy reported revenues in excess of expenses of $60,000. Smith's drawings during 20X3 were $20,000. In Spiffy's financial statements, what amount should be reported as Capital-Smith?
a.
$390,000
b.
$400,000
c.
$410,000
d.
$415,000

Answer 39

a
$390,000

Correct! Smith will recognize initial capital of $350,000 based on the amount paid for the business. This will be increased by the $60,000 by which revenues exceeded expenses and reduced by the $20,000 in drawings to give an ending balance of $390,000.