chapter 4 Flashcards
Financial Statement Disclosure
Question: 1 Which of the following statements is correct regarding fair value measurement?
A. Fair value is a market-based measurement.
B. Fair value measurement does not consider restrictions.
C. Fair value is an entity-specific measurement.
D. Fair value measurement does not consider risk
Answer (A) is correct.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Thus, fair value is a market-based measurement.
For interim financial reporting, the computation of a company’s second quarter provision for income taxes uses an effective tax rate expected to be applicable for the full fiscal year. The effective tax rate should reflect anticipated
Available Tax & Foreign Tax Rates Planning Alternatives
The estimated annual effective tax rate should be based upon the statutory rate adjusted for the current year’s expected conditions. These conditions include anticipated investment tax credits, foreign tax rates, percentage depletion, capital gains rates, and other tax planning alternatives. The rate should also include “the effect of any valuation allowance expected to be necessary at year end for deferred tax assets related to originating deductible temporary differences and carry forwards during the year.”
The following would be considered a Level 2 observable input that could be used to determine an asset or liability’s fair value:
Interest rates that are observable at commonly quoted inQuoted prices for identical assets and liabilities in markets that are not active is an example of a Level 2 input.
Level 2 inputs are observable.tervals are an example of a Level 2 input. Level 2 inputs are observable.
Quoted prices for similar assets and liabilities in markets that are active is an example of a Level 2 input. Level 2 inputs are observable.
he fair value for an asset or liability is measured as:
The cost of the asset less any accumulated depreciation or the carrying value of the liability on the date of the sale.
B. The price that would be received when selling an asset or paid when transferring a liability in an orderly transaction between market participants.
C. The price that would be paid to acquire the asset or received to assume the liability in an orderly transaction between market participants.
D. The appraised value of the asset or liability.
Answer (B) is correct.
The fair value of an asset or liability is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
In financial reporting of segment data, which of the following must be considered in determining whether an operating segment is a re portable segment?
For the purpose of identifying reportable operating segments, revenue is defined to include sales to external (unaffiliated) customers and intersegment sales or transfers. In accordance with the revenue test, a reportable operating segment has revenue equal to 10% or more of the total combined revenue, internal and external, of all of the entity’s operating segments.
Subsequent events affecting the realization of assets ordinarily will require recognition in the financial statements because such events typically represent the
An entity recognizes in the financial statements subsequent events that provide information relative to conditions existing at the balance sheet date, including the estimates inherent in statement preparation. All information that becomes available prior to the issuance of the financial statements should be used by management in its evaluation of the conditions on which the estimates underlying the statements were based. Subsequent events affecting the realization of assets typically represent the culmination of conditions that existed at year end.
Disclosure of information about significant concentrations of credit risk is required for
Most financial instruments.
B. Financial instruments with off-balance-sheet market risk only.
C. Financial instruments with off-balance-sheet credit risk only.
D. Financial instruments with off-balance-sheet risk of accounting loss only.
Answer (A) is correct.
GAAP require the disclosure of information about the fair value of financial instruments, whether recognized or not (certain nonpublic entities and certain instruments, such as leases and insurance contracts, are exempt from the disclosure requirements). GAAP also require disclosure of all significant concentrations of credit risk for most financial instruments (except for obligations for deferred compensation, certain instruments of a pension plan, insurance contracts, warranty obligations and rights, and unconditional purchase obligations).
Opto Co. is a publicly traded, consolidated entity reporting segment information. Which of the following items is a required entity-wide disclosure regarding external customers?
A. The fact that transactions with a particular external customer constitute more than 10% of the total entity revenues.
B. The identity of any external customer providing 10% or more of a particular operating segment’s revenue.
C. The identity of any external customer considered to be “major” by management.
D. Information on major customers is not required in segment reporting.
Answer (A) is correct.
Information about products and services and geographical areas is reported if it is feasible to do so. If 10% or more of revenues is derived from one external customer, (1) that fact, (2) the amount from each such customer, and (3) the segment(s) reporting the revenues must be disclosed.
Giaconda, Inc., acquires an asset for which it will measure the fair value by discounting future cash flows of the asset. Which of the following terms best describes this fair value measurement approach? A. Cost. B. Income. C. Observable inputs. D. Market.
Answer (B) is correct.
The income approach uses valuation methods based on current market expectations about future amounts, e.g., earnings or cash flows. It converts future amounts to one present discounted amount. Examples are present value methods and option-pricing models.
Which of the following information should be disclosed in the summary of significant accounting policies?
A. Adequacy of pension plan assets relative to vested benefits.
B. Guarantees of indebtedness of others.
C. Refinancing of debt subsequent to the balance sheet date.
D. Criteria for determining which investments are treated as cash equivalents.
Answer (D) is correct.
All significant accounting policies should be disclosed as an integral part of the financial statements. Disclosure of the policy for determining which investments are treated as cash equivalents is required.
Which of the following material events occurring after the December 31, Year 6, end of the reporting period does not ordinarily result in adjustment of the financial statements before they are issued on February 28, Year 7?
A. Write-off of a receivable from a debtor who had suffered from a deteriorating financial condition for the past 6 years. The debtor filed for bankruptcy on January 20, Year 7.
B. A major business combination completed on January 20, Year 7. Negotiations had begun in December of Year 6.
C. Settlement of extended litigation on January 20, Year 7, in excess of the recorded year-end liability.
D. A 3-for-5 reverse stock split consummated on January 20, Year 7.
Answer (B) is correct.
An entity recognizes in the financial statements adjusting events after the reporting period. These provide evidence about conditions existing at the end of the reporting period. However, the business combination did not occur until after year end. Hence, it required only disclosure, not recognition in the statements.
C. Settlement of extended litigati
nancial statements must disclose significant risks and uncertainties. The required disclosures include
A. Quantified comparisons of the relative importance of the different businesses in which the entity operates.
B. Information about a significant estimate used to value an asset only if it is probable that the financial statement effect of a condition existing at the balance sheet date will change materially in the near term.
C. Risk-reduction techniques that have successfully mitigated losses.
D. Vulnerability due to a concentration if a near-term severe impact is at least reasonably possible.
Answer (D) is correct. The currenAnswer (D) is correct. The current vulnerability due to concentrations must be disclosed if certain conditions are met. Disclosure is necessary if management knows prior to issuance of the statements that the concentration exists at the balance sheet date; it makes the entity vulnerable to a near-term severe impact; and such impact is at least reasonably possible in the near term. A severe impact may result from loss of all or a part of a business relationship, price or demand changes, loss of a patent, changes in the availability of a resource or right, or the disruption of operations in a market or geographic area.t vulnerability due to concentrations must be disclosed if certain conditions are met. Disclosure is necessary if management knows prior to issuance of the statements that the concentration exists at the balance sheet date; it makes the entity vulnerable to a near-term severe impact; and such impact is at least reasonably possible in the near term. A severe impact may result from loss of all or a part of a business relationship, price or demand changes, loss of a patent, changes in the availability of a resource or right, or the disruption of operations in a market or geographic area.
Taft Corp. discloses operating-segment information. The following information is available for Year 4: Operating Traceable Segment Sales Operating Expenses A $1,000,000 $ 600,000 B 800,000 500,000 C 600,000 350,000 $2,400,000 $1,450,000 Additional Year 4 expenses, not included above, are as follows: Indirect operating expenses $360,000 General corporate expenses 240,000 In the measure of segment profit or loss reviewed by the chief operating decision maker, appropriate common operating expenses are allocated to segments based on the ratio of a segment’s sales to total sales, but general corporate expenses are not. Segment C’s Year 4 profit for external reporting purposes was A. $250,000 B. $160,000 C. $100,000 D. $130,000
Answer (B) is correct. The reported amount of each segment item, such as profit or loss, is the measure reported to the chief operating decision maker for purposes of making resource allocation and performance evaluation decisions regarding the segment. Hence, expense allocations are included in the calculation of reported segment profit or loss only if they are included in the measure of segment profit or loss reviewed by the chief operating decision maker. Thus, to determine externally reported profit, both the traceable operating expenses and the indirect expenses must be subtracted from operating revenue. Accordingly, 25% of Taft’s indirect operating expenses should be allocated to Segment C on the basis of the ratio of Segment C’s sales to total sales ($600,000 ÷ $2,400,000). The general corporate expenses are excluded from the calculation of the reported profit of Segment C. As indicated below, Segment C’s profit is $160,000. Segment C Sales $ 600,000 Traceable expenses (350,000) Allocated indirect expenses ($360,000 × 25%) (90,000) Segment profit $ 160,000
The summary of significant accounting policies should disclose the
A. Reasons that retrospective application of a change in an accounting principle is impracticable.
B. Basis of profit recognition on long-term construction contracts.
C. Future minimum lease payments in the aggregate and for each of the 5 succeeding fiscal years.
D. Adequacy of pension plan assets in relation to vested benefits.
Answer (B) is correct.
Certain items are commonly required disclosures in a summary of significant accounting policies: (1) the basis of consolidation, (2) depreciation methods, (3) amortization of intangibles, (4) inventory pricing, (5) recognition of revenue from contracts with customers, and (6) recognition of revenue from franchising and leasing operations.
A doubt about newly formed Nev Company’s ability to continue as a going concern was disclosed in its annual financial statements for December 31, 20X6. In March 20X7, management solved the problem that caused the going concern disclosure. Which of the following must the management of Nev disclose in the first quarter financial statements of 20X7?
A. The principal conditions or events that raised the substantial doubt.
B. Evaluation of the significance of the conditions or events that raised the substantial doubt.
C. The plans that alleviated the substantial doubt about the entity’s ability to continue as a going concern.
D. All of the answers are correct.
When substantial doubt about an entity’s ability to continue as a going concern was alleviated as a result of management’s plans, the entity must disclose the following:
Principal conditions or events that raised the substantial doubt
Management’s evaluation of the significance of those conditions or events
Management’s plans that alleviated the substantial doubt.
When there is a change in the reporting entity, how should the change be reported in the financial statements?
A. Currently, including note disclosures.
B. Retrospectively, including note disclosures and application to all prior period financial statements presented.
C. Prospectively, including note disclosures.
D. Note disclosures only.
A change in reporting entity results in statements that are effectively those of a different entity. This change is retrospectively applied to interim and annual statements, including note disclosures, and application to all prior-period financial statements presented.
Martin Corporation has the following data related to its operating segments.
Inter-
Identi-
Unaffiliated
segment
Operating
fiable
Segment
Revenues
Revenues
Profit (Loss)
Assets
A
$ 90
$10
$(100)
$ 600
B
70
15
50
600
C
40
-0-
(20)
150
D
250
30
180
1,500
E
300
20
130
800
Totals
$750
$75
$ 240
$3,650
Based on the revenue criterion only, which of Martin’s segments is (are) reportable?
A. Segment E only.
B. Segments A and D only.
C. Segments A, B, D, and E only.Answer (C) is correct. An operating segment of a business is considered reportable if its reported revenue, including sales to external customers and intersegment sales or transfers, is at least 10% of the combined revenue of all operating segments. Unaffiliated Intersegment Combined Segment Revenues Revenues Revenues Percentage A $ 90 $10 $100 12.1% B 70 15 85 10.3% C 40 0 40 4.8% D 250 30 280 33.9% E 300 20 320 38.8% Totals $750 $75 $825 100.0% Accordingly, only Segment C is not reportable based on the revenue criterion.
Which of the following should be disclosed for each reportable operating segment of an entity?
Profit or loss
Total assets
Answer (B) is correct.
An operating segment is a component (1) engaged in business from which it may earn revenues and incur expenses, (2) whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resource allocation and to assess performance, and (3) for which separate financial information is available. An operating segment is reportable if it meets one of the quantitative thresholds (revenue, assets, or absolute amount of profit or loss). Disclosures include a measure of profit or loss and total assets for each reportable segment.
Bard Co., a calendar-year corporation, reported income before income tax expense of $10,000 and income tax expense of $1,500 in its interim income statement for the first quarter of the year. Bard had income before income tax expense of $20,000 for the second quarter and an estimated effective annual rate of 25%. What amount should Bard report as income tax expense in its interim income statement for the second quarter? A. $7,500 B. $6,000 C. $5,000 D. $3,500
Answer (B) is correct. Interim period tax expense equals the estimated annual effective tax rate, times year-to-date “ordinary income,” minus the tax expense recognized in previous interim periods. Accordingly, the income tax expense reported in the interim income statement for the second quarter is calculated as follows: First quarter pre-tax income $10,000 Second quarter pre-tax income 20,000 Total year-to-date income $30,000 Times: estimated effective annual tax rate 25% Total tax expense $ 7,500 Minus: income tax expense for first quarter (1,500) Income tax expense for second quarter $ 6,000
Interim financial reporting should be viewed primarily in which of the following ways?
A. As reporting for an integral part of an annual period.
B. As if the interim period were an annual accounting period.
C. As useful only if activity is spread evenly throughout the year.
D. As reporting under a comprehensive basis of accounting other than GAAP.
Answer (A) is correct.
Each interim period primarily is an integral part of an annual period. Ordinarily, the results for an interim period should be based on the same accounting principles the entity uses in preparing annual statements. Certain principles and practices used for annual reporting, however, may require modification at interim dates so that interim reports may relate more closely to the results of operations for the annual period.
Bean Co. included interest expense and depreciation expense in its determination of segment profit, which Bean’s chief financial officer considered in determining the segment’s operating budget. Bean is required to report the segment’s financial data in accordance with GAAP. Which of the following items should Bean disclose in reporting segment data?
Answer (A) is correct.
The objective is to provide information about the different types of business activities of the entity and the economic environments in which it operates. Disclosures include a measure of profit or loss and total assets for each reportable segment. Other items typically disclosed include revenues from external customers and other operating segments, interest revenue and expense, depreciation, depletion, amortization, unusual items, equity in the net income of equity-based investees, income tax expense or benefit, and other significant noncash items.
he fair value measurement (FVM) of an asset
A. Is based on the expected use by the reporting entity.
B. Includes the entity’s own credit risk.
C. Assumes transfer, not a settlement.
D. Reflects the highest and best use by market participants.
Answer (D) is correct.
The FVM is based on the highest and best use (HBU) by market participants. This use maximizes the value of the asset. The HBU is in-use if the value-maximizing use is in combination with other assets in a group. An example is machinery. The HBU is in-exchange if the value-maximizing use is as a standalone asset. An example is a financial asset.
On January 15, Year 2, before the Mapleview Co. released its financial statements for the year ended December 31, Year 1, it settled a long-standing lawsuit. A material loss resulted and no prior liability had been recorded. How should this loss be disclosed or recognized in the Year 1 financial statements?
A. The loss should be disclosed, but the financial statements themselves need not be adjusted.
B. The loss must be recognized in the financial statements.
C. The loss should be disclosed in an explanatory paragraph in the auditor’s report.
D. No disclosure or recognition is required.
Answer (B) is correct.
Subsequent events that provide additional evidence with the respect to conditions that existed at the balance sheet date, including the estimates inherent in preparing the financial statements, must be recognized in the financial statements of the year affected by the subsequent event. Settlement of a lawsuit is indicative of conditions existing at year end and calls for recognition in the statements.
For interim financial reporting, a company’s income tax provision for the second quarter should be determined using the
A. Statutory tax rate for the year.
B. Effective tax rate expected to be applicable for the full year as estimated at the end of the first quarter.
C. Effective tax rate expected to be applicable for the full year as estimated at the end of the second quarter.
D. Effective tax rate expected to be applicable for the second quarter.
Answer (C) is correct.
At the end of each interim period, the entity should estimate the annual effective tax rate. This rate is used in providing for income taxes on a current year-to-date basis.
