Diagnostic 1 05/27/16

Question 1

Fair Value Framework—Introduction and Definitions

For which of the following circumstances is the guidance for determining fair value as provided in the fair value framework presented in ASC 820, “Fair Value Measurement,” least likely to apply?

a) Determination of the fair value to be assigned to land acquired in a business combination.
b) Determination of the fair value of a bond liability for applying the fair value option.
c) Determination of the fair value of legal services received in exchange for an entity’s common stock.
d) Determination of the fair value of a production facility when assessing whether or not an impairment loss has occurred.

Answer 1

CORRECT Answer:
c) Determination of the fair value of legal services received in exchange for an entity’s common stock.

Explanation:
You Answered Correctly!
The guidance for determining fair value provided in the fair value framework is not appropriate for determining the fair value of legal services received in exchange for an entity’s common stock. ASC 820 specifically exempts share‐based payment transactions (and inventory valuing and other minor items) from the purview of the fair value framework.

Question 2

Fair Value Framework—Introduction and Definitions

The determination of fair value may be for:

• A Standalone Asset or Liability (Yes/No?)
• A Group of Assets or Liabilities (Yes/No?)

Answer 2

CORRECT Answer:

• A Standalone Asset or Liability (Yes)
• A Group of Assets or Liabilities (Yes)

Explanation: You Answered Incorrectly
The determination of fair value may be not only for a standalone asset or liability (e.g., a financial instrument or an operating asset), but also for a group of assets or liabilities taken as a unit (e.g., an asset group or a line of business).

Question 3

Recognition and Measurement

In which one of the following circumstances is the entry price to acquire an asset least likely to represent fair value of the asset?

a) An investment security is acquired for cash through a public market.
b) A machine is acquired from a wholesaler by giving an interest‐bearing note.
c) A significant amount of raw material inventory is acquired for cash from a bankrupt supplier.
d) Land and a building are acquired in the open market by giving a mortgage to a lender.

Answer 3

CORRECT Answer:
c) A significant amount of raw material inventory is acquired for cash from a bankrupt supplier.

Explanation:
You Answered Correctly!
Since the raw material inventory was acquired from a supplier in bankruptcy, it is likely that the transaction occurred when the seller was under duress. Therefore, it is likely that the price paid (an entry price) does not represent fair value ‐ an exit price at which the inventory could be sold by a seller not under financial duress.

Question 4

FASB and Standard Setting

What is the primary protection for investors against fraudulent financial reporting by corporations?

a) Criminal statutes.
b) The requirement that financial statements be audited.
c) The fact that all firms must report the same way.
d) The integrity of management.

Answer 4

CORRECT Answer:
b) The requirement that financial statements be audited.

Explanation:
You Answered Correctly!

The audit of the financial statements by independent third parties is the primary protection. The auditors do not prepare the information, nor do they have employment ties with either the reporting firm or the intended audience of the financial statements.

However, even the audit of financial statements is not a perfect protection as indicated by the frequency of fraud and audit failure.

Question 5

Inputs and Hierarchy

Which of the following statements concerning the fair value hierarchy used in ascertaining fair value is/are correct?

I. Quoted market prices should be adjusted for a “blockage factor” when a firm holds a sizable portion of the asset being valued.

II. Quoted market prices in markets that are not active because there are few relevant transactions cannot be used.

Answer 5

CORRECT Answer:
Neither I nor II.

Explanation:
You Answered Incorrectly.
Quoted market prices should not be adjusted for a “blockage factor” when a firm holds a sizable portion of the asset being valued. A “blockage factor” occurs when an entity holds a sizable portion of an asset (or liability) relative to the trading volume of the asset or liability in the market. Using a “blockage factor” would adjust the market value for the impact of such a large block of securities being sold, but is not permitted in determining fair value.

Question 6

FASB and Standard Setting

The FASB is a(n):

a) Private sector body.
b) Governmental unit.
c) International organization.
d) Group of accounting firms.

Answer 6

CORRECT Answer:
a) Private sector body.

Explanation:
You Answered Incorrectly.
The FASB is a private sector body although it is subject to scrutiny by the SEC, an agency of the federal government.

Over the years, the U.S. Congress has maintained a fairly consistent preference for keeping the standard setting process within the private sector.

Question 7

Objectives, Qualitative Characteristics

During the 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 does 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 7

CORRECT Answer:
c) Enterprise performance but not directly provide information about management performance.

Explanation:
You Answered Incorrectly.
Financial statements only provide direct information about enterprise performance. There are too many factors affecting the performance of the enterprise to isolate the contribution of management.

Question 8

Fair Value Framework—Introduction and Definitions

Which of the following benefits is the fair value framework intended to accomplish with respect to fair value measurement and fair value reporting?

• Increased Consistency (Yes/No?)
• Increased Comparability (Yes/No?)

Answer 8

CORRECT Answer:

• Increased Consistency (Yes)
• Increased Comparability (Yes)

Explanation:
You Answered Correctly!
The framework for the use of fair value in GAAP is intended to achieve both increased consistency and increased comparability in fair value measurement and reporting.

Question 9

Inputs and Hierarchy

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 9

CORRECT Answers:
c) Quoted market prices on a stock exchange for an identical asset.

Explanation:
You Answered Incorrectly.
Historical performance and return on Driver’s investment in Favre would not be the best means of determining the fair value of Driver’s investment in Favre. Historical performance and return on investment uses past data (inputs) which may not reflect the entity’s current or future performance, prospects, or risks. While such past data may be observable, and therefore level 2 in the hierarchy of inputs for valuation purposes, they are not the best inputs for valuation purposes. Quoted market prices on a stock exchange for identical assets would be level 1 inputs and the most reliable evidence of fair value.

Question 10

Disclosure Requirements

Which of the following statements, if any, concerning disclosures about fair value measurements in periods subsequent to initial recognition is/are correct?

I. The fair value hierarchy level within which fair value measurements fall must be disclosed.

II. Quantitative fair value measurement disclosures must be in tabular format.

Answer 10

CORRECT Answer:
Both I and II are correct.

Explanation:
You Answered Incorrectly.
It is true that fair value amounts must be disclosed separately for each level of the fair value hierarchy (Statement I), but it also is true that quantitative disclosures about fair value must be in tabular format (Statement II).

Question 11

Accrual Accounting

Compared to its 2004 cash‐basis net income, Potoma Co.’s 2004 accrual‐basis net income increased when it:

a) Declared a cash dividend in 2003 that it paid in 2004.
b) Wrote off more accounts receivable balances than it reported as uncollectible accounts expense in 2004.
c) Had lower accrued expenses on December 31, 2004, than on January 1, 2004.
d) Sold used equipment for cash at a gain in 2004.

Answer 11

CORRECT Answer:
c) Had lower accrued expenses on December 31, 2004, than on January 1, 2004.

Explanation:
You Answered Correctly!
If the accrued expenses account (a current liability, often called accrued expenses payable) decreased during 2004, then a greater amount of cash was paid for those expenses in 2004 than were accrued in 2004. This would cause cash‐basis net income to be less than accrual‐basis net income. Cash‐basis net income reflects expenses paid; accrual‐basis net income reflects expenses recognized (accrued).

Question 12

Financial Accounting Standards Codification

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 12

CORRECT Answer:
b) A proposed accounting standards update.

Explanation:
You Answered Incorrectly.
Statements of position (SOP) were issued by the AICPA from 1974—2009 and are no longer issued. Any SOP addressing accounting guidance have been superseded by the FASB Codification.

Question 13

Financial Statements

Which of the following would be reported as an investing activity in a company’s statement of cash flows?

a) Collection of proceeds from a note payable.
b) Collection of a note receivable from a related party.
c) Collection of an overdue account receivable from a customer.
d) Collection of a tax refund from the government.

Answer 13

CORRECT Answer:
b) Collection of a note receivable from a related party.

Explanation:
You Answered Correctly!
Collection on a note receivable from a related party is an investing activity. The company is lending money to the related party and lending is not a primary business activity – the fact that the loan is in the form of a note implies that it is interest bearing.

Question 14

Constraints and Present Value

What is the underlying concept governing the Generally Accepted Accounting Principles pertaining to recording gain contingencies?

a) Conservatism.
b) Relevance.
c) Consistency.
d) Faithful representation.

Answer 14

CORRECT Answer:
a) Conservatism

Explanation:
You Answered Correctly!
Gain contingencies are not recognized, but loss contingencies that are probable and estimable are recognized. This is a classic example of conservatism, which suppresses positive information under conditions of uncertainty but requires the reporting of negative information when the negative outcome is likely.

Question 15

FASB and Standard Setting

Choose the correct statement about GAAP.

a) GAAP are laws.
b) Only publicly traded companies must comply with GAAP.
c) It is a violation of SEC regulations for publicly traded companies to depart from GAAP.
d) Firms may not restate financial statements previously issued.

Answer 15

CORRECT Answer:
c) It is a violation of SEC regulations for publicly traded companies to depart from GAAP.

Explanation:
You Answered Incorrectly.
Essentially, all companies that rely on external sources of capital require financial statements and, therefore, must comply with GAAP.

For example, a privately‐held firm may require a loan. In order to obtain the loan, the firm must present audited financial statements.

Question 16

Assumptions, Accounting Principles

According to the conceptual framework, the process of reporting an item in the financial statements of an entity is:

a) Allocation.
b) Matching.
c) Realization.
d) Recognition.

Answer 16

CORRECT Answer:
d) Recognition.

Explanation:
You Answered Correctly!
Recognition is the strongest reporting action that can be taken. When an item is recognized, that means it will appear in the financial statements, perhaps not as an individual line item, but definitely part of one. Many other items find their way into the footnotes, but are not recognized.

Question 17

Recognition and Measurement

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) Market.
b) Income.
c) Cost.
d) Observable inputs.

Answer 17

CORRECT Answer:
b) Income

Explanation:
You Answered Incorrectly.
The market approach to fair value measurement of an asset does not measure fair value by discounting future cash flows of the asset. The market approach to fair value measurement uses prices and other relevant information generated by market transactions involving assets or liabilities that are identical or comparable to those being valued. Discounting future cash flows would be an income approach to determining fair value.

Question 18

Fair Value Framework—Introduction and Definitions

Which one of the following is not a purpose of the fair value framework as set forth in ASC 820, “Fair Value Measurement”?

a) Provide a uniform definition of “fair value” for GAAP purposes.
b) Provide a framework for determining fair value for GAAP purposes.
c) Establish new measurement requirements for financial instruments.
d) Establish expanded disclosures about fair value when it is used.

Answer 18

CORRECT Answer:
c) Establish new measurement requirements for financial instruments.

Explanation:
You Answered Incorrectly.
Providing a uniform definition of “fair value” for GAAP purposes is one of the purposes of the fair value framework, as is providing a framework for determining fair value and establishing expanded disclosures about fair value when it is used.

Question 19

SEC Reporting Requirements

Which of the follow is required by Regulation S‐K to be included in the Management’s Discussion and Analysis (MD&A) that is part of the 10‐K?

a) The Balance Sheet.
b) Discussion of risks and uncertainties.
c) Accounting fees and services.
d) Executive compensation.

Answer 19

CORRECT Answer:
b) Discussion of risks and uncertainties.

Explanation:
You Answered Correctly!
The SEC requires that the MD&A provide a “discussion and analysis” on operating results, liquidity, and capital resources, trends, and risks and uncertainties. Where there are significant increases in sales, management must discuss the extent that price, volume, or new products contributed to the increase.

Question 20

Financial Statements

In Dart Co.’s year two single‐step Income Statement, as prepared by Dart’s controller, the section titled “Revenues” consisted of the following:

Sales $250,000
Purchase Discounts $3,000
Recovery of accounts written off $10,000

Total Revenues: $263,000

In its year two single‐step Income Statement, what amount should Dart report as total revenues?

Answer 20

CORRECT Answer:
$250,000

Explanation:
You Answered Incorrectly.
This calculation includes the purchase discounts, which is incorrect. Total revenue is only the $250,000 in sales.

Question 21

Disclosure Requirements

When an entity uses the fair value option for eligible financial assets and liabilities, which one of the following is not an expected outcome of the disclosures required of that entity?

a) Users being able to understand management’s reasons for using the fair value option.
b) Users being able to understand how changes in fair value affect net income.
c) Replace the kind and amount of information that would have been provided if the fair value option had not been used with information related to fair value.
d) Users being able to understand the difference between fair value and cash flows.

Answer 21

CORRECT Answer:
c) Replace the kind and amount of information that would have been provided if the fair value option had not been used with information related to fair value.

Explanation:
You Answered Incorrectly.
The disclosures required when the fair value option is used are intended to enable users to understand the differences between fair value and cash flows.

Question 22

Financial Accounting Standards Codification

U.S. GAAP includes a very large set of accounting guidance. Choose the correct statement.

a) The FASB Accounting Standards Codification includes guidance about items that are not under the purview of the Generally Accepted Accounting Principles, such as the income tax basis of accounting.
b) Authoritative guidance from FASB Statements adopted before the FASB Accounting Standards Codification does not appear in the Codification.
c) There is an implied hierarchy within the FASB Accounting Standards Codification, with FASB Statements assuming the top level.
d) International accounting standards are not included in the FASB Accounting Standards Codification.

Answer 22

CORRECT Answer:
d) International accounting standards are not included in the FASB Accounting Standards Codification.

Explanation:
You Answered Correctly!
IFRS are not U.S. GAAP and thus are not included in the Codification.

Question 23

SEC - Role and Standard-Setting Process

The SEC enforces the corporate registration requirements of the Securities Act of 1933 as one of its principal objectives. These requirements are intended to provide information that enables the SEC to:

a) Evaluate the financial merits of the corporation offering the securities to the public.
b) Ensure that investors are provided with adequate information on which to base investment decisions.
c) Guarantee that the facts contained in the registration statement are accurate.
d) Assure investors of the accuracy of the financial statements.

Answer 23

CORRECT Answer:
b) Ensure that investors are provided with adequate information on which to base investment decisions.

Explanation:
You Answered Correctly!
The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. In order to carry out the mandates in the Securities Act of 1933, the SEC is ensuring that investors are provided with adequate information on which to base investment decisions. www.SEC.gov, What We Do.

Question 24

Assumptions, Accounting Principles

On December 31, 2002, Brooks Co. decided to end operations and dispose of its assets within three months. At December 31, 2002, the net realizable value of the equipment was below historical cost.

What is the appropriate measurement basis for equipment included in Brooks’ December 31, 2002, Balance Sheet?

a) Historical cost.
b) Current reproduction cost.
c) Net realizable value.
d) Current replacement cost.

Answer 24

CORRECT Answer:
c) Net realizable value.

Explanation:
You Answered Correctly!

When a firm is in liquidation, historical cost and entry values (replacement cost) are no longer relevant.

The going concern assumption supports the historical cost principle. The firm is no longer a going concern. The only amounts relevant are the amounts to be received on sale of the assets. Net realizable value is the net value to be received, after the costs of getting the asset ready for sale are deducted.

Question 25

Financial Accounting Standards Codification

Which of the following statements includes the most useful guidance for practicing accountants concerning the FASB Accounting Standards Codification.

a) The Codification includes only FASB Statements.
b) The Codification is the sole source of U.S. GAAP, for nongovernmental entities.
c) The Codification significantly modified the content of GAAP when it became effective.
d) An accountant can be sure that all SEC rules are included in the Codification.

Answer 25

CORRECT Answer:
b) The Codification is the sole source of U.S. GAAP, for nongovernmental entities.

Explanation:
You Answered Correctly!
The Codification includes all authoritative GAAP for nongovernmental entities.

Question 26

Fair Value Framework—Introduction and Definitions

In determining the fair value of a nonfinancial asset, assessing the highest and best use of the asset must take into account all but which one of the following?

a) What is physically possible.
b) What is financially feasible.
c) How the reporting entity would use the asset.
d) What is legally permissible.

Answer 26

CORRECT Answer:
c) How the reporting entity would use the asset.

Explanation:
You Answered Incorrectly.
In determining the fair value of a nonfinancial asset, what is legally permissible (and what is physically possible and financially feasible) should be taken into account in assessing the highest and best use of the asset.