FAR 1 Flashcards
The SEC is comprised of five commissioners, appointed by the President of the United States, and five divisions. Which of the following divisions is responsible for overseeing compliance with the securities acts?
The Division of Corporate Finance oversees the compliance with the securities acts and examines all filings made by publicly held companies.
The SEC is comprised of five commissioners, appointed by the President of the United States, and five divisions. divisions. Which of the following divisions is responsible for completing the investigation and takes appropriate actions when there is a violation of a securities law (except the Public Utility Holding Company Act).
The Division of Enforcement completes the investigation and takes appropriate actions when there is a violation of a securities law (except the Public Utility Holding Company Act). This division makes recommendations to the Justice Department concerning any punishments or potential criminal prosecution.
The SEC is comprised of five commissioners, appointed by the President of the United States, and five divisions. divisions. Which of the following divisions is responsible for overseeing the secondary markets, exchanges, brokers, and dealers.
The Division of Trading and Markets oversees the secondary markets, exchanges, brokers, and dealers.
The SEC is comprised of five commissioners, appointed by the President of the United States, and five divisions. divisions. Which of the following divisions is responsible for overseeing the investment advisers and investment companies under the Investment Company Act of 1940 and the Investment Advisers Act of 1940.
The Division of Investment Management oversees the investment advisers and investment companies under the Investment Company Act of 1940 and the Investment Advisers Act of 1940.
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:
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.
A nonaccelerated filer, as established by the U.S. Securities and Exchange Commission, includes companies with less than exactly what amount in public equity float?
A nonaccelerated filer is defined by the SEC as an entity with less than $75 million in public market value.
Which of the following reports would a company file to meet the U.S. Securities and Exchange Commission’s requirements for unaudited, interim financial statements reviewed by an independent accountant?
Form 10-Q is the form for quarterly filing by a public entity with securities listed in the United States.
What is the Form 10-K?
Form 10-K is the form for annual filing by a public entity with securities listed in the United States.
What is the form 14A Proxy Statement?
The proxy statement is the form by which management requests the right to vote through proxy for shareholders at meetings.
What is the Form S-1?
Form S-1 is the basic registration form for new securities to be listed in the United States.
Wood Co.’s dividends on noncumulative preferred stock have been declared but not paid. Wood has not declared or paid dividends on its cumulative preferred stock in the current or the prior year and has reported a net loss in the current year. For the purpose of computing basic earnings per share, how should the income available to common stockholders be calculated?
The dividends on the noncumulative preferred stock and the current-year dividends on the cumulative preferred stock should be added to the net loss.
the dividends subtracted in computing basic EPS are (1) the annual dividend commitment on cumulative preferred whether or not declared or paid, and (2) declared dividends on noncumulative preferred whether paid or not. The firm has negative income. This answer means that the dividends reduce the numerator further - beyond the loss. The final numerator amount is less than (more negative than) the loss. Also, arrear dividends are never included in EPS because they were subtracted in computing EPS in a previous year.
During the current year, Comma Co. had outstanding: 25,000 shares of common stock, 8,000 shares of $20 par, 10% cumulative preferred stock, and 3,000 bonds that are $1,000 par and 9% convertible. The bonds were originally issued at par, and each bond was convertible into 30 shares of common stock. During the year, net income was $200,000, no dividends were declared, and the tax rate was 30%.
What amount was Comma’s basic earnings per share for the current year?
One year of preferred stock dividends is subtracted from income in the numerator of EPS because the stock is cumulative. The amount of dividends declared does not affect the calculation. The bonds are not relevant because basic EPS does not assume conversion of the bonds. The calculation is: Basic EPS = [$200,000 - (8,000 × $20 × .10)]/25,000 = ($200,000 − $16,000)/25,000 = $7.36.
Chape Co. had the following information related to common and preferred shares during the year:
Common shares outstanding, 1/1 700,000
Common shares repurchased, 3/31 20,000
Conversion of preferred shares, 6/30 40,000
Common shares repurchased, 12/1 36,000
Chape reported net income of $2,000,000 at December 31. What amount of shares should Chape use as the denominator in the computation of basic earnings per share?
Weighted average shares outstanding are weighted by the number of months the shares were outstanding during the year. The easiest way to do this is to take each change in common stock and multiply by the number of months remaining - add the shares that increased shares outstanding and subtract shares that reduced shares outstanding.
Shares Months Wtd avg
700,000 12/12 700,000
- 20,000 9/12 - 15,000
\+40,000 6/12 +20,000
-36,000 1/12 - 3,000
702,000
Strauch Co. has one class of common stock outstanding and no other securities that are potentially convertible into common stock. During Year 1, 100,000 shares of common stock were outstanding. In Year 2, two distributions of additional common shares occurred:
On April 1, 20,000 shares of treasury stock were sold, and on July 1, a 2-for-1 stock split was issued.
Net income was $410,000 in Year 2 and $350,000 in Year 1.
What amounts should Strauch report as earnings per share in its Year 2 and Year 1 comparative income statements?
The 2-for-1 split in Year 2 does not substantively change the value of any shares outstanding. Without retroactive application, EPS would be cut roughly in half in Year 2 compared to Year 1. Yet there was little substantive change in the performance of the firm. For reporting in Year 2:
Weighted average shares, Year 1 = 100,000(2) = 200,000.
EPS, Year 1 = $350,000/200,000 = $1.75.
Weighted average shares, 2006 = [100,000 + 20,000(9/12)]2 = 230,000
EPS, 2006 = $410,000/230,000 = $1.78.
Had the Year 1 shares not been adjusted for the split, Year 1 EPS would be $3.50 = $350,000/100,000, or roughly double the EPS of Year 2. Without retroactive application, it would appear that the firm had a drastic reduction in EPS in Year 2. The retroactive application of the split ensures that the base on which EPS is computed uses the same measuring unit.
The treasury stock method of entering stock options into the calculation of diluted EPS:
Is called the treasury stock method because the proceeds from assumed exercise are assumed to be used to purchase treasury stock.
Firms may use the proceeds from the exercise of stock options for any purpose. However, to promote uniformity in reporting, and to reduce the dilution from exercise, the assumption is that the proceeds are used to purchase the firm’s stock on the market. This reduces the net number of new shares outstanding from assumed exercise.
A firm with a net income of $30,000 and weighted average actual shares outstanding of 15,000 for the year also had the following two securities outstanding the entire year: (1) 2,000 options to purchase one share of stock for $12 per share. The average share price during the year was $20, (2) cumulative convertible preferred stock with an annual dividend commitment of $4,500. Total common shares issued on conversion are 2,900. Compute diluted EPS for this firm.
The options and convertible preferred stock are potential common stock (PCS). First compute basic EPS as the basis for diluted EPS, and also as a benchmark for determining whether the two potential common stock securities are dilutive. Basic EPS = ($30,000 – $4,500)/15,000 = $1.70. The preferred dividend is subtracted from income because the preferred is cumulative. Then determine the numerator and denominator effects of the PCS to enter them into diluted EPS in the order of lowest ratio of numerator to denominator effect (n/d) first. The option’s numerator effect is zero; the denominator effect = 2,000 – (2,000)$12/$20 = 800. 2,000 shares would be issued upon exercise but under the treasury stock method the firm is assumed to apply the proceeds from exercise (2,000 × $12) and purchase shares of the firm’s stock for $20 each. Thus, the n/d for options = 0/800 = 0. The n/d for the convertible preferred stock is the ratio of dividends that would not have been declared if the stock converted, to the common shares assumed issued on conversion. n/d = $4,500/2,900 = $1.55. Enter the options into diluted EPS first, because the options have the lower n/d. DEPS tentative = ($30,000 − $4,500)/(15,000 + 800) = $1.61. The convertible preferred is dilutive because its n/d ratio of $1.55 is less than $1.61, the tentative or first-pass amount for diluted EPS. DEPS final = ($30,000 – $4,500 + $4,500)/(15,000 + 800 + 2,900) = $1.60.
LM Company has net income of $130,000, weighted average shares of common stock outstanding of 50,000, and preferred dividends for the period of $20,000. What is LM’s earnings per share of common stock?
Earnings per share (EPS) is calculated on net income available to the common stockholders, $130,000 − $20,000, or $110,000, divided by weighted average shares of common stock outstanding, 50,000. The EPS = $110,000 / 50,000 = $2.20
If everything else is held constant, earnings per share is increased by:
Purchase of treasury stock.
Earnings per share is calculated by dividing earnings (profit) available to common stockholders by weighted average number of shares of common stock outstanding. If the denominator is decreased by purchasing treasury stock, then the EPS result is increased.
Cott Co.’s four business segments have revenues and identifiable assets expressed as percentages of Cott’s total revenues and total assets as follows:
Revenues Assets
Ebon 64% 66%
Fair 14% 18%
Gel 14% 4%
Hak \_\_ 8%_ _ 12%_
100% 100%
====== ======
Which of these business segments are deemed to be reportable segments?
Ebon, Fair, Gel, and Hak
FAS 131, issued in 1997, uses the term “operating segments” rather than business segments. All four meet at least one of the three criteria for a reportable segment. A segment needs to meet only one of these criteria to be reportable (that is, required to report income and other data separately).
The three criteria are (summarized):
segment revenue is 10% or more of total revenue for all reported operating segments,
segment profit or loss is 10% or more of total profit for those segments reporting a profit, or 10% of total loss for those segments reporting a loss, whichever is greater in absolute amount, and
segment assets are 10% or more of total assets of all operating segments. Thus, each segment meets at least one of the three criteria.
Grum Corp., a publicly owned corporation, is subject to the requirements for segment reporting.
In its income statement for the year ending December 31, 2004, Grum reported revenues of $50,000,000, operating expenses of $47,000,000, and net income of $3,000,000. Operating expenses include payroll costs of $15,000,000. Grum’s combined identifiable assets of all industry segments at December 31, 2004 were $40,000,000.
In its 2004 financial statements, Grum should disclose major customer data if sales to any single customer amount to at least
Under FAS 131 (1997), if revenues from transactions with a single customer amount to 10% or more of a firm’s total revenue, that fact must be disclosed, along with the total revenues from each such customer.
For this firm with revenues of $50,000,000, 10% of total revenues is $5,000,000.
Yellow Co. received a large worker’s compensation claim of $90,000 in the third quarter for an injury occurring in the third quarter. How should Yellow account for the transaction in its interim financial report?
Recognize $90,000 in the third quarter.
The worker’s compensation claim should be reported in the period incurred, the third quarter. This is a transaction that occurred in the third quarter and does not impact other quarters.
On January 16, Tree Co. paid $60,000 in property taxes on its factory for the current calendar year. On April 2, Tree paid $240,000 for unanticipated major repairs to its factory equipment. The repairs will benefit operations for the remainder of the calendar year. What amount of these expenses should Tree include in its third quarter interim financial statements for the three months ended September 30?
Interim reporting treats each interim period as an integral part of the annual period. The two expenditures, in this problem, benefit more than one quarter. Thus, the expenses are recognized in the periods benefited, rather than only in the period of expenditure. The property taxes benefit all four quarters; therefore, $15,000 ($60,000/4) is recognized each quarter. The repair benefits three quarters; therefore, $80,000 ($240,000/3) is recognized each quarter. The sum of the two amounts is $95,000 to be recognized in quarter three.
A planned volume variance in the first quarter, which is expected to be absorbed by the end of the fiscal period, ordinarily should be deferred at the end of the first quarter if it is:
Paragraph 14.d. of APB Opinion 28 states: “Purchase price variances or volume or capacity cost variances that are planned and expected to be absorbed by the end of the annual period, should ordinarily be deferred at interim reporting dates.”
The reason for the deferral is that, from the point of view of the entire reporting year, there will be no volume variance. The Opinion requires the integral view of interim reporting for most items - that an interim period is an integral part of the annual period. Recognizing, rather than deferring, the variance in the first quarter would cause the reporting of the first quarter results to be unrepresentative of the annual period of which it is a part.
Kell Corp. reported $111,000 of net income for the quarter ended September 30, 20X5. Additional information for the quarter:
- A $60,000 gain from discontinued operation, realized on April 30, 20X5, was allocated equally to the second, third, and fourth quarters of 2005.
- A $16,000 cumulative-effect adjustment (dr.) resulting from a change in inventory valuation method was recognized on August 2, 20X5. The new method was used for the quarter ended September 30. The $111,000 earnings amount does not reflect the cumulative effect.
In addition, Kell paid $48,000 on February 1, 20X5, for 20X5 calendar-year property taxes. Of this amount, $12,000 was allocated to the third quarter of 20X5.
For the quarter ended September 30, 20X5, Kell should report net income of:
The gain from discontinued operations should be recognized entirely in the second quarter. There is no meaningful basis on which to allocate the gain. It is a one-time occurrence. The cumulative effect is not recognized in income. The firm’s treatment of the property tax cost is correct. The cost relates to the entire year. Therefore, each quarter should bear 1/4 of the cost.
Third quarter net income = $91,000 = $111,000 − $60,000/3.
Which one of the following is not an other comprehensive basis of accounting?
Pure accrual basis accounting is not an other comprehensive basis of accounting. The concept of “other comprehensive basis” means a comprehensive basis of accounting other than pure (or full) accrual accounting.
Alco, Inc., a small manufacturing company, prepares its financial statements using its income tax basis of accounting. In December, 2012, it determined that an error had been made in the amount of rent expense reported in its 2011 tax return. How should Alco account for the amount of the rental expense error in its 2012 financial statements?
The amount of the rental expense error made in the tax return (and financial statements) of the prior period would be reported as a prior period adjustment in Alco’s 2012 financial statements.
If a company that is not a public business entity wants to apply the simplified hedge accounting approach to a cash flow hedge of a variable rate borrowing with a receive-variable, pay-fixed interest rate swap, which of the following is a condition that must be met?
The variable interest rate on the interest rate swap and the variable interest rate on the hedged borrowing are linked to the same index.
To qualify for simplified hedge accounting, one of the criteria is that both the swap and the hedged borrowing are linked to the same index.
A private company decided to adopt one of the standards issued by the Private Company Council. What are the requirements upon adoption of the PCC standard?
Apply the new standard on a prospective basis.
Adoption of a private company standard is done on a prospective basis.
Even though the SEC delegates the creation of accounting standards to the private sector, the SEC frequently comments on accounting and auditing issues. The main pronouncements published by the SEC are:
Financial Reporting Releases (FRR).
The main pronouncements published by the SEC are the Financial Reporting Releases (FRR) and the Staff Accounting Bulletins (SAB).
Which of the following is the annual report that is filed with the United States Securities and Exchange Commission (SEC)?
Form 10-K.
What is Form 8-K?
Form 8-K is used to report significant events that effect the company such as a business combination or bankruptcy.
What is Form 10-Q?
Form 10-Q is the quarterly report filed with the SEC.
What is Form S-1?
Form S-1 is filed with the SEC in a public offering.
A nonaccelerated filer, as established by the U.S. Securities and Exchange Commission, includes companies with less than exactly what amount in public equity float?
A nonaccelerated filer is defined by the SEC as an entity with less than $75 million in public market value.
Which of the following reports would a company file to meet the U.S. Securities and Exchange Commission’s requirements for unaudited, interim financial statements reviewed by an independent accountant?
Form 10-Q is the form for quarterly filing by a public entity with securities listed in the United States.
What is 14A Proxy Statement?
The proxy statement is the form by which management requests the right to vote through proxy for shareholders at meetings.
Which of the following is not a required component of the 10-K filing?
Product market share.
The market share of the company’s product is not a required disclosure. The company may chose to voluntarily present this information, but it is not a required disclosure.
Which regulation governs the form and content of financial statement disclosures?
Regulation S-X
Regulation S-X governs the form and content of financial statements and financial statement disclosures for publicly traded entities
What does the Sarbanes Oxley govern?
Sarbanes Oxley enhances corporate governance to mitigate financial accounting abuses.
What does S-K govern?
Regulation S-K governs the form and content of non-financial statement disclosures.
Which of the following 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?
Discussion of risks and uncertainties.
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.
A company that is a large accelerated filer must file its Form 10-Q with the United States Securities and Exchange Commission within how many days after the end of the period?
40 days
A large accelerated filer is a company with worldwide market value of outstanding voting and nonvoting common equity held by nonaffiliates of $700 million or more. A large accelerated filer must file its 10Q within 40 days after quarter end.
True or False
A company can use either the purchase or the pooling method for business combinations.
False
True or False
Total revenues for a consolidated entity are calculated by adding the total revenue of the parent for the year and the total revenue of the subsidiary from the date of acquisition, less any intercompany sales.
True
True or False
Goodwill is amortized over a period of forty years.
False
True or False
Goodwill is classified and included with other intangible assets for purposes of measuring impairment.
False
True or False
Intangible assets with indefinite lives are not amortized.
True
True or False
The stockholder equity accounts in the consolidated balance sheet are those of the parent company.
True
True or False
The effect of unrealized profits and sales between the acquirer and acquiree is classified as an intercompany transaction and must be eliminated.
True
True or False
A newly identified intangible asset must meet the contractual legal or the separability criterion to be recognized as an intangible asset at the time of consolidation.
True
Multi Step Income Statement
Net Sales COGS =Gross Margin \+Operating Expenses =Operating Margin -Interest Income \+Interest Expense - Other Rev, Gains, Expenses, & Losses =Pretax income from Continuing Operations \+Income Tax Expense -Income from continuing operations -Income from discontinued operations (next tax) =Net Income
EPCS
Income from continuing operations:
Income from continuing operations:
Net income:
Under GAAP, which of the following can be issued as the primary form of public financial statement disclosure for a parent and its subsidiaries?
Under GAAP, only consolidated financial statements may be issued as the primary form of public disclosure for a parent and its subsidiaries. Parent only statements and separate parent and subsidiary statements may not be issued in lieu of consolidated financial statements.
Which one of the following methods, if any, may a parent use on its books to carry an investment in a subsidiary that it will consolidate?
A parent may use the cost method, the equity method, or any other method on its books to carry an investment in a subsidiary that it will consolidate. The method that is used on its books will affect the consolidating process, but the final consolidated financial statements will be the same regardless of the method the parent uses on its books.
Aceco has significant investments in three separate entities. These investments are:
- 40% ownership of the voting stock of Kapco.
- 60% ownership of the voting stock of Placo.
- 100% ownership of the voting stock of Simco
Which of Aceco’s investments would be consolidated with Aceco in its consolidated financial statements?
Since Aceco owns controlling interest in Placo (60%) and in Simco (100%), each would be consolidated with Aceco. Kapco would not be consolidated, because Aceco does not have controlling interest in Kapco. In Aceco’s consolidated financial statements, Kapco would be shown as an investment.
Sun Co. is a wholly owned subsidiary of Star Co. Both companies have separate general ledgers and prepare separate financial statements. Sun requires stand-alone financial statements. Which of the following statements is correct?
Consolidated statements should be prepared by Star, the parent, and not by Sun, the subsidiary. Star has an investment in and control of Sun, which is the basis for preparing consolidated statements; Sun does not have an investment in, or control of, Star. Thus, there is no basis for Sun to prepare consolidated statements.
The preparation of consolidated statements likely will require the following information about the subsidiary’s assets and liabilities at the date of acquisition:
Both book values and fair values of a subsidiary’s assets and liabilities will need to be determined at the date of acquisition in order to prepare consolidated financial statements after a business combination.
Penn, Inc., a manufacturing company, owns 75% of the common stock of Sell, Inc., an investment company. Sell owns 60% of the common stock of Vane, Inc., an insurance company.
In Penn’s consolidated financial statements, should consolidation accounting or equity method accounting be used for Sell and Vane?
Consolidation used for both Sell and Vane.
If one looked just at Penn’s interest in Vane’s result of 45% (75% × 60%), one might say that the equity method would be appropriate.
However, because Sell owns 60% of Vane, it controls Vane and would need to consolidate Vane. Because Penn owns 75% of Sell, it controls Vane and would need to consolidate Sell, which consolidated Vane. Thus, all three would be consolidated, making this response correct.
An investor will report an investment in its financial statements using a different method than it uses to carry the investment on its books if its minimum ownership of the investee is:
50+%
If an investor owns 50+% (up to and including 100%) of an investee, it will normally carry the investment on its books using the cost method, the equity method, or some other method, but it will report the investment in its financial statements as a consolidated subsidiary. The method used on the investor’s books will be different than the method used to report the investment in financial statements.
Consolidated financial statements are typically prepared when one company has a controlling financial interest in another unless:
The subsidiary is in bankruptcy.
Currently, the only reasons allowable for not consolidating a majority-owned subsidiary is where control does not reside with the majority owner, making this the correct response.
Which of the following information that exists at the date of an acquisition will be needed to carry out the consolidating process?
I. Book values of a subsidiary’s assets and liabilities.
II. Fair values of a subsidiary’s assets and liabilities.
III. Parent’s cost of its investment in the subsidiary.
In order to prepare consolidated financial statements, the parent needs the book values and fair values of a subsidiary’s assets and liabilities at the date of the business combination as well as the Parent’s cost of its investment in the subsidiary.
Consolidated financial statements are based on the concept that:
In the preparation of financial statements, economic substance takes precedence over legal form.
The preparation of consolidated financial statements is based on the concept that economic substance takes precedence over legal form. In form, the corporations are separate legal entities, but in substance, they are under the common economic control of the parent’s shareholders.
A subsidiary, acquired for cash in a business combination, owned inventories with a market value different from the book value as of the date of combination. A consolidated balance sheet prepared immediately after the acquisition would include this difference as part of:
Inventories
The difference between (fair) market value and book value of inventories would be recognized by adjusting inventories to fair value on the consolidated balance sheet.
On November 30, 2004, Parlor, Inc. purchased for cash at $15 per share all 250,000 shares of the outstanding common stock of Shaw Co.
On November 30, 2004, Shaw’s balance sheet showed a carrying amount of net assets of $3,000,000. On that date, the fair value of Shaw’s property, plant, and equipment exceeded its carrying amount by $400,000.
In its November 30, 2004, consolidated balance sheet, what amount should Parlor report as goodwill?
Goodwill is the difference between the purchase price of $3,750,000 (250,000 × $15.00) and the fair value of the net assets ($3,000,000 + $400,000) or $350,000.
A subsidiary, acquired for cash in a business combination, owned equipment with a market value in excess of book value as of the date of combination. A consolidated balance sheet prepared immediately after the acquisition would treat this excess as:
Plant and Equipment
The excess of (fair) market value over book value of equipment would be recognized by writing up plant and equipment to fair value on the consolidated balance sheet.
Beni Corp. purchased 100% of Carr Corp.’s outstanding capital stock for $430,000 cash. Immediately before the purchase, the balance sheets of both corporations reported the following:
Beni Carr Assets $2,000,000 $750,000 Liabilities $ 750,000 $400,000 Common stock 1,000,000 310,000 Retained earnings \_\_250,000 \_\_40,000 Liabilities and
stockholders’ equity $2,000,000 $750,000
On the date of purchase, the fair value of Carr’s assets was $50,000 more than the aggregate carrying amounts. In the consolidated balance sheet prepared immediately after the purchase, the consolidated stockholders’ equity should amount to:
$1,250,000
On the date of a business combination using acquisition accounting, the consolidated stockholders’ equity will exactly equal the parent company stockholders’ equity. This will continue to be the case as long as the parent company uses a complete equity method of accounting for the subsidiary.
Pride, Inc. owns 80% of Simba, Inc.’s outstanding common stock. Simba, in turn, owns 10% of Pride’s outstanding common stock.
What percentage of the common stock cash dividends declared by the individual companies should be reported as dividends declared in the consolidated financial statements?
Dividends declared by Pride 90%
Dividends declared by Simba 0%
Subsidiary dividends are never considered part of consolidated dividends. They are either eliminated in the consolidation entries or allocated to reducing noncontrolling interests. In this problem, 80% of Simba’s dividends will be eliminated as intercompany, and 20% will be allocated to reducing noncontrolling interest.
In addition, since 10% of the dividends of Pride never go outside the consolidated entity, they are not considered dividends of the consolidated entity either.
Rowe Inc. owns 80% of Cowan Co.’s outstanding capital stock. On November 1, Rowe advanced $100,000 in cash to Cowan. What amount should be reported related to the advance in Rowe’s consolidated balance sheet as of December 31?
$-0-
All intercompany receivables and payables should be eliminated in the preparation of a consolidated balance sheet so that no intercompany receivables/payables are reported. In this question, an eliminating entry should be made that eliminates (credits) Rowe’s receivable from Cowan against (debits) Cowan’s payable to Rowe, both for $100,000. Since the receivable/payable is between the affiliated entities, 100% (not 80%) of the intercompany amount should be eliminated.
On December 31, 2005, Grey, Inc. owned 90% of Winn Corp., a consolidated subsidiary, and 20% of Carr Corp., an investee in which Grey cannot exercise significant influence. On the same date, Grey had receivables of $300,000 from Winn and $200,000 from Carr.
In its December 31, 2005, consolidated balance sheet, Grey should report accounts receivable from affiliates of:
$200,000
A 90% owned subsidiary will be consolidated, and any intercompany receivables such as these are eliminated from both parties’ books in the consolidating process.
Therefore, the $300,000 receivable from Winn will not appear on the consolidated balance sheet at all. The $200,000 from Carr is a receivable from an affiliate (20% owned) and will need to be reported as such.
King, Inc. owns 70% of Simmon Co.’s outstanding common stock. King’s liabilities total $450,000, and Simmon’s liabilities total $200,000. Included in Simmon’s financial statements is a $100,000 note payable to King. What amount of total liabilities should be reported in the consolidated financial statements?
$550,000
The consolidated financial statements should reflect 100% of the assets and liabilities of the subsidiary less any intercompany balances. Therefore the balance on the consolidated balance sheet should be: $450,000 + 200,000 − 100,000 = $550,000.
Which one of the following is not a characteristic of intercompany bonds?
When bonds become intercompany, they are written off of the books of the issuing affiliate and the investing affiliate.
The liability and investment related to intercompany bonds are eliminated only on the consolidating worksheet. They are not written off the books of either the issuing or the investing affiliate. From the perspective of the separate companies, the liability and investment related to the bonds continue to exist, but for consolidated purposes, they have been constructively retired.
On December 31, 2008, Pico acquired $250,000 par value of the outstanding $1,000,000 bonds of its subsidiary, Sico, in the market for $200,000. On that date, Sico had a $100,000 premium on its total bond liability.
Which one of the following is the amount of premium or discount on Pico’s investment in Sico’s bonds?
$50,000 discount
The premium or discount on a bond investment is the difference between the par value of the bonds and the price paid for the bonds in the market. If the price paid is more than par value, there is a premium on the bond investment. If the price paid is less than par value, there is a discount on the bond investment. In this case, the price paid for the investment ($200,000) is less than the par value of the bonds ($250,000) by $50,000. Therefore, there is a $50,000 discount on Pico’s investment.
On December 31, 2008, Pico acquired $250,000 par value of the outstanding $1,000,000 bonds of its subsidiary, Sico, in the market for $200,000. On that date, Sico had a $100,000 premium on its total bond liability.
Which one of the following is the net carrying value of Sico’s total bond liability?
$1,100,000
A premium on a bond liability results from the sale of the bonds at a price in excess of par (face) value. Therefore, a premium would be added to par value to get net carrying value. Sico’s premium on its bond liability ($100,000) should be added to the par (or face) value of its bond liability ($1,000,000) to determine the net carrying value of the liability. Thus, the answer should be $1,000,000 par value + $100,000 premium = $1,100,000 net carrying value.
On December 31, 2008, Pico acquired $250,000 par value of the outstanding $1,000,000 bonds of its subsidiary, Sico, in the market for $200,000. On that date, Sico had a $100,000 premium on its total bond liability.
Which one of the following is the net amount of gain or loss that will be recognized by Pico in its December 31, 2008, consolidated financial statements as a result of its intercompany bonds?
$75,000
In the elimination of intercompany bonds, the intercompany bond liability at par will be eliminated against the intercompany bond investment at par. Therefore, the gain or loss recognized as a result of constructive retirement of intercompany bonds is the net of the premium or discount on the bond liability and the premium or discount on the bond investment. In this case, there is a total $100,000 premium on the bond liability, but because only one-fourth ($250,000/$1,000,000 = 1/4) of the bonds are intercompany, only one fourth of the premium is eliminated. Thus, $25,000 of premium on the bond liability (a credit) will be eliminated against the $50,000 discount on the bond investment (also a credit). As a result of eliminating the two credits ($25,000 + $50,000 = $75,000), a $75,000 gain on constructive retirement will be recognized.
On December 31, 2008, Pico acquired $250,000 par value of the outstanding $1,000,000 bonds of its subsidiary, Sico, in the market for $200,000. At that date, Sico had a $100,000 premium on its total bond liability.
Assume each company maintains its premium or discount in a separate account. Which one of the following will be the intercompany bond elimination entry made on the December 31, 2008 consolidating worksheet?
DR: Bonds Payable
Premium on Bonds Payable
Discount on Bond Investment
CR: Investment in Bonds
Gain on Constructive Retirement
The Investment in Bonds (a debit balance, so it will be credited) and the Bonds Payable (a credit balance, so it will be debited) will be eliminated against each other at par value ($250,000). The Discount on Bond Investment $50,000 (a credit balance, so it will be debited) and the Premium on Bonds Payable $25,000 (a credit balance, so it will be debited) will be eliminated resulting in a Gain on Constructive Retirement of $75,000, a credit balance.
Combined statements may be used to present the results of operation of:
Companies under common management: Yes
Commonly controlled companies: Yes
Combined financial statements are used (when consolidated statements are not appropriate) to show the aggregate results both for companies under common management and for companies under common control (and for unconsolidated subsidiaries).
Nolan owns 100% of the capital stock of both Twill Corp. and Webb Corp.
Twill purchases merchandise inventory from Webb at 140% of Webb’s cost. During Year 4, merchandise that cost Webb $40,000 was sold to Twill. Twill sold all of this merchandise to unrelated customers for $81,200 during Year 4. In preparing combined financial statements for Year 4, Nolan’s bookkeeper disregarded the common ownership of Twill and Webb.
By what amount was unadjusted revenue overstated in the combined income statement for Year 4?
$56,000
Since all the goods have been sold outside the combined entity, income recognition is correct.
However, sales and cost of goods sold have been recorded at two different points (i.e., the sale from Webb to Twill and the sale from Twill to outsiders). To the combined entity, Webb’s cost of merchandise (the original cost to the combined entity) is what is needed for cost of goods sold, and Twill’s sales (the amount the merchandise was sold for outside the combined entity) is needed for sales.
This means that the sale from Webb to Twill and the cost of goods recorded by Twill need to be eliminated. That amount is $56,000 (computed as $40,000 cost to Webb × transfer price to Twill of 140% of cost = $56,000).
In the preparation of combined financial statements, would the following issues be treated in the same way as when preparing consolidated financial statements or in a different way?
Minority Interest: Same
Foreign Operations: Same
Different Fiscal Periods: Same
According to ASC 810, if problems associated with minority interest, foreign operations, different fiscal periods, or income taxes occur in the preparation of combined financial statements, they should be treated in the same manner as in the preparation of consolidated financial statements. Therefore, all three items should be treated in the same manner as in consolidated statements.
Wood Co.’s dividends on noncumulative preferred stock have been declared but not paid. Wood has not declared or paid dividends on its cumulative preferred stock in the current or the prior year and has reported a net loss in the current year. For the purpose of computing basic earnings per share, how should the income available to common stockholders be calculated?
The dividends on the noncumulative preferred stock and the current-year dividends on the cumulative preferred stock should be added to the net loss.
In general, the dividends subtracted in computing basic EPS are (1) the annual dividend commitment on cumulative preferred whether or not declared or paid, and (2) declared dividends on noncumulative preferred whether paid or not. The firm has negative income. This answer means that the dividends reduce the numerator further - beyond the loss. The final numerator amount is less than (more negative than) the loss. Also, arrear dividends are never included in EPS because they were subtracted in computing EPS in a previous year.
During the current year, Comma Co. had outstanding: 25,000 shares of common stock, 8,000 shares of $20 par, 10% cumulative preferred stock, and 3,000 bonds that are $1,000 par and 9% convertible. The bonds were originally issued at par, and each bond was convertible into 30 shares of common stock. During the year, net income was $200,000, no dividends were declared, and the tax rate was 30%.
What amount was Comma’s basic earnings per share for the current year?
$7.36
One year of preferred stock dividends is subtracted from income in the numerator of EPS because the stock is cumulative. The amount of dividends declared does not affect the calculation. The bonds are not relevant because basic EPS does not assume conversion of the bonds. The calculation is: Basic EPS = [$200,000 - (8,000 × $20 × .10)]/25,000 = ($200,000 − $16,000)/25,000 = $7.36.
Jen Co. had 200,000 shares of common stock and 20,000 shares of 10%, $100 par value cumulative preferred stock. No dividends on common stock were declared during the year. Net income was $2,000,000. What was Jen’s basic earnings per share?
$9.00
Earnings per share is: (net income - preferred dividends)/common shares outstanding. Preferred stock dividends are $100 × 10% × 20,000 shares = $200,000. Earnings per share is (2,000,000-200,000)/200,000=$9 per share.
Balm Co. had 100,000 shares of common stock outstanding as of January 1. The following events occurred during the year:
4/1 Issued 30,000 shares of common stock.
6/1 Issued 36,000 shares of common stock.
7/1 Declared a 5% stock dividend.
9/1 Purchased as treasury stock 35,000 shares of its common stock. Balm used the cost method to account for the treasury stock.
What is Balm’s weighted average of common stock outstanding at December 31?
139,008
More than one approach is available to compute WA (each yields the same answer) but perhaps the easiest is to weight each item separately going forward to the end of the year. This approach yields 139,008 = 100,000(12/12) + 30,000(9/12) + 36,000(7/12) - 35,000(4/12). The beginning shares are outstanding the entire year (12/12). The next two items are weighted for the fraction of the year they are outstanding. Stock dividends and splits are retroactively applied to all items before their issuance - hence the multiplication by 1.05. The treasury shares are removed from the average for 4/12 of the year - these shares already reflect the stock dividend.
Chape Co. had the following information related to common and preferred shares during the year:
Common shares outstanding, 1/1 700,000
Common shares repurchased, 3/31 20,000
Conversion of preferred shares, 6/30 40,000
Common shares repurchased, 12/1 36,000
Chape reported net income of $2,000,000 at December 31. What amount of shares should Chape use as the denominator in the computation of basic earnings per share?
702,000
Weighted average shares outstanding are weighted by the number of months the shares were outstanding during the year. The easiest way to do this is to take each change in common stock and multiply by the number of months remaining - add the shares that increased shares outstanding and subtract shares that reduced shares outstanding.
Shares Months Wtd avg 700,000 12/12 700,000 - 20,000 9/12 - 15,000 \+40,000 6/12 +20,000 -36,000 1/12 - 3,000 702,000
Strauch Co. has one class of common stock outstanding and no other securities that are potentially convertible into common stock. During Year 1, 100,000 shares of common stock were outstanding. In Year 2, two distributions of additional common shares occurred:
On April 1, 20,000 shares of treasury stock were sold, and on July 1, a 2-for-1 stock split was issued.
Net income was $410,000 in Year 2 and $350,000 in Year 1.
What amounts should Strauch report as earnings per share in its Year 2 and Year 1 comparative income statements?
Year 2 $ 1.78
Year 1 $ 1.75
For EPS purposes, stock dividends and splits are retroactively applied to all periods presented, and to all share changes within the year of the split or dividend.
For reporting in Year 2:
Weighted average shares, Year 1 = 100,000(2) = 200,000.
EPS, Year 1 = $350,000/200,000 = $1.75.
Weighted average shares, 2006 = [100,000 + 20,000(9/12)]2 = 230,000
EPS, 2006 = $410,000/230,000 = $1.78.
On January 31, 2004, Pack, Inc. split its common stock 2 for 1, and Young, Inc. issued a 5% stock dividend. Both companies issued their December 31, 2003, financial statements on March 1, 2004.
Should Pack’s 2003 earnings per share (EPS) take into consideration the stock split, and should Young’s 2003 EPS take into consideration the stock dividend?
Pack’s 2003 EPS - Yes
Young’s 2003 EPS - Yes
EPS is used primarily as an input to predictions of future earnings. The stock split and dividend cause the number of shares outstanding to increase, and thus affect the future earnings prospects on a per share basis. These events should be included in the computation of EPS even though they did not occur as of the balance sheet date. Financial statement users view the information as if it were current as of the date of publication.
A company reported net income available to common stockholders of $2,000,000 for the year ended December 31, year 2. The company had 1,500,000 shares of common stock outstanding as of January 1, year 2, and issued 500,000 additional shares of common stock on May 1, year 2. What amount is the company’s basic earnings per share for the year ended December 31, year 2?
$1.09
Basic earnings per share (EPS) is net income available to common shareholders divided by the weighted average shares outstanding. This question provided the net income so the task is to compute the weighted shares outstanding. The beginning shares outstanding are 1,500,000 plus the shares issued during the year of 500,000 × 8/12 (333,333), or 1,833,333. Therefore, basic EPS is $2,000,000 ÷ 1,833,333 = $1.09.
A company had 400,000 shares of common stock issued and outstanding on January 1, year 1, and had the following equity transactions for year 1:
Transactions Date
Issued 200,000 new shares for cash April 1
Issued new shares as a result of a 3-for-1 stock split
July 1
Purchased 300,000 shares treasury stock for cash
October 1
What should the company use as the denominator for the calculation of basic earnings per share for year ended December 31, year 1?
1,575,000
The weighted average shares outstanding are calculated as follows:
({[400,000+(200,000×9/12)]×3}−300,000×3/12)=1,575,000(1,574,999rounded)
LM Company has net income of $130,000, weighted average shares of common stock outstanding of 50,000, and preferred dividends for the period of $20,000. What is LM’s earnings per share of common stock?
$2.20
Earnings per share (EPS) is calculated on net income available to the common stockholders, $130,000 − $20,000, or $110,000, divided by weighted average shares of common stock outstanding, 50,000. The EPS = $110,000 / 50,000 = $2.20
If everything else is held constant, earnings per share is increased by:
Purchase of treasury stock.
Earnings per share is calculated by dividing earnings (profit) available to common stockholders by weighted average number of shares of common stock outstanding. If the denominator is decreased by purchasing treasury stock, then the EPS result is increased.
Why do preferred stock dividends appear in the calculation of earnings per share (EPS)?
Preferred stock dividends are subtracted from the earnings for the period in the calculation of earnings per share.
Earnings per share (EPS) is calculated on net income available to the common stockholders, divided by weighted average shares of common stock outstanding. The preferred dividends must be subtracted from the net income, as that amount is not available to the common stockholders.
AB Company reported earnings per share of $10.50 on income before discontinued operations, ($2.00) on income (loss) attributed to discontinued operations, and $8.50 on net income. Which EPS figure is more relevant to a potential investor?
$10.50
Potential investors and current investors are interested in the future earnings potential of the entity. Thus, they are interested in the earnings per share on continuing income, which would be the $10.50 per share. The EPS attributed to discontinued operations cannot be used in predicting future earnings, as they are one-time events.
For which of the following income statement sections is earnings per share calculated?
Income before discontinued operations.
Earnings per share (EPS) is calculated on income before discontinued operations, and net income.
The treasury stock method of entering stock options into the calculation of diluted EPS:
Is called the treasury stock method because the proceeds from assumed exercise are assumed to be used to purchase treasury stock.
Firms may use the proceeds from the exercise of stock options for any purpose. However, to promote uniformity in reporting, and to reduce the dilution from exercise, the assumption is that the proceeds are used to purchase the firm’s stock on the market. This reduces the net number of new shares outstanding from assumed exercise.
A firm with a net income of $30,000 and weighted average actual shares outstanding of 15,000 for the year also had the following two securities outstanding the entire year: (1) 2,000 options to purchase one share of stock for $12 per share. The average share price during the year was $20, (2) cumulative convertible preferred stock with an annual dividend commitment of $4,500. Total common shares issued on conversion are 2,900. Compute diluted EPS for this firm.
$1.60
Basic EPS = ($30,000 – $4,500)/15,000 = $1.70
The option’s numerator effect is zero; the denominator effect = 2,000 – (2,000)$12/$20 = 800. 2,000 shares would be issued upon exercise but under the treasury stock method the firm is assumed to apply the proceeds from exercise (2,000 × $12) and purchase shares of the firm’s stock for $20 each. Thus, the n/d for options = 0/800 = 0. The n/d for the convertible preferred stock is the ratio of dividends that would not have been declared if the stock converted, to the common shares assumed issued on conversion. n/d = $4,500/2,900 = $1.55. Enter the options into diluted EPS first, because the options have the lower n/d. DEPS tentative = ($30,000 − $4,500)/(15,000 + 800) = $1.61. The convertible preferred is dilutive because its n/d ratio of $1.55 is less than $1.61, the tentative or first-pass amount for diluted EPS. DEPS final = ($30,000 – $4,500 + $4,500)/(15,000 + 800 + 2,900) = $1.60.
The following information pertains to Ceil Co., a company whose common stock trades in a public market:
Shares outstanding at 1/1 100,000
Stock dividend at 3/31 24,000
Stock issuance at 6/30 5,000
What is the weighted average number of shares Ceil should use to calculate its basic earnings per share for the year ended December 31?
126,500
The stock dividend is considered to be outstanding since the beginning of the year. The weighted average is therefore:
100,000+24,000+ (5,000X6/12) = 126,500.
A public entity sells steel for use in construction. One of its customer’s accounts for 43% of sales, and another customer accounts for 40% of sales. What should the entity disclose in its annual financial statements about these two customers?
The amount of the entity’s revenue from each of the two customers.
The entity must disclose the amount of revenues received from a single customer that total 10% or more of total revenues.
Opto Co. is a publicly traded, consolidated enterprise reporting segment information. Which of the following items is a required enterprise-wide disclosure regarding external customers?
The fact that transactions with a particular external customer constitute more than 10% of the total enterprise revenues.
This is one of the disclosures required in FAS 131. The identity of the customer does not need to be disclosed, but the segment reporting the revenue must be identified. Such a segment would meet one of the three quantitative thresholds for reporting segment information. The three thresholds are 10% of revenue, income, and assets.
Which of the following types of entities are required to report on business segments?
Publicly traded enterprises
FAS No. 131 requires that a public business enterprise report financial and descriptive information about its reportable operating segments.
In financial reporting of segment data, which of the following must be considered in determining if an industry segment is a reportable segment?
Sales to unaffiliated customers - YES
Intersegment sales - YES
There are three possible quantitative tests to determine if a segment is reportable. If one or more of the tests is met, the segment is reported. One of these tests is the revenue test. This test determines if the segment’s revenue, which includes both sales to external (unaffiliated customers) and intersegment sales, is 10% or more of the combined revenue of all the company’s operating segments. Therefore, both items are considered.
Correy Corp. and its divisions are engaged solely in manufacturing operations. The following data (consistent with prior years’ data) pertain to the industries in which operations were conducted for the year ending December 31, 2005:
Industry Total revenue Operating profit Identifiable
assets at
12/31/89
A $10,000,000 $1,750,000 $20,000,000
B 8,000,000 1,400,000 17,500,000
C 6,000,000 1,200,000 12,500,000
D 3,000,000 550,000 7,500,000
E 4,250,000 675,000 7,000,000
F 1,500,000 225,000 3,000,000
$32,750,000 $5,800,000 $67,500,000
In its segment information for 2005, how many reportable segments does Correy have?
Five
Using the three quantitative thresholds (tests) from FAS 131 (Disclosures about Segments), the five following segments are reportable operating segments:
A, B, C and E meet the test: Reported revenue, including external and internal, is 10% or more of the combined revenue of all reported operating segments. 10% of $32,750,000 is $3,275,000. The revenues of A, B, C and E all exceed this amount.
D meets the test: Its assets (here $7,500,000 for D) are 10% or more of the combined assets of all operating segments (here $6,750,000 = .10 × $67,500,000).
F meets none of these tests.
Note: Some of the above segments meet more than one test. Only one needs to be met for a segment to be reportable.
Cott Co.’s four business segments have revenues and identifiable assets expressed as percentages of Cott’s total revenues and total assets as follows:
Revenues Assets
Ebon 64% 66%
Fair 14% 18%
Gel 14% 4%
Hak \_\_ 8%_ _12%_
100% 100%
====== ======
Which of these business segments are deemed to be reportable segments?
Ebon, Fair, Gel, and Hak
FAS 131, issued in 1997, uses the term “operating segments” rather than business segments. All four meet at least one of the three criteria for a reportable segment. A segment needs to meet only one of these criteria to be reportable (that is, required to report income and other data separately).
The three criteria are (summarized):
segment revenue is 10% or more of total revenue for all reported operating segments,
segment profit or loss is 10% or more of total profit for those segments reporting a profit, or 10% of total loss for those segments reporting a loss, whichever is greater in absolute amount, and
segment assets are 10% or more of total assets of all operating segments. Thus, each segment meets at least one of the three criteria.
Grum Corp., a publicly owned corporation, is subject to the requirements for segment reporting.
In its income statement for the year ending December 31, 2004, Grum reported revenues of $50,000,000, operating expenses of $47,000,000, and net income of $3,000,000. Operating expenses include payroll costs of $15,000,000. Grum’s combined identifiable assets of all industry segments at December 31, 2004 were $40,000,000.
In its 2004 financial statements, Grum should disclose major customer data if sales to any single customer amount to at least
$5,000,000
Under FAS 131 (1997), if revenues from transactions with a single customer amount to 10% or more of a firm’s total revenue, that fact must be disclosed, along with the total revenues from each such customer.
For this firm with revenues of $50,000,000, 10% of total revenues is $5,000,000.
What information should a public company present about revenues from foreign operations?
Disclose separately the amount of sales to unaffiliated customers and the amount of intracompany sales between geographical areas.
Segment disclosure requires that companies disclose the amount of sales to unaffiliated customers by geographical region. They also require disclosure of intracompany sales between geographical areas. These cannot be aggregated but must be reported separately.
Terra Co.’s total revenues from its three business segments were as follows:
Segment Sales to
unaffiliated
customers Intersegment
sales Total
revenues
Lion $70,000 $30,000 $100,000
Monk 22,000 4,000 26,000
Nevi 8,000 16,000 24,000
—— —– ——
Combined $100,000 $50,000 $150,000
Elimination - (50,000) (50,000)
—— —– ——
Consolidated $100,000 $ - $100,000
======== ====== =======
Which business segment(s) is (are) deemed to be reportable segment(s)?
Lion, Monk, and Nevi
Under FAS 131, a segment is reportable if its sales (including intersegment sales) are at least 10% of total combined revenues (including intersegment sales) for all segments.
Total combined sales are $150,000. Thus, all three segments are reportable because the combined sales of each exceed $15,000.
Yellow Co. received a large worker’s compensation claim of $90,000 in the third quarter for an injury occurring in the third quarter. How should Yellow account for the transaction in its interim financial report?
Recognize $90,000 in the third quarter.
The worker’s compensation claim should be reported in the period incurred, the third quarter. This is a transaction that occurred in the third quarter and does not impact other quarters.
On January 16, Tree Co. paid $60,000 in property taxes on its factory for the current calendar year. On April 2, Tree paid $240,000 for unanticipated major repairs to its factory equipment. The repairs will benefit operations for the remainder of the calendar year. What amount of these expenses should Tree include in its third quarter interim financial statements for the three months ended September 30?
$95,000
Interim reporting treats each interim period as an integral part of the annual period. The two expenditures, in this problem, benefit more than one quarter. Thus, the expenses are recognized in the periods benefited, rather than only in the period of expenditure. The property taxes benefit all four quarters; therefore, $15,000 ($60,000/4) is recognized each quarter. The repair benefits three quarters; therefore, $80,000 ($240,000/3) is recognized each quarter. The sum of the two amounts is $95,000 to be recognized in quarter three.
How are discontinued operations that occur at midyear initially reported?
Included in net income and disclosed in the notes to interim financial statements.
Discontinued operations are not related to any other interim period. Therefore, it would be erroneous to allocate their financial statement effects to more than one interim period.
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?
$6,000
Interim income tax expense equals the difference between (1) the total income tax through the end of the interim period at the estimated annual tax rate, and (2) the income tax expense recognized in previous interim periods of the same year. For the second quarter, income tax expense therefore is computed as ($10,000 + $20,000)(.25) − $1,500 = $6,000.
An inventory loss from a permanent market decline of $360,000 occurred in May Year 1. Cox Co. appropriately recorded this loss in May Year 1 after its March 31, Year 1, quarterly report was issued.
What amount of inventory loss should be reported in Cox’s quarterly income statement for the three months ended June 30, Year 1?
$360,000
Unless temporary, declines in the market value of inventory should be recognized in full in the interim period in which they occur.
They should not be deferred to a later period. In this way, the quarterly financial statement reports a significant event for that quarter.
This is an example of an exception to the overall view adopted by the APB with regard to interim reports: that interim reports should be an integral part of the annual period.
On June 30, 20X5, Mill Corp. incurred a $100,000 net loss from disposal of a business segment. Also, on June 30, 20X5, Mill paid $40,000 for property taxes assessed for the calendar year 20X5.
What amount of the foregoing items should be included in the determination of Mill’s net income or loss for the six-month interim period ended June 30, 20X5?
$120,000
The disposal loss cannot be allocated to interim periods. It does not relate to any interim period other than the one in which it occurred. Thus, it is recognized completely in the earnings for the six month period ended June 30.
The property tax is allocated to interim periods based on time expired. The $40,000 tax relates to the entire year of 20X5. With half of the year elapsed at June 30, half of the tax should be recognized in expense. The sum of the amounts to be recognized at June 30 is $120,000 ($100,000 + $20,000).
An inventory loss from a market price decline occurred in the first quarter, and the decline was not expected to reverse during the fiscal year.
However, in the third quarter, the inventory’s market price recovery exceeded the market decline that occurred in the first quarter.
For interim financial reporting, the dollar amount of net inventory should:
Decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the decrease in the first quarter.
When interim period inventory market value declines are not considered temporary (not expected to reverse), they are recognized in the quarter in which the decline occurs. Later recoveries are recognized as gains to the extent of previous losses only. The inventory may not be marked up above cost.
On March 15, 20X4, Krol Co. paid property taxes of $90,000 on its office building for the calendar year 20X4.
On April 1, 20X4, Krol paid $150,000 for unanticipated repairs to its office equipment. The repairs will benefit operations for the remainder of 20X4.
What is the total amount of these expenses that Krol should include in its quarterly income statement for the three months ended June 30, 20X4?
$72,500
One-fourth of the property taxes should be recognized for the second quarter income statement: $22,500 = $90,000/4. Although the entire annual amount was paid in the first quarter, only 1/4 of the total annual amount should be recognized in each quarter. This allocation is based on benefits received (the benefits that flow from payment of property taxes). It is reasonable to assume that each quarter benefits the same amount.
The repair cost benefits three quarters on an equal basis because it was paid at the beginning of the second quarter. Therefore, 1/3 of the cost, or $50,000, should be reported in the income statement for the second quarter.
Thus, the total expense to be recognized in the second quarter is $72,500 ($22,500 + $50,000).
Due to a decline in market price in the second quarter, Petal Co. incurred an inventory loss. The market price is expected to return to previous levels by the end of the year. At the end of the year, the decline had not reversed. When should the loss be reported in Petal’s interim income statements?
In the fourth quarter only.
Temporary declines in inventory value are not recognized in the interim period in which they occur. This decline was expected to be temporary, i.e. it was expected to reverse. Therefore, it is not recorded until the fourth quarter, at which time the normal annual LCM valuation is applied because the decline had not reversed. Had the decline in the second quarter been deemed permanent, it would have been recognized in the second quarter.
For interim financial reporting, a company’s income tax provision for the second quarter of 20X4 should be determined using the:
Effective tax rate expected to be applicable for the full year of 2004 as estimated at the end of the second quarter of 20X4.
To ensure the most current information, an estimate of the applicable tax rate for the entire year is made at the end of each quarter. Also at the end of each quarter, the tax for the entire portion of the year elapsed is computed, including previous quarters of that year. Finally, the previous quarters’ tax is subtracted, yielding the income tax for the latest quarter.
ASC 270, Interim Reporting, concluded that interim financial reporting should be viewed primarily in which of the following ways?
As reporting for an integral part of an annual period.
The fundamental principle underlying interim reporting is that interim reports should be considered an integral part of the annual reporting period. This has important implications for interim reporting. There are exceptions to this principle, however.
A planned volume variance in the first quarter, which is expected to be absorbed by the end of the fiscal period, ordinarily should be deferred at the end of the first quarter if it is:
Favorable - Yes
Unfavorable - Yes
“Purchase price variances or volume or capacity cost variances that are planned and expected to be absorbed by the end of the annual period, should ordinarily be deferred at interim reporting dates.”
The reason for the deferral is that, from the point of view of the entire reporting year, there will be no volume variance. The Opinion requires the integral view of interim reporting for most items - that an interim period is an integral part of the annual period. Recognizing, rather than deferring, the variance in the first quarter would cause the reporting of the first quarter results to be unrepresentative of the annual period of which it is a part.
Kell Corp. reported $111,000 of net income for the quarter ended September 30, 20X5. Additional information for the quarter:
A $60,000 gain from discontinued operation, realized on April 30, 20X5, was allocated equally to the second, third, and fourth quarters of 2005.
A $16,000 cumulative-effect adjustment (dr.) resulting from a change in inventory valuation method was recognized on August 2, 20X5. The new method was used for the quarter ended September 30. The $111,000 earnings amount does not reflect the cumulative effect.
In addition, Kell paid $48,000 on February 1, 20X5, for 20X5 calendar-year property taxes. Of this amount, $12,000 was allocated to the third quarter of 20X5.
For the quarter ended September 30, 20X5, Kell should report net income of:
$91,000
The gain from discontinued operations should be recognized entirely in the second quarter. There is no meaningful basis on which to allocate the gain. It is a one-time occurrence. The cumulative effect is not recognized in income. The firm’s treatment of the property tax cost is correct. The cost relates to the entire year. Therefore, each quarter should bear 1/4 of the cost.
Third quarter net income = $91,000 = $111,000 − $60,000/3.
Which of the following statements, if any, concerning the modified cash basis of accounting is/are correct?
I. The modified cash basis of accounting employs some elements of accrual accounting.
II. To be acceptable, modifications to the cash basis of accounting must have substantial support in practice.
Both I and II.
The modified cash basis of accounting employs some elements of accrual accounting (Statement I) and the modifications to cash basis must have substantial support in practice (Statement II). Both statements are correct.
Which one of the following is not an other comprehensive basis of accounting?
Pure accrual basis.
Pure accrual basis accounting is not an other comprehensive basis of accounting. The concept of “other comprehensive basis” means a comprehensive basis of accounting other than pure (or full) accrual accounting.
Alco, Inc., a small manufacturing company, prepares its financial statements using its income tax basis of accounting. In December, 2012, it determined that an error had been made in the amount of rent expense reported in its 2011 tax return. How should Alco account for the amount of the rental expense error in its 2012 financial statements?
As a prior period adjustment.
The amount of the rental expense error made in the tax return (and financial statements) of the prior period would be reported as a prior period adjustment in Alco’s 2012 financial statements.
Which of the following items would be recognized in financial statements prepared using an income tax basis of accounting relating to permanent differences?
Nontaxable Income - YES
Nondeductible Expenses - YES
Both nontaxable income items (e.g., life insurance proceeds from the death of an officer) and nondeductible expenses (e.g., premium cost of life insurance on an officer) would be recognized in financial statements prepared using an income tax basis of accounting.
When a set of financial statements is prepared using the cash basis or the modified cash basis of accounting, which one of the following is least likely to be an appropriate financial statement title?
Income Statement
When the cash basis or the modified cash basis of accounting is used, the title Income Statement, which is appropriate when the accrual basis of accounting is used, should be replaced by the title Statement of Cash Receipts and Cash Disbursements. This helps distinguish that the statement is not based on full accrual accounting consistent with U.S. GAAP.
If a company that is not a public business entity wants to apply the simplified hedge accounting approach to a cash flow hedge of a variable rate borrowing with a receive-variable, pay-fixed interest rate swap, which of the following is a condition that must be met?
The variable interest rate on the interest rate swap and the variable interest rate on the hedged borrowing are linked to the same index.
To qualify for simplified hedge accounting, one of the criteria is that both the swap and the hedged borrowing are linked to the same index.
A private company decided to adopt one of the standards issued by the Private Company Council. What are the requirements upon adoption of the PCC standard?
Apply the new standard on a prospective basis.
Adoption of a private company standard is done on a prospective basis.
The Private Company Council has issued modified accounting for private companies for what aspect of Goodwill?
Goodwill amortization.
The PCC allows private companies to amortize goodwill over a period to not exceed 10 years.
The following information pertains to Jet Corp. outstanding stock for Year 1:
Common stock, $5 par value
Shares outstanding, 1/1/01 20,000
2-for-1 stock split, 4/1/Year 1 20,000
Shares issued, 7/1/Year 1 10,000
Preferred stock, $10 par value, 5% cumulative
Shares outstanding, 1/1/Year 1 4,000
What are the number of shares Jet should use to calculate Year 1 earnings per share?
45,000
The weighted average shares outstanding for this firm for Year 1 is: 45,000 = [20,000(2) + 10,000(1/2)]. The split affects only the shares issued before date of the split. The July 1 issuance is weighted only by 1/2 a year because the shares were outstanding only 1/2 a year. EPS is computed only on common stock outstanding. The preferred shares have no effect on the computation.
A company had the following outstanding shares as of January 1, year 2:
Preferred stock, $60 par, 4%, cumulative 10,000 shares
Common stock, $3 par 50,000 shares
On April 1, year 2, the company sold 8,000 shares of previously unissued common stock. No dividends were in arrears on January 1, year 2, and no dividends were declared or paid during year 2. Net income for year 2 totaled $236,000. What amount is basic earnings per share for the year ended December 31, year 2?
$3.79
Basic EPS = Net Income - Preferred Dividends / Weighted shares outstanding. The numerator is $236,000 - preferred dividends [($60 × 10,000) × .04 = 24,000] = $212,000. The denominator is 50,000 (12/12) + 8,000 (9/12) = 56,000 shares. $212,000 / 56,000 = $3.786 or $3.79.
What qualifies as a reportable operating segment?
To qualify as a segment, a component must meet one of the three criteria. For all three criteria, the segment must account for 10% or more of the combined amount for all operating segments. Reporting to the company-wide chief operating decision maker is also a requirement of an operating segment.
The following information pertains to revenue earned by Timm Co.’s industry segments for the year ending December 31, 2005:
Segment Sales
to unaffiliated
customers Intersegment sale Total revenue Alo $5,000 $3,000 $8,000 Bix 8,000 4,000 12,000 Cee 4,000 - 4,000 Dil 43,000 16,000 59,000 Combined 60,000 23,000 83,000 Elimination - (23,000) (23,000) Consolidated $60,000 - $60,000
======== ====== ======= In conformity with the revenue test, Timm's reportable segments were
Only Bix and Dil.
To meet the revenue test, an operating segment must have total sales (including intersegment sales) of 10% or more of the combined segment sales (including intersegment sales). $83,000 is the test number.
Only Bix with $12,000 of total sales and Dil with $59,000 have sales in excess of $8,300 (.10 × $83,000).
A corporation issues quarterly interim financial statements and uses the lower cost or net realizable value to value its inventory in its annual financial statements. Which of the following statements is correct regarding how the corporation should value its inventory in its interim financial statements?
Inventory losses generally should be recognized in the interim statements.
Only temporary losses expected to be recovered are not recognized in interim periods. Because most inventory losses are permanent.
In general, an enterprise preparing interim financial statements should:
Use the same accounting principles followed in preparing its latest annual financial statements.
Interim financial statements generally should reflect the same accounting principles used in preparing annual financial statements. Interim periods are considered an integral part of the annual period, with some exceptions.
Farr Corp. had the following transactions during the quarter ended March 31, 20X5:
Loss on early extinguishment of debt $ 70,000
Payment of fire insurance premium for calendar year 20X5 100,000
What amount should be included in Farr’s income statement for the quarter ended March 31, 20X5?
Extinguishment loss - $ 70,000
Insurance expense - $ 25,000
In large measure, accounting principles for interim periods are the same as for annual periods. The extinguishment loss is a one-time event and is recognized entirely in the first quarter. The insurance payment covers an annual period. Thus, only 1/4 of the payment, or $25,000 ($100,000 × .25), is allocated to the first quarter.
Financial Statements prepared on a modified cash basis of accounting would contain items measured on which, if either, of the following bases?
Cash Basis - YES
Accrual Basis - YES
A modified cash basis of accounting would contain items (accounts) measured under both the cash basis of accounting and the accrual basis of accounting. The modified cash basis of accounting uses cash basis accounting modified to incorporate accrual basis accounting for certain types of transactions/events. Modifications must be logical and consistent with accrual basis accounting under U.S. GAAP.
In financial statements prepared on the income-tax basis, how should the nondeductible portion of expenses, such as meals and entertainment, be reported?
Included in the expense category in the determination of income.
Despite the fact that these expenses are not deductible for tax purposes, they are still business expenses and need to be included in the determination of income on the financial statements. In addition, the income tax return requires information on the total meals and entertainment expense in order to calculate the deductible amount.
Hahn Co. prepared financial statements on the cash basis of accounting. The cash basis was modified so that an accrual of income taxes was reported.
Are these financial statements in accordance with the modified cash basis of accounting?
Yes.
Under a strict cash basis of accounting, revenues and expenses are recorded only when cash is received or paid. Under a modified cash basis of accounting, certain accruals and/or deferrals are recorded for financial-statement purposes.
The most common modifications are the capitalization and amortization of long-lived assets and the accrual for income taxes (recognition of income tax expense and related liability).
The following is Gold Corp.’s June 30 trial balance:
Cash overdraft $ 10,000
Accounts receivable, net $ 35,000
Inventory 58,000
Prepaid expenses 12,000
Land held for resale 100,000
Property, plant, and equipment, net 95,000
Accounts payable and accrued expenses 32,000
Common stock 25,000
Additional paid-in capital 150,000
Retained earnings 83,000
_________ _________
$300,000 $300,000
======== ========
Additional information:
Checks amounting to $30,000 were written to vendors and recorded on June 29 resulting in a cash overdraft of $10,000. The checks were mailed on July 9.
Land held for resale was sold for cash on July 15.
Gold issued its financial statements on July 31.
In its June 30 balance sheet, what amount should Gold report as current assets?
$225,000
Current assets are those assets expected to be consumed or realized in cash within one year of the balance sheet date. There is no overdraft because the checks were not sent as of the balance sheet date. Thus, the balance sheet should disclose $20,000 in cash ($30,000 − $10,000).
The land held for resale is a current asset because it is expected to be sold in the next year (and the corroboration of this expectation was known before the issuance of the financial statements).
Cash $ 20,000 Net accounts receivable 35,000 Inventory 58,000 Prepaid expenses 12,000 Land held for resale 100,000 Total current assets $225,000
On October 31, Dingo, Inc. had cash accounts at three different banks. One account balance is segregated solely for a November 15 payment into a bond sinking fund. A second account, used for branch operations, is overdrawn. The third account, used for regular corporate operations, has a positive balance.
How should these accounts be reported in Dingo’s October 31 classified balance sheet?
The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability.
The accounts are with different banks. Thus, the accounts cannot be offset against one another.
The overdraft is a liability because the bank honored a check or withdrawal causing the account to be negative. The firm owes the bank this amount.
The regular corporate account is part of the cash account, a current asset. The segregated account is a long-term investment. The cash in this asset is set aside for a specific purpose. There is no intent to use the cash for ordinary operating purposes.
The following information pertains to Grey Co. on December 31, 20X3:
Checkbook balance $12,000
Bank statement balance 16,000
Check drawn on Grey’s account, payable to a vendor, dated and recorded 12/31/X3 but not mailed until 1/10/X4 1,800
On Grey’s December 31, 20X3 balance sheet, what amount should be reported as cash?
$13,800
The correct cash balance is the balance per the checkbook ($12,000) plus the $1,800 check written to the vendor, for a total of $13,800.
This check reduced the balance in the checkbook but was not mailed. Thus, the amount remains in Grey’s cash balance at the end of the year. The bank statement balance is not the correct balance because information about transactions affecting cash near the end of the month, recorded by Grey, did not reach the bank by the cutoff date.
Cook Co. had the following balances on December 31, 20X4:
Cash in checking account $350,000
Cash in money market account 250,000
U.S. Treasury bill, purchased 12/1/X4, maturing 2/28/X5 800,000
U.S. Treasury bond, purchased 3/1/X4, maturing 2/28/X5 500,000
Cook’s policy is to treat as cash equivalents all highly liquid investments with a maturity of three months or less when purchased. What amount should Cook report as cash and cash equivalents in its December 31, 20X4, balance sheet?
$1,400,000
The first three items in the list are included in cash and cash equivalents. If no restrictions apply, cash in checking accounts ($350,000) is always included in cash. Per ASC Topic 305, cash equivalents are short-term, highly liquid investments that are readily convertible into cash and have maturities of three months or less from the date of purchase by the entity. Common examples are Treasury bills, commercial paper, and money market funds. In this case, the cash equivalents are the money market account ($250,000) and the Treasury bill ($800,000). Therefore, total cash and cash equivalents is $1,400,000 ($350,000 + $250,000 + $800,000). The maturity of the Treasury bond was at least 12 months (3/1/X4 to 2/28/X5) from the date of purchase; therefore, it should not be reported in cash and cash equivalents. The reason for the three-month rule is to minimize price fluctuations due to interest rate changes. A security with a fluctuating price is not “equivalent” to cash. One year is too long a time to expect interest rates to remain stable.
The following are held by Smite Co.:
Cash in checking account $20,000
Cash in bond sinking fund account 30,000
Postdated check from customer dated one month from balance sheet date 250
Petty cash 200
Commercial paper (matures in two months) 7,000
Certificate of deposit (matures in six months) 5,000
What amount should be reported as cash and cash equivalents on Smite’s balance sheet?
$27,200
The cash balance is $20,200: the sum of the checking account balance and the petty cash. Because it has a maturity of less than three months, the only cash equivalent is the $7,000 of commercial paper. The final sum of these two accounts is $27,200.
Alton Co. had a cash balance of $32,300 recorded in its general ledger at the end of the month, prior to receiving its bank statement. Reconciliation of the bank statement reveals the following information:
Bank service charge: $15
Check deposited and returned for insufficient funds check: $120
Deposit recorded in the general ledger as $258 but should be $285
Checks outstanding: $1,800
After reconciling its bank statement, what amount should Alton report as its cash account balance?
$32,192
The reconciliation should be as follows: Book balance $32,300 Less bank fees (15) Less NSF check (120) Plus deposit transposition error (285 – 258) 27 Corrected book balance $32,192
A bank reconciliation with the headings “Balance per Books” and “Balance per Bank” lists three adjustments under the former and four adjustments under the latter. The company makes separate adjusting entries for each item in the reconciliation that requires an adjustment. How many adjusting entries are recorded?
3
Only amounts adjusting the balance per books require an adjusting entry because only those amounts explain why the firm’s recorded cash balance is not the same as the true cash balance. Common adjustments of this type include bank service charges, notes collected, and interest. The firm cannot alter the bank balance.
Hilltop Co.’s monthly bank statement shows a balance of $54,200. Reconciliation of the statement with company books reveals the following information:
Bank service charge $10
Insufficient funds check 650
Checks outstanding 1,500
Deposits in transit 350
Check deposited by Hilltop and cleared by the bank for $125
but improperly recorded by Hilltop as $152
What is the net cash balance after the reconciliation?
$53,050
The reconciling items that need to be adjusted to the bank balance are: checks outstanding (−1,500) and deposit in transit (+350). The net cash after the reconciliation is: Bank balance $54,200 − 1,500 + 350 = $53,050. The bank service charge and insufficient funds are already reflected in the bank balance. The error is on Hilltop’s books, not on the bank statement, and therefore it does not need to be included in the reconciliation.
On June 1, 2005, Pitt Corp. sold merchandise with a list price of $5,000 to Burr on account. Pitt allowed trade discounts of 30% and 20%.
Credit terms were 2/15, n/40 and the sale was made FOB shipping point. Pitt prepaid $200 of delivery costs for Burr as an accommodation.
On June 12, 2005, Pitt received from Burr a remittance in full payment amounting to
$2,944
$5,000(1 - .30)(1 - .20)(.98) + $200 = $2,944.
The chain trade discounts are applied to each successive net amount as shown in the calculation, and the cash discount of 2% is then applied to the final invoice amount.
The cash discount applies because the payment was made within 15 days of purchase. The goods were shipped FOB shipping point. Therefore, title transferred to Burr at the shipping point, meaning Burr bears the shipping charges. Because Pitt prepaid them as an accommodation, Burr must reimburse Pitt for the $200, the last term in the calculation leading to $2,944.
Alfisol, Inc. offers sales discounts of 2% on all credit sales paid within 15 days. For year 1, gross credit sales totaled $150,000 and 75% of Alfisol’s customers took advantage of the discount. Under the net method
For cash receipts after the discount period, discounts not taken must be credited for $750.
Under the net method, sales are initially recorded net of discounts. Payments received after the discount period total $37,500 ($150,000 × 25%), and the amount of discounts forfeited is $750 ($37,500 × 2%). Under the net method, the entry to record these receipts is
Dr Cash 37,500
Cr. AR 36,750
Cr. Discounts not taken 750
Steven Corporation began operations in year 1. For the year ended December 31, year 1, Steven made available the following information:
Total merchandise purchases for the year $350,000
Merchandise inventory at December 31, year 1 $70,000
Collections from customers $200,000
All merchandise was marked to sell at 40% above cost. Assuming that all sales are on a credit basis and all receivables are collectible, what should be the balance in accounts receivable at December 31, year 1?
$192,000
The first step is to determine sales for year 1. The cost of goods sold in year 1 is $280,000 ($350,000 purchases less $70,000 ending inventory). Note that beginning inventory is zero because the company began operations in year 1. Since all merchandise was marked to sell at 40% above cost, year 1 credit sales are $392,000 ($280,000 cost of goods sold × 140%). The second step is to determine the ending balance in accounts receivable.
A/R
Dr. Beg 0
Dr. Credit Sales $392,000
Cr. Collections $ 200,000
End Balance 192,000
When the allowance method of recognizing uncollectible accounts is used, how would the collection of an account previously written off affect accounts receivable and the allowance for uncollectible accounts?
Accounts receivable - No Effect
Allowance for uncollectible accounts - Increase
When an account is written off, the journal entry is debit the allowance for uncollectible accounts and credit accounts receivable. If the account is subsequently collected, an entry is made to reinstate the account receivable by debiting accounts receivable and crediting the allowance for uncollectible accounts. A second entry is made for the cash collection which involves debiting cash and crediting accounts receivable. Therefore, there is no change in accounts receivable when a previously written-off account is collected; accounts receivable is debited for the reinstatement, and credited for the payment. However, when the previously written-off account is collected, there is an increase in the allowance for uncollectible accounts.
When the allowance method of recognizing bad debt expense is used, the entries at the time of collection of a small account previously written off would
Increase the allowance for doubtful accounts.
The solutions approach is to determine the journal entries necessary to (1) reestablish and (2) collect the account receivable.
The entry to reestablish the account would be
Accounts receivable xx
Allowance for doubtful accounts xx
The entry to record collection would be
Cash xx
Accounts receivable xx
The net effect is an increase in a current asset account, cash, and an increase in a contra asset account, allowance for doubtful accounts.
The following information relates to Jay Co.’s accounts receivable for 2004:
Accounts receivable, 1/1/04 $ 650,000
Credit sales for 2004 2,700,000
Sales returns for 2004 75,000
Accounts written off during 2004 40,000
Collections from customers during 2004 2,150,000
Estimated future sales returns at 12/31/04 50,000
Estimated uncollectible accounts at 12/31/04 110,000
What amount should Jay report for accounts receivable, before allowances for sales returns and uncollectible accounts, on December 31, 2004?
$1,085,000
The question is asking for the gross accounts receivable balance, before allowances for future sales returns, allowances, and uncollectible accounts:
AR 1/1 + Credit sales - Sales returns - Write-offs - Collections = AR 12/31
$650,000 + $2,700,000 − $75,000 − $40,000 − $2,150,000 = $1,085,000
Gibbs Co. uses the allowance method for recognizing uncollectible accounts. Ignoring deferred taxes, the entry to record the write-off of a specific uncollectible account
Affects neither net income nor working capital.
The entry is:
Allowance for uncollectible accounts xxxx
Accounts receivable xxxx
The allowance is contra to accounts receivable and thus the entry does not affect net accounts receivable. The entry does not affect current assets, working capital, or income. However, the entry does reduce gross accounts receivable. Thus, the answer “affects neither net income nor working capital” is the only possible correct answer. The answer “affects neither net income nor accounts receivable” is incorrect if “accounts receivable” is interpreted as gross accounts receivable.
Marr Corp. reported rental revenue of $2,210,000 in its cash basis federal income tax return for the year ended November 30, 2004. Additional information is as follows:
Rents receivable - November 30, 2004 $1,060,000
Rents receivable - November 30, 2003 800,000
Uncollectible rents written off during the fiscal year 30,000
Under the accrual basis, Marr should report rental revenue of
$2,500,000
The cash basis revenue in the tax return is the amount of rent collected for tax purposes.
beg. rent receivable + accrual revenue - collections -write-offs = end. rent receivable
$800,000 + accrual revenue - $2,210,000 - $30,000 = $1,060,000
accrual revenue = $2,500,000
During the year, Hauser Co. wrote off a customer’s account receivable. Hauser used the allowance method for uncollectable accounts. What impact would the write-off have on net income and total assets?
Net income - No Effect
Total assets - No Effect
Under the allowance method for uncollectible accounts there is no impact on the balance sheet or net income when the receivable is written off. The estimated uncollectible is recognized at the time of the sale; therefore, when the account is written, off the allowance and the accounts receivable are both reduced resulting in no effect on the income statement or balance sheet.
Adam Co. reported sales revenue of $2,300,000 in its income statement for the year ended December 31, 2005. Additional information was as follows:
12/31/04 12/31/05 Accounts receivable $500,000 $650,000 Allowance for uncollectible accounts (30,000) (55,000)
Uncollectible accounts totaling $10,000 were written off during 2005. Under the cash basis of accounting, Adam would have reported 2005 sales of
$2,140,000
Under the cash basis of accounting, sales equals cash collected from customers. An equation or T account may be used to determine this amount:
AR, beginning + Sales - Write-offs - customer collections = AR, ending
$500,000 $2,300,000 $10,000 ? = $650,000
Solving for the unknown (?) amount, customer collections equals $2,140,000.
This is the amount collected from customers, and is the amount that would be reported as sales under the cash basis method of accounting.
Bee Co. uses the direct write-off method to account for uncollectible accounts receivable.
During an accounting period, Bee’s cash collections from customers equal sales adjusted for the addition or deduction of the following amounts:
Accounts written off - Deduction
Increase in accounts receivable balance - Deduction
Under the direct write-off method, write-offs are credited directly to accounts receivable (AR). No allowance account is used. Under the terms of the question, accounts receivable increased during the year.
Increase in AR = sales - cash collections - write-offs
cash collections = sales - increase in AR - write-offs.
Orr Co. prepared an aging of its accounts receivable at December 31, 2005 and determined that the net realizable value of the receivables was $250,000. Additional information is available as follows:
Allowance for uncollectible accounts at 1/1/05 - credit balance $ 28,000
Accounts written off as uncollectible during 2005 23,000
Accounts receivable at 12/31/05 270,000
Uncollectible accounts recovery during 2005 5,000
For the year ended December 31, 2005, Orr’s uncollectible accounts expense would be
$10,000
Beginning allowance balance + uncollectible accounts expense - write-offs + recoveries = ending allowance balance
$28,000 + uncollectible accounts expense − $23,000 + $5,000 = ($270,000 − $250,000)
Uncollectible accounts expense = $10,000
Under the aging method, the ending allowance balance equals the difference between gross accounts receivable ($270,000) and net realizable value of accounts receivable ($250,000).
Write-offs decrease the allowance balance, and uncollectible accounts expense increases the allowance.
Recoveries also increase the allowance because the amount by which the allowance was decreased when the account was written off is reinstated on recovery.
On the December 31, 2005 balance sheet of Mann Co., the current receivables consisted of the following:
Trade accounts receivable $ 93,000
Allowance for uncollectible accounts (2,000)
Claim against shipper for goods lost in transit (Nov. 2005) 3,000
Selling price of unsold goods sent by Mann on consignment at 130% of cost (not included in Mann’s ending inventory) 26,000
Security deposit on lease of warehouse used for storing some inventories 30,000
Total $150,000
========
On December 31, 2005, the correct total of Mann’s current net receivables was
$94,000
Only the first three items are included in net receivables:
Trade accounts receivable $93,000
Allowance for uncollectible accounts (2,000)
Claim against shipper for goods lost in transit (Nov. 2005) 3,000
Net receivables $94,000
The claim for lost goods is a definite receivable. The firm has a current claim on another entity. The goods on consignment should be included in Mann’s inventory at cost, not in accounts receivable at sales value. They have not been sold. The security deposit is not included in current receivables because the firm will likely not receive this deposit back during the next fiscal year.
On December 1, 2005, Tigg Mortgage Co. gave Pod Corp. a $200,000, 12% loan.
Pod received proceeds of $194,000 after the deduction of a $6,000 nonrefundable loan origination fee. Principal and interest are due in 60 monthly installments of $4,450, beginning January 1, 2006. The repayments yield an effective interest rate of 12% at a present value of $200,000 and 13.4% at a present value of $194,000.
What amount of accrued interest receivable should Tigg include in its December 31, 2005 balance sheet?
$2,000
The term “accrued interest receivable” refers to the cash amount of interest due. The cash amount of interest due is based on the contractual interest rate and face value. The loan origination fee is a way of increasing the effective interest but it does not affect the cash interest component. The $2,000 accrued interest = (.12)(1/12)($200,000).
Frame Co. has an 8% note receivable, in the original amount of $150,000, dated June 30, 2003. Payments of $50,000 in principal plus accrued interest are due annually on July 1, 2004, 2005, and 2006.
In its June 30, 2005, balance sheet, what amount should Frame report as a current asset for interest on the note receivable?
$8,000
As of June 30, 2005, only one payment has been received (July 1, 2004). Thus, $100,000 of principal balance has been outstanding for an entire year as of the balance sheet date. Interest receivable on June 30, 2005 is thus $8,000 (.08 × $100,000).
Leaf Co. purchased from Oak Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments of $5,009. The note was discounted to yield a 9% rate to Leaf. At the date of purchase, Leaf recorded the note at its present value of $19,485.
What should be the total interest revenue earned by Leaf over the life of this note?
$5,560
Total interest revenue is the amount received over the term of the note less the present value of the note: 5($5,009) − $19,485 = $5,560.
Leaf paid $19,485 for the note, and will receive 5($5,009) over the note term. The difference is interest revenue.
On January 2, 2003, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a $600,000 noninterest-bearing note due January 2, 2006.
There was no established exchange price for the equipment. The prevailing rate of interest for a note of this type on January 2, 2003, was 10%. The present value of $1 at 10% for three periods is 0.75.
In Emme’s 2003 income statement, what amount should be reported as gain (loss) on sale of machinery?
($30,000) loss.
The proceeds on sale are measured as the present value of the note because there is no established market value for the equipment. The loss on sale is computed as:
Carrying amount $480,000
Less proceeds on sale: $600,000(.75) = 450,000
Equals loss on sale $ 30,000
The proceeds do not reflect the entire $600,000, because the difference between the note’s face value of $600,000 and its present value is interest to be recognized over the term of the note.
Each of Potter Pie Co.’s 21 new franchisees contracted to pay an initial franchise fee of $30,000.
By December 31, 2005, each franchisee had paid a nonrefundable $10,000 fee and signed a note to pay $10,000 principal plus the market rate of interest on December 31, 2006 and December 31, 2007.
Experience indicates that one franchise will default on the additional payments. Services for the initial fee will be performed in 2006.
What amount of net unearned franchise fees would Potter report on December 31, 2005?
$610,000
The $610,000 net unearned fee revenue = (21)($30,000) − $20,000. This amount includes the notes received, but does not include the one expected uncollectible note.
The notes receivable balance, recorded along with the unearned revenue, will not reflect the note expected to be uncollectible. Bad debt expense is not recorded for this note because there has been no revenue recognized against which to match the expense.
On June 1, 2005, Yola Corp. loaned Dale $500,000 on a 12% note, payable in five annual installments of $100,000 beginning January 2, 2006. In connection with this loan, Dale was required to deposit $5,000 in a noninterest-bearing escrow account.
The amount held in escrow is to be returned to Dale after all principal and interest payments have been made. Interest on the note is payable on the first day of each month beginning July 1, 2005. Dale made timely payments through November 1, 2005. On January 2, 2006, Yola received payment of the first principal installment plus all interest due.
On December 31, 2005, Yola’s interest receivable on the loan to Dale should be
$10,000
Because the last interest payment was made on November 1, the interest for November and December is unpaid as of December 31, 2005. Therefore, two months of interest is receivable, as of December 31, 2005, for a total receivable of $10,000 = (2/12)(12%)($500,000). No principal payments have yet been made as of this date.
On December 30, 2005, Chang Co. sold a machine to Door Co. in exchange for a noninterest-bearing note requiring ten annual payments of $10,000. Door made the first payment on December 30, 2005. The market interest rate for similar notes at the date of issuance was 8%. Information on present value factors is as follows:
Period Present value
of $1 at 8% Present value of
ordinary annuity of $1 at 8%
9 0.50 6.25
10 0.46 6.71
In its December 31, 2005, balance sheet, what amount should Chang report as note receivable?
$62,500
The note receivable should be reported at the present value of the nine remaining payments. The first payment was made at the date of the sale. The remaining nine payments comprise an ordinary annuity as of December 31, 2005 because the next payment is due one year from that date.
Therefore, the present value and reported note value on that date is 6.25($10,000) = $62,500.
On December 31, 1999, Key Co. received two $10,000 noninterest-bearing notes from customers in exchange for services rendered. The note from Alpha Co., which is due in nine months, was made under customary trade terms, but the note from Omega Co., which is due in two years, was not. The market interest rate for both notes at the date of issuance is 8%. The present value of $1 due in nine months at 8% is .944. The present value of $1 due in two years at 8% is .857. At what amounts should these two notes receivable be reported in Key’s December 31, 1999, balance sheet?
Alpha - $ 10,000
Omega - $ 8570
The note from Alpha Co. is a short-term asset. It is reported at the face value of $10,000. The note from Omega is discounted as a single sum for two time periods at 8% to be reported at $10,000X.857=$8,570.
On March 31, 2005, Vale Co. had an unadjusted credit balance of $1,000 in its allowance for uncollectible accounts. An analysis of Vale’s trade accounts receivable on that date revealed the following:
Age Amount Estimated uncollectible 0 − 30 days $60,000 5% 31 − 60 days 4,000 10% Over 60 days 2,000 $1,400 What amount should Vale report as allowance for uncollectible accounts in its March 31, 2005, balance sheet?
$4,800
The sum of the products of the AR amounts and uncollectible percentages yield the required ending allowance balance (the third AR category’s estimated uncollectible has already been computed): $60,000(5%) + $4,000(10%) + $1,400 = $4,800.
For the year ending December 31, 2005, Beal Co. estimated its allowance for uncollectible accounts using the year-end aging of accounts receivable. The following data are available:
Allowance for uncollectible accounts, 1/1/05 $42,000
Provision for uncollectible accounts during 2005 (2% on credit sales of $2,000,000) 40,000
Uncollectible accounts written off, 11/30/05 46,000
Estimated uncollectible accounts per aging, 12/31/05 52,000
After year-end adjustment, the uncollectible accounts expense for 2005 should be
$56,000
The balance in the allowance for uncollectible accounts before the 2005 adjustment is: $42,000 beginning balance − $46,000 write-offs = -$4,000 (debit balance). The desired ending balance under aging is $52,000.
Therefore, the required increase to the account is $56,000, and this amount is uncollectible accounts expense. The aging method first determines the required ending balance in the allowance account based on the age of receivables, and THEN adjusts the allowance account to that balance.
The $40,000 provision is based on credit sales, and is thus to be ignored in the question.
Inge Co. determined that the net value of its accounts receivable on December 31, 2005, based on an aging of the receivables, was $325,000. Additional information is as follows:
Allowance for uncollectible accounts - 1/1/05 $ 30,000
Uncollectible accounts written off during 2005 18,000
Uncollectible accounts recovered during 2005 2,000
Accounts receivable at 12/31/05 350,000
For 2005, what would be Inge’s uncollectible accounts expense?
$11,000
This question requires a determination of the pre-adjustment balance in the allowance account, and the ending balance. The difference between these two amounts is the increase in the account needed, which is also the amount recognized as bad debt expense. The aging method first determines the required ending balance in the allowance account, and then places the amount needed to increase the account to this required balance into the allowance account.
The pre-adjustment allowance balance =
Beginning balance - Write-offs + Recoveries =
$30,000 − $18,000 + $2,000 = $14,000
The ending allowance balance =
$350,000 ending gross AR − $325,000 ending net value of AR = $25,000
Therefore, bad debt expense is the amount needed to bring the allowance balance up to the ending balance of $25,000. The increase needed is $11,000 ($25,000 − $14,000).
Hall Co.’s allowance for uncollectible accounts had a credit balance of $24,000 on December 31, 2003. During 2004, Hall wrote off uncollectible accounts of $96,000. The aging of accounts receivable indicated that a $100,000 allowance for doubtful accounts was required on December 31, 2004. What amount of uncollectible accounts expense should Hall report for 2004?
$172,000
Beginning allowance balance $24,000
Less write-off (96,000)
Equals pre-adjustment allowance balance (72,000) (debit)
The allowance balance normally is a credit. For the ending balance in the account after adjustment to be $100,000 credit, the account must be increased $172,000 by recognizing uncollectible accounts expense.
Under the aging method, uncollectible accounts expense equals the amount required to increase the allowance balance to the indicated total based on the aging of receivables.
Ward Co. estimates its uncollectible accounts expense to be 2% of credit sales. Ward’s credit sales for 2004 were $1,000,000. During 2004, Ward wrote off $18,000 of uncollectible accounts. Ward’s allowance for uncollectible accounts had a $15,000 balance on January 1, 2004. In its December 31, 2004 income statement, what amount should Ward report as uncollectible accounts expense?
$20,000
The credit sales method does not adjust the allowance balance to a required ending amount, but rather simply places the appropriate percent of sales into uncollectible accounts expense and the allowance account. 2% × $1,000,000 = $20,000.
Marr Co. had the following sales and accounts receivable balances, prior to any adjustments at year end:
Credit sales $10,000,000
Accounts receivable 3,000,000
Allowance for uncollectible accounts (debit balance) 50,000
Marr uses 3% of accounts receivable to determine its allowance for uncollectible accounts at year end. By what amount should Marr adjust its allowance for uncollectible accounts at year end?
$140,000
The amount of the adjustment to get the $50,000 debit balance to a $90,000 (3% × $3,000,000) credit balance is $140,000.
After being held for 40 days, a 120-day, 12% interest-bearing note receivable was discounted at a bank at 15%. The proceeds received from the bank equal
Maturity value less the discount at 15%.
The bank charges its discount (its fee) on the maturity value, which is the face value of the note plus 12% interest for 120 days. The bank charges 15% on this amount for the 80 remaining days in the note term. Thus, the proceeds equal the maturity value less its fee.
Ace Co. sold King Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments. This note was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of $1 for five periods are as follows:
8% 3.992
9% 3.890
What should be the total interest revenue earned by King on this note?
$5,560
Total interest over the life of the note equals the total amount paid by Ace over the life of the note less the proceeds to Ace. The proceeds equal the present value of the payments at the 9% yield rate. The annual payment is found using the 8% rate because that rate is contractually set and determines the annual payment.
The annual payment P is found as: $20,000 = P(3.992). P = $5,010
Total interest revenue = total payments by Ace - proceeds to Ace
= 5($5,010) − $5,010(3.89) = $5,560.
Roth, Inc. received from a customer a one-year, $500,000 note bearing annual interest of 8%. After holding the note for six months, Roth discounted the note at Regional Bank at an effective interest rate of 10%. What amount of cash did Roth receive from the bank?
$513,000
Maturity value of the note: $500,000(1.08) $540,000
Less discount to the bank: $540,000(.10)(6/12) (27,000)
Equals proceeds to Roth $513,000
The bank charges its discount on the maturity amount, for the period it holds the note. In effect, it is charging interest on interest yet to accrue (for the last six months). This procedure is followed because the maturity value is the amount at risk.
On July 1, 2005, Lee Co. sold goods in exchange for a $200,000, 8-month, noninterest-bearing note receivable. At the time of the sale, the note’s market rate of interest was 12%.
What amount did Lee receive when it discounted the note at 10% on September 1, 2005?
$190,000
Six months remain in the note term at the date of discounting.
Maturity value of note: $200,000
Less discount: $200,000(.10)(6/12) (10,000)
Equals proceeds on note $190,000
Red Co. had $3 million in accounts receivable recorded on its books. Red wanted to convert the $3 million in receivables to cash in a more timely manner than waiting the 45 days for payment as indicated on its invoices. Which of the following would alter the timing of Red’s cash flows for the $3 million in receivables already recorded on its books?
Factor the receivables outstanding.
Factoring is a sale of receivables. This allows Red Co. to sell the receivables and receive cash immediately upon sale.
On November 1, 2004, Davis Co. discounted with recourse at 10%, a one-year, noninterest-bearing, $20,500 note receivable maturing on January 31, 2005.
What amount of contingent liability for this note must Davis disclose in its financial statements for the year ended December 31, 2004?
$20,500
The firm is contingent for the maturity amount, which for a noninterest-bearing note is the face value. If the maker of the note fails to pay the bank or financial institution with whom Davis discounted the note, Davis would be called on to pay the entire maturity amount.
Milton Co. pledged some of its accounts receivable to Good Neighbor Financing Corporation in return for a loan. Which of the following statements is correct?
Milton will retain control of the receivables.
In a pledge arrangement, the title remains with the originator, in this case with Milton Co.
On April 1, Aloe, Inc. factored $80,000 of its accounts receivable without recourse. The factor retained 10% of the accounts receivable as an allowance for sales returns and charged a 5% commission on the gross amount of the factored receivables. What amount of cash did Aloe receive from the factored receivables?
$68,000
The net cash received when the receivables were factored was $80,000 × .85 (100% - 10% - 5%) = $68,000.
Choose the correct accounting by the creditor for a loan impairment. Column (1): recognize a loss or expense upon recognizing the impairment. Column (2): rate of interest to use in computing the revised book value of the receivable after the impairment.
1 - Yes
2 - Original Effective Rate
A loan impairment is recorded by reducing the net book value of the receivable to the present value of probable future cash inflows, discounted at the original rate in the receivable. The original rate is used because the loan continues to exist. The loss to the firm is measured at the rate existing when the original loan was created. The difference between the book value and present value, at the date of recognizing the impairment, is recorded as an expense or loss. There is no reason to report overstated assets.
A creditor’s note receivable has a carrying value of $60,000 at the end of Year 1. Based on information about the debtor, the creditor believes the note is impaired and establishes the new carrying value of the note to be $25,000 at the end of Year 1. During Years 2 and 3, the debtor pays $14,000 on the note each year (total payments, $28,000). For Year 3, under which method of the two indicated is interest revenue recognized?
Interest Method - YES
Cost Recovery Method - YES
The interest method recognizes interest revenue each year until the note is collected because the note was written down to present value when the impairment was recorded. The estimated future cash flows to be received include interest, which is recognized over the remaining term of the note. The cost recovery method recognizes interest revenue only after cash equal to the new carrying value is collected. During Year 3, total collections surpassed the $25,000 new carrying value. $3,000 of interest revenue is recognized under this method in Year 3 ($28,000 − $25,000).
Under IFRS, a cash generating unit (CGU) is:
The smallest group of assets that generates independent cash flows from continuing use.
A CGU is the smallest group of assets that can be identified that generates cash flows independently of the cash flows from other assets.
When a note receivable is determined to be impaired,
A loss or expense is recognized as equal to the difference between the note carrying value and the present value of the cash flows expected to be received.
A note is considered to be impaired if the present value of remaining cash flows is less than book value, using the rate in the note. This is caused by an expected delay in timing of cash flows or reduction in amount of cash flows compared with the original agreement. The creditor makes the determination that the note is impaired and writes the note down to present value. A loss is recorded for the decline in carrying value to present value.
During a reporting period, a computer manufacturing company used raw materials of $50,000, had direct labor costs of $75,000, and factory overhead of $30,000. Other expenses were for advertising of $5,000, staff salaries of $10,000, and bad debt of $3,000. The company did not have a beginning balance in any inventory account. All goods manufactured during the period were sold during the period. What amount was the company’s cost of goods sold during the reporting period?
$155,000
Since there is no beginning or ending inventory, the cost of goods sold equals the cost of materials used ($50,000), the direct labor costs ($75,000), and the ($30,000) or $155,000. The other costs, advertising, staff salaries, and bad debt expense, are not part of cost of goods sold.
On June 1, Year 2, Archer, Inc. issued a purchase order to Cotton Co. for a new copier machine. The machine requires one month to produce and is shipped f.o.b. destination on July 1, Year 2, and is received by Archer on July 15, Year 2. Cotton issues a sales invoice dated July 2, Year 2, for the machine. As of what date should Archer record a liability for the machine?
July 15, Year 2
The term f.o.b. destination means that title transfers to the buyer when it arrives at the destination. A liability is recorded when the title transfers.
Delar Co. completed its year-end physical count of inventory. The inventory was valued at first-in, first-out (FIFO) costs and totaled $500,000. Delar subsequently noted the following two items:
1,000 units of inventory with a FIFO cost of $10 each were shipped and billed to a customer, f.o.b. destination. These items were included in the physical count.
6,000 units at a FIFO cost of $5 each were held on consignment for one of its suppliers, but were excluded from the physical count.
What amount should Delar report as inventory at year end?
$500,000
Goods on consignment are excluded from ending inventory and goods shipped f.o.b. destination are included. There is no adjustment need to the $500,000 inventory value.
West Retailers purchased merchandise with a list price of $20,000, subject to trade discounts of 20% and 10%, with no cash discounts allowable.
West should record the cost of this merchandise as
$14,400
This is a chain discount and the correct recorded cost is $20,000(1 - .20)(1- .10) = $14,400. Each successive discount in a chain discount is applied to the previous net amount.
On October 20, 2005, Grimm Co. consigned 40 freezers to Holden Co. for sale at $1,000 each and paid $800 in transportation costs.
On December 30, 2005, Holden reported the sale of 10 freezers and remitted $8,500. The remittance was net of the agreed 15% commission.
What amount should Grimm recognize as consignment sales revenue for 2005?
$10,000
Consignment sales revenue is the revenue recognized on consignment sales.
In this case, total consignment revenue is 10 × $1,000 = $10,000. The commission and transportation costs are expenses that reduce earnings on consignment revenues, but they do not affect total revenues to be recognized.
The following information applied to Fenn, Inc. for 2005:
Merchandise purchased for resale $400,000
Freight-in 10,000
Freight-out 5,000
Purchase returns 2,000
Fenn’s 2005 inventoriable cost was
$408,000
Merchandise purchased for resale $400,000
Freight-in 10,000
Purchase returns (2,000)
Total inventoriable cost $408,000
Freight-out is a delivery expense. It is not inventoried because the goods have reached salable condition before incurring this cost. Only costs that contribute to preparing inventory for sale are inventoried.
On December 28, 2005, Kerr Manufacturing Co. purchased goods costing $50,000. The terms were FOB destination. Some of the costs incurred in connection with the sale and delivery of the goods were as follows:
Packaging for shipment $1,000
Shipping 1,500
Special handling charges 2,000
These goods were received on December 31, 2005. In Kerr’s December 31, 2005 balance sheet, what amount of cost for these goods should be included in inventory?
$50,000
Kerr will pay only $50,000 for the goods. None of the other costs listed are incurred by Kerr. Rather, the seller will incur those costs.
Even the shipping costs are borne by the seller because the terms are FOB destination. This means that title does not transfer to the buyer (Kerr) until the goods reach the destination. The seller owned the goods in transit and therefore incurred the transportation cost. Kerr’s recorded cost is $50,000.
The following items were included in Opal Co.’s inventory account on December 31, 2004:
Merchandise out on consignment, at sales price, including 40% markup on selling price $40,000
Goods purchased, in transit, shipped FOB shipping point 36,000
Goods held on consignment by Opal 27,000
By what amount should Opal’s inventory account at December 31, 2004 be reduced?
$43,000
The merchandise out on consignment is included in inventory at selling price. But inventory must be measured at cost. $40,000 = cost + .40($40,000). Thus, cost = $24,000. Therefore, inventory should be reduced by the $16,000 of markup on the merchandise out on consignment.
The goods held on consignment should be removed from the inventory because these goods do not belong to Opal.
Hence, the total reduction from inventory is $43,000 ($16,000 + $27,000). The goods in transit are properly included in inventory because they were shipped FOB shipping point, which means the goods belong to Opal when the goods reach the common carrier at the shipping point.
Herc Co.’s inventory on December 31, 2005 was $1,500,000, based on a physical count priced at cost, and before any necessary adjustment for the following:
Merchandise costing $90,000, shipped FOB shipping point from a vendor on December 30, 2005, was received and recorded on January 5, 2006.
Goods in the shipping area were excluded from inventory although shipment was not made until January 4, 2006. The goods, billed to the customer FOB shipping point on December 30, 2005, had a cost of $120,000.
What amount should Herc report as inventory in its December 31, 2005, balance sheet?
$1,710,000
The correct ending inventory balance is $1,710,000 ($1,500,000 + $90,000 + $120,000).
The $90,000 of merchandise is included because it was shipped before year-end and the title was transferred to Herc at the shipping point (before year-end). The $120,000 also is included because the goods have not been shipped. The FOB designation is irrelevant because the goods have not yet reached a common carrier.
The following information pertains to Deal Corp.’s 2004 cost of goods sold:
Inventory, 12/31/03 $ 90,000
2004 purchases 124,000
2004 write-off of obsolete inventory 34,000
Inventory, 12/31/04 30,000
The inventory written off became obsolete due to an unexpected and unusual technological advance by a competitor. In its 2004 income statement, what amount should Deal report as cost of goods sold?
$150,000
Beginning inventory $ 90,000 Plus purchases 124,000 Less write-off (34,000) Less ending inventory (30,000) Equals cost of goods sold $150,000 The write-off cannot be counted in cost of goods sold because it is a decrease in inventory not associated with sales.
The following information pertained to Azur Co. for the year:
Purchases $102,800 Purchase discounts 10,280 Freight-in 15,420 Freight-out 5,140 Beginning inventory 30,840 Ending inventory 20,560
What amount should Azur report as cost of goods sold for the year?
$118,220
Cost of goods sold is determined (in a periodic inventory system) as:
Beginning Inventory $ 30,840
+ Net Purchases $107,940
= Goods Available for Sale $138,780
- Ending inventory 20,560
= Cost of Goods Sold $118,220 Note net purchase is computed as
+ Purchases $102,800
- Net Purchases 107,940
= Goods Available for Sale $138,780
- Purchases Discounts (10,280)
+ Freight-in 15,420
Net Purchases includes any purchase discounts (or allowances) and other cost of getting the goods in place and condition for resale, including freight-in. Freight-out (to customers) is a selling cost. Therefore, Azur Co.’s cost of goods sold would be:
The following information was taken from Cody Co.’s accounting records for the year ended December 31, 2005:
Decrease in raw materials inventory $ 15,000
Increase in finished goods inventory 35,000
Raw materials purchased 430,000
Direct labor payroll 200,000
Factory overhead 300,000
Freight-out 45,000
There was no work-in-process inventory at the beginning or end of the year. Cody’s 2005 cost of goods sold is
$910,000
The correct answer is $910,000:
Raw materials purchased $430,000 Plus decrease in raw materials 15,000* Direct labor 200,000 Factory overhead 300,000 Less finished goods increase (35,000) ** Cost of goods sold $910,000
*The decrease in raw materials is added to the amount purchased resulting in the cost of materials incorporated into production. In other words, $15,000 of materials purchased in 2005 were placed into production in 2005. The total cost of materials brought into production in 2005 equals $445,000.
** The increase in finished goods represents costs incurred in the current period to finish inventory that was not sold in the current period. Therefore, these costs must be removed in determining cost of goods sold.
Freight-out is not a manufacturing cost but rather is a distribution cost.
Therefore, freight-out is not inventoried.
There is no change in work-in-process inventory to affect the calculation.
Beck Co.’s inventory of trees is as follows:
Beginning Inventory 10 trees @ $ 50 March 4 purchased 6 trees @ 55 March 12 sold 8 trees @ 100 March 20 purchased 9 trees @ 60 March 27 sold 7 trees @ 105 March 30 purchased 4 trees @ 65
What was Beck’s cost of goods sold using the last in, first out (LIFO) perpetual method?
$850
The perpetual method recognizes each purchase and sale at the time it occurs. The total value of cost of sales using perpetual LIFO is ((6 × $55) + (2 × $50) + (7 × $60)) = $850, as shown in the table below.
Trees remaining Cost of trees sold
Begin Inv 10 @ $ 50
10 @ $50
March 4 purchased 6 @ 55
10 @ $50
6 @ 55
March 12 sold 8 @ 100 8 @ 50
6 @ $55 = $330
2 @ $50 = 100
March 20 purchased 9 @ 60
8 @ 50
9 @ 60
March 27 sold 7 @ 105
8 @ 50
2 @ 60
7 @ $60 = 420
March 30 purchased 4 @ 65
8 @ 50
2 @ 60
4 @ 65
Total cost = $850
Units Unit cost Total cost Units on hand Balance on 1/1 2,000 $1 $2,000 2,000 Purchased on 1/8 1,200 3 3,600 3,200 Sold on 1/23 1,800 1,400 Purchased on 1/28 800 5 4,000 2,200 Nest uses the LIFO method to cost inventory. What amount should Nest report as inventory on January 31 under each of the following methods of recording inventory?
Under the LIFO (last-in, first-out) inventory method, goods sold are assumed to be the most recently acquired goods (at their related costs). Therefore, goods remaining (ending inventory) are assumed to be the earliest acquired goods (at their related costs). If the perpetual LIFO inventory method is used, when goods are sold, they are assumed to be the goods acquired just prior to the sale.
Thus, Nest’s sale of 1,800 units on 1/23 would have consisted of the 1,200 units acquired 1/8 and 600 units (of the 2,000) in beginning inventory. Ending inventory on January 31 would be:
1,400 units of beginning inventory @ $1 each = $1,400
800 units purchased 1/28 @ $5 each = 4,000
2,200 units in ending inventory reported @ = $5,400
If the periodic LIFO inventory method is used, ending inventory (and cost of goods sold) are determined only at the end of the period. Therefore, Nest’s sale of 1,800 units on 1/23 would have consisted of (by assumption at the end of the period) 800 units acquired on 1/28 and 1,000 units (of the 1,200) acquired on 1/8. Ending inventory on January 31 would be:
200 units of the 1,200 purchased 1/8 @ $3 = $ 600
2,000 units (all) of beginning inventory @ $1 = 2,000
2,200 units in ending inventory reported @ = $2,600
During periods of inflation, a perpetual inventory system would result in the same dollar amount of ending inventory as a periodic inventory system under which of the following inventory valuation methods?
FIFO - Yes
LIFO - No
Under a perpetual inventory system, the cost of goods sold (COGS) is determined at the time of each sale. In a perpetual FIFO inventory system, the cost of each sale (COGS) would be based on the cost of the earliest acquired goods on hand at the time of the sales. The cost of the most recently acquired goods would remain in ending inventory. In a perpetual LIFO inventory system, the cost of each sale (COGS) would be based on the cost of goods acquired just prior to the sale. The cost of the earlier acquired goods would remain in inventory.
Under a periodic inventory system, the costs of goods sold (COGS) and ending inventory are determined only at the end of the period. In a periodic FIFO inventory system, the cost of sales for the period (COGS) would be based on the cost of the earliest acquired goods available during the period. The cost of the most recently acquired goods would remain in ending inventory. In a periodic LIFO inventory system, the cost of sales for the period (COGS) would be based on the last goods acquired during the period. The cost of the earliest acquired goods would remain in ending inventory. The above descriptions can be summarized as follows for determination of COGS:
Inventory System/Method Cost of goods sold determined using FIFO Cost of goods sold determined using LIFO
Perpetual Earliest goods acquired Latest goods acquired prior to each sale
Periodic Earliest goods acquired Latest goods acquired during the period
Since cost of goods sold for the period would be the same under both perpetual FIFO and periodic FIFO, ending inventory would be the same under both perpetual FIFO and periodic FIFO. Cost of goods sold (and ending inventory) would not be the same under perpetual LIFO as under periodic LIFO because the perpetual system recognizes cost of goods sold based on the cost of goods acquired just prior to each sale, whereas the periodic system recognizes cost of goods sold based on cost of goods acquired prior to the end of each period.
Ashe Co. recorded the following data pertaining to raw material × during January 2005:
Units Date Received Cost Issued On Hand 1/1/05 Inventory $8.00 3,200 1/11/05 Issue 1,600 1,600 1/22/05 Purchase 4,800 $9.60 6,400
The moving-average unit cost of × inventory on January 31, 2005 is
$9.20
Units beginning inventory remaining at year-end (3,200 − 1,600)$8 = $12,800
Plus 1/22 purchase: 4,800($9.60) = 46,080
Ending inventory $58,880
Ending unit cost: $58,880/6,400 = $9.20
The moving average method costs issues at the unit cost of goods on hand at that point. Thus, the issue was costed at $8.00 per unit. The cost per unit changes with each purchase.
Generally, which inventory costing method approximates most closely the current cost for each of the following?
Cost of goods sold - LIFO
Ending inventory - FIFO
LIFO assumes the sale of the most recent purchases first and thus results in cost of goods sold that is the most current value. FIFO assumes the sale of the earliest purchases first (and beginning inventory before any purchases) and thus results in ending inventory that is the most current value. FIFO is sometimes called LISH: last in still here.
When the FIFO inventory method is used during periods of rising prices, a perpetual inventory system results in an ending inventory cost that is
The same as in a periodic inventory system.
FIFO produces the same results for periodic and perpetual systems. FIFO always assumes the sale of the earliest goods acquired. Therefore, unlike LIFO periodic, goods can never be assumed sold before they are acquired.
Cost of goods sold and ending inventory are the same under FIFO for both a periodic and a perpetual system.
A company decided to change its inventory valuation method from FIFO to LIFO in a period of rising prices. What was the result of the change on ending inventory and net income in the year of the change?
Ending inventory - Decrease
Net income -Decrease
Ending inventory would decrease because under LIFO, the latest items purchased (and therefore the most costly) are considered sold, leaving the earliest items purchased (and therefore the least costly) in inventory. This is opposite to the effect under FIFO.
The same is true for net income because now, under LIFO, cost of goods sold is increased relative to FIFO because the cost of the latest and most costly items are considered sold first.
Which inventory costing method would a company that wishes to maximize profits in a period of rising prices use?
FIFO
FIFO assumes the sale of the earliest goods first. With rising prices, the earliest goods reflect the lowest prices. Therefore, cost of goods sold under FIFO is the lowest of the cost flow assumptions. With the lowest cost of goods sold, gross margin and income are the highest among the available cost flow assumptions (LIFO and average being the others).
In 2005, Cobb adopted the dollar-value LIFO inventory method.
At that time, Cobb’s ending inventory had a base-year cost and an end-of-year cost of $300,000. In 2006, the ending inventory had a $400,000 base-year cost and a $440,000 end-of-year cost.
What dollar-value LIFO inventory cost would be reported in Cobb’s December 31, 2006, balance sheet?
$410,000
The price level index for 2006 is 1.1 ($440,000/$400,000). Ending 2006 DV LIFO inventory equals the beginning inventory DV LIFO plus the increase in inventory at base-year dollars converted to 2006 prices:
Ending DV LIFO = Beginning DV LIFO + (increase at base-year dollars)(1.1)
= $300,000 + ($400,000 − $300,000)(1.1) = $410,000.
In January, Stitch, Inc. adopted the dollar-value LIFO method of inventory valuation. At adoption, inventory was valued at $50,000. During the year, inventory increased $30,000 using base-year prices, and prices increased 10%. The designated market value of Stitch’s inventory exceeded its cost at year-end. What amount of inventory should Stitch report in its year-end balance sheet?
$83,000
Beginning inventory of $50,000 is at base-year dollars and the current year increase of $30,000 is also at base-year dollars. The current year layer must be converted to current year costs ($30,000 × 1.10) = $33,000. Ending dollar value LIFO is the beginning dollar value LIFO (in this case it was adopted in January so the beginning inventory must be $50,000) plus the current year layer of $33,000 or $83,000. Note that the sentence “The designated market value of Stitch’s inventory exceeded its cost at year end” is a distracter. It is simply stating that there is not an issue with the lower of cost or market since cost is lower.
Bach Co. adopted the dollar-value LIFO inventory method as of January 1, 2006.
A single inventory pool and an internally computed price index are used to compute Bach’s LIFO inventory layers. Information about Bach’s dollar-value inventory follows:
Inventory
Date at base-year cost at current-year cost
1/1/06 $90,000 $90,000
2006 layer 20,000 30,000
2007 layer 40,000 80,000
What was the price index used to compute Bach’s 2007 dollar-value LIFO inventory layer?
1.33
The question provides the ending inventory for 2007 at current cost by layer. The sum of the current cost column ($200,000) is the current cost of the entire inventory at the end of 2007. The sum of the base-year cost for the three years is $150,000. Hence, under this assumption, the ratio of current cost for the total inventory at the end of 2007 to the base-year cost is 1.33 ($200,000/$150,000). This index is then multiplied by the 2007 layer in base-year dollars to derive the increment to DV LIFO ending inventory.
Brock Co. adopted the dollar-value LIFO inventory method as of January 1, 2003. A single inventory pool and an internally computed price index are used to compute Brock’s LIFO inventory layers. Information about Brock’s dollar-value inventory follows:
Inventory
_________________________________
Date at base-year cost at current-year cost at
dollar-
value LIFO
1/1/03 $40,000 $40,000 $40,000
2003 layer 5,000 14,000 6,000
__________ __________ __________ __________
12/31/03 45,000 54,000 46,000
2004 layer 15,000 26,000 ?
__________ __________ __________ __________
12/31/04 $60,000 $80,000 ?
========= ========== ==========
What was Brock’s dollar-value LIFO inventory on December 31, 2004?
$66,000
The ending inventory is used to construct the internal price index. At the end of 2004, the ratio of current cost to base-year cost for ending inventory is $80,000/$60,000 = 1 1/3 or 4/3. This ratio is applied to the 2004 layer at base-year cost, yielding $20,000 ($15,000 × 4/3). This amount is the increase to DV LIFO. Therefore, ending 2004 DV LIFO is $66,000 ($46,000 + $20,000).
Lyon Co. estimated its ending inventory using a method based on the financial statements of prior periods in order to prepare its quarterly interim financial statements. What type of inventory system and method of estimating ending inventory is Lyon using?
The gross profit method can be used to estimate interim inventory, and the gross profit method is a periodic inventory system.
A flash flood swept through Hat, Inc.’s warehouse on May 1. After the flood, Hat’s accounting records showed the following:
Inventory, January 1 $ 35,000 Purchases, January 1 through May 1 200,000 Sales, January 1 through May 1 250,000 Inventory not damaged by flood 30,000 Gross profit percentage on sales 40%
What amount of inventory was lost in the flood?
$55,000
The gross margin method of estimating inventory is used to solve this problem. The cost of inventory lost cannot be identified by count but it can be estimated.
First, an estimate of cost of goods sold is subtracted from the cost of goods available on the date of the flood yielding the total amount of inventory that would have been present on May 1.
Second, the amount of inventory not lost is subtracted from the May 1 estimated total inventory. The result is an estimate of the amount lost.
With gross profit being 40% of sales, cost of goods sold must be 60% of sales, on average. Therefore, the estimate of cost of goods sold is $150,000 (.60 × $250,000). Beginning inventory ($35,000) + Purchases ($200,000) = Goods available = $235,000. Subtracting $150,000 of cost of goods sold yields $85,000 of inventory on May 1 ($235,000 − $150,000).
With $30,000 of inventory still accounted for, the amount of lost inventory at cost is $55,000 ($85,000 − $30,000).
The following two inventory items were purchased as a group in a liquidation sale for $1,000.
Replacement Carrying Value
Item Cost On Seller's Books A $400 $390 B 700 755
The firm purchasing the inventory records item A at what amount?
$364
When items are purchased as a group, the total cost of the group is allocated to the individual items based on fair value. Replacement cost is the appropriate value to use in this case. The total replacement cost of the items is $1,100 ($400 + $700). Therefore, Item A is allocated 4/11 of the purchase cost, or $364 = ($400/$1,100)$1,000.
When marking up a specific line of household items for resale, a retailer computes its markup as 40% of cost. For purposes of estimating ending inventory using the gross margin method, what percentage is applied to sales when estimating cost of goods sold?
71
The gross margin method applies the cost to sales ratio to sales in order to derive an estimate of cost of goods sold. Subtracting the resulting estimate of cost of goods sold from the cost of goods available for sale yields an estimate of ending inventory without counting the items. This firm determines the selling price to be 140% of cost because the markup is 40% of cost. Cost plus markup yields selling price. Therefore, the cost to sales ratio is 1.00/1.40 or .71.
A firm’s inventory was destroyed by fire on August 14 of the current year. Fortunately, the firm had insurance to cover the loss. However, most of the inventory records were also destroyed in the fire. The average gross margin percentage is 40%, beginning inventory was $200,000, and $1,000,000 of purchases had been made through August 13. The firm had recorded sales of $1,200,000 through that date. Estimate the cost of the inventory lost in the fire.
$480,000
The gross margin method estimates the cost of inventory at the time of the fire as follows: Beginning inventory $200,000 + $1,000,000 Purchases = Ending inventory + Cost of goods sold. The estimate of cost of goods sold is found by multiplying the cost to sales ratio and sales. The gross margin percentage plus the cost to sales ratio is 1; therefore, cost/sales is .60 (= 1 - .40). Estimated cost of goods sold is $720,000 (= .60($1,200,000)). The equation is Beginning inventory $200,000 + Purchases $1,000,000 = Ending inventory + Cost of goods sold $720,000. Solving for ending inventory yields $480,000.
How does the retail inventory method establish the lower-of-cost-or-market valuation for ending inventory?
By excluding net markdowns from the cost-to-retail ratio.
Although the result is approximate, by excluding net markdowns from the denominator of the cost-to-retail ratio, the ratio is a smaller amount, resulting in a lower ending inventory valuation.
Data for a firm using the FIFO-LCM retail inventory method is as follows:
Cost Retail Beginning inventory $ 300 $ 467 Net purchases 1,200 2,000 Net additional markups 100 Net markdowns (300) Sales $1,700
Compute cost of goods sold.
$1,169
Ending inventory at retail = $567 (= $467 + $2,000 + $100-$300-$1,700). The cost-to-retail ratio includes both the beginning inventory amounts, purchases and net markdowns. C/R = $300 + $1,200/($467 + $2,000 + $100) = .5843. Ending inventory at cost = $567(.5843) = $331. Cost of goods sold = $300 + $1,200 - $331 = $1,169.
Union Corp. uses the conventional retail method of inventory valuation. The following information is available:
Cost Retail Beginning inventory $12,000 $ 30,000 Purchases 60,000 110,000 Net additional markups 10,000 Net markdowns 20,000 Sales revenue 90,000
If the lower of cost or market rule is disregarded, what would be the estimated cost of the ending inventory?
$19,200
The cost to retail ratio under FIFO is: [$12,000 + $60,000/($30,000 + $110,000 + $10,000)] = .48.
Ending inventory at retail is $30,000 + $110,000 + $10,000 − $20,000 − $90,000 = $40,000.
Ending inventory at cost, therefore, is .48($40,000) = $19,200.
The retail inventory method includes which of the following in the calculation of both cost and retail amounts of goods available for sale?
Purchase returns.
The retail method measures beginning inventory and net purchases at both cost and retail. It then applies the average relationship between cost and retail (based on beginning inventory and purchases) to ending inventory at retail to determine ending inventory at cost.
Purchase returns reduce net purchases at both cost and retail because returns represent amounts included in gross purchases that are not available for sale.
Choose the correct inclusions to the cost-to-retail ratio computation under the dollar-value LIFO retail method.
Beginning Inventory - No
Net Markdowns - YES
DV LIFO retail uses the FIFO (not LCM) cost-to-retail ratio. Under LIFO, a layer added during a period should reflect only the cost and retail amounts pertaining to that period. Thus, beginning inventory amounts are not used in calculating the ratio. Also, because LIFO may contain inventory layers for several preceding periods, excluding net markdowns is not an effective way to accomplish the LCM valuation objective. Thus, net markdowns are included in the cost to retail computation.
A firm uses the dollar value LIFO retail method and has $2,000 in beginning inventory at retail at the beginning of the current year. The base year equivalent of this amount is $1,600. The base year index is 1.00. The beginning inventory reported in the Balance Sheet is $800. During the current year, the firm purchased $12,000 of inventory at cost and marked that up to $40,000. Sales for the year were $28,000. The relevant ending price index is 1.60. What amount does this firm report as inventory in its Balance Sheet at the end of the current year?
$4,232
EI retail, current index = $2,000 + $40,000-$28,000 = $14,000
EI retail, base = $14,000/1.6 = $8,750
Increase in EI retail, base = $8,750-$1,600 = $7,150
Increase in EI retail, current = $7,150(1.6) = $11,440
C/R (use FIFO, not LCM) = $12,000/$40,000 = .30
Increase in EI, cost = .30($11,440) = $3,432
EI, cost = $800 + $3,432= $4,232
Information for a firm using the dollar value (DV) LIFO retail method follows. The cost to retail (C/R) is provided along with price level indices. The data reflects the use of the method through year one.
Retail Retail DV LIFO Layer Base Index Current C/R Cost Base $200 1.00 $200 .40 $80 year one 80 1.10 88 .34 $30
For year two, ending inventory at retail (by count) totaled $450. The ending price-level index for the year was 1.15. The cost-to-retail ratio was .42. What is the ending inventory for financial reporting purposes for this firm?
$164
The DV LIFO retail process applies the DV LIFO method to retail dollars, and then deflates the retail layer added, now reflecting current prices, to cost, using the cost-to-retail ratio. The calculations are:
Ending inventory, retail, at base = $450(1.00/1.15) = $391
Increase in retail, current = $111(1.15/1.00) = $128
Increase in cost = $128(.42) = $54
Ending inventory at cost = ($80 + $30) + $54 = $164
Moss Co. has determined its December 31, 20X4 inventory to be $400,000 on a FIFO basis. Information pertaining to that inventory follows:
Estimated selling price $408,000
Estimated cost of disposal 20,000
Normal profit margin 60,000
Current replacement cost 360,000
Moss records losses that result from applying lower of cost or net realizable value. On December 31, 20X4, what should be the net carrying value of Moss’ inventory?
$388,000
Lower of cost or net realizable value applies to inventories that are carried at FIFO or Average cost. Net realizable value is selling price less cost of disposal. In this case it is $408,000 − $20,000 = $388,000.
The replacement cost of an inventory item is below the net realizable value and above the net realizable value less the normal profit margin. The original cost of the inventory item is below the net realizable value less the normal profit margin.
Under the lower of cost or market method, the inventory item should be valued at
Original cost.
In LCM, market value is replacement cost if replacement cost is between the ceiling value (net realizable value) and the floor value (net realizable value less normal profit margin).
This is the situation in this question. The original cost is below the floor value. Thus, market exceeds cost and the item is recorded at cost (lower of cost or market).
Kahn Co., in applying the lower of cost or market method, reports its inventory at replacement cost. Which of the following statements are correct?
The original cost is greater
than replacement cost
The net realizable value, less a
normal profit margin, is greater
than replacement cost
The original cost is greater
than replacement cost - YES
The net realizable value, less a
normal profit margin, is greater
than replacement cost - NO
Under LCM, the market value of inventory is the middle of three figures (in amount):
replacement cost
net realizable value
net realizable value less normal profit margin.
If the middle figure (market) is less than cost, then the inventory is reported at market. The inventory in this question is reported at replacement cost, which means that replacement cost is market value and replacement cost is less than cost. Also, replacement cost is the middle of the three figures (or tied with one of the other two).
Net realizable value less normal profit margin could not exceed replacement cost because that would imply that replacement cost is the lowest of the three figures, which contradicts the fact that replacement cost is market value.
Therefore, in terms of the question,
(1) original cost is greater than replacement cost, and
(2) net realizable value less normal profit margin is not greater than replacement cost.
At the end of the year, Ian Co. determined its inventory to be $258,000 on a LIFO (last in, first out) basis. The current replacement cost of this inventory was $230,000. Ian estimates that it could sell the inventory for $275,000 at a disposal cost of $14,000. If Ian’s normal profit margin for its inventory was $10,000, what would be its net carrying value?
$251,000
The “ceiling” for LCM (lower of cost or market) valuation is $261,000 net realizable value ($275,000 selling price less $14,000 disposal cost). The “floor” is net realizable value less normal profit margin or $251,000 ($261,000 − $10,000). Replacement cost of $230,000 is below the floor so “market” value is the floor, or middle, of the three amounts ($251,000). This amount is less than cost of $258,000. Therefore, the lower of cost or market valuation is $251,000.
The original cost of an inventory item is above the replacement cost. The inventory item’s replacement cost is above the net realizable value. Under the lower of cost or market method, the inventory item should be valued at
Net realizable value.
Inventory must be carried at lower of cost (such as LIFO or market. Market is replacement cost subject to a ceiling and floor. The ceiling for replacement cost is net realizable value (selling price less cost to complete) and the floor is net realizable value less normal profit margin. Use simple numbers to help solve this abstract question. In this question original cost (assume = 100) is greater than market ((replacement cost) assume = 80). Market (80) is greater than net realizable value (assume = 70). Market is subject to a ceiling of net realizable value (70). In this case the inventory would be valued at net realizable value.
The replacement cost of an inventory item is below the net realizable value and above the net realizable value less a normal profit margin. The inventory item’s original cost is above the net realizable value. Under the lower of cost or market method, the inventory item should be valued at
Replacement cost
The easiest way to answer a question like this is to make up simple numbers. The following simple numbers were made up to fit the abstract information in the question. Lower of cost or market states you record the inventory at the lower of original cost or market value (replacement cost) within the range of a ceiling and a floor. The numbers below show that replacement cost is lower than original cost and within the floor and ceiling. Replacement cost is the correct answer.
Original cost $10
Net realizable value 9
Replacement cost 8
NRV less normal PM 7
When an inventory overstatement in year one counterbalances in year two, this means:
A prior period adjustment is recorded if the error is discovered in year two.
Counterbalancing simply means that the effect of the inventory error in the second year is opposite that of the first year. Discovery in year two provides an opportunity for the firm to correct year two beginning retained earnings, which is overstated by the error in year one. The overstatement of inventory in year one caused cost of goods sold to be understated and income overstated in year one. The prior period adjustment, dated as of the beginning of year two, is a debit to retained earnings for the after-tax effect of the income overstatement in year one. Inventory is credited for the amount of the overstatement. This allows year two to begin with corrected balances.
If ending inventory for 20x5 is understated because certain items were missed in the count, then:
Net income for 20x5 will be understated and CGS for 20x6 will be understated.
Use the equation BI + PUR = EI + CGS. When EI is understated, CGS must be overstated to maintain the equation. Net income, therefore, is understated (20x5). Then next year, BI is also understated because BI for 20x6 is EI for 20x5. Using the equation, if BI is understated, CGS is also understated to maintain the equation.
Bren Co.’s beginning inventory at January 1, 2005 was understated by $26,000, and its ending inventory was overstated by $52,000. As a result, Bren’s cost of goods sold for 2005 was:
Understated by $78,000.
The effect of the beginning-inventory error is to understate cost of goods sold $26,000. The effect of the ending-inventory error is to understate cost of goods sold $52,000. The total effect then is to understate cost of goods sold $78,000.
These effects are analyzed by using the equation:
Beginning inventory + Purchases-Ending inventory = Cost of goods sold
For example, if beginning inventory is understated, then the right hand side of the equation (cost of goods sold) must also be understated by the same amount.
Losses on purchase commitments are recorded at the end of the current year when:
The contractual cost of the inventory in an irrevocable purchase contract exceeds the current cost.
Both qualities are required for a loss to be recognized. The firm must honor a contract in a later period by paying more than current cost and, thus, is in a loss position at the end of the current year.
At the end of 20x4, a firm recognized a loss on a contractual commitment to purchase inventory for $60,000. The value of the inventory at the end of 20x4 is $52,000. When the inventory was actually purchased in 20x5, its value had risen to $62,000. Choose the correct statement concerning reporting in 20x5.
The inventory is recorded at $60,000.
The maximum recorded value of the inventory is $60,000, which is the contractual amount and, also, the cost. If the firm can sell the inventory for more than $60,000, then gross margin will be recognized. The value of the inventory more than fully recovered, but gains are limited to the amount of previously recognized losses, which in this case, is $8,000.
A corporation entered into a purchase commitment to buy inventory. At the end of the accounting period, the current market value of the inventory was less than the fixed purchase price, by a material amount. Which of the following accounting treatments is most appropriate?
Describe the nature of the contract in a note to the financial statements, recognize a loss in the Income Statement, and recognize a liability for the accrued loss.
The firm has committed to a fixed price but must recognize the loss in the period the decline in price occurred, much like under lower-of-cost-or-market. Inventory is not reduced because the firm has not purchased the inventory under contract. There is no asset to reduce, but the decrease in net assets is accomplished by recording the liability for the portion of the purchase price that has no value.
In October of year one, a firm committed to a purchase of inventory at a total cost of $26,000. The contract is irrevocable and specifies a delivery date in March of year two. At the end of year one, the market value of the inventory under contract is worth $23,000 at current cost. Choose the correct reporting for the year one financial statements:
A liability of $3,000 is reported in the Balance Sheet.
The firm has committed to a purchase for a total cost of $26,000, but at year-end, the value of the item to be received is $3,000 less. The firm cannot postpone the loss and liability recognition because the reduction in the firm’s earnings and net assets has already occurred. The economic events causing the loss have occurred as of the Balance Sheet date.
As of December 31, Year 2, a company has an inventory item that was originally purchased for $80 in Year 1. The inventory item was written down to its net realizable value of $60 as of December 31, Year 1. As of December 31, Year 2, the inventory item had a net realizable value of $75 and a replacement cost of $65. Normal profit margins for this company are 20%. Under IFRS, what is the carrying amount of the inventory item as of December 31, Year 2?
$75
Under IFRS, the inventory would be carried at the lower of cost or NRV. The NRV at the end of Year 2 is $75.
At the end of year 1, a company reduced its inventory cost from $100 to its net realizable value of $80. As of the end of year 2, the inventory was still on hand, and its net realizable value increased to $150. Under IFRS, what journal entry should the company record for year 2 to properly report the inventory value?
Debit inventory for $20 and credit expense for $20.
Under IFRS, inventory is carried at the lower of cost or net realizable value. Recovery of previous write-downs is allowed. Therefore, in year 2, the company can recover the previous write-down of $20 ($100 – 80) but cannot write the inventory above the original cost. The entry to record the recovery is a debit to inventory and credit to expense or cost of goods sold for $20.
The following information relates to a company’s year-end inventory:
Inventory cost $ 910
Selling price of inventory $1,000
Normal profit margin 10% of selling price
Current replacement cost $740
Cost of completion and disposal $100
Under IFRS, what is the company’s year-end inventory balance?
$900
IFRS reports inventory at lower of cost or net realizable value. Net realizable value is the selling price less the cost to complete or dispose of the inventory. The net realizable value is the selling price of $1,000 less the cost to complete of $100, or $900. Net realizable value is less than the cost ($910) so the inventory is reported at $900.
A company issued a purchase order on December 15, Year 1, for a piece of capital equipment that costs $100,000. The capital equipment was shipped from the vendor on December 31, Year 1, and received by the company on January 5, Year 2. The equipment was installed and placed in service on February 1, Year 2. On what date should the depreciation expense begin?
February 1, Year 2
Depreciation expense should begin on the date that the asset is placed into service and therefore, contributing to the generation of revenues. The depreciation expense should begin on February 1, Year 2.
A corporation issued debt to purchase 10 acres of land for development purposes. Expenditures related to this purchase are as follows:
Description Amount Purchase price $1,000,000 Real estate taxes in arrears 15,000 Debt issuance costs 2,000 Attorney fee—title search on land 5,000
The company should record its acquisition of the land in its financial statements at a value of
$1,020,000
The costs capitalized to the land are all costs to get the land ready for use (development). Those costs are: the cost of the land, the real estate taxes in arrears, and the attorney fee for the title search.
debt issue costs are a financing cost
Newt Co. sold a warehouse and used the proceeds to acquire a new warehouse. The excess of the proceeds over the carrying amount of the warehouse sold should be reported as a(an):
Part of continuing operations.
The gain or loss on the sale of an asset is part of continuing operations as it is expected that a company will sell existing assets from time to time as the assets are replaced.
GAAP does not allow the gain or loss on the sale of the old asset to adjust the cost of the new asset.
The sale of a single asset is not a segment of the business; therefore, the warehouse is not a discontinued operation.
The FASB eliminated the category for extraordinary gains and losses.
Talton Co. installed new assembly line production equipment at a cost of $185,000. Talton had to rearrange the assembly line and remove a wall to install the equipment. The rearrangement cost was $12,000 and the wall removal cost was $3,000. The rearrangement did not increase the life of the assembly line but it did make it more efficient. What amount of these costs should be capitalized by Talton?
$200,000
This response includes all the costs to get the equipment ready for use. The rearrangement costs and the wall removal costs were needed to put the equipment into use. The rearrangement costs made the production more efficient.
On December 1, 20X5, East Co. purchased a tract of land as a factory site for $300,000. The old building on the property was razed and salvaged materials resulting from demolition were sold.
Additional costs incurred and salvage proceeds realized during December 20X5 were as follows:
Cost to raze old building $25,000
Legal fees for purchase contract and to record ownership 5,000
Title guarantee insurance 6,000
Proceeds from sale of salvaged materials 4,000
In East’s December 31, 20X5 Balance Sheet, what amount should be reported as land?
$332,000
The correct answer, $332,000, equals: $300,000 + $25,000-$4,000 + $5,000 + $6,000.
The net cost to raze the old building ($21,000) is capitalized to land because it is a cost necessary to bring the land into its intended condition. The legal fees and title guarantee cost, likewise, must be incurred to avoid future legal problems, and thus contribute to the value of the land.
On October 1, 20X4, Shaw Corp. purchased a machine for $126,000 that was placed in service on November 30, 20X4. Shaw incurred additional costs for this machine, as follows:
Shipping $ 3,000
Installation 4,000
Testing 5,000
In Shaw’s December 31, 20X4 Balance Sheet, the machine’s cost should be reported as:
$138,000
Every cost listed is a cost necessary to place the asset into its intended condition and location. This is the general rule for capitalizing costs to plant assets.
Thus, all four costs are capitalized to the machine yielding a final capitalized value of $138,000 ($126,000 + $3,000 + $4,000 + $5,000).
Derby Co. incurred costs to modify its building and to rearrange its production line. As a result, an overall reduction in production costs is expected. However, the modifications did not increase the building’s market value, and the rearrangement did not extend the production line’s life.
Should the building modification costs and the production line rearrangement costs be capitalized?
Building modification costs - YES
Production line rearrangement costs - YES
The criterion for capitalizing post-acquisition costs is not whether the market value of the overall asset is increased. Rather, the criteria are (1) increase in useful life or (2) increase in productivity or efficiency including cost reduction.
An overall reduction in production costs meets the second criterion. Therefore, both costs are capitalized rather than immediately expensed.
Lano Corp.’s forestland was condemned for use as a national park. Compensation for the condemnation exceeded the forestland’s carrying amount. Lano purchased similar, but larger, replacement forestland for an amount greater than the condemnation award.
As a result of the condemnation and replacement, what is the net effect on the carrying amount of the forestland reported in Lano’s Balance Sheet?
The amount is increased by the excess of the replacement forestland’s cost over the condemned forestland’s carrying amount.
The two transactions are not related. The land account is decreased by the book value of the land condemned and increased by the cost of the land purchased. The relative magnitudes of the book values are shown below:
award > book value of condemned land
cost of new land > award
Therefore: cost of new land > book value of condemned land
Thus, the land is increased by the net amount: cost of new land-book value of old land
On December 1, 20X5, Boyd Co. purchased a $400,000 tract of land for a factory site. Boyd razed an old building on the property and sold the materials it salvaged from the demolition.
Boyd incurred additional costs and realized salvage proceeds during December 20X5 as follows:
Demolition of old building $50,000
Legal fees for purchase contract and recording ownership 10,000
Title guarantee insurance 12,000
Proceeds from sale of salvaged materials 8,000
In its December 31, 20X5, Balance Sheet, Boyd should report a balance in the land account of:
$464,000
Land purchase price $400,000 Plus demolition of old building 50,000 Less salvage proceeds (8,000) Plus title insurance 12,000 Plus legal fees 10,000 Equals recorded land cost $464,000
The net demolition cost is included in land because it is a cost required to prepare the land for its eventual use.
Merry Co. purchased a machine costing $125,000 for its manufacturing operations and paid shipping costs of $20,000. Merry spent an additional $10,000 testing and preparing the machine for use.
What amount should Merry record as the cost of the machine?
$155,000
All three costs are included for a total of $155,000. Both the shipping and testing costs are necessary to place the asset into its intended location and condition for use. This is the criterion for capitalizing costs on acquisition of plant assets.
Oak Co., a newly formed corporation, incurred the following expenditures related to land and building:
County assessment for sewer lines $ 2,500
Title search fees 625
Cash paid for land with a building to be demolished 135,000
Excavation for construction of basement 21,000
Removal of old building $21,000 less salvage of $5,000 16,000
At what amount should Oak record the land?
$154,125
The amounts necessary to get the land ready for its intended purpose attach themselves as a part of the total cost of the land. This would be the: $2,500+625+135,000+16,000=$154,125
A plant asset under construction by a firm for its own use was completed at the end of the current year. The following costs were incurred:
Materials $60,000
Labor 30,000
Incremental overhead 10,000
Capitalized interest 20,000
The asset has a service life of 10 years, estimated residual value of $10,000, and will be depreciated under the double declining balance method. At completion, the asset was worth $105,000 at fair value. What amount of depreciation will be recognized on the asset in total over its service life?
$95,000
The sum of the four listed costs is $120,000, which exceeds fair value of $105,000. Therefore, the asset is capitalized at $105,000, the lesser of the two amounts. Subtracting the $10,000 residual value yields $95,000 depreciable cost-the total depreciation over the life of the asset.
Immediately after a note payable was signed, its present value was $30,000. This note and $20,000 cash were used to acquire a used plant asset at the beginning of the current year. The interest rate implied in the note is 6%. Total interest payments due on the note over its term amount to $4,000. The term exceeds one year. No payments on the note are due during the current year. What amount of interest expense is recognized for the first year (current year) on this note, and what amount is capitalized to the plant asset account?
Interest Expense - $ 1,800
Capitalized Amount - $ 50,000
The interest expense recognized for the first year is .06($30,000) = $1,800. Although no interest is paid, interest is accrued, increasing the carrying value of the note. The asset is capitalized at $50,000, the sum of cash down payment and present value of the note. The interest over the note term is not capitalized because it does not assist in the process of placing the asset into its intended condition and location.
Plant assets are occasionally acquired by means other than by paying cash. Choose the correct statement about such acquisitions.
If a building is acquired by issuing an amount of stock that is significant in relation to the amount of stock outstanding before the exchange, the fair value of the building should be used to initially debit the building account.
The more objective or readily determinable value is used for recording the building. If the number of shares is significant in relation to the total shares outstanding, the stock price will be affected by the increase in the shares outstanding resulting from the purchase. The more objective value is the appraised value of the building.
When debt is incurred to purchase a plant asset, only the principal value of the debt (its present value) is capitalized. The interest subsequently paid is not considered part of the cost of the equipment because it does not contribute to the asset’s value in use.
A firm began the construction of its new manufacturing facility in January of 20x2. The following expenditures were made on construction in that year:
Jan. 1 $40,000
Mar. 1 120,000
Oct. 31 96,000
Debt outstanding the entire year:
6%, $60,000 construction loan
4%, $90,000 note payable not related to construction
6%, $90,000 note payable not related to construction
Compute interest to be capitalized using the weighted average method.
$8,190
Average accumulated expenditures is $156,000 = $40,000 + $120,000(10/12) + $96,000(2/12). This method uses the average interest rate on all interest bearing debt, weighted by principal. That rate is the quotient of the interest on all the debt divided by the principal on all the debt. The rate = ($3,600 + $3,600 + $5,400)/$240,000 = .0525. Interest capitalized = (.0525)$156,000 = $8,190.
Two approaches are available for applying interest rates to average accumulated expenditures for the purpose of capitalizing interest. These approaches are called the specific method and the weighted average method. In some cases, these approaches yield the same results. Two situations may be encountered in practice for a specific period:
(1) average accumulated expenditures exceed total interest bearing debt (principal) and
(2) the interest rates on all interest bearing debt instruments are the same.
Which situation yields the same results for the two approaches?
both (1) and (2).
When average accumulated expenditures exceeds interest bearing debt, all interest for the period is capitalized because all debt could have been avoided if the construction had not taken place. Also, if the interest rates on all debt are the same, then the two approaches yield the same results because, ultimately, only one interest rate is applied to average accumulated expenditures for computing capitalized interest.
Debt is frequently incurred when plant assets are acquired. For example, debt may be incurred on the purchase of plant assets. Debt may also be incurred during the construction of plant assets. How is the interest in these two cases treated for financial reporting?
Debt for purchase - Expensed
Debt during construction - Capitalized
Interest on debt incurred when purchasing a plant asset, is incurred after the asset has reached its intended condition and location. Therefore, it is expensed as incurred. Debt incurred during the construction of plant assets is considered avoidable and also incurred before the asset has reached its intended condition and location. Therefore, it is capitalized to the asset in the same way material, labor, and overhead are capitalized. The interest is expensed as part of depreciation during the service life of the asset.
Papa Company acquired land with an office building on it from its subsidiary, Sonny Company, for $110,000. Prior to the sale, Sonny’s carrying value of the land was $60,000 and its net carrying value of the building was $50,000. At the time of the transaction, Papa appropriately determined that the land had a fair value of $75,000 and the building had a fair value of $35,000. At what amount should Papa record the land and building on its books at the date of the transaction?
Land - $ 75,000
Building - $ 35,000
Papa should record the land and building on its books at the appropriately determined fair value at the date of the transaction. The prior carrying values on Sonny’s books are not relevant to the amounts at which Papa should record the assets on its books, but are relevant to the amounts that should be reported in the consolidated financial statements.
At the beginning of the year, Cann Co. started construction on a new $2 million addition to its plant. Total construction expenditures made during the year were $200,000 on January 2, $600,000 on May 1, and $300,000 on December 1. On January 2, the company borrowed $500,000 for the construction at 12%. The only other outstanding debt the company had was a 10% interest rate, long-term mortgage of $800,000, which had been outstanding the entire year. What amount of interest should Cann capitalize as part of the cost of the plant addition?
$72,500
First calculate the Average Accumulated Expenditures (AAE). This gives you the amount of borrowing from which to calculate avoidable interest ($625,000). Next calculate avoidable interest ($72,500) and actual interest (($500,000 × 12%) + ($800,000 × 10%) = $140,000). The amount that can be capitalized is the lesser of the avoidable interest or actual interest. The amount that can be capitalized is $72,500.
AAE 200,000 12/12 200,000 600,000 8/12 400,000 300,000 1/12 25,000 625,000
Avoidable interest
500,000 12% 60,000
125,000 10% 12,500
72,500
During Year 1, Bay Co. constructed machinery for its own use and for sale to customers. Bank loans financed these assets both during construction and after construction was complete.
How much of the interest incurred should be reported as interest expense in the Year 1 Income Statement?
Interest incurred for machinery for own use -
Interest incurred after completion
Interest incurred for machinery held for sale - All interest incurred
Interest during construction on assets constructed for a firm’s own use is capitalized until construction is complete. Thus, only the interest incurred after completion is expensed.
Interest is capitalized on the construction of assets for sale only if the assets are large, individual, discrete projects, such as ships or real estate developments. The equipment constructed for sale does not appear to be a discrete item in that sense and, thus, none of the interest is capitalized. It is all expensed.
Average accumulated expenditures for year five on a construction project amounted to $70,000. The total cash invested in the project by the end of year five, was $160,000. During year six, the firm spent another $240,000 (total) on the project, uniformly throughout the year. Compute average accumulated expenditures for year six.
$280,000
Average accumulated expenditures is the amount of debt for the annual period that could have been avoided. In this case, the firm has $160,000 already invested in the project at the beginning of year six. That amount represents $160,000 in debt, that could have been avoided for year six if the firm had not been involved in the construction project. The expenditures during year six were incurred evenly. Average accumulated expenditures therefore = $160,000(12/12) + $240,000/2 = $280,000. Also, [$160,000 + ($160,000 + $240,000)]/2 = $280,000.
A firm has spent the last two years constructing a building to be used as the firm’s headquarters. At the end of the first year of construction, the balance of building under construction was $400,000, which includes capitalized interest. During year two, the firm paid $240,000 to the contractor on March 1, and $600,000 on October 1. The building was not finished by the end of the second year. The firm had one loan outstanding all year, an 8%, $3,000,000 construction loan. Compute capitalized interest for year two.
$60,000
Average accumulated expenditures for the second year = $400,000(12/12) + $240,000(10/12) + $600,000(3/12) = $750,000. Interest capitalized = .08($750,000) = $60,000. Note that the interest capitalized in year one is compounded in year two because year one capitalized interest is included in average accumulated expenditures for the second year.
A company with a June 30 fiscal year-end entered into a $3,000,000 construction project on April 1 to be completed on September 30. The cumulative construction-in-progress balances at April 30, May 31, and June 30 were $500,000, $800,000, and $1,500,000, respectively. The interest rate on company debt used to finance the construction project was 5% from April 1 through June 30 and 6% from July 1 through September 30. Assuming that the asset is placed into service on October 1, what amount of interest should be capitalized to the project on June 30?
$11,666
Interest is capitalized on the project’s average expenditures times the interest during that period. Key here is to use the 5% annual interest over the three months (April, May, and June).
Average expenditures:
500,000 + 800,000 + 1,500,0003 = 933,333
Interest rate for 3-month period: .05 × 3/12 × .0125
Capitalized interest: 11,666
On June 18, 20X5, Dell Printing Co. incurred the following costs for one of its printing presses:
Purchase of collating and stapling attachment $84,000
Installation of attachment 36,000
Replacement parts for overhaul of press 26,000
Labor and overhead in connection with overhaul 14,000
The overhaul resulted in a significant increase in production. Neither the attachment nor the overhaul increased the estimated useful life of the press. What amount of the above costs should be capitalized?
$160,000
All four costs should be capitalized because they result in an increase in the productivity of the asset. Costs that increase EITHER the life OR productivity are capitalized. Either type of increase results in enhanced asset values. $160,000 is the sum of the four costs listed.
Many years after constructing a plant asset, management spent a significant sum on the asset. Which of the following types of expenditures should be capitalized in this instance:
(1) an expenditure for routine maintenance that increases the useful life compared with deferring the maintenance,
(2) an expenditure that increases the useful life of the asset compared with the original estimate assuming normal maintenance at the required intervals,
(3) an expenditure that increases the utility of the asset.
(1) NO
(2) YES
(3) YES
Post-acquisition expenditures, which increase the useful life (assuming normal maintenance) or the utility (usefulness or productivity) of the asset, are capitalized. Such expenditures provide value for more than one year. The original useful life of an asset assumes regular maintenance. Therefore, regular maintenance does not increase the intended useful life of the asset.
On January 1, 20X5, Dix Co. replaced its old boiler. The following information was available on that date:
Carrying amount of old boiler $ 8,000
Fair value of old boiler 2,000
Purchase and installation price of new boiler 100,000
The old boiler was sold for $2,000.
What amount should Dix capitalize as the cost of the new boiler?
$100,000
The disposal of the old boiler and purchase of the new boiler are separate transactions. The loss on disposal has no effect on the capitalized cost of the new boiler, which is recorded at its $100,000 purchase cost.
A building suffered uninsured fire damage. The damaged portion of the building was refurbished with higher quality materials. The cost and related accumulated depreciation of the damaged portion are identifiable. To account for these events, the owner should:
Capitalize the cost of refurbishing, and record a loss in the current period equal to the carrying amount of the damaged portion of the building.
When the cost and accumulated depreciation of a component or portion of a larger asset is identifiable, and that component or portion is replaced, the replacement is treated as two separate transactions:
(1) disposal of the old component (for zero proceeds in this case, due to the fire damage) and
(2) purchase of the new component.
Thus, a loss equal to the book value of the old component is recognized for (1) and the amount paid to purchase the new component is capitalized as a separate purchase for (2).
List the non accelerated methods of
depreciation.
Straight-line method
Service hours method
Units of output method
What type of allocation is depreciation
considered?
Systematic and rational allocation of
capitalized asset cost to time periods
How do we calculate the annual
straight-line depreciation amount of an
asset?
(Cost − Salvage value) / Useful life
Depreciation is included in overhead
and allocated to production based on
machine hours or direct labor for what
type of asset?
Manufacturing assets
How do we calculate depreciation
based on service hours?
Depreciation rate × Service hours used
Depreciation rate = (Cost −
Salvage value) / Estimated hours
Define “book value.”
Original cost less accumulated
depreciation to date
Ott Co. purchased a machine at an original cost of $90,000 on January 2, Year 1. The estimated useful life of the machine is 10 years, and the machine has no salvage value. Ott uses the straight-line method to calculate depreciation. On July 1, Year 10, Ott sold the machine for $5,000. What is the amount of gain or loss on the disposal of the machine?
$500 gain
The gain or loss on the disposal of an asset is the difference between the net book value (NBV) and the selling price. The annual depreciation of the machine is $9,000 ($90,000/10 years). The asset was held for 9.5 years, so accumulated depreciation is $85,500. NBV is $4,500 ($90,000 less accumulated depreciation of $85,500). The sale is a gain of $500 because the selling price is greater than the NBV ($5,000 − $4,500).
In year 6, Spirit, Inc. determined that the 12-year estimated useful life of a machine purchased for $48,000 in January year 1 should be extended by three years. The machine is being depreciated using the straight-line method and has no salvage value. What amount of depreciation expense should Spirit report in its financial statements for the year ending December 31, year 6?
$2,800
This is a change in estimate and is handled currently and prospectively by allocating the remaining book value at the beginning of year 6 over the revised estimate of remaining years at that point. Through the beginning of year 6, the asset has been used five years. Therefore, seven years remain in the original book value. The book value at the beginning of year 6 is 7/12 × $48,000 or $28,000. The remaining useful life of seven years is extended to 10. Therefore, depreciation expense for year 6 is $28,000 × 1/10 or $2,800.
Net income is understated if, in the first year, estimated salvage value is excluded from the depreciation computation when using the
Straight-line method - YES
Production or use method - YES
When salvage value is excluded from the computation of depreciation, excessive depreciation is recognized each year under BOTH methods. Therefore, income is understated for both methods.
Annual depreciation under straight-line is:
(1/n)(cost-salvage)
where n is the number of years in the useful life.
Annual depreciation under the production method is:
(current year production/tot.est.production)(cost-salvage)
In both cases, if salvage value is excluded from the computation, depreciation is overstated because cost, rather than depreciable cost, is used as the basis for depreciation.
Zahn Corp.’s comprehensive Balance Sheet at December 31, 2005 and 2004 reported accumulated depreciation balances of $800,000 and $600,000, respectively. Property with a cost of $50,000 and a carrying amount of $40,000 was the only property sold in 2005.
Depreciation charged to operations in 2005 was:
$210,000
The accumulated depreciation on the property sold was $10,000 ($50,000 cost less $40,000 carrying value). The sale of property requires that the accumulated depreciation on the property be removed from the accounts.
Thus, the $10,000 amount is a decrease in accumulated depreciation. With an overall increase of $200,000 in accumulated depreciation during the period ($800,000-$600,000), depreciation must have been $210,000 ($200,000 + $10,000).
What factor must be present to use the units of production (activity) method of depreciation?
Total units to be produced can be estimated.
Without an estimate for total units to be produced, depreciation could not be computed. Annual depreciation under this method is:
(Cost-salvage value)/(Total estimated production).
The quantity in square brackets is the rate of depreciation per unit.
On January 1, 20X5, Brecon Co. installed cabinets to display its merchandise in customers’ stores. Brecon expects to use these cabinets for five years.
Brecon’s 20X5 multi-step Income Statement should include:
One-fifth of the cabinet costs in selling, general, and administrative expenses.
With a five year life, 1/5 of the cost of the cabinets is expensed as depreciation. The cabinets are not involved in the manufacturing of the goods. Rather, they are used to help sell the merchandise.
Thus, the depreciation is not included in cost of goods sold; rather, it is included in selling, general, and administrative expenses.
In which of the following situations is the units of production method of depreciation most appropriate?
An asset’s service potential declines with use.
This method is most appropriate when the service potential of an asset can be estimated reliably in terms of a physical variable, such as miles to be driven, or number of units of output that can be produced by the asset.
Over time, as more units are produced, the service potential of the asset declines because the total number of units that can be produced is finite. Over time, the number of units that can be produced by the asset in the future declines. The primary causative agent for depreciation under the units of production method is, thus, the actual use of the asset in production.
On January 2, Year 1, Lem Corp. bought machinery under a contract that required a down payment of $10,000, plus 24 monthly payments of $5,000 each, for total cash payments of $130,000.
The cash-equivalent price of the machinery was $110,000. The machinery has an estimated useful life of 10 years and estimated salvage value of $5,000. Lem uses straight-line depreciation.
In its Year 1 Income Statement, what amount should Lem report as depreciation for this machinery?
$10,500
The capitalized cost of the equipment is $110,000, not the total of the cash payments to be made. The latter amount includes interest.
Thus, annual depreciation is $10,500:
($110,000-$5,000)/10.
Ichor Co. reported equipment with an original cost of $379,000 and $344,000 and accumulated depreciation of $153,000 and $128,000, respectively, in its comparative financial statements for the years ended December 31, 20X5 and 20X4.
During 20X5, Ichor purchased equipment costing $50,000 and sold equipment with a carrying value of $9,000.
What amount should Ichor report as depreciation expense for 20X5?
$31,000
Net equipment at end of 20X4: $344,000-$128,000 = $216,000
Equipment purchase 50,000
Book value of equipment sold (9,000)
Depreciation in 20X5 ?
Equals net equipment at end of 20X5: $379,000-$153,000 = $226,000
Solving for depreciation yields $31,000 depreciation for 20X5.
What depreciation method does
not use salvage value?
Double-declining balance
How do we calculate the rate
used in double declining balance?
Straight-line rate: Number of years divided into 1 (i.e., if 5 years, 1 / 5 = 20%). Twice the straight-line rate: 20% × 2 = 40%
When is the inventory method of
depreciation used?
When the inventory items are
smaller homogeneous groups of
assets and individual records for
the assets are not maintained
What depreciation method is
used for group/composite assets?
The straight-line method to
groups rather than individual
assets
List the type of costs capitalized
for natural resources.
Acquisition
Exploration
Development
What costs are included in the full
costing method for exploration
costs?
All costs of exploring for the
resource are capitalized to the
natural resources account.
Define “depletion.”
Refers to the allocation of the
cost of the natural resource to
inventory
List the methods of accounting
for exploration costs.
Successful efforts
Full costing
List the depletion rate formula.
(Natural resources account
balance − residual value)/(Total
estimated units)
What costs are included in the
successful efforts method for
exploration costs?
Only the costs of successful
exploration efforts are capitalized
to the natural resources account.
What is the classification of
natural resources on the balance
sheet?
Non current asset
List the general test for
impairment.
Book value > Recoverable cost
When is a held-for-sale asset
impaired?
It is impaired when book value
exceeds its fair value less cost to
sell at the end of the reporting
period.
How is the amount of impairment
loss on asset in use determined?
The amount by which the
carrying value of the asset
exceeds its market value
How is the amount of impairment
loss on assets held for disposal
determined?
Fair value less cost to sell
How are assets grouped for
impairment testing?
Assets are grouped at the lowest
possible organizational level
where cash flows can be
identified.
What items must be reported for
impairment losses?
Report the loss as part of ordinary
income and also disclose:
The asset impaired.
The events leading to
impairment.
The amount of the
impairment loss.
The method of determining
fair value, including interest
rate.
List the impairment tests for
assets in use.
Sum net future cash flows
from asset (recoverable
cost)
If sum > book value, no
impairment
If sum < book value,
impairment
How are assets grouped for
impairment testing under
International Financial Reporting
Standards (IFRS)?
At the “cash-generating unit”
level
Are reversals of impairment
allowed under International
Financial Reporting Standards
(IFRS)?
Yes, they are allowed.
Under International Financial
Reporting Standards (IFRS_, how
is the impairment loss presented
if the asset is carried at fair value?
Any impairment loss would be
classified out of other
comprehensive income and into
earnings.
Vore Corp. bought equipment on January 2, 20X4 for $200,000. This equipment had an estimated useful life of five years and a salvage value of $20,000. Depreciation was computed by the 150% declining balance method.
The accumulated depreciation balance at December 31, 20X5 should be:
$102,000
Depreciation in 20X4 = $200,000(1.50/5) = $ 60,000
Depreciation in 20X5 = ($200,000-$60,000)(1.50/5) = 42,000
Accumulated depreciation balance at the end of 20X5 $ 102,000
The declining balance class of depreciation method does not deduct salvage value when computing depreciation although care must be taken not to depreciate the asset below salvage value. Also, the rate of depreciation applied to book value is the percentage of the method (150% in this case) divided by the useful life of the asset. Double declining balance, for example, is 200%/n or 2/n where n = useful life.
On April 1, 20X4, Kew Co. purchased new machinery for $300,000. The machinery has an estimated useful life of five years, and depreciation is computed by the sum-of-the-years’-digits method.
The accumulated depreciation on this machinery at March 31, 20X6 should be:
$180,000
$180,000, the correct answer, equals $300,000[(5 + 4)/(5 + 4 + 3 + 2 + 1)].
Two full years of depreciation have been recorded, and the SYD method uses the number of years left at the beginning of each year as the numerator of the fraction used in depreciation. At the beginning of the first and second years, five and four years of the asset’s life remained, respectively. The denominator is the sum of the digits up to the asset’s useful life (5).
A fixed asset with a five-year estimated useful life and no residual value is sold at the end of the second year of its useful life.
How would using the sum-of-the-years’-digits method of depreciation, instead of the double declining balance method of depreciation, affect a gain or loss on the sale of the fixed asset?
Gain - Decrease
Loss - Increase
Under SYD, total depreciation through the first two years is [(5 + 4)/(1 + 2 + 3 + 4 + 5)]Cost = (9/15)Cost.
Therefore, book value remaining is (6/15)Cost = .4Cost.
Depreciation, year one = (2/5)Cost = .4Cost
Depreciation, year two = (2/5)(Cost-Depreciation, year one)
= (2/5)[Cost-(2/5)Cost]
=.4[Cost-.4(Cost)]
= .4(.6Cost) = .24 Cost
Total depreciation for the two years is therefore .4(Cost) + .24(Cost) = .64(Cost). Book value remaining is (1-.64)Cost = .36 Cost.
The asset has a larger book value under SYD after two years. For a given amount of proceeds on disposal, the larger book value under SYD causes any gain on disposal to be smaller than under DDB and any loss greater than under DDB. In other words, the gain decreases and the loss increases, relative to DDB.
Spiro Corp. uses the sum-of-the-years’ digits method to depreciate equipment purchased in January 20X3 for $20,000. The estimated salvage value of the equipment is $2,000, and the estimated useful life is four years.
What should Spiro report as the asset’s carrying amount as of December 31, 20X5?
$3,800
The carrying amount (book value) of a depreciable asset is its original cost less accumulated depreciation. Under sum-of-the-years’ digits method of calculating depreciation expense (and, therefore, accumulated depreciation), the net depreciable cost (original cost less estimated salvage value) is multiplied by a factor consisting of:
Numerator = the number of years the current year is from the end of the life of the asset
Denominator = the sum of numbers (digits) for each year in the life of the asset
For Spiro, the net depreciable cost is $20,000-$2,000 = $18,000. Since the equipment has an estimated useful life of four years, the sum of the digits for each year would be 1 + 2 + 3 + 4 = 10, the denominator for calculating each year’s depreciation. Depreciation for the four years would be:
Thus, at the end of 20X5 the carrying amount is $3,800, which also can be calculated as salvage value 2,000 + (1/10 × $18,000) = $2,000 + $1,800 = $3,800.
A depreciable asset has an estimated 15% salvage value. Under which of the following methods, properly applied, would the accumulated depreciation equal the original cost at the end of the asset’s estimated useful life?
Straight-line - NO
Double-declining balance - NO
Salvage value is the portion of the asset’s cost not subject to depreciation. Total depreciation, under any method, is limited to depreciable cost (cost less salvage value). The declining balance methods do not subtract salvage when computing depreciation. Care must be taken to avoid depreciating an asset beyond salvage value.
South Co. purchased a machine that was installed and placed in service on January 1, 20X4 at a cost of $240,000. Salvage value was estimated at $40,000. The machine is being depreciated over 10 years by the double declining balance method. For the year ended December 31, 20X5, what amount should South report as depreciation expense?
$38,400
Depreciation in 2004 = $240,000(2/10) = $48,000
Depreciation in 20X5 = ($240,000-$48,000)(2/10) = $38,400
The DDB method’s rate is always twice the straight-line rate, or 2/useful life. The method does not subtract salvage value when computing depreciation, but it also does not reduce book value below salvage value. The depreciation in any year is the rate times the beginning net book value of the asset.
On January 1, Year 1, Crater, Inc. purchased equipment having an estimated salvage value equal to 20% of its original cost at the end of a 10-year life. The equipment was sold December 31, Year 5, for 50% of its original cost.
If the equipment’s disposition resulted in a reported loss, which of the following depreciation methods did Crater use?
Straight-line.
The asset was sold when 1/2 of its useful life was expired. (The asset was used 5 years and had an original useful life of 10 years.) If an asset is sold at a loss, then the book value at the date of sale exceeds the proceeds from sale by the amount of the loss. Let C = original cost, and BV = book value at date of sale.
Then BV-proceeds = loss Proceeds = .50C according to the question data.
Thus, BV-.50C = loss. Thus, BV must exceed 50% of the original cost because BV-.50C is a positive number.
The only method from among those listed in the answer alternatives that leaves a BV greater than 50% of original cost after 50% of the useful life has expired is the SL method. The book value after the fifth year under SL is C-(C-.2C)(5/10) = .6C.
DDB’s book value after five years is much less than 50% of original cost because it is an accelerated method. The same holds for SYD. And under composite methods of depreciation, individual assets do not have a separately recorded book value. When sold, accumulated depreciation is debited for the difference between original cost and proceeds. No gain or loss is recognized. Thus, the composite method could not apply in this question.
Choose the best association of terms in the natural resources accounting area with the conceptual framework.
Successful efforts method-definition of asset.
The successful efforts method capitalizes only the cost of exploration efforts that locate the resource. As such, only those efforts that yield a probable future benefit are capitalized. This is a direct application of the asset definition, which requires that an asset have a probable future benefit.
A firm began a mineral exploitation venture during the current year by spending (1) $40 million for the mineral rights; (2) $100 million exploring for the minerals, one-fourth of which were successful; and (3) $60 million to develop the site. Management estimated that 20 million tons of ore would ultimately be removed from the property. Wages and other extraction costs for the current year amounted to $10 million. In total, 2 million tons of ore were removed from the deposit in the current year. The entire production for the period was sold. Compute cost of goods sold under the successful efforts method.
$22.5 million
The depletion rate = [$40 + (.25)($100) + $60]/20 = $6.25/ton. Depletion = 2,000,000($6.25/ton) = $12,500,000. Because all the ore removed was sold, cost of goods sold includes the entire amount of depletion and the extraction costs. Cost of goods sold = $12,500,000 + $10,000,000 = $22,500,000. Note, that extraction costs is included in inventory (and therefore, cost of goods sold), but not in the deposit (and therefore, not in depletion).
A firm began a mineral exploitation venture during the current year by spending (1) $40 million for the mineral rights; (2) $100 million exploring for the minerals, one-fourth of which were successful; and (3) $60 million to develop the site. Management estimated that 20 million tons of ore would ultimately be removed from the property. Wages and other extraction costs for the current year amounted to $10 million. In total, 2 million tons of ore were removed from the deposit in the current year. The entire production for the period was sold. What amount of depletion is recognized during the current year under the full costing method?
$20 million
The depletion rate = ($40 + $100 + $60)/20 = $10/ton. Depletion = 2,000,000($10/ton) = $20,000,000. Depletion for a period is the cost of the deposit allocated to the inventory removed for the period. In this case, the entire amount is included in cost of goods sold because there is no ending inventory. However, if there had been ore left at the end of the period, the $10/ton rate would have been applied to the units remaining. That would not change the answer to the question, however.
On December 31, 20X4, a building owned by Pine Corp. was totally destroyed by fire. The building had fire insurance coverage up to $500,000.
Other pertinent information as of December 31, 20X4, follows:
Building, carrying amount $520,000
Building, fair market value 550,000
Removal and cleanup cost 10,000
During January 20X5, before the 20X4 financial statements were issued, Pine received insurance proceeds of $500,000. On what amount should Pine base the determination of its loss on involuntary conversion?
$530,000
The sum of the carrying value ($520,000) and removal/cleanup cost ($10,000) is the amount to compare to the insurance proceeds when computing the loss. The fire caused the latter costs to be incurred; therefore, the cleanup costs should be included in the loss.
The fair value of the property would not figure into the recorded loss because the building account does not reflect this amount.
On July 1, 20X4, one of Rudd Co.’s delivery vans was destroyed in an accident. On that date, the van’s carrying value was $2,500.
On July 15, 20X4, Rudd received and recorded a $700 invoice for a new engine installed in the van in May 20X4, and another $500 invoice for various repairs. In August, Rudd received $3,500 under its insurance policy on the van, which it plans to use to replace the van.
What amount should Rudd report as gain (loss) on disposal of the van in its 20X4 income statement?
$300
The gain of $300 is the difference between the insurance proceeds and the sum of the carrying value of the van plus the cost of the new engine. The repair cost is expensed. It does not increase the value of the van. $300 = $3,500 − $2,500 − $700.
In January 20X2, Winn Corp. purchased equipment at a cost of $500,000.
The equipment had an estimated salvage value of $100,000, an estimated 8-year useful life, and was being depreciated by the straight-line method. Two years later, it became apparent to Winn that this equipment suffered a permanent impairment of value.
In January 20X4, management determined the carrying amount should be only $175,000, with a 2-year remaining useful life, and the salvage value should be reduced to $25,000.
In Winn’s December 31, 20X4, balance sheet, the equipment should be reported at a carrying amount of:
$100,000
The post-impairment carrying value is $175,000 at the beginning of 20X4. This amount is the new basis for depreciation. Depreciation in 20X4 is $75,000 [($175,000 − $25,000)/2].
The revised salvage value is used. After deducting the 20X4 depreciation expense of $75,000 from the $175,000 beginning book value, the ending 20X4 book value is $100,000.
Which of the following conditions must exist in order for an impairment loss to be recognized?
The test for impairment for an asset in use is whether the carrying value (book value) is less than its recoverable cost. An asset’s recoverable cost is the sum of its estimated net cash inflows projected for its remaining life.
When book value > recoverable cost, the carrying value is not recoverable. In other words, the asset is booked at more than the sum of its future net cash inflows.
For example, if an asset’s carrying value is $100 and its recoverable cost is $80, then its carrying value is not recoverable (only $80 is recoverable). The AMOUNT of the loss recognized is the difference between carrying value and fair value, but that difference is not used for TESTING whether an asset is impaired.
That difference is not the condition leading to the impairment loss.
Last year, Katt Co. reduced the carrying amount of its long-lived assets used in operations from $120,000 to $100,000 in connection with its annual impairment review. During the current year, Katt determined that the fair value of the same assets had increased to $130,000. What amount should Katt record as restoration of previously recognized impairment loss in the current year’s financial statements?
$0
Recovery of impairment losses is prohibited under U.S. GAAP.
Four years ago on January 2, Randall Co. purchased a long-lived asset. The purchase price of the asset was $250,000, with no salvage value. The estimated useful life of the asset was 10 years. Randall used the straight-line method to calculate depreciation expense. An impairment loss on the asset of $30,000 was recognized on December 31 of the current year. The estimated useful life of the asset at December 31 of the current year did not change. What amount should Randall report as depreciation expense in its income statement for the next year?
$20,000
The net book value of the asset at the time of impairment was $150,000: $250,000 cost less $100,000 accumulated depreciation (4 years of depreciation at $25,000 a year). After the impairment of $30,000, the net book value is $120,000 ($150,000 − 30,000). The remaining life is 6 years and annual depreciation is $20,000.
An asset group is being evaluated for an impairment loss. The following financial information is available for the asset group:
Carrying value $100,000,000
Sum of the undiscounted cash flows 95,000,000
Fair value 80,000,000
What amount of impairment loss, if any, should be recognized?
$20,000,000
Determination of impairment for an asset held in use is a two-step process. First the carrying value (CV) is compared to the recoverable cost (undiscounted cash flows). Since the CV is more than the recoverable cost, the second step must measure the impairment loss. The impairment loss is measured as the difference between CV and fair value (FV). The CV is $100 million and the FV is $80 million so the impairment loss is $20 million.
Restoration of the carrying value of a long-lived asset is permitted under IFRS if the asset’s fair value increases subsequent to recording an impairment loss for which of the following?
Held for use - YES
Held for disposal - YES
Under IFRS the impairment loss can be recovered if the asset is held for use or disposal.
Under IFRS the test for asset impairment is to compare the carrying value of the asset to its recoverable amount. Which of the following is the recoverable amount according to IFRS?
The greater of fair value less cost to sell or value in use.
The greater of fair value less cost to sell or value in use is the recoverable amount according to IFRS.
Under International Financial Reporting Standards (IFRS), what two methods can be used to adjust accumulated depreciation?
- The proportional method
2. The reset method
What happens during the reset
method?
Accumulated depreciation is reset to zero by closing it to the building account, and then the building is adjusted for the revaluation.
Under International Financial
Reporting Standards (IFRS), how
is interest during construction
accounted for?
It is expensed or capitalized.
Where is revaluation surplus reported under International Financial Reporting Standards (IFRS) until the property, plant, and equipment (PPE) is sold?
It is reported in equity.
Under International Financial
Reporting Standards (IFRS), is
revaluation of property, plant,
and equipment (PPE) allowed?
Yes, revaluation is allowed
How frequently do companies have to review depreciation policies under International Financial Reporting Standards (IFRS)?
Companies have to review the
policies annually
During a period of rising prices, this method results in a higher net income.
FIFO
This inventory cost flow assumption is prohibited under IFRS.
LIFO
Method that uses historical sales margins to estimate ending inventory.
Gross profit
Method that is appropriate when there is a relatively small number of significant dollar value items in inventory.
Specific identification
Average cost must be calculated each time additional inventory is purchased.
Moving average
Method that averages the cost of all items on hand and purchased during the period.
Weighted average
This method results in the lowest ending inventory in a period of rising prices.
LIFO
Method that uses a price index to measure changes in inventory.
Dollar-value LIFO
If used for tax purposes, this method must also be used for financial reporting purposes.
LIFO
The cost of goods sold balance is the same whether a perpetual or periodic inventory system is used.
FIFO
Understate ending inventory
Current-year income - Understate
Ending retained earnings balance, current year - Understate
Income of next year - Overstate
Ending retained earnings balance, next year - No Effect
Purchase and receive goods in current period, but record purchase in next period; goods are included in inventory.
Current-year income - Overstate
Ending retained earnings balance, current year - Overstate
Income of next year - Understate
Ending retained earnings balance, next year - No Effect
Goods purchased FOB shipping point were in transit at year−end and not included in inventory; purchase was recorded.
Current-year income - Understate
Ending retained earnings balance, current year - Understate
Income of next year - Overstate
Ending retained earnings balance, next year - No Effect
Goods shipped to a customer FOB destination were in transit at year−end and were included in inventory. The sale was not recorded.
Current-year income - No Effect
Ending retained earnings balance, current year - No Effect
Income of next year - No Effect
Ending retained earnings balance, next year - No Effect
On June 30, Almond Co.’s cash balance was $10,012 before adjustments, while its ending bank statement balance was $10,772. Check number 101 was issued June 2 in the amount of $95 but was erroneously recorded in Almond’s general ledger balance as $59. The check was correctly listed in the bank statement at $95.
The bank statement also included a credit memo for interest earned in the amount of $35 and a debit memo for monthly service charges in the amount of $50.
What was Almond’s adjusted cash balance on June 30?
$9,961
The adjusted cash balance is computed as $10,012 − corrected #101 amount ($95 − $59) + $35 interest − $50 service charge = $9,961. Check #101 was recorded for $59 but should have been recorded for $95.
When the allowance method of recognizing uncollectible accounts is used, the entries at the time of collection of a small account previously written off would
Increase the allowance for uncollectible accounts.
The entries are:
DR: Accounts receivable
CR: Allowance for uncollectibles
DR: Cash
CR: Accounts receivable
The first entry reinstates the amount of allowance used up when the account was originally written off. The normal balance in the account is a credit. The first entry increases the account.
When the allowance method of recognizing bad debt expense is used, the allowance would decrease when a(an)
Specific uncollectible account is written off.
The allowance account is increased when estimated uncollectible accounts expense is recognized. The allowance records the expected reduction in net accounts receivable until accounts are written off.
Then, when accounts actually become uncollectible and are written off, the allowance is decreased because it is no longer needed. The identity of the specific uncollectible account is known and that account is also decreased.
When the allowance method of recognizing uncollectible accounts is used, the entry to record the write-off of a specific account
Decreases both accounts receivable and the allowance for uncollectible accounts.
The entry is:
DR: Allowance for uncollectible accounts XXXX
CR: Accounts receivable XXXX
Both accounts are decreased.
The entry identifies the specific accounts receivable written off. That reduction takes the place of the earlier estimate, which created the allowance account in the first place.
Tinsel Co.’s balances in allowance for uncollectible accounts were $70,000 at the beginning of the current year and $55,000 at year end. During the year, receivables of $35,000 were written off as uncollectible. What amount should Tinsel report as uncollectible accounts expense at year end?
$20,000
To determine the amount of uncollectible expense (bad debt expense) use T accounts. Solve for ?? = 20,000
Allowance for uncollectible accounts
70,000 Beg balance
Write-offs 35,000 Bad debt expense
55,000 End balance
In its December 31 balance sheet, Butler Co. reported trade accounts receivable of $250,000 and related allowance for uncollectible accounts of $20,000.
What is the total amount of risk of accounting loss related to Butler’s trade accounts receivable, and what amount of that risk is off-balance sheet risk?
Risk of accounting loss - 230,000
Off-balance sheet risk - 0
This question requires an understanding of two accounting concepts:
- Risk of accounting loss on accounts receivable (credit risk). This is the risk of loss resulting from not collecting amounts due from sales made on credit, and is the total amount of loss that Butler would suffer if those who owe it failed to make any payments and the receivables proved to be of no value. Since Butler’s net carrying value of accounts receivable is $230,000 ($250,000 − $20,000), that is the amount of risk of accounting loss.
- Off-balance sheet risk: This is the amount of risk of loss that does not show on the balance sheet. Since all of Butler’s net accounts receivable show on the balance sheet, there is no off-balance sheet risk associated with the accounts receivable.
Which method of recording uncollectible accounts expense is consistent with accrual accounting?
Allowance - YES
Direct write-off - NO
The allowance method recognizes the estimate of bad debt expense (uncollectible accounts expense) in the year of sale. This is an example of accrual accounting, which measures expenses when incurred and revenues when earned.
The direct write-off method recognizes bad debt expense in the year of write-off, which may be after the year of sale. The direct write-off method is not consistent with accrual accounting.
The following information pertains to Tara Co.’s accounts receivable on December 31, Year 4
Days outstanding Amount Estimated % uncollectible
0-60 $120,000 1%
61-120 90,000 2%
Over 120 100,000 6%
$310,000
========
During Year 4, Tara wrote off $7,000 in receivables and recovered $4,000 that had been written off in prior years. Tara’s December 31, Year 3, allowance for uncollectible accounts was $22,000. Under the aging method, what amount of allowance for uncollectible accounts should Tara report on December 31, Year 4?
$9,000
The data on write-offs and recoveries is not relevant. The aging method computes a required ending allowance balance based on the aging schedule. That required ending balance is the sum of the products of the receivables in each age category and the uncollectible percentage: $120,000(.01) + $90,000(.02) + $100,000(.06) = $9,000.
The write-offs and recoveries do affect the preadjustment allowance balance and therefore the amount of uncollectible accounts expense to recognize. In this case, the preadjustment balance is $19,000 ($22,000 − $7,000 + $4,000), which means no uncollectible accounts expense would be recognized in 2004 because the preadjustment balance is more than sufficient (exceeds the $9,000 required balance).
Mare Co.’s December 31, Year 5, balance sheet reported the following current assets:
Cash $ 70,000
Accounts receivable 120,000
Inventories 60,000
Total $250,000
========
An analysis of the accounts disclosed that accounts receivable consisted of the following:
Trade accounts $ 96,000
Allowance for uncollectible accounts (2,000)
Selling price of Mare’s unsold goods out on consignment, at 130% of cost, not included in Mare’s ending inventory 26,000
_________
Total $120,000
========
On December 31, Year 5, the total of Mare’s current assets is
$244,000
Corrected total current assets is computed as follows:
$250,000 − $26,000 + $26,000/1.30 = $244,000.
The only adjustment needed is to remove the unrecognized gross margin on the unsold inventory out on consignment.
Although the cost of the inventory of $20,000 ($26,000/1.30) is incorrectly classified in accounts receivable, that misclassification does not affect the total for current assets because accounts receivable is part of current assets. Subtracting the $26,000 removes the inventory at selling price. Adding the $26,000/1.30 term adds the cost of the inventory back to current assets. Inventory is reported at cost, not selling price, because the items are unsold. Including them at selling price would imply profit recognition before sale.
Rue Co.’s allowance for uncollectible accounts had a credit balance of $12,000 on December 31, Year 1. During Year 2, Rue wrote-off uncollectible accounts of $48,000. The aging of accounts receivable indicated that a $50,000 allowance for uncollectible accounts was required on December 31, Year 2. What amount of uncollectible accounts expense should Rue report for Year 2?
$86,000
The preadjusted ending 2003 allowance balance is a $36,000 debit ($12,000 cr. beginning balance − $48,000 dr. from write-offs). When accounts are written off, the allowance is debited and accounts receivable is credited. The aging schedule indicates that a $50,000 ending credit allowance balance is required. Therefore, $86,000 of uncollectible accounts expense must be recognized to change the allowance balance from $36,000 dr. to $50,000 cr. An equation or T account approach also can be used to analyze the allowance account: Beginning balance $12,000 - write-offs $48,000 + uncollectible accounts expense (?) = Ending balance $50,000. Solving for uncollectible accounts expense yields $86,000.
Under the allowance method of recognizing uncollectible accounts, the entry to write-off an uncollectible account
Has no effect on net income
The entry is
DR: Allowance for uncollectible accounts XX
CR: Accounts receivable XX
This entry decreases the allowance because the purpose for which the account was created has now been realized (an uncollectible account). The entry has no effect on income because neither account in the entry is an income account.
Delta, Inc. sells to wholesalers on terms of 2/15, net 30. Delta has no cash sales but 50% of Delta’s customers take advantage of the discount. Delta uses the gross method of recording sales and trade receivables. An analysis of Delta’s trade receivables balances on December 31, revealed the following:
Age Amount Collectible
0 − 15 days $100,000 100%
16 − 30 days 60,000 95%
31 − 60 days 5,000 90%
Over 60 days 2,500 $500
$167,500
=========
In its December 31 balance sheet, what amount should Delta report for allowance for discounts?
$1,000
Only the accounts in the 0 − 15 day age category can take the discount, because the discount period ends 15 days after the sale (2/15, n30).
The discount percentage is 2% (2/15, n30). One-half of the customers take the discount. Therefore, the expected discounts to be taken after December 31 are: (.5)($100,000)(.02) = $1,000. This expected discount amount reduces net sales and net accounts receivable for the current year because it is based on current-year sales.
When the allowance method of recognizing uncollectible accounts is used, how would the collection of an account previously written off affect accounts receivable and the allowance for uncollectible accounts?
Accounts receivable - No Effect
Allowance for uncollectible accounts - Increase
The collection reverses the reduction in the allowance account when the specific account was written off. There is no net change in gross accounts receivable because the account was collected.
The two journal entries often given for this transaction are:
(1) dr. Accounts receivable,
cr. Allowance;
(2) dr. Cash;
cr. Accounts receivable.
The first entry reinstates the allowance. The offsetting debits and credits for accounts receivable in both two entries provide an internal record of the transaction.
Marr Co. had the following sales and accounts receivable balances prior to any adjustment at year end:
Credit sales $10,000,000
Accounts receivable 3,000,000
Allowance for uncollectible accounts 50,000
Marr uses 3% of accounts receivable to determine its allowance of uncollectible accounts at year-end. By what amount should Marr adjust its allowance for uncollectible accounts at year-end?
$40,000
When uncollectible accounts are based on receivables, the adjustment is the amount needed to bring the allowance up to the required amount based on those receivables. With $3,000,000 in receivables, the required ending allowance balance is $90,000 (.03 × $3,000,000). There is $50,000 in the allowance account before adjustment. Therefore, $40,000 must be added. That is the amount debited to bad debt expense, and credited to the allowance account.
On August 15, Year 1, Benet Co. sold goods for which it received a note bearing the market rate of interest on that date. The four-month note was dated July 15, Year 1.
Note that the principal, together with all interest, is due November 15, Year 1.
When the note was recorded on August 15, which of the following accounts increased?
Interest receivable.
The note was received one month into its term. Like a bond issued between interest dates and which collects accrued interest from the bondholder since the most recent interest payment date, this note is recorded with interest receivable for one month.
Benet earns only three months of interest revenue because that is the length of time it will hold the note.
On December 31, Year 1, Jet Co. received two $10,000 notes receivable from customers in exchange for services rendered. On both notes, interest is calculated on the outstanding principal balance at the annual rate of 3% and payable at maturity.
The note from Hart Corp., made under customary trade terms, is due in nine months and the note from Maxx, Inc. is due in five years. The market interest rate for similar notes on December 31, Year 1 was 8%. The compound interest factors to convert future values into present values at 8% follow:
Present value of $1 due in nine months: .944
Present value of $1 due in five years: .680
At what amounts should these two notes receivable be reported in Jet’s December 31, Year 1, balance sheet?
Hart - 10,000
Maxx - 7820
The 9-month note is reported at face value ($10,000) because current notes need not be measured at present value. The 5-year note is reported at $7,820, the present value of the future cash flows. The five years of interest is payable at maturity.
$7,820 = $10,000 + $10,000(.03)(5 years)], which is the present value of the note plus the present value of the 3% interest.
On Merf’s April 30, Year 1, balance sheet, a note receivable was reported as a noncurrent asset and its accrued interest for eight months was reported as a current asset. Which of the following terms would fit Merf’s note receivable?
Principal is due August 31, Year 2. Interest is due August 31, Year 1 and August 31, Year 2.
Although the question does not indicate when the principal is due, the candidate must choose one of the answer alternatives. This answer is the only possible answer.
Accrued interest for eight months at April 30 indicates that the end of the twelfth month is August 31. Under this answer alternative, interest is payable at least once per year, thus interest is due August 31, Year 1, four months after the balance sheet date, and again in one year.
Generally, the principal amount of a note is due when the last interest payment is due. Therefore, because the note is classified noncurrent, the principal would be due on an August 31 at least one year after April 30, Year 1, the date of the current balance sheet. Thus, this answer is a possible answer. None of the other answers are possible.
Pie Co. uses the installment sales method to recognize revenue. Customers pay the installment notes in 24 equal monthly amounts, which include 12% interest.
What is an installment note’s receivable balance six months after the sale?
The present value of the remaining monthly payments discounted at 12%.
The question does not specify the exact meaning of the term “note receivable balance.” When the term “gross” is not applied, it is safe to assume that the balance referred to is the net balance, that is, net of interest yet to be recognized.
Notes are reported at present value, which is the amount net of interest yet to be recognized. However, note balances under the installment method include deferred gross margin yet to be realized, because deferred gross margin is subtracted as a separate line item.
Thus, the question is referring to the notes receivable balance exclusive of interest yet to be recognized, but inclusive of deferred gross margin yet to be realized. The note’s balance is the present value of the remaining payments. This is a two-year note. Therefore, valuation at present value is required. The note’s valuation is the present value of the remaining payments at the original discount rate.
Estimates of price-level changes for specific inventories are required for which of the following inventory methods?
Dollar-value LIFO.
DV LIFO is based on price level indices. The ending inventory is determined at current cost, and then reduced to the price level existing at the base-year (the year LIFO was adopted). The ending inventory measured in base-year dollars is compared to beginning inventory measured in base-year dollars. The difference is the increase in inventory measured in base-year dollars. This difference is then raised to the current-year price level and added to beginning inventory DV LIFO, yielding ending inventory DV LIFO.
Thus, price-level changes are used throughout this method.
Price-level changes are used as a means of estimating the ending inventory. Individual item costs are not maintained or used in the valuation of inventory.
On January 2 of the current year, LTTI Co. entered into a three-year, non-cancelable contract to buy up to 1 million units of a product each year at $.10 per unit with a minimum annual guarantee purchase of 200,000 units. At year end, LTTI had only purchased 80,000 units and decided to cancel sales of the product. What amount should LTTI report as a loss related to the purchase commitment as of December 31 of the current year?
$52,000
This amount represents the amount of the minimum guaranteed amount ($60,000 {200,000 units a year × 3 years × $.10}) less what was already purchased ($8,000 {80,000 units × $.10}) = $52,000.
A company determined the following values for its inventory as of the end of its fiscal year:
Historical cost $100,000
Current replacement cost 70,000
Net realizable value 90,000
Net realizable value less normal profit margin 85,000
Fair value 95,000
Under IFRS, what amount should the company report as inventory on its Balance Sheet?
$90,000
Since historical cost is greater than any of the other values, the question is to what value should the inventory be marked down? This answer is correct because it is the net realizable value and the IFRS requires the lower of cost or net realizable value.
A company manufactures and distributes replacement parts for various industries. As of December 31, year 1, the following amounts pertain to the company’s inventory:
Item Cost NRC SP Cost/sell or
dispose Norm PM
Blades $41,000 $ 38,000 $ 50,000 $ 2,000 $15,000
Towers 52,000 40,000 54,000 4,000 14,000
Generators 20,000 24,000 30,000 2,000 6,000
Gearboxes 80,000 105,000 120,000 12,000 8,000
What is the total carrying value of the company’s inventory as of December 31, year 1, under IFRS?
$191,000
Inventory under IFRS is reported at the lower of cost or net realizable value (NRV) where NRV is the selling price less the cost to complete or dispose. The table below calculates the NRV for each inventory item.
NRV Cost Lower of
Cost or NRV Blades 50,000 − 2,000 = 48,000 41,000 41,000 Towers 54,000 − 4,000 = 50,000 52,000 50,000 Generators30,000 − 2,000 = 28,000 20,000 20,000 Gearboxes120,000 − 12,000 = 108,00080,000 80,000 Total 191,000
A manufacturer has the following per-unit costs and values for its sole product:
Cost 10.00
Current replacement cost 5.50
Net realizable value 6.00
Net realizable value less normal profit margin 5.20
In accordance with IFRS, what is the per-unit carrying value of inventory in the manufacturer’s statement of financial position?
6.00
IFRS requires that inventory be reported at the lower of cost or net realizable value. Net realizable value is defined by IAS 2 as “the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.” In this question, NRV is lower than cost, therefore the inventory should be reported at NRV of 6.00.
Under IFRS, when an entity chooses the revaluation model as its accounting policy for measuring property, plant, and equipment, which of the following statements is correct?
When an asset is revalued, the entire class of property, plant, and equipment to which that asset belongs must be revalued.
When remeasurement to fair value is used, it must be applied to the entire class or components of PPE.
A company has a parcel of land to be used for a future production facility. The company applies the revaluation model under IFRS to this class of assets. In year 1, the company acquired the land for $100,000. At the end of year 1, the carrying amount was reduced to $90,000, which represented the fair value at that date. At the end of year 2, the land was revalued, and the fair value increased to $105,000. How should the company account for the year 2 change in fair value?
By recognizing $10,000 in profit or loss and $5,000 in other comprehensive income.
Under IFRS an increase in an assets fair value above original cost are recorded in a revaluation surplus account and any decreases in an assets fair value below the original cost are recorded as losses to the income statement. Therefore, the 10,000 decrease in year 1 would have been recorded as a loss to the income statement and the 15,000 increase in year 2 would be recorded as a 10,000 gain to the income statement and 5,000 gain in revaluation surplus (OCI).
On January 1, year one, an entity acquires a new piece of machinery for $100,000 with an estimated useful life of 10 years. The machine has a drum that must be replaced every five years and costs $20,000 to replace. Also included in the cost of the machine is an inspection fee of $8,000. Continued operations of the machine requires an inspection every four years after purchase. The company uses the straight-line method of depreciation. Under IFRS what is the depreciation expense for year one?
$13,200
Under IFRS the components of the asset must be depreciated over their estimated useful life. Therefore, the $100,000 cost is broken down into the following components:
Depreciable value Life Depreciation
$72,000 10 yr. $7,200
20,000 5 yr. 4,000
8,000 4 yr. 2,000
$13,200
A transportation company purchased a passenger bus for $100,000 on January 1, year 1. The company expects the bus to be used for 20 years if it follows a maintenance schedule of replacing the engine after 10 years and replacing the seats every 8 years. It estimates that the current cost to replace the engine is $25,000 and the current cost to replace the seats is $10,000. The company uses straight-line depreciation, and the bus has no residual value. The company considers any component equal to or greater than 10% of the overall cost to be significant. Under IFRS, how much depreciation expense should the company recognize for the bus for the year ended December 31, year 1?
$7,000
Under component depreciation, the asset is separated into component parts, and each part is depreciated over its useful life. The bus would be separated into three parts and depreciated as follows: Bus 65,000 ÷ 20 years = 3,250 Engine 25,000 ÷ 10 years = 2,500 Seats 10,000 ÷ 8 years = 1,250 Total 100,000 7,000
On December 31, 2005, Vey Co. traded equipment with an original cost of $100,000 and accumulated depreciation of $40,000 for productive equipment with a fair value of $60,000.
In addition, Vey received $30,000 cash in connection with this exchange. There is commercial substance to the exchange.
What should be Vey’s carrying amount for the equipment received at December 31, 2005?
$60,000
When there is commercial substance to the exchange, the acquired asset is measured at fair value. In this case, the value is $60,000 as given in the problem. This amount also equals the fair value of assets given up in the exchange. The implied fair value of the asset exchanged is $60,000 + $30,000 cash received, or $90,000. The fair value of assets given up is therefore $90,000 less $30,000 cash received, or $60,000. The full journal entry for the exchange is: dr. plant asset 60,000; dr. accumulated depreciation, 40,000; debit cash 30,000; credit plant asset 100,000; credit gain, 30,000. The gain equals the difference between the fair value of the asset exchanged (90,000) and its book value (60,000).
On January 1, Feld traded a delivery truck and paid $10,000 cash for a tow truck owned by Baker. The delivery truck had an original cost of $140,000, accumulated depreciation of $80,000, and an estimated fair value of $90,000. Feld estimated the fair value of Baker’s tow truck to be $100,000. The transaction had commercial substance. What amount of gain should be recognized by Feld?
$30,000
The book value of the delivery truck is $60,000 ($140,000 − $80,000). Its fair value is $90,000. A gain of $30,000 is therefore implied. Cash was paid and the exchange had commercial substance. Therefore, the gain is fully recognized. If the exchange lacked commercial substance, no gain would be recognized.
Which of the following statements describes the proper accounting for losses when nonmonetary assets are exchanged for other nonmonetary assets?
A loss is recognized immediately, because assets received should not be valued at more than their cash-equivalent price.
The loss recognized on the exchange equals the book value of the asset transferred less its fair value at the time of the exchange. The fair value is less than book value. The amount recorded for the asset acquired is its fair value, or the fair value of the asset transferred plus or minus cash paid or received, whichever is more reliably determinable. By using the lower fair value of the asset transferred to measure the value of the asset acquired, the asset acquired will not be overstated above its fair value.
Which of the following statements correctly describes the proper accounting for nonmonetary exchanges that are deemed to have commercial substance?
It recognizes gains and losses immediately.
Gains and losses from nonmonetary exchanges that have commercial substance are recognized immediately.
Bensol Co. and Sable Co. exchanged similar trucks with fair values in excess of carrying amounts. In addition, Bensol paid Sable to compensate for the difference in truck values.
The exchange has commercial substance.
As a consequence of the exchange, Sable recognizes
A gain equal to the difference between the fair value and carrying amount of the truck given up
With commercial substance, the exchange is measured at fair value. The full gain is recognized and is equal to the difference between the fair value of the asset given up and its book value.
For example, assume the following values: new asset fair value 20, old asset fair value 26, cash received 6, old asset cost 30, old asset accumulated depreciation 9. The full entry is: dr. New Truck 20; dr. Accumulated Depreciation 9; dr. Cash 6; cr. Old Truck 30; cr. Gain 5.
The gain equals the old asset’s fair value of 26 and its book value of 21 (30 − 9).
During 2004, Beam Co. paid $1,000 cash and traded inventory, which had a carrying amount of $20,000 and a fair value of $21,000, for other inventory in the same line of business with a fair value of $22,000.
The exchange was made to facilitate sales to their respective customers.
What amount of gain (loss) should Beam record related to the inventory exchange?
$0
There is a $1,000 gain inherent in the transfer of the old (Beam’s) inventory item (fair value of $21,000 - carrying amount of $20,000). If Beam’s item were sold, gross profit of $1,000 would result. However, under GAAP, exchanges of inventory made to facilitate sales are an exception to fair value measurement. Therefore, no gain or loss is recognized and the inventory received is valued at the book value of the inventory given up plus cash paid, for a total of $21,000. This amount is $1,000 less than the new inventory’s fair value because the $1,000 gain is disallowed.
Yola Co. and Zaro Co. are fuel oil distributors. To facilitate the delivery of oil to their customers, Yola and Zaro exchanged ownership of 1,200 barrels of oil without physically moving the oil. Yola paid Zaro $30,000 to compensate for a difference in the grade of oil.
On the date of the exchange, cost and market values of the oil were as follows:
Yola Co. Zaro Co. Cost $100,000 $126,000 Market values 120,000 150,000
In Zaro’s income statement, what amount of gain should be reported from the exchange of the oil?
$0
This exchange was made to facilitate a sale of inventory to customers.
Under FAS 153, this is one of the exceptions to measuring exchanges of nonmonetary assets at market value. In this case, the exchange is measured at book value; no gain or loss is recognized. The oil received by Zaro would be measured (debited) at book value ($126,000) less cash received ($30,000), or $96,000. Cash would be debited for $30,000. The oil exchanged would be credited for $126,000.
No gain or loss is recognized.
On June 30, 2005, Finn, Inc. exchanged 2,000 shares of Edlow Corp. $30 par value common stock for a patent owned by Bisk Co. The Edlow stock was acquired in 2003 at a cost of $50,000.
At the exchange date, Edlow common stock had a fair value of $40 per share, and the patent had a net carrying amount of $100,000 on Bisk’s books.
Finn should record the patent at
$80,000.
The patent is valued at the market value of the stock exchanged, which is $80,000 ($40 × 2,000 shares).
In general, the recorded value of purchased intangibles is the value of the consideration given or the value of the intangible, whichever is more reliable. The book value of the seller is not a reliable substitute for market value. There is no reliable amount given for the market value of the patent.
A company exchanged land with an appraised value of $50,000 and an original cost of $20,000 for machinery with a fair value of $55,000. Assuming that the transaction has commercial substance, what is the gain on the exchange?
$30,000
The gain on an exchange of nonmonetary assets is based on the fair value and book value of the asset exchanged. The land with a fair value of $50,000 is given for machinery. The company is using the land as legal tender. The gain will be the difference between the book value and the fair value of the asset given or $50,000 − $20,000 = $30,000.
Bayberry Co. has an asset with a cost of $200,000 and accumulated depreciation of $120,000. Driftwood Co. has an asset with a cost of $250,000 and accumulated depreciation of $160,000. Both assets have a fair value of $100,000. Bayberry and Driftwood find it mutually advantageous to exchange assets, and the exchange results in improved future cash flows for both companies. What amount, if any, is Bayberry’s gain on the exchange?
$20,000
The gain on the exchange would be the difference between the carrying value of the asset exchanged and the fair value of that asset. Bayberry’s carrying value is $80,000 and the fair value is $100,000; therefore, the gain to Bayberry is $20,000.
Under International Financial Reporting
Standards (IFRS), what two methods can be
used to adjust accumulated depreciation?
- The proportional method
2. The reset method
What happens during the reset method?
Accumulated depreciation is reset to zero by
closing it to the building account, and then the
building is adjusted for the revaluation.
Under International Financial Reporting
Standards (IFRS), how is interest during
construction accounted for?
It is expensed or capitalized.
Where is revaluation surplus reported under
International Financial Reporting Standards
(IFRS) until the property, plant, and equipment
(PPE) is sold?
It is reported in equity.
Under International Financial Reporting
Standards (IFRS), is revaluation of property,
plant, and equipment (PPE) allowed?
Yes, revaluation is allowed.
How frequently do companies have to review
depreciation policies under International
Financial Reporting Standards (IFRS)?
Companies have to review the policies
annually.
What is the fair value of acquired assets if cash
is paid in exchange?
Fair value of acquired asset = Fair value of asset
exchanged + Cash paid
List the characteristics of an exchange that
indicate commercial substance
The amount of cash paid or received on
exchange is significant in relation to the
fair value of the assets exchanged.
The functions of the assets exchanged
are different.
Define “nonmonetary asset.”
An asset that does not have a fixed nominal or
stated value, as is the case with cash, accounts
receivable, and other monetary assets
In a nonmonetary exchange, under what
circumstances is fair value not used to value an
asset?
Fair value of either asset is not
determinable.
Exchange is made to facilitate a sale.
Exchange lacks commercial substance.
What is the preferred valuation for an acquired
asset in a nonmonetary exchange?
The fair value of assets given in the exchange
When do you use list price?
List price should not be used for fair value
because they are notoriously inflated.
What is the fair value of acquired assets if cash
is received in exchange?
Fair value of acquired asset = Fair value of asset
exchanged – Cash received
Solen Co. and Nolse Co. exchanged trucks with fair values in excess of carrying amounts. In addition, Solen paid Nolse to compensate for the difference in truck values.
The exchange lacks commercial substance.
As a consequence of the exchange, Solen recognizes
Neither a gain nor a loss.
Solen has an implied gain given that the fair value of its asset exceeds its book value. But when there is no commercial substance, such gains are recognized only when cash is received. Solen paid cash on the exchange.
Slad Co. exchanged productive assets with Gil Co. and, in addition, paid Gil $100,000 cash. The following information pertains to this exchange:
Assets Carrying amts Fair values
Relinquished by Gil $75,000 $140,000
Relinquished by Slad 40,000 40,000
In Slad’s books, the assets acquired should be recorded at what amount?
$140,000
The entry is:
Asset (new) 140,000
Asset (old book value) 40,000
Cash 100,000
Slad has no gain because the fair value and carrying value of its asset (old) are the same. Slad has given up total consideration worth $140,000 at fair value, for an asset worth $140,000. There is no unrecognized gain on similar assets to diminish the recorded value of the new asset.
The entry is the same regardless of whether the exchange has commercial substance because the fair value of assets exchanged equals their book value in total ($140,000). There is no implied gain or loss.
May Co. and Sty Co. exchanged nonmonetary assets. The exchange did not culminate an earning process for either May or Sty (the exchange lacked commercial substance). May paid cash to Sty in connection with the exchange.
The book value of the asset exchanged exceeded its fair value for both firms. Therefore, a loss on the exchange should be recognized by
May - YES
Sty - YES
The fair value of each asset is less than book value implying that both firms have a loss. Losses are recognized in full regardless of whether there is commercial exchange.
Amble, Inc. exchanged a truck with a carrying amount of $12,000 and a fair value of $20,000 for a truck and $5,000 cash. The fair value of the truck received was $15,000.
At what amount should Amble record the truck received in the exchange assuming the exchange lacks commercial substance?
$15,000
There is an implied gain of $8,000, the difference between the $20,000 fair value of the old asset and its $12,000 book value. Because the proportion of cash received is 25% ($5,000/$20,000), the entire gain is recognized and the acquired asset is recognized at fair value ($15,000).
Note that the answer would be the same had there been commercial substance.
In an exchange of plant assets, Transit Co. received equipment with a fair value equal to the carrying amount of equipment given up. Transit also contributed cash.
The exchange lacks commercial substance.
As a result of the exchange, Transit recognized
A loss equal to the cash given up.
The fair value of the new asset equals the old asset’s book value. Because cash was paid, the fair value of the old asset is less than the fair value of the new asset.
Therefore, the fair value of the old asset is also less than the old asset’s book value resulting in a loss.
Using dollar amounts, assume the fair value of the new asset is $10. The book value of the old asset is also $10 by assumption. Assume Transit paid $2 cash.
Then the fair value of the old asset is $8 implying a loss of $2, the amount of cash paid. Even without commercial substance, losses are recognized in full.
Slate Co. and Talse Co. exchanged similar plots of land with fair values in excess of carrying amounts. In addition, Slate received cash from Talse to compensate for the difference in land values.
The exchange lacks commercial substance.
As a result of the exchange, Slate should recognize
A gain in an amount determined by the ratio of cash received to total consideration.
When commercial substance is lacking, gains are recognized in proportion to the amount of cash received.
In a barter transaction where advertising services provided are exchanged for advertising services received, under which of the following situations can the advertising provider recognize revenue for the services performed? Assume the accounting is under IFRS guidelines.
When there is a nonbarter transaction for similar advertising services that can be reliably measured with a different counterparty
The fair value of the advertising services provided can be reliably measured by reference to a nonbarter transaction for similar advertising with a different counterparty (SIC Interpretation 31, para 5).
Which of the following is not requirement for an asset to be categorized as a plant asset?
Have a useful life of at least three years.
A useful life of at least three years is NOT a requirement for classification of a plant asset. The plant asset must have a useful life extending more than one year beyond the Balance Sheet date.
Which of the following is a required footnote disclosure on property, plant, and equipment?
Range of useful lives of plant assets.
Depreciation methods of plant assets.
Accumulated depreciation related to plant assets.
All items listed are required disclosures: useful life, depreciation methods, and the accumulated depreciation of plant asset. Read through select disclosures of the financial statements of real companies-this will help reinforce the disclosure requirements and jog your memory because you will remember reading about the disclosure.
Theoretically, which of the following costs incurred in connection with a machine purchased for use in a company’s manufacturing operations would be capitalized?
Insurance on machine while in transit. - YES
Testing and preparation of machine for use. - YES
Both costs should be capitalized because they are costs necessary to place the asset into its intended use and location. Neither should be expensed as incurred.
Campbell Corp. exchanged delivery trucks with Highway, Inc. Campbell’s truck originally cost $23,000, its accumulated depreciation was $20,000, and its fair value was $5,000. Highway’s truck originally cost $23,500, its accumulated depreciation was $19,900, and its fair value was $5,700. Campbell also paid Highway $700 in cash as part of the transaction. The transaction lacks commercial substance. What amount is the new book value for the truck Campbell received?
$3,700
When a transaction lacks commercial substance and cash is paid, the new asset is recorded at the book value of the old asset plus any cash given. Campbell has the same economic position as before the exchange - a different truck used in the same manner and $700 less cash. The new truck is the BV of the old asset ($3,000) plus the cash paid ($700) or $3,700.
Charm Co. owns a delivery truck with an original cost of $10,000 and accumulated depreciation of $7,000. Charm acquired a new truck by exchanging the old truck and paying $2,000 in cash. The new truck has a fair value of $5,000 at the time of the exchange. What amount of gain or loss should Charm recognize?
$0
This is an exchange with no commercial substance because the exchange was one truck for another. When cash is given and there is no commercial substance, a gain is not recognized. This transaction is an even exchange in value. Charm gave the old truck with a net book value of $3,000 ($10,000 – 7,000) plus $2,000 in cash, or a total of $5,000. The consideration given of $5,000 equals the fair value of the new truck, $5,000.
A company has a long-lived asset with a carrying value of $120,000, expected future cash flows of $130,000, present value of expected future cash flows of $100,000, and a market value of $105,000. Under IFRS what amount of impairment loss should be reported?
$15,000
This response is the difference between carrying value and recoverable amount. According to IFRS the recoverable amount is the greater of fair value less cost to sell ($105,000) or value in use ($100,000). Value in use is the discounted cash flows. Therefore, this asset is has an impairment of $15,000 because the recoverable amount is $105,000 and the carrying value is $120,000.
A company has a long-lived asset with a carrying value of $120,000, expected future cash flows of $130,000, present value of expected future cash flows of $100,000, and a market value of $105,000. What amount of impairment loss should be reported?
$0
The recoverable cost (expected future cash flows) of $130,000 exceeds the $120,000 book value. Therefore, the asset is not impaired, and no loss is recorded. Although both the market value and present value of the future cash flows are less than book value, as long as the nominal sum of future cash flows ($130,000) exceeds book value, no impairment is recorded. The firm is expected to recover its book value.
Restorations of carrying value for long-lived assets are permitted if an asset’s fair value increases subsequent to recording an impairment loss for which of the following?
Held for use - No
Held for disposal -Yes
If an asset is held for disposal, previous losses can be recovered. The logic is that the recovery will be realized in the near future if the asset is in the process of being disposed. In contrast, an asset held for use CANNOT recover previous impairment because there is no certainty regarding the ultimate realization of those losses.
Gown, Inc. sold a warehouse and used the proceeds to acquire a new warehouse. The excess of the proceeds over the carrying amount of the warehouse sold should be reported as a(an):
Part of continuing operations.
The excess of proceeds over the carrying value increases the net assets of the firm, is recorded as an ordinary gain, and is included in income from continuing operations. The purchase of the new warehouse is an unrelated transaction.
Carr, Inc. purchased equipment for $100,000 on January 1, 20X2. The equipment had an estimated 10-year useful life and a $15,000 salvage value. Carr uses the 200% declining-balance depreciation method. In its 20X3 Income Statement, what amount should Carr report as depreciation expense for the equipment?
$16,000
The 200% declining balance depreciation method is also called the double declining balance method or DDB. Because this is a declining balance method, the book value at the beginning of 20X3 must be computed, and that is affected by depreciation in 20X2. For 20X2, depreciation under DDB is 2/10 × $100,000 or $20,000. Note that salvage value is not subtracted when computing depreciation because the “declining balance” is book value. For 20X3, depreciation is 2/10 × ($100,000-$20,000) = $16,000 because the book value at the beginning of 20X3 is reduced by 20X2 depreciation.
A building suffered uninsured water and related damage. The damaged portion of the building was refurbished with upgraded materials. The cost and related accumulated depreciation of the damaged portion are identifiable.
To account for these events, the owner should:
Capitalize the cost of refurbishing and record a loss in the current period equal to the carrying amount of the damaged portion of the building.ca
When the portion of an asset that is removed from a larger asset has identifiable costs and accumulated depreciation amounts, those amounts are removed from the books. The difference between these two amounts is the carrying value of the damaged portion of the larger asset. There is no insurance. Therefore, the carrying value of the damaged portion is written off as a loss. The replacement assets are capitalized at cost. The entries are:
Portion removed New materials
Loss Asset
Accumulated depreciation Cash
Asset
A firm is constructing a warehouse for its own use and purchased the land for the site immediately before beginning construction. Interest is capitalized on which of the following:
Warehouse - YES
Land - No
The average accumulated expenditures for purposes of capitalizing interest during construction of the warehouse includes the land cost, but the interest is capitalized to the warehouse only. The land is not under construction.
Sun Co. was constructing fixed assets that qualified for interest capitalization. Sun had the following outstanding debt issuances during the entire year of construction:
$6,000,000 face value, 8% interest.
$8,000,000 face value, 9% interest.
None of the borrowings were specified for the construction of the qualified fixed asset. Average expenditures for the year were $1,000,000. What interest rate should Sun use to calculate capitalized interest on the construction?
8.57%
Neither debt issuances were identified as the construction loan. Therefore, the interest rate must be determined based on the weighted average of the interest on all of the debt outstanding during the year. The calculation is as follows:
$6,000,000 × .08 = $480,000
$8,000,000 × .09 = $720,000 Totals $14,000,000 $1,200,000 $1,200,000 / $14,000,000 = 8.57%
A manufacturing firm purchased used equipment for $135,000. The original owners estimated that the residual value of the equipment was $10,000. The carrying amount of the equipment was $120,000 when ownership transferred. The new owners estimate that the expected remaining useful life of the equipment was 10 years, with a salvage value of $15,000. What amount represents the depreciable base used by the new owners?
$120,000
The purchase price of the asset acquired less its salvage value is the asset’s depreciable cost. In this case, total depreciation on the asset is limited to $120,000 ($135,000 purchase price-$15,000 salvage value). The cost to the seller and the previous salvage value are not relevant to the new owner.
A state government condemned Cory Co.’s parcel of real estate. Cory will receive $750,000 for this property, which has a carrying amount of $575,000. Cory incurred the following costs as a result of the condemnation:
Appraisal fees to support a $750,000 value $2,500
Attorney fees for the closing with the state 3,500
Attorney fees to review contract to acquire replacement property 3,000
Title insurance on replacement property 4,000
What amount of cost should Cory use to determine the gain on the condemnation?
$581,000
The total value to be compared to the amount received from the government in computing the gain:
Carrying amount $575,000
Plus appraisal fees to support a $750,000 value
2,500
Plus attorney fees for the closing with the state 3,500
Equals total cost to compare to $750,000 received from state $581,000
The second and third items in the above list essentially reduce the net proceeds from the state and thus decrease the gain. The $3,000 and $4,000 amounts pertaining to the replacement property are not associated with the existing property and do not affect the gain on its condemnation.
Papa Company acquired land with an office building on it from its subsidiary, Sonny Company, for $110,000. Prior to the sale, Sonny’s carrying value of the land was $60,000 and its net carrying value of the building was $50,000. At the time of the transaction, Papa appropriately determined that the land had a fair value of $75,000 and the building had a fair value of $35,000. At what amount should the land and building be reported on Papa’s consolidated statements prepared immediately after the transaction?
Land - $ 60,000
Building - $ 50,000
Even though there was no profit or loss on the intercompany transaction, it resulted in amounts being redistributed between the depreciable asset office building and the non-amortizable asset land, which would result in different amounts of depreciation expense than if the transaction had not occurred. Therefore, the intercompany transaction must be “eliminated” so that the consolidated statements would show land at $60,000 and buildings at $50,000. (Sonny also would need to assess the building for possible impairment.)
Young Corp. purchased equipment by making a down payment of $4,000 and issuing a note payable for $18,000. A payment of $6,000 is to be made at the end of each year for three years. The applicable rate of interest is 8%. The present value of an ordinary annuity factor for three years at 8% is 2.58, and the present value for the future amount of a single sum of one dollar for three years at 8% is .735. Shipping charges for the equipment were $2,000, and installation charges were $3,500. What is the capitalized cost of the equipment?
$24,980
The capitalized cost is the sum of the down payment, present value of the note payments, and the shipping and installation charges. $4,000 + $6,000(2.58) + $2,000 + $3,500 = $24,980. The present value of the three payments required on the note is capitalized, which excludes the interest included in those payments. The two charges are capitalized because they were incurred to place the asset into its intended condition and location.
Land was purchased to be used as the site for the construction of a plant. A building on the property was sold and removed by the buyer so that construction on the plant could begin.
The proceeds from the sale of the building should be:
Deducted from the cost of the land.
The proceeds from the building removed and sold reduce the cost of the land to the buyer. Had the building been razed, the net razing cost would be added to the land. Compared to the latter situation, the case in the problem results in a cost savings.
What is the required accounting treatment
when an investor has control of an investee?
Treat as a subsidiary and consolidate investee
with investor (consolidated financial
statements)
What is the basis for general guidelines for
determining the level of influence over an
investee?
The nature and extent of ownership
What is the basis for general guidelines for
determining the level of economic influence
over an equity investee?
The nature and extent of ownership rights
List the investor’s considerations in selecting
the correct accounting for an investment.
The nature of the investment
The extent of the investment
Management’s intent
List the investor’s considerations in selecting
the correct accounting for an investment.
Whether the investment is a debt or equity security Whether there is readily determinable fair value Management's intent on how long the investment will be held
Identify the three possible levels of influence
over an investee for accounting purposes.
- Not significant
- Significant influence but not control
- Control
Define “debt securities.”
Securities representing the right of the creditor
to receive from the debtor a principal amount
at a specified future date and to receive
interest as payment for providing use of funds
Define “equity securities.”
Securities representing ownership or the right
to acquire ownership interest
List the guidelines for determining no
significant influence in an investment.
The investment is: In debt securities; In nonvoting stock; Temporary in nature; Less than 20% ownership of voting stock.
