FAR-2 Flashcards
The FASB is a(n):
A. Private sector body.
B. Governmental unit.
C. International organization.
D. Group of accounting firms.
A
The FASB has no official connection with the U.S. Government although the SEC, an agency of the federal government, can modify or rescind an accounting standard adopted by the FASB..
The FASB has maintained that:
A. The interests of the reporting firms will be a primary consideration when developing new GAAP.
B. GAAP should have little or no cost of compliance.
C. New GAAP should be neutral and not favor any particular reporting objective.
D. GAAP should result in the most conservative possible financial statements.
C
One of the objectives of the FASB in setting standards is to develop rules that are unbiased. FASB statements generally do not reflect any reporting bias.
For example, the requirement to expense all research and development costs is uniform across all firms and does not favor one firm over another.
Generally Accepted Accounting Principles may be described as:
A. The standards used in preparing financial statements.
B. The rules used in preparing tax returns.
C. Guidelines for establishing a strong system of internal control.
D. Guidelines for keeping a business entity profitable and solvent.
A
GAAP governs what is included in financial statements, and to a reasonable extent, how it is presented. GAAP is concerned with what accounts are included in financial statements, their amounts, and additional information that must be disclosed but which is not included in those accounts.
In reference to proposed accounting standards, the term “negative economic consequences” includes:
A. The cost of complying with GAAP.
B. The inability to raise capital.
C. The cost of government intervention when not in compliance with GAAP.
D. The failure of internal control systems.
B
A proposed standard may cause firm earnings to fall, for example when they are adopted. Firms will be concerned that lower earnings may make it more difficult to sell stock or to secure loans.
As a result, negative economic consequences become a focal point for arguments against the proposed standard.
Choose the correct statement about GAAP.
A. GAAP are laws.
B. Only publicly traded companies must comply with GAAP.
C. It is a violation of SEC regulations for publicly traded companies to depart from GAAP.
D. Firms may not restate financial statements previously issued.
C
The SEC requires that all registrants provide financial statements that comply with GAAP and will sanction firms and individuals involved in financial reporting that does not comply with GAAP.
Essentially, all companies that rely on external sources of capital require financial statements and, therefore, must comply with GAAP.
For example, a privately-held firm may require a loan. In order to obtain the loan, the firm must present audited financial statements.
What is the primary protection for investors against fraudulent financial reporting by corporations?
A. Criminal statutes.
B. The requirement that financial statements be audited.
C. The fact that all firms must report the same way.
D. The integrity of management.
B
The audit of the financial statements by independent third parties is the primary protection. The auditors do not prepare the information, nor do they have employment ties with either the reporting firm or the intended audience of the financial statements.
However, even the audit of financial statements is not a perfect protection as indicated by the frequency of fraud and audit failure.
A company records items on the cash basis throughout the year and converts to an accrual basis for year-end reporting. Its cash-basis net income for the year is $70,000. The company has gathered the following comparative Balance Sheet information:
Beginning of year End of year Accounts payable $ 3,000 $ 1,000 Unearned revenue 300 500 Wages payable 300 400 Prepaid rent 1,200 1,500 Accounts receivable 1,400 600 What amount should the company report as its accrual-based net income for the current year?
A. $68,800
B. $70,200
C. $71,200
D. $73,200
C
The general rule to convert from cash to accrual is to add the beginning liability balances and subtract the ending liability balances; also, subtract beginning asset balances and add ending asset balances.
Young & Jamison's modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses? A. $125,000 B. $135,000 C. $165,000 D. $175,000
The approach on this question is to first calculate the cash-based operating expenses. Cash-based operating expenses are $150,000. The next step is to adjust the cash-based expense for the prepaid and accrued expenses. Beginning of the year prepaid expenses were paid in the prior year, but the expense was incurred (or consumed) in the current year, and end of the year prepaid expenses were paid this year but will be consumed next year. Therefore, you add the beginning of the year prepaid and subtract the end of the year prepaid expenses from the cash-based number.
Cash-based expenses will also be adjusted for the accrued expense. Beginnings of the year accrued expenses were not paid last year, but were last year’s expense item paid this year. End of the year accrued expenses were not paid this year, but are this year’s expense paid next year. Therefore, you subtract beginning of the year accrued and add end of the year accrued expenses to the cash-based number.
Cash-based operating expenses $150,000
Add the beginning of the year prepaid expenses, 10,000.
Subtract the end of the year prepaid expenses, (15,000).
Subtract the beginning of the year accrued expenses, ( 5,000).
Add the end of the year accrued expenses, 25,000.
Accrual-based operating expenses, $165,000
Before 2001, Droit Co. used the cash basis of accounting. As of December 31, 2001, Droit changed to the accrual basis. Droit cannot determine the beginning balance of supplies inventory.
What is the effect of Droit’s inability to determine beginning supplies inventory on its 2001 accrual basis net income and December 31, 2001, accrual basis owners’ equity?
2001 net income 12/31/01 owner’s equity
No effect No effect
No effect Overstated
Overstated No effect
Overstated Overstated
C
Supplies expense for 2001 under the accrual method is: supplies expense = beginning supplies + purchases - ending supplies.
** If beginning supplies cannot be determined, then it is assumed to be zero and supplies expense is understated, causing 2001 income to be OVERSTATED. However, total supplies expense for the entire life of the business is unaffected by the inability to determine beginning supplies for 2001. Total supplies expense for the life of the business is total purchases less ending inventory in 2001. These two amounts are determinable, and thus, owners’ equity at the end of 2001 can be determined.
Bird Corp.’s trademark was licensed to Brian Co. for royalties of 15% of the sales of the trademarked items. Royalties are payable semiannually on March 15 for sales in July through December of the prior year, and on September 15 for sales in January through June of the same year.
Bird received the following royalties from Brian:
March 15 September 15
2004 $5,000 $7,500
2005 6,000 8,500
Brian estimated that the sales of the trademarked items would total $30,000 for July through December 2005.
In Bird’s 2005 Income Statement, the royalty revenue should be:
A. $13,000
B. $14,500
C. $19,000
D. $20,500
A
2005 royalty revenue is the amount earned in 2005, REGARDLESS of when it is received.
The September receipt of $8,500 accounts for the royalties earned the first half of 2005. Royalties for the second half are estimated to be .15($30,000) = $4,500. ***Although this is an estimate, if reliable, it provides relevant information. Waiting for the exact amount is not justified in this case. The small increase in reliability does not justify postponing recognition in 2005. Thus, total royalty revenue for 2005 is $13,000, which equals $8,500 + $4,500.
On November 1, 2005, Key Co. paid $3,600 to renew its insurance policy for three years. At December 31, 2005, Key’s unadjusted trial balance showed a balance of $90 for prepaid insurance and $4,410 for insurance expense.
What amounts should be reported for prepaid insurance and insurance expense in Key’s December 31, 2005, financial statements?
Prepaid Insurance Insurance expense
$3,300 $1,200
$3,400 $1,200
$3,400 $1,100
$3,490 $1,010
Prepaid insurance at year end is $3,400, which is the portion of the prepayment on November 1 that continues to the next three years.
Of the 36 months of coverage purchased, 34 months remain at December 31: $3,400 = (34/36)($3,600). Insurance expense includes three items: (1) the $90 of prepaid insurance remaining in the trial balance that has expired, (2) the $200 of insurance expense related to the November 1 purchase above ($3,600-$3,400 remaining prepaid), and (3) the expense portion of the $4,410 insurance expense amount in the unadjusted trial balance ($4,410-$3,600) = $810. This firm must have expensed the entire $3,600 November 1 purchase because it was not reflected in prepaid insurance. The difference of $810 reflects actual expense. Therefore, total insurance expense equals $1,100 = $90 + $200 + $810
Which of the following would be reported as an investing activity in a company’s statement of cash flows?
A. Collection of proceeds from a note payable.
B. Collection of a note receivable from a related party.
C. Collection of an overdue account receivable from a customer.
D. Collection of a tax refund from the government.
B
Collection on a note receivable from a related party is an investing activity. The company is lending money to the related party and lending is not a primary business activity – the fact that the loan is in the form of a note implies that it is interest bearing.
Which of the following statements includes the most useful guidance for practicing accountants concerning the FASB Accounting Standards Codification.
A.
The Codification includes only FASB Statements.
B.
The Codification is the sole source of U.S. GAAP, for nongovernmental entities.
C.
The Codification significantly modified the content of GAAP when it became effective.
D.
An accountant can be sure that all SEC rules are included in the Codification.
B
The Codification includes all authoritative GAAP for nongovernmental entities.
Which of the following documents is typically issued as part of the due-process activities of the Financial Accounting Standards Board (FASB) for amending the FASB Accounting Standards Codification?
A. A proposed statement of position.
B. A proposed accounting standards update.
C. A proposed accounting research bulletin.
D. A proposed staff accounting bulletin.
B
Changes and updates to the Codification are accomplished through Accounting Standards Updates (ASUs).
U.S. GAAP includes a very large set of accounting guidance. Choose the correct statement.
A.
The FASB Accounting Standards Codification includes guidance about items that are not under the purview of the Generally Accepted Accounting Principles, such as the income tax basis of accounting.
B.
Authoritative guidance from FASB Statements adopted before the FASB Accounting Standards Codification does not appear in the Codification.
C.
There is an implied hierarchy within the FASB Accounting Standards Codification, with FASB Statements assuming the top level.
D.
International accounting standards are not included in the FASB Accounting Standards Codification.
D
IFRS are not U.S. GAAP and thus are not included in the Codification.
Note:
There is no longer a hierarchy of GAAP. All Generally Accepted Accounting Principles are equally authoritative.
Suppose Winston incorporated and had the following accounts. Indicate how each of the following is classified on the financial statements. Below is a list of classifications. If none of the listed classifications apply, answer NA.
Balance sheet classification Income statement classifications A. Current asset H. Revenue B. Noncurrent asset I. Expense C. Current liability J. Contra revenue D. Noncurrent liability E. Owner's equity F. Contra asset G. Contra equity ----------------------------------------------------------------------- Balance sheet classification Income statement classification 1. Bonds payable, due in year 8 2. Treasury stock 3. Accounts payable 4. Sales discounts 5. Notes payable, due in nine months 6. Inventory 7. Accounts receivable 8. Common stock 9. Cost of goods sold 10. Allowance for uncollectible accounts
BS IS
- Bonds payable, due in year 8 D NA
- Treasury stock G NA
- Accounts payable C NA
- Sales discounts NA J
- Notes payable, due in nine months C NA
- Inventory A NA
- Accounts receivable A NA
- Common stock E NA
- Cost of goods sold NA I
- Allowance for uncollectible accounts F NA
Under East Co.’s accounting system, all paid insurance premiums are debited to prepaid insurance. For interim financial reports, East makes monthly estimated charges to insurance expense with credits to prepaid insurance.
Additional information for the year ended December 31, 2005, is as follows:
Prepaid insurance at December 31, 2004 $105,000
Charges to insurance expense during 2005 (including a year-end adjustment of 17,500) 437,500
Prepaid insurance at December 31, 2005 122,500
What was the total amount of insurance premiums paid by East during 2005?
A. $322,500
B. $420,000
C. $437,500
D. $455,000
D
Beginning prepaid balance $105,000
+ Premiums paid plug & answer
- Expense charges - $437,500
= Ending prepaid balance $122,500
Premiums paid = $455,000
In financial statements prepared on the income-tax basis, how should the nondeductible portion of expenses, such as meals and entertainment, be reported?
A. Included in the expense category in the determination of income.
B. Included in a separate category in the determination of income.
C. Excluded from the determination of income but included in the determination of retained earnings.
D. Excluded from the financial statements.
A
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.
The following trial balance of Trey Co. at December 31, 2005 has been adjusted except for income tax expense.
Dr. Cr. Cash $550,000 Accounts Receivable, net 1,650,000 Prepaid taxes 300,000 Accounts payable $ 120,000 Common stock 500,000 Additional paid-in capital 680,000 Retained earnings 630,000 Foreign currency translation adjustment 430,000 Revenues 3,600,000 Expenses 2,600,000 \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
$5,530,000 $5,530,000
Additional information: •During 2005, estimated tax payments of $300,000 were charged to prepaid taxes. Trey has not yet recorded income tax expense. There were no differences between the financial statement and the income tax income, and Trey’s tax rate is 30%.
•Included in accounts receivable is $500,000 due from a customer. Special terms granted to this customer require payments in equal, semiannual installments of $125,000 every April 1 and October 1.
In Trey’s December 31, 2005 Balance Sheet, what amount should be reported as total current assets?
A. $1,950,000
B. $2,200,000
C. $2,250,000
D. $2,500,000
A
Current assets are assets that are collectible within one year. The sum of the stated current assets is $2,500,000 ($550,000+$1,650,000+$300,000). However, once the current tax bill is calculated, the prepaid taxes of $300,000 are transferred into a tax expense account to cover the $300,000 in current year tax expense. In addition, $250,000 of the special accounts receivable is not due for over one year and is, therefore, non-current.
Therefore, current assets should be $1,950,000 ($2,500,000-$300,000-$250,000).
U Co. had cash purchases and payments on account during the current year totaling $455,000. U’s beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U’s accrual-basis purchases for the year?
A. $441,000
B. $469,000
C. $505,000
D. $519,000
A
Using an equation, or a T-account, to analyze accounts payable (AP) yields accrual purchases: Beginning AP ($64,000) \+ Accrual purchases - Cash payments ($455,000) = Ending AP ($50,000).
Solving for accrual purchases yields $441,000.
Reid Partners, Ltd., which began operations on January 1, 2003, has elected to use cash-basis accounting for tax purposes and accrual-basis accounting for its financial statements.
Reid reported sales of $175,000 and $80,000 in its tax returns for the years ended December 31, 2004 and 2003, respectively. Reid reported accounts receivable of $30,000 and $50,000 in its Balance Sheets as of December 31, 2004 and 2003, respectively.
What amount should Reid report as sales in its Income Statement for the year ended December 31, 2004? A. $145,000 B. $155,000 C. $195,000 D. $205,000
B
When converting from cash-basis sales to accrual-basis sales, sales must be adjusted for the net change in accounts receivable. There has been a net decrease in receivables of $20,000 over the course of the year from $50,000 to $30,000. Thus, accrual sales would decline by $20,000 as compared to cash sales (which included the additional receivables collected). Therefore, this response of $155,000 ($175,000-$20,000) is correct.
Zeta Co. reported sales revenue of $4,600,000 in its Income Statement for the year ended December 31, 2001. Additional information is as follows:
12/31/00 12/31/01 Accounts receivable $1,000,000 $1,300,000 Allowance for uncollectible accounts (60,000) (110,000)
Zeta wrote off uncollectible accounts totaling $20,000 during 2001. Under the cash basis of accounting, Zeta would have reported 2001 sales of:
A. $4,900,000
B. $4,350,000
C. $4,300,000
D. $4,280,000
D
The question requires a solution for cash collected on accounts receivable. Using the information for accounts receivable, the collections amount can be found:
Beginning balance $1,000,000
+ sales + $4,600,000
- collections solving
- write offs - $20,000
= ending balance $1,300,000
collections = $4,280,000 Under the cash basis of accounting, sales equals cash collections.
Sanni Co. had $150,000 in cash-basis pretax income for the year. At the current year end, accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from their previous year-end balances. Compared to the accrual-basis method of accounting, Sanni’s cash-basis pretax income is:
A. Higher by $4,000.
B. Lower by $4,000.
C. Higher by $36,000.
D. Lower by $36,000.
C
The $20,000 AR decrease implies that cash received on account was $20,000 greater than accrual sales. Cash-basis income is, therefore, $20,000 greater than accrual income for this difference. The $16,000 accounts payable increase implies that more inventory was purchased and included in accrual cost of goods sold than was paid. Cash-basis income is, therefore, $16,000 more than accrual income for this difference. In total, cash-basis income is $36,000 greater than accrual income.
Savor Co. had $100,000 in cash-basis pretax income for 1999. At December 31, 1999, accounts receivable had increased by $10,000 and accounts payable had decreased by $6,000 from their December 31, 1998, balances. Compared to the accrual-basis method of accounting, Savor's cash pretax income is: A. Higher by $4,000. B. Lower by $4,000. C. Higher by $16,000. D. Lower by $16,000.
cash-basis income is $100,000. The journal entries for an increase and a decrease in accounts payable respectively are:
DR: Accounts receivable 10,000
CR: Sales 10,000
————————
DR: Accounts payable 6,000
CR: Cash 6,000
The increase in accounts receivable should be ADDED to the cash income as it was not considered and is recognized as earned for accrual income. The decrease in accounts payable was subtracted for cash-basis income***. This is NOT a reduction in accrual income, and as a result, should be ADDED back to the cash income. The computation is: 100,000+10,000+6,000 = 116,000, or a $16,000 increase from cash to accrual. In other words, the cash-basis income is $16,000 LOWER than accrual income.
Young & Jamison’s modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses?
A. $125,000
B. $135,000
C. $165,000
D. $175,000
C
The approach on this question is to first calculate the cash-based operating expenses. Cash-based operating expenses are $150,000. The next step is to adjust the cash-based expense for the prepaid and accrued expenses. Beginning of the year prepaid expenses were paid in the prior year, but the expense was incurred (or consumed) in the current year, and end of the year prepaid expenses were paid this year but will be consumed next year. Therefore, you add the beginning of the year prepaid and subtract the end of the year prepaid expenses from the cash-based number.
Cash-based expenses will also be adjusted for the accrued expense. Beginnings of the year accrued expenses were not paid last year, but were last year’s expense item paid this year. End of the year accrued expenses were not paid this year, but are this year’s expense paid next year. Therefore, you subtract beginning of the year accrued and add end of the year accrued expenses to the cash-based number.
Cash-based operating expenses $150,000
Add the beginning of the year prepaid expenses, 10,000.
Subtract the end of the year prepaid expenses, (15,000).
Subtract the beginning of the year accrued expenses, ( 5,000).
Add the end of the year accrued expenses, 25,000.
Accrual-based operating expenses, $165,000
Under East Co.’s accounting system, all paid insurance premiums are debited to prepaid insurance. For interim financial reports, East makes monthly estimated charges to insurance expense with credits to prepaid insurance.
Additional information for the year ended December 31, 2005, is as follows:
Prepaid insurance at December 31, 2004 $105,000
Charges to insurance expense during 2005 (including a year-end adjustment of 17,500) 437,500
Prepaid insurance at December 31, 2005 122,500
What was the total amount of insurance premiums paid by East during 2005?
A. $322,500
B. $420,000
C. $437,500
D. $455,000
D
Beginning prepaid balance $105,000
+ Premiums paid Solving
- Expense charges -$437,500
= Ending prepaid balance $122,500
Premiums paid = $455,000
Accrual or Deferral ?
1. Depreciation expense xx
Accumulated deprecation xx
2. Interest receivable xx
Interest revenue xx
3. Rent expense xx
Prepaid rent xx
4. Unearned revenue xx
Rent revenue xx
5. Wage expense xx
Wages payable xx
Accrual/Deferral
1. Depreciation expense xx
Accumulated deprecation xx Deferral
2. Interest receivable xx
Interest revenue xx Accrual
3. Rent expense xx
Prepaid rent xx Deferral
4. Unearned revenue xx
Rent revenue xx Deferral
5. Wage expense xx
Wages payable xx Accrual
SFAC 5 provides guidance on measuring assets and liabilities. The following measurement methods are available to measure assets and liabilities, as shown in the list below. Identify the appropriate valuation method for each item.
Measurement methods A. Historical cost or historical proceeds B. Current cost C. Current market value D. Net realizable value or settlement rate E. Present value of future cash flows --------------------------------------- Account 1. Long-term receivables 2. Available for sale securities 3. Equipment 4. Warranty obligations 5. Short-term payables 6. Accounts receivable 7. Bonds payable, due in ten years 8. Trading securities
Account
- Long-term receivable E. PV of future cash flows
- Available for sale securities C.Current market value
- Equipment A. Historical Cost/Proceeds
- Warranty obligations D.NRV or Settlement rate
- Short-term payables A. Historical Cost/Proceeds
- Accounts receivable D.NRV or Settlement rate
- Bonds payable, due 10 yrs E. PV of future cash flows
- Trading securities C. Currrent market value
Terms
A. Recognition G. Gains
B. Comprehensive Income H. Net Income
C. Faithful representation I. Earnings
D. Revenues J. Realization
E. Predictive Value K. Replacement Cost
F. Comparability L. Current Market Value
- Component of relevance. __
- Increases in net assets from incidental or peripheral transactions affecting an entity. __
- The process of converting noncash resources and rights into cash or claims to cash. __
- Enhancing qualitative characteristic of relevance and faithful representation. __
- The process of formally recording an item in the financial statements of an entity after it has met existing criteria and been subject to cost-benefit constraints and materiality thresholds. __
- All changes in net assets of an entity during a period except those resulting from investments by owners and distributions to owners. __
- Inflows or other enhancements of assets of an entity or settlements of its liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing operations.__
- The amount of cash, or its equivalent, that could be obtained by selling an asset in orderly liquidation. __
- The quality of information that helps users to increase the likelihood of correctly forecasting the outcome of past or present events. __
- A performance measure concerned primarily with cash-to-cash cycles. __
Rationale:
- (E) SFAC 5 states that “Relevance is a primary qualitative characteristic. To be relevant, information about an item must have feedback value or predictive value (or both) for users and must be timely.”
- (G) SFAC 6 states that “Gains are increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity except those that result from revenues or investments by owners.”
- (J) SFAC 5 states that “Revenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash.”
- (F) SFAC 8 states that “Comparability, including consistency, is an enhancing quality that interacts with relevance and faithful representation to contribute to the usefulness of information.”
- (A) SFAC 5 states that “Recognition is the process of formally recording or incorporating an item into the financial statements of an entity as an asset, liability, revenue, expense, or the like.” SFAC 5 continues the recognition concept by stating, “An item and information about it should meet four fundamental recognition criteria to be recognized and should be recognized when the criteria are met, subject to a cost-benefit constraint and a materiality threshold.”
- (B) SFAC 5 states that “Comprehensive income is a broad measure of the effects of transactions and other events on an entity, comprising all recognized changes in equity (net assets) of the entity during a period from transactions and other events and circumstances except those resulting from investments by owners and distributions to owners.”
- (D) SFAC 6 defines revenues as “inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.”
- (L) SFAC 5 defines current market value as “the amount of cash, or its equivalent, that could be obtained by selling an asset in orderly liquidation.”
- (E) Predictive value is the quality of information that helps users to increase the likelihood of correctly forecasting the outcome of past or present events (SFAC 8).
- (I) SFAC 5 states that “Earnings is a measure of performance during a period that is concerned primarily with the extent to which asset inflows associated with cash-to-cash cycles substantially completed (or completed) during the period exceed (or are less than) asset outflows associated, directly or indirectly, with the same cycles.”
According to the conceptual framework, the quality of information that helps users increase the likelihood of correctly forecasting the outcome of past or present events is called:
A. Confirmatory value.
B. Predictive Value.
C. Representational faithfulness.
D. Faithful representation.
B
Predictive value is the ingredient that helps users increase the likelihood of forecasting the outcome of events. Financial statement information is useful if it helps users make decisions about investing and extending credit. These decisions involve predictions of a firm’s future financial performance, position, and cash flows.
Which of the following characteristics relates to both accounting relevance and faithful representation?
A. Free from material error.
B. Completeness.
C. Neutrality.
D. Comparability.
D.
Comparability is the quality of information that enables users to identify similarities and differences between sets of information. For information to be comparable, it must be both relevant (make a difference to a user) and reliable (be accurate and trustworthy).
Note :
Neutrality, or freedom from bias, is one of the three ingredients, or components, of faithful representation.
What is the conceptual framework intended to establish?
A. Generally Accepted Accounting Principles in financial reporting by business enterprises.
B. The meaning of “present fairly in accordance with Generally Accepted Accounting Principles.”
C. The objectives and concepts for use in developing standards of financial accounting and reporting.
D. The hierarchy of sources of Generally Accepted Accounting Principles.
C
The concepts statements, also collectively called The Conceptual Framework, provide the general underpinnings for specific GAAP. In a way, it is a “constitution” for developing specific accounting principles. The concepts statements are not GAAP, however.
According to the conceptual framework, neutrality is an ingredient of:
Faithful representation Relevance
Yes Yes
Yes No
No Yes
No No
YES/NO
Neutrality is one of the ingredients of faithful representation, along with completeness and free from material error. Neutrality means lack of bias-that financial reporting does not have a preconceived objective or agenda
According to the FASB conceptual framework, which of the following is not an enhancing qualitative characteristic?
A. Comparability.
B. Confirmatory value.
C. Verifiability.
D. Timeliness.
B. Confirmatory value.
Confirmatory value is an ingredient of relevance. It does not relate to faithful representation. Faithful representation can be broken down into completeness, free from material error, and neutrality.
Note: Comparability. Comparability, the quality of information that allows users to identify similarities and differences between different sets of data, is an enhancing characteristic of accounting information. Comparability contributes to both relevance, the quality of information that makes a difference in decision-making, and faithful representation, the quality of information that renders it objective and unbiased. Data that is comparable with other reported data is more useful for decision making and therefore more relevant. It also improves the faithful representation of the data. Data that is not comparable with other data sets may not be as faithful a representation as data that is comparable.
According to the FASB conceptual framework, predictive value is an ingredient of:
Relevance Faithful representation
No No
Yes Yes
No Yes
Yes No
YES/NO
Predictive value is one of the ingredients of relevance, one of the primary characteristics of accounting information. The other ingredient of relevance is confirmatory value.
Predictive value is not an ingredient of faithful representation. Faithful representation is the other primary characteristic of accounting information. Its three main ingredients are completeness, free from material error, and neutrality.
Which of the following characteristics of accounting information primarily allows users of financial statements to generate predictions about an organization?
A. Reliability. B. Timeliness. C. Neutrality. D. Relevance. The question is asking which of the following terms captures predictive value. Predictive value along with confirmatory value is a component of relevance.
D. Relevance.
The question is asking which of the following terms captures predictive value. Predictive value along with confirmatory value is a component of relevance.
On December 31, 2002, Brooks Co. decided to end operations and dispose of its assets within three months. At December 31, 2002, the net realizable value of the equipment was below historical cost.
What is the appropriate measurement basis for equipment included in Brooks’ December 31, 2002, Balance Sheet?
A. Historical cost.
B. Current reproduction cost.
C. Net realizable value.
D. Current replacement cost.
C
When a firm is in liquidation, historical cost and entry values (replacement cost) are no longer relevant.
The going concern assumption supports the historical cost principle. The firm is no longer a going concern. The only amounts relevant are the amounts to be received on sale of the assets. Net realizable value is the net value to be received, after the costs of getting the asset ready for sale are deducted.
According to the FASB conceptual framework, certain assets are reported in financial statements at the amount of cash or its equivalent that would have to be paid if the same or equivalent assets were acquired currently. What is the name of the reporting concept?
A. Replacement cost.
B. Current market value.
C. Historical cost.
D. Net realizable value.
A
Replacement cost is the amount to be paid for an item at the current time. This concept is used in the lower-of-cost-or-market inventory valuation procedure. Replacement cost is an example of an entry price-the amount required to be paid currently to obtain an asset already held.
Ande Co. estimates uncollectible accounts expense using the ratio of past actual losses from uncollectible accounts to past net credit sales, adjusted for anticipated conditions. The practice follows the accounting concept of: A. Consistency. B. Going concern. C. Matching. D. Substance over form
C
The matching principle requires that we recognize and match expenses with the revenues generated. For all sales in a given period, some will be uncollectible. The cost of those uncollectible accounts is matched in the period that the revenue is recognized.
The SEC defines a foreign private issuer as any issuer other than a foreign government, except an issuer that where more than 50% of the outstanding voting securities are directly or indirectly owned by residents of the U.S. and what other condition?
A. The business of the issuer is administered principally in the foreign country.
B. More than 50% of the assets of the issuer are located in the foreign country.
C. The majority of its executive officers or directors are U.S. citizens or residents.
D. All of the above.
C
A foreign private issuer is any foreign issuer other than a foreign government, except an issuer that meets the following conditions:
A. More than 50% of the outstanding voting securities are directly or indirectly owned by residents of the U.S., AND
Any of the following:
1.The business of the issuer is administered principally in the U.S.
2. More than 50% of the assets of the issuer are located in the U.S.
3.The majority of its executive officers or directors are U.S. citizens or residents.
Rule 205, Securities Act 1933
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:
A. Federal Reporting Updates (FRU).
B. Financial Reporting Releases (FRR).
C. Staff Auditing Bulletins (SAB).
D. Accounting Principles Opinions (APO).
B
The main pronouncements published by the SEC are the Financial Reporting Releases (FRR) and the Staff Accounting Bulletins (SAB).
Note:
The Accounting Principles Board (not associated with the SEC) issued Opinions, which were termed Accounting Principles Board Opinions. Many have been superseded by the pronouncements of the FASB.
The SEC is comprised of five commissioners, appointed by the President of the United States, and four divisions. Which of the following divisions is responsible for overseeing compliance with the securities acts?
A. Division of Corporate Finance.
B. Division of Enforcement.
C. Division of Trading and Markets.
D. Division of investment management.
A
The Division of Corporate Finance oversees the compliance with the securities acts and examines all filings made by publicly held companies
For which of the following circumstances is the guidance for determining fair value as provided in the fair value framework presented in ASC 820, “Fair Value Measurement,” least likely to apply?
A. Determination of the fair value to be assigned to land acquired in a business combination.
B. Determination of the fair value of a bond liability for applying the fair value option.
C. Determination of the fair value of legal services received in exchange for an entity’s common stock.
D. Determination of the fair value of a production facility when assessing whether or not an impairment loss has occurred.
C
The guidance for determining fair value provided in the fair value framework is not appropriate for determining the fair value of legal services received in exchange for an entity’s common stock. ASC 820 specifically exempts share-based payment transactions (and inventory valuing and other minor items) from the purview of the fair value framework.
In determining the fair value of a nonfinancial asset, assessing the highest and best use of the asset must take into account all but which one of the following?
A. What is physically possible.
B. What is financially feasible.
C. How the reporting entity would use the asset.
D. What is legally permissible
C
In determining the fair value of a nonfinancial asset, how the reporting entity would use the asset would NOT be taken into account in assessing the highest and best use of the asset. The highest and best use is based on use of the asset by market participants, not by the reporting entity.
Which one of the following is not a purpose of the fair value framework as set forth in ASC 820, “Fair Value Measurement”?
A. Provide a uniform definition of “fair value” for GAAP purposes.
B. Provide a framework for determining fair value for GAAP purposes.
C. Establish new measurement requirements for financial instruments.
D. Establish expanded disclosures about fair value when it is used.
C
Establishing new measurement requirements for financial instruments, or for any other asset or liability, is NOT one of the purposes of the fair value framework. Measurement requirements or elections are determined by other pronouncements; the “Fair Value Measurement” pronouncement establishes standards to be followed in determining (measuring) fair value when it is used.
For which one of the following described assets does the guidance for determining fair value as provided in ASC 820, “Fair Value Measurement,” not apply?
A. Accounts receivable.
B. Investments in debt securities to be held-to-maturity.
C. Investments in equity securities held for trading.
D. Inventory reported at lower of cost or market.
D
Inventory valuation under lower of cost or market is specifically exempt from the fair value measurement guidance provided by ASC 820, “Fair Value Measurement.” The use of lower of cost or market valuation places upper (“ceiling”) and lower (“floor”) limits on the measurement of “market” that may not result in a true fair value measurement. Thus, the measurement of inventory at “market” is one of the few exceptions to the use of ASC 820 guidance for fair value measurement.
Which of the following statements concerning the determination of fair value is/are correct?
I. The determination of fair value is based on a hypothetical transaction.
II. The determination of fair value is based on an exit price.
III. The determination of fair value of a nonfinancial asset should be based on the intended use of the asset by the reporting entity.
A. I only.
B. II only.
C. I and II only.
D. II and III only.
C
Both Statements I and II are correct. The determination of fair value is based on a hypothetical transaction and on the use of a (hypothetical) exit price. Statement III is not correct. The determination of fair value of a nonfinancial asset should be based on the highest and best use of the asset by market participants, not based on the intended use by the reporting entity.
In determining the fair value of an asset in the most advantageous market, the market based exit price should be adjusted for
Transaction Cost Transportation Cost
Yes Yes
Yes No
No Yes
No No
NO/YES
In determining the fair value of an asset in the most advantageous market, the market based exit price would not be adjusted for transaction cost associated with executing the (hypothetical) transaction, but would be adjusted for transportation cost to get the asset to the principal or most advantageous market.
A company owns a financial asset that is actively traded on two different exchanges (market A and market B). There is no principal market for the financial asset. The information on the two exchanges is as follows
Quoted price of asset Transaction costs Market A $1,000 $ 75 Market B 1,050 150
What is the fair value of the financial asset? A. $ 900 B. $ 925 C. $1,000 D. $1,050
C
The fair value of the financial asset is $1,000, the quoted price in the most advantageous market, but without adjusting that price for transaction costs. Since there is no principal market for the financial asset, the most advantageous market must be used to determine fair value. The most advantageous market is the market that maximizes the amount that would be received to sell the asset (or minimizes the amount that would be paid to transfer a liability), after taking into account transaction costs and transportation costs. Thus, the most advantageous market is Market A, determined as:
Market A Market B Quoted price of asset $1,000 $1,050 Transaction cost ( 75) ( 150) Net Proceeds $ 925 $ 900
Even though transaction costs are considered in determining the most advantageous market, the price in the most advantageous (or principal) market used to measure the fair value of the asset (or liability) is not adjusted for transaction costs [ASC 820-10-35-9B]. Therefore, the quoted price of the asset in the most advantage market, unadjusted for the transaction costs, is fair value.
On January 1, year 1, Peabody Co. purchased an investment for $400,000 that represented 30% of Newman Corp.'s outstanding voting stock. For year 1, Newman reported net income of $60,000 and paid dividends of $20,000. At year end, the fair value of Peabody's investment in Newman was $410,000. Peabody elected the fair value option for this investment. What amount should Peabody recognize in net income for year 1 attributable to the investment? A. $ 6,000 B. $10,000 C. $16,000 D. $18,000
C
Since Peabody has elected to report the investment in Newman using the fair value option, it should recognize its share of cash dividends received during the period (.30 x $20,000 = $6,000) and the increase in the fair value of the investment ($400,000 > $410,000 = $10,000), or $6,000 + $10,000 = $16,000.
