FAR 3

Question 1

On January 1, Year 1, Harrow Co. as lessee signed a 5-year noncancelable equipment lease with annual payments of $100,000 beginning December 31, Year 1. Harrow treated this transaction as a finance lease. The five lease payments have a present value of $379,000 on January 1, Year 1, based on interest of 10%. What amount should Harrow report as interest expense for the year ended December 31, Year 1?

A. $10,000
B. $27,900
C. $37,900
D. $50,000

Answer 1

C. $37,900

Don’t overthink it.

Question 2

Last year, an entity wrote off a $3,000 accounts receivable that was deemed uncollectible. During the current year, the entity recovered $2,000 of the $3,000 account previously written off. All of the following statements regarding the recovery of the accounts receivable are true except:

A. Accounts receivable balance is unchanged.
B. Carrying value of accounts receivable decreases.
C. Allowance for credit losses balance increases.
D. Credit loss expense decreases.

Answer 2

D. Credit loss expense decreases.

Question 3

Oak Co. leased equipment for its entire nine-year useful life, agreeing to pay $50,000 at the start of the lease term on December 31, Year 1, and $50,000 annually on each December 31 for the next eight years. The present value on December 31, Year 1, of the nine lease payments over the lease term, using the rate implicit in the lease, which Oak knows to be 10%, was $316,500. The December 31, Year 1, present value of the lease payments using Oak’s incremental borrowing rate of 12% was $298,500. Oak made a timely second lease payment. What amount should Oak report as finance lease liability in its December 31, Year 2, balance sheet?

A. $228,320
B. $243,150
C. $284,320
D. $298,150

Answer 3

B. $243,150

In this scenario, Oak Co. has a nine-year finance lease because the lease term is for the equipment’s useful life (ie, nine years). Using the 10% interest rate implicit in the lease, the PV of lease payments (ie, lease liability) is $316,500. The first $50,000 payment was made at lease inception, reducing the lease liability to $266,500 ($316,500 − $50,000). The December 31, Year 2, lease liability balance is $243,150, calculated as follows:

Year 2 payment $50,000
Less: Year 2 interest expense ($266,500 beginning liability balance × 10%) (26,650)
Year 2 liability reduction $23,350

December 31, Year 2 liability balance ($266,500 − $23,350 Year 2 reduction) $243,150

Question 4

On January 2, Year 4, Raft Corp. discovered that it had incorrectly expensed a $210,000 machine purchased on January 2, Year 1. Raft estimated the machine’s original useful life to be 10 years and its salvage value at $10,000. Raft uses the straight-line method of depreciation and is subject to a 30% tax rate. In its December 31, Year 4, financial statements, what amount should Raft report as a prior-period adjustment?

A. $102,900
B. $105,000
C. $165,900
D. $168,000

Answer 4

B. $105,000

Because prior-period adjustments are made as of the beginning of the earliest period presented, the 12/31/Year 4 F/S require a net adjustment for Years 1-3. Raft will make the following entry:

Equipment 210,000
Retained earnings
105,000
Accumulated depreciation
60,000
Current income tax liability
45,000
If the machine had been capitalized, a $210,000 asset would have been recorded instead of an expense.

With a useful life of 10 years and a salvage value of $10,000, depreciation of $20,000 per year ([210,000 − 10,000] ÷ 10 years) should have been recorded for Years 1, 2, and 3. Therefore, accumulated depreciation of $60,000 (20,000 × 3 years) is recorded.

The asset’s adjusted carrying value will increase total income before taxes by $150,000 (210,000 − 60,000). As a result, an income tax liability (excluding penalties and interest) of $45,000 ($150,000 × 30% tax rate) is recorded for the taxes Raft should have paid had it properly capitalized the machine.

The retained earnings adjustment ($105,000) is the net adjustment required (ie, plug) to balance the entry.

Question 5

Which of the following is a governmental fund that uses the current financial resources measurement focus?

A. Enterprise fund.
B. Internal service fund.
C. Special revenue fund.
D. Private-purpose trust fund.

Answer 5

C. Special revenue fund.

How each fund category measures and reports activities can be summarized as follows:

Governmental funds (eg, special revenue fund) have a budgetary focus and emphasize the reporting of sources, uses, and balances of current financial resources.

Proprietary funds (eg, enterprise fund, internal service fund) have an operations orientation and use the economic resources approach(Choices A and B).

Fiduciary funds (eg, private-purpose trust fund) focus on how a trustee manages the assets entrusted to it and uses the economic resources approach(Choice D).

Question 6

Scurry Company has 500,000 shares of $8 par common stock issued and outstanding as of January 1, Year 5, originally issued for $14 per share. During Year 5, Scurry Company had the following transactions involving its own stock:

On March 6, acquired 12,000 shares of treasury stock at a cost of $12 per share.
On April 18, resold 4,000 shares of treasury stock at $15 per share.
On June 11, resold an additional 2,000 shares of treasury stock at $18 per share.

If Scurry uses the par value method of accounting for treasury stock, what will be the balance in additional paid-in capital from treasury stock as a result of these transactions?

A. $0
B. $24,000
C. $48,000
D. $72,000

Answer 6

B. $24,000

Under this method, recording the reacquisition of common stock (C/S) depends on the difference between the repurchase price and the combined amount of par value and the APIC-C/S associated with the original stock issuance.

If the repurchase price is less than the original issuance price (ie, par value plus original APIC-C/S), a credit to APIC-T/S is required (Choice A).

If the repurchase price is greater than the original issuance price, additional debits to APIC-T/S (from previous T/S transactions) and/or retained earnings are required.

A resale of T/S is reported like a new issuance, except that T/S is credited instead of C/S. Any excess is recorded as APIC-C/S (not APIC-T/S). In this scenario, T/S is repurchased at a cost ($12) less than the original issue price ($14). This creates $24,000 APIC-T/S as shown in the following entry:

Repurchase on March 6
Treasury stock ($8 par × 12,000) 96,000
APIC-C/S ($14 issue price − $8 par = $6 ×12,000) 72,000
Cash ($12 repurchase price × 12,000)
144,000
APIC-T/S ($8 par + $6 − $12 = $2 × 12,000)
24,000

Question 7

On December 31, Year 1, Red Co. leased a machine from Green Co. for a seven-year period. Equal annual payments under the lease are $105,000, including $7,500 allocated annually for taxes and insurance, and are due on December 31 of each year. The first payment was made on December 31, Year 1, and the second payment was made on December 31, Year 2. The seven lease payments are discounted at 9% over the lease term. The present value of lease payments at the inception of the lease and before the first annual payment was $576,500. The lease is appropriately accounted for as a finance lease by Red Co. In its December 31, Year 2, balance sheet, Red Co. should report a lease liability of

A. $408,935
B. $429,065
C. $471,500
D. $576,500

Answer 7

A. $408,935

Red’s $105,000 annual lease payment includes $7,500 in taxes and insurance. The first payment was made on December 31, Year 1 (ie, lease inception), reducing the lease liability to $471,500 ($576,500 initial liability − $105,000 payment) (Choices C and D). The December 31, Year 2, liability equals $408,935 as calculated below.

Annual lease payment (Year 2) $105,000
Less: Year 2 interest expense ($471,500 Year 1 balance × 9%) (42,435)
Year 2 liability reduction $62,565

December 31, Year 1 lease liability $471,500
Less: Year 2 liability reduction (62,565)
December 31, Year 2 lease liability $408,935

Question 8

An issuer of bonds uses a sinking fund for the retirement of the bonds. Cash is transferred to the sinking fund and subsequently used to purchase investments. The interest and dividends earned in the sinking fund are

Added to fund balanceReported as income
A. Yes Yes
B. Yes No
C. No Yes
D. No No

Answer 8

A. Yes Yes

Question 9

Which following statement is a correct statement about the direct write-off method for calculating credit loss expense?

A. It is in accordance with GAAP.
B. It uses an allowance for credit losses account.
C. It tends to understate accounts receivable on the balance sheet.
D. It recognizes credit loss expense when a specific account is determined to be uncollectible.

Answer 9

D. It recognizes credit loss expense when a specific account is determined to be uncollectible.

Question 10

Oz, a nongovernmental not-for-profit arts organization, received $50,000 from Ame Company to sponsor a play given by Oz at the local theater. Oz gave Ame 25 tickets, which generally cost $100 each. Ame received no other benefits. What amount of ticket sales revenue should Oz record?

A. $0
B. $2,500
C. $47,500
D. $50,000

Answer 10

B. $2,500

In this scenario, Oz received $50,000, which consists of both an exchange (ie, ticket revenue) and a contribution (ie, contribution revenue). The fair value of the tickets Oz provided to Ame is $2,500 ($100 × 25 tickets), which is the recognized ticket sales revenue. This revenue is similar to a for-profit entity selling goods or services to a customer.

Question 11

Selected information for Irvington Company is as follows:

December 31,

Year 1 Year 2
Preferred stock, 8%, par $100, nonconvertible, noncumulative $125,000 $125,000
Common stock 300,000 400,000
Retained earnings 75,000 185,000
Dividends paid on preferred stock for year ended 10,000 10,000
Net income for year ended 60,000 120,000
Irvington’s return on common stockholders’ equity, rounded to the nearest percentage point, for year 2 is

A. 17%
B. 19%
C. 23%
D. 25%

Answer 11

C. 23%

Irvington’s return on common stockholders’ equity for year 2 is computed by dividing net income available to common stockholders (net income less preferred dividends) by average common stockholders’ equity.

$120,000 − $10,000 = 23%
($375,000 + $585,000) / 2

Question 12

Case Cereal Co. frequently distributes coupons to promote new products. On October 1, Year 4, Case mailed 1,000,000 coupons for $.45 off each box of cereal purchased. Case expects 120,000 of these coupons to be redeemed before the December 31, Year 4, expiration date. It takes 30 days from the redemption date for Case to receive the coupons from the retailers. Case reimburses the retailers an additional $.05 for each coupon redeemed. As of December 31, Year 4, Case had paid retailers $25,000 related to these coupons and had 50,000 coupons on hand that had not been processed for payment. What amount should Case report as a liability for coupons in its December 31, Year 4, balance sheets?

A. $35,000
B. $29,000
C. $25,000
D. $22,500

Answer 12

A. $35,000

(Choice A)

120,000 coupons expected to be redeemed × ($.45 + $.05) $60,000
Less amount already paid (25,000)
Liability at 12/31/Y4 $35,000
The 50,000 coupons on hand are included in the ending liability and account for $25,000 of the total liability [50,000($.45 + $.05)]. The $25,000 already paid represents another 50,000 coupons [$25,000/($.45 + $.05)].

Therefore, another 20,000 coupons have yet to be redeemed out of a total of 120,000 redemptions. These 20,000 coupons account for the remaining $10,000 of the liability [20,000($.45 + $.05)].

Question 13

On January 2, year 3, to better reflect the variable use of its only machine, Holly, Inc. elects to change its method of depreciation from the straight-line method to the units-of-production method. The original cost of the machine on January 2, year 1, is $50,000, and its estimated life is ten years. Holly estimates that the machine’s total life is 50,000 machine hours.

Machine-hour usage was 8,500 during year 2 and 3,500 during year 1. Machine-hour usage for year 3 is 3,800.

Holly’s income tax rate is 30%. Holly should report the accounting change in its year 3 financial statements as a(an)

A. Estimate change recognizing $3,800 of depreciation in year 3.
B. Estimate change recognizing $4,000 of depreciation in year 3.
C. Cumulative effect of a change in accounting principle of $1,400 in its income statement.
D. Adjustment to beginning retained earnings of $1,400.

Answer 13

B. Estimate change recognizing $4,000 of depreciation in year 3.

A change in depreciation method is accounted for as an estimate change. The remaining book value at the beginning of the year of change is allocated over the remaining useful life using the new method.

Book value January 1, year 3 = $50,000 - ($50,000/10)2 = $40,000.

Estimated remaining machine hours at January 1, year 3 = 50,000 − 8,500 − 3,500 = 38,000.

Depreciation expense for year 3 = 3,800($40,000/38,000) = $4,000.

Question 14

How is a change in accounting principle treated?

Answer 14

Retrospective

Question 15

How is a change in accounting estimate treated?

Answer 15

Prospective

Question 16

How is a change in reporting entity treated?

Answer 16

Restrospective

Question 17

How is an error correction treated on the FS?

Answer 17

Retroactive

Question 18

Ray Corp. issued 200 of its 8%, ten-year, $1,000 face value bonds for $240,000. Each bond contained 100 detachable stock warrants, each of which was for one share of Ray’s common stock at $12 per share. Immediately after issuance, the market value of each warrant was $2, and the market value of the bonds without the warrants was $196,000. What amount of discount on the bonds should Ray record at issuance?

A. $0
B. $678
C. $4,000
D. $39,322

Answer 18

B. $678

In this scenario, Ray Corp. must first calculate the warrant FV before determining the relative FV percentages for bonds and warrants. Each bond contains 100 warrants with a market value of $2 each. Ray sold 200 bonds, resulting in 20,000 warrants (200 bonds × 100 warrants per bond). The warrant FV is $40,000 (20,000 warrants × $2 per warrant). The bond discount is $678, calculated as follows:

Determine relative fair value percentages:
FV of bonds (given) $196,000
FV of warrants 40,000
Total FV $236,000

% allocated to bonds ($196,000 / $236,000) = 83.05%

Allocate issue proceeds to bonds and warrants:
Proceeds $240,000
% allocated to bonds 83.05%
Carrying value (CV) of bonds $199,322

Discount on bonds payable is $678 ($200,000 face value − $199,322 CV)

Question 19

On January 2, Vole Co. issued bonds with a face value of $480,000 at a discount to yield 10%. The bonds pay interest semiannually. On June 30, Vole paid bond interest of $14,400. After Vole recorded amortization of the bond discount of $3,600, the bonds had a carrying amount of $363,600. What amount did Vole receive upon issuing the bonds?

A. $360,000
B. $367,200
C. $476,400
D. $480,000

Answer 19

A. $360,000

Because the bonds in this scenario were issued at a discount, an amount less than FV ($480,000) was received. To calculate the amount Vole Co. received at issuance, determine the discount at June 30 from the carrying amount given, $363,600. Work backwards to calculate the discount at bond issuance.

Discount June 30 $480,000 FV − $363,600 CV = $116,400
Discount January 2 $116,400 + $3,600 amortization = $120,000
Bond Proceeds $480,000 FV − $120,000 discount = $360,000

Question 20

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 used, what would be the estimated cost of the ending inventory?

A. $24,000
B. $20,800
C. $20,000
D. $19,200

Answer 20

D. $19,200

(Choice D)

The cost to retail ratio using the retail inventory method 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.

Question 21

In its December 31, Year 4 balance sheet, Demark Inc. reported accounts receivable of $800,000 before allowance for credit losses of $25,000. Credit sales during Year 5 were $630,000, and collections from customers, excluding recoveries of $5,000, totaled $740,000. During Year 5, accounts receivable of $20,000 were written off. Demark estimated that $35,000 of the accounts receivable at December 31, Year 5, was uncollectible. In its December 31, Year 5 balance sheet, what amount should Demark report as accounts receivable before allowance for credit losses?

A. $635,000
B. $670,000
C. $675,000
D. $690,000

Answer 21

B. $670,000

In this scenario:

Recoveries of $5,000 require reinstating the accounts by increasing A/R and the allowance for credit losses, then recording the collection with an increase to cash and a decrease to A/R. The two entries to A/R offset one another.

The entry for credit losses required to obtain the $35,000 ending balance of the allowance does not involve A/R.

The ending balance of A/R is $670,000.

AR
Beg. Bal. Collections
Cred. sales Write-offs
Rein. Accts Rec. Collec.
End Balance

800000 740000
630000 20000
5000 5000
670000

Question 22

Murphy Co. had 200,000 shares outstanding of $10 par common stock on March 30 of the current year. Murphy reacquired 30,000 of those shares at a cost of $15 per share and recorded the transaction using the cost method on April 15. Murphy reissued the 30,000 shares at $20 per share and recognized a $150,000 gain on its income statement on May 20. Which of the following statements is correct?

A. Murphy’s comprehensive income for the current year is correctly stated.
B. Murphy’s net income for the current year is overstated.
C. Murphy’s net income for the current year is understated.
D. Murphy should have recognized a $150,000 loss on its income statement for the current year.

Answer 22

B. Murphy’s net income for the current year is overstated.

There are two methods used to account for T/S transactions: cost and par value. In this question, the cost method is used. However, no matter which method is followed, all transactions involving T/S generally affect only stockholders’ equity accounts (never income statement accounts). No gain or loss is ever recognized on any T/S transaction.

In this scenario, Murphy Co. incorrectly recorded the $150,000 [($20 − $15) × 30,000] excess proceeds from reissuance as a gain from the sale stock. Accordingly, net income for the current year is overstated (Choices A, C, and D).

Note: A correcting entry will be required to reclassify the gain as APIC-T/S.

Question 23

If bonds are issued at a premium, total interest expense recorded over the life of a bond equals the cash interest payments

A. Less the premium.
B. Less par value.
C. Plus the premium.
D. Plus par value.

Answer 23

A. Less the premium.

Question 24

For a marketable debt securities portfolio classified as available-for-sale, which of the following should be included in the period’s net income?

A. Unrealized holding gains and losses related to market risk during the period.
B. Realized gains and losses on securities sold during the period.
C. Unrealized holding gains and losses when reclassifying the securities as held-to-maturity.
D. None because all the gains and losses are included in other comprehensive income.

Answer 24

B. Realized gains and losses on securities sold during the period.

The remaining change in FV is considered market risk and not reported in income until the securities are disposed of. Until then, unrealized holding gains and losses due to market risk are reported in other comprehensive income (OCI)(Choice A).

When the securities are sold or management reclassifies them as trading securities, the gains and losses are realized in the current period’s net income (Choice D). However, if an AFS security is reclassified as held-to-maturity, the unrealized holding gains and losses are not reported in net income; instead, they are amortized over the life of the security (Choice C).

Question 25

The composite depreciation method

A. Is applied to a group of homogeneous assets.
B. Is an accelerated method of depreciation.
C. Does not recognize gain or loss on the retirement of single assets in the group.
D. Does not subtract salvage value from the base of the depreciation calculation.

Answer 25

C. Does not recognize gain or loss on the retirement of single assets in the group.

Question 26

Which of the following are observable inputs used for fair value measurements?
I. Bank prime rate.
II. Default rates on loans.
III. Financial forecasts.

A. I only.
B. I and II only.
C. I and III only.
D. I, II and III.

Answer 26

B. I and II only.

(Choice B) The bank prime rate and the default rates are both observable inputs. A financial forecast is developed by an entity and is an unobservable input or Level 3 input.

Question 27

Mod Cons Appliances entered into a contract to provide Reilly Clean Laundromat with 10 premium washer-dryer packages at $2,150 per package. The premium washer-dryer package includes a washing machine, a dryer, and a 5-year repair plan for each appliance.

Mod Cons offers a washer package with a washer and a washer repair plan for $1,350 and a dryer package with a dryer and a dryer repair plan for $950. Mod Cons regularly sells individual washing machines at $1,200 each and individual dryers at $900 each. It sells 5-year repair plans at $300 for washing machines and $100 for dryers. Rounding to the nearest $100, how much of the Reilly contract revenue should be allocated to washing machines?

A. $10,100
B. $10,800
C. $10,300
D. $12,000

Answer 27

A. $10,100

In this contract, there are two smaller bundles that will get the first allocation. A washer with a maintenance plan is a smaller bundle that is sold for $1,350; the discount is allocated as follows:

Washer $1,200 80% $120 $1,080
Maint.plan $300 20% $30 $270
Total $1,500 $150 $1,350

A dryer with a maintenance plan is a smaller bundle that is sold for $950; the discount is allocated as follows:

Dryer $900 90% $45 $855
Maint.
plan $100 10% $5 $95
Total $1,000 $50
$950

With a package price of $2,150 for all four items, there is a remaining discount of $150 ($2,300 − $2,150). Revenue allocated to washers for 10 packages is $10,100 (10 × $1,010), calculated as follows:

Washer $1,080 47% $1,010
Washer maint. plan 270 12% 252
Dryer 855 37%
799
Dryer maint. plan 95 4%
89
Total $2,300 100% $2,150

Question 28

At December 31, Year 3, before recognizing any depreciation expense for Year 3, X Company has a machine with an original cost of $360,000 and accumulated depreciation of $90,000. The machine is used to manufacture a specific product and, at December 31, Year 3, has a remaining useful life of 7 years with no salvage value. The machine was used to produce 10,000 units in the current year, 20,000 total units in the previous two years, and is expected to be used to produce an additional 50,000 units over its remaining life. If X Company uses the units of production method for calculating depreciation, depreciation expense in Year 3 will be (rounded):

A. $36,000
B. $38,570
C. $45,000
D. $60,000

Answer 28

C. $45,000

In this scenario, the total number of units in the useful life is not directly given and must be calculated as 80,000 units (ie, 20,000 in previous years + 10,000 in the current year + 50,000 in future years). The per-unit depreciation (Step 1) is $4.50; therefore, the depreciation expense for Year 3 (Step 2) is $45,000:

Step 1 Depreciation expense per unit = Cost - Salvagevalue
/Totalunitsinlife =
$360,000 -$0
/80,000units = $4.50perunit

Step 2 Depreciation expense for Year 3 =
Depreciationexpenseperunit
×
Unitsusedinyear =
$4.50 perunit × 10,000 units
= $45,000

Per-unit depreciation of $4.50 could also be calculated as the remaining amount to be depreciated of $270,000 ($360,000 cost − $90,000 accumulated depreciation) divided by 60,000 units (current 10,000 + future 50,000).

Question 29

Universe Co. issued 500,000 shares of common stock in the current year. Universe declared a 30% stock dividend. The market value was $50 per share, the par value was $10, and the average issue price was $30 per share. By what amount will Universe decrease stockholders’ equity for the dividend?

A. $0
B. $1,500,000
C. $4,500,000
D. $7,500,000

Answer 29

A. $0

Large stock dividends (ie, greater than 20–25% of the outstanding shares) are recorded at par value whereas small stock dividends (ie, less than 20–25%) are recorded at fair value. The reason for the different treatment is that the fair value of the stock is not deemed to be a realistic estimate after a large stock dividend occurs since a large dividend will normally cause a reduction in the selling price of the shares.

Because Universe Co. issued a 30% stock dividend, the dividend is recorded at par value or $1,500,000 (500,000 × 30% × $10). Retained earnings are decreased and common stock is increased by $1,500,000, resulting in $0 change to stockholders’ equity.

Question 30

On December 31, Year 1, Fort, Inc. issued 1,000 of its 8%, ten-year, $1,000 face value bonds with detachable stock warrants at par. Each bond carried a detachable warrant for one share of Fort’s common stock at a specified option price of $25 per share. Immediately after issuance, the market value of the bonds without the warrants was $1,080,000 and the market value of the warrants was $120,000. In its December 31, Year 1 balance sheet, what amount should Fort report as the carrying value of its bonds payable?

A. $880,000
B. $900,000
C. $975,000
D. $1,000,000

Answer 30

B. $900,000

In this scenario, Fort, Inc. must determine the amount of proceeds assigned to the bonds. The discount is the difference between the face value and the allocated bond value. Because the issue date is December 31, no amortization of the discount is required. The bond’s December 31, Year 1, carrying value (CV) is $900,000 ($1,000,000 face − $100,000 discount), as calculated below.

Determine relative fair value percentages:
FV of bonds (given) $1,080,000
FV of warrants (given) 120,000
Total FV $1,200,000

% allocated to bonds ($1,080,000 / $1,200,000) = 90%

Allocate issue proceeds to bonds and warrants:
Proceeds (ie, face value when sold at par)
(1,000 bonds × $1,000) $1,000,000
% allocated to bonds 90%
CV of bonds $900,000

Discount on bonds payable is $100,000 ($1,000,000 − $900,000)