FAR 4

Question 1

How do you treat Change in estimate, Change in accounting principle and change in error for Financial statements?

Answer 1

Change in estimate only affects only current and subsequent events

Restating prior years F/S is only required when comparative F/S are shown for PY adjustments of subsequently discovered correction of errors, changes in entity or changes in accounting principle

An accounting change of principle is shown net of tax on the R/E statement

Question 2

What are the four enhancing qualitative characteristics?

Answer 2

comparability, verifiability, timeliness and understandability. These characteristics enable relevant, faithfully represented information to be more useful.

Question 3

On January 1, Year 1, Company X purchases a new steel punch press machine for
$350,000. At the date of purchase, the machine had an estimated useful life of five
years and an estimated salvage value of $50,000. The company uses straight-line
depreciation. On July 1, Year 1, the production manager determined that the estimated
useful life on the machine will be one-half year less than originally expected. Assuming
that the company prepares journal entries on a quarterly basis and that the accounting
department was not notified of the change in estimated useful life until December 31,
what is the journal entry necessary to reflect the correct depreciation for this machine
at December 31, Year 1 (quarter end)?

Answer 3

($350,000 − $50,000) / 5 years = $60,000 Annual depreciation (or $15,000 quarterly)

Depreciable base 1/1/Y1: $300,000 = 60,000/2
Less: 6 months depreciation: 30,000 ($15,000 × 2 quarters)
Depreciable base 6/30/Y1: (300,000-30,000) = $270,000
Divide: Remaining useful life: 4 years

Annual (quarterly)
depreciation: $67,500/4 = ($16,875) The new quarterly rate is $16,875.

Unaware of the change in estimated life, the accounting department only recorded
depreciation expense of $15,000 in the third quarter. Therefore, the fourth quarter
depreciation expense (debit) is: $1,875 + $16,875 = $18,750. The $1,875 is a “catch-up”
entry for Q3 (excess of new amount over $15,000).
The accumulated depreciation (contra) account is a credit for the same amount

Question 4

Gates Accounting Services (GAS), a sole proprietorship, entered into a new 18-month
office space contract on September 15, Year 1, paying the full $36,000 rent contract to
the real estate company on that day (lease expiration March 15, Year 3). Assuming that
GAS reports on a calendar year-end and that journal entries are posted on a quarterly
basis (only), what adjusting journal entry (if any) would be made to the prepaid rent
account prior to closing the December 31, Year 1, financial statements?

Answer 4

Choice “A” is correct. During Year 1, GAS incurred 3½ months of rent expense with each
full month of rent expense totaling $2,000 ($36,000/18 months). Because the scenario
facts indicate that journal entries are posted on a quarterly basis, September’s one-half
month’s rent expense of $1,000 has been debited with a corresponding $1,000 credit to
prepaid rent on September 30. GAS would then recognize three months of rent expense
on December 31, Year 1, recording a $6,000 debit adjusting journal entry to rent expense
and a corresponding $6,000 credit to prepaid rent (an asset account).

Question 5

All of the following are accurate required disclosures when reporting accumulated
other comprehensive income and other comprehensive income (under all formats),
except:
A. For each component of other comprehensive income, report the changes in
the accumulated balances.
B. The tax impact of each component included in the current year’s other
comprehensive income must be reported.
C. Report total accumulated other comprehensive income on the balance sheet
as an item of equity.
D. Reclassification adjustments, and their effect on both net income and other
comprehensive income, are reported in the footnotes.

Answer 5

Choice “D” is correct. This represents an inaccurate required disclosure. All
reclassification adjustments, including the effect on reported net income and other
comprehensive income, must be presented in the statement in which the components
of net income and the components of other comprehensive income are presented (not
the footnotes).

Question 6

A firm may capitalize interest on all of the following assets during the construction
period with the exception of which of the following?
A. High-end manufactured inventory
B. Land improvements
C. New office building for employees
D. Real estate development project intended for future sale

Answer 6

Choice “A” is correct. Interest costs related to routinely manufactured inventory cannot
be capitalized, even if the inventory has a high-end dollar value. Capitalized interest is
permitted for inventory on hand that is a special order for a customer.
Choice “B” is incorrect. It is permissible to capitalize interest on land improvements.
Choice “C” is incorrect. Interest costs on the construction of a new office building for
employees’ internal use can be capitalized.
Choice “D” is incorrect. Interest costs on real estate development projects may be
capitalized if intended for sale or lease

Question 7

Under East Co.’s accounting system, all insurance premiums paid 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, Year 2, is as follows:

Prepaid insurance at December 31, Year 1 $105,000

Charges to insurance expense during Year 2
(including a year-end adjustment of $17,500) 437,500

Prepaid insurance at December 31, Year 2 122,500

What was the total amount of insurance premiums paid by East during Year 2?

A. $455,000
B. $420,000
C. $332,500
D. $437,500

Answer 7

Choice “A” is correct. $455,000 insurance premiums paid during Year 2.

Prepaid Insurance

Begin balance at 12/31/Year 1: $105,000
Add payments + 455,000
Sub Total 560,000
Less expense - (437,500)
Ending balance at 12/31/Year 2 $ 122,500

Question 8

Sag, Inc. has the following information relating to its defined benefit plan as of
December 31:
Projected benefit obligation
Unrecognized prior service cost 600,000
Current-year amortization of pension gains 250,000
Unrecognized pension gains 1,400,000
Current-year return on plan assets 450,000
Ignoring taxes, what amount would Sag report as accumulated other comprehensive
income on its December 31 balance sheet under U.S. GAAP?
A. $2,000,000
B. $(350,000)
C. $800,000
D. $1,500,000

Answer 8

Choice “C” is correct. Under U.S. GAAP, unrecognized prior service cost and
unrecognized net gains or losses must be reported in accumulated other
comprehensive income, net of tax, until recognized as part of pension expense through
amortization. Prior service cost increases pension expense and is recorded as a debit to
OCI. Net gains decrease pension expense and are recorded as a credit to OCI.
Accumulated OCI is reported on an after-tax basis. The amount in accumulated OCI is
as follows:

Unrecognized prior service cost $ (600,000)

Unrecognized pension gains 1,400,000

Ending Balance for AOCI $ 800,000

Choice “A” is incorrect. The unrecognized prior service cost and unrecognized pension
gains are netted against each other, not added, since the unrecognized prior service
cost represents a future addition to pension expense and the unrecognized pension
gain represents a future offset to pension expense.

Choice “B” is incorrect. The unrecognized pension gains at the end of the year, not the
current-year amortization, is included in accumulated other comprehensive income.

Choice “D” is incorrect. The current-year amortization of pension gains and the return
on plan assets for the current year are part of current-year pension expense and are not
included in the calculation of accumulated other comprehensive income.

Question 9

Under U.S. GAAP, is the cumulative effect of an inventory pricing change on prior years
earnings reported on the financial statements for

Answer 9

The cumulative effect of a change in accounting principle is now
reported as an adjustment to beginning retained earnings when it is considered
practicable to calculate the cumulative effect.

Under U.S. GAAP, when making a change to LIFO, it is generally considered impracticable to calculate the cumulative
effect of the change (in most cases, data on the historical LIFO layers in not available). When changing from one inventory method to LIFO cannot get accurate data on LIFO layers from previous years.

*In a change to LIFO, the beginning inventory dollar amount becomes the first LIFO layer.
No cumulative effect adjustment is made. The change is accounted for prospectively.

*In a change from LIFO to weighted average, there is no such impracticability. The
cumulative effect is computed and the change is handled retrospectively

Question 10

Orr Co. prepared an aging of its accounts receivable at December 31 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 – credit balance
Accounts written off as uncollectible 23,000
Accounts receivable at 12/31 270,000
Uncollectible accounts recovery 5,000

Answer 10

Allowance for Uncollectible Accounts
Beginning balance $28,000
Add: Uncollectible accounts exp. 10,000 ← squeeze X - being solved for
Recovery of previous write-offs 5,000
Subtotal 43,000
Less: Accounts written off (23,000)
Ending balance ($270,000 − 250,000) $20,000

Question 11

What information should a public company present about revenues from its reporting
segments?

Answer 11

Choice “D” is correct. Unaffiliated customers sales and intracompany sales must be
disclosed separately.

Question 12

Samuels receives $20,000 in cash from a customer on April 1 for the sale of
merchandise. The merchandise was carried at $16,000 on Samuels’ books and Samuels
anticipates having to refund 25 percent. Two months later, the customer returns the
expected amount of goods to Samuels.

Which of the following line items correctly reflects the journal entries by Samuels on the
applicable date?

Answer 12

Choice “B” is correct. The merchandise was sold for 25 percent above cost ($20,000 in
sales versus $16,000 in cost). The journal entries will be as follows:
April 1:

Debit (Dr) Credit (Cr)
Cash 20K
COGS 16K
Inventory 16K
Refund liability 5K
Revenue 15K

The refund liability should be booked for 25 percent of the sale price, with the revenue
representing the remaining 75 percent (the portion Samuels expects to receive).

June 1:

Refund liability 5K
Inventory 4k (25% * CGS = 16K)
Cash 5K
COGS 4K

When the refund occurs, the liability is removed from the books and the inventory is
returned to Samuels.

Question 13

Smile Inc. purchased a computer on May 1 for $12,000 with an estimated salvage value
of $1,500 and a three-year life. What is the depreciation expense for the year ended
December 31, using the double-declining method of depreciation?

Answer 13

Depreciation expense:

$12,000 × (2/n) × (number of months in service relative to a full year)

$12,000 × (2/3) × (8/12) = $5,333

Question 14

A transaction was reported as a nonmonetary exchange of assets. Under which of the
following circumstances should the exchange be measured based on the reported
amount of the nonmonetary asset surrendered?

Answer 14

When a transaction involving a nonmonetary exchange lacks commercial substance, the reported amount of the nonmonetary asset surrendered is used to record the newly acquired asset. If the transaction has commercial substance, the fair value approach is used.

Question 15

Samm Corp. purchased a plot of land for $100,000. The cost to raze a building on the
property amounted to $50,000 and Samm received $10,000 from the sale of scrap
materials. Samm built a new plant on the site at a total cost of $800,000 including
excavation costs of $30,000. What amount should Samm capitalize in its land account?

Answer 15

Choice “B” is correct. $140,000: The proper amount to capitalize to land, includes the
cost of $100,000 plus the cost to raze the building of $50,000, less the sale of scrap
materials of $10,000.

Question 16

During the current year, Kam Co. began offering its goods to selected retailers on a
consignment basis. The following information was derived from Kam’s current year
accounting records:

Beginning inventory: 122,000
Purchases 540,000
Freight in 10,000
Transportation to consignees 5,000
Freight out 35,000
Ending inventory (held by Kam ) 145,000
Ending inventory (held by consignees) 20,000
In year-end income statement, what amount should Kam report as cost of goods sold?

Answer 16

Rule: Consignor must include consigned goods (in the hands of the consignee) in his
own inventory, at his cost plus warehousing costs of consignor before goods are
transferred to consignee plus shipping costs to consignee.

Choice “B” is correct, $512,000 cost of goods sold on the income statement.

Beginning inventory 122,000
Add:
Purchases 540,000
Freight in 10,000
Transportation to consignees 5,000
=
Cost of goods available for sale 677,000

Less: ending inventory

Held by Kam (145,000)
Held by consignees (20,000)
=
Cost of goods sold $512,000

Question 17

During the current year, Orr Co. incurred the following costs:

Research and development services performed by Key Corp. for Orr $150,000

Design, construction, and testing of preproduction prototypes and models 200,000

Testing in search for new products or process alternatives 175,000

In its current year income statement, what should Orr report as research and
development expense under U.S. GAAP?

Answer 17

Under U.S. GAAP, R&D contracted out to a third party, preproduction prototypes and models costs, and, costs for searching for new products or new process alternatives are reported as R&D expense.

Question 18

Aln Co. incurred the following expenses during the current period:

Routine ongoing efforts to improve an existing product $ 50,000

Troubleshooting in connection with breakdowns during commercial production $ 75,000

Routine testing of products during commercial production for quality-control purposes $100,000

What is the total amount of research and development expense incurred by Aln during the
current period?

Answer 18

Routine efforts to improve a product that already exists, troubleshooting, and routine quality-control testing are specifically not considered research and development (R&D) costs. = $0

Question 19

How is Dividend Revenue recorded under the Fair Value method when Dividends received is greater than the undistributed earnings since the date of investment?

Answer 19

Rule: Dividend Revenue, under the FV method, should be recognized to the extent of cumulative earnings since acquisition & remainder goes to return on Capital beyond that point.

Question 20

What happens when an AFS security is transferred into the trading category?

Answer 20

-No longer recognized in OCI but Recognize in earning immediately.

Question 21

Do you disclose Concentration of credit risk in the Notes? And would you require disclosure about Market risks in the same way?

Answer 21

Concentration credit risk - the risk that the other parties financial instrument will not perform - must be disclosed.

Market risk does not need to be disclosed.

Question 22

A company leases trucks and properly classifies the leases as finance leases. The leases have a 10-year term, and the lease calculations were done three years ago when interest rates were lower. Which of the following is the appropriate accounting treatment, if any, for the application of the fair
value option to lease transactions?

Answer 22

Entities may choose to measure certain assets and liabilities at fair value. The fair value option applies to financial assets (e.g., debt and equity securities) and liabilities (e.g., notes payable). Excluded from the fair value option are investments in subsidiaries, pension benefit
assets/liabilities and assets and liabilities recognized under leases.

Therefore, fair value measurement is not an option for these capital leases.

Question 23

In Year 1, Lee Co. acquired, at a premium, Enfield, Inc. 10-year bonds classified as a held-to-maturity investment. At December 31, Year 2, Enfield’s bonds were quoted at a small discount. Which of the following situations is the most likely cause of the decline in the bonds’ market value?

Answer 23

If interest rates have increased, then the bonds’ interest rate would be less attractive to investors now than when the bonds were originally issued.

This would most likely cause a decline in the bonds’ market value. Note that because the bond investment is classified as held-tomaturity, the investment will be reported at amortized cost, not fair value.

Question 24

Based on an evaluation of current conditions and future expectations, Beach Co. determined that the decline in the fair value (FV) of a debt investment was below the amortized cost but above the present value of the principal and interest expected to be collected. The investment was classified as available-for-sale on Beach’s books. The controller would properly record the credit loss based on the CECL model under U.S. GAAP by including it in which of the following?

Answer 24

Using the current expected credit losses (CECL) model, when an available-for sale debt security has a fair value that is below amortized cost, the asset must be written down to the lower fair value by recording a credit loss that is recognized on the income statement. As a component of NI from continuing operations.

Even though the fair value is above the present value of expected cash flows, an available-for-sale security can be sold at any time so the credit loss is limited to the difference between amortized cost and fair value.

Question 25

On July 2, Year 1, Wynn Inc., purchased as an available-for-sale debt security a $1,000,000 face value Kean Co. 8% bond for $910,000 plus accrued interest to yield 10%. The bonds mature on January 1, Year 7, and pay interest annually on January 1. On December 31, Year 1, the bonds had a market value of $945,000. On February 13, Year 2, Wynn sold the bonds for $920,000. In its December 31, Year 1, balance sheet, what amount should Wynn report for available-for-sale investments in debt securities?

Answer 25

The security would be recorded at fair value on July 2, Year 1, or $910,000. Accrued interest is a receivable and does not affect cost.

The $90,000 discount is not amortized on
short-term investments. On December 31, Year 1, the investment would be adjusted to fair value, $945,000.

The unrealized holding gain of $35,000 would be reported as a separate component of other comprehensive income

Question 26

How do you record unrealized Gains or Losses on OCI?

Answer 26

The AFS will be shown net of tax, as a separate line item or combined with the other components that make up OCI.

Never shown in Net Income.

Question 27

How are Equity securities generally reported?

Answer 27

At (FVTNI), Fair value through Net Income. As either unrealized G or L.

Unrealized holding gains and losses on equity securities are included in earnings as they occur.

Question 28

What is the primary reason companies buy Trading Securities?

Answer 28

Are securities Bought & sold with the intent of generating profits on short-term differences in price.

Valued at FV on the statement of financial position (B.S.)

Unrealized G’s or L’s are recorded in Earnings (N.I.)

Question 29

What is the rule of how and where AFS and Trading securities need to recorded and treated?

Answer 29

Rule: Unrealized Gains and losses are reported as follows: Trading debt securities-reported at FV with unrealized gains and losses included in earnings (along with “realized” gains and losses, if any).

AFS debt securities - reported at FV with unrealized gains and losses reported as a separate component of OCI until realized.

Question 30

Based on the current expected credit loss model, a company records the following journal entry at year-end related to a five-year bond issued by Jenins Corp.

Debit Credit loss $23,000

Debit Unrealized loss – AFS 9,000

           Credit Allowance for credit losses            $23,000

           Credit Valuation allowance                      9,000

The security is classified as available-for-sale and has an amortized cost of $250,000 and current fair value of $218,000. Based on the journal entry above, the present value of expected future cash flows must be closest to:

Answer 30

Although the total difference between amortized cost ($250,000) and fair value ($218,000) is $32,000, the credit loss is equal to the difference between amortized cost and the present value of expected cash flows (interest and principal to be received).

If the credit loss is recorded at $23,000, the present value must be equal to $250,000 − $23,000, or $227,000. The
additional $9,000 difference between the present value and fair value is recorded as an unrealized loss in other comprehensive income (OCI)