FAR 4 Flashcards
Potter Co. has the following contingencies, all resulting from lawsuits in progress during the current year:
Probable loss contingency $1,500,000
Reasonably possible loss contingency 500,000
Remote loss contingency 300,000
Probable gain contingency 700,000
How much should be disclosed in Potter’s notes to the financial statements for the current year?
Contingent lossContingent gain
A. $0 $0
B. $1,500,000 $700,000
C. $2,000,000 $700,000
D. $2,300,000 $0
C. $2,000,000 $700,000
A contingency relates to an existing condition that depends on the outcome of some future event outside of an entity’s control (eg, pending litigation). Disclosure of a contingent gain or loss in the notes to the financial statements (F/S) is based on the contingency’s probability of occurrence, which can be classified as remote, reasonably possible, or probable.
A probable or reasonably possible contingency must be disclosed. Many F/S users want to be aware of contingent events, including the nature of the event and the possible outcomes.
A remote contingency is generally not disclosed because it is not likely the event will occur and usually would not affect the decision-making of F/S users.
Note: Although probable contingent gains and losses are similarly disclosed, only probable and estimable contingent losses ($1,500,000 in this scenario) are accrued in the F/S (ie, conservatism).
Potter Co. will disclose the probable ($1,500,000) and reasonably possible ($500,000) contingent losses for a total of $2,000,000. Potter will also disclose the $700,000 probable contingent gain.
Werth Company’s outstanding capital stock at March 31, Year 2, consisted of the following:
10,000 shares of 4% cumulative preferred stock, par value $10 per share, fully participating as to dividends. Dividends are in arrears from Year 1.
150,000 shares of common stock, par value $2 per share.
On March 31, Year 2, Werth declared dividends of $50,000. What was the amount of dividends payable to Werth’s common shareholders?
A. $27,000
B. $34,500
C. $37,500
D. $42,000
B. $34,500
A dividend must be declared to be paid. However, if preferred stock is cumulative, any undeclared annual dividend not paid in the previous year(s) accumulates (dividends in arrears) and is paid in the future when declared. Preferred stock has a stated annualdividend preference (eg, 4%), which is paid before the common shareholders.
Preferred stock also may be participating, meaning once the common shareholders are paid an equivalent percentage of par value dividend (eg, 4%), any excess dividend declared is allocated between the two classes of stock. The allocation is based on relative par value.
In this case, the preferred shareholders are entitled to an annual dividend of $4,000
10,000 × $10 par×4%
. An equivalent percentage dividend for common shareholders would be $12,000
150,000 × $2 par×4%
. The total dividends payable to preferred and common shareholders are $15,500 and $34,500, respectively, and are calculated as follows:
On January 1, Year 1, Grout Co. entered into a 5-year finance lease for a new truck with annual payments of $20,000 beginning January 1, Year 1. Based on an implicit interest rate of 6%, the five lease payments have a present value of $89,300 at lease inception. What amount should Grout report as interest expense for the year ended December 31, Year 1?
A. $4,158
B. $4,800
C. $5,358
D. $6,000
A. $4,158
In this scenario, Grout Co. signed a 5-year finance lease with an implicit rate of 6%. The PV of lease payments (ie, lease liability) is given as $89,300. After the first payment at lease inception, the liability balance equals $69,300: $89,300 PV of lease payments − $20,000 annual payment. Interest expense for Year 1 is $4,158: $69,300 liability balance × 6% interest rate × (12 months outstanding / 12 months).
Each of the following statements is correct regarding the current expected credit loss model, except
A. FASB prescribes a specific method for estimating expected credit losses.
B. The net carrying value of accounts receivables equals what is expected to be collected.
C. The allowance for credit losses is used to reflect the total estimate of expected credit losses.
D. A current estimate of expected losses is measured each reporting period.
A. FASB prescribes a specific method for estimating expected credit losses.
Bach Co. adopted the dollar value LIFO inventory method as of January 1, Year 1. A single inventory pool and an internally computed price index are used to compute Bach’s LIFO inventory layers. Information about Bach’s dollar value inventory follows:
Date At base
year cost At dollar-value
LIFO cost
1/1/YR1 $90,000 $90,000
Year 1 layer $20,000 $30,000
Year 2 layer $40,000 $80,000
What was the price index used to compute Bach’s Year 2 dollar value LIFO inventory layer?
A. 1.09
B. 1.25
C. 1.33
D. 2.00
D. 2.00
Dollar-value LIFO (DVL) focuses on the dollar value of ending inventory (EI) rather than units. By using a price index, the effect of inflation is removed before the change in inventory value is considered. The year DVL is adopted (ie, the base year) always has a price index of 1.00.
Applying DVL involves:
converting the current EI into equivalent base-year dollars by dividing by the current price index
comparing the “deflated” EI with the prior-year base cost to determine whether a new layer is created or part of an older layer is used. If a new layer is needed, it is restated (ie, inflated) from base-year dollars back to current-year dollars.
Note: Depending on the data provided in the question, performing all the calculations may not be necessary.
In this case, the starting point is restating Year 2’s $40,000 base-year LIFO layer back to current dollars for DVL (step 3). The formula is: New LIFO layer in base-year dollars × Current-year index = Current-year DVL. However, the index is not given, so solving for it is necessary. The index used for Bach Co.’s dollar-value LIFO inventory layer is 2.00 as calculated below.
$40,000 × Index = $80,000
Index = $80,000 / $40,000
Index = 2.00
Sussman Co. prepared cash-basis financial statements for the month ended January 31. A summary of Sussman’s January activities follows:
Credit sales of $5,600.
Collections of $1,900 relating to January credit sales.
Accrued salaries of $1,200.
By what amount will Sussman’s cash-basis income for the month ended January 31 increase as a result of restating these activities to the accrual basis of accounting?
A. $2,500
B. $3,700
C. $4,400
D. $4,900
A. $2,500
Accrual-basis entities recognize revenue when it is earned and recognize expenses when they are incurred. Conversely, cash-basis entities recognize revenue when cash is received and expenses when they are paid.
There are several formulas that can be manipulated to convert cash-basis net income (NI) to accrual-basis (required by GAAP), and vice versa. For example, an increase in accounts receivable (A/R) indicates that more credit sales occurred in a period than cash collections on credit sales. Accrual-basis revenue is higher and calculated by adding the increase in A/R to the cash-basis revenue.
Sussman must increase its cash-basis NI ($1,900) by $2,500 to arrive at its accrual-basis NI ($4,400) for January. Cash- and accrual-basis income can be calculated as follows:
$1,900 Cash receipts (Cash NI)
3,700 End. − Beg. A/R [($5,600 − $1,900) − $0]
(1,200) End. − Beg. accr. expenses ($1,200 − $0)
$4,400 Accrual NI
Lute Corporation sells furnaces that include a three-year warranty. Lute can contract with a third party to provide these warranty services. Lute elects the fair value option for reporting financial liabilities. At what amount should Lute record the warranty liability on the balance sheet?
A. The cost of expected warranty services.
B. The present value of expected warranty costs.
C. The fair value of the contract to settle the warranty services.
D. The fair value of the contract to settle less the cost to provide services.
C. The fair value of the contract to settle the warranty services.
(Choice C) Warranty services can be recorded at the fair value only if the contract can be settled by a third party. Therefore, the fair value is considered the settlement amount of the contract.
On December 31, year 2, Foster, Inc. appropriately changed to the FIFO cost method from the weighted-average cost method for financial statement and income tax purposes. The change will result in a $150,000 increase in the beginning inventory at January 1, year 3. Assuming a 30% income tax rate, the period-specific effect of this accounting change for the year ended December 31, year 2, is
A. $0
B. $45,000
C. $105,000
D. $150,000
C. $105,000
(Choice C) This answer is correct. The change results in a $150,000 increase in the inventory valuation for ending inventory at December 31, year 2, which means the before-tax effect on income in year 2 is also $150,000. Since the period-specific effects must be reported net of year 2 effects, the tax effect is $45,000 (30% × $150,000) and must be subtracted to leave a period-specific effect of $105,000 ($150,000– $45,000). The $150,000 increase in inventory should be added to the balance in inventory on the year 2 comparative balance sheet, $105,000 is the increase in net income, and the income tax payable account will increase by $45,000.
On December 31, Year 1, Moss Co. issued $1,000,000 of 11% bonds at 109. Each $1,000 bond was issued with 50 detachable stock warrants, each of which entitled the bondholder to purchase one share of $5 par common stock for $25. Immediately after issuance, the market value of each warrant was $4. On December 31, Year 1, what amount should Moss record as discount or premium on issuance of bonds?
A. $40,000 premium.
B. $90,000 premium.
C. $110,000 discount.
D. $200,000 discount.
C. $110,000 discount.
In this scenario, the market value of Moss Co.’s warrants is $4/warrant. If each $1,000 bond receives 50 warrants, then there are 50,000 warrants ([$1,000,000 face value / $1,000/bond] × 50 warrants/bond). The total warrant FV equals $200,000 (50,000 warrants × $4/warrant).
The warrant FV is subtracted from the issue proceeds to determine the amount assigned to the bonds and corresponding bond discount. Since $890,000 is less than face value, the difference represents a $110,000 discount.
Determine FV assigned to bond:
Issue proceeds ($1,000,000 face × 1.09) $1,090,000
FV of warrants 200,000
Remaining FV assigned to bond $890,000
Determine bond discount:
Bond face value $1,000,000
Less: FV assigned to bond (ie, carrying value) 890,000
Discount on bonds payable $110,000
Grant Co. issued $500,000 face value, five-year, 8% bonds on December 31, Year 1. The bonds pay interest annually and were sold to yield 7%. Present value factors are as follows:
7% 8%
Present value of $1, five periods 0.712986 0.680583
Present value of ordinary annuity of $1, five periods 4.100197 3.992710
Present value of annuity due of $1, five periods 4.387211 4.312127
What amount of long-term liability should Grant report on December 31, Year 1, for this sale?
A. $500,000
B. $512,777
C. $520,501
D. $531,981
C. $520,501
In this scenario, Grant Co. issued $500,000 face value, five-year, 8% (ie, stated rate) bonds on December 31, Year 1. The bonds pay interest annually and were sold to yield 7% (ie, market rate). The annual interest payment is $40,000 ($500,000 face value × 8% stated rate). Because payments occur at the end of each period, the ordinary annuity factors apply. The long-term liability balance of Grant’s bonds is $520,501, calculated as follows:
PV of principal = Face value × PV of $1 @ 7% $500,000 × 0.712986 $356,493
PV of interest payment = Interest × PV ordinary annuity @ 7% $40,000 × 4.100197 164,008
PV of the bonds (long-term liability balance)
$520,501
During periods of rising prices, a perpetual inventory system would result in the same dollar amount of ending inventory as a periodic inventory system under which of the following inventory cost flow methods?
A. FIFO.
B. LIFO.
C. Both FIFO and LIFO.
D. Neither FIFO nor LIFO.
A. FIFO.
The following condensed balance sheet is presented for the partnership of Alfa and Beda, who share profits and losses in the ratio of 60:40, respectively:
Cash $ 45,000
Other assets 625,000
Beda, loan 30,000
$700,000
Accounts payable $120,000
Alfa, capital 348,000
Beda, capital 232,000
$700,000
Alfa and Beda decide to liquidate the partnership. If the other assets are sold for $500,000, what amount of the available cash should be distributed to Alfa?
A. $255,000
B. $273,000
C. $327,000
D. $348,000
B. $273,000
In this scenario, no mention is made of Beda repaying the loan. Therefore, one can assume it was not repaid, and the amount of the loan will reduce the cash distributed to Beda. Alfa will receive $273,000 as calculated below.
Step 1 Sell noncash assets $500,000 − $625,000 = ($125,000) loss
Step 2 Allocate loss to partners Alfa: ($125,000) × 60% = ($75,000)
Beda: ($125,000) × 40% = ($50,000)
Step 3 Pay liabilities ($45,000 beginning cash + $500,000) − $120,000 = $425,000 remaining cash
Step 4 Distribute cash based on capital accounts Alfa capital: ($348,000 − $75,000) = $273,000
Beda capital: ($232,000 − $50,000) = $182,000 − $30,000 loan = $152,000
Check figure: ($273,000 + $152,000) = $425,000
According to ASC Topic 820, the market that has the greatest volume and level of activity is the
A. Most advantageous market.
B. The most relevant market.
C. The independent market.
D. The principal market.
D. The principal market.
Sally collects a nonrefundable up-front fee of $192 when a new customer signs up for a 24-month contract for services. A monthly fee of $32 is also assessed for each customer. How much revenue does Sally record on the date the contract is signed?
A. $0
B. $40
C. $192
D. $224
A. $0
(Choice A) Correct! Sally does not recognize revenue until services have been provided. The nonrefundable up-front fee of $192 is recognized over the life of the contract, in this case, over 24 months.
During 2005, Krey Co. increased the estimated quantity of copper recoverable from its mine. Krey uses the units-of-production-depletion method.
Which of the following statements correctly describes the appropriate accounting for this change?
A. Accumulated depletion is recalculated back to the date of acquiring the mine and the depletion for each period included in the annual report will reflect the new estimate.
B. The effect of the change on all prior years is treated as a catch-up adjustment in the 2005 income statement.
C. The change in estimate is applied as of the beginning of 2005 for current and future periods.
D. The retained-earnings balance at the beginning of 2005 is adjusted for the effect of the change on prior years.
C. The change in estimate is applied as of the beginning of 2005 for current and future periods.
This is an accounting-estimate change. These accounting changes are handled currently and prospectively by applying the new estimate to the current and future periods, if affected. The effect of the change on prior years’ earnings is not computed, because the new information causing the estimate change was not known at that time.
Cumulative effects are reported for accounting principle changes, not estimate changes, because the effect of the change on prior years is computed and reported for accounting principle changes only.
