FAR 9 Flashcards
On its December 31, 2005 balance sheet, Shin Co. has income tax payable of $13,000 and a current deferred tax asset of $20,000, before determining the need for a valuation account.
Shin had reported a current deferred tax asset of $15,000 at December 31, 2004. No estimated tax payments are made during 2005. At December 31, 2005, Shin determines that it is more likely than not that 10% of the deferred tax asset would not be realized.
In its 2005 income statement, what amount should Shin report as total income tax expense?
$10,000
income tax expense is the net sum of the income tax liability for the year, the changes in the deferred tax accounts, and the change in the valuation account for deferred tax assets.
Tax liability (current portion of income tax expense): $13,000 Less increase in deferred tax asset: $20,000 - $15,000 ($5,000)
Plus increase in valuation account: .10($20,000)
$2,000
Equals income tax expense
$10,000
The increase in the deferred tax asset causes income tax expense to decrease relative to the tax liability, because, as a result of transactions through the end of the current year, future taxable income will be reduced. This reduction is not realized in the current year as a reduction in the tax liability. Therefore, the anticipated future reduction is treated as an asset at the end of the current period. When realized, the asset is reduced in a future year.
The increase in the valuation allowance, which is contra to the deferred tax asset, reduces the deferred-tax-asset effect, because it is an amount of the deferred tax asset not likely to be realized.
Lore Co. changed from the cash basis to the accrual basis of accounting during 2005. The cumulative effect of this change should be reported in Lore’s 2005 financial statements as a
Prior period adjustment resulting from the correction of an error.
How are changes in accounting estimates accounted for?
Changes in accounting estimate are accounted for currently and prospectively and are reported in income from continuing operations.
How are accounting principle changes accounted for?
Accounting-principle changes, as well as changes in the application of principles, are accounted for using the retrospective approach, which recognizes the effect of the change on all prior years affected as an adjustment to retained earnings at the beginning of the year of change
At December 31, 2004, Off-Line Co. changes its method of accounting for demo costs from writing off the costs over two years to expensing the costs immediately.
Off-Line makes the change in recognition of an increasing number of demos placed with customers that did not result in sales. Off-Line has deferred demo costs of $500,000 at December 31, 2003, $300,000 of which were to be written off in 2004 and the remainder in 2005.
Off-Line’s income tax rate is 30%. In its 2004 retained-earnings statement, what amount should Off-Line report as cumulative effect of change in accounting principle?
$0
The change in accounting principle is indistinguishable from a change in accounting estimate. This change can be effected by changing the useful life of the demo costs to zero - a change in estimate. The firm should write off the remaining unamortized costs at the beginning of the year of change. Earnings in 2004 will be reduced by $500,000 before tax as a result.
On January 2, 2005, Air, Inc. agrees to pay its former president $300,000 under a deferred-compensation arrangement.
Air should have recorded this expense in 2004, but did not do so. Air’s reported income tax expense would have been $70,000 lower in 2004 had it properly accrued this deferred compensation.
In its December 31, 2005 financial statements, Air should adjust the beginning balance of its retained earnings by a
The after-tax amount of the overstatement of 2004 earnings is $230,000 ($300,000 - $70,000 tax effect).
2004 income is overstated by this amount, because the expense and tax effect were not recorded. Ending 2004 retained earnings is overstated by $230,000. Therefore, beginning 2005 retained earnings must be decreased (debited) $230,000. This is accomplished by adjusting the beginning 2005 retained earnings balance with a Prior period adjustment of $230,000 (debit).
A firm’s natural resources exploitation site will require an expenditure of $5 million to reclaim the site for environmental purposes. That expenditure is expected to be made five years from now. The present value today of that amount is $3.5 million. Because of this obligation, (1) by what amount will total depletion on the site increase, and (2) how much accretion expense will be recognized over the five years? (in millions)
The natural resources account is increased by the asset retirement obligation, which is the present value of the $5 to be paid later, or $3.5. Therefore, total depletion over the venture’s life increases by that amount. The growth in the obligation over time is the accretion expense. The $3.5 amount will grow to $5 in five years, at which time the expenditure of that amount is made. The journal entry to record the asset retirement obligation is a debit to the natural resources account of $3.5 and a credit to the asset retirement obligation of $3.5.
How is ending ARO calculated?
The ending balance of the ARO should be the beginning balance plus the discounted cash flow estimate of the new asset plus accretion expense less the amount paid.
What is the only method of accounting acceptable for a new business combination?
The purchase method of accounting is the only currently acceptable method of accounting for a business combination
What is excluded from ASC 805 Business Combination accounting methods?
The formation of a joint venture, the acquisition of assets that do not constitute a business, a combination between entities under common control, a combination between not-for-profit organizations, and the acquisition of a for-profit entity by a not-for-profit organization are the only combinations specifically excluded from the scope of ASC 805.
What is a reacquired right asset?
A reacquired right is a right granted by an acquirer to the acquiree prior to a business combination that is reacquired when the acquirer gains control of the acquiree or the asset in a business combination. For example, the acquiree may have acquired the right to use the acquirer’s trade name as part of a franchise agreement. A reacquired right is an intangible asset that is amortized by the acquirer over the remaining contractual period of the contract that grants the right.
Which one of the following kinds of eliminations, if any, will be required in every consolidating process?
An intercompany investment elimination will be required in every consolidating process (to eliminate the parent’s investment against the subsidiary’s shareholders’ equity). Intercompany receivables/payables and intercompany revenues/expenses eliminations will not be required in every consolidating process. Those kinds of eliminations will be required only if the affiliated companies have engaged in intercompany transactions that resulted in such balances.
The choice of methods that a parent uses on its books to account for its investment in a subsidiary will affect the:
While the method a parent uses on its books to account for its investment in a subsidiary will affect the consolidating process, the choice of methods will not affect the final consolidated financial statements. The final consolidated financial statements will be the same regardless of the method used by the parent on its books; only the details of the process of developing those statements will be different. The primary difference will be in the nature of the investment eliminating entry on the worksheet.
A subsidiary, acquired for cash in a business combination, owned equipment with a market value in excess of book value as of the date of combination. A consolidated balance sheet prepared immediately after the acquisition would treat this excess as:
Plant and Equipment
If the parent uses the cost method to account for its investment in a subsidiary, the parent will recognize:
the parent’s share of the subsidiary’s dividends.
What is the purpose of a reciprocity entry?
The purpose of the reciprocity is to bring the investment account (on the worksheet) in balance with the subsidiary’s retained earnings as of the beginning of the period being consolidated.
On January 2 of the current year, Peace Co. paid $310,000 to purchase 75% of the voting shares of Surge Co. Peace reported retained earnings of $80,000, and Surge reported contributed capital of $300,000 and retained earnings of $100,000. The purchase differential was attributed to depreciable assets with a remaining useful life of 10 years. Peace used the equity method in accounting for its investment in Surge. Surge reported net income of $20,000 and paid dividends of $8,000 during the current year. Peace reported income, exclusive of its income from Surge, of $30,000 and paid dividends of $15,000 during the current year. What amount will Peace report as dividends declared and paid in its current year’s consolidated statement of retained earnings?
$15,000
Parco owns 100% of its subsidiary, Subco, which it acquired at book value. It carries its investment in Subco on its books using the equity method of accounting. At the beginning of its 2009 fiscal year, the investment in Subco account was $552,000. During 2009, Subco reported the following:
Net Income $42,000
Dividends Declared/Paid 12,000
There were no other transactions between the firms in 2009.
In preparing its 2009 fiscal year consolidated statements, which one of the following is the amount of the investment eliminating entry that Parco will make as a result of its ownership of Subco?
The amount of an investment eliminating entry is the balance in the investment account as of the beginning of the period being consolidated. In this case, that was $552,000. If the parent uses the equity method to account for its investment in the subsidiary, the entries it makes during the year are reversed so that the investment account has its beginning of the year balance.
On January 1, 20x1 Ritt Corp. purchased 80% of Shaw Corp.’s $10 par common stock for $975,000. Ritt’s cost reflects an appropriate fair value measure for all of Shaw’s outstanding common stock. The original cost to the noncontrolling investors for the 20% of Shaw’s common stock not acquired by Ritt was $200,000. At the date of Ritt’s purchase, the carrying amount of Shaw’s net assets was $1,000,000. The fair values of Shaw’s identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net) which were $100,000 in excess of the carrying amount. Which one of the following is the amount of noncontrolling interest that should be reported in a consolidated balance sheet prepared immediately following the business combination?
Noncontrolling interest at the date of the business combination should be the noncontrolling interest proportionate share of total fair value at that date, including goodwill. The total fair value of Shaw (including goodwill) at the date Ritt acquired 80% of Shaw’s common stock would be $1,218,750 ($975,000/.80). The noncontrolling interest would be .20 x $1,218,750 = $243,750, the correct answer. The investment eliminating entry made immediately following the business combination would be:
On January 1, 20x6 Ritt Corp. purchased 80% of Shaw Corp.’s $10 par common stock for $975,000. On this date, the carrying amount of Shaw’s net assets was $1,000,000. The fair values of Shaw’s identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net) which were $100,000 in excess of the carrying amount. Those plant assets had a 10-year remaining life, depreciated on a straight-line basis. The fair value of the 20% noncontrolling interest in Shaw was properly determined to be $200,000 at that time. For the year ended December 31, 20x6, Shaw had net income of $190,000 and paid cash dividends totaling $125,000. Which one of the following is the amount of goodwill that should be recognized as a result of the business combination?
Goodwill is determined as the excess of investment value over the fair value of the subsidiary’s net assets. Investment value is the sum of the parent’s investment (which is the fair value of consideration paid) + the fair value of any noncontrolling interest, which in this question is $975,000 + $200,000 = $1,175,000. The fair value of Shaw’s identifiable net assets is book value $1,000,000 + write up in plant assets $100,000 = $1,100,000. Therefore, goodwill is investment value $1,175,000 - fair value of identifiable assets $1,100,000 = $75,000, the correct answer.
