Far module 2 Flashcards
rranty is for five years and can be sold separately at a cost of $10,000. Which of the following statements is most accurate in regard to this transaction?
A. The warranty will represent 20 percent of the allocated contract price. B. The price of the contract will be allocated $10,000 to the warranty and $35,000 to the refrigerator. C. The refrigerator and warranty together represent a single performance obligation. D. The contract price should be adjusted to $50,000.
Choice “A” is correct. The warranty, because it can be sold separately, will be treated as a separate performance obligation from the sale of the refrigerator. As such, the $45,000 contract price will need to be allocated between the warranty and the refrigerator. Based on the separate values of $10,000 for the warranty and $40,000 for the refrigerator (totaling $50,000), the most appropriate allocation will be 20 percent of the contract price ($9,000) for the warranty and 80 percent of the price ($36,000) for the refrigerator.
Choice “B” is incorrect. Both the warranty and the refrigerator will be allocated values in proportion to their individual stand-alone values within the overall contract price of $45,000. The allocation should be $9,000 for the warranty and $36,000 for the refrigerator.
Choice “C” is incorrect. The refrigerator and warranty are separate performance obligations.
Choice “D” is incorrect. The contract price does not need to be adjusted. It should remain at $45,000 and the price allocated to each component.
Which of the following is used in calculating the income recognized in the fourth and final year of a contract when revenue is recognized over time?
Actual
Total Costs
Income Previously
Recognized
A. Yes
Yes
B. No
Yes
C. No
No
D. Yes
No
Choice “A” is correct. When revenue is recognized over time, annual gross profit equals [total cost incurred/total expected cost] × [total expected gross profit] less total gross profit previously recognized. In the final year of the contract, actual rather than expected amounts are used.
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MCQ-05084
Application
Sonex Construction Co. incurred the following costs and made the following estimates in the first two years of a three-year construction project.
Year 1 Year 2
Actual current year costs incurred
1,200,000
1,000,000
Estimated costs to complete contract
1,800,000 550,000
Contract price
5,000,000 5,000,000
Billings and collections
2,500,000 1,500,000
If revenue is recognized over time, how much gross profit would Sonex recognize in Year 2?
A. $650,000 B. $562,500 C. $1,000,000 D. $800,000
Explanation
Choice “C” is correct.
Year 1 Year 2
Contract Price
5,000,000
5,000,000
Cumulative actual costs
1,200,000
2,200,000
Estimated remaining costs
1,800,000
550,000
Estimated total gross profit
2,000,000
2,250,000
Multiply by completion percentage
40%*
80%**
Cumulative gross profit recognized
800,000
1,800,000
Less previously recognized gross profit
0
800,000
Current year gross profit to be recognized
800,000
1,000,000
*[1,200,000 ÷ 3,000,000] = 40%
**[2,200,000 ÷ 2,750,000] = 80%
Choices “B”, “D”, and “A” are incorrect per the above calculation.
Frame construction company’s contract requires the construction of a bridge in three years. The expected total cost of the bridge is $2,000,000, and Frame will receive $2,500,000 for the project. The actual costs incurred to complete the project were $500,000, $900,000, and $600,000, respectively, during each of the three years. Progress payments received by Frame were $600,000, $1,200,000, and $700,000, respectively. Assuming that revenue is recognized over time, what amount of gross profit would Frame report during the last year of the project?
Choice “A” is correct. The expected gross profit from this contract is $500,000 ($2,500,000 sales price − $2,000,000 anticipated costs). The actual project costs are $2,000,000 ($500,000 + $900,000 + $600,000).
In the first year, the percentage of completion was 25% ($500,000 / $2,000,000), so gross profit of $125,000 (25% x $500,000) was recognized.
In the second year, the percentage of completion was 70% [($500,000 + $900,000) / $2,000,000], so cumulative gross profit was $350,000.
Finally, in the third year, the project was completed, so the remaining 30% of the profit is recognized: $500,000 x 30% = $150,000.
Choices “D”, “C”, and “B” are incorrect as per the explanation above.
Jersey Inc. is a retailer of home appliances and offers a service contract on each appliance sold. Jersey sells appliances on installment contracts, but all service contracts must be paid in full at the time of sale. Collections received for service contracts should be recorded as an increase in a:
A. Sales contracts receivable valuation account. B. Service revenue account for the amount paid in full. C. Unearned service revenue account. D. Stockholders' valuation account.
Explanation
Choice “C” is correct. Collections received for service contracts should be recorded as an increase in an unearned service revenue account.
Choices “A” and “D” are incorrect. Since service contracts must be paid in full at the time of sale, valuation accounts (receivables or equity) are not involved.
Choice “B” is incorrect. Service revenue is recognized over time as the customer receives the benefits of Jersey Inc.’s performance as it performs the service performance obligation.
If revenue is recognized over time, the calculation of the income recognized in the third year of a five-year construction contract includes the ratio of:
A. Costs incurred in year 3 to total estimated costs. B. Costs incurred in year 3 to total billings. C. Total costs incurred to date to total estimated costs. D. Total costs incurred to date to total billings.
Choice “C” is correct. When revenue is recognized over time, the percentage of completion is calculated as follows:
Total cost to date
Total estimated cost of contract
Choices “B”, “A”, and “D” are incorrect, per the explanation above.
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MCQ-07538
Application
Loomis Inc. received $90,000 on March 1, Year 2, for work to be performed over the next six months. The company, which has a fiscal year-end of June 30, records revenue evenly over the period of work performance. In its June 30, Year 3, financial statements, Loomis will record a:
A. Debit to deferred revenue of $30,000. B. Credit to deferred revenue of $30,000. C. Credit to revenue of $60,000. D. Debit to revenue of $60,000.
Explanation
Choice “A” is correct. On March 1, Year 2, Loomis will record the following journal entry:
Debit (Dr) Credit (Cr)
Cash
$90,000
Deferred revenue
$90,000
On the Year 2 financial statements (ending June 30, Year 2), Loomis will record the following journal entry:
Debit (Dr) Credit (Cr)
Deferred revenue
$60,000
Revenue
$60,000*
- (recognizing four of the six months)
When work is completed on August 31, Year 3, Loomis will recognize the remaining two months of revenue:
Debit (Dr) Credit (Cr)
Deferred revenue
$30,000
Revenue
$30,000
This question asks about the June 30, Year 3 statements, so the company will record a debit to deferred revenue of $30,000, recognizing the remaining two months of revenue and removing the liability.
Choice “B” is incorrect. Deferred revenue is credited for $30,000 in Year 2 rather than in Year 3.
Choice “C” is incorrect. The revenue credit is $60,000 in Year 2.
Choice “D” is incorrect. Recognizing revenue requires a credit, rather than a debit. Also, revenue will be credited for $30,000 in Year 3.
The cumulative effect of a change in accounting estimate should be shown separately:
A. It should not be recorded separately on any financial statement. B. On the retained earnings statement as an adjustment to the beginning balance. C. On the income statement after income from continuing operations and before discontinued operations. D. On the income statement above income from continuing operations.
Choice “A” is correct. A change in estimate is handled prospectively. No cumulative effect adjustment is made and no separate line item presentation is made on any financial statement. If a material change is being made, appropriate footnote disclosure is necessary.
Choices “D”, “C”, and “B” are incorrect, per the above explanation.
What amount, before income taxes, should be reported in the Year 4 retained earnings statement as the cumulative effect of the change in accounting principle?
A. $5,000 decrease. B. $2,000 increase. C. $0. D. $3,000 decrease.
Choice “A” is correct. $5,000 decrease.
The cumulative effect of change in accounting principle is determined as of the beginning of the year of change if comparative financial statements are not presented. In this case, the year of change is Year 4, so the cumulative effect is the difference in inventory as of the end of Year 3. [Note that inventory is a balance sheet item, so the change is based on the balances at the end of the last year the prior method was used. Had this question shown annual income statement amounts of cost of goods sold, we would have had to look at all the past years in the aggregate.] This will allow us to arrive at the adjustment to obtain the amount of retained earnings that would have been reported at the beginning of the period of change if the new accounting principle had been used for all prior periods.
Year 3
FIFO (current method)
83,000
Weighted average (new method)
(78,000)
Decrease in retained earnings
5,000
On January 1, Year 1, Pell Corp. purchased a machine having an estimated useful life of 10 years and no salvage. The machine was depreciated by the double declining balance method for both financial statement and income tax reporting. On January 1, Year 6, Pell changed to the straight-line method for financial statement reporting but not for income tax reporting. Accumulated depreciation at December 31, Year 5, was $560,000. If the straight-line method had been used, the accumulated depreciation at December 31, Year 5, would have been $420,000. Pell’s enacted income tax rate for Year 6 and thereafter is 30%. The amount shown in the Year 6 income statement for the cumulative effect of changing to the straight-line method should be:
A. $0. B. $98,000 credit. C. $98,000 debit. D. $140,000 credit.
Choice “A” is correct. A change in the method of depreciation is now considered to be both a change in method and a change in estimate. These changes should be accounted for as changes in estimate and handled prospectively. The new depreciation method should be used as of the beginning of the year of change and should start with the current book value of the underlying asset. No retroactive or retrospective calculations should be made, and no adjustment should be made to retained earnings. And, certainly, the cumulative effect should not be reflected on the income statement any more.
Choices “C”, “B”, and “D” are incorrect, per the above explanation.
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MCQ-00226
Application
While preparing its Year 3 financial statements, Dek Corp. discovered computational errors in its Year 2 and Year 1 depreciation expense. These errors resulted in overstatement of each year’s income by $25,000, net of income taxes. The following amounts were reported in the previously issued financial statements:
Year 2 Year 1
Retained earnings, 1/1
700,000
500,000
Net income
150,000
200,000
Retained earnings, 12/31
850,000
700,000
Dek’s Year 3 net income is correctly reported at $180,000. Which of the following amounts should be reported as prior period adjustments and net income in Dek’s Year 3 and Year 2 comparative financial statements?
Year
Prior Period
Adjustment
Net Income
A.
Year 2
-
$150,000
Year 3
($50,000)
$180,000
B. Year 2
($25,000)
$125,000
Year 3
-
$180,000
C. Year 2
($50,000)
$150,000
Year 3
-
$180,000
D. Year 2
-
$125,000
Year 3
-
$180,000
Explanation
Choice “B” is correct. Because these are comparative financial statements, prior period adjustments require retroactive treatment for the years presented. Because Year 1 is not presented, the Year 1 correction is shown as a prior period adjustment of $25,000 to retained earnings statement of Year 2. The Year 2 net income is decreased by $25,000 to correct the overstatement of net income in that period.
Mill Co. reported pretax income of $152,500 for the year ended December 31. During the year-end audit, the external auditors discovered the following errors:
Ending inventory
$30,000 overstated
Depreciation expense
$64,000 understated
What amount should Mill report as the correct pretax income for the year ended December 31?
A. $186,500 B. $246,500 C. $118,500 D. $58,500
Choice “D” is correct. The pretax income of $152,500 is too high as a result of both errors.
Ending inventory that is overstated by $30,000 implies that cost of goods sold (COGS) is understated by the same amount. $30,000 should be added to COGS, which will reduce pretax income.
Depreciation expense is understated by $64,000. Adding in this expense will also reduce pretax income.
$152,500 − $30,000 − $64,000 = $58,500.
Choice “A” is incorrect. This choice implies that depreciation is overstated (not understated) by $64,000.
Choice “B” is incorrect. This choice incorrectly adds back both the $30,000 in overstated ending inventory and $64,000 in understated depreciation expense.
Choice “C” is incorrect. This choice implies that COGS is overstated (not understated) by $30,000.
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. $168,000 B. $165,900 C. $105,000 D. $102,900
Choice “C” is correct. If the machine had been correctly capitalized in Year 1, Raft would have recorded annual depreciation of $20,000 [($210,000 cost - $10,000 salvage)/10 year life] in Year 1, Year 2 and Year 3, for total accumulated depreciation of $60,000. The prior period adjustment is the difference between the $60,000 in total expense that should have been reflected in retained earnings on January 1, Year 4 and the $210,000 that was incorrectly recorded:
Correct accounting - Depreciation expense Year 1 - Year 3
60,000
Incorrect accounting - Asset purchased expense in Year 1
-210,000
Prior period adjustment, before tax
150,000
The prior period adjustment must be reported net of tax:
$150,000 x (1 - 30%) = $105,000
Which of the following phrases best describes a Level 1 input for measuring the fair value of an asset or liability?
A. Unadjusted quoted prices for identical assets or liabilities in active markets. B. Inputs that are principally derived from or corroborated by observable market data. C. Quoted prices for similar assets or liabilities in active markets. D. Inputs for the asset or liability based on the reporting entity’s internal data.
Choice “A” is correct. Level 1 inputs are quoted prices in active markets for identical assets and liabilities on the measurement dates when no adjustments are required.
Choice “B” is incorrect. Inputs that are principally derived from or corroborated by observable market data are examples of Level 2 inputs.
Choice “C” is incorrect. Quoted prices for similar assets or liabilities in active markets are Level 2 inputs.
Choice “D” is incorrect. Inputs based on the reporting entity’s internal data are examples of Level 3 inputs.
A change from the cost approach to the market approach of measuring fair value is considered to be what type of accounting change?
A. Change in accounting estimate. B. Change in accounting principle. C. Change in valuation technique. D. Error correction.
Choice “A” is correct. A change in the valuation technique used to measure fair value is a change in accounting estimate.
Choice “B” is incorrect. Per SFAS No. 157, a change in valuation technique is a change in accounting estimate, not a change in accounting principle.
Choice “C” is incorrect. Although a change from the cost approach to the market approach is a change in valuation technique, a change in valuation technique is not defined as a type of accounting change, but instead falls into the category of changes in accounting estimate.
Choice “D” is incorrect. Both the market approach and the cost approach are acceptable methods of measuring fair value per SFAS No. 157; therefore, switching between these methods is not the correction of an error. Additionally, an error correction is not a type of accounting change.
Each of the following would be considered a Level 2 observable input that could be used to determine an asset or liability’s fair value, except:
A. Quoted prices for similar assets and liabilities in markets that are active. B. Interest rates that are observable at commonly quoted intervals. C. Internally generated cash flow projections for a related asset or liability. D. Quoted prices for identical assets and liabilities in markets that are not active.
Choice “C” is correct. Internally generated cash flow projections for a related asset or liability would be better classified as a Level 3 input rather than a Level 2 input because the internally generated cash flow projection is based on “unobservable” inputs reflecting a company’s “own assumptions” about the way the related asset or liability would be priced.
Choice “A” is incorrect. Quoted prices for similar assets and liabilities in markets that are active are a Level 2 input.
Choice “B” is incorrect. Interest rates that are observable at commonly quoted intervals are a Level 2 observable input.
Choice “D” is incorrect. Quoted prices for identical assets and liabilities in markets that are not active are a Level 2 observable input.
Crossroads Co. chooses to report a financial asset at its fair value. The asset trades in two different markets; however, neither market is the principal market for the financial asset. In the first market, sales proceeds are $76, which is net of transaction costs of $6. In the second market, the sales proceeds are $80, which is net of transaction costs of $1. What amount should Crossroads report as the fair value of the asset?
A. $80 B. $76 C. $82 D. $81
Choice “D” is correct. If the principal market (the market with the greatest volume and level of activity) cannot be identified, the most advantageous market should be used when determining the fair value of a financial asset. The most advantageous market will be the one which generates the highest net price, after considering transaction costs. However, the transaction costs will not be incorporated into the fair value. The second market generates the highest net price of $80 after considering transaction costs; therefore, it should be used for fair value purposes. The fair value amount will exclude transaction costs, which results in a fair value of $81 for the asset.
Choice “A” is incorrect. Though the transaction costs are used to determine the most advantageous market, they are not used to determine the fair value of the asset.
Choice “B” is incorrect. The first market is not the most advantageous market since the selling price less transaction costs results in the lower of the two market values.
Choice “C” is incorrect. This answer correctly adds back the transaction costs in determining fair value, but it incorrectly uses the price provided in the first market. The first market is not the most advantageous market since the selling price less transaction costs results in the lower of the two market values.
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. $71,200 C. $70,200 D. $73,200
Explanation
Choice “B” is correct. One approach for converting from cash-basis to accrual-basis is as follows:
Add increases in current assets. For example, when AR increases, the increase is not considered to be income under the cash basis because the cash has not been collected, but the increase is income under the accrual basis.
Subtract decreases in current assets. Conversely, when AR decreases, then cash-basis counted it as revenue when the cash was collected, but under the accrual basis, the income was recognized in a prior period and should not be recognized again in the current period.
Add decreases in current liabilities. For example, when AP decreases, this represents a cash outflow that is recorded as an expense under the cash basis. However, under the accrual basis the paid expenses were recorded in a prior period and should not be recorded again in the current period.
Subtract increases in current liabilities. Conversely, when AP increases, this represents expenses incurred under the accrual basis method that have not been recorded under the cash basis method because they have not been paid.
Therefore, starting with the $70,000, we add the $2,000 decrease in AP, subtract the $200 and $100 increases in unearned revenue and wages payable, add the $300 increase in prepaid rent, and finally subtract the $800 decrease in accounts receivable:
$70,000 + $2,000 - $300 + $300 - $800 = $71,200
