FAR SU3

Question 1

What is considered a Discontinued Operation?

Answer 1

1. It (a) has been disposed of or (b) is classified as held for sale.
2. Its disposal is a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.

Question 2

Examples of disposals related to discontinued operations

Answer 2

Examples are disposal of:

i. A major geographical area
ii. A major line of business
iii. A major equity method investment
iv. Other major parts of an entity

Question 3

What is considered a component of an entity’s operations and cash flows? (there are 5)

Answer 3

A component of an entity has operations and cash flows that are clearly distinguishable for operating and financial reporting purposes. A component may be:

1. A reportable segment
2. An operating segment
3. A reporting unit
4. A subsidiary
5. An asset group

Question 4

Where is Discontinued Operations presented on the Income Statement?

Answer 4

After the results of continuing operations

Question 5

How must a disposed component be disclosed on the income statement?

Answer 5

If a component (discontinued operation) is disposed of during the period, any gain or loss on disposal must be disclosed on the face of the income statement or in the notes.

Question 6

When a component (discontinued operation) is classified as held for sale, how is its value measured?

Answer 6

It is measured at the lower of its carrying amount or fair value minus cost to sell.

Question 7

(T/F) Even after component is classified as held for sale, depreciation or amortization of assets is still allowed.

Answer 7

False

From the moment the component is classified as held for sale, operating results do not include depreciation or amortization of assets.

Question 8

(T/F) When a component that has a major effect on the entity’s operations and financial results is classified as held for sale, its operating results are reported in discontinued operations in the period(s) when they occur.

Answer 8

True

When a component that has a major effect on the entity’s operations and financial results is classified as held for sale, its operating results are reported in discontinued operations in the period(s) when they occur.

Question 9

(T/F) No amounts of earnings per share for a discontinued operation need to be presented in the financial statements.

Answer 9

False

Basic and diluted EPS amounts for a discontinued operation are presented on the face of the income statement or in the notes.

Question 10

What is required to in order to to voluntarily change an accounting principle?

Answer 10

If financial information is to be comparable and consistent, entities must not make voluntary changes in accounting principles unless they can be justified as preferable.

Question 11

3 Types of Accounting Changes

Answer 11

1. A change in accounting principle
2. A change in accounting estimate
3. A change in the reporting entity

Question 12

What is a Change in Accounting Principle (Retrospective Application)?

Answer 12

A change in accounting principle occurs when an entity (1) adopts a generally accepted principle different from the one previously used, (2) changes the method of applying a generally accepted principle, OR (3) changes to a generally accepted principle when the principle previously used is no longer generally accepted.

A change in principle does not include the initial adoption of a principle because of an event or transaction occurring for the first time.

Question 13

What is a Change in Accounting Estimate (Prospective Application)?

Answer 13

A change in accounting estimate results from new information. It is a reassessment of the future status, benefits, and obligations of assets and liabilities. Its effects must be accounted for only in (1) the period of change and (2) any future periods affected (prospectively).

Question 14

What is a Change in the Reporting Entity?

Answer 14

a. A change in the reporting entity results in statements that are effectively those of a different entity.
1. Most such changes occur when
a. Consolidated or combined statements replace those of individual entities,
b. Consolidated statements include different subsidiaries, or
c. Combined statements include different entities.
2. A business combination or consolidation of a variable interest entity is not a change in the reporting entity.

b. A change in the reporting entity is retrospectively applied to interim and annual statements.

Question 15

When does a Retrospective Application happen?

Answer 15

Retrospective application is required for all direct effects and the related income tax effects of a change in principle.

Retrospective application requires the carrying amounts of (1) assets, (2) liabilities, and (3) retained earnings (or other components of equity or net assets) at the beginning of the first period reported to be adjusted for the cumulative effect (CE) of the new principle on the prior periods.

Question 16

When do you apply a Prospective Application?

Answer 16

The prospective application must be applied from the beginning of the accounting period in which the accounting estimate was changed.

A change in estimate inseparable from a change in principle is accounted for as a change in estimate.

Question 17

When does a Change in the Reporting Entity occur?

Answer 17

A change in the reporting entity results in statements that are effectively those of a different entity. Most such changes occur when:
1. Consolidated or combined statements replace those of individual entities,
2. Consolidated statements include different subsidiaries, or
3. Combined statements include different entities.
OR
A business combination or consolidation of a variable interest entity is not a change in the reporting entity.

Question 18

When is an Error Correction necessary?

Answer 18

An error in prior statements results from:

1. A mathematical mistake
2. A mistake in the application of GAAP
3. An oversight or misuse of facts existing when the statements were prepared

A business combination or consolidation of a variable interest entity is NOT a change in the reporting entity.

Question 19

(T/F) Retrospective application is required for all indirect effects and the related income tax effects of a change in principle.

Answer 19

False

Retrospective application is required for all direct effects and the related income tax effects of a change in principle.

Question 20

(T/F) A change in estimate inseparable from a change in principle is accounted for as a change in accounting estimate.

Answer 20

True

A change in estimate inseparable from a change in principle is accounted for as a change in estimate. An example is a change in method of depreciation, amortization, or depletion of long-lived, nonfinancial assets.

Question 21

(T/F) Items of profit or loss related to corrections of errors in prior period statements are included in net income in the current period.

Answer 21

False

Error corrections must be reported in single-period statements as adjustments to the opening balance of retained earnings. Correction of prior-period errors must not be included in net income.

Question 22

(T/F) If a prior-period error affecting net income is self-correcting over two periods, the financial statements do not have to be restated.

Answer 22

False

An error that affects prior-period net income is counterbalancing if it self-corrects over two periods. However, despite the self-correction, the financial statements remain misstated. They should be restated if presented comparatively in a later period.

Question 23

What is Earning Per Share (ESP)?

Answer 23

Earnings per share (EPS) is the amount of current-period earnings that can be associated with a single share of a corporation’s common stock.

Question 24

What is Basic Earning Per Share (BESP)?

Answer 24

All corporations must report two BEPS amounts on the face of the income statement. Their numerators are income from continuing operations and net income, respectively.

(Income available to common shareholders)/
(Weighted-average number of common shares outstanding)

Question 25

BEPS Numerator

Answer 25

Income statement amount
– Dividends on preferred stock for the current period
= Income available to common shareholders

Question 26

BEPS Denominator

Answer 26

The weighted-average number of common shares outstanding is determined by relating the portion of the period that the shares were outstanding to the total time in the period.

Stock dividends and stock splits require an adjustment to the weighted-average of common shares outstanding.

Contingently issuable shares are shares issuable for little or no cash consideration upon satisfaction of certain conditions.

Question 27

What is Diluted Earning Per Share (DESP)?

Answer 27

An entity with only common stock outstanding (a simple capital structure) must report only BEPS amounts but not DEPS.

Dilution is a reduction in BEPS (or an increase in loss per share) resulting from the assumption that

1. Convertible securities (preferred stock or debt) were converted;
2. Options, warrants, and their equivalents were exercised; or
3. Contingently issuable common shares were issued.

Question 28

DEPS Denominator

Answer 28

Start with the BEPS denominator. Then increase the BEPS denominator to include the weighted-average number of additional shares of common stock that would have been outstanding if dilutive PCS had been issued.

Question 29

DEPS Numerator

Answer 29

Start with the BEPS numerator. The BEPS numerator is adjusted to add back any dividends on convertible preferred stock and the after-tax interest expense (an amount that includes amortization of discount or premium) related to any convertible debt.

Question 30

Calculation of DEPS (example)

Green Company’s current year BEPS is $40 ($400,000 income available to common shareholders ÷ 10,000 weighted-average number of common shares outstanding). No dividend was declared this year, and the company’s effective tax rate is 30%. The following PCS were outstanding during the year:

$500,000 face amount, 10-year, 6%, convertible bonds. The bonds were originally issued at par, and each $5,000 bond is convertible into 10 of Green’s common shares.
10,000 shares of $20 par, 10%, cumulative, convertible preferred stock. The conversion ratio is 5 shares of preferred stock to 2 shares of common stock.

Assuming that the bonds and the preferred stock are dilutive securities, the DEPS for the period is calculated as follows:

Answer 30

Adjustment of BEPS Numerator

Convertible bonds: The BEPS numerator is adjusted to add back the after-tax amount of interest expense recognized in the current period associated with the convertible bonds. Because the bonds were issued at par, interest expense is calculated using the bonds’ stated rate. Thus, the amount added back is calculated as follows:

$500,000 face amount × 6% × (1.0 – .30) = $21,000

Cumulative convertible preferred stock: The BEPS numerator is adjusted to add back any convertible preferred dividends that were declared or accumulated. No dividends were declared. However, the income available to common shareholders of $400,000 reflected the dividends accumulated for the current period on cumulative convertible preferred stock. Thus, the amount added back is calculated as follows:

10,000 preferred shares × $20 par × 10% = $20,000

Adjustment of BEPS Denominator

Convertible bonds: The BEPS denominator is increased to include the weighted-average number of additional shares of common stock that would have been outstanding if the dilutive convertible bonds (PCS) had been converted. Thus, the increase is calculated as follows:

($500,000 face amount ÷ $5,000 par) × 10 = 1,000 common shares

Cumulative convertible preferred stock: The BEPS denominator is increased to include the weighted-average number of additional shares of common stock that would have been outstanding if the dilutive convertible preferred stock (PCS) had been converted. Thus, the increase is calculated as follows:

10,000 preferred shares ÷ (5 ÷ 2) conversion ratio = 4,000 common shares

The DEPS for the year is $29.40

Question 31

What is The If-Converted Method?

Answer 31

The if-converted method calculates DEPS assuming the conversion of all dilutive convertible securities at the beginning of the period or at the time of issue, if later.

The conversion of antidilutive securities (those whose conversion increase EPS or decrease loss per share) is not assumed. Thus, convertible PCS are antidilutive if the current dividend or after-tax interest per common share issuable exceeds BEPS.

Question 32

What is Treasury Stock Method?

Answer 32

The Treasury Stock Method is used to determine the dilutive effect of outstanding call options, warrants, and their equivalents.

Call options and warrants are dilutive only if the average market price for the period of the common shares is greater than the exercise price of the options or warrants (they are in the money).

Equivalents include nonvested stock granted to employees, stock purchase contracts, and partially paid stock subscriptions.

Question 33

What is Reverse Treasury Stock Method?

Answer 33

The Reverse Treasury Stock Method is used to determine the dilutive effect of PCS is the reverse treasury stock method. It is used when the entity has entered into contracts to repurchase its own stock, for example, when it has written put options held by other parties.

When the contracts are in the money (the exercise price exceeds the average market price), the potential dilutive effect on EPS is calculated by

1. Assuming the issuance at the beginning of the period of sufficient shares to raise the proceeds needed to satisfy the contracts,
2. Assuming those proceeds are used to repurchase shares, and
3. Including the excess of shares assumed to be issued over those assumed to be repurchased in the calculation of the DEPS denominator.

Options held by the entity on its own stock, whether they are puts or calls, are not included in the DEPS denominator because their effect is antidilutive.

Question 34

Earning Per Share Income Statement Disclosure

Answer 34

EPS disclosures are made for all periods for which an income statement or earnings summary is presented. For each period for which an income statement is presented, the following are disclosed:

1. A reconciliation by individual security of the numerators and denominators of BEPS and DEPS for income from continuing operations, including income and share effects
2. The effect of preferred dividends on the BEPS numerator
3. PCS not included in DEPS because it would have had an antidilutive effect in the periods reported

Question 35

(T/F) A public entity must report in the income statement earnings per share (EPS) effects of transactions that are unusual in nature or infrequent in occurrence.

Answer 35

False

The results of material events or transactions that are unusual in nature, infrequent in occurrence, or both must be reported separately in income from continuing operations. The EPS effects of those items must not be presented on the face of the income statement. Earnings per share for continuing operations and net income must be reported.

Question 36

(T/F) Potential common stock is dilutive if its inclusion in the calculation of EPS results in a reduction of EPS (or an increase in loss per share).

Answer 36

True

Potential common stock is dilutive if its inclusion in the calculation of EPS results in a reduction of EPS (or an increase in loss per share).

Question 37

(T/F) To determine the dilutive effect of convertible securities on diluted earnings per share, conversion is assumed to have occurred at the later of the beginning of the period or the time of issuance.

Answer 37

True

The if-converted method is used to determine the dilutive effect of convertible securities on diluted EPS (DEPS). The if-converted method assumes that the convertible security was converted at the beginning of the period or time of issuance, if later.

Question 38

(T/F) Call options held by the entity on its own stock are always dilutive and must be included in the DEPS denominator.

Answer 38

False

Options held by the entity on its own stock, whether they are puts or calls, are not included in the DEPS denominator because their effect is antidilutive.

Question 39

(T/F) Outstanding call options and warrants are dilutive if the exercise price exceeds the average market price for the period.

Answer 39

False

The treasury stock method is used to determine the dilutive effect of outstanding call options and warrants issued by the reporting entity. Dilution occurs if the average market price for the period exceeds the exercise price.

Question 40

(T/F) The effect of preferred dividends on the BEPS numerator must be disclosed for all periods for which an income statement or earnings summary is presented.

Answer 40

True

EPS amounts are disclosed for all periods for which an income statement or earnings summary is presented.

Question 41

Contract Revenue Recognition Core Principle

Answer 41

The core principle is that an entity recognizes revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in the exchange.

This guidance applies to all contracts with customers except the following:

1. Leases
2. Financial instruments
3. Contractual rights and obligations within the scope of specific topics, such as receivables, derivatives and hedging, insurance, and guarantees (other than product or service warranties)
4. Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers

Question 42

Five-Step Model for recognizing revenue from contracts with customers

Answer 42

Step 1: Identify the contract(s) with a customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract.
Step 5: Recognize revenue when (or as) a performance obligation is satisfied.

Question 43

What is a contract?

Answer 43

A contract is an agreement between two or more parties that creates enforceable rights and obligations.
A contract is accounted for under ASC 606 if all of the following criteria are met:
1. The contract was approved by the parties.
2. The contract has commercial substance.
3. Each party’s rights can be identified regarding
a. Goods or services to be transferred and
b. The payment terms.
4. It is probable that the entity will collect substantially all of the consideration to which it is entitled according to the contract.
a. Probable means the future event is likely to occur.

Question 44

How is Variable Consideration valued?

Answer 44

Variable consideration is estimated using one of the following methods:

a. The expected value is the sum of probability-weighted amounts in the range of possible consideration amounts. This method may provide an appropriate estimate if an entity has many contracts with similar characteristics.
b. The most likely amount is the single most likely amount in a range of possible consideration amounts. This method may provide an appropriate estimate if the contract has only two possible outcomes. For example, a construction entity either will receive a performance bonus for finishing construction on time or will not.

Question 45

What is a contract liability?

Answer 45

A contract liability is recognized for an entity’s obligation to transfer goods or services to a customer for which the entity has received consideration from the customer.

Deposits and other advance payments by the customer, such as sales of gift certificates, are recognized as contract liabilities.

Question 46

What is a contract asset?

Answer 46

A contract asset is recognized for an entity’s right to consideration in exchange for goods or services that the entity has transferred to a customer. However, the entity must have an unconditional right to the consideration to recognize a receivable.

A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Question 47

Costs to Obtain or Fulfill a Contract

Answer 47

The incremental costs of obtaining a contract with a customer must be capitalized (recognized as an asset) if the entity expects to recover them.

Question 48

Costs to Obtain or Fulfill a Contract

Answer 48

The cost of obtaining a contract may be expensed as incurred if its amortization period is 1 year or less.

Question 49

Costs to Obtain or Fulfill a Contract

Answer 49

Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained must be expensed as incurred.

Question 50

Costs Incurred to Fulfill a Contract

Answer 50

Costs incurred to fulfill a contract must be capitalized (recognized as an asset) only if they meet all of the following criteria:

a. The costs relate directly to a current or anticipated contract.
b. The costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future.
c. The costs are expected to be recovered.

Question 51

(T/F) The core principle applying to accounting for revenue from contracts with customers is that revenue is recognized when the transaction price is allocated to performance obligations.

Answer 51

False

The core principle is that an entity recognizes revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in the exchange. Below is the five-step model for recognizing revenue from contracts with customers.

Step 1: Identify the contract(s) with a customer.

Step 2: Identify the performance obligations in the contract.

Step 3: Determine the transaction price.

Step 4: Allocate the transaction price to the performance obligations in the contract.

Step 5: Recognize revenue when (or as) a performance obligation is satisfied.

Question 52

(T/F) In a contract with a customer, one performance obligation may involve a promise to transfer a distinct good and a customer’s material right to acquire additional such goods at a discount.

Answer 52

False

A performance obligation is a promise in a contract with a customer to transfer to the customer (1) a good or service that is distinct or (2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. A contract may include a customer option to acquire additional goods or services for free or at a discount (e.g., coupon, discount voucher, sales incentives, etc.). If the option provides a material right to the customer, the result is a separate performance obligation in the contract.

Question 53

(T/F) The transaction price for a contract with a customer is determined after consideration of the time value of money if the time between payment and delivery is more than 1 year.

Answer 53

True

The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. To determine the transaction price, an entity should consider the effects of the time value of money. The transaction price should not be adjusted for the effect of the time value of money if the time between the payment and the delivery of the promised goods or services to the customer is 1 year or less.

Question 54

(T/F) The revenue recognized for a contract with a customer must reflect the cash selling price.

Answer 54

True

The revenue recognized must reflect the price that a customer would have paid for the promised goods or services if the cash payment had been made when they were transferred to the customer (i.e., the cash selling price).

Question 55

(T/F) A performance obligation is satisfied at a point in time if the customer simultaneously receives and consumes the benefits as the entity performs.

Answer 55

False

A performance obligation can be satisfied either over time or at a point in time. Recognizing revenue over time requires transfer of the control of goods or services to a customer over time and therefore satisfaction of a performance obligation over time. One of the following criteria must be met:

1. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
2. The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
3. The asset created has no alternative use to the entity, and the entity has an enforceable right to payment for the performance completed to date.

Question 56

Recognition of Revenue Over Time- Input Method

Answer 56

The input method recognizes revenue on the basis of (a) the entity’s inputs to the satisfaction of the performance obligation relative to (b) the total expected inputs to the satisfaction of that performance obligation.

a. Examples of input include:
1. Costs incurred,
2. Labor hours expended,
3. Resources consumed,
4. Time elapsed, or
5. Machine hours used.

Question 57

Recognition of Revenue Over Time Cost-to-Cost Method

Answer 57

In long-term construction contracts, costs incurred relative to total estimated costs often are used to measure the progress toward completion. This method is the cost-to-cost method.

1. Only costs that contribute to progress in satisfying the performance obligation are used in the cost-to-cost method. Thus, the following costs must not be included in measuring the progress:
   a. Costs incurred that relate to significant inefficiencies in the entity’s performance (e.g., abnormal amounts of wasted materials or labor) that were not chargeable to the customer under the contract
   b. General and administrative costs not directly related to the contract
   c. Selling and marketing costs

Question 58

Recognition of Revenue Over Time Output Method

Answer 58

The output method recognizes revenue based on direct measurement of (a) the value of goods or services transferred to the customer to date relative to (b) the remaining goods or services promised under the contract.

Examples of output methods include:

1. Appraisals of results achieved
2. Milestones reached
3. Units produced
4. Units delivered

Question 59

Recognition of Revenue Over Time- Recognizing a Loss

Answer 59

As soon as an estimated loss on any project becomes apparent, it must be recognized in full, regardless of the methods used.

Question 60

(T/F) Examples of output for a performance obligation recognized over time include costs incurred, resources consumed, and time elapsed.

Answer 60

False

The input method recognizes revenue on the basis of (1) the entity’s inputs to the satisfaction of the performance obligation relative to (2) the total expected inputs to the satisfaction of that performance obligation. Examples of input include (1) costs incurred, (2) labor hours expended, (3) resources consumed, (4) time elapsed, or (5) machine hours used.

Question 61

During all of the year just ended, Littlefield, Inc., had outstanding 100,000 shares of common stock and 5,000 shares of noncumulative, $7 preferred stock. Each share of the latter is convertible into three shares of common. For the year, Littlefield had $230,000 income from continuing operations and a $575,000 loss on discontinued operations; no dividends were paid or declared. Littlefield should report diluted earnings (loss) per share (DEPS) for income from continuing operations and for net income (loss), respectively, of

Answer 61

$2.00 and $(3.00)

The noncumulative convertible preferred stock is dilutive because its assumed conversion will have no effect on the DEPS numerator and will increase the denominator by 15,000 (5,000 × 3) shares. DEPS for income from continuing operations is $2.00 ($230,000 ÷ 115,000 shares). Net loss equals the $230,000 income from continuing operations minus the $575,000 loss on discontinued operations, or $345,000. This amount divided by the 115,000 shares results in a diluted net loss per share of $3.00.

NOTE: When a discontinued operation is reported, the control number to establish whether potential common stock are dilutive or antidilutive is BEPS from continuing operations.

Question 62

At December 31, Year 1, Lex, Inc., had 600,000 shares of common stock outstanding. On April 1, Year 2, an additional 180,000 shares of common stock were issued for cash. Lex also had $5 million of 8% convertible bonds outstanding at December 31, Year 2, which are convertible into 150,000 shares of common stock. The bonds were dilutive in the Year 2 DEPS computation. No bonds were issued or converted into common stock during Year 2. What is the number of shares that should be used in computing DEPS for Year 2?

Answer 62

885,000

DEPS should be based on the weighted-average number of (1) shares of common stock outstanding and (2) the shares of common stock assumed to have been issued to reflect the conversion of the bonds. The weighted-average number of shares for Year 2 should therefore be 885,000, based on 750,000 shares outstanding for the entire year (600,000 beginning balance + 150,000 from the hypothetical conversion of bonds) and 180,000 additional shares issued on April 1.

750,000 × (3 ÷ 12) = 187,500
930,000 × (9 ÷ 12) = 697,500
885,000

Question 63

An entity recognizes revenue from a long-term contract over time. However, early in the performance of the contract, it cannot reasonably measure the outcome, but it expects to recover the costs incurred. Revenue should be recognized based on

Answer 63

A zero profit margin

When the outcome of the contract is not reasonably measurable but the costs incurred in satisfying the performance obligation are expected to be recovered, revenue must be recognized only to the extent of the costs incurred. Revenue recognized is based on a zero profit margin until the entity can reasonably measure the outcome of the performance obligation.

Question 64

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?

Answer 64

$105,000

Expensing the machine in Year 1 resulted in an after-tax understatement of net income equal to $147,000 [$210,000 × (1.0 – .30 tax rate)]. Not recognizing annual depreciation of $20,000 [($210,000 – $10,000 salvage value) ÷ 10 years] in Years 1-3 resulted in an after-tax overstatement of net income equal to $42,000 [($20,000 × 3 years) × (1.0 – .30 tax rate)]. Thus, the prior period adjustment is for a net understatement of $105,000 ($147,000 – $42,000).

Question 65

On January 31, Year 3, Pack, Inc., split its common stock 2 for 1, and Young, Inc., issued a 5% stock dividend. Both companies issued their December 31, Year 2, financial statements on March 1, Year 3. Should Pack’s Year 2 basic earnings per share (BEPS) take into consideration the stock split, and should Young’s Year 2 BEPS take into consideration the stock dividend?

Answer 65

Yes to Both

When a stock dividend, stock split, or reverse split occurs at any time before issuance of the financial statements, restatement of BEPS or DEPS is required for all periods presented. The purpose is to promote comparability of EPS data among reporting periods.

Question 66

The concept of consistency is sacrificed in the accounting for which of the following income statement items?

• Change in accounting principle when the cumulative effect on any prior period is not known.
• Gain from bargain purchase.
• Discontinued operations.
• Loss on disposal of a component of an entity.

Answer 66

Change in accounting principle when the cumulative effect on any prior period is not known.

Changes in accounting principles ordinarily are accounted for by retrospective application. However, if it is impracticable to determine the cumulative effect of applying the change to any prior period, the change is applied prospectively. Thus, similar events are not accounted for in the same way in succeeding accounting periods.

Question 67

The scope of the FASB’s standard on revenue from contracts with customers (ASC 606) includes

• Loan guarantee contracts.
• Lease contracts.
• Product or service warranty contracts.
• Insurance contracts.

Answer 67

Product or service warranty contracts.

An entity must apply the guidance on revenue from contracts with customers to all contracts with customers except for (1) lease contracts, (2) insurance contracts, (3) financial instruments, (4) guarantees (other than product or service warranties), and (5) nonmonetary exchanges between entities in the same line of business to facilitate sales to customers. Accordingly, product or service warranties are within the scope of the new standard.

Question 68

The input method loss recognition

Answer 68

A loss is reported immediately irrespective of the accounting method used.

Question 69

With respect to the computation of earnings per share, which of the following would be most indicative of a simple capital structure?

• Common stock, convertible preferred stock, and debt outstanding.
• Common stock, preferred stock, and debt outstanding.
• Common stock, preferred stock, and convertible debt outstanding.
• Common stock, preferred stock, and stock options outstanding.

Answer 69

Common stock, preferred stock, and debt outstanding.

A simple capital structure has only common stock outstanding. A complex capital structure contains potential common stock. Potential common stock includes options, warrants, convertible securities, contingent stock requirements, and any other security or contract that may entitle the holder to obtain common stock.

Question 70

Mann, Inc., had 300,000 shares of common stock issued and outstanding at January 1. On July 1, an additional 50,000 shares of common stock were issued for cash. Mann also had unexercised stock options to purchase 40,000 shares of common stock at $15 per share outstanding at the beginning and end of the year. The average market price of Mann’s common stock was $20 during the year. What is the number of shares that should be used in computing diluted earnings per share (DEPS) for the year ended December 31?

• 335,000
• 325,000
• 360,000
• 365,000

Answer 70

335,000

The weighted average shares outstanding needs to be calculated. On July 1, 50,000 shares of common stock were issued. Hence, for the purpose of calculating Mann’s weighted-average number of shares, 300,000 shares should be considered outstanding for the first 6 months and 350,000 shares for the second 6 months. Therefore, the weighted average shares outstanding equals 325,000.
Dilutive call options and warrants are included in DEPS. These options are assumed to be exercised at the beginning of the period using the treasury stock method. This method assumes the options are exercised and the $600,000 of proceeds (40,000 options × $15) is used to repurchase shares. In the DEPS computation, the assumed repurchase price is the average market price for the period ($20), so 30,000 shares are assumed to be repurchased ($600,000 ÷ $20). The difference between the shares assumed to be issued and those repurchased (40,000 – 30,000 = 10,000) is added to the weighted average of common shares outstanding to determine the DEPS denominator. Thus, 335,000 (325,000 + 10,000) shares should be used in computing DEPS for the year ending December 31.

Question 71

On December 1, Year 1, Shine Co. agreed to sell an operating segment on March 1, Year 2. As a result, the segment qualified as a component of an entity classified as held for sale. This operating segment represents a major geographical area. Throughout Year 1, the segment had operating losses that were expected to continue until its disposition. However, the gain on disposal was expected to exceed the operating segment’s total operating losses in Year 1 and Year 2. The amount of estimated net gain from disposal recognized in discontinued operations in Year 1 equals

• Zero.
• The entire estimated net gain.
• All of the operating segment’s Year 1 operating losses.
• The operating segment’s December Year 1 operating losses.

Answer 71

Zero

A component of an entity, e.g., an operating segment, reporting unit, subsidiary, or asset group, may be disposed of or classified as held for sale. Thus, the gain on disposal will be recognized when it occurs in Year 2.